The economic reforms introduced in the 1990s, as well as the monetary and fiscal policies implemented in recent years, have placed Peru among the Latin America and Caribbean region’s top macroeconomic performers. During the past decade, Peru managed to bring inflation down to an average of 2.3% and achieve a 5.7% yearly economic growth average.
Editor's choice
- Background: Julio Velarde
The resilience of the Peruvian economy is also reflected in its external and fiscal indicators. Currently the central bank’s official reserves are above $47bn. At 30% of gross domestic product (GDP) – more than five times short-run foreign obligations, and 92% of the financial system’s liabilities with the private sector – Peru’s foreign assets provide one of the most powerful financial buffers in the region. On the fiscal front, public debt is 23.5% of GDP (just 12% if public sector deposits in the financial system are deducted). The average maturity is about 12 years, considerably longer than for most developed economies.
Testing times
Peru’s new place as one of the world’s most dynamic emerging economies owes much to Peruvians’ willingness to learn from the past and support responsible policies. In particular, since the 1990s, monetary discipline has mustered growing social consensus, and is widely viewed by the population as pivotal for stability, growth and equity. In particular, the central bank has done its job not only by contributing to the foundations of sustained growth, but by acting in a timely manner to ensure business continuity in the face of sudden disruptions. This was put to the test especially during the financial crisis that surfaced in 2008.
The impact of the global financial crisis on developed economies has been studied extensively since it started two years ago: widespread uncertainty persists in financial markets; the spillovers on the real economy have left behind a trail of sluggish growth and stubborn unemployment; and fiscal sustainability is a source of serious concern. Although economic recovery appears to be taking hold gradually in the industrial world, reduced income and wealth continue to keep consumption and investment down. In contrast, Latin American and Caribbean countries, and Peru in particular, were much less affected than in past crises thanks to the sound fundamentals built in recent years.
Calming the crisis
At the beginning of the crisis, against the possibility of a 'sudden stop' episode, it was crucial to preserve liquidity in the financial sector, both in domestic and foreign currency, to prevent an abrupt disruption in credit to the private sector and harmful spillovers on the real sector. Along these lines, in addition to extending the maturities for instruments employed to inject liquidity temporarily, new instruments were used, including the announcement of treasury bond purchases in the secondary market. In a dollarised economy such as Peru, it is also key to smooth out high exchange rate fluctuations to prevent negative balance sheet effects triggered by currency mismatches.
It was only then that the central bank moved on to provide monetary stimulus. With panic receding in financial and exchange rate markets at the beginning of 2009, the central bank reduced its policy rate several times to provide additional stimulus, bringing it to a historic low of 1.25%.
As we have argued several times before, with decreasing global uncertainty, interest rate reductions no longer exacerbated capital account risks. And with a stabilised financial sector and the transmission mechanism intact, policy rate cuts translated swiftly into lower short- and medium-term market interest rates. Bank and capital market funding became available to firms at a lower cost, and the economy rapidly resumed growth.
Contrary to other economies, credit to the private sector never contracted in Peru. In sum, monetary policy preserved financial liquidity, prevented spillovers to the real sector, and kept credit flowing to businesses and consumers. As the fiscal stance also became countercyclical, in 2009 the economy expanded almost 1%, one of the few positive growth rates in the world.
Building on growth
Peru has also understood that, in times of financial stability and solid growth, an important challenge is how to manage windfall gains. Experience shows that favourable economic prospects can go hand in hand with a surge in short-term capital inflows, credit and domestic demand that may become inconsistent with inflation targets and current account sustainability. In this context, once the recovery was well under way – growth was 8.8% in 2010 – the gradual withdrawal of monetary stimulus was reinforced with higher reserve requirements in both domestic currency and dollars, including on bank obligations with non-residents. The aim was to sterilise the impact of capital inflows and encourage local financial intermediaries to seek long-term external financing.
In addition to the fiscal problems in several European economies and the possibility of contagion effects on the rest of the continent, the recent downgrade of US public debt has created uncertainties in financial markets about US fiscal solvency.
In the emerging world, there are persistent doubts about China’s ability to keep high growth rates without overheating its economy, and market participants wonder whether the tightening policies introduced recently to cool it down might turn out to be overly restrictive. China is currently one of the major engines of world growth, as well as Peru’s main commodity buyer.
Good to grow
In this new international environment, and with decreasing domestic political concerns, Peru is expected to expand around potential growth, at an annual pace of 6% to 6.5% in 2011 to 2013. At an expected 10% annual growth rate, private investment will become a main driver of growth, with confirmed investment commitments amounting to $50bn over the period.
With relatively stable terms of trade, Peru's current account is expected to post a deficit of 3% of GDP between 2011 and 2013, to be financed with long-term capital entries of about 6% of GDP. The public sector will likely attain a small surplus during the period, which will be used to bring the public debt down to 18% of GDP (7% in net terms).
It took Peru 21 years to overcome a long period of stagnation and economic disarray and regain the per capita income level attained in 1975. Today, per capita GDP has surpassed the latter by 29%, but is still below several countries in the Latin America and Caribbean region. Because of this, policies geared to enhance per capita standards need to remain at the top of the national agenda. In this respect, it is fundamental to preserve a high rate of investment as percentage of GDP (currently 25%); continue to encourage productivity growth; improve the quality of education; and take full advantage of Peru’s demographic bonus, reflected in a declining dependency ratio (the ratio of children and ageing adults to the working-age population) until 2030.
Policies aimed to ensure a continuing increase in per capita income were key in accelerating poverty reduction in the past decade (from 55% in 2000 to 31% in 2010), and therefore need to remain in place to continue in this trend.
Julio Velarde is Peru's central bank governor
