EMERGING MARKETS RESEARCH

8 March 2012

PERU Seeing is believing

Even though President Humalas popularity has recovered after the intensification of social conflicts at the end of last year, businesses seem to remain incredulous about the governments capacity to face the countrys challenges. Business confidence has remained relatively low despite some recovery in recent months, which continues to limit investment growth. Attention is concentrated on the future of the mining project Conga. Businesses are waiting for the final outcome of this case as a signal of the business environments outlook. Despite the political risk we perceive and the economic implications it might have, the countrys fundamentals remain strong. Even though we expect an acceleration of public expenditures, we still think the public sector will register surpluses in the next two years. We maintain a neutral position in our credit portfolio for Peru. The spreads are tight compared with other low betas in the region, and the balance of risk is skewed negatively: spreads could underperform if social conflicts escalate, but their outperformance is likely to be limited if the situation remains unchanged.
Alejandro Arreaza +1 212 412 3021 Alejandro.Arreaza@barcap.com Alejandro Grisanti +1 212 412 5982 alejandro.grisanti@barcap.com Donato Guarino +1 212 412 5564 donato.guarino@barcap.com www.barcap.com

Is Humala gaining governability?

In Growth threatened by social conflicts, The Emerging Markets Quarterly, December 6, 2011, in the context of increased protest surrounding key mining projects, we highlighted the risk of a negative effect on economic activity from an increase in the number of conflicts. Since then, President Humalas popularity has recovered, which could be interpreted as a gain in governability after the crisis created by the paralyzation of the mining project Conga, which led to a reshuffling of the cabinet at the end of last year. Nonetheless, the number of social conflicts has been increasing, which suggests to us that the risks remain latent there, while the government still seems to face the task of proving its ability to deal with the countrys challenges. Seven months after his inauguration, Humalas popularity remains relatively high by Peruvian standards. Compared with an Ipsos-Apoyo August poll conducted after his inauguration, his approval rating has gained 4pp, reaching 59% and exceeding the level that his predecessors Alan Garcia and Alejandro Toledo had at the same stage of their administrations by 9pp and 31pp, respectively (Figure 1). Nonetheless, when analyzing his performance by socioeconomic strata, we can see that the increase is partly explained by a rise among the higher income population, from which Humala reaches a 75% approval; meanwhile, he has registered a 7pp decline in the lowest income population, which was his original political base. The persistence of this trend could certainly weaken the political support of the government and create some governability problems. However, despite this decline, Humalas leadership still seems considerably strong, enjoying an approval

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 5

Barclays Capital | Peru: Seeing is believing

Figure 1: Humalas popularity vs his predecessors (%)

70 65 60 55 50 45 40 35 30 25 1 2 3 Humala
Source: Ipsos-Apoyo

Figure 2: Increasing number of social conflicts

255 250 245 240 235 230 225 220 215 210 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12

4 Garcia

6 Toledo

Social conflicts
Source: Peruvian Ombudsman

rating above 55% in all segments of the population. Moreover, given the First Lady Nadine Heredias high popularity and influence in government decisions, markets should consider her and her eventual successor, while we think the possibility of a constitutional reform to introduce reelection (a fear that rose during the electoral campaign) has decreased.
In a scenario in which Humala could lose political support, a return to the populist road could still be a temptation

The risks ahead come from the persistence of structural factors, such as weak institutions and the lack of a state presence in certain regions of the country, which could tend to undermine governability. For instance, given the existence of rising rents from mineral extraction, voters who gave Humala a mandate to increase redistribution are likely to intensify their demand and, eventually, if not satisfied, withdraw their political support. In such circumstances, threatened by already visible frictions inside his government coalition, a return to the populist road could still be a temptation. Time will tell, but this is something that market participants should be aware of when considering Perus credit profile, in our view, especially taking into account its high valuation.

Weak confidence breaks investment

Business confidence has remained relatively low, which continues to limit investment growth

Despite President Humalas high approval rating, it has not been possible for the government to totally recover business confidence, which has led to the persistent deceleration trend in economic activity (Figure 3), given a slower contribution of investment to growth. GDP growth fell from 7.8% in H1 11 to 6.1% in H2, and we expect this trend to continue in 2012, estimating a growth of 5.8% mainly supported by persistently strong consumption and a rebound of public expenditures. Certainly, this GDP growth continues to be relatively high; however, unless there is a recovery in investment, a lower capital accumulation could reduce potential growth. This could also weaken job creation, which could undermine the strong consumer confidence that is supporting consumption growth. In this context, the future of the mining project Conga has more importance than a USD6.9bn investment over the next four years. Businesses are waiting for the final outcome of this case as a signal of the business environments outlook. That means that weak investment confidence could affect economic activity for most of the year, considering that, in the past, a recovery in economic activity after a decline in confidence has had a lag of three to five months. The projects environmental impact is being reassessed by international experts. However, beyond the technical arguments about the projects viability, the situation has become increasingly politicized, which heightens the possibility that the involved parties will hold their views and just use parts of the experts assessments that support their positions.
2

Social conflict is not unfamiliar in Peru; however, as the stakes increase, conflicts tend to intensify, deteriorating the business environment

8 March 2012

Barclays Capital | Peru: Seeing is believing

Figure 3: Weak business confidence undermines growth

75 70 65 60 55 50 45 40 35 30 Aug-07 Apr-08 Dec-08 Aug-09 Apr-10 Dec-10 Aug-11 Industrial Confidence
Source: INEI, Barclays Capital

Figure 4: Still strong fundamentals (% GDP)

14 12 10 8 6 4 2 0 -2 -4
35.0 33.0 31.0 29.0 27.0 25.0 23.0 21.0 19.0 17.0 15.0 2006 2007 2008 2009 2010 2011 2012F 2013F 3.0 2.5 2.0 1.5 1.0 0.5 0.0 (0.5) (1.0) (1.5) (2.0)

GDP

Fiscal balance (RHS)

Source: INEI, Barclays Capital

Public debt

Assuming that the government holds the position taken by President Humala that Conga should be carried on, the project might move forward, but conflicts are likely to continue too. Certainly, social conflict is not unfamiliar in Peru; however, as the stake increases, the risk is that the conflicts tend to intensify, deteriorating the business environment.

Above all, fundamentals remain strong

Public sector is expected to register surpluses in the next two years and keep reducing indebtedness level

Despite the political risk we perceive and the economic implications it might have, the countrys fundamentals remain strong. The rapid increase in government revenues due to still relatively high growth and favorable commodities prices, as well as expenditures cut due to the withdrawal of the fiscal stimulus implemented after the 2008 crisis, has led to a significant improvement in the fiscal balance. Last year, the public sector registered a surplus of 1.8% of GDP. Even though we expect an acceleration of public expenditures that would deteriorate the fiscal balance, we still expect it to register surpluses in the next two years (1.0% and 0.6% of GDP in 2012 and 2013, respectively). This, coupled with the growth outlook, is expected to hold the decline to around the 20% of GDP level. There has also been an improvement on the external front, with the current account deficit declining from 1.7% in 2010 to 1.3% in 2011. This improvement was also supported by the better-than-expected performance of non-traditional exports. Given a moderation in mineral prices, we expect a deterioration in the current account balance and estimate a deficit of 2.0% of GDP in 2012; however, this is more than compensated for by the FDI flow. To mitigate the appreciation pressures, the BCRP has maintained a strong FX intervention. In the first two months of the year, it already purchased USD3.7bn, with an average of USD85mn per day, six times the average in the same year-ago period. We expect this intervention to be reduced in the coming months; however, we think the reserve position will likely keep growing and exceed USD56bn by the end of the year, approaching 30% of GDP, which will leave the country in a strong position in case of an eventual lower capital inflow.

Monetary stimulus is not expected as long as inflation remains above the upper bound of the target and GDP remains close to potential

In terms of inflation, as growth slows, we expect a progressive moderation in prices during the year to return it to the target range. However, strong consumption has allowed producers to transfer higher costs to the consumer despite slower demand growth, and higher energy and food prices could be a risk ahead. Therefore, even if the economy is decelerating, we do not expect monetary stimulus as long as inflation remains above the upper bound of the target and GDP remains close to potential. We still expect the BCRP to
3

8 March 2012

Barclays Capital | Peru: Seeing is believing

keep the monetary policy rate unchanged during the year and rely more on the fiscal stimulus to contain further deceleration of the economy. As long as the cause of the growth moderation is a confidence shock, an interest rate cut might not be effective enough to stimulate investment and reaccelerate growth.

Strategy: Balance of risks not favorable; we remain neutral

We maintain a neutral position in our credit portfolio for Peru. Despite strong fundamentals, price action has been dominated by political risks well before the election. Indeed, while debt metrics have been enviable, Peru's bonds volatility has increased considerably over the past year compared with other low-beta credits at first because of the political uncertainty of the Humala administration and more recently due to the intensification of the social conflicts.
The balance of risk is skewed negatively: spreads could underperform if social conflicts escalate

While we do not think the current conflicts pose a threat to the ability to repay USD debt, they may increase the risk premium, which could negatively affect performance. Hence, since Perus long-end bonds are trading only 20-25bp wider than other Latin American lowbeta credits (Brazil in particular), we think this is fair to marginally expensive and remain neutral while awaiting further developments. In our view, the balance of risk is skewed negatively: spreads could underperform if social conflicts escalate, but outperformance is likely to be limited if the situation remains unchanged. On the bond curve, in line with our sovereign credit strategy, we recommend extending exposure to the long end of the curve, which remains steep by historical standards because of the recent supply. Indeed, new supply is unlikely, in our view, because Peru just re-tapped the PE50s for more than USD500mn. Furthermore, the long-end spread remains attractive, especially in a supportive global environment that we consider our base-case scenario for the next quarter. Finally, we are not overly concerned about US Treasury movements, which should remain range-bound; hence, they should not be a risk for spreads. Our favorite picks are the PE33s and PE50s.

Figure 5: Perus premium to Brazil is marginally higher than pre-election crises levels
90 80 70 60 50 40 30 20 10 0 -10 -20 Jan 10

Figure 6: PE33s and PE50s still the cheapest bonds on the curve
Spread (bp) 240 220 200 180 160 140 120 100 80 2.00 4.00 6.00 Duration
Source: Barclays Capital

PE 33

PE 50 PE 37

PE 25 PE 16 PE 19

8.00

10.00

Jul 10

Jan 11

Jul 11

Jan 12 Average

Peru 37s - Brazil 41s

Source: Barclays Capital

8 March 2012

Barclays Capital | Peru: Seeing is believing

Figure 7: Peru: Macroeconomic Forecasts

2008 Activity Real GDP (% y/y) Private Consumption (% y/y) Private Fixed Capital Investment (% y/y) Exports (% y/y) Imports (% y/y) GDP (USD bn) External Sector Current Account (USD bn) CA (% GDP) Trade Balance (USD bn) Net FDI (USD bn) Gross External Debt (USD bn) International Reserves (USD bn) Public Sector Public Sector Balance (% GDP) Primary Balance (% GDP) Gross Public Debt (% GDP) Prices CPI (% Dec/Dec) FX (PEN per USD, eop) 6.7 3.14 1yr Ago Real GDP (y/y) CPI (% y/y, eop) Exchange Rate (PEN per USD, eop) Monetary Policy Benchmark Rate (%, eop)
Source: BCRP, INE, Haver, Barclays Capital

2009

2010

2011

2012F

2013F

9.8 8.7 25.9 8.2 20.1 127.4

0.9 2.4 -15.1 -3.2 -18.6 126.8

8.8 6.4 22.1 1.3 24.0 155.2

6.9 6.3 11.7 8.8 9.8 176.4

5.8 6.3 7.5 6.8 7.7 196.1

6.0 5.8 8.0 6.2 8.7 216.0

-5.3 -4.2 2.6 6.2 34.8 31.2

0.2 0.2 6.0 5.2 35.7 33.2

-2.6 -1.7 6.8 7.1 40.5 44.1

-2.3 -1.3 9.3 7.5 43.2 48.8

-3.8 -2.0 8.9 7.9 46.5 56.7

-4.1 -1.9 6.9 8.3 49.5 62.9

2.3 3.7 24.0

-1.6 -0.3 27.2

-0.5 0.6 23.2

1.8 2.9 21.7

1.0 2.1 20.1

0.6 1.6 18.7

0.3 2.88 Last 5.7 3.85 2.67 4.25

2.3 2.80 12Q2F 5.5 3.84 2.66 4.25

4.7 2.73 12Q3F 5.8 3.13 2.65 4.25

2.9 2.64 12Q4F 6.3 2.90 2.64 4.25

2.3 2.65 13Q1F 6.0 3.09 2.64 4.25

8.8 2.66 2.80 3.75

8 March 2012

Analyst Certification(s) We, Alejandro Arreaza, Alejandro Grisanti and Donato Guarino, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. Important Disclosures For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to http://publicresearch.barcap.com or call 212-526-1072. Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays Capital may have a conflict of interest that could affect the objectivity of this report. Any reference to Barclays Capital includes its affiliates. Barclays Capital and/or an affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives thereof). The firm's proprietary trading accounts may have either a long and / or short position in such securities and / or derivative instruments, which may pose a conflict with the interests of investing customers. Where permitted and subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly interact with its trading desk personnel to determine current prices of fixed income securities. The firm's fixed income research analyst(s) receive compensation based on various factors including, but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), the profitability and revenues of the Fixed Income Division and the outstanding principal amount and trading value of, the profitability of, and the potential interest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing information was obtained from Barclays Capital trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document. Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise. In order to access Barclays Capital's Statement regarding Research Dissemination Policies and Procedures, please refer to https://live.barcap.com/publiccp/RSR/nyfipubs/disclaimer/disclaimer-research-dissemination.html.

Disclaimer This publication has been prepared by Barclays Capital, the investment banking division of Barclays Bank PLC, and/or one or more of its affiliates as provided below. It is provided to our clients for information purposes only, and Barclays Capital makes no express or implied warranties, and expressly disclaims all warranties of merchantability or fitness for a particular purpose or use with respect to any data included in this publication. Barclays Capital will not treat unauthorized recipients of this report as its clients. Prices shown are indicative and Barclays Capital is not offering to buy or sell or soliciting offers to buy or sell any financial instrument. Without limiting any of the foregoing and to the extent permitted by law, in no event shall Barclays Capital, nor any affiliate, nor any of their respective officers, directors, partners, or employees have any liability for (a) any special, punitive, indirect, or consequential damages; or (b) any lost profits, lost revenue, loss of anticipated savings or loss of opportunity or other financial loss, even if notified of the possibility of such damages, arising from any use of this publication or its contents. Other than disclosures relating to Barclays Capital, the information contained in this publication has been obtained from sources that Barclays Capital believes to be reliable, but Barclays Capital does not represent or warrant that it is accurate or complete. The views in this publication are those of Barclays Capital and are subject to change, and Barclays Capital has no obligation to update its opinions or the information in this publication. The analyst recommendations in this publication reflect solely and exclusively those of the author(s), and such opinions were prepared independently of any other interests, including those of Barclays Capital and/or its affiliates. This publication does not constitute personal investment advice or take into account the individual financial circumstances or objectives of the clients who receive it. The securities discussed herein may not be suitable for all investors. Barclays Capital recommends that investors independently evaluate each issuer, security or instrument discussed herein and consult any independent advisors they believe necessary. The value of and income from any investment may fluctuate from day to day as a result of changes in relevant economic markets (including changes in market liquidity). The information herein is not intended to predict actual results, which may differ substantially from those reflected. Past performance is not necessarily indicative of future results. This communication is being made available in the UK and Europe primarily to persons who are investment professionals as that term is defined in Article 19 of the Financial Services and Markets Act 2000 (Financial Promotion Order) 2005. It is directed at, and therefore should only be relied upon by, persons who have professional experience in matters relating to investments. The investments to which it relates are available only to such persons and will be entered into only with such persons. Barclays Capital is authorized and regulated by the Financial Services Authority ('FSA') and member of the London Stock Exchange. Barclays Capital Inc., U.S. registered broker/dealer and member of FINRA (www.finra.org), is distributing this material in the United States and, in connection therewith accepts responsibility for its contents. Any U.S. person wishing to effect a transaction in any security discussed herein should do so only by contacting a representative of Barclays Capital Inc. in the U.S. at 745 Seventh Avenue, New York, New York 10019. Non-U.S. persons should contact and execute transactions through a Barclays Bank PLC branch or affiliate in their home jurisdiction unless local regulations permit otherwise. Barclays Bank PLC, Paris Branch (registered in France under Paris RCS number 381 066 281) is regulated by the Autorit des marchs financiers and the Autorit de contrle prudentiel. Registered office 34/36 Avenue de Friedland 75008 Paris. This material is distributed in Canada by Barclays Capital Canada Inc., a registered investment dealer and member of IIROC (www.iiroc.ca). Subject to the conditions of this publication as set out above, Absa Capital, the Investment Banking Division of Absa Bank Limited, an authorised financial services provider (Registration No.: 1986/004794/06), is distributing this material in South Africa. Absa Bank Limited is regulated by the South African Reserve Bank. This publication is not, nor is it intended to be, advice as defined and/or contemplated in the (South African) Financial Advisory and Intermediary Services Act, 37 of 2002, or any other financial, investment, trading, tax, legal, accounting, retirement, actuarial or other professional advice or service whatsoever. Any South African person or entity wishing to effect a transaction in any security discussed herein should do so only by contacting a representative of Absa Capital in South Africa, 15 Alice Lane, Sandton, Johannesburg, Gauteng 2196. Absa Capital is an affiliate of Barclays Capital. In Japan, foreign exchange research reports are prepared and distributed by Barclays Bank PLC Tokyo Branch. Other research reports are distributed to institutional investors in Japan by Barclays Capital Japan Limited. Barclays Capital Japan Limited is a joint-stock company incorporated in Japan with registered office of 6-10-1 Roppongi, Minato-ku, Tokyo 106-6131, Japan. It is a subsidiary of Barclays Bank PLC and a registered financial instruments firm regulated by the Financial Services Agency of Japan. Registered Number: Kanto Zaimukyokucho (kinsho) No. 143. Barclays Bank PLC, Hong Kong Branch is distributing this material in Hong Kong as an authorised institution regulated by the Hong Kong Monetary Authority. Registered Office: 41/F, Cheung Kong Center, 2 Queen's Road Central, Hong Kong. This material is issued in Taiwan by Barclays Capital Securities Taiwan Limited. This

material on securities not traded in Taiwan is not to be construed as 'recommendation' in Taiwan. Barclays Capital Securities Taiwan Limited does not accept orders from clients to trade in such securities. This material may not be distributed to the public media or used by the public media without prior written consent of Barclays Capital. This material is distributed in South Korea by Barclays Capital Securities Limited, Seoul Branch. All equity research material is distributed in India by Barclays Securities (India) Private Limited (SEBI Registration No: INB/INF 231292732 (NSE), INB/INF 011292738 (BSE), Registered Office: 208 | Ceejay House | Dr. Annie Besant Road | Shivsagar Estate | Worli | Mumbai - 400 018 | India, Phone: + 91 22 67196363). Other research reports are distributed in India by Barclays Bank PLC, India Branch. Barclays Bank PLC Frankfurt Branch distributes this material in Germany under the supervision of Bundesanstalt fr Finanzdienstleistungsaufsicht (BaFin). This material is distributed in Malaysia by Barclays Capital Markets Malaysia Sdn Bhd. This material is distributed in Brazil by Banco Barclays S.A. This material is distributed in Mexico by Barclays Bank Mexico, S.A. Barclays Bank PLC in the Dubai International Financial Centre (Registered No. 0060) is regulated by the Dubai Financial Services Authority (DFSA). Principal place of business in the Dubai International Financial Centre: The Gate Village, Building 4, Level 4, PO Box 506504, Dubai, United Arab Emirates. Barclays Bank PLC-DIFC Branch, may only undertake the financial services activities that fall within the scope of its existing DFSA licence. Related financial products or services are only available to Professional Clients, as defined by the Dubai Financial Services Authority. Barclays Bank PLC in the UAE is regulated by the Central Bank of the UAE and is licensed to conduct business activities as a branch of a commercial bank incorporated outside the UAE in Dubai (Licence No.: 13/1844/2008, Registered Office: Building No. 6, Burj Dubai Business Hub, Sheikh Zayed Road, Dubai City) and Abu Dhabi (Licence No.: 13/952/2008, Registered Office: Al Jazira Towers, Hamdan Street, PO Box 2734, Abu Dhabi). Barclays Bank PLC in the Qatar Financial Centre (Registered No. 00018) is authorised by the Qatar Financial Centre Regulatory Authority (QFCRA). Barclays Bank PLC-QFC Branch may only undertake the regulated activities that fall within the scope of its existing QFCRA licence. Principal place of business in Qatar: Qatar Financial Centre, Office 1002, 10th Floor, QFC Tower, Diplomatic Area, West Bay, PO Box 15891, Doha, Qatar. Related financial products or services are only available to Business Customers as defined by the Qatar Financial Centre Regulatory Authority. This material is distributed in the UAE (including the Dubai International Financial Centre) and Qatar by Barclays Bank PLC. This material is distributed in Saudi Arabia by Barclays Saudi Arabia ('BSA'). It is not the intention of the Publication to be used or deemed as recommendation, option or advice for any action (s) that may take place in future. Barclays Saudi Arabia is a Closed Joint Stock Company, (CMA License No. 09141-37). Registered office Al Faisaliah Tower, Level 18, Riyadh 11311, Kingdom of Saudi Arabia. Authorised and regulated by the Capital Market Authority, Commercial Registration Number: 1010283024. This material is distributed in Russia by OOO Barclays Capital, affiliated company of Barclays Bank PLC, registered and regulated in Russia by the FSFM. Broker License #177-11850-100000; Dealer License #177-11855-010000. Registered address in Russia: 125047 Moscow, 1st Tverskaya-Yamskaya str. 21. This material is distributed in Singapore by the Singapore branch of Barclays Bank PLC, a bank licensed in Singapore by the Monetary Authority of Singapore. For matters in connection with this report, recipients in Singapore may contact the Singapore branch of Barclays Bank PLC, whose registered address is One Raffles Quay Level 28, South Tower, Singapore 048583. Barclays Bank PLC, Australia Branch (ARBN 062 449 585, AFSL 246617) is distributing this material in Australia. It is directed at 'wholesale clients' as defined by Australian Corporations Act 2001. IRS Circular 230 Prepared Materials Disclaimer: Barclays Capital and its affiliates do not provide tax advice and nothing contained herein should be construed to be tax advice. Please be advised that any discussion of U.S. tax matters contained herein (including any attachments) (i) is not intended or written to be used, and cannot be used, by you for the purpose of avoiding U.S. tax-related penalties; and (ii) was written to support the promotion or marketing of the transactions or other matters addressed herein. Accordingly, you should seek advice based on your particular circumstances from an independent tax advisor. Barclays Capital is not responsible for, and makes no warranties whatsoever as to, the content of any third-party web site accessed via a hyperlink in this publication and such information is not incorporated by reference. Copyright Barclays Bank PLC (2012). All rights reserved. No part of this publication may be reproduced in any manner without the prior written permission of Barclays Capital or any of its affiliates. Barclays Bank PLC is registered in England No. 1026167. Registered office 1 Churchill Place, London, E14 5HP. Additional information regarding this publication will be furnished upon request.

US20911