OECD Economic Outlook, Volume 2022 Issue 2

Peru

GDP is projected to grow by 2.6% in 2023 and 2.9% in 2024, driven mainly by higher mining production and exports and the recovery of tourism. Still elevated inflation and tighter financial conditions will weigh on household consumption. High political uncertainty, low business confidence and structurally slow budget execution at regional and local levels will constrain investment. Inflation, which has started to decline, will converge to the 2% target in the course of 2024. Informality, above pre-pandemic levels, will widen inequalities.

The central bank should maintain a restrictive stance to ensure inflation expectations get re-anchored. Safeguarding fiscal sustainability will hinge on maintaining the envisaged fiscal consolidation path. With formal job creation lagging, and high poverty and food and energy prices, targeted fiscal support to the most vulnerable is needed. A tax reform to increase structurally low public revenues would help to address pressing infrastructure and social needs, enhance tax progressivity and make growth more inclusive. Expanding electricity generation from renewable resources would help reduce fossil fuel dependence and costs.

Social unrest in mining and high inflation are weighing on growth

After surpassing pre-pandemic levels in 2021, economic activity has lost momentum. Economic activity grew by 3.5% in the first half of 2022, driven by a fast job recovery, pension fund withdrawals and rapid credit growth, leading to buoyant household consumption. Between July and September, economic activity was up only by 1.7% year-on-year. The recovery in sectors most positively affected by the easing of COVID-19 restrictions started to dissipate and was offset by weakness in mining and agriculture. Much of the drag in mining production stems from protest-related disruption in copper mines. Political uncertainty has undermined business confidence and manufacturing output has contracted in the last three months. Softer exports together with higher oil prices and the resulting larger import bill are widening the current account deficit. Employment has recovered and is above pre-pandemic levels, but informality has increased, reaching 70% of the workforce.

Peru

Source: BCRP; and INEI.

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Peru: Demand, output and prices

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Annual headline consumer price inflation peaked at 8.8% in June and is now on a downward trajectory, but remains high. Core inflation reached 5.7% in October. The main drivers of high inflation have been rising food and energy prices. In addition, the currency has depreciated amid domestic political and global uncertainties, pushing one-year ahead inflation expectations to 4.8% in October, above the central bank inflation tolerance range of 1-3%. Wage increases have been contained, and real wages were down by 1.3% from a year earlier in August.

Monetary and fiscal policy will remain restrictive

To protect households from high inflation, the government has taken emergency measures, including waiving most taxes on petrol, giving vouchers to the poor to buy cooking gas and food, and increasing cash transfers for vulnerable households and the elderly. The government has also raised the minimum wage by 10% and allowed for a sixth extraordinary withdrawal from pension funds since the pandemic began. The government has appropriately committed to an ambitious fiscal consolidation path to ensure fiscal sustainability and maintain the credibility of the fiscal framework. In 2022, the fiscal deficit will be 2% of GDP, well below the limit of 3.7% foreseen by the fiscal rule. A welcome return to pre-pandemic fiscal rules should help to bring public debt under 30% of GDP by 2032, from 36% of GDP in 2021, and the fiscal deficit within 1% of GDP by 2026. Lagging formal job creation and high levels of poverty signal a need to provide targeted fiscal support. With inflationary pressures receding, the central bank will soon end the monetary policy tightening cycle, keeping policy rates unchanged until mid-2024 to ensure inflation expectations are re-anchored.

Economic growth will remain weak in an uncertain environment

Household consumption growth will be supported by the liquidity remaining from pension fund withdrawals and job creation but will be dampened by still high inflation, low household confidence, and significant monetary tightening. Recent SMEs financing support measures, new and extended tax exemptions and measures to foster public-private partnerships will support private investment, but only partly offset the impact of political uncertainty and high interest rates on business confidence and investment. Public investment will be subdued due to local and regional structurally low budget execution. GDP growth will pick up in 2024 as monetary conditions ease and global growth turns up. Inflation should slowly converge to the 2% target by the second half of 2024. The main downside risks to the outlook include increased domestic political uncertainty, higher-than-expected monetary policy tightening in advanced economies, social unrest related to fertiliser shortages and food and energy prices. Higher or lower growth in China, the main trading partner, could affect commodity prices and demand for exports.

Reforms to reignite growth and decrease inequalities are needed

Raising productivity and investment will hinge on stronger competition, higher quality public infrastructure and improved state capacity. A recent stimulus programme aims to boost investment, but implementation will remain challenging. More investment in renewables can help to diversify the economy and boost productivity, while reducing dependence on fossil fuels and costs. In the medium term, introducing a carbon tax and phasing out fossil fuel subsidies could support these efforts and create fiscal space to support the most vulnerable. Ensuring adequate funding for social and infrastructure spending will require improved spending efficiency and higher tax revenues. Reducing tax evasion and expenditures while enhancing the progressivity of the system will be key for inclusive growth. Expanding social protection coverage and benefits of social assistance programmes and reducing labour charges for low-income workers would curb informality. Improving the quality of public education and professional training would boost productivity and reduce informality and inequalities.