Responsible spending: Fiscal policy takes time to stimulate the economy

Faced with slower GDP growth in 2014 and 2015, Peru is working to reinvigorate economic expansion through a series of counter-cyclical fiscal measures, aimed at developing infrastructure and education in particular. However, these spending packages have so far met with mixed results and will likely require more time to yield the broader benefits envisaged.

Mario Guerrero, head of economic research at the Canada-based Scotiabank, told OBG that the key issue is that around two-thirds of total government spending is carried out by regional governments, not by the central administration in Lima. “Regional governments were elected in October 2014 in a campaign that was marked by controversy over claims of corruption,” he told OBG. “As a result, the new administrations that have taken office since then have been extremely cautious on the spending front and are reluctant to launch big new projects. That may imply a delay of six months.”

It also has to be borne in mind that regional governments usually spend only around 70% of their annual budget, although there are sharp variations. In the first 10 months of 2015, for example, the regional government in Piura was reported to have utilised only 45% of its budget. According to press reports, the regional government of Puno, in turn, had executed only 19% of a special budget for preventive measures against natural disasters such as flooding caused by the tropical weather system El Niño.

Other analysts agree that regional public sector expenditure management systems need to be strengthened. Gonzalo Zegarra, executive director of Semana Económica, a financial weekly, told OBG,“There have been problems with the decentralisation of government. At the local level there is a lack of project and budget management skills, which leads to chronic underspending.” Zegarra added that regional governors cannot be re-elected for consecutive terms in office, which last only four years. While this ban is designed to promote democratic alternation, it has the unintended consequence of preventing the accumulation of public sector budget management experience.

Need For Capacity Building

A report by the World Bank in October 2015 highlighted what it said was the need for further reform within the decentralised system of government. The report said major disparities in income and access to basic services needed to be tackled, citing a misalignment in the allocation of responsibilities and resources, and a “lack of institutional capacity at the municipal level”. The bank also underscored then need for capacity building at regional and local levels. It went on to make the point that the dominance of Lima, with 28% of the population and 54% of GDP, has sometimes been at the expense of other regionally based economic development opportunities. The implication is that fiscal policy should support infrastructure and investment that promotes regional growth and development. “Lima’s expansion has provoked an increased need for relocating industrial companies. As a result, this has raised the demand for industrial park spaces in the outskirts of the capital,” Jorge Reategui, CEO of Peruvian development firm Bryson Hills, told OBG.

Modest Fiscal Deficit

The overall fiscal picture in 2015 has been one of falling government revenues, caused by falling commodity exports, declining economic activity and income, and fuel tax reductions implemented in late 2014. A lower value of mining exports has also taken its toll: in the first seven months of 2015 mining accounted for 6.2% of total government tax revenue, compared to 17.5% in 2011.

Spending, meanwhile, has been increasing, as the government has sought to stimulate the economy. As a result, the non-financial public sector has swung from a budget surplus to a deficit. However, this counter-cyclical shift towards deficit spending has been slower and smaller than the authorities had hoped. Efforts to boost public sector spending in 2015 had mixed results. Total first-half non-financial public sector expenditure was 17.8% of GDP, marginally down on the 17.9% achieved in the first half of 2014. An analysis of the data shows that the most dramatic change has taken place in public sector capital spending, principally due to the very sharp slowdown in regional government development projects. Gross fixed public sector capital formation had grown by 0.1% in the first half of 2014, but was down by 0.2% for that year as a whole. In the first half of 2015, however, it plummeted by 19.7%. In its May 2015 report, the Central Reserve Bank of Peru (Banco Central de Reserva del Perú, BCRP) reported that it believed there would be enough of a second-half catch-up to end the year with an overall drop of just 2.2%.

By the time it issued its September 2015 report, however, the BCRP recognised further slippage and forecast a 9.6% contraction for the year, before public sector investment would return to positive growth territory with expansion of 5.1% in expected in 2016. However, it has to be recognised that this investment turn-around could be further delayed by the April 2016 elections and the time it might take the new government, due to take office in July 2016, to define and begin implementing its priorities.

The 12-month fiscal result had been in surplus since the beginning of 2011, peaking at just over 2.7% of GDP in mid-2012, when economic growth was particularly strong. Throughout 2014, as revenues began to fall, relative to previous years, and the government sought to take a more fiscally expansive stance, the surplus narrowed, turning into a deficit for the first time in the last quarter of that year.

In the 12 months to the second quarter of 2015 there was a deficit equivalent to 1% of GDP. In its September 2015 report on the economy the BCRP predicted that the deficit would reach 2.2% of GDP in 2015, an increase on its earlier projection of 2%. Thereafter it forecast that the deficit would expand further to 2.7% of GDP in 2016.

2016 Budget

The draft 2016 budget was approved by the Cabinet and submitted to Congress at the end of August 2015. It called for a total spend of PEN138.49bn ($44.2bn), representing a nominal increase of 6% on the opening budget approved for 2015. Of the total, PEN89.78bn ($28.7bn) or 64.8%, was allocated to current expenditure, PEN36.98bn ($11.8bn, 26.7%) for capital expenditure, and the remaining PEN11.73bn ($3.7bn, 8.5%) was earmarked for debt service payments.

The Ministry of Economy and Finance (Ministerio de Economía y Finanzas, MEF) said the overall aim of the budget was to support economic recovery while maintaining responsible fiscal management. The MEF also highlighted that the budget sought to prioritise investment and increase resources to take preventive measures against El Niño weather disruption, as well as to ameliorate any damage that might be caused. A special budget category, known as the Programme to Reduce Disaster Vulnerability, was given a PEN2.09bn ($667.1m) allocation, double the level in 2015. Further support was also available through a special fund and contingent credit lines with international multilateral lending institutions. Another budget priority was education spending, where efforts would be made to close the gap in provision between urban and rural areas, and improve teachers’ salaries as well as the physical infrastructure of schools. Spending on social programmes was set to increase by 6.2% in nominal terms to PEN5.35bn ($1.7bn). The ministry noted that the capital expenditure budget represented an increase of 12.2% on 2015 levels.

An important feature of the budget for 2016 is its attempts to facilitate more streamlined spending by regional governments. Article 13 of the budget law allows regional governments to reallocate spending within the overall budgets assigned to them. During the debate on this regulation, Alonso Segura, minister of finance, said that without this authority, each regional government budget change would need to be sent back to Lima for congressional approval, generating over 2200 requests for amendment.

Borrowing Requirement

According to the BCRP, the fiscal deficit estimated for 2015 and projected for 2016 on the basis of the budget proposal would generate a manageable non-financial public sector financing requirement. In 2015 this was estimated at PEN21.55bn ($6.9bn), of which the majority, or PEN16.32bn ($5.2bn), would be raised through domestic and international bond issues.

The expected 2016 financing requirement was PEN23.72bn ($7.57bn), of which most – PEN17.57bn ($5.6bn) – would again be raised through bonds. As a result of this extra financing need, gross public sector debt, expressed as a proportion of GDP, would rise from 20.1% in 2014 to 22.4% in 2015, and to 24.2% in 2016. However, no further growth was expected in 2017, when, the debt ratio is expected to stabilise at 24.2% as a result of the recovery of the economy.