Arequipa mining recovery drives growth, while export-oriented sectors and tourism offer investment opportunities

Located in the southern Peru, the department of Arequipa – and its capital, also called Arequipa – is bordered by six other departments: Ica and Ayacucho to the north-west, Apurímac and Cusco to the north, and Puno and Moquegua to the south-east. There are seven other provinces in the Arequipa region,namely Camaná, Caravelí, Caylloma, Condesuyos, Islay, Castilla and La Unión, comprising a total of 109 districts. The National Institute for Statistics and Computing (Instituto Nacional de Estadística e Informática, INEI) estimates that the population of Arequipa is set to reach a total of 1.3m people in 2017, representing 4.1% of the country’s population.

In 2015 Arequipa had about 693,100 economically active people, down from approximately 700,200 in 2014. The unemployment rate in 2015 stood at 3.9%, against 4.6% in 2014.

Economic Structure & Growth

In 2015 Arequipa represented the second most important economic region across the whole of Peru, after Lima. According to the Central Reserve Bank of Peru (Banco Central de Reserva del Perú, BCRP), Arequipa contributed 5.4% to gross value added (GVA) and 4.9% to GDP in Peru that year. The department’s GVA, as reported by the INEI in 2007 constant prices, grew at an estimated rate of 3.8% in 2015. In that year the fastest growing sectors in Arequipa, viewed in terms of GVA, were mining, which contributed 19.9%, followed by telecommunications and information services at 9.7%, other services (4.7%), and transport, storage, mail and messaging (3.9%).

Notwithstanding this, in that same year the chief economic activities, identified in terms of their share in regional GVA, were mining, which comprised 23.9%, followed by other services at 18.4%, then manufacturing (14.4%) and commerce (11.6%).

When looking at the latest composite index of regional activity published by the Peruvian Economy Institute (Instituto Peruano de Economía, IPE) in the third trimester of 2016, Arequipa posted the second highest growth in Peru. Indeed, during this period, Arequipa expanded by 29.3%, second only to Apurímac’s impressive 223%. This performance confirms what has been a positive growth trend for the region since mid-2015, due in large part to the strong expansion of the mining sector, namely in copper and molybdenum. The IPE also ranked Arequipa third out of the 24 regions measured for competitiveness in 2016, reflecting an improvement relative to 2015, when it came in 5th place. Additionally, in the IPE’s fourth edition of its regional competitiveness index, Arequipa ranked second in infrastructure, third in economic environment, fourth in health and education, and fifth in labour.

Regional Government

The regional government of Arequipa is composed of a local council, a governor and a coordination council. The council essentially exercises a regulatory and supervisory role over the executive branch, which is headed by the regional presidency. The coordination council is a consultative body, the purpose of which is to facilitate local government coordination with municipalities. It is comprised of provincial mayors and local civil society representatives, the latter of which are elected by civil society organisation delegates for a period of two years.

Arequipa is currently governed by Yamila Osorio Delgado, the “Arequipa, Tradition and Future” candidate who won with 50.6% of the votes in a close second election round in December 2014. Yamila and her vice-governor, Víctor Raúl Cadenas Velázquez and Arequipa’s eight-member regional council – elected in October 2014 – are serving a four-year mandate, in the same period as the first round of the regional government elections.

Public Investment

Government debt contracted to finance past public projects and declining mining royalties have strained the public purse, limiting the government’s ability to continue supporting and developing public investment initiatives.

According to data from the regional government of Arequipa, payments towards BBVA debt, which constitutes sovereign debt deriving from financing of the Majes-Siguas II irrigation project and the Certificates of Regional and Local Public Investment (Certificado de Inversión Pública Regional y Local, CIPRL) related to the Puente Chilina bridge totalled PEN33.54m ($9.9m) in 2016.

At the same time, mining canon, a key source for funding public investment in Peru, reached PEN 21.9m ($6.5m) in 2016 for Arequipa, down from PEN356.8m ($105.8m) in 2015. While this may have seemed in line with a declining trend in mining royalty allocations across the country, including in Arequipa since 2012, the sharpness of the fall inevitably raised questions in the department about the impact to be borne on the execution of ongoing and planned public projects. Despite this, some analysts have argued that the situation may yet improve going forward, thanks to the expansion of Cerro Verde and the raft of mining projects currently under consideration and development (see analysis).

Key regional government investments in November 2016 focused on the PEN129m ($38.2m) MajesSiguas II irrigation project, the PEN7.9m ($2.3m) improvement to the main hospital in the district of Camaná, and a PEN103.5m ($31.4m) investment in the phase one and two upgrades in between the Uchumayo district and the capital city.

Private Investment

Faced with financing constraints after taking office, the regional government immediately made attracting private investment a priority. Indeed, as Brunno Alonso Gambetta Paredes, regional manager for the promotion of private investment, told OBG, “To achieve this, the regional government first set out to establish a series of priority projects to then attract the interest of private investors and developers.” By 2016 Arequipa had secured five project proposals.

The projects presented in 2016 consisted of a PEN3.2bn ($948.5m) investment for the construction of hydroelectric dams in Lluta and Llucta, to be developed as part of the Majes-Siguas II irrigation project; a PEN11m ($3.3m) hospital solid waste treatment facility; a PEN5m ($1.5m) fishing port; and a PEN42m ($12.5m) citizen security initiative. In addition to this, at the time of writing Gambetta Paredes told OBG of ongoing talks regarding a project to build two hospitals in Arequipa that, once completed, should add 1-2% to Arequipa’s GDP, and in turn, produce a positive effect on regional employment, tax collection and economic diversification.

There are two modes for attracting private investment to the listed projects in Arequipa; public-private partnerships and through the Obras Por Impuestos, or Public Works for Taxes, programme which consist of the substitution of income tax payments for the execution of public work projects in a municipal or regional location. “The construction of the two hydroelectric dams associated with the Majes-Siguas II irrigation project tops the list of government priorities,” Gambetta Paredes told OBG. “The signing of the contract is expected for December 2017, following which will be followed by a two-year period issued for environmental impact assessment (EIA) and four years to the start of construction work. The hospital solid waste treatment plant is still under evaluation; however, the citizen security initiative and the small fishing port – the two Public Works for Taxes projects approved in 2016 – are scheduled to be executed during the second semester of 2017,” he added.

Together, the citizen security initiative and the small fishing port topped the PEN47m ($13.9m) yearly ceiling established for Public Works for Taxes projects in Arequipa, meaning the regional government has reached its limit for Public Works for Taxes initiatives it can implement in 2017.

Mining

Arequipa is a department traditionally dependent on mining. The sector accounted for the largest share of regional GVA in 2015, at 23.9% and posted the highest sector growth rate of the region at 19.9% in that same year as measured by the INEI.

Arequipa also generated the greatest number of jobs in the Peruvian mining sector, as measured in terms of average direct employment. Indeed, according to the Ministry of Energy and Mines ( Ministerio de Energía y Minas, MINEM) as of January 2017, Arequipa registered 31,077 directly employed people in the mining sector, or 17.6% of the total population hired in Peruvian mining.

Moreover, in January 2017 Arequipa ranked first in the country for the production of copper and molybdenum, third in the production of gold, sixth in silver, seventh in lead and eight in zinc. According to data from the Central Reserve Bank of Peru (Banco Central de Reserva del Perú, BCRP), overall mining production in Arequipa embarked on an upward growth trend in September 2015, which continued until at least December 2016, according to he most recent figures available. In January 2017 the majority of mining production segments in the Arequipa department registered positive growth year-onyear (y-o-y), including molybdenum, which grew by 67.1%, gold (43.1%), copper (17.9%) and silver (1.4%). Minerals that registered negative growth included zinc, which contracted 2.3% and lead at 29.5%.

Going forward, there is still much mining potential to be exploited in Arequipa, as evidenced by the large number of projects currently under evaluation. While there are various factors at play in each project’s success, experience seems to show that a solid social strategy goes a long way (see analysis).

Trade & Transport

Mining products represent the largest overall share of exports coming out of Arequipa. In 2016 the sector accounted for $3.89bn, or 87.8%, out of a total $4.43bn in exports, as reported by the Association of Peruvian Exporters. Other significant exporting industries included textiles, comprising 3.2% of the total, agriculture with 3.0%, and iron and steel metallurgy at 2.3%.

Managed by the Terminal Internacional del Sur (TISUR), the Port of Matarani is Arequipa’s chief port and Peru’s main mining harbour. “Some 70% of Matarani’s exports come from the mining sector, while cereals make up 11% and containers comprise 4%.” Mauricio Núñez del Prado Eguiluz, commercial manager of TISUR, told OBG. Despite being the main gateway for minerals, there still room for growth at the port. “We are only using 46 ha of 160 ha available in our concession. And, while we are ready to take on additional traffic related to developing mining and agricultural projects in Arequipa, we also looking at ways of improving our container traffic, especially in coffee.” At present, the majority of container traffic must travel over land up to Callao.

Energy Gap

Mining is a significant consumer of energy in Arequipa. According to the latest information from MINEM, Arequipa had an effective electricity generation capacity of 379 MW in 2014, or around 3.7% of Peru’s total capacity. That year, Arequipa generated 1012 GWh, equivalent to 2.2% of Peru’s total production. This failed to meet local needs, given that regional consumption stood at 2723 GWh. In fact, with the exception of 2006, Arequipa has been dealing with electricity shortages since 2005. However, this deficit is compensated for by the department’s connection to the National Interconnected Electrical System.

Energy Projects

Energy investments in recent years, especially in the construction of gas-fired thermal power plants and electricity transmission lines, have sought to increase Arequipa’s energy capacity to reduce the region’s reliance on energy sources from central Peru, yet there are still a number of pending projects. Worth an estimated $278m, the Mantaro-Marcona-Socabaya-Montalvo transmission line is expected to be ready by June 2017 and will install a capacity of 1600 MVA. Another project, originally awarded in 2014 to a consortium, including Brazilian conglomerate Odebrecht, Spanish firm Enagás and the Lima-based Graña & Montero, the Southern Peruvian Gas Pipeline, which will cost an estimated $7.3bn, is currently on standby until a new tender can take place at the end of 2017.

The project came to a stand-still when Odebrecht withdrew from the project due to a lack of funding. While visiting Arequipa in January 2017, President Pedro Pablo Kuczynski declared that there would be a new tender process to finance the project within nine months. In the meantime, the government is planning to improve gas distribution to the south of Peru through the development of a mobile liquefied natural gas network operated by Gas Natural Fenosa. The project involves building a number of regasification plants, two of which will be located in Arequipa, and then transporting the gas via trucks. This plan should contribute to answering an estimated potential demand of 585m standard cu feet per day in the medium term, driven by mining, energy and petrochemicals projects.

Ultimately, given the existing energy shortage and an increasing electricity demand driven by mining growth, there is likely to be continued room for investment in the energy sector in Arequipa.

Renewable Energies

Conventional sources of energy are not Arequipa’s only option for meeting energy demand. “Arequipa has potential in solar, wind and geothermal energies,” Gambetta Paredes told OBG. For example, Arequipa currently holds two of the handful of operating solar power plants in the country: the 20-MW Majes Solar 20T located in the district of Majes and the 20-MW Repartición Solar 20T located in the district of La Joya.

The region is estimated to have some of the highest potential for solar in the world, with 2600 annual hours of sunlight and weather favouring commercial exploration. As of November 2015 three companies had responded to the government’s fourth tender on renewable energies, including a project to develop a photovoltaic power plant in the district of La Joya. “The results of the tender may come out in 2017,” Gambetta Paredes told OBG.

In 2014 solar power represented 10.6% of Arequipa’s energy production capacity, compared to 51.2% hydroelectric and 1.4% wind. The remaining 34.3% was generated from thermal power.

Manufacturing

Arequipa, as described by the BCRP, is the second industrial pole of Peru, hosting a large number of major local and regional companies producing consumer goods, inputs and capital goods. As of 2014, 85% of manufacturing companies in Arequipa operated in a select set of fields, including the production of food and beverages, metal products, garments, shoes, editing and printing, and furniture and textile products. Microsized companies accounted for 96.2% of regional manufacturing firms and 93.6% of manufacturing companies that were located in Arequipa. Despite its significance, the manufacturing sector has displayed a rather unstable performance over the past few years. Manufacturing represented 19.4% of Arequipa’s GVA in 2007, as measured by the INEI, against an estimated 14.4% in 2015. Moreover, in 2015 manufacturing GVA in Arequipa contracted by approximately 6%, contrasting with a peak expansion of 5.5% just four years earlier.

According to the latest data from the BCRP in 2016, primary manufacturing decreased by 2.8%, with total manufacturing contracting by 2.4%. This was caused by significant declines in subsectors including metallic products, which fell by 58%; canned and frozen fish, which declined 50.8%; textiles and clothing production (6.8%), dairy products (5.9%) and non-primary manufacturing (2.5%). However, not all subsectors experienced contractions; pencils and related products grew by 33.2%, followed by plastic products (20.7%), cement (6.8%) and copper product production (2.6%).

Sector challenges reportedly include, among other factors, competition from informal markets, high logistical costs, deficiencies in the transport system, the dependency on the Port of Callao for container exports, and bureaucratic barriers.

Notwithstanding these issues, Arequipa preserves a diversified productive base, with substantial room for growth and investment in a number of key export-oriented areas as the production of alpaca garments, which represented only 1.1% of the manufacturing sector in 2014 (see analysis).

Construction

Construction recorded double-digit growth until 2014, according to the INEI. For 2015, however, the INEI estimated an 11.7% contraction in construction in Arequipa, reflecting an overall slowdown in economic growth in previous years. According to the BCRP, there are essentially two construction segments in the department of Arequipa: a construction segment made up of informal, small-scale companies; and a modern segment in charge of undertaking large-scale, public investment projects and real estate development, as well as productive infrastructure works.

Pending investments in infrastructure and real estate developments should boost construction sector growth in the future, namely in housing, where there is an estimated potential demand for 208,000 units and an immediate, effective demand for 21,000 units. In fact, domestic cement sales, as reported by the Arequipa section of the BCRP in December 2016, posted positive growth rates over the year, reaching approximately 2.3m tonnes, the equivalent of a 6% growth rate for the year.

“In 2017 growth in the cement industry will largely be driven by the self-construction market — which represents 60% of total cement sales — and a government push to bridge the infrastructure gap,” Humberto Vergara, general manager at Cementos Yura, a Arequipa-based cement company, told OBG.

Agriculture

Arequipa is widely seen as having strong potential for the development of export-oriented agriculture, premised on the usage of modern technologies in the production process and a better management system. In 2015 agriculture, livestock game and forestry constituted the sixth largest economic activity in Arequipa, representing an estimated 6.6% of regional GVA.

In 2014, however, according to the BCRP, only 10.4% of the sector was comprised of export-oriented agricultural production and agro-industry, as compared to 54.3% of agricultural production for domestic markets. Even so, it was the former subsector that contributed the most to growth during the last period evaluated by the BCRP. Indeed, export-oriented agricultural and agro-industry grew by 50.8% from 2015 to 2016, and contributed approximately 5.1% to overall sector growth.

To take advantage of this untapped potential, the regional government has been pushing forward the Maje-Siguas II irrigation project, which should reportedly expand the agricultural frontier by another 38,500 ha, allowing for the cultivation of both permanent and temporary crops.

The project has an estimated cost of $550m and will be developed over a period of five years. Unlike the first phase, the project’s second stage should focus on irrigation and agro-exports. The project’s benefits are projected to include an annual $360m boost to exports, 6000 additional jobs in the construction of hydraulics, 90,000 direct employment opportunities in agriculture, 100,000 indirect employment opportunities in industry and services, some 4500 in the construction of hydroelectric dams and 300 during dam operations.

The Maje-Siguas II irrigation project is also expected to support the development of a city in the district of San Juan de Siguas which has a potential population of between 300,000 to 500,000 people.

Tourism

Arequipa has significant potential to develop a tourism industry, and an offering that includes a varied range of natural landscapes and cultural, gastronomic and business attractions.

The historical city centre of the department’s capital, Arequipa, is a designated UNESCO World Heritage Site. There are also a substantial number of secondary attractions, including the village of Yanahuara, known for its pearly white volcanic architecture; Cayma, an area known for its beautiful beaches; and Sabandía, which is known for mountainous countryside and dramatic hillside steppes. Other noteworthy attractions include the valleys and canyons of Colca and Cotahuasi, the valley of the volcanoes, the petroglyphs of Toro Muerto, the National Sanctuary of the Mejía Lagoons, and the National Reserve of Salinas and Aguada Blanca.

With a total of 40 daily roundtrip flights, including via LATAM Airlines, Peruvian Airlines, Avianca and LC Perú, the region has seen an increasing number of tourist arrivals, as well as developing tourism infrastructure. Between 2005 and 2015 the number of tourists arriving to Arequipa grew at an average annual rate of 7.4%, with domestic arrivals growing 8.5% and international arrivals 3.2%.

During the same period, the total number of classified and non-classified hotel establishments increased from 608 to 1132, albeit including only one five-star hotel, El Libertador, and seven four-star establishments in 2015. “Developing more upscale, four and five-star hotels in Arequipa will help the city strengthen its position as a meetings, incentives, conferences, and events tourism hub in the region,” Enrique Bedoya, general manager at the Cerro Juli Convention Centre, told OBG. In 2016 Arequipa held a series of international and national events, including several discussions of the Asia-Pacific Economic Cooperation Forum, which had the city welcoming approximately 2000 delegates.

Financial Services

Financial sector inclusion, as measured by the number of bank offices, ATMs and banking agents, has grown significantly in recent years in Arequipa, going from 225 units in 2010 to 988 units in 2015, ultimately topping the list in Peru.

However, there is an important distinction to be made between multiple banking and municipal savings and credit unions in Arequipa, insofar as the latter provide the largest share of credit to micro and small-sized companies, which represent the majority of firms in the region.

Indeed, as of 2015 municipal savings and credit unions in Arequipa provided 17.7% of their credit to micro-sized firms and 41.8% to small-sized firms in the private sector, against 2.4% and 11.7% in multiple banking credit, respectively.

As a segment, microfinancing for micro, small and medium-sized enterprises (MSMEs) in Arequipa has grown at particularly high rates in recent years. “Micro-credits targeting MSMEs posted growth rates of 8% in 2015-16, as compared to 3 to 4% in 2010-11,” Wilber Dongo Díaz, central business manager at Caja Arequipa, told OBG. “Today there are about 40 institutions offering microcredit services to MSMEs in Arequipa, six of which have developed a successful expansion strategy. Yet, the market is still going through a consolidation stage, as evidenced by the number of mergers and acquisitions,” he added.

With a balance of $1.15bn in 2017, Caja Arequipa is no doubt a major financial player in Peru, ranking first in Arequipa, which comprises 40% of its business. For Dongo Díaz, the future of microfinancing in Arequipa is bright, especially as key mining, irrigation and agricultural projects in the region move ahead, allowing the financial institution’s clients to channel their savings into the development of parallel personal businesses. According to the latest data from the BCRP, direct credits to companies grew by 12.5% in 2016, while direct credits to individuals remained relatively stable, dropping only slightly by 0.1% due to a combination of a 4.4% growth in consumer credits but a contraction of 6.4% in mortgages.

Outlook

The outlook for Arequipa is largely positive, for a number of reasons. To begin, growth in the mining sector has been picking up speed since 2015 and there are several major mining projects in the department’s pipeline, a number of which already have approved EIAs.

On top of this, there is a list of priority projects supported by the regional government that should help contribute to the Arequipa’s growth over time. As they move forward, these projects are bound to translate into greater employment, government revenue and economic diversification, in turn, stimulating expansion in banking inclusion, as well as savings, credit and investment in micro and smallsized enterprises. Reported growth expectations in the self-construction market and credit to MSMEs, for instance, seem to corroborate this view.

As new mining and other industry projects come on-line, demand for electricity is also likely to grow – driven in part by the mining industry – thus generating opportunities for investment in electricity generation, as has been the case in recent years. In this context, there is potential for growth and investment in renewable energies, especially solar power. Other areas exhibiting room for growth include, in particular, export-oriented business such as agriculture and textiles, as illustrated respectively by the development of Maje-Siguas II irrigation project and the alpaca garments industry (see analysis). In addition, the tourism industry has displayed potential for growth in recent years.

While the present government has taken a number of significant measures to attract private investment, not least with the establishment of a priority project list at the beginning of it term in office, the advancement of key development projects and therefore their impact on the economy will no doubt depend on the ability of key stakeholders to help ensure community involvement.

Moreover, in the medium to long term, addressing outstanding obstacles, such as substantially high logistic costs, over-dependency on the Port of Callao and significant bureaucratic barriers, may also contribute to improving economic competitiveness.