Business in the balance: Peru’s fight to remain an emerging market

 

Written by Jean Stephens on 21 October 2015

 

Continuing our series on frontier and emerging markets, we focus here on Peru – a country which was recently rated by CNN as one of the best emerging market cities for startups.

Peru is renowned for its business friendly government, business startup support and investment in the ecosystem. Peru’s GDP figure grew by 5% last year and over the last eight years has averaged 7% economic growth. The warm welcome for businesses, and the support which Peru offers, are hugely attractive to investors.

I was consequently interested to hear that the MSCI (formerly the Morgan Stanley Capital International index), who developed the All Country World Index (ACWI), recently opened a discussion on whether to downgrade Peru’s title to a frontier market based on the fact that they only fit three of the securities criteria for emerging market investability. The MSCI uses categories such as volatility, yield, quality and momentum to provide benchmarks for investors when comparing economies. The categories of ‘frontier’, ‘emerging’ and ‘developed markets’ have become recognised (albeit occasionally contentious) definitions across the globe. As such, any change in status is likely to affect the environment for doing business in Peru.

At a recent meeting in New York, the Peruvian Economic Minister and other senior officials presented their arguments to investors and the media defending their index categorisation. Peru has demonstrated that it is prepared to go to great lengths to retain its classification. With the removal of capital gains tax and a proposed ten-year financial plan, Peru has developed a competitive strategy which would appeal to many investors and is attractive, irrelevant of the country’s index status.

Peru’s economy is heavily reliant on commodities and consequently, has suffered from the fall in prices alongside the slow-down in global economic growth. Some analysts have argued that Peru has weathered the storm reasonably well; for instance, Peru’s currency only dropped 7% in value, compared to Columbia and Brazil, which dropped 21% and 31% respectively (against the US Dollar). As such, Peru presents a variety of factors to consider in its case to remain an emerging market.

Whilst reclassification may appear to be a change on paper only, the impact of such a reclassification could be wide reaching. As a frontier market, Peru’s reputation would suffer in comparison to their neighbours such as Chile, Colombia and Mexico. It would mean that they were associated with countries that are known for their volatility. Whilst this may be an obvious characteristic of both frontier and emerging markets, the distinction between the two is not universally agreed, and, in a globally volatile economy, such an extent of risk is not broadly welcomed by all investors.

An alternative view is that reclassification could be beneficial as frontier markets are known for potentially huge returns on investors’ capital – unparalleled by the rest of the global economy. Frontier markets were developed because investors found that emerging markets developed to such an extent that they were in tandem with the US economy, and so failed to provide the diversification they once did. Frontier markets offer an investment with greater potential for development. However, potential for higher return comes hand-in-hand with greater risk. Many frontier markets do not have their own stock market; rely heavily on telecommunication, financial and consumer-company stocks which provide a monthly income; and are typically illiquid.

It can be anticipated that just as with the upgrade in index category of Qatar and the UAE to emerging markets in 2014, which had a beneficial impact on these countries’ economies, a degrade in categorisation could have the opposite effect. Peru fears that a reclassification will encourage investors to flee with their cash, further removing liquidity from the Peruvian economy and dissuading new investors from entering the market.

However, whilst the decision hangs in the air, it is comforting to observe that whatever the real impact of a change in status, Peru has taken the threat seriously and acted decisively. Whatever the decision, I am hopeful that Peru’s competitive financial plans ensure that it remains an attractive environment for business and investment.

RSM's member firm in Peru provides tax, audit and consulting services to growing companies.