Second Act

By Guerrero, Antonio | Global Finance, October 2010 | Go to article overview
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Second Act

Guerrero, Antonio, Global Finance

In his second term, Peru's president Alan Garcia is making amends for the shambles he left his country in after his first term.

Peruvian president Alan Garcia is leading one of the world's most impressive political and economie comeback stories. While his first term ended in 1990 with an economy in shambles, his return to power in 2006 has led to one of Latin America's most impressive economic recoveries. With the nation's economy expected to grow substantially this year, the "new and improved" Garcia's pro-market policies have put Peru firmly back on the map for international investors.

Garcia, once known as the "crazy horse" for his economic and political blunders, had been remembered as the president who caused the nation's economy to plunge by 10%, pushed inflation to 7,000% and defaulted on $14 billion worth of debt. When his term was over, he went into exile in Colombia and France for nearly nine years. Yet, since his election to a second term four years ago, Peru has enjoyed a strong economic recovery, boosted international reserves to more than $40 billion and received its first investment grade rating.

Peru hasn't been immune to the turmoil in the global markets, though. Last year the economy barely grew at all, turning in a meager 0.9% GDP increase. This year looks considerably better: The central bank recently revised its 2010 forecast upward to between 7.5% and 8%, from a previous 6.6%. Though copper, gold and commodities account for 75% of Peruvian exports, noncommodity sectors are driving growth this year. In July the economy grew 9% year-on-year, although within that there were vast disparities between different sectors. Mining and oil grew only 0.6% while manufacturing grew 17%, construction 12%, finance and insurance 12%, and electricity and water 11%. The nation's economy expanded by 8.2% during the first half of the year, making it one of the region's most dynamic. Morgan Stanley predicts 6.4% growth next year.

"Peru's economy has benefited from strong export-driven growth mostly because of its unique industrial mix focused mostly on copper, gold and zinc mining," says Andrew Karolyi, professor of finance and global business at Cornell University's Johnson School of Management. "China, with its voracious appetite for resources, is a major trading partner. I do not think this is a transitory phenomenon, but it will not be sustainable at this unusually high rate of growth."

While the elevated growth levels might not last in the long term, the Garcia administration is concerned that things may be getting out of control in the short term. "There is a danger of overheating, but we don't see it yet," die central bank's president, Julio Velarde, told participants at a conference in Lima in July. "If private spending starts to rise in an exaggerated way, obviously we will have to withdraw the monetary stimulus that we've had until now."

The central bank has been gradually applying the brakes on the economy and did so again last month, hiking its benchmark interest rate for the fifth consecutive month. Rates are still relatively low, at 3%, but bank reserve requirements have also been upped four times after private credit grew by 16% during the second quarter, compared with the same period last year. Marginal reserve requirements for foreign banks were doubled in September to 120% of short-term sol deposits. Peru was only Latin America's second country, after Brazil, to boost borrowing costs this year. Goldman Sachs predicts the benchmark rate will end the year at between 4% and 4.25%.

Higher interest rates are expected to push companies to pursue bond issues as a financing alternative. Corporate bond registrations were up 35% year-on-year during the second quarter of the year. The outcome could be a deepening of the country's capital markets.

The central bank has purchased nearly $8 billion to halt the currency's strengthening on the heels of hefty capital inflows.

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