Scattered across rural Peru are the ruins of thousands of casas hacienda (estate houses), reduced to broken porticos and crumbled walls. These decayed structures recall one of the most radical land reforms ever undertaken in a noncommunist country. In the 1970s a leftist military government expropriated 15,286 rural properties and 9m hectares (22m acres) of land. It was a heavy-handed response to gross inequality in landholding and near-servile labour relations that stemmed from the Spanish conquest.
The bureaucrats turned the estates into top-down co-operatives, which soon failed. Food imports soared for two decades. But the reform had an unintended consequence. In the 1980s the co-ops divided up their land among around 300,000 beneficiaries. That laid the foundations of a market-based agricultural revolution in Peru, featuring medium- and small-scale farmers who export fruit, vegetables, spices and grains.
The reform was also unfair. The landowners received compensation totalling 15 billion soles (then around $350m), of which 73% was in bonds, redeemable over 20 to 30 years and paying annual interest of 4-6%. According to one calculation, that amounted to only a tenth of the market price. When Peru’s economy collapsed in the 1980s, the government eventually stopped servicing the bonds. Although there were individual hard-luck stories, most of the landowners built new and successful urban lives. As for Peru, after a quarter of a century of macroeconomic stability and rapid growth, it has become a Latin American success story with an investment-grade credit rating since 2008.
Now, some 40 years later, these forgotten agrarian-reform bonds are the subject of an international dispute. Gramercy, a Connecticut hedge fund, filed an arbitration claim last month against Peru’s government under the investment clause of the country’s free-trade agreement (FTA) with the United States of 2009. Gramercy claims to have bought some 10,000 of the bonds in 2006-08, and is demanding $1.6 billion for them. It has waged an aggressive lobbying and publicity campaign claiming that Peru is in “selective default”, though financial markets have shrugged at this.
So far, so like the case in which “vulture funds” extracted $5 billion from Argentina’s new government earlier this year. Except that these are bearer (ie, unregistered) bonds issued under Peruvian law as compensation, not as an investment instrument. The dispute turns in part on how to update their value, given that Peru went through hyperinflation and two currency reforms after they were issued. In 2001 the Constitutional Tribunal ruled that the unpaid bondholders should receive “market value”. In 2013 it specified that this should be calculated by reference to the dollar. A government decree then set out a procedure for registration and a complex mathematical formula for payment of the bonds. Gramercy claims the 2013 judgment was rigged and says the formula offers only 0.5% of what it thinks it is owed.
The government counters that Gramercy made a speculative purchase at heavily discounted prices because of the legal uncertainty surrounding repayment, something it says the fund’s own due diligence recognised. Gramercy refuses to disclose how much it paid for the bonds; the government says its claim would give it a return of up to 4,000%.
Gramercy’s purpose may be simply to make a nuisance, in the hope that Peru’s new government, which takes over on July 28th and has a large quota of bankers and businessmen, makes a better offer. Certainly the official repayment formula, which has yet to be applied, looks like a ruse to avoid revaluing the bonds and should be reviewed.
Bigger issues are at stake in this dispute. The Peruvian bondholders have indeed had rough justice. But as Enrique Mayer, a Peruvian anthropologist, wrote of the agrarian reform: “The irony is that landlords, as they complained about the lack of due legal process in expropriation, were the ones whose parents and grandparents had so patently disregarded laws or arbitrarily manipulated them.” A rigorous attempt to apply the rule of law to history would start with the conquistadors.
Hyperinflation confiscated the incomes, pensions and assets of many Peruvians. Why should only holders of agrarian bonds be fully compensated? This is a political question, for Peruvians to decide. But no reasonable person could construe Gramercy’s speculative punt on archaic local IOUs as a foreign investment of the kind that the FTA is designed to protect. By invoking the FTA Gramercy is doing its bit to discredit free trade and globalisation. Its case should be thrown out.
The Economist July, 16, 2016
