Government at a crossroads between fighting the virus and reviving the economy
The president, Martín Vizcarra, had a strong showing at the beginning of the Covid-19 crisis. Mr. Vizcarra promptly closed ports and airports in early March and put the whole population under lockdown on March 16th, in line with the so-called “hammer” strategy. Moreover, taking advantage of Peru’s strong fiscal position and substantial Treasury savings (14% of GDP), the president decided to offset these costs by providing resources to the healthcare system, cash transfers to about three-quarters of vulnerable families, and supporting illiquid firms in an effort to prevent the collapse of the payment system. However, after more than eight weeks in lockdown, the infection rate continues to increase and it is unclear when it will begin to ease.
Initially, the government blamed informality for the problems in managing lockdown conditions; an estimated 72% of the labor force works in the informal economy and the vulnerable middle classes make up two-thirds of the total population. Being a cash-dependent economy, many Peruvians live on their daily earnings and rely on daily trips to markets. Mistakes in the way that the lockdown support was distributed, such as the government’s decision to pay cash transfers through the physical banking network rather than use e-banking, meant much of the population had to continue to leave their homes every day. Moreover, the government failed to complement mass lockdown with measures such as targeted isolation of the vulnerable population, the declaration of virus-free zones, and mapping of the asymptomatic population.
On May 2nd the government issued an executive decree, initiating the re-opening of the economy. It divided the economic reopening into four monthly phases, beginning in May. For the first phase, 37 subsectors were identified, with the economy anticipated to reach 70% capacity by end-May, from 44% at the beginning of the month. However, this relies on firms undergoing a complicated approval process and absorbing the cost of protecting their employees and introducing safety measures. The finance minister, María Antonieta Alva, in her speech to Congress on May 12th, said that the re-opening was conditional on there being no second wave of infections. With so many countries having experienced a resurgence of the virus, having failed to contain the spread or achieve stabilization of the death rate, a very gradual re-opening may prove necessary.
Real GDP fell by 16.2% y/y in March, signaling the start of a deep economic recession. Moreover, as this is a year-on-year comparison, with the lockdown starting in mid-March, this report may underestimate the true contraction rate. We anticipate sharper drops in April and May, following several months of lockdown. A more accurate picture may be offered by the quarter-on-quarter comparison, in which real GDP fell 12.2%, saar, in 1Q20 and is forecast to contract by 70% q/q, saar, in 2Q20. Thereafter, the economy should rebound gradually, to a 17.0% y/y contraction in 2020, and we expect a strong 6.5% y/y rebound in 2021.
One side-effect of the recession has been the surge in lay-offs. The April Metropolitan Lima employment report indicates that around 335,000 workers lost their jobs in March and a further 3.1m in April, on a non-seasonally adjusted basis (our monthly estimates). Moreover, estimates indicate that household income has dropped sharply, with informal incomes worst affected. The unemployment rate has surged, despite the government’s stated aim of protecting employment. We believe that this has resulted from the faulty design of, and delays to, the implemented programs. For instance, the government failed to adapt its very successful Reactiva Perú program, aimed at illiquid firms, to support firms in retaining their workforces, as was successfully achieved by the US government. Moreover, the actions of the Labor Ministry were ambivalent, initially offering limited flexibility on labor laws and regulations, then ultimately issuing the so-called “suspensión perfecta,” which allowed firms to suspend their labor forces while temporarily halting the payment of their wages, for the duration of the Covid-19 crisis.
The Banco Central de Reserva del Perú (BCRP, the central bank), using its full toolkit, has been a critical part of the policy response. Initially, the BCRP cut its policy rate to 0.25%, its lowest historical rate. In addition, it has opted to adopt unconventional policies, such as expanding its balance sheet, replicating the US Federal Reserve (the Fed, the US central bank) Quantitative Easing (QE) program. Although, in the past, the BCRP has used these instruments, the scale of the expansion of its balance sheet is unprecedented. Together with the Finance Ministry and Cofide, the state-owned bank, it launched the Reactiva Peru program, aimed at firms experiencing illiquidity, with loans guaranteed by the government. The program extended to 98% of the loans for small enterprises (SMEs) and 80% for large firms. The program was initially allocated PEN30bn (about US$8.8bn) but, since 91% had been placed on May 10th last week, it has been extended to PEN60bn (about 8% of GDP). The BCRP successfully used a competitive auction for banks to tighten interest rates and, on average, rates reached only 1.1% per annum.
The BCRP’s balance-sheet challenge would be to accommodate the withdrawal of Treasury deposits. It is apparent that the government will finance part of its fiscal expansion with Treasury assets, a portion of which is deposited with the BCRP: of US$74.4bn net international reserves, US$11.8bn are financed by Treasury deposits. However, the BCRP’s holding PEN49bn in Treasury deposits would mean a withdrawal would cancel out both sides of the BCRP’s balance sheet—dollars and soles. To retain the BCRP’s firepower for FX interventions, the government has applied to the IMF for a Contingent Credit Line (CCL), a facility available to emerging economies with sound fundamentals. Last week, Kristalina Georgieva, the IMF’s Executive Director, recommended the IMF Board approve an US$11bn CCL for Peru.
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