Peru: Staff Report for the 2013 Article IV Consultation

KEY ISSUESContext: The overall state of the economy remains strong despite lower metal pricesand market turbulence in mid-2013. The economy is still operating somewhat nearpotential and continues to be one of the most dynamic in the region. However, the paceof growth slowed in 2013 as a result of external shocks and lower domestic confidence.Headline inflation increased due to a combination of supply shocks and exchange rate"pass-through" effects. The current account deficit has widened recently due to a fall inexports. Against this background, fiscal policy provided a positive impulse, while theCentral Reserve Bank of Peru (BCRP) eased monetary policy to support activity andallowed greater exchange rate flexibility to protect the economy from external shocks.Perspective: The outlook is positive with balanced risks. On the upside, a fasterimplementation of structural reforms and elimination of investment bottlenecks cangreatly increase growth potential. On the downside, unexpected effects of thewithdrawal of monetary stimulus in the U.S. could affect Peru through higher cost ofinvestment.Near-term policy mix: The current policy mix is broadly adequate. With the economyclose to full-employment and inflationary expectations in check, a relatively neutralpolicy stance should be maintained. Monetary policy should remain flexible as long-terminterest rates in the U.S. start to gradually rise. Fiscal stance should remain broadlyneutral, while the exchange rate should continue to show flexibility, strengthening itsrole as a shock absorber. If the external environment deteriorates further, the authoritieshave significant buffers that can be used to support demand to limit the negative effectof an external shock on domestic demand. Additional macro-prudential measures couldalso be employed, including those contributing to the de-dollarization of the economy.Medium-term challenges: Over the medium term, the economy will need to adjust to alower growth rate in China (one of Peru's principal trading partners) by fosteringproductivity improvements and sustaining investment growth. It will be key to perseverewith the structural reform agenda to enhance potential growth prospects. Deepening ofthe reforms is needed to bolster competitiveness through increases in labor marketflexibility, upgrades in human capital, the elimination of infrastructure gaps, andfostering financial deepening.