Shallower recession in 2020, and stronger rebound in 2021

PERU - Forecast 19 Oct 2020 by Alfredo Thorne

We tweaked our forecasts last week, on the back of the most recent reports. We now expect a shallower recession in 2020, with real GDP contracting by 13.7% y/y, less than our July forecast of -17% y/y. We also forecast a stronger rebound in 2021, reaching 11.1% y/y (from 6.5% y/y previously). The new forecast projects a similar Q4 2020, and a stronger H1 2021, when we expect the economy to gain some momentum. However, the forecast projects convergence with the long-term growth rate from H2 2021, after the new government takes office. We remain downbeat in 2020 relative to the market consensus, continuing to forecast a deep recession, and upbeat in 2021, with one of the stronger rebound projections among consensus forecasts. Despite the forecast for strong rebound in 2021, real GDP should remain 4.2% below the 2019 level, with convergence with pre-COVID-19 levels taking place sometime in 2022.

Four factors justify the change in our forecasts. First, there’s the brighter external outlook, mostly resulting from higher commodity prices, but also from stronger export performance. Net exports should contribute positively to growth from Q4 2020, as import demand will remain subdued, and exports will rebound in H1 2021. Second, the contagion curve has flattened, allowing the government to proceed with the final phase of economic reopening. After peaking in August, both the official contagion and death curves started to ease, finally flattening at the beginning of September. Moreover, the excess deaths curve has followed the same trend. Third, there is a reduced drag on public-sector investment, and a strong rebound in government consumption (mainly transfers to individuals). Finally, albeit still modest, there are signs of private investment, particularly housing investment, bottoming out.

Daily deaths owing to COVID-19 started to fall in the second week of August, and are currently at their mid-April level. Both Lima, the hardest-hit region in terms of absolute numbers, and the rest of the country, have seen daily deaths drop significantly. Finally, the number of hospitalized patients has diminished rapidly, from a record 14,181 on August 16th, to 9,962 on September 15th, and then 6,272 last week. The reasons for this steep downward trend are debatable. While some analysts argue that the principal causes are the government’s aggressive campaign to make citizens aware of the dangers of COVID-19 through advertising, and the subsequent increase in voluntary social distancing, several facts undermine this statement.

What, then, is the reason for this steep decline in epidemiological numbers? Could it be that the spread of the virus has itself slowed down?

At national level, we estimate that 15.8 million people have contracted COVID-19; that is, 48% of the population. The most interesting finding is that, according to this methodology, three regions have surpassed the theoretical threshold of 70%, which would imply that they have attained “herd immunity.” Thirteen of the 25 regions reportedly have a seroprevalence (the portion of the population that is infected) of above 40%, including the capital, Lima, with a huge 62.3%. While some regions, particularly in the highlands, remain vulnerable to a second wave, according to our findings the majority of the country may benefit from at least temporary immunity from re-infection. This could be supported by the seroprevalence study that is being carried out by the government during October. As we explain in more detail below, this would mean a significant boost for the economy, with economic activity consequently normalizing faster than expected.

Our most recent forecast projects (based on Banco Central de Reserva del Peru estimates) the external sector adding to overall growth in 2020 and (mildly) in 2021. We are revising our 2020 current account balance (CAB) projection to -$154 million, from -$2.8 billion previously (-0.1% of GDP from -1.4). For 2021, we are widening marginally our CAB forecast to -$3.5 billion from -$3.2 billion (-1.6% of GDP from -1.4%). For the capital account balance, offering a reading on total capital inflows, we use the forecasts from the BCRP, that anticipate a mild decline in 2020, to $7.2 billion (from a previously forecast $9.5 billion) and, for 2021, an increase to $4.4 billion from $4 billion. In both years, the net balance of payments (NBP), defined as the sum of CAB and the capital account, and indicating the net capital inflows into the economy, remains positive, adding to overall growth. For 2020, the NBP was revised to $7.1 billion from $6.7 billion previously and, for 2021, it remained unchanged at $925 million. These net inflows should translate into an increase in the BCRP’s international reserves.

Distinguishing our forecasts from the consensus is our assumption that aggregate demand will remain soft during the initial phase of the recovery and strengthen in 2021. Our main thesis is that most of the initial recovery is explained by the supply shock resulting from the economic reopening that started in May. Firms have resumed output normalization, but aggregate demand has lagged and, eventually, supply will have to converge with demand. This explains why the recovery faltered in August and September, when real GDP lost momentum. Unfortunately, estimates of inventories are unreliable, but the inventory series obtained from the BCRP’s PMI survey indicates that firms continued to accumulate excess inventories. Moreover, in this same survey, firms reported demand relative to expectations, and this has remained well below the 50 neutral level, and lower than the overall PMI headline index.

Recent developments justify some revision of the fiscal account forecasts for 2020 and 2021. As noted in our previous forecast, in response to the COVID-19 shock, the government decided to propose an economic plan with three key areas: providing guaranteed loans for firms; fighting the sanitary emergency; and providing support to the economy (including support for families and firms). The magnitude of the economic plan was first calculated at 12% of GDP (in March), but began increasing over time, and is now estimated at more than 20% of GDP. When the Ministry of Finance presented its official macroeconomic projections in August, it proposed a fiscal deficit of 10.7% of GDP in 2020, and 6.2% of GDP in 2021.

Projecting how politics would influence economic decisions has been a challenging exercise. For instance, we had expected that the impeachment attempts, first of Finance Minister María Antonieta Alva, and then of President Martín Vizcarra, in September would have undermined business expectations and, consequently, private investment decisions. However, the BCRP’s September PMI report indicates that business expectations improved. Our perception, based on historical experience, is that politics has an economic effect on long-term performance, in terms of giving rise to a lower potential growth rate. High uncertainty undermines private investment and permanent job creation, and discourages long-term capital inflows. This justifies our decision in our last report to cut the potential growth rate to 2.5% per year, from 3.5% pre-COVID-19. The effect of politics on cyclical growth in an economy that is rebounding from a very deep recession, boosted by government expenditure and financed with accumulated Treasury savings, would be marginal.

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