Peru
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Peruvian economy is in a growing path, led by the strengthening of the extreme sector: improvements in the prices of commodities, especially gold and copper, that have led to a greater mining production and an increase in the volumes exported. Considering a favorable world context, the figures could be even better. However, the political uncertainty has reduced growth to a certain extent.
It must be pointed out that Peru has had a good performance under the FMI program (SBA), program that has helped to maintain sound bases for policies whose objective is to achieve macroeconomic stability, reduce the vulnerability of Peru associated to a high dollarization and public debt, and promote private investment.
Peru continues with its commitment of discipline in the macroeconomic policies in accordance with the program of the International Monetary Fund (See Table Summary). These measures permitted a low inflation, a stable exchange rate, a rapid growth of exports and a relative strenth in the financial system.
The domestic political situation continues to be weak since the popular support of President Alejandro Toledo is low and there is no stable majority in Congress.
I. Political Aspects
Peru, as in the case of other countries of Latin America, has had to face an adverse political climate with scandals due to the poor handling of public funds and institutional corruption, among others. President Toledo has had a difficult task. Thus, although improvements have been observed in the economic activities, there still exist weaknesses in the political institutionality, events that have reduced the trust of the citizens. This is shown by the figures of the surveys for the approval of the presidential management. Only 6% approve Toledo’s administration and even some pressure groups have commenced activities to request an advance of the presidential elections that are scheduled for the year 2006, This low popular backing is due to the fact that president Alejandro Toledo has been incapable of providing effective leadership and the persistence of political and personal scandals.
II. Analysis of the Principal Macroeconomic Variables
1. Growth of the GDP.
The growth of the product has been maintained robust and with a broad base. During 2003 GDP grew 4% real (see graph 1). Between 2000-2003 the service sector, formed by transportation, communications, governmental services, restaurants and hotels, has grown over 30%. In the meantime, trade, manufacture and mining each represent 15% of the total growth.
The figures of the first quarter of 2004 reveal that the rate of growth has been strongly maintained, with a GDP increasing 4.6% real with respect to the same period of 2003. The sector of the greatest expansion continues to be mining, fundamentally, metallic mining, with an increase of 14%.
It is expected that economy will continue with a sound growth, led by exports and investments (for the second half of the year a large scale gas project commences). However, underemployment and unemployment are maintained high in spite of some improvements in urban employment in recent months. At the same time, the level of total poverty is also high (55%) and extreme poverty is around 25%.
According to the IMF report there are barriers that obstruct growth in Peruvian economy, within which the following can be highlighted:
-Inadequate infrastructure: The roads and ports are of poor quality which translates into high costs of transportation making access to the market difficult.
-High Labor costs: These costs are associated to the payment of high taxes and indemnifications, which constitutes an important barrier to promote formal employment in large firms, which employ around 20% of the active population.
-Ineffective Judicial system: Makes difficult the effort of contracts and of a prompt solution of commercial dispute weakening the investment climate.
-Low Financial Intermediation: The efficiency can be affected by the recent introduction of a tax on financial transactions, since the cost of the credit for medium and small enterprises is high.
-Agricultural Production Under its Potential:
This reflects an inadequate infrastructure, a weak legal frame for the use of water and the lack of well-defined property rights in rural areas.
The vulnerability of Peru derives from external and domestic risks. An external shock could negatively affect the prices of exported raw materials, while the domestic risks are related with the political uncertainty of the next elections in 2006.
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2.External Sector
A. Trade Balance
The trade balance of Per has improved substantially in the last years. This is due to better prices and the expansion in the mining sector. The prices of exported products grew by 8% in 2003 and it is expected that in 2004 they will increase by 13%, which is explained to a large extent from the increase in the price of copper, gold and other minerals exported.
It must be underlined that Peru is one of the principal mining countries of the world, it is the second silver and tin producer, third in zinc, fourth in lead, fifth in copper and sixth in gold. In 2003 these products represented 51.5% of all the exports.
For 2004 a surplus is expected in the trade balance due to better exchange terms and the increase of the volumes transacted, fundamentally due to the strong demand of the United States and Chinese markets. During 2003 there was an increase of 1% of the total volumes traded.
In addition it must be pointed out that the effort to liberalize trade and improve structural factors have deteriorated competitiveness of the tradable products, and therefore it is very important that Peruvian exports should increase and diversify.
Peru has a trade system that is relatively liberal. The trade of goods and services represents as an average 35% of the GDP. However in developed countries these represent 50% of the GDP.
More than half the Peruvian exports are concentrated in mining products, so that an eventual free trade treaty with the U.S.A., a great commercial partner of Peru, is key to the non-traditional dynamism of the sector, such as textiles and agricultural products. And the negotiations are well under way.
Within the factors that will determine the commercial exchange of Peru with the rest of the world in the medium term are the mining investments, such as the first stage of the natural gas project Camisea, where it is expected that the volume imported of oil will decline in 15% in 2006y with respect to the average growth of the last years. At the same time, it is expected that textile exports will continue to grow around 15% to 20% per annum. However, there are latent risks such as the eventual drop in the prices of the commodities and the effects that the termination of the Multifiber Agreement will have.
B.Current Account and financial Indicators.
The external position of Peru has started to strengthen since the year 2003. The deficit in current account fell from 2% in 2002 to 1.8% in 2003 (See graph 2), which follows the growth of the exports of commodities.
The flow of private capital continues strong, particularly direct foreign investment in the sector of natural resources.
A continuous improvement has also been observed in the financial indicators. The international reserves have maintained growth since 2001 to reach a figure of US$ 11,000 million in May of this year.
Likewise, the General index of the Lima Stock Exchange had an increase on June 15 of this year of 14% (in US), which is due to better prices of mineral products. .
The sovereign risk of Peru continues low with respect to the region, although this increased by 400 base points at the end of April. Some analyses expect that during the second half of the year the sovereign spread will be maintained between a range of 550-65 base points due to the political uncertainty, the evolution of the prices of commodities, the noise generated by an eventual royalty on mining , bill of law that is in the last legislative stage for its approval and the evolution that the North American interest rate will have.
3. Economic Policy
Monetary Policy
The Central Bank of Peru fixed an inflation goal of 2.5% with a variation that is ± 1% of the goal. The Board of the Central Bank of Peru announces annual/ monthly programs at the beginning of each year/month with respect to the interest rate in the operations of the bank system. This rate fixes a reference in the bands for the interbank rate.
The monetary policy has been efficacious to dilute the inflationary pressures.
During the first half of 2003, the inflationary dynamic was influenced by a shock in the supply. These factors helped the inflation rate to be in the lower part of the band, permitting a more expansive monetary policy. The reference interest rate was reduced 4 times (25 base points in July, September and November, and 50 base points in August). The action of the Central Bank of Peru involved reduction in the interbank interest rates, which declined 3.8% in December 2002 to 2.5% in December 2003, which was associated to a general reduction in the interest rate in soles. For the year 2004 it is expected that the inflation rate shall be around 2.5% according to IMF projections.
Exchange Policy.
The Peruvian authorities indicate that the exchange rate is an instrument to reach the goal of monetary policy, which is to control the inflation. As regards the interventions in the exchange market they are of sterilization to avoid conflicts with the monetary policy.
Since mid 2003 the interventions of the Central Bank have increased in favor of supporting the stability of the currency. This is due to the increasing flow of foreign currency towards the country, which could attempt against the exporting competitiveness of exports.
The intervention of the Central Bank has implied net average monthly purchases of US$ 133 million.
In the last two years (2003-2004), the exchange rate has been stable between 3.45-3.53 new soles per dollar.
Fiscal Policy
For the next two years the management of the fiscal policy must be responsible to reduce the fiscal deficit, according to the program prepared by the Government, called Route Sheet The fical deficit must be reduced from 17% of the GDP in 2003 to 1.4% in 2004.
The government also promised to reduce the Public Debt/GDP ratio from 47.5% in 2003 to 41% in 2006. 92% of the debt is in foreign currency.
Finally the Law of Fiscal Responsibility and Transparency must be promoted.
4. Relation of Peru with the IMF
The Peruvian authorities asked the Monetary Fund to continue supporting Peru through the SBA program for a period of 26 months, covering until August 20067 when the new administration assumes power. The Peruvian authorities indicated that this would help to anchor the economic policy and improve the expectations of the investors.
On June 9 of this year the International Monetary Fund approved US$ 422.8 million of the Stand-By Arrangement Program of 26 months to Peru to support the economic program of the country (see summary table) until mid 2006. the approval permits the disbursement of US$ $ 118 million under this agreement.
.5. Structural Reforms
The Peruvian authorities promised to make a series of structural reforms with the purpose of stimulating the economic growth and the promotion of employment.
Program 2004-2006 includes measures to stimulate private investment and improve the administration of the resources of the public sector. Most of these reforms have the support of the World Bank and the Interamerican Development Bank. The following measures must be underlined:
-Strengthening of the property rights through the establishment of courts that resolve commercial disputes. The efficiency of the mechanisms of resolutions which are not judicial will be accelerated and improved. These courts will commence to operate in Lima at the end of September of this year.
-Private investment will be stimulated through operations of public-private concessions for operations of construction and maintenance of ports and roads.
-The authorities will attempt to improve the administration of the resources of sector through the creation of more space for social expense and infrastructure.
-Reform of pensions, since at present an amendment was proposed in Congress for the pension plan (Cédula Viva). The object of this reform is to improve the administration and eliminate fraudulent payments. The reform also seeks to eliminate the relation between pensions and increase in salary of public employees. This measure will permit reducing the expense of the central government in about 0.2% of the GDP. During 2004 the authorities are committed also to design a plan of reform for the pension regime of police and military forces, at the same time that they will continue working in Congress to stop the initiative of free disaffiliation that will permit the free transfer of affiliates between the public and the private system.
-The authorities plan to introduce a system that will ensure that the State companies will not fix artificially low prices for the oil. .
-The authorities are making efforts to gradually reduce the sectoral and regional tax exceptions.
-The program includes also a reduction of the labor costs. Thus, one of the tasks of the Government is to avoid an increase in minimum salary during 2004. the last time that the minimum salary was raised was 12% in September 2003.
-Integration of Peru will be strengthened in the global economy through bilateral and multilateral negotiations. Discussions commenced on May 18 2004 about the Free Trade Treaty with the United States. This possible agreement would promote industrial exports intensive in labor and would favor the access to the market of non-traditional products. The government authorities point out that there has been progress in the negotiations of a free trade treaty with Thailand
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Table: Summary Program 2004-2006
Graph No. 1
Growth of GDP
e: estimated
p: projected
Source: FMI
Graph No. 2:
Trade of Goods and Services
(% of GDP)
Source: IMF
Graph No. 3:
Composition Public Debt 2003
International Bonds
International Organizations
Paris Club
Others
Source: IMF
Table No 2: Macroeconomic Indicators
2002 / 2003 / 2004 / 2005 / 2006Growth of real GDP (%) / 4.9 / 4 / 4 / 4.5 / 4.5
Investment of private sector (% of GDP) ) / 15.6 / 15.7 / 15.4 / 15.8 / 16
Investment of Public sector (% of GDP)) / 3.1 / 2.8 / 2.8 / 2.9 / 2.9
National Saving (% of GDP)) / 16.4 / 16.3 / 16.7 / 17.5 / 17.8
Inflation at the end of the period (%) / 1.5 / 2.5 / 2.5 / 2.5 / 2.5
Deficit Account current (% of GDP) ) / 2.1 / 1.8 / 0.7 / 0.8 / 0.7
Total fiscal Deficit (% of the GDP) ) / 2.2 / 1.7 / 1.4 / 1 / 1
Primary fiscal Deficit (% of the GDP) ) / 0 / 0.4 / 0.8 / 1.4 / 1.5
Debt Public sector (GDP (%) / 47.1 / 47.6 / 44.7 / 43.0 / 41.1
Foreign Debt (% of GDP / 49.3 / 48.7 / 45.9 / 51.7 / 48.4
Source: IMF
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