Andean Group - November 2011 (ISSN 1741-4466)

Peru is preparing to protect itself from the looming international downturn.  The economy is one of the fastest growing in the region, with 7.5% year-on-year growth in August, according to the national statistics agency (Inei). This growth is export-led and heavily dependent on mining exports, which in turn are heavily reliant on international demand. Thanks to the recent mining windfall, the new government led by President Ollanta Humala inherited a comfortable fiscal surplus and a strong balance of payments position, which the new administration can now use to help cushion the economy. Luis Miguel Castilla, the new economy and finance minister, insists that Peru “will not be passive in confronting the economic crisis”.

Exports in the eight months to August were valued at US$30.4bn, up 37.7% on the same period of 2010. José Luis Silva, the minister for trade and tourism, has forecast full year export revenues of over US$40bn, up20% on 2010, in large part due to record international mining, metals and agri-commodity prices.

Like several of its fellow commodity-export dependent countries in South America, the big risk to Peru comes from China. China was Peru’s top trading partner in 2011. With China’s main export markets in Europe and the US still struggling, China’s demand for raw materials from its South American suppliers may taper off.  China is also trying to engineer a soft landing for its domestic economy, which is suffering from high inflation and an overheated property market. That means that China may not be able to throw a lifeline to the rest of the world by cooking up its domestic demand in 2012. In terms of the European crisis, the risk to Peru is also in reduced financing, as risk averse investors seek their traditional safe havens (in the US dollar, for instance) and the big mining companies and other multinationals pull back funds from their emerging market subsidiaries to European and US headquarters – as happened in 2008.

In order to reduce its external vulnerability, Peru ultimately needs to expand its domestic market. The government plans to pump-prime through the local economy through a series of social policies, including direct cash-transfer programmes designed to put a floor under extreme poverty, in keeping with the now ‘Go-To’ Brazilian model. And Brazil-style, Peru needs to create a bigger middle class that might help it move away from the traditional boom and bust cycle tied to the international price of minerals and metals.

The new government also acknowledges the need for regional capacity building so as to help administrations spend (efficiently) the money the central government sends their way. On 5 November Minister Castilla announced new technical assistance and training schemes for regional governments to this end.

Study flags up ‘distorting’ mining revenues

The Revenue Watch Institute (RWI), a US-based non-profit policy institute, recently publishing preliminary findings of a study into the impact of mining revenues on a small coastal district, Ite, in the Tacna region of southern Peru.  Since 2003, Ite has been flooded with revenues from a local mining project operated by Southern Peru Copper Corporation. This influx inflated the municipal government’s annual budget from less than US$500,000 to over US$13m a year. Since Peruvian law requires these sub-national funds to be used in investment projects, the municipality went on a massive infrastructure construction spree. That led to huge labour shortages on local farms and an agriculture crisis in the area. RWI notes that although there are similarities between Dutch disease and distortions at the sub-national level caused by a sudden influx of oil and mining revenues, the case of Ite “seems a different kind of disease. There is indeed decreased competitiveness across other sectors [in Ite], but this decline follows a surge of local currency into the district, and the resulting municipal wage increase in the wake of sub-national expenditure rules.”

• Ite

In Peru, 50% percent of the income tax revenues from mining and hydrocarbon drilling activities is distributed among the regional and local governments in the areas where extraction takes place.