Growth in Peru this year will be lower than originally forecast, coming in around 3%, but it is far better than the regional average of 0.5%. Maintaining it next year might prove difficult.
In its latest macro-economic forecast published in late August, the Economy and Finance Ministry (MEF) lowered projections for growth for next year to 4.3%, down from 5.5%. It also cut the forecast for private investment one point to 2%, increased the debt ceiling one point to 3% of GDP and drastically revised its trade figures, projecting a trade deficit of $2.7bn instead of a surplus of $355m.
The numbers reflect the precipitous drop in the prices for copper and gold, Peru’s top exports, and the expected increase in interest rates by the US Federal Reserve that has already led to capital outflows and a depreciation of Peru’s nuevo sol, which dropped more than 9% on the year through August.
“The government did not respond with the necessary counter-cyclical policies to boost growth,” says Elmer Cuba, an economist and director of Macroconsult, a research and consulting firm in Lima. “This is the first time in history that we were in a position with the resources to respond to a rainy day and we chose not to open the umbrellas.”
The less favourable outlook was calculated before the sudden turbulence in August in China’s economy — China is Peru’s leading trade partner — and internal factors, particularly the real chance of natural disasters provoked by the El Niño phenomenon. On top of this is the upcoming presidential election in April 2016, which could lead to a decline in public investment if past elections are an indicator. Public investment dropped off unexpectedly this year.
Finance minister Alonso Segura talked about even more pressures during a presentation to Congress in early September, saying the persistent crisis in Brazil and other Latin American countries could hit Peru.
While Peru’s commodity exports flow to developed economies, manufactured goods such as textiles stay in the region, and the manufacturing sector, which has been declining all year, could be hit even harder. Manufacturing was down 4.8% year-on-year in July, according to the country’s national statistics institute.
PASSIVE APPROACH
President Ollanta Humala, who took office in July 2011 and is constitutionally barred from seeking another five year term next year, had originally raised fears that his administration would follow the lead of left-wing governments in the region, boosting the role of the state and opening the spigot of public spending.
The exact opposite has happened and economists say the administration’s fear of being seen as free-spending left-wingers allowed domestic and international pressures to accumulate without a proper response, knocking points off growth.
Oscar Dancourt, an economist at the Catholic University of Peru and former board member of the central bank, says the administration spent 18 months from early 2014 crafting stimulus policies that focused on streamlining bureaucracy and lowering taxes — the corporate tax rate fell two points to 28% this year and will decline two more points by 2019 — that are not going to spark growth or investment.
“The government’s assessment of the slowdown was wrong from the start,” he says. “The issue here is that the prices of raw material fell and instead of counter-cyclical policies they focused on changing norms. Mining companies stopped investing because of prices, not regulations. It was a passive approach that did not work.”
SPUTTERING ALONG
Edward Glossop, an emerging markets economist at Capital Economics in London, is more upbeat about the economy’s capacity to expand, but agrees that the administration should have been more focused on guaranteeing that the public investment component of the recovery plans worked.
“One of the key reasons why the recovery has been sputtering is that policymakers have really struggled to implement their fiscal reform package,” he says. “Construction of public works projects has not gotten off the ground and that is one of the key reasons why growth has not picked up as anticipated.”
Public investment this year will expand around 1.5%, well below the 9.3% forecast by the administration at the start of the year. The bulk of the problem has been at the sub-national level, with investment by local and regional governments off more than 30% compared to the previous year. The MEF and central bank have been forecasting an upswing in investment capacity in the second half of the year, but so far this has not materialised.
Part of this stems from the change in leaders, with newly elected officials having taken office in January 2015. Peru has one of the highest turnovers of elected officials in the region, with just two out of 25 governors currently serving second terms. The problem could be even more acute in 2019 because of legislation approved this year limiting mayors and governors to just one four year term.
Dancourt says the government blamed the change on local and regional leaders, but the MEF was also at fault. The percentage of the budget assigned to sub-national governments has declined steadily in the past few years and in 2016 will be at the lowest level this decade.
The learning curve for new authorities has not only affected state-planned projects but also public works supported by a creative programme that allows companies to invest in projects in lieu of a percentage of their tax bill.
OXI CRASH
The programme, known locally as OxI, has approved a total of 164 projects in six years with a total investment above $500m. The government made changes in 2013 and the programme ballooned, with 85 projects worth around $230m approved in 2014. It has crashed this year — only 10 projects with a value of $17m had been approved as of August.
Pablo de la Flor, head of corporate affairs for Banco de Crédito (BCP), the largest participant in the programme, says the drop this year was caused by the change in elected officials, but he also says new changes slowed the pace and added to the bureaucracy companies face when they want a project approved.
He remains bullish, however. “BCP enthusiastically supports the OxI mechanism, seeing it as a great opportunity to efficiently earmark the resources that we would pay in taxes to the Treasury,” he says. The bank currently has more than 50 OxI projects with a total investment above $150m.
EL NINO
The rough going could be made much worse if Peru has to confront the extraordinary El Niño phenomenon at the end of this year and into 2016. El Niño brings warm water to South America’s Pacific coast, changing ocean and air currents. It has a global impact but tends to whack Peru and neighbouring countries hardest at the outset.
El Niño displaces normally cold, resource-rich water, causing fish schools to flee and havoc in the fishing industry that generates more than $2bn in revenue. (Peru is the largest producer in the world of fishmeal that is used in aquaculture and as fertiliser.) It also provokes rains along the normally arid coast, where approximately 45% of the agro-export business is located.
The last big one in 1997-98 cost the country around $4bn in damages and lost revenue, but Peru is far more developed today, with more enterprises and infrastructure at risk. The government has already earmarked more than $1bn for prevention and mitigation work, anticipating a repeat of the past. A report by Banco de Crédito estimates that GDP would expand by just 1.2% in 2016 if the worst-case scenario plays out, more than three points below the government’s forecast.
POSITIVE COUNTERBALANCE
There are, nevertheless, some encouraging signs that could work in Peru’s favour. While ore prices remain low, mining output has increased and should expand even faster in 2016. Mining output was up by 15.6% year on year in July and should end the year expanding by double digits. Production of copper, the largest export, was up 30% in July. Two big copper projects, Constancia operated by Canada’s Hudbay and Toromocho, operated by China’s Chinalco, began operating at capacity this year.
Next year will be even better, with two vast projects coming on line. Las Bambas, operated by China’s MMG Limited, and an expansion of Cerro Verde, operated by US giant Freeport-McMoRan, will add nearly 800,000 tons of copper next year. The country’s total copper output should increase by 40% by the end of 2016, making Peru the world’s second biggest producer of the red metal after Chile.
The government expects additional mining production to add one point to growth next year. Another point should come from big public works projects that were slow getting started but are now ramping up. These include the $6bn second line of the Lima Metro, the $4bn construction of a second natural gas pipeline and the $3.4bn modernisation of the state-owned Talara oil refinery.
The state’s investment agency, ProInversión, has around $20bn of investment projects already approved. The government also calculates more than $50bn in potential mining investment from projects that have been approved but delayed because of prices and, in some cases, conflicts. Three big projects, with combined capex of $11.5bn, have been stalled by opposition from the communities where they were to be built.
The government’s 2016 budget, while not as expansive as in previous years, is 6.6% above the current budget. It includes large increases in outlays on education and transportation, two sectors that should inject liquidity into the market if plans are followed.
Capital Economics’ Glossop says Peru could hit the 2016 target if growth conditions remain as they were at the start of the second quarter — GDP expanded by nearly 4% in June — and external factors do not worsen substantially.
“We are still confident that Peru will rebound. We are not going to see the meteoric growth from the start of the decade but Peru has the conditions to return to 5% growth,” says Glossop.