## _cr1421 ## Source details **Canonical URL:** [_cr1421](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1421.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1421.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1421.pdf.json) --- ### Initiatives to Speed Up Investment - Macroeconomic context and recent developments: - Economy operating "somewhat near potential" with a "very small negative output gap." - Economic growth decelerated in 2013 to about 5 percent (yoy) in the first three quarters of 2013, down from 6⅓ percent in 2012. - Unemployment rate declined to 5⅓ percent in November 2013. - Inflation: 2¾ percent (yoy) by year-end 2012; increased to slightly over 3 percent (yoy) in some months in the second half of 2013; expected to remain close to the upper limit of the target band of 3 percent by end-2013. - BCRP policy rate cut from 4¼ percent to 4 percent in November 2013. - Net international reserves (NIR) built up to US$64 billion (about 32 percent of GDP) and were expected to reach US$67 billion for 2013. - Staff estimated the cost of sterilization of FX purchases at about ½ percent of GDP. - NFPS overall surplus increased to 2¼ percent of GDP in 2012 and was estimated to have fallen to ½ percent of GDP in 2013. - Public debt expected to be below 20 percent of GDP in 2013. - Total financial assets of the NFPS expected to reach over 15 percent of GDP by end-2013 (of which about 4 percent of GDP belongs in the fiscal stabilization fund). - Staff estimates a NFPS structural fiscal surplus above ½ percent of GDP in 2013, resulting in a fiscal impulse of about 1 percent of GDP. - Diagnosed bottlenecks and rationale: - Growth moderation in 2013 attributed to adverse external conditions, weaker metal prices, decline in exports, moderation in private investment, and lower domestic confidence. - Public investment implementation slower than planned despite acceleration efforts. - Authorities identified capacity constraints and the need to improve investment climate and public investment performance. - Initiatives announced: - Special team in the Ministry of Economy and Finance (MEF) to identify and reduce bottlenecks and speed up investment projects. - Over 50 projects accounting for around 10 percent of GDP identified and under close monitoring to ensure completion. - Committee appointed to launch public private partnerships (PPP); a new PPP law to broaden scope and modalities. - Sub-national support and project continuity: - September 2013 support measures approved for local and regional governments affected by reduced mining-taxation revenues. - Assistance to be delivered as transfers within current budgeted expenditure envelope. - Credit line offered, available to local governments able to repay with future resource income. - Complementary fiscal framework reforms: - New legislation approved by Congress in October 2013, to be applied to the 2015 budget, aiming to: - introduce a counter-cyclical component to budget formulation; - strengthen accountability by introducing a fiscal council; - delineate better fiscal practices between national and sub-national levels. - Design followed recommendations of a 2012 commission, with participation by BCRP, IMF technical assistance, and independent experts. ### External Position, Financial Sector, and Risks - External position and financing (first nine months of 2013 unless specified): - Terms of trade deteriorated by 3½ percent (yoy). - Export volumes fell 3¾ percent (yoy). - Import volume growth about 6¾ percent (yoy). - Current account deficit: 5½ percent of GDP (first nine months of 2013). - Current account deficit financed by private capital inflows amounting to some 8 percent of GDP (mainly FDI). - International bond issuance by Peruvian firms in H1 2013: US$6½ billion (3 percent of GDP), compared to US$3½ billion during 2012. - Non-residents held about 57 percent of sovereign bonds. - Peruvian banks produced large net short-term capital outflows of about 3½ percent of GDP in Q2–Q3 2013 to reduce short-term external liabilities. - Selected balance of payments indicators (2013, percent of GDP): - Current Account (2013): -4.9 - Exports (2013): 20.5 - Imports (2013): -20.7 - Financial Account (2013): 6.3 - Private sector (net) (2013): 6.6 - Foreign direct investment (2013): 5.7 - Overall Balance (2013): 1.4 - External stability and vulnerabilities: - Real effective exchange rate broadly in line with fundamentals; some methodologies indicate slight overvaluation. - International investment position (IIP) improved over the last decade: negative IIP halved since early 2000s; foreign liabilities shifted toward non-debt items. - Net international reserves remain comfortable. - Peru maintains Article VIII obligations; open capital account; macro-prudential measures do not constitute capital flow management measures. - External tail risk from U.S. monetary policy: - Main external risk: disorderly/unexpected unwinding of the USFR’s unconventional monetary policy. - USFR announced on December 18, 2013 it will begin reducing its purchase of assets by US$10 billion a month to US$75 billion a month starting in January 2014. - May 2013 news of possible gradual USFR "tapering" destabilized emerging economies; in Peru capital flows slowed, corporate bond issuances curtailed, long-term sovereign yields increased. - Disorderly rapid withdrawal of USFR stimulus could cause sudden stops and reversal of some (non-FDI) capital flows, pressuring the financial system and decelerating growth. - Financial sector soundness (as of September 2013 unless specified): - Banks account for almost 90 percent of financial system assets. - Banks’ CAR: 14 percent. - Banks’ NPL ratio: 2 percent. - Banks’ ROE: 21½ percent. - High dollarization over 45 percent increases vulnerability. - Non-banks represent over 10 percent of financial system assets; low dollarization about 10 percent. - Non-banks’ CARs: 13½ for Cajas Rurales to about 18 for Empresas Financieras. - Financial soundness indicators (2013, selected): - Total NPL to Deposit Ratio (2013): 2.6 (percent) - Total Provisioning to NPL (2013): 23.5 (percent) - Total Return on Equity (2013): 21.5 (percent) - Total Capital Asset Ratio (2013): 14.0 (percent) - Sovereign ratings and political/social context: - Standard & Poor’s raised long-term sovereign foreign currency rating to BBB+ (from BBB) and local currency rating to A- (from BBB+) in August 2013. - Fitch raised ratings in October 2013. - Moody’s maintained Baa2 with a positive outlook. - Regional and municipal elections: October 2014; Presidential and legislative elections: April 2016. - About 150 disputes earlier in the year involving extractive industries; Minas Conga US$5 billion project stalled and expected to be reconsidered in 2015. ### Outlook, projections, and risks - Near term projections and staff views: - Regional output: around 2½ percent in 2013 and about 3 percent in 2014. - China projected to decelerate to 7½ percent in 2013 and to 7 percent over the medium term. - Staff projections: 2013 GDP near potential; growth slowing to about 5 percent. 2014: real GDP growth rebound to 5½ percent as large mining projects come on stream. - Authorities’ growth view: slightly above 5 in 2013 and 6 percent in 2014. - Inflation: 2.3 percent in 2013 and 2 percent in 2014. - External current account deficit to decline in Q4 2013 and about 5 percent of GDP in 2014. - Medium term: - Staff projects growth at potential of about 5¾ percent and inflation at 2 percent. - Primary fiscal surpluses expected to be anchored above 1 percent of GDP. - Gross public debt sustainable and declining to well below 20 percent of GDP; net debt turning negative. - Risks: - Short-term risks well balanced. - Domestic upside: faster operation of mining projects, faster infrastructure implementation, improved investor facilitation, policy reforms. - External downside: disorderly USFR unwinding causing capital flow reversals. ### Fiscal stance and policy recommendations - 2014 budget stance: - 2014 budget envisages a zero overall fiscal balance. - Applying historic budget execution rates implies a small surplus of about ⅓ percent of GDP for 2014. - Structural fiscal surplus reduced to 0.4 percent of GDP in 2014 (from 0.7 percent in 2013) after cycle and commodity adjustments. - Implies a mildly counter-cyclical fiscal impulse of about ⅓ percent of GDP in 2014. - Full implementation of the 2014 budget would yield a fiscal impulse of about ⅔ percent of GDP, which could pose a small overheating risk. - Medium-term fiscal recommendation: - Staff supports small structural surpluses on the order of ½ percent of GDP annually to address contingent liabilities and natural disaster risks and to maintain buffers. - Scale-up of public investment should be matched with enhancements in public financial management capacity, including sub-national levels. - Authorities’ position: - Authorities favor a structural deficit of 1 percent of GDP (the highest allowed under the new framework); methodology for calculating structural balance still being designed. - Staff cautioned against an unduly expansionary policy in 2015. - Monetary policy: - November 2013 policy rate reduction considered adequate by staff. - BCRP should remain vigilant and flexible in 2014; avoid additional easing unless evidence of renewed slowdown emerges. ### Exchange rate, FX intervention, and macro‑prudential guidance - Maintain exchange rate flexibility as shock absorber. - BCRP became a net seller of foreign exchange while allowing depreciation as capital inflows declined. - Staff recommends limited FX intervention to limit volatility and contain excessive balance-sheet risks; intervene sterilized to prevent large swings in credit expansion and interbank rate. - Encourage deepening of forwards and derivatives markets to support de-dollarization. - Macro-prudential measures should deter dollar loan growth and un‑hedged FX exposures; maintain or increase spread between reserve requirements on dollar and local currency deposits. ### Operational policy triggers for shocks (Risk Assessment Matrix summary) - Protracted volatility and capital flow reversal (high likelihood, high impact): use exchange rate as shock absorber and international reserves; ease monetary and macro‑prudential policies; consider temporary fiscal impulse. - Financial stress in Euro area (medium likelihood, high impact): similar set of responses. - Sharp slowdown in China (medium likelihood, low impact): allow higher exchange rate flexibility; use liquidity buffers and easing; consider temporary fiscal stimulus if credit conditions affected. - Sustained decline in commodity prices (low likelihood, high impact): use exchange rate as shock absorber; ease fiscal policy temporarily; structural measures to improve productivity and investment climate. - Reversal in private sector investment (low likelihood, high impact): exchange rate to absorb initial shock; ease fiscal policy temporarily. ### Real estate and housing indicators - High-end real estate in Lima: price per square meter increased by 245 percent in U.S. dollar terms since mid-2007. - Ratio of house prices to annual rental income increased to 15½ in 2013 from around 13½ in 2010. - Peru’s ratio is second highest in the region behind Brazil (18); lower than North America and emerging Europe/Asia markets (22 to 28). - Current sale prices equal on average 15½ years of rental income; Global Property Guide recommended range: 12.5 to 25. - Supply mismatch: more than 50 percent of effective demand is for housing priced below US$40,000 while only 4 percent of supply goes to this market. - Recent prudential actions expected to slow mortgage credit and house price growth. ### Structural reforms and inclusion - Structural reforms under way: civil service reform, private pension system reform, capital market regulation changes, labor market competitiveness measures, measures to boost productivity (credit insurance for SME exports, fund for science, innovation and technology). - Social outcomes: - Beneficiaries of conditional cash transfer program increased from around 1 million in 2011 to over 1½ million by mid-2013. - Program’s budget grew almost 30 percent in the last year reported. - Child malnutrition reduced to around 18 percent in 2012 from 28½ percent in 2007. - Poverty reduced to 25¾ percent in 2012 from 55½ percent in 2005. - Tax revenue pressures from falling metals revenues; exemptions amount to about 2 percent of GDP. - New fiscal law provides for publication of data on exemptions and contingent liabilities. ### Recent measures to speed investment (2013 package) - Administrative: monitoring team for investment projects; measures to facilitate investment process; promote negotiable bills for SMEs. - Tax: faster VAT refunds; tax credits for research spending and personnel training (for a three‑year period, extendable); extension of tax liability reductions for investments in public goods. - New legislation: certification of non‑existence of archeological objects reduced to 20 days (automatic approval if government fails to respond); expropriation provision separates acquisition from reparation payment to speed land acquisition; one‑stop‑shop for environmental impact studies requires terms of reference ready in less than a month; stock market law reduces requirements and costs for SMEs. ### Staff appraisal summary - Economy remains strong with large policy buffers; with growth near potential, macroeconomic policies should remain relatively neutral unless additional turbulence occurs. - Preserve policy flexibility and maintain good track record of appropriate policy responses. ### Final source attribution *International Monetary Fund — Excerpt from staff report text provided in content unit _cr1421.* ### 1. Initiatives to Speed Up Investment ____________________________________________________________ 25 ### 1. Initiatives to Speed Up Investment ### Macroeconomic context and recent developments - The economy was operating "somewhat near potential" with a "very small negative output gap." - Economic growth decelerated in 2013 to about 5 percent (yoy) in the first three quarters of 2013, down from 6⅓ percent in 2012. - Unemployment rate declined to 5⅓ percent in November 2013. - Inflation developments: - Inflation was 2¾ percent (yoy) by year-end 2012. - Inflation increased to slightly over 3 percent (yoy) in some months in the second half of 2013 and was expected to remain close to the upper limit of the target band of 3 percent by end-2013. - Monetary and reserve developments: - BCRP policy rate cut from 4¼ percent to 4 percent in November 2013. - Net international reserves (NIR) built up to US$64 billion (about 32 percent of GDP) and were expected to reach US$67 billion for 2013. - Staff estimated the cost of sterilization of FX purchases at about ½ percent of GDP. - Fiscal position: - NFPS overall surplus increased to 2¼ percent of GDP in 2012 and was estimated to have fallen to ½ percent of GDP in 2013. - Public debt expected to be below 20 percent of GDP in 2013. - Total financial assets of the NFPS expected to reach over 15 percent of GDP by end-2013 (of which about 4 percent of GDP belongs in the fiscal stabilization fund). - Staff estimates a NFPS structural fiscal surplus above ½ percent of GDP in 2013, resulting in a fiscal impulse of about 1 percent of GDP. ### Diagnosed bottlenecks and rationale for speeding up investment - Growth moderation in 2013 was attributed largely to adverse external conditions, weaker metal prices, a decline in exports, moderation in private investment, and lower domestic confidence. - Public investment implementation had been slower than planned, despite government efforts to accelerate it, leading to stronger-than-expected 2012 fiscal outcomes. - The authorities identified capacity constraints and the need to improve the investment climate and public investment performance to support growth. ### Initiatives announced to accelerate investment (public and PPP) - A special team was appointed within the Ministry of Economy and Finance (MEF) to identify and reduce bottlenecks and speed up investment projects. - Over 50 projects accounting for around 10 percent of GDP have been identified and are under close monitoring to ensure completion. - A committee responsible for launching public private partnerships (PPP) was appointed; and a new PPP law will broaden the scope and modalities under which these partnerships could be established. ### Measures to support sub-national governments and project continuity - In September 2013, support measures were approved for local and regional governments to prevent interruptions in ongoing projects affected by reduced mining-taxation revenues earmarked to the regions. - Assistance to be delivered in the form of transfers within the current budgeted expenditure envelope. - A credit line was offered, available to all local governments that are able to repay debt with future resource income. ### Complementary fiscal framework reforms - New legislation strengthening the fiscal framework was approved by Congress in October 2013 and will be applied to the 2015 budget. - The new framework aims to: - introduce a counter-cyclical component to budget formulation; - strengthen accountability by introducing a fiscal council; - delineate better the relationship and fiscal practices between the national and sub-national levels. - The design followed recommendations of a commission of experts appointed in 2012 and involved participation by the BCRP, technical assistance from the Fund, and independent experts. *Source: IMF staff report text provided in content unit _cr1421 - 1. Initiatives to Speed Up Investment* ### 9. The external position has deteriorated mostly due to weak export performance and ### 9. The external position has deteriorated mostly due to weak export performance and higher interest rates abroad ### External position: recent developments and financing - Terms of trade deteriorated by 3½ percent (yoy) in the first nine months of 2013. - Export volumes fell 3¾ percent (yoy) in the first nine months of 2013. - Import volume growth remained strong at about 6¾ percent (yoy). - Current account deficit: 5½ percent of GDP (first nine months of 2013). - Current account deficit financed by private capital inflows amounting to some 8 percent of GDP (mainly FDI). - International bond issuance by Peruvian firms in H1 2013: US$6½ billion (3 percent of GDP), compared to US$3½ billion during 2012. - Non-residents maintained holdings of sovereign bonds at around 57 percent of the total. - Peruvian banks used liquidity to reduce short-term external liabilities, producing large net short-term capital outflows of about 3½ percent of GDP in Q2–Q3 2013. - Overall balance of payments indicators (selected): - Current Account (2013): -4.9 (percent of GDP) - Exports (2013): 20.5 (percent of GDP) - Imports (2013): -20.7 (percent of GDP) - Financial Account (2013): 6.3 (percent of GDP) - Private sector (net) (2013): 6.6 (percent of GDP) - Foreign direct investment (2013): 5.7 (percent of GDP) - Overall Balance (2013): 1.4 (percent of GDP) ### External sector stability and vulnerabilities - EBA and CGER methodologies indicate the real effective exchange rate is broadly in line with fundamentals; some methodologies indicate a slight overvaluation. - International investment position (IIP) improved over the last decade: negative IIP halved since the early 2000s and foreign liabilities composition shifted significantly into non-debt items. - Net international reserves remain comfortable across metrics. - Peru does not maintain exchange restrictions or multiple currency practices subject to Fund jurisdiction (Article VIII, Section 2 (a) or 3). - Macro-prudential measures aim at enhancing financial stability and do not constitute capital flow management measures; Peru has an open capital account. ### External tail risk related to U.S. monetary policy - The main external risk is a disorderly/unexpected unwinding of the USFR’s unconventional monetary policy. - The USFR announced on December 18, 2013 that it will begin reducing its purchase of assets by US$10 billion a month to US$75 billion a month starting in January 2014. - News of possible gradual USFR “tapering” in May 2013 destabilized many emerging economies; in Peru capital flows slowed, corporate bond issuances were curtailed, and long-term sovereign bond yields increased. - A disorderly and rapid withdrawal of USFR stimulus could cause sudden stops and reversal of some (non-FDI) capital flows to Peru, pressuring the financial system and decelerating growth. ### Financial sector: soundness and risks - Overall assessment: financial sector remains solid and healthy. - Banks: - Account for almost 90 percent of financial system assets. - Capital to risk-weighted asset ratios (CAR): 14 percent (as of September 2013). - Non-performing loan ratios (NPL): 2 percent (as of September 2013). - Return-on-equity (ROE): 21½ percent (as of September 2013). - High dollarization of over 45 percent increases vulnerability to exchange rate fluctuations. - BCRP and SBS employed macro-prudential policies; BCRP increased RR on dollar liabilities during the first four months of 2013 to limit dollar loan expansion and encourage substitution by nuevos soles credits. - Non-banks: - Represent over 10 percent of financial system assets. - Low dollarization of about 10 percent limits FX risk exposure. - Financial health worsened recently: NPLs, profitability, and provisioning indicators deteriorating due to softer economic conditions and concentrated portfolios in consumer and small- and micro-enterprise loans. - Remain well-capitalized: CARs ranging from 13½ for Cajas Rurales to about 18 for Empresas Financieras. - Financial soundness indicators (selected, end of period): - Total NPL to Deposit Ratio (2013): 2.6 (percent) - Total Provisioning to NPL (2013): 23.5 (percent) - Total Return on Equity (2013): 21.5 (percent) - Total Capital Asset Ratio (2013): 14.0 (percent) ### Sovereign ratings and social/political context - Credit rating actions in 2013: - Standard & Poor’s raised long-term sovereign foreign currency rating to BBB+ (from BBB) and long-term sovereign local currency rating to A- (from BBB+) in August 2013. - Fitch raised ratings in October 2013 (noted as the best rating in Latin America after Chile). - Moody’s maintained Baa2 with a positive outlook. - Reasons cited for upgrades: continued robust growth, establishment of a fiscal stabilization fund, buildup of international reserves, and improved fundamentals. - Political calendar and social tensions: - Regional and municipal elections: October 2014. - Presidential and legislative elections: April 2016. - About 150 disputes earlier in the year involving extractive industries over environmental and compensation issues. - The US$5 billion Minas Conga project stalled due to social discontent; company expected to reconsider in 2015. ### Outlook and projections (near term and medium term) - External and global environment: - Regional output growth projected around 2½ percent in 2013 and about 3 percent in 2014. - China projected to decelerate to 7½ percent in 2013 and to 7 percent over the medium term (WEO-based). - USFR unwinding announced will lead to higher long-term interest rates in 2014. - Terms of trade deterioration: 3¼ percent in 2013 and 1 percent in 2014. - Staff projections: - 2013: GDP near potential; growth slowing to about 5 percent. - 2014: Real GDP growth rebound to 5½ percent as large mining projects come on stream. - Authorities’ growth view: slightly above 5 in 2013 and 6 percent in 2014. - Inflation: 2.3 percent in 2013 and 2 percent in 2014 (middle of inflation band). - External current account deficit to decline in Q4 2013 with mining and fishing export recovery; about 5 percent of GDP in 2014. - Medium-term: - Staff projects growth at potential of about 5¾ percent and inflation at 2 percent. - Current account expected to diminish over the medium term with increases in mining exports and stabilized global growth. - Primary fiscal surpluses expected to be anchored above 1 percent of GDP. - Gross public debt sustainable and declining to well below 20 percent of GDP; net debt turning negative. ### Risks: upside and downside - Short-term: risks well balanced. - Domestic upside risks (could raise growth above baseline): - Faster operating capacity of large mining projects. - Faster implementation of large infrastructure projects. - Greater effectiveness of the investor facilitator office. - Faster adoption of authorities’ reform agenda. - Recent macroeconomic stimulus may have quicker-than-expected effects given softer conditions. - External downside risks: - Disorderly unwinding of USFR policy could disrupt global financial flows, cause sudden stops, and reverse non-FDI capital flows, pressuring financial system and growth. ### Fiscal stance, policy mix, and recommendations - 2014 budget and near-term fiscal stance: - 2014 budget envisages a zero overall fiscal balance. - Applying historic budget execution rates implies a small surplus of about ⅓ percent of GDP for 2014. - Structural fiscal surplus reduced to 0.4 percent of GDP in 2014 (from 0.7 percent in 2013) after cycle and commodity adjustments. - This implies a mildly counter-cyclical fiscal impulse of about ⅓ percent of GDP in 2014. - Full implementation of the 2014 budget would yield a fiscal impulse of about ⅔ percent of GDP, which could pose a small overheating risk. - Medium-term fiscal recommendation: - Staff supports small fiscal structural surpluses on the order of ½ percent of GDP annually to address contingent liabilities and natural disaster risks and to maintain fiscal buffers. - The new fiscal framework is an important step to reduce pro-cyclicality and achieve appropriate savings. - Staff recommended the structural target be set considering desired financial balances and public investment path. - Scale-up of public investment should be matched with enhancements in public financial management capacity, including sub-national levels, to ensure high rates of return. - Authorities’ position: - Authorities favor a structural deficit of 1 percent of GDP (the highest allowed under the new framework); methodology for calculating the structural balance is still being designed and expected to be proposed by a commission. - Staff cautioned against an unduly expansionary policy in 2015. - Monetary policy: - The November 2013 policy rate reduction was considered adequate by staff given the decelerating economy, contained inflation within the BCRP band, anchored inflation expectations, and weak confidence. - BCRP should remain vigilant and flexible in 2014. - Additional monetary easing should be avoided unless evidence of renewed economic slowdown emerges, as undue easing may compromise objectives. *Source: IMF staff report content (Peru).* ### 2014. Without knowing the methodology used by the authorities to measure the fiscal balance, it is difficult to assess ### _cr1421 - 2014. Without knowing the methodology used by the authorities to measure the fiscal balance, it is difficult to assess ### Fiscal methodology and fiscal stance - The authorities target a structural fiscal deficit of 1 percent of GDP, but without disclosure of the methodology for measuring the structural balance it is difficult to assess whether this implies a positive or negative fiscal impulse. - If a heavily backward-looking price for metals is used to gauge the relevant structural price, this could produce: - a relatively low “shadow” price of metals; - relatively low structural revenues; - a structural deficit higher than 1 percent of GDP, which would require fiscal tightening to hit the authorities’ objective. - If the commission were to follow a methodology similar to staff’s, then, if fully executed, it would entail a fiscal impulse of over 1 percent of GDP in 2015. ### Monetary policy, inflation, and interest rates - The BCRP remains committed to the inflation target band (1–3 percent) and has generally kept inflation within the band since the implementation of inflation targeting in 2002. - Authorities indicated willingness to consider additional monetary easing if the economy remained weak and inflation expectations stayed low, while remaining committed to the inflation target. - Possible instruments for easing: - lower reserve requirements to foster private credit growth; - further lowering of the policy rate if the economy remained weak. - Authorities’ views: - If long-term interest rates in the U.S. were to increase, the flexible exchange rate would adjust and not necessarily require a change in Peruvian monetary policy. - Higher long-term U.S. rates would lead to re-pricing of long-term Peruvian bonds while short-term rates in nuevos soles would likely remain anchored to the policy rate. - Staff view: - Further monetary easing might not be appropriate if U.S. monetary conditions tighten, as it could fuel capital outflows. ### Exchange rate policy and FX intervention - Maintaining exchange rate flexibility has helped cushion the economy against external shocks. - As the current account deficit deteriorated and private capital inflows declined, the BCRP became a net seller of foreign exchange while allowing the currency to depreciate. - Staff recommendations: - Continue strengthening the role of the exchange rate as a shock absorber. - Allow exchange rate to be driven by fundamentals. - Use limited foreign exchange intervention to limit volatility and contain excessive balance-sheet risks in a highly dollarized economy; such intervention should be sterilized to prevent large swings in credit expansion and undue movements in the interbank rate. - Encourage deepening of forwards and other derivatives markets to help private sector internalize exchange rate risks and support de-dollarization. - Authorities’ stance: - Committed to a flexible exchange rate regime, intervening to ensure orderly functioning of the FX market without targeting a predetermined exchange rate level. - Concerned about excessive volatility given a relatively dollarized economy. ### Macro-prudential policy and financial sector vulnerabilities - Recent macro-prudential measures aim to deter the growth of dollar loans; additional measures are needed to discourage un-hedged foreign exchange exposures. - The high positive spread between reserve requirements on dollar deposits and those on local currency deposits should be maintained or increased to discourage dollarization; effects would include: - downward pressure on dollar deposit rates; - upward pressure on dollar loan rates. - In the event of reversals of capital inflows, authorities would unwind previous tightening of reserve requirements while maintaining the spread between dollar and local currency RR to provide adequate credit. - Regulatory standards should continue to be strengthened in line with Basel III while ensuring adequate private credit provision (Annex V). - The overall financial system remains healthy and strong, but recent deterioration of financial soundness indicators for some non-bank deposit-taking institutions warrants closer monitoring and supervision. ### Spillovers, external risks, and policy triggers for using buffers - Inward and outward spillover risks are limited; inward spillovers are more relevant. - Inward spillovers via capital flows mainly from the U.S. and Canada, and to a lesser extent Spain and Chile; foreign banks (mainly from Spain, Canada, and the U.S.) play a big role but are locally funded. - Inward spillovers could also occur via trade channels through commercial ties with China and the U.S. - Outward spillovers are limited and relate to regional trade with Chile, Colombia, and Mexico and other countries in the region. - Authorities and staff agreed that vulnerabilities have increased but current buffers are sufficient to address a variety of shocks; preserving policy flexibility and a good track record of appropriate policy responses is instrumental. - Two important external risks identified: - (i) uncertainty related to the withdrawal of monetary stimulus in the U.S. in the short-term; - (ii) deterioration in growth prospects in China over the medium-term. - Recommended policy responses (as summarized in the Risk Assessment Matrix): - Protracted economic and financial volatility, including capital flow reversal (high relative likelihood, high impact): use exchange rate as a shock absorber and international reserves to avoid overshooting; ease monetary and macro-prudential policies to avoid a credit squeeze; consider a temporary fiscal impulse. - Financial stress in Euro area re-emerges (medium relative likelihood, high impact): use the exchange rate as shock absorber and international reserves; ease monetary and macro-prudential policies; temporary fiscal stimulus. - Sharp slowdown in China (medium relative likelihood, low impact): allow for higher exchange rate flexibility and use liquidity buffers, repo operations and dollar swap auctions together with easing monetary conditions; consider temporary fiscal stimulus if credit conditions affect activity. - Sustained decline in commodity prices (low relative likelihood, high impact): use exchange rate as shock absorber, ease fiscal policy temporarily, and undertake structural measures to improve productivity and investment climate; consider temporary fiscal expansion to ease adjustment to lower income. - Reversal in private sector investment (low relative likelihood, high impact): exchange rate could initially absorb some shock; ease fiscal policy temporarily to smooth impact on aggregate demand and income. - Operational guidance: - Use of reserves, liquidity buffers, repo operations and dollar swap auctions can help ensure liquidity in the financial system. - In the event of a sudden capital outflow that pressures credit and growth, a temporary fiscal stimulus might be appropriate within limits of the new fiscal framework. - Given expected tightening in the U.S., further domestic monetary easing might not be appropriate as it could fuel capital outflows; BCRP expects to manage an independent monetary policy to achieve domestic objectives while using macro-prudential measures and a floating exchange rate. ### Preserving strong growth momentum and structural reforms - Peru has a solid growth record and favorable investment climate; cross-country indicators: - World Economic Forum’s “Global Competitiveness Report” for 2013: Peru retained its 61st position (out of 148 countries; and 3rd in Latin America). - World Bank’s “Doing Business Report” for 2013: Peru is in 43rd place (out of 189 countries). - Main strengths: macroeconomic policies and market efficiency. - Main weaknesses: weak public institutions, weak governance, education, and infrastructure; contract enforcement and insolvency resolution; inefficiencies in business opening and building permits; lack of urban planning deterring manufacturing investment. - Structural reforms under way: - Far-reaching civil service reform bill: standardizes workplace regulations and salary scales, increases training, institutes performance evaluations; approved by Congress and expected to enter into effect shortly. - Private pension system reform: aims to generate greater public access and lower fees; compulsory membership of independent workers was delayed by Congress in September 2013 for one year; SBS is implementing regulations to facilitate access and revising investment guidelines for private pension funds. - Capital market regulation: regulations to reduce cost of issuing new securities approved; legislation pending on strengthened corporate governance and financial reporting requirements; initiative to align taxation of capital instruments across MILA and Pacific Alliance countries is in progress. - Labor market competitiveness improvements: ongoing reform of Certification and Normalization of Labor Competition enacted in 2012, aiming to reduce high costs of employment and raise labor productivity through training, education credits, scholarships, better training centers, and increasing share of foreign workers in specialized career streams; over five years authorities expect productivity improvements of 20–30 percent. - Measures to boost productivity: introduction of credit insurance for exports for SMEs; establishment of the fund for science, innovation and technology; reforms to strengthen national system of quality and develop logistical services in transportation. ### Social outcomes and inclusion - Significant progress has been made in reducing poverty and child malnutrition and broadening social programs: - Beneficiaries of the conditional cash transfer program increased from around 1 million in 2011 to over 1½ million by mid-2013. - The program’s budget grew almost 30 percent in the last year reported. - Child malnutrition reduced to around 18 percent in 2012 from 28½ percent in 2007. - Poverty reduced to 25¾ percent in 2012 from 55½ percent in 2005. - Challenges remain in improving systems for targeting extreme poverty and expanding transparency (e.g., registry of beneficiaries). ### Tax revenue and fiscal transparency - Tax revenue is under pressure from falling metals revenues. - Institutional reforms and overhaul of SUNAT were approved and progress was made in doubling capacity, coverage and control processes, evident in good performance of income and sales taxes. - Ongoing work: - Improving risk controls, especially in customs; - Better diagnosing system bottlenecks; - Improving information systems. - Additional efforts needed to: - Continue improving tax collections; - Reduce informality and tax evasion; - Decrease exemptions which amount to about 2 percent of GDP. - The new fiscal law provides for publication of data on exemptions and contingent liabilities along with budget documentation to increase transparency and accountability. *International Monetary Fund — Excerpt from staff report discussions with Peruvian authorities (2013–2014).* ### 34. The authorities need to continue enhancing financial supervision and ### 34. The authorities need to continue enhancing financial supervision and ### Financial supervision and macro‑prudential framework - Dominance of large and complex financial conglomerates could be a source of systemic vulnerabilities and has contributed to the high interest rate spreads relative to regional and income peers. - Recommendation: further enhance the macro‑prudential policy framework through: - Oversight of corporate and household balance sheets. - Strengthening the legal or regulatory framework for financial stability. - Recent targeted prudential measures implemented in 2013: - Capital charges on higher loan‑to‑value mortgages, dollar mortgages, and second homes. - Higher dollar reserve requirements. - Need for measures to discourage un‑hedged foreign exchange exposures of households and corporations. - Maintain the high spread between reserve requirements on dollar deposits and on local currency deposits to discourage dollarization. - Close monitoring and strengthened supervision warranted for non‑bank deposit‑taking institutions given recent deterioration in their financial soundness indicators. ### Capital markets, competition, and alternative funding - Increasing competition and easing access to alternative sources of funding through capital market reforms would facilitate effective allocation of savings and help reduce interest rate spreads. - Recent measures and proposals: - Reduction of commissions on the Lima Stock Exchange by 53 percent, effective November 2013, to reduce transaction costs and attract more small and medium‑sized companies. - Creation of a private offering regime for sophisticated investors with minimal requirements. - Streamlining the debt offering regime. - Strengthening the equity offering regime in line with recent technical assistance recommendations. - Creation of MILA (integration of Chilean, Colombian, and Peruvian stock markets) expected to increase market liquidity and the spectrum of investible assets. - Recent law reduces requirements and costs for accessing finance through the capital market for medium‑sized and small companies. ### Structural reforms and inclusive growth - Perseverance in structural reform implementation is essential to preserve growth momentum and fulfill social goals. - Staff highlights needed reforms: - Greater labor market flexibility. - Upgrade human capital. - Define a comprehensive public investment strategy. - Reduce informality. - Achieve ambitious tax revenue targets to raise funds for social needs. - Strengthen the judicial system. - Recent initiatives to speed up investment (2013 package) focused on administrative enhancements, tax incentives, and new legislation: - Administrative: creation of a monitoring team for investment projects; measures to facilitate investment process; promote negotiable bills for SMEs. - Tax: faster VAT refunds; tax credits for research spending and personnel training (for a three‑year period, extendable thereafter); extension of tax liability reductions for investments in public goods. - New legislation: certification of non‑existence of archeological objects reduced to 20 days (automatic approval if government fails to respond); expropriation provision separates acquisition from reparation payment to speed land acquisition (process expected to take a few months versus previously two to three years); one‑stop‑shop for environmental impact studies requires terms of reference ready in less than a month (previously one to two years); stock market law reduces requirements and costs for SMEs. ### Staff appraisal: macroeconomic outlook and policy stance - Overall state of the economy remains strong despite lower metals prices and recent market turbulence; Peru continues to be one of the most dynamic economies in the region with large buffers from past policy implementation. - With growth somewhat near potential, macroeconomic policies should remain relatively neutral unless additional turbulence or downside risks materialize. - Risks: - External risks tilted to the downside: possible reversal of terms of trade gains if growth deteriorates in main trading partners; sudden stops and reversal of some (non‑FDI) capital flows due to tightening global financial conditions could pressure the financial system and decelerate growth. - Domestic risks on the upside: faster implementation of large mining and infrastructure projects could increase growth. - Recommendation: preserve policy flexibility and maintain a good track record of appropriate policy responses. ### Fiscal policy and new macro‑fiscal framework - 2014 budget fiscal objectives are broadly appropriate to maintain macroeconomic stability. - Staff estimates the outcome will most likely be a small surplus (instead of a planned balance), which is counter‑cyclical given an emerging negative output gap. - Staff recommends aiming for small structural surpluses of around ½ percent of GDP a year over the medium term to address contingent liabilities and natural disaster risks. - Importance of integrating fiscal risks and the need to close infrastructure and social gaps when implementing the new fiscal framework; strong political commitment and steady implementation of a fiscal rule are important. - Key provisions of the new macro‑fiscal framework approved in 2013: - After general elections, new administrations within 90 days of taking office must present a declaration of macro‑fiscal policy with a numerical structural fiscal objective for the presidential period which cannot be a deficit higher than 1 percent of GDP. - The limit of non‑financial public spending must be aligned to the structural fiscal objective; if prior year spending was less than budgeted, subsequent year’s spending can be adjusted upwards by no more than 0.2 percent of GDP. - Countercyclical policy: if there is a positive or negative output gap of at least 2 percent of potential GDP, the spending limit should be adjusted through transitory counter‑cyclical measures which together cannot exceed 0.5 percent of GDP. - Fiscal revenues: if measures generate a permanent increase in fiscal revenues of at least 0.3 percent of GDP, the spending limit can be adjusted by the same amount. - Regional and local governments: level of debt cannot be more than 100 percent of the average total current revenues of the last four years; annual growth of non‑financial expenditure cannot exceed the moving average growth of annual revenues over the past four years; governments can only borrow under the state guarantee and only for capital projects. - Corrective measures: in case of upward deviations from the spending limit, corrective measures are to be taken within two years if over‑spending is below 0.5 percent of GDP and immediately if it is above this threshold, with an exception when there is a negative output gap of more than 2 percent of potential GDP. ### Monetary policy and exchange rate policy - With inflation expectations in check, a neutral monetary policy in the near term would be appropriate; the BCRP should focus on maintaining core inflation in check. - BCRP needs to exercise caution managing monetary policy in the context of a likely increase in long‑term global interest rates. - Greater exchange rate flexibility observed over the past year is welcome; the exchange rate has been used as a shock absorber and should continue to be driven by fundamentals over the medium and long term. - Limited foreign exchange intervention may be necessary to reduce volatility and contain excessive balance‑sheet risks in a highly dollarized economy; given external risks, intervention is more likely on the sale side and should be properly sterilized to prevent a credit crunch and unnecessary upward pressure in the interbank rate. - Increasing exchange rate flexibility is expected to create further incentives for deepening forwards and other derivatives markets, stimulating de‑dollarization. ### Buffers, risks, and policy responses to shocks - Current buffers are sufficient to address possible short‑term shocks. - Increased risk aversion from U.S. Federal Reserve “tapering” could reverse capital inflows, requiring resolute central bank actions to maintain confidence and orderly markets (as in 2008–09). - If slower global growth leads to lower external demand and deteriorating terms of trade, exchange rate should act as shock absorber though dollarization poses risks. - Monetary and macro‑prudential policies should be relaxed to support activity in the event of slowdown; if slowdown is pronounced, consider a measured and temporary fiscal impulse. ### Revenue mobilization and tax effort - Resolute efforts necessary to achieve ambitious tax targets; staff welcomes progress in doubling capacity, coverage, and control processes reflected in good performance of income and sales taxes. - To reach tax collections comparable with other emerging markets, decisive steps are needed: continue reforms, reduce informality, tax evasion, and exemptions. ### Real estate market assessment (Box 3) - High‑end real estate in Lima: price per square meter increased by 245 percent in U.S. dollar terms since mid‑2007; mid‑market evolved similarly. - Studies indicate deviations from fundamentals have been minimal: co‑integrated VAR and BBVA (2012) suggest housing market near fair values. - Traditional metrics: - Accessibility index (home price/per capita income) compares well regionally and has remained stable. - Ratio of house prices to annual rental income increased to 15½ in 2013 from around 13½ in 2010. - Peru’s ratio is the second highest in the region behind Brazil (18), but lower than North American and emerging Europe/Asia markets (22 to 28). - Current sale prices equal on average 15½ years of rental income; Global Property Guide normal price ratio recommended range is between 12.5 and 25. - Supply-demand imbalances and limited land/infrastructure have put upward pressure: more than 50 percent of effective demand is for housing priced below US$40,000 while only 4 percent of supply goes to this market. - Recent prudential actions (see above) are expected to slow mortgage credit and house price growth. *Source: IMF staff report excerpts in content unit _cr1421 - 34. The authorities need to continue enhancing financial supervision and* ### Box 4. Peru: Currency Mismatches in the Corporate Sector ### Box 4. Peru: Currency Mismatches in the Corporate Sector ### Decline in economy-wide currency mismatch - The average foreign exchange imbalances of non-financial firms in Peru narrowed to about 5 percent of total assets in 2012, from 25 percent in 1999 (excluding derivatives). - This decline occurred as part of last decade’s economy-wide de-dollarization process. ### Sectoral differences in FX imbalances - Manufacturing, construction and large scale retail (consumption) retain large FX imbalances of between 7 and 17 percent of total assets. - The economy-wide average decline masks these sectoral disparities. ### Private sector U.S. dollar securitized debt - Since end-2010, U.S. dollar denominated debt securities placed abroad increased 2½ times. - Peruvian firms issued U.S. dollar senior debt notes in the amount of some US$6 billion thus far in 2013. - Overall, Peruvian-issued international debt securities stand at about US$15 billion or 6⅔ percent of GDP. - Immediate-term debt service commitments are relatively small (about US$1 billion a year) and unlikely to create balance of payments difficulties. ### Vulnerability to exchange rate volatility and estimated losses - Market analysts estimate that a depreciation of the nuevo sol by about 10 percent (equivalent to the rate of depreciation year-to-date as of September) would cause a 1 percent loss of Peruvian firms’ assets, on average. - Sector-specific estimated losses (in percent of total assets) based on a 10 depreciation of the PEN/US$ exchange rate: - Trade: losses of over 7 percent of total assets - Manufacturing: losses between 2 and 4 percent of total assets - Construction: losses between 2 and 4 percent of total assets - Large scale retail (consumption): losses between 2 and 4 percent of total assets - Banking: virtually no loss of its own (and would actually experience small gains) - Mining: would actually experience small gains - Large losses in non-bank sectors or individual firms could point to potential risks for banks despite banks’ limited own losses. - Note: The calculations do not include off balance sheet items such as forward contracts, which may be providing FX cover to these imbalances. ### Policy recommendation - Strengthen macro-prudential policies through oversight of corporate and household balance sheets to help contain currency mismatch risks. - While sector-targeted macro-prudential policies for the financial sector are welcome, systematic oversight of corporate and household balance sheets could help contain risks originating from the non-financial sectors. *International Monetary Fund* ### Box 6. Why is Peru Growing Faster Than Other Countries in the Region? ### Box 6. Why is Peru Growing Faster Than Other Countries in the Region? ### Regional growth patterns and context - Commodity exporters (mostly South America) have grown, on average, 4¾ percent a year since 2003, (compared to about 3 percent the previous decade). - Non-commodity exporters have grown only about 2½ percent a year since 2003. - The region benefited from an unprecedented improvement in terms of trade and favorable external financial conditions during 2003–12. - Peru exhibited an annual average growth of 6½ percent during 2003–12 (almost twice the average of the prior decade), similar to emerging Asian economies. ### Drivers of growth in commodity-exporting Latin America - Labor and capital accumulation were the main drivers of growth in the region. - An output-decomposition exercise finds that factor accumulation accounted, on average, for 80 percent of the output growth among commodity exporters. - Employment gains explain the high labor contribution to growth. - High capital contribution reflects favorable external financial conditions and high investment (including FDI) in the primary sector associated with the commodity price boom. - Productivity (TFP) growth mostly turned positive after declines in previous decades, reflecting the expansionary cycle in 2003–12 and structural shifts such as movement away from the informal sector; however, TFP growth remains tepid in most countries compared with emerging Asia. ### Why Peru outperformed: contributions of TFP, capital, and informality decline - In Peru, improvements in TFP played a key role in driving growth momentum, similar to emerging Asian economies. - TFP accounted for almost 2½ percentage points of output growth on average during 2003–12. - Higher TFP growth—along with increases in the capital stock—explains most of the pickup in growth compared with previous decades. - After declines in the 1980s and 1990s, TFP growth in Peru turned positive, reaching annual average rates of almost 2½ percent—one of the highest in the region. - The marked decline in labor informality has played an important role in explaining Peru’s higher TFP contribution. ### Recent developments and medium-term outlook - Growth has been moderating due to weaker external and domestic demand; output is close to potential. - Inflation moderated significantly in 2012 but has hovered around the upper limit of the target band starting mid-2013; food and commodity prices stayed elevated and exchange rate pass-through put pressure on prices. - Unemployment has reached historic lows; market sentiment declined during the year but picked up in October (Figure references in source). - Fiscal surpluses are estimated to have declined in 2013 due to lower revenue and higher spending; the fiscal impulse was positive and significant in 2013 but is projected to be near zero over the medium term. - Commodity-related revenue is estimated to have declined in 2013 but projected to remain stable in the near term. - Public expenditure-to-GDP ratio is expected to stabilize after 2013; overall and structural fiscal balances are projected to be close to zero in the next few years. - The current account deficit has widened recently but is more than financed by capital inflows; buoyant FDI accounts for much of the capital inflows. - Metal prices and the terms of trade have deteriorated recently due to softer external demand; short-term capital inflows appear to be reversing. - Exchange rate: after appreciating to historical low levels last year, the nuevo sol has depreciated this year. - Financial conditions: bond and equity fund flows reversed following the Fed's announcement of tapering; equity prices and market capitalization retreated reflecting declines in metal prices; sovereign spreads and sovereign bond yields have increased recently. - Financial sector: private sector credit growth continued to moderate, particularly in foreign currency; dollarization of business loans remains high though it has decelerated sharply; deposit-taking institutions are well-capitalized and provisioned with comfortable liquidity and profitability ratios. - Balance-sheet vulnerabilities: net international investment position has steadily improved; nonresident holdings of government securities have risen rapidly; non-performing loan ratios have recently risen again with growing credit card debt; housing prices have risen but remained close to fundamentals. ### Risks and constraints to future growth - Growth will be more challenging going forward; recent deceleration raises concerns about prospects in Peru and the region. - Estimates of potential growth rates for 2013–17 are generally lower than those observed in recent years. - As low global interest rates that facilitated large capital flows start to rise and commodity prices stabilize, growth of physical capital is likely to moderate. - The contribution of labor will be limited by constraints associated with tight labor markets and, in some cases, demographic issues. - In Peru, growth is projected to slow down in the next years (reflecting both cyclical and structural issues), yet potential growth will remain among the highest in LAC at quite robust rates. ### Key numeric findings and projections (as reported) - Commodity exporters: average growth since 2003 = 4¾ percent a year. - Non-commodity exporters: average growth since 2003 = 2½ percent a year. - Peru: average growth 2003–12 = 6½ percent; TFP contribution ≈ 2½ percentage points of output growth (2003–12); TFP growth annual average ≈ 2½ percent after turning positive. - Estimates of potential output growth for 2013–17 are generally lower than recent realized rates (see Figure 3 in source for country ranges and comparisons). *Prepared by S. Sosa, based on Sosa et.al. (2013), “Is the Growth Momentum in Latin America Sustainable?” IMF Working Paper No. 13/109.* ### Annex I. Spillovers from the U.S. Federal Reserve ### Annex I. Spillovers from the U.S. Federal Reserve ### Announcement of Tapering — The Shock - The U.S. Federal Reserve (USFR) announcement of tapering asset purchases on May 22, 2013 triggered large market moves in Peru. - Exchange rate and yields in the five-week period between May 21 and June 24, 2013: - Exchange rate: depreciation of 5 percent. - 10-year local currency sovereign bond yield: jump of over 160 basis points. - Market volatility peaked between May 21 and June 24, 2013; volatility moderated somewhat in subsequent months but left enduring consequences for capital flows, the FX market, corporate financing, and sovereign bond yields. ### Spillovers — Capital Flows and Balance of Payments - Net capital inflows (percent of GDP): - Q1 2013: 13½ percent of GDP. - Q3 2013: 4¼ percent of GDP. - Drivers of the fall in net capital inflows: - Drop in FDI. - Slowdown in corporate bond issuance in international markets. - Reduction in short-term net external liabilities. - Non-residents’ holding of sovereign bonds: steady at about 56½ percent of total. - Overall balance of payments (percent of GDP): - Q2 2013: -0.2 percent of GDP. - Q3 2013: -0.8 percent of GDP. - Peru: Balance of Payments, 2013 (In percent of GDP) - Current account: Q1 -5.2, Q2 -5.5, Q3 -5.7 - Capital account: Q1 13.4, Q2 6.8, Q3 4.2 - FDI: Q1 8.7, Q2 4.8, Q3 4.0 - Portfolio: Q1 2.1, Q2 6.3, Q3 2.3 - MLT loans: Q1 0.9, Q2 -1.5, Q3 2.2 - Public sector: Q1 0.8, Q2 -2.3, Q3 0.4 - Short-term: Q1 0.9, Q2 -0.6, Q3 -4.6 - o/w commercial banks: Q1 0.1, Q2 -1.3, Q3 -3.7 - Errors and omissions: Q1 0.7, Q2 -1.6, Q3 0.6 - BOP: Q1 8.9, Q2 -0.2, Q3 -0.8 - Change in NIR 1/: Q1 8.9, Q2 -0.2, Q3 -0.8 - FX intervention 2/: Q1 8.5, Q2 1.6, Q3 -6.7 - Public sector FX transactions: Q1 -3.6, Q2 -2.8, Q3 -0.7 - Public sector FX deposits: Q1 2.8, Q2 -0.1, Q3 1.0 - FX deposits of financial intermediaries: Q1 0.9, Q2 0.8, Q3 5.2 - Net interest gains: Q1 0.3, Q2 0.3, Q3 0.3 - Other net transactions: Q1 -0.1, Q2 0.0, Q3 0.0 - Source: BCRP and Fund staff estimates. - 1/ Does not include valuation changes. - 2/ Does not include sells of dollar-indexed securities, which are settled in local currency. ### FX Market, Resident Behavior, and Central Bank Intervention - Residents' additional demand for U.S. dollars magnified FX market impact; local pension funds (AFPs) reallocated into U.S. dollars after the nuevo sol depreciation in May–June 2013. - Central bank (BCRP) interventions: - In Q3 2013, BCRP sold US$3⅓ billion (about 1½ percent of GDP) in the FX market. - Overall balance of payments deficit in Q3 2013 was about US$½ billion (about ¾ a percent of GDP). - Dynamics of FX sold by BCRP: - Significant share purchased by residents (AFPs), deposited in the financial system, and recycled back to the BCRP as reserves via deposits by financial intermediaries (particularly commercial banks). - Banking sector liquidity and short-term external liabilities: - Dollar deposits at commercial banks increased significantly in Q3 2013. - Banks used increased liquidity to reduce short-term external liabilities, which fell by about 3¾ percent of GDP. ### Corporate Financing and Shift to Local Currency - Composition of corporate financing shifted toward local sources and local currency after the tapering announcement. - International bond issuance: - Net inflow of about US$5 billion during the first half of 2013 (about twice the amount registered for the whole year in 2012); bond issuances in international capital markets halted thereafter. - Corporate financing behavior in Q3 2013: - Increased demand for local financing, particularly bank credits. - Firms appear to resort to long-term external loans for foreign currency needs and to local markets for shorter maturities. - Peru: Net corporate debt financing, 2013 (In US$ billions) - International: Q1 2.1, Q2 2.6, Q3 1.1 - Bond issuance: Q1 1.7, Q2 3.4, Q3 0.0 - Long-term loans: Q1 0.5, Q2 -0.8, Q3 1.1 - Local: Q1 -0.3, Q2 -0.2, Q3 2.0 - Bond issuance: Q1 0.1, Q2 -0.3, Q3 0.3 - Bank credit: Q1 -0.4, Q2 0.1, Q3 1.6 - National currency: Q1 0.1, Q2 0.5, Q3 1.0 - Foreign currency: Q1 -0.5, Q2 -0.4, Q3 0.6 - Source: BCRP and Fund staff estimates. ### Sovereign Bond Yields and U.S. Yield Spillovers - Five-week reaction to USFR announcement and U.S. 10-year treasury yield increase: - U.S. 10-year treasury yield increased 78 bps between May 22 and June 25, 2013. - Peru’s 10-year local currency bond yield jumped 162 bps in the same five-week period. - Cross-country comparison (May 22 - Jun 25 and May 22 - Nov 26): - Peru’s increase in the 10-year bond yield was larger than most emerging economies listed. - Empirical effect of U.S. 10-year yield on Peruvian local currency bond yields (effect of 100 bps shock in U.S. 10-year yield, in bps): - Peruvian 10-year: about 91 bps. - Peruvian 5-year: about 93 bps. - Peruvian 3-year: about 101 bps. - The null hypothesis that the effect is 1 to 1 cannot be rejected at the 95 percent confidence level. - Despite repricing and uncertainty, non-residents continued to hold a large share of Peruvian bonds and marginally increased holdings since April 2013. - Methodology note: - A two-stage least squares regression of Peru’s local currency bonds on the U.S. 10-year Treasury yield and other factors (Peru’s CDS, sovereign spread, exchange rate volatility, policy rate, VIX) was used, employing first lags as instruments to address potential endogeneity. ### Policy Responses and Implications - BCRP and authorities’ actions during and prior to the shock: - FX intervention: spot market purchases and sales to contain volatility; net FX purchases during 2010–12 amounted to about US$26 billion (13 percent of 2012 GDP). - Additional central bank purchases of US$5.2 billion through April 2013. - Macroprudential measures: raising average and marginal reserve requirements on local and foreign currency liabilities; raising pension fund external investment limit from 26 to 36 percent between June 2010 and April 2013 to encourage outflows. - Effects of policy measures: - Contained impacts of inflows on credit growth and asset prices. - Central bank’s ample FX reserves reduced susceptibility to capital flow reversals in the context of long-term, non-debt creating inflows. *Source: Annex I. Spillovers from the U.S. Federal Reserve, _cr1421 — Peru mission report.* ### Annex III. Natural Resource Wealth, Investment and ### Annex III. Natural Resource Wealth, Investment and Commodity Prices ### Natural resource endowments and production - Peru is rich in various natural resources, especially minerals. In 2011, Peru occupied a leading position in the global production of seven minerals: - copper (second after Chile); - silver (second after Mexico); - tin (third after China and Indonesia); - zinc (third after China and Australia); - lead (fourth after China, Australia, and the U.S.); - molybdenum (fourth after China, the U.S., and Chile); - gold (sixth after China, Australia, the U.S., Russia, and South Africa). - In Latin America, Peru was first in the production of gold, lead, tin, and zinc and second in the production of cadmium, copper, mercury, molybdenum, phosphate rock, selenium, and silver. - It also has large actual and potential reserves, including of natural gas (Table 1). - In 2012, Peruvian mine production amounted to US$27 billion, equivalent to 4.1 percent of global mining production value, placing Peru in seventh place among the world's major mining producers. ### Sector dependence and GDP shares - In 2011, Peru’s resource GDP constituted about 18 percent of nominal domestic product, comparing to about 13 percent in 2001. - In real terms, the sector’s share of GDP decreased from over 15 percent to about 13 percent between 2001 and 2011. - Sector growth: - After growing at an average of 5.2 percent in the first half of the 2000s, the sector’s growth slowed in 2012 to 3.5 percent. - Exports of minerals reached 13 percent of GDP in 2012, growing 6 percentage points over the past decade in value terms. ### Investment in the minerals sector: scale and composition - Investment in the minerals sector grew at an annual rate of 32 percent on average during 2003–12 (in real terms). - Investment as a share of total private investment increased from 3 percent to over 20 percent in the last decade. - As of end-2012, mineral commodity investments by mineral were: - copper: US$35.4 billion; - gold: US$6.9 billion; - iron ore: US$6.8 billion; - copper-zinc: US$2.1 billion; - polymetallic minerals: US$0.6 billion; - silver: US$0.6 billion. - Foreign direct investment (about 70 percent of which goes to the extractive sector) has tripled over the last decade to some 6 percent of GDP in 2012. - In 2012, Peru was fifth in the global destination for exploration of nonferrous metals, behind Canada, Australia, the U.S., and Mexico. - Capacity projections: - Copper production could double by 2016 with coming on stream of four large mines (Toromocho, Las Bambas, Constancia, and Cerro Verde) and quadruple in 2021 if the intended investment materializes without major delays (Table 3). - Table 3 totals (from ministry data): - Total Current: 28,224 (US$ million) - Submitted and in Exploration (24 projects): 29,299 (US$ million) - TOTAL: 57,523 (US$ million) ### Drivers of minerals investment and empirical links to global metal prices - Key factors behind strong minerals investment growth: - favorable global metal prices; - low cash costs of extraction especially copper; - macroeconomic stability; - judicial framework in the minerals sector; - good investment climate; - evolving engagement of operating companies with the local community. - Global metal prices grew at 16 percent annually on average during 2003–12. - Empirical analyses show investment in the minerals sector is significantly and positively affected by global metal prices. - VAR model result (quarterly, real terms): - A one-standard-deviation shock to global metal prices (about 8 percent in a quarter) is likely to raise total private investment by about 5 percent in the following year after the shock. - Correlation statistics and graphical diagnostics reported: - Correlation between Peru’s real private investment and global metal prices: 0.5. - Estimated linear relationship in a scatter fit: y = 0.3x + 35 (as reported in the figure). ### Total private investment and broader macro effects - Total private investment grew at an annual rate of 13 percent on average during 2003–12. - Investment in non-minerals sectors grew at an annual rate of 10 percent during 2003–12. - Cumulative impulse response analysis (figure) indicates private investment responds positively to one-standard-deviation shocks of global metal prices (percent responses shown across quarters in the chart). --- ### Annex IV. China’s Spillovers to Peru ### Correlation and trade links - The correlation of quarterly GDP growth rates of Peru and China is 0.5. - Peru sells 17 percent of its total exports to China (about 4 percent of GDP in 2012), and about 81 percent of its metals exports go to China. - Cross-country comparison (2008–12, real terms) shows: - Over a third of Peru’s copper exports went to China; - 64 percent of gold exports went to China; - 22 percent of other mineral commodities went to China. - China’s mineral imports from Peru remain a relatively small share of China’s total mineral imports from the world. ### Main spillover channels and empirical findings - The main channel for China’s growth to spill over to Peru is through its impact on global commodity prices, and hence Peru’s terms of trade (TOT) — the "price effect" rather than a "quantity effect." - Peru’s TOT (not mineral export volumes) co-moves with China’s growth, suggesting price-channel dominance. - Correlations and causality: - Correlation between Peru’s TOT and investment growth is 0.4. - Correlation between TOT and private consumption growth is 0.3. - Empirical analyses suggest Peru’s TOT Granger-causes and has statistically significant effects on growth of investment and private consumption with one-quarter lag. - Mechanism: TOT impacts domestic income and imported capital and consumer goods, affecting investment and consumption. ### Quantitative spillover estimates - Structural VAR model (endogenous variables: China’s real GDP growth, Peru’s TOT, exchange rate vis-à-vis the U.S. dollar, export volumes, and Peru’s real GDP growth) impulse responses: - A one-percentage-point decline in China’s real GDP growth in one year is likely to result in: - a statistically significant deterioration in Peru’s TOT; - a significant depreciation of the nuevo sol; - a significant decline of 0.4 percentage points in Peru’s real GDP growth over the year. - Medium-term impact (Vector Error Correction Models): - A permanent slowdown of one percentage point in China’s growth would reduce Peru’s potential growth by about 0.2–0.4 percentage points, mainly through its permanent impact on Peru’s TOT. - Example scenario: If China’s growth permanently slows to 7.5 percent from about 10.5 percent in the last decade, this would likely bring down Peru’s medium-term growth to between 5.3 and 5.9 percent. --- ### Annex V. Prudential Measures and Credit Development — Overview ### Prudential framework and performance - Proactive use of prudential measures helped prevent the buildup of financial sector vulnerabilities during the global financial crisis and recent capital inflow surges. - Private sector credit continued to grow at about 10 percent at end-2009 (during the crisis). - Authorities employed macroprudential measures in addition to standard capital, provisioning, and liquidity requirements to contain risks associated with currency and maturity mismatches, interconnectedness, and business cycles. - Peruvian banks have surpassed both national and Basel III prudential requirements. ### Capital adequacy and Basel III alignment (percent) - Legal/regulatory minima and actual (Sep 2013) reported: - Basel II– minimum: Common equity 2.0; Tier 1 4.0; Regulatory capital 8.0; Leverage ratio ... - Basel III– minimum 2/: Common equity 3/4.5; Tier 1 6.0; Regulatory capital 8.0; Leverage ratio 3.0 - Basel III– minimum plus 2.5% buffer: Common equity 7.0; Tier 1 8.5; Regulatory capital 10.5; Leverage ratio ... - Peru– minimum 3/: Common equity 4.3; Tier 1 5.0; Regulatory capital 10.0; Leverage ratio ... - Actual (Sep 2013) ratios by institution type (percent): - Banks: Common equity 8.3; Tier 1 10.1; Regulatory capital 13.7; Leverage ratio 5.7 - Financial companies: 14.0; 14.0; 17.9; 12.1 - Cajas municipales: 13.3; 13.4; 15.3; 12.2 - Cajas rurales: 11.9; 11.9; 13.6; 9.2 - Financial system: 8.9; 10.5; 14.0; 6.3 - Notes and implementation schedule: - 3/ Current requirements. Common equity and Tier 1 capital requirements are implicit. Tier 2 capital cannot be greater than Tier 1 capital and hybrids are considered into Tier 1 capital up to 17.65% of common equity. - 1/ Capital adequacy ratios are defined as ratios of risk weighted asset and leverage ratio is defined as Tier 1 capital/Total (on– and off– balance sheet) exposure. - 2/ The schedule for Basel III implementation is as follows: - (i) Minimum common equity: 3.5% in 2013, 4.0% in 2014 and 4.5% in 2015; - (ii) Capital conservation buffer: 0.625% in 2016, 1.25% in 2017, 1.875% in 2018, and 2.5% in 2019; - (iii) Minimum Tier 1 capital: 4.5% in 2013, 5.5% in 2014, and 6.0% in 2015. *International Monetary Fund staff compilation from Annex III–V (selected figures and analysis as provided).* ### 3. Peru’s financial institutions have already surpassed both national and Basel III ### 3. Peru’s financial institutions have already surpassed both national and Basel III regulatory capital requirements ahead of time. ### Capital adequacy and leverage - Common equity capital ratios at deposit taking institutions as of September 2013: - Banks: 8.3 percent - Financial companies: 14 percent - Basel III minimum (plus conservation buffer) requirement for common equity capital: 7 percent for 2019. - Tier 1 capital ratios as of September 2013: - Banks: 10 percent - Financial companies: 14 percent - Basel III minimum (plus conservation buffer) requirement for Tier 1: 8.5 percent for 2019. - Total CAR (capital adequacy ratio) as of September 2013: - Rural micro-finance institutions: 13.6 percent - Financial companies: 17.9 percent - Basel III minimum (plus conservation buffer) requirement for total CAR: 10.5 for 2019. - Average leverage ratios as of September 2013: - Banks: 5.7 percent - Cajas municipales (municipal microfinance institutions): 12.2 percent - Basel III recommended minimum leverage ratio: 3 percent. ### Liquidity requirements and LCR implementation - Peru’s pre-existing minimum liquidity ratio (LR) requirements (late 1990s), calculated daily, separate for local and foreign currencies: - Minimum required LRs: local currency 8 percent; foreign currency 20 percent. - SBS issued new regulation including a liquidity coverage ratio (LCR), aligned with Basel III recommendations: - SBS LCR requirement: 100 percent. - SBS’s definition of ‘high quality assets’ is more restrictive than Basel III’s, entirely excluding corporate bond holdings. - Basel III LCR definition and schedule (as stated in source footnote): - Basel III requires LCR (stock of high quality liquid assets to difference between next 30 days outflows and minimum of next 30 days inflows and 75 percent of next 30 days outflows) to be at least 100 percent. - Basel III schedule for implementation: 60% in 2015, 70% in 2016, 80% in 2017, 90% in 2018, and 100% in 2019. - SBS schedule for LCR implementation (as stated in source footnote): 80% in 2014, 90% in 2015 and 100% in 2016. ### Actual liquidity ratios (Sep 2013) versus minimums - LRs in local currency (actual Sep 2013): - Financial companies: 30 percent - Rural micro-finance institutions: 51 percent - Minimum requirement: 8 percent - LRs in foreign currency (actual Sep 2013): - Banks: 57 percent - Rural micro-finance institutions: 87 percent - Minimum requirement: 20 percent - Estimated average LCR for the financial system as a whole (Peruvian definition) as of September 2013: 163 percent. - SBS’s minimum LCR requirement: 100 percent. - Only financial companies have LCR less than 100 percent; their LCR: 83 percent. - SBS requirement for financial companies in 2014: 80 percent. ### Provisioning and dynamic provisioning - Dynamic provisioning regime implemented since November 2008; activated when GDP growth surpasses certain thresholds relative to potential output growth. - Dynamic provisioning rates by credit type: - Corporate loans: 0.4 percent - Loans to medium size firms: 0.3 percent - Loans to small and micro enterprises: 0.5 percent - Mortgages: 0.4 percent - Consumer loans: 1 to 1½ percent - Provisioning by Peruvian financial intermediaries: well in excess of 100 percent of non-performing loans with the exception of rural microfinance institutions. ### FX risk limits, additional capital and provisioning for FX exposures - SBS limits on banks’ FX derivative positions: - Global FX long positions: 50 percent of regulatory capital - Global FX short positions: 10 percent of regulatory capital - Absolute value of net positions in financial products derived from foreign currency: 20 percent of regulatory capital or S/. 300 million, whichever is higher - Additional capital requirement for FX exposures (in place since July 2010): - 2.5 percent of firms’ exposure to FX credit risk initially, which will reach 8 percent by the end of 2015. - Provisioning requirement for entities that do not adequately assess credit risk associated with exchange rate mismatches: - Up to 1 percent of their direct loans in foreign currency. ### Macro-prudential use of reserve requirements (RR) by BCRP - RRs imposed on local and foreign currency deposits and short-term external liabilities to contain vulnerabilities associated with capital flows. - Current spread between local currency and foreign currency marginal RRs: 35 percentage points. - Marginal RR ratios: - Local currency liabilities: 15 percent (with a 15 percent limit on average RR ratio) - Foreign currency domestic liabilities: 50 percent (with a 45 percent limit on the average RR ratio) - Short-term external liabilities: 50 percent - Excess liquidity buffer partly due to high reserve requirements by the central bank, which are included in definitions of liquid assets for LRs and of high quality assets for LCRs. ### Progress on FSAP recommendations for banking oversight - Include credit cooperatives under SBS’s supervision and in the FSD: - Progress: Draft law being coordinated with the association of credit unions. - Increase the number and caliber of SBS’ on-site inspection staff: - Progress: On-site and off-site inspections integrated; new staff hired; special attention to training. - Develop benchmarks to evaluate the effectiveness of management: - Progress: Definitions of criteria and principles are in the project Risk Matrix of Risks PE 2013-2015. - Tighten regulations on related party intra-group transactions: - Progress: New regulations and definitions of Ultimate Beneficiary Owners in the process PE 2013; definition of groups and related parties to be updated. - Strengthen consolidated supervision and regulate holdings: - Progress: Not implemented yet; requires change in law. ### Private sector credit dynamics - Prudential measures helped build financial sector resilience against external shocks. - Despite the global credit crunch during the recent global financial crisis, credit growth in Peru remained relatively robust. - Macro-prudential policy instruments helped keep credit growth under control during surges in capital inflows. - After moderating in the first half of the year due to regulatory measures and slowdown in economic growth, growth in private credit is picking up again as the central bank has begun unwinding some macro-prudential measures. *Source: IMF staff report (excerpt)._ ### 11. All things considered, there is no evidednce that implementation of Basel III ### _cr1421 - 11. All things considered, there is no evidednce that implementation of Basel III ### Impact of Basel III recommendations on private credit growth - The text finds "no evidednce that implementation of Basel III recommendations has a negative impact on private credit growth." - Peru has not officially stated it was implementing Basel III, but "it has been implementing elements of Basel III recommendations since 2008." - Despite implementation of Basel III elements since 2008, "private credit growth remained strong since then and Peru’s credit growth is consistent with the level of financial deepening." - The central bank’s actions indicate concern about "excessive growth": "the fact that the central bank has been hiking reserve requirements in recent years also suggests that the concern has been more on the excessive growth side than the contrary." ### Recent private credit performance (figures preserved) - "Private credit growth slowed in real terms to 12.5 percent at end-2012 (from 14.0 percent at end-2011) due to macro-prudential measures aimed at mitigating the impacts of surges in capital flows." - Historical context in the broader report: growth rebounded to "8.8 percent in 2010" and was sustained at high levels in "2011–12." - Other relevant quantitative references in the report (contextual): real GDP reached "4.7 percent in 2011"; end-period inflation fell to "2.6 percent in 2012"; end-2013 inflation reached "2.9 percent"; projected real GDP growth "5.5 percent in 2014"; projected current account deficit "4.8 percent of GDP in 2014." ### Policy guidance and recommendations - Continue implementing macro-prudential measures that target vulnerabilities without unduly constraining private credit growth. - "Going forward, it would be important to continue strengthening the coordination between the BCRP and SBS to ensure that the credit channel continues to work properly." - Maintain policy tools to address excessive credit growth (e.g., reserve requirements) while monitoring effects on credit supply and financial intermediation. ### Key takeaway - Implementation of Basel III elements in Peru since 2008 has not coincided with a contraction in private credit growth; instead, private credit has remained strong and growth developments appear consistent with financial deepening. Continued coordination between prudential and monetary authorities (BCRP and SBS) is emphasized to preserve functioning of the credit channel. *Source: PERU — STAFF REPORT FOR THE 2013 ARTICLE IV CONSULTATION — INFORMATIONAL ANNEX (excerpt)._cr1421 - 11. All things considered, there is no evidednce that implementation of Basel III* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1421.pdf_