Navigating Uncertainty: Q&A with Julio Velarde, Central Bank Governor Of Peru

Julio Velarde, central bank governor of Peru, speaks about how the central bank can support Peru’s economy in this time of financial uncertainty.

Global Finance: Peru’s politics are uncertain, but its economy remains resilient. How long can it last?

Julio Velarde: Current political uncertainty has already led to a slowdown in economic activity. Historically, the Peruvian economy has demonstrated its resilience in times of uncertainty, like during the political crises of 2000 and 2018. Before the 2020 pandemic, from 2018 to 2019, Peru maintained an average growth rate of about 3.1%. Over the past two decades, Peru stands out as one of the fastest-growing countries in Latin America.

The Peruvian economy has strong macroeconomic fundamentals anchored by two pillars: (i) the autonomy and independence of the Central Reserve Bank of Peru (BCRP), which prioritizes monetary stability, and (ii) a fiscal discipline that results in comparatively low public debt levels.

An additional favorable factor for medium-term growth is that Peru is a major producer of minerals, primarily copper. Currently, it ranks among the top three economies with known reserves. The development of mining projects will remain a significant driving force for the Peruvian economy in the coming years.

Another key component will be infrastructure investment projects, which will enhance connectivity and reduce transportation times and costs. These projects will not only boost the country’s productivity and competitiveness (thereby promoting job creation) but also further stimulate both domestic and international tourism.

These factors will set the stage for long-term growth and boost total factor productivity.

GF: How can the central bank best support the economy?

Velarde: The best contribution to sustaining economic growth is to keep inflation under control. In the context of uncertain political conditions, it is critical for public institutions to retain credibility, as is the case with the BCRP. The public understands the BCRP’s mandate for monetary stability and knows that it has constitutional autonomy to achieve this purpose. Even now, when inflation and its expectations surpass the target band (between 1% and 3%), private sector forecasts foresee a return within the band by early 2024.

The BCRP raised the policy rate between August 2021 and January 2023 to fight inflation and bring it back to the target. However, it started on September 14 to cut policy rates with a reduction of 25 basis points. As a result of the previous tightening, total inflation decreased from 8.8% in June 2022 to 5.6% in August 2023. According to the BCRP’s latest forecasts, inflation would reenter the target band by early 2024, and core inflation is expected to do the same by the end of the current year. Additionally, the exchange rate has exhibited less volatility than in other countries in the region.

GF: How do you see the economy evolving this year?

Velarde: While growth forecasts for 2023 have been adjusted downward, Peru is anticipated to recover during the second half of the year. The launching of mining projects, increased public spending (primarily investment-based), and the implementation of infrastructure projects will yield higher household incomes and foster a more robust confidence climate for consumption and investment. Lower inflation will also contribute to a recovery in consumer confidence.

GF: What is worrying you the most?

Velarde: While the Peruvian economy can build on its solid fundamentals to continue its growth path, unexpected developments could hinder this progress. Potential setbacks include severe El Niño events, which could curtail both private consumption and investment, impacting sectors like fishing and agriculture. Additionally, slower-than-expected growth in Peru’s trading partners could lead to reduced demand for our exports, which in turn might result in declining export prices and overall value.

The intensification of the tech and trade war between the U.S. and other advanced economies against China, along with heightened conflict in Eastern Europe, could disrupt supply chains. Such disturbances might lead to increased costs in transportation, inputs, and raw materials, particularly food and energy. Our vulnerability to these events depends on their intensity and duration.

The BCRP operates with a risk-control approach, enabling it to act preemptively using various tools within its monetary policy framework. This strategy allows us to mitigate potential impacts on economic activity and inflation while ensuring the smooth operation of financial markets.

GF: What do you forecast for the region in the next 12 months?

Velarde: Generally, the region’s economic performance has exceeded expectations, prompting an upward revision in the 2023 growth forecast. This favorable outcome is partly attributed to positive external shocks, such as the rise in global oil prices benefiting exporters like Mexico and Colombia.

Additionally, Mexico is expected to increase trade activity, primarily with the U.S., a positive ripple effect of the U.S.-China trade tensions.

Argentina stands out as an exception, with its growth rate expected to fall more significantly than initially expected. This is partly attributed to challenges in the agricultural sector due to adverse weather conditions, as well as high inflation and election-related uncertainty.