This note is a rough attempt to cut through the hype and examine the opportunities offered to Peru by Fitch’s recent upgrading. The investment grade awarded to Peru by Fitch last week is good news, but all that “on the road to the first world” talk from finance minister Luis Carranza is premature and triumphalist, just what we don’t need to hear right now. Some wiser words came from the ex-finance minister Pedro Pablo Kuczinsky (‘PPK’ is the person who could, if he wanted, rightly claim most of the credit for this move to investment grade) on Friday. He said that investment grade is just a step towards the modernization of Peru, and was quick to point out that over 40% of the population still live in abject poverty.
Well said, PPK. Certainly a lot more balanced than the eulogies coming from every possible source of bias right now. Of course you’d expect Alan’s government to pump this for all it’s worth (and more), but the bandwagon is full of others, such as Scotiabank who report that Peru is “better placed than most other countries with investment grade.”
A few things that come to mind on reading that:
1) As Peru’s third biggest bank they would say that though, wouldn’t they? 2) Peru now has the lowest investment grade rank from only one of the three major ratings agencies……suddenly it’s “better placed than most other investment grade countries? EH??? 3) Scotiabank’s main argument is that Peru has tons of international reserves. Well, that could be applied to non-investment grade countries like Brazil, or even international pariahs such as Argentina or Venezuela. 4) See point 1)
Ok, enough already. I think we can agree that the investment grade is a good thing, but there’s also too much hype flying around right now. It would be useful to look at what Peru could reasonably expect from this going forward. Firstly, investment grade sounds very promising, but what does it mean? Apart from the normal blurb that the country can “reasonably be expected to punctually honour its obligations etc etc”, the whole point of it is Fitch announcing to the world, “Hey everybody, we think you can invest in Peru.” Ok, fair enough. Now the question is HOW can you invest? Well basically there are three ways. There’s portfolio equity investment (buying stocks), there’s portfolio debt investment (buying bonds) and there’s foreign direct investment (FDI), meaning you buy into the country itself by (for example) setting up a factory or going into a long term JV agreement with local firms.
Of the three, it’s recognized by those who look at these things (World Bank, IMF, IADB, BID, all them banking dudes etc) that FDI brings the best benefits to the country. When overseas money moves into a country via bonds or stock, it’s relatively easy to move out again quickly. But FDI money is there for the long term and is more stable by nature. So let’s look at a couple of stats on FDI, starting with how the world FDI cake was carved up last year.
Here’s a chart that breaks down all the FDI that happened in 2007. First thing to say is that of the U$1,537Bn charted by the United Nations UNCTAD body last year, over U$1,000Bn was invested in the developed economies (Europe, USA, Japan). This leaves about U$500Bn to the developing economies. Amongst those, China and Hong Kong combined for U$121Bn. Then come a range of countries that attracted good chunks of FDI, including Russia (U$48.9Bn), Singapore (U$36.9Bn), Brazil (U$37.4Bn) and Mexico (U$36.7Bn). Then places like India and Africa (the whole continent) brought in much less.
It’s quite a patchy scene, all in all. But when it comes to Latin America, the 12% of so of total world FDI that made it down here had two main destinations, as the next pie chart shows. Brazil and Mexico combined last year to take 59% of regional FDI. Add in Chile and Colombia, and just 23% of the pie is left for the other 15 LatAm states.
Here’s the same chart, but taking a longer time frame of FDI between 2004 and 2007. If we compare the two, the main thing to note is the larger percentage of FDI now arriving in Brazil.
There are different things going on here. The three big FDI destinations, Brazil, Mexico and Chile, have quite separate dynamics.
Brazil: Not investment grade, but getting close. Large population, reasonable growth levels with low inflation (so far). Commodities a big part of export mix, but also adding value to recent exports. Strong currency in recent times. As an aside, interest rates have been dropping but still attract “carry trade” type investment.
Mexico: Investment grade, with large population. Very heavily weighted to USA exports (80% going to the USA, as opposed to the typical 30% of other LatAm countries). FDI in Mexico has been aimed at producing export goods for the US market taking advantage of relative cheap salaries (eg auto manufacture).
Chile: LatAm’s best investment grade by a long way. Stable investment scenario since early 90s. The gov’ts consistently do “what the West wants” of a developing nation. Much of FDI in primary sectors (mining, energy generation etc), which have been booming recently, thus attracting more FDI.
So it seems there is no single recipe for attracting FDI. Brazil shows that investment grade is NOT necessary for attracting large amounts of foreign money to your shores. And if we look back at India for a moment, it has the same investment grade as Peru but attracted a very small amount of money in FDI last year when compared to the size of the country and its population.
As for the total amount of FDI already in the countries, here’s a chart that shows how the stock of FDI built up over the years compares to annual GDP in 2005 and 2006. The anomaly is Chile, with over FDI stock at over 50% of annual GDP. Venezuela has seen the ratio dropping, probably due to the rise in oil prices, and therefore GDP, while the FDI stock hasn’t moved much at all. Overall, the 2006 ratio in LatAm stood at 30%, with the world ratio at 24.8%. Thus the Peru ratio of 20% of so suggests there is plenty of room for FDI to take a bigger role in the country (on a comparative basis at least).
However, we saw before that the three big FDI countries in LatAm have different attractions. We also noted that despite having investment grade, India has attracted very little world money thus far. We can therefore say that investment grade is not some automatic door to riches, but, as PPK said, a stepping stone towards the modernization.
So the big question is, “What can Peru offer?” Well the obvious answer is ‘metals mining’, as over 60% of country exports are in copper, gold, zinc and all their friends. What’s worth pointing out here is that there is already U$9Bn in FDI slated for the Peru mining sector from now until 2011, so any “investment grade bounce” calculation would have to take that into account. What Peru can also offer is low running costs for investments such as factories, as the high poverty levels in many parts of the country will be able to supply low cost labour (in relative world terms). I’m reminded of Mexico in that sense, though without the geographic example of sitting right next door to the USA.
Finally, I’m also reminded of a recent article by Armen Kouyoumdjian that made it clear that FDI is not one thing but many, and the quality of the investment is all-important too. If Peru starts taking on every trade deal without thinking of the future (something that Garcia has recently mentioned he’d do), it may end up with less from its own development than it anticipates.