Alphacast Highlight - Peru October 2022 Macro Brief

Despite the recent slowdown, Peru is recording one of the highest rates of growth in the last decade across LATAM, falling behind Colombia only. However, most of this growth happened before the pandemic. After the Covid-19 outbreak, Peru has been struggling to return to its pre-Covid growth trend. Regarding politics, the government of Pedro Castillo became a turning point: political paralysis has eroded the investment climate, and the ongoing political tumult has subdued the economic growth outlook. On the markets, a larger global economic slowdown would undoubtedly have negative reverberations on Peru’s copper returns and economy. Added to this, at the local level the lagged effect of monetary and fiscal adjustment, and lower consumption driven by lower disposable income stopped the activity, while the drop in business expectations may further affect the dynamics of investment. In addition, the Central Bank is not discarding further hikes of the interest rate if inflation is not lowered within the target range, which could affect the level of economic activity. On a positive note, Peruvian fiscal and external balances are good compared with other peers, sovereign ranking is still good (BBB), the debt level (34% of GDP), and interest burden (1.4%) are quite low.

Activity

Peru's economic activity has been losing dynamism in the second half of this year and as a result, after advancing 3.5% in the first half, is showing signs of stagnation. On the side of primary activities (-1.1% Feb-22, -2.6% Aug-22) mining production (the mining leaped from +0.1% Feb-22 to -5% Aug-22) has been affected by growing social and political conflicts that affect investment dynamics. On the other hand, in terms of non-primary activities (+6.4% Feb-22, +2.7% Aug-22), the positive effect of the relaxation of sanitary isolation is diminishing. Moreover, high inflation, increases in interest rates, and lower disposable income affected consumption and consumer confidence. The monthly index of activity recovered 0.92% in August compared to the previous month, while in annual terms it showed an improvement of 1.68%. For the rest of the year, growth is expected to be moderate. According to the Multiannual Macroeconomic Framework published by the Ministry of Economy and Finance, the Peruvian gross domestic product (GDP) could close 2022 with a rise of 3.3%, amid the internal political crisis and the impacts of the war between Russia and Ukraine.

Inflation

In September, Peru's consumer price index advanced 0.52% monthly, decelerating for the third consecutive month. This is explained by the rise in food prices due to supply problems and by the readjustment in the rate of drinking water, offset by lower transportation prices. With this result, annual inflation increased slightly reaching 8.53% (vs. +8.40% Aug-22), and is reluctant to go down. Inflation excluding food and energy (+5.51% YoY), which marks a trend in price dynamics, has been increasing since the beginning of the year (+4.26% YTD). Expectations for the next 12 months are correcting downwards from the peak reached in June (5.35% YoY) standing at 4.89%, but they are still above the target range established by the Central Bank (between 1% to 3% YoY).

Monetary Policy

The process of lowering inflation is slow and costly. Despite the slowdown in economic activity, the interest rate increased again for the fifteenth consecutive time, going from 6.5% to 7% in October. The decision was tied to the increase in inflation compared to the same period of the previous year, going from 8.4% in August to 8.53% in September, and above all, to the downward resistance of inflation that does not include food and energy (5.39 % Aug-22, 5.51% Sep-22). In real terms, the reference rate stands at 2.11% (+1.65% Sep-22), moving away from the neutral level set by the Central Bank, which implies a restrictive position of the monetary policy. Going forward, further monetary adjustments are not ruled out if downward persistence continues.

FX & Markets

Peruvian Sol was nominally stable since January (+0.2%). 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. The combo of fiscal and monetary tightening has kept the Sol under control and so far immune to global turmoil. The Central Bank began its steadily tightening cycle in august 2021, rising the rate to 7%.

Peru's country risk closed October at 228bps (-269bps vs. Latam). Although throughout the last decade Peruvian risk perception has been more aligned with Chile than with the region, the violent social demonstrations in favor and against leftist president Pedro Castillo (since March 22 onwards) have caused strong volatility in the Peruvian EMBI. With a high spread with respect to its two-year average (+100bps), the Peruvian risk premium is trading at similar values to the peak related to Covid-19 (305 bps in Apr-20). 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, -7.7% YTD). As of Sep-22, it is trading at Dec-18 prices and -21.5% vs. Feb-20

Fiscal

Peru's primary deficit reached in Ago-22 -0.9% 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 higher income, above all, by the higher income tax collection and VAT, and by the moderation of non-financial expenses. 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). The independence of Peru's Central Reserve Bank and low public debt (33.4% GDP in Q1-22, vs Uruguay's 35.6% GDP and Chile's 35.8% GDP) cushion populist pressures on social spending, promoted by President Pedro Castillo, which captures the main fiscal challenge for next year.

Trade & CA

In the first half of the year, there has been a deterioration in the external accounts due to the lower terms of trade that have fallen -9.17% so far in 2022. However, the terms of trade registered a slight rebound in August, increasing 5.4% in a month. This advance was favored by higher export prices, mainly gas, copper, and zinc, and by the drop in import prices, particularly food, industrial inputs, hydrocarbons, and capital goods. So far this year, the currency continues to be the second most appreciated currency in the region (-3.4% YTD), despite the weak depreciation in July.

The current account deficit widened to 5.5% of GDP in the first half of 2022 amid mining profit repatriation and high fuel import costs. Meanwhile, copper prices have fallen. Fitch expects a widened current account deficit of 4.7% of GDP in 2022 and 3.5% of GDP in 2023, up from 2.3% of GDP in 2021. Also, if debt interest is taken into account, the deficit amounts to 6.7% YoY (% GDP). Peru’s net external creditor position, a large external liquidity buffer and an IMF flexible credit line, and large net foreign direct investment inflows remain credit strengths