Kuczynski began his five-year term at a critical time for Peru. The economy is expanding faster than most others in the region, but below potential. Gross domestic product grew by 4.1% in the first six months of this year. That’s ahead of the 3.8% target the previous government set in its multi-annual macroeconomic indicators in April and the forecasts of the IMF and other multilateral agencies.
What’s more, inflation in July eased into the 1%-3% target band for the first time in 17 months and the central bank now expects inflation to come in at 2.8% for the year, down from initial forecasts of 3.5%. The local currency, the sol, is also stronger than anticipated, appreciating 1.8% against the dollar in the first seven months of the year, much better than the central bank’s initial projection of a 7% decline for the year.
“Economic growth will give the Kuczynski government room to maneuver,” says Luis Hurtado, an associate for macro strategy at Canada’s CIBC Capital Markets. “The central bank is doing a good job returning inflation to the target range and the sol is doing relatively well.”
Exports, while still well below the record $45 billion at the end of the last decade, have stabilized. The trade deficit for the first six months of the year clocked in at $840 million, far below the $2.2 billion deficit recorded in the same period last year. The Kuczynski government announced in August that it would begin implementing plans to boost exports, with the goal of reaching $70 billion by 2021.
“The goal of $70 billion may sound too ambitious, but we think that it is feasible. We are working on an integrated system that will address the recurring problems faced by exporters to provide a systematic solution,” says Eduardo Ferreyros, minister for foreign trade and tourism.
Although most numbers are promising, the Kuczynski government will have to deal with a larger-than-expected fiscal deficit that could complicate its plans to ramp up public investment while reducing taxes.
The fiscal deficit was equivalent to 3.3% of GDP in the 12 months ending in July. That month’s deficit alone was double what it had been last July. The administration has announced that it will increase its estimate of the fiscal deficit to 2.5% of GDP for 2017, up from the 1.8% the previous government had included in its debt calculations. The Kuczynski administration still plans to lower the deficit to 1%, but allows it will take longer to get there.
“Looser fiscal policy is not a concern in the immediate term because government debt is quite low, but it will reinforce a pro-cyclical economic policy,” says Adam Collins, Latin America economist with London-based Capital Economics.
Alfredo Thorne, the finance minister, says the higher fiscal deficit will provide the government with approximately $1.5 billion more for the 2017 budget, helping to ensure that the economy grows by a sustainable 5% annually starting next year.
Ambitious growth
Kuczynski’s growth plan revolves around a mix of policies to ramp up public-sector investment, encourage private funding sources and increase the buying power of Peruvians through lower taxes and formal job creation.
Although public investment fell by 5% in June, pundits such as Spain’s BBVA predict a pick-up in the final quarter of 2016, forecasting public investment will end the year around 6% above 2015 levels.
Thorne said that the government has identified $18.8 billion in public/private partnerships that have been awarded but have snagged in bureaucracy. The government is confident that major public works projects, including the $6 billion second line of Lima Metro in the capital and several other large-scale investments, will take off. Planned investment in the Metro for 2016 is pegged at $685 million, but only 17% of that was invested in the first half of the year, according to the Transportation Ministry.
Transportation Minister Martín Vizcarra announced in early August that the government had already uncorked one project, the long-stalled construction of the $1.1 billion second runway at Lima’s international airport. The runway was included in the initial concession granted to Lima Airport Partners 16 years ago, but delays involving expropriating properties and finishing basic infrastructure mounted. Construction is now slated to start in the first quarter of 2017.
The government also plans to move quickly to fulfill Kuczynski’s campaign promise, which he has repeated daily since taking office, of providing water and sewage services to all households, as well as increasing the budgets in education, healthcare and security.
It is a tall order. A report by AFIN, an infrastructure association of private companies, estimates that Peru needs to invest $68.8 billion between 2016 and 2020 in infrastructure, including $19 billion in the water/sewage, education and healthcare sectors. Transportation improvements will cost even more, at $21.3 billion.
Increased public investment will coincide with measures to stimulate private investment, which dropped by 4.4% in 2015. Credicorp Capital forecasts private investment will decline another 4.5% this year.
A critical issue is finding a way to get mining companies to move on large-scale projects. Mining groups invested $42 billion between 2011 and 2016, but no new mega projects are under development. Investment in mining was a paltry $1.6 billion in the first five months of this year, according to the most recent data from the Energy and Mines Ministry, down 44.7% compared to the same five months of 2015 (see mining article on page 29).
The government hopes to boost private investment through an array of proposals, including tax breaks for large companies that reinvest and lower taxes for small and medium-sized enterprises. The president harped on his long-term goal of formalizing the economy during his inaugural address. Kuczynski pledged to double to 60% the number of workers on payroll and receiving benefits, up from just 31.7% now in the formal economy.
A major component of Kuczynski’s plan to grow the formal sector involves reducing Peru’s value-added tax (VAT), from 18%. The government has said it will shave off one point in January and work toward lowering it to 15% by 2021. The logic is that a lower VAT would encourage small businesses to formalize their employment practices and also put more money in workers’ pockets, stimulating growth from the private sector.
Potential gridlock
Lowering the VAT, as well as running a higher fiscal deficit, could put the administration at odds with the dominant party in Congress, Fuerza Popular, headed by Keiko Fujimori, who the president defeated in the June election.
Fuerza Popular holds 73 out of the 130 seats in the unicameral Congress, giving it enough votes to reject legislation for lowering taxes or increasing the debt ceiling. VAT collection was down 6.2% in July compared to the same month last year, the steepest decline in 14 months, according to BCR.
The Fujimoristas in Congress have argued that a reduction in the VAT rate would make this shortfall worse. The government counters that tax collection could increase by two points if government policies are implemented.
The government’s not-so-secret weapon, say Hurtado and Collins, is the president himself, who has spent his long career moving between the public and private sectors, piling up contacts. “Kuczynski is the driver for foreign investors looking at Peru,” says Collins. “He is a well-known quantity and this is what investors like.” LF