S&P Shot across the bows for Peru banks and government

By Nicholas Asheshov

The downgrade in New York by Standard & Poors, S&P, of Peru’s banking system last week came a day before S&P whammed the Brazil government debt to junk.

The Brazil move is a much bigger hit to a much bigger player but the Peru bank rating is a new sign that Peru is being priced firmly down even though its numbers are better than those of most of the neighbors.

The bank downslide came days before the Minister of Finance, Alonso Segura, was in New York to try to talk Morgan Stanley’s MSCI unit into postponing its decision, announced last month, (PT, Aug.21, 2015) to push the category of the Lima Bolsa de Valores, the stock exchange, from Emerging Market out to Frontier. Other countries to which this has happened this year include Morocco and Argentina.

Peru’s handful of international-style companies, like the Banco de Credito (BAP), Cia de Minas Buenaventura (BVN), Southern Peru Copper (SPCC), Graña y Montero (GRAM) and Hochschild (HOC) among them, are quoted in New York or London. But the downgrade of the Lima exchange will have a negative effect on the finances of the AFPs, the pension funds which by law are forced to invest in local paper.

A warning and further downgrades

The latest bank ratings are shots across the bows of the government and of its creditors — there is no question about the stability of any of the four main Lima banks, the Credito, the Continental, Interbank and Scotiabank. But it means further downgrades by the New York rating outfits like Moody’s and Fitch are possible as Peru’s economy continues to slow down. The rest of the Emerging and Frontier world is slow and getting slower, too, but the main reasons for the latest S&P bank ratings is the poor performance of the government and of the Central Bank in Lima.

The immediate practical effects are a bruise rather than broken bones. It will add, perhaps, 50 or 100 basis points, getting on for one percentage point, to the still-cheap cost to banks here of borrowing in New York. This is currently around 4% to 5% p.a., a gift by the standards of other times.

The change in status comes, too, as financial markets everywhere see-saw with a general trend down. Commodities, products and companies are being reassessed. De Beers has reduced the price of its latest gem quality diamonds by nine percent. Silver continues below $15/oz, less than half the price of 2013, gold at under $1,100 instead of $1,900, and copper at $2.30, half its price three years ago.

S&P says the quality of the Lima banks’ business will get worse as the economy deteriorates.

This is another way of saying that the quality of the balance sheets of Peruvian companies is seen by S&P as deteriorating too, in line with the mishandling of public finances by the Ministry of Economy and Finance, MEF, and the Central Bank, the BCRP.

Dangerous increase of reference lending rate

Part of the problem is that the Central Bank continues to prop up the price of the Nuevo Sol, spending $1 billion of its reserves every month. Last week it revalued, not devalued, the Sol, from S/.3.31=US$1 to S/.3.21 defying, perhaps with a certain sense of humor, international financial gravity.

In the same vein but even more questionably, the BCRP increased its reference lending rate from 3.25% to 3.50%, signaling too that this will go to over 4.25% next year.

The reason for this startling move is to rein in inflation. It will have, in fact, no effect on inflation though it will slow the economy, increase unemployment even further, raising the possibility of a return of the stagflation of the 1970s and 1980s, a specter that is becoming a reality in Brazil.

Elsewhere, starting with China, those central banks where the reference rate is not already close to zero are lowering rates to as near-zero as they can in a well-established effort to blow life into sagging economies.

The increase by the Central Bank in Lima of the reference rate is dangerous to the point of incomprehensible. The experience of the past five years has been conclusive that the old monetary buttons to control inflation, which rarely worked anyway, today turn out to be a well-aimed shot in the dark straight into the foot. Instead, increasing rates produces in today’s leveraged markets a sharp halt, a sudden stop. With it comes deflation.

This happened famously in 2011 when the European Central Bank raised rates and produced an instant Europe-wide recession. Other countries making the same mistake in the past few years have included Norway, Sweden, Israel and Australia, all of which quickly had to do a U-turn and reduce rates to stave off a collapse in their economies.

Now Peru, with a government and Congress focused on other issues, is allowing a crew of olde economists to make the same mistake.

The Central Bank in Lima also continues to squander its reserves on propping up the price of the Sol. Everywhere else they are cheapening their currencies against the dollar, starting with the Chinese, the ones who are supposed to be buying Peru’s copper, Venezuela’s oil and Germany’s BMWs.

But there are no signs of a recovery in the world economy. The price of copper edged further down towards $2/lb.

At that price Peru’s budget deficit in 2016 will be 5%, as a proportion of GDP, not just the two or three percent that the government says it is projecting. Peru’s government has been in surplus for the past dozen years.

Peru and Brazil

Peru’s situation has some similarities with Brazil. Government finances in both are getting worse due to mismanagement and to the fall in commodities prices.

But Peru’s financial and political problems, however grimy as seen from Lima, are nothing compared to those of Brazil which is already into a solid recession with a surge in inflation.

Another difference is that Peru will have a new government in less than a year. In Brazil it is a lame duck government mired in confusion with the best part of four years to go, and with no Plan B. Peru’s total foreign debt, public and private, knocking on $40 bn, is a tiny figure compared with Brazil. For instance, Petrobras alone owes $135 bn — it is one of the world’s biggest issuers of bonds. The cost of insuring Brazil bonds against default is today as bad as Turkey and Russia. The Peru cost is, rightly, insignificant, a big change from 20 years ago and a huge difference from Brazil, Venezuela, Argentina and Ecuador.

There are two big problems for the Peru outlook. The first is that the world economy shows no sign of improving. The only country in the top ten doing well is India, at 7%, with the United States, Germany and the United Kingdom as also-rans at between two and three percent who dare not increase the cost of government credit from zero for fear of tipping back into recession. Brazil and Russia are in recession and financial distress. China has lost the plot and will be in no shape to rescue the third world or anyone else —Russia for instance— for a decade. The rising China tide that raised commodity boats so far this century is flowing back down and out, taking —for the moment, at least— Peru with it.

Citibank said this week that there is a better than evens chance of a world recession.

There’s not much Peru can do but prepare for this El Niño-sized rainy day.

Instead the government, at the end of its tether, is acting as if it believed its own starry-eyed projections. This includes putting soles interest rates up to slow the economy. The Banco Central economists apparently believe their projection of four percent growth for 2016 even though a recession is a certainty. They are putting on the brakes, the only country in the world to be doing so.

The banks 

Last week S&P said it had revised its Banking Industry Risk Assessment on Peru to group ‘5’ from group ‘4’. S&P also revised its rating for banks operating only in Peru to ‘bbb-‘ from ‘bbb’ due to a higher economic risk.

  • “We revised our economic risk score to ‘6’ from ‘5’. We consider that economic resilience has weakened amid lower growth prospects.
  • “The trend.” on economic risk remains negative because we’re still concerned that rapid credit growth could increase economic imbalances risk.
  • “As a result, we’re lowering our ratings on five Peruvian banks.”

Standard & Poor’s Ratings Services lowered its ratings on the following Peruvian banks: Banco de Credito del Peru; Banco Interamericano de Finanzas S.A.; BBVA Banco Continental; MiBanco, Banco de La Microempresa S.A.; and Banco Internacional del Peru —Interbank.

S&P said it was not, however, marking down Scotiabank —three years ago the Bank of Nova Scotia, the controlling partner, increased Scotiabank’s capital.

The S&P report continues: “The downgrade (of the banking system) reflects our view of rising economic risk for banks operating in Peru. The greater economic risk reflects our reassessment of Peru’s growth prospects. We believe that Peru’s growth trajectory will no longer be consistently well above that of its peers with a similar stage of economic development.

“Also, our trend on economic risk remains negative, reflecting the persistent rapid growth in credit and private-sector leverage in the past few years, which has been weakening the Peruvian banks’ credit quality in the past three years.

“In our view, domestic banks now face tougher operating conditions, which we believe weakened their financial profiles, notably in terms of asset quality and capital and earnings.

“We expect growth to average 3.7% annually between 2015 and 2018 and to average 2.8% in per capita terms, which will protract Peru’s catch-up with more developed peers.

“We now expect Peru’s economic growth to be slower absent more successful concerted efforts to advance structural reforms to keep up productivity improvements and continue to increase social inclusion, such as improving labor market flexibility, infrastructure, reducing bureaucracy and informality, and improving education quality.”

Wall St does not seem to be taking its own warnings about Peru too seriously.

Analysts at Morgan Stanley, the New York bank that is downgrading Peru from Emerging Market to Frontier Post, is recommending clients to buy shares of the Banco de Credito, Credicorp (BAP.N): and predicts an impressive 40% profit by the end of next year.

MS says the Credito offers an “attractive Risk Reward”, predicting that the shares will go from today’s $107 to $150 by the end of 2016.

The MS Buy recommendation came only days after S&P’s rating downgrade of Credicorp from BBB to BBB- because of “rising economic risk for banks operating in Peru,”

“reassessment of Peru’s (lower) growth prospects,” “weakening credit quality in the past three years,” and “persistent rapid growth in credit and private sector leverage.”

MS Peru bank analysts see Peru’s economy accelerating to the 3-4% GDP growth range, fastest among the large economies in Latin America.

Nick Asheshov was editor of the Andean Air Mail & Peruvian Times during the 1970s and 1980s, and of The South Pacific Mail, Santiago during the 1990s. He was Latin America Editor of Institutional Investor, New York over the same period. He lives in Urubamba, where he writes a blog and where he has been prominent in the hotel and railway business. 

This article appeared in the Peruvian Times Sept 17 2015