Voice of the Andes

A volatile market impacted by Covid-19 has challenged the commodity-dependent economy of Peru.

The Executive Board of the International Monetary Fund (IMF) approved a successor two-year arrangement for Peru under the Flexible Credit Line (FCL) in an amount equivalent to 4.0035 billion SDR (approx. $5.4 billion USD) [1] and noted the cancellation by Peru of the previous arrangement in the amount of 8.07 billion SDR in May 2022. The Peruvian authorities stated their intention to treat the new arrangement as precautionary.

The FCL was established on 24 March 2009, as part of a major reform of the Fund’s lending framework. It allows its recipients to draw on the credit line at any time and is designed to flexibly address both actual and potential balance of payments needs to help boost market confidence. Drawings under the FCL are not phased nor tied to ex-post conditionality as in regular IMF-supported programs. This large, upfront access with no ex-post conditionality is justified by the very strong policy fundamentals and institutional policy frameworks and sustained track records of countries that qualify for the FCL, which gives confidence that their economic policies will remain strong, and they will respond appropriately to the balance of payments difficulties that they are encountering or could encounter.

Following the Executive Board’s discussion on Peru, Kenji Okamura, Deputy Managing Director, made the following statement: “Peru’s very strong economic fundamentals and policy frameworks — anchored by a credible inflation targeting framework, a flexible exchange rate, effective financial sector supervision and regulation, and a solid medium-term fiscal framework — have allowed the authorities to deliver a comprehensive and timely response to the Covid-19 pandemic and promote growth. As a result, and spurred by robust external demand, favourable terms of trade, and a surge in construction, Peru’s economy recovered strongly in 2021, registering one of the highest growth rates in the region.

“Nevertheless, the Peruvian economy remains exposed to elevated risks, including from renewed waves of the Covid-19 pandemic, slowing economic activity in key trade partner countries, the war in Ukraine, tighter global financial conditions, and political uncertainty. The new arrangement under the Flexible Credit Line will continue to play an important role in supporting the authorities’ macroeconomic strategy by providing insurance against tail risks and bolstering market confidence.

“The authorities intend to treat the arrangement as precautionary and exit the arrangement when external conditions allow. The lower level of access requested — 300 percent of quota, down from 600 percent in the FCL approved in 2020 — as part of the authorities’ strategy of gradually phasing out the use of the facility is a reflection of the country’s very strong fundamentals, including the additional buffers built with the accumulation of international reserves, as well as the decline in external financing needs, since the 2020 arrangement.”

This follows a IMF consultation with Peru in April. It confirmed economic activity in Peru rebounded strongly in 2021 from its deepest downturn in decades. The strong policy response in 2020 help mitigate the impact of the pandemic and created the conditions for a rapid recovery. Progress in the vaccination campaign allowed a gradual lifting of Covid-19 mobility restrictions. Real GDP rose 13.3 per cent in 2021, supported by robust external demand, favourable terms of trade, and pent-up domestic demand. Real GDP surpassed its pre-pandemic level but remains below its pre-pandemic trend. Labor force participation and total employment haven’t fully recovered. Poverty increased significantly in 2020 and is still above pre-pandemic levels despite some improvement in 2021. Volatility in financial markets has increased amid heightened political uncertainty.

Uncertainty around the outlook is high and the balance of risks is tilted to the downside. Growth is expected to slow to 3.0 per cent in 2022 as external conditions tighten and the policy stimulus is withdrawn. External risks from ongoing geopolitical tensions, a sharp tightening of global financial conditions, extended global supply chain disruptions, and an abrupt growth slowdown in China, Peru’s main trade partner could weigh on growth.

Domestically, new Covid outbreaks could prompt the reintroduction of containment measures, while political uncertainty and social unrest could weigh on private investment. Inflationary pressures could be more persistent, requiring faster tightening of monetary policy. More rapid progress on containing the pandemic, both globally and domestically, and reduced political uncertainty could result in positive surprises.

Peru’s very strong policy frameworks and macroeconomic buffers, further complemented by an FCL arrangement expiring on May 27, will help shield the economy from downside risks. Strong external and fiscal accounts, adequate reserve coverage, access to international capital markets, low public debt, and a resilient financial sector provide Peru with ample buffers to face adverse shocks.

Executive Directors agreed with the thrust of the staff appraisal. They commended the Peruvian authorities for a decisive macroeconomic policy response, sustained by very strong policy frameworks and buffers, that helped mitigate the impact of the Covid-19 pandemic and support a strong economic recovery. Directors noted, however, that the macroeconomic outlook remains uncertain, and external and domestic risks are still elevated. Against this background, they concurred that the policy mix should strike a balance between responding to rising inflation and managing downside risks to growth, as the impact of the pandemic on employment and poverty continues to be reversed. Directors also underscored the importance of maintaining and further strengthening policy institutional frameworks.

Directors agreed that fiscal policy should remain broadly neutral in the short term but a gradual consolidation, encompassing revenue mobilisation and expenditure rationalisation, including pension reforms, will be necessary to address emerging spending needs while preserving fiscal sustainability. They welcomed the authorities’ steps to clarify policy intentions by aligning the fiscal rules and the medium-term budgeting framework, as well as their commitment to strengthen the Fiscal Council with technical assistance from the Fund.

Directors agreed that further tightening of monetary policy is warranted to bring inflation and inflation expectations back to the target range and help adjust to tighter global financial conditions. While foreign exchange intervention is warranted to contain excess volatility, Directors underscored that reducing its frequency would facilitate market development and de-dollarisation.

Directors supported the gradual unwinding of pandemic-era prudential policies in a context of limited financial system vulnerabilities. They concurred that closing remaining regulatory and supervisory gaps and further enhancing systemic risk assessment will be important to strengthen financial resilience. Directors noted that exploring the introduction of a central-bank digital currency will require a thorough assessment of risks and costs.

The Directors also agreed that a renewed structural reform agenda in the context of the OECD accession process will be critical to mitigate scarring from the pandemic and support a green and inclusive recovery. They stressed the importance of addressing informality in the labour market, especially among women. More effective public services and greater transparency, including through civil service reform and anti-corruption measures, as well as a stable and predictable legal and regulatory environment, will be key to these efforts. Steps will also be needed to reduce risks from climate change, ease the transition to a low-emission economy, and contribute to global mitigation efforts.

Fast Fact
In August 2022, Hellmann Worldwide Logistics reported to hold all the shares in the Peruvian joint venture, Hellmann Worldwide Logistics S.A.C, after Carlos Augusto Dammert, President of the Board, decided to sell his stake of 50 per cent. The company has been integrated into Hellmann’s global network. German business, Hellmann, has been active in Peru since 1992 and created the joint venture with Carlos Augusto Dammert in 1998. In Peru’s logistics market, the joint venture specialised in airfreight export, focusing mainly on perishable logistics. Hellmann aims to strengthen the company’s market position in other verticals such as automotive logistics, also beyond the country’s borders. Jose Luis Moreano will remain general manager and Dammert will act in an advisory capacity.

Fast Fact
SAF-Holland is reported to hold more than 50 per cent of the market share of fifth wheels in Peru.

Fast Fact
Peru’s economy expanded by 3.3 per cent year-on-year in the second quarter of 2022, easing from the 3.8 per cent growth seen in the three months leading to March. It was the sixth consecutive quarter of growth in the Peruvian economy, supported by a 4.6 per cent expansion in household consumption as the surge in employees working from home supported consumer activity. At the same time, fixed capital formation rose by 1.2 per cent, amid a 3.7 per cent gain in construction activity. On the other hand, government expenditure contracted by 2.8 per cent, as lower spending in healthcare and defence more than offset higher expenditure for public education.

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