Economy rebounds despite political headwinds
A month after the mid-November political crisis that led to street protests and the election of the caretaker Francisco Sagasti government, an uneasy truce has held in Congress. While political brinkmanship has continued, confrontation has eased. We will first discuss the positive developments, and then examine the problems that remain. Sagasti has managed to put together a Cabinet and gain congressional approval of it, and has succeeded in winning congressional approval of the 2021 budget before the November 30th deadline. This was easier said than done.
But in politics, mistakes are paid for dearly. Sagasti took over in difficult circumstances, amid violent confrontations between police and street protesters. On limited evidence, members of the political left, including Sagasti’s own supporters, blamed the police (and, specifically, their use of rubber bullets) for the killing of two street protesters, although police chiefs dismissed these claims. In response, Sagasti committed to investigating the killings fully, and to prosecuting those found responsible. Removing police heads to instill reform has been a practice resorted to by previous presidents and interior ministers. However, this time was different, as police use of force was at the center of the political debate.
This commitment could be construed as a political miscalculation. It is perhaps unsurprising, coming from an academic with little political training. Nonetheless, in the midst of a legitimacy crisis, when a new president needs to assert himself, and to reassure a country where the police and armed forces still wield tremendous power, he has opened further cracks in the political system, and in a government designed to last only eight months.
One example of how these cracks undermine policymaking was Congress’s repeal of the Agriculture Promotion Law (APL). On November 30th, agricultural workers blocked the Southern Highway in the state of Ica, about 300 kilometers from Lima, and demanded wage increases and the repeal of the APL. In 2000, during the government of Alberto Fujimori, Congress had approved this legislation favoring the agriculture sector. It provided tax and labor benefits to firms that invested in agricultural development. This Law was extended for 10 more years in 2009 and, on December 2019, during the congressional shutdown, then-president Martín Vizcarra employed his executive powers to extend the APL (with some amendments) for a further 10 years.
The government’s decision to repeal the Law will only hurt agricultural workers, who will now be compensated in line with the legislation applied to the rest of the labor force under the General Labor Regime (GLR). This means, first, that their minimum compensation will drop to PEN30 (around $8) per day, from PEN39 per day, since the APL mandated that all benefits be bundled into daily wages. Second, they will lose their health care benefits and special allowance for the time they remained employed (Compensación por Tiempo de Servicios, CTS). Under the APL, workers could either resort to the government-subsidized Sistema Integral de Salud (SIS) or to a workers’ contributive health system (ESSALUD). With workers now being compensated under the GLR, they can only resort to ESSALUD if they are employed full time, which is frequently not true of agricultural workers, who typically undertake seasonal and other temporary work. Moreover, they could also lose their CTS, as the law indicates that, to be eligible for this benefit, workers need to be fully employed for at least 30 days a month.
Most recent high-frequency reports confirmed that economic performance has improved, justifying our decision to revise up our real GDP growth forecast for 2020 to -12% y/y, from -12.4% y/y in November 27th; and to keep 2021 unchanged, at 9.7% y/y. Although the 2021 forecast may seem impressive, this is largely explained by a low-base effect from the deep recession in 2020. In fact, by the end of 2021 real GDP will remain 4.9% below its pre-COVID-19 level. This cautious forecast is justified by the high uncertainty resulting from the political crisis, and the imminence of the April 11th presidential and congressional elections.
With the economic reopening in May driving the recovery, it is apparent that the supply side of the economy has led the recovery, and that aggregate demand has lagged. This is evident, for instance, from the inventory and orders cycle in the Banco Central de Reserva del Perú’s (BCRP, the central bank) Purchasing Managers indices (PMIs). An increase in undesired inventories indicates that supply is growing ahead of demand; and an increase in the orders index signals that demand is normalizing.
Turning to the high-frequency aggregate demand reports, it is apparent that both government and private fixed investment has performed better than we expected. Private consumption, and (to a lesser extent) government consumption, have continued to subtract from overall growth, in accordance with our own forecasts. Net external demand was also aligned with our forecasts.
On November 29th, Congress enacted the public Budget Law for 2021. Two main points arise from our reading of this. First, the budget calls for total expenditure of PEN183 billion (around $50 billion) or about 24.3% of our 2021 forecast GDP. This implies a 3.2% increase relative to the approved 2020 budget (enacted in November 2019). Second, largely as a result of the COVID-19 shock, financing needs including debt servicing are forecast to reach PEN48 billion (26% of total public expenditure).
How will the financing gap be covered? Unfortunately, the 2021 budget law is unclear about this, and Sagasti and Finance Minister Waldo Mendoza have indicated that they plan to issue about $13 billion on international markets. But even this seems a gross estimate of their financing needs, rather than a concrete commitment. It is apparent that the government has four alternative sources it could use. First, close inspection of the public-sector net assets in the financial system indicate that, as of October 31st, 2020, they have net assets of PEN46.3 billion ($12.9 billion) which could be drawn down. Second, in May 2020, the International Monetary Fund committed to an $11 billion Flexible Credit Line (FCL) and, following Colombia’s example, the government can draw down up to $5 billion from this line. Third, the government has ready access to multilateral lending institutions, such as the International Bank of Reconstruction and Development and the Inter-American Development Bank. Finally, as shown in the most recent $4 billion debt issuance, they can issue dollar and soles debt on international financial markets.
Now read on...
Register to sample a report