Fitch affirms Peru at BBB+, outlook stable

Peru's credit ratings reflect its strong public and external balance sheets and its credible and consistent macro policies, which have entrenched macroeconomic and financial stability. 

These strengths balance vulnerabilities from Peru's high commodity dependence, financial dollarization, and low government revenue base, as well as its lower income per capita, social indicators, and institutional quality than the 'BBB' median. 

Fitch expects macroeconomic policy continuity against an uncertain political backdrop. 

President Pedro Pablo Kuczynski faces a second impeachment vote related to ongoing broad Odebrecht corruption investigations - which affect most political parties - three months after he narrowly survived an impeachment vote in December 2017. 

In the event that the president leaves office and the first and second vice-presidents decline to govern, early presidential elections must be convened. 

In that case, Fitch would expect to assess the platforms of the candidates that emerge. An early presidential election in the current political environment increases the probability that an 'outsider' candidate not affiliated with an established political party could emerge. 

Governability challenges remain a downside risk through 2021 reflecting the executive's lack of a party majority in Congress and the ongoing corruption investigations. 

Peru has a robust macro and fiscal policy framework, in Fitch's view. However, prolonged political uncertainty could dampen investment and economic growth prospects. 

While growth has picked up, economic growth performance is converging with the 'BBB' median: the country's three-year average growth decelerated to 3.3% versus 2.8% for the median for 2015-2017. 

Mining investment and public investment for flooding reconstruction and the Pan-American Games are expected to drive 3.5% economic growth in 2018. 

Large infrastructure projects delayed either due to the legal resolution process of corruption claims or administrative delays could begin to advance in late 2018-2020. 

These and new mining investments pose upside risk to the GDP growth forecasts. 

Peru's monetary policy regime remains credible. Average inflation fell to 2.8% yoy in March 2018, from 4% in December 2016, and expectations are well-anchored in the central bank's 2%+/-1% target band. 

The central bank has eased monetary policy, cutting its policy rate by a cumulative 150 bp in the easing cycle since April 2017 in response to economic slack. 

Financial dollarization has fallen over the last five years, supporting monetary policy transmission mechanisms, allowing for greater exchange-rate flexibility and mitigating risks from currency mismatches.

Peru maintains strong public finances. Fitch's estimate of general government debt, 23.9% of GDP in 2017, is lower than the 'BBB' median at 40.7%. 

The government is drawing on the financing flexibility provided by its liquid government assets and the fiscal stabilization fund (now at 3% of GDP) to limit the impact on government borrowing of natural disaster reconstruction spending. As a result, we expect the fiscal buffer to be less than other commodity-exporting peers. 

The general government met its budget deficit of 3% of GDP in 2017, the first year of the nominal fiscal target. 

Fitch expects the deficit to peak at 3.3% of GDP in 2018 and the government to begin consolidating public finances in 2019. Tax revenues have fallen by around 4pp of GDP since 2013, but we expect revenue/GDP to start growing again due to improving mining revenues, economic activity, and tax administration and enforcement efforts. 

A relatively strong international reserve position and modest current account deficit offset vulnerabilities from Peru's mining export dependence, partial financial dollarization, and non-resident holdings of 44% of local government securities. 

Peru is a net external creditor, and its 1.4% of GDP average current account deficit forecast for 2018-2019 is expected to be fully financed by foreign direct investment.

The central bank holds external liquidity at more than 12 months of current external payments (international reserves of USD61.4 billion) supporting Peru's international liquidity ratio above 200%. 

The government has reduced exchange-rate risk to its balance sheet by increasing the Sol-denominated share of its debt to 67% from 57% during 2017 through liability management. It has also increased the market for its PEN treasury bonds by enabling non-resident investors to access them directly through Euroclear.

(END) NDP/RMB