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Global Economic Outlook
Peru: September 2010 Outlook Update
By Bertrand Delgado and Juan Lorenzo Maldonado
- Strong domestic demand led to the closing of the output gap in H1 2010, while inflation expectations are getting closer to the upper bound of the target range.
- This demand and inflation expectations are pushing the central bank to continue removing excessive monetary stimulus.
- The main risk to our outlook is an outright recession in the U.S. and negative surprises in the polls ahead at the presidential elections in April 2011.
Outlook Update: Economy Booms While Political Chatter Begins
Peru registered a robust and better-than-expected economic performance in H1 2010 (8.2% y/y) benefiting from solid growth in domestic demand (11% y/y), especially investment (20% y/y). However, a low base and higher commodity prices also helped. Not only private (24.6% y/y) but also government investment (33% y/y) increased, while household spending grew 5.6% y/y and public consumption stayed elevated at 13.2% y/y. Net exports continued to be a drag on growth, as imports (16.6% y/y) outpaced exports (0.7% y/y), and the sharp fall in inventories since Q3 2008 reversed in Q2 2010. In seasonally adjusted terms, Peru’s GDP growth reached 3.1% q/q or 12.9% SAAR in Q2 2010, contributing to the closure of the output gap. Based on this solid performance, we revised up our 2010 GDP growth to 7.8% from 6.8% at the beginning of August; however, our core view remains the same: GDP will likely slow down to 7.4% y/y in H2 2010, consistent with less accommodating macroeconomic conditions and slower global growth, and beneficial base effects should subside. Global conditions permitting, these conditions should also push Peru’s GDP to a 6.3% y/y expansion in 2011.
Figure 1: Actual GDP vs. Trend (SA, HP Filter), Forecast in Box
Source: Central Bank and RGE
Our projected economic expansion implies that Peru will grow well above potential (6.5- 7%) in 2010 but stabilize in 2011. Consequently, inflation pressures have increased in Q3 2010, as we expected. Peru’s annual inflation reached 2.31% y/y in August (1.82% y/y in July), and we see it moving closer to the upper bound of the target range (1- 3%) at 2.9% by the end of 2010, with the risk to the upside. Looking forward, 2011 inflation dynamics will be determined by slower growth and less accommodating fiscal and monetary conditions, thus remaining contained at around 2.6% y/y.
Figure 2: Reference Rate and Inflation, Forecast in Box
Source: BCRP and RGE
Interesting dynamics are evolving ahead of the April 2011 presidential elections. According to a poll released by IMA at the end of August, Keiko Fujimori (Fuerza 11), the daughter of former President Alberto Fujimori, was in first place in opinion polls as of August 2. However, her numbers are being negatively affected by perceptions of corruption and illegal activity related to her father’s administration. IMA’s polls now place her in second place at 18.3% and only two points above former President Alejandro Toledo. Meanwhile, Lima’s Mayor Luis Castañeda (National Solidarity Party) is leading in polls with 21.2%. Toledo, of the Peru Posible party, who has not yet declared his candidacy, is enjoying a remarkable rise in support, registering 16.8% in polls. IMA’s poll showed Ollanta Humala (Nationalist Party) in the fourth place with 7.6%.
Although it is still too early to make any meaningful analysis, as political dynamics tend to be very volatile in Peru, we point out that if Toledo—who is in large part responsible of Peru’s economic success—participates in the presidential election, it would be a very welcome event for investors. This is not only because he is a well known figure internationally and committed to market friendly policies, but also because he would be able to reduce Humala’s chances. Needless to say, Humala has been moving toward a more conciliatory and moderate stance and appears to be less radical than in the last presidential elections—an overall positive for political dynamics for Peru. Meanwhile, October elections for mayors and regional governors may shed some light on people’s perception of parties, which might play an important role in the presidential dynamics.
How We Differ From Consensus: Bullish Thanks to Domestic Demand
According to the August Consensus Economics survey, analysts expect Peru’s GDP to expand an average of 6.7% y/y in 2010—ranging from 4.8-7.5%, and 5.2% y/y in 2011—ranging from 3-6.1% y/y. Our 7.8% y/y and 6.3% y/y are above consensus. However, we think consensus will move higher as the survey was taken before stronger-than-expected economic activity numbers were released. Overall, it appears that the consensus and RGE agree on a strong domestic demand-driven growth.
Risks: Foreign Demand
A possible slump in global economic activity continues to be the main threat to our forecast. This time, the increasing risk of a double dip driven by an outright recession in the U.S. (not our base-case scenario) would undermine Peru’s growth prospects, export revenues and capital flows. Moreover, looking at 2011, concerns over Greece’s solvency and Europe’s uncertain growth path will resurge and pose risks to global dynamics once again.
Policy Implications: Strong Tightening Schedule to Balance Stronger Growth
The BCRP continued to remove monetary stimulus in Q3 2010, strengthening the pace of tightening in August with a 50-bp hike and continuing in September with another 50-bp hike to 3%. Since the beginning of the tightening cycle in May 2010, the central bank has raised the reference rate by 175 bps. The stronger hiking schedule is consistent with the continuing revision of reserve requirements, which in late August were increased to 120% for incoming funds deposited in local currency. However, the BCRP seems to have turned toward a more dovish stance as hinted by the September meeting’s press release, as an uncertain global scenario poses risks to the domestic recovery. At this juncture, we expect the central bank to hike the reference rate to 3.5-4% in 2010 and to 4.5- 5% in 2011.
On FX policy we anticipate the central bank to continue intervening in the market in order to contain excessive volatility on the local currency and increase international reserves so as to buffer against external shocks.