APPF7/EC.REPORT/2

  Report on the Peruvian Economic Situation

Submitted by the Peruvian Delegation

 

Executive summary

The Peruvian delegation to the APPF VII General Assembly submits the present document on the basis of the report prepared by PromPerú (as a summary of Reports on the Peruvian economy published by Banco de Crédito del Perú, BankBoston, BBV, Deutsche Bank, Flemings, ING Barings, JP Morgan, Lehman Brothers, Morgan Stanley Dean Witter, Santander Investment, SG Cowen and Warburg Dillon Read between June and September 1998).  According to the reports, the El Niño phenomenon and the Asian crisis – two external influences uncontrollable by the government’s economic policy – continue to be determining factors of the Peruvian economic situation in 1998.  Although Peru’s economy is somewhat more vulnerable than last year, a solid macro-economic foundation and a responsible fiscal and monetary policy place Peru in a favorable position to deal with these adverse conditions.
 
 
 

1. The economic situation

a. The El Niño phenomenon and the Asian crisis

After the first half of 1998, the effects of the Asian crisis, and especially those  of El Niño, were considerably stronger than anticipated.  For Peru, 1998 has become “one of the most trying years in recent history” (Lehman Brothers).  The strong rains and floods accompanying the El Niño phenomenon destroyed 22.000 homes and damaged 260.000 more (BankBoston).  BankBoston values the infrastructure damage at US$600 million, while other banks estimate between US$720 million and US$750 million (Warburg Dillion Read) or even US$1 billion (Lehman Brothers).

Economic activity reached its lowest point in April and May, as GDP fell by 4.1% and 3.3% respectively in comparison with last year’s figures for these same months (Flemings).  June finally saw the end  of this mini-recession (Santander Investment), when GDP was up by 0.1%.  In all, during the first semester GDP fell by o.4% when compared to last year’s figures (Banco de Crédito, Lehman Brothers).  The fishing industry was worst hit by El Niño.  Between January and May, production fell by 70% in comparison with last year’s figures for the same period (ING Barings).

Other sectors that suffered from El Niño were agriculture and manufacturing, especially fishmeal production (BBV).  Mining was affected both by damage to roads and a corresponding increase in transport costs (Santander Investment), combined with falling metal prices due to the Asian crisis (ING Barings).  However, all banks are predicting a strong recovery of economic activity during the second half of the year.

As the economic sectors struck by El Niño and the Asian crisis are important for Peruvian exports, the country’s foreign accounts also suffered adverse effects.  During the year’s first five months, the Peruvian trade deficit reached US$1.5 billion, compared with US$600 million for the same period in 1997.  A massive decrease in fishing and mining exports (by US$469 million and US$163 million respectively) are behind this higher deficit (BBV, Morgan Stanley).  As a result, the current account deficit of the first quarter reached 7.5% of the GDP (ING Barrings), representing the weakest element in this year’s macro-economic framework.

However, analysts agree that this gap will not cause instability in regard to the balance of payments.   Up to the present, the country has not met any difficulties in financing the current account deficit with long term capital, especially foreign direct investment (ING Barings, Morgan Stanley, Santander Investment).  Therefore, despite the international economic upheaval, Peru’s International Net Reserves not only remained stable but grew slightly above US$10.5 billion (BankBoston, ING Barrings, Morgan Stanley, Warburg Dillon Read).  This places Peru in a favorable position to face possible speculative attacks:  BankBoston mentions that the country’s International Net Reserves would meet 11 months of import.

This capability of maintaining a stable economy in spite of adverse conditions is mostly due to a responsible fiscal and monetary policy, that was unanimously praised by the banks.  Analysts agree that the goal of reaching a primary surplus of 1.7% of GDP, included in the International Monetary Fund’s Extended Facility Program, has a high priority for the government, even if it entails sacrificing growth (BankBoston, Deutsche Bank, ING Barings, JP Morgan, Lehman Brothers, Morgan Stanley, Santander Investment).  In this way, Peru has shown that “by having appropriate economic policies in place, a government can mitigate the impact of external shocks” (Lehman Brothers).  This attitude may be interpreted as a sign of responsibility that leads Peru to stand out among other emerging economies (Santander Investment), and to be counted as having “one of the strongest fiscal positions in Latin America” (ING Barings).

The Camisea project

By mid-July analysts were struck by the Shell/Mobil Consortium’s decision to terminate its contract with the Peruvian government for the exploitation of the Camisea gas deposit.  The importance of this decision is due to the project’s magnitude:  the deposit contains gas and liquid gas valued at US$22 billion, and – according to Shell – it requires an investment of US$4 billion (Deutsche Bank).  The disagreements that led to the contract’s termination involved the distribution of gas in Lima, the price structure for gas used for power production and the possibility of including in the contract a clause allowing the consortium to export gas to Brazil (Deutsche Bank).  ING Barings describes the government’s negotiating position as a “tough decision to make, whether or not its rationale was justified on the grounds of establishing an efficient power-producing sector and preventing a potential monopoly”.

The government has already presented a new strategy for the  project’s continuation.  It separates the project into three stages, exploitation, transmission and distribution of gas in Lima, each operated by a different firm.  According to Banco de Crédito, this design requires a joint analysis of all three stages, a complex process that could delay the project.  BankBoston estimates that the project’s execution will begin in two years, and according to Deutsche Bank, the government now estimates that the arrival of gas in Lima will take place by the year 2003 instead of 2002.

The banks also analyze the possible repercussions of Shell/Mobil’s decision, consisting mainly in a delay of the positive effects the Camisea project would have on the Peruvian economy.  The strong inflow of direct investment funds would increase the  country’s economic growth by 1 or 2 percentage points during the first years (Deutsche Bank, ING Barings).  Moreover, the project would entail a decrease in electricity costs, which in turn would enhance the competitive edge of Peruvian business companies (Banco de Crédito).

On the other hand, the project would also have some effects on the balance of payments.  A long-term consequence would be to eliminate Peru’s dependence on oil imports, which currently creates a permanent trade deficit in the energy sector (Banco de Crédito) that in 1997 reached US$400 million (ING Barings).  In the short term, however, a delay would have a positive effect on the current account deficit, as expensive imports of capital goods would be necessary in order to initiate the project’s next stage (Flemings, ING Barings).

2. Forecasts for 1998 and 1999

a. Economic activity

During the first semester, GDP growth (-0,4%) was less than previously expected by the analysts, inducing the banks to lower their growth forecasts for 1998.  Estimates now fluctuate between 2.2% (JP Morgan) and 4.0% (SG Cowen).  Morgan Stanley describes this result as "not a bad showing at all", if one takes into consideration that in 1983, when a another strong El Niño coincided with the debt crisis, Peruvian GDP fell by 12%.  The banks are predicting a strong recovery of economic activity during the second semester of 1998, especially in those sectors most affected by the El Niño phenomenon.  Fishing season will bring along a strong recovery of that sector during the fourth quarter, and the same applies to the fishmeal industry (Santander investment).  On the other hand, agriculture will also benefit enormously, since the El Niño rains have replenished water reservoirs (Lehman Brothers, Santander Investment).  JP Morgan also predicts a stabilization of commodity prices, which in turn would benefit the mining sector.
There are some factors that delay recovery during 1998, or postpone it until 1999.  Initially, many banks estimated that the government program destined to repair the infrastructure damaged by El Niño would provide a strong impulse to the economy during this year's second semester.  Now they predict that most of the program's expenditures - around 1.8 billion New Soles (Banco de Crédito) - will be made during 1999, since in 1998 the effort to reach fiscal goals is taking priority (Banco de Crédito, BankBoston, BBV, Beutsche Bank, Morgan Stanley).  Domestic demand and consumption, also affected by external influences, will slowly recover during the fourth quarter (Deutsche bank, Santander Investment).

With the exception of SG Cowen (4.5%), all banks are predicting at least a 5% growth for 1999, possibly one of the highest in the region according to Morgan Stanley.  The most optimistic forecast was issued by Santander Investment (7.1%).  Deutsche Bank, (6.8%), a bank whose estimate is also above average (6.8%), explains that this growth rides on a strong impulse from the fishing sector's recovery, whose 1999 growth is estimated at 73%.  Continuing investment in the mining sector will favor its development, despite low prices.  An additional impulse will come from the post - El Niño reconstruction program.

Finally, one has to take into account a statistical effect: for 1999, growth will be estimated on a smaller basis.
 
 

b. Fiscal policy

In may, tax collection had fallen by 1.1% compared to the same period last year, due to GDP reduction during April and May (Banco de Crédito).  This led to a primary surplus of only 2% of GDP, compared to 2.7· for the period January to May 1997 (Deutsche Bank), making it necessary to postpone part of the reconstruction expenditures until 1999.  The banks don't doubt the priority given to fiscal goals in the government's economic policy.

In view of the presidential elections during the year 2000, there are some fears about increased political pressure on fiscal management, but no changes are expected in either economic or fiscal policies (BankBoston, ING Barings).

c. Inflation

According to the banks, this year's inflation will be higher than last year's rate of 6.5%.  The cause is the influence of El Niño on food prices, where supply experienced a decrease.  Annualized inflation reached its highest point (8.43%) in April (BankBoston, Santander Investment), but since then the situation has gradually returned to normal as a result of sound fiscal policy and the disappearance of the El Niño effects (BBV).  In July, annualized inflation had already reached 7.4% (BankBoston).  For the whole year, banks are predicting inflation between 6.9% (BankBoston) and 8.7% (Warburg Dillon Read).

d. External balances and the exchange rate

For 1988, analysts are predicting a current account deficit between 6.0% (Flemings) and 6.6% (Banco de Crédito, SG Cowen).  According to BankBoston, this would make the Peruvian economy slightly more vulnerable than last year.  Moreover, the financing of the deficit would become more difficult after the postponement of several big investment projects, Camisea being the most important one.  On the other hand, Santander Investment argues that in the future the sum of several smaller investment projects in the industrial, mining, energy and service sectors should be enough to offset the negative effect on the balance of payments, as happened during in first quarter.  Likewise, during the next years, the government hopes to generate investments of USS$800 million through privatization of airports, roads and harbors (BankBoston, Santander Investment).

There are also some signs that the country's foreign countries have already overcome their worst moment (BankBoston),  May's trade deficit was US$230 million, a substantial decrease from US$344 million in April (JP Morgan).  A fast recovery of exports will probably help to close the foreign gap  (Lehman Brothers).  Fishing exports will soon return to normal, and the mining sector is believed to experience a continuous growth in production (Morgan Stanley).  Commodity prices may also develop favorably for Peruvian exports, according to JP Morgan: between August and December, the weighted average of the prices of Peru's most important commodities (fishmeal, gold, copper) increased by 3.5%.
Finally, a restrictive fiscal policy and a flexible exchange rate are lowering the pressure on external accounts (SG Cowen), so that the foreign deficit will probably not cause significant instabilities in the exchange rate.  The Central Reserve bank has not experienced any problems in dealing with some minor speculative actions by temporarily increasing interest rate (Lehman Brothers).  Even so, during the last months the devaluation of the New Sol has accelerated slightly (7.7% between January and July), as a consequence of the trade deficit and the uncertainty in international markets (BankBoston),  However, this will have a positive effect on the Peruvian economy's international competitiveness (SG Cowen).  By the end of the year, analysts expect the exchange rate to reach between 2.90 (Flemings, Lehman Brothers) and 3.10 (SG Cowen) New Soles per US Dollar.