The International Monetary Fund and World Bank representatives that will gather in Lima this week will likely laud the host country’s economic success over the past 15 years and with good reason. That success, which has made Peru’s economy one of the fastest growing in the region, has been built both on responsible macroeconomic policies and the respect for the rule of law. Left out of that praise and good feelings about the success of institutions and the law will be a long-standing default that the government of Peru has yet to resolve.
The default stems from the bonds that the then leftist-military government gave to landholders from whom it seized their property from 1969 to 1981 in a land redistribution program. Even the socialist military government at the time, though, wanted to avoid being accused of stealing property, so the generals and colonels issued bonds to the former landowners which were intended to provide compensation for the expropriated property. Those bonds were never paid in full, however, and the landholders remain uncompensated.
At issue is whether the government will end the longstanding default on these bonds. It has proposed a method of doing so, but in a way that distorts the current value of the land bonds. The bonds were issued over four decades ago—four decades in which Peru has undergone hyperinflation, two new currencies and, more recently, an impressive economic boom, which included a dramatic increase in the value of real estate. The Ministry of Economy has put forward a means of establishing the current value of the bonds, but the formula dramatically undervalues the bonds as a result of basic mathematical errors as well as by overvaluing the Peruvian currency relative to the dollar and tying the interest rates to one-year U.S. treasury bonds. The resulting value, according to an independent report, is a woefully inadequate—.50 percent of the bonds’ value compared to using the more generally accepted means of calculating current value, the Consumer Price Index (CPI). In other words, by paying these long-waiting holders of debt less than one-hundredth the amount they are owed, more than 40 years after seizing their land, what the Peruvian government is proposing is exactly what the military government was seeking to avoid: expropriating citizens’ property.
If this were a dispute between the Ministry of Economy and the bondholders, it would be one thing. But what makes it worse is that Peru’s respected judicial system—much reformed and recovered since the days of the Alberto Fujimori government—has jumped into the fray and has become sullied in the process. In July 2013, the Constitutional Court reaffirmed the government’s obligation to repay the debt but, after executive pressure, rejected a standard measure of determining the value of the outstanding debt and endorsed the flawed method proposed by the ministry.
What made the decision suspicious was that it came after President Ollanta Humala warned—after learning of a draft decision that would require payment using the CPI method—that the “current Constitutional Court should refrain from issuing decisions on sensitive cases” so near the end of its term. Later, an investigative report revealed that the final decision had been re-written to favor the president’s position and the already signed majority decision endorsing the CPI method was doctored using White Out (liquid paper) to make it appear to be a dissenting opinion. The political pressure and high-court shenanigans can’t help but bring back memories of the dark days of judicial interference and corruption under the Fujimori years.
All this comes as a surprise from what has been one of the region’s best examples of the commitment to rule of law and the market and their economic benefits. Peru has become one of Latin America’s most avid signers of free-trade agreements, including the 12-member Trans-Pacific Partnership that was just signed this week and will link together all the major Pacific Rim countries representing 40 percent of the world economic output. The lynchpin of those agreements and Peru’s ability to compete with its high-flying members hinges on the respect for property and the rule of law—including pending obligations from the past.
That’s what makes the Peruvian government and Constitutional Court’s recent decisions and the swirl of influence peddling and corruption more than just a violation of the bondholder’s rights but a threat to the country’s ability to attract investment. In justifying its methodology to undervalue the bonds, the Ministry of Economy has argued that paying them in full would create a strain on the Peruvian economy. But as former Economy Minister of Peru Ismael Benavides Ferreyros has argued, paying over the long term the $5.1 billion in estimated debt using the CPI method would only increase the ratio of debt to GDP by 2.3 percent. Even better, it would reduce Peru’s cost of accessing international credit markets, likely saving it $18 billion over 30 years.
This dispute goes beyond arcane formulas to determine current value and the long-suffering holders of 40 year old debt. Peruvians and, in particular, Peru’s international business class need to understand what is at stake here: not just the integrity and effectiveness of the judicial system but international opinion on how the government and the judicial system treats property and legal obligations. The world—including investors and obviously the bondholders—will be watching how the government and its judicial system resolves this seemingly minor but increasingly troubling longstanding issue.
This article also appeared in the Miami Herald.