Top 20. Peruvian Companies. Standard&&Poor s Av. L.N. Alem 855 3er Piso. Argentina. Argentina Tel: argentina@standardandpoors.

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1 Top 20 Peruvian Companies Standard&&Poor s Poor s Standard Av. L.N. Alem 855 3er Piso Av. L.N. Alem 855 3er Piso BuenosAires AiresC1001AAD C1001AAD Buenos Argentina Argentina Tel: Tel: argentina@standardandpoors.com argentina@standardandpoors.com

2 Introduction Dear reader, Standard & Poor s Ratings Services is pleased to present TOP 20 Peruvian Companies a report focusing on a selected group of Peruvian entities which we consider to be among those with the best credit quality in the country. Within the next pages, there is a detailed section on the methodology applied to determine the selected list of companies. Over the last five years, Peru s creditworthiness has steadily improved with rising terms of trade and stable macroeconomic policies and higher levels of investment that supported growth. Low fiscal deficits or surpluses, proactive debt management, an autonomous central bank with an inflation-targeting regime, a floating exchange rate, strengthening bank supervision, and numerous free trade agreements are some of the key macroeconomic factors that underpinned the country s economic performance over the last decade. Peru s economic performance has shaped the country s corporate sector during the last decade. As the country s economy, the fate of many of the major corporations is tied to the swings of the global economy, especially the evolution of commodities in general and metals and minerals in particular. However, prudent financial policies and cash management have allowed most players to grow and withstand external shocks improving their creditworthiness through the cycle. These characteristics will emerge from the individual analyses included in this publication. We have also included commentaries on the sovereign rating of Peru, the financial system, as well as information on Latin America and criteria and methodology to provide a broader analytical framework. We trust that the investor community, both in Peru and overseas, will find this report an important reference tool that will facilitate investment decisions. Pablo F. Lutereau Senior Director Analytical Manager, Corporate Ratings Standard & Poor s Top 20: Peruvian Companies 1

3 The analyses in this publication are Standard & Poor s opinions based on limited publicly available information, do not constitute Standard & Poor s ratings or definitive indications of what ratings Standard & Poor s would assign, and are not recommendations to purchase, hold or sell any securities or make any investment decision. Standard & Poor s will not update, modify or surveil these analyses.

4 Table of Contents Introduction Selection Criteria and Methodology Commentaries Republic of Peru 8 Latin America s Resilience, Recovery, And Consolidation 18 How Vulnerable Are Latin American Corporates To Commodity Prices? A Sensitivity Analysis 25 Latin America Is Seeing a Rise in Privately Financed Infrastructure Projects 32 South American Banks Should Support Rapid Credit Growth 35 Will Future Flow Securitizations Help Fund Peru s Growing Mining Export Industry? 40 Selected Financial Data and Credit Statistics Peer comparison 46 Credit Reports Alicorp S.A.A. 50 Compañía de Minas Buenaventura S.A.A. 52 Corporación Lindley S.A. 54 Edegel S.A.A. 56 Empresa de Distribución Eléctrica de Lima Norte S.A.A. - EDELNOR 58 EnerSur S.A. 60 Gloria S.A. 62 Luz del Sur S.A.A. 64 Minera Barrick Misquichilca S.A. 66 Minera Yanacocha S.R.L. 68 Minsur S.A. 70 Petróleos del Perú Petroperú S.A. 72 Saga Falabella S.A. 74 Shoughang Hierro Perú S.A.A. 76 Sociedad Minera Cerro Verde S.A.A. 78 Supermercados Peruanos S.A. 80 Telefónica del Perú S.A.A. 82 Telefónica Móviles S.A. 84 Unión de Cervecerías Peruanas Backus y Johnston S.A.A. 86 Volcán Compañía Minera S.A.A. 88 Understanding Ratings and Definitions Guide To Credit Rating Essentials 92 Glossary Of Financial Ratio Definitions 95 Incorporating Adjustments Into The Analytical Process 96 Standard & Poor s Rating Definitions 98 Contact List Top 20: Peruvian Companies 3

5 Copyright 2011 by Standard & Poor s Financial Services LLC (S&P), a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved. No content (including ratings, credit-related analyses and data, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of S&P. The Content shall not be used for any unlawful or unauthorized purposes. S&P, its affiliates, and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions, regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an as is basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact or recommendations to purchase, hold, or sell any securities or to make any investment decisions. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P s opinions and analyses do not address the suitability of any security. S&P does not act as a fiduciary or an investment advisor. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process. S&P may receive compensation for its ratings and certain credit-related analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P s public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at

6 Selection Criteria and Methodology Our selection process encompassed different stages aimed at building a short list of 20 Peruvian companies with superior credit quality. For that, we scrutinized the key sectors of the Peruvian economy, identifying those elements that help companies achieve strong business risk profiles, such as size, cost efficiency, management experience, degree of business integration, geographic and product diversity, etc. Having identified those companies with good business risk profiles, we centered our analysis on those that make public disclosure of its financial statements. Among those, we searched for the ones with healthy financial risk profiles, evidenced by cash flow stability, conservative debt leverage, prudent financial policies, adequate liquidity and financial flexibility and good access to debt markets. Top 20: Peruvian Companies 5

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8 Commentaries Top 20: Peruvian Companies 7

9 Republic of Peru Richard Francis, New York (1) ; Sebastián Briozzo, Buenos Aires (54) ; Current Rating Sovereign Credit Rating Foreign Currency BBB/Stable/A-3 Local Currency BBB+/Stable/A-2 Major Rating Factors Strengths: High real GDP growth, supported by a significant rise in investment. A low and declining general government debt burden. Weaknesses: Still-evolving political institutions in the context of significant economic, social, and ethnic fragmentation as well as high poverty levels. A significant (albeit declining) level of financial dollarization, with 45% of bank claims on residents in U.S. dollars as of June Rationale The ratings on the Republic of Peru reflect our expectation that broad fiscal and monetary policy continuity under Ollanta Humala s new government will support stronger economic policy flexibility and growth. In July 2011, Mr. Humala President- Elect at the time signaled macroeconomic policy continuity by reappointing the respected president of the central bank, Julio Velarde, and appointing another respected technocrat, Luis Miguel Castilla, to head the finance ministry. Since taking office on July 28, the government has emphasized its goal to promote social inclusion and has laid out plans to increase social and infrastructure spending as well as boost public-sector wages. However, the government has also signaled its intent to implement these priorities gradually and within the limits of a prudent fiscal approach by tying expenditures to increased revenues, partly from the mining sector. Therefore, assuming a fairly steady currency, net general government debt to GDP likely will continue to decline gradually over the next three years. Although raising taxes on mining will be a policy priority, Mr. Humala has stated that keeping the sector reasonably attractive to investors is critical to economic growth and tax collection. The government s commitment to economic stability and a positive investment climate support the ratings on Peru. We believe that these factors likely will underpin solid growth through 2013 despite global uncertainties. Peru s still-evolving political institutions in the context of significant economic, social, and ethnic fragmentation as well as high poverty levels continue to constrain the ratings. The country s monetary vulnerability is also a constraint. Peru has a significant (albeit declining) level of financial dollarization, with 45% of bank claims on residents in U.S. dollars as of June Peru s diversifying economic structure and high levels of investment, including foreign direct investment (FDI), should support the country s robust growth prospects over the next three to five years. Although the country s net external liability position was 86% of current account receipts at year-end 2010, close to 40% of the gross liability is FDI. Standard & Poor s Ratings Services expects that Peru s net inward FDI will continue to exceed the current deficit, which we estimate to be 2%-3% of GDP from Our local-currency rating on Peru is one notch higher than the foreign-currency rating because in our opinion, the combination of monetary flexibility and the growing local-currency debt market provide slightly better capacity to service nuevos soles-denominated debt issued in the domestic market. Our A- transfer and convertibility (T&C) assessment reflects our opinion that the likelihood of

10 the sovereign restricting access to foreign exchange that Peru-based nonsovereign issuers need for debt service is moderately lower than the likelihood of the sovereign defaulting on its foreign-currency obligations. Although the government has some foreign-exchange restrictions, they are on the capital account, and the economy is open to trade. Outlook The stable outlook balances Peru s ongoing success in attracting gas and mining investment with the country s political and external vulnerabilities. We likely would upgrade Peru if economic growth outside sectors related to energy and mining accelerates, dollarization diminishes significantly, and fiscal performance does not fall victim to potential political rifts. Conversely, we could lower the ratings if political pressures arising fr om the large informal economy, widespread poverty, and significant income disparities make the country susceptible to populism. In our opinion, the government s ability to address the underlying causes of its population s discontent will be key to the continued improvement of the government s creditworthiness. Table 1 Peru s Summary Statistics Year ended Dec e 2012f 2013f 2014f GDP per capita (US$) 2,848 3,276 3,763 4,400 4,352 5,215 5,596 5,939 6,454 6,966 Real GDP per capita growth (%) (0.3) Narrow net external debt/current account receipts (%) (0.1) (9.0) (15.5) (27.7) (31.1) (34.4) (39.2) Gross external financing needs/current account receipts + usable reserves Change in general government debt/gdp (%) (3.9) (1.8) (0.9) (1.5) (1.0) (0.5) (0.5) (0.5) Net general government debt/gdp (%) General government interest paid/general government revenues (%) Domestic claims private nonfinancial public enterprises/ GDP (%) CPI growth (%) e Estimate. f Forecast. Political Environment: Broad Consensus On Macroeconomic Policy Amid A Still-Fragile Political Environment Maintaining and enhancing stability In July 2011, Ollanta Humala, President-Elect at the time, signaled macroeconomic continuity by reappointing the respected president of the central bank, Julio Velarde, to his post and appointing another respected technocrat, Luis Miguel Castilla, to head the finance ministry. On the fiscal front, the government has emphasized its goal of promoting social inclusion while reaffirming its commitment to keep spending within the limits of a prudent fiscal policy. The government has laid out plans to increase social and infrastructure spending as well as boost public-sector wages, but it has signaled its intent to implement these initiatives gradually and tie them to increased revenues, partly from the mining sector. Although raising taxes on the mining sector will be a policy priority, President Humala would like to keep the sector reasonably attractive to investors, as this is critical for future economic growth and tax collection. Growing consensus on the macroeconomic front, but a lack of debate on reform There is a stronger consensus on sound macroeconomic policies across Peru s political class than ever before. Most of the political parties in Congress, including Mr. Humala s Nationalist Party, approved a bill strengthening the old Fiscal Responsibility Law. More than in the past, the political class in Peru seems to accept the restrictions that a sound macroeconomic framework imposes on other areas of public policy. However, the debate has yet to touch on more fundamental issues, namely, how to improve the country s still-weak political and economic institutions. Social issues such as education, health, and justice have only Top 20: Peruvian Companies 9

11 recently gained priority in the government s political agenda in the aftermath of the presidential victory of President Humala. He will seek to balance his keeping his campaign promises to increase social spending with maintaining sound macroeconomic policies and a good investment climate that supports growth. private consumption will likely rise by more than 5.5% over the next three years, further underpinning growth prospects. There are risks ahead A decade of high GDP growth has led to higher employment and purchasing power. Rapidly increasing levels of consumption in middle-income areas of Lima further demonstrate this trend. If it continues, it is likely that economic growth and social cohesion will sustain each other. However, despite the government s intention to boost social spending, its ability to implement social programs to date has proven weak, given institutional capacity constraints. For example, although the government has sought to reduce income inequalities through substantial revenue transfers to the poorest regions, weak local institutions have made it difficult to increase infrastructure and social spending. Large transfers of mining revenue to municipalities and regions have also shown that many of these entities do not have sufficient expertise to evaluate or implement projects. In fact, some municipalities in Peru have high levels of liquid funds that they are unable to spend. Social conflict in mining areas has proven difficult to manage and could be a significant challenge to the new administration. Economic Prospects: Expectations Are For Solid Growth Over Next Three Years Economic structure: diversification is underway Peru s GDP per capita, expected at $5,596 in 2011, is nearly double the level in 2005 (the year before President Alan Garcia came to power). Economic growth will likely reach 6.5% in 2011 and will likely remain at more than 5.5% from Continued high levels of investment, especially in the mining sector, will largely fuel this growth. FDI is expected to top $35 billion over the next four years. As a result of the high level of investment, we expect that exports will rise by more than 8% in Peru s extended growth trajectory started with the boost stemming from investment in largescale projects (gas development by Camisea and other mining projects, for example) and the rise in commodity prices in late However, today s sources of growth are more diversified. Because of rising levels of employment and disposable income, Investment is a key driver of economic growth Over the past two years, there has been a strong resurgence of domestic investment, particularly private investment, after a decline in 2009 as a result of global economic uncertainties. Investment has rebounded strongly and should reach 28% of GDP in A continued high level of investment is crucial to achieving growth rates higher than 6%, allowing Peru to reduce poverty, which affects about 30% of its population. Maintaining economic growth and social stability will depend on rising employment. Another positive development is that employment levels, which lagged the economic expansion at the beginning of the cycle, have grown more rapidly since mid-2005, in tandem with increasing domestic demand. Total FDI was $7.3 billion in While the mining and hydrocarbons sectors continue to draw the largest share of private investment, it has become more broad based. A number of large private investments continue including the second phase of Camisea, a liquefied natural gas project. Large mining investments continue as well, including Southern Peru Copper s projects such as Tía María and the expansions of the Toquepala and Cuajone mines. Investments are also funding the expansion of mines and concentration plants at Yanacocha, Shougang, and Milpo. There are several large oil and gas projects underway. In addition to more broadbased sectoral investment, there has been increased FDI from Asia, especially China, South Korea, and Japan. Peru has signed free trade agreements with each over the past three years. 10 Top 20 Peruvian Companies

12 Despite the increase in investment, various bottlenecks remain. Although Peru is rich in resources, improving human capital (and, therefore, productivity) is still a major challenge for the country s medium- and long-term economic development. School attendance is not low by Latin American standards, but the poor quality of public education is a major weakness; a comprehensive reform in this sector is still pending. One of biggest constraints for growth is infrastructure. However, over the longer term, education will likely be a bigger factor. The government would need to reduce high labor market informality and improve the quality of public investment and social spending across all levels of government to alleviate infrastructure and social gaps, supporting ongoing export diversification and poverty alleviation. Strengthening public institutions, advancing administrative simplification, and promoting education attainment would boost human capital and entrench high productivity growth. Table 2 Peru s Economic Indicators Year ended Dec e 2012f 2013f 2014f GDP per capita (US$) 2,848 3,276 3,763 4,400 4,352 5,215 5,596 5,939 6,454 6,966 Real GDP per capita growth (% change) (0.3) Investment/GDP (%) Net foreign direct investment/gdp (%) Depository corporation claims on the resident nongovernment sector/gdp (%) e Estimate. f Forecast External Finances: Moderate Current Account Deficits Going Forward Peru has had significantly favorable terms of trade in 2011, as expectations are for the price of metals especially copper to rise by 18% after increasing by nearly 38% in Despite these improved terms of trade, the current account deficit will likely deteriorate to 2.7% of GDP in as imports grow even more rapidly than exports, partly because of FDI. It is important to note that after two years of stagnation, the volume of traditional exports will likely expand by more than 8% per annum in as a number of large mining projects begin. Higher levels of international reserves and current account receipts have kept the country s external liquidity as measured by its gross external financing needs to current account receipts plus usable reserves relatively stable at an estimated 72.9% despite a larger current account deficit (see Chart 2). Favorable terms of trade, coupled with rising export volumes, have led to continued improvement in Peru s external accounts. Peru s narrow net external position (net of liquid assets only) is at an expected 27% of current account receipts in Top 20: Peruvian Companies 11

13 Mining exports changing the scales As noted, strong mineral prices combined with significant volume expansion will lead to continued improvement in Peru s external indicators. The dynamism of traditional exports, which account for 79% of total exports, support the strong performance of exports in However, we expect that nontraditional exports will rise by nearly 21% in Although 21% is relatively a small portion of total exports, this figure is still significant, particularly because nontraditional exports have more of an impact on employment than traditional exports. Some of these latest developments were supported by access to the U.S. market through the free trade agreement with the U.S. that went into effect on Feb. 1, Furthermore, Peru has signed a number of other free trade agreements, including those with Canada, Singapore, Mexico, Chile, China, South Korea, and Japan. Mineral exports account for roughly 60% of Peru s total exports, with copper alone constituting 24% and gold 18%. Oil and gas exports are growing as a share of total exports as well. They now account for nearly 10% of the total. Peru s external position should improve further over the next five years. It is important to note that this is not solely based on higher commodity prices. In addition, we expect that export volumes will increase substantially for many of Peru s key mining sector exports. However, higher levels of imports stemming partly from FDI will likely lead to current account deficits of 2%-3% in In addition, the central bank s international reserves have increased significantly over the last two years, growing by nearly $15 billion (nearly 50%) to reach $48 billion in 2011 compared with $33 billion in Standard & Poor s expects that the combination of good fiscal management, volume growth of exports, and high FDI levels will continue to underpin Peru s external accounts over the medium term. In the future, the government s fiscal consolidation strategy and successful financing through the domestic market using local-currency-denominated debt will constrain the growth of the stock of external debt. Table 3 I Peru s External Indicators Gross external financing needs/current account receipts plus usable reserves Year ended Dec e 2012f 2013f 2014f Narrow net external debt/current account receipts (0.1) (9.0) (15.5) (27.7) (31.1) (34.4) (39.2) Current account receipts/gdp Net foreign direct investment/gdp Current account balance/gdp (4.2) 0.2 (1.5) (2.7) (2.7) (2.6) (1.4) Current account balance/current account receipts (13.5) 0.6 (5.3) (8.9) (8.7) (8.4) (4.5) Net external liabilities/current account receipts Usable reserves/current account payments (months) Usable reserves (Mil. US$) 11,002 14,006 23,555 25,347 27,331 38,041 40,230 42,484 45,176 49,911 e Estimate. f Forecast. Fiscal Policy: Higher Revenues Will Finance The Government s Social Programs In the midst of an election year, with buoyant revenues and restrained government spending, the government ran a large fiscal surplus of 5% of GDP in the first half of However, an increase in spending in the second half of the year will likely lead to an overall fiscal surplus for the year of 1% of GDP in Tax revenues should rise by 13% in 2011 to reach 20.5% of GDP, up from 19.8% in Spending, which was subdued in the first half of 2011, will likely rise significantly over the second half of the year to reach 19.5% of GDP, but this is still down from 20.4% in Top 20 Peruvian Companies

14 points of the total 19% VAT from the current two percentage points as well as their take of various mining revenue sharing funds to 20% of the total from 10%. There is a growing consensus on the importance of fiscal responsibility in Peru. Fiscal rationalization became easier when relatively high economic growth allowed the government to make some expenditure concessions without damaging the final-balance target. Continuing fiscal consolidation under a less-favorable international economic environment will still be a risk. The Fiscal Responsibility Law established a ceiling of 1% of GDP for government deficits in periods of economic expansion. Despite recent improvements, expanding the country s still-relatively-low tax burden will be an ongoing challenge, especially given its high dependence on mining-related revenue (accounting for nearly a quarter of total central-government revenue). Tax rates are already high, and the problem has its origins in high levels of informality and tax evasion. In addition to windfall taxes on the mining sector, expanding the tax base would likely be more fundamental to increasing the tax burden without damaging the formal economy. Enhanced tax administration at SUNAT, the Superintendency of Tax Administration, could also expand tax revenues. As noted, on the expenditure side, President Humala has made explicit his major objective of boosting social expenditure as well as improving public infrastructure. The decentralization process, initiated in 2002, continues to transfer functions to local and regional governments. Some decentralization of health and primary education has begun as well. The various levels of government still need to clarify responsibilities to avoid duplication. Under President Garcia s administration, transfers to the local and regional governments doubled by increasing their take of the value added tax (VAT) to four percentage Peru s still-high dependence on the commodity sector highlights the importance of developing stronger countercyclical economic policies. Because dollarization and low levels of financial intermediation still constrain monetary policy, fiscal policy must play a dominant role. The Fiscal Responsibility Law incorporated a countercyclical fiscal fund into Peru s government structure. That fund totaled only about 2% of GDP at year-end The government introduced multiannual budgeting in 2010 to move toward a medium-term expenditure framework. Debt and interest burdens One of Peru s major accomplishments was debt reduction and improved debt structure. Standard & Poor s expects the government s debt to reach 13% of GDP (in net terms) in 2011 compared with nearly 20% in (Government deposits both at the central bank and the local banking system will likely total 8% of GDP at year-end 2011). Active debt management has recently gradually reduced interest- and exchange-rate vulnerability and postponed major amortization over the next four years (in particular, after the Paris Club debt buyback operations). The government has also been working extensively to deepen the domestic capital market for issuances in Peruvian nuevo sols, allowing the country to replace foreigncurrency-denominated debt with its local-currency counterpart. Significantly, Peru issued a 30-year bond denominated in local currency in the Peruvian market at a fixed interest rate in More than 46% of Peru s total debt is now denominated in Top 20: Peruvian Companies 13

15 local currency, having increased very rapidly from 18% at year-end Also, exposure to variable interest rates declined to about 12% of debt in March 2011 from 55% in Furthermore, the duration of Peru s total debt is now nearly eight years, diminishing the burden of servicing the debt and rollover risk. Contingent liabilities Domestic credit to GDP is 25%. However, the high level of dollarization poses some additional risks. Table 4 I Peru s Fiscal Indicators Year ended Dec e 2012f 2013f 2014f Change in general government debt/gdp (3.9) (1.8) (0.9) (1.5) (1.0) (0.5) (0.5) (0.5) General government balance/gdp (0.5) (1.9) (0.4) General government primary balance/gdp (0.6) General government revenue/gdp General government expenditure/gdp General government interest paid/general government revenues Net general government debt/gdp General government debt/gdp e Estimate. f Forecast. Monetary Policy: Further Institutionalization Of Monetary Policy Since December 2010, the central bank has raised the policy rate by a cumulative 300 basis points (bps) from a historical low of 1.25%. The Central Bank raised the benchmark policy rate 25 bps in its May monetary policy meeting. We expect that the inflation rate will remain at the upper target of its 1%-3% band in 2011, in large part because of an increase in food and oil prices. Furthermore, inflation should stay within this range over the medium term. The current administration reappointed Julio Velarde, a well-respected economist, as Central Bank president at the beginning of its term. However, there is room for greater institutionalization of the monetary authority by a constitutional amendment delinking the appointment of the central bank president and board members from the presidential cycle. A still-high, though declining, level of financial dollarization, the still-low level of financial intermediation, and the continuing process of greater monetary institutionalization continue to constrain monetary policy flexibility. The central bank has implemented a system of inflation targeting and formally liberalized the exchange rate. The central bank also began to put in place higher reserve requirements over the course of It is doing this to deter short-term capital inflows to buffer the inflation targeting framework and the risks posed to financial stability posed by large short-term capital inflows. 14 Top 20 Peruvian Companies

16 Gradualism is a key notion in monetary policy strengthening Although there is more transparency in the implementation of monetary policy and the government is deepening the local capital market, major obstacles remain to fully develop monetary policy into a stronger anchor with a countercyclical role. Among the challenges are the still-high level of dollarization and low financial intermediation. The government s strategy of increasing the use of domestic currency began to yield favorable results. The share of foreign-currency participation to total loans decreased significantly to 45% as of June 2011 from 63% at year-end Financial intermediation will have to increase if Peru is to achieve more freedom to pursue a more active and effective monetary policy. In tandem with dynamic consumption and domestic investment, lending is growing at higher rates than nominal GDP, showing variations of slightly more than 20% year-over-year. As a result of the high credit growth, the central bank began to implement policy measures in an effort to slow growth by tightening prudential regulations on consumer loan and implementation of new pro-cyclical provisioning rules. Furthermore, reforms to enhance the bank surveillance and intervention regimes and implement enhanced capitalization requirements in line with Basel II are being undertaken. Domestic credit to GDP will likely reach 26% at year-end 2011, recovering from a record low of 17.7% in Table 5 I Peru s Monetary Indicators Year ended Dec e 2012f 2013f 2014f CPI growth Effective general overnment interest rate (interest/debt) e Estimate. f Forecast Comparative Analysis: Better Economic Indicators And A Weaker Political Stance Peru s regional peers in Latin America are Brazil (BBB-/Positive/A-3), Panama (BBB-/Positive/A-3), and Mexico (BBB/Stable/A-3). (All ratings are longterm foreign currency sovereign credit ratings as of Sept. 15, 2011.) Extra-regional peers include Russia (BBB/Stable/A-3), Thailand (BBB+/Stable/A-2), and India (BBB-/Stable/A-3). Growing consensus on macroeconomics balanced by still-weak social stability Although consensus on the direction of macroeconomic policies is deepening, Peru s social and ethnic divisions still resemble those of its Andean neighbors, Bolivia (B+/Positive/B) and Ecuador (B-/Positive/C). However, the divisions in Peruvian society are narrower than those of its neighbors. Political instability in the other Andean countries continues to impede economic policy despite the region s overall strong economic performance. Peru is thus situated between the rest of the region and higher-rated countries, an unusual position where the risk of economic policy reversal diminishes as the entire political class backs the general direction of current economic policies. In Peru, as in other Andean nations, consensus on the economic policy might weaken if the population does not believe that economic growth is reaching them. A lack of social progress over time might erode the political sustainability of current policies, making them more vulnerable to adverse shocks, whether domestic or external. More diversified sources of growth have moderated this risk over the past three years by reducing GDP dependence on the export of primary products. Therefore, the more diverse economic growth pattern since 2005 has led to higher employment, helping distribute the benefits more widely and evenly. The dynamism of domestic consumption is another indication of this trend. Although there are similar patterns in other Latin American countries, Peru s extraordinarily high GDP growth rates reflect the importance of such developments in a country that has long been poor and politically unstable. Greater overall satisfaction with the current economic model, if confirmed, is a key positive credit factor because it provides additional political stability. Top 20: Peruvian Companies 15

17 Relatively high and sustained economic growth, but from still-low per capita income Peru s GDP has grown higher than the BBB median in real terms over the last five years. We expect it to continue to perform at levels significantly higher than those of the BBB median for the next three years. However, Peru s GDP per capita of $5,596 is still well below the BBB median s $10,860 and all of its peers, with the exceptions of India ($1,618) and Thailand ($5,243). A broader indicator of human development is the UNDP Human Development Index. Peru is 63rd on the list, which is better than most of its key peers with the exceptions of Panama (54th) and Mexico (56th). Solid budget performance compensates for Peru s stilllimited fiscal revenues The fiscal consolidation strategy implemented by the last two administrations and expected to continue under the Humala administration has led to a sharp improvement in the level of general government debt. Peru s fiscal performance has improved markedly over the last five years, with a surplus of 1.0% of GDP expected in 2011, significantly outperforming the BBB median s 2.8% deficit. In fact, Peru will likely maintain a small surplus over the next two years compared with deficits of 2%- 2.5% of GDP for the BBB median. Consequently, Peru s net general government debt at 14% of GDP in 2011 has fallen well below the BBB median s 35% and well below Brazil s 42% and Mexico s 35%. We expect that Peru s net general government debt to GDP will gradually decline further over the next three years, while the BBB median s should rise marginally. Notwithstanding these achievements, Peru s fiscal flexibility remains limited. On the revenue side, its fiscal revenue to GDP is still low for an economy at this stage of development, given the high levels of poverty and infrastructure needs. Peru s general government revenue, at about 20.5% of GDP, is much lower than that of the BBB median (34%). Mexico is the only country with a lower level of revenues at 18.3%, though India s 21.2% is low as well. Despite the low level of government revenue, Peru s debt level in terms of revenues is now lower than the BBB median and that of all of its peers. Peru s debt to revenues ratio lies at the BBB median of 107%. Peru s ratio has improved markedly over the last three years. 16 Top 20 Peruvian Companies

18 As in other Latin American countries, favorable international conditions led to a strong positive adjustment in Peru s external accounts. The strong accumulation of international reserves and higher levels of current account receipts have led to improvements in its external liquidity, as measured by the gross financing requirement over current account receipts and usable reserves. The ratio has improved to 73% in 2011 from 85% in 2008 versus the 106% for the BBB median. Of its peers, only Thailand s at 68% and Brazil s at 73% are similar to Peru s. In addition to a dynamic export sector, the lower government borrowing requirements resulting from fiscal consolidation and the replacement of external debt by domestic indebtedness also played a significant role in the adjustment. Therefore, Peru s narrow net external position has improved to a creditor position of 27.4% of current account receipts. Again, only Thailand and Russia have similarly strong positions, with 43.6% for Thailand and 38.8% for Russia. Related Criteria And Research Sovereign Government Rating Methodology and Assumptions, June 30, 2011 Rating history Sovereign Rating And Country T&C Assessment Histories Default history Sovereign Defaults And Rating Transition Data, 2010 Update Ratings Detail (As Of 15-Sep-2011)* Republic of Peru Sovereign Credit Rating Foreign Currency Local Currency Certificate Of Deposit Local Currency A-2 Senior Unsecured (14 Issues) Senior Unsecured (23 Issues) Sovereign Credit Ratings History BBB/Stable/A-3 BBB+/Stable/A-2 BBB BBB+ 30-Aug-2011 Foreign Currency BBB/Stable/A-3 23-Aug Jul Jul Nov-2006 BBB-/Positive/A-3 BBB-/Stable/A-3 BB+/Positive/B BB+/Stable/B 14-Jul-2008 Local Currency BBB+/Stable/A-2 23-Jul Nov-2006 Current Government Ollanta Humala of the Peruvian Nationalist Party Election Schedule Next Presidential elections: April 2016 BBB-/Positive/A-3 BBB-/Stable/A-3 *Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor s credit ratings on the global scale are comparable across countries. Standard & Poor s credit ratings on a national scale are relative to obligors or obligations within that specific country. Top 20: Peruvian Companies 17

19 Latin America s Resilience, Recovery, And Consolidation Lisa M Schineller, New York (1) ; lisa_schineller@standardandpoors.com During the recent global recession, Latin America showed unprecedented resilience and recovered quickly. On a weighted average, real GDP for the region climbed 6.5% in 2010 after a decline of only 1.9% in 2009 (see table 1). Standard & Poor s Ratings Services expects a combination of domestic and external demand to continue to support the region s economic growth, with real GDP rising by 4.5% in 2011 and 4.2% in (Listen to the related podcast titled, Latin America: Credit Quality Improves As The Region Rebounds From Global Recession, dated June 17, 2011.) To be sure, the pace of growth differs somewhat within the region. Economies in South America have expanded faster than those in Central America, and we expect that to continue because of South America s high share of commodity exports, especially to fast-growing emerging countries in Asia. Mexico and Central America have recovered more slowly because of their closer economic links with the U.S. Nonetheless, we expect remaining output gaps to close during 2011 and economic activity to moderate going into 2012, consolidating at a pace consistent with trend rates of growth. The recovery in domestic demand and narrowing (or already closed) output gaps, coupled with high commodity prices for both food and energy, have contributed to an uptick in inflation. Current inflation for the region is about 7.4%, which is generally several percentage points higher than at the beginning of Two exceptions are Mexico and Venezuela, though the latter still with inflation of more than 20%. However, inflation is still quite low relative to the region s inflationary past, and to date is still below 2008 s uptick. The medium-term foundation for domestic demand has never been stronger given a broadening of the middle class, formalization of labor markets, and deeper credit markets. But external links have propelled economic growth as well. Supportive terms of trade for commodity exporters and capital inflows in have contributed to strong domestic demand in many countries. A decline in commodity prices or a sharp slowing in capital inflows presents downside risk for the region. The stronger macroeconomic foundation that helped Latin America withstand the recession should help mitigate future economic shocks. The buoyancy of external and domestic demand, however, poses risks. One is the potential build-up of excesses, or bubbles, which could make an eventual economic slowdown a hard landing. In fact, some governments are taking pre-emptive steps to avert these risks, including managing currency appreciation, capital inflows, and growth in domestic credit, and to a lesser extent, tightening fiscal spending. Table 1 Latin America---Growth And Inflation Outlook (Year-over-year % change) Latin American Weighted Average f 2012f Real GDP (1.9) Consumer Prices Argentina* Real GDP Consumer Prices* Brazil Real GDP (0.6) Consumer Prices Chile Real GDP (1.7) Consumer Prices Colombia Real GDP Consumer Prices Mexico Real GDP (6.1) Consumer Prices Panama Real GDP Consumer Prices Peru Real GDP Consumer Prices Venezuela** Real GDP (3.3) (1.4) Consumer Prices** *Historical figures are based on official data, and forecasts are market estimations. **Venezuela CPI is national. f--forecast. A Greater Resiliency To External Shocks Over the last decade, Latin America governments implemented various policies that have strengthened 18 Top 20 Peruvian Companies

20 their underlying economic fundamentals. The region s external position improved, including a decline in net debt and financing needs (see charts 1 and 2). The accumulation of international reserves to more than US$620 billion in 2010 from about US$150 billion in 2002 played an important role in the improvement of these external indicators. This much lower external vulnerability was a key component enabling governments to secure financing from official and multilateral creditors during the global crisis until capital markets reopened. Healthier fiscal positions include lower debt and deficits (see charts 3 and 4). In addition, better terms for government borrowing, such as the ability to issue local currency debt in domestic markets at fixed rates, and with longer maturities, further reduces fiscal vulnerability. Flexible monetary and exchange rate regimes and a successful track record of containing inflation enabled central banks to cut interest rates during the crisis in contrast with previous crises. Latin America s banking systems, whose strength improved significantly as a result of more conservative policies following the region s own banking crises in the 1980s, 1990s, and early 2000s, also provided a foundation to weather the global recession. Comparatively high capitalization levels above the minimum Basle standards, predominantly domestic currency, local deposit financing, stronger regulation, and consolidated supervision characterize the prominent banking systems in the region. Deeper local capital markets that developed alongside these sounder fundamentals provide more flexibility for companies to fund themselves locally and in domestic currency. In our view, these factors should also help the region manage future negative global shocks. Chart 2 Chart 3 Chart 4 Chart 1 Top 20: Peruvian Companies 19