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Peru Election Signals Greater Risk for Latin America

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Peru's left-wing presidential candidate, Pedro Castillo, speaks to supporters from the balcony of his party's headquarters on June 10th in Lima.

The success of far-left socialist candidate in Peru's presidential election drives currency to all-time low against the dollar; signals greater risk for LATAM.

Socialist labor leader Pedro Castillo has apparently won by the narrowist of margins, just 50.2%, over the more business-friendly candidate, Keiko Fujimori, the daugher of former autocratic President Alberto Fujimori in an election held just over a week ago.  The result won't be final until all challenges have been decided by the country's electoral council, but barring something unforseen Ms. Fujimori will have lost for the third time.

The somewhat surprising victory by Mr. Castillo is a worrying sign that Peru, a country that had become a model for economic reform among emerging-market nations, may be shifting away from the free-market policies that have made the Andean nation one of the most successful economies in Latin America in the past 15 years.

The country has been in political choa since November of last year when then President Manuel Merino resigned only six days after his interim government took office following mass protests related to the economic hardships caused by the coronavirus pandemic.  Mr. Merino took office after the ouster of President Martin Vizcarra over corruption allegations.

Peru's economy was hammered by the pandemic contracting 11% in 2020, according to data firm Statista, but is forecast to rise 8.5% this year. 

The election of Mr. Castillo, an ardent anti-capitalist who leades a Marxist-inspired political party, creates more uncertainty for a country that while unstable politically has been one of Latin America's most stable economies.  During the election, Mr. Castillo promised to nationalize mining projects and frequently lauded the leftist revolutionary governments of Cuba and Venezuela.

More importantly, the Peruvian election is the latest in a string of anti-market political developments in Mexico, Argentina and Chile that indicate Latin America could be reverting back to its pro-government, populist roots and away from the market-oriented reforms that over the past three decades have served to elevate the region's economic, investment and credit status.

Suprisingly, the current political shift in Peru is taking place in the midst of a commodities boom that should help the less developed, commodities-based economies of Latin America.  Overall, commodities are up 18% on the year, according to the Dow Jones Commodity Index, by far the largest increase in commodities since before the crash of 2015.

But fears of an anti-market government taking control in Lima has pressured the country's currency, the sol, as one week after the election it reached an all-time low against the dollar dropping to 3.928 and capping two years of volatility for a currency that from 2016 to 2019 was one of Latin America's most stable (see nearby chart).

In the pandemic year of 2020, the sol had a volatility rate of 9.21%, according to volatility data compiled by CreditPulse, making it the fifth most volatile in the region behind only Venezuela, Argentina, Brazil and Uruguay.  In 2019, the sol rose 1.63% against the dollar in a year in which the greenback was down less than a percent.  In three of the past six years, the sol has risen in value against the dollar -- a rare feat for an emerging-market currency.

In the first quarter of the year, the sol was down only 3.23% against a dollar that was up 2.98%, but the sol's decline picked up steam in April and May as it became apparent the second round of elections would pit Mr. Castillo against the more establishment, but unpopular, Ms. Fujimori, daugher of jailed former dictator Alberto Fujimori.

The market values of Peru's two largest publicly-traded companies, both traded on the NYSE, dipped as the market capitalization of gold and silver mining giant Buenaventura Mining Company fell from $2.9 billion on June 1st to $2.38 billion on June 22nd, a decline in value of 18% in three weeks.  Meanwhile, the country's large cement producer, Cementos Pacasmayo SAA, lost $165 million of its market value in one week.

During the election, Mr. Castillo promised to nationalize Peru's large companies and frequently commended the revolutionary governments of Cuba and Venezuela -- two extremely under-developed countries in which the government controls almost all aspects of the economy.