Peru: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
15 Jul 2016
eISBN:
9781475582741
ISBN:
9781475582741
Language:
English
Keywords:
ISCR; CR; commodity; Peru; exchange rate; commodity exporters' emerging economies; oil price decline; tot shock; FX intervention; commodity tot shock; Commodity price shocks; Commodity prices; Current account; Current account deficits; Commodity price fluctuations
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This Selected Issues paper presents a comparative analysis of the macroeconomic adjustment in Chile, Colombia, and Peru to commodity terms-of-trade shocks. The study is done in two steps: (1) an analysis of the impulse responses of key macroeconomic variables to terms-of-trade shocks and (2) an event study of the adjustment to the recent decline in commodity prices. The experiences of these countries highlight the importance of flexible exchange rates to help with the adjustment to lower commodity prices, and staying vigilant in addressing depreciation pressures on inflation through tightening monetary policies. On the fiscal front, evidence shows that greater fiscal space, like that of Chile and Peru, gives more room for accommodating terms-of-trade shocks.

Abstract

This Selected Issues paper presents a comparative analysis of the macroeconomic adjustment in Chile, Colombia, and Peru to commodity terms-of-trade shocks. The study is done in two steps: (1) an analysis of the impulse responses of key macroeconomic variables to terms-of-trade shocks and (2) an event study of the adjustment to the recent decline in commodity prices. The experiences of these countries highlight the importance of flexible exchange rates to help with the adjustment to lower commodity prices, and staying vigilant in addressing depreciation pressures on inflation through tightening monetary policies. On the fiscal front, evidence shows that greater fiscal space, like that of Chile and Peru, gives more room for accommodating terms-of-trade shocks.

The Adjustment To Commodity Price Shocks in Chile, Colombia and Peru1

This chapter presents a comparative analysis of the macroeconomic adjustment in Chile, Colombia, and Peru to commodity terms-of-trade shocks. The study is done in two steps: (i) an analysis of the impulse responses of key macroeconomic variables to terms-of-trade shocks and (ii) an event study of the adjustment to the recent decline in commodity prices. The experiences of these countries highlight the importance of flexible exchange rates to help with the adjustment to lower commodity prices, and staying vigilant in addressing depreciation pressures on inflation through tightening monetary policies. On the fiscal front, evidence shows that greater fiscal space, like in Chile and Peru, gives more room for accommodating terms-of-trade shocks.

A. Introduction

1. The “commodity super-cycle” has come to an end as commodity prices have been decreasing steadily since 2011, and this external shock is likely to be persistent. Commodity prices experienced a remarkable increase during the 2000s, the so-called commodity super-cycle, which was only slightly interrupted by the global financial crisis, generating a terms of trade (ToT) boom for many commodity-exporting economies. For instance, in Chile and Peru, terms of trade doubled from 2000 to 2011, and in Colombia they increased by 70 percent. However, the prices of metals and oil declined after 2011 and mid-2014, respectively. Through deteriorating ToT, the shock resulted in lower national incomes, wider current account deficits, and weaker national currencies.

2. Large ToT movements can have important implications for macroeconomic performance as relative prices and incomes change. This chapter compares the macroeconomic adjustment in Chile, Colombia, and Peru in response to fluctuations in commodity prices. This comparison is relevant as these are commodity exporters’ emerging economies (mainly copper for Chile and Peru, and oil for Colombia) that are comparable in size and have sound macroeconomic frameworks in place, including fiscal rules and inflation-targeting regimes.

3. First, macroeconomic responses to a commodity ToT shock are estimated. Using a vector auto-regression methodology (VAR), the implications of movements in the ToT (using a country-specific commodity price index) on government revenues and expenditures, GDP growth, the real effective exchange rate (REER), and the current account are analyzed. Once the relevant shocks are identified, impulse response and forecast error variance decomposition analyses are conducted.

4. Second, an event study of the actual adjustment to the recent drop in commodity prices is presented. In the three economies, current account and trade deficit widened, while currencies depreciated significantly. However, despite these similar patterns, the timing and size of the adjustment has differed between these economies, largely because metal prices began their downward adjustment in 2011, while oil prices started to decline only since mid-2014. Thus, Chile and Peru are in the final stages of the adjustment process, while Colombia is in the midst of adjusting to more recent price declines in oil. The experiences of Chile, Colombia, and Peru highlight the importance of flexible exchange rates to help with the adjustment to new commodity prices.

5. This chapter is organized as follows. Section B describes the data and presents the methodology used to estimate the impact of commodity prices on key macroeconomic variables. Section C presents the results. Section D presents an event study and Section E concludes.

B. Data and Methodology

6. A country-by-country VAR to analyze the implications of a shock in commodity prices on key macroeconomic variables is estimated. Following Medina (2016), the analysis mostly relies on a country-specific bivariate VAR estimation. In particular, the model used is:

[1b12b211] [ytzt] = [c10c20] + [a11(L)a12(L)a21(L)a22(L)] [yt−1zt−1] + [eytezt]

where yt is the country-specific commodity price index (included in all regressions); zt is the macroeconomic variable of interest; c10 and c20 are the constant terms; aij(L) is the polynomial lag operator; and eit is the uncorrelated disturbance. The domestic variables of interest include: public expenditures, public revenues, and real GDP. However, for the external variables a three-variable VAR is estimated which includes the REER, current account, and the commodity price index. The identification of structural shocks is achieved through a Cholesky decomposition, assuming that the domestic variables do not affect the terms of trade contemporaneously. For each VAR, the number of lags is determined based on the Aikaike information criterion. The estimation uses quarterly data from the first quarter of 1999 until the last quarter of 2015 and a country-specific commodity price index aimed at capturing the impact of variations in commodity prices at the country level.2 All the series are seasonally adjusted and log-differenced (owing to nonstationary) except the current account balance which is expressed as a percentage of GDP.

C. Results from VAR Methodology

Impulse response function analysis

7. Public primary expenditures behave differently across the three countries in response to a commodity price shock. Figure 1 shows the estimated accumulated impulse response functions of primary expenditures. In the case of Chile, a one standard deviation shock to commodity prices leads to a one percent decline in primary expenditure. However, in the case of Peru, this shock leads to an increase of 2 percent in primary expenditures. Finally, primary expenditures in Colombia are insensitive to commodity price shocks after some initial volatility.

Figure 1.
Figure 1.

Accumulated Response of Primary Expenditures

In percent

Citation: IMF Staff Country Reports 2016, 235; 10.5089/9781475582741.002.A001

Source: IMF staff calculations.

8. For all three countries, a positive shock to commodity prices is associated with higher GDP growth and public revenues. Figure 2 shows the estimated accumulated response functions for public revenues and real GDP growth. Regarding public revenues, Chile experiences the biggest increase of around 8 percent after 4 quarters. In Colombia and Peru, the responses are more moderate, peaking at 4 and 1.5 percent respectively after 3 quarters. With respect to real GDP growth, the initial response is broadly similar in the three cases up to two quarters ahead. However, in the medium term, Peru is the country that benefits the most from a positive ToT shock.

Figure 2.
Figure 2.

Accumulated Response of Public Revenue and GDP Growth

Citation: IMF Staff Country Reports 2016, 235; 10.5089/9781475582741.002.A001

9. With respect to the external adjustment, the REER and the current account appear to be more flexible in the case of Colombia. Figure 3 shows the estimated accumulated response functions for the REER and the current account. Intuitively, a positive commodity price shock should lead to an appreciation in the real exchange rate. Indeed, the results suggest that relationship for both Chile and Colombia, with a stronger appreciation in the latter. However, in Peru, the REER depreciates slightly, perhaps owing to the active intervention policy of the Central Reserve Bank of Peru. With respect to the external current account, the shock to commodity prices has a stronger positive effect in the case of Colombia, while in Chile and in Peru the current account adjusts in similar ways during the initial five quarters. Over the medium term, the current account improves more in Chile, possibly related to the response of the REER.

Figure 3.
Figure 3.

Accumulated Response of the REER and the Current Account

Citation: IMF Staff Country Reports 2016, 235; 10.5089/9781475582741.002.A001

Forecast error variance decomposition analysis

10. Fiscal expenditures and revenues in Chile and Peru are similarly affected by the fluctuations in commodity prices, but not in Colombia. Table 1 presents the estimated variance decomposition of forecast errors of expenditures and revenues, which allows quantifying the contribution of a shock in commodity prices to fluctuations in the domestic variable of interest.

Movements in commodity prices account for about 5 percent of variations in primary expenditures at a 10-quarter horizon for both Chile and Peru, while they account for only 2 percent in Colombia. Similarly, commodity price fluctuations explain 25 and 20 percent of fluctuations in revenues in Chile and Peru respectively, and roughly 3 percent in the case of Colombia.

Table 1.

Variance Decomposition of Forecast Errors of Expenditures and Revenues

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Source: IMF staff calculations.Source: IMF staff calculations.

11. Commodity price fluctuations play a remarkable role in accounting for variations in

GDP, the REER, and the current account. Table 2 presents the estimated variance decomposition of forecast errors of real GDP, the REER, and the current account. The contribution of commodity prices shock to the variance of real GDP is on average 10 percent, broadly similar in the three cases. As expected, the variation in commodity prices account for a large part of the variance in the REER, especially in Chile and Colombia where the contributions are estimated at around 34 and 24 percent respectively.3 Similarly, the fluctuations in commodity prices account for a significant part of the variance of the current account, with a larger share in Chile and Colombia.

Table 2.

Variance Decomposition of Forecast Errors of Real GDP, the REER, and the Current Account

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Source: IMF staff calculations.Source: IMF staff calculations.Source: IMF staff calculations.

D. Event Study

12. The timing and size of the shock in Chile and Peru have been different than in Colombia. While the price of copper has been declining since 2011, the oil price decline began in the second half of 2014 (Figure 4). Thus, Chile and Peru are in the final stages of the adjustment process, while Colombia is in the midst of adjusting to the more recent oil price declines. Moreover, the shock that Colombia suffered was more severe in that oil prices plunged by about 40 percent in 5 quarters, whereas the price of copper took 18 quarters to decrease by 45 percent. As expected, these large commodity price shocks deteriorated ToT substantially, with Colombia experiencing the largest impact (Figure 4). Thus, the contribution of ToT to Gross National Disposable Income after the shock was negative and sizeable, especially in Colombia (Figure 5).

Figure 4.
Figure 4.

Commodity Prices and ToT

Citation: IMF Staff Country Reports 2016, 235; 10.5089/9781475582741.002.A001

Figure 5.
Figure 5.

Contributions of ToT to Gross National Income Growth Rates

Citation: IMF Staff Country Reports 2016, 235; 10.5089/9781475582741.002.A001

13. The exchange rate and current account adjustments are important elements of the macroeconomic response to the terms of trade fall, with Peru’s FX intervention delaying adjustment (Figure 6). In the case of Chile, when the terms of trade initially started to fall, the exchange rate was relatively slow to adjust. However, by the end of its adjustment process, Chile’s real effective exchange rate had depreciated by 5 percent. In contrast, given the magnitude and speed of the shock, Colombia experienced a sharp and fast real depreciation of its exchange rate of around 18 percent. Peru, however, had a minor real appreciation of about 6 percent, which could be in part the result of the Central Bank of Peru interventions in the FX market to prevent sharp movements in its currency. Consistent with this more muted adjustment in the real exchange rate, the current account deficit in Peru has deteriorated from 2 percent of GDP in 2011 to 4.4 percent of GDP in 2015. The exchange rate adjustment in Chile allowed for a significant current account correction, with a deficit that is now mostly closed. Finally, in Colombia the current account deteriorated as a result of the oil prices decline, and has yet to reflect the adjustment in quantities.

Figure 6.
Figure 6.

REER and the Current Account

Citation: IMF Staff Country Reports 2016, 235; 10.5089/9781475582741.002.A001

14. In Chile, most of the adjustment in the current account comes from import contraction. In Chile, the current account deficit initially widened due to the decline in the value of its traditional exports. However, after 18 quarters the current account deficit was roughly zero. This was achieved mainly by a decline in imports (from 35 to 30 percent of GDP) rather than a pick-up of non-traditional exports (Figure 7). In Peru, there have not been significant fluctuations in non-traditional exports and imports, consistently with a stickier current account deficit and more stable FDI (Figure 8).

Figure 7.
Figure 7.

Non-traditional Exports and Imports

Citation: IMF Staff Country Reports 2016, 235; 10.5089/9781475582741.002.A001

Figure 8.
Figure 8.

Foreign Direct Investment

Citation: IMF Staff Country Reports 2016, 235; 10.5089/9781475582741.002.A001

15. Currency depreciation has greatly influenced inflation dynamics, thus reducing the space for countercyclical policies in these countries. In the three cases, the shock to commodity prices created inflationary pressures (Figure 9), which reduced the policy space to conduct countercyclical monetary policy and pushed central banks in the three countries to raise the policy rate in order to keep inflation inside the target range (Figure 9). Moreover, in the case of Colombia, the tightening of monetary policy has also aimed at moderating domestic demand in order to contain the widening current account deficit. These timely policy actions supported the credibility of the inflation targeting regimes, and contained inflationary pressures.

Figure 9.
Figure 9.

Inflation and the Monetary Policy Rate

Citation: IMF Staff Country Reports 2016, 235; 10.5089/9781475582741.002.A001

16. On the fiscal front, primary balances have deteriorated steadily in all three countries (Figure 10). In line with the VAR analysis above, the shock to commodity prices reduced commodity related revenues, which is reflected in the lower growth rates of public revenues observed after the shock (Figure 11). At the same time, except for the case of Colombia, the growth rate of public expenditures remained broadly stable (Figure 11). This might reflect the fact that at the time the shock hit, Colombia was already featuring a primary deficit while both Chile and Peru exhibited surpluses. Thus, the latter two countries had more room to implement a gradual fiscal adjustment, which helped smoothing the adjustment to the shock.

Figure 10.
Figure 10.

Primary Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 235; 10.5089/9781475582741.002.A001

Sources: Haver Analytics and Fund staff calculations.Note: Far Chile and Peru t = 2011: and Colombia t = 2014. A period represents a year.
Figure 11.
Figure 11.

Public Revenues and Expenditures

Citation: IMF Staff Country Reports 2016, 235; 10.5089/9781475582741.002.A001

17. In all three cases we observe a slowdown in total domestic demand at the time the shock hit, with a curious resilience of the Colombian economy in the face of a sharper shock (Figure 12). However, one salient difference is that the initial slowdown in Chile and Peru was significantly more abrupt than in Colombia, despite the shock being more acute in the latter. Furthermore, in the final stages of the transition, Chile had a stronger adjustment in domestic demand than Peru, which is consistent as well with the adjustment in the current account explained above. The macroeconomic adjustment in these countries has also affected the dynamics of real GDP growth (Figure 12). In the cases of Chile and Peru, real GDP growth has decreased continuously after the fall in their terms of trade. Colombia seems to be following the same path as GDP growth also declined after oil prices started plunging. However, the strong policy frameworks in place allowed these countries to withstand the large ToT shock and still post positive growth rates. Moreover, GDP growth has already started to recover in the case of Peru.

Figure 12.
Figure 12.

Total Domestic Demand and Real GDP Growth

Citation: IMF Staff Country Reports 2016, 235; 10.5089/9781475582741.002.A001

E. Conclusions

18. Overall, despite a slowdown in activity, GDP growth remained resilient to the terms of trade shocks in the three countries, reflecting their sound policy frameworks. GDP growth has declined in all three countries in the past couple of years but remained positive and is already recovering in the case of Peru. Fiscal loosening, especially in Chile and Peru (which had larger fiscal space), contributed to smooth the adjustment to the shock. Going beyond the recent episode, the impulse-response analysis suggests that the “usual” behavior of public spending in Peru and Chile is quite different from what happens in Colombia: following ToT shocks, public spending tends to be more procyclical in Peru than in Chile, while it does not react to ToT shocks in Colombia. The importance of having a fiscal buffer to smooth the negative effects of external shocks should remain a key consideration for fiscal policy in Peru going forward.

19. More exchange rate flexibility underpins faster current account adjustments to ToT shocks. A rapid depreciation of the currency in Chile is probably the biggest factor behind the full adjustment in its current account deficit. However, in real effective terms, this was not the case for Peru, probably as a result of the active FX intervention by the central bank to smooth volatility. As a result, Peru’s current account deficit remained elevated by 2015 at 4.4 percent of GDP. Looking ahead, a continued gradual real depreciation of the sol and an increase in mining exports are expected to halve the Peruvian current account deficit by 2021.

20. Robust monetary frameworks have limited the response of inflation to ToT shocks.

These countries’ credible inflation targeting regimes limited the inflationary pressure by both strong communication and hikes in the policy rate. In Chile and Peru, where the ToT shocks started about five years ago, inflation is already moving back toward the target range, and staff expects the same to happen in Colombia.

References

  • Gruss, Bertrand, 2014, “After the Boom-Commodity Prices and Economic Growth in Latin America and the Caribbean,” IMF Working Paper No. 14/154 (Washington: International Monetary Fund).

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  • International Monetary Fund, 2016, “Latin America and the Caribbean: Managing Transitions,” Chapter 2, Regional Economic Outlook: Western Hemisphere (Washington).

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  • Medina, Leandro, 2016, “The Effects of Commodity Price Shocks on Fiscal Aggregates in Latin America,” IMF Economic Review.

1

Prepared by F. Roch.

2

This commodity price index was constructed by Gruss (2014).

3

These results are consistent with those presented in the April 2015 WHD Regional Economic Outlook.

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Cover IMF Staff Country Reports
Peru: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.
Volume/Issue:
Volume 2016: Issue 235
Publisher:
International Monetary Fund
ISBN:
9781475582741
ISSN:
1934-7685
Pages:
64
DOI:
https://doi.org/10.5089/9781475582741.002

Accumulated Response of Primary Expenditures

In percent

Accumulated Response of Public Revenue and GDP Growth

Accumulated Response of the REER and the Current Account

Commodity Prices and ToT

Contributions of ToT to Gross National Income Growth Rates

REER and the Current Account

Non-traditional Exports and Imports

Foreign Direct Investment

Inflation and the Monetary Policy Rate

Primary Balance

(Percent of GDP)

Public Revenues and Expenditures

Total Domestic Demand and Real GDP Growth