Severing ties with the far left will cost Castillo some political capital but could also allow him to advance the more pragmatic aspects of his agenda.

Pedro Castillo won the Peruvian presidential election on June 6 promising to overhaul the country’s economic system to favor the poor. Before this year, however, little was known about Castillo beyond vague campaign slogans. Investors were particularly worried about Peru Libre, the political party that propelled him to the presidency. Peru Libre is a socialist party. Its key figure is Vladimir Cerron, a Cuban-educated neurosurgeon and self-declared Marxist. Cerron was not allowed to run for president in the election due to a prior corruption conviction; he therefore joined forces with Castillo, who was not part of Peru Libre.

After Castillo was declared the winner of the election, Peruvian 2060 bonds fell by more than 7.5% in two weeks. To calm investors, Castillo nominated Pedro Francke as minister of finance. Francke, a former World Bank economist, committed to orthodox policies: respecting private property, controlling inflation and maintaining a balanced budget. Similarly, Castillo said that he would reappoint the current central bank president, Julio Velarde, showing a commitment to continued orthodox monetary policy. Later, after three months in power, Castillo fired the three most radical members of his cabinet.

By dismissing figures close to Peru Libre, Castillo severed his ties with Cerron. Similarly, Cerron announced that Peru Libre, which controls 37 out of 130 congressional seats, would not support the president anymore. Losing this congressional support is a setback for Castillo. Furthermore, Castillo’s small margin of victory (0.26 percentage points) and still developing platform mean that he lacks a mandate and has limited political capital. Castillo will attempt to build coalitions with other parties in congress, but such alliances tend to crumble overnight. In addition, macro headwinds in 2022 like higher inflation and slower global growth are likely to irritate an impatient electorate that has seen five presidents in four years.

That said, compared to South American peers—most with a bleak short-term outlook—Peru has reason for optimism. In our view, the market was too quick to judge Castillo. If he adheres to the moderate playbook, he is likely to boost investor confidence and attract more investment. Further, breaking from Peru Libre should allow him to reach out to moderate parties to advance his pragmatic agenda.

The risk of Peru becoming the next Venezuela has diminished significantly. Since the post-election sell-off, we have covered our underweight in Peru hard currency and have established long positions in local currency and corporates, where the correction was especially pronounced.