Political crisis will impact the economy
Politics was again at center stage this month, first with Congress’s interpellation of Finance Minister María Antonieta Alva, and then the proposed impeachment of President Martín Vizcarra. Since the election of Pedro Pablo Kuczynski to the presidency in 2016, there has been a power struggle between the Executive and Legislative branches, which has revealed deep-rooted institutional weakness. To date, the economy has proven strong, and has withstood the shock of the COVID-19 pandemic; however, the long-term damage will become evident over time in terms of lower potential growth rates, and we forecast a drop to 2.5% per year, from a previous 3.5% before 2019.
Congress submitted 82 questions about Alva’s performance at the Finance Ministry since the COVID-19 pandemic began, and the interpellation was completed on September 7th. According to the Constitution, following an interpellation, Congress may submit an impeachment motion with the support of one quarter (33 members) of Congress. Congress obtained this approval last week; the Constitution dictates that this motion must be voted upon within 4-10 working days following the interpellation. Congress met on September 14th, and failed to secure the 66 votes needed to impeach Alva. To put this process in context, last time a finance minister was interpellated was 14 years ago (Kuczynski), due to the suspension of a clean-water project -- and a finance minister was last impeached back in 1879.
In the impeachment motion, Congress is obliged to justify its decision. However, in politics, what is omitted is sometimes more relevant than what is said. With presidential and congressional elections due in less than a year, it is apparent that the parties in Congress are using the impeachment to position themselves more strongly. The fact that the finance minister has had to fend off most of the populist legislation that has been tabled in recent times makes her an obvious target of the most radical parties.
On September 10th, Congress started an impeachment process against Vizcarra. The head of the Supervisory Committee in Congress, Edgar Alarcón, a former head of the Government Comptroller Office and a political foe of Vizcarra, aired compromising audio recordings featuring the president. In one of these, Vizcarra can be heard making remarks that some lawyers argue are legally compromising. Allegedly, there are more than 200 of these audio recordings in existence. Radical political parties in Congress believe they contain sufficient evidence with which to impeach the president. Since the impeachment process started, the more moderate political parties have indicated that they would not support it and, at the time of this writing, it is unclear that the radical groups hold sufficient votes to approve it.
The impeachment highlights deeper fissures in Peruvian politics. The first is the institutional weakness in the resolution of conflicts between the Executive and Legislative branches. Both Vizcarra now, and Kuczynski before him, have been exposed to a power struggle with Congress. It becomes apparent that constitutional procedures are weak when a president fails to secure a majority in Congress. It is unlikely that this would be solved by a ruling by the Tribunal Constitucional (TC, Constitutional Tribunal), but to allow the gap to remain or widen would further weaken prospects of institutional reform.
Secondly, the fight between the Executive and Legislative branches is deeper than is evidenced by a few audio recordings in the case of Vizcarra, or supposed evidence of corruption in the case of Kuczynski; it is a confrontation between regression and progress. It is apparent that the political forces in Congress resist reform and that the electoral system fails to ensure support for reform. It fails to instill a fully democratic representation that compels congressmen and women to faithfully represent voters. This rupture is preventing progress, by allowing powerful groups to gain access to political positions, reinforcing the practice of “crony capitalism.”
On August 30th, as mandated by the Constitution, the government submitted its 2021 Budget Laws and the macro-framework that underlies budget estimates. More relevant to market participants may be the analysis of the overarching Multiannual Macroeconomic Framework (MMM) laying out the macro-framework, fiscal finances, and deficit financing with a projection of four years, from 2021 through 2024. On growth, this framework offers a relatively upbeat outlook, with the economy forecast to contract by 12% y/y in 2020, then jumping by 10% y/y in 2021, and averaging 4.5% y/y in the next three years, through 2024. Underlying this outlook is the view that the economy will follow a “v-shaped” recovery, reaching 88% of pre-COVID-19 levels by end-2020. For 2021, boosted by the large fiscal stimulus program, amounting to 20% of GDP (the largest among emerging markets), the government forecasts a strong rebound of 10%, the largest since 1994. Finally, the 4.5% annual average growth forecast for 2021-2024 is much faster than the pre-COVID-19 estimated potential growth rate of 3.5%, and is based on the implementation of economic reforms whose effects are still uncertain.
Our view is more downbeat (although we acknowledge that we sit at the opposite end of the spectrum of the forecast profile, with consensus somewhere in the middle). We expect a deeper, protracted recession, inducing real GDP to fall by 17% y/y in 2020, rebounding more mildly the following year, to 6.8% y/y, and averaging 3% y/y in 2022-2024. Although there are signs that the economy is rebounding, these are largely owing to a supply-side effect resulting from the reopening of the economy, together with a more positive external environment. However, aggregate demand remains soft, particularly private investment and consumption. Underlying our view is the assumption that the drag from the recession, including higher structural unemployment and heavily-hit company balance sheets, could poison the recovery, unless the government engages in a more comprehensive recovery program. Moreover, with a new government taking over in mid-2021, it is difficult to argue that economic reform will be effective, and we opt for a more neutral outlook, with the growth rate converging with a lower potential growth rate of 2.5% per year.
Our forecasts anticipate a lower fiscal deficit in 2020, reaching 8.7% of GDP, and a larger one in 2021, of over 8%, mainly resulting from lower revenues. The forecast for 2022-2024 will also require adjustment, but much depends upon the policies implemented by the next government. On the debt to GDP ratio, the government fails to capture fully the effect of the loan losses on the 13% of GDP of government guarantees granted in its 2020 fiscal program. For instance, assuming a loan loss of 10% on these programs, the debt to GDP ratio would jump to 40.4% in 2023 (as opposed to the official forecast of 39.1%) when the government guarantee expires and firms are obliged to honor their loans.
The most recent economic reports confirm that the economy sustained its economic recovery in July, but some August demand-side reports already indicate that it is losing momentum. This is in line with our own forecasts, anticipating a strong Q3 2020, when real GDP is forecast to grow 95.5% q/q, saar, after having fallen 71.1% q/q, saar, in Q2 2020. However, as the positive mean-reversion supply shock resulting from the economic reopening that started in May subsides, the economy will gradually converge to its 2.5% y/y long-term growth rate and, in the transition to this rate, we forecast real GDP to reach 4.6% q/q, saar in Q4 2020. We cannot predict the full impact of the current political crisis and we are, therefore, keeping unchanged our forecast of a drop of 17% y/y in 2020, and a 6.8% y/y rebound in 2021. However, there is a risk that this crisis will impact the economy more powerfully in the medium term, and that we will need to revise down our Q4 2020 and full-year 2021 real GDP growth forecasts.
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