OECD Economic Outlook, Volume 2023 Issue 1

Peru

Peru’s GDP is expected to grow by 1.7% this year and by 2.9% in 2024. Political uncertainty, extreme weather events, high interest rates and inflation will constrain private consumption and investment. Slow budget execution by subnational governments will hamper public investment, partly offset by a recent package of measures to boost investment. The recovery in tourism and copper production will boost exports. Inflation is expected to slow and return to target by early-2024.

The central bank should maintain a restrictive stance to anchor inflation expectations. Maintaining the planned fiscal consolidation path will ensure the sustainability of public debt. Implementing a tax reform to increase public revenues and enhance tax progressivity is needed to address pressing infrastructure and social needs. Expanding quality early childhood education will be key to reduce informality and increase female labour force participation, boosting potential growth.

Social unrest and extreme weather are weighing on growth

Economic activity has slowed sharply due to social unrest, extreme weather conditions, political uncertainty, high inflation, and monetary tightening. GDP contracted by 0.4% year-on-year in the first quarter of the year with construction, agriculture and tourism hardly hit. After a sharp decline at the beginning of the year, mining is recovering as social unrest and road blockades dissipate, and a newly established mine starts fully operating. Cyclone-related supply-chain disruptions in March added to the economic slowdown. Private investment was particularly hard hit in the first quarter of the year, declining by 12% with respect to the same quarter last year. Private consumption also slowed, with a modest year-on-year increase of 0.4%. However, other short-term indicators, such as electricity generation, suggest an ongoing recovery and historically high public investment growth in the first four months of the year provides support.

Peru: Activity and inflation indicators

Source: INEI; and BCRP.

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Peru: Demand, output and prices

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Annual headline inflation decreased to 7.9% in May after peaking at 8.8% in June 2022. While energy price inflation has slowed, food prices continue to add to inflation owing to social unrest and cyclone related-supply-chain disruptions. Core inflation edged down to 5.1% in May from a peak of 5.9% in March 2023. Furthermore, 12-month ahead inflation expectations declined further to 4.2% in April. Wage increases have been contained, and real wages are 5% below their 2019 level. Risks associated with global financial conditions are mitigated by large currency reserves and low public debt. The financial sector remains resilient amid well-capitalised banks, with large liquidity buffers.

Monetary and fiscal policy will remain restrictive

The central bank has raised rates quickly to battle inflation and has recently paused its tightening cycle owing to the deceleration in economic activity and receding inflation expectations. Headline inflation has started to soften, but with core inflation persisting and inflation expectations still above target, monetary policy should remain restrictive. The policy rate is assumed to remain stable until the end of 2023, when it would start to be gradually reduced. To protect households from high inflation and support the weak economy, the authorities launched a fiscal support programme, complying with the fiscal rules, that will partly offset the negative impact of political uncertainty with a combination of targeted and temporary cash transfers, public investment, and credit relief for SMEs. Fiscal policy should remain prudent in line with the planned fiscal consolidation and rebuild fiscal buffers to be able to face additional shocks, including natural hazards.

Economic growth will remain weak in an uncertain environment

Political uncertainty, high inflation and tight financial conditions will weigh on business and consumer confidence. Inflation should slowly converge to within the 1-3% target range by early 2024 allowing an easing of monetary policy and supporting household consumption and investment. Policies to boost public investment and public-private-partnerships, as part of the implementation of the Con Punche Peru stimulus plan and measures to address the climate emergency, will support domestic demand, and the recovery in tourism and copper production will boost exports. Domestic risks stem primarily from high political uncertainty, and renewed flare-ups in social unrest. El Niño, a natural event that has become more frequent due to climate change, is projected to be mild but remains a risk as it can evolve rapidly, leading to heavy rainfall and large economic losses and endanger the planned fiscal consolidation. A slower than anticipated upturn in China, Peru’s main trading partner, and lower copper prices would negatively affect exports, fiscal revenues, and prospects for investment.

Reforms to reignite growth and close gender gaps are needed

Raising long-term growth will hinge on improving state capacity at the national and subnational levels and addressing corruption to ensure the delivery of high-quality public services and infrastructure. Adequate funding for social and infrastructure spending and closing regional gaps will require improved spending efficiency and higher tax revenues. These could be achieved by lowering tax evasion and tax expenditures and enhancing the progressivity of taxation. Reducing labour charges would increase social protection coverage and curb informality, particularly for low-income, young, and female workers. Improving access to high-quality early childhood education would reduce informality, improve female labour market participation and job quality, and boost productivity.