Peru posts strong economic growth in Q1 thanks to mining and healthy private consumption

Economic growth summary

Headline GDP growth came in at 4.4% year on year (y/y) in the first quarter of 2016, which was a result of dynamic private consumption, while very healthy mining activity has played a large role in positive economic growth results Peru has posted in recent months. Private consumption was bolstered by growing family incomes, which were a result of growing employment opportunities, as well as healthy credit growth rates. Families spent their earnings at a faster pace during the first quarter; domestically produced services and consumption goods were at the forefront of the most popular items. Headline private consumption grew at a robust 4.1% y/y. Public-sector consumption was also healthy, growing at 12.7% y/y, driven by increased output in the public administration category, as well as in the defence sector. Fixed investment struggled, and posted a moderate 2.2% contraction, mainly caused by weakness in the purchase of machinery and equipment. Weakness in the investment in new capital goods was split equally between domestically produced machinery and equipment and imported machinery and equipment.

The healthy first quarter results were also strongly supported by major output gains in the mining sector. Specifically, IHS has observed enormous gains in the volume output from the copper sector. The price weakness has been leveraging downward pressure on copper revenues, though in the last two quarters we have finally seen revenue growth begin to show strong signs of recovery. The above graph helps illustrate the evolution of heavy volume output growth and price weakness, and how that has translated to copper foreign-exchange earnings.

The industrial side of economic growth through the first quarter has been mainly driven by the mining and extractive industries, though other noteworthy contributions were made by fishing and agricultural, while the construction sector also posted a nice recovery for the start of 2016. The mining sector has been growing at double-digit y/y rates since the third quarter of 2015, mainly driven by the enormous output gains in copper.

Exchange rate, inflation, and interest rates summary

In the late part of the first quarter the exchange rate began to experience a rapid appreciation, followed by a jagged path of off and on depreciation and appreciation. In recent weeks, the exchange rate has tended towards a more stable rate, though a depreciation trend has returned. Overall, our baseline call for high volatility remains in play, though we expect the exchange rate to stay below the peak levels of weakness in late February 2016. The moderately stronger currency will help support stable inflation, given that the strong depreciation had been putting upward pressure on inflation rates.

The overall growth rate of the economy is projected to remain below potential for 2016 and into 2017; the current policy rate at 4.25% is accommodative and will tend to promote economic activity at a time when Peru is in need. After months of worrisome inflation rates, expectations for inflation have begun to trend downward and towards the central bank's medium-term target range. With headline inflation receding moderately, we expect the central bank's monetary tightening cycle to remain on hold. Our expectations continue to include assumptions that price levels are not disrupted by strong resurgences in food prices; however, with erratic weather patterns possible, that downside risk remains on the radar, though not part of the baseline. Overall, while inflation remains unthreatening and economic growth is below potential, we expect the policy rate to remain near current levels. The international environment of broadly weak commodity prices supports this outlook related to domestic interest rates. By year-end 2016 we project Inflation at 2.5%.

Outlook and implications

The broadly improving Peruvian economy will support continued healthy private consumption. Our baseline assumption expects the relatively positive employment landscape to continue, which will support family income levels, which is the foundation of the private consumption strength. Weak commodity prices will likewise provide support to private consumption; while prices for the inputs of consumer goods remain weak, that will tend to help keep prices favourable for consumers. Regarding low commodity prices, and specifically regarding metals prices, the trend of low prices is likewise expected to continue throughout 2016. The moderate recovery that has been observed since the beginning of 2016 has provided some relief; however, robust and sustainable price recoveries are very unlikely. Fundamentals remain broadly unchanged, and there is little reason to expect the international environment can support any surge in metals prices. However, it is similarly unlikely that prices blow through the floor established in late 2015 and early 2016; overall, prices are likely to remain near current levels or experience light growth into the short term, or it is possible to see a mild correction that would not push prices lower than the previously established lows. Investment will again be lacklustre in 2016, due to weak commodity prices, though recovery from the extreme lows in recent quarters will bring some improvements. Overall, we are projecting GDP growth near 3.4% by year-end 2016.