DBRS Upgrades Peru to BBB, Trend Remains Positive

DBRS, Inc. (DBRS) has upgraded the Republic of Peru’s long-term foreign and local currency issuer ratings to BBB from BBB (low). In addition, the short-term foreign and local currency issuer ratings were upgraded to R-2 (high) from R-2 (middle). The trend remains Positive on all ratings.

The upgrade reflects Peru’s strong fiscal performance and high rates of growth, which have led to a substantial reduction in public debt and, more recently, the accumulation of fiscal savings. Underpinning this improvement in the public sector balance sheet has been a prolonged period of sound macroeconomic policymaking. In addition, the trend remains positive. This reflects DBRS’s assessment that growth prospects are favorable, fiscal accounts are in a healthy position, and the economy is well-prepared to manage adverse shocks. Ongoing prudent policy management in the context of rapid economic growth would further strengthen the sovereign’s credit profile, as public debt levels continue to decline and social indicators continue to improve.

Macroeconomic stability, structural reforms and favorable terms of trade have created the conditions for strong investment-led growth. The economy expanded at an average annual rate of 6.5% over the last decade. This impressive growth performance has been accompanied by a sharp reduction in poverty, employment gains and improved standards of living. Moreover, the medium-term growth outlook remains positive, despite the recent moderation in global commodity prices. Major investment projects in the mining and energy sectors are expected to substantially increase output over the next four years, including a 90% increase in copper production from 2012 to 2016 according to the Ministry of Finance. Efforts to develop public infrastructure and increase social spending will further support the economy’s transformation.

Peru’s strong growth performance continued in 2012, despite lower export prices. The economy expanded 6.3%, driven by buoyant domestic demand. In particular, investment grew 14.9%, in real terms, as the public sector ramped up capital spending in the second half of the year. With a long list of investment projects underway, Peru is expected to remain one of the fasting growing economies in Latin America. Consensus forecasts point to GDP growth of 6.3% in 2013 and 2014.

Fiscal accounts in 2012 posted a surplus for the second consecutive year. Revenues outperformed expectations and capital spending came in under budget, resulting in a surplus of 2.1% of GDP. Peru’s strong fiscal track record and high rates of economic growth over the last decade have had a favorable impact on debt dynamics. Public debt fell below 20% of GDP in 2012, and the government has accumulated substantial fiscal savings. In net terms, public debt amounts to just 5% of GDP.

Downside risks to the outlook largely stem from the external environment. A sharp slowdown in the global economy would affect Peru principally through financial and terms of trade channels. As a large commodity exporter, Peru is highly exposed to fluctuations in commodity prices. Weaker growth in the United States or China could lead to lower commodity prices and have strong negative effects on exports, investment and fiscal revenues.

However, Peru is well-positioned to weather an adverse shock. Peru has space to provide counter-cyclical fiscal and monetary support if the growth weakens. High net inflows of foreign direct investment, which averaged 4.3% of GDP annually over the last decade, fully finance the current account deficit. External debt is at moderate levels and reserves totaled $67.7 billion (34% of GDP) in February 2013. In addition, the banking system, which is well capitalized and profitable, has limited reliance on external funding.

On the other hand, large capital inflows present risks in the domestic economy. The central bank is utilizing various tools, including higher reserve requirements, to guide price stability while preventing the buildup of financial imbalances. Nevertheless, continued vigilance will be needed to ensure that capital inflows amid strong domestic demand do not generate inflation risks or unhealthy credit dynamics.

To sustain growth momentum over the medium term, Peru will likely need to address several structural challenges. Specifically, infrastructure bottlenecks, poor education outcomes and a large informal market constrain productivity growth and economic diversification. At the same time, government institutions, particularly at the sub-national level, have limited capacity to allocate resources efficiently and attend to social needs, even as public demands on the state are increasing. DBRS recognizes that the government is taking steps to address these challenges, including measures to facilitate infrastructure investment, develop local capital markets and improve public administration. However, the potential benefits of these initiatives are only likely to be visible over the medium term.

In addition, concerns over the rapid expansion of extractive industries amid severe poverty and inequality have fostered discontent in many rural communities and increased the frequency of social conflicts. Measures taken by the Humala administration, such as the consultation bill, could help allay tensions among stakeholders and build consensus on socially-inclusive growth strategies. On the other hand, sustained opposition to extractive industries could negatively affect the investment climate and potentially weaken economic growth.

Prudent policy management amid favorable terms of trade have substantially improved the public sector balance sheet and provided the foundation for major advances in the country’s social and economic development. If changes to the macroeconomic policy mix weaken the economy’s resilience to adverse shocks or social conflicts negatively affect the investment outlook, the trends could be revised from Positive to Stable. Conversely, solid economic growth alongside responsible fiscal management could result in an upgrade of the ratings.

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

The principal applicable methodology is Rating Sovereign Governments, which can be found on our website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Michael Heydt
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 19 October 2007
Most Recent Rating Update: 17 December 2012

For additional information on this rating, please refer to the linking document under Related Research.