Peru shifts from big gains
to consistent growth

Published: 28 April 2009

Andean country remains a prime investment destination

The depth of the global financial crisis remains concealed yet its impact has forced once-resilient economies to succumb to the worsening global economic backdrop. From the US, through Europe and Asia, the crisis has spread across Latin America as shown by the region's weakening local currencies and declining exports.

This was not apparent during the first half of 2008 as Latin America seemed strong enough to withstand the global crisis. Then, signs of the region's vulnerability to the global downturn were seen in Colombia, Argentina, Chile, Venezuela and Mexico, reflecting badly on their 2008 growth rate and 2009 outlook. The weighted-average growth in Latin America slowed to 4 per cent in 2008 from 5.4 per cent in 2007.

Few economies in Latin America showed immunity to the global downturn in 2008. From these select few, the Peruvian economy remains the most resilient in the region. This emerging market has maintained steady growth since 2003.

Withstanding the crisis

During the third and fourth quarter of 2008, when the region began suffering from reduced economic activity in industrial production, retail sales and employment, Peru's growth was unstoppable. Its currency, the nuevo sol, depreciated slightly compared to the Colombian peso, Chilean peso, Brazilian real and the Mexican peso. As a reaction to market volatility, Peru's central bank, the Central Reserve Bank of Peru (BCRP), reduced its reserve requirements and sold dollars in the FX market to avoid its local currency from depreciating further. Analysts expected the Peruvian economy would remain strong amid the global financial turmoil. True enough, the economy eluded contraction and posted 9.8 per cent growth in 2008, surpassing that of China, the world's third-largest economy, which grew 9 per cent last year.

HSBC Chief Economist for Peru Javier Finkman confirmed that Peru is the third-fastest-growing economy in Latin America. "High growth in 2008 was based on a huge boost in investment.
Private investment grew 25.6 per cent in 2008 and public investment expanded to 42 per cent," Mr Finkman said.

Amid the record-breaking growth, he said, Peru had just started dealing with the blows from the crisis. "The Peruvian central bank reacted quickly through releasing some liquidity through different measures mostly reducing reserve requirements and this offset the initial effects of the crisis. But the crisis is so large and significant that it will affect Peru no matter what," he added.

The Andean country's inability to remain insulated from the crisis has reflected on Peru's macroeconomic outlook for 2009. HSBC expects economic growth to slow to 1.8 per cent. Though this could be considered a huge drop from Peru's accelerating GDP over the years, the growth still exceeds the entire region's rate, which has been pegged at -1.8 per cent in 2009.

Blow by blow

The Peruvian economy has been dependent on commodity exports, which constitute almost two-thirds of its total exports. In 2008, copper and gold made up almost 42 per cent of Peru's exports. Given the worldwide slump in commodity prices, Peru's main industry, mining, is expected to shrink 4.4 per cent in 2009 from an annualised rate of 7.8 per cent last year, according to estimates given by Peru's statistical agency, El Instituto Nacional de Estadística e Informática , and the BCRP.

"The key question is, 'What kinds of investments will be there in Peru for this year?' The significant part of growth in Peru has been based on investment. This is highly volatile but it takes longer to react," Mr Finkman said. "The mining industry's contribution to Peru's GDP is dependent on commodity prices as well as the mining firms' option to cut back investments due to the current global economic situation. We are seeing capital outflows in several economies and we don't expect Peru to differentiate from those suffering a retreat of capital flows."

Despite this, Peru has maintained its investment grade status. Mr Finkman said Standard & Poor's and Fitch Ratings based their credit rating on the country's significant improvement of macroeconomic data and accumulation of reserves. However, he noted that the economy's investment indicators still have a lot to improve as "not all of its institutional data is consistent with the investment grade".

Source: Central Reserve Bank of Peru and HSBC

Another factor critical to Peru's outlook during this period of global economic instability is its highly dollarised economy. Mr Finkman attributed the huge deceleration in Peru's growth to the country's dollarised liabilities.

"Peru has roughly 60 per cent of its external debts denominated in dollars. There is a risk that Peruvians will have to devalue further but when they try to devalue in a highly dollarised economy, a lot of problems might be created because of these dollarised debts," Mr Finkman said. Since Q3 2008, the BCRP sold net USD4.5 billion of its reserves in an effort to manage the pressures on the nuevo sol. "Peru is a textbook case of fear of floating where a high level of dollarised liabilities limits the ability of the authorities to allow the currency to weaken significantly. The Peruvian central bank recognised that they cannot devalue further . . . which poses a significant risk for Peru that it may end up with a non-competitive currency," he said.

Resisting the downturn

"Peru's USD3.2 billion anti-crisis package launched in November 2008 has proven to be significant. It is why we are not forecasting a contraction in the economic activity of Peru and still looking forward to an almost two per cent growth."

Mr Finkman added that Peru's relatively good performance in 2009 is due to the tremendous growth it attained for the past years. "The good news is that Peruvians have fiscal savings to push the package. They already announced that they will tap all multilateral contingent funding available to move forward. That will help a lot in offsetting part of the global crisis."

The administration of Peru's President Alan Garcia has also been forging and renewing trade alliances with countries
other than the US since early last year. In November 2008, Peru renewed its free trade agreement (FTA) with China. If Peru's trade negotiations with Korea, the European Union, Japan, Singapore and Chile, among others, become successful, the country's FTA deals will make up 70 per cent of its foreign trade.

Despite the global financial crisis, the Andean country has shown its potential to sustain growth. "Peru's potential as a main supplier of mining products to the global economy still remains," Mr Finkman said. Peru's economic growth rate was expected to recover to 3 per cent in 2010 and reach 4-5 per cent in 2011. "If the global economy recovers in 2010, the Peruvian economy will recover very quickly," he said.