After years of political unrest in Peru, the relative calm of recent months has led to international investors becoming increasingly interested in the country's government bonds.
Foreign investors now hold 39% of Peru's government bond holdings, the highest of any emerging market. This underlines the increasingly positive sentiment regarding the fixed income outlook in Peru. Moody's currently has a moderately stable Baa1 credit rating on Peruvian bonds.
This came after years of political unrest made investors wary of the Latin American country. Lawmakers called for President Dina Boluarte's resignation earlier this year amid allegations of unjust enrichment. Calls for impeachment have currently fallen silent and Boluarte and Congress are now at an impasse.
But now “Peru has a bit of a head start,” said Pramol Dhawan, Pimco head of emerging markets portfolio management. “It has recognized the need to provide international investors with positive returns on domestic assets and that central banks must align with international investors and provide positive returns on domestic assets.”
Fixed income securities background
The distinguishing features of the Peruvian economy include its low debt ratio, among the lowest of its Latin American peers, and its stable currency, the sol. According to the International Monetary Fund, Peru's debt amounts to 33% of its GDP. That's significantly less than Brazil's 86.7% and less than Chile's 40.5%.
The Central Bank of Peru also cut interest rates to 5.25% at its September meeting, the lowest in Latin America. Dhawan highlighted that Peru also has the steepest yield curve in the world and emerging markets – a stark contrast to the inverted yield curves in the US and many other countries.
“Real returns are high and the curve is steep; and like that [Fed] “As the rate-cutting cycle continues, there is still great upside potential for Peruvian local bond duration,” said David Austerweil, associate portfolio manager for emerging markets fixed income strategy at VanEck.
A 2-year Soberano bond, the country's local currency bond, currently yields 4.661% and the 10-year Soberano's yield was last at 6.428%. Bank of America relies on Soberanos, the government bonds in local currency.
Ironically, Peru's political dysfunction – which has left Congress deadlocked and unable to pass meaningful legislation – has likely strengthened Peru's financial health.
“In some ways, the lack of strong leadership has led to better results in fixed income,” Austerweil added.
Dhawan also emphasized that Peruvian bonds are a high-quality market for foreign investors. Dhawan noted that the political unrest is not affecting the country's debt market outlook. The fixed income backdrop is supported by the relative stability of the Peruvian central bank.
“Peru has created an ecosystem that is largely conducive to international investment,” Dhawan said. “The central bank is seen as the adult in the room… It is now confirming what we think it should do, which is to normalize policy in line with domestic conditions.”
What about the stock market?
The Peruvian equity backdrop is less clear. The MSCI Peru Index is up 24.8% in 2024 and 55.8% over the past 12 months. This makes it an outperformer compared to the MSCI Emerging Markets and World indiceswhich have only increased by 15.2% and 16.7% since the beginning of the year and by around 23% and 30% in the last 12 months.
“While the commodity bonus has helped Peru in the short term, without a properly functioning political system it is difficult to imagine a good equity story in the longer term,” Dhawan said.
Mining companies are among the stocks with the highest market capitalization in Peru, making the stock market highly exposed to cyclical factors. Peru is one of the world's largest producers of metals such as copper, silver and zinc.
Notably, copper prices are up 24.5% year to date – and commodity prices are expected to continue rising as recent stimulus measures in China raise hopes of a recovery in economic activity. However, the raw materials sector remains very volatile and subject to external conditions, complicating the equity environment.
“Without a major commodity supercycle, which is not our base case, it is difficult to see any kind of sustained growth, outperformance of trend without being more conducive,” Dhawan said.