IMF Executive Board Concludes 2012 Article IV Consultation with Peru

On February 13, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Peru.¹

Background

Strong economic performance and sound macroeconomic management continued in 2012. Economic growth is estimated at 6⅓ percent of gross domestic product (GDP) in 2012, and the economy is near its potential. Economic activity was driven by domestic demand, in particular investment, as the weak external environment is taking a toll on exports and widened the external current account deficit. Inflation declined to 2¾ percent (y-o-y) in December 2012, falling with the inflation target band (1‒3 percent) as the adverse supply shocks unwound after being above the upper limit of the target band during the first ten months of 2012.

Monetary policy has been geared to deal with a surge in capital inflows. While the Banco Central de Reserva del Perú (BCRP) has kept the policy rate unchanged at 4¼ percent since May 2011, monetary conditions tightened in 2012 through the use of reserve requirements. The large capital inflow, of which about one-half is in the form of foreign direct investment (FDI), has led BCRP to a policy of foreign exchange intervention cum sterilization, to avoid a sharp appreciation of the currency in the context of a dollarized economy. Private credit growth has remained at around 16½ percent (y-o-y) for the first ten months of 2012, with significant growth in the consumer and mortgage segments—both also reporting a pickup in U.S. dollar lending. The banking system continues to be sound, profitable and well-capitalized.

The fiscal stance was tighter than envisaged in the 2012 budget. The non-financial public sector overall surplus is estimated to have reached over 2 percent of GDP in 2012, (higher than the 1 percent surplus included in the 2012 budget), due to higher-than-forecasted revenues and the lower budget implementation despite efforts to accelerate public sector investment.

The near-term outlook remains favorable but risks to the economy lurk in both directions. Real GDP growth is projected at around potential (6−6½ percent) in 2013 supported by domestic demand and elevated commodity prices. Inflation in 2013 is expected to remain subdued and converging to the mid-point of the target band (1−3 percent). On downside risks, the economy is most vulnerable to a growth shock in China that permeates through lower commodity prices in the short term. The lack of a medium-term plan for U.S. fiscal consolidation could also hamper Peru’s economy over the medium term. Upside risks to growth and inflation could result from ample global liquidity and capital inflows in the context of low growth in advanced economies. Over the medium term, the economic outlook hinges on bolstering resilience to shocks and fostering productivity growth.

Executive Board Assessment

Directors commended Peru’s impressive macroeconomic performance, underpinned by strong fundamentals and sound policy management. Growth is strong, inflation and public debt are low, and progress has been made in reducing poverty and improving living standards. The near term outlook remains favorable despite the adverse external environment. However, risks to the outlook are related to terms of trade shocks on the downside, and to excess global liquidity and a surge in capital inflows on the upside. Directors emphasized the importance of continued implementation of flexible and coordinated policies as well as structural reforms to maintain macroeconomic stability and foster more inclusive long term growth.

Directors considered near term fiscal policy to be broadly adequate and took note that the 2013 budget targets a surplus. While the current fiscal framework has served Peru well in reducing debt and building public sector savings, Directors saw merit in strengthening the framework by establishing an appropriate anchor which aims at ensuring prudent management of non renewable resources and intergenerational equity, and enhancing the predictability of public spending. They looked forward to the recommendations of the commission appointed by the authorities. Directors welcomed the efforts to strengthen tax administration and compliance and agreed that these measures will create space for priority social programs.

Directors supported the neutral stance of monetary policy given low inflation and well anchored inflation expectations. However, they encouraged the authorities to remain vigilant and flexible to changing domestic and global conditions. Proactive use of reserve requirements, in coordination with other prudential measures, should help manage excess liquidity and strong credit dynamics. Directors welcomed the central bank’s recent modifications to its intervention policy which is expected to increase exchange rate flexibility. Continued efforts in this regard would help provide a buffer against external shocks, reduce sterilization costs and assist the private sector to better internalize foreign exchange risks.

Directors agreed that stronger macro prudential measures would help limit the buildup of financial vulnerabilities in the context of large capital inflows, strong credit growth, and increases in asset prices. They noted that enhanced institutional coordination between the monetary, financial and fiscal authorities in managing systemic risks and designing macro prudential policy would facilitate a prompt policy response. Directors supported closer monitoring of corporate and household balance sheets to better assess macro financial risks.

Directors underscored the importance of structural reforms to foster a more sustainable and inclusive growth path. Priorities should focus on enhancing competitiveness, defining a nationwide strategy to remove infrastructure bottlenecks, improving the business climate, and developing local capital markets to further facilitate investment and better allocate savings. Stronger emphasis on improving education and healthcare will also be important.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.