Recession proof

From the Economist Intelligence Unit ViewsWire

Despite a global bust and slowing domestic growth, Peru's economy remains in good shape

Peru had one of the best-performing economies in Latin America last year, with GDPgrowth of 9.8%—higher even than that of China (9%). Despite a severe global economic bust and sharply decelerating domestic growth, the Andean country is likely to remain, relatively speaking, a star performer in 2009.

Peru’s growth has exceeded that of most other countries in the region during the last seven years, driven by high global minerals prices and expanding output from the natural-resources sector, including from the huge Camisea natural-gas field. In 2008 only Uruguay’s spectacular rate of growth of 11% eclipsed that of Peru. Yet all economies have been slowing since the latter months of last year in response to deteriorating external conditions, a tightening of credit, and more cautious consumers and investors. Many will slip into recession this year. Peru will not be one of them.

The country’s GDP growth rate did decline in the fourth quarter of 2008, to a three-year low of 6.7% year on year, from 10.7% in the third. Real export growth slumped to 2.1% year on year from 6.5% in the third quarter. Domestic demand growth remained relatively strong, however, despite easing to 9.3% after nine consecutive quarters of double-digit gain. Private consumption rose by 8%, after hitting a 13-year high of 9.5% in the third quarter, while gross fixed capital investment expanded by 22.3%. By contrast, government consumption fell by 0.4%, the first decline in six years, although this was mainly due to a high base of comparison.

Back to the past

For Peruvians used to dynamic growth in recent years, this deceleration may feel like the end to the boom times. This year the trends will accelerate: sharply lower prices for commodities (80% of Peru’s exports) and lower capital inflows will affect the external accounts and further erode consumer and business confidence.

The impact of a surge in inflation in 2008—the highest in a decade—combined with rising unemployment will curb real household incomes this year, while slower credit growth will further hinder private consumption. Demand for Peru's exports will also diminish in the context of recession in the US and Europe and markedly lower growth in Asia. Global demand for Peru's mineral exports, in particular, will fall in 2009 and remain weak in 2010.

Nonetheless, with sound public finances and a still-substantial cushion of international reserves, the Peruvian authorities are in a strong position to provide a significant counter-cyclical boost to the sharply decelerating economy. An aggressive fiscal stimulus plan will cushion the blow of an expected contraction of private investment and slowing private demand growth. Most of the government spending will go to infrastructure projects, the building of low-cost housing and other social programmes. Also, the central bank has been easing monetary policy, and began a cycle of interest-rate cuts in February. However, aggressive cuts in the policy rate are not anticipated.

These measures should allow the economy to keep growing at a moderate pace of 3.1% (versus a government target of 5%), with an uptick to 4.1% in 2010, according to the latest Economist Intelligence Unit forecasts. While well below the growth trend of recent years, this will place Peru, again, among the fastest-growing countries in the region.

Political knock-on effects

The problem for the government of President Alan García, which is increasingly unpopular, is that social unrest could increase as the economy slows. Administrative inefficiencies, along with political fragmentation, will impair the effectiveness of policies aimed at mitigating the impact of the global economic downturn on lower-income Peruvians. Even before the latest downturn, living standards were falling over the past year as a result of high inflation.

Electoral factors will increasingly factor into the equation ahead of the 2011 presidential contest. If the government is unable to deliver on pledges of improved social conditions in the midst of the economic downturn, the appeal of the political opposition will be boosted.