After a considerable slowdown in 2014, a recovery in economic growth is projected for 2015 and 2016. This recovery will be driven by the reversal of the adverse supply shocks that affected the economy in 2014 – climate factors caused temporary disruptions in mining, fishing and agriculture – and by a fiscal stimulus. Meanwhile, it is expected that new mines become operational as well as new important infrastructure projects which will boost growth by the end of this year and the next one.
Growth will remain weak but a gradual recovery is expected
Economic activity has shown a poor performance mainly as a result of three factors. First, private consumption slowed down due to lower dynamism in the labor market which reduced job creation and increased the unemployment rate. Furthermore, food prices have risen and some surveys have revealed that more households face difficulties to pay their debts. Second, growth was adversely hit by the contraction in public investment, especially by the drop of approximately 50% of sub-national government investments, which implement more than half of all public investment. Finally, private investment also fell due to the worsening of business expectations. This suggests that investment will continue being sluggish in 2015.
Source: Central Bank of Peru.
Fiscal and monetary policy support the recovery but structural policies can boost long run growth
Fiscal policy is expected to be expansionary in 2015 and neutral in 2016. Firstly, a drop in fiscal revenues is foreseen due to various tax measures announced at the end of last year to boost activity in the short and medium term. Among these measures are a reduction in corporate and personal income tax rates, a decrease in the Selective Tax on Fuel and the simplification of the VAT schemes. On the other hand, government expenditure in investment is projected to recover finance infrastructure projects. Specifically, it is estimated that the government will invest around 0.7% of GDP in new infrastructure projects. Therefore, prospects are that the fiscal deficit will be 2 % of GDP, consistent with a decreasing trend in the gross public debt to GDP ratio at levels that will not affect the sustainability of public accounts.
Inflation is currently at the upper bound of the target band. This year, the Central Bank has lowered the policy interest rate by 25 basis points and the domestic currency has depreciated by more than 5%, in spite of the of the large interventions in the markets to contain it. Given the high level of dollarization of credit (around 40%) and considerable currency mismatches, a sharp depreciation can have a systemic impact and harm significantly economic activity. The space for new cuts in the interest rate is limited because it could increase pressures in the exchange rates. While the Central Bank could continue relying on international reserves to delimit depreciation, exchange rate interventions would reduce liquidity in the system pushing upwards the interest rate and offsetting the effect of the initial cut. Therefore, if needed, the Central bank could continue reducing reserve requirements in domestic currency to expand credit.
In the coming years growth will gain momentum thanks to the increase in mining production, especially copper, as a result of the new mines beginning to operate, which will jointly produce the equivalent of 42% of total production in 2014. Therefore, mining contribution to GDP will be around 1% to GDP in the next two years. However in the long-run, lower levels of metal prices suggest that the mining sector may no longer be an engine of strong growth. Therefore, to boost productivity and growth of potential output, structural policies are required. In particular, policies to reduce the very high level of informality, improve access to quality education and reducing the large gaps in infrastructure are required to boost productivity and competitiveness in the country.
The risks to the outlook are external as well as internal
Two important external risks remain. First, there is the risk of a stronger than expected slowdown of growth in China that could reduce terms of trade even further. Second, higher volatility in financial markets triggered by faster than expected increase in U.S. interest rates could lead to a reversal of capital flows and stronger pressures to the exchange rate creating a high risk given the country’s level of dollarization. On the domestic side, downside risks are related to a weaker than expected recovery in investment that could be affected by continuing social tensions in mining regions, or a stronger than expected impact from El Niño weather phenomenon.