OECD Economic Outlook, Volume 2023 Issue 2

Peru

GDP growth is projected to decline to 0% this year, and to gradually pick up to 2.3% in 2024 and 2.7% in 2025. High interest rates and inflation, political uncertainty and severe weather are constraining domestic demand. Government efforts to revamp infrastructure will support investment, despite high interest rates and implementation challenges. Tourism and copper production are set to rebound, enhancing exports. Inflation is expected to continue to slow and reach the 1-3% target range by early 2024, supporting private consumption.

There is room for further gradual monetary easing, as inflation and inflation expectations are falling towards the target. The planned gradual reduction of the fiscal deficit over the next years should be implemented in adherence with fiscal rules to maintain low public debt and rebuild fiscal buffers. A fiscal reform to increase public revenues and spending efficiency is needed to address pressing infrastructure and social needs. A comprehensive strategy to fight widespread informality, including lower non-wage labour costs and better skills, would boost productivity and equity.

El Niño is weighing on economic activity

After a first quarter disrupted by social unrest, economic activity declined further in the second and third quarters of 2023 due to the El Niño adverse impact on fisheries, agriculture and related industries. GDP declined by 0.6% between January and September, with respect to the same period last year. Mining has sustained growth, bouncing back as social unrest subsided and a new copper mine began its operations, supporting exports and reducing the current account deficit. However, this has not offset weakness in private consumption and investment. Business confidence has improved slightly but is still very weak. A significant increase in central government public investment has helped to mitigate the economic slowdown, despite the decline in subnational government investment.

Peru: Economic growth and inflation indicators

Source: INEI (Instituto Nacional de Estadística e Informática); and Central Reserve Bank of Peru.

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Peru: Demand, output and prices

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Headline inflation has declined but is still above the target range. Core inflation has also dropped, with both goods and services prices edging down. While energy inflation has decreased sharply, food inflation has declined at a more gradual pace, because of still high fertiliser prices and extreme weather conditions. Wage increases have been contained, and real wages are 7% below their 2019 level. The central bank started the normalisation cycle in September cutting the policy rate in three consecutive meetings by a total of 75 basis points in face of declining inflation expectations and a weak economy. Risks associated with volatile global financial conditions are mitigated by large currency reserves and low public debt.

The planned fiscal restraint should be implemented

The fiscal deficit is on track to hit the limit foreseen in the fiscal rule, implying a moderate fiscal impulse this year. This reflects efforts to stimulate the economy against the backdrop of social unrest and severe weather. Exceptional support to mitigate the climate emergency is limited to 2023 and 2024. However, unexpected revenue shortfalls due to the economic slowdown, coupled with higher-than-expected climate emergency expenditures could challenge adherence to fiscal rules. Following the strategy of implementing a tighter fiscal policy and gradually reducing the fiscal deficit over the next three years is essential to maintain public debt at a sustainable level and rebuild fiscal buffers. These plans should stabilise public debt-to-GDP ratio slightly below the debt rule of 30% of GDP. As inflation expectations return to the target and severe weather dissipates, monetary authorities are expected to continue reducing the policy rate, bringing the monetary policy stance to neutral by 2025 with policy rates declining to 4%. The central bank is expected to remain cautious due to upward inflation risks associated with the El Niño weather phenomenon.

GDP growth will rebound once severe weather subsides

Growth is expected to pick up as climate-related headwinds dissipate from the second quarter of 2024. Inflation is expected to reach the target range by the second quarter of 2024, once the impact on food prices of severe weather subsides, and core inflation will enter the target range in the first quarter of 2024. Lower inflation, the easing of financial conditions and improving business and consumer confidence will support domestic demand. Investment will be upheld by government measures included in the Unidos programme to boost public infrastructure, private investment and public-private partnerships, while exports will benefit from the better performance of mining and tourism. Still, domestic and external risks are unusually high. A slower than anticipated recovery in China, which is Peru’s main trading partner, and lower copper prices would have a detrimental effect on exports, fiscal revenues, and prospects for investment. The unpredictable nature of El Niño poses risks, with potential economic setbacks and inflation spikes. Higher global oil prices could also add inflationary pressures. Political uncertainty and renewed flare-ups in social unrest also remain key risks.

Greater spending efficiency and tax revenues are needed

Better spending efficiency and higher tax revenues will be needed to maintain fiscal sustainability and create the necessary fiscal space to address increasing social needs and expand critical infrastructure. Greater spending efficiency will require enhancing the capacities of local governments to implement investment projects and clearly defining the spending responsibilities of national and subnational governments, while gradually granting regions more tax powers and improving the tax collection capacity of local governments. Higher tax revenues can be achieved by strengthening tax administration, reducing tax expenditures, completing and updating the cadastre, and simplifying corporate tax schemes. A comprehensive strategy to foster formalisation, including lower non-wage labour costs, more flexible employment regulation, better skill-upgrading opportunities and stronger tax and labour law enforcement would promote poverty alleviation, narrow inequality, and boost productivity and tax revenues. A pension reform is necessary to improve the extremely low coverage of the system.