Peru's value-added industries and small businesses aim to boost industry and retail growth

 

As the world’s third-largest producer of copper and zinc and with the sixth-largest gold reserves, for a country with a population of just 30m people, Peru has historically commanded a large presence in the global commodities market. This was especially true over the 10 years spanning 2002-12, when prices increased substantially during the global commodities “supercycle”. Over this period the country became one of the fastest-growing Latin American economies, with an average annual growth rate of 6.4%.

Production Challenge

However, when the cycle came to an end in 2013, Peru’s industrial sector entered a period of decline, exerting a negative effect on the overall economy. Industrial production as a percentage of GDP fell by 6.7% to reach 13% in 2016, according to the National Institute of Statistics (Instituto Nacional de Estadística e Informática, INEI). Sector employment was also hit, falling by almost 6% in 2016. Sales, likewise, have been subdued. However, despite the recent challenges, the sector remains a significant component of the economy. Although it recorded a loss of 150,000 jobs in 2016 the sector still employs around 1.5m people and accounts for 18% of the country’s tax revenues. The level of formality in the sector – at 37% – is a full 10 points higher than the national average and 10 times higher than that of the primary sector, where formality stands at just 6%. Industrial workers are also better educated, with 82% holding secondary qualifications, and their earnings are above average.

Furthermore, almost two-thirds of Lima’s GDP (61.3%) is generated by industry, underpinning the capital’s higher-than-average-per-capita income. The sector accounts for 44% of household consumption, led by the food sector, which generates over 32% of total sector sales. The industrial sector also receives 14% of total foreign direct investment and 23% of corporate credit, and, critically, it supplies 15% of total exports.

According to the latest data from the National Superintendency of Tax Administration (Superintendencia Nacional de Administración Tributaria, SUNAT), total manufacturing sales contracted by 0.5% in 2016, despite witnessing an upwards trend in the second half of the year. Although lacklustre, this was a better performance than in 2015, when sales contracted by 4.3% overall. At the start of 2017, however, sales recovered, with growth reaching 10.6% in January – 5 percentage points higher than the same period of 2015. This was followed by a dip of 1.5% in February and a slight rise in March of 0.1%. In line with the overall trend, the sales of non-primary manufacturers shrank by 0.5% in 2016 compared to a contraction of 2% in 2015. The output of primary manufacturing, meanwhile, fared better. After posting negative growth of 0.8% in 2016, sales rocketed at the start of 2017 to 47.1%, driven mainly by a surge in sales of fish products of 198%.

Exports

Evidencing the recent challenges, Peru’s non-traditional exports, which encompass industrial exports, fell by 8% in 2014-16 to reach $10.7bn in 2016, down from $11.6bn in 2014. The decline was most acute in the textiles sector, which contracted by 40%. In November 2016 the government agency Infotrade reported 5997 non-traditional exporting companies on its books, down from 7664 two years previously, which means that while they may still be operational, 1667 companies ceased exporting.

While challenging conditions have caused exports to fall, local production for domestic consumption has risen, which could help boost the production levels of non-primary manufacturing. Carlos Campillo, general manager of Mexichem Peru, told OBG, “The slowdown of the country’s growth has helped consumption rates of local products increase to the detriment of imported ones, due to lower prices of locally made products.”

New Industrial Policy

Both the mining sector and the large number of small-scale businesses operating in Peru are key motors of the economy. Amid the falling export revenues and GDP growth resulting from the end of the supercycle, the Ministry of Production (Ministerio de la Producción, PRODUCE) announced a renewed emphasis on diversifying the economy and providing greater added value to production.

Under the previous government of President Ollanta Humala, PRODUCE set a target of returning Peru to a 7% real GDP growth rate through the development of the country’s secondary and tertiary industrial sectors via private partnerships.

The central pillar of this policy was the National Plan for the Diversification of Production. The plan created public-private working groups for those industries identified as having the strongest growth potential. Forestry products and aquaculture, for example, were two targeted groups, along with textiles.

Complimenting these efforts to diversify and move up the value chain, the industrial policy of the current administration of President Pedro Pablo Kuczynski is focused less on the state emphasising individual industries than on creating improved operating conditions for the private sector as a whole, and in particular small businesses, which contribute roughly 22% of GDP and 75% of employment in the country.

Doing Business

Aside from changes to the framework governing public-private partnerships – as well as reforms to SUNAT and ProInversión, the private investment promotion agency – the administration has also created new tax brackets for small and medium-sized enterprises (SMEs). Along with this, it has also amended regulations relating to setting up businesses in the country: companies can now obtain business licences and register at de centralised government offices, which will also provide advice and training for business owners. In addition, President Kuczynski has placed major emphasis on the formalisation of the labour force, which has been identified as one of the main obstacles to sustainable growth over the medium and long term. Of the 16m jobs in the country, 11m are informal. Alfonso Grados Carraro, the minister of labour and employment promotion, is working on a labour reform to be unveiled in July 2017, which will partly seek to streamline the number of labour regimes in the country, with the aim of benefitting the SME sector.

While these reforms are likely to improve the business environment in Peru, industry stakeholders are quick to point out that in terms of regulation, there is still much to do to improve the country’s competitiveness, especially for small business owners. For example, Umberto Calderón, general manager of veterinary products producer Agrovet Market, told OBG, “One of the main challenges faced by local producers when expanding is the high cost of registering patents.”

Floods Crisis

Non-primary manufacturing was severely affected by severe flooding in 2016, caused by the El Niño phenomenon. In early April 2017 President Kuczynski told international media that the floods – the worst Peru has seen in two decades – would mean lower economic growth for the year.

Initially, the government had forecast real GDP growth of 4.8% in 2017, up from 3.9% in 2016, but this expectation has now been revised to 3-3.5%, with a rebound projected for 2018 of 4-5%. Speaking in early April Alfredo Thorne, the minister of economy and finance, stated that first quarter GDP results looked “fairly weak”, at about 2% at most.

Although 2016’s the El Niño was weaker than those of 1983 and 1998, Thorne noted that the destruction this time round was much more dramatic, not least because of the rapid economic growth of the past decade. The extent of the damage, he said, reflected the fact that Peru’s economy is about 10 times the size it was in 1982-83. In 2016 flooding destroyed around 250 bridges, whereas in the 1982-83 emergency, 47 bridges were lost. Likewise, almost 200,000 homes were destroyed, compared to 111,000 in 1997-98 and 94,000 in 1982-83. Consultancy Maximixe estimated the total cost of damages caused by the flooding to be over $5bn. However, the government estimates that its Reconstruction with Change plan, which was approved by Congress in May 2017, may run as high as $6.4bn.

Speaking to local media, Carlos Casas, an economist at the Universidad del Pacífico, noted that the flood damage should be understood as disinvestment, or negative investment, on the basis that the reconstruction effort, which could last three to four years, is effectively an effort to rebuild capital stock that existed as of December 2015.

In that sense, the disaster could damage the economy’s growth capacity over an extended period, as it has lost vital inputs. The flooding crisis impacted the entire logistical chain for the productive sector, for example, with deleterious effects.

Nevertheless, Casas agreed with Thorne that the reconstruction effort would contribute positively to aggregate demand, amid increased public investment in infrastructure, with a particular boost for the industrial sector. Also taking a positive view, Francisco Grippa, chief economist for BBVA Research Peru, likewise emphasised that there should be a natural economic rebound starting in the first quarter of 2018, as those sectors affected by the rains bounce back.

While Lima is Peru’s industrial hub, according to the National Society of Industries (Sociedad Nacional de Industrias, SNI), 22% of industrial production outside of Lima is located in the 874 districts affected by the flooding crisis. As a result, the SNI expects a negative result for the sector in 2017. Other experts, including Grippa, are also now expecting a negative result in the non-primary sector, although primary manufacturing, sustained by the strength of the fisheries sector, will help offset this weakness and sustain overall manufacturing performance. However, assuming the government can kickstart the reconstruction effort and make progress with its planned national infrastructure development plans, this should boost industrial activity related to construction and other ancillary sectors. The government is aiming to boost public investment by 15% in 2017, a level significantly higher than the 8-10% minimum advised by private economists.

Reactivation Plans

In the wake of the floods crisis, then-minister of production Bruno Giuffra, now minister of transport and communications announced specific plans to reactivate micro and small enterprises (MSEs) in the 11 regions placed under a state of emergency during the floods crisis, along with PROMOMYPE events in Lima and the north and south of the country publicising the programmes and services that PRODUCE and other public sector entities are using to boost the development of MSEs. According to the minister, about 14,000 formal manufacturing companies were affected by the flooding crisis, of which almost all – 95.6% – were micro companies, while 3.7% were small companies. The PROMOMYPE scheme aims to connect MSEs with the private sector and the state, providing inputs for the reconstruction effort, stimulating activity and jobs in flood-damaged zones. The government hopes the scheme will help some 20,000 MSEs in the short term. According to Giuffra, who spoke to local press, the scheme will provide credit for state purchases, allowing formal MSEs “...that meet price and quality conditions” to participate.

Looking Ahead

Economists were divided on what the figures released by the INEI for March 2017 mean for future growth. According to the institute, in that month year-on-year (y-o-y) growth stood at just 0.71%, compared to 3.71% in March 2016, contributing to an overall first quarter of 2017 result of 4.4%. For those who like to see the glass as half full, the results – which were better than expected – were evidence of Peru’s resilience and a pointer towards greater recovery over the rest of the year, as the substantial task of post-flood reconstruction and other planned public infrastructure work gets under way, stimulating domestic economic activity. By contrast, others drew attention to the fact that the growth in March rested almost exclusively on the fisheries sector and, taking into account the third consecutive negative seasonally-adjusted figure, warned that Peru could be headed for a technical recession. Indeed, some economists warned that the government’s official GDP growth target of 3% for 2017 was starting to look materially impossible. The upshot is that there is a risk of quite a subdued year for the economy in 2017, unless the government is able – quite literally – to rebuild Peru, and quickly.

Commenting on the latest economic data, Giuffra highlighted the 1.8% y-o-y growth in the manufacturing sector, largely the result of the increase in primary manufacturing caused by the surge in the industrial production of fish products. While the growth in the non-primary sector was marginal, Giuffra said consumer goods consumption was recovering, citing increased production of paper and carton, furniture and intermediate goods. He also forecast a further rise in intermediate goods for the construction sector in support of the reconstruction effort.

Policy Vision

Speaking to OBG in February 2017, Franciso Dumler, vice-president of development at economic and social development company Grupo Invertir, called for a greater emphasis on an industrial policy focused on adding value and integrating Peru into global supply chains. He suggested the country should take better advantage of its free trade agreements, which cover 95% of the country’s exports. He also pointed to the potential for specialisation, including in sectors like textiles, technology and gastronomy. Commenting on the potential for the development of industrial specialist clusters, which have worked well in other regional countries such as Chile and Mexico, he noted that Peruvian industry still does not have access to sites at realistic prices. “This should be government policy”, Dumler emphasised. He also stressed the need for infrastructure development, emphasising the need for it to be “focused towards necessities”.

Outlook

While there are disagreements regarding the short-term forecast for industry, the consensus for 2018 is more upbeat. By then, reconstruction and other infrastructure projects should be well under way, delivering the positive shock that the domestic economy, and the sector, requires. Lingering concerns may relate to the ability of local municipalities to speedily execute the reconstruction works, so the onus will be on the central government to oversee and track progress, and to provide assistance where it is most required.

 

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The Report: Peru 2017

Industry & Retail chapter from The Report: Peru 2017

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