Escaping Meltdown, For Now: Peru’s Economy Goes On

Peruvian President Pedro during a speech in Juliaca. Source: Carlos Mamani/AFP

Despite being hardly hit by the Covid-19 pandemic and a permanent state of political crisis, Peru’s economy is doing remarkably better than it should due to a fresh wave of domestic investments and an increase in public spending. However, the country still faces serious challenges to its long-term economic health.

After going through five presidents in the past five years, and living through a pandemic that devasted markets around the world, Peru still managed to record an impressive 13.3% GDP growth in 2021. Now, with successive impeachment attempts against sitting president Pedro Castillo, nationwide protests, and a war in Ukraine disrupting global supply chains; one could be excused to think that this is the year that the Peruvian economy would crumble for good. And yet, according to projections revised by the International Monetary Fund in April 2022, the country’s GDP is still expected to grow by 3% in 2022. Among major economies in South America, expectations for the Peruvian economy are far worse than only Colombia and Argentina. This article explores the reasons behind Peru’s resilience towards recent political shockwaves and discusses a few challenges yet to be faced by the country’s economy.

FAILURE OF THE OLD MODEL

IMF GDP Growth Projections for Latin America in 2022. Source: AS-COA

Peru has long been heralded as one of Latin America’s main success stories. From the beginning of the twenty-first century institutional reforms took the country from a position of hyperinflation and economic decline to becoming one of the strongest performers in the region. In the late 1990s and early 2000s, seizing the momentum provided by favorable external conditions which included a commodity boom, Peru engaged in a series of important macroeconomic reforms. These reforms included fiscal discipline, monetary stringency, and market deregulation that led to a strong increase in foreign investment in the country. The result was an average GDP growth of 6.4% between 2004 and 2013, approximately 2 percent higher than the rest of the Latin American average.

However, foreign investment was not there to save Peru during its post-pandemic recovery, as investments are still far from 2019 levels. According to the United Nations Economic Commission for Latin America and the Caribbean, annual FDI inflows in Peru fell by 87.8% in 2020, dropping from USD 8.05 billion in 2019 to USD 982 million in 2020, the worst level since 2020. An inflow of USD 6.2 billion in 2021 has marked a robust recovery for the Peruvian economy. Yet, Peru is far from regaining its attractiveness as FDI flows will most likely not return to the pre-2020 levels.

A NEWLY FOUND INTERNAL INVESTMENT IMPETUS AND STATE INTERVENTIONISM

Foreign direct investment inflows, 2019 and 2020. Source: ECLAC

When investors from the outside were not very keen to bet their money on Peru, national private equity found its way to boost the country’s recovery. In 2021, private investment in Peru increased by 34% relative to 2020 and 12% relative to 2019. These investments especially in the mining sector helped propel Peru’s economy to achieve a higher-than-expected recovery. For instance, Anglo American Perú alone was responsible for USD 5.5 billion in new investments in 2021, representing approximately a 30% increase in investments for the mining sector, one of the most important in Peru.

There has been a lack of international funds. It was up to the Peruvian government for the first time in a while to take charge of economic recovery by using the oldest trick in the Keynesian macroeconomic book: public spending. Notably, public spending in 2021 was the biggest in Peru’s history, with PEN 39.1 billion (USD 10.21 billion) in expenditure. This figure represents a 21% increase from the previous record, set in 2018, and a 38% increase from 2020.

NEAR-TERM BET, LONG-TERM RISKS

Peru’s newly found internal investment clout has been able to keep the country’s economy afloat despite the political upheaval. Peru’s economy isn’t permanently safe, it just managed to put off the worst-case scenario. A persistent lack of reforms to modernize the country and a growing public debt present a more serious risk for the country in the long run than a temporary drought of foreign capital.

BCRPData, the statistics department of the Peruvian central bank, reported that business confidence in the long-term health of the Peruvian economy has hit its lowest level since May 2020. Additionally, BBVA Research predicts private investment to fall by 5.4% in 2022, not only due to political crisis but also due to the failure of some mining projects on which the country is very dependent. Therefore, national private investment may have helped the country regain traction in its post-pandemic recovery, but future flows are nothing but dubious. The political infighting keeps the country from making new reforms to steer the country away from its dependency on the export of primary goods.  

On the fiscal side, Peru’s debt to GDP ratio worryingly increased from 25.2% in the first quarter of 2019 to 35.9% in the last quarter of 2021, way over the 30% ceiling established by the legislative decree n. 1276, the golden standard of fiscal responsibility established by the country in December 2016. Furthermore, the country is expected to run a fiscal deficit of 2.5% of its GDP, in 2022, which is also an overshoot of the 1% ceiling established by Peru’s fiscal rules. Soon, President Castillo will find himself between a rock and a hard place in spite of his continuous escapes from successive impeachment attempts. His administration will need to decide whether to rein in public spending and face public outcry or let Peru’s budget likely go out of control.

  • Will Castillo have enough support to implement necessary measures to keep Peru’s public debt in check or will he succumb to the idiosyncratic tendencies of the populists?
  • If Castillo chooses austerity, will he have enough political clout to withstand continuous attempts to oust him from office?
  • Will Peru ever be reinstated as the golden destination for FDI in Latin America?

Suggested readings:

Chavez, Benjamin, and Jaime Dupuy. “Inward FDI in Peru and its policy context”. 2010.

Valenzuela, Arturo. “The crisis of presidentialism in Latin America.” Politics, Society, and Democracy. Routledge, 2018. 121-139.

Camarero, Mariam, Laura Montolio, and Cecilio Tamarit. “Understanding German FDI in Latin America and Asia: A comparison of GLM estimators.” Economies 8.1 2020: 19.

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