Peru- Concluding Statement of the 2012 Article IV Consultation Mission
December 18, 2012
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Sound macroeconomic management and strong economic performance continued in 2012, and the economy is now running close to its potential. In addition, several structural reforms have been implemented. The near-term outlook remains favorable, but subject to risks. In particular, negative terms of trade shocks could reduce exports, investment and growth; while ample global liquidity and capital inflows could lead to overheating. Monetary policy should continue to be neutral if underlying inflation remains subdued and expectations well-anchored. Macro-prudential measures should be used more proactively to limit the buildup of financial vulnerabilities in the context of large capital inflows and strong credit growth. Additional exchange rate flexibility will help the Peruvian economy to absorb external shocks, and assist the private sector to better internalize foreign exchange risks. Prudent implementation of the 2013 budget is expected to continue. The fiscal framework should cement a prudent management of non-renewable resources and avoid pro-cyclicality. To address long-term challenges and improve growth prospects, Peru should tackle long-standing structural bottlenecks to enhance productivity and revamp infrastructure through a well-designed national investment strategy.
A. Context, Outlook and Risks
1. Growth performance in 2012 exceeded expectations, with inflation converging to the target band. Real GDP growth is projected to slow to 6.3 percent in 2012 with the output gap closing by year-end. Stronger-than-envisaged domestic demand—in particular private investment—has offset weaker export performance due largely to lower export prices. Inflation declined to 2.7 percent in November 2012, falling within the inflation target range (1 to 3 percent), reflecting the reversal of food supply shocks. The current account deficit is estimated to have increased to almost 4 percent of GDP in 2012, mostly due to deteriorating terms of trade and strong import growth. However, the external current account deficit is more than financed by foreign direct investment (FDI) inflows. The financial sector remains sound, profitable, and well-capitalized, but credit dollarization remains high.
2. Macroeconomic policies were geared towards managing the surge in capital inflows and strong credit growth.
- The fiscal stance was tighter than envisaged. The overall fiscal surplus of the non-financial public sector (NFPS) is estimated to have reached 2.1 percent of GDP in 2012, which helped sterilization efforts. As in the previous year, the stronger fiscal outcome was due to higher-than-forecasted revenues and under-executed expenditures. The structural fiscal surplus as measured by IMF staff is expected to have reached 1.6 percent of GDP.
- Monetary conditions were tightened through reserve requirements. While the BCRP has kept the policy rate unchanged at 4¼ percent since May 2011, average reserve requirements have been hiked by a cumulative 375 basis points since early 2011 to dampen strong credit growth. The Nuevo sol has appreciated by about 4¾ percent in real effective terms this year. The BCRP has intervened in the foreign exchange market with a net purchase of US$12 billion as of end-November 2012, to avoid a sharp appreciation of the currency in the context of a dollarized economy (about ⅓ of deposits and less than ½ of credits in the banking system remain in U.S. dollars) with an open capital account. Gross international reserves will reach US$64 billion in 2012 (32 percent of GDP), accompanied by increasing sterilization costs.
- Prudential regulations were strengthened. The mission welcomes recently adopted prudential measures, including liquidity requirements in line with Basel III criteria, as well as higher provisioning and capital requirements to help financial institutions internalize foreign exchange credit risks. The mission also welcomes measures to deter FX lending in automobile and other consumer loans.
3. The near-term outlook remains favorable but risks lurk in both directions. Real GDP growth is projected at potential, supported by buoyant domestic demand and continued elevated commodity prices, while inflation is expected to remain subdued.
- Downside risks from the global economy could have a significant effect on Peru primarily through terms of trade shocks. The combination of a sharp relapse in global growth and a return of global risk aversion is the principal tail risk that could encumber the growth outlook. A significant fall in metal prices—triggered by a larger-than-envisaged slowdown in China, Peru’s largest trading partner—would have a significant negative effect on exports, investment and growth prospects.
- Upside risks could result from ample global liquidity and capital inflows in a context of anemic growth in advanced economies. Peru’s combination of long-standing macroeconomic stability and prudent policy management with positive growth prospects could further stimulate large and sustained capital inflows that could test the absorption capacity of the economy and pose significant policy challenges. Despite subdued inflation prospects, strong capital inflows could result in buoyant domestic demand dynamics, heightened overheating risks and potential credit and asset price booms.
B. The Challenges of the Near-Term Policy Mix
4. The current policy stance appears broadly adequate, but should remain flexible to react to risks associated with strong domestic demand dynamics, large capital inflows and rapid credit growth.
- Fiscal policy. The approved 2013 budget aims at a fiscal surplus of about 1 percent of GDP, in line with the multi-year macroeconomic framework published in mid-2012. Staff estimates that the fiscal surplus could be about ½ percent of GDP higher in 2013 due to strong metal prices and normal levels of expenditure execution. The 2013 budget includes a number of measures related to strengthening tax compliance and enforcement as well as additional spending on social programs and wages for civil servants whose salaries have been frozen for several years. Despite the strong fiscal position for 2013, the budget accommodates an increase in primary spending of about 10 percent in real terms to gradually achieve the goals set by the government on social inclusion and public sector reforms to promote a better civil service. Staff estimates that there will be a structural expansion of about ½ percent of GDP, which is mildly pro-cyclical in part due to the higher-than-budgeted surplus in 2012. Prudent implementation of the 2013 budget is expected to continue.
- Monetary policy. In view of the expected fall in inflationary pressures (as supply shocks unwind) and the tightening in monetary conditions resulting from hikes in reserve requirements, the mission supports the central bank decision to keep policy rates on hold. The proactive use of reserve requirements, in coordination with prudential measures, should help in containing risks associated with strong private credit dynamics.
- Exchange rate policy. The exchange rate is broadly in line with fundamentals, but the current account deficit has widened recently due to strong import growth. The mission supports efforts to allow for higher exchange rate flexibility. This will help enhance the shock absorber role of the exchange rate over the medium term, help the private sector internalize exchange rate risks and reduce sterilization costs.
- Macro-prudential measures. To reduce the buildup of external borrowing, additional macro-prudential measures may be required. To deter domestic FX lending, existingregulation may prove insufficient in light of the expected appreciation of the Nuevo sol and easy global financial conditions. Furthermore, macro-prudential measures could also penalize more heavily FX lending at long-term maturities. Finally, strengthening supervision may be required to ensure that banks adequately assess FX credit risks.
5. The authorities are relatively well-positioned to cope with negative spillovers. Under a scenario of global financial disruption and a surge in risk aversion which leads to a reversal of capital inflows, the central bank can deploy resolute actions to maintain confidence and ensure orderly functioning of markets through higher exchange rate flexibility and the use of reserves, liquidity buffers, repo operations and dollar swap auctions. Exchange rate flexibility should play a key buffering role. Under a long-term global stagnation scenario, monetary and macro-prudential policies should be eased as the first line of defense. If a sharp deterioration in terms of trade materializes, a fiscal stimulus—in conjunction with the above—could be effective to ease the adjustment in economic activity and employment.
6. If upside risks materialize, policy coordination may prove challenging to ensure a timely and effective response to overheating risks. In the context of large capital inflows and strong domestic demand dynamics, a multipronged and more coordinated policy response may be needed to confront the macroeconomic challenges. Under this scenario, tightening monetary conditions will need to rely on a combination of quantitative measures, including reserve requirements, hikes in policy rates and higher exchange rate flexibility. In parallel, tighter prudential measures would help prevent the buildup of financial underlying vulnerabilities in light of rapid credit growth. In coordination with warranted macroeconomic policies adjustment, additional targeted, transparent and temporary measures, including those to ease limits on investments abroad by the private pension funds or to deter external financing, may be used in response to a surge in capital inflows. If upside risk materialize, fiscal policy could also make additional efforts in moderating the pace of government spending to complement monetary policy.
C. Medium-Term Challenges to Ensure High Economic Growth
7. Peru needs to put in place an ambitious reform agenda to enhance potential growth, supported by a more socially inclusive strategy. The mission concurs with the authorities’ view that economic growth will need to be increasingly driven by higher productivity. It agrees with the authorities on the need to deepen structural reforms. Key pillars include: (i) enhancing competitiveness by boosting human capital and maintaining labor market flexibility; (ii) defining a nationwide strategy to remove infrastructure bottlenecks; (iii) improving the business climate to foster investment and innovation (including enhancing formality and strengthening institutions); and (iv) further developing the local capital markets to facilitate investment and better allocate savings. These reforms, together with more effective implementation of social programs in line with the agenda of the Ministry of Social Development and Inclusion, will allow the authorities to deliver more socially inclusive economic growth.
8. Since elevated commodity prices are expected to persist, the authorities have the opportunity to put Peru on a sustainable high long-term growth path. Adopting a firm and prudent medium-term anchor for fiscal policy would help contain demand pressures in the short run, while laying the basis for balanced economic growth and equitable spending of mining wealth across generations. Critically, the authorities need to define a comprehensive public investment strategy that upgrades infrastructure and removes bottlenecks. This will require identifying infrastructure needs and capacity constraints at the national and subnational levels, establishing priorities, and evaluating financing needs while identifying opportunities for PPPs over the medium term.
9. The authorities are working on strengthening the fiscal framework, including by adopting an adequate fiscal anchor that considers non-renewable wealth. Building on the success of Peru’s Fiscal Responsibility and Transparency Law in reducing public debt and ensuring fiscal responsibility, a fiscal anchor should enhance the predictability of public spending growth in the medium term taking into account commodity prices and consider intergenerational equity in the use of natural resource wealth. An anchor would also need to consider fiscal risks associated with contingent liabilities and natural disasters, as well as the need to close the infrastructure and social gaps over time. Given capacity constraints, fiscal savings in the short term could be partially deployed as capacity expands to ensure high quality of investment. Over the medium-term, staff sees merit in running a small structural fiscal surplus of around 1 percent of GDP to address unexpected contingencies. A strong political commitment as well as the steady implementation of a fiscal rule is equally important. The mission also suggests a communication strategy to gain public support for fiscal savings in Peru under the current elevated commodity price cycle. Over the medium term, the trend in current expenditure should be moderated to avoid challenges to macroeconomic management.
10. The mission welcomes the authorities’ recent efforts to strengthen tax administration, but achieving medium-term tax targets will be challenging. Peru’s tax collections are low compared with other emerging markets in terms of revenue mobilization and tax effort (i.e., the ratio of actual revenues to potential) while investment and public social spending is lower than in other emerging economies with similar per-capita income. The strengthening of SUNAT is a step in the right direction but requires further upgrading. The mission endorses the authorities’ efforts to raise tax compliance. The government’s goal of raising tax revenues to 18 percent of GDP by 2016 will allow the country to achieve similar tax collections as in other emerging economies and will help expand social programs. Staff encourages the authorities to take the necessary measures to ensure that the ambitious tax objective is achieved.
11. It will be important to continue enhancing financial supervision and prudential measures, to limit the buildup of systemic risks. Further capital inflows to Peru risk fuelling credit and asset price booms. The presence of financial conglomerates, coupled with continued strong credit growth, could increase systemic vulnerabilities as financial deepening may result in uncharted credit risks. In this regard, the mission welcomes the proactive use of prudential measures and efforts to improve corporate governance and supervision of conglomerates. Going forward, consideration should be given to strengthening the financial resolution framework for systemic stress conditions and revisiting the initiative to include cooperatives under SBS supervision. Additional coordination in managing systemic risks and designing macro-prudential policy could facilitate prompt policy response. Also, the mission recommends monitoring household and corporate sector balance sheets, including FX mismatches, in a systematic way to better assess macro-financial risks.
The mission would like to thank the authorities and senior officials at the Central Bank, Ministry of Finance, Superintendency of Banks, and other ministries and public and private agencies, for their cooperation and frank and cordial discussions.