3 Reasons Explain the Strength of the Peruvian Economy even with the Weakness of Democracy in the Country

Wealth Management3 Reasons Explain the Strength of the Peruvian Economy even with the...

The ranking of the Economic Information Unit (EIU) lowered the Latin American country from a “failed democracy” to a “hybrid regime” between democracy and authoritarianism. But the Peruvian economy has been on a sustainable growth trajectory for almost 30 years, with few interruptions.

Peru suffers from permanent political instability. Since 2017, the country has had six presidents.

Pedro Castillo was the last to fall, giving way to Dina Boulwart, the first woman to lead the country in history.

The Economic Information Unit (EIU), the research and analysis division of The Economist magazine group, recently published its traditional index that assesses the “quality of democracy” around the world and downgraded the South American country from a “democracy with faults” to a qualification of “mixed system”, that is, it appears in effects of authoritarianism.

Peru was ranked 75th in the ranking (Brazil also experienced a decline in its index, ranking 51st).

The Economist Intelligence Unit attributed the reclassification of Peruvians to Castillo’s failed coup attempt last December, which led to his resignation from power and his subsequent imprisonment. All this in a political environment that has already been quite unstable in recent decades.

But in the midst of a great political upheaval, the Peruvian economy has accumulated almost 30 years of sustained growth, with few interruptions, which leads many specialists to speak of a “Peruvian economic miracle.”

The numbers are compelling. According to the World Bank, GDP has doubled in value by six since 1993.

In 2001, 20.3% of Peruvians would live on less than $2.15 a day in 2022; This number dropped to 5.8% of the population.

Despite the discontent of broad sectors with the preservation of inequality in the country -many voices suggest that the GDP data mask the social realities of Peru-, the macroeconomic figures of recent history are cited as an example of success throughout the world. world.

Waldo Mendoza, an economist at the Pontifical Catholic University of Peru and a former economy minister, told BBC Mundo, the BBC’s Spanish-language service.

How has the economy managed to progress amid the ongoing political storm in Peru? There are many reasons.

Central bank independence

Experts say that the independence of the Central Reserve Bank of Peru (BCRP) and its handling of monetary policy have been one of the pillars of Peru’s economic balance.

“The independence granted to the BCRP by the 1993 constitution allowed it to have a very technical and professional administration, completely independent of the economic and political cycle,” Carolina Trivelli, a researcher at the Institute of Peruvian Studies, told BBC Mundo.

The Foundation’s Board of Directors, made up of seven members, is elected by the government and Congress, but once appointed, they are totally independent.

In a rare example of continuity in Peruvian institutions, BCRP director Julio Velarde has been in office since 2006 and has seen presidents from across the political spectrum pass by.

When Pedro Castillo confirmed him in office, the markets saw the decision as a sign of confidence in the Peruvian economy, given the doubts that had arisen about the economic policy that the new president could adopt.

Thus, despite the constant changes of direction in the country’s government and Congress, its central bank has been able to follow a coherent policy focused on fiscal balance, containing inflation and preserving the value of the Peruvian currency.

Former Minister Mendoza points out that “the central bank had a traditional role in the fight against inflation and continues to fulfill it now in difficult circumstances, since there are external inflationary pressures and the bank had to act by aggressively raising interest rates.”

The economic model preserved in the constitution

The economic model applied in Peru in recent years was enshrined in its 1993 constitution.

Approved during the government of Alberto Fujimori and criticized by many, especially by the left (which pointed out the democratic deficiencies), the Magna Carta laid the foundations for the growth that followed the approval of the constitutional text and allowed poverty levels to be reduced in the country.

Article 62 of the constitution prohibits the modification of contracts signed by subsequent laws, which means strong protection for foreign companies that invest in the country, and thus guarantee that the terms of their operations are not modified.

For some analysts, this removed the fear of expropriations and nationalizations typical of other Latin American countries, which had allowed the country to attract large amounts of investment.

But critics point out that dealing with multinational companies in the export of raw materials, especially minerals, is not fair and requires greater bargaining power on the part of the state.

In the campaign that led him to the presidency, Pedro Castillo made renegotiation with foreign companies one of his flags, but his government did not fulfill these promises.

There is another important point in article 79, which specifies that Congress has no initiative to create or increase public spending, which has contributed to fiscal balance in recent years. However, a recent decision by the Constitutional Court proposes a new interpretation to limit its scope.

Fluctuations that help stabilize the currency

Waldo Mendoza pointed out that if we look at the behavior of the exchange rate in Latin America, Peru is the least volatile.

In other words, the Peruvian currency is one of the least susceptible to fluctuations in value relative to the reference currency, the US dollar, and does not tend to depreciate sharply in adverse economic times typical of other economies in the region.

Despite all the political hurricane, the country ended 2022 with a depreciating dollar exchange rate, and the Peruvian currency ranked fourth in a Bloomberg ranking that classifies the main Latin American currencies.

One of the reasons for avoiding sharp devaluations of the sol is Peru’s “dirty float” policy, in which the exchange rate fluctuates, but with occasional interventions by the local central bank (a model also followed by the Central Bank of Brazil).

Peru has accumulated more than $74 billion in international reserves, which are among the highest in Latin America in terms of GDP.

This is a very reasonable amount of resources that the Central Reserve Bank of Peru can gather in the blink of an eye to prevent excessive depreciation of its currency.

Mendoza assures that “reserves are a kind of insurance against ‘cancer’ and allow action in complex circumstances that would bring down any state.”

This financial protection is also one of the reasons why Peru is one of the countries with the lowest public debt in the region.

Challenges that have not yet been overcome

The advances of recent years have not solved all of the country’s problems, and there is no shortage of voices suggesting that the benefits of growth have not been shared equally.

“GDP growth by itself does not reflect all social reality. Access to basic services such as health or education,” Julieta Aileen Almada, a specialist in economic history at the National University of Córdoba in Argentina, told BBC Mundo.

“A lot has been done to reduce monetary poverty, but many people are still far from living in the conditions in which they should,” says Carolina Trivelli, a researcher at the Institute of Peruvian Studies.

“We have income to provide better services,” said Velarde himself, director of the Central Bank of Peru.

It was a criticism of rulers at various levels in a country where the lack of management capacity of public bodies and frequent corruption scandals have become the main concern.

But the growth of recent decades has not helped to correct the deficiencies in infrastructure, the supply of basic resources such as water or public health services, which have become especially evident during the coronavirus pandemic.

The forecast for the near future is not very optimistic. Investment in mining, the traditional engine of growth, appears to have been held back by the uncertainty and ongoing social conflicts surrounding big exploration.

And the international context, characterized by inflation and the war in Ukraine, is not encouraging for an economy like Peru’s, which, given its open nature, is highly permeable to what is happening abroad.

The BCRP projects growth of 3% between 2022 and 2023, which is less than what is needed to continue reducing poverty.

“To continue reducing poverty as we have done in recent years, we need to grow at 4% or 5% in a sustainable way,” says Trevelli.

Growing more and ensuring that the benefits reach all Peruvians will be the challenge of keeping the “Miracle of Peru” alive.

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