Election race is polarized, while recovery temporarily pauses
The presidential race has grown polarized, according to the most recent opinion polls. Although this is a surprise, in our January Forecast we suggested that this could happen during the last leg of the campaign. We described three possible scenarios: first, a strong winner emerging (with George Forsyth’s impressive performance in the polls supporting that possibility), although this was by no means a certainty. The second scenario was a fractured result, with several candidates in the running up to Election Day (the evidence indicated that, after Forsyth, the next five candidates had less than 10% of the vote each). The third possibility was a polarized election result, which we suggested would largely depend upon candidates’ individual strategies. We argued that this could be prompted by low-popularity candidates adopting radical ideologies, in an attempt to make it into the second round.
Three recent opinion polls have confirmed this polarization, which has materialized in phases. First, there’s the ascension of Yonhy Lescano of Acción Popular, who initially jumped into first place in the Instituto de Estudios Peruanos’ (IEP) poll released in late February. Then, the March Datum and Ipsos polls indicated that Lescano had consolidated his undisputed first place, with 13% and 16.8% of the vote, respectively. More surprising was the rise in the popularity of Rafael López of Renovación Popular, as indicated in the March Ipsos poll. López, who has jumped into third place, with 9.3% of the vote, slightly below Forsyth, has 11.2%, and is ahead of both Keiko Fujimori and Verónika Mendoza, who have 8.6% and 8.4%, respectively. López is a conservative, right-wing, prominently Roman Catholic entrepreneur associated with former Lima mayor Luis Castañeda (who is being investigated on corruption charges, and is currently under house arrest). In fact, López is running as the candidate of Castañeda’s political party, Solidaridad Nacional, which has been rebranded as Renovación Popular.
Disruptive policy promises have been one characteristic of this election campaign, which have yielded benefits to both Lescano and López. These candidates have positioned themselves at either ideological extreme. They have similarly defensive strategies — compelling voters to contain the threat that the other candidate poses toward national stability. Lescano argues that a vote for him is a vote for the poor, and in favor of equal social opportunities; López would argue the opposite: he champions the containment of the left. Surprisingly, both aim at the dissatisfied population, and the deep economic crisis resulting from the pandemic has increased the size of that population. Both say that they would fight cronyism and corruption, and would design policies to favor low-income households. They are the two sides of populism — one from the left, and one from the right. Being opposite sides of the same coin, the risk is that many voters will feel compelled to vote for one in order to nullify the other and that, as a consequence, both will move to the second round.
Economic reports offering a first reading of Q1 2021 performance indicate that the economic recovery paused. The recovery phase that started in May 2020, when the government of Martín Vizcarra opened up the economy following the strict lockdown initiated in mid-March, has halted. This has been consistent with our own forecast, which projected a weak H1 2021, followed by a re-acceleration in H2 2021, and extending into 2022. Even our initial January forecast, projecting a real GDP advance of 9.7% y/y in 2021 and 5.4% y/y in 2022, forecast this deceleration. Later, after the government of Francisco Sagasti decreed the February 2021 lockdown, the forecast was shaved to 6.5% y/y for 2021, and raised to 7.5% y/y for 2022. We are, therefore, below market consensus for 2021, and above it for 2022 (according to Latin Focus).
It is unclear what exactly prompted the economic deceleration in early January, but all high-frequency reports confirm the loss of momentum. This was the case, for instance, with Google’s daily mobility data, and the 7-day moving average of electricity output, which offers a close gauge of overall real GDP performance, and signaled a deceleration from January. By then, signs that a second wave of infection was on its way were apparent, likely dampening consumer and business expectations. Moreover, the election campaign saw a rise in political risk. The first signs were evident in the Purchasing Managers Index (PMI) reports of the Banco Central de Reserva del Perú. After holding on well through December, the overall PMI and its components fell in January.
Although the election result poses the main risk to our H2 2021 forecast, three drivers support the possibility of an economic rebound sometime after the June presidential election’s second round. First is the vaccination program. While Peru joined the global vaccination rollout in December 2020, lagging most other countries, the program has accelerated rapidly in recent months. Second -- a young trend, but one that should gather strength during the rest of the year -- is the execution of public works. In our view, public works will expand by 19% y/y in 2021, and should add about 1 percentage point to overall real GDP for the year. Third, a stronger boost should result from external demand. Commodity prices, an area to which Peru has a strong exposure, have boomed, and Peru’s two main trading partners, China and the United States, should lead the global economic recovery. Most recent export reports have not yet recorded this effect, although some export components, such as agriculture and fishing produce, have performed well.
Most recently, Peru’s Soberano local-currency and Global hard-currency bonds have underperformed and, year-to-date, yields on the bonds due in 2032 and 2031 have increased by 105 and 107 basis points, respectively. At the same time, the PEN:USD spot rate has been sold off, hitting 3.7 to the dollar on March 15th, from 3.62 on December 31st. Most commentators have read this as evidence of increased political risk. History tells us that, during every election campaign, local asset prices sell off, and this time is unlikely to be an exception.
However, a closer inspection of the performance of global asset prices gives rise to one question in particular: how much of the fall in local asset prices is owing to political risk, and how much to the sell-off of U.S. Treasury bonds resulting from the massive fiscal stimulus recently approved by the U.S. Congress? In fact, the total U.S. fiscal stimulus, including what was passed during the Trump administration, reached 14 ppts of GDP, the largest stimulus ever approved. Unsurprisingly, yields on the 10-year U.S. Treasury bonds have widened by 72 bp since December 31st.
The conclusion from this exercise is that most of the increase in the Soberanos yield is explained by the increased issue of U.S. Treasury bonds, and expected depreciation of the currency. Once these effects are netted out, the political risk will remain very low, expected at between 20 bp and 70 bp. The estimates differ, and the political risk calculated using Peru global bonds and excluding the expected depreciation from the identity is moving upwards, while the one using Soberanos and including the expected exchange rate risk is moving downwards. Our hypothesis is that there is a mispricing in the Soberanos market, which eventually would have to correct.
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