Activity to decelerate in 2022, after a strong 2021 rebound

In 2022, activity was set to decelerate sharply, owing to a high comparison base. Growth in household consumption (66% of GDP) will lose steam, affected by escalating consumer prices, which reached a 24-year high in April 2022. Food & non-alcoholic beverages, transport, housing, water, electricity, gas & other fuels have mainly driven the increase. The three groups represent 46% of Peru´s consumer price index basket, thus the sharp negative shock on households´ purchasing power. Moreover, credit conditions have also been retightened (from a minimum of 0.25% per year up to August 2021 to 5% in May 2022). Conversely, recent measures announced by policymakers, such as the rise in minimum wages and the temporary tax reductions on essential goods and fuels, could somewhat smooth the negative impact. In addition, in May 2022, Congress approved a sixth round of pension withdrawals, with the potential disbursement estimated at 3.6% of 2021 GDP. Meanwhile, private investment is expected to contract, impacted by tighter local and global financing conditions and the uncertain political scenario (keeping investors´ confidence subdued). Similarly, public investments should also perform poorly, influenced by the lack of political focus. Finally, exports (29% of 2021 GDP) are expected to contribute positively, benefiting from still-high copper prices and the rising global green agenda requiring higher volumes of red metal (including renewables and electric vehicles). Nonetheless, downside risks are related to a more challenging landing of global growth (including in its major client China) and frequent community-led protests at mines in Peru, which have gathered steam in the first half of 2022 (thus affecting productivity).

Twin deficits to narrow in 2022, notably the external one

After substantial fiscal consolidation in 2021, the budget deficit should slightly improve this year as activity recovers, and the fiscal stimulus (3% of GDP in 2021 and 14% of GDP in 2020) is gradually dismantled. In April 2022, the Ministry of Finance presented to Congress a bill that seeks a more gradual return to the fiscal rules suspended in 2020-2021 due to the COVID-19 crisis. The proposal points to a maximum gross public debt of 38% of GDP in 2023 and then converging towards 30% of GDP by 2032. Regarding the fiscal deficit, it considers that the latter should not be greater than 2.4% of GDP in 2023, then reducing the cap to 2% in 2024, 1.5% in 2025, and 1% in 2026.

The external account shortfall should also narrow in 2022, as the trade balance surplus is expected to increase. More precisely, decelerating domestic activity will lead to lower import expansion (26% of 2021 GDP). Moreover, strong mineral commodity prices, representing roughly 63% of total exports or 18% of 2021 GDP (notably copper and gold), should offset the widening in the net energy deficit (equivalent to 1% of GDP in 2021). Furthermore, the income deficit should also improve thanks to lower profit repatriations. Additionally, the services deficit could also curb, underpinned by travel revenues amid improving the COVID-19 health situation (albeit recent social tensions represent a downside to domestic tourism). On the financing side, while the jittered local political environment could affect foreign direct investments (2.8% of GDP in 2021), they should be sufficient to cover the expected lower external account shortfall in 2022. It is also important to note that firm foreign exchange reserves (equivalent to 35% of 2021 GDP and ensuring 19 months of import coverage) are essential buffers against potential external headwinds. Finally, total external debt (private and public) as of Q4 2021 stood at 45% of GDP (with 27% as medium and long-term public debt).

Public dissatisfaction mounts as inflation escalates, leading Pedro Castillo´s moribund government to walk a tightrope

Peru faced a wave of protests in March-April 2022, mainly driven by the sharp rise in fertilizer and fuel prices (a knock-on effect of the war in Ukraine), which led policymakers to announce a set of measures aiming to appease the protesters. These include a 10% hike in the minimum wage from 1 May (benefiting 30% of the workforce), a 3-month suspension of the excise fuel tax (at the cost of roughly USD 65 million per month), and the temporary elimination of consumption tax on some essential goods. In addition, it was also promised that USD 182 million would be allocated to acquire fertilizers for small producers. This landscape has further weakened Pedro Castillo´s leftist government (in office since July 2021), with his popularity dropping to a meager 19% in April 2022 (from 38% in August 2021). Schoolteacher, union leader, and son of peasant farmers, Castillo has never held an elected position before. He has failed to improve governability, having changed the prime minister four times and faced two impeachment attempts since the start of his mandate. Regarding his ousting attempts, the first motion occurred in December 2021 due to “moral incapacity,” a term in Peru´s constitution that holds a vague definition according to critics and that Congress has used six times since 2017 to try to remove presidents. The second attempt was in March 2022, underpinned again by “moral incapacity” encompassing corruption allegations, the controversial appointment of ministers, and accusations that Castillo favors giving landlocked neighbor Bolivia access to the Pacific Ocean. Furthermore, risks to government continuity go beyond the opposition’s frequent impeachment attempts. On 28 April 2022, eight lawmakers from the ruling Peru Libre party presented a bill to cut Castillo’s term from five to two years and set general elections for 2023. They argued that Castillo is going through a “legitimacy crisis.”