Accelerated growth in Peru supported by a smooth political transition and increased public spending

After a political transition that threatened business confidence and investment projects in Peru, local and international economic agents have regained optimistic outlooks. As one of South America’s top performers due to its structural reforms and fiscal discipline, Peru is seeing an economic rebound due to rising commodity prices and an export-oriented mining sector. The business community has largely embraced political shifts. Key associations – such as the National Confederation of Private Business Institutions, the Association of Exporters, the National Society of Industries, and the National Society of Mining, Petroleum and Energy – were the first to express support for President Martín Vizcarra Cornejo upon his March 2018 swearing-in.

The top international sovereign ratings agencies – Fitch, Moody’s and Standard & Poor’s – also expressed trust in the administration. Moody’s affirmed that despite political instability, which weighed on Peru’s credit rating, greater investment in infrastructure is anticipated in the near term, supported by the country’s robust institutional framework. The resignation of former President Pedro Pablo Kuczynski is likely to temporarily delay infrastructure projects, but investments, including public-private partnership (PPP) projects, will remain the government’s priority (see analysis).

GDP by Sector

The the Ministry of Economy and Finance (Ministerio de Economía y Finanzas, MEF) projects GDP growth will accelerate from 2.5% in 2017 to 3.6% in 2018, bolstered by a 17.5% and 4.5% increase in public and private investment, respectively. The IMF, for its part, revised its growth forecast to 3.7% in July 2018, one of the highest rates in Latin America. The longer-term outlook is more optimistic, with higher average growth and domestic demand over the 2018-21 period. The MEF expects private investment to support fiscal consolidation efforts from 2019, reactivating the virtuous cycle of investment, employment and consumption.

Services were the largest contributor to GDP in 2017 at 59.9%, followed by industry (32.5%) and agriculture (7.6%), according to the World Bank. Peru’s National Institute of Statistics and Informatics (Instituto Nacional de Estadística e Informática, INEI) offers slightly different numbers, with services comprising 53.4% of GDP, industry 18.7%, extractive sectors 18.6%, and import duties and other taxes 9.3%. There has been little change in this broader distribution since the early 2000s, though services’ stake expanded by 4.4 percentage points in 2008-17. That said, there have been significant shifts in subsectors. Agriculture, mining and ICT have seen particularly strong growth, with the latter expanding by an average of 10.2% over 2008-17.

Furthermore, travel and tourism are on a growth trajectory, with the World Travel & Tourism Council forecasting these will increase their GDP contribution from 3.8% in 2017 to 4.5% in 2018. Construction has also been earmarked as having growth potential, particularly due to reconstruction plans following the El Niño weather pattern in 2017 and increased building activity in Lima. With the government focused on infrastructure projects through PPPs, construction recorded 2.2% expansion in 2017 and made up 5.1% of GDP.

Budget Breakdown

Upon his assumption of office President Vizcarra vowed to prioritise government spending on education and health. Other focuses include water sanitation and strengthening police capacity to combat organised crime issues. The government set aside a total of just over PEN157bn ($48.3bn) for 2018, a 10% increase over 2017. The budget amounts to 21% of GDP, with 74.2%, 15.6% and 10.2% assigned to the national, regional and local governments, respectively. In terms of sectors receiving public investment, education received the largest allocation at 17.5%, followed by government planning, management and reserve contingencies with 16.8%; health with 10.2%; and then transport (9.6%); social security (8%); public debt (7.5%); and public safety (6%).

Several sectors received a significant boost in funding in 2018. Government planning, management and reserve contingencies saw the most substantial increase, with an additional PEN7.9bn ($2.3bn), a 43.1% rise over 2017. The next-largest boost was in health, which grew by 16.2% (PEN2.2bn, $677m). Although education remains a stated focus for public spending and received the largest amount of resources, its budget only rose by 4.8% (PEN1.2bn, $369m). Transport, defence and national security, and justice also received notable expansions in outlays of 6.9%, 9.7% and 7.3%, respectively. However, allocations to other sectors declined or remained largely unchanged – the sanitation budget was slashed by almost 23%, equivalent to PEN1.3bn ($400m), and no changes were made to the allowances for public order and safety or social security.

Although the 2019 budget has yet to be announced, David Tuesta, the former minister of economy and finance, has suggested the government may try to trim spending. Tuesta has hinted that cuts would primarily occur in consulting services, as well as the executive and legislative branches of government. Unverified reports have claimed the government may also cut the health budget, but this seems unlikely given President Vizcarra’s commitment to overhauling the health system.

Changing Policies

Only weeks after President Vizcarra took office the MEF presented an update to its “Multiannual Macroeconomic Framework 2018-21”, with a targeted 5% GDP growth by 2021 and plans to reduce the annual budget deficit from 3.5% of GDP in 2018 to 1% by 2021. These optimistic forecasts were supported by reconstruction efforts and the economic push provided by the Pan-American Games.

In the context of Peru’s efforts to enter the OECD, the country must implement a policy of deregulation and simplification of regulatory frameworks. “The government under President Vizcarra understands that foreign investment goes hand-in-hand with caring for the environment,” Victor Montero, a professor in the Economic Department at Ricardo Palma University of Lima, told OBG. “Both are key to achieving economic development, even above the local market,”

Stimulus Plan

To meet its fiscal growth and consolidation goals, the government created the Economic Stimulus Plan in March 2017 to boost production in the short to medium term and strengthen fiscal accounts to generate a pro-growth space. The plan contains five pillars, the first of which is to boost public investments to meet the growth target of 17.5% in 2018.

To work towards this goal, the authorities have modified regulations to accelerate reconstruction, allocated a supplementary PEN2bn (616m) budget and offered incentives to regional governments to further attract investment. The institution of a single window system is anticipated to facilitate the execution of projects. This would expedite trade procedures, enabling the relevant personnel to electronically process all procedures to obtain permits, certifications, licences and other authorisations that they will need for the transport of goods used in reconstruction projects.

Another pillar of the plan is to accelerate GDP growth to 4.7% by 2021 – since revised upwards to 5% – supported by the development of competitive platforms, as well as the identification and elimination of barriers in sectors with strategic advantages. Furthermore, a framework to support small and medium-sized enterprises is set to be established, including more favourable financing conditions and other measures that have been successfully instituted by foreign governments.

Lastly, the authorities aim to reform the tax framework by improving the deduction system and increasing control over tax collection. These measures should help increase public tax revenue by 1.9% of GDP.

Domestic Consumption

Domestic household consumption is expected to peak in 2018 following several challenging years – particularly 2017, when consumer spending eased by 4%, the largest decrease since 2010.

According to World Bank data, the average Peruvian household spends more than 32% of its budget on food and beverages, followed by housing (18.7%), transport (11.8%), telecommunications (8%) and health (6%). Domestic consumption has largely failed to keep pace with economic performance. While GDP growth averaged 3.6% over 2013-17, spending by volume was relatively stagnant, expanding by 1% or less in 2013-15 and contracting slightly in 2016 and 2017.

However, according to Kantar Worldpanel, an international consumer insight firm, household consumption is expected to rebound to 2-5% in 2018, driven by strong growth projections in construction and agriculture. The value and volume of household consumption is forecast to rise by 4.5% and 2.5%, respectively.

Household Debt

Statistics on household savings and debt are neither up to date nor comprehensive. However, domestic debt levels are generally much lower than in neighbouring countries. Chilean consumers had the highest household debt-to-GDP ratio in 2016, at 42%, and the regional average was around 20%. In contrast, consumer debt in Peru was just below 6% in 2017.

The Superintendency of Banking, Insurance and Pensions (Superintendencia de Banca, Seguros y Administradoras de Fondos de Pensiones, SBS) estimated that 66% of Peruvians actively saved money in 2016, with this rate higher in rural areas (72%) than urban ones (65%). A marked majority (68%) of people who saved kept their money outside of the formal financial system, and of this group, 74% stored their savings at home.

According to the SBS’s most recent data on credit, 30% of Peruvians took out some sort of loan in 2014, with 52% of these outside the formal financial system. Economically disadvantaged households were especially likely to take this route, with 61% of impoverished people with debt using informal lenders. Following this trend, 14% of citizens took out a line of credit from a financial institution in 2014, and approximately 14% had a credit card in 2016, with significant differences between regions – 2% of the rural population had a credit card, compared to 16% of urban dwellers.

Employment & Demographics

Employment statistics highlight an ageing working population, high levels of informal employment and the dominance of services. The INEI estimated the country’s working-age population at 24m people in the first quarter of 2018, representing 1.4% growth over the same period of 2017.

Of this potential labour force, 72.8% were economically active, and unemployment was relatively low at 5.1%. Of the 16.6m employed citizens, 51.3% were considered “adequately employed”, meaning they earned above the monthly minimum wage – which was increased from PEN850 ($262) to PEN961 ($294) in January 2018 – and worked more than 35 hours per week. Average monthly earnings in urban areas were PEN1536 ($470) between April 2017 and March 2018, a 2.1% year-on-year (y-o-y) contraction.

Men comprised 56% of the working population and women 44% in early 2018, with nearly half (47.2%) of these people between 25 and 44 years of age, and 34.5% aged 45 or older. The latter group recorded the highest y-o-y growth rate of 3.9% – more than double that of the general labour force – indicating an ageing workforce. Education levels are relatively low: only 19.6% of those in employment had a university degree, and 76.6% had at least completed secondary school.

There is also a notable difference in employment dynamics for urban and rural areas, which had labour participation rates of 70.6% and 81.3%, respectively. This has seen little variation since 2015, and informal employment is especially prevalent in urban areas. Between April 2017 and March 2018 the INEI estimated that 67.1% of the working population in urban areas were informally employed, a 5.1% y-o-y increase.

In terms of sector, 40.6% worked in services in the first quarter of 2018, followed by agriculture, fisheries and mining (25.5%); industry (19.1%); manufacturing (8.8%); and construction (6%). Agriculture, fisheries and mining recorded the highest y-o-y increase, with 9.1% employment growth, followed by construction (7.3%).

Poverty

In 2017 Peru’s poverty rate increased for the first time since the turn of the century, due in part to the deceleration of the economy and a decline in formal employment. According to the INEI, 375,000 additional citizens descended into poverty in 2017, bringing the total to 6.91m people, or 21.7% of the population. Lima alone – where the rate climbed from 11% to 13.3% in 2017 – accounted for around half of this increase.

Poverty rates are much higher in rural areas, where 44.4% of people existed on less than PEN338 ($104) per month in 2017, a 0.6 percentage point increase on the previous year. Meanwhile, urban areas saw an increase of 1.2 percentage points, bringing the rate to 15.1%.

Consultants told local press in 2018 that this rise was due to the structure of the economy – growth was largely driven by mining and hydrocarbons, which are not associated with job creation to the same extent as other sectors. However, some domestic economists and analysts foresaw this expansion in poverty. “With anaemic growth of 2.5% in 2017, it was likely that poverty would stagnate or increase, and unfortunately, the latter happened,” Elmer Cuba, partner at Macroconsult, told local press in early 2018.

In 2018 this trend is likely to reverse: the economic rebound is anticipated to cause a reduction in poverty. Cuba and other forecasters have said they expect production growth to be driven mainly by non-extractive sectors, which have much higher demand for labour, therefore stimulating job creation.

Consulting firm Maximixe published a study in 2017 estimating that storms from El Niño caused more than PEN17.3bn ($5.3bn) – 3.9% of GDP – worth of infrastructure damage. However, in relative economic terms the weather pattern had less of an impact than previous iterations of the phenomenon. According to the National Institute of Civil Defence, the 1982-83 El Niño caused $1bn in destruction, equivalent to nearly 7% of GDP in 1983, and the Development Bank of Latin America estimated damage of the 1997-98 El Niño at $3.5bn, worth more than 4.5% of GDP.

In 2017 El Niño was relatively short and not as intense as it has been in the past, resulting in a speedy economic recovery in the affected regions – they even grew at an accelerated pace in the second half of the year, consultants told local press. This rebound reduced the prevalence of poverty in these areas.

2018 Projections

Despite challenges in 2017, the primary sectors are set to record a strong performance in 2018. Mining and hydrocarbons are forecast to grow by up to 6.5%, as mining has benefitted from a more favourable operating environment. The sector is estimated to have expanded by 8.2% in 2017 and should further increase by 2.8% in 2018. Meanwhile, manufacturing is anticipated to record its highest output in five years, rising by up to 3.7% in 2018. This is due to accelerating private consumption – which encourages the production of manufacturing-oriented mass consumption – as well as the favourable international environment, thus bolstering exportable manufacturing.

Large infrastructure projects should support a projected 7.2% expansion in 2018, the highest rate since 2013. Among the mega-infrastructure initiatives are: the reconstruction plan, a $7.4bn plan to rebuild the northern regions affected by severe flooding in 2017; the 2019 Pan-American Games, with planned investment of $900m; Line 2 of the Lima Metro ($5.7bn); and the Talara Refinery ($5.5bn). The construction sector provides jobs for 6% of the employed population.

“GDP could grow at a rate of 3.5% in 2018, but this will be fundamentally dependent on the speed with which public and private investments can react,” César Peñaranda, executive director at the Institute of Economics and Business Development of the Lima Chamber of Commerce, told OBG. “Public expenditure can help attract private investment, as is the case with PPPs through initiatives such as Works for Taxes. Growth will also depend on tax collection, which has eased, thus limiting the government’s ability to manoeuvre in an evolving landscape.” In the medium to long term the economy could expand at an accelerated pace if it implements reforms to increase productivity, Peñaranda continued (see analysis).

Summit of the Americas 

Contributing to the positive outlook, the Eighth Summit of the Americas – an event attended by authorities from more than 33 countries across North and South America in April 2018 – culminated in the Lima Commitment, containing 57 initiatives to combat corruption. During the summit, businesspeople committed to preventing and attacking corruption within their organisations. “If the companies comply with the anti-corruption commitments made, a historic change in the region’s business culture will be marked,” Alberto Moreno, president of the Inter-American Development Bank, told local press.

Concerned about corruption and slow development, around 300 companies collaborated to produce the “Action for Growth: Policy Recommendations and Plan of Action 2018-21 for Growth in the Americas”, suggesting a focus on five key areas: transparency, digitalisation, trade, energy and human skills.

Meanwhile, 1200 participants attended the third Business Summit, discussing the infrastructure deficit, the agro-industrial revolution, financial and technological integration of countries throughout the Americas, and further inclusion of women.

Outlook

The services, trade and manufacturing sectors – which collectively account for 67.8% of employment – remain key to economic dynamism. Recovery in these sectors, and resulting employment growth, should drive increases in domestic demand. Furthermore, the acceleration of private consumption should boost production and consumer optimism.

Increased public expenditure in 2018 reversed two consecutive years of fiscal conservatism, with especially notable rises in the budgets for education, health, infrastructure and the reconstruction plan. Various infrastructure and mining projects beginning operations in 2018 further point to upcoming economic prosperity. However, to fully capitalise on this and ensure that social development accompanies GDP growth, political instability, corruption and poverty must be minimised.