Analysis: Peru’s political crises are finally hurting its economy

Since 2011, Peruvians have lived under seven different presidents, while four former heads of state have been arrested or wanted on corruption charges.

However, in the same period, Peru has clung to the title of the fastest-growing major Latin American economy.

That period of exceptional growth should end this year, according to a Reuters analysis of World Bank and International Monetary Fund data, which places Colombia ahead of Peru.

The slowdown in growth hides a painful reality for the world’s second-largest copper producer. Its economy is finally beginning to deteriorate after years of escalating political crises that have come to a head with President Pedro Castillo and a hostile congress, damaging private investment and public spending.

Global economic pressures such as pandemic-triggered inflation have hit Latin America hard, but the signs for the economy are particularly pessimistic in Peru.

“I think there is no other option but to say that it is the government that is affecting (economic) expectations because businesses are doing well,” said Pedro Francke, who was Castillo’s first economy minister before resigning earlier this year.

Castillo became president in July 2021, scaring investors during his campaign with a radical plan to redistribute wealth and change the constitution. But while in government, he handed the reins of the economy to a group of moderate technocrats, while the executive has not implemented any significant economic reforms.

Now, Castillo and his allies face many scandals. He faces six investigations, one of them for allegedly obstructing justice by firing a minister. Congress has tried to impeach him twice, without success.

“Politics and economics can no longer be treated as separate issues in Peru,” Fitch said in a report this week.

Peru’s economy ministry declined to comment.

Despite the negative outlook, Peru’s economy is expected to remain one of the fastest growing in Latin America, according to the IMF. Meanwhile, Moody’s, Fitch, and S&P told Reuters that they do not see imminent risks that would merit downgrading the country’s rating, which remains investment grade.

Large Peruvian companies have shown solid results so far this year. Nevertheless, the government is expected to lower its growth expectations for this year, according to the new economy minister, Kurt Burneo.

The government expects growth of 3.6%, but Burneo has said the figure could be as low as 2.2%, although he later argued that it could be a bit higher.

“Today Peru is facing one more stress test (…) but what is not going to be able to be saved is economic growth,” said David Tuesta, the president of the Peruvian Competitiveness Council, a group funded by big business.

A LOW-SPENDING POPULIST

Castillo came to power promising to increase public spending with new social programs and raise taxes on mining.

But his government has dispensed with a slowdown in public spending, despite record tax revenues, while congress shelved the proposed mining tax reform.

Peru’s fiscal deficit now stands at a very conservative 1% of GDP, a dramatic reduction compared to the 8.9% the country had in 2020. This reduction was achieved without the government adopting an austerity policy.

“The bad news is that this deficit reduction is due (…) to the government’s inability to spend even on the things it wants to spend on,” said Moody’s Jaime Reusche.

Central government public spending had contracted 5% this year compared to the same period in 2021 when Castillo was not yet in power.

With less than two weeks as economy minister, Burneo has already said that Peru risks going into recession if the government does not find a way to increase public spending and has criticized the central bank for raising the interest rate to fight inflation.

Many analysts believe Castillo will not finish his term in 2026, although opposition congressmen have said they do not have enough votes to remove him for now.

But even if they were to remove Castillo, the president’s removal might not have affected the economy enough to reverse Peru’s slowing growth trend.

“It should not have a major impact on economic activity or real growth,” Reusche said.

With information from Reuters