Peru - Economic Briefing December 2008

Economy To Grow At Fastest Pace In The Region

The outlook for next year is deteriorating as the developed world’s recession will erode export growth, a key driver of the current business cycle. Furthermore, some companies have begun to delay mining projects, as falling commodity prices promise diminished returns. That said, the country is likely to maintain its position as the fastest-growing economy in the region. Separately, during the Asia-Pacific Economic Cooperation (APEC) meeting in Lima, Peru and Japan signed an investment protection agreement that could pave the way for free-trade negotiations. In addition, Peru and China successfully concluded talks for a free-trade agreement that could be signed in March 2009.

Economy expands faster than expected

In the third quarter, the economy expanded 9.5% over the same period last year.  The reading was below the 11.0% growth observed in the second quarter (previously reported: +10.9% year-on-year) but exceeded last month’s Consensus Forecast of 8.9%.  The domestic side of the economy continued to be the main growth engine.  Consumption expanded at the same pace observed in the second quarter (+8.6% year-on-year).  Investment decelerated but continued to expand at a staggering speed (Q2: +35.8% yoy; Q3: +31.6% yoy).  Meanwhile, in the external sector, exports of goods and services decelerated markedly (Q2: +11.1% yoy; Q3: +6.8% yoy), whereas imports slowed down only slightly and continued to outpace exports (Q2: +28.4% yoy; Q3: +23.4% yoy).  As a result, the net contribution from the external sector to overall growth diminished from a negative 3.5 percentage points in the second quarter to a negative 4.0 percentage points in the third.  At the sector level, the slowdown over the second quarter was mainly the result of slower growth in mining, manufacturing and construction.

Economic growth begins to moderate

The economy is showing signs of a slowdown in the final quarter of the year.  According to preliminary estimates from the Ministry of Economy, the economy expanded 7.5% annually in October and 7.8% in November, well below the 9.5% growth recorded in the third quarter.  Nevertheless, with less than a month until the end of the year, the recent financial market turbulence is unlikely to dent this year’s growth estimates.  In its October Inflation Report, the Central Bank estimated that the economy would grow 9.3% this year, more than a full percentage point above the 8.0% estimate published in May.  Consensus Forecast participants see full-year growth at 9.0%.  For next year, however, Consensus Forecast participants continue to adjust their projections downward, as the developed world will experience a full-blown recession, thus diminishing external demand for emerging market economies.  Moreover, international commodity prices have already experienced a huge correction in recent months in anticipation of weaker demand.  In addition, Peru will suffer from a slowdown in domestic demand.  Anecdotal evidence suggests that companies are delaying mining projects in the country, which will curb investment growth.  Private consumption, the other engine of growth, is likely to moderate as well in the wake of sluggish consumer confidence.  In recent months, consumer confidence has deteriorated due to the global financial turmoil and increasing inflation, which is eroding consumers’ purchasing power.  According to APOYO Consultoría, the consumer confidence index (INDICCA, Índice de Confianza del Consumidor de APOYO) remained unchanged in November at 41 points.  Hence, consumer confidence remains well below the 50-point threshold that separates optimism from pessimism for the tenth consecutive month.  Against this backdrop, the Central Bank expects the economy to expand 6.5% in 2009.  The Ministry of Economy shares this assessment in the budget for 2009 and Minister Luis Valdivieso has indicated that there will not be cuts in public infrastructure projects despite the lower tax revenues estimated for next year.  Consensus Forecast panellists, however, continue to cut their forecasts and now expect the economy to expand a more moderate 5.5%, which is 0.6 percentage points below last month’s projection.

Inflation at highest rate in more than a decade

In November, consumer prices increased 0.31% over the previous month.  The reading almost halved the 0.61% price rise observed in October and also came in below market expectations of a 0.42% increase.  The November reading, which was largely influenced by higher prices for housing, utilities and household equipment, constituted the smallest monthly increase since April.  Nonetheless, as a result of the November price increase, annual headline inflation rose from 6.5% in October to 6.8%, which is the highest rate observed since August 1998.  At the current level, annual headline inflation more than triples the Central Bank’s 2.0% target for this year, and also exceeds the ±1% tolerance margin around the target rate by a wide margin.  In fact, the Central Bank does not see inflation falling back into the target range until the second half of 2009.  While reaching the target range will take time, additional indicators suggest that inflation will begin to decline.  In November, wholesale price inflation declined for the first time since April 2007, from 10.9% in October to 10.5%.  Simultaneously, money growth, which had been at a twelve-year high during the second quarter, has begun to moderate.  In October, the monetary base increased 36.8% year-on-year after growing at rates above 50% during May and June.  Consensus Forecast panellists see inflation moderating only to 6.3% by the end of this year, which is up 0.2 percentage points from last month’s Consensus.  For next year, panellists expect inflation to moderate to 3.9%, which is 0.1 percentage points above last month’s forecast.

Long-term capital inflows continue to finance current account deficit

In the third quarter, the current account balance incurred a deficit of US$ 1.0 billion.  The figure contrasted the US$ 500 million surplus observed in the third quarter of last year but represented an improvement compared to the US$ 1.6 billion deficit registered in the previous quarter.  The current account deficit was largely financed by important long-term capital inflows (US$ 1.7 billion) that were oriented to fund key investment projects in the private sector.  The improvement in the current account over the second quarter was mainly due to a decline in the investment income deficit (Q2: US$ 2.8 billion deficit; Q3: US$ 2.1 billion).  The trade surplus, in contrast, declined for the fourth consecutive quarter, from US$ 910 million in the second quarter to US$ 821 million in the third.  Exports decelerated notably from 25.5% annual growth in the second quarter to 15.8%.  Simultaneously, imports slowed down from 67.9% to 50.6%.  As a result of the third quarter reading, the moving annual current account deficit doubled from US$ 1.5 billion in the second quarter to US$ 3.0 billion.  Consensus Forecast participants anticipate the current account deficit to reach US$ 3.8 billion by the end of this year.  Next year, the current account deficit will widen to US$ 5.1 billion.