Payday Looms on Dictator’s Defaulted Bonds in Peru: Andes Credit
Jose Poma was a university student when his grandfather’s rice plantation was seized in 1971 under the land redistribution law of Peruvian dictator Juan Velasco Alvarado.
Now a 59-year-old mining engineer in Lima, Poma is still waiting for the government to honor the bonds his family received as compensation for the loss of their 30-hectare (74-acre) holding. Yesterday, Peru’s highest court ordered the government to come up with a plan within the next six months to repay Poma and his fellow creditors.
How the government repays holders of the defaulted debt has implications for all of Peru’s bond investors. An association of 2,000 creditors who own the four-decade-old debt says the securities are worth $4 billion. Former Deputy Economy Minister Carlos Casas says Peru may have to issue new securities to repay creditors, boosting the supply of government bonds at time when they’ve already lost 7.4 percent this year, the worst rout in Latin America. Last week, President Ollanta Humala urged the Constitutional Court to delay its decision.
“This debt has been at the bottom of the list of priorities for successive governments whose position was that the bonds weren’t worth anything,” Casas, who is now head of the economics department at Universidad del Pacifico in Lima, said in a phone interview before the ruling. “Humala can’t like the thought of paying for what Velasco did.”
Randa Mussallam, a spokeswoman at the president’s office, declined to comment on the ruling.
The court gave the government six months to explain how it will register the debt, establish its value and the forms of payment. Once it has quantified the value of a bond registered, the government has eight years to pay its holder with new bonds, cash or farm land, according to the ruling posted on the court’s website. The defaulted bond’s value will be calculated in U.S. dollars and adjusted for accumulated interest, using U.S. Treasuries as a benchmark.
“If the state is consistent with its debts, it’s evident that it has no other option but to honor them,” according to the ruling. The payment “will without doubt have an inevitable fiscal impact, impossible to be taken on immediately without damaging significant areas or sectors of the economy. The payment must be made taking into account principles of equilibrium, sustainability and budgetary progressivity.”
Adaepra, an association of creditors, filed a lawsuit with the court in 1996, to press for payment after the government of Alberto Fujimori said two currency changes in a decade had reduced the value of the entire debt to 17.5 soles ($6.30). Though the court ruled in favor of the bondholders in 2001, the government didn’t carry out the sentence, leading them to file a fresh challenge.
Speculators purchased land bonds in the secondary market, paying 10 percent to 20 percent of their estimated value, and are the largest holders of the debt, Santiago Gastanadui, a member of Humala’s Gana Peru party and the president of Congress’s constitutional committee, told reporters July 12.
In March 2011, then-Finance Minister Ismael Benavides said Gramercy Funds Management LLC and UBS AG were among the holders of the securities. Jose Cerritelli, an economist at Gramercy, and UBS spokeswoman Megan Stinson declined to comment.
According to yesterday’s ruling, repaying the original bondholders will take priority over bonds that were transferred to third parties.
The government paid back some bondholders following the court’s 2001 ruling, valuing the claims on a case-by-case basis, Finance Minister Miguel Castilla said in a July 13 interview with Lima-based Radio Programas.
Poma’s family holds its land bonds in a safe-deposit box and hasn’t pressed the finance ministry for payment.
“If they’d paid back when they confiscated the farm, that would have been the end of it,” Poma said in a phone interview from Lima before the ruling. “It was theft, and caused huge damage.”
The Constitutional Court must take into account the potential economic impact of its decision on any further payments, Castilla said.
“Any event that that may affect the country’s fiscal stability is a concern for us,” he said.
Richard Francis, an analyst at Standard & Poor’s in New York, said a ruling that forces the government to pay bondholders the $4 billion they say they’re owed will have a minimal impact on Peru’s credit rating. The country is rated BBB, the second-lowest investment grade.
It “would be manageable,” Francis said in an e-mail. “The government’s debt level is very low.”
Peru’s public debt of 99.3 billion soles was equivalent to 19 percent of gross domestic product as of March 31, compared with 46 percent a decade ago.
The economy will expand about 6 percent this year, compared with 6.3 percent in 2012, according to the finance ministry. The country’s budget surplus will narrow to 0.7 percent of GDP this year from 2.2 percent in 2012.
“They’re in a better fiscal position” than in the past, though “in the short term it’s not the best time,” Enrique Alvarez, the head of Latin America fixed income at IdeaGlobal, said in a telephone interview from New York before the ruling. “Growth has been affected by a clear drop in commodity prices and a slowdown in domestic spending.”
Velasco, who took power in a bloodless coup in 1968, began the land redistribution program the following year, seizing companies’ agricultural holdings and turning them over to worker cooperatives. In return, landholders received government bonds with maturities of as long as 30 years and yielding as much as 6 percent.
About 4,000 landholders were issued bonds worth a total of 17.5 billion soles de oro, Peru’s currency at the time. Velasco’s successors repaid some of the debt until the currency was replaced in 1985 by the inti amid surging inflation. Six years later, the nuevo sol was introduced.
The court ruling comes at a time when borrowing costs are surging as a drop in copper and gold, which account for half of Peru’s exports, saps economic growth.
Yields on Peru’s benchmark sol bond due 2020 have climbed 144 basis points, or 1.44 percentage points to 5.11 percent, from a record low 3.67 percent on April 19, according to data compiled by Bloomberg. The 7.4 percent drop in Peru’s local bonds this year is the biggest among five Latin American countries tracked by Bank of America Corp.
The extra yield investors demand to own Peruvian government bonds instead of U.S. Treasuries narrowed 14 basis points, or 0.14 percentage point, to 160 basis points at 2:11 p.m. in Lima, according to JPMorgan Chase & Co.
The cost to protect Peruvian debt against non-payment for five years fell two basis points to 127 basis points, according to data compiled by Bloomberg. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.
The sol has depreciated 7.6 percent to 2.7620 per U.S. dollar this year.
Failure to carry out the court’s ruling risks prompting bondholders to seek international arbitration to force the government to pay all debt at once, Casas said.
“The idea will be to push back the cost of repaying the bonds,” Casas said. “The government won’t accept paying the entire amount now.”
Luis Huguet, vice president of the bondholder group, said his members are willing to exchange their bonds for sol-denominated government debt.
“No one is asking for them to pay in cash,” Huguet said in a phone interview from Lima before the ruling. “What they need to do is swap the bonds for sol bonds. I don’t know what they’re waiting for. We’ve been waiting for 40 years. It’s about time they paid up.”
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