Ready for Reactivation

Economic growth in Peru is expected to rebound to between 3.5% and 4% this year and accelerate even more in 2003. The government’s plan is built around a wide-ranging tax reform and an ambitious privatisation agenda.

Investors in Peru see Pedro-Pablo Kuczynski as a man with whom they can do business. The former investment banker, who returned from the US to Lima to take the helm at the Ministry of Economy and Finance is, in the words of one foreign executive, “on the same page” when it comes to what needs to be done to get the economy moving again.

In the first six months of the Toledo administration, ‘PPK’ has not had things all his own way, facing an unruly Congress and a population crying out for quick fixes. But there were signs in early 2002 that he and Prime Minister Roberto Dañino, also well regarded by investors, are managing to impose their points of view and their agendas.

Kuczynski admits relations with Congress have not been easy: “As a result of the political context, Congress has been very keen to promote social legislation, right the wrongs of the past, and so on. The other thing about the Congress is that this is the first time you have a majority elected on a constituency basis, rather than through a proportional representation list. So it has more local interests than in the past.”

The continuing revelations of misdeeds committed by Vladmiro Montesinos, head of intelligence under former president Alberto Fujimori, further complicates the scene. “During these first few months of the government, there have been a lot of investigations and accusations about the past. This complicates management somewhat,” he explains. “Despite all this, I think the agenda we set out for this ministry at the beginning is being carried out pretty much on schedule.”

The international credit rating agencies like the changes taking place in Peru. Standard&Poor’s, which rates the sovereign BB-, raised its outlook to positive from stable in January. It noted the government’s “increasing ability to work internally and with Congress in formulating and implementing economic policies. The authorities passed important legislation on pension reform [and] resisted pressure by Congress to adopt more restrictive labor practices in the construction and maritime sectors. Finally, the authorities signed a letter of intent with the International Monetary Fund, whose centerpiece is comprehensive tax reform, aimed at improving the system’s neutrality and equity.” Moody’s also changed its ratings outlook to stable from negative, pointing to “renewed commitment to fiscal discipline” and highlighting the likelihood of a stronger political base for the government within Congress. Moody’s gives Peru a Ba3 rating.

Kuczynski took office knowing there was an urgent need to revive the economy, which had posted average growth of only 1% from 1998 to 2000. Growth last year fell to just 0.2%. A series of external shocks and domestic crises going back to 1997 have taken their toll on confidence. He points to a series of fiscally expansive, short-term measures taken last year aimed at lifting the economy, such as a cut in a special wage tax to 2% from 5% and an increase in public sector pensions and salaries. In November and December 2001, says Kuczynski, indicators such as sales tax receipts and construction activity showed that the economy was bouncing back. December’s gross domestic product grew 4.1% year-on-year and sales tax receipts in January, reflecting Christmas takings, were more than 10% higher than a year before. “Things are taking off. The only question is at what rate this recovery will happen in 2002. It is very important that relations with Congress send the right message to the private sector. More populist measures will slow recovery,” says Kuczynski.

Eduardo de las Casas, country treasurer and corporate finance head at Citibank in Peru, says: “Everything is ready for reactivation – but it is not just about the local environment. We have a difficult world slowdown.”

The government expects growth to rebound to between 3.5% and 4% in 2002 and accelerate to 5% in 2003. The IMF has sanctioned the government’s 2002-2003 economic program and approved a two-year, $316 million stand-by agreement. The program is built around a wide-ranging tax reform and an ambitious agenda of privatisations: good relations with Congress will be vital to achieve progress on politically sensitive issues.

Some analysts are more pessimistic than the government, predicting growth nearer to 3% this year and pointing out that around half of that will be attributable to rise in mining output following last year’s start of production at the giant Antamina copper and zinc project. Some voice more concerns about longer-term prospects.

Hugo Santa María, principal economist at the Apoyo consultancy in Lima, says: “There is no work on things that will allow us to grow strongly from 2003 onwards.”

Challenge Ahead
Juan Carlos García, manager of Banco Wiese Sudameris’s economic studies division, however agrees that GDP growth will be around 3.8% this year, driven by a predicted 8% expansion of the primary sector. But he also says 2003 will be a big challenge. “That is why it is important to advance strongly in the privatisations: if they are aggressive and there is good news, investment should react,” he says. “The risk is that if the government doesn’t work together better politically and push forward the reforms, there will not be a feed-through into the economy – and when you have to have a fiscal adjustment towards the end of the year, things could deflate quite quickly.”

Peru is estimated to have posted a public-sector fiscal deficit of 2.4% of GDP in 2001. For 2002 the government is promising a reduction to 1.9% of GDP, with the chance to ease the target by another 0.3% if privatisations go well. Kuczynski says that for 2002 the government, “Will have to push a more comprehensive tax reform, with elimination or at least reduction of exemptions: that is going to be tough.”

Apoyo’s Santa María predicts the deficit will be 2.2-2.4% this year. But Kuczynski maintains the government’s fiscal goal is achievable. “The [International Monetary] Fund and our guys calculated tax revenues very conservatively. I think we will spend more than budgeted but we will also collect more than budgeted,” he explains.

Boosting the Tax Take
The minister believes there is plenty of scope to increase the overall ‘tax take,’ currently a paltry 12.1% of GDP. The IMF program pledges an increase to 12.6% in 2003. “I think we can do better than that,” says Kuczynski. “The basic target over the next two or three years will be to get it to 15% without raising tax rates.”

Other elements of Peru’s accord with the IMF envisage inflation being pegged to 2.5% this year and 2% in 2003 – last year is estimated to have closed with zero-inflation, or even slight deflation – and a small rise in international reserves, which are already enough to cover ten months’ imports. The current account deficit is projected to remain under 3% of GDP.