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Paraguay and Peru break trend as LatAm economies slow

In a region where slow or negative growth has been dominant for the past year, Paraguay and Peru have proven to buck the trend. As their economies’ growth again exceeds expectations for next year and with Paraguay now preparing to tap international bond markets, their Latin American neighbours ought to heed their successes to keep investors interested.

Oct 6, 2016 // 11:51AM

Over the years investors have pinpointed Brazil, Argentina, Mexico, Colombia and others as the rising stars among the LatAm economies, but sooner or later political turbulence, oil price fluctuations, corruption and fiscal mismanagement (sometimes a combination of the above) take hold and undercut progress. In the past 5-6 years Paraguay, alongside Peru, has been a notable exception – less ‘flashy’ in periods of prosperity, yet more stable when crises hit the region.

Paraguay’s progress had not gone unnoticed with rating agencies: in March 2015 Moody’s slightly lowered its outlook to Ba1 stable, with S&P following up in June with a BB rating and stable outlook. While the slight decline can be attributed to the general economic downturn across Latin America, the latest assessments of Paraguay keep it within sight of investment grade ratings.

As Moody’s noted, a drop in soy and other commodity prices undermined asset quality and had a negative impact on Paraguay’s banks, which have relatively weak loan loss reserve coverage. But relative economic stability, manifested in low unemployment and steady household borrowing levels will provide a safety net.

The country already successfully tapped into international bond markets in March, raising US$600mn with a 10-year dollar bond. The government now plans to sell another US$558mn worth of debt on local and cross-border bonds next year, hoping to finance infrastructure development and modernisation.

Asuncion’s market-friendly approach is reaping rewards. Bloomberg recently reported that the global oil giant Gunvor group invested into Paraguayan petroleum supplier Monte Alegre SA. Another example was Brazil’s IT firm M2Sys opening its operations in the capital Asunción, citing the open legislative policy and desire to modernise as the country’s main attractions.

Meanwhile Peru’s high level of dollarisation has left the country vulnerable to currency fluctuations, it acted to manage with a PEN10.25bn (US$3.02bn) bond in a debt swap transaction last week.

“Peru has suffered from high degree of dollarisation in its financial sector – about 40% is denominated in US dollars, confirmed Capital Economics’ EMs economist Edward Glossop. “This raised household and corporate borrowing risks, but the good news is that the country is taking measures to de-dollarise. Assuming that foreign currency borrowing doesn’t spike in the future, this won’t become a problem for Peru.”

Speaking to Reuters, Peru’s Finance Minister Alfredo Thorne said the country will now focus on selling debt to local markets, “concentrating sovereign bonds into fewer maturities and allowing foreign investors to buy its treasury notes.”

Success factors

Paraguay’s growth forecast for the remainder of the year of 3.5% pitches it alongside regional leaders. Peru, in turn, is tipped to see growth rise to 3.7% and 4.1% in 2016 and 2017 respectively, according to an IMF report.

Paraguay’s central bank sees diversification as having been key to the country’s success. It noted that strong growth in 2016 is in large part due to measures taken to diversify the country’s economy, as growth not only comes from the energy and agricultural sector, but also from development of infrastructure, industry and the tertiary sector.

Reacting swiftly to macroeconomic factors such as falling commodity prices by redirecting the country’s export markets from the struggling Brazil and Russia towards more unconventional partners, such as Vietnam and Qatar, also helped to soften the blow. This, along with low tax rates and cheap energy costs, gave the economy enough flexibility to stay healthy through the recent regional downturn.

Like Paraguay, Peru’s advantage stems from starting from a lower base, being poorer than some of the other states in the region. This led to the ‘catch-up’ growth over recent years.

Both countries also share political stability and, with it, continuity of fiscal and monetary policy – something that has been lacking in other Latin American nations.

More importantly, as Glossop highlighted, what has been instrumental in making Peru’s economy rise as others stumble is their fiscal prudence during the commodities boom.

“When Mexico, Brazil and others ran-up huge public spending programmes as commodity prices soared, Peru ran a public sector budget surplus from 2006 to 2013,” he explained. “As a result, public debt has remained low, and Peru is now under less pressure to tighten its fiscal policy and is able to offer more attractive tax rates.”

Unlike larger and wealthier commodity-exporting neighbours, Peru largely missed out on the high oil price binge, but that was ultimately one of the factors playing in its favour. The sudden fall in prices didn’t directly impact the country’s trade revenues, and the investment it made into mining projects in 2011-12 has had a delayed effect, only now beginning to produce higher outputs.

Paraguay and Peru’s success stands in stark contrast to its neighbours – overall, the IMF expects the Latin American and Caribbean economy to shrink further by 0.6% this year. It is being driven down by the continued plight of Venezuela, whose GDP dropped 6.2% last year and is expected to fall further 10% by the end of 2016. Brazil’s 3.3% decline sent shockwaves around the region this year, but it appears to have bottomed out and next year could bring moderate growth of 0.5%.

Falling consumer demand and a weak peso in Chile and aftershocks from another failed peace deal in Colombia mean that only Peru and Paraguay have managed to show consistent growth year-on-year in 2016.

As the region gets on the road to recovery next year, it will be vital to future prosperity for the big economies to heed the lessons of the previous crisis and look up towards their less powerful, but often more successful neighbours if they are able to remain attractive to investors.

The temptation to go on a spending spree, running up huge debt to GDP ratios and borrowing excessively, can be strong at times of prosperity. What is much harder, though, is to maintain a grounded fiscal policy, keep budget deficit at bay and maintain investor-friendly tax environment and consistent, predictable economic model that remains stable through global highs and lows.


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