Peru Central Bank Statement

Author: | Published: 5 Sep 2017
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International shocks had a significant impact on emerging market economies (EMEs) during 2016. At the beginning of the year, markets were still adjusting to the new financial conditions created by the start of the US monetary policy normalisation.

Expectations at the time revolved around a steep path of interest rate hikes, which put pressure on EME currencies against the dollar; and exchange-rate passthrough pushed inflation away from target in many EMEs. In Peru, reports about a significant probability of an El Niño event during the first quarter of 2016 affected the sowing cycle. This combination of negative supply shocks plus exchange rate depreciation drove inflation beyond 4%, above the target range.

The Central Reserve Bank of Peru (BCRP) follows an inflation targeting (IT) scheme, with the overnight interbank interest rate as operating target, with an aim to stabilise inflation within a 1%-3% range. Inflation expectations (3.4% in January 2016) can be instrumental in assessing IT performance. In this context, the BCRP raised its interest rate twice (January and February), to 4.25%, to keep inflation expectations anchored. Meanwhile, given the non-fundamental exchange rate volatility, the BCRP used $1.3 billion (0.5% of GDP) to neutralise potential negative balance sheet effects during January and April 2016.

By the end of April, pressures on the currency had subsided, as the path of US Federal Reserve interest rate hikes was revised downwards and commodity exports outperformed market expectations. In this scenario, the BCRP purchased $2 billion during June and July. As a result, net purchases in the year reached $786 million. The interest rate hikes and a lower exchange rate contributed to reducing inflation and inflation expectations. As a consequence, headline inflation fell back within the target range in July and remained at around 3% for the rest of the year, a significant improvement relative to the 12-month inflation performance as of December 2015 (above 4%).

Growth momentum was resilient in 2016, as GDP expanded by 3.9% even in the face of adverse external conditions. On the heels of a 14.9% contraction in export prices in 2015, an additional 3.8% decrease prompted a further decline in mining investments. While prices fell, production volumes increased, particularly due to the expansion of Cerro Verde and the beginning of operations of Las Bambas, two important copper mining projects.

The considerable expansion in primary output (9.8%) resulting from these projects was, however, not accompanied by new investments in the sector, which contributed significantly to an overall contraction in private investment (-6.1%). Likewise, public expenditure fell by 0.5%, as the new administration emphasised fiscal discipline. Even in these conditions, the non-primary sector expanded, albeit modestly (2.3%).

Despite these hurdles, by end-2016 Peru was the fastestgrowing country in the region, with one of the lowest inflation rates. The macroeconomic stability attained during the last decades is key to remaining on a path to become a high-income economy and further improving social indicators. Looking ahead, stronger export prices and the consequent recovery in domestic demand will improve the economic outlook.

Nonetheless, global challenges remain considerable, as core central banks converge at a faster pace towards their post-crisis 'new normal' and the world leans towards more protectionist trade policies. However, the BCRP will step up its efforts to monitor new developments and react to them in an effective and timely manner.




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