Peru is keeping on course with reforms that are likely to boost public revenues, and is on track to post a fiscal surplus of over 1% of GDP this year
When Peru’s newly-elected president Ollanta Humala appointed Luis Miguel Castilla as his finance minister, he chose the man who was the number-two official in the same department under his predecessor. Castilla has repaid that trust, as several analysts say. Eric Curiel, strategist at Esemplia Emerging Markets, an equities manager, says Castilla was key in maintaining a stable economic strategy during the transition of power after the left-leaning Gana Peru won power in July 2011.
“People were concerned about the policies they were going to embrace, and whether they would follow the path of [Venezuela’s] Hugo Chavez,” he says. “He has confounded expectations and embraced very market-friendly policies such as managing the investment in the mining sector.”
Reforms in mineral taxation were a priority in the new administration’s programme and are expected to boost public revenues by $1 billion a year or 0.5% of GDP, while preserving competitiveness of the sector that makes up 11% of the economy and three-quarters of its exports.
Pablo Goldberg, head of emerging market research at HSBC, says the finance ministry played a role in ensuring the new government saw the “benefits of keeping the course” in many aspects of macroeconomic policy. “There were important concerns in the market about what could have happened and whether [Gana Peru] could have taken a different approach,” he says.
On the macroeconomic front, the IMF expected economic growth to slow to a still respectable 5.5% this year after 6.7% last year and 8.8% in 2010. Peru is expected to post a fiscal surplus of 1.1% in 2012, having taken action last year to withdraw economic stimulus worth 2.25% of GDP. “The tighter-than-envisaged policy stance was useful in reducing overheating concerns and rebuilding fiscal buffers,” the IMF said in its latest Article IV assessment.
Castilla, who has survived three cabinet reshuffles, has also won support in the financial markets. Fitch, the credit ratings agency, has raised its long-term foreign currency rating for Peru to BBB on expectations Humala’s team will run a sound budget and support growth.
“This is the result of very solid fiscal management and macroeconomic management in general,” says Irene Mia, Latin American editor at the Economist Intelligence Unit. “But overall it has the important effect of reassuring markets.”
Before moving into politics, Castilla worked in the Andean Development Corporation (CAF) and also consulted for the World Bank. He has a doctorate in economics from Johns Hopkins University in the US and a master’s degree from McGill University in Canada.
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Continuity in the macroeconomic management of the country, in trade policy and in keeping commitments signed by previous governments have been important ingredients for Peru’s success, finance minister Luis Miguel Castilla says.
But in addition, a clear approach to trying to distribute fairly the gains from the economy’s growth to the population through improved social programmes and trying to deal with reform issues that had been long neglected have pushed the country forward.
Among the reforms now are dealing with illegal mining, pursuing tax reform and fighting large-scale tax evasion and contraband, as well as trying to improve the coverage of the pension system and the quality of services for the population.
Castilla maintains the country’s growth estimate at 6% for this year, depending on the outlook for commodity prices and for Peru’s trading partners.
“In this regard, we have downside risks if commodity prices were to plummet. Our estimates are in line with market estimates that this may change. The growth of our trading partners is in line with estimates from the IMF and projections from independent analysts,” he says. “This obviously presumes that the world will not collapse or go into recession as it did in 2008–2009.”
If, however, that were to happen, and Peru suffered a shock that reduced its fiscal revenue, it could be mitigated by the 1.1% of GDP surplus that is built into the budget – close to 7 billion nuevos soles ($2.7 billion). “This is a buffer that we have in case there are lower prices and lower growth next year.”
The country also has a fiscal stabilization fund, equivalent to 4% of GDP, which can be tapped in the case of recessions or large-scale natural disasters. The central bank “also has its own instruments” to stimulate the economy if needed, Castilla says.
One of his priorities is “not underestimating that we are sailing in seas of turmoil. The first priority is making sure that we can pursue appropriate fiscal policies if we were to receive external shocks from Europe or elsewhere, including the slowdown in Chinese growth. We need to monitor the crisis and make sure that we adopt compensating policies as needed.”
Improving the capacity of the three levels of government – local, regional, and national – to execute their budgets efficiently and transparently is another priority for Castilla. “This is very important, especially in public investment; we have an important infrastructure gap, and this is part of social policy in terms of narrowing the gap in access to basic services in rural areas.
“We have put together a fund that will finance joint investment in water and sewage, roads and telecom in rural areas. It is not only about closing the gaps to be able to compete in global markets, but as a way of addressing social inclusion in rural areas, using infrastructure as the key instrument,” he says.
His third priority is reforming the civil service, prioritizing salary increases to link them to productivity, ensure that career progress is based on merit and valuable employees are retained. “We have had a brain drain the past five or six years from the government because of low salaries,” Castilla says.
Another priority, complementary to the pension reform that has already started, will be to deepen and expand the capital markets. “We still have a very shallow capital market with very few instruments, and it is costly for small and medium-sized enterprises to finance their needs in the capital markets.”
Boosting competitiveness is another critical area, given that the external environment will be “less benign” over the next few years, says the minister. “Obviously there are four or five critical issues – education, human capital, the infrastructure gap, improving the quality of the labour force and making a clear bet in R&D and innovations – which we are working on.”