Moving up: Strong macroeconomic growth continues as development progresses

In a little more than two decades Peru’s modern economic narrative has been drastically transformed thanks to continued macroeconomic growth and prudent fiscal planning. Much of this transformation is owed to high commodity prices, which have ensured the maximum value for Peru’s natural resources, though growth in recent years has also been driven by an expanding construction sector and strong internal demand. Economic planning must now look towards sustaining growth in the long term as the country transitions from an efficiency-driven to a knowledge-driven economy.

Moving Forward

Numerous obstacles lay ahead, including a large informal economy, social inequality, a substandard education system and a overall deficit in infrastructure. While short-term macroeconomic growth is a near certainty, it is the medium- to long-term future that must now be assured as the country is still susceptible to cyclical changes in global mineral prices since nearly two-thirds of exports come from the mining sector. Nonetheless, Peru watchers are cautiously optimistic about the country’s prospects for continued economic development, such as the IMF, which granted Peru a “favourable outlook” with risks still present. Low inflation, a healthy public fiscal position, growth in non-primary sectors and a strong investment framework have been, and will continue to be, driving factors on the road to economic development.

Looking Back

Out of the economic chaos of the 1980s – which was caused by hyperinflation, social and political uncertainty, and a struggling quasi-state capitalist system – emerged the almost entirely unknown figure of Alberto Fujimori. A Peruvian of Japanese descent, Fujimori spent his career as an academic, rising to eventually become the head of the National Assembly of University Rectors before taking over the reins as president following the surprising defeat of renowned author Mario Vargas Llosa in the 1990 elections. Fujimori’s divisive reign as president would eventually end with his imprisonment on charges of corruption, human rights violations and abuse of power.

However, his economic agenda from 1990-2000 shaped the country’s modern economic narrative. During his time in office Fujimori oversaw the implementation of wide-ranging neoliberal reforms that would open Peru’s model of state capitalism to privatisation in key sectors such as telecommunications and energy. He also supervised the elimination of price controls, subsidies and foreign exchange restrictions, all of which would set Peru on a course for economic recovery and stable growth throughout the 1990s, to be followed by a boom in the first decade of the new millennium.

Modern Developments

Under the administrations of Presidents Alejandro Toledo, Alan Garcia and incumbent Ollanta Humala, consecutive governments have continued to support the economic policies implemented by Fujimori with remarkable results. Indeed, over the course of the past decade, the economy has grown and diversified by leaps and bounds. Several factors have been instrumental to Peru’s rising status as a leading emerging market, including the signing of free trade agreements (FTAs), prudent fiscal management, the strengthening of energy security through the commercialisation of the giant Camisea natural gas field, economic diversification through the growth of non-primary sectors such as construction and the emergence of a global commodity price “super cycle”.

Competitive Rankings

Peru ranked 61st overall in the World Economic Forums’ (WEF) “Global Competitiveness Report 2013-14”, which was six places higher than its ranking two years prior, and above regional peers Colombia (69th) and Uruguay (85th), yet below Mexico (55th) and Brazil (56th). The WEF cited liberal policymaking and its impact on improved efficiency for goods (52nd) and financial markets (40th). However, it identified weaknesses in public institutions (124th), red tape (107th) and infrastructure (91st) as barriers to the evolution toward higher-value economic activities.

In the World Bank’s 2014 “Doing Business” rankings Peru remained stationary from its previous position of 42nd out of 189 countries – behind only Chile (34th) in Latin America. However, this still represents a significant improvement from its 62nd place in the 2009 rankings. Moreover, Peru is ranked highly in the investor protection category at 16th and registering property (22nd), though it was found lacking in the categories of enforcing contracts (105th), resolving insolvency (110th) and dealing with construction permits (117th). Despite the fact that the country is not without its challenges, Peru’s broadly positive rankings are an accurate reflection of its strong macroeconomic environment.

By The Numbers

Over the course of the past decade, Peru has arguably been one of Latin America’s top performers in terms of macroeconomic growth. In 2012 the Central Reserve Bank of Peru (Banco Central de Reserva del Perú, BCRP) estimated it was the fastest-growing South American country, with GDP expanding by 6.3%, a full percentage point higher than Chile’s second-best 5.3%. Economic growth is continuing along a pre-existing trend as GDP expansion averaged 7.1% from 2005-11, according to data from the BCRP. GDP grew 4.6% in the first quarter of 2013 and 5.6% in the second – again the highest in South America and more than a full percentage point ahead of Chile’s 4.1% growth in the second quarter. In a November 2013 report the BCRP said it expected GDP growth for 2013 to remain between 5.2% and 5.4%, with expected growth rates for 2014 and 2015 between 5.5% and 6.0%.

Over the past few years domestic demand has been one of the primary drivers of GDP growth, expanding at a rate of 8.2% from 2005 to 2011, though it slowed, if only slightly, to 7.3% in 2012 and is expected to grow at 6.5% and 5.8% in 2013 and 2014, respectively, according to the BCRP. As September 2013 the BCRP said domestic demand would grow 6.5% in 2013, lower than the previous estimate of 7%, and 6.1% in 2014. In the first quarter of 2013 domestic demand grew 8.1%, slowing down to 6.1% in the second quarter of that year. Increased consumption from both the public and private sectors has played a significant role in stimulating domestic demand, although investment has been the key driver alongside growth in some of the economy’s non-primary sectors.

Public Policy

The Ministry of Economy and Finances (Ministerio de Economía y Finanzas, MEF) is responsible for outlining economic policy through the Multiannual Macroeconomic Framework (MMF). Generally speaking the MEF, along with the BCRP, has taken a counter-cyclical approach to economic management. Prudent planning, in addition to increased revenues from mineral exports, has played a key role in reducing public debt and increasing net international reserves. As a testament to Peru’s outstanding economic management, Julio Velarde, president of the BCRP, was selected as Latin America’s best central bank governor in 2010 by UK-based financial news source Emerging Markets, after which Luis Miguel Castilla, the minister of economy and finance, took home the prize of best finance minister in Latin America in 2012 from the same publication.

Gross public debt as a percentage of GDP has more than halved from 46.9% in 2003 to 19.7% in 2012 and was reported to be around 18% in September 2013. It is expected to continue falling to 17.3% by 2015, while the MEF would like to keep the nominal public debt figure below $40bn (22.6% of 2011 GDP), according to the MMF 2014-16. Meanwhile, the BCRP’s net international reserve position has improved significantly over the past decade, increasing from $9.60bn in December 2002 to $63.99bn in December 2012 and around $66.5bn by November 2013.

Budget & Revenue

In November 2012 Congress approved the 2013 budget, which was around 13% higher than that of the previous year, with a heavy focus on social inclusion, investment promotion and national development. The $41.9bn budget also targets a non-financial fiscal surplus of 1.1% of GDP in 2013. In November 2013 the government approved the 2014 budget, set at PEN118.9bn ($44.78bn), a 9.7% increase over the 2013 allocation.

For the period from 2013-15 the MEF has targeted an average fiscal surplus equal to 0.1% of GDP, in a context of declining international prices of minerals and increasing demands for public expenditure on social programmes and public infrastructure. The central government’s conservative budget is part of its counter-cyclical policy as it seeks to position itself in such a way that it can manoeuvre fiscally in the event of another international economic crisis.

Central government tax revenues have generally risen in conjunction with broader economic growth over the past decade, increasing from PEN24.17bn ($9.10bn) in 2002 to PEN84.08bn ($31.66bn) in 2012, according to the National Superintendent of Customs and Tax Administration (Superintendencia Nacional de Aduanas y de Administración Tributaria, SUNAT). Tax collection in Peru remains relatively underdeveloped, in large part due to an extensive informal economy. In its MMF 2014-16 the MEF indicated it is seeking to increase tax collection efforts on six fronts, including tax evasion, which could boost revenue from value-added tax by as much as 35% and income taxes by as much as 50%, placing more emphasis on increasingly widespread electronic transactions and improving the collection and recovery of tax debts. For its part SUNAT picked up the pace in 2012 as individual tax collection assessments, audits and verifications nearly doubled to 230,000 from the 118,000 recorded in 2011.

Despite the challenges collecting taxes, in 2012 the central government’s total revenues increased 10.3% on the 2011 intake. As of October 2013 the government had collected PEN85bn ($32.01bn) for the year to date, up 5% over the same period in 2012.

Monetary Policy

The BCRP’s monetary policy has changed in recent months. The announcement of tapering of the US Federal Reserve’s quantitative easing programme has changed the dynamics of foreign funding and capital flows, and the sol has begun to show signs of weakening. In addition, bank credit growth fell to an average annual rate of 13.5% during the first 10 months in 2013, which is below the 18.7% seen in 2011-12. As a result the BCRP has been reducing reserve requirements in soles since April 2013. This policy is likely to continue as long as market conditions remain the same. In June 2013 the average reserve stood at 20%, decreasing to 19% in August, 17% in September and 16% in October. The aftereffects of hyperinflation during the 1980s and early 1990s are still being felt today as Peru effectively maintains a dual currency monetary system with 30.8% of market liquidity held in US dollars at the end of 2012, while the dollarisation of deposits was reported at 38.2%, following recent BCRP figures.

Maintaining A Tight Hold On Inflation

Inflationary pressure, primarily driven by supply-side factors, has been relatively modest in recent years, despite spiking in 2008-09 during the global financial crisis. Indeed, inflation has been within the BCRP’s targeted range during the entirety of the past decade – except when it rose to more than 4% in 2008. As of the end of May 2013 core inflation stood at 1.92%, while inflation excluding food and fuel, the principal factors driving domestic inflation, was 1.39%, according to data from the BCRP. The 12-month inflation rate was reported at 2.46%, well within the BCRP’s targeted range of 1-3%.

The BCRP sees the rising price of crude oil as the dominant inflationary risk for Peru on the international front, particularly given geopolitical tensions in the Middle East. However, an uncertain international economic climate caused by the aftershocks of the global financial crisis is also a concern.

Future domestic threats include adverse weather conditions weakening agricultural production and inflating food prices, and potential bottlenecks in electricity generation cutting supply, which could also potentially inflate prices. Even so, inflation is anticipated to continue falling to the BCRP’s targeted 2% in 2013 and 2014. This would give Peru the lowest inflation rate in South America – its 2012 inflation rate was lowest after only Chile.

Consumer Confidence

The emergence of a growing middle class has also been a boon to broader economic growth. Peru is now classified as an upper-middle-income country by the World Bank, and per capita income has nearly tripled over the past decade from $2047 in 2001 to $6621 in 2012.

The population’s rising disposable income has had a significant impact on the growing retail, service and real estate industries, as well as on the country’s lenders. Private consumption, one of the primary motors of domestic demand, grew at an average annual rate of 5.1% from 2001-11, according to data from the BCRP; in 2012 private consumption grew a further 5.8% and the central bank expected consumption to remain stable at a rate of 5.2% in 2013, according estimates from September 2013.

Consumer confidence was last reported at 59 points at the end of 2012. Consumer confidence above 50 is judged as “optimistic”, while marks below 50 are considered “pessimistic” – consumer confidence has not been pessimistic since January 2010.

Employment

Another widely used benchmark for economic growth and development is found in employment statistics. Mario Alberto Guerrero Corzo, a senior analyst at Scotiabank, told OBG, “Unemployment levels in Peru have remained relatively low for some time now. It is our sub-employment and informal economy which have been major impediments to economic growth.” As in many areas of South America, the informal economy in Peru is significant, and estimates of its proportion in the wider economy range from 50-60% (see analysis).

Investment Climate

Both public and private investment continues to swell as mega-projects in mining, energy and infrastructure are being constructed all over the country. The investment portfolio of the nation’s mining sector is particularly hefty with an estimated $57.4bn destined for mining projects over the next decade.

Broken down by sector, 2012 foreign direct investment (FDI) capital contribution inflows were directed towards energy projects (31.87%), communications (31.64%), finance (27.46%), mining (6.77%) and construction (1.32%), according to data from ProInversión, the national investment promotion agency. While the central bank was registering a downward trend in FDI for 2013, a rise of 14% is expected in 2014.

Increased revenues have allowed government funds to be channelled into major infrastructure projects over the past 10 years. Public investment has risen from $3.6bn in 2007 to $10.4bn in 2012, with a projected $12.2bn in 2013, according to the MEF’s MMF 2014-16. Public investment has expanded at an average annual rate of 16.8% from 2005-11, while the BCRP reports it expanded 20.9% in 2012 after contracting 18% in 2011. As of September 2013, expansion is expected to slow to 20.1% in 2013, before dropping to 13.5% in 2014 and 10% in 2015. Public investment from 2005-11 was primarily funnelled into infrastructure projects, with transport projects receiving 29% of total public investment, followed by sanitation (18%), education (16%) and agriculture (11%), a trend likely to continue in the future.

Already announced private investment projects total $45.6bn for 2013-15, with the majority going into mining and energy projects, according to data from the BCRP. Indeed, $21.22bn worth of private investments will go into the mining sector over the next two years, while hydrocarbons will receive $6.78bn, followed by electricity ($5.27bn), industry ($2.72bn) and infrastructure ($2.3bn). After private investment expanded at 14.3% from 2005-11, including the 15.1% decline in 2009, it rose by 13.6% in 2012 and will increase at a more moderate pace of 8% between 2014 and 2016, according to BCRP forecasts.

FDI has been the primary catalyst for growth in several sectors over the past decade, including mining and telecommunications, with FDI flows increasing from $1.07bn in 2001 to $12.24bn in 2012, according to recent figures from BCRP. However, FDI is expected to fall slightly to $12bn in 2013, with a further drop to $9.39bn in 2014. Despite the projected decrease, the 2014 value is still 14.1% higher than 2011 figures. Juan Carlos Odar Zagaceta, head of economic studies at the Banco de Crédito de Peru, told OBG, “FDI inflows have evolved in recent years. Whereas we have traditionally seen the majority of funds coming into the country from places like the US and Spain, we are now experiencing more diversity with the emergence of new investment sources, such as China.” Following data from ProInversión, in 2001 the trio of Spain, the US and the UK accounted for 67% of all FDI stock as capital contributions; more than a decade later in 2012, the same top three investor nations registered 54% of the total, but Latin American neighbours Brazil, Colombia and Chile together accounted for 16%.

Framework & Incentives

Although the emergence of economic, social and political stability over the past 20 years has piqued the interest of investors, none of it would have been possible without a legal framework that protects investors’ rights, and in particular foreign investors. Fujimori’s administration laid the groundwork for this when it passed the Foreign Investment and Promotion Law (Legislative Decree 762) in 1991, the Law for Private Investment Growth (Legislative Decree 757) in 1992 and the Regulations of the Private Sector Investment Guarantee System (Supreme Decree 62-92-EF) also in 1992. The framework established in the early 1990s provides numerous assurances to private investors while opening the gates to foreigners interested in investing not only in private sector companies, but in public sector ones as well. Indeed, very few restrictions exist surrounding foreign investment, although there is a regulation that foreigners may not acquire land, mining, water or energy projects within 50 km of the national border without the backing of a Supreme Decree and Cabinet approval. For the most part foreigners are afforded the same rights as Peruvian nationals and may participate in any income-generating activity free of prohibition or restriction.

Moreover, the 1993 constitution contains provisions to guarantee protection for private sector and foreign investors. Included within the constitution is the freedom to hold and dispose of foreign currency and the right of private investors to take contractual disagreements with the state to national and international arbitration.

ProInversión is also responsible for supervising and promoting private and foreign investment in the country, negotiating international investment agreements under Legislative Decrees 757 and 762, as well as issuing legal stability agreements (LSAs). LSAs can be of particular importance to long-term investors as they guarantee the stability of income tax regimes, as well as the free availability of foreign currency and profit remittances in addition to more general protections afforded through universal law. LSAs also offer protection for international companies receiving investment through stability of labour regulations and export promotion regimes.

Ratings

Economic progress and improvements in fiscal planning and investment frameworks have not gone unnoticed by major ratings agencies. Moody’s, Standard & Poor’s (S&P) and Fitch have each attributed Peru an investment grading in the past five years. S&P upgraded Peru’s long-term foreign currency status in August 2013 to “BBB+”. Fitch raised Peru’s foreign currency credit rating to “BBB+” in October 2013, while Moody’s upgrade was announced in August 2012 to “Baa2”, an equivalent to Fitch and S&P’s “BBB”. As a result, Chile is the only major Latin American economy ranked higher, with Mexico and Brazil now a level lower.

Perhaps more importantly, Peru has received the highest marks in the region from ratings agencies in terms of its prospects as the only country to receive a positive outlook on its debt rating from both S&P and Moody’s, with Fitch maintaining its stable outlook for the country. At the time of writing the only other countries to have received a positive outlook from any of the three agencies were Mexico, Colombia and Brazil – though the latter was downgraded to stable by Moody in October 2013.

Extractive Industries

If the driver of economic progress were attributed to a single factor, it would be investment and expansion in the extractive industries. While the mining sector continues to bring in billions of dollars through the export of gold, copper and other minerals, the energy industry is, often times literally, the fuel that sustains the country’s rapid economic growth. Before the discovery of the Camisea natural gas field in the centre of the country, Peru was facing a potential energy shortage, and only through the rapid construction of thermoelectric natural-gas-fired power plants has it managed to meet growing energy demands.

In 2011 the combined mining and hydrocarbons sectors contracted slightly at a rate of 0.2%, while growth was also sluggish in 2012, with the two sectors combining to expand 2.2% and slowing further to 0.94% in the first half of 2013.

However, a recovery is expected with the completion of several major mining projects that will increase the national output of copper, zinc and natural gas and propel growth to 3.1% in 2013 and 11.4% in 2014, according to data from the BCRP.

Growth Of Non-Primary Sectors

Despite the larger overall input of primary sectors such as mining and hydrocarbons over a more prolonged period, in recent years strong growth in Peru’s non-primary sectors – such as construction, commerce and the service industry – have also contributed significantly to driving GDP growth. Between 2005 and 2011 growth in the non-primary sectors averaged 7.8%, twice the 4% rate achieved by primary sectors; non-primary growth reached 7% in 2012 and 5.9% in the first half of 2013, compared to primary sector figures of 2.0% and 1.4%, respectively. Partly due to broad economic progress, the rapid expansion of non-primary sectors suggests that a process of economic diversification is under way. However, even as non-traditional exports and non-primary industries continue to grow, so too do primary sectors, and by 2014 the BCRP sees expansion in primary sectors once again outpacing that of non-primary sectors, estimating growth of 6.3% and 6.1%, respectively.

Construction

Of the non-primary growth drivers the construction sector has shown the greatest propensity for expansion in line with the general rise in domestic demand experienced in recent years. From 2005-11 the sector expanded at an average annual rate of 11.8%. After seeing growth slow to 3.4% in 2011, the construction industry rebounded in 2012, expanding once again at double-digit rates with a 15.1% increase in GDP in 2012 and 13.2% in the first half of 2013, according to data from the BCRP.

Furthermore, it is expected to continue growing, albeit at a more moderate pace, with forecast rates of 11% in 2013, 8.3% in 2014 and 8% in 2015. The sector’s recent run of success has also been supported by an increasing demand for both commercial and residential real estate, as well as the continued spending on major infrastructure projects both in Lima and around the country. Demand for real estate, despite the continual rolling out of new projects, has in fact pushed housing prices up significantly in Lima and other major urban centres and even sparked some fears of a looming bubble.

Capital Markets

The Lima Stock Exchange’s ( Bolsa de Valores de Lima, BVL) general index (IGBVL) gained 5.94% in 2012 before falling 26.71% in the first half of 2013 due to hints that the US was moving to end its quantitative easing programme, as well as lower expectations for corporate results and metals prices, according to the market’s July 2013 report.

This followed a contraction of 16.7% in 2011 after a strong recovery period in 2009 and 2010 when the IGBVL expanded 101% and 65%, respectively, following a 60% drop during the global financial crisis.

The 2012 growth in the market was led by banks (+38.9%) and utilities (+22.5%), while junior mining companies reported the largest drop of 17.5%, according to data from the BVL. Farming (-9.64%), banks and finance companies (-7.75%) and utilities (-5.46%) suffered most in the 2013 drop, though telecommunications (+9.66%) and junior mining (+8.88%) saw major increases despite the market’s worrying performance overall. Though relatively underdeveloped when compared with neighbouring bourses in Colombia, Chile and Brazil, the BVL’s market capitalisation closed 2012 with a 26.2% annual rise to $153.4bn before decreasing to $112.09bn in November 2013.

Activity remained fairly stagnant as trading volumes fell from $7.82bn in 2011 to $7.62bn in 2012 and $3.77bn in the first half of 2013. Volumes have yet to recover to anywhere near the peak level of $12.4bn recorded in 2007, the year before the global financial slowdown. This was also portrayed in the nominal figure for trade deals, which was reported as 32% less in 2012 when compared with 2011 activities – primarily a result of weak participation from retail investors. Work is under way to diversify and deepen the capital markets in Peru. The creation of the Latin American Integrated Market (Mercado Integrado Latinoamericano, MILA) with Colombia and Chile in 2011, though seeing a paucity of cross-border trades in its first two years of existence, has the potential to bring increased trade to the BVL.

In 2012 the BVL implemented what is known as an Alternative Securities Market (Mercado Alternativo de Valores, MAV) to act as a vehicle for bringing small and medium-sized enterprises to the bourse by loosening reporting requirements and rates. In early 2013 the exchange signed an agreement with the London Stock Exchange that will see upgraded trading software which should speed up transaction times. These moves were further supported in June 2013 with the passing of the Securities Market Promotion Act (Law No. 30050). Castilla explained that the law aims to incorporate 200 new firms into the exchange and double the number of investors trading on the market.

Infrastructure

A 2012 study published by the Association for the Promotion of National Infrastructure (Asociación para el Fomento de la Infraestructura Nacional, AFIN), the Universidad del Pacífico and the Universidad ESAN estimates Peru’s infrastructure gap has grown to $87.98bn for the period from 2012-21. In December 2011 the Ministry of Transport and Communications revealed its five-year infrastructure investment programme of roughly $20.5bn, a figure it would have to triple in 2016 in order to close the country’s infrastructure gap by 2021.

Broken down by sector the study identified energy as having the largest deficit in infrastructure at $32.99bn, equivalent to 37.5% of the total. Following the energy sector is transportation infrastructure, which is responsible for an additional $20.94bn (23.8%), telecommunications $19.17bn (21.8%), hydraulic infrastructure $8.68bn (9.9%), and water and sanitation infrastructure $5.34bn (6.1%).

Julio César Bustamante Velasco, the head of economic studies at AFIN, further emphasised this deficit. He told OBG, “Current economic growth certainly has a ceiling which is limited by a lack of infrastructure.” Bustamante added, “Public-private partnerships (PPPs), although becoming more commonplace, are too few and far between to really extend infrastructure development to the areas that need it most.”

Though not yet fully exploited, recent government initiatives are focusing more on PPPs. The Inter-American Development Bank found that Peru, Chile and Brazil contained the best environments in Latin America for developing PPPs. The bank found that broader macroeconomic growth and a well-developed legal framework have provided the basis for subsequent governments’ push to improve the PPP environment. The second line of Lima’s new metro system, a $5.7bn co-financed project currently being tendered by ProInversión, is one example of new PPPs being promoted throughout the economy.

Current Account

Substantial foreign investments pushed the current account balance into the red again in 2012, with the BCRP reporting a $6.8bn deficit, more than double the $3.3bn deficit recorded the previous year. The current account balance is expected to remain stable in 2013 and 2014, posting deficits of $10.25bn and $10.37bn, respectively.

Peru has posted a trade surplus in each of the past seven years, with these fluctuating between a low of $2.57bn in 2008 to a peak of $9.3bn in 2011 before moderating to $4.53bn in 2012. Imports increased with economic growth from $12.1bn in 2005 to $41.1bn in 2012 and are anticipated to continue rising to reach $49bn by 2015.

Even so imports have yet to catch up with exports; with annual export revenues more than doubling from $17.4bn in 2005 to $46.3bn in 2011 on the back of ever-increasing global commodity prices. Gold and copper exports alone contributed around $20bn to the country’s exports in 2012 (77.4% of mineral exports and 44.1% of total exports) and $8.9bn through the first six months of 2013 (77.2% of mineral exports and 43.7% of total exports.) Overall, exports fell slightly in 2012 to $45.64bn as commodity prices stabilised and in some cases decreased, though exports are expected to reach $45.7bn by 2014 due to increased production from the new mining projects, according to data from the BCRP. Another key factor in the continued accrual of export revenues stems from the plethora of bilateral trade agreements that have been signed in the past decade as more than 90% of Peru’s international trade in 2012 was carried out with countries that either already have a trade agreement in force, soon to be in force or under negotiation.

Trading Partners

Over the past decade Peru has signed numerous FTAs, including agreements with important trading partners and major global markets such as the US, China and the EU. The country currently boasts 19 trade agreements in force, including agreements with its two largest trading partners, China and the US. In 2012 China overtook the US as Peru’s largest trading partner.

According to Guerrero, apart from, and perhaps more importantly than, providing reduced and zero-tariff entry for Peruvian products to foreign markets, FTAs provide the country with the ability to pivot from one market to another with relative ease. Another added benefit of the ever-increasing trade deals, according to Hugo Perea Flores, chief economist of BBVA Banco Continental, is that the FTAs have compelled local companies to further improve productivity and efficiency to remain competitive in a global marketplace. Despite having successfully ridden the most recent wave of high commodity prices, some fear the fact that exported goods are still heavily concentrated in minerals could put the country at risk in the event of a collapse of global mineral prices. Additionally, Odar explained to OBG, while trade flows continue to increase with each passing year, there is still a lack of added-value to exports due to a dearth of downstream manufacturing capability.

Eastern Ties

It was undoubtedly China’s thirst for natural resources that led to the drastic price increases in minerals such as copper and iron on a global scale and that trend has resonated in Peru. China is one of the country’s most important sources of FDI inflows. However, increasing ties with the East are not limited to China as economic integration advances with other Asian nations, such as Japan and South Korea, and is symptomatic of a broader economic integration between Latin America and Asia.

Spreading The Wealth

“The emerging middle class is generally a positive for the country and has helped drive growth in retail and service industries, but without adequate social infrastructure long-term economic success will elude us,” Perea told OBG. Social inclusion was an important theme in Humala’s campaign for the presidency and it is now a key objective of his administration. There were initially fears in some parts of the business community that Humala’s government would take a hard left turn. Instead, the current administration has shown its desire to realise its goals on the social front through the continued development and growth of the economy.

During a period of strong economic growth from 2004 to 2012 the percentage of Peru’s population living below the national poverty line nearly decreased by half from 58,7% in 2004 to 25.8% in 2012, according to INEI’s National Household Survey. In 2011, the latest year for which statistics are available, the World Bank reported the country’s Gini index – where 1 is equivalent to perfect inequality and 0 perfect equality – at 0.481. Though far improved from the 0.556 scored in 2002, Peru still has a considerable way to go in improving income disparities.

In an interview with OBG, Karina Olivas, country representative of the World Bank, remarked that the rural-urban gap in terms of economic and social development remains large as economic benefits from recent economic growth have benefitted Peruvian cities first. Rural towns and communities also contain the highest rates of poverty, malnutrition, and water and health infrastructure deficits.

In an effort to improve social equality President Humala established the Ministry of Social Inclusion and Development (Ministerio de Desarrollo e Inclusión Social, MIDIS) in October 2011 to implement policy agenda. MIDIS now oversees several new social programmes including Juntos, which is a cash distribution programme for the poor, and Cuna Mas, a social programme focused on ensuring proper nutrition and care for infants. MIDIS also supervises the Cooperating Fund for Social Development.

Olivas also said that another factor that could hinder development in the Andean nation without proper reform, and one of the most common complaints among businesspeople in international surveys, is the education system. In the WEF’s 2013-14 “Global Competitiveness Survey” Peru’s health and primary education system ranked 95th out of 148 nations. Additionally, an inadequately educated workforce was a common issue for respondents.

Fernando Figueroa Manrique, the director of macroeconomic forecasting at the MEF, told OBG, “Peru ranks well on the international stage in terms of investment ratings, economic growth and general business climate. However, it continues to rank poorly in terms of social infrastructure, poverty alleviation and social mobility, all of which are equally important factors in spurring long-term development.”

Ensuring A Smooth Transition

As Peru continues down the path towards economic progress with the eventual goal of establishing a high-value, knowledge-based economy, several other development obstacles exist apart from the infrastructure gap and social inequality. The presence of a large informal economy full of micro and small enterprises has and will continue to limit efficiency (see analysis). In the area of innovation, a key component in the transition to a knowledge-based economy, several factors are also stifling progress beyond deficiencies within the education system.

Gabriel Aguirre, the head of economic analysis at the American Chamber of Commerce in Lima, told OBG, “Peru is currently in a stage of transitioning towards an innovation-driven economy. However, factors which could help stimulate innovation, such as the promotion of entrepreneurship and the reduction of bureaucracy, have not seen enough progress.” Indeed, the WEF’s “Global Competitiveness Report” ranked Peru 106th in innovation capacity and 122nd in the broader innovation category.

Moreover, despite prudent fiscal management, government inadequacies in several areas are some of the most common complaints from both local and foreign businesspeople. The top three most problematic factors for doing business were reported as inefficient government bureaucracy, corruption and restrictive labour regulations. Meanwhile, the WEF survey ranked Peru 128th in burden of government regulation, 109th in legal efficiency of challenging regulations, 126th in judicial independence and 131st in public trust of politicians.

Outlook

While Peru may be one of the most dynamic emerging economies not only in Latin America, but globally, it is certainly not without its difficulties. In the short term the country faces risks associated with its exposure to global commodity prices as well as ongoing social conflicts in the extractive industries. In the medium to long term it faces a serious infrastructure gap in several sectors, as well as a lagging education system, social inequality and a significant informal economy – all of which affect innovation and market efficiency.

However, despite these factors, Peru’s broader macroeconomic environment has and will continue to grow in the short to medium term. Prudent fiscal planning has provided the government with a strong position from which to continue driving economic growth even during otherwise sluggish periods.

High levels of domestic demand and the growth of non-primary sectors appear to be early signs of economic diversification, with the construction, retail and services sector in particular showing strong growth in recent years. Moreover, social inequality has now risen to the top of national debate and the government’s agenda. Infrastructure spending, though possibly not as high as it could be, is also a concern. If Peru can maintain its current course, addressing these issues one by one, its prospects for long-term economic and social development are excellent.

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The Report: Peru 2014

Economy chapter from The Report: Peru 2014

Cover of The Report: Peru 2014

The Report

This article is from the Economy chapter of The Report: Peru 2014. Explore other chapters from this report.

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