Reconstruction efforts in Peru following El Niño Costero expected to stimulate manufacturing

In 2017 Peru was struck by the El Niño Costero floods, and some industrial segments were forced to stop production as a result. Despite that, significant growth in non-primary manufacturing segments – such as food products, paper and cardboard, and construction equipment and machinery – helped the sector record a relatively positive outcome for the year.

However, El Niño was not the only thing to impede sector growth, as efforts to enhance and stabilise the industrial sector have not been realised, despite policies such as the Economic Reactivation Plan 2016-19. Uncertainty and instability in the sector could also be one reason why industrial projects slated for 2018-19 have the lowest investment forecast at 4.7%, compared to mining at 35.5% and infrastructure (21.9%).

With a long history in the production of raw materials, the manufacturing sector continues to grow to include a greater variety of value-added products, and to play a significant role in formalising the labour market. 2017 marked a turnaround for the sector after a 7.3% decline in production over four years, the worst deceleration manufacturing has seen in 70 years.

Sector Breakdown

“The Global Competitiveness Report 2017-18”, published by the World Economic Forum, placed Peru in 72nd position, five spots lower than its ranking in 2016 and 11 positions below its 2013 ranking. GDP growth was also on a downward trajectory, decelerating from 3.9% in 2016 to 2.5% in 2017, primarily due to a slowdown in the primary sectors, which contributed 2.1% to GDP in 2016 compared to 0.6% in 2017. Similarly, the non-primary sectors also registered low GDP growth in 2017, with 2.4%.

According to the National Society of Industries (Sociedad Nacional de Industrias, SNI), in 2017 the manufacturing segment represented 13% of GDP, 18% of tax revenues, 1.5m jobs, 15% of exports, 44% of household consumption, 14% of foreign investment and 23% of business loans. Overall, manufacturing GDP dropped by 0.3% between 2016 and 2017, mainly due to a deceleration in the production of beams, posts, assembly boards and prefabricated wood material for construction, according to the National Institute for Statistics and Computing (Instituto Nacional de Estadística e Informática, INEI). This was also the result of lower domestic and international market demand from the US, Mexico, Bolivia and Chile. However, the segment did witness production growth in the iron subsector and the fishmeal and frozen products subsector, at 6.8% and 9.2%, respectively.

Production & Investment

From February 2017 to 2018 the volume of cement production grew by 0.5%, despite difficulties in the reconstruction of areas affected by El Niño and the subsequent slowdown in public and private investment. The slight growth in production was due to the construction of mining units, office buildings, shopping centres, social infrastructure, condominiums and multi-family housing.

As for the manufacturing of chemical substances and products, the physical volume of production grew by 42%, explained by growth in the manufacturing of basic chemical substances, fertilisers and nitrogen compounds, plastics and synthetic rubber in primary forms at a rate of 3.6%, and the manufacturing of other chemical products at 5.5%. “The growth of the production of chemical substances has a lot of potential,” Claudia Marchini, country manager at water treatment and chemicals distributor IXOM told OBG. “There is great scope for chemical products in the water treatment industry, especially since the national and regional governments are increasingly focusing efforts on improving water treatment in Peru.”

Andreas Von Wedemeyer, president of SNI, told local press in February 2018 that Peru needs to attract further foreign investment to resume economic growth and increase business confidence. The Central Reserve Bank of Peru’s Survey on Macroeconomic Expectations showed a 7.1-percentage-point fall between January and February 2018. According to Von Wedemeyer, out of every 100 investments within the Pacific Alliance, only seven were made into Peru, and of every 1000 worldwide, the figure was four.

Manufacturing

Manufacturing of products of mass consumption rose by 0.2% in 2017. Notable performers included footwear, which expanded in volume by 16.2%, food products (14.7%), and paper and cardboard (12.7%), while toilet and cleaning products (-14.9%) and pharmaceutical products (-8%) performed poorly as a result of lower demand.

Meanwhile, manufactured exports witnessed a reduction of 1.9% due to lower production and in some cases also to logistical problems caused by El Niño Costero. Despite these challenges, the subsector still performed better in 2017 than in 2016 and 2015, when exports contracted by 4.2% and 6.3%, respectively. This can be attributed to the boost of niche markets and the entry of new customers during the last months of 2017. The manufactured goods that observed a poor export performance were canned foods (-2.9%), clothing (-4.3%), and threads and fabrics (-1.6%).

Subsectors related to raw materials decreased in volume by 3.2% because of lower wood production, which contracted by 32%. In addition, lower external demand led to less editing and printing activities, and a reduction in the manufacturing of chemical products. In contrast, the plastics industry registered an increase of 1.3% after two years of decline due to the recovery of domestic demand in construction and sanitation.

Construction-related subsectors, such as the production of electrical machinery, iron and steel, and cement also saw a 0.4% contraction in output, although again, not as pronounced as in 2016 and 2015, when production dropped by 5.1% and 3.6%, respectively. Its performance was impacted by lower demand for metallic products, electrical machinery, construction materials, transport material and industrial services. The best performing subsector was general machinery and equipment, which recorded growth of 22.8%.

The largest investment made in the industrial sector in 2017 came from industrial conglomerate Gloria, worth $101m, most of which went towards its dairy production plant in Huachipa. Backus, a local beer company part of the SABM iller Group, invested $59m to expand the capacity of its breweries, distribution centres, plastic boxes and glass containers, and transport units, while Unión Andina de Cementos invested $39m, mainly in the hydroelectric power station Carpapata III, thermal plant infrastructure, and the Atocongo and Condorcocha power stations. According to the 2016 Peru Top Publications (PTP), PetroPeru, a publicly run oil company, had the highest revenue of state institutions in the country with PEN11.4m ($3.5m). PTP’s top-10 companies also included the La Pampilla oil refinery owned by Spanish energy group Repsol, which recorded revenue of PEN8.6m ($2.6m) to rank fifth.

Government Proposals

In April 2018 Raúl Pé rezReyes was sworn in as the new minister of production after the departure of Daniel Córdova. That month Mara Seminario, general manager of Fundación Romero told local press that the new minister would need to: help companies formalise and set aside bureaucratic procedures, work with the National Superintendency of Tax Administration (Superintendencia Nacional de Aduanas y de Administración Tributaria, SUNAT) to encourage entrepreneurs to pay taxes, promote visibility programmes on entrepreneurship, and promote the link between public and private sectors to encourage innovation among small and medium-sized enterprises (SMEs). The government responded by affirming that they would focus on four pillars for the reactivation of the industry, which are formalisation of the market, strengthening of the labour force, promotion of innovation and technological enhancement, and improvement of the regulatory framework.

To create a more competitive tax regime, in 2017 the government proposed to reduce compliance costs, improve the transparency of the SUNAT and use technology to enhance processes. Also in that year the then-prime minister Fernando Zavala told local press that the Ministry of Production (PRODUCE) had prepared a roadmap to improve industrial parks, airports and ports. The plans are specifically focused on upgrading infrastructure that will facilitate trade and reduce logistics costs.

The creation of industrial parks originated from the need to relocate the local industry and offer spaces designed for industrial use. Many of these projects are located in the districts of Lurín and Chilca, in southern Lima. According to the Colliers International 2017 Industrial Report, the projects in Lima are led by five developers: Centro Industrial La Chutana, Indupark (Chilca), Inversiones Centenario (Lurín), Bryson Hills (Huachipa) and Piura Futura (Piura). “The new parks need to have modern technologies and processes,” Mónica Rivera, sub-general manager of Indupark, told OBG. “Challenges for the development of industrial parks include scarcity of land, high prices and a lack of sanitation knowledge.” Juan Varilias, president of the Association of Exporters, told local press in early 2018 that PRODUCE should be working on the development of two complementary instruments: special economic zones (SEZs) and industrial parks, since they have proven successful in other countries. Lieneke Schol, former minister of production, responded in March 2018 by declaring the relaunch of the SME promotion programme Myperu Purchases, the development of a roadmap for industrial parks within the UN Industrial Development Organisation’s Programme for Country Partnership framework, promotion of the national programme Your Company and the modernisation of supply markets at the national level.

Trade Tax

There is a 25% surcharge on logistics for international trade in Peru. According to Von Wedemeyer in February 2018, a more competitive foreign trade policy requires an effective commercial defence (anti-dumping), technical regulation at an international level and control of undervaluation by using tariff per kilo. Von Wedemeyer argued that policy reforms are essential, as demonstrated by the 700 industrial companies that have already stopped exports, closing operations and migrating to neighbouring countries with better conditions. In response to this, in 2017 a joint collaboration between the Ministry of Foreign Trade and Tourism, Ministry of Economy and Finance (Ministerio de Economía y Finanzas, MEF), Ministry of Transport and Communications, Ministry of Labour and Employment Promotion and SUNAT outlined 13 measures aimed at increasing the competitiveness of international trade and reducing logistics costs. These were classified as measures linked to Customs operations, foreign trade logistics and the improvement of institutional coordination.

In May 2018, under the Supreme Decree No. 091-2018, the MEF hiked the selective consumption tax (SCT) for alcoholic and sugary drinks, as well as cigarettes and gas. Under the new standard, used vehicles have a 40% SCT and beverages with more than six grams of sugar per 100 ml will incur 25% tax.

Employment

Companies closing down might be a factor affecting workforce numbers. According to the INEI 2017 Permanent Employment Survey, Lima’s employed population rate slowed from 1.8% in 2016 to 1.5% the following year. At the productive sectors level, only commerce (5.8%) and services (1.8%) grew. By contrast, employment declined in the construction and manufacturing sectors by 4.3% and 1.4%, respectively. The unemployment rate, meanwhile, increased from 6.7% to 6.9%. According to the SNI, at the end of 2017 there were 2.1m informal workers, with almost 450,000 new informal jobs. Informal labour increased from 72% in 2016 to 73.3% in 2017, marking a record year in terms of informal job creation. As a means to incentivise the formal sector, Supreme Decree No. 004-2018-TR was passed in March 2018, increasing the minimum salary to PEN930 ($286.3) from PEN850 ($261.7).

Opportunity in Reconstruction

As reconstruction of private and public infrastructure progresses, industrial activities linked to construction and other related areas will also be stimulated. Reconstruction efforts are likely to have the biggest impact on ceramics, majolica, cement, bricks, iron, cables, plastic pipes, paints, varnishes, glass, wood, doors, metal windows, lighting, hardware and machinery maintenance. Additionally, the improved environment in various subsectors could attract greater inflows of investment.

Infrastructure reconstruction could also create opportunities for the automotive industry. “Reconstruction of the country after the floods and mudslides that devastated many regions in 2017 will provide numerous opportunities for collaboration between the private and public sectors in 2018,” Toshiro Hayashi, president of Toyota, told OBG. “Light pick-up trucks will be in high demand,” he added.

Plastic products – such as pluvial drainage pipes, made of plastic polymers like PVC and polyethylene – were also considered essential materials to the country’s reconstruction efforts.

New Trends

Worldwide initiatives have been launched to promote environmental care and sustainable development as a basis for long-term economic growth, such as Rio+20, the UN’s 2030 Agenda for Sustainable Development and the Paris Agreement. According to the 2017 National Survey of Companies, Peru’s industrial practices are reflective of an increasingly sustainable sector. For instance, 16.6% of manufacturing companies in Peru reuse production waste. This indicator is associated with the reduction of natural resources extraction, implying advances in the eco-industry. Similarly, 6.2% of industrial companies send their waste to other firms to use, 1.8% treat sewage water and 3.7% utilise environmental management tools. The subsectors that were most aligned with eco-friendly practices in 2016 were chemicals, common metals, and computer and electronic equipment.

The automotive industry is also obliged to meet new eco-friendly requirements. Edwin Derteano, president of the Automotive Association of Peru, told local media in April 2018 that all vehicles entering Peru from that month onwards must use Euro IV fuel, a low-emissions diesel petrol that complies with European emissions control standards. Repsol and PetroPeru have committed to producing the Euro IV fuel, with the first compatible fuel to be available in August 2018 and the second in 2021. Import of vehicles with less-advanced technology will incur a fine of up to PEN1.6m ($492,600). “The change from Euro III to Euro IV will be costly for companies in the sector, which is why it is important that the government tackles informal Euro III-vehicle imports,” Hayashi told OBG.

Technology

The 2017 Manufacturing Vision Study by US firm Zebra Technologies revealed that one of the main trends manufacturing companies worldwide are adapting to Industry 4.0. The report states that around 50% of manufacturers will use wearable technology, automated systems and other emerging technologies by 2022, while 64% of manufacturers expect full data connection between production, supply chains and employees, compared to the 43% in 2017.

Mary Wong, general manager of GS1 Perú, told local press in October 2017 that approximately 1% of the country’s private sector was fully transformed in accordance with Industry 4.0. Large and mid-sized companies are working towards this transformation, but many remain without digital systems. One barrier to obtaining this goal is an unqualified labour force, who lack the necessary digital and management skills. There are concerns that if Peru does not join the rest of the world and adopt this trend, its industries will become less competitive. Therefore, emphasis on developing and strengthening technical school programmes will be vital to addressing these gaps.

Outsourcing

According to Global Research Marketing, 86% companies in Peru outsourced their operations as of October 2017. Recruitment was the most outsourced service, accounting for 33.5% of the total, followed by management of dining areas (29.5%), payroll administration (28.9%), storage management (20.2%) and trademarking services (15%). The greatest demand for outsourcing services comes from mining with 50%, retail with 30%, and about 20% spread among fishery, telecommunications manufacturing, construction and others. Brazil headed outsourcing in the region with 33.5% of market share, followed by Colombia with 30.8%, Argentina with 19% and Peru with 5.1%. Oscar Nuñez Villanueva, president of Overall Business, told local press in October 2017 that “a reactivation of mining and industrial projects is expected over the short term, which will have a positive impact on the growth of outsourcing services”.

Outlook

Despite the uncertainty of proposed policies as a result of the change in administration in March 2018, GDP growth forecasts by BBVA Research in February 2018 for 2018 and 2019 are positive, at 3.5% and 3.8%, respectively. Estimates for the industrial sector were also favourable, with PRODUCE predicting that the sector will expand by 3.7% in 2018, driven by the manufacturing segment. Industrial fishing and primary metals are the principal activities that are expected to promote the growth of primary manufacturing, while in the non-primary subsector the production of consumer goods and intermediate products are forecast to contribute to advancing Peru’s industrial sector.