Mission Concluding Statement 

Peru: Staff Concluding Statement of the 2024 Article IV Mission

March 22, 2024

Washington, DC: An International Monetary Fund (IMF) mission met with the Peruvian authorities and other counterparts during February 21 – March 7 to discuss recent economic developments and policy priorities. This concluding statement summarizes the mission’s main takeaways.

The Economy is Recovering after Consecutive Shocks

The economy had a slight contraction in 2023, due to multiple consecutive shocks, while inflation decelerated rapidly. Economic growth declined to -0.6 percent in 2023, due to climate-related shocks and social turmoil. Inflation is converging towards the target thanks to the BCRP’s decisive monetary policy tightening. Strong supervision maintained financial stability. The fiscal position remained strong, although the fiscal deficit (of the non-financial public sector) reached 2.8 percent of GDP (above the fiscal rule target of 2.4 percent of GDP), reflecting a shortfall in tax revenues due to the economic slowdown. Led by sizable import compression and better terms of trade, the current account registered a surplus of 0.6 percent of GDP. International reserves remain at a comfortable level of about 28 percent of GDP.

A rebound is expected in 2024 with growth converging towards its potential over the medium term. A strong recovery in agriculture and fishing after El Niño ends, ongoing momentum in mining, and a looser monetary policy (consistent with lower inflation) are expected to support a growth revival. However, only a modest recovery in private consumption and investment is expected, as political uncertainty continues to hamper consumer and business confidence. Real GDP is projected to grow by around 2.5 percent in 2024 with a negative output gap closing gradually until 2026. The current account is envisaged to return to a low deficit in 2024 as growth normalizes and to stabilize at about -1.5 percent of GDP in the medium term. Inflation is expected to decrease towards the middle of the target band, aided by the normalization of supply shocks and a negative output gap, while the BCRP continues with its easing cycle to bring the policy rate to a neutral level.

Evolving risks are broadly balanced, and Peru has ample buffers to cope with shocks. Key domestic risks include an intensification of political uncertainty, social unrest, and climate-related shocks. Key external risks comprise weak trading-partner growth, commodity price volatility, and a sharp tightening of global financial conditions. On the upside, a decisive resurgence in confidence, catalyzed by large infrastructure and mining projects, could strengthen private consumption and investment. Peru’s proven macroeconomic resilience is reinforced by very strong buffers including low public debt, abundant international reserves, access to international capital markets on favorable terms, and access to the Flexible Credit Line (FCL).

Ensuring a Resilient and Inclusive Recovery

The BCRP’s data-driven monetary policy easing remains appropriate. With inflation entering the target band and anchored inflation expectations, additional data-dependent monetary policy easing is warranted. With the interest rate differential against the U.S. expected to narrow, the BCRP should continue to allow exchange rate flexibility.

The authorities could use targeted macroprudential measures to facilitate de-dollarization. Credit dollarization has fallen from around 49 percent in mid-2013 to 22 percent in 2022, but the trend has stalled. The authorities could consider foreign exchange targeted macroprudential measures and removing hurdles to the development of capital markets to reduce unhedged positions.

The authorities remain committed to the fiscal prudence. The 2024 budget envisages a deficit of the non-financial public sector of 2 percent of GDP, consistent with the fiscal rule target. While the required adjustment is within reach, given available fiscal space, if lingering effects from the shocks in 2023 lead to lower-than-expected revenues, delaying the consolidation by one year (setting a fiscal target for 2024 of 2.5 percent of GDP instead of 2.0 percent) could help support the growth recovery and lessen the risk of missing the target again. New tax benefit and unfunded spending initiatives by Congress would also jeopardize attaining the target. Recent announcements to restructure the governance of Petro-Peru are steps in the right direction, but further financial support should be conditional on the viability of the firm. Improving fiscal policy guidance could also bolster fiscal policy credibility.

Revenue mobilization measures could strengthen fiscal consolidation plans in the medium term. The fiscal deficit is set to gradually decline by 0.5 percent of GDP per year to reach a deficit of 1 percent of GDP by 2026, to preserve medium-term fiscal sustainability. To achieve these targets, a more balanced composition of the envisaged consolidation would be preferable, given Peru’s relatively low tax burden. To increase revenues, the authorities could also consider expanding taxes to the digital economy; homogenizing the tax rates on capital and labor income; and curtailing sectoral tax benefits, special regimes, and other tax expenditures. Personal income tax revenues are modest, partly due to low rates, but also because of the high-income thresholds that effectively exempt the majority of formal workers. The authorities’ plans to improve tax administration and compliance are important but will likely require additional resources for the tax authority.

A long-awaited pension reform is urgently needed to address low coverage and adequacy. A reform proposal is being considered by Congress with noteworthy initiatives, such as expanding the minimum and social pension, introducing automatic enrollment, and periodically assessing parameters. However, the proposal could maximize its impact by clarifying the language limiting withdrawals, increasing the coverage and benefit amounts for the minimum and social pensions (to reduce old-age poverty with only a limited fiscal cost), and improving the targeting of the non-contributory pension. Over the medium term, a comprehensive pension reform remains essential to fully address weak coverage and adequacy. New rounds of early withdrawals from the private pension scheme are ill advised, as they undermine old-age income support and the functioning of the domestic capital market.

Enhancing Financial Sector Resilience

Systemic risks are limited, but the authorities should continue to closely monitor and proactively contain financial vulnerabilities. Banks remain profitable, with ample liquidity and capital buffers. As the economy recovers, non-performing loans are expected to decline gradually. The regulator should remain vigilant of emerging pockets of vulnerability, particularly in small financial institutions (which were relatively more affected by weak economic growth) and ensure that private pension funds have appropriate liquidity cushions against potential withdrawals.

Fully operationalizing new regulations and closing remaining gaps would enhance financial resilience. Most financial institutions are prepared for the full implementation of the Basel III capital requirement in September 2024. New rules for countercyclical capital buffers and provisioning will be effective in June 2024, but the SBS should consider recalibrating their activation criteria. Recovery and resolution plans for domestic systemically important banks have been submitted for review and should be later extended to the financial group level. The authorities should build on their success and continue lowering barriers to entry for Fintech providers, while maintaining appropriate risk-based regulation, implementing interoperability regulations, and introducing frameworks for Open Banking and Finance.

Lifting Productivity and Boosting Resilience

Policies to boost productivity should focus on removing constraints for firms to grow. GDP growth has disappointed since 2014, with average and potential growth falling to about 2.5 percent, driven by a decline in total factor productivity growth, which has been broad based across firm size, region, and industry. This decline could be related to special corporate tax regimes, as well as labor legislations and regulations that do not create incentives for formalization and growth. Progress in improving regulatory quality, particularly in simplifying procedures for business formalization and construction and operating licenses, is welcome. Efforts should continue to focus on simplifying legislations and regulations that impose excessive costs for formalizing or growing a business.

Given Peru’s high vulnerability to climate change, increased efforts in building resilience are needed to unlock output gains. Climate change will likely increase damages from natural disasters and undermine potential growth in the future. The authorities have made progress in enhancing public infrastructure, bolstering financial resilience, and identifying adaptation gaps. Nevertheless, climate spending remains low, budget planning lacks adequate costing of key adaptation measures, and territorial planning should be strengthened. Scaling up investments in climate adaptation and resilience would unlock significant potential output gains and fiscal savings over the long term. A recent government initiative to shift the focus to ex-ante resilience building to climate change is a positive step.

Digital technologies and artificial intelligence offer a pathway to enhance productivity. There has been progress in FinTech and GovTech, including recent innovations in digital payments and wallets that have increased financial account ownership, as well as VAT e-invoicing and electronic tax payments. Artificial intelligence holds the potential to elevate productivity, especially in the finance, government, education, health, IT, and construction sectors, by increasing the quality-to-price ratio and improving services. Automation through artificial intelligence also presents social challenges as workers will need to transition to new jobs. It is crucial, therefore, to encourage workers to develop skills for effectively integrating artificial intelligence into their work.

Effective governance institutions would also reinforce inclusive growth. The authorities reaffirmed their commitment to combating corruption to attract investment and augment the trust in government. Several anti-corruption frameworks are in place (such as integrity officers in public agencies, digital platforms for citizen complaints, and a beneficial ownership registry), but their implementation must be prioritized and supported with adequate resources. Independence and integrity of judicial bodies should be enhanced through robust judicial vetting processes and reduction in the high reliance on temporary judges. Improving coordination among relevant agencies could contribute to effective prosecution and ending corruption impunity.

A more ambitious reform agenda is required to durably raise growth. Government’s efforts in cutting red tape and unblocking large infrastructure projects, streamlining the tax system, and reforming the procurement framework; and the recently approved political reform are welcome. The OECD accession process provides a clear roadmap for critical reforms to enhance local government capacity, improve the business climate, reduce informality, and reform the civil service, to boost productivity and green and inclusive growth.

The mission would like to thank the Peruvian authorities for their cooperation and fruitful discussions during our visit.