## cr18225-perubundle

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---

### Context
- Peru described as "one of the top performers in Latin America since the turn of the century" during a commodity boom.
- Macroeconomic anchors:
  - Inflation target range: 1–3 percent.
  - Fiscal rule ceiling for public debt: 30 percent of GDP.
- Tailwinds and headwinds:
  - Commodity terms of trade picked up since mid-2016 but remain below the 2010–2014 average.
  - Domestic headwinds: slow rebuilding of infrastructure and housing after severe floods and landslides, logistical challenges, capacity constraints, and spillovers from the Lava Jato corruption investigation.
- Political context and actions:
  - President Kuczynski resigned in March 2018 following impeachment attempts related to Odebrecht.
  - Minimum wage hike of around 9½ percent approved in March.
  - New President Vizcarra requested special legislative powers in six areas and passed law 30737 clarifying civil damages in corruption cases.
  - Fiscal measures: excise tax hikes, improving tax administration, and streamlining current expenditures.

### Recent developments (macroeconomic, monetary, fiscal, external, financial)
- Growth and output:
  - 2017 GDP growth: 2½ percent.
  - Output gap: remains negative.
  - 2018Q1 GDP growth: 3.2 percent (yoy).
- Inflation and monetary policy:
  - Headline inflation in May 2018: 0.9 percent.
  - Core inflation in May 2018: 2.1 percent.
  - Inflation expectations in May 2018: 2.2 percent.
  - BCRP policy rate reduced from 4¼ to 2¾ percent starting May 2017 and on hold since April 2018.
  - Marginal reserve requirement rates on FX and local currency liabilities reduced from 70 and 6.5 percent in December 2016 to 36 and 5 percent, respectively, in June 2018.
- Fiscal sector:
  - Tax revenues growth (January–April 2018): 21 percent (yoy).
  - Public investment growth about 14 percent (y/y).
  - 12-month cumulated deficit of the NFPS through April 2018: 2.7 percent of GDP.
  - Public debt closed 2017 at 25¼ percent of GDP.
  - Recent fiscal measures: excise tax increase with full-year gain of 0.4 percent of GDP; decree reducing current spending by 0.3 percent of GDP relative to the 2018 budget.
- External sector:
  - 2017 current account deficit: 1.3 percent of GDP.
  - Exports grew 21 percent in 2017.
  - Gross international reserves in 2017: US$63.7 billion (nearly 30 percent of GDP), close to 280 percent of the ARA metric.
  - BCRP purchased $5.2 billion (2.4 percent of GDP) in the spot market in 2017.
  - Non-resident holdings of local currency bonds: around 5.1 percent of GDP in Q1 2018; ownership share around 39 percent in March 2018.
- Financial sector:
  - NPL ratio in March 2018: 3.4 percent of total loans.
  - Loan provisioning coverage: 151 percent.
  - Banking system ROA in March 2018: 2.1 percent.
  - Banking system ROE in March 2018: 18 percent.
  - Capital adequacy ratio in February 2018: 15.2 percent.
  - Deposit dollarization below 40 percent by March 2018; loan dollarization around 30 percent.
  - Credit growth in 2017: about 5.5 percent; picked up to around 7 percent as of end-March 2018.

### Outlook and risks
- Growth projections:
  - 2018 growth forecast: 3.7 percent (driven by domestic demand and public investment rising about 0.4 percent of GDP; overall fiscal impulse of 0.2 percent of GDP).
  - 2019 growth projected to accelerate above 4 percent, then gradually decline back to potential thereafter.
  - Potential (estimated): 4 percent.
- Inflation outlook:
  - Headline inflation expected to gradually return to the center of the BCRP’s 1–3 percent target range.
- Fiscal outlook:
  - Fiscal deficit expected to converge to 1 percent of GDP by 2021 in line with the fiscal rule.
- Risk channels and stress results:
  - Growth-at-risk (GaR): external conditions are the largest drivers of short-horizon growth risk; even at the 5th percentile, projected growth about 2.1 percent 1-year ahead and 1.7 percent 3-year ahead.
  - Banking stress test: sector can withstand a severe GDP shock (deviation of around 9½ percent over three years from the baseline) and a sol depreciation of nearly 20 percent.
  - Corporate stress tests: sector broadly capable of withstanding adverse macro shocks, with vulnerabilities in some domestic-oriented sectors.
- Key downside risks:
  - Domestic: delays to public investment projects and PPPs due to capacity constraints and corruption investigations.
  - External: more protectionist trade policies, a slowdown in China, or a more rapid increase in international interest rates.

### Short-term policy recommendations
- Maintain countercyclical fiscal and monetary policies in the short run; structural reforms are essential complements.
- Expand public investment given the negative output gap and reconstruction needs; focus on execution capacity, especially at subnational level.
- Monetary policy: remain data dependent; communications improvements recommended.
- Exchange rate policy: allow two-way flexibility; limit FX interventions to disorderly market conditions.
- Macroprudential: increase capital surcharges for systemic banks and consider countercyclical provisioning for smaller banks.

### Tax reform and fiscal framework
- Tax system described as complex with numerous special regime exemptions and overlapping withholding schemes.
- Priority reform areas:
  - Reduce compliance gaps, especially the VAT gap, estimated around 3 percent of GDP.
  - Move towards a less fragmented income tax regime.
  - Make personal income taxes more progressive.
  - Rationalize tax exemptions.
  - Increase revenues from property taxes.
- Medium-term budget framework:
  - Importance of maintaining progress toward implementation of the medium-term budget framework as consolidation begins in 2019–20.
  - Multi-annual allocations should be treated as credible ceilings.
- Authorities’ revenue expectations:
  - Authorities believe proposed tax administration measures could increase revenues by nearly two percent of GDP by 2021.

### Monetary policy: stance, rationale and enhancements
- Current stance:
  - Real policy rate stands at just 0.6 percent.
  - BCRP’s estimate of the neutral rate: around 1¾ percent.
  - Core inflation and inflation expectations near the mid-point of the target range (two percent).
  - Staff baseline suggests limited scope for additional cuts given projected narrowing of the output gap.
- Suggested enhancements:
  - Improve communications on conditions for future policy rate moves.
  - Allow greater exchange rate flexibility to stimulate market development and support dedollarization.
  - Restrict interventions to disorderly market conditions; interventions in 2017 amounted to 2½ percent of GDP.

### Financial stability, structure and regulatory recommendations
- Systemic concentration:
  - Two largest conglomerates control around US$67 billion (33 percent of GDP).
  - Four largest banks hold around 80 percent of private banking sector assets.
- Off-balance sheet exposures:
  - Notional value of untriggered guarantees approximately 121 percent of total capital for large banks in the sample; 90 percent are “cartas fianzas”.
  - SBS analysis: about 40 percent of construction-related guarantees at very low risk; stress-test used remaining 60 percent and found an additional decline of 0.3 p.p. in system-wide total capital.
- Dedollarization and FX exposure:
  - Current dollarization: around 40 percent of deposits and 30 percent of loans remain dollarized.
  - Recommendation: increase risk weights on FX loans in line with recent Basel III guidelines; tie changes in FX reserve requirements to dedollarization or macrofinancial shocks.
  - FX reserve requirement ratio reported: 36 percent.
- Supervisory and macroprudential framework:
  - Pass legislation to migrate supervision of cooperatives to the SBS.
  - Remove legal limitations for consolidated supervision of financial conglomerates; continue transition to risk-based supervision of insurance.
  - Improve macroprudential framework by enhancing mandates for the BCRP and the SBS and implement a memorandum of understanding for coordination.
- Financial inclusion and development:
  - Branch penetration quadrupled over the last decade; overall financial depth remains low.
  - Recommendations: strengthen competition and consumer protection frameworks; reform the e-wallet Billetera Móvil (BiM) to increase interoperability and digitize government payments; consider fintech regulatory approaches such as regulatory sandboxes.

### Growth, governance, and social protection
- Productivity and misallocation:
  - TFP growth outperformed LAC peers during the boom but disappointing recently.
  - Labor productivity remains at one-fifth of the U.S. level.
  - Misallocation is a key driver of low productivity; manufacturing shows substantial misallocation (misallocation term positive but close to zero) and services worse.
  - Priority areas: education, infrastructure, institutions, and labor market reform.
- Governance and Lava Jato fallout:
  - Corruption identified as the greatest problem to doing business; Odebrecht fallout reduced GDP growth by an estimated 0.8 percent of GDP in 2017.
  - Recommended measures: conflict of interest statements, improved exchange of financial intelligence, strengthen asset declaration systems (verification, beneficial ownership, public access), enhanced AML/CFT supervision, beneficial ownership registry, customer due diligence for PEPs.
- Poverty, redistribution, and resource revenue sharing:
  - Less than a quarter of the population below the national poverty line in 2017; poverty increased in 2017 after strong declines during the boom.
  - Recommendation: increase tax revenues and make personal income tax more progressive; re-think distribution of natural resource revenues to reduce horizontal inequities.
- Pensions and social protection:
  - Contribution densities: SPP 40 percent, SNP 34 percent (affiliates contribute for 4 to 5 months out of 12 on average).
  - Projected replacement rates (2018–2047):
    - SNP (baseline): decline from over 40 percent in 2020 to around 20 percent in 2047.
    - SPP (baseline): decline marginally from around 25 to 22 percent.
    - Baseline real rate of return for SPP: 4.2 percent; upside scenario 5.2 percent yields replacement rates of 30 instead of 22 percent in 2047.
  - Reform scenarios and impacts:
    - Fee reduction of 0.5 percentage points: raises replacement rates by over 3 percentage points.
    - Broadening contribution base by including 13th and 14th salaries: increases replacement rates by close to 3 percentage points.
    - Increasing contribution rates by 5 percentage points: largest effect but may adversely affect labor formalization.
    - Reducing SNP vesting period by 5 years: raises average replacement rates by over 5 percentage points and reduces inequities, with fiscal implications.

### Authorities’ views and alignment with staff
- Authorities share staff’s short-term outlook and consider medium-term growth could reach 5 percent with planned reforms.
- Commitments: improve execution and quality of public investment; strengthen tax policies and administration; streamline current expenditure; enhance governance; boost competitiveness.
- Authorities stressed commitment to the fiscal rule and expected acceleration of public investment in 2018–19, noting subnational capacity constraints.
- Authorities noted no regulatory barriers to market entry in financial sector; agreed off-balance sheet items warrant monitoring.

### Staff appraisal and institutional engagement
- Staff sees a window of opportunity due to higher commodity prices and reduced political uncertainty to address domestic challenges and lift potential growth.
- Remaining headwinds: slow reconstruction following El Niño damages and investment drag from Lava Jato.
- Staff recommends the next Article IV consultation on a 12-month cycle.

### Annex I — Implementation of Past Fund Advice (selected)
- Fiscal policies: short-term reconstruction stimulus and tax-to-GDP increases in progress; excise rate increases implemented and electronic invoicing mandated for some agents as of January 1, 2018.
- Monetary and FX policies: monetary easing completed; FX reserve requirement changes partially implemented and being normalized.
- Financial policies: formalizing Financial Stability Council not implemented; broadening supervisory perimeter in progress (bill approved to reform supervision of cooperatives).
- Structural policies: labor market flexibility not implemented; informality reduction, infrastructure closing, business climate improvements, and anti-corruption measures are in progress.

### Annex II — External Sector Assessment (selected)
- Current account developments:
  - CA deficit shrank from 2¾ percent of GDP in 2016 to 1¼ percent of GDP in 2017.
  - Medium-term CA deficit expected to widen to about 2 percent of GDP as investment and domestic demand recover.
- External position assessment:
  - CA-based approach: positive current account gap of 1.6 percent of GDP in 2017 (external position moderately stronger than implied by fundamentals).
  - EBA CA norm: -2.6 percent of GDP (standard error 1 percent of GDP); cyclically adjusted CA deficit estimated at -1.0 percent of GDP.
- Net International Investment Position (IIP):
  - IIP strengthened to -36½ percent of GDP in the last year; projected to improve slightly to about -33–34 percent of GDP in the medium term.
- Reserves and adequacy:
  - Gross international reserves: US$63.7 billion in 2017 (nearly 30 percent of GDP), about 280 percent of the ARA metric (230 percent when augmented for commodity-export uncertainty); subtracting large FX banking liabilities yields 162 percent of the augmented ARA metric.
- BCRP FX interventions:
  - 2017 spot purchases: $5.2 billion (2.4 percent of GDP); limited use of non-spot instruments.

### Annex III — Macro-Financial Stability Update (selected)
- Financial soundness:
  - Banks well-capitalized, liquid and profitable; NPLs 3.4 percent and provisioning coverage 151 percent.
  - Credit growth moderate: around 5.5 percent in 2017; negative credit gap since 2016.
- Stress tests:
  - Banking system resilient to severe macrofinancial shocks; in adverse scenario large banks remain above CAR threshold of 10 percent, some small banks fall below.
  - Liquidity stress tests show limited FX liquidity risk due to high FX reserve requirements.
- Systemic risk and concentration:
  - High concentration is main systemic risk: average pairwise correlation of credit portfolios 84 percent across products.
- Non-financial sector:
  - Corporate leverage increased; DAR share in 2017: 3 percent of total corporate debt of the sample (sample firms total debt USD 18.8 billion in 2017).

### Corporate sector stress tests (sample of 93 firms)
- Median interest coverage above one.
- Debt-at-risk (DAR) under scenarios:
  - Baseline to Scenario 1: DAR increases from 3 to 6 percent.
  - Scenario 2: DAR rises to 11 percent.
  - Scenario 3: DAR rises to 12 percent.
- Sectoral effects: domestic-oriented sector accounts for bulk of rise in DAR; export-oriented sector marginally affected.
- Scenario definitions:
  - Scenario 1: exchange rate shock of 15 percent.
  - Scenario 2: 15 percent exchange rate shock, earnings decline of 15 percent, interest expense decline of 30 percent.
  - Scenario 3: exchange rate and earnings shocks doubled to 30 percent, interest expense shock at 30 percent.

### Asset prices, forecasts and risk matrix highlights
- Equities: general index rose by 28 percent in 2017 vs 2016.
- Housing: prices stabilized; price-to-rent relatively high in region but absolute value not excessive.
- Forecast performance: Peru current-year RMSE 0.84; Trading Partners 0.57; EMDEs 1.07; LAC 0.65.
- Key country-specific risks (selected):
  - Odebrecht spillovers (Likelihood M, Impact M (↓)); policy: persevere with structural reforms, strengthen anticorruption and AML.
  - Tightening global financial conditions (Likelihood H, Impact H (↓)); policy: de-dollarization, macroprudentials, allow exchange rate flexibility.

### GARCH model and foreign participation in local-currency yields (Peru and panel evidence)
- Model: conditional heteroscedasticity (GARCH(1,1)) with foreign participation variable; monthly sample March 2006–February 2018.
- Panel regression findings (LATAM and full sample): higher foreign participation associated with lower long-term yields (coefficients significant and negative).
- Peru GARCH results (Table 2):
  - Mean equation coefficients (Coefficient / Z-stat):
    - Lagged 10-year yield: 0.73 (29.84)***.
    - Key policy rate: 0.092 (4.87)***.
    - US 10-year yield: 0.12 (5.46)***.
    - Expected inflation: 0.54 (8.99)***.
    - Share of foreign participation: -0.014 (-7.37)***.
  - Variance equation:
    - Foreign participation coefficient: -0.00029 (-1.21) (statistically insignificant).
  - Model fit: R-squared 0.89; number of observations 144.
- Interpretation:
  - Non-resident participation lowers contemporaneous yields by 1.4 basis points per percentage point of foreign participation; long-term impact about 6 basis points.
  - No evidence that foreign participation increases yield volatility for Peru in this specification.
  - Possible reason: strong macro policies and ample buffers (high reserves, low public debt, well-capitalized banking system) mitigate volatility risks.

### Statistical framework, data, and recent information (selected)
- Statistical assistance: SRF for central bank developed; bridge table linking bank source data to BCRP report form 2SR completed; further SRF work needed for other depository corporations.
- FSIs: Peru has reported FSIs quarterly since June 2011.
- Data dissemination: selected latest observations include Consumer Price Index May 2018; International Reserve Assets latest observation 05/31/18; Consolidated Balance Sheet of Banking System latest observation 05/15/18.
- Recent updates since staff report (Statement by IMF Staff Representative, July 9, 2018):
  - Congress granted special legislative powers on June 19.
  - New Finance Minister Carlos Oliva took office on June 7.
  - Monthly GDP increased by 7.8 percent in April (y-o-y).
  - Headline inflation re-entered target range in June at 1.4 percent (y-o-y).
  - BCRP reduced marginal reserve requirement on FX liabilities from 36 to 35 percent on June 28, releasing $0.17 billion in liquidity.

*Source: cr18225-perubundle — International Monetary Fund.*

### 1. Productivity Trends at the Macro and Micro Level ____________________________________________ 20

### 1. Productivity Trends at the Macro and Micro Level ____________________________________________ 20

### Context
- Peru has been "one of the top performers in Latin America since the turn of the century" during a commodity boom, helping to close the income gap with the largest Latin American economies and reduce poverty significantly.
- Macroeconomic outcomes cited:
  - Inflation target range: 1–3 percent.
  - Fiscal rule ceiling for public debt: 30 percent of GDP.
- Tailwinds and headwinds:
  - Commodity terms of trade picked up since mid-2016 but remain below the 2010–2014 average.
  - Domestic headwinds include slow rebuilding of infrastructure and housing after severe floods and landslides, logistical challenges, capacity constraints, and spillovers from the Lava Jato corruption investigation.
- Political developments noted:
  - President Kuczynski resigned in March 2018 following impeachment attempts related to Odebrecht.
  - A minimum wage hike of around 9½ percent was approved in March.
  - Regional elections in October 2018.
- Policy actions by new President Vizcarra:
  - Requested special legislative powers in six areas: (i) tax policy and administration; (ii) competitiveness; (iii) post-El Niño reconstruction and closing infrastructure gaps (already granted); (iv) anti-corruption measures; (v) protection of vulnerable groups (and preventative measures); (vi) modernization of the state.
  - Passed law 30737 clarifying civil damages in corruption cases and rules for asset transfers by construction companies under investigation or convicted.
  - Fiscal measures include excise tax hikes, improving tax administration, and streamlining current expenditures.

### Recent Developments
- Growth and employment:
  - 2017 GDP growth: 2½ percent.
  - Output gap: remains negative.
  - 2018Q1 GDP growth: 3.2 percent (yoy).
- Inflation and monetary policy:
  - Headline inflation in May 2018: 0.9 percent.
  - Core inflation in May 2018: 2.1 percent.
  - Inflation expectations in May 2018: 2.2 percent.
  - BCRP policy rate reduced from 4¼ to 2¾ percent starting May 2017 and on hold since April 2018.
  - Marginal reserve requirement rates on FX and local currency liabilities reduced from 70 and 6.5 percent in December 2016 to 36 and 5 percent, respectively, in June 2018.
- Fiscal sector:
  - Tax revenues growth (January–April 2018): 21 percent (yoy).
  - Public investment growth about 14 percent (y/y).
  - 12-month cumulated deficit of the NFPS through April 2018: 2.7 percent of GDP.
  - Public debt closed 2017 at 25¼ percent of GDP.
  - Recent fiscal measures: excise tax increase with full-year gain of 0.4 percent of GDP; decree reducing current spending by 0.3 percent of GDP relative to the 2018 budget.
- External sector:
  - 2017 current account deficit: 1.3 percent of GDP.
  - Exports grew 21 percent in 2017.
  - Central bank interventions use mainly non-spot instruments; episodes of volatility around mid-December and February 2018.
  - No changes in capital flow management measures since last Article IV consultation; five CFMs described in Annex II.
- Financial sector:
  - NPL ratio in March 2018: 3.4 percent of total loans.
  - Loan provisioning coverage: 151 percent.
  - Banking system ROA in March 2018: 2.1 percent.
  - Banking system ROE in March 2018: 18 percent.
  - Capital adequacy ratio in February 2018: 15.2 percent.
  - Deposit dollarization below 40 percent by March 2018; loan dollarization around 30 percent.
  - Credit growth in 2017: about 5.5 percent.
  - Financial Conditions Index described as relatively neutral for the past two years.

### Outlook and Risks
- Growth projections:
  - 2018 growth forecast: 3.7 percent (driven by domestic demand and public investment rising about 0.4 percent of GDP; overall fiscal impulse of 0.2 percent of GDP).
  - 2019 growth projected to accelerate above 4 percent, then gradually decline back to potential thereafter.
  - Potential (estimated): 4 percent.
- Inflation outlook:
  - Headline inflation expected to gradually return to the center of the BCRP’s 1–3 percent target range.
- Fiscal outlook:
  - Fiscal deficit expected to converge to 1 percent of GDP by 2021 in line with the fiscal rule.
- Risks:
  - Domestic downside risks: further delays to public investment projects and PPPs due to capacity constraints and corruption investigations.
  - External downside risks: more protectionist trade policies, a slowdown in China, or a more rapid increase in international interest rates.
  - Growth-at-risk (GaR) findings:
    - External conditions are the largest drivers of Peru’s short-horizon growth risk.
    - Even at the 5th percentile of its growth distribution implied by current financial conditions, projected growth would be about 2.1 percent 1-year ahead and 1.7 percent 3-year ahead.
  - Buffers and stress test results:
    - Ample buffers: low public debt and high international reserves.
    - Banking sector stress test: the sector can withstand a severe GDP shock (deviation of around 9½ percent over a period of three years from the baseline) and a sol depreciation of nearly 20 percent.
    - Corporate stress tests: sector broadly capable of withstanding adverse macroeconomic shocks, with vulnerabilities in some domestic-oriented sectors.

### Policy Discussions and Recommendations
- Short run: countercyclical fiscal and monetary policies remain appropriate; structural reforms are essential complements.
- Priorities identified:
  - Strengthen the tax system.
  - Improve public investment and PPP management.
  - Buttress macroprudential policies and financial sector oversight.
  - Tackle governance vulnerabilities.
  - Enhance the pension system’s social protection role.
- Delivering short-term fiscal impulse and initiating medium-term consolidation:
  - Support planned increase in public investment and focus on boosting execution capacity given a negative output gap and reconstruction needs.
  - Steps to improve capital expenditure framework:
    - Strengthen long-term planning and credibility of investment budgeting.
    - Better prioritization.
    - Simplify project monitoring and evaluation.
    - Increase execution transparency.
    - Build subnational government capacity.
    - Ensure PPP projects in pipeline and ongoing projects continue to move forward.
  - Medium-term consolidation strategy:
    - Focus consolidation on the revenue side and streamlining current expenditure.
    - Authorities plan to reduce the deficit to 1 percent of GDP by 2021.
    - Recent measures: excise tax increases (full-year gain of 0.4 percent of GDP) and decree reducing current spending by 0.3 percent of GDP.
    - Higher commodity prices projected to boost revenues by 0.6 percent of GDP in the baseline scenario.
    - If revenue overperforms, staff would support increasing public investment further.

*Source: cr18225-perubundle - 1. Productivity Trends at the Macro and Micro Level; cr18225-perubundle - 1. Productivity Trends at the Macro and Micro Level ____________________________________________ 20; https://www.imf.org/-/media/files/publications/cr/2018/cr18225-perubundle.pdf*

### 14.      Staff supports the authorities focus on a tax reform that simplifies the system, levels

### 14.      Staff supports the authorities focus on a tax reform that simplifies the system, levels 

### Tax reform and fiscal framework
- The tax system is described as complex, with numerous special regime exemptions (including tax stability contracts), and widespread and overlapping withholding schemes.
- Priority reform areas:
  - Reduce compliance gaps, especially the VAT gap, which is estimated to be around 3 percent of GDP.
  - Move towards a less fragmented income tax regime.
  - Make personal income taxes more progressive.
  - Rationalize tax exemptions.
  - Increase revenues from property taxes.
- Medium-term budget framework:
  - Staff stressed importance of maintaining progress towards implementation of the medium-term budget framework, useful as fiscal consolidation begins in 2019–20.
  - Authorities encouraged to implement IMF recommendations ahead of the 2019 budget exercise.
  - Multi-annual allocations should be treated as credible ceilings, rather than implicit floors for negotiation.
- Authorities’ revenue expectations:
  - Authorities believe proposed tax administration measures could increase revenues by nearly two percent of GDP by 2021, creating space for public investment while complying with the fiscal rule.

### Monetary policy: data dependent and credible
- Current stance and rationale:
  - The current monetary stance is appropriate and should remain data dependent.
  - The BCRP loosened monetary conditions in response to weaker than expected growth and declining inflation outturns and expectations.
  - The real policy rate stands at just 0.6 percent.
  - The BCRP’s estimate of the neutral rate is around 1¾ percent.
  - Core inflation and inflation expectations are near the mid-point of the target range (two percent).
  - Staff’s baseline suggests limited scope for additional interest rate cuts given a projected narrowing of the output gap.
- Suggested enhancements to monetary policy management:
  - Communications: further improve guidance on conditions for future policy rate moves.
  - Exchange rate flexibility:
    - The sol was useful in 2014–16 adjustments but remains more stable than other LA6 currencies.
    - Intervention in 2017 and limited 2018: amounted to 2½ percent of GDP in 2017.
    - Future interventions should be limited to disorderly market conditions.
    - Allowing two-way exchange rate flexibility likely to stimulate market development and support dedollarization efforts.
    - Peru has supporting elements (credible inflation targeting, ample buffers, financial stability) to minimize risks from greater exchange rate flexibility.
- BCRP and authorities’ stance:
  - The BCRP noted policy rate cuts supported cyclical recovery and sees limited risks of accelerating inflation given the negative output gap and anchored expectations.
  - The BCRP has no plans to modify its communication strategy.
  - On exchange rate policy, intervention seeks to prevent excess volatility in a context of partially dollarized banking credit.
  - Authorities consider the real exchange rate aligned with fundamentals and consistent with a projected current account deficit of 1.7 percent of GDP in 2018.

### Financial stability and financial development
- Banking sector resilience and monitoring:
  - Stress tests found the banking sector resilient to macroeconomic shocks, but a broader set of financial vulnerabilities should be monitored.
- High concentration:
  - Peru’s financial sector is highly concentrated and dominated by financial conglomerates.
  - The two largest conglomerates control around US$67 billion (33 percent of GDP), and more than half of banking system assets are owned by conglomerates registered abroad.
  - Large banks have similar loan portfolios and credit risk is strongly correlated among banks.
  - Policy recommendation: increase capital surcharges for systemic banks to levels in line with the Basel III framework.
  - Increase countercyclical provisioning of smaller banks to strengthen shock-absorption capacity.
- Off-balance sheet exposures:
  - Banks hold significant off-balance sheet exposures as untriggered guarantees.
  - The notional value of untriggered guarantees is approximately 121 percent of the total capital for the large banks in the sample.
  - 90 percent of the guarantees are “cartas fianzas”.
  - SBS analysis: about 40 percent of construction-related guarantees is at very low risk of being triggered; stress test used the remaining 60 percent and found an additional decline of 0.3 p.p. in system-wide total capital, roughly equal among large and small banks.
  - Recommendation: close monitoring of idiosyncratic and potentially concentrated off-balance exposures.
- Dedollarization and currency exposures:
  - Dollarization has declined from a peak level of around 80 percent in the early 2000s.
  - Current dollarization: around 40 percent of deposits and 30 percent of loans remain dollarized.
  - Peru has a high share of nonresidents holding local currency bonds: 39 percent in Q1 2018.
  - Nonresident holdings as share of GDP: 5.1 percent in Q1 2018.
  - Staff analysis: increased foreign participation significantly reduces long-term bond yields and shows no evidence of increased volatility.
  - Recommendation: increase risk weights on FX loans in line with recent Basel III guidelines to encourage dedollarization.
- FX reserve requirements:
  - Peru’s ratio of FX reserve requirements is 36 percent.
  - These act as a prudential buffer and dedollarization tool; changes should be tied to the dedollarization process or addressing adverse macrofinancial shocks.
- Supervisory and macroprudential framework:
  - Passing legislation to migrate supervision of saving and credit cooperatives to the SBS is important.
  - Need to remove legal limitations and enhance a supervisory framework for consolidated supervision of financial conglomerates.
  - Continue transition to risk-based supervision of the insurance sector.
  - Improve macroprudential framework by giving enhanced mandates for macroprudential policy to the BCRP and the SBS and implementing a memorandum of understanding to strengthen coordination, potentially paving the way for a formal coordination mechanism.
- Financial inclusion and development:
  - Branch penetration has quadrupled over the last decade, but overall financial depth remains low relative to fundamentals and the region.
  - High concentration may indicate lack of competition in some segments.
  - Recommendation: strengthen legal and institutional framework to oversee competition, market conduct, and consumer protection.
  - Reform the e-wallet Billetera Móvil (BiM): increase interoperability with bank accounts, digitize government payments, and expand access criteria.
  - Consider studying fintech regulatory approaches elsewhere (e.g., regulatory sandboxes) to support innovation while managing risks.

### Growth, governance, and social protection
- Productivity and misallocation:
  - TFP growth outperformed LAC peers and a broader group of EMDEs during the commodity boom but has been disappointing in recent years.
  - Labor productivity remains at one-fifth of the U.S. level.
  - Priority areas to boost productivity: education, infrastructure, institutions, and labor market reform.
  - Staff analysis suggests misallocation of resources is a key driver of low productivity.
  - To reduce misallocation, remove barriers limiting growth of productive firms, including distortions from tax incentives, burdensome regulation, and limited access to credit.
- Governance and Lava Jato fallout:
  - The Lava Jato scandal had a major impact on the economy; governance is a priority.
  - Law 30737 should reduce uncertainty in the construction sector.
  - Recommended measures: require conflict of interest statements from public officials; improve timely exchange of information and financial intelligence among anti-corruption agencies; strengthen the asset declaration system (verification, beneficial ownership information, and public access); enhance risk-based AML/CFT supervision and reporting for suspicious transactions; create a beneficial ownership registry; ensure customer due diligence for politically exposed persons.
- Poverty, redistribution, and natural resource revenue sharing:
  - Poverty and inequality declined markedly during the commodity boom; poverty increased in 2017.
  - Less than a quarter of the population was below the national poverty line in 2017.
  - Much progress driven by real labor income gains of lower-skilled workers in the nontradable sector.
  - Recommendation: increase tax revenues and make personal income tax more progressive by closing loopholes, avoiding preferential treatments, and combating tax evasion and avoidance, especially for higher-income households.
  - Consider re-thinking distribution of natural resource revenues to reduce horizontal inequities while compensating producer regions; revenue-sharing formulas could better reflect spending needs (population size and poverty levels).
- Pensions and social protection:
  - Pension coverage in Peru is low relative to the region.
  - Replacement ratios in the public defined benefit plan (SNP) and private defined contribution plan (SPP) are projected to be below 30 percent in the medium term.
  - Non-contributory pillar (Pension 65) will remain important and should be broadened.
  - In the public system, shortening the minimum 20-year contribution period would allow more low-income workers to receive a pension.
  - In the private system, recommended reforms: lower high pension management fees; remove excessive flexibility to withdraw lump-sum amounts; consider increasing contributions (with caution due to potential adverse impact on labor formality).
  - Over the longer term, consider a larger institutional reform to better integrate private and public pillars while balancing adequacy, coverage, and fiscal sustainability.
  - Fiscal costs of pension reforms should be carefully assessed and reforms must be communicated to set realistic expectations.

### Authorities’ views and alignment with staff
- Short- and medium-term growth:
  - Authorities share staff’s view on short-term outlook; they consider growth could reach 5 percent in the medium term given planned reforms.
  - Commitments: improve execution and quality of public investment; strengthen tax policies and administration; streamline current public expenditure; enhance governance; boost competitiveness.
  - Planned reforms and a new investment cycle linked to high commodity prices expected to boost potential growth.
- Fiscal rule and public investment:
  - Authorities stressed commitment to the fiscal rule and lifting public investment execution.
  - Expect streamlined reconstruction processes and acceleration of several large infrastructure projects to significantly boost public investment in 2018–19, but acknowledge lack of capacity at subnational level as a significant challenge.
- Financial sector:
  - Authorities noted no regulatory barriers for market entry; market outcomes affected by informality which raises due diligence costs.
  - Agreed risks are contained and off-balance sheet items warrant continued close monitoring.
- Structural reform agenda:
  - Authorities and staff agree on priorities: improving governance and boosting productivity are immediate priorities addressed in the request for special legislative powers; pension, education, and labor reforms to follow in coming years.

### Staff appraisal
- Window of opportunity:
  - High commodity prices and reduced political uncertainty create a window for addressing domestic challenges and lifting potential growth.
  - Commodity prices have picked up significantly since mid-2016, supporting a rebound.
  - Appointment of the new administration has reduced political uncertainty, improving confidence and conditions for reform implementation.
- Remaining headwinds:
  - Domestic headwinds include slow reconstruction following El Niño damages and investment drag from the Lava Jato corruption scandal.

*International Monetary Fund — Chapter/section content provided in cr18225-perubundle*

### 35.      The economy is recovering and risks are broadly balanced in 2018. Growth is expected

### 35.      The economy is recovering and risks are broadly balanced in 2018. Growth is expected

### Macro outlook and risks
- Growth is expected to reach 3¾ percent in 2018 given the fiscal stimulus and rebounding private investment.
- In 2019–20, growth is likely to increase further, before converging to potential of 4 percent in the medium term.
- Headline inflation is expected to gradually return to the center of the BCRP’s target range as food price inflation normalizes.
- The 2017 external position is assessed to be moderately stronger than implied by fundamentals, although the gap is expected to narrow in 2018 and beyond.
- While risks are broadly balanced in 2018, risks are tilted to the downside thereafter.
- The financial sector is sound, and the economy maintains significant buffers to withstand adverse shocks.

### Short-term policy recommendations
- Countercyclical fiscal and monetary policies remain appropriate in the short term.
- Expanding public investment is recommended given the negative output gap and significant reconstruction needs.
- Given the key role of subnational governments in public investment, continuing efforts to build their capacity remains essential.
- Monetary policy has been appropriately eased to complement the fiscal stimulus; looking ahead, monetary policy should remain data dependent.
- The BCRP could consider enhancing communications of its policy guidance.
- Exchange rate flexibility should remain an important shock-absorber; FX interventions should be limited to disorderly market conditions.

### Financial sector resilience and macroprudential measures
- Additional macroprudential measures would help strengthen financial sector resilience, including:
  - increasing capital surcharges for systemic banks
  - countercyclical provisioning for smaller banks

### Medium-term fiscal strategy and structural reforms
- The authorities’ strategy of combining medium-term fiscal consolidation with structural reforms aimed at boosting productivity is sound.
- The authorities’ commitment to the fiscal responsibility framework is commendable.
- Revenue mobilization through strengthening tax policy and administration, supplemented with the streamlining of current expenditure, will allow gradual consolidation in line with the fiscal rule.
- Consolidation will create space for much needed investment to help close the infrastructure gap.
- Increasing the progressivity of the personal income tax system and expenditures will enhance redistribution.
- Complementary structural reforms to tackle high informality and low productivity are recommended, including:
  - reforms to strengthen Peru’s institutions and governance
  - improvements in education
  - increased labor market flexibility
  - enhanced financial deepening and inclusion
- The pension system could be reformed to enhance social protection.
- Re-thinking the distribution of natural resource revenues is warranted to help reduce horizontal inequities between regions.

### Productivity, governance, and social outcomes (Boxes summary)
- Productivity trends:
  - The commodity boom helped increase labor productivity relative to advanced economies.
  - Sectoral output per worker data show labor productivity increases in construction, utilities, transportation and manufacturing.
  - Standard growth decompositions and preliminary firm-level manufacturing analysis show capital accumulation was a key driver of higher labor productivity.
  - Misallocation of resources is likely a key driver of weak aggregate TFP levels; staff estimates show that in Peru the misallocation term is positive but close to zero for the manufacturing sector, suggesting substantial misallocation which is more severe than in most LA peer countries.
  - Misallocation has not improved in recent years and is even more severe in the services sector than in the manufacturing sector.
- Governance and corruption:
  - Corruption is identified as the greatest problem to doing business in Peru.
  - The fallout from the Odebrecht case reduced GDP growth by an estimated 0.8 percent of GDP in 2017 by freezing large investment projects (e.g. Southern Peru Gas Pipeline).
  - Fiscal governance is particularly vulnerable, with weaknesses in public investment management (evaluation and selection of projects, PPPs, coordination/monitoring of subnational governments).
  - Significant number of mayors are under investigation on corruption charges, indicating severe governance weaknesses at state and district levels and serious weaknesses in PFM at the regional level.
  - Cross-country indicators suggest tax efficiency is below average; weaknesses include auditing processes, high stock of arrears, and inadequate attention to managing institutional risks.
  - Transparency and financial integrity: practices meet most principles of the IMF’s Fiscal Transparency Code at good or advanced level, but weaknesses include limited effectiveness of auditing and control institutions and concerns with PPPs.
  - Implementation and enforcement of corruption laws tend to be weak due to inefficiencies in controls, investigation, and sanction mechanisms.
  - AML/CFT national risk assessment identified significant corruption risks, including use of companies and real estate as vehicles of laundering corruption proceeds.
- Poverty and inequality:
  - Poverty reduction during the commodity boom was broad based and especially large in some of the poorest regions in the interior; regions that benefited from larger natural resource (canon) transfers reduced poverty by more than others.
  - Much of boom-time progress reflected real labor income gains for lower-skilled workers, especially in nontradable sectors.
  - Government transfers played a positive role in poverty reduction but to a lesser extent.
  - Employment and wages increased in the nontradable sector; services contributed most to employment growth, while construction saw double digit real income growth and the largest expansion in employment.
  - Manufacturing performed poorly during the boom in terms of employment growth, consistent with a Dutch disease crowding-out effect.

### Institutional engagement
- Staff expressed appreciation for the authorities’ constructive engagement.
- It is recommended that the next Article IV consultation take place on the 12-month cycle.

*PERU INTERNATIONAL MONETARY FUND.*

### Box 4. Pension Projections and Reform Scenarios

### Box 4. Pension Projections and Reform Scenarios

### Contribution densities and distributional patterns
- Contribution densities:
  - SPP: 40 percent.
  - SNP: 34 percent.
- Interpretation: affiliates contribute for 4 to 5 months out of 12 months per year on average over their working life.
- Inequality in coverage:
  - High income households have substantially higher contribution densities.
  - The top income quintile is four times as likely to reach the minimum 20-year contribution period in the SNP as the bottom quintile.

### Projected replacement rates (2018–2047) — baseline and sensitivity
- Method: staff projections use observed contribution densities to project replacement rates for pension cohorts from 2018–2047.
- SNP (baseline):
  - Average replacement rates projected to decline from over 40 percent in 2020 to around 20 percent in 2047.
  - Decline largely reflects past reforms making the system more sustainable but less generous.
- SPP (baseline):
  - Average replacement rates decline marginally over time from around 25 to 22 percent.
- Sensitivity to real rate of return (SPP):
  - Baseline assumption: real rate of return = 4.2 percent.
  - Upside scenario: real rate of return = 5.2 percent (instead of 4.2 percent).
  - Result: replacement rates in 2047 would be 30 instead of 22 percent.

Note on assumptions:
- Footnote: "While real rates of return in Peru have been historically higher than 5 percent, the baseline scenario assumes they converge over time towards levels achieved by a 'best practice' fund, such as the Norwegian Government Pension Fund Global."

### Reform scenarios and quantitative impacts
- Lowering fees through improved industrial organization in the private system:
  - Fee reduction: 0.5 percentage points.
  - Impact: would raise replacement rates by over 3 percentage points.
- Broadening the contribution base (making pension contributions obligatory for the 13th and 14th monthly salaries):
  - Impact: would increase replacement rates by close to 3 percentage points.
- Increasing contribution rates:
  - Increase considered: 5 percentage points.
  - Impact: has the largest effect on replacement rates, but could adversely affect labor formalization.
- SNP vesting (minimum contribution) period reduction:
  - Reduction considered: lower the 20-year minimum contribution (vesting) period by 5 years.
  - Impact: would raise average replacement rates by over 5 percentage points and reduce inequities (because lower income affiliates are much less likely to reach the 20-year mark than affiliates in higher income segments), but would have fiscal implications.

*Sources: National Authorities and IMF staff estimates.*

### Annex I. Implementation of Past Fund Advice

### Annex I. Implementation of Past Fund Advice

### Fiscal policies
- Implement short-term fiscal stimulus plan to address flood-related reconstruction needs, underpinned by strong public investment management. Keep a focus on enhancing capacity to implement projects at the subnational level.
  - Authorities’ response: In progress. The authorities are ramping up public investment spending, with significant increase expected in 2018. They have received special legislative powers to amend the framework for reconstruction, aimed at improving the rate of project execution.
- Raise the tax to GDP ratio. Streamline tax administration and reduce VAT exemptions and informality.
  - Authorities’ response: In progress. The authorities have increased excise rates on selected products. In addition, they are advancing in the implementation of tax administration measures to reduce tax evasion, including via electronic invoices. The latter became mandatory for a set of agents on January 1st in 2018.
- Improve the PPP framework and introduce a comprehensive approach to monitoring fiscal risks. Publish an annual comprehensive fiscal risk statement, covering contingent liabilities and risks associated with investment plans.
  - Authorities’ response: In progress. The authorities have advanced in issuing regulations regarding the functioning of Proinversion, the agency in charge of PPPs. In addition, the August 2017 Multiannual Macroeconomic Framework included a section assessing the explicit contingencies faced by the NFPS, although a formal fiscal risk statement is still to be issued.

### Monetary and exchange rate policies
- Complement fiscal policy with easier monetary policy as needed.
  - Authorities’ response: Completed. The monetary policy stance has been appropriately loosened.
- Tie future changes in the FX reserve requirements to the de-dollarization objectives.
  - Authorities’ response: Partially implemented. The authorities have traditionally used FX reserve requirements as a tool with multiple objectives, which include: building buffers given the dollarization of the banking system, and regulating credit conditions. During the past year, given other dedollarization tools are now available, the BCRP has been focusing on reducing FX reserve requirements to what they consider a more neutral level with respect to local currency reserve requirements.
- Limit FX interventions to cases of disorderly market conditions.
  - Authorities’ response: Partially implemented. The authorities continue to implement flexible exchange rate regime without targeting any particular level of exchange rate. Spot market interventions have been close to zero so far in 2018, and intervention using other instruments has been two-way.

### Financial policies
- Formalize the Financial Stability Council.
  - Authorities’ response: Not implemented. The authorities’ view is that current arrangements are working well and there is no need to designate a formal committee for macroprudential policy.
- Broaden the financial supervisory perimeter.
  - Authorities’ response: In progress. A bill to reform the supervision of cooperatives and bring the large institutions under the purview of the SBS has been approved by Congress.
- Enhance financial deepening and inclusion.
  - Authorities’ response: In progress. The state-owned Banco de la Nación modified its statute to be able to issue e-money, and implemented new online and mobile payment channels. Improvements to the Securities Market Law were made, and there are plans to reform the Alternative Stock Market.

### Structural policies
- Increase labor market flexibility.
  - Authorities’ response: Not implemented.
- Reduce economic informality.
  - Authorities’ response: In progress. The authorities agree that this is priority which will require a multi-faceted approach.
- Close infrastructure gap.
  - Authorities’ response: In progress. The authorities are implementing an ambitious public investment agenda which will contribute to improving infrastructure.
- Improve business climate.
  - Authorities’ response: In progress. The authorities requested special legislative powers to formulate policy in the area of competitiveness.
- Strengthen implementation of anti-corruption and AML/CFT measures.
  - Authorities’ response: In progress. The authorities have implemented regulation to limit the use of FX cash transactions when they exceed specific thresholds. The authorities are also requesting special legislative powers from Congress to legislate in the area of integrity and anti-corruption.

*Source: Annex I. Implementation of Past Fund Advice*

### Annex II. External Sector Assessment

### Background and key developments
- Current account (CA) developments:
  - CA deficit shrank from 2¾ percent of GDP in 2016 to 1¼ percent of GDP in 2017, driven by a significant (nearly 2.3 percent of GDP) improvement in the balance of goods and services.
  - Over the medium term, the CA deficit is expected to widen to about 2 percent of GDP as investment and domestic demand recover.
- REER developments:
  - In the past five years, the REER gravitated closer to its 20-year historical average. The REER has been trending downwards since the peak observed in 2013. The real depreciation since Q1 2017 was driven due to lower relative prices. At present, the REER index is very close to the 20-year historical average.
- Financial account and inflows:
  - Net private sector inflows declined to below 0.5 percent of GDP in 2017 as FDI was nearly offset by higher outflows (accumulation of foreign assets by pension funds and higher loan repayments).
  - Non-resident holdings of local currency bonds picked up since late 2016; stock of non-resident holdings is around 5 percent of GDP.
- Net International Investment Position (IIP):
  - IIP improved from -54 percent of GDP in the late 90s to -23½ percent of GDP in 2011, then trended down driven by FDI accumulation, strengthening to -36½ percent of GDP in the last year.
  - External assets: 56 percent of GDP (central bank holdings almost 30 percent of GDP; foreign assets of the financial system 16 percent of GDP).
  - Liabilities: large FDI liabilities 45½ percent of GDP; moderate external indebtedness (public and private external debt amounts close to 36 percent of GDP); other liabilities 11 percent of GDP.
  - IIP projected to improve slightly to about -33–34 percent of GDP in the medium term.
- Reserves and reserve adequacy:
  - Gross international reserves increased by $2 billion in 2017, reaching US$63.7 billion (nearly 30 percent of GDP), or close to 280 percent of the ARA metric (above the 100–150 percent adequacy range).
  - Reserves are about 230 percent of the ARA metric when augmented for commodity-export uncertainty.
  - Subtracting large FX liabilities to the banking sector yields reserves at 162 percent of the augmented ARA metric.
- BCRP FX interventions:
  - In 2017, BCRP purchased $5.2 billion (2.4 percent of GDP) in the spot market.
  - Use of non-spot instruments (FX swaps and adjustable CDs) was generally two-way, with cumulative sum limited to 0.12 percent of GDP.
  - In the first five months of 2018, spot market transactions were close to zero; intervention through other instruments continued two-way with limited cumulative amount.

### Assessment
- External position:
  - The CA-based approach suggests a positive current account gap of 1.6 percent of GDP in 2017, implying the external position in 2017 was moderately stronger than level consistent with medium-term fundamentals and desirable policies.
  - EBA current account regression: CA norm estimate of -2.6 percent of GDP (standard error 1 percent of GDP).
  - Cyclically adjusted CA deficit estimated at one percent of GDP.
  - CA gap in 2017: 1.6 percent of GDP.
  - REER regression results are mixed: index-based regressions suggest REER broadly in line with fundamentals; level-based regression indicates REER is overvalued.
  - The assessment places more weight on the CA regression-based approach.
- External sustainability:
  - The external sustainability approach suggests IIP would be stabilized with a current account deficit of 2.2 percent of GDP, marginally wider than the medium-term projected CA deficit, suggesting the IIP is sustainable.
  - This method implies the REER gap is close to zero.
- Selected reported indicators and estimates (2017):
  - Actual CA: -1.3
  - Cyclically adjusted CA: -1.0
  - CA norm: -2.6
  - CA gap: 1.6
  - o/w Policy gaps: -0.3
  - Elasticity: -0.2
  - (Table note) REER gap (in percent) and other REER regression outputs reported in the source.

*Source: Annex II. External Sector Assessment*

### Annex III. Macro-Financial Stability Update

### A. Financial sector risk assessment — key findings
- Financial soundness indicators (FSIs):
  - Banks are well-capitalized, liquid and profitable.
  - Non-performing loans (NPLs) have continued to edge up as economic activity slowed, mainly driven by deterioration in SME portfolios, but are adequately provisioned at 151 percent.
  - Compared with regional countries, Peru has average capital adequacy and liquidity ratios, and slightly higher than average profitability.
- Credit developments:
  - Financial sector credit growth was moderate at around 5.5 percent in 2017, with a negative credit gap since 2016.
  - Credit growth was stronger in FX compared to local currency in 2017.
  - Credit growth picked up to around 7 percent as of end-March 2018.
- Dollarization:
  - Credit dollarization has stabilized at around 30 percent since end-2015.
  - Deposits not in soles: 39 percent as of April 2018 (42 percent at end-2016).
  - In March 2018, the BCRP introduced measures allowing foreign currency loans to increase if local currency credit to enterprises rises more than proportionally, subject to certain thresholds.
- Stress testing and resilience:
  - FSAP stress testing found the banking system appears resilient to severe macrofinancial shocks.
  - In the adverse scenario, large banks experience credit losses but remain above the minimum regulatory capital adequacy ratio (CAR) threshold of 10 percent due to initial strong capital and profitability; a few small banks fall below the threshold.
  - Liquidity stress tests show limited FX liquidity risk owing to significant buffers from high FX reserve requirements.
  - Interconnectedness: cross-sectoral exposures of the banking sector are small; interbank contagion analysis did not find large risks of direct or indirect contagion.
- Systemic risk and concentration:
  - High concentration is the main systemic risk factor: the four largest banks hold around 80 percent of private banking sector assets.
  - Systemic risk indicators show the probability of a systemic crisis has fallen since 2010, but conditional probabilities indicate that distress in one bank makes distress in another very likely due to highly correlated credit portfolios (average pairwise correlation 84 percent across products).

### B. Non-financial sector risk assessment — key findings
- Corporate leverage and debt-at-risk:
  - Corporate leverage has increased for large Peruvian firms, and repayment capacity has declined, but debt-at-risk (DAR) represents only a small portion of total corporate debt.
  - The share of DAR in 2017 is only 3 percent of total corporate debt of the sample.
  - Sample firms had total debt of USD 18.8 billion in 2017, or an estimated 20 percent of total debt of Peruvian firms (based on total credit to firms of USD 55.9 billion and outstanding bonds of USD 38.6 billion in 2017).

*Source: Annex III. Macro-Financial Stability Update*

### 7.      Staff sensitivity analysis indicates that the corporate sector is in general resilient,

### cr18225-perubundle - 7.      Staff sensitivity analysis indicates that the corporate sector is in general resilient,

### Corporate sector: stress-test findings
- Sample: 93 firms.
- General finding: corporate sector is in general resilient; median interest coverage is above one.
- Debt-at-risk (DAR) under stress scenarios:
  - Baseline to Scenario 1: overall share of DAR increases from 3 to 6 percent (Scenario 1).
  - Scenario 2: DAR rises to 11 percent.
  - Scenario 3: DAR rises to 12 percent.
- Sectoral differences:
  - Export-oriented sector: impact of shocks on DAR is marginal.
  - Domestic-oriented sector: share of distressed debt at least doubles and accounts for the bulk of the rise in overall DAR.
- Scenario definitions (staff footnote):
  - Scenario 1: exchange rate shock of 15 percent.
  - Scenario 2: 15 percent exchange rate shock and decline in earnings of 15 percent and decline in interest expense of 30 percent.
  - Scenario 3: exchange rate and earnings shocks doubled to 30 percent, with shock to interest expense at 30 percent.

### Asset prices: equities and housing
- Equities:
  - General index rose by 28 percent in 2017 compared to 2016.
  - Price-to-equity (PE) ratio: Peru in line with regional countries; slightly higher than MSCI Emerging Markets.
  - MSCI: In May 2017, two additional firms (Volcan and Graña y Montero) were included, increasing constituents to five and reducing reclassification risk.
  - Regulatory change: authorities introducing risk-based capital requirements for mutual funds and broker dealers via improvements to the Securities Market Law in July 2017.
- Housing:
  - Housing prices have stabilized; cross-country indicators do not suggest misalignment, though monitoring is warranted.
  - Price-to-rent ratio: Peru relatively high in Latin America distribution, but absolute value not excessive.
  - Cross-country housing-price indicators place Peru in the bottom-half of the price distribution of a broader sample of countries.
  - Note: property price indices in Peru only reflect the capital, Lima.

### Forecast performance and recent shocks
- GDP forecast errors:
  - Peru's recent forecast errors smaller than EMDE average but larger than LAC peers.
  - Larger forecast error mainly due to large overestimation of growth in 2014.
  - In 2017, domestic shocks (Odebrecht corruption scandal and el Nino) reduced growth by one percent relative to the April WEO forecast.
- Root Mean Square Error (Current Year Forecast Errors):
  - Peru: 0.84
  - Trading Partners: 0.57
  - EMDEs: 1.07
  - Latin America and the Caribbean: 0.65

### Risk Assessment Matrix — selected country-specific and external risks and staff advice
- Country-specific risks:
  - Extended uncertainty/spillovers from Odebrecht investigation (Likelihood M, Impact M (↓))
    - Policy advice: Persevere with structural reforms to increase investment execution and PPP frameworks; strengthen anticorruption institutions; seek synergies between anticorruption and AML tools.
  - Extreme weather events (El Niño) (Likelihood L, Impact L (↓))
    - Policy advice: Maintain preparedness; respond with countercyclical macro policies as needed.
  - Systemic banking sector event due to concentration and portfolio homogeneity (Likelihood L, Impact H (↓))
    - Policy advice: Increase capital surcharges for systemic banks; continue enhanced supervision; address concentration in the banking sector.
  - Positive commodity-price spillovers (Likelihood M, Impact M (↑))
    - Policy advice: Use upside to address infrastructure gap and advance structural reforms.
- External risks:
  - Tightening global financial conditions, sharp interest rate increases, USD strengthening, higher volatility (Likelihood H, Impact H (↓))
    - Impact: Strained balance sheets for USD debtors; funding pressures; higher borrowing costs; increased defaults for unhedged FX debtors.
    - Policy advice: Continue de-dollarization and macroprudential policies; allow exchange rate flexibility while smoothing excessive volatility; monitor systemic risks.
  - Structurally weak growth in advanced economies / China slowdown (Likelihood H/M, Impact M/M (↓))
    - Policy advice: Exchange rate flexibility; use liquidity buffers and policy space for countercyclical measures; accelerate structural reforms.
  - External policy uncertainty and divergence (Likelihood M, Impact M (↓))
    - Policy advice: Exchange rate flexibility; use fiscal buffers; countercyclical monetary policy instruments.

### Public sector debt sustainability (selected indicators and projections)
- Nominal gross public debt (percent of GDP): 21.5, 24.4, 25.3, 26.6, 27.6, 27.7, 27.2, 26.6, 26.2 (series as presented).
- Public gross financing needs (percent of GDP): 1.0, 3.7, 5.5, 4.9, 3.6, 2.9, 1.5, 1.5, 2.4.
- Real GDP growth (percent): 4.4, 4.1, 2.5, 3.7, 4.1, 4.2, 4.2, 4.1, 4.0.
- Ratings (listed): Moody's A3 stable; S&P's BBB+ stable; Fitch BBB+ stable.
- Contribution to change in gross public sector debt (cumulative and identified flows shown in table):
  - Change in gross public sector debt (cumulative series): 0.2, 0.4, 1.0, 1.3, 1.0, 0.1, -0.5, -0.6, -0.5, 0.8.
  - Identified debt-creating flows (cumulative): -1.1, 0.7, 1.6, 2.2, 1.5, 0.6, -0.3, -0.3, -0.2, 3.5.
  - Primary deficit (series): -1.2, 1.5, 2.0, 2.1, 1.4, 0.5, -0.4, -0.4, -0.4, 2.7.
- Baseline scenario underlying assumptions (In percent):
  - Real GDP growth: 3.7, 4.1, 4.2, 4.2, 4.1, 4.0.
  - Inflation: 1.3, 2.0, 2.0, 2.0, 2.0, 2.0.
  - Primary Balance (excludes interest income): -2.1, -1.4, -0.5, 0.4, 0.4, 0.4.
  - Effective interest rate: 5.8, 6.0, 6.3, 6.5, 6.5, 6.5.
- Alternative scenarios included Historical Scenario and Constant Primary Balance Scenario with their own parameter series (as presented).

### Non-resident holdings of local currency sovereign bonds (Annex VII)
- Ownership share: around 39 percent in March 2018.
- Historical range: low of 17 percent in 2009; peak of 58 percent in early 2013.
- Expressed as percent of GDP: 5.1 percent of GDP in Q1 2018.
- Drivers of past increases: interest rate differential, expectations of sol appreciation, facilitation via Global Depository Note (GDN) mechanism; recent placement through Euroclear (about 1.4 percent of GDP).
- Impact on yields (panel regression results):
  - LATAM sample: increase in foreign participation by a percentage point reduces yields by 4.1–4.4 basis points (statistically significant at 1 percent).
  - Broader sample (21 EMEs): range of estimates from 3.3 to 5.3 basis points.
- Benefits vs. risks:
  - Benefits: lower local currency yields, increased market liquidity, market development.
  - Risks: higher volatility, stronger transmission of external shocks, potential for sudden stops and reversals.

*Source: cr18225-perubundle (IMF).*

### 4.      A conditional heteroscedasticity (GARCH) model with foreign participation included in

### 4.      A conditional heteroscedasticity (GARCH) model with foreign participation included in

### Model specification
- Mean equation:
  - r_t^LT = θ_0 + θ_1 r_{t−1}^LT + θ_2 r_t^ST + θ_3 r_t^{US} + θ_4 π_t^e + θ_5 FP_t + ε_t
  - ε_t ~ N(0, σ_t^2)
- Variance equation (GARCH(1,1) with foreign participation as exogenous):
  - σ_t^2 = ϕ + α ε_{t−1}^2 + β σ_{t−1}^2 + γ FP_t

### Estimation sample
- Monthly sample from March 2006 to February 2018.

### Panel regression (Latin American sample and full sample) — selected coefficients and statistics
- Share of foreign participation:
  - Columns (1)–(3) (Latin American sample): -0.044***, -0.044***, -0.041*** with t-stats (-13.7), (-14.68), (-5.1)
  - Columns (4)–(6) (Full sample): -0.033***, -0.033***, -0.053*** with t-stats (-3.76), (-3.71), (-3.80)
- Policy interest rate:
  - Latin American: 0.34***, 0.33***, 0.33*** with t-stats (6.63), (6.59), 6.74
  - Full sample: 0.342***, 0.34***, 0.33*** with t-stats (5.14), (5.52), (5.01)
- US 10-year yield:
  - Latin American: 0.58**, 0.57**, 0.58** with t-stats (3.09), (3.45), (3.51)
  - Full sample: 0.29, 0.27, 0.22 with t-stats (1.6), (1.61), (1.49)
- 12-m inflation expectations:
  - Latin American: 0.67**, 0.65***, 0.64*** with t-stats (4.45), (4.85), (5.17)
  - Full sample: 0.145, 0.148, 0.19 with t-stats (0.93), (0.98), (1.23)
- 12-m expected ER appreciation:
  - Selected coefficient: 0.019 (t-stat (0.72)); another reported value -0.0049 (t-stat (-0.16))
- Fiscal balance:
  - Latin American: -0.11**, -0.094*, -0.11** with t-stats (-3.18), (-2.5), (-3.60)
  - Full sample: -0.23***, -0.22***, -0.22*** with t-stats (-3.37), (-3.38), (-3.11)
- Stock of public debt:
  - Latin American: 0.0086, 0.0098 with t-stats (0.58), (0.64)
  - Full sample: -0.0065, -0.0059 with t-stats (-0.2), (-0.18)
- Current account balance:
  - Latin American: -0.13**, -0.14*, -0.13* with t-stats (-2.93), (-2.63), (-2.62)
  - Full sample: -0.05**, -0.051**, -0.046 with t-stats (-2.17), (-2.24), (-1.49)
- Sample sizes and fit:
  - No. of observations: 175 (columns 1–3); 729, 741, 741 (columns 4–6)
  - No of countries: 5 (columns 1–3); 21 (columns 4–6)
  - Adj. R-squared (overall): 0.85, 0.85, 0.84 (Latin American); 0.59, 0.59, 0.57 (Full)

Note: T-statistics based in robust standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1
- LATAM sample includes Argentina, Brazil, Chile, Mexico, and Peru.
- Full sample includes LATAM and Bulgaria, China, Hungary, India, Indonesia, Latvia, Lithuania, Malaysia, Philippines, Poland, Romania, Russia, South Africa, Thailand, Turkey, and Ukraine.

### GARCH model results for Peru (Table 2)
- Mean equation (Coefficient / Z-stat):
  - Lagged yield on 10-year bonds in Peru: 0.73 (29.84)***
  - Key policy rate: 0.092 (4.87)***
  - Yield on 10-year US bond: 0.12 (5.46)***
  - Expected inflation: 0.54 (8.99)***
  - Share of foreign participation: -0.014 (-7.37)***
- Variance equation (Coefficient / Z-stat):
  - Constant: 0.04 (3.26)***
  - Lagged squared residual: 1.05 (4.39)***
  - GARCH(-1): -0.04 (-5.09)***
  - Foreign participation: -0.00029 (-1.21)
- Model fit and sample:
  - R-squared: 0.89
  - Number of observations: 144

### Key findings and interpretation
- Mean equation:
  - High degree of yield persistence: lagged 10-year yield coefficient = 0.73 (29.84)***.
  - Non-resident (foreign) participation reduces the mean contemporaneously by 1.4 basis points per percentage point of foreign participation (share coefficient -0.014), implying a long-term impact of about 6 basis points.
- Variance equation:
  - GARCH coefficients α and β are statistically significant, indicating the presence of heteroscedasticity (volatility clustering).
  - Foreign participation in the variance equation is statistically insignificant (coefficient -0.00029, Z-stat -1.21), indicating no evidence that foreign participation increases yield volatility for Peru in this specification.
- Possible explanation offered in the source:
  - The absence of a positive volatility effect from foreign participation may be attributable to the strength of macroeconomic policies and ample buffers in Peru: high reserves, low fiscal debt, and a well-capitalized banking system. These factors reduce the risk of abrupt market corrections and may increase incentives to invest in sol-denominated securities.

### Implications and directions
- Empirical implication:
  - Foreign participation appears to lower contemporaneous yields and does not raise yield volatility in the GARCH(1,1) specification for Peru over the sample used.
- Research implication:
  - The source notes that future research is needed to further investigate the relationship between foreign participation and yield volatility.
- Policy-relevant considerations (implicit in interpretation):
  - Maintaining strong macroeconomic policies and ample buffers (reserves, low fiscal debt, bank capitalization) can mitigate potential volatility risks from higher foreign participation.
  - Monitoring yield persistence and the effect of foreign participation on yields is important for debt management and market development strategies.

*IMF staff report content (cr18225-perubundle).*

### 2008. The mission completed the work on the SRF for the central bank and developed a bridge table

### cr18225-perubundle - 2008. The mission completed the work on the SRF for the central bank and developed a bridge table

### Statistical framework and technical assistance
- The mission completed work on the SRF for the central bank and developed a bridge table linking the source data reported by banks to the BCRP to the report form 2SR (other depository corporations).
- The mission identified shortcomings in the management of the database that generate the accounts of the other depository corporations sector at the BCRP.
- After the completion of two technical assistant missions the BCRP sent a first version of the SRFs in October 2016.
- A follow up technical assistance took place in June-July 2017.
- Significant progress has been achieved in terms of SRFs for the central bank and other depository corporations, but further work is needed for the SRFs of the other depository corporations.

### Financial soundness indicators (FSIs)
- Peru started reporting data and metadata for financial soundness indicators (FSIs) with a quarterly frequency in June 2011.

### External sector statistics and reserves reporting
- The BCRP prepares quarterly data on the balance of payments and international investment position largely in line with the recommendations of the fifth edition of the Balance of Payments Manual (BPM5).
- Departures from BPM5 include:
  - lack of coverage of assets held abroad and land acquisition abroad by residents;
  - not recording on an accrual basis some external debt transactions.
- The BCRP has been reporting since August 2001 weekly data on international reserves in accordance with the Operational Guidelines for Data Template on International Reserves and Foreign Currency Liquidity.
- Since August 2006, the BCRP is including the full amount of the liquidity requirements in the reserve template both under official reserve assets and as a contingent net drain (as specified in Section III of the Data Template).
- Peru disseminates quarterly data on external debt with an eight week lag on the National Summary Data Page with a hyperlink to the Fund’s website.

### Data dissemination frequencies and data quality (selected items)
- Exchange Rates: Latest observation 06/13/18; Date received 06/13/18; Frequency of data D; Frequency of reporting M; Frequency of publication D.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Latest observation 05/31/18; Date received 06/07/18; Frequency of data D; Frequency of reporting M; Frequency of publication W.
- Reserve/Base Money: Latest observation 05/31/18; Date received 06/07/18; Frequency of data W; Frequency of reporting M; Frequency of publication W.
- Broad Money: Latest observation 05/31/18; Date received 06/07/18; Frequency of data W; Frequency of reporting M; Frequency of publication W.
- Central Bank Balance Sheet: Latest observation 05/31/18; Date received 06/07/18; Frequency of data W; Frequency of reporting M; Frequency of publication W.
- Consolidated Balance Sheet of the Banking System: Latest observation 05/15/18; Date received 06/07/18; Frequency of data W; Frequency of reporting M; Frequency of publication W.
- Consumer Price Index: Latest observation May 2018; Date received 06/07/18; Frequency of data M; Frequency of reporting M; Frequency of publication M.
- Revenue, Expenditure, Balance and Composition of Financing – CG and GG: Latest observation Q1 2018; Date received 05/31/18; Frequency of data Q; Frequency of reporting Q; Frequency of publication Q.
- International Investment Position: Latest observation Q1 2018; Date received 05/24/18; Frequency of data Q; Frequency of reporting Q; Frequency of publication Q.
- External Current Account Balance: Latest observation Q1 2018; Date received 05/24/18; Frequency of data Q; Frequency of reporting Q; Frequency of publication Q.
- Gross External Debt: Latest observation Q1 2018; Date received 05/24/18; Frequency of data Q; Frequency of reporting Q; Frequency of publication Q.
- Footnotes and definitions provided in the table specify D = Daily, W = Weekly, M = Monthly, Q = Quarterly, A = Annually, I = Irregular, NA = Not Available, and assessments of methodological soundness and accuracy using O, LO, LNO, NO, NA.

### Recent information since the staff report (Statement by IMF Staff Representative, July 9, 2018)
- Congress granted the special legislative powers requested by the government on June 19 with 81 favorable votes (23 against). Once the associated regulation is published, the government will have sixty days to legislate in areas including economic management, taxation and competitiveness, integrity and the fight against corruption, social protection, and modernization of the public sector.
- The new Finance Minister, Carlos Oliva, took office on June 7 and announced continuity with respect to fiscal policy; excise tax increases recently implemented will not be reversed.
- Monthly GDP increased by 7.8 percent in April (y-o-y).
- Headline inflation re-entered the Central Bank’s target range (1-3 percent) in June and stood at 1.4 percent (y-o-y).
- The Central Bank did not intervene in spot or non-spot FX markets in June (data available until June 28); on June 28, the Central Bank reduced the marginal reserve requirement rate on FX liabilities from 36 to 35 percent, releasing $0.17 billion in liquidity to the financial system.
- EMBI spreads widened by only 0.73 percent in June.

### Macroeconomic background and recent developments (Statement by Executive Director for Peru)
- Peru’s macro record:
  - 19 free trade agreements and an average tariff rate of 0.9 percent.
  - GDP growth: 5.1 percent on average (2001-2017), second highest in region after Panama.
  - Inflation: 2.7 percent on average (2001-2017), second lowest in region after El Salvador.
  - General government gross debt: 23.3 percent of GDP.
  - Sovereign rates in domestic currency: 5.5 percent for a 10-year bond.
- Peru experienced 19 years of uninterrupted economic expansion as of 2017, with only three years of growth below 2 percent (1999, 2001, and 2009).
- Recent macro indicators (January–May 2018 and related periods):
  - Economy growing at 4.6 percent between January and May 2018.
  - Formal employment in the private sector growing at 3.8 percent in the first four months of 2018.
  - Construction sector expansion of 7 percent in January-May 2018 after prior contractions/low growth.
  - Mortgage loans increased 8 percent; VAT collections grew 12 percent (during a similar period).
- Current account deficit: declined from -2.7 to -1.3 percent of GDP in 2016 and 2017, respectively.
- External debt: 35.7 percent of GDP.
- International reserves: remained relatively stable at around 30 percent of GDP.
- The authorities hold Treasury deposits in the financial system equivalent to 15 percent of GDP, resulting in a net public debt of less than 10 percent of GDP.

### Monetary policy
- The Central Reserve Bank of Peru (BCRP) follows an inflation targeting (IT) regime and addresses financial risks from partial dollarization (30 percent of loans are dollar-denominated).
- As of June 2018:
  - Headline inflation: 1.4 percent.
  - Core inflation: 2.2 percent.
- The BCRP reduced the interest rate 6 times, from 4.25 percent in April 2017 to 2.75 percent in March 2018.
- The output gap became negative (-1 percent) prior to the rate cuts.
- Forecasted inflation and inflation expectations: 2.2 percent (noted in staff discussion).
- Higher reserve requirements for dollar deposits are used to discourage financial intermediation in foreign currency and promote de-dollarization; latest reductions in reserve requirements are consistent with normalization to a steady-state.

### Fiscal policy
- Fiscal stance and targets:
  - Limit for the fiscal deficit raised to 3.5 percent of GDP in 2018 to face infrastructure and reconstruction needs after El Niño; forecasted deficit likely to be close to 3 percent.
  - Aim to achieve a fiscal deficit of 1 percent by 2021.
  - Cap on public debt of 30 percent of GDP and steady-state fiscal deficit of 1 percent of GDP.
  - Target to stabilize gross public debt at about 27 percent of GDP in the medium term.
- Fiscal balances and revenues:
  - After 4 years of declining fiscal revenues, in the first half of 2018 fiscal revenues increased 18 percent compared to the same period in 2017, reaching a 12-month ratio of 19 percent of GDP (higher by 1 percentage point).
- Revenue measures:
  - Government raised excise taxes equivalent to 0.4 percent of GDP on goods with negative externalities (diesel fuel, cigarettes, alcoholic beverages, sugary drinks, etc.).
  - SUNAT is working on full digitalization of the VAT payment process by 2019.
  - Peru signed an agreement with 122 countries in the context of the BEPS plan.
- Expenditure measures:
  - Government approved measures to reduce non-critical expenses equal to 0.3 percent of GDP.
  - Changes in the Fuel Price Stabilization Fund (FEPC) expected to create annual savings up to 0.2 percent of GDP.
- Legislative measures to support public investment:
  - Law passed in March 2018 to provide clarity on civil damages in corruption cases to allow continuity of public investment projects equivalent to 4.5 percent of GDP.

### Reforms, infrastructure, and potential growth
- Congress granted special legislative powers covering tax policy and administration (including BEPS), competitiveness, post-El Niño reconstruction, anti-corruption measures, protection of vulnerable groups, and modernization of the state.
- Authorities aim to empower the Consejo Nacional de Competitividad y Formalización and continue implementation of Mesas Ejecutivas to address sectoral barriers (e.g., aquaculture and forestry).
- Major infrastructure projects planned in the year include expansion of the international airport and restart of the second line of the Lima metro.
- The authorities view the current recovery as an opportunity to reform the state to improve public services (education, security, health), recognizing medium-term capacity constraints.

### Financial sector and resilience
- Credit to the private sector increased from 28 percent of GDP in 2000 to 40 percent in 2017.
- Number of borrowers increased from 1 million to 7 million; population is 31 million.
- Goals of Financial Inclusion 2021: greater depth in financial markets, broaden coverage of financial services to promote digital payments, and create adequate financial ecosystems.
- The Superintendence of Banks and Insurance Companies (SBS) has strengthened supervision and regulation; Congress extended SBS perimeter to include cooperatives.
- Banking system attributes:
  - Very well capitalized and profitable.
  - Highly resilient to liquidity shocks due to reserve requirements.
  - SBS is working to increase capital buffers for domestic systemic banks and to implement the Net Stable Funding Ratio (NSFR).
- FSAP assessment:
  - Peru’s financial sector remains solid since the previous evaluation (2011) and has adequate buffers to manage severe shocks.
  - Banking sector stress test found that profits and previously accumulated countercyclical buffers would be instrumental to withstand a negative cumulative GDP growth shock of 9.5 over a three-year period.
  - Similar satisfactory results were found for the corporate sensitivity analysis.
  - Use of the new Growth-at-Risk (GaR) methodology in Peru’s FSAP is welcomed.

### Conclusion
- Base scenario: clear economic recovery in a low inflation environment, with a sustainable fiscal position and very healthy balance of payments.
- The Peruvian economy has ample buffers to face negative shocks in case of a deterioration of international conditions.

*Source: cr18225-perubundle - 2008. The mission completed the work on the SRF for the central bank and developed a bridge table*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18225-perubundle.pdf_