Abstract
KEY ISSUES Context: Peru remains one of the best performing economies in Latin America, with solid macroeconomic fundamentals, strong policy frameworks, and visible gains in poverty reduction. Like most of the region, Peru faced a challenging external environment in 2014. External shocks were compounded by domestic supply disruptions and a drop in subnational public investment, and growth decelerated sharply. Headline inflation was slightly above the upper band of the central bank’s (BCRP) target range due to supply shocks, but expectations remained well anchored. The external current account deficit declined slightly despite weaker external conditions. Outlook and risks: Growth is expected to recover in 2015 and over the medium term, contingent on production at new mines approaching capacity, priority infrastructure projects advancing, and shocks to terms of trade fading. However, downside risks dominate. Externally, these include a surge in global financial volatility, further dollar appreciation, or lower commodity prices and external demand. Domestic downside risks include weaker investment, uncertainties surrounding 2016 Presidential elections, and persistent social conflicts. A faster unwinding of supply shocks or a more complete pass- through of lower food and fuel global prices constitute upside risks. Near-term policy mix: The policy mix is broadly adequate to support the recovery and maintain macroeconomic stability. The immediate priority is expediting the execution of public investment in line with government plans, while avoiding increases in non-priority current spending. Monetary policy should remain responsive to inflation expectations and external developments. Exchange rate flexibility should be the main line of defense against any additional external pressures. The timely use of macro-prudential tools and ongoing de-dollarization efforts should further solidify financial stability. Medium-term prospects: With the end of the commodity boom, a push to deepen structural reforms will be necessary to sustain potential growth and diversify the economy. Revenue losses would need to be offset to finance structural reforms, investment, and inclusion along a gradual fiscal consolidation path. Streamlining legal requirements and red tape is rightly a government reform priority and the ambitious education reform and inclusion polices should stay their course within the framework of fiscal discipline. Persevering with labor market reform remains important.
1. This statement provides additional information that has become available since the staff report was issued. It does not alter the thrust of the staff appraisal.
2. Headline economic indicators remain broadly consistent with the baseline scenario in the staff report.
Advance estimates suggest activity in primary sectors started to pick up in March, with mining up 8.7 percent (y/y) and fishing up 17.7 percent (y/y). The rebound in mining follows scheduled production plan increases, while the uptick in fishing relates to the previously announced start of the fishing season. Leading indicators also suggest an improvement in April, with production of electricity up 5.8 percent (y/y), the highest rate in over a year.
On the fiscal front, regional public investment grew 31.5 percent (y/y) in April, the highest rate since February 2014.
Headline inflation fell slightly to 2.98 percent (y/y) in April, back within the central bank’s target range. Inflation excluding food and fuel was 2.6 percent (y/y).
3. The authorities have taken additional steps to stimulate growth broadly in line with staff’s recommendations.
Import tariffs for a group of key agricultural products were reduced to better align international and domestic prices. If these reductions are passed onto the consumer, they could help ease inflationary pressures and support economic activity.
A recently approved law facilitates budget reallocations and transfers to accelerate the execution of the 2015 budget; and a decree enables the issuance of sovereign bonds (for about 0.2 percent of GDP) to finance 174 investment projects.
A draft law submitted to congress will extend some existing measures until end-2015, including: (i) the suspension of pension and social security tax payments on holiday bonuses; (ii) the flexible use of excess funds in unemployment insurance accounts; and (iii) monthly updates of oil price stabilization bands.
4. The central bank approved new measures to increase liquidity in local currency, promote de-dollarization, and smooth FX excess volatility. To provide liquidity in local currency at fixed rates and longer maturities, the central bank will implement a new repo operation with banks’ loan portfolios and auction public sector deposits at the central bank. The increased liquidity will help reduce the periodic spikes in local currency interbank interest rates. To further encourage de-dollarization, the central bank also instituted an additional reserve requirement on dollar deposits for institutions that do not meet certain de-dollarization targets compared to December 2014. Finally, an additional reserve requirement on FX derivatives aims to moderate excess volatility in the FX market.