Peru: are we entering in a new crisis? by Marco Morante Monday September 23rd, 2013

Last month newspapers’ headlines were talking about a statement made by Ollanta Humala to the media: “The crisis has arrived, but we have a solid economy”; indeed there is a global crisis going on and indeed the Peruvian economy growth’s expectation is not the very same as in just a few months ago; but, is Peru about to enter in another crisis as the ones suffered in past years? Disregarding the several replies, opinions and views of the message that our president really intended to give, let us remember Peru’s past crisis and understand the economic frame in which these crisis developed.

A little bit of Peruvian’s Recent Crisis History1

In the early 80’s, during Fernando Belaúnde’s government, “El Niño” phenomenon affected severely the northern coast of Peru, impacting mainly in the agricultural sector (consumption), the public and private investment suffered an important contraction, also the external demand was affected due to the crisis generated by the adjustments of the debt in México (having a deep effect in all economies in Latin America). In year 1983, the metal prices fall meant for Peru difficulties for the payment of the external debt and a high increase in inflation, reaching a concerning 163% inflation for the last year of the “Sol” (1985). Also, in this year the economy suffered a contraction in the GdP growth: a decrease of 9.3%, the largest one until that moment in the Central Bank records. After this critical period, a new president was elected in 1985: Alan García’s first government would intend to surpass the big economic crisis left by Belaúnde’s government. At the beginning the recovery was going well, even could be said very well; in fact in 1986 Peru experienced a growth of 12.1%, one of the largest boosts in its economy of the history, the thing is that inflation for those first years averaged around 80%. García’s administration cut down the current expenses and capital formation, falling to only 29% of the GdP in the first year of government, the trade balance was also in the negative side (imports increased, while exports were still low), these negative factors plus the announcement made in July 1987 in which was declared the nationalization of the Peruvian banking system (affecting the internal and external financing sources), announced the breaking point for the probably worst economic crisis in Peru of the recent times and a surely top 10 for the world hyperinflation charts (more than 7,000% for year 1990). The exportation of goods and services contracted, also did the consumption and public/private investment due to the fiscal crisis (public services collapsed), all this impacted negatively to the demand and the GdP, falling a severely 13.4% in 1989; since the beginning of this crisis until the end (1990 Vs. 1987) the economy fell 25.6%. After 1990 elections, Alberto Fujimori was elected as the new president. During his government, several “economic shocks” were applied in order to reestablish the economy. Inflation was drastically reduced to only 11.13% by the end of his first government (1995) and GdP growth recovered to the levels before García’s crisis, having the highest growth of the Central Banks’ records ever (12.8% in 1994). Even with the “El Niño” phenomenon in 1992 and the “cholera” epidemic the economy only fell 0.43%. In Fujimori’s second government, in 1998 with the falling of the international metal prices due to the Asian, the Mexican and the Russian crisis, a contraction in the private investment affects negatively the manufacturing and commerce sector; this went even worse when an extreme “El Niño” Phenomenon stroked Peru. During this crisis, the economy fell only 0.66%. The historical data gives prove that the Peruvian economy began to show the first signs of strengthening and armoring against internal and external shocks. After this period, Peruvian economy has been constantly growing each year, some years below its nowadays potential, but this was the very beginning of the economy that Peru is today. A recent prove of this strengthening materialized in 2008, when the probably worst financial crisis of the recent times took place. It all started on the Tuesday, September 16th, 2008: all the stocks of almost all the markets had a very strong drop, almost every diary in the world published in their first page the bankruptcy declaration of Lehman Brothers announced the day before, the fourth largest investment bank in the US and one of the most important of the world with a 158-year history (worth mentioning that this bank survived two World Wars).

Peruvian economy went well in 2008, growing an outstanding 9.8% (almost 50% more than our current potential), the highest one since 1994. In 2009 the thing was different; but even when GdP only grew by 0.9% it cannot be called a crisis (as the ones of the 80’s and 90’s), a deceleration could be a more proper term. But, how did this global financial crisis didn’t stroke Peru as tough as in the past as in other regions? The sum of several factors History reminds us that big catastrophes occur when many adverse factors appear at the same time, such as in the Titanic sinking, this also applies to economy. We have seen in Peru’s past crisis that several internal and external factors appeared at the same time, but how well prepared is and was the Peruvian economy to receive the iceberg? In order to answer this and the previous question, let’s first briefly list the things that made Peru crash in the mid past. One of the constant factors was the presence of “El Niño” phenomenon affecting a country with little infrastructures to support such calamity. We are not saying that every time there is “El Niño” there will be a crisis, this could be any Act of God (as defined in finance) that we are not prepared to face. Another crisis factor was the appearance of other crisis in other parts of the world (i.e. Mexico, Asia, Russia in such time), but an important thing to difference is that it is not the other countries’ crisis what affects a country; it is how dependent a country is on others. And finally, the one factor that depends on us Peruvians: the good or bad decisions made by the leaders of the nation. Clearly, the first two factors of the abovementioned cannot be controlled but they can surely be mitigated. The 2008 global financial crisis represents a very welltaken exam for the Peruvian economy capacity. Countercyclical measures were implemented: monetary policy reference rates were reduced, measures to stimulate the economy and to promote liquidity were taken. During the 90’s and the first years of the 2000 decade the current account (“CA”) balance showed deficit; nevertheless, since 2000 to 2006 the CA balance began a constant growth, from 2000 to 2003 still Peru had a deficit, but since year 2004 the balance begins to show a surplus every year more significant, mainly due to the increase of exports and remittances from Peruvian emigrants. It is important to bear this in mind because when the 20082009 crisis arrived, the countercyclical measures previously mentioned were financed by this surplus. An interesting indicator to track is the external debt in respect to the international reserves (other factors could be considered for a more accurate vision, i.e. GdP volume, maturity of the debt, etc.). In 1985 this indicator was 9.0x, this means that the amount of debt was 9 times the reserves of such time, in 1990 the indicator was 43.0x (now we know why there was trouble to repay the debt in those years); after Fujimori’s election this number began to lower, reaching 4.9x in 1995 and 3.4x in 2000, this meant more reserves to cover the amount of debt at such time. In 2005 we reached a healthy 2.0x and in 2008 was 1.2x, a very high amount of reserves when the crisis arrived. All this, plus the low inflation and fiscal surpluses of the previous years led Peru to a bumpy but yet successful way through the crisis, showing the real strength and capacity of the Peruvian economy and allowed Peru to quickly recover the confidence of investors. This crisis affected us but we were prepared, unlikely past crisis. Nowadays, the World is facing the North American and European crisis, but the good news is that Peru is still prepared and still has the instruments that had in the previous crisis. As mentioned before, this factor would affect Peru if a dependency on an economy in crisis exists; today exports are not focused on a single destination as they were before. Today, the ratio of external debt in respect to international reserves is 0.9x, this means that we have more reserves than debt. Many analysts criticize this position, but let’s remember that we are facing just one of the three factors that have stroked Peru in previous deep crisis. Even in the middle of a world crisis, in a recent publication in Gestión2, Julio Velarde, president of Peruvian Central Bank, stated that Peru’s GdP for 2013 would probably be around 5.5% or 5.6%. This is almost potential GdP for Peru. It is not the intention to say that Peru is indestructible and a crisis will never again impact Peru, but the history has taught us that for a deep crisis to occur, several factors have to sum, including not being prepared to receive those shocks. Today, that is not the case. So, we can surely quote President Humala’s words: “…but we have a solid economy”.

Gestión, Wednesday September 18th, 2013 – Year 23, Number 6577, Page 4
2

Exhibit A – Phillip’s Curve and Okun’s Law for Peru

Phillips Curve Unemploy. % 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Inflation %

9.2% 8.9% 9.4% 8.3% 8.6% 8.5% 7.9% 7.9% 7.6% 6.9% 7.0% 5.9%

2.0% 0.2% 2.3% 3.7% 1.6% 2.0% 1.8% 5.8% 2.9% 1.5% 3.4% 3.7%

Peru ‐ Phillip's Curve (2001 ‐ 2012)
7.0% 6.0% 5.0%
Inflation %

4.0% 3.0% 2.0% 1.0% 0.0% 5.0% 6.0% 7.0% 8.0% Unemployment Rate % 9.0% 10.0%

Okun's Law 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Change in unemploy. %

GdP %

Peru ‐ Okun's Law (2002 ‐ 2012)
11.0% 9.0%
GdP %

‐3.3% 5.6% ‐11.7% 3.6% ‐1.2% ‐7.1% 0.0% ‐3.8% ‐9.2% 1.4% ‐15.7%

5.0% 4.0% 5.0% 6.8% 7.7% 8.9% 9.8% 0.9% 8.8% 6.9% 6.3%

7.0% 5.0% 3.0% 1.0% ‐10.0% ‐5.0% 0.0% 5.0% Change in unemployment rate %

‐15.0%

10.0%

Source: BCRP, Trading Economics

Exhibit B – Peruvian GdP Evolution

Peruvian GdP Evolution
Millions of nuevos soles (1994) 300,000 30%

250,000

20%

200,000

10%

GdP % var. 150,000 0%

100,000

‐10%

50,000

GdP

‐20%

‐ 1980 1985 1990 1995 2000 2005 2010

‐30%

Source: BCRP

Exhibit C – Balance of Payments for Peru

International Reserves Evolution Vs. External Debt
Millions of US$ 70,000 60,000 50,000 4 3.5 3 2.5 30,000 2 20,000 10,000 ‐ 1980 ‐10,000 ‐20,000 1985 1990 1995 2000

Exchange Rate 40,000

External Debt/Reserves

Financial Account

1.5 1

Curent Account
2005

2010 0.5 0

Source: BCRP

Peru: are we entering in a new crisis?
Millions of nuevos soles (1994) 300,000 250,000 200,000

Peruvian GdP Evolution
12% 10% 8%

A story of success: the 2008 - 2009 Crisis
Tuesday, September 16th, 2008: the probably worst financial crisis of the recent began with the bankruptcy declaration of Lehman Brothers announced the day before. All the stocks of almost all the markets had a very strong drop. Peruvian economy went well in 2008, growing an outstanding 9.8% (almost 50% more than our current potential), the highest one since 1994. In 2009 the thing was different; but even when GdP only grew by 0.9% it cannot be called a crisis (as the ones of the 80’s and 90’s), a deceleration could be a more proper term. The 2008 global financial crisis represents a very well-taken exam for the Peruvian economy capacity. Countercyclical measures were implemented: monetary policy reference rates were reduced, measures to stimulate the economy and to promote liquidity were taken.

Last month newspapers’ headlines were talking about a statement made by Ollanta Humala to the media: “The crisis has arrived, but we have a solid economy”; indeed there is a global crisis going on and indeed the Peruvian economy growth’s expectation is not the very same as in just a few months ago; but, is Peru about to enter in another crisis as the ones suffered in past years?

GdP % var. 150,000 100,000 50,000 6% 4% 2% 0% 2001 2003 2005 2007 Source: BCRP 2009 2011

A little bit of Peruvian’s Recent Crisis History 1982 to 1983
Millions of nuevos soles (1994)

Peruvian GdP Evolution 140,000

“El Niño” phenomenon affected severely the northern coast while the debt crisis in Mexico took place (having a deep effect in all economies in Latin America). Metals prices fall meant for Peru difficulties for the payment of the external debt.

GdP % var. 120,000 100,000 80,000 60,000

GdP

10% ‐ ‐10%

GdP
‐30% Millions of US$ 80,000 60,000 40,000

International Reserves Evolution Vs. External Debt
Values no within the scale: 402x in 1987, 59x in 1989, 43x in 1990 20 15 10

1988 to 1990
At the beginning of García's first government recovery was going well, in 1986 Peru experienced a growth of 12.1%, one of the largest boosts in its economy of the history. The administration cut down the government current expenses and capital formation. Negative trade balance and declaration of Peruvian banking system nationalization (affecting the internal and external financing sources).

‐50% 40,000 20,000 ‐ 1980 1985 1990 Source: BCRP 1995 2000 ‐70%

External Debt/Reserves 20,000

The chart to the left graphs the international reserves and the external debt, plus a line with a relation betweern these two. In 1985, the amount of debt was 9 times the reserves at such time, in 1990 the indicator was 43.0x, this means that at times of big time crisis in Peru, there were almost no reserves to help mitigate any shock. After this, in 1995 the ratio was 4.9x and 3.4x in 2000, this meant more reserves to cover the amount of debt at such time. In 2005 we reached a healthy 2.0x and in 2008 was 1.2x, a very high amount of reserves when the crisis arrived. This, plus the low inflation and fiscal surpluses of previous years led Peru through the crisis, showing the real strength and capacity of its economy and allowed Peru to quickly recover the confidence of investors.

Reserves
1980 1985 1990 1995 2000 2005 2010

5 ‐

‐90% ‐ ‐20,000 ‐40,000 ‐60,000

External Debt

‐5 ‐10 ‐15 ‐20

7,650%

was 1990 inflation

25.6%

fell down the GdP during this period

Largest contractions occurred during the governments of Belaunde and Garcia.

1992
During Fujimori's government, several “economic shocks” were applied in order to reestablish the economy. Inflation reduced to only 11.13% by 1995. Even with the “El Niño” phenomenon in 1992 and the “cholera” epidemic the economy only fell 0.43%

1998
Fall down of the international metal prices due to the Asian, the Mexican and the Russian crisis, a contraction in the private investment affects negatively the manufacturing and commerce sector; this went even worse when an extreme “El Niño” Phenomenon stroked Peru. During this crisis, the economy fell only 0.66%.

‐80,000 Source: BCRP

The North American and European Crisis
Nowadays, the World is facing the North American and European crisis, but the good news is that Peru is still prepared, the economy still has the armor that had in the previous crisis. Today, the ratio of external debt / international reserves is 0.9x, (we have more reserves than debt); also, Peru is not entirely dependent on any of these economies.

12.8%

was the 1994 GdP growth, the highest registered

3.7%

was the inflation in 2000, the lowest since 1960

The historical data gives prove that the Peruvian economy began to show the first signs of strengthening and armoring against internal and external shocks. After this period, Peruvian economy has been constantly growing each year, some years below its nowadays potential, but this was the very beginning of the economy that Peru is today.

Julio Velarde stated that Peru’s GdP for 2013 would probably be around 5.5% or 5.6%. This is almost potential GdP. Peru has the instruments to get through and, as we have seen, for a deep crisis to occur, several factors have to sum, including not being prepared to receive those shocks. Today, that is not the case. So, we can surely quote President Humala’s words: “…but we have a solid economy”.

Por Marco Antonio Morante Muroy Universidad Pacífico - Maestría en Finanzas Entorno Económico - PhD Vanina Farber