Economic recovery and political conflict
While the economy is showing clear signs of improvement, the political realm is riven by strife. Corruption allegations linked to Brazilian construction firms’ scandals seem to be extending to all ambits of government. Still-unclear information from Brazil suggests that Keiko Fujimori’s 2011 presidential campaign may have received Odebrecht financing, while a member of the majority, Daniel Salaverry, levied a constitutional accusation against Attorney General Pablo Sanchez, charging that his attorneys lacked diligence in persecuting local construction firms that worked in consortia with Odebrecht. Congress has also insisted that President Pedro Pablo Kuczynski appear before the commission investigating the Brazilian firms’ scandals. There is a strong conviction that all these actions are politically motivated. But the prosecutor has gone much further, asking the judge to raid two of Fuerza Popular’s political offices – an action that puts the three branches of government at loggerheads.
Primary activities stagnated in October, with negative growth for mining, fisheries, and possibly agriculture. But non-primary activities have started to perform satisfactorily, with growth at 3%+, with the construction sector especially strong, due in part to the spectacular public investment rebound. And private investment is reviving at last. So we see growth at 2.5% - 2.6% y/y in October. As expected, domestic demand, practically stagnant since Q4 2016, has rebounded, growing 2.4% in Q3; we expect it to top 4% in Q4. We see recovery continuing, with strong performance in H1 2018 if political confrontations do not spiral upward.
Inflation plummeted after food prices fell back, after skyrocketing on the heels of El Niño. Core inflation (excluding changes in food and energy prices) is also falling. In November the core number was 2.2%, and this reveals that second-round effects after El Niño were absent. This can be attributed to still-weak domestic aggregate demand, and the persistence of currency revaluation.
Congress approved the 2018 budget at the end of November, with no material changes from the executive branch’s August draft. It implies 3.5% deficit, half of its increase due to planned outlays for post-El Niño reconstruction.
Certain issues could influence long-term fiscal sustainability. First, there is widespread consensus on the need to increase fiscal revenues. Second, the government has set very high targets for public investment. Finally, the Ministry of Finance released its strategy for asset and liability management for 2018-2021. As expected, the central element is the need to continue raising the share of public debt denominated in soles.
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