The Peruvian economy is at a crossroads. Over the last two decades it has been one of the fastest-growing economies in the region, enjoying macroeconomic stability, a strong mining sector, an open economy, and growing agro-industry and services sectors. Unlike some of its neighbours, Peru has been remarkably resilient to global headwinds. Positive GDP growth has continued despite the end of the commodities boom. Yet the growth rate has slowed and the initial impetus of a first wave of structural reforms has faded. The question now is whether the new government that took office in July 2016 can address problems, implement further reforms and re-accelerate the economy.
Background
Peru is a dynamic Latin American economy. According to statistics from the central bank (Banco Central de Reserva del Perú, BCRP), Peru had a nominal GDP of $195.4bn in 2015, making it the sixth largest among Latin American nations, following Brazil, Mexico, Argentina, Colombia and Chile. The country has an open economy, with trade representing 44% of GDP. Within that figure, exports of goods and services are equivalent to 21.3% of GDP, while imports of goods and services account for 23.7%.
While extractive industries, including metals, mining, and oil and gas production, play a key role, the economy is diversified. According to World Bank data, in 2015 the agriculture sector contributed 7.6% of GDP, a figure which was only down slightly from nearly 9% in 2000. Industry, including mining, accounted for 32.8% of GDP, up from 31.9% at the turn of the century. The services sector made up 59.4% of GDP, which was virtually unchanged from its contribution 15 years earlier. Within industry, the manufacturing subsector experienced a relative contraction, with its share of GDP falling to 14.5% in 2015, down from 16.7% in 2000. This reduction can be attributed to the commodities boom, which boosted the relative share of primary production in Peru, as it did for other commodity exporters, such as neighbouring Brazil.
A key differentiating factor is that during the last decade Peru has consistently been the fastest-growing economy in Latin America. Almost uniquely for the region, the country has registered consistent positive growth rates for an uninterrupted 18 years up to 2016. While the pace of growth has slowed as the long commodities boom ebbed after 2012, Peru still achieved an average growth rate of 5.9% in the 10 years leading up to 2015, which was almost double the comparable 3% rate for Latin America as a whole and ahead of all the largest Latin American economies.
Across the region Peru was outpaced only by Panama, which achieved an average growth rate of 7.6% over the same period. The scale of the economy’s growth and structural change is illustrated by the fact that during the more than decade-long commodities boom the poverty rate fell from nearly half the population at 49.2% in 2006 to under a quarter at 21.8% in 2015, according to the World Bank. Furthermore, the percentage of Peruvians living under extreme poverty dropped from 11.2% in 2007 to 3.8% in 2016, according to figures from the National Institute of Statistics and Information. According to the National Institute of Statistics and Informatics, Peru’s population is estimated to have reached nearly 31.5m in 2016, with a current annual growth rate of 1.3%.
Location, Location
The country has three main regions, each with a different mix of economic activities. The coast, including the capital Lima, is known for fishing and agro-industry, including the production of rice, asparagus, cotton, sugar cane and fruit. The Andes Mountain range has extensive mineral deposits including copper, gold, zinc and silver. Livestock is also important in mountainous areas of the country. The third region is the Amazon, known primarily for oil and gas deposits, as well as for forestry. The main Pacific coast port of Callao is located near the capital Lima. To the north, the inland Port of Iquitos, on the Amazon River, is an important hub for trade with Brazil and Colombia. The Pan-American Highway links Lima to the country’s northern and southern coasts. A central highway, as well as rail links, connect the capital to mining areas in the central highlands.
Competitive Edge
In the World Economic Forum’s 2016-17 Global Competitiveness Index, Peru ranked 67th out of 138 countries, having moved up two positions from the previous year. This placed it just ahead of the mid-way point on the global table. The Global Competitiveness Index is compiled using qualitative and quantitative assessments across a range of indicators, and expressed as a numerical score on a scale of 1 to 7. Peru achieved a score of 4.23, the sixth-best performer in Latin America. Countries in the region that ranked higher were Chile (33rd), Panama (42nd), Mexico (51st), Costa Rica (54th) and Colombia (61st). Peru was ahead of Uruguay (73rd), Jamaica (75th), Guatemala (78th) and Brazil (81st), among others.
The index score is based on the analysis of 12 separate areas or pillars. Peru’s strongest performance was achieved in the eighth pillar, financial market development. This includes a range of sub-indicators, such as ease of access to loans, soundness of banks and financing through the local equity market. In this area the country scored 4.7, ranking it 26th globally.
Another area of strength was the third pillar, macroeconomic environment, which includes fiscal responsibility, savings capacity and inflationary controls. Here Peru achieved a score of 5.4, ranking 33rd. In addition, the country performed well in terms of market size, with a score of 4.4, putting it in 48th place worldwide.
Peru’s weakest area was the 12th pillar, innovation. This includes sub-indicators such as capacity for innovation, quality of scientific research institutions, and company spending on research and development, among others. Overall Peru scored 2.8 on this pillar and ranked 119th worldwide. The second-weakest pillar was the first, institutions, relating to the efficiency of the legal system, business costs of crime and violence, judicial independence and public trust in politicians. On this pillar Peru scored 3.4 and ranked 106th. The third-weakest pillar was the fourth, relating to health and primary education, which covers such sub-indicators as the prevalence of malaria and tuberculosis, primary education enrolment rate and infant mortality. On this pillar Peru scored 5.3, ranking 98th.
Relative to the average for Latin America, Peru scored better for its macroeconomic environment, financial market development and labour market efficiency. However, it underperformed in areas such as technological readiness and innovation. The Global Competitiveness Index also includes a survey in which market players identify the most problematic factors for doing business. In Peru’s case, the greatest challenges were listed as inefficient government bureaucracy, cited by 19% of respondents, followed by restrictive labour regulations (15.4%), corruption (12.6%) and inadequate supply of infrastructure (11%).
Business Friendly
Another broad measure of Peru’s environment for businesses can be found in the World Bank’s “Doing Business 2017” report. This annual report measures the ease of doing business across 10 selected activities, such as starting a new company, obtaining construction permits, getting electricity and paying taxes. Across all 10 categories Peru ranked 54th out of 190 countries in terms of the overall ease of doing business. The highest rankings were for obtaining credit (16th), registering property (37th) and dealing with construction permits (51st). Areas of comparative weakness included paying taxes, which required on average nine payments a year and 260 hours of administrative effort, which put Peru in 105th place on this metric. Also somewhat difficult was starting a business, which required an average of six separate procedures and 26 days, leading to a ranking of 103rd. The World Bank did report, however, that Peru had initiated reforms to make tax payments less costly by decreasing the corporate income tax rate during the period under review.
The New Team
The new Peruvian government, which took office at the end of July 2016, can arguably claim to have the greatest macroeconomic experience of any administration over the last three decades. President Pedro Pablo Kuczynski was educated at Oxford and Princeton, and has a long track record of working for the IMF, the World Bank and several US-based investment banks. He also served as minister for energy and mines in the early 1980s, and as minister of economy and finance and then prime minister during the government of President Alejandro Toledo during 2001-06. Although he was elected as leader of a small political party, Peruvians for Change (Peruanos Por el Kambio, PPK), President Kuczynski sought to make his ministerial appointments on merit and experience, rather than by party affiliation.
Alfredo Thorne was appointed minister of economy and finance in July 2016. He, too, has a background working for the World Bank, in investment banking and as a consultant. Julio Velarde, the president of the BCRP and in office for two consecutive five-year terms since 2006, was confirmed to remain in the role for a third term for the 2016-21 period, giving a strong signal that the government will maintain continuity in monetary policy. Velarde is a former dean of Universidad del Pacífico and has also worked for a wide range of international organisations, including the International Labour Organisation, the Inter-American Development Bank and the World Bank.
Prime Minister Fernando Zavala also has a background in business. He was previously chief executive at Backus, a Peruvian brewery that was taken over by Anheuser-Busch InBev in 2016. Zavala also served as minister of economy and finance in 2005-06.
Political Considerations
An important political point that has bearing on economic policy is the fact that the PPK party won just 18 of the 130 seats in Congress. Fuerza Popular (FP), the party of Keiko Fujimori, seized an overall majority with 73 seats. Presidential candidate and FP leader Keiko Fujimori lost the second round of the presidential run-off election held in June 2016 to Kuczynski by a narrow margin. Both the PPK and FP share a common commitment to market-friendly economic policies, but the FP is slightly more inclined to favour populist political positions. In his five-year term President Kuczynski will need to rely on FP support to enact his legislative agenda.
At the start of the new administration, the government was able to negotiate a 90-day period during which, by agreement with the FP, it received the authority to push through new legislation by presidential decree. Granting a new president such initial fasttrack authority is a long-standing tradition in Peru. The 90-day period started in September 2016 and ran through early January 2017. President Kuczynski used it to introduce over 100 new reforms, covering five areas: stimulus measures for the domestic economy; action against crime; improvement to water and sewage facilities; anti-corruption measures; and a restructuring of state-owned oil company Petroperú.
Imf Assessment
In July 2016 the IMF published its annual Article IV consultation report on the state of the Peruvian economy. As the report came only a month before the new government took office, it serves as a convenient base-line assessment of the strengths and weaknesses of the economic reality that the Kuczynski administration was inheriting. One of the key points made in the report was that the Peruvian economy had enjoyed strong and balanced growth for some years, and in fact remained the fastest growing of the larger Latin American economies. This had been achieved despite the effects of the 2008-09 global financial crisis and the downturn in the global commodity cycle after 2012.
The IMF praised the country for having built up and carefully managed sizeable fiscal and monetary buffers over the preceding five years. Peru’s investment-grade rating had been consolidated, economic diversification had been fostered, private investment had been “crowded in” through partnerships in infrastructure projects and reforms had been made in the civil service, education and health care. The new government would therefore inherit “an economy with a solid foundation, good institutional frameworks in place, and structural reforms in train”.
Road Ahead
Looking forward, however, the IMF did see a number of challenges. Lower international metals prices had hit exports, investment and fiscal revenues. GDP growth had slowed sharply in 2014 to 2.4%, before recovering to 3.3% in 2015. Inflation rose by a percentage point to 4.4% in the year to December 2015, reflecting various factors including food supply shortfalls and a pass-through from currency depreciation. The authorities had reacted in a timely manner, with the BCRP raising the policy interest rate by one percentage point to 4.25% in September 2015. To counter commodity price shocks the government switched to a more expansionary fiscal policy, although capital spending remained sluggish.
In its 2016 report the IMF expected the economy to grow strongly in 2016 and 2017, by 3.7% and 4.1%, respectively, on the back of rising mining production and infrastructure investment. Downside risks were considered to be mainly external and included the possibility of slower growth in China, which would reduce demand for metal exports, and possible financial turbulence in emerging and developed economies. Upside risks were mainly domestic and included a greater-than-expected surge in business confidence if the new government was to be able to “announce decisive productivity- enhancing reforms”. More rapid execution of the infrastructure project pipeline might also lift growth prospects for the following two years.
In terms of policy recommendations, the IMF argued that with the output gap – the difference between actual and potential growth – closing in late 2017, there was no case for loosening fiscal policy. It recommended that the new government should seek a gradual fiscal consolidation so as to improve pension sustainability and build reserves against natural disasters. It also suggested controlling the government’s current expenditure to prioritise capital spending. Reducing informality and tax exemptions should boost revenues. With the commodities boom unlikely to return with anything like its former vigour, the fund also argued that growth-enhancing structural reforms, including lowering the costs of hiring and firing workers, increasing investment in non-extractive industries and achieving poverty reduction should now become a higher priority.
Government Policies
In his inaugural speech in August 2016, President Kuczynski said his priorities for the economy would be to invest in infrastructure, revive the ailing mining industry and extend basic services. One of his government’s key aims would be to double the number of people in formal employment. Speaking to the local press in August 2016, Alfonso Grados Carraro, minister of labour and employment promotion, said there would be a concerted effort to bring more workers out of informality and into tax-paying and benefits-receiving jobs, with a particularly emphasis on young entrepreneurs. Eduardo Ferreyros, minister of foreign trade and tourism, told local press in August 2016 that his target was for Peru to export $70bn worth of goods by the end of the government’s five-year term in 2021, up from $33bn in 2015, and to attract 7m tourists, up from 3.5m in 2015.
Fiscal Targets
While keeping to broad, mid-term fiscal deficit reduction targets, the new government sought some greater near-term flexibility to stimulate the economy. Congress agreed to a request from the Ministry of Economy and Finance, to partially relax fiscal targets. The maximum deficit target for 2017 was eased to 2% of GDP, up from the previously agreed 1.8%, while the targets for subsequent years were held steady at 2% in 2018, 1.8% in 2019, 1.5% in 2020 and 1% of GDP in 2020. The change in 2017 was estimated to release around PEN5bn ($1.5bn), which would be spent on priority areas including improving water and sanitation, education, health care and infrastructure development. The 2017 budget was set at PEN142.5bn ($42.2bn), roughly around 20% of GDP. Thorne said that to manage the country’s debt profile there would also be new bond issues in 2017 and some debt restructuring.
By January 2017, when the president’s extraordinary 90-day authority to issue emergency decrees expired, a total of 112 regulations had been issued. Most of these were considered pro-business moves designed to encourage foreign investment and economic growth. They included a reduction in value-added tax from 18% to 17% and the simplification of the paperwork necessary to set up small and medium-sized enterprises (SMEs). The tax burden on SMEs was also reduced, making it easier for them to pay taxes. Some of the new laws were designed to promote mining investment and encourage small-scale illegal miners to register and obtain land titles. These changes included simplification of the process for applying for smallscale mining licences and a doubling of the length of mining concessions granted by the government to 30 years, up from 15 years previously. Daniel Córdova, president of Grupo Invertir, told OBG, “The government is placing the right emphasis on concessions as the key to bridging the country’s potential PEN280bn [$83bn] in mining investments in the next five years.”
Threat To Growth
In the first nine months of the new government, an unexpected political development emerged as a serious threat to its policies designed to accelerate GDP growth. A number of corruption allegations surfaced and investigations that, taken together, had the effect of delaying key public sector investment projects. A major corruption case involved Odebrecht, Brazil’s largest construction company, which has significant operations within Peru. In December 2016 Odebrecht agreed to pay a record $3.5bn fine to Brazilian, Swiss and US authorities after admitting having paid bribes to secure contracts in a number of international jurisdictions.
In Peru Odebrecht company executives admitted to having paid $29m in bribes to officials in three different governments between 2001 and 2015. Local prosecutors also filed charges against former President Toledo after a former Odebrecht executive implicated him. Consistent with his electoral promise to crack down on corruption, President Kuczynski said Odebrecht would no longer be allowed to bid for new public contracts in the country, and would have to withdraw from all its existing projects in Peru.
The decision has had unwanted negative knock-on effects on one of the country’s biggest investment projects, the Southern Peru Gas Pipeline (Gasoducto Sur Peruano, GSP), a $7bn, 1000-km gas pipeline project designed to pump gas from the Camisea field in the Amazon region to the Pacific Coast. The 34-year concession to build and operate the pipeline had been awarded to a consortium in which Odebrecht held a 55% stake with two other partners, Enagás of Spain and Graña y Montero of Peru. It had been hoped that after the corruption revelations Odebrecht might sell its stake to another firm, enabling it to withdraw without the concession collapsing. However, attempts to find a buyer were unsuccessful. The consortium failed to close the project-funding package by the January 2017 deadline, leading the government to formally cancel the concession, triggering a $262m penalty charge. An entirely new competitive tender would need to be launched, implying a delay of 12-15 months.
The project was reportedly 37% completed at the time the concession was cancelled. Critically, from a macroeconomic point of view, the suspension of the GSP project meant that billions of dollars of capital spending earmarked for 2017 could not now be released until 2018 or 2019. In early February 2017 Gonzalo Tamayo, the minister for energy and mines, told local press that the suspension of the GSP project would reduce Peruvian GDP growth in 2017 by somewhere between 0.5 and 1 percentage point. At least in part reflecting this setback, the Ministry of Economy and Finance lowered its 2017 growth forecast from 4.8% to 3.8%.
Recent Scandal
Other complications also affected the pipeline for capital projects. A long-standing $520m project to build a new airport at Chinchero to serve Cusco, an important tourist destination, was threatened by separate claims of financial impropriety. Opposition parties have alleged that an addendum to the 40-year concession awarded by the previous government to the Kuntur Wasi consortium contained clauses that were prejudicial to the state. At the end of February 2017 Martín Vizcarra, the former minister of transport and communications and current vice-president, said the public-private partnership (PPP) to build the airport would be delayed for at least three months, as the office of the comptroller-general investigated potential irregularities. In May 2017 Vizcarra stepped down from his post in connection with the Chinchero contract. Fears that the Odebrecht enquiries could have a paralysing effect on some areas of business activity were also increased when the board of Graña y Montero presented its resignation. The company is Peru’s largest builder, employing a workforce of 30,000. The board resigned after allegations that its members may have been aware of the improper payments made by Odebrecht. The group resignation was designed to allow a new leadership to rebuild confidence, after the company’s share price dropped by two-thirds since the start of 2017.
New Stimulus Package
The government responded to the corruption enquiries and project delays in two different ways. First, it sought to inject additional stimulus into the economy to offset the interruption of key projects. Second, it announced further anti-corruption measures designed to increase fines and penalties, but also to protect the state from the losses generated by illegal activity. In March 2017 Thorne announced a package of fiscal reforms and other measures designed to inject PEN5.5bn ($1.6bn) into the economy and to help push expected GDP growth in 2017 just above the 4% mark. The minister said the money would be channelled to boost employment, transport and communications infrastructure, as well as regional and local governments. To support the recovery in mining the government was contributing to social funds, which includes money used by local governments to spend on welfare and service provision in areas where mining development is planned.
Many projects in isolated areas are subject to prior local community approval, and in some cases that in turn hinges on the provision of local government-funded services such as electricity, paved roads, or education and health facilities. Thorne said the new stimulus measures had been announced because “the environment has changed and is now much more challenging for Peru”. He added that the government had identified 12 mining projects worth $18.7bn within the overall mining project pipeline, which might reach the approval stage during 2017.
In his inauguration speech President Kuczynski also acknowledged that the corruption allegations were “a hole in the road” in the country’s desired transition to faster economic growth. The aim of the government, he said, was to seek to implement drastic anti-corruption measures that would not compromise economic growth. However, he noted that the loss of the single most important infrastructure project, the GSP, would made it difficult to achieve this aim. Regarding social funds, he also said that the government hoped it would reach PEN500m ($148.2m). Separate from that special funding, by the end of the first quarter of 2017 the government would have transferred a total of PEN2.5bn ($741m) to local governments to fund drinking water and sewerage projects. Like his economy minister, President Kuczynski was optimistic that large-scale mining projects might help fill the capital-spending gap. He told local press in March 2017 that there are plans to expand capacity at the Shougang Hierro Perú iron ore mine, which he described as “a silent project that is not much talked about, but that will be a world-class mine.”
At The Source
Among the government’s additional anti-corruption measures, Congress voted unanimously at the beginning of March to reform Article 41 of the 1993 Constitution to make the crime of corruption imprescriptible. This means that there will be no statute of limitations for crimes against state assets. The government also said it was creating a special Retention and Reparation Trust Fund into which fines and other charges would be paid. Companies facing formal charges of corruption would be prevented from transferring funds abroad until a court judgement was reached and all fines or charges due to the state were paid. The measure would affect transfers linked to the repatriation of capital, the sale of assets and shares abroad, and the repatriation of profits. International payments relating to debt servicing by companies under investigation would be subject to government approval.
Economic Performance
BCRP data for 2016 showed that GDP grew by 3.9%, an impressive result given that the Latin American region as a whole suffered a small contraction. Despite sluggish global demand, Peru’s net exports made a positive contribution to growth, with exports of goods and services rising by 12.9%. Imports of goods and services, however, were up by only 0.3%. Private consumption rose by 3.5%, while government consumption gained 4.9%.
The data did, however, confirm concerns over the performance of investment. Real gross fixed investment dropped by 4.2% during the year. The fall in investment explains the relatively weak level of import growth, since Peru is a net importer of machinery and equipment required for large investment projects. Inflation was 3.2%, just outside the 1-3% target range of the BCRP. Of some concern was that economic recovery was, at least in the short term, not boosting employment. Unemployment rose to 7.2% in the three months to the end of January 2017, up from 6.6% in the same period a year earlier.
By sectors, growth was led by mining and hydrocarbons, which increased by 16.3%; the sector represented 14.4% of total economic activity, according a February 2017 report by Wells Fargo Securities. Analysis suggested that the extractive sector had contributed two percentage points, about half the growth in GDP. The weakest sectors were fisheries, manufacturing and construction, which experienced contractions of 10.1%, 1.6% and 3.2%, respectively. Telecommunications and IT services expanded by 1.8%, while public sector utilities also did well, registering growth of 7.3%. Commerce, which represents 10.2% of GDP, grew by a subdued 1.8%.
Outlook
Considered in a Latin American context, Peru has an undoubtedly strong outlook in terms of economic growth, macroeconomic stability and export performance. Yet, in the domestic debate over economic policy, analysts seek to focus on possible impediments to growth. César Peñaranda Castañeda, executive director of the Institute of Economics and Business Development at the Lima Chamber of Commerce, told OBG that the key issue for the future was to get the rate of investment back on a growth track. He said, “I see two big issues as Peru seeks a sustainable growth path. One is macroeconomic stability, which we have had for 26 years. There was a recent red light regarding our fiscal deficit, but that has been addressed. The other is the rule of law and the strength of institutions, including the need to combat corruption. We must do more on that front.”
Rodrigo Acha, assistant manager of economic analysis at the American Chamber of Commerce in Lima, made a sharp distinction between the short-term situation on the one hand, and the medium- to long-term forecast on the other. He argued that in the short term the government’s reform agenda is being held back by corruption allegations relating to previous administrations. However, he insisted that the medium- to long-term view for the country is very solid. “I am 65-70% optimistic.” Acha told OBG. “I call that moderate optimism, not cautious optimism. When you say you are cautious you mean there is uncertainty. I do not think there is uncertainty over Peru’s direction. We are definitely moving in the right direction over the next five years, with an agenda based on liberalising the economy and making it more agile.”
Guillermo Arbe, chief economist at Scotiabank Peru, told OBG, “The economy started 2017 at a somewhat slower pace than we had hoped, and growth in 2017 may be lower than the 3.8% registered in 2016, perhaps slipping to 3.5%.” He attributed this to two factors of short-term uncertainty. One was the international environment and the pace at which global commodity prices might recover. The other concerned the impact of the Odebrecht scandal on Peru’s pipeline of capital projects, where the risk was that some of the PPPs expected to drive economic growth in 2017 would not actually be able to move forth until 2018 or 2019.
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