Lima’s coastline: the Peruvian economy is expected to recover in 2015 and over the medium term, says the IMF (photo: JTB PhotoUIG/Newscom)
Economic Health Check
Peru remains one of the best performers in Latin America, with solid macroeconomic policies and fundamentals, and visible gains in poverty reduction.
But the country faced a challenging external environment in 2014. Lower metal prices and moderate trading partner growth were a major drag on private investment and exports. External shocks were compounded by a drop in subnational public investment and temporary supply disruptions in fishing, mining, and agriculture.
Against this background, growth decelerated to 2.4 percent in 2014—from 5.8 percent a year earlier.
To support growth, the authorities embarked on a series of stimulus measures, including tax cuts, increases in fiscal spending, and other steps to expedite investment projects. Monetary conditions were also eased against stable inflation expectations, which helped lower lending rates and promote credit to the private sector.
Gradual rebound
According to the report, growth is expected to recover to about 3¾ percent this year, assuming a reversal of last year’s supply shocks and the successful implementation of policy stimulus.
Growth should rise in 2016−17 if new mines and large infrastructure projects start operations and terms of trade shocks fade. Inflation should converge toward the mid-point of the 1-3 percent target range by end-2015, and the current account deficit will narrow over the medium term as mining exports gain ground.
While important external risks loom on the horizon, strong policies and fundamentals place Peru in a comfortable position to respond to future shocks.
Supporting the recovery
While the fiscal stimulus measures were timely and will support the recovery, the report noted that they should be effectively implemented and gradually withdrawn, while avoiding hikes in non-priority current spending. Over the medium term, the report recommended targeting a small structural fiscal surplus of ½ percent of GDP to preserve buffers against commodity shocks, natural disaster risks, and contingent liabilities.
Monetary policy has been adequately accommodative, and inflation expectations have remained well-anchored within the 1-3 percent target band, the report noted. Looking ahead, monetary policy should continue to respond to changes in inflation expectations and external developments. Exchange rate flexibility will be key to cushion any additional external pressures, while limited foreign exchange intervention may be necessary to smooth excessive volatility that could undermine financial stability.
Ensuring financial stability
The report said that the new de-dollarization measures should help strengthen Peru’s financial system. New local currency repurchase agreements and additional reserve requirements on foreign currency deposits will help to reduce dollarization and enhance the functioning of monetary policy. Strengthening prudential requirements on dollar lending to un-hedged borrowers and improving data and analysis of private sector balance sheets should help.
Exchange rate flexibility will support de-dollarization by encouraging the private sector to hedge its foreign exchange exposures. Deepening financial and capital markets should also be an important component of the de-dollarization agenda. Balance sheet information for medium and small firms and households should be collected to better assess risks from currency mismatches.
The financial system remains strong and stable, although the deterioration of balance sheets of smaller non-bank institutions requires close monitoring.
Boosting potential growth
Lower metal prices, the moderation of growth in China, and less dynamic investment suggest that potential growth may have slowed from the highs of the past decade. Boosting potential output will require firm implementation of structural reforms to enhance productivity, investment, human capital, and formal employment.
Streamlining legal requirements and red tape is rightly a reform priority of the government and the ambitious education reform and inclusion polices should stay their course within the framework of fiscal discipline. The report noted that persevering with labor market reform remains a challenge.
