DBRS Confirms BBB (low) Ratings to Peru on Strong Recovery

DBRS Inc. (DBRS) has today confirmed the Republic of Peru’s Long-Term Foreign Currency Debt and Long-Term Local Currency Debt at BBB (low), and maintained Stable trends on both ratings. The Stable trends balance the resilience of Peru’s economy, which is quickly recovering from the global financial crisis, with a relatively unpredictable political environment ahead of the 2011 presidential elections.

The ratings are underpinned by sound macroeconomic management. Peru’s rules-based fiscal framework, good track record of controlling inflation and well regulated financial system enabled the government and the Central Bank (BCRP) to pursue a strong policy response to help cushion the effects of the crisis. In spite of these aggressive counter-cyclical measures, growth fell sharply in 2009 as Peru’s terms of trade deteriorated, driven by the fall in prices of some of its main mining export products. Nevertheless, the economy is rebounding briskly in 2010, with growth expected to surpass 8%. Growth has been helped in part by favorable terms of trade, as the price of copper has recovered and the price of gold has continued to rise.

Due to prudent fiscal management and robust economic growth, gross public debt declined from 47.1% of GDP in 2003 to 26.6% in 2009, among the lowest in Latin America. Debt reduction has been accompanied by a gradual shift to domestic currency financing and fixed rate debt.

The ratings are also supported by a strong liquidity position, with low external debt and reserves of $44.1 billion. As a result, Peru is well positioned to weather a resurgence in external volatility and the Central Bank can provide foreign currency liquidity as needed. This is especially relevant given the high level of financial dollarization that still characterizes the Peruvian economy, with resident dollar denominated deposits still accounting for 41% of total deposits.

Macroeconomic stability, greater openness to trade and investment and productivity-enhancing structural reforms have raised Peru’s economic growth potential. From 2002 to 2008, Peru was one of the fastest growing economies in the world, expanding at an average annual rate of 6.8%. Given its vast natural resources and recent initiatives to develop the country’s infrastructure, Peru is likely to experience sustained economic growth, with potential growth estimated at 6% of GDP.

Despite these strengths, the ratings are constrained by the risk of a return to populist policies. The political implications of regional inequality and social conflict, as well as the fragmented nature of the political party system present the single greatest risk to macroeconomic stability. Consistent and high economic growth has generated improvements in living standards and a significant decline in the poverty rate, diminishing the likelihood of policy reversal. However, the risk that a populist politician could win the presidential elections in April 2011 and undermine Peru’s sound macroeconomic framework still exists.

Another constraint on the ratings is the weak institutional capacity of the public sector. Government institutions, particularly at the sub-national level, often lack the capacity to allocate public resources efficiently, develop infrastructure and address the country’s deep social development needs. Reforms have supplied sub-national governments with additional assistance, streamlined public investment procedures and provided incentives to improve performance. Despite this, DBRS remains concerned about the quality of public spending.

The ratings are also constrained by Peru’s exposure to the commodity-price cycle. Peru exports a well-diversified group of primary products, and non-traditional exports are growing. These factors, combined with a prudent fiscal policy and abundant foreign currency liquidity, mitigate exposure to commodity-price volatility. At the same time, however, commodities are important to economic growth, the balance of payments and government revenues. Mining and energy products accounted for 68% of exports on average from 2005 through 2009.

A further constraint on the ratings is the high level of financial dollarization. Dollarization creates currency mismatches and balance sheet vulnerabilities throughout the economy that carry exchange rate and liquidity risks. Steps taken by the central bank have succeeded in gradually reducing dollarization, but the share of dollarized credit and deposits remains well above optimal levels, at approximately 44%.

The presence of a large informal sector also impairs credit quality. It is inefficient, drags down productivity growth, reduces the tax base and contributes to poor working conditions. Over two-thirds of the workforce is in the informal sector and high non-wage costs hinder formal job creation.

Peru’s macroeconomic policy framework has provided economic stability and the foundation for economic growth and social development. If the next administration is committed to policy continuity and prudent fiscal management, then continued economic growth alongside improvements in the state’s institutional capacity to deliver goods and services could put upward pressure on the ratings. However if the policy framework is not preserved, the ratings will come under downward pressure.

Notes:
All figures are in U.S. Dollars unless otherwise noted.

The applicable methodology is Rating Sovereign Governments, which can be found on our website under Methodologies.

The sources of information used for this rating include the Ministry of Economics and Finance Multi-annual Macroeconomic Framework 2011-2013, Central Bank (BCRP) Financial Stability Report dated November 2010, BCRP Inflation Report dated December 2010, BCRP Economic Statistics Database and Superintendency of Banks, Insurance, and AFP Statistical Bulletin. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Pedro Auger
Rating Committee Chair: Alan G. Reid

Initial Rating Date: 19 October 2007
Most Recent Rating Update: 22 December 2010

For additional information on this rating please refer to the linking document located below.