December 22, 2008 / 3:44 PM / in 10 years

As boom slows, Peru scrambles to gin up economy

LIMA (Reuters) - Peru’s economy likely grew at its fastest pace in 14 years in 2008, making it one of the world’s top-performing economies, but the global crisis is already tempering output as businesses doubt whether the government’s stimulus package to extend the boom will work.

Copper, zinc, and lead minerals being processed into concentrates float in giant refining tubs at the Cerro Lindo mine of Peruvian mining company Milpo near Chincha February 19, 2008. REUTERS/Mariana Bazo

This month, the government scrambled to put together a financing plan of up to $12.25 billion to prop up growth next year in an economy that is widely forecast to have grown more than 9.0 percent this year.

But President Alan Garcia’s economic stimulus plan faces a series of hurdles: lots of the spending would be carried out by regional governments that have little experience with big projects, corruption allegations often delay construction projects in Peru, and the government has yet to secure about half of all cash called for by the stimulus package.

“The Achilles’ heel of this plan is a severe problem which is that the state has not been modernized,” said Alejandro Indacochea, an economist at the Catholic University in Lima.

The government said it expects the economy to grow 6.5 percent next year, and that 7.0 percent is possible, but analysts said growth of 5.0 percent or less was likely.

“Even assuming execution of the plan will be less than stellar, there will still be some pass through ... and ultimately, it will have a positive impact,” said Enrique Alvarez of research firm IDEAglobal in New York.

In the first phase of the stimulus package, the government will spend about $3.2 billion, 13 percent above and beyond what it had budgeted for 2009. Additional outlays, some of which would require getting multilateral loans, will be made depending on the depth of the slowdown.

The government is trying to get its plan off the ground as crucial engines of Peru’s economy are deteriorating quickly after 88 straight months of growth.

Prices for Peru’s metals exports, the traditional motor, have fallen in half and China, which helped drive much of the recent boom by buying Peruvian zinc and copper, could see its growth rate drop by half to 5.0 percent next year.

The drop in prices caused export receipts to fall for the first time in six years in October, and dragged down tax revenues too.

Before it announced the plan, the government said it expected a fiscal surplus next year of 1.0 percent of GDP. But falling tax revenues, combined with stimulus spending equal to 2.47 percent of gross domestic product in the first phase, are likely to cause a fiscal deficit next year.

Peru’s industry association has said its members will trim investments for next year by 36 percent, despite nearly daily pleas by Garcia for businesses to boost spending.

COMMODITIES FALL; CREDIT COSTS RISE

More importantly, with metals prices sinking, foreign investors have halted or delayed billions of dollars in investment to develop new mines.

That leaves domestic consumption and housing construction as the healthiest sectors. They have both expanded 20-30 percent a year over the past two years on a surging supply of credit and relatively low interest rates.

But strong domestic demand, combined with falling exports, has pushed up imports. As a result, a current account deficit of about 3.0 percent of GDP is expected next year.

That deficit could put depreciation pressure on the local currency, the sol, and slightly pressure inflation.

The central bank has said that inflation, which hit 6.0 percent this year, should ease in 2009 toward its target of 2.0 percent as prices crater globally.

But so far it has been reluctant to cut its base interest rate from 6.5 percent to help growth next year.

Instead, it has injected liquidity into the economy by cutting deposit requirements, and frustrated a business sector that is clamoring for a rate cut because commercial lenders have raised rates.

“Regardless of how much public spending grows, it won’t be enough to offset the slowdown in private investment, as credit rates are rising and commodities prices are falling,” said Pablo Secada, a former executive in Peru’s finance ministry.

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