Peru's economy has shrunk but it should escape recession – The Economist

The Economist, Sep 2nd 2009 From the Economist Intelligence Unit

Peru’s economy has been one of the most resilient in Latin America since the global recession began, but it has not avoided a dramatic slowdown in growth. Indeed, economic activity contracted in the second quarter of 2009 by 1.1% year on year, the first quarterly GDP contraction since 2001. The shrinkage is mainly the result of a decline in foreign demand, particularly for Peru’s key mineral exports, as well as a strong drop in domestic investment. However, the economy is not expected to fall into recession this year, as growth will rebound in the second half.

While second-quarter GDP contracted, growth in the first half of 2009 was still positive, although barely, at 0.3%, year on year. This is a massive deceleration from the 9.8% rate of growth posted in 2008 and 8.9% in 2007. Peru has experienced among the highest growth rates in Latin America since 2002.

Yet Peru will be able to escape recession thanks to countercyclical measures and ongoing commodity demand from Asia. We expect GDP growth to reach 1.3% for full-year 2009, and to rise to 2.7% in 2010 as strengthening external demand boosts exports and investment.

Stimulating policies

Peru has been in a strong position to run a countercyclical policy to shore up the economy during the global recession, owing to sound public finances (Peru is a net public creditor) and the comfortable cushion provided by international reserves held by the Banco Central de Reserva del Perú (BCRP, the Central Bank). This has allowed officials to implement robust monetary and fiscal measures to stimulate growth so far, and they are prepared to act further.

The Central Bank has implemented an aggressive monetary-easing policy, which is now nearing an end, and in late 2008 the government announced a US$3.2bn (2.7% of GDP) stimulus package, partly drawing on a US$3.3bn fiscal stabilisation fund. The boost to credit from lower interest rates is likely to be partly offset by both conservative lending practices by the banks and caution from household and business borrowers owing to a weaker economic outlook, but credit should pick up again later in 2009 as confidence recovers. Further, the government will seek to bolster private investment via infrastructure concessions and a more attractive operating environment, although the global recession, credit rationing and risk aversion will dampen interest.

Speedier implementation of the fiscal stimulus package along with the positive effects of the interest-rate cuts will be felt in the second half of 2009. To further support growth, the government plans to increase spending in 2010 by 13.1%, according to a budget bill sent to Congress on August 28th. This will raise spending to Ns81.86bn (US$27.89bn) from this year's Ns72.36bn. Congress must pass the 2010 budget by late October.

Still a star performer

Thanks to these measures and Peru’s overall macroeconomic strength—and despite the slowdown from its previous high rates of growth—it will again outperform most other countries in the region in the next two years.

Government consumption and investment growth, which will rise sharply in 2009 as the government attempts to stimulate the economy through new spending on public works and social programmes, will remain high in 2010 ahead of the 2011 presidential election. GDP growth will be positive though still weak, at just 1.3% this year. In 2010 household demand will recover gradually, in line with lower borrowing costs and some recovery of investment activity, boosting growth moderately to 2.7%.

Although export volumes fell by 3% in the first quarter of 2009 (following real export growth of 8.2% in 2008), we expect less dramatic contractions in the remainder of the year and forecast a full-year 2009 contraction in real exports of 1.5%. In 2010 export growth will remain weak as global demand proves slow to recover, but will be supported by a free-trade agreement with China, which is due to come into operation next year. Real imports, which surged by 20% in 2008, also contracted in the first quarter of 2009—by a higher-than-expected 13.7%—as demand for all categories of imports eased. With domestic demand set to contract in the remainder of 2009, import growth will continue to fall sharply from a high base of comparison.

On the supply side, industrial activity will be held back by low domestic and global demand. Mining output will remain a key—although weaker—driver of growth in the outlook period. Parts of the agricultural and food-processing sectors will take advantage of the free-trade agreement with the US to boost production in 2009-10. Public-sector infrastructure projects will provide some respite for the construction sector, although growth will slow markedly on a year-over-year basis. In January-April construction sector activity expanded by only 3.4%, down from growth of 16.5% in full-year 2008.