Alphacast Highlight - Peru December 2022 Macro Brief

Pedro Castillo was dismissed for trying to dissolve the legislative House and to establish an "exception government". Consequently, Dina Boluarte took over in his place. Far from being resolved, the conflict deepened, social discontent heated up and the government declared a state of emergency on December 14. Despite the recent slowdown, Peru is recording one of the highest rates of growth in the last decade across LATAM, only behind Colombia. That said, Peru has been struggling to return to its pre-Covid growth trend. Regarding capital markets, a larger global economic slowdown would undoubtedly have negative reverberations on Peru’s copper returns and economy. The Central Bank is not discarding further hikes of the interest rate if inflation is not lowered within the target range. On a positive note, Peruvian fiscal and external balances are showing strong performance. Moreover, both outstanding debt level (34% GDP), and interest burden (1.4% GDP) are quite low.

Activity

Peru's economic activity lost dynamism in the second half of 2022. The Q3 closed at 1.7%, slowing down its pace compared to the previous ones (vs. +3.8% Q1, +3.3% Q2). Growth was tempered to a greater extent by the contraction of primary production (-1.1% Feb-22, -0.8% Sep-22). Mining production has been affected by increasing social and political conflicts in the main mines. In addition, fishing was affected by a lower household and industrial consumption, which in turn reduced primary manufacturing. On the other hand, in terms of non-primary activities (+6.4% Feb-22, +2.3% Oct-22), the positive effect of the relaxation of sanitary isolation is diminishing.

The high-frequency activity index for October registered a rise of 0.57% MoM. The main drivers were the construction sector -thanks to rising public investment- and the mining sector -because of the start of operations at the Quellaveco copper unit-. According to BCRP estimates, Q4 is expected to growth by 2.7% and 2022 by 2.9%. For the next 12 months, the projections were corrected downwards (+2.57% Sep, +2.35% Oct, +2.33% Nov). The revision is explained by a lower expansion in non-primary goods due to the lower dynamism of private consumption.

Inflation

In November, the Consumer Price Index accelerated 0.52% MoM (vs. 0.32% Oct-22), reaching 8.45% year-on-year (vs. 8.28% Oct-22). This is mainly due to the increase in food prices and an adjustment in electricity rates. Moreover, inflation without food and energy is resisting downwards. In short-term, inflation is expected to decline, albeit at a slower pace. Expectations for the next 12 months are correcting downwards from the peak reached in June (5.35% YoY) standing at 4.68%, but they are still above the target range established by the Central Bank (between 1% to 3% YoY). The BCRP expects inflation to return to the target range in the fourth quarter of next year.

Monetary Policy

The BCRP kept on tightening its monetary policy position that began in August 2021, hiking the reference rate by 25 basis points, from 7.25% in November to 7.5% in December. . In real terms, the reference rate is 2.82%, after reaching a historical minimum of -2.53% percent in August 2021. In this regard, the reference rate moves away from the neutral level set at 1 .5% by the Central Bank. Despite both the moderation in the dynamics of economic activity and the inflationary trend has not been tamed, the BCRP has not given signs that the monetary adjustment process has concluded.

FX & Markets

Peruvian Sol was nominally stable since January (+0.31%). The PEN has somewhat stabilized after a dramatic 2021 when the currency fell almost 20% in anticipation of Pedro Castillo's presidential victory in mid-2021. However, since October to date (22-Dec) the sol appreciated 3.78% in an environment of lower domestic demand for dollars, weaker dollar worldwide and higher copper price. All in all, the sol remains one of the few emerging market currencies to have gained against the US dollar so far this year.

Peru's country risk closed November at 228bps (-240bps vs. Latam). Although throughout the last decade Peruvian risk perception has been more aligned with Chile than with the region, the violent social demonstrations and political rampage (since Mar-22 onwards) have caused strong volatility in the Peruvian EMBI.

Peru's fixed income, the least impacted by Covid-19 in the region (-7.1% between Feb-20 and Apr-20, vs -12.1% for Colombia or -21.8% for Mexico), incorporates in its yields this negative outlook for 2022 (EMBI Peru JPM Total Return Index, -16.4% YTD). Also, The Peru equity ETF trades recovered 10% from the October floor, absorbing the news of the presidential vacancy and the moderation in the Fed's rate hikes.

Fiscal

Peru's primary deficit reached in Sep-22 -0.4% GDP (12-month sum), below the average of the last 5 years (-2.4% GDP) and again in line with the fiscal prudence that characterized the 5 years prior to covid-19 (-1.2% GDP). This is explained by the increase in income, mainly from Tax on General Sales (IGV) and income tax collection andlower expenses in current transfers. Considering that Peru has a low level of interest expenditures relative to the region (1.4% GDP vs. Argentina's 1.7% GDP and Uruguay's 2.1% GDP), the overall deficit was -1.8% GDP (vs. -3.8% average over the last 5 years). Meanwhile, spending would be slightly reduced as a percentage of GDP compared to the previous year, because of lower COVID-related expenditure.

Trade & CA

External accounts deteriorated due to the lower terms of trade. They have fallen -16.9% so far in 2022 mainly due to higher import prices (oil, food, and industrial inputs). Despite this, the currency continues to be the second most appreciated currency in the region (-16.9% YTD), despite the weak depreciation in July.

The current account deficit widened to 4.4% of GDP in Q3. This increase in the deficit so far this year responds to the high international prices of food and energy, stronger demand for imported products and lower growth in export shipments. On the contrary, the lower primary income deficit partially offset this trend, due to the lower profits of companies with foreign direct investment (FDI) in the country. The BCRP forecasts a current account deficit equivalent to 4.5% GDP in 2022. When taking into account debt interest, the deficit would amount 6.1% GDP.