Peru’s economy refuses to pull out of its slump despite a dizzying array of stimulus measures adopted by President Ollanta Humala’s administration since midway through last year.
The economy expanded by 2.4% in 2014, its slowest rate of growth since 2009 and far below the government’s original forecast of 6%. The finance ministry (MEF) had expected a big bump in GDP growth in the final months of last year but that did not happen, with growth at 0.2% in November and 0.5% in December.
Growth this year was initially forecast at 4.8% but has already been lowered to closer to 4%. “The economy will begin to expand but first quarter growth is going to be low,” said finance minister Alonso Segura in mid-March on the sidelines of a World Bank event in Lima.
The minister claimed that even at the lower level, Peru would still be South America’s fastest growing economy in 2015. January’s growth rate of 1.7%, according to the National Statistics and Information Institute, was better than the previous two months but still low and below forecasts.
Economists are worried Peru could fall into a recession as the government’s pillars for growth — public investment, increased mineral production and stimulus packages to reduce red tape and lower taxes — are taking much longer than expected to kick in. Francisco Rodríguez, chief Andean economist at Bank of America Merrill Lynch, forecasts growth this year at around 2%, half the forecasts from multilaterals like the Inter-American Development Bank and International Monetary Fund.
Bigger levers needed
Germán Alarco, an economist and researcher at Peru’s Universidad del Pacífico, says the government would get lucky this year if growth were to equal that of 2014. The problem, he argues, is that the Humala government not only reacted late to the fall in the prices of minerals, the backbone of the economy, but also mistakenly believed that measures to cut red tape would be enough to stimulate growth.
“The economy required a strong counter-cyclical policy but instead we got changes to labour and environmental standards,” he says. “Eliminating red tape is necessary but it is not going to get the economy growing above 5%.”
The government’s stimulus policy came in phases, with the first efforts focused on streamlining administrative procedures to speed up mining and energy investment. The government expects more than $80bn in extractive investment between now and the end of the decade and the policy changes were meant to reduce approval times from two years to a few months.
The most innovative proposal came late last year, when the finance ministry announced a final component of the stimulus package to reduce corporate and personal income taxes and drop tariffs on more than 1,500 products. The legislation, published on December 31, 2014, cut the corporate tax rate from 30% to 28%. It will fall another point in 2017 and to 26% in 2019. The reform created two new tax brackets for individuals, lowering taxes paid by low and middle-income workers from 15% to 8%. It also dropped taxes paid by independent professionals two points to 8%.
The government estimates that the changes will shave about $1.5bn from fiscal revenues, but simultaneous increases in corporate and individual liquidity will eventually add more than two points to GDP growth.
The calculations for growth this year are based principally on an additional percentage point coming from public investment and another from increased mineral output, principally copper. More mining would compensate for the continued decline in copper and gold prices, which have put downward pressure on the country’s exports.
The mining sector expanded by 5.6% in January, the key reason the economy grew during the month, but there are signs that growth will be softer than expected.
The price of copper has fallen 7.8% so far this year and gold is down 2.3%. The government has forecast a big jump in copper production, which is expected to double to 2.5m tonnes a year by the end of 2016, but so far it has been disappointing. Copper production was down year-on-year in December and flat in January, a long way from the double digit increase forecast. Gold production did rise by 1.9%, according to the energy and mines ministry.
Mineral exports in 2014 were $19.2bn, down 18% from the previous year, pulling total exports down 10% to $38.2bn. That gave Peru a $2.5bn trade deficit in 2014, its largest ever, according to the Central Reserve Bank (BCR).
Oil price pain
Expectations in the energy sector may also be too rosy for this year. The price of crude is creating havoc for the mid-sized companies that populate Peru’s oil sector. Texas-based BPZ Resources, which operates the second largest offshore block, filed for Chapter 11 bankruptcy protection in early March. Its partner in that block, Canada’s Pacific Rubiales, recently reported a quarterly loss and has suspended dividend payments.
The bright spot could be in natural gas exploration and production. Several firms, including Argentina’s Pluspetrol, China’s CNPC and US-based Hunt Oil will carry out critical exploration campaigns this year in the gas-rich south-eastern jungle. Ground preparation is under way for the start of construction on a $4bn southern gas pipeline. Work could begin in April.
The boost from public investment is also coming as a trickle, when the government had expected a torrent. Public investment was down by 27% in January compared to the same month last year, the steepest monthly decline since the international financial crisis in 2009. This is partly explained by the inauguration on January 1 of new regional and district authorities but public works projects have been slow out of the gates at all levels.
Big projects, such as the southern pipeline and the $6bn second line of the Lima Metro, have started but are only in the initial stages of construction. Outlays are likely to be less than expected this year.
However, government authorities, while admitting that growth is not kicking in as they expected, remain bullish. “The first half of the year for subnational governments will be complicated but public investment will normalise throughout the year,” says Segura. “We are also going to see a clear recovery in primary sectors.
Bond in the offing
The minister and other MEF staff undertook a road trip in mid-March to the UK and US to talk up Peru’s fundamental macroeconomic strengths. It was billed as a non-deal roadshow but the expectation is for a new sovereign bond issue in the first half of the year.
“There is appetite for Peruvian paper,” says Roberto Flores of Peruvian brokerage Inteligo SAB. “The economy is in a weak cycle right now but investors recognise that the fundamentals are strong.”
The Central Reserve Bank has also adopted a long list of policy changes since the start of the year to stimulate growth and address exchange rate pressures. It lowered the prime interest rate to 3.25% in January and could cut it another 50bp this year. The sol fell 6.4% against the dollar in 2014.
The Bank has announced a substantial reduction in reserve requirements in the local currency, dropping the rate to 8% in February. It was the seventh consecutive monthly drop and analysts say the BCR could bring it down to 6% without too much trouble. Reserve requirements in soles have fallen from 30% in August 2013. It has simultaneously increased the reserve requirements in dollars to 60% to encourage a de-dollarisation of deposits. The BCR estimates that the changes in the first two months of the year will pump around $3bn of liquidity into the economy.
BCR governor Julio Velarde says that while growth is taking longer to speed up, he estimates an increase in primary sectors, including agriculture and fisheries, in addition to mining, will add at least 1.5 percentage points to growth this year.
Most observers, including Alberto Rodríguez, the World Bank’s representative in the Andean region, see two other issues weighing on growth in the coming year. The first is the Humala administration’s push to join the 34-member OECD in 2020. Peru would become the third member in the region after Chile and Mexico if it meets the requirements.
Rodríguez says OECD membership would “change the way the Peruvian state operates”. The government has identified 16 critical areas where it needs to improve performance to get into the exclusive economic club.
The other big issue is the April 2016 presidential elections and keeping political noise from affecting economic growth. While President Humala is constitutionally barred from standing again, authorities have registered 20 parties for the election. Early frontrunners are former congresswoman Keiko Fujimori, who lost to Humala in 2011, former finance minister Pedro Pablo Kuczynski, who came in third in 2011, and Alan García, who has already served twice, in 1985-90 and 2006-11.
Alfonso García Miró, head of the business umbrella group Confiep, says political disruption could keep investors away. “There is the risk, especially in extractive sectors, of investors taking a wait-and-see attitude as elections approach,” he says.
IMF 15 Road to Lima
Peru — and much of Latin America — will get a chance to showcase its economic changes when the World Bank and IMF hold their annual meetings in Lima in October. It will be the first time in nearly five decades that Peru has hosted the meetings, which should attract more than 15,000 people from the 188 member countries.
Alberto Rodríguez at the World Bank says the meeting highlights the changes Latin America and the Caribbean have undergone in the past two decades. “When you attended a meeting in the region 15-20 years ago, it was about debt, default and structural adjustment. Today, it is about growth and how to lower poverty and improve standards of living,” he says.
The BCR presented on March 9 the first in a series of reports to prepare the debate for the Lima meetings, entitled Forgotten Ones: chronic poverty in Latin America and the Caribbean.
“We need to grow to be inclusive, but we also recognise that we have to be inclusive to have long-term, sustainable growth,” said finance minister Segura, presenting the report.
Peru has made great strides – reducing poverty from 55.6% in 2005 to 23.9% in 2013, according to the World Bank.
Rodríguez says the Lima meeting will be a chance not only to look at what has been done but to “reflect on the next steps. The progress has been important but there is still a long way to go.” — L.C.