New short- and medium-term measures to support economic growth

In the first half of 2014, the government approved a range of measures designed to support economic activity. These fell broadly into two categories: short-term measures, intended to have a counter-cyclical effect to address the slowdown in 2014, and medium-term measures, expected to improve competitiveness and productivity, and thus raise the potential for growth.

According to research by BBVA, the cost of these measures will reduce the size of the budget surplus that the government expects to post for the year 2014, and in subsequent years will contribute to a moderate budget deficit. However, Peru’s debt is still expected to continue falling over the years to come.

Counter-Cyclical Impulse

The new short-term measures are of a largely transitory nature, focused on stimulating consumer demand and public investment. For example, to raise family spending power, the government announced in July 2014 the payment of a special bonus for that month to all public sector workers; the expedition of previously announced salary increases for members of the armed forces and the police; pay rises for teachers; and higher pensions.

Additionally, for both public and private sector workers, the government raised the proportion of savings that people can draw down from their accounts under the Compensation for Time of Service scheme, which is a type of unemployment benefit that accumulates over time from workers’ salary contributions.

Further public spending will be directed at initiatives to counteract the effects of the El Niño phenomenon, the refurbishment of educational facilities and the modernisation of equipment in health clinics, with an emphasis on acquiring goods, where possible, from small businesses. To facilitate access to housing, extra funding will go to two government programmes aimed at helping low-income citizens buy and pay for their properties, known locally as the “family housing bonus” and the “timely payer bonus”. The combined cost of these measures should equal slightly more than one percentage point of GDP, based on estimates by BBVA.

Improving Productivity

Over the medium term, the government is looking to boost growth through changes to the tax code, which are designed to reduce transaction costs for companies, and through the simplification of the procedures for obtaining various commercial permits and licences.

Roberto Flores, head of strategy and economic research at Inteligo, noted that several planned largescale private investments had been caught up in bureaucratic blockages – referred to as cases of tramitología – arising from regulations brought in at the start of President Ollanta Humala’s term.

“We had reached the point where a project that would previously have taken one year to complete was taking two to three years as a result of the extra regulations and permits required,” Flores told OBG. “Recognising the problem, Humala announced a package of reforms in the first half of 2014 to address these blockages and accelerate investment.”

Indeed, Mario Alberto Guerrero, an analyst at Scotiabank, argued that Humala had adopted a much more pragmatic approach to regulation since taking office than he had previously advocated on the campaign trail. Still, in the case of the mining industry, Guerrero told OBG, “Environmental regulations have rightly remained strict by international standards, although Peru continues to be a highly attractive market for mining companies due to its huge untapped potential.”

Among the medium-term measures announced in the first half of 2014 was the elimination of incentives for regulatory authorities to impose as many fines as they could on companies. The government expects this, combined with changes to the Law of Health and Safety at Work designed to ease some of the costs of compliance with this law for employers, to tackle some of the causes of businesses choosing to stay informal.

Improvements in education will also be targeted over the medium term, particularly in terms of the quality of school buildings, a re-evaluation of the structure of teachers’ careers and the promotion of new teaching methods. Government spending on education will thus rise by PEN4bn ($1.43bn) in 2015 – equal to 0.5% of GDP – raising the total education budget to the equivalent of 3.5% of GDP (see Education chapter).

Along with the extra funds, specific initiatives included in the reform of the Certification and Normalisation of Labour Competition – which saw the provision of improved training opportunities through education credits and scholarships, the enhancement of the quality of professional training centres, and an increase in the share of foreign workers in specialised career streams – are expected to improve productivity by 20-30% over the next five years, according to the IMF.

The increase in education spending will be accompanied by additional capital and current spending in other sectors. For instance, PEN8.4bn ($3bn) of new funding has been allocated towards the updating of hospital equipment in the period between 2014 and 2016 (see Health chapter).

Social programmes will also benefit from additional spending, with the Qali Warma National School Nutrition Programme, which provides healthy meals to schoolchildren, being expanded to cover all children of primary school age. Meanwhile, an additional 30,000 police officers are to be recruited by the end of 2014 to boost security, which has increasingly become a concern among Peruvian citizens.

Systematic Change

While targeted increases in government spending will boost the economy in the short to medium term, attaining a higher rate of potential growth will require institutional reform as well.

According to Christian Laub, president of the Lima Stock Exchange and CEO of Credicorp Capital, this is an area in which Peru has lagged behind in comparison to the progress the country has seen in terms of economic development over the past decade. “We need to continue developing our political system and institutions to ensure that they catch up with the status our economy has reached, based on the ratings accorded to it by the ratings agencies,” Laub told OBG.

“While ministries such as the Ministry of Economy and Finance are well developed, we see the greatest need for reform in those ministries whose work brings their employees into direct contact with the public, for example the Ministry of Internal Affairs, which controls the police, the Ministry of Education, and the Ministry of Health,” Jose Luis Sarrio, a partner and head of the international business centre at Grant Thornton Peru, told OBG. The desired improvements to public services require a greater willingness to embrace change and to innovate, which Sarrio believes is less commonly found in the public sector than in the private sector. “This is a change in culture and working practices that will take a generation to bring about,” he cautioned.

Added to this is the lack of continuity in policy development and implementation stemming from frequent personnel changes in many ministries. Indeed, Sarrio noted that it is no coincidence that the parts of government that operate best are the ministries that have seen the most continuity in their leadership and the various superintendencies, which benefit from a degree of independence. Meanwhile, Flores argued that what Peru needs are structural reforms that can survive not just ministerial changes but successive electoral cycles.

Maintaining Momentum

In its Peru country report, published in January 2014, the IMF similarly urged the country to persevere with its reform agenda, noting that “going forward, structural policies will need to continue to be implemented swiftly to strengthen growth prospects over the medium term”.

The IMF highlighted tax collection as an area where progress has been made in recent years, reflected in the improvement witnessed in sales and income tax collection rates following the overhaul of the country’s National Customs and Tax Administration, but equally one where further reform is required.

“Additional efforts are needed to continue improving tax collections, reduce the high level of informality and tax evasion, and decrease exemptions which amount to about 2% of GDP,” the IMF report stated.

On a more general level, policy measures that generate further increases in productivity will be the main driver in sustaining economic growth and thereby enabling Peru to achieve convergence with the higher level of income seen in other regional economies such as Chile, according to the IMF.

Notwithstanding the work that lies ahead, the private sector has drawn confidence from the reforms announced in 2014. “Providing that the government’s initiatives to reduce the bureaucratic burden on companies are applied intelligently, we expect these measures to cancel out the external factors that have weighed on growth in the first half of 2014,” Melvin Escudero, CEO of El Dorado Investments, told OBG.

BBVA also welcomed the measures announced in the first half of 2014, assessing them as correctly targeting the twin major challenges that Peru faces – on the one hand, countering the cyclical downturn in GDP growth in the short term, and on the other hand improving the stock of both human and physical capital in order to raise the country’s growth potential in the long term.