Peru Central Bank Statement

Author: | Published: 19 Oct 2018
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Peru's growth in 2017 was 2.5%, below its potential, affected as it was by two large shocks: the El Niño phenomenon, which seriously damaged basic infrastructure and had a negative impact on consumption; and the Odebrecht corruption investigations, which hit Peru's most important construction companies. However, as their impact began to dissipate, growth recovered to 3.2% year-on-year in Q1 2018. Leading indicators (i.e., key aggregate variables such as electricity and cement consumption, imports, public investment and bank credit) point to close to 5% in Q2 2018. This rebound is supported by growing terms of trade, global recovery at a solid pace and an expansionary monetary and fiscal stance.

Since last year, the Central Reserve Bank of Peru (BCRP) cut interest rates six times (150 basis points), from 4.25% to 2.75%; a level considered appropriate as long as inflation remains on target and output is below potential. 12-month inflation was 1.4% in 2017 and 0.9% in May 2018, mainly due to the reversal of the sharp increase in food prices triggered by El Niño. Core inflation is at 2%, in the middle of the BCRP inflation target, and inflation expectations 12 months ahead are around 2.2%.

The BCRP also cut reserve requirement rates (RRRs). RRRs in domestic currency were reduced from 6.5% to 5% and the maximum average and marginal RRRs in foreign currency were cut from 65% to 36%. As a result of more expansionary domestic credit conditions, year-on-year credit expansion accelerated from 4.1% in April 2017 to 8.6% in April 2018, driven mainly by higher credit demand from the mining, manufacturing and service sectors and by a more expansionary monetary policy.

Fiscal policy is also supporting the recovery. The BCRP estimates a fiscal impulse of 0.4 points of GDP in 2018, which is consistent with 12.6% and 3.6% increases in public investment and consumption, respectively. Public investment will be driven mainly by the reconstruction of infrastructure destroyed in 2007 by the El Niño phenomenon.

The rebound in commodity prices also explains in part the cyclical recovery in Q2 2018. However, in contrast with the previous period of high commodity prices, this time global financial conditions are not equally expansionary. Therefore, for sustaining medium-term growth at around 6% –which is feasible, given Peru's potential, particularly in agroindustry– it is critical to press forward with structural reforms, particularly in the labour market. It is also crucial to cut red tape and improve the quality of public goods. Otherwise, the BCRP expects medium-term growth to stabilise at 4.5%-5.0%.

Good times are not without challenges. The BCRP foresees some volatility in financial markets, triggered by the reversal of the Fed's expansionary monetary policy. However, since 2009 Peru has enhanced its macroeconomic buffers, particularly international reserves and fiscal savings, and has significantly reduced vulnerabilities such as high financial dollarization. Dollarization in Peru has declined to 29% (with household credit dollarization currently at 11%), which significantly reduces bank assets' exposure to sudden exchange rate fluctuations. Additionally, Peru maintains international reserves close to 28% of GDP (more than five times external short-term liabilities); and net public debt has decreased to 10% of GDP.