Public Information Notice No. 10/50

Public Information Notice: IMF Executive Board Concludes 2010 Article IV Consultation with Peru

April 15, 2010

On April, 14, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Peru.¹

Background

Peru’s economic performance over the last decade has been impressive by domestic and international standards. Strong economic fundamentals, a sound institutional policy framework, and a solid track-record of prudent macroeconomic policies helped reduce vulnerabilities, achieve record-high economic growth, and advance significantly with poverty reduction. Reflecting on these achievements, Peru was granted investment grade by Fitch and Standard & Poor’s in 2008 and by Moody’s at end-2009, consolidating its standing among major emerging market economies. Peru’s medium-term prospects remain bright, linked to sustained efforts in the implementation of an ambitious structural reform agenda.

Peru’s economic resilience during the global financial crisis was the result of the proactive policy response and sound fundamentals. Growth in Peru decelerated sharply in 2009, due to the global financial crisis, but remained positive at about 1 percent for the year, despite a few months in negative territory. Thanks to the strong buffers built in recent years, Peru was able to implement a significant monetary and fiscal policy response, which helped to avoid a credit crunch, support domestic demand and sustain employment. The central bank injected substantial liquidity in the financial system and lowered the policy rate to an historic low of 1.25 percent. A significant fiscal stimulus plan was introduced, which entailed a positive fiscal impulse of about 2.5 percent of GDP in 2009. Peru’s financial sector proved resilient to the global financial crisis thanks to the sound prudential framework put in place in past years and its strong initial standing, and it has remained well-capitalized, liquid and profitable. Peru’s external financial account showed also resilience to the global financial crisis, with a resurgence of capital inflows and appreciation pressures in recent months. To moderate currency volatility, the central bank has intervened in the foreign exchange market, purchasing US$2.5 billion so far this year.

Economic activity is expected to grow strongly in 2010, with limited slack in resource utilization thanks to the successful policy response. With the economy already gaining momentum, a sustained improvement in global conditions and the remaining stimulus, staff projects growth at 6.25 percent this year and 6 percent in 2011. Peru’s recovery appears less dependent on policy support than in other advanced and emerging market economies, as it did not open a significant output gap and the balance sheets of the corporate, household, and financial sectors remain unimpaired. Moreover, the balance of risks to growth in Peru appears tilted to the upside, linked to prospects of renewed capital inflows to strong emerging markets and domestic demand dynamics, including the cyclical rebuilding of inventories and acceleration of private investment projects put on hold last year. A relapse in global growth and a return of global risk aversion are the principal tail risk that could encumber the growth outlook for Peru.

Executive Board Assessment

Executive Directors commended the Peruvian authorities for their impressive track-record of prudent macroeconomic policies which helped limit the impact of the global crisis and jump start a vigorous economic rebound. Given its strong fundamentals, the economy is expected to return to rapid growth. Peru’s medium–term outlook remains bright, supported by the authorities’ ambitious reform agenda.

Directors noted that the balance of risks to Peru’s growth is tilted to the upside because of domestic demand dynamics and renewed capital inflows. They agreed that, with limited slack in resource utilization, these risks call for early withdrawal of policy stimulus to avoid a buildup in inflationary pressures. Directors also noted that a renewed surge in capital inflows would require close monitoring and would benefit from a strategy that focuses on fiscal consolidation and greater exchange rate flexibility. Directors observed that normalizing monetary conditions may rely on a combination of measures, including reserve requirements, along with macro–prudential measures to prevent credit and asset booms.

Directors welcomed the authorities’ intention to manage spending plans carefully to achieve in 2011 the fiscal deficit limit established by the Fiscal Responsibility and Transparency Law. They supported the plans to strengthen the Oil Price Stabilization Fund (FEPC) for addressing the rising liabilities and reducing fiscal risks. Directors also welcomed the authorities’ interest in exploring ways to reduce pro-cyclicality of the fiscal framework.

Directors noted the progress made with de-dollarization over the last decade and agreed that improved fundamentals would continue to advance this process and allow the exchange rate to play a larger role as shock absorber. A gradual increase in currency flexibility could foster the development of foreign exchange hedging instruments and reduce dollarization.

Directors commended the authorities’ resolve to further solidify Peru’s strong prudential framework, with some regulatory norms ahead of international standards. The challenge would be to reassess the framework in light of the moving international standards, and incorporate in it the elements relevant for Peru. Directors noted that it would be important to continue strengthening macro–prudential supervision. Consideration could be given to assessing the scope for incorporating systemic risk into the regulatory framework, reviewing the crisis resolution framework, and extending the prudential perimeter to cooperatives and public financial institutions.

Directors welcomed the authorities’ ambitious reform agenda to preserve high growth over the medium term, underpinned by continued prudent macroeconomic policies. The authorities’ plans to further develop Peru’s capital market would be key to effectively channel resources to sustained capital formation over the long term. Directors encouraged the authorities to continue with their poverty reduction efforts.