Country Report Peru at a Glance: 2003-04

Country Report

Peru

Peru at a glance: 2003-04

OVERVIEW The president, Alejandro Toledo, completed two years in office on July 28th with another attempt to relaunch his government. He has a new business- oriented cabinet, headed by a new prime minister, Beatriz Merino, and has admitted to previous mistakes. The new cabinet will not be given a long honeymoon period, but initial public reaction has been cautiously positive. The cabinet is under tight fiscal restraints, and is unlikely to be able to meet the demands that brought people onto the streets in recent months; the Economist Intelligence Unit expects more protests. Opposition parties will take advantage of Mr Toledo’s weakness, but they have little interest in forcing him out of office. The government will continue to press for the extradition of the former president, Alberto Fujimori. It will keep economic policy broadly pro-market and focused on prudent fiscal management, but some policy dilution can be expected. Solid economic growth and continued improvements in the efficiency of the Superintendencia Nacional de Administración Tributaria (Sunat, the tax authority) will help the government to increase revenue collection in 2003-04. Nonetheless, the government will miss its fiscal deficit targets. We remain pessimistic about the prospects for the world economy this year, and cautious looking into 2004. Economic growth will reach 3.8% in 2003 and 2004. Inflation will remain low and the exchange rate stable, and the current-account deficit will stay at around 2% of GDP.

Key changes from last month Political outlook • There are no major changes to our political forecast; the public reaction to the new cabinet has so far been cautiously positive. Economic policy outlook • The prime minister has signalled that the privatisation programme may be relaunched, but only in consultation with regional governments. Economic forecast • There are no changes to our economic forecast.

August 2003

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Outlook for 2003-04

Political outlook

Domestic politics The president, Alejandro Toledo, completed two years in office on July 28th with another attempt to relaunch his government. He has a new business- oriented cabinet, headed by a new prime minister, Beatriz Merino, and has admitted to mistakes in his first two years of government. The new cabinet will not be given a long honeymoon period, but initial public reaction has been cautiously positive. Mr Toledo’s popularity remains low, and protests have continued, although not at the level that led Mr Toledo to declare a month-long state of emergency in May. Ms Merino has a reputation as an honest and efficient administrator with a no-nonsense style, but the hostility of the main opposition party, the Partido Aprista Peruano (Apra), and some legislators within Mr Toledo’s party could be handicaps as she carves out a role for herself in the government. The fiscal position is tight and it is unlikely that the new cabinet is going to be able to meet the many demands that have brought people onto the streets in 2003. Additional targeted protests could emerge in the coming months. Ms Merino will look to position herself clearly at the helm of the day-to-day workings of government. Much will depend on her relationship with the president himself and his willingness to assume a lower profile in some areas of government. Although unpopular tax measures provided an immediate motive for the resignation of the cabinet of the former prime minister, Luis Solari, in June, the crisis that preceded the ministerial changes was caused more by Mr Toledo himself than by his ministers. Having proven himself to be a largely ineffective leader, Mr Toledo will have to rely heavily on, and delegate to, his second-in-command. Mr Toledo’s party, Perú Posible, is in a minority position in Congress and is plagued by infighting. The demands of the so-called hardline of the Perú Posible legislators could slacken to a degree after the failure to secure two key positions: the premiership (for which the party nominated Carlos Ferrero) and the president of Congress, for which David Waisman was the proposed candidate. Perú Posible’s alliance with the Frente Independiente Moralizador (FIM) will also remain tenuous in the coming months. Even with a new prime minister, any legislation sponsored by the executive, such as tax measures, will have a difficult passage through Congress. However, although opposition parties, particularly Apra, will take advantage of Mr Toledo’s weakness, they have little interest in forcing him out of office. The leader of Apra, Alan Garcia, is more concerned with convincing the Peruvian public of his ability to govern at a future date. Fiscal restraints will also make it difficult for Mr Toledo to fulfil another pledge to increase spending in order to combat a recent upsurge of activity by the Sendero Luminoso (Shining Path) guerrilla group. Additional actions by the rebels would shake investor confidence. The kidnapping of 71 gas pipeline workers in June has revealed serious inadequacies in Peru’s intelligence services.

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International relations As Plan Colombia, a US-funded drug-eradication programme, intensifies, efforts by Colombian guerrilla groups and drug mafias to establish safe havens and drug production bases in Peru’s Amazon region will be the only serious threat to stability from neighbouring countries. Peru will reinforce its military presence along the Putumayo River to prevent border incursions, and will keep the Colombian authorities informed of these operations. The government will prioritise a bilateral trade agreement with the US over talks towards an eventual Free-Trade Area of the Americas (FTAA). The Peruvian government continues to seek the extradition of the former president, Alberto Fujimori, who resigned his post while abroad in 2000 and remains in exile in Japan. The Japanese government—on account of Mr Fujimori’s parentage—has granted Mr Fujimori residency in Japan, and has so far refused to hand him over. Peruvian prosecutors have filed a dozen charges against Mr Fujimori with Interpol, ranging from treason, corruption and abandoning office, to murder. Peruvian diplomats have held news conferences to publicise what they see as Japanese intransigence and to gain international support for their request to have Mr Fujimori stand trial.

Economic policy outlook

Policy trends The government will endeavour to keep economic policy broadly pro-market and focused on prudent fiscal management, but some policy dilution can be expected given the government’s weak congressional position and the likeli- hood of further protests. However, there is consensus on many important policy issues, such as the need to increase competitiveness to exploit tariff-free access to the US for a wide variety of exports from Andean countries under the Andean Trade Promotion and Drug Eradication Act (ATPDEA). In his annual address to the nation on July 28th Mr Toledo promised an overhaul of the tax system which would replace the temporary one-point increase in sales and value-added tax (VAT). No further details were made available, but an announcement was promised within 90 days. The appointment of the former mines and energy minister, Jaime Quijandría, as minister of finance, was seen as a positive sign by investors. Ms Merino has announced that the privatisation programme, which has been stalled since mid-2002, might be relaunched, but only in consultation with local governments, to avoid the problems of mid-2002, when the announcement of an electricity privatisation sparked riots. The government will also move forward with the sale of concessions to manage transport infrastructure. A Ports Law has been passed, which will allow the government to sell 30-year concessions to the private sector to manage five regional ports.

Fiscal policy Sustained economic growth and continued improvements in the efficiency of the Superintendencia Nacional de Administración Tributaria (Sunat, the tax authority) are helping the government to increase revenue collection. However, since the budget for 2003 was agreed, the government has committed to a pay settlement for teachers and an increase in security spending, and it now appears unlikely—despite a temporary increase in the sales and VAT rates—that

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the government will reach its target for the non-financial public-sector deficit, of 1.9% of GDP, this year. The Economist Intelligence Unit expects the deficit to narrow to 2.1% of GDP in 2003, and to 1.6% of GDP in 2004, again just outside the target, of 1.4% of GDP. The government is making good progress in increasing the efficiency of revenue collection. In the first six months of the year, tax revenue increased by 12.6% year on year in real terms. Income tax receipts were up by 35.4% year on year in real terms, much of which was owing to a one-off rise in back payments on tax arrears. However, regular income tax (personal and corporate) also increased sharply, by 26.3% year on year in real terms. VAT receipts were also up, by 11.5% year on year in real terms.

Monetary policy Monetary policy will continue to target an inflation rate of 1.5-3.5%. The Banco Central de Reserva del Perú (the Central Bank) has warned that if deflation becomes too much of a risk (prices fell in every month between April and July, leaving annual inflation at 2%), monetary policy would be loosened. There is scope to do this in the second half of 2002 while remaining within the target range. The dollarisation of the economy in the late 1980s, when confidence in the currency was shattered by hyperinflation, is slowly being reversed. Broad money—as defined by M2—in local currency rose by 18% in 2002, and local currency bank credit to the private sector grew by 7.2%, compared with a rise of 2.1% in broad money denominated in US dollars, and a 3.4% contraction in US dollar-denominated credit to the private sector. The Central Bank will work to accelerate de-dollarisation and deepen local credit and capital markets.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2001 2002 2003 2004 Real GDP growth World 2.2 2.9 2.9 3.7 US 0.3 2.4 2.2 3.2 EU 1.5 1.0 0.7 1.8 Exchange rates ¥:US$ 121.5 125.3 117.1 115.5 US$:€ 0.90 0.94 1.12 1.18 SDR:US$ 0.79 0.77 0.72 0.70 Financial indicators US$ 3-month commercial paper rate 3.61 1.70 1.01 1.33 US$ 3-month Libor 3.78 1.80 1.11 1.42 Commodity prices Gold (US$/troy oz) 271.1 310.3 338.8 315.0 Copper (US cents/lb) 71.5 70.4 74.5 83.0 Oil (Brent; US$/b) 24.5 25.0 26.8 18.9 Food, feedstuffs & beverages (% change in US$ terms) -1.9 12.7 2.1 1.8 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. We remain pessimistic about the prospects for the world economy this year and cautious looking into 2004. Global economic performance should improve

slowly in the coming months, primarily owing to stronger consumer demand in the US as income tax cuts feed through. We expect that global GDP growth will be just 2.9% in 2003 at purchasing power parity (PPP) weights (2% at market exchange rates), the same rate as 2002. A return to a more normal rate of growth in most major markets by the second half of 2004 suggests that world GDP growth will average 3.7% in 2004. There are many risks to our global forecast. Three in particular are a cause for concern: the risk of deflation in Germany and, to a lesser extent, in the US; the risk that the US dollar collapses against the euro and possibly against the yen; and the risk that US domestic demand stalls or starts to contract, most probably because the decline in the US dollar triggers a more general decline in US domestic asset prices. A downturn in the US economy would have damaging consequences for investment in the Peruvian economy. Prices for Peru’s main export commodities, gold and copper, will continue to recover in 2003-04, with gold prices staying above recent annual averages and copper prices recovering from late 2003 onwards.

Economic growth GDP growth maintained its dynamism of late 2002 in the first half of 2003, with growth of 4.5% year on year in the first six months of 2003. Growth dipped slightly in April and May, owing in part to a high base of comparison— the recovery started in April 2002—but jumped again in June, to 5.7% year on year. Construction will continue to expand firmly in 2003-04, propelled by a low-cost government housing programme and the development of the giant Camisea natural gas project. As construction is labour-intensive and has a positive impact on the rest of the economy, employment and domestic demand will also benefit. Agriculture and textiles exports will be assisted by the ATPDEA, which came into effect in October 2002, granting tariff preferences to Bolivia, Colombia, Ecuador and Peru for access to the US market for around 6,000 agricultural, cotton and wool exports. We expect the recent dynamism in the mining sector to continue on the back of strong investment, boosted by six- year highs for gold prices. However, growth in Peru’s main exports markets will remain weak in 2003, and domestic public investment will be limited by the need to reduce the fiscal deficit. Given these constraints, economic growth will rely to a large extent on growth in private investment. Continued political uncertainty could constrain this growth. Although we are not assuming that Mr Toledo’s government will fall over the forecast period, it is a risk, and such an eventuality would seriously undermine Peru’s economic recovery. We forecast growth of 3.8% in 2003 and 2004. Loans to complete the Camisea natural gas project have been delayed owing to environmental concerns. The Inter-American Development Bank (IDB) has delayed a US$75m loan to complete an offshore liquefied natural gas export terminal 8km north of a maritime reserve in Paracas, and the US Export-Import Bank (EximBank) and the Corporación Andian de Fomento (CAF, the Andean Development Corporation) are also considering loans totalling US$225m for the project. Construction on the terminal’s onshore plant, 210km south of the capital, Lima, has already begun. Environmentalists are also concerned about

erosion along a stretch of the pipeline through pristine rain forest, as well as its possible detrimental effect on isolated indigenous communities. The environmental groups want the banks to make any loans conditional on improvements to environmental controls. Should the IDB grant its loan, EximBank and the CAF would follow suit. The project is 70% complete, and the Peruvian government remains confident that the project will remain on schedule to start delivering cheaper fuel to Lima by mid-2004. It is due to start exporting gas to the west coast of the US by 2007. Camisea is important to Peru as it will provide a strong boost to economic growth, help to reduce energy costs, and also reverse Peru’s hydrocarbons deficit. Although there is a risk of the loans not being granted, we consider that the project is too important for the government to backtrack on, and that any environmental conditions would be met. This would at worst produce a short delay to the start of operations.

Inflation The Central Bank is targeting a year-end inflation rate of 1.5-3.5%, which is an attainable target. There have been few inflationary pressures so far this year, despite firm domestic demand growth. After four months of slowly falling prices, the main risk at present appears to be that of deflation, and the Central Bank is likely to loosen monetary policy if this trend continues. Inflation reached 2% in the 12 months to July 2003, towards the low end of its target range, and we forecast a year-end rate of 2.1% in 2003, rising to 2.9% by end-2004.

Exchange rates The nominal exchange rate has varied little since 1999, and we forecast continued exchange rate stability in 2003-04, supported by price stability, ample reserves and robust capital inflows. The nuevo sol depreciated by just 0.3% in real terms in 2002, closing the year at Ns3.51:US$1, and has so far appreciated slightly in 2003, reaching Ns3.48:US$1 on August 12th. The Central Bank will maintain a hands-off policy to allow the market to determine the exchange rate, limiting its brief interventions to the provision of liquidity in the event of external or domestic shocks. We forecast that the exchange rate will remain stable in real terms, averaging Ns3.48:US$1 in 2003 and Ns3.43:US$1 in 2004.

External sector In 2002 the trade balance recorded a surplus for the first time since 1990, owing to strong growth in mining exports following the opening in July 2001 of the massive Antamina copper and zinc mine. Export growth will be boosted further in the forecast period by the ATPDEA, output increases in mining (mining projects to a total value of US$8.3bn are scheduled to come into operation in 2003-10) and rising commodity prices. International prices of gold, Peru’s largest single export earner, rose to a six-year high in early 2003. Production volumes of the metal will continue to increase in 2003-04. As a result, we expect Peru to maintain its trade surplus over the forecast period, moderating in 2004 as import demand rises ahead of export earnings. The current-account deficit has narrowed in recent years in the wake of increased export earnings and lower imports, as domestic demand has been depressed. The deficit reached US$1.2bn in 2002 (2.1% of GDP), compared with a peak of US$4.6bn (8.6% of GDP) in 1995. We expect the current-account deficit to narrow further in 2003 before increasing from 2004 onwards, owing to a

slight deterioration in the incomes deficit as corporate profit remittances increase, particularly from mining and telecommunications.

Forecast summary (% unless otherwise indicated) 2001a 2002a 2003b 2004b Real GDP growth 0.6 5.3 3.8 3.8 Industrial production growth -0.8 4.2 5.0 5.2 Gross fixed investment growth -9.2 -0.5 6.9 8.5 Unemployment rate (av) 9.2 8.9 9.2 9.4 Consumer price inflation (av) 2.0 0.2 2.2 2.5 Consumer price inflation (year-end) -0.1 1.5 2.1 2.9 Short-term interbank rate 20.4 14.7 15.4 16.0 NFPS balance (% of GDP)c -2.5 -2.3 -2.1 -1.6 Exports of goods fob (US$ bn) 7.0 7.6 8.6 9.0 Imports of goods fob (US$ bn) 7.3 7.4 8.2 8.6 Current-account balance (US$ bn) -1.2 -1.2 -1.1 -1.3 Current-account balance (% of GDP) -2.2 -2.1 -1.8 -1.9 External debt (year-end; US$ bn) 27.5 27.9d 29.9 29.8 Exchange rate Ns:US$ (av) 3.51 3.52 3.48 3.43 Exchange rate Ns:US$ (year-end) 3.44 3.51 3.45 3.44 Exchange rate Ns:¥100 (av) 2.89 2.81 2.97 2.97 Exchange rate Ns:R (av) 4.46 4.56 4.85 4.90 a Actual. b Economist Intelligence Unit forecasts. c Non-financial public sector, excluding privatisation receipts. d Economist Intelligence Unit estimates.

Editors: Martin Pickering (editor); Charles Seville (consulting editor) Editorial closing date: August 16th 2003 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule