Train Crash Preview

By John Mauldin

 

Today we will summarize something I’ve been thinking about for a long time.
 
Exactly how will we get from the credit crisis, which I think is coming in the next 12–18 months, to what I call the Great Reset, when the global debt will be “rationalized” via some form of nonpayment. Whatever you want to call it, I think a worldwide debt default is likely in the next 10–12 years.

I began this tale last week in Credit-Driven Train Crash, Part 1. Today is Part 2 of a yet-undetermined number of installments. We may break away for a week or two if other events intrude, but I will keep coming back to this. It has many threads to explore. I’m going to talk about my expectations given today’s reality, without the prophetically inconvenient practice of predicting actual dates.

Also, while I think this is the probable path, it’s not locked in stone. Later in this series, I’ll describe how we might avoid the rather difficult circumstances I foresee. While it is difficult now to imagine cooperation between the developed world’s various factions, it has happened before.
 
There are countries like Switzerland that have avoided war and economic catastrophe. We’ll hope our better angels prevail while taking a somber look at the more probable.

The experts who investigate transport disasters, crimes, and terror incidents usually create a chronology of events. Reading them in hindsight can be haunting—you know what’s coming and you want to scream, “Don’t do that!” But of course, it’s too late.

We do something similar in economics when we look back at past recessions and market crashes. The causes seem obvious and we wonder why people didn’t see it at the time. In fact, some people usually did see it at the time, but excessive exuberance by the crowds and willful ignorance among the powerful drowned out their warnings. I’ve been in that position myself and it is quite frustrating.

As I outlined this, the steps seemed to fall in four stages. I’ve dubbed them:

  • The Beginning of Woes

  • Lending Drought

  • Political Backlash

  • The Great Reset

Again, the precise route and speed are uncertain, but the probable destination is not. Consider this a kind of “road map” to orient us for the journey. Now, let’s look at each stage.

The Beginning of Woes

Last week, I described how legendary railroad engineer Casey Jones was barreling along when an unexpected train appeared ahead. He saved his passengers at the cost of his own life. Today’s high-yield bond market has no such hero, and I think the crisis will begin there.

The problem will be what I mentioned last week: massive illiquidity. Trading can and will dry up in a heartbeat at the very time people want to sell. In late 2008, the high-yield bond benchmarks lost a third of their value within a few weeks, and many individual bond issues lost much more, in large part because buyers disappeared.
 


 
The same thing happened in the dot-com recession, though not quite as dramatically. There were still several whipsaws and a particularly terrible month in June 2002.
 


 
This time, I believe the collapse will go deeper and happen faster because Dodd-Frank has decimated market makers’ ability to cushion it. Likewise, the Fed will be reluctant to bail out ridiculously priced bonds like WeWork and its many covenant-lite, unsecured brethren. And rightly so, in my view.

(By the way, Over My Shoulder subscribers can now read Louis Gave’s important Illusion of Liquidity report here. It’s a must-read if you own any kind of bonds. Soon I will share a great Grant Williams letter on the unfolding high yield madness, too. Click here to learn how you can get it.)

But if it’s not high yield, something else will set off the fireworks. There’s always a train that shouldn’t be there, a dog that didn’t bark, always something. We may not even recognize it at the time. Remember, then-Fed Chair Ben Bernanke said in 2007 that the subprime debt problem was “contained.” Whatever starts the next credit crisis, authorities will assure us it is “contained.” (Spoiler: It won’t be.)

Last week, I read a powerful chapter by my friend William White, former chief economist for the Bank of International Settlements and now chairman for the OECD economic committee. I read everything from Bill that I can get my hands on. He is my favorite central banker in the world. This paragraph jumped out at me (emphasis mine):

the trigger for a crisis could be anything if the system as a whole is unstable. Moreover, the size of the trigger event need not bear any relation to the systemic outcome. The lesson is that policymakers should be focused less on identifying potential triggers than on identifying signs of potential instability.

This implies that paying attention to macroeconomic “imbalances” may pay bigger dividends than trying to assess financial instability through highly disaggregated “risk maps” of the sort currently being encouraged by the G20 and the IMF. The latter are not only expensive to monitor, but potential rupture points in the financial fabric can change rapidly in real time.

Perhaps more important, serious economic and financial crises can have their roots in imbalances outside the financial system.

 
As I will show in this letter and others, the system itself is unstable.
 
Predicting the actual trigger in advance is difficult. I can imagine numerous possible “triggers” for the coming credit crisis.

As in the biblical book of Revelation, the initial credit crisis stemming from the fall of high-yield bonds will be merely the beginning of woes. Illiquidity will spread as lower-end corporate bonds fall to junk ratings. Legal and contractual constraints will then force institutions to sell, pressuring all except the highest-grade corporate and sovereign bonds. Treasury and prime-rated corporate bond yields will go down, not up (see 2008 for reference on this). The selling will spill over into stocks and trigger a real bear market—much worse than the hiccups we saw earlier this year.

I give the probability of the credit crisis in the high-yield junk bond market somewhere close to 95%. For the record, nothing is 100% certain, as we don’t know the future. But I think this is pretty much baked in the cake.
 

Remember how Peter Boockvar describes the new cycle. Instead of recession pushing asset prices lower, lower asset prices trigger the recession. That will be the next stage as falling stock and bond prices hit borrowers. Rising defaults will force banks to reduce their lending exposure, drying up capital for previously creditworthy businesses. This will put pressure on earnings and reduce economic activity. A recession will follow.

This will not be just a US headache, either. It will surely spill over into Europe (and may even start there) and then into the rest of the world. The US and/or European recession will become a global recession, as happened in 2008.

Aside: Europe has its own set of economic woes and multiple potential triggers. It is quite possible Europe will be in recession before the ECB finishes this tightening cycle. With European rates already so low, and the ECB having already bought so much corporate debt, I wonder how else they will try to bring their economy out of recession? Everything is on the table.

As always, a US recession will spark higher federal spending and reduce tax revenue, so I expect the on-budget deficit to quickly reach $2 trillion or more. Within four years of the recession’s onset, total government debt will be at least $30 trillion, further constraining the private capital markets and likely raising tax burdens for everyone—not just the rich.
 

Meanwhile back at the ranch, job automation will intensify with businesses desperate to cut costs. The effect we already see on labor markets will double or triple. Worse, it will start reaching deep into the service sector. The technology is improving fast.

Needless to say, the working-class population will not like this and it has the power to vote. “Safety net” programs and unemployment benefit expenditures will skyrocket. The chart below from Philippa Dunne of The Liscio Report shows the ratio of workers covered by unemployment insurance is at its lowest level in 45 years. What happens when millions of freelancers lose their incomes?

Source: The Liscio Report

 
The likely outcome is a populist backlash that installs a Democratic Congress and president. They will then raise taxes on the “rich” and roll back some of the corporate tax cuts and increase regulatory burdens. They may even adopt my preferred consumption-oriented Value Added Tax (VAT)… but without the “reduce income taxes and eliminate payroll taxes” part that I suggested in 2016.

 At a minimum, this will create a slowdown but more likely a second recession. Recall (if you’re old enough) the back-to-back recessions of 1980 and 1982. That was an ugly time for those of us who lived through it.

Of course, that presumes a recession before the 2020 election. It may not happen—I put the odds at about 60–70%. Also, it is possible the Democrats will fumble what for them will be a golden opportunity. I’m not sure Republicans should view that as a “win” because they will then have to deal with the eventual recession themselves instead of being in opposition. I think by the latter part of the 2020s, US total government debt will be at $40 trillion. You think Washington is paralyzed now? You’ve seen nothing yet.

My friend Neil Howe thinks we could see a socially conservative, fiscally liberal party gain power. (Some would argue one already did, given the current GOP’s spending binge.) But in any scenario, I see very little chance the federal government will shrink or reduce its impact on the economy. That is already a big problem and will only grow.
 

Unemployment may approach the high teens by the end of the decade and GDP growth will be minimal at best. What do you call that condition?

Certainly not business as usual. Long before that happens, the Federal Reserve will have engaged in massive quantitative easing. There’s a lot of misunderstanding about QE, so let me clarify something important.

Quantitative easing is not about “printing money.” It is buying debt with excess bank reserves and keeping that debt on the Fed’s balance sheet as an asset. The Bank of Japan is an example. They did not put currency (yen) into the market. That’s how Japan still flirts with deflation and its currency has gotten stronger. QE is the opposite of printing money, though there is a relationship. That’s one reason central bankers like it.

As this recession unfolds, we will see the Fed and other developed world central banks abandon their plans to reverse QE programs. I think the Federal Reserve’s balance sheet assets could approach $20 trillion later in the next decade. Not a typo—I really mean $20 trillion, roughly quintuple what they did after 2008. They won’t need to worry about the deflation that usually accompanies such deep recessions (dare we say depression?) because the Treasury will be injecting lots of high-powered money into the economy via deficit spending. But since we have never been in this territory before, I must say this is only my guess.

If that’s what they do, will it work? No. The world simply has too much debt, much of it (perhaps most) unpayable. At some point, the major central banks of the world and their governments will do the unthinkable and agree to “reset” the debt. How? It doesn’t matter how, they just will. They’ll make the debt disappear via something like an Old Testament Jubilee.

I know that’s stunning, but it’s really the only possible solution to the global debt problem. Pundits and economists will insist “it can’t be done” right up to the moment it happens—probably planned in secret and announced suddenly. Jaws will drop, and net lenders will lose.

While all that is brewing, technology will keep killing jobs. Many mainstream commentators and serious analysts like Karen Harris (see The Great Jobs Collision) are projecting that 20–40 million jobs will be lost in the US alone and hundreds of millions across the developed world.

As we get into the 2020s, the presidency and Congress will again be whipsawed, and we will begin to discuss Bernie Sanders’ “crazy” universal basic employment idea, or others like it. By then, the idea will not be considered crazy, but the only feasible choice. Even conservative politicians can see the light when they feel the heat.

All of this is going to lead to the most tumultuous decade in US history, even if we somehow (hopefully) avoid throwing a war into the mix, as is typical of the end of a Fourth Turning. Typically, the end of a Fourth Turning (which started in 2007, according to Neil Howe), has been accompanied by wars. This one could, too, though I think we will more likely see multiple low-grade skirmishes.

If we somehow get through all that, and particularly the Great Reset, the 2030s should be pretty good. In fact, think incredible boom and future. No one in 2039 will want to go back to the good old days of 2019. Our kids will think it was the Stone Age. But we have to get there first.
 

I keep coming back to this train-wreck metaphor because it fits so well. I said Casey Jones plowed into a train that wasn’t supposed to be there. The full story is a little more complicated.

Railroads in 1900 knew the danger of collisions. They took extensive precautions to make sure it didn’t happen. The stopped train in front of Casey Jones had pulled off onto a siding like it was supposed to. The error was that its last four cars were stuck on the main line because an air hose had broken, locking their brakes.

This is a good analogy for our financial system. We know bad things can happen. We have systems to prevent them and limit their damage. Those systems are only as good as the people who manage them… and even then, surprises happen, and the safeguards fail.

What broken air hose will push the financial system close to collapse and bring on the Great Reset? I don’t know, nor do I know when it will break. But I’m quite sure it will happen. Now is the time to get ready. There’s no Casey Jones to save us.

Winston Churchill said America always does the right thing—after we try everything else. Maybe we can find that middle and “work it out” before the crisis. America has shifted before. Maybe that’s only a dream, but it’s one we better hope comes true.

In later letters, we will talk about how to protect your portfolios and trade through the coming crises. You don’t have to go gently into that good night. You can get off the train. There is plenty of time, but you need to start planning now.
 

A quick note to anyone who had trouble with last week’s offer on the Dragon Professional speech recognition software. A technical problem kept some of you from getting the 50% discount I had arranged. That is now fixed, so please try again if you were deterred. You can click here or call Nuance customer service at 888-781-1189 to order. Dragon greatly increased my writing productivity and I know it will help yours, too.

Next week, I go to Raleigh, North Carolina, where I’ll see some old friends like Mark Yusko and speak at The Investment Institute. Then in June, I’ll be in Cleveland for an overdue medical checkup with Dr. Mike Roizen. I then intend to stay home, write, rest, and workout for June and July. I’m sure something will intrude, but that is the plan as of now.

Last week, I met with (and spoke for) my friends at Swan Global Management and learned more about Puerto Rico and lower taxes. Much of their top management has already moved to the island. I also met with my old friend Raghuram Rajan, former Reserve Bank of India head and now on the Chicago Booth faculty. What a great conversation that was. I am, at this very moment, flying back from Orange County where I spent some quality time with my great friend Rob Arnott.

In between all that, I had some great phone calls. I love talking to some of the smartest people I know, just sharing their thoughts with me. When you can get Woody Brock or Lacy Hunt to explain the world to you? Priceless. Pick up your phone and call your friends and family. That touch point is priceless for all of us.

With that, I will hit the send button. Have a great week!

Your planning on ways to get through and to the other side of the Great Reset analyst,
 



John Mauldin
Chairman, Mauldin Economics


Iran Crisis

Trump Drives Wedge Between Germany and France

Donald Trump's move to withdraw from the nuclear agreement with Iran should have pulled the European Union together, but Angela Merkel has instead chosen to appease the U.S. president. Criticism of her stance is mounting in Brussels and Berlin. By SPIEGEL Staff

     French President Emmanuel Macron


It isn't often that Peter Altmaier, who is about as pro-European as they come, casts doubts on proposals coming out of Brussels. But last week, he opposed a plan by the European Commission to pay damages to European companies affected by American sanctions against Iran. "We have no legal possibility to protect or make exceptions for German companies against decisions made by the American government," the German Economics minister said.

He warned against discussing "premature proposals."

But nobody in Brussels cared to listen. By the time German Foreign Minister Heiko Maas met with his counterparts from Britain and France a few days later, Federica Mogherini, the European Union's top diplomat, had prepared a paper that paved the way for the very measures Altmaier had warned against.

The result is that nine days after U.S. President Donald Trump's decision to withdraw from the nuclear deal with Iran Europe has found an initial response to Washington's affront. The European Commission has announced that it intends to protect European companies from American sanctions with the so-called "blocking statute."

It wasn't the answer that Germany -- or at least its chancellor and its economics minister -- would have given. It was the answer of Emmanuel Macron, the politician currently at Europe's helm. Behind the scenes, it was largely Macron applying the pressure, whereas Germany seemed to shy away from a confrontation with Trump.

From the very start, Berlin and Paris have been charting different courses on the future of the trans-Atlantic relationship. Should Europe appease Donald Trump or defy him? Should Europe risk a trade war with the U.S. over its Iran decision? Do the Europeans stand a chance of swaying Trump with resolute resistance or will the situation continue to escalate?

It's an age-old question of foreign policy, and also one of the most important: finding the correct response to pressure and coercion. Is appeasement the right way to go? Or will that just encourage the bullies of international politics? It has traditionally been a question most often raised when dealing with Vladimir Putin and the other strongment of the world.

Maximum Pressure

There is no doubt about the Americans' determination. Trump prefers applying maximum pressure -- and makes no exception for America's allies in Europe. Richard Grenell, the new American ambassador in Berlin, has very openly linked the issue of Iran to the trade dispute between the U.S. and Europe. Last week, Grenell told the New York Times that if the Europeans back Trump in his position on Iran that the president might not levy punitive tariffs against Europe on steel and aluminum.

Conversely, that also means that if the Europeans don't fall into line with Trump that they will be facing a trade war. "With friends like that, who needs enemies," EU Council President Donald Tusk said earlier this week.

Europe, of course, can only get anywhere if it agrees on a joint position. And that is proving difficult for Berlin. The Germans would like to rescue the Iran deal, but they don't really want to fight to do so. Paris, on the other hand, is prepared for confrontation. "Berlin is focusing more on appeasement whereas Paris fears that each concession will just encourage Trump to act even more brazenly," says one high-ranking EU official.

And the difference in tone between Berlin and Paris is indeed conspicuous. "There's nothing we can do about it" -- that, essentially, is the message from the Chancellery in Berlin. In Paris, on the other hand, officials are saying: "We can't accept that."

It the usual reflexive tendency: Germany shrinks in timidity while France proudly stands its ground. "If we accept that other major powers, even if they are our allies, decide for us, then we are no longer sovereign," Macron warned at this week's EU summit in Sofia.

The French president has recognized the opportunity that opposition to the U.S. sanctions presents. It provides him with a perfect chance to prove to the French people why they really need Europe. He believes that only Europe can stand up to the deal-breaking Americans.

In Berlin, meanwhile, the focus is on "realpolitik" -- the notion that there isn't much Europe can do to oppose Trump. Officials in the German capital believe that the U.S. president will play hardball when it comes to Iran.

A Lack of Political Will

What really appears to be the problem, however, is a lack of political will. When push comes to shove, the Iran deal is likely less important to Altmaier than the dispute over the Trump administration's threat of punitive tariffs on steel and aluminum imports from Europe. He wants to prevent the dispute from boiling into a full-fledged trade war that would spread to the heart of the German economy -- the automobile industry. As a major exporter, America's punitive tariffs would hit Germany much harder than they would France.

"The U.S. can't be the world's economic police," French Economy Minister Bruno Le Maire said earlier this month. Le Maire and French Foreign Minister Jean-Yves Le Drian called a demonstrative joint press conference inside the monumental Finance and Economics Ministry in Paris looking like they were ready go toe-to-toe with Washington.

Le Drian spoke of "our determination to fight to ensure that the decisions taken by the United States don't have any repercussions on French businesses." Le Maire added: "All of Europe is faced with the challenge of asserting its economic sovereignty."

Former French Prime Minister Jean-Pierre Raffarin, who coordinated resistance to Georg W. Bush's invasion of Iraq between Paris, Berlin and Moscow, is even calling for the creation of a G-4 comprised of France, Germany, Russia and China in order to stand up to Trump. France still views itself as a global power and, as such, isn't afraid of patching together alliances that suit the moment.

That's still a bridge too far for Germany. For a person as committed to trans-Atlantic relations as Altmaier, the idea of an alliance with Russia and China against the United States is a nightmare scenario. This is further complicated by the fact that the alliance wouldn't just be against the U.S., but also Israel. Sources within the Chancellery openly admit that there is an Israeli component when it comes to the German government's approach with Iran. Whenever you speak about Iran, they say, you also have to have an eye to Israel.

But at the center of the dispute with the U.S. is the economy. In France, it's large multinational corporations like oil giant Total and carmaker Peugeot that would be hit by the American sanctions.

In Germany, however, the share of small- to medium-sized companies that are not heavily dependent on U.S. sales is high. They would likely be able to continue doing business with Iran since U.S. sanctions wouldn't hurt them. Total, on the other hand, announced on Wednesday that it was suspending plans for a major project -- entailing the exploration of the Iranian South Pars gas field -- in the Persian Gulf.

Trade with Iran isn't of great significance for either Germany or France. Only 0.3 percent of French exports go to the country and only 0.2 percent of Germany's.

Symbolic Gestures

In other words, measures to protect European companies will for the most part only have a symbolic political effect. They're a signal to Trump that there are certain things the Europeans won't put up with. And a signal to the Iranians that the EU is truly fighting to save the deal. The reformers in Tehran need that signal to prevent hardliners from withdrawing from the nuclear deal.

The blocking statute that the European Commission is currently pushing would fine European companies that obey the U.S. sanctions. At the same time, the EU would pay damages to companies that defy the U.S. sanctions. The European Council, the powerful body representing the EU member states, now has two months to act before the law goes into effect. Germany would only be able to stop it if there is a qualified majority on the council opposing the rule.

The "blocking actions" were originally agreed to by the EU in 1996 to counter U.S. sanctions against Iran, Libya and Cuba due to the effects they were having on European Union member states. At the time, Clinton moved to wave extraterritorial sanctions on EU companies doing business in those countries, so the statute was never applied.

Even though the chances are low of keeping companies in Iran, even with the statute in place, Foreign Minister Maas, in contrast to Altmaier, has still concluded that the EU move sends the right message to the U.S. administration.

Altmaier, on the other hand, views the idea of the blocking statute critically. And the Chancellery even views it as "absurd." If Maas and Altmaier are unable to reach some kind of agreement on their position, then the German government's representative in Brussels will have to abstain from any vote -- which would provide further proof that it is Macron and not Merkel who is leading Europe at the moment.

Another idea envisions the European Investment Bank (EIB) becoming active in Iran. Back in November, EU foreign ministers instructed the bank to expand its mandate in order to make the financing of projects in Iran possible. But it could take quite a while until that actually happens. So far, the bank's External Lending Mandate has been changed. And since April, Iran has been included in Annex 2 of the "potential" countries that could obtain aid. Money, though, can only flow once a country has been placed on Annex 3 -- the level at which Lebanon finds itself.

The next step would be a framework agreement between the EU and Iran that would establish the basis for financing specific projects. The main problem here is that EIB is active in the U.S., the world's biggest financial market, and could be exposed to American sanctions there.

Growing Criticism

It's not just Macron who is heaping pressure on Chancellor Merkel. There are also members of her own cabinet and party who are critical of how lightly the chancellor is treading on the subject. On Tuesday, Maas expressed agreement in Brussels with his French counterpart, who is pushing together with top EU diplomat Federica Mogherini for measures to be taken. Maas said in Brussels that Europeans aren't powerless and that, even if it won't be easy, there are surely "possibilities and instruments" for acting.

"We shouldn't focus too much on being accommodating or appeasement," says Roderich Kiesewetter, a member of Merkel's conservative Christian Democratic Union (CDU) who is also the party's foreign policy point person in parliament. "Instead, we should develop a more self-confident European attitude. The French are right when they say we shouldn't be sitting on our hands and doing nothing. It's only on the basis of clear positions and determination that we can continue a dialogue with the U.S. that will serve our interests."

There has also been vocal criticism in Brussels of Merkel's cautious position. "We're just encouraging further measures by kowtowing," says Elmar Brok, a prominent member of the European Parliament with the CDU. "That's why we need to draw a line." Trump may not like strong negotiating partners, he adds, "but he does respect them just as all strong people only respect strong people." A signal is needed, he says, "to show that we won't put up with everything." Yielding to Trump, Brok warned, would merely reinforce the president's assessment that he can do whatever he wants to the Europeans.

Iranian Foreign Minister Mohammad Javad Zarif, for his part, said he would not accept a "there's nothing we can do" attitude from the Europeans. "The EU, Russia and China together are no less powerful than the U.S.," says Ali Majedi, Iran's ambassador to Berlin. He says the Europeans demonstrated success in standing up together against Trump in the dispute over punitive tariffs. Now, he says, Tehran expects the same with the nuclear deal.

"If the EU, Russia and China use the instruments available to them to enable Iran to benefit economically from the deal, then we will also stick to the agreement," Majedi says. Then, he says, a discussion could take place about Iran's role in the region or its controversial ballistic missiles program, but it would all have to be done independently of the nuclear agreement.

"If there are expectations that Iran will renegotiate the deal and make further concessions, then that is unacceptable," he adds.


By Markus Becker, Christiane Hoffmann, Peter Müller, Christoph Schult and Gerald Traufetter


Fed Sees Next Hike Soon, Signals Modest Inflation Overshoot OK

Bloomberg


Federal Reserve officials said the economic outlook warranted another interest-rate hike “soon” and signaled they would welcome a modest overshoot of their 2 percent inflation target, indicating they’re in no rush to tighten more aggressively.

“Most participants judged that if incoming information broadly confirmed their current economic outlook, it would likely soon be appropriate for the committee to take another step in removing policy accommodation,” minutes released Wednesday of the Federal Open Market Committee’s May 1-2 meeting said.

A temporary period of inflation “modestly above 2 percent would be consistent with the committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations,” according to the minutes.


While the report all but confirms the central bank is on track to raise interest rates at their next meeting in June, Fed officials were reluctant to declare victory on achieving their inflation goal on a sustainable basis. At the same time, they flagged potential changes to the statement at future meetings to indicate rates were no longer as stimulative, and discussed adjustments in the rate of interest on excess bank reserves to relieve some pressures in the money markets.

“It was noted that it was premature to conclude that inflation would remain at levels around 2 percent, especially after several years in which inflation had persistently run below the committee’s 2 percent objective,” the minutes said.


Symmetric Goal

At the meeting, U.S. central bankers left the target range for the benchmark policy rate unchanged at 1.5 percent to 1.75 percent after raising rates in March, and inserted a second reference to their “symmetric” 2 percent inflation goal in the policy statement on their decision.

Investors had already widely expected officials to raise rates when the FOMC meets June 12-13, according to interest-rate futures prices. Policy makers have been split on whether a total of three or four hikes are warranted for the full year.


Financial markets were unsettled in the days running up to the May FOMC meeting amid concerns over a U.S.-China trade dispute, with stock prices falling and 10-year Treasury yield rising toward 3 percent.

President Donald Trump has threatened tariffs on as much as $150 billion in Chinese imports, with China vowing to retaliate in kind. While the nations announced a truce over the weekend, Trump has since said he wasn’t pleased with the trade negotiations, and tweeted Wednesday that the U.S. may need to change the direction of talks to get a final agreement.

Policy makers relayed concerns from regional business contacts who warned of possible adverse effects from tariffs and trade restrictions, such as delays or pullbacks in capital spending.

In addition, “it was noted that the potential for higher Chinese tariffs on key agricultural products could, in the longer run, hurt U.S. competitiveness.”

Yield Curve

The minutes showed officials discussed the flattening yield curve, or the shrinking gap between the yields on long-dated Treasury bonds and short-term securities. That spread -- which turned negative in the run-up to every recession in the past 40 years -- has recently narrowed to around the lowest levels since 2007.

While a few policy makers said the yield curve may have become “a less reliable signal of future economic activity,” several others stressed that an inverted yield curve has historically “indicated an increased risk of recession,” according to the minutes.

Fed officials met after data showed price gains finally hitting their target after undershooting for most of the last few years. New York Fed President William Dudley and San Francisco’s John Williams, who’ll replace him next month, have both since said they’re comfortable with a modest inflation overshoot, signaling no rush to speed up the central bank’s gradual pace of policy tightening.

Preferred Measure

Inflation, according to the Fed’s preferred indicator, reached 2 percent in March. Data released two days after the meeting showed unemployment dipped in April to 3.9 percent, the lowest since 2000, while year-over-year gains in average hourly earnings were steady at 2.6 percent.

 Italy: An Anti-Euro Government Takes Power In the Heart Of The Eurozone

 

Ah, Italy. My people; fun to be around, a nightmare to govern. And now an existential threat to the European Union, the euro currency, and the global bond markets.

After suffering for over a decade under a monetary regime designed by and for efficient economies like Germany, the Italian people have finally said enough, giving a majority of their votes in this month’s election to parties that promise relief – though rather different forms of relief – from the burdens of a stable currency. From last week’s Guardian UK:
Italy’s new government, likely to be formally confirmed within the next few days, sets a perilous precedent for Brussels: it marks the first time a founding member of the EU has been led by populist, anti-EU forces. From the EU’s perspective, the coalition of the anti-establishment Five Star Movement (M5S) and the far-right League looks headstrong and unpredictable, possibly even combustible. Leaked drafts of their government ‘contract’ include provision for a ‘conciliation committee’ to settle expected disagreements.  
Mainly it looks alarming. Both parties toned down their fiercest anti-EU rhetoric during the election campaign, dropping previous calls for a referendum on eurozone membership… But as they approach power, the historical Euroscepticism of the M5S and the League is resurfacing. An incendiary early version of their accord called for the renegotiation of EU treaties, the creation of a euro opt-out mechanism, a reduction in Italy’s contribution to the EU budget and the cancellation of €250bn (£219bn) of Italian government debt.

It’s important to remember that until very recently Italy’s short-term government paper traded with negative yields. That is, if you wanted to lend them money you had to pay them rather than the other way around. This was largely because everyone assumed that the European Central Bank would give Italy effectively unlimited amounts of credit to ensure that it stuck around and played nice.

Now, not so much. Italian bond yields are spiking and spreads relative to German and other supposedly risk-free bonds are rising. And the ECB feels no compulsion to bail out this particular set of Italian politicians.

Italy 10-year bond yield

What exactly does this mean for the euro? Well, that depends on whether the new government follows through on its voters’ desire to start prepping for a departure from the eurozone and a return to the lira – a currency that can be devalued at Rome’s pleasure.

Were this to happen, Italian paper worth hundreds of billions of euros would …well…it’s not clear what it would do. If Italy converted its outstanding debt to lira that would be a breach of contract, triggering a legal orgy with wholly unpredictable consequences, one of which might be its banishment from the global money markets.

If Italy tried to leave the EU, we can take the never-ending Brexit quagmire and raise it an order of magnitude, and even then we’re probably underestimating the disruption.

Is Italy Just Another Emerging Market?

It might be helpful to stop thinking of Italy – and several other “peripheral” EU members — as advanced developed countries and instead put them in the “emerging market” category.

In which case they have lots of company. From Doug Noland’s most recent Credit Bubble Bulletin:

Where to begin? Contagion… The Argentine peso dropped another 5.0% this week, bringing y-t-d losses to 23.7%. The Turkish lira fell 3.9%, boosting 2018 losses to 15.4%. As notable, the Brazilian real dropped 3.7% (down 11.5% y-t-d), and the South African rand sank 4.0% (down 3.0% y-t-d). The Colombian peso fell 3.0%, the Chilean peso 2.7%, the Mexican peso 2.7%, the Hungarian forint 2.3%, the Polish zloty 2.1% and the Czech koruna 2.0%. 
EM losses were not limited to the currencies. Yields continued surging throughout EM. Notable rises this week in local EM bonds include 54 bps in Brazil, 27 bps in South Africa, 34 bps in Hungary, 36 bps in Lebanon, 25 bps in Indonesia, 28 bps in Peru, 14 bps in Turkey, 20 bps in Mexico and 11 bps in Poland.  
Dollar-denominated EM debt was anything but immune. Turkey’s 10-year dollar bond yields spiked 41 bps to 7.16%, the high going back to May 2009. Brazil’s dollar bond yields surged 29 bps to 5.58%, the highest level since December 2016. Mexico’s dollar yields jumped 18 bps to 4.64%, the high going all the way back to February 2011. Dollar yields rose 19 bps in Chile, 28 bps in Colombia, 19 bps in Indonesia, 14 bps in Russia, 14 bps in Ukraine and 167 bps in Venezuela (to 32.80%). Losses are mounting quickly for those speculating in EM debt. 
Bonds throughout the euro zone periphery were under pressure. Greek 10-year yields surged 50 bps to a 2018 high 4.50%. Portuguese yields jumped 19 bps to 1.87%, and Spanish yields gained 17 bps to 1.44%. Elsewhere, Australian 10-year yields rose 12 bps to 2.90%, and New Zealand yields rose 14 bps to 2.86%.

There’s a recurring “death spiral” element to emerging market debt, in which these countries temporarily stabilize their finances, get cocky, start borrowing in major currencies like the dollar on the assumption that their local currencies will continue to strengthen, thus allowing them to pay off their external currency loans with ease…and then fall prey to traditional overspending, corruption and inflation temptations, causing their currencies to fall and their debts to become unmanageable.

Here we go again, with the added twist of populist political parties rising around the world, promising to extricate their countries from the clutches of elite parasites.

If this has a “2008” feel to it, that’s because crises frequently begin at the periphery and move towards the core. Initially the core markets and asset classes watch with smug amusement as the hinterlands burn while terrified capital flows to the center, actually boosting the value of core assets.

But in the end everybody (except for short sellers and gold bugs) pays a price for each generation’s late-cycle hubris.


An Overlooked and Underdeveloped Region in Southern Mexico

By George Friedman and Allison Fedirka


On the whole, Mexico is a fairly prosperous country. It ranks 15th in the world in terms of gross domestic product and is classified as an upper middle-income country by the World Bank.  But its wealth is not distributed evenly, and Guerrero state is a perfect example of the poverty and underdevelopment that exists in many parts of the country.

Located on the Pacific coast and 120 miles (200 kilometers) southwest of Mexico City, Guerrero state had the most homicides of any state in Mexico last year. There are at least six major drug trafficking organizations operating in the state and competing for territory. Some areas of Guerrera (most notably the Chilpancingo-Chilapa corridor) have almost no government presence and are controlled mainly by drug cartels that offer to “protect” local residents in exchange for their labor in poppy fields. Though this can be attributed partly to geography—the state is mountainous and therefore hard to secure from the outside—it’s also due to the fact that the state was not seen as a priority during various points in Mexico’s history.

Left Out of the Infrastructure Boom

Why have these conditions developed in Guerrero, while other parts of the country have prospered? One reason is the lack of infrastructure. Mexico experienced a wave of infrastructure development after the second French intervention in the 1870s, and again during the early years of the Porfirio Diaz government in the 1880s. In 1860, Mexico had only 150 miles of disjointed railway, but just 24 years later, this number grew to 7,500 miles. Initially, officials wanted to construct a rail line linking Veracruz (on the east coast) with Acapulco (a port city in Guerrero) via Mexico City. But ultimately, they did not follow through with this plan, and Guerrero was largely left out of the infrastructure boom—a fact that has limited the state’s development ever since.

Guerrero’s mountainous terrain makes infrastructure development costly. Heavy rains during summer months also make construction harder and increase the cost of maintenance for existing tracks. At the start of the railway boom, private companies and investors from the US, UK, and elsewhere funded infrastructure projects, choosing which projects to invest in based on business interests. In Guerrero, these interests mainly related to mining because the northern part of the state is rich in minerals and metal deposits. This provided enough financial incentive to construct a railway from Mexico City to Iguala, a city located in the mining region and relatively close to Mexico’s capital.


Source: Geopolitical Futures (Click to enlarge)

 
But when metal prices fell at the end of the 19th century, investor interest in the state waned. It was around this time (in 1898) that the federal government stepped in to regulate railway construction. This put the final nail in the coffin for Guerrero’s development.

The federal government intervened for two reasons. First, it needed to fill the gap left by the private sector. The fall in metal prices hit Guerrero particularly hard, but it affected the mining industry, and therefore infrastructure development, across the country. This had almost immediate impacts on the local populations and economies that the Diaz government had been so dedicated to supporting in the previous decade.

Second, the government wanted a national approach to infrastructure development to ensure that those projects receiving the most support and investment were in the best interests of the country. This resulted in legislation that limited foreign participation in infrastructure, gave the government more control, and introduced a period of time in which projects needed government subsidies before they could move forward. But the central government did not consider Guerrero a priority for rail construction, and the extension of the railway to Acapulco was abandoned.


Source: Geopolitical Futures (Click to enlarge)

 
Guerrero is also poorly connected by roads. The first and only major highway in Guerrero connects Acapulco to Mexico City. It was built in 1927 and followed the original dirt road that connected the cities. The construction of the highway significantly affected the state’s development, as economic activity and population centers grew in those areas with access to it. These areas included Acapulco, Chilpancingo, and Iguala, as well as somewhat smaller centers just off the highway like Taxco and Chilapa. A third of the state’s population lives in the first three municipalities—when the other three are added, it’s nearly half the population. Even today, the areas of Guerrero that are not along the main highway are underdeveloped, desolate, and disconnected from economic activity in the rest of the country. Securing these areas would require heavy investment in terms of both finances and personnel.


Source: Geopolitical Futures (Click to enlarge)


Limited Coastal Development

Guerrero has one key advantage: its access to the Pacific Ocean. Ports usually serve as engines for economic growth and development because they help facilitate trade. Port cities offer benefits for businesses in terms of logistics and often develop into economic hubs themselves. But this hasn’t been the case with Guerrero’s main port, Acapulco.

From 1565 to 1814, Acapulco was one of the primary ports used by New Spain, and then Mexico, for trade with China and other Asian countries. However, trade with these countries was secondary to trade with Europe, which meant that ports on Mexico’s Atlantic coast took priority.

It was difficult for Acapulco and the surrounding area to fully capitalize on trade with Asia. The port received large shipments from Asia only twice a year because crossing the Pacific Ocean took an incredibly long time given the distance between Mexico and China, as well as the limits of maritime navigation and technology. A trip that now takes two to three weeks took several months back then. Goods were unloaded at the port and a local fair was set up to sell them. After four to six weeks, the fairs would close and the goods would be sent to Mexico City. There, they would be consumed or delivered to other parts of the viceroyalty. As such, Acapulco was mainly used as a transit point for commerce and goods on their way to the capital, and as a result, it did not develop into a major commercial hub.

Once Acapulco lost its position as a major Pacific shipping port for New Spain, it never regained it. Mexico’s fight for independence severely disrupted Spanish control over trade and territory, and this impacted  Acapulco. Mexican General Jose Maria Morelos took the city of Acapulco in 1814, at which point Spain redirected trade to other ports. In the years that followed, Mexico’s central government focused on securing territory from incursion by the US, France, and even the residents of Guerrero, (which at the time, was not yet a state of its own). In the early 20th century, construction of the Panama Canal was in full swing, which caused development in Acapulco to stagnate even more. The canal allowed goods to be shipped to Mexico’s east coast faster and more inexpensively. Within Mexico, Manzanillo Port (also on the Pacific coast) quickly surpassed Acapulco in terms of infrastructure development, and in 1908, Porfirio Diaz designated Manzanillo as an official port of entry.

Today, the ports of Manzanillo and Lazaro Cardenas dominate Mexico’s Pacific maritime trade. Despite increased trade between Mexico and Asian markets and the fact that, globally, Pacific trade is starting to overtake Atlantic trade, Acapulco cannot take advantage. The private sector continues to shy away from investing there, partly because of security concerns in Guerrero and partly because of competition from more developed and reliable ports in other areas of Mexico. This leaves the Mexican government as the primary source of funding for major infrastructure projects, but even the government is reluctant to sink money into this part of the country.

Peru: Staff Concluding Statement of the 2018 Article IV Mission

 
May 23, 2018
 
 
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
 
I. Context and Recent Developments
 
1. Peru has been one of the top performers in Latin America since the turn of the century, but growth has slowed more recently. Robust growth helped reduce poverty significantly, inflation has remained low, the fiscal position has strengthened, dollarization has declined markedly, and financial deepening has continued. More recently, the worst floods and landslides in recent history and fallout from the Lava Jato corruption scandal contributed to a slowdown in GDP growth to 2.5 percent in 2017.

2. After the resignation of President Kuczynski, the new cabinet has moved quickly to implement measures and request special legislative powers from Congress. Fiscal measures include excise tax hikes, improving tax administration, and streamlining current expenditures.

Law 30737 provides more clarity on civil damages in corruption cases and sets out rules for asset transfers by construction companies under investigation or those convicted. Special powers were requested in six areas: (i) tax policy and administration; (ii) competitiveness; (iii) post-El Niño reconstruction and closing infrastructure gaps (already granted); (iv) anti-corruption measures; (v) protection of vulnerable groups (and preventative measures), and (vi) modernization of the state.

II. Outlook and Risks
 
3. Growth is expected to rebound to 3.7 percent in 2018, with inflation converging to the center of the BCRP’s target band. GDP growth of 3.2 percent in the first quarter and high frequency indicators for April point to a rebound in economic activity this year. A key driver is public investment rising, while private investment is also projected to grow after four weak years. The latter will be supported by easy monetary conditions, and a more favorable credit and investment climate that typically follows commodity price improvements. With food price inflation normalizing throughout the year, headline inflation is expected to gradually increase toward the center of the central bank target range.

4. Growth is projected to accelerate to over four percent in 2019, gradually approaching potential thereafter.  Given higher commodity prices and the government’s reform agenda, staff has increased its estimate of medium-term potential growth to 4 percent from 3¾ percent.

Strong domestic demand, especially higher private investment should be the key driver. After a remarkable adjustment in 2016-17, the current account deficit will widen somewhat given the impact of stronger import demand, narrowing the small gap with its current estimated equilibrium level. Fiscal policy is expected to start a gradual consolidation in 2019, with the fiscal deficit converging to 1 percent of GDP by 2021, as stipulated by the fiscal rule.

5. Risks are broadly balanced. On the domestic front, key downside risks include further delays to public investment projects and PPPs given capacity constraints and the ongoing corruption investigations. On the external front, more protectionist trade policies, a slowdown in China, or a more rapid increase in international interest rates could adversely affect Peru via weaker growth of exports and tighter financing conditions. Higher spillovers from commodity prices, as observed in Peru in the past, present the main source of near-term upside risk. The authorities’ efforts to reduce impediments to investment projects could also bear fruit earlier than expected.

III. Policy Recommendations
 
6. In the short term, countercyclical fiscal and monetary policies remain appropriate while structural reforms are an indispensable complement. Key challenges include strengthening the tax system, improving public investment and PPP management, buttressing macroprudential policies and financial sector oversight, tackling governance vulnerabilities, and enhancing the pension system’s social protection role.

Monetary Policy
 
7. The current monetary stance is appropriate and should remain data dependent. The BCRP has appropriately loosened monetary conditions in response to weaker than expected growth developments and declining inflation outturns and expectations. The real policy rate now stands at just 0.6 percent, significantly below the BCRP’s estimate of the neutral rate (around 1¾ percent), implying substantial monetary stimulus. Under staff’s baseline scenario, this suggests limited scope for additional interest rate cuts given core inflation and inflation expectations near the mid-point of the target range (two percent), and a projected narrowing of the output gap.

8. Credible and agile monetary policy management has been central to macroeconomic stability in Peru, and the BCRP could consider further enhancements in the following areas:
  • Communications . The inflation targeting regime has brought significant transparency gains. The BCRP could consider enhancements in the communication of its guidance of the conditions for future policy rate moves.
  • Exchange rate flexibility . This remains important and FX interventions should continue to be limited to disorderly market conditions. Allowing further two-way exchange rate flexibility could help stimulate market development and support dedollarization efforts.
Fiscal Policy

9. Staff supports the planned increase in public investment and the focus on boosting execution capacity as an immediate priority. With the economy facing a negative output gap, and significant reconstruction needs associated with last year’s flooding and landslides, expanding public investment—which has a high multiplier—remains appropriate. Important steps to improving the framework for capital expenditure include strengthening long-term planning and credibility of investment budgeting, better prioritization, simplifying project monitoring and evaluation, and increasing execution transparency. Given the key role local governments play for investment, continuing efforts to build subnational capacity remains essential. It will also be important that PPP projects—both ongoing and in the pipeline—continue to move forward.

10. The authorities’ strategy to focus the medium-term consolidation effort on the revenue side and streamlining current expenditure is appropriate. In line with the fiscal rule, the authorities are planning to reduce the deficit to 1 percent of GDP by 2021. The focus on raising revenue is welcome given Peru’s tax revenues appear low compared to other countries, the existing infrastructure gaps, and the need to maintain government expenditure in key social areas. In this regard, the recent increase in excise taxes is welcome. Higher commodity prices should also contribute to fiscal consolidation by significantly boosting revenues. If revenue overperforms, staff would support increasing public investment further. Finally, there is likely scope to cut some waste in current expenditure.

11. Staff supports the authorities focus on a tax reform that simplifies the system, levels the playing field and improves tax administration. The tax system is complex, with numerous special regime exemptions, and widespread and overlapping withholding schemes. Priority should be given to reducing the compliance gaps (especially in the VAT), moving towards a less fragmented income tax regime, making personal income taxes more progressive, rationalizing tax exemptions, and increasing revenues from property taxes.

Financial Sector Policy

12. As noted in Peru’s ongoing Financial Sector Assessment Program, the banking sector remains sound but it is still important to continue monitoring a broad set of vulnerabilities.

Stress tests show that the financial sector can withstand even severe macrofinancial shocks. 

Nevertheless, pockets of vulnerability warrant close attention:
  • Peru’s financial sector is highly concentrated, and dominated by financial conglomerates. Even though the interbank contagion analysis did not find large risks of either direct exposures between large banks or indirect risk coming from fire sales effects, large banks have similar loan portfolios and credit risk is strongly correlated among banks. As a result, shocks that trigger common exposures have the potential to become systemic events, since the banking system is concentrated. To mitigate these risks, capital surcharges for systemic banks should be increased in line with the Basel III framework, which the SBS is currently considering. Furthermore, increasing countercyclical provisioning in smaller banks would strengthen their capacity to withstand potential shocks. 
  • Off-balance sheet exposures should continue to be monitored, although stress tests do not suggest they pose a significant current risk.
   
13. Peru’s broad toolkit has helped facilitate significant dedollarization in recent decades, and further measures could help cement this. To make additional progress, the authorities could increase risk weights on FX loans along the lines suggested by recent Basel III guidelines. Regarding FX reserve requirements, changes should be tied to either the dedollarization process or addressing adverse macrofinancial shocks.

14. Staff welcomes the authorities’ plans to strengthen financial sector oversight, but notes that further efforts in some specific areas remain important. There is still a need to remove legal limitations and enhance the supervisory framework that would strengthen the SBS’s capacity for consolidated supervision of financial conglomerates. The passing of the pending legislation migrating the supervision of the saving and credit cooperatives to the SBS would constitute another important step. Continuing the process of transitioning to risk-based supervision of the insurance sector is also important. In addition, the authorities could improve their macroprudential framework even further, including by giving enhanced mandates for macroprudential policy to the BCRP and the SBS, and by implementing a memorandum of understanding to strengthen coordination.

15. Financial development efforts should focus on expanding financial access and inclusion, and addressing high concentration. While progress has been made, overall financial depth in Peru remains low relative to the region. High concentration could also indicate a lack of banking competition in some segments. The authorities should strengthen the legal and institutional framework to more effectively oversee all aspects of competition, market conduct, and consumer protection.

16. Regarding financial inclusion, reforming the e-wallet Billetera Móvil (BiM) and approaches to fintech used elsewhere should be considered. The uptake of BiM is below expectations. It could benefit from interoperability with bank accounts, digitization of government payments, and expanded access criteria for the mobile money platform. Fintech institutions, while currently limited in scale, could provide new solutions for financial inclusion. Drawing lessons from regulatory approaches emerging elsewhere, such as the adoption of regulatory sandboxes (e.g., see Singapore and the U.K.), would be instrumental to develop the fintech sector by appropriately supporting innovation while managing risks.

Structural Reforms

17. A multi-pronged approach is needed to boost potential growth. Despite some convergence, labor productivity is one-fifth of the U.S. Staff and the authorities agree on many of the priority areas to boost productivity and reduce misallocation of resources, including: education, infrastructure, institutions, and labor market reform. Removing barriers which limit growth of productive firms and labor formalization is also important, including distortions created by tax incentives, burdensome regulation, and limited access to credit.
 
18. The Lava Jato scandal has had a major impact on the economy and the authorities rightly view governance as a priority. Law 30737 should reduce uncertainty in the construction sector, while requiring conflict of interest statements from public officials (as envisioned in the special legislative powers) would be a welcome step to help reduce corruption. In addition, apart from broadly improving fiscal governance, staff recommends: improving timely exchange of information and financial intelligence among anti-corruption agencies; strengthening the asset declaration system (i.e., verification, beneficial ownership information and public access); enhancing risk-based AML/CFT supervision and the reporting system for suspicious transactions; creating a beneficial ownership registry; and ensuring customer due diligence for politically exposed persons. Staff stands ready to further support the authorities in their efforts.

19. While poverty and inequality declined markedly during the commodity boom, they increased in 2017 and a recalibration of policies may be warranted. Increasing tax revenues will help protect needed infrastructure and social spending. Increasing progressiveness of the personal income tax system will also enhance redistribution. Given highly concentrated transfers and a lack of absorptive capacity at the subnational level, it would be worthwhile re-thinking revenue sharing formulas to reduce horizontal inequities. Specifically, in addition to natural resource production, they could better reflect spending needs, for example population size and poverty levels.

20. The pension system could be reformed to enhance social protection and reduce inequities, but tradeoffs necessitate public consultation and careful communication. Given low pension coverage, the non-contributory pillar (Pension 65) will remain important, and should be broadened.

In the public system, shortening the minimum 20-year contribution period would allow more low-income workers to receive a pension. In both these areas, fiscal costs should be carefully assessed. Several reforms could help increase replacement ratios in the private system.

Specifically, high pension management fees should be lowered and excessive flexibility to withdraw lump-sum amounts removed. Increasing contributions could also be considered, but might adversely impact labor formality. Given these reforms will still lead to replacement rates well below OECD levels, it will be crucial to communicate realistic expectations to the public.

Over the longer term, a larger institutional reform should also be pursued to better integrate the private and public pillars, considering tradeoffs between pension adequacy, coverage and fiscal sustainability.

We would like to take this opportunity to thank the Peruvian authorities and private sector representatives for their hospitality and open and constructive dialogue.

Table 1. Peru: Selected Economic Indicators 
                        
Prel.
Proj.






2016
2017
2018
2019
2020
2021
2022
2023
(Annual percentage change; unless otherwise indicated)
Production and prices
Real GDP
4.1
2.5
3.7
4.1
4.2
4.2
4.1
4.0
Real domestic demand
1.1
1.6
4.5
4.7
4.7
4.5
4.5
4.5
Real domestic demand (contribution to GDP)
1.1
1.6
4.4
4.7
4.6
4.5
4.5
4.5
Consumption (contribution to GDP)
2.0
1.7
3.0
2.9
2.9
3.0
3.1
3.1
Investment (contribution to GDP)
-1.0
-0.1
1.4
1.8
1.8
1.5
1.3
1.4
Net Exports (contribution to GDP)
3.0
0.9
-0.7
-0.6
-0.4
-0.3
-0.4
-0.5
Output gap (percent of potential GDP)
-0.6
-1.1
-1.1
-0.8
-0.4
-0.2
0.0
0.0
Consumer prices (end of period)
3.2
1.4
2.2
2.0
2.0
2.0
2.0
2.0
Consumer prices (period average)
3.6
2.8
1.3
2.0
2.0
2.0
2.0
2.0
External sector
Exports
7.6
21.3
13.2
4.0
3.6
3.6
3.9
4.1
Imports
-5.9
10.0
9.9
6.0
5.7
5.6
5.1
5.7
Terms of trade (deterioration -)
-0.7
7.3
6.0
0.4
-0.2
-0.5
0.2
0.4
Real effective exchange rate (depreciation -)
-2.4
1.4
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
Money and credit 1/ 2/
Broad money
4.3
7.7
8.5
8.5
7.9
7.6
7.5
7.6
Net credit to the private sector
5.0
5.1
7.2
7.3
6.8
6.6
6.5
6.6
(In percent of GDP; unless otherwise indicated)
Public sector
NFPS revenue
23.2
23.0
23.4
23.9
24.3
24.7
24.7
24.6
NFPS primary expenditure
24.6
24.9
25.4
25.2
24.7
24.2
24.2
24.2
NFPS primary balance
-1.4
-1.9
-2.0
-1.3
-0.4
0.5
0.5
0.5
NFPS overall balance
-2.5
-3.1
-3.3
-2.7
-1.9
-1.0
-1.0
-1.0
NFPS structural primary balance 4/
-1.2
-1.5
-1.7
-1.1
-0.4
0.5
0.5
0.5
External sector
External current account balance
-2.7
-1.3
-1.7
-1.8
-1.9
-2.0
-2.0
-2.0
Gross reserves







In billions of U.S. dollars
61.7
63.7
64.7
65.2
65.2
65.2
65.2
65.2
Percent of short-term external debt 3/
450
312
486
461
514
516
517
523
Percent of foreign currency deposits at banks
230
232
229
231
234
238
242
249








Debt
Total external debt 5/
38.2
35.7
33.1
31.2
30.2
28.9
27.6
26.4
Gross non-financial public sector debt 6/
24.4
25.3
26.8
27.8
27.9
27.4
26.8
26.3
External
10.3
8.7
8.7
8.4
8.7
8.5
8.2
8.0
Domestic
14.0
16.6
18.2
19.4
19.3
18.9
18.6
18.3
Savings and investment
Gross domestic investment
22.6
21.4
21.9
22.6
23.3
23.8
24.1
24.4
Public sector (incl. repayment certificates)
4.8
4.5
4.8
5.0
5.0
5.0
5.0
5.1
Private sector (incl. inventories)
17.8
16.9
17.1
17.6
18.2
18.7
19.0
19.4
National savings
19.9
20.2
20.2
20.7
21.3
21.8
22.1
22.4
Public sector
2.7
2.0
2.2
3.0
3.8
4.7
4.8
4.8
Private sector
17.2
18.1
18.0
17.7
17.5
17.0
17.2
17.6
Memorandum items
Nominal GDP (S/. billions)
659.7
701.8
749.0
796.9
848.1
901.6
958.0
1016.6
GDP per capita (in US$)
6,208
6,762
7,198
7,533
7,823
8,133
8,486
8,864



Sources: National authorities; UNDP Human Development Indicators; and Fund staff estimates/projections.
           
1/ Corresponds to depository corporations.
           
2/ Foreign currency stocks are valued at end-of-period exchange rates.
           
3/ Short-term debt is defined on a residual maturity basis and includes amortization of medium and long-term debt.
           
4/ Adjusted by the economic cycle and commodity prices, and for non-structural commodity revenue. The latter uses as equilibrium commodity prices a moving average estimate that takes 5 years of historical prices and 3 years of forward prices according to IMF World Economic Outlook.
           
5/ Includes local currency debt held by non-residents and excludes global bonds held by residents.
           
6/ Includes repayment certificates.
           
IMF Communications Department