Weathering the storm
Published: 12 October 2011
A double blow: systemic and idiosyncratic
After expanding at Asian rates in the past five years (an annual 8.8 per cent on average in 2006-10, excluding 2009) the Peruvian economy is set to decelerate in the coming months.
Growth will recede to 6.4 per cent in 2011, stepping down further to 5.3 per cent in 2012. Slower growth would come about mainly from weaker demand, both internal and external. Thus, Peru could be subject to a double blow that has both a systematic and an idiosyncratic component.
The systematic factor arises from global conditions and impacts the economy mainly through the trade channel. Our global scenario features anaemic growth in the developed economies but no slump in commodity prices mainly due to the resilience of activity in China, as domestic demand could compensate for weaker exports.
... weaker activity prospects in the developed nations should have a direct impact on Peru's income
Given the openness of the Peruvian economy, the external shock could weigh more heavily on activity. We must keep in mind that 45 per cent of total exports are still being marketed to the US and Europe (China and other Latam countries account for about 28 per cent) so that the weaker activity prospects in the developed nations should have a direct impact on Peru's income.
Moreover, in the absence of a renewed commodities push, investment could all the same suffer a momentum loss, considering the strong correlation between the growth rate of private real investment and the price of exports. Of course, the main risk is that the global backdrop deteriorates further than what we envisage in our base scenario.
On a positive note, Peruvian external sales are to some extent hedged, as about 22 per cent consist of gold shipments which tend to be negatively correlated with copper (which accounts for 25 per cent of exports). This suggests that Peru is relatively shielded against an even steeper downturn of external conditions, particularly in the case of a sudden stop of capital inflows.
The idiosyncratic factor has to do with the local players' fear that President Ollanta Humala could relapse into his previous nationalistic stance. Business sentiment is still running low despite Mr Humala's efforts to please investors through market-friendly appointments and the moderate impact of the new mining tax on the industry's profitability following his victory in the run-off presidential election last June.
True, the recently approved Ley de Consulta Previa (Law of Previous Consultation) could lead to legal uncertainty, as it grants indigenous communities the right to be surveyed on new mining or energy projects. Also, there are other initiatives under consideration that could have a negative bearing on the business environment (eg a labour reform that raises layoff costs, caps to interest rates, revision of contracts during the previous administration and tariffs on fibres imported from China and India).
However, fears of President Humala radicalising remain unwarranted. Such a move could backfire in terms of popularity by hurting growth dynamics. Not only has the notion that Mr Humala is delivering his campaign promises boosted his popularity, but also the fact that he has pledged to uphold economic reforms, which were backed by 70 per cent of the electorate in the first round vote back in April. His recent appointment of a moderate central bank board (Banco Central de Reserva del Perú – BCRP) surprised the market to the upside. This has been interpreted as a sign of even stronger commitment to a sound monetary policy, aligned with inflation targeting.
A counter-cyclical arsenal in store
The government appears ready to introduce a new round of stimulus if the global backdrop deteriorates further. However, monetary and fiscal easing should be moderate insofar as the current crisis is not expected to have the same intensity as the 2008-09 episode.
On the fiscal front, the Humala administration has already announced a 0.5 per cent of GDP package, although there is room for additional fiscal expansion (resources in the Stabilisation Fund amount to USD6 billion or 3.4 per cent of GDP).
During the onset of the 2008-9 global financial crisis, the Peruvian government launched a 2.5 per cent of GDP counter-cyclical fiscal programme. There were implementation issues and an important part of the package was implemented too late. Learning from the experience, the government issued a decree of urgent necessity that creates a fast track for some public investment projects to be implemented by ministries and sub-national governments.
Though the size of the fiscal package is lower now, it can be quickly be escalated and implementation should be more timely. Still, public accounts should not get derailed. The commitment to a prudent fiscal management continues to be one of Mr Humala's strongest pro-market credentials, while there are several locks built into the Peruvian legal framework to hinder above-budget expenditure increases. As a result, we look to a 0.6 per cent of GDP deficit for the non-financial public sector in 2012 following a 0.8 per cent of GDP surplus this year.
... the central bank has explicitly outlined its commitment towards keeping inflation at the targeted level but in a positive growth environment
As regards monetary policy, in recent statements the central bank has explicitly outlined its commitment towards keeping inflation at the targeted level but in a positive growth environment. Unless leading indicators point to a sharp slowdown in activity, we have pencilled in a single 50bp cut in the benchmark rate in Q1 2012, to 3.75 per cent. The interest rate cut could come as a response to growth hovering around 4 per cent y-o-y in the first quarter, the slowest pace in eight quarters. Reducing marginal reserve requirements is another option, as monetary policy could be limited at the margin by the objective of smoothing changes in the exchange rate, since FX management is constrained by the high level of financial dollarisation (about 45 per cent of loans in the financial system are dollar-denominated).
The current account deficit should increase moderately from 2.1 per cent of GDP in 2011 to 2.7 per cent next year, as exports decelerate and imports continue to rise in tandem with domestic activity. Most of this shortfall would be financed via foreign direct investment (3 per cent of GDP in 2012), as portfolio inflows could become modest.
Importantly, Peru appears shielded against a reversal of capital flows. Netting out commercial banks' reserves at the BCRP (USD8.1 billion) and short term external liabilities (USD7 billion), international reserves amount to USD33.4 billion (19 per cent of GDP), a 6 to 1 ratio vis à vis our projected current account shortfall for 2012 and nearly as much as the total medium and long term external debt stock (USD35.2 billion).
Ramiro Blazquez
Ramiro Blazquez is Senior Economist within the Latin America Research Team based in Argentina, covering Ecuador, Venezuela, Chile and Argentina.
He is a graduate of the Universidad Torcuato Di Tella with an Executive MBA in Business and Economics. Before joining HSBC, he worked for the International Monetary Fund in Buenos Aires, the Center for Financial Research at the Universidad Torcuato Di Tella and the Presidential Office of the Argentine Republic.
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