Latin America: Peru prospers by playing the long game
Peru’s strong fundamentals protected the country from the harsh economic conditions in the region. But as solid commodity-led growth returns, will the chance to diversify into a broader economic model be lost?
Peru’s finance minister Alonso Segura says the current government has made
Alonso Segura became Peru’s finance minister as the deteriorating global economic environment bit Latin America hardest in September 2014: growth registered 1.1% quarter-on-quarter in Q4 2014, the lowest level since the financial crisis in 2008. It was still positive, but for an economy that had enjoyed average per capita GDP growth rates of 2.9% since 2000 and had been around 6% for the previous couple of years, it was a slump.
Falling demand for commodities hit export revenues, while currency depreciation, in an economy with high levels of dollarization, played havoc with internal demand and debt dynamics. Global liquidity was drying up, removing the cheap financing options of the last decade. There were fears that Peru’s growth rate was returning to the inertia of the period between 1961 and 1990, when annual growth barely nudged positive in a region that averaged 2%.
Segura, though, was confident of the country’s ability to respond. First, he was fully aware of the situation, having been an adviser to his predecessor, Luis Miguel Castilla. Second, as part of Castilla’s team, he had already begun to apply fiscal countercyclical stimuli. Third and most important, he was inheriting a country that over the last 15 years had wisely used the benefits of the commodity cycle, building reserves during the boom years that remained strong even after the 2009 financial crisis.
'Counter external shock'
In 2014 gross public debt as a proportion of GDP was 20.1%, the second best in the region after Chile (15.1%) and far better than its commodity-exporting peers (Colombia at 44.3% in 2014 and Brazil 65.2%). Peru’s fiscal balance was -0.3% in 2014 versus an average of -2% for all countries rated A3 by Moody's and better than Chile’s -1.5% (Brazil’s was -6.2%). Total investment as a percentage of GDP was at 26.2% – up from 13.9% in 1990. The country’s average inflation between 2005 and 2014 was the lowest in the region, at just 2.9%. Peru was also the second highest-rated Latin American economy.
“We began implementing countercyclical fiscal policies in the formation of the 2014 budget,” says Segura. “After I was sworn in in September, I launched other measures to boost the size of the fiscal impulse to try to counter the external shock. But the key point is that we had reacted before that, and I think we have had better results than most countries in the region – at least the countries that depend on commodities like Peru.
"The economy has been accelerating quarter on quarter. The economy grew by almost one percentage point more in 2015 than in 2014 and, at 3.3%, grew the most in the Pacific Alliance. This year, it is looking even better. Our medium-term framework, which has just been released, says there is a target of 3.8%, but goes up to 4%. I think we are going to be in the upper end of that range for 2016.”
Peru’s strong fiscal position and strong reserves (at over 30% of GDP it has the highest proportion in the region) give the country the space to respond to the crisis without materially damaging its position. This comes from a mix of natural wealth in commodities and a sound policy framework.
A 1999 fiscal law laid the foundations for fiscal discipline and the low-debt economy. The independent bank built up reserves and kept inflation low. An investor-friendly law gives international capital equal status with local investors and there are no restrictions on profit remittances and dividends, which has meant strong investment inflows.
As Peru goes to the polls to elect a new president on June 5, the market seems unconcerned about the outcome. The strength of the country’s framework has been accepted. No one expects current discipline to give way, especially now Segura has steered growth rates back towards a 4% target.
“Of course there is no elected government yet,” says Segura in response to his views on what comes next. “[The next president] will be inheriting a very stable economy with a better perspective than most in the region, but it is still a very complex scenario for Latin America in general. The capacity to grow is less and so you have to steer and continue reforming. I’m optimistic that the next government will do so. I can’t tell you if it will, I can just tell you that I hope so for the good of my country.”
Peru’s resurgent growth looks set to give the next president a positive inheritance. Investments in new copper mines will come on stream in the next couple of years. Projects, such as increases to existing mines Toromocho and Constancia and new production from Cerro Verde and Las Bamabas, should expand Peru’s total copper production by 76% by 2018 over 2014’s output.
And despite today’s low historical cost of copper, Peru has several in-built advantages that make these initiatives profitable: the cash cost of production is 19% below world average; the industry’s labour costs are 58% lower than the global average; and electricity costs are also 33% below the global average. In short, Peru is never going to be a marginal producer of copper.
Segura also points to the infrastructure projects that are starting construction as another source of growth for the next government. In 2014 and 2015 the government awarded a total of 20 public-private partnership projects, taking the current administration’s total of PPPs to 29, worth a combined total of more than $20 billion.
Segura says that the government’s reforms to the PPP and infrastructure regulatory framework were essential to encourage private-sector participation. These projects include many of the largest in Peru: the Southern Gas Pipeline ($5.8 billion), Line 2 of the Lima Metro ($6.8 billion), Chinchero International Airport at Cusco ($775 million) and the Moyobamba-Iquitos transmission line ($589 million).
The third engine of continued growth is the expansion of domestic demand as the economic profile of the country changes. Since 2004 the expansion of wealth has been impressive In 2004 the country had 1.22 million households in socio-economic classes A to C. In 2014 this had more than doubled to 2.76 million; by 2021 the number of prosperous households is expected to reach 4.24 million. That should bring huge consumption-led growth.
Moreover, data provided by the finance ministry show the low comparative consumption of average Peruvians across a range of retail indicators. For example, in Chile there are five shopping centres per million inhabitants; in Peru there are two. In Chile in 2015 there were 23 vehicle sales per 1,000 inhabitants, 17 in Brazil, while in Peru there were six. And the banks have lots of space to drive the coming boom in consumption: Chile’s banking system has credit worth 79% of GDP, Brazil has 50% and Peru 32%.
Segura has been chief economist and head of strategy at Banco de Crédito del Peru (Peru’s largest bank), chief economist of Scotiabank Peru and at the IMF was executive director for the Southern Cone and economist at the financial affairs department. He has good understanding of the country’s banking system and its importance in driving economic growth.
“Relative to other countries our financial system still has space to grow,” says Segura. "Our solvency ratios are very high – they are way above Basel III, so the banking system is very solid. The issue is how we can grow it faster."
A key part of accelerating that growth will come from bringing in the large informal sector. Segura points to the high levels of informal labour and tax evasion in the Peruvian economy as a restriction on both private- and public-sector expansion. To that end the government recently introduced mobile banking services to boost financial inclusion.
“It’s a very important initiative that we introduced a few months ago,” says Segura. “The Peruvian model is different to that seen in Africa. Ours is not based on one brand or company. We have launched an open platform where all financial institutions participate. That’s unique and it leads to bank transactions as individuals and micro-enterprises move through the use of mobiles and into the banking system.”
However, if Peru is to fulfil its aspiration to avoid the middle-income trap, it still faces big challenges. The question is whether or not the next government will have the same long-term perspective to continue the often difficult reforms.
The depreciation of the sol since 2014 (by 26% to February this year, though it has since strengthened by 8%) has boosted the government’s attempts to diversify its economy. In July 2014 the government introduced a National Productive Diversification Plan to boost non-commodity businesses and exports. It combines with the current administration’s efforts to boost productivity through reform of the civil service and the cutting of bureaucracy.
Much of this reform agenda targets industries that have been constrained by regulatory burden. Segura uses the example of forestry to demonstrate the growth that relatively simple reforms can unleash.
“Peru has tremendous potential for forestry, but the legal framework wasn’t in tune,” he says. “If you had space for a plantation, then you couldn’t really plant trees because it was against the law to cut down trees. So you couldn’t practically plant trees – so you had to go with crops such as sugar cane.
"We have been adjusting the legislation to enable dynamic forestry, and that has already attracted commitments of more than $1 billion in forestry funds coming into the sector right now. That’s just one example, we are looking at other sustainable ways to diversify the economy.”
While Segura says the current government has made strides towards the goal of administrative simplification, there is more to be done: “We have created task forces, but I think it has to be scaled up.”
“I truly hope that whoever wins will continue the medium-term reforms that we have left them and the fiscal responsibility has to continue and they will have to abide by that,” says Segura. “I hope they will respect that and continue that, and then there are some other reforms that they should undertake – some of them we tried but we didn’t have the opposition backing that we needed.”
What reforms were abandoned?
“Those linked to labour costs and the labour market,” says Segura. “We need, as a country, to take a fresh look at the labour market. We proposed two laws regarding labour issues [but were unable to get them through Congress].
"Also, Latin America is facing a new environment and we need to take a fresh look at the fiscal expenditures to seek better efficiencies through all levels of government. We started looking at this in the second half of the administration – around 2014 – but at that stage [of the political cycle] it is very hard to get political consensus on an issue like that. The next government should look at these things fresh out of the gate.”
Segura says the recent appreciation of the sol should not prevent the diversification effort as long as it remains linked to the fundamentals. He argues that the ability of the Peruvian economy to continue to diversify and to compete in modern industries and use innovative technologies is linked more to the government’s attempts to improve the country’s human capital. That has also been the driver of the government’s focus on education, an area where Peru lags not only the OECD average to which it aspires, but also its regional peer group.
The government has increased spending on education, from 2.9% of GDP in 2014 to 4.1% in 2016. It is still a relatively modest total given the country’s needs, but it is a dramatic increase. How confident is Segura that the government is investing efficiently in education, something notoriously difficult to manage and measure?
“We are starting from a very low base, so improving results shouldn’t be difficult,” he says. “For example, in terms of the level of reading comprehension of 15 year olds, we are below all comparator countries.”
Peru’s biggest education reforms cover teachers, teaching standards and evaluation – as well as recruiting 250,000 new teachers. “We are improving compensation but based on results,” he says. “The second element is longer school hours. Before, we couldn’t teach a full day because we didn’t have enough resources, so we are developing a parallel infrastructure plan for the education.”
The curriculum is being changed, too. English is being introduced as a second language, along with a new, large scholarship programme.
“It’s a different approach – we are spending the money wisely,” says Segura. “For the first time we have an economist as the minister of education and we are planning in a very technical way.”
Segura points to the interconnected nature of the government’s attempts to boost innovation and competitiveness. The infrastructure plan to put Peru online with national broadband will be launched in 189 provinces by the end of June. “These types of efforts should pay off in terms of productivity, and in the next 10 years you will see the fruits of these efforts filtering into higher potential. Education reforms will lead to a dramatic increase in education results – you will start to see the impact.”
As the deadline approaches for the new presidential elections Segura says the whole administration is running to get as much completed before the handover deadline. “We hope to get three or four more projects announced – we have such a strong pipeline,” he says.
That pipeline and the results of all the recent reforms will soon pass to the next administration. For now at least, Segura has done all he can. What comes next? “We will be in government until July 28 and we are all trying to get as much done as we can. So I suppose I will think about what comes next on July 29.”
The interview ends, before he adds contemplatively: “Actually, I will take a long holiday. These have been stressful times for ministers of finance in the region – I talk to my colleagues all the time and it has been tough for all of us. So first I will take a long holiday. And then I will see.”