The Andean nation’s bond yields are twitching, and for good reason: Peru’s presidential runoff has become a referendum on law and order, with the spectre of capital flight looming large. The frontrunner, a populist firebrand promising to hang criminals from lampposts, has sent a shiver through the Lima Stock Exchange. For a country that has been a darling of emerging market investors, this is a jarring reversal. The question now: can fiscal discipline survive a populist victory?
Let us look at the numbers. The Peruvian sol has lost ground against the dollar over the past month, a classic symptom of political uncertainty. The benchmark BVL index has shed gains, reflecting a market that hates surprises. The source of the jitters is the rise of a candidate who openly flirts with capital controls and pledges to rewrite the constitution. To investors, this is the stench of default, or worse, expropriation.
The crux of the campaign is insecurity. Peru has seen a surge in violent crime, with homicides rising 20% last year. The incumbent government’s limp response has fuelled public anger, and the populist has cleverly monetised this anxiety. But the markets see a different kind of violence: the potential shredding of property rights. In a world where capital is footloose, Peru cannot afford to be seen as hostile to business. The risk of capital flight is real. Already, dollarisation of bank deposits has ticked up, as Peruvians hedge their bets.
Yet the populist’s opponent, a centrist economist, is struggling to gain traction. He speaks of fiscal discipline, of inflation targeting, of the need to maintain the Central Bank’s independence. All sensible stuff, but the electorate is in no mood for technocratic prudence. They want blood, not bond yields. The danger is that Peru, once a poster child for sound money, could become another cautionary tale of how populism trumps prudence.
What does this mean for the gilt-edged assets? If the populist wins, expect a spike in borrowing costs. The yield on Peru’s 10-year bonds has already risen 50 basis points since the campaign began. A full-blown panic could push it higher. The Central Bank will be forced to tighten, but that will crudely choke growth. The irony is that the populist’s promises of handouts will be paid for by printing money, stoking inflation. The poor, who are his base, will be first to suffer.
The market is also watching the neighbouring economies. A Peruvian default could trigger contagion in Latin American debt markets. Chile and Colombia, which have their own political turbulence, would feel the heat. Global investors are already jittery; the last thing they need is a populist experiment in the Andes.
But perhaps we are getting ahead of ourselves. The centrist still has a chance if he can pivot to a law-and-order message without sacrificing fiscal orthodoxy. He needs to convince voters that a firm hand on criminals does not mean a sledgehammer to the economy. The market would forgive a temporary uptick in public spending on policing if it is offset by credible long-term commitment to balanced budgets. So far, the message has been muddled.
For now, I am bearish on Peruvian risk assets. The volatility is not going away. My advice to clients: hedge your soles exposure and take profits on Peruvian equities. The uncertainty premium will remain until the ballots are counted. And even then, the real risk is not the result but the aftermath. A populist victory would be a watershed moment, not just for Peru but for the credibility of fiscal conservatism in emerging markets. The bottom line is simple: when insecurity is the order of the day, capital goes elsewhere. Peru must choose wisely, for the market’s patience is not infinite.
