Central Bank of Peru Governor Julio Velarde speaks about the effects of the pandemic and war in Ukraine as well as Peru’s outlook for the next year.
Global Finance: What is the economic outlook for Peru in the coming 12 months? What are the main risks?
Julio Velarde: There is a recovery underway, with annual growth at 3.2% as of the second quarter of 2022, driven considerably by private consumption, which expanded by 4.9% over the same period. Among other indicators, formal employment surged at an annual pace of 6.1% in June, far exceeding pre-pandemic levels.
It is important to emphasize that current growth is the result of an adequate and timely response to the Covid-19 pandemic, which prevented a breakdown of payment chains and supported credit countercyclically at a moment of sharp economic contraction. Moreover, Peru’s terms of trade have declined in recent months due to the performance of commodity prices but continue to be above historic levels.
In this context, gradual recovery is expected to continue in the next months, although it may be affected by headwinds from external developments. Risks are mostly associated with a faster-than-expected withdrawal of monetary stimulus in advanced economies due to persistent inflation pressures, international geopolitical tensions and further disruptions in global value chains. Those factors may cause further deceleration in world economic activity, capital outflows from emerging market economies [EMEs] and greater persistence in food and fuel inflation.
GF: After the health crisis and the war in Ukraine, is there something that should prompt central banks to change policy?
Velarde: The Central Reserve Bank of Peru [BCRP] responded to the Covid-19 pandemic by cutting its policy interest rate to historic lows and expanding its balance sheet through a set of complementary measures. Later, the surge in inflation led to a gradual withdrawal of monetary stimulus by raising the policy rate, to 6.50% in August, to anchor inflation expectations. Going forward, the BCRP will consider the necessary adjustments in its monetary stance to ensure that inflation returns to within the target band over the forecast horizon.
The significant increase in international food and fuel prices since the second half of last year, aggravated by geopolitical developments, has driven global inflation to levels not seen in many years, well exceeding central banks’ inflation targets in both advanced economies and Latin America.
Currently, central banks should focus on one: designing monetary policy flexibly (i.e., using a range of instruments and considering local financial conditions) to keep inflation low and stable; and two: communicating their policies clearly to the markets as a way to keep inflation expectations anchored to target. The former calls for adequate central bank liquidity and balance sheet management to reinforce monetary transmission; and the latter relies on prudent language, especially during high-uncertainty episodes.
GF: Do you think emerging country central banks showed a quicker and more effective response to inflation than many industrial-country central banks?
Velarde: EMEs, including LatAm countries, correctly moved ahead to withdraw monetary stimulus, as they are more vulnerable to inflation risks than advanced economies. Peru implemented a gradual withdrawal to avoid surprising the markets and stoking uncertainty and volatility, especially in local fixed-income and currency markets. The BCRP’s real interest rate is still somewhat below, but close to, the estimated 1.50% neutral rate. It is currently the lowest in LatAm, basically reflecting a normalization of monetary policy to pre-pandemic levels.
In contrast, the Fed and the ECB started to raise interest rates several months after EME central banks, in a context of high uncertainty where inflation shocks were initially considered temporary and not significantly persistent, considering that interest rates in advanced economies had remained low since the 2008-09 global financial crisis without necessarily exacerbating inflation and inflation expectations.
GF: What is the economic outlook for Latin America in general?
Velarde: LatAm has been affected by declining commodity prices, enhanced domestic political tensions and more limited fiscal space due to higher indebtedness during the pandemic.
In the short term, policy rates are expected to move in tune with the business cycle. However, the main challenge is to steer the economy into a sustainable medium-term path via prudent monetary policies and, crucially, key structural reforms.
In this context, the region is expected to grow moderately this year and next, at an average pace not exceeding 3%—and below 2%, in some cases. At the same time, inflation will decline gradually, in line with the unwinding of supply shocks that occurred over the past year.
GF: How strong is the banking sector and lending to businesses?
Velarde: The banking sector remains healthy despite the large impact of Covid-19 in 2020. A timely and swift monetary response, in the form of liquidity operations—amounting to around nine percentage points of GDP—and a reduction in the policy interest rate, to a historical low of 0.25%, promoted countercyclical credit growth and led to quick recovery. GDP contracted by 11% in 2020 but rebounded by 13.6% in 2021. At the same time, credit to the private sector expanded by 11% in 2020 and 4.4% in 2021. In 2021, credit slowed down as firms had to repay the loans received in 2020 under a government-guaranteed loan program. Excluding the latter, credit to the private sector expanded by 9.4% in 2021. Credit growth accelerated in 2022, reflecting a rebound in household loans and total credit [at annual growth rates of 16.5% and 6.7% as of July, respectively]. Regarding business loans, SME credit growth was particularly strong, at an annual pace of 11% as of July.
Financial system profits have recovered steadily since early 2021, to pre-pandemic levels in 2022, due to solid growth in business and household loans and improved credit quality. Non-performing loan ratios and provisioning are gradually returning to pre-pandemic levels. And capital buffers exceed total loans by nine percentage points, reflecting banks’ capacity to absorb potential losses, if risks materialize, and to further expand credit to the private sector.
GF: What keeps you awake at night?
Velarde: Mostly, the increased uncertainty prevailing in today’s world. Particularly, shocks to the economy have become more frequent in recent years, sometimes hitting simultaneously and with unprecedented force, thereby complicating optimal monetary policy design. Examples include the health crisis, geopolitical tensions, technological shifts, digital transformation and climate change. In this environment, central bankers must be ready to address rapidly evolving conditions in a timely manner.
