Executive summary
Peru's solid macroeconomic institutions, including fiscal rules, an independent Central Bank and strong financial regulation, have fuelled high economic growth, ensured macroeconomic stability, and substantially reduced poverty over the past two decades. This has allowed the country to mitigate the economic and social impacts of major shocks in recent years. After a significant economic downturn due to the COVID-19 pandemic, the economy bounced back quickly but has since slowed down sharply (Figure 1) amid lower global growth related to Russia’s war of aggression against Ukraine, increased political uncertainty, high inflation, tight financial conditions and more recently widespread social unrest and extreme weather conditions. High metal prices have supported the economy.
Source: Central Bank and National Statistics Institute.
The impact of these shocks has manifested in inflationary pressures, with rising prices hitting hard many vulnerable families. Thanks to the swift tightening of monetary policy, inflation expectations have started to ease, and headline and core inflation decelerated but remain high. The Central Bank should maintain a restrictive stance to bring inflation sustainably back to target. While employment has recovered to pre-pandemic levels, job quality has further deteriorated, which together with inflationary pressures could result in persistent higher poverty and inequality.
Economic growth is projected at 1.1% this year, and gradually pick up to 2.7% in 2024 (Table 1). High interest rates and inflation and political uncertainty will constrain private consumption and investment. Government efforts to relaunch infrastructure investment and several announced PPP projects will support investment. Tourism and copper production are expected to recover and boost exports. Inflation is expected to continue slowing down and reach the 1-3% target range by early 2024. Risks associated with tighter global financial conditions are mitigated by large currency reserves and low public debt. The financial sector remains resilient amid well-capitalised banks, with large liquidity buffers. Political uncertainty and renewed flare-ups in social unrest remain key risks.
Frequent natural disasters exacerbated by climate change lead to infrastructure damage, exacerbate supply chain disruptions, and contribute to inflation, ultimately reducing medium-term growth. El Niño, a natural event that has become more frequent, is expected to be mild this year, but remains a risk as it can rapidly evolve, causing heavy rainfall and economic losses that could jeopardize fiscal consolidation. To combat climate change, Peru has pledged to achieve carbon neutrality by 2050. A forthcoming strategy for the climate transition with concrete milestones and policies is an opportunity to reach this ambitious goal. Meeting emission targets will depend largely on progress in combating deforestation, a key source of emissions, and increasing the use of renewable energy sources.
Prudent fiscal policies and strong commitment to fiscal rules have provided large buffers, that helped the country withstand recent shocks. A recent stimulus programme aims at boosting investment, protecting households from high inflation and supporting a weak economy, while complying with fiscal rules. Going forward, fiscal policy should remain prudent in line with the planned fiscal consolidation and rebuild fiscal buffers to prepare for future shocks, including natural hazards.
To meet increasing demands for social services and infrastructure while maintaining fiscal sustainability, increasing spending efficiency and tax revenues will be necessary. Tax revenues at 17% of GDP are low compared to other countries (Figure 2). Low tax compliance, high informality, significant tax expenditures, an incomplete and outdated cadastre, and a high threshold to start paying personal income taxes contribute to low tax collection. The complexity of multiple corporate tax schemes causes high tax evasion, encourages informality, incentivizes firms to remain small and leads to low productivity.
Macroeconomic stability and trade openness have made for strong growth in commodity-exporting sectors. However, economic performance has weakened in the last decade, and convergence to OECD countries has stalled. To revive and broaden growth and improve living standards for all, there is a need to continue strengthening basic growth enablers.
Peru has a thriving private sector, but low competition due to the dominance of a small number of large business groups is a concern. A general merger control scheme was introduced in 2021 and is a major step in the right direction. Peru’s well-regarded competition authority could be further strengthened to enhance enforcement. Weak competition is, at least partly, the result of excessive regulatory compliance costs. The creation of one-stop shops that integrate national and sub-national procedures for starting a business would help in easing regulations for formal firms.
A weak rule of law (Figure 3) leads to an insufficiently stable and predictable business environment, discouraging investment, trade, and entrepreneurship. Strengthening judicial independence and efficiency, including replacing temporary judges with permanent positions that have clear criteria for tenure and career progress, and advancing digitalisation and interoperability of court information systems, could be a cornerstone of a wider reform agenda to improve the rule of law.
Source: World Bank, Worldwide Governance Indicators.
High corruption hampers the government’s ability to implement policy, collect revenues, and enforce laws and regulations. A comprehensive strategy is essential for effectively deterring corruption, including strengthening existing preventive integrity measures combining them with reforms in various areas that discourage, prevent, and sanction corruption. Key areas for reform are justice and civil service. This will not only enhance accountability and effectiveness of the public sector but it will also foster trust in institutions and promote social cohesion.
The State’s capacity to implement much-needed public investment and deliver high-quality public services is limited by a fragmented civil service. Overreliance on administrative service contracts results in high turnover, loss of experience, and insufficient deterrence against corruption. A fresh start is needed to effectively implement the 2013 civil service reform that has seen limited progress.
To enhance public service quality and address regional inequalities, restructuring fiscal decentralization is necessary. This includes clearly defining spending responsibilities of national and subnational governments, and gradually grant regions more taxing powers. Enhancing the capabilities, effectiveness, and coordination of public investment planning, particularly at the local level, will play a crucial role in improving the implementation and efficiency of infrastructure investments.
Peru has one of the highest levels of informality in Latin America (Figure 4), with around 80% of workers in informal jobs and limited access to employment protection or social security benefits. High informality left workers unprotected during the COVID-19 pandemic and is a key factor perpetuating inequality and poverty, calling for a comprehensive reform agenda.
Low access to high-quality education and high labour costs of formalisation are key drivers of informality. Weak educational outcomes, high non-wage costs that finance formal-sector social security benefits, strict employment protection regulation, and a relatively high minimum wage whose level is close to the median wage put a high price on formal jobs and generate a vicious circle that perpetuates informality. Improving labour law and tax enforcement, streamlining the tax corporate system and business regulatory environment are also key to reducing informality.
Expanding access to high-quality education is crucial to raise productivity, reduce labour market gender gaps, and promote formality. Extended COVID-19 related school closures, have worsened pre-existing weak education outcomes and inequalities, given significant disparities in digital preparedness. Widespread access to high-quality early childhood education remains limited, particularly in rural and vulnerable areas. Improving access to high-quality education at all levels will require enhancing teaching quality and school infrastructure, particularly in disadvantaged regions.
Reducing informality and expanding social protection will require that a basic level of social protection is available to all Peruvians. This calls for increasing spending on conditional cash transfers, social pensions and the health system, while a more comprehensive set of benefits supports those who can contribute more. Reducing social contributions for low-income workers will be key to boost formalisation.
To successfully tackle the challenges ahead and implement the required comprehensive structural reform agenda, it is essential to build consensus and foster political stability.