DBRS Confirms Peru at BBB (low), Trend Revised to Positive

DBRS, Inc. (DBRS) has confirmed its ratings on the Republic of Peru’s long-term foreign and local currency securities at BBB (low), and changed the trends from Stable to Positive. The ratings balance the comparatively low level of public debt and a credible macroeconomic policy framework with the government’s weak institutional capacity and the economy’s exposure to the commodity price cycle. The Positive trends reflect macroeconomic policy continuity with greater policy space to face adverse shocks and favorable medium-term growth prospects.

In June 2011, Ollanta Humala won the second round of the presidential elections, and President Humala’s administration has maintained the sound and prudent fiscal and monetary policy framework that has been one of the hallmarks of Peru’s economic performance, while pledging to respect the rule of law and to improve social inclusion. DBRS views the presence of a prudent and credible macroeconomic policy framework as key for the ratings, as it underpins the economy’s resilience in the face of adverse shocks.

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 2009 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 rebounded briskly, with GDP growth of 8.8% in 2010 and an estimated 6.9% for 2011. This positive economic performance has been helped in part by favorable terms of trade, as the price of copper and gold have recovered.

As an economy that is well integrated into the world economy through commodity exports and financial links, it is exposed to global economic conditions. The presence of downside risks arising from continuing concerns over sovereign debt and bank balance sheets in some advanced economies – in particular, the Euro area – or a slowdown of growth in China, could have negative impacts on Peru’s economy through financial or terms of trade channels. Nevertheless, the presence of a credible macroeconomic policy framework, combined with a low level of public debt at 20.1% of GDP, a Fiscal Stabilization Fund of 3.2% of GDP and high external liquidity with international reserves of US$53 billion or 30% of GDP (up from US$35.5 billion in August 2008), provide room for policies to mitigate these risks.

Due to prudent fiscal management and robust economic growth, gross public debt declined from 47.1% of GDP in 2003 to an estimated 20.1% of GDP in 2011, among the lowest in Latin America. Debt reduction has been accompanied by a gradual shift to domestic currency financing and fixed-rate debt. As a result, exchange rate and interest rate risks for the sovereign have fallen, strengthening the government’s capacity to face adverse shocks. Similarly, the Central Bank has accumulated large foreign currency reserves, enabling it to provide dollar liquidity as needed. This is especially relevant given the high level of financial dollarization that characterizes the Peruvian economy, with resident dollar-denominated deposits accounting for 41% of total deposits.

The Peruvian economy faces several long-term structural challenges that could constrain the country’s economic and social development. First, the public sector often lacks the institutional capacity to allocate its limited resources in an effective manner. As incomes grow it is likely that the demands on the State will intensify with respect to social needs, infrastructure provision, and regulatory and supervisory capacity. Second, as a country richly endowed with natural resources, its economy remains vulnerable to volatility in commodity prices. Third, dollarization across the economy creates currency mismatches and balance sheet vulnerabilities that carry exchange rate risk. Fourth, a large and low-productivity informal sector endures.

Peru’s macroeconomic policy framework has provided economic stability and the foundation for economic growth and social development. DBRS views the presence of a prudent and credible macroeconomic policy framework as key for the ratings. A change in policy that weakens the economy’s resilience to face adverse shocks could bring the trends to Stable. Continuing prudent fiscal management alongside solid growth prospects and improvements in the state’s institutional capacity to deliver goods, services, and infrastructure investment could place upward pressure on the ratings.

Notes:
All figures are in US Dollars unless otherwise noted.

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

The sources of information used for this rating include the BCRP, Ministry of Economy and Finance, INEI, ECLAC, Banking Insurance and Pension Supervisor (SBS), IMF and Haver Analytics. 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 under Related Research.