Peru's Next 'Golden Decade' Ahead: Consider iShares MSCI Peru Capped ETF

| About: iShares MSCI (EPU)

In 2014, there prevails a context of heightened uncertainty in the global economy. It is expected to reach an annual growth below 4% by 2015. However, the vast majority of analysts foresee another buoyant year for developed stock markets. The reduction of the monetary stimulus by the Federal Reserve, will result in periods of volatility in both emerging and developed economies. Also, further reduction of financial tensions has supported growth, although one should be aware of the various risk factors that could further harm the emerging economies. One of the main threats to the Peruvian economy would be the case of a sharp deceleration in China. This event would have an impact on prices and volumes of commodities exported by Peru. In general, the outlook for many emerging economies, is being threatened by a continued reduction in capital inflows. However, the present macroeconomic framework reflects the low likelihood of the occurrence of a systemic risk in any of the developed economies.

Expanding Economy

Peru's GDP expanded at a rate of 5.1% in 2013; a much lower figure than the 6.3% for the previous year. Nevertheless, BBVA estimates that the Peruvian economy will grow moderately in 2014, to a figure of 5.7%. Despite the slowdown last year, Peru remains one of the most dynamic economies in the region, and with one of the biggest potential in a long-term perspective. Since the early 90s, Peru has implemented a number of structural changes in order to increase domestic and external demand, and its presence in the global framework.

Stable Political Environment

The political ambiance for this coming year will be dominated by regional and municipal elections concerning candidature for the presidential elections that will be held in 2016. Presently, Ollanta Humala is the president of the Peruvian nation. Humala has made a great effort in sustaining the rising middle class that demands a better quality of public services and infrastructure. Also, reforms in the health and education sector, have been of great transcendence in the present government, which attempts to reduce high levels of poverty and social exclusion. Humala has been quite optimistic about the Peruvian economy, "We have maintained strong economic growth that has stood out internationally for its quick progress and its solidity in the face of the recent world economic crisis."

Low Public Debt and Increasing Confidence

Another detail that justifies the economic outlook for Peru, is the level of public debt to its GDP. In 2013, this stood at 18.1%, compared with an average of 31% for Latin America, and 76% for the Caribbean. Such level of debt, allows the country to implement easy monetary policies, in the event that a systemic risk arises in the global markets. In addition to the low interest rates that has helped the financing of budget deficits, the Peruvian economy has seen increasing private investments, results of an improving business confidence. Both business and consumer confidence, ended the year 2013 positively: 59 and 52, respectively; a figure greater than 50 indicates that the economy is expanding.

Slow Shift to a Consumerist Society

For Peru to sustain such growth rate, the Andean country must make greater efforts in diversifying its economy to a consumerist society less dependent on the mining industry. The chart below indicates a converging relationship of domestic demand and exports, estimating a possible variation of the Peruvian economy towards a more consumerist state. Overall, the sectors related to domestic demand (commerce, services, etc.), will continue to provide long-term support. However, the country will see a substantial rise in exports over the next two years due to the recent influx of large mining projects.

Growing Mining Sector

BMI View: Peru's mining sector will grow steadily over the coming years. Mining sector will grow an average of 4.4% a year through to 2017, reaching a value of US$23.1bn, although Peru will remain a key global producer of other metals such as zinc, silver, and tin.

The fall of the prices on commodities in 2013 marked a deceleration in Peru's economy. Peru is the third largest exporter of copper in the world, and is expected to double its production by 2016. According to Banco de la Nación, a Peruvian bank, incoming projects will elevate copper production around 75% by 2015. Although the volume of these exports will be higher, prices will be linked largely to the demand for metals from China. Among the new projects, there is: Toromocho, Las Bambas, Constancia, the extension of Antamina, Cerro Verde, Antapaccay, and Marcona. Vast majority of Latin American countries base their economy mainly on the export of raw materials. The advantage held by Peru, is that in comparison to other Latin American countries, their mining sector is broadly diversified by different metals; Peru is a leading producer of copper, silver, tin, lead, zinc, and gold.

Social Inclusion Still an Issue

In the coming decade, the Peruvian government should foster the social inclusion of deprived areas by improving infrastructure and access to public services. Among the main problems faced by Peru, is the exclusion of a large part of the population to basic services. About 24% of the population resides in rural or marginal areas, and over 6% of the population is illiterate. The average expenditure on education to GDP ratio over the past few years has been around 2.7%; a deplorable figure. The goal of all emerging economies, as the name suggests, is to see a middle class emerge. The problem with Peru, is that much of the economic growth of the past decade has been the result of prolonged foreign investments, rather than an increase in domestic demand.

Investment Outlook:

Personally, I would not consider buying EPU if I were to hold it for 6-to-12 months, however, I am very bullish over the next couple of decades. In general Peru is a country with a high long-term growth potential. It is possible that from a social and economic standpoint, Peru is yet decades behind from other countries in the region. However, the pronounced attempt to diversify its economy, and the vast array of natural resources, indicates the potential growth for the nation. Both rating agencies, Moody's and Standard & Poor's, placed a lower medium grade on the nation's sovereign credit: Baa2 and BBB+, respectively.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.