Interview: Julio Velarde
With high levels of economic growth, what measures are planned to keep inflation under control?
JULIO VELARDE: The Peruvian economy grew 6.9% in 2011 and is expected to expand about 5.7% in 2012. At present, we are not seeing demand pressure given that the economy is growing at capacity. Headline inflation was high in 2011 due to temporary supply shocks from commodity price fluctuation in the first half of the year and the impact of La Niña during the second half that affected crop productivity. However, core inflation, which does not take into account food and energy, was close to target at 2.4%. Commodity prices seem to have stabilised, and we do not see significant demand pressure in the short term. Consequently, inflation should return to the central bank’s target of 1-3% in 2012.
The Central Reserve Bank of Peru was one of the first central banks in Latin America to raise interest rates in May 2010. We increased the rates from 1.25% to our current benchmark rate of 4.25%. The central bank has kept its benchmark interest rate unchanged as the global economic growth remains uncertain.
We also use other instruments, such as reserve requirements on deposits, to keep inflation levels under control. Given the impact of interest rates and our policies on reserve requirements, Peru is clearly not behind the curve. Therefore, even though headline inflation is above target, this year’s and next year’s inflation expectations are still within the target.
To what extent is the central bank ready to act if appreciation hurts export competitiveness?
VELARDE: The main reason for foreign exchange (forex) intervention is less out of concern with the effects on trade if the currency over-appreciates, and more of an issue regarding financial stability, because in Peru 46% of total credit is dollar-denominated. Our objective is to avoid a risk of over-appreciation followed by strong rebound effects. Therefore, forex operations aim to moderate exchange rate volatility rather than to simply intervene for trade reasons. We do not use the exchange rate as a policy instrument nor do we have a target for it. This type of forex intervention is absolutely consistent with the inflation-targeting regime that we have embraced since 2002.
It is also consistent with our policy of International Reserve accumulation, which proved very helpful when the global economy was affected by financial turmoil in 2008. At that time, like any emergent economy, we witnesses a severe capital outflow that could have had a significant impact on the real economy if a third of Peruvian international reserves had not been available for allocation to avoid a credit crunch. All the liquidity requirements of the financial system, both in domestic and foreign currency, were met while the exchange rate smoothly depreciated by way of forex interventions.
How do you see credit levels and project financing in Peru continuing to develop?
VELARDE: Peru placed first in a global ranking of best business and policy environments for microfinance, indicating that the credit available to small and medium-sized enterprises in Peru is among the most advanced in the developing world. Microfinance costs remain relatively high because of the administrative costs, risks and incidence of inconsistency in small enterprise bookkeeping. Nevertheless, more and more credit is being directed to such firms, and interest rates are even being lowered in cases where good credit records have been established.
To improve project financing, we need to develop the domestic capital market. Peru’s capital market is still at an early stage compared to countries like Colombia and Chile. The issuing process needs to be simplified, and excessive legal regulations for institutional investors, such as pension funds, must be eased to boost the capital market. Thankfully, the new superintendent is making progress in the desired direction. When key players are able to move freely and without excessive regulation in the bond market, we can expect a much faster growth in the Peruvian capital market.
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