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) and short-term foreign and local currency issuer ratings at R-1 (low). The trend on all ratings is Stable.

The ratings are underpinned by Peru’s (1) sound macroeconomic management, (2) low public debt, and (3) solid external position. The economy is adjusting to a large and persistent terms-of-trade shock, and after two years of slow growth there are signs of recovery. Although Peru is not expected to repeat the growth performance of the previous decade, the medium-term outlook remains favorable. Furthermore, both candidates in the June 5th presidential run-off – Keiko Fujimori and Pedro Pablo Kuczynski – are supportive of the current macroeconomic policy framework.

Peru’s economy is recovering despite a challenging external environment. Declining commodity prices, weaker regional demand, and difficulties executing public investment contributed to slower growth over the last two years. Peru expanded just 2.4% in 2014 and 3.3% in 2015 compared to average growth of 6.4% from 2004 to 2013. However, economic activity is picking up, led by rising mining output – copper production is set to double from 2014 to 2017 – and increasing public investment. The IMF expects growth of 3.7% in 2016 and 4.1% in 2017, although DBRS sees upside risk to this forecast.

Investment levels, though declining, remain relatively high and underpin Peru’s medium-term outlook. The investment rate is expected to average 23% of GDP from 2016-2020, down 3 percentage points from 2011-2015 but still high compared to regional peers. Drivers of investment include the mining sector, which remains highly competitive, as well as infrastructure development.

The economy is adjusting to the commodity-price shock in an orderly manner. The current account deficit is expected to narrow from 4.4% of GDP in 2015 to 3.9% this year as mining exports increase, imports remain subdued and exchange rate depreciation facilitates the adjustment. Net inflows of foreign direct investment, though lower, continue to provide most of the external financing. In the event of an adverse shock, Peru has low external debt and ample foreign exchange liquidity. On the domestic front, inflation is above the 3% upper limit of the central bank’s target range but price pressures are easing. Policymakers withdrew some stimulus from September 2015 to February 2016 to ensure inflation expectations remain anchored but monetary policy is still supportive of the recovery.

Peru benefits from a low level of public debt, a substantial stock of savings and limited financing needs. Gross general government debt amounted to 23% of GDP in 2015. This compares favorably to most regional peers and other emerging markets. If financial assets held by the general government are included, net debt amounted to just 6% of GDP. Sound debt management has also reduced risks associated with market volatility. Peru has limited financing needs in the coming years and modest exposure to interest rate risk.

The growth outlook, however, is not as strong as in the past. The IMF projects average GDP growth from 2017 to 2021 of 3.7%, which is above most large Latin American economies but well below the rates Peru achieved from 2004-2013. Structural impediments constrain higher productivity growth and economic diversification. In addition, government institutions, particularly at the subnational level, have limited capacity to allocate resources efficiently, even as public demands on the state are increasing.

One key challenge is the high level of labor informality. One-half to two-thirds of the workforce is informal, which has adverse implications for productivity and social security coverage. Widespread informality is, in part, due to Peru’s high non-wage labor costs. Congress passed legislation in 2014 to reduce non-wage costs for younger workers but backtracked last year amid public opposition.

The infrastructure gap poses another major challenge. Inadequate infrastructure increases transportation costs, limits market access, and is an obstacle to international competitiveness. According to the 2015-16 Global Competitiveness Report by the World Economic Forum, Peru ranked 112th out of 140 countries in terms of the overall quality of infrastructure. The government has substantially increased public investment through public works and public-private partnerships, but given the pace of growth, bottlenecks could intensify if infrastructure development does not quickly advance.

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 strengthens, it could negatively affect the investment climate and potentially weaken economic growth.

RATING DRIVERS
The Stable trends reflect DBRS’s view that risks to the ratings are broadly balanced. In the unlikely event that macroeconomic management weakens or social conflicts materially affect Peru’s medium-term investment outlook, the trends could be revised to Negative. On the other hand, 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 strengthens Peru’s growth potential through productivity gains and economic diversification.

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. These can be found on www.dbrs.com at:
http://www.dbrs.com/about/methodologies

The sources of information used for this rating include Ministerio de Economía y Finanzas, Banco Central de Reserva del Perú, INEI, National Office of Electoral Processes, The Conference Board Total Economy Database, World Bank Worldwide Governance Indicators, World Economic Forum Competitiveness Report, International Monetary Fund, OECD, Haver Analytics, and DBRS. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

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 May 2015

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