DBRS Confirms Republic of Peru at BBB (high), Stable Trend

DBRS, Inc. has confirmed the Republic of Peru’s long-term foreign and local currency issuer ratings at BBB (high). In addition, DBRS has confirmed the short-term foreign and local currency issuer ratings at R-1 (low). The trend for all ratings is Stable.

The confirmation reflects Peru’s strong public sector balance sheet and sound macroeconomic policymaking. Benefitting from a prolonged period of rapid economic growth and prudent fiscal management, Peru has reduced public debt to low levels and built up substantial fiscal savings. Furthermore, DBRS believes that Peru’s growth outlook remains favorable despite lower commodity prices and tighter global financing conditions. However, these strengths are counterbalanced by several rating constraints, including Peru’s weak institutional capacity, high exposure to commodity prices, infrastructure bottlenecks and high labor informality.

The Stable trends reflect DBRS’s view that 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. Conversely, the ratings could experience upward pressure over the medium term if (1) sound macroeconomic management is maintained and (2) progress on the structural reform agenda sustains Peru’s growth performance through productivity gains and economic diversification.

Peru’s economic performance has been exceptional. The economy expanded at an annual compound rate of 6.1% over the last decade, one of the strongest growth performances among emerging markets. This impressive record has been accompanied by a sharp reduction in poverty, employment gains and improved standards of living. However, a contraction in public and private investment combined with temporary supply-side shocks and deteriorating terms of trade led to a notable deceleration last year. The economy expanded just 2.4%. The slowdown appears to be bottoming out and growth is expected to pick-up over the next two years, driven by a reversal in the supply shocks and the support of expansionary fiscal and monetary policy. The IMF projects GDP growth of 3.8% in 2015 and 5.0% in 2016.

Although the economy is not expected to repeat the growth performance of the previous decade amid permanently lower commodity prices, Peru’s medium-term outlook is positive. Mega-projects in the mining and energy sectors are expected to begin or expand operations over the next three years, thereby substantially increasing production. Moreover, the development of various large infrastructure projects is expected to sustain relatively high levels of investment and bolster the economy’s medium-term outlook.

Peru’s strong fiscal track record and high rates of growth over the last decade have had a favorable impact the public sector balance sheet. Gross public debt at 20% of GDP in 2014 is low compared to other emerging economies. With the accumulation of substantial fiscal savings, public debt in net terms amounts to just 4% of GDP. As a result, the government has space to provide fiscal support to the economy, if necessary. In addition, the recent adoption of a new budgetary framework that incorporates a structural fiscal rule should reinforce fiscal discipline, facilitate counter-cyclical policy and improve budget transparency over the medium term.

Notwithstanding a large current account deficit, Peru is well-positioned to manage potential volatility stemming from the normalization of U.S. monetary policy. High net inflows of foreign direct investment (FDI) in large part reflect Peru’s need for investment-related capital goods and a reduction in FDI is likely to be broadly matched by a decline in imports. External debt is at moderate levels and the banking system, which is well capitalized and profitable, has limited reliance on external funding. Moreover, exchange rate flexibility in the context of a credible inflation-targeting regime is assisting the external adjustment. The current account deficit is likely to narrow within the next three years due to an expected sharp rise in commodity export volumes as several large mining projects begin operations. In the event of turbulence in global markets, Peru has ample foreign exchange liquidity with $62 billion (30% of GDP) in reserves.

On the other hand, Peru – as a large commodity exporter – is highly exposed to fluctuations in international metal prices. Copper prices declined over 30% from the end of 2010 to the third week of May 2015, with negative implications for Peru’s exports, fiscal receipts and overall growth. Further declines in commodity prices present downside risks. In particular, sharp downward revisions to growth in China could have large adverse effects on Peru through the terms of trade channel. In the event of a permanent shock, however, exchange rate flexibility combined with modest fiscal and monetary policy support could help cushion the short-term effects on the real economy as Peru gradually adjusts to less favorable global conditions.

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 workforce 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, improve education outcomes and strengthen 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 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, have not allayed tensions among stakeholders in some parts of the country. 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 Ministry of Economy and Finance, Central Reserve Bank of Peru, National Institute of Statistics and Information, Superintendent of Banks, Insurance and Pensions (SBS), International Monetary Fund, ECLAC, The Conference Board Total Economy Database, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer and did not include participation by the issuer or any related third party.
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: 30 May 2014

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