Peru: Best in the Class

The heady consumerism in Lima is a sharp contrast from the gloom that is spreading across the planet. The streets of Miraflores are chocked with brand new imported cars. World class restaurants are booked to capacity, and tony shops populate the upscale neighborhood of San Isidro. Peru was one of the main beneficiaries of the commodity boom. The country was transformed from a backwater of poverty and violence into one of the leading economies of Latin America. Peru’s poverty rate was cut in half since the start of the decade—falling to less than 30%. The improvement in living standards was most notable in urban and coastal regions, which saw the poverty rate fall to only 20%. Child malnutrition plunged by half during the same period, easing the country’s burgeoning social problems. Of course, the commodity boom was the main driver for the improvements. Exports surged four-fold since the start of the decade, while imports jumped more than 350%. This allowed the Peruvian central bank to accumulate an unprecedented level of international reserves—representing almost 30% of GDP. The accumulation of foreign assets allowed Peru to reduce its stock of external debt, bolster its pension funds and create a thick cushion of savings to withstand the external turmoil. This makes Peru one of the most resilient economies in Latin America, and the star of the emerging markets class.

Unwilling to sit on the sideline, the Peruvian government is taking measures to prepare for the external onslaught. A tightening of fiscal policy reduced government spending significantly. Capital spending will increase only 5% y/y in 2008—versus an expansion of 35.5% y/y in 2007. The collapse in commodity prices is eroding Peru’s balance of payments, and the country will post its first current account deficit in more than four years. Nevertheless, the slowdown in domestic demand will reduce imports and help stabilize the external accounts. Large investments in the export sector will also allow the embarkation of new products and boost export volumes. Peru is experiencing an agricultural revolution, transforming thousands of hectares of desert wasteland into productive farms—thanks to the implementation of new irrigation systems and technology. Peru is the world leader in the production of asparagus, and it is becoming a major exporter of grapes. In many ways, Peru is following the trail that was blazed by Chile more than two decades ago as it mobilized its vast natural resources for the export market. This is one of the reasons why Chilean investors are pervasive throughout Peru, investing heavily in infrastructure, retailing, mining and agro-products.

Although Peru is the shining star of Latin America, many people are concerned about the political situation. Peru’s political party system is weak. President Alan Garcia hails from APRA, the country’s traditional political machine, but the party is a shadow of its former glory. Moreover, it is rife with corruption. With a support rate of only 19%, President Garcia’s popularity is one of the lowest among Latin American presidents, even though his economy is one of the most resilient. At the same time, the populist leader, Ollanta Humala, is building a grass roots movement in the Andean sierra. His Peruvian Nationalist Party has close ties with Venezuelan President Hugo Chavez, and he advocates increasing the royalties and taxes on mining companies. Humala is the leading contender for the presidential elections in 2010. The deceleration of the Peruvian economy may play well into his hands. Industrial production is starting to sour. The production of capital goods fell 5.7% y/y in August. Political analysts hope that the improvement in living conditions will sap some of the support for Humala, but the country is running against the clock. Lima is the key to winning Peru’s presidential election, and a lingering prosperity should help. This is why the government and the central bank are so committed to preserving economic stability in the face of a severe global downturn. The star student of Latin America is about to face one of the biggest tests of its modern history, let’s hope it passes with flying colors.