Peru - Economic Briefing February 2002

El Niño Threatens Mining-Induced Recovery (continued)

Deflation firmly established after January price drop

In January, consumer prices dropped by 0.52% over the previous month.  The price decline represents the highest drop in consumer prices of the sixth deflationary months observed in the past twelve months.  The January price decline was driven by an abundant supply of agricultural products, which served to exert downward pressure on food prices.  In addition, the category of housing, fuels and electricity registered a steep decline, as fuel prices dropped and electricity tariffs were lowered.  As a result of the January price decline, the annual inflation rate dropped further to -0.8% following the 0.1% deflation registered in December last year.  Producer prices also remain under downward pressure.  In January, they declined another 0.18% and the annual rate of producer price variation now stands at -2.5%.

Thus, for the first time in more than four decades monetary authorities face the task of reflating the economy.  In order to achieve this objective, the Central Bank has moved to a system of explicit inflation targeting from its previous system of managing policy via bank liquidity targets and steering of the monetary base.  In its recently announced Monetary Policy Programme for 2002 (29 January), the Central Bank sets out a 2.5% target for year-end inflation with a 1% margin of tolerance on either side of the centre.  The inflation target is based on rather conservative assumptions with regard to the macroeconomic development this year.  Monetary authorities assume that GDP growth will reach 3.5% and that domestic demand will increase by 3.4%.  The table summarises the key indicators underlying the current inflation target of the Central Bank.  Panellists expect the more benign economic environment to put some upward pressure on prices. 

Table

IMF approves stand-by credit as fiscal reform and privatization receipts keep budget deficit in check

On 1 February, the International Monetary Fund (IMF) approved a two-year US$ 316 million stand-by credit for Peru for to support the government's economic program for 2002-2003.  The IMF stated that the Peruvian government intends to treat the stand-by credit as precautionary and does not plan to make any drawings.  The Fund acknowledged that the planned tax reform, which constitutes the centrepiece of Toledo’s economic program, would improve the current fiscal system through a widening of the tax base.  The increased revenue flows and further public expenditure restraint would serve to lower the public sector deficit.  In addition, the government’s privatization and concession program should help to attract private investment in important infrastructure sectors and provide financing for fiscal deficits. To allow for additional spending on infrastructure needs, the fiscal deficit target for 2002 could be increased moderately to the extent that privatization receipts in the year exceed the IMF’s baseline projection.  The Fund expects the combined public sector overall balance to reach 1.9% of GDP in 2002, dropping to 1.4% next year.  Panellists are less optimistic and see hjgher public sector deficits this year.

Rating agencies Standard &Poor’s and Moody’s mark up outlook ahead of sovereign bond issue

On 24 January, rating agencies Standard and Poor’s and Moody’s improved their outlook on Peru while maintaining their ratings.  Standard & Poor's affirmed its “BB-“ long-term foreign currency sovereign credit ratings and revised the outlook on long-term ratings to ‘positive’ from ‘stable’.  Moody's brightened its outlook to “stable” from “negative”, maintaining the Ba3 rating.  The agencies highlighted the Toledo administration's success in legislative approval in an opposition dominated Congress and approval of the IMF stand-by agreement as key reasons for the decision.  The improved outlook will help boost the planned since Peruvian authorities are preparing a sovereign bond issue in international markets for up to US$ 1.5 billion, the first major auction of its type in more than 70 years.  The government said the upcoming auction would include up to US$ 1 billion in Brady bond buy-backs of the total of US$ 3.5 billion in outstanding Brady bonds and up to US$ 500 million in new debt.

Note:  The above text is an abridged version of the LatinFocus Consensus Forecast briefing on Peru.  For more details please click here.

For five-year forecasts, please click here.