Itaú BBA - PERU – Growth weakened in 2017, with bigger fiscal imbalance but smaller current account deficit

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PERU – Growth weakened in 2017, with bigger fiscal imbalance but smaller current account deficit

February 23, 2018

The increase of metal prices will boost growth in 2018

Peru’s GDP growth weakened in 2017, battered by idiosyncratic shocks such as El Niño (which not only affected natural resource sectors, but also caused negative wealth effects) and corruption scandals (that paralyzed some of the largest infrastructure projects in the country, and created a full-blown political crisis by 4Q17). According to the Central Bank (BCRP), GDP growth posted 2.2% year-over-year in 4Q17 (from 2.9% in 3Q17), with annual growth for 2017 at 2.5% (from 4% in 2016). At the margin, quarter-over-quarter annualized growth slowed down to 1% in 4Q17 (from 3% qoq/saar in 3Q17).  

Domestic demand was poor in 2017 while exports stood out as the engine of growth, just like in 2016, but growth sources have begun a rebalancing process in 2H17 (as higher metal prices spurred investment in the mining sector). Domestic demand grew at an anemic 1.3% in 2017 (from 1.1% in 2016), with an improvement in private investment (0.1%, from -5.9%) offset by softer private consumption (2.5%, from 3%). Public sector expenditure (1.1%, from -0.2%) also supported domestic demand in 2017, driven by public consumption (1.6%, from -0.5%) whereas public investment (-0.1%, from 0.6%) actually fell in spite of the government’s efforts to pump in fiscal stimulus. Finally, we note that exports of goods & services grew 8.5% in 2017 (from 9.5% in 2016) outstripping the growth of imports of goods & services (4%, from -2.2%). Nevertheless, after 14 consecutive quarters of contraction, private investment grew in 2H17 in line with the rise of the terms of trade (7.3% in 2017, following 5 years of decline, mainly because of higher copper and zinc prices).

We expect an acceleration of GDP growth, to 4%, in 2018. Even though the political crisis will probably linger, putting a risk on investment decisions, this will be more than offset by the positive effects of higher terms of trade (largely determined by metal prices), expansionary macroeconomic policies (mostly fiscal, but also monetary), and – to lesser extent – some rebound in infrastructure investment (mainly Line 2 of Lima’s subway, Lima’s airport expansion, and the Majes Siguas II irrigation project). 

Given robust export volumes and higher metal prices, Peru’s current account deficit (CAD) narrowed between 2016 (2.7% of GDP) and 2017 (1.3% of GDP). The adjustment was substantial, in light of the fact that the CAD has shrunk to almost one fourth of its size in in only two years (it stood at 4.8% of GDP in 2015). However, according to our calculations, the quarterly seasonally adjusted CAD increased in 4Q17 (to 3.2% of GDP, from 0.9% of GDP in 3Q17) mainly due to softer exports (affected by a one-off postponement of the fishing season and a decline in copper export volumes) and stronger imports (led by imports of capital goods, reflecting the strengthening of investment). We believe that the weakening of exports in 4Q17 was temporary, considering that copper export volumes (down by 9.7% year-over-year in 4Q17) are usually highly correlated to copper output (up by 3.5% in 4Q17) while the postponement of the fishing season added 0.3% of GDP to the quarterly CAD (equivalent to the fall of fishing exports in 4Q17). Looking at the components of the current account, we note that the trade surplus rose to 2.9% of GDP (from 1% of GDP in 2016), the largest in 5 years. Meanwhile, other components showed smaller variations: services balance (-0.7% of GDP in 2017, from -1% of GDP in 2016), net income (-5.2% of GDP, from -4.7% of GDP), and transfers (1.7% of GDP, from 2% of GDP). On the financing side, we highlight that Peru’s CAD is fully-funded by net foreign direct investment (3% of GDP in 2017, from 3.4% of GDP in 2016). 

The nominal fiscal deficit widened to 3.2% of GDP in 2017 (from 2.6% of GDP in 2016) which implies that the fiscal deficit cap for last year (3% of GDP) was breached for the first time since the inception of the fiscal rule in 2013. Originally, this cap was set for the structural deficit – that is, the nominal deficit adjusted for long-term metal prices and potential GDP growth – but in 2016 the incoming PPK administration (with the approval of Congress) changed the definition of the caps to link them to the nominal result. Currently, the targets are 3.5% of GDP in 2018 (accommodating the fiscal stimulus), 2.9% of GDP in 2019, 2.1% of GDP in 2020, and 1% of GDP in 2021 (long-term target). To be sure, Peru’s fiscal rule is toothless as there are no consequences for breaching it (other than the erosion of credibility in the face of investors and rating agencies, if this lack of compliance is recurrent). Turning to public debt, both gross (24.8% of GDP in 2017, from 23.8% of GDP in 2016) and net (9.5% of GDP in 2017, from 6.9% of GDP in 2016) measures increased, although the latter increased more than the former because the government shed financial assets from the fiscal stabilization fund (to cover its funding gap).  

Alexander Müller

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