State borrowing allows governments to pursue undertakings they would otherwise find impossible. Whether for large infrastructure projects or social reforms, public borrowing can create greater prosperity or expensive mistakes. When the latter are the result and the borrowing was done domestically, the public is hurt doubly, both as borrower and as investor. In the case of bonds issued by the Peruvian government during sweeping land reforms in the 1970s, the citizens left with state bonds that eventually defaulted and whose value was whittled away by inflation anyway, weren’t even willing investors. They were forced to fund the nationalization of their own assets and, in the end, didn’t even actually receive the full sum of the paltry compensation offered.
The political pressure for land reform in Peru in the middle of the last century was substantial yet, until the late 1960s, sweeping reforms were not undertaken as they had been elsewhere. In the early 1960s, just 0.2% of land tracts, the large latifundio, comprised 68% of total farm area. On the other end of the spectrum, 83% of the number of holdings, the small minifundio, made up just 6% of that area. These small farms supported an ever-growing class of small landowners who had to make the most of their small plots to survive. So, these small farms suffered from declining productivity driven by the consequences of overuse, like soil erosion and land exhaustion.
The issue was driving civil unrest, particularly among peasants in less productive mountainous areas. Large farms were occupied and management forcibly taken over by rural workers. Elected Presidents were unable to resolve the issue, helping trigger a military coup that replaced democratic government with a left-of-center military regime in 1968, led by General Juan Velasco Alvarado.
The new administration implemented a land reform law in 1969. Land reform, it was hoped, would create a rural middle class which would support Peruvian industrialization both politically and, with surplus financial resources, economically. Between 1969 and 1979, some 15,826 properties comprising over nine million hectares of land were expropriated. For comparison, in 1961, Peru had a total farm area of 18.6 million hectares. The government handed over the land to smaller landowners and farmer co-operatives.
Compensation was given but the payment for the land was based on their assessed value for tax purposes. This meant that the compensation amounted to perhaps just one-tenth of the market value of the land. The payment would be made in a combination of cash and bonds but largely the latter. While cattle and improvements on the land were paid for in cash, the land itself was paid for in bonds. Some landowners refused to accept the bonds altogether, holding out hope they could reclaim their lands.
The portion of the land reform compensation that was made in securities was represented by bearer bonds to be repaid in full after between twenty and thirty years. One class of bonds, Class A, were due in twenty years and paid interest of 6% in single annual payments. Class B, otherwise similar, were due in twenty-five years and paid 5% interest. Class C were due in thirty years and paid 4% interest. These land reform bonds were issued as late as 1982 and an estimated 13.28 billion soles de oro worth of bonds were issued, but the precise sum was uncertain. Soles de oro were Peru’s currency at the time.
The bonds were structured to amortize with annual principal repayments. Initial holders would have to wait to monetize their bonds any further though. They were not freely transferable until 1979 but thereafter did trade for some time on Peru’s stock exchange in Lima. There was also another avenue for early redemption. The government arranged that the land reform bonds could be redeemed early by investing money in industrial projects. For each sol in fresh funds invested in industrial projects, one sol in these bonds could be redeemed early by presenting them for payment to Peru’s Agricultural Development Bank. This bank was also responsible for servicing the bonds.
Inflation and Default
Peru’s economy began to suffer a severe downturn later in the 1970s. This was the beginning of a depression and an episode of hyperinflation that would last into the early 1990s. During these years, agricultural output fell and food imports rose. Hyperinflation took hold as the old soles de oro lost value. Inflation reached an annual rate of 80% in the late 1970s and this rose to a peak of 12,000% in 1990.
Amidst this economic depression, the government was in default on its land reform bonds by 1980. The Agricultural Development Bank closed in 1984 and two currency reforms, one in 1985 and another in 1991, meant that the currency in which the bond were issued ceased to exist altogether. In any case, the value of the annual payments would have been reduced virtually to zero by the inflation. As such, bondholders would not have cared much that these tiny payments, unadjusted for inflation, had stopped. Having lost hope, bondholders ceased to submit their coupons for payment.
Eventually, Peru’s economy turned the corner as the country embraced more conventional economic ideas. It secured new trade agreements with the United States, China, and Europe and obtained investment-grade credit ratings. It did this despite the continuing default on the land reform bonds. Peru’s government no longer recognized them as outstanding obligations; they were ignored. Still, in the 1990s, the government made some indications it would be willing to repay the debts but presumably only in their miniscule nominal values. This would hardly have even a symbolic value.
Nonetheless, because of the improved economic, fiscal, and political conditions, some bondholders did see an opportunity for a superior repayment. In response to a lawsuit brought forth by a professional association of Peruvian engineers, the country’s relatively recently-formed Constitutional Tribunal declared in 2001 that bondholders needed to be made whole on an inflation-adjusted basis.
Unfortunately for the aging holders, this produced no quick change. First, there was no government tracked inflation metric in Peru that dated to before 1994. Second, the government resisted, worried about the effects of taking on such a repayment, in part because depending on exactly how many bonds existed and how one calculated what this repaid sum should be, the amount due could be very large. Bills were introduced in the Peruvian Congress to address the issue and one finally passed in 2006 only to be vetoed by the President. Three new bills proposed between 2007 and 2011 each failed. Little progress was made for over a decade.
After all this debate and legal proceedings, even in 2012, the public did not know for sure how many bonds were outstanding, let alone what they were worth, or should be worth. Estimates ranged from 1 billion to 8 billion U.S. dollars; the latter amounted to roughly 4% of GDP. A 2006 estimate by Peru’s Ministry of Economy arrived at a figure of $3.121 billion.
In 2013, the Constitutional Tribunal declared once more that the bonds should be adjusted for all of the intervening inflation and be repaid within a decade. The government was given six months to come up with a plan but it was hardly any more willing this time around. In the absence of a consumer price index, the adjustment would be made based on the soles de oro’s valuation against the U.S. dollar.
Still, the government of Peru produced a complicated and counterintuitive inflation adjustment that bondholders felt severely undervalued their holdings. The valuation would have meant the elimination of the vast majority of the value of the bonds measured by any reasonable approach. Some put the price being offered at just 0.5% or less of the bonds’ fair value. Holders accepting this paltry sum of money also had to agree not to seek any more recovery through judicial proceedings.
The redemption plan would also have given the government eight years to repay the bonds and this only after taking two years to verify the authenticity of the bonds submitted and that only after a five-year registration period. There was also priority given to older natural persons owning bonds and lower priority for younger holders and lower priority still for legal persons holding land reform bonds. Dead last were holders who acquired the bonds for speculative purposes.
Despite all this, during these years of delay, investment firms had been buying land reform bonds on the secondary market. This was not an easy thing to do since they were bearer bonds, that is represented only by the paper certificates, and weren’t really intended to be transferable securities but really just a deferred payment to a specific landowner. One hedge fund manager, Gramercy Funds Management bought 9,656 of the bonds between 2006 and 2008 for $33.2 million and demanded $1.8 billion for them. The hedge fund pursued arbitration against the government of Peru through a provision in the free-trade agreement between the United States and Peru.
In 2022, Gramercy won its case in arbitration proceedings. The hedge fund was awarded $100 million which, after deducting legal expenses, amounted to a 7.22% interest rate on the hedge fund’s investment in the land reform bonds. As for the land reform itself, Peruvian agriculture did recover far sooner than this. Co-op land was eventually subdivided and handed over directly to the land reform’s beneficiaries. This supported a market-oriented redevelopment of the sector.
Defunct securities, largely written off as a loss, rarely re-emerge. When they do, it is worth noting. While the land reform bonds are a relic from a period of political and economic despair, their newfound relevance is a testament to Peru’s subsequent economic recovery. Had it not recovered, there would have been no chance for repayment. So, despite the obvious disputes between the Peruvian government and the hedge funds holdings its old land reform bonds, the two do not have entirely misaligned interests.
More from the Tontine Coffee-House
Read about another bond left abandoned by history, internal bonds offered to Soviet citizens by the government of the Soviet Union in 1982. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.
1. Congressional Report Services, Peru Land Bonds – September 11, 2015.
2. “Let’s Sue the Conquistadors.” The Economist, 16 July 2016.
3. Sales, Alfonso, et al. HR Ratings, 2015, Peruvian Agrarian Debt Bonds – Bond Class A, B & C.
4. Saleth, R. Maria. “Land Reform under Military: Agrarian Reform in Peru, 1969-78.” Economic and Political Weekly, vol. 26, no. 30, 27 July 1991, pp. 85–92.
5. United Nations Commission on International Trade Law. Gramercy Funds Management LLC and Gramercy Peru Holdings LLC v. Republic of Peru. Final Award, 6 Dec. 2022.
6. Wade, Terry, and Marco Aquino. “Peru Faces Multibillion-Dollar Cost to Clean up ‘Fiscal Skeleton.’” The Globe and Mail, 2 Nov. 2012.