Peru’s roaring economy
Hold on tight
The biggest threats to Latin America’s economic star are overconfidence and complacency
Feb 2nd 2013
WALK down Calle Gamarra in Lima’s La Victoria district and you might imagine you are in Kowloon. For a dozen blocks, Gamarra and its side streets are packed with multitudes and lined by high-rise buildings, the older ones of rough and ready brick, the newer ones of glass. At ground level every square metre is occupied by shops and galleries selling clothes. The buildings above are an anarchic mixture of offices and workshops.
Gamarra is the humming heart of the rag trade in Peru, a country blessed with top-quality cotton as well as alpaca and vicuña fibre. It is home to more than 15,000 separate businesses. Since at least part of the industry is informal (ie, not legally registered), nobody knows how much Gamarra turns over, but estimates range from $1.3 billion to $3 billion a year. Not long ago La Victoria was known for crime, grime and chaotic poverty. Now Gamarra is pedestrianised and patrolled by municipal police. Nearby, investors are planning an $80m shopping centre combined with new workshop space, according to Carlos Neuhaus, who is advising them.
But Peru’s domestic market is doing even more to power Gamarra’s growth, according to Alberto Sánchez Aizcorbe, the mayor of La Victoria. The country is enjoying a virtuous circle of economic growth. On the one hand, foreign investment is pouring into mining, hydrocarbons and big infrastructure projects. On the other, the commodity boom’s export income has provided tax revenues and underpinned the currency, allowing public investment to reach record levels and the domestic market for consumer products of all kinds to take off. The result has been eight years of growth averaging 7% a year—faster than anywhere else in Latin America except (much smaller) Panama.
No wonder that Peruvian businessmen are ebullient—the most optimistic among those in 44 countries surveyed by Grant Thornton, an accountancy firm. The main business association expects growth of between 7% and 9% this year. Four big mining projects will double Peru’s output of copper, its largest single export, in the next four years, according to Raúl Salazar of Macroconsult, a Lima consultancy.
Yet amber lights are starting to flash. The first concerns the currency, the sol, which has seen its remorseless strengthening against the dollar gather pace in recent weeks (see chart). Last year imports of consumer goods surged by about 25% and the current-account deficit was close to 4%, up from 2% in 2011. Profit margins for farmers and manufacturers are falling.
Most of the capital flooding into the country is for direct investment, but a growing share is footloose money seeking higher returns than the rich world offers. Peruvian officials say much of the appreciation is warranted by growth, eschew talk of a “currency war” and point out that other South American currencies have also strengthened.
They reject a Brazilian-style tax on capital inflows. “We are one of the most open economies of Latin America. It would not be very consistent to talk up our openness and at the same time introduce controls,” says Luis Miguel Castilla, the finance minister.
Nevertheless, Mr Castilla says he is “concerned” about the exchange rate. Since mid-January, the Central Bank has intervened more heavily in the market, buying $800m in less than a week. The government is also taking steps to speed capital outflow: it will pay maturing foreign debt out of tax revenues rather than issue new global bonds, and plans to prepay more than $1 billion of debt this year.
The second worry is a credit and housing boom. The price per square metre for apartments in posher Lima districts has doubled since 2007 in constant soles (and almost tripled in dollars). Bank credit has been growing at an annual rate of around 20% for the past four years. Richard Webb, a former central-bank governor, warns of the “near-impossibility of avoiding financial excesses”. The current governor, Julio Velarde, is doing what he can: he has raised already stiff reserve requirements for banks. He points out that property prices are still lower than in Santiago and Bogotá.
A third worry is Peru’s education system, which is weak even by regional standards. Nevertheless, productivity is growing, Mr Castilla says, partly because the strong sol is allowing companies to import machinery. To stave off skills shortages the government has improved tax incentives for worker training. Many informal businesses are registering at least part of their operations.
The fourth worry is political fragility. Ollanta Humala, the president, is popular. Businessmen are delighted that he has dropped much of his earlier leftism. But those who deem it sufficient to have a sound economic team look complacent. Peru’s political institutions are dysfunctional. Mr Humala, a former army officer, has no party to speak of. Felipe Ortiz de Zevallos, a business consultant, points out that only two of 25 regional presidents represent a national political party. The Congress is paralysed by factionalism, the police are often venal and the courts worse. “Everything is tied together with string,” says Mr Ortiz de Zevallos.
So far the string is holding. Even the more sober among analysts reckon that, barring accidents, the country should be able to grow by between 4% and 5% a year for the next five years, more than most of Latin America. Even so, it will take clear heads and strong wills to prevent the party getting out of hand.