PERU

The country’s flexible exchange rate, inflation-targeting system and rules-based fiscal policy have maintained macroeconomic stability. However, the far-left candidate Pedro Castillo, elected in July 2021, is likely to alter the direction of public policy towards increasing social and health spending, renegotiating existing free-trade agreements (FTAs) and increasing the state’s presence in pensions and state-owned enterprises.

We expect a strong rebound of real GDP growth to +7.0% in 2021 from a steep contraction in 2020 (-11.1%) and then a gradual return to pre-pandemic growth levels at +3.5% in 2022 and 2023. The robust recovery is due to base effects; a boost to Peru’s main exports (copper, gold, silver, zinc), given higher commodity prices and rising demand from China and the US, as well as continued government support to households and businesses. Our forecast assumes a gradual re-opening of the economy, a lower impact of new Covid-19 waves as economic actors adapt and an acceleration of the vaccination program as the government has ordered enough vaccines to cover most of Peru's population. Risks are tilted to the downside as new variants such as Delta could generate new waves of infections and lead to tighter mobility restrictions.

Inflation is expected to remain within the central bank’s target of +2% / -+1% in 2021 (+2.8%) and 2022 (+2.5%). Consumer prices have increased slightly above the target since June 2021 but we expect the Banco Central de Reserva del Peru (BCRP) to tighten monetary policy with at least one hike before the end of the year to keep inflation below target.  In 2020, the BCRP reduced the rate by 200bps to 0.25%, a historically low level. In addition, an interest rate hike could assuage pressures on the Peruvian sol (PEN), which has depreciated substantially in a context of high political uncertainty since the presidential elections in July 2021, which led to significant capital flight.

Peru’s business environment risk is good overall as it ranked 76th out of 190 countries in the 2020 World Bank Doing Business Survey. Yet, Peru has lost 20 ranks since 2017 and lost three ranks in the Latin American region (it now ranks 6th). While registering property (55th), dealing with construction permits (65th), getting credit (37th) and protecting investors (45th) are particularly positive, important shortcomings remain regarding the ease of starting a business, paying taxes and trading across borders. Rule of law and control of corruption are also important areas of concern. In addition, the new administration is likely to promote further state intervention in the economy, which could dent the business environment.

Political risks are also on the rise. Political turmoil followed the presidential election as Castillo’s right-wing opponent, Keiko Fujimori, contested the election on the grounds that it was fraudulent. She conceded his victory after a month, but risks to political stability remain as Castillo’s policies may trigger social unrest. Castillo may struggle to implement reforms given his weak mandate as results were very close and given the fragmented nature of Congress.  However, the president’s re-appointment of the central bank governor, Julio Verlarde, known for his steady monetary stance, and the choice of a moderate economy minister signal that the government may opt for a more centrist approach and ensure some degree of policy continuity.