Peru aims to provide social services and revive the economy

Once known as a country scarred by economic and social upheaval, Peru has now experienced nearly two decades of economic growth alongside the continued establishment of democratic principles – increasingly so since the turn of the millennium. Buoyed by high commodity prices, the mineral-rich country grew at an average annual rate of 6.2% in the 10 years to 2014, cementing its status as one of the fastest growing economies in Latin America.

Rapid growth further enabled Peru to make significant strides in improving social indicators, particularly regarding poverty rates. However, the end of the recent commodity cycle saw GDP growth slow to a decade low of 2.4% in 2014 – as global commodity prices fell and Chinese demand for Peruvian minerals eased – sending Peru into uncharted waters.

Elected in mid-2016, President Pedro Pablo Kuczynski is set to lead the country through the next five years as it navigates a rapidly changing global political and economic environment. Among other key goals, the new administration has pledged to place special emphasis on improving social services, the revival of the economy and the fight against corruption.

Political History

Peru’s journey to economic and political stability was a long and arduous one. After gaining independence from Spanish colonial rule in 1821, the country endured a long period of political instability. Power shifted tenuously between democratically elected governments – with occasional military coups – until a Constitutional Assembly was formed in 1979, spearheaded by the centre-left American Revolutionary Popular Alliance (Alianza Popular Revolucionaria Americana, APRA), one of the oldest surviving parties in the country.

The 1980s were marked by economic hardship and the rise of guerrilla warfare and armed violence. In 1980, some 12 years after being deposed by a military coup, Fernando Belaúnde Terry re-gained power through democratic elections. Belaúnde, who embraced liberal policies, sought to reverse the agrarian reforms with the adoption of IMF-backed austerity policies and an ambitious road-building programme. However, a global downturn in commodity prices and a series of natural disasters during his presidency – running 1980-85 – sparked hyperinflation, accompanied by rising foreign debt and high unemployment, pushing the country into an economic crisis.

Rebel groups began to emerge during that period as well, in particular the Shining Path (Sendero Luminoso), a violent Maoist-inspired guerilla movement, and the Túpac Amaru Revolutionary Movement (Movimiento Revolucionario Túpac Amaru, MRTA), a smaller leftist resistance group. Through bombings, assassinations and other attacks against the state, rebel groups engaged in a systematic campaign of economic sabotage that lasted for two decades with significant economic and social costs for the country.

Democratic Roots

The election of Alan García of the APRA in 1985 marked not only the country’s first peaceful government transition in 40 years, but also its deep desire for change. After campaigning on a platform of heterodox economic reforms, García attempted to reign in hyperinflation and foreign debt by imposing price and exchange controls, among other measures. Although he managed to do this with some success during his first two years, by 1989, García’s last full year in office, inflation had reached 3398%. The economy contracted by 11.7% that year, sending the country back into turmoil after defaulting on its debt payment, as insecurity continued to increase. By 1990 the Shining Path had been officially designated as a terrorist organisation by governments around the world, having gained control of large swaths of rural land at home, particularly in southern Peru.

Facing economic turmoil and increasing insecurity, the country took to the polls in 1990 to elect an unlikely political outsider, Alberto Fujimori, in a surprising outcome. The son of Japanese immigrants to Peru, Fujimori pledged to lead the country out of the economic crisis and defeat guerrilla groups. In an effort to bring hyperinflation and fiscal debt under control, Fujimori introduced a set of free market reforms, including the large-scale privatisation of state-owned enterprises, the elimination of price controls and the easing of regulations to attract foreign direct investment (FDI). The measures, which became know as the “Fuji shock”, succeeded in bringing the fiscal deficit and inflation under control. The country enjoyed average GDP growth of 3.9% in the period from 1991 to 1997, after having seen an average annual decline of 2.2% in the period from 1976 to 1990.

Authoritarian Legacy

Unfortunately, Fujimori’s regime gradually grew more authoritarian. In 1992 Fujimori suspended the constitution in a “self-coup”, which strengthened the executive branch of government and the military, allowing him to spearhead a successful and brutal counter-insurgency military campaign against guerrilla groups. The Shining Path’s leader, Abimael Guzmán, was captured in 1992 and sentenced to life in prison, and by the end of 1994 more than 5000 fighters had surrendered under a limited government amnesty programme, while an additional 1500 had been captured.

After obtaining approval for a new constitution in 1993, Fujimori secured his re-election in 1995. In his second term, Fujimori continued to improve security. The capture of Oscar Ramírez, Guzmán’s successor, in 1999 dealt a decisive blow to the Shining Path, which subsequently splintered into small factions. However, discontent was growing following the rise in authoritarianism and political violence. Fujimori resigned in 2000 before completing his term, and fled to Japan amid rising protests. In 2009 the former president was sentenced to 25 years in prison for crimes against humanity, embezzlement and bribery.

During his 10-year tenure as president, Fujimori was linked to various crimes, including state-sponsored massacres, illegal telephone tapping and inappropriate use of state funds. A Truth and Reconciliation Commission was created in 2001 to investigate political violence committed in the 1980s and 1990s. The commission’s final report estimated that more than 69,000 Peruvians lost their lives during the 20-year period – either killed or forcibly “disappeared” by subversive groups or government forces. Though in prison, Fujimori continues to shape Peruvian politics, primarily through his daughter, Keiko Fujimori, two-time presidential candidate and leader of the opposition Popular Force party.

Growth & Stability

The post-Fujimori period saw the gradual strengthening of market-friendly economic policies under President Alejandro Toledo of the centre-left party Perú Posible, who remained in power from 2001 to 2006. Toledo, the country’s first president of indigenous heritage, succeeded at reducing the fiscal deficit through an increase in tax collection, though his most notable achievement was the signing of a free trade agreement with the US in 2005. His legacy, however, was tainted by corruption. In 2005 Toledo was found guilty of electoral fraud by a congressional commission, dating back to 2000.

Alan García was re-elected in 2006, defeating rival Ollanta Humala in a runoff vote. In his second term, García embraced market-friendly reforms, continuing the fiscal discipline and open trade policies of his predecessors. Driven by global high commodity prices, the country achieved 7% average annual GDP growth during his term (2006-2011), emerging as one of the fastest growing economies in the region, as well as a major recipient of FDI.

Nonetheless, rising crime and coca production – coupled with significant inequality, the fast pace of mining development and corruption scandals – continued to fuel social discontent. Two years into his presidency, García’s cabinet resigned over a bribery scandal involving oil contracts, and the following year his administration faced large-scale protests by indigenous groups in the Amazon over land rights.

In the 2011 elections, Ollanta Humala, leader of the Peru Wins alliance, defeated Keiko Fujimori with just over 51% of the popular vote. A former army officer, Humala had led an unsuccessful rebellion against former president Fujimori in 2000 and ran against García in the 2006 elections, positioning himself as a nationalist and anti-globalisation advocate. By 2011 however, Humala had adopted a more moderate centre-left platform. In his inaugural speech, Humala pledged to continue free market policies, narrow income inequality and eliminate social exclusion, particularly among the country’s indigenous population.

End Of A Cycle

The country’s rapid growth continued during Humala’s first years in office, with GDP expanding by 6% and 5.9% in 2012 and 2013, respectively. However, by 2014 it became apparent that the commodities-led boom was coming to an end, with growth slowing to 2.4% that year, according to the IMF. The Humala administration responded by introducing several economic stimulus packages aimed at bolstering growth, including a set of reforms to environmental regulations in order to spur investment in the mining sector. The IMF reported that GDP growth recovered to 3.3% in 2015, driven largely by higher metals and fishing production, as well as a partial recovery in services and commerce.

However, these government-led measures were not enough to prevent a downturn in FDI inflows, which fell from nearly $12bn in 2012 to $7.8bn in 2015, according to Peru’s Central Reserve Bank. The impact of lower metal prices on export revenues was also clear. Peru’s total exports declined from $42bn in 2013 to $33bn the following year.

During his presidency (2011-16), Humala tried – with varying degrees of success – to strike a balance between maintaining rapid economic growth and investor confidence while responding to social inequality at a pace that satisfied his political supporters. Yet, his administration was unable to avoid violent protests in mining areas, and corruption allegations – which led to multiple reshufflings of his cabinet – further tainted his legacy. Humala entered his last year in office with record low approval ratings, estimated at 17% in June 2015, according to Ipsos Perú. Nevertheless, his contribution in reducing inequality was significant. According to authorities, an estimated 1.3m Peruvians were lifted out of poverty in 2011-15.

New Era

In the 2016 elections, Pedro Pablo Kuczynski, from the centre-right Peruvians for Change party, defeated Keiko Fujimori in the runoff vote, with 50.1% of the popular tallies – the narrowest victory in the country’s recent history. An economist and former Wall Street investment banker, Kuczynski assumed office on July 28, 2016, pledging to improve social services, stimulate economic growth and formal employment, improve citizen safety and fight corruption.

Among the new government’s top priorities is guaranteeing access to potable water to every Peruvian by 2021, a commitment which will require an estimated $15bn investment, as well as extending access to sanitation services. Peru has made major strides to combat poverty in the past decade. The National Institute of Statistics and Informatics (Instituto Nacional de Estadística e Informática, INEI) reports that the poverty rate declined by 36 percentage points between 2004 and 2015, from 58.7% to 21.8%. Nevertheless, some 7m Peruvians are still living in poverty, without access to basic services. Of those, 33.2% have no access to clean water and 66.1% have no access to sanitation services. Kuczynski also plans to counter inequality with new measures to improve the standard of social services, in particular education and health, and to promote growth in rural areas with increased technical support for small-scale farming.

Matching its stated commitments, the government’s budget for 2017 of PEN142.5bn ($42.2bn) – a 4.7% increase from the previous year – prioritises five key areas: national security, justice, education, health and infrastructure. Education received the largest allocation, at nearly PEN26.2bn ($7.8bn), or 18.4% of the total amount. Funding for water and sanitation projects increased by 71.6%, with over PEN5.9bn ($1.7bn) allocated to projects across the country.

Economic Revival

On the economic front, President Kuczynski aims to boost growth by further reducing bureaucratic barriers to investment, increasing formalisation of small businesses and stimulating capital investment in infrastructure, particularly in projects aimed at facilitating the continued diversification of key sectors. Kuczynski’s economic package includes additional breaks for small businesses, a reduction of the national sales tax from 18% to 15% and a minimum wage increase, among others. The measures are expected to boost growth to 5% and generate some 3m jobs in the next five years.

The country’s gradual recovery is also under way. Peru’s GDP expanded by 3.9% in 2016, according to the INEI, and the country is expected to continue to lead in the region in 2017, with the IMF projecting growth to exceed 4%, significantly above the 0.8% average growth forecast for the region.

Corruption

Fighting corruption is also set to figure prominently on the new president’s agenda, after a massive scandal rocked the country’s political establishment in 2016. In a growing anti-corruption probe, Odebrecht, Brazil’s largest construction company, admitted to paying nearly $800m in bribes for more than 100 construction and engineering projects in a dozen countries, including Peru. The construction giant – which has been active in infrastructure, energy, irrigation and industrial projects for several decades in Peru – admitted to paying $29m in bribes to secure contracts between 2005 and 2014, a period which spanned the presidencies of Toledo, García and Humala. Ongoing investigations threaten to imprison a number of high-ranking Peruvian officials, including Toledo, the target of an international arrest warrant.

In addition to the political fallout, the anti-corruption probe may have a significant economic impact. The investigation has temporarily stopped advancement of key projects, including the $5bn Southern Gas Pipeline, in which Odebrecht has a 55% stake (see Construction & Real Estate chapter). Alfredo Thorne, the minister of finance, has warned the corruption case is likely to hinder growth prospects in 2017 by slowing investment. The minister has downgraded Peru’s growth outlook from 4.8% in January 2017 to 3.8%. In February 2017 Peru demanded PEN200m ($59.3m) in reparations from the company, and the following month Kuczynski told local media that Odebrecht could be walking away from all of its ongoing projects in Peru within six months.

To curb corruption and increase transparency, Kuczynski intends to introduce a series of measures, including legislation to prevent politicians found guilty of corruption from returning to politics. Though the cost of corruption is hard to quantify, Peruvian authorities estimate it costs more than 1% of GDP annually.

Security

National security is another priority for the current administration. Kuczynski has already announced plans to increase training, infrastructure and logistics for the police force and penitentiary system, as well as an overhaul of the judiciary. To this end, the budget for the Ministry of the Interior is set to gradually rise to PEN22.6bn ($6.7bn), lifting spending from its current level of 1.35% of GDP to 2.3% by 2021.

Perceived insecurity is an increasingly important concern for Peruvians, according to a March 2016 poll by Ipsos Perú. Data from the National Criminal Policy Observatory depicts a gradually rising national murder rate, which increased from 5.4 per 100,000 residents in 2011 to 7.2 in 2015. However, murder rates in Callao, home to the country’s most important port, reached 15.2 per 100,000 inhabitants in 2015 – more than double the national average. The high incidence of criminal activity around the port is largely attributed to clashes between local criminal groups for control of the drug trade. Unprecedented murder and extortion in the region led Humala to declare a 50-day state of emergency in December 2015 to allow the government to respond effectively.

While the Shining Path is now largely defunct, the group retains the remnants of a political following and remains active, with small rebel units engaged in the cocaine trade, primarily in the Apurimac, Ene and Mantaro River Valleys region, the country’s main coca growing region. The area is estimated to account for 70% of the 450 metric tonnes of cocaine exported by Peru each year. Humala’s efforts to reduce coca cultivation – a combination of initial eradication measures and a productive reconversion policy later – led to a significant decline in coca production. Figures fell by 35% in 2011-15, from 62,500 ha to 40,300 ha, according to the UN Office on Drugs and Crime. The decline, coupled with an exponential increase in cultivation in Colombia, saw the latter surpass Peru to become the leading cocaine producer in 2015.

Continuing the downward trend in coca cultivation remains a key goal for Kuczynski. The new president is expected to build on Humala’s policies, strengthening crop substitution efforts and guaranteeing state presence in the river valleys region, with the goal of reducing coca cultivation to 25,000 ha by 2021.

Foreign Policy

In regards to foreign policy, Kuczynski is also expected to continue to champion free trade as his predecessors have done for the past decade. Since 2006 Peru has signed trade deals with the US, Canada, Singapore, China, South Korea, Mexico, Japan, the EU, Thailand, Costa Rica, Panama, Venezuela, Chile and Cuba. A new agreement with Honduras took effect in January 2017, and the country is currently in negotiations with El Salvador, India and Turkey. Furthermore, Peru is an active member of the Pacific Alliance – along with Mexico, Colombia and Chile – which seeks deeper integration in services, capital, investment and the movement of people.

Though Congress has yet to ratify the agreement, Peru has also concluded negotiations for participation in the Trans-Pacific Partnership, a multilateral free trade deal initially set to bring together 12 Pacific Rim nations and now represents about 40% of the world’s economy. In January 2017 US President Donald Trump withdrew from the partnership, not only sending the future of the deal into question, but signalling what many have termed the beginning of a new approach to trade. At a time when more economies are eyeing protectionist measures, Peru appears committed to free trade policies. In response to the withdrawal, Kuczynski called for the establishment of a broader Asia-Pacific accord with China and India, defending trade as vital for domestic job creation.

In a bid to strengthen bilateral ties and attract fresh investment, Kuczynski visited China on his first trip abroad. The visit underscores China’s growing influence in Peru. The Asian giant is a key trade partner and source of foreign investment, accounting for 29.2% of total Peruvian exports in 2016. Between 2013 and 2015 the country attracted more than $13bn in investments by Chinese companies, primarily for copper projects and fishmeal assets.

Outlook

Increasing volatility in financial markets, a slowing Chinese economy and uncertainty from the Trump administration in the US are some of the external headwinds Peru faces at present. Domestically, delays in infrastructure projects and a possible decline in confidence in the government following the Odebrecht corruption scandal could pose further economic and political risks. The fact that Congress is dominated by the rival Popular Force party – which has 73 of the 130 seats – mean pushing reforms through will also likely require significant political engagement.

However, Peru’s outlook for the short-to-medium term remains positive. Despite the recent deceleration in GDP growth, Kuczynski inherited an economy with a solid foundation, good institutional frameworks and ongoing structural reforms: aspects that should assist the country in navigating today’s rapidly changing global political and economic environment.