Peru: Trapped in its own web
Once again, politics has taken a front seat in Peru. Although the president, Martín Vizcarra, and his cabinet initially were perceived by the public to have dealt well with the Covid-19 crisis when it erupted in mid-March, recently they have experienced a drop in popularity. Firstly, and despite the long lockdown period enforced by the government, the infections and deaths curves have failed to flatten. Secondly, the ensuing economic recession has been deep, and several analysts, including ourselves, anticipate a deeper fall than that which will be experienced by other countries in the region. Finally, there has begun a period of confrontation between the government and the new Congress. Although, initially, the government and the new Congress held common objectives, Congress has overtaken Mr. Vizcarra in terms of its support of populist initiatives, with about 300 draft bills to be voted upon.
Is Peru falling into left-wing populism? This is a very difficult question to answer. Certainly, there are signs from Congress and the government indicating that there is a bias in that direction. However, with an economy close to standstill and the government running down its fiscal reserves, there is limited room for either conservatism or economic reforms. The final reckoning may come at the time of the presidential and congressional elections, scheduled for early 2021. The fact that this election may take place amid the worst economic slump since the depression of the 1930s may well make the economy the focus of the election campaign, as in the 1990s election. One key difference is that, since then, the country has enjoyed a well-managed market economy, with the benefits filtering down to the lowest income levels.
Real GDP growth forecasts anticipating the economy falling deeper into recession raise the question of why this is happening. Our hypothesis is that there are two factors that explain this divide: the long lockdown, and the sharp aggregate demand shock, which has not been fully offset by the fiscal contingency program.
The strong aggregate domestic demand shock resulted from two forces moving in opposite directions: on one hand, the drop in personal incomes resulting from job losses; and, on the other hand, the fiscal contingency program, aimed at offsetting this income loss. Our estimates indicated that, to offset the drop in personal incomes, formal and informal workers would receive funds currently equivalent to 8.7% of GDP or 13.2% of total private consumption. At first sight, this appears substantial. However, most of this support would be supplied by a reduction in workers’ mandatory savings and, by extension, a reduction in future consumption. In addition, of the 8.7% of GDP, only 2.6 percentage points had been used to offset the drop in personal incomes to end-May; the rest has been committed to but not yet disbursed.
In the past two weeks, four key reports have been released offering a reading of the economy in April and May. The messages were that the GDP growth rate slowed rapidly in April, but the May reports offered some hopeful signs that the slump is bottoming out. However, this latter message needs to be confirmed by the rest of the high-frequency reports scheduled to be release in the coming weeks. The April GDP report indicated that real GDP contracted by 40.5% oya in that month. On the month-on-month (m/m), seasonally adjusted comparison, real GDP fell 24% m/m, sa, the sharpest historical drop since records began and following a 10.4% m/m, sa, fall in March. Preliminary May reports (including daily estimates of electricity output and the PMI reports from the Banco Central de la Reserva del Perú (BCRP, the central bank) offered some encouraging signs.
One side-effect of the government’s large fiscal contingency program would be its impact on net indebtedness. Our forecasts anticipate an overall fiscal deficit of 10% of GDP in 2020 and net government lending amounting to an additional 8% of GDP. Fitch Ratings and the independent Fiscal Council reports released in the last two weeks have highlighted that the fiscal expansion resulting from the Covid-19 crisis would deplete fiscal savings, increasing the debt-to-GDP ratio, and put Peru in the category of middle-indebted investment-grade countries.
Few would dispute that the government’s decision to launch a large fiscal contingency program will undermine the fiscal accounts and that a side-effect of this is an increase in the gross debt to GDP ratio. However, future fiscal discipline would depend on two key factors: firstly, the commitment to fiscal discipline of the next government, due to take office in July 2021 and, secondly, post-Covid economic performance. With an economy coming out of deep recession, it may be advisable to make a gradual fiscal adjustment that would support the economic recovery while at the same time exerting moderate fiscal discipline.
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