September 19, 2017 / 5:19 PM / a month ago

Fitch Affirms Peru at 'BBB+'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, September 19 (Fitch) Fitch Ratings has affirmed Peru's Long-term Foreign Currency Issuer Default Ratings at 'BBB+' with a Stable Outlook. A full list of rating actions is at the end of this release. KEY RATING DRIVERS Peru's creditworthiness is underpinned by its track record of macro-policy credibility, consistency, and flexibility, which has delivered macroeconomic and financial stability. Strong fiscal and external balance sheets counterbalance the country's high commodity dependence, low government revenue base, financial dollarization and structural constraints in terms of income per capita, social indicators and institutional quality. Fitch expects Peru's economy to expand by 2.3% in 2017, lower than initially forecast due to El Nino-related flooding damage and delays to large infrastructure projects. Growth is now picking up driven by reconstruction spending and a small recovery in mining investment after three years of contraction. Economic growth could rise to 3.7% in 2018 under Fitch's baseline scenario as public investment rises and private investment advances in infrastructure public private partnership (PPP) concessions that have been delayed. The Peruvian economy has grown faster than the 'BBB' median, 3.6% versus 3.0% per year on average, over the past five years, although its potential growth rate is gradually converging toward the 'BBB' median. Downside risks to Fitch's baseline economic forecast for 2018-2019 could materialize from further administrative delays to infrastructure projects, commodity price shocks, and subdued mining investment. Inflation remains low, albeit above target, at 3.17% year over year (yoy) in August 2017. Peru's inflation-targeting monetary policy regime is credible, supported by the anchoring of inflation expectations within the central bank's 2%+/-1% target band, despite the presence of financial dollarization and transitory exchange-rate and weather-related shocks. The Sol has appreciated 3% relative to the US dollar during 2017, limiting import-price pass-through. The central bank has eased monetary policy, cutting the policy rate by a cumulative 75bps year to date to 3.5% in response to the weaker economic performance in 1H17. Peru maintains a strong external balance sheet with a small current account deficit. The country remains a small net external creditor, 1.8% of GDP in 2017. External liquidity (supported by USD62 billion in international reserves) exceeds 300% of current external liabilities, including non-resident holdings of the government's Sol-denominated bonds (43% of the total). The current account deficit is expected to remain close to 2% of GDP during 2017-2019, which will be fully financed by FDI. These strengths partially offset vulnerabilities from Peru's high dependence on mining exports, financial dollarization (29% of private credit), and non-resident capital flows. The general government has a strong balance sheet with debt and interest burdens projected at 25.6% of GDP and 6.4% of revenues in 2017 (versus 41% of GDP and 7.1% revenues for the BBB median). Peru's small fiscal stabilization fund, 4% of GDP, and unrestricted central government deposits, 4.9% of GDP, provide additional financing flexibility. The government has increased its budget deficit target to 2.9% of GDP for 2017 and 3.3% for 2018 to finance reconstruction following El Nino flooding damage (costing 3.2% of GDP in total over four years). The government plans to draw 1% of GDP from its stabilization fund for reconstruction over the period and use natural disaster credit lines from multilaterals. The remainder of the government's gross financing needs (deficits and amortizations totalling 3.3% of GDP in each of 2017 and 2018) will be met principally with central government deposits (including pre-financed resources for 2017) and Sol-denominated bond issuance. Government revenues have fallen to 18.3% of GDP in 2017 from their peak of 22.8% in 2013. The Kuczynski administration will need to boost government revenues to meet its fiscal consolidation target of returning to a primary budget surplus by 2021. To date, the government has raised the corporate income tax rate, implemented a tax amnesty for the repatriation of taxable foreign assets during 2017-2018, and taken steps to broaden the tax base. However, lower economic growth and difficulties reducing tax evasion pose risks to closing the revenue gap. Fitch's baseline scenario assumes a more conservative rise of tax revenues than the budget forecasts and expects that the administration will if necessary make spending adjustments to meet its fiscal consolidation path. Poor executive-legislative relations could limit policy space for major fiscal reforms, however, if fiscal revenues underperform expectations. The Kuczynski administration has experienced six ministerial departures from the cabinet during its first 14 months and received a no-confidence vote on the cabinet on September 15, partially as a result of pressure from the majority Fuerza Popular party in the congress, contributing to tension in domestic politics. In addition, cabinet instability could add to the administrative delays that have slowed public and private investment, particularly in large PPP infrastructure projects, affecting growth expectations. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Peru a score equivalent to a rating of 'BBB-' on the LT FC IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows: --Macro: +1 notch: Peru's policy framework has developed a track record of policy coherence and credibility leading to entrenched macroeconomic and financial stability, and generated counter-cyclical fiscal policy space. --Public finances: +1 notch: Peru's rules-based fiscal stabilization fund and government deposits augment the government's financing flexibility. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centered averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The main risk factors that, individually or collectively, could trigger a negative rating action are: --Underperformance of government revenues resulting in a faster-than-expected rise in the general government debt burden or the erosion of fiscal buffers; --Weakening investment and growth prospects; --A negative external shock - such as a sharp decline in the price of Peru's main commodity exports - resulting in weaker macroeconomic performance and deterioration in fiscal and external balance sheets. Conversely, the main factors that could lead to a positive rating action are: --Higher growth that reduces Peru's income gap and improves social indicators relative to higher-rated sovereigns; --Strengthened institutional capacity that improves the effectiveness of economic and social policy implementation; --Significant improvements in Peru's fiscal and external balance sheets and material reduction of financial dollarization. KEY ASSUMPTIONS --Fitch expects China's economy, a major mining export partner, to grow 6.7% in 2017, 6.3% in 2018, and 6.1% in 2019. --Fitch assumes copper prices will stabilize near current levels during 2017-2019. The full list of rating actions is as follows: --Long-term foreign-currency IDR affirmed at 'BBB+'; Outlook Stable --Long-term Local-Currency IDR affirmed at 'A-'; Outlook Stable --Short-term Foreign-Currency IDR affirmed at 'F2' --Short-term Local-Currency IDR affirmed at 'F1' --Country Ceiling affirmed at 'A-' --Issue ratings on long-term senior-unsecured foreign-currency bonds affirmed at 'BBB+' --Issue ratings on long-term senior-unsecured local-currency bonds affirmed at 'A-' Contact: Primary Analyst Kelli Bissett-Tom Associate Director +1-212-908-0564 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Richard Francis Director +1-212-908-0858 Committee Chairperson Charles Seville Senior Director +1-212-908-0277 Media Relations: Benjamin Rippey, New York, Tel: +1 646 582 4588, Email: benjamin.rippey@fitchratings.com. 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