By Jaime Reusche
& Anne Van Praagh
LIMA -- Low and affordable government debt, substantial fiscal savings, a strong balance sheet and solid fiscal policy credibility underpin the Government of Peru's A3 rating and stable outlook, says Moody's Investors Service in its annual analysis of the sovereign. Solid economic fundamentals, an absence of major macroeconomic imbalances and strong economic institutions have upheld Peru's long-standing track record of macroeconomic stability, market-friendly policies, and prudent fiscal management.
The sovereign's main credit challenges relate to its political environment. Corruption, political infighting, a weak judicial system, low levels of education and an inefficient bureaucracy at the local and regional government level are the greatest institutional challenges facing the sovereign. These issues affect governability and policy execution, detract from the efficient allocation of resources, and impose substantial costs to the economy.
"The 2015 fiscal stimulus, afforded by ample fiscal buffers and low debt levels, prevented a further slowdown in economic activity and worsening of economic sentiment," says Vice President - Senior Analyst Jaime Reusche. "The economic recovery remains fragile, but the authorities are making full use of the sovereign's fiscal strength to cushion the effect of the negative external environment."
Economic performance in the first half of 2015 points to a tepid recovery supported by a reversal of supply shocks, and a gradual firming of domestic demand. Moody's expects private investment will no longer be a drag on economic activity by the second half of the year. Although fiscal measures are intended to and cushion the impact of adverse shocks, they will not be sufficient to drive growth by themselves.
For 2015, Moody's projects GDP will increase over 3.0%, with growth accelerating in the second half of the year and the recovery extending into 2016. As a result of the counter-cyclical stimulus, Moody's forecasts that the fiscal deficit will widen to 1.8% of GDP in 2015. Given a negative output gap, the government deficit will remain consistent with medium-term structural deficit targets.
Moody's expects the authorities will gradually withdraw the fiscal stimulus in 2016 as the economic recovery firms up. "The policy stance will provide support for the still-fragile economic recovery while the announced consolidation path signals a steadfast commitment to fiscal prudence, benefiting from the sovereign's strong fiscal policy credibility," continued Reusche. In the event of continued weak economic activity through 2016, fiscal rules provide flexibility to maintain an expansionary fiscal stance if a negative output gap is present.
Moody's does not expect Peru's credit quality to change significantly over the next year or two. Although upward pressure on the sovereign's rating is unlikely over the medium term, a substantial increase in income levels or a significant strengthening of governance indicators, especially related to political institutions, would contribute to improving creditworthiness.