Improved Expectations, With A Growth Challenge Ahead
We continue to envisage a relatively optimistic scenario for the Peruvian economy, though certainly less optimistic than the authorities do. GDP grew by a stronger 4.2% y/y in the first eight months of 2016, due to an 9.5% expansion of primary sector activity, driven by the production ramp-up of the Las Bambas and Cerro Verde mines. But other non-primary activities have failed to pick up. We see primary activities continuing to grow in 2017, driven by mining output and a rebound in the fishing industry. But primary activities will exhibit weak growth after 2017, with mining investment low.
So reaching our 2017 projection of 4.3%, will demand the recovery of non-primary sectors, especially in domestic demand. This is the great challenge facing the new administration.
We see the external current account deficit at 3.6% of GDP by yearend, an improvement from 2015’s 4.8%. This is mainly due to imports decline, caused by weak domestic demand growth, especially by investment decline. We foresee net private capital inflows as insufficient to finance the CAD in coming years, so the public sector will be used as a source of net capital inflows for the international reserves not to decrease.
Business confidence has improved markedly. President Pedro Pablo Kuczynski’s outstanding credentials, and perhaps relief at the end of the lackluster Ollanta Humala regime, is a factor. The government is also accelerating large PPP infrastructure projects, such as the number 2 metro line, and the Southern Peru Gas pipeline. Hence, we expect some recovery in private investment. The government also plans to bolster private consumption, including via a VAT rate cut. The executive branch and the opposition-controlled congress have managed to establish a surprisingly good working relationships so far. We think GDP growth in the next three years could average 4%.
After peaking at 4.5% early this year, headline inflation and to a lesser extent the core measure are strongly declining, now to around 3% (the upper limit of the inflation target range). We expect rates to end the year apace.
The Central Bank has kept its policy rate constant at 4.25%, after raising rates 100 bp since H2 2015 and in February 2016. We expect the Bank to leave rates unchanged for the rest of the year, assuming a Fed hike 25 bp in December. But the Bank could be forced to increase its rate in tandem with any Fed hikes next year: we assume by 25 bp, if the Fed limits its hikes to 50 bp.
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