Peru: Concluding Statement of the 2017 Article IV Mission

IMF News, May 26, 2017

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Peru: Concluding Statement of the 2017 Article IV Mission

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• Published: May 26, 2017

I. Context and Recent Developments

• Peru has experienced average growth of over 5¼ percent since 2000, with reduced unemployment and poverty, low single-digit inflation, strengthened fiscal position, and markedly reduced dollarization.
• Government structural reforms aim to modernize the economy, increase formality, and lift potential growth by addressing investment procedures, tax collection, financing costs, labor market, and social protection. Specific reforms include:
  • a new institutional framework for public and public-private infrastructure investment;
  • cutting administrative procedures and promoting digitalization of processes;
  • a new tax regime for small and medium enterprises to make the tax system more progressive, reduce compliance costs, stimulate electronic payments, and formalize the value chain;
  • moves to modernize labor regimes and the establishment of a Social Protection Commission to deliver a comprehensive and fiscally sustainable social security reform to increase coverage while reducing informality.
• Recent domestic shocks and external challenges:
  • The Odebrecht corruption scandal (broke in December 2016) is weighing on investment and confidence.
  • One of the worst flooding and landslides in over 50 years (related to el Niño) caused widespread infrastructure damage and raised domestic food prices.
  • Commodity prices have recovered somewhat since late 2016 but remain significantly lower than during the commodity boom.
  • Uncertainty about the U.S. outlook and potential rises in protectionist pressures globally.
• Authorities’ responses:
  • Ministry of Economy and Finance fiscal package of 1.3 percent of GDP targeted at reconstruction needs and public investment.
  • Near-term relaxation in the fiscal consolidation path.
  • Exemption from healthcare contributions (nine percent of monthly wages) for employers hiring new young entrants.
  • Initiatives to support affordable housing developments and easing SMEs’ access to financing.
  • SBS allowed banks to restructure retail debt in disaster-affected areas for up to six months without affecting borrowers’ credit ratings.
  • BCRP reduced reserve requirements four times since December 2016 and cut the policy rate by 25 basis points in May 2017 (first cut in 15 months).

II. Outlook and Risks

• Growth projections and contributors:
  • Exports’ contribution to economic growth projected to decline from nearly 2½ percentage points in 2016 to just over ½ percentage point in 2017 due to copper projects reaching full capacity.
  • Government contribution to growth expected to increase by nearly 1 percentage point reflecting planned increase in government investment and stimulus/reconstruction funds.
  • Overall growth expected to decline to about 2.7 percent in 2017.
  • Inflation should gradually return to the target range as weather-related factors abate and food inflation declines.
• Medium-term projection:
  • After a bounceback in 2018–19, growth projected to converge to potential of 3¾ percent in the medium term.
  • Output gap expected to close by 2021, with government accelerating consolidation toward the (one percent deficit) target in the fiscal rule.
• Risks:
  • Downside risks in 2017: additional delays in investment project execution; larger-than-expected flood-related damages; faster rise in international interest rates; global spillovers from protectionism or a slowdown in China.
  • Upside potential in the medium term: faster implementation of structural reforms (e.g., meaningful labor market reform from Social Protection Commission recommendations); new mining projects; higher infrastructure spending in systemically important countries pushing up commodity prices.
  • Upside could increase potential growth to 4-4.5 percent.

III. Policy Recommendations

• Overarching guidance:
  • A combination of countercyclical policies and structural reforms is appropriate given domestic headwinds and challenging external conditions.
  • Short-term: agile fiscal and monetary policies to meet reconstruction needs while preserving fiscal and inflation anchors.
  • Structural reforms are essential to close infrastructure gaps, diversify the production base, reduce informality, deepen financial intermediation, and improve governance including fighting corruption.

A. Tackling Multiple Fiscal Objectives

• Short-term fiscal stance:
  • A moderate and temporary fiscal loosening is justified given prior prudent fiscal policy and low net public debt.
  • The fiscal stimulus plan is appropriate given the output gap and expected domestic demand deterioration, but success depends on executing a high level of investment spending.
  • Staff welcomes efforts to raise execution rates, including annual transfers to subnational governments earlier in the year (by the end of the first quarter).
  • Medium-term credibility depends on converging back to the original deficit target of one percent.
• Fiscal rules and revenue:
  • Move away from a structural balance rule has advantages and challenges; the new headline deficit target maintains checks and balances (e.g., the Fiscal Council) and contains escape clauses for reconstruction.
  • Headline deficit targets require sustained efforts to broaden the tax base and avoid recourse to procyclical spending; avoiding increased spending rigidities is recommended.
  • Tax-to-GDP ratio has fallen to a low of around 14 percent of GDP.
• Institutional and transparency enhancements:
  • Staff welcomes plan to establish a medium-term budgeting framework (MTBF) to improve consistency between annual budget and macro-fiscal aggregates.
  • Recommendations to improve the PPP framework, procurement phase, and capacity at Proinversión.
  • Publish an annual comprehensive fiscal risks statement covering contingent liabilities and risks associated with investment plans.

B. Striking the Right Monetary Policy Balance

• Monetary stance and communication:
  • With a widening output gap, temporary weather-related price pressures expected to abate, and core inflation within target, staff supports BCRP’s recent policy rate reduction.
  • Fiscal policy should be first line of defense if flood damage is larger-than-expected; monetary policy can complement if demand deteriorates further.
  • BCRP should remain data dependent and monitor inflation expectations closely for persistent drift above the target range.
  • Future changes in local currency reserve requirements should be clearly tied to the credit cycle; clear communication on the temporary nature of price shocks is essential.
• Exchange rate and FX operations:
  • Increased exchange rate flexibility and unwinding of BCRP’s FX swaps have fostered market-determined exchange rates.
  • Peru’s external position assessed as broadly consistent with fundamentals and appropriate policy settings.
  • Future FX interventions should be limited to cases of disorderly market conditions to help develop hedging markets.

C. Fostering Financial Stability and Development

• Financial system soundness:
  • System remains sound; stability risks mainly from adverse economic developments and substantial exchange rate depreciation.
  • Corporate leverage has increased but sensitivity analysis suggests low risks.
  • Banks show high profitability and capitalization ratios, and low nonperforming loan ratios.
  • Growing financial cooperatives segment shows more variability; dollarization has declined but remains a structural risk.
  • BCRP and SBS solvency stress tests indicate largest risks come from decelerating economic growth and a large sudden currency depreciation; buffers appear sufficiently strong.
  • Joint probability of distress of the seven largest banks has declined since its peak in 2010 and remains at a low level. [1]
• Recommended measures to guard stability:
  • Consolidate dedollarization gains (e.g., targets on banks’ share of dollar loans; consider increasing FX provisions for FX loans to unhedged borrowers).
  • Establish a financial stability council to formalize regular meetings between BCRP, MEF, and SBS while maintaining mandates and autonomy of agencies.
  • Broaden regulatory and supervisory perimeter, bringing larger cooperatives under direct SBS supervision.
  • Develop a national house price index including other major cities to allow comprehensive risk assessment.
• Financial deepening and inclusion:
  • Branch penetration quadrupled over the last decade, but overall financial depth remains low relative to fundamentals and the region.
  • Global Findex (2014): about 30 percent of Peruvian population aged over 15 has a bank account (regional 51 percent; income peers 58 percent).
  • Capital markets lack depth and liquidity despite recent reforms; private mobile payment initiatives (Billetera Móvil) are welcome.
  • Further efforts to reduce informality and increase literacy and financial education are important.

D. Increasing Potential Growth through Structural Reforms

• Multi-pronged reform agenda:
  • Need to raise potential growth in the context of lower commodity prices by improving education, infrastructure, innovation, and institutions.
  • Comprehensive package likely required, including making labor regulations significantly more flexible and ensuring labor costs grow in line with productivity to reduce informality.
  • Social Protection Commission has an important mandate for these reforms.
• Anti-corruption and governance:
  • Odebrecht case underscored corruption problems; government measures include extending bans for corrupt public officials, designating a special investigative team for the Odebrecht case, barring companies that admitted/been convicted of corruption from new bids, and ringfencing their assets in Peru.
  • Additional measures likely needed: strengthen anti-corruption legal framework and institutions, adopt international best practices for the Office of the Comptroller General.
  • Implement effective anti-money laundering measures in line with international standards, e.g., enhanced due diligence for politically exposed persons.

Concluding thanks to Peruvian authorities and private sector representatives for their hospitality and open and constructive dialogue.

Source: Peru: Concluding Statement of the 2017 Article IV Mission

References

• Peru and the IMF
• IMF Policy Advice -- A Factsheet
• The IMF and Good Governance -- A Factsheet
• Mission Concluding Statements
• PRESS CENTER
• https://www.imf.org/en/home