Peru Recovering Gradually After Slowing in 2014

Growth slowed in 2014, but is expected to rebound to 3¾ percent in 2015

Fiscal stimulus measures need to unwind gradually

Measures to reduce dollarization to strengthen financial system

Peru remains one of the best performers in Latin America, with solid macroeconomic policies and fundamentals, and visible gains in poverty reduction.

But the country faced a challenging external environment in 2014. Lower metal prices and moderate trading partner growth were a major drag on private investment and exports. External shocks were compounded by a drop in subnational public investment and temporary supply disruptions in fishing, mining, and agriculture.

Against this background, growth decelerated to 2.4 percent in 2014—from 5.8 percent a year earlier.

To support growth, the authorities embarked on a series of stimulus measures, including tax cuts, increases in fiscal spending, and other steps to expedite investment projects. Monetary conditions were also eased against stable inflation expectations, which helped lower lending rates and promote credit to the private sector.

Gradual rebound

According to the report, growth is expected to recover to about 3¾ percent this year, assuming a reversal of last year’s supply shocks and the successful implementation of policy stimulus.

Growth should rise in 2016−17 if new mines and large infrastructure projects start operations and terms of trade shocks fade. Inflation should converge toward the mid-point of the 1-3 percent target range by end-2015, and the current account deficit will narrow over the medium term as mining exports gain ground.

While important external risks loom on the horizon, strong policies and fundamentals place Peru in a comfortable position to respond to future shocks.

Supporting the recovery

While the fiscal stimulus measures were timely and will support the recovery, the report noted that they should be effectively implemented and gradually withdrawn, while avoiding hikes in non-priority current spending. Over the medium term, the report recommended targeting a small structural fiscal surplus of ½ percent of GDP to preserve buffers against commodity shocks, natural disaster risks, and contingent liabilities.

Monetary policy has been adequately accommodative, and inflation expectations have remained well-anchored within the 1-3 percent target band, the report noted. Looking ahead, monetary policy should continue to respond to changes in inflation expectations and...