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Economic Environment

Economic Growth
Using monthly GDP estimates, year-on-year growth for the first four months of the year was 2%,
and the EIU expects growth to remain lackluster in 2017. Although the unimpressive results are in
part due to the negative effect of flooding brought on by the El Niño weather phenomenon, poor
public investment and private demand have also weighed on economic growth. Under the EIU’s
baseline scenario, GDP growth will be 2.4% in 2017, bolstered by export growth. Hopes for an
increase in private and government demand towards the end of the year have diminished, and the
EIU now expects recovery to happen during 2018. However, investment growth in 2017-2018 will
remain modest, owing to transparency issues, congressional opposition, and ineffective and
cumbersome regulatory procedures that hinder public expenditure and project implementation.
These problems have recently been exemplified by two projects: the Gasoducto del Sur, a gas
pipeline scheme that reverted to the state after financing fell through owing to corruption
investigations, and the Chinchero airport, the controversy over which led to the ousting of two
ministers and the scrapping of the entire project.
The EIU expects the reforms needed to facilitate investment to be completed by 2018, but by 2019
the economy will have lost momentum and investment will be sluggish, owing to a slowdown in
China in 2018 and a mild recession in the US in 2019. The EIU expects GDP growth to average
2.9% in 2018-2019, before picking up to an average of 3.9% in 2020-2021, with private domestic
demand— and imports—speeding up as conditions improve.
Despite increased access to credit, a rise in government conditional cash transfers and falling poverty, private
consumption growth will suffer from lower consumer confidence in 2017-2019, driven by uncertainty,
unimpressive economic growth and a transitory increase in the unemployment rate. Conditions will improve
in 2020-2021, and consumption growth will average 3.9%. It is unlikely that consumption will return to the
growth rates seen in the past decade, given limited progress in addressing levels of labor informality that are
among the highest regionally. Peru’s economy will remain dominated by the mining sector, but the main
productivity gains will come from the agro industrial sector, which has grown quickly in recent years.
Manufacturing will continue to face constraints related to external competition, fluctuations in global
demand competition and a lack of skilled labor. All of this will discourage investment in the sector, leaving
foreign investment mainly focused on the mining sector.

Inflation
Despite a pick-up owing to supply shortages brought on by extreme weather, the EIU expects
annual inflation to return to a downward trajectory in the coming months, ending 2017 at 2.6% and
remaining inside the BCRP's 1-3% target band in 2018-2021.Lower demand pressures will help the
BCRP to bring inflation into the target band, although higher international energy costs and
moderate currency weakening will counter this to some extent. There are several risks to this
forecast, including adverse weather, which could drive up food prices, as well as pronounced
currency depreciation, which would lead to higher import costs.
Population and Employment
Peru's population will increase at an average rate of 1.0% over the forecast period, equivalent to an
additional 1.2 million people and reaching 32.70 million by 2020. Although the 0-14 years age group
will lose about 113,000 people in 2016-2020, those aged 15-64 will increase by 1.0 million and
account for 66.1% of the total population. The 65+ year’s segment will grow at an average rate of
3.6 % per year to form a modest 7.6% of the population by 2020 when the age dependency ratio
will be 11.5% - a rise of 10.5% in 2015. Unemployment stood at 5.2% in 2015 and it is expected to
average 5.5% over the forecast period.
Fiscal Policy
The non-financial public-sector (NFPS) deficit is forecast to widen from 2.6% of GDP in 2016 to
3.1% in 2018, before restrained expenditure and good tax collection allow it to gradually narrow to
1.3% in 2021. In terms of outlays, capital expenses will be the government's primary focus. In early
May the government presented Congress with a US$6.4bn (3.2% of 2016 GDP) public investment
package over 2017-2020 to both boost economic growth and address infrastructure shortcomings
that were made evident during floods in February March this year. Funding has still not been
approved, but the government has also not presented the details of the plan (it plans on doing so in
late August). Despite the expected negotiations in Congress, the plan will be approved. Regardless,
the government's capacity to implement all the measures is in doubt, given its past performance;
hence, our forecast does not foresee complete compliance. Furthermore, the infrastructure plan will
raise outlays, and push capital and overall expenditure respectively to highs of 8.5% of GDP and
31.2% of GDP in 2018. As for revenue, the EIU expect improved tax collection in 2017-2021. This is
due in part to reforms at the tax authority and changes to tax legislation introduced in January 2017,
which included an increase in corporate income tax to 29% and attempts to broaden the tax base.
These changes will result in higher receipts in GDP terms over the forecast period. In 2017-18
these will only partly offset the rise in spending, but will result in deficit reductions in 2019-2021,
when the EIU expects public expenditure to be reined in.
The EIU forecasts that the public debt/GDP ratio will rise from 23.8% of GDP in 2016 to average 29% of GDP
in 2020-2021. Nonetheless, this level will be low by regional and global standards. Peru will retain good
access to voluntary financing from domestic and international markets and, in the event that external
conditions deteriorate sharply (not our baseline scenario), the country would be able to access multilateral
funding with relative ease.

Monetary Policy
Given sluggish economic activity and ebbing inflation pressures, the Banco Central de Reserva del
Perú (BCRP, the central bank) has both the opportunity and cause for monetary easing. On July
13th the BCRP cut its rate policy rate for the second time this year, bringing it to 3.75%. In line with
our baseline expectation of continued low growth and easing inflation, the EIU expects a further cut
in 2017, to 3.5%.
In 2018 the bank will be wary of pursuing overly expansionary policy in the context of rising interest
rates in the US. A loosening of monetary policy in the US in 2019- 20 will provide breathing space
for the BCRP to allow for more expansionary policy to support economic growth. By 2021 the
Peruvian economy will be on an upswing, allowing the central bank to start a tightening cycle.
Foreign Trade and Current Account
The trade surplus will remain above US$4bn during the 2017-2021 forecast period, as exports will
be supported by a partial recovery in the prices of Peru’s key commodities exports, as well as
sluggish import growth due to low demand growth in 2017-2019. As percentage of GDP, the trade
surplus will remain mostly stable in 2017-2019, averaging 1.9% of GDP. The EIU expects the
primary income deficit to remain below the level seen in previous years, at an average of 4.4% of
GDP in 2017-2021.
The secondary income (transfers) surplus will average 1.8% of GDP in 2017-21, owing to high
levels of remittances. As a result, the current-account deficit will remain mostly stable, averaging
1.7% of GDP in 2017 21. Peru’s current account deficit will be financed by inward foreign direct
investment (FDI) flows, which are expected to reach US$5.7bn (2.7% of GDP) in full-year 2017. The
EIU expects inflows to average 2.4% of GDP in a more challenging international environment in
2018-19, before recovering slightly, to 2.8% of GDP in 2021. FDI will not reach the levels seen in
2010 12, when inflows averaged 5.5% of GDP.
Foreign reserves stood at US$62.4bn in July 18th, equivalent to 16.2 months of import cover,
according to our import forecasts for 2017. The EIU expects reserves to grow slightly in nominal
terms in 2017-2021 (especially in 2017-18), as the BCRP will prefer to accumulate reserves in the
context of a surplus in the balance of payments. Although import cover will ease to 14.5 months by
2021, this will offer ample protection against external shocks.
Exchange Rate
After appreciating during the first four months of 2017, the sol has since hovered at around S3.25:1US$1. In
the coming months, the EIU expects the sol to gradually depreciate, ending the year at S3.3: US$1. On an
annual average basis, however, the EIU expects the exchange rate to strengthen in full-year 2017 before
depreciating by an average of 1.3% per year in 2018-2021. Debt and investment inflows will provide support
for the sol. The EIU expects the BCRP to continue to intervene in currency markets to smooth volatility while
accumulating reserves. The BCRP will continue to support the ongoing process of de-dollarization and
protection of the financial sector, which is moderately exposed to currency risk. The balance of risks is tilted
towards greater sol

Kind Regards,

Jackeline Oshiro
Business Intelligence & SFE Head Andean Region
Biopharma | Global Operations