DBRS Upgrades the Republic of Peru to BBB (high), Stable Trend

DBRS, Inc. (DBRS) has upgraded the Republic of Peru’s long-term foreign and local currency issuer ratings to BBB (high) from BBB, and upgraded the short-term foreign and local currency issuer ratings to R-1 (low) from R-2 (high). The trend for all ratings has been revised to Stable from Positive.

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 financial savings. Underpinning this improvement in the public sector balance sheet has been a prolonged period of sound macroeconomic policymaking. These strengths counter several rating constraints, which include Peru’s weak institutional capacity, exposure to commodity-price volatility and infrastructure bottlenecks. The Stable trend reflects DBRS’s assessment that Peru’s growth prospects remain favorable, despite deteriorating terms of trade, fiscal accounts are in a healthy position, and the economy is well-prepared to manage adverse shocks.

Risks to the ratings are broadly balanced. If changes to the macroeconomic policy mix weaken the economy’s resilience or social conflicts materially affect Peru’s medium-term investment outlook, the trends could be revised to Negative from Stable. Conversely, the ratings could experience upward pressure over the medium term if (1) sound macroeconomic management is sustained and (2) progress on the structural reform agenda strengthens Peru’s growth performance through productivity gains and economic diversification.

Peru’s economic performance over the last decade has been exceptional. Macroeconomic stability, greater openness to trade and investment, and productivity-enhancing structural reforms have raised Peru’s growth potential. These supply-side factors have been complemented by favorable external financing conditions and positive terms of trade dynamics. As a result, the economy expanded at an average annual rate of 6.6% over the last decade (based on national accounts with base year 1994). This impressive growth record has been accompanied by a sharp reduction in poverty, employment gains and improved standards of living.

Moreover, the medium-term outlook is positive even as Peru’s terms of trade deteriorate and global financing conditions tighten. Major investment projects in the mining and energy sectors are expected to substantially increase output over the next four years, including a twofold increase in copper production from 2013 to 2017 according to the Ministry of Finance. The development of public infrastructure and increased social spending will further support the economy’s transformation. The IMF projects GDP growth of 5.5% in 2014 and 5.8% in 2015.

Fiscal accounts in 2013 posted a surplus for the third consecutive year. The government boosted public investment and increased spending on civil servant salaries without putting stress on public finances. 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 to 19% of GDP in 2013, and the government has accumulated substantial fiscal savings. In net terms, public debt amounts to just 4% of GDP. Looking ahead, the new fiscal framework, which was approved in October 2013, will reinforce fiscal discipline, facilitate counter-cyclical policy and improve budget transparency.

Notwithstanding a large current account deficit, Peru is well-positioned to manage potential volatility stemming from normalization of U.S. monetary policy. High net inflows of foreign direct investment, which averaged 4.5% of GDP annually over the last decade, provide a stable source of external funding. External debt is at moderate levels and the banking system, which is well capitalized and profitable, has limited reliance on external funding. Moreover, Peru has ample foreign exchange liquidity in the event of turbulence in global markets. Reserves at the central bank totaled $64.8 billion (31.4% of GDP) in April 2014.

On the other hand, Peru – as a large commodity exporter – is highly exposed to fluctuations in international metal prices. A prolonged slowdown in the global economy would affect Peru principally through the terms of trade channel. In particular, a sharp downward revision to growth in China could lead to lower commodity prices and have strong negative effects on Peru’s exports, investment and fiscal accounts. Nevertheless, exchange rate flexibility combined with fiscal and monetary policy support would help cushion the short-term effects on the real economy if a shock materializes.

In the medium term, Peru will likely need to address several structural challenges in order to sustain high rates of growth. 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. The government is taking steps to address these challenges, including measures to facilitate infrastructure investment, develop local capital markets and improve public administration. The potential benefits of these initiatives, if successful, are only likely to be visible over the medium term.

In addition, concerns over the rapid expansion of extractive industries amid widespread poverty and regional 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. However, if opposition to extractive industries intensifies, it could negatively affect the investment climate and potentially weaken economic growth.

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

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS 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, Banking Insurance and Pension Supervisor (SBS), IMF, ECLAC, 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.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Michael Heydt
Rating Committee Chair: Roger Lister
Initial Rating Date: 19 October 2007
Most Recent Rating Update: 29 April 2013

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