IMF Executive Board Concludes 2011 Article IV Consultation with PeruPublic Information Notice (PIN) No. 11/158
December 14, 2011
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On December 05, 2011, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Peru, and considered and endorsed the staff appraisal without a meeting on a lapse-of-time basis.12
The Peruvian economy emerged largely unscathed from the 2008–09 global crisis supported by strong fundamentals and proactive macroeconomic response. Real Gross Domestic Product (GDP) expanded rapidly at 8.75 percent in 2010, one of the highest in the region, driven by private domestic demand. The recovery was propped by significant macroeconomic policy stimuli, a quick turnaround of terms of trade and favorable external financial conditions, with renewed capital inflows. Inflation, after falling to 0.25 percent in 2009, rebounded to 2 percent by end-2010 as demand picked up, the center of the target band of 1–3 percent. A new government, led by President Ollanta Humala, took office in July 2011, promising more social inclusion and continued macroeconomic stability.
Activity is expected to decelerate on the heels of tighter policies and a weaker external demand. Real GDP growth is expected to reach 6.75 percent in 2011, driven mainly by private consumption. Inflation is projected at 3.75 percent at end-2011, due mostly to supply shocks but also some demand pressures. Credit growth has stayed at about 20 percent in 2010–11.The financial sector remains sound, profitable and well-capitalized, assisted by the authorities’ active use of prudential instruments.
The outlook is for continued albeit lower growth with short-term risks titled markedly to the downside given global uncertainty. Real GDP growth is projected at 5.25 percent in 2012, slightly below trend (estimated at 6 percent), mostly due to softer external demand conditions, while inflation would decline to 2.5 percent. Inflation expectations for 2012 remain well-anchored on account of the strong inflation targeting framework. The external current account deficit would remain stable at around 2.5 percent of GDP next year as the strong terms of trade continue. Once international turbulence subsides, strong growth prospects in Peru and abundant international liquidity could increase capital inflows.
On the policy front, macroeconomic policies have focused on limiting overheating risks. The government began unwinding the previous fiscal stimulus in 2011. The fiscal position switched to an annualized fiscal surplus of about 5.5 percent of GDP in the first half of 2011 as revenues remained buoyant despite tax cuts, and expenditures were restrained due to low implementation of investment projects at the sub-national level and the presidential elections. Monetary policy has been tightened as demand recovered, with the policy rate increasing a total of 300 basis points to 4.25 percent between mid-2010 and May 2011. This was complemented with active hikes in reserve requirements. Since then, the central bank has remained on hold in light of the uncertain global economic outlook.
Executive Board Assessment
In concluding the 2011 Article IV consultation with Peru, Executive Directors endorsed staff’s appraisal, as follows:
The policy mix seems broadly adequate to maintain macro stability and foster growth. The main challenge is to ensure a timely and flexible implementation of policies to confront changing domestic economic conditions in an external environment of heightened uncertainty.
The 2012 budget proposal seems appropriate. Efforts to reinvigorate public spending in the second half of 2011 are welcome as the fiscal stance was becoming somewhat tight. Still, there will be a higher-than-expected surplus for 2011. The proposed 2012 budget, which aims at a surplus of 1 percent of GDP and entails a structural expansion of 0.75 percent of GDP, is broadly adequate as activity is expected to be softer. Additional short-term social spending can be accommodated within the expenditure limits established by the 2012 budget.
Given the uncertain external environment, monetary policy can remain on hold. In view of the expected fall in inflationary pressures (as the impact of higher oil and food prices is absorbed) and the previous tightening in monetary policy, staff supports the central bank decision to keep policy rates unchanged, at least until a clearer picture on the global outlook emerges. The authorities should continue monitoring private credit developments and ensuring risks remain contained.
Against a background of heightened risks to the global outlook, policies should remain flexible. Peru’s solid fundamentals and scope for policy response are likely to mitigate the effects of a weak world economy. As a first line of defense, and consistent with the functioning of an inflation targeting regime, monetary policy could be eased as inflation prospects decline and the output gap widens, while fiscal policy activates automatic stabilizers. Against the background of potential global financial volatility, some foreign exchange support would be warranted. Reserve requirements may be loosen if liquidity conditions become stressed or if domestic credit decelerates too rapidly.
Should tail risks in global conditions materialize, additional policy stimulus could be deployed to limit the fallout. The buildup of buffers in the last few years suggests there is space to implement a sizable policy response. Yet, the uncertainty about the nature and duration of the external shock makes advisable a gradual use of these buffers. The central bank has the capacity to inject considerable liquidity and cut rates more aggressively if external financial conditions deteriorate (although potential pressures in the foreign exchange market could become a constraint). As with the fiscal stimulus implemented in 2009, infrastructure and maintenance projects can prove effective to help sustain domestic demand and employment. Under this scenario, the policy response would only help mitigate the shock, with economic activity likely being below potential in the short term. Therefore, it will be important to design and communicate clearly the authorities’ strategy and objectives, and ensure continuity in the policy framework.
Giving more weight to structural measures to anchor fiscal policy would help cementing macroeconomic stability. This approach helps reducing procyclicality risks, enhances predictability, and accumulates fiscal buffers. Staff sees merits of targeting moderate structural overall balances of 1 percent of GDP in the medium-term to cope with the volatile global environment, contingent liabilities, and Peru’s vulnerability to natural disasters. In the short-term, current Fiscal Responsibility and Transparency Law parameters could be calibrated to maintain a relatively stable structural result, with limits to expenditure growth, unless a discretionary fiscal reaction is called for.
Tax mobilization efforts will be key to the sustainability of the social agenda. Staff welcomes the authorities’ plans to strengthen tax administration to increase the tax ratio to 18 percent of GDP by 2016 to provide additional resources to cover increasing social programs and public investments in the medium-term. The approval of the revised mining taxation framework, with due consideration for competitiveness in the sector, is a welcome first step. Staff also welcomes the authorities’ efforts to reduce tax evasion, but warns that in the event these efforts did not yield the expected results, tax measures could be considered.
Going forward, Peru’s improved fundamentals will foster further de-dollarization, allowing the exchange rate to play a larger role as shock absorber. Staff believes that some additional exchange rate flexibility, gradually implemented, is important for the private sector to strengthen its ability to assess foreign exchange risk, and may contribute to de-dollarize. Financial dollarization remains high and has actually increased in some segments given low international interest rates and appreciation expectations. A gradual increase in exchange rate flexibility would foster the development of hedging instruments and private sector awareness about managing currency risk, thereby allowing the exchange rate to play a larger role as a shock absorber.
The financial sector is strong, and the prudential framework is ahead in the implementation of proposed international standards. Peru’s financial sector remains sound, profitable and well-capitalized. Most prudential regulations aligned with Basel III will be applied ahead of the internationally-agreed schedule, with banks well positioned to implement them. Monitoring corporate balance sheets, including foreign exchange and derivative positions, will be critical to assess vulnerabilities. Formalizing an institutional setup for macro-prudential policies would facilitate monitoring systemic risks more effectively, and enhance analysis and coordination across institutions.
Peru’s bright economic prospects will benefit from an ambitious reform agenda to maintain high potential growth. Staff concurs with the view that growth will need to be increasingly driven by higher productivity over the medium term. Key pillars to ensure high growth include: (i) enhancing competitiveness by boosting human capital and infrastructure and maintaining labor market flexibility; (ii) improving the business climate to foster investment and innovation (including enhancing formality); and (iii) further developing the local capital markets to facilitate investment and better allocate savings.