November 17, 2015
Egan-Jones Assigns A First-time Rating Of "BB" To The Republic Of Peru's International Bonds
New York, NY - Egan-Jones Ratings Company, Inc. ("Egan-Jones") today issued the following three ratings (non-NRSRO) on Peruvian sovereign debt:
- Peruvian Foreign Currency Bonds: Rating "BB"
- Peruvian Local Currency Bonds ("Soberanos"): Rating "BB-"
- Peruvian Land Reform Bonds: Rating "D"
"A longstanding principle in an investment-grade rating is that no other obligation by the issuer should be in default," said Sean Egan, founding principal of Egan-Jones. "Peru fails to meet this basic test, and we are surprised that the Land Reform Bonds default has not been noted in ratings of Peruvian sovereign debt by other major credit rating agencies. Importantly, this ongoing default is not disclosed in Peru’s current SEC filings."
Egan-Jones will be hosting a webcast at 11:30 a.m. ET today, November 17, to discuss the ratings.
The webcast has concluded. Click here to download the presentation (PDF).
The principal drivers of Egan-Jones’ rating actions are as follows:
- Weak institutions, which are particularly evident in the sovereign’s spotty repayment track record, weak public investment execution, and pervasive social conflict;
- Fiscal strength is somewhat counterbalanced by an economic structure that is highly dependent upon commodities; and
- Vulnerability to event risk mainly related to (i) natural disasters, (ii) high levels of economic dollarization, and (iii) reversal of capital flows after
the U.S. Federal Reserve hikes rates.
I. Weak Institutions
Peru’s chief credit weakness relates to its institutions.
First and foremost, Egan-Jones notes that Peru has a spotty repayment track record. Specifically, the Peruvian government remains in default on its Land Reform Bonds.
"A longstanding principle in an investment-grade rating is that no other obligation by the issuer should be in default," said Sean Egan, founding principal of Egan-Jones.
"Peru fails to meet this basic test, and we are surprised that the Land Reform Bonds default has not been noted in ratings of Peruvian sovereign debt by
other major credit rating agencies. Importantly, this ongoing default is not properly disclosed in Peru’s current SEC filings."
According to the Egan-Jones rating methodology, "Character – the integrity of management or in the case of sovereigns, leadership, structure and policy" is the first of five
key assessment criteria to evaluate credit quality.
In Egan-Jones’ view, Peru has exhibited a lack of willingness to act in an even-handed manner with its creditors. The foreign currency bonds and local currency "Soberanos"
are currently paying, while the Land Reform Bonds are experiencing current and ongoing default.
The Land Reform Bonds were issued between 1969 and 1982 and remain unpaid. Through a recent administrative decree, Peru has made a unilateral offer to pay the Land Reform Bonds in an
amount equal to less than 0.5% of the amount owed (i.e. a 99.5% haircut). In addition, Peru’s proposed process subordinates both holders of the bonds
who are entities rather than individuals, and purchasers of the bonds on the secondary market. The process also requires bondholders to waive all rights
to future legal remedies as a precondition to register their Land Reform Bonds.
Egan-Jones believes that Peru’s current treatment of the Land Reform Bonds potentially sets a dangerous legal precedent for all Peruvian sovereign obligations, as holders may be subject
to an involuntary reduction in principal and subordination to other creditors of Peru based on their status as a natural person or entity and as an
original or secondary purchaser.
The government has publicly claimed that a July 2013 Constitutional Tribunal decision provides the legal basis for its 2014 administrative process. However, the Constitutional Tribunal
justified the dramatic change in the valuation methodology based on a conclusion that the government is unable to pay rather than well-established
legal precedent. Moreover, recent media reports have noted a criminal investigation into the matter by prosecutors in Peru. In addition, a
former justice of the Constitutional Tribunal has filed a criminal complaint alleging that white-out was used to forge a portion of the July 2013
ruling. These events support Egan-Jones’ concerns about the independence of Peru’s judiciary, as well as the willingness of Peru’s executive and
judicial branches to respect creditor rights and abide by the rule of law.
In addition to Peru’s spotty repayment track record, Egan-Jones notes that the sovereign has several other institutional shortcomings. Weakness of fiscal institutions is evident in the
government’s structural inability to execute budgeted investment projects – through October 2015, just 54% of public investment in the budget had been executed.
Further indications of Peru’s institutional weakness are apparent in the inflation rate which remains above the upper bound of the central bank’s target range, shortcomings in data
transparency, and pervasive social conflicts that have the potential to become politically destabilizing.
II. Fiscal Strength Somewhat Counterbalanced by Commodity Dependence
Peru’s key strength is its fiscal position. The overall debt stock is low at around 20% of GDP and the government has a Fiscal Stabilization Fund amounting to roughly $9.2 billion
(4.6% of GDP), while debt affordability is sound, with interest payments amounting to only around 5% of government revenues.
Nevertheless, Peru’s economy remains highly dependent upon commodities through the growth, fiscal, and external channels.
Due in part to the impact of lower commodity prices, Egan-Jones expects Peru’s real GDP growth to remain below 3% in 2015, compared to an average of 6.4% from 2004-2013 when commodity
prices were high.
Although Peru posted fiscal surpluses for six out of the past ten years when commodity prices were high, its new normal in the current commodity price environment will be to post fiscal
deficits. Egan-Jones expects a fiscal deficit of roughly -2.0% of GDP in 2015, and anywhere from 2.2% to 2.7% of GDP in 2016. Although debt ratios remain low, they will begin to rise as the government issues more debt to finance these deficits.
On the external front, lower prices for the bulk of Peru’s exports have led to a deterioration of the current account, which will post a deficit above 4% of GDP this year and next.
Nearly 70% of Peru’s exports are primary goods, most of which are made up of minerals.
III. Vulnerability to Event Risk
Peru remains structurally vulnerable to multiple event risks.
First, the country’s geography leaves it vulnerable to natural disasters such as earthquakes and climate events like El Niño. Although the magnitude of this year’s El Niño event remains
unclear, a severe event such as the one in 1997-1998 has the potential to reduce Peru’s growth by up to three percentage points.
Second, the economy as a whole remains highly dollarized. Roughly half of the government’s debt is denominated in foreign currency, while 68% of private credit and 54% of banking system
deposits are denominated in foreign currency. This reality leaves the country exposed to exchange rate risk. Although the central bank intervenes to stem the extent of the
Nuevo Sol’s depreciation, this practice has led to a decline in the country’s international reserves position since 2013. Net international reserves currently stand at $62 billion
which bodes well when compared to several other Latin American countries. However, the portion of those reserves available for monetary policy amounts to only $48 billion, given
that some $14 billion are comprised of public sector deposits and the government’s Fiscal Stabilization Fund.
Third, although the government’s debt stock is low at around roughly 20% of GDP, over half of the total debt stock is held by non-residents while nearly 40% of the domestic debt stock is
also held by non-residents. As such, there is a material risk of capital flow reversal when the U.S. Federal Reserve hikes rates later this year or in 2016.
Webcast – November 17, 2015 – 11:30 am ET
The Egan-Jones ratings reports on the Peruvian International Bonds, Peruvian Sovereign Bonds, and Peruvian Land Reform Bonds can be found at www.egan-jones.com.
Sean Egan, founding principal of the Egan-Jones Ratings Company, Inc., will be hosting a webcast at 11:30 a.m. ET on November 17, 2015 to discuss the firm’s ratings on Peruvian sovereign
debts and recent events supporting these ratings.
The webcast has concluded. Click here to download the presentation (PDF).
Individuals without online access may dial: 877 378 9048 (US) or +1 832 323 6976 (intl.) and use the call ID 82965298 to hear the audio portion of the presentation. Individuals wishing to
view the presentation slides shown during the webcast and/or submit questions should participate in the webcast online.
About Egan-Jones Ratings Company, Inc.
Egan-Jones started providing credit ratings in 1995 for the purpose of issuing timely, accurate ratings. The firm rapidly gained credibility by flagging the failures of Enron and WorldCom,
and has since established itself as a leading global provider of credit ratings with prescient and timely ratings on Countrywide Financial, Lehman Brothers, MBIA, Ambac Financial,
the airline industry and the sovereign debt of Greece, Italy and Spain.
Egan-Jones has been designated as a nationally recognized statistical ratings organization ("NRSRO") by the U.S. Securities and Exchange Commission ("SEC"), is recognized
by the National Association of Insurance Commissioners ("NAIC") as a Credit Rating Provider, and in 2014 was certified by the European Securities and Markets Authority
("ESMA") as a Credit Rating Agency ("CRA"). Because of its ESMA-certified status, Egan-Jones is also considered an External Credit Assessment Institutions
("ECAI") across the whole European economic area. Studies by the U.S. Federal Reserve and prestigious academic institutions have confirmed that over time, ratings from the
largest NRSROs tend to converge toward the Egan-Jones rating.
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