Taking stock of Peru’s latest political crisis - Capital Economics
Latin America Economics

Taking stock of Peru’s latest political crisis

Latin America Economics Update
Written by William Jackson

The impeachment of Peru’s president, Martín Vizcarra, has rattled the country’s financial markets and may pave the way for looser (and more populist) fiscal measures in the coming months. Given the country’s strong balance sheet, such policies should have a positive effect on economic growth in the near term. But these latest political events add to the impression that political instability is here to stay, which may depress private investment and the country’s longer-term prospects.

  • The impeachment of Peru’s president, Martín Vizcarra, has rattled the country’s financial markets and may pave the way for looser (and more populist) fiscal measures in the coming months. Given the country’s strong balance sheet, such policies should have a positive effect on economic growth in the near term. But these latest political events add to the impression that political instability is here to stay, which may depress private investment and the country’s longer-term prospects.
  • The decision to oust the president came as a surprise – Mr. Vizcarra survived a similar vote in September and has popular support. It’s not clear exactly why congress opted to remove Mr. Vizcarra now, although there had been long-running disputes as Mr. Vizcarra tried to push through anti-corruption legislation and resisted congress’ efforts to push through populist policies.
  • Mr. Vizcarra has been replaced by the speaker of congress, Manuel Merino, who will hold office until the current presidential term ends in July (elections to choose the next president are due in April). Mr. Merino is a centre-right politician and seen as business friendly. But as speaker he also helped congress push through policies (e.g. partial pension withdrawal bills) that worried the central bank and finance ministry.
  • Further pension withdrawal bills (which allow citizens to draw down savings held in private pension funds) and/or measures to loosen fiscal policy seem likely in the coming months. This, combined with the increase in uncertainty, has rattled investors – the sol (which is usually very stable) fell by over 1% against the dollar yesterday and the stock market dropped by 6.5%.
  • Despite the adverse reaction in financial markets to these events, it seems unlikely that there will be much of a negative impact on the economy. It looks like financial conditions in Peru tightened yesterday, but only modestly. And while protests flared up after the impeachment vote, Mr. Vizcarra’s conciliatory tone should help to prevent social unrest from becoming prolonged or particularly disruptive.
  • Note, too, that Peru’s economy has a very strong balance sheet. The public finances were in a good position coming into this crisis and, while the public debt ratio will jump sharply this year, we think it will still only be around 40% of GDP. Meanwhile, the central bank has large foreign exchange reserves (at $72bn, some eight times larger than the country’s short-term external debt). Against this backdrop, the central bank should feel confident that it can leave the policy rate at 0.25% when it meets tomorrow.
  • Indeed, to the extent that these developments mark a shift towards looser fiscal policy, near-term economic growth prospects may have even improved. There’s still a very large output gap in the economy – in August, output was some 14% below its pre-crisis peak. So there’s a lot of scope for demand to strengthen without encountering capacity constraints. And with Peru’s COVID-19 outbreak improving and the lockdown being lifted, measures that boost household incomes are more likely to translate into higher consumption than precautionary savings.
  • Nonetheless, the latest bout of turmoil in Peru’s governing circles adds to the impression that political instability is here to stay. This is the second impeachment of a president in just over two years (Mr. Vizcarra came to power after his predecessor was impeached). And there is growing public disillusionment with the political class, particularly members of congress.
  • The last congressional elections (in January of this year) resulted in the most popular party winning only 10% of the vote and the longer-established parties saw a sharp fall in support. The race to be next president is still very open, but whoever wins will face difficulties winning congressional support and passing legislation. (To give some context, the party of one leading presidential contender, George Forsyth, a former international footballer, only won 11 out of 130 congressional seats this year.)
  • The upshot is that businesses are likely to face an increasingly unpredictable environment, dampening investment and Peru’s longer-term growth prospects which, otherwise, are among the brightest in Latin America.

William Jackson, Chief Emerging Markets Economist, william.jackson@capitaleconomics.com