As the annual meetings of the IMF and the World Bank take place in Latin America for just the second time ever, Peru has been cast sharply into the global spotlight.
There is no single LatAm current: each economy has its own dynamics, advantages and hurdles. Nonetheless, the Andean country offers a snapshot of some of the themes that have driven Latin American economies — and emerging markets more generally — in recent years.
Peru represents some of Latin America’s positive trends: a growing middle class, rapidly expanding GDP and a deepening financial industry. At the same time, Peru’s development reflects some of the pitfalls that have also hit its neighbors. The country has struggled to bring its infrastructure up to scratch. Commodities exports, and growth in China, have been crutches for economic expansion. And, despite the growth, still-limited domestic savings pools make the country vulnerable to outflows from global investors.
Those hurdles have waylaid Peru’s rapid growth that characterized years past. Finance Minister Alonso Segura says the country’s potential GDP expansion now sits around 4.5% a year. The country is aiming higher: “What we want, and what our policies are aimed towards — investment in human capital, infrastructure, national diversification, civil service reform, red tape, etcetera — aim at pushing that growth rate towards the 6% rate that we had in the past,” says Segura. “That’s the aim, that’s our goal.”
The biggest task ahead for Peru in the coming decades, he says, is to avoid the middle income trap: to make sure the economy continues to grow in size and efficiency. The recipe could equally be applied to many others across the region.
Cutting the dependence on commodities for economic growth is a critical first step on this path, says Segura. “Latin American commodity exporting countries are facing a significant downward pull from the reversal of prices making it more urgent to overcome this dependence.”
To achieve that, Peru must improve its educational standards and diversify its economy, says Segura, who was appointed finance minister a year ago, after a stint as chief advisor to his predecessor, Luis Miguel Castilla. A national diversification plan aims to better insert Peruvian businesses in global value chains, across industries, regions and company sizes, he says.
Improving the country’s infrastructure is the third leg to the strategy, he says: “We need to connect the country.”
Across Latin America, governments have rolled out multiple initiatives to attract private investment into their infrastructure programs. Among them, Brazil has introduced tax incentives for bonds financing infrastructure projects, and Colombia’s finance ministry has been working with lenders and investment banks to devise a bankable structure for the private sector to finance its jumbo 4G road building program.
For close to a decade, developers of Peruvian projects have had access to a bond funding structure, known by the awkward acronym CRPAO, that offers government backing of payments.
Still, many in the industry privately gripe about the length of time it takes for infrastructure projects to advance in Peru. It’s a characterization Segura disputes, pointing to the fact that Peru is second among Latin American and Caribbean countries in the World Bank’s Doing Business ranking.
“Nobody said PPPs are easy,” he says. “These infrastructure projects are complex projects. There’s no country in the world where these projects are easy.”
Yet he concedes that there is room to improve, and says the ministry is working hard to cut red tape and streamline processes.
“You have to adapt gradually, and that’s what we’re doing,” he says.
“We’re introducing mechanisms to assess the quality of the legislation that is required, for infrastructure permits, or anything.”
Boasting a swath of liberal trade agreements with countries near and far, Peru’s economy is closely integrated with the global financial system and is pushing further with participation in the regional Trans-Pacific Partnership and Pacific Alliance arrangements. Yet Segura says there is more to be done.
“The next step, beside moving forwards with the TPP and Pacific Alliance, is to make even better use of the preferential access that we have,” says Segura. “That’s when we go back, for example, to the national production diversification plan and how we can integrate better to global value chains.”
While Peru’s exporters may trade with a diverse range of countries, they could further broaden the sectors of focus, he says. Additionally, the country needs to tackle non-tariff barriers, such as permits and licenses, he says.
The country has pursued a strategy of open global trade links so as to hedge against changes in any single economy or region. While Segura says mining will always be important for Peru’s economy, it is important not to make a one-sided bet regarding trade.
“We have a free-trade agreement with China, we have a free-trade agreement with the US, and we’re seeking integration with the Pacific Alliance. One of the main concepts of integrating to the world is not to put your eggs in one basket.”
Deeper ties with global economies, however, also puts the country at the mercy of volatility in international markets. The fall of Peru’s currency, the Nuevo Sol, over the past year, underscores the dynamic. The currency was down around 16% by late August, compared to a year earlier.
Global panic on emerging market currencies picked up in August as China loosened the trading band for the Yuan, a surprise move that pushed its value down. Segura characterized the fall as “just one more element” in a global shift in monetary policy, driven primarily by the strengthening of the dollar. Ultimately, he says, currencies should reflect the fundamentals of their issuing economy.
Peru’s sol has stuck closer to its true value than some other emerging market currencies, he says. That limited its rise when LatAm’s foreign exchange was strengthening against the dollar in years past — but has also protected it from dramatic drops experienced by neighboring currencies in recent months, he says.
“The Peruvian Nuevo Sol didn’t deviate from its fundamentals, it never deviated from fundamentals and probably many other currencies did deviate from fundamentals,” says Segura. “That’s why now on the way back they have much more to correct. So that’s a big part of it.”
As global markets rebalance after the financial crisis, traders, investors, borrowers and policymakers the world over continue to guess as to the trajectory of US interest rates. The US Federal Reserve is expected to normalize the cost of borrowing dollars in the years ahead.
The short-term effects of such rate risks have been tough on emerging economies in the past. Segura says stronger macroeconomic frameworks in place in emerging markets will help cushion the blow this time around. Further, market transparency is not what it was.
“The flow of information was not as instantaneous as it is today. There was much less call for discriminating one country from the next one. It was more of a common trend,” he says.
Rate fluctuations should be expected, but Peru has done what is needed to continue drawing in investment over a long term horizon, he says.
“You’re always going to have over short term windows some of these reversals in market enthusiasm,” says Segura. “You’re always going to have some of that.” LF