I wouldn’t bank on it 

Peru's economic landscape amidst interest rate cuts and uncertainties. 

The Central Reserve Bank of Peru (“BCRP”) recently made a pivotal move in November, announcing a strategic reduction in its benchmark interest rate, lowering it from 7.25% to 7.0%. This decisive action marked the third consecutive cut in interest rates since September and was in line with the expectations of economists and financial experts. The BCRP’s proactive decision aligns with a broader global trend of declining inflation rates observed since the latter part of 2021. 

Peru, like many other nations, has experienced a notable decrease in inflation rates, particularly evident since June. This decline has been primarily attributed to the dissipation of transitory effects on inflation, mainly caused by supply constraints on specific food items. 

Consequently, this reduction in the benchmark interest rate, aimed at stimulating economic activity, comes at a crucial juncture for Peru—a country once hailed as the fastest-growing economy in Latin America but now grappling with recessionary pressures “and it is starting to seriously concern people who were not concerned before.” The Peru based asset manager continued, “Banks have begun to shorten credits, observing increased delinquency, and companies struggling to pay their debts, creating a negative cycle that could lead to a severe economic slowdown with high rates.”

“banks have begun to shorten credits, observing increased delinquency, and companies struggling to pay their debts, creating a negative cycle.”

Asset manager, Peru

However, Economy Minister Alex Contreras expressed optimism at the start of November, citing promising economic indicators. Following the BCRP’s announcement, the iShares Peru ETF experienced a notable rally, reaching levels not witnessed since early September, when the first interest rate cut since 2020 was implemented. “The pace of further cuts will depend on various factors, such as the Fed, the El Niño phenomenon and the developments in the Arab conflict,” stated a Peruvian economist and political analyst.

Despite these positive signals, analysts project a prudent and cautious approach to further monetary policy discussions. “The only person with the ability to halt the recession is Julio Velarde [Chairman of the Central Reserve Bank of Peru] by lowering rates.” The asset manager continued, “If he doesn’t contribute by lowering rates, the reactivation will be very difficult because nobody trusts this government.” While favourable monetary conditions, decreasing inflation rates and prevailing economic slack imply the possibility of additional interest rate reductions, the risks associated with climatic phenomena like El Niño and the dynamics of external financial conditions necessitate careful consideration and vigilance.

“The only person with the ability to halt the recession is Julio Velarde [Chairman of the Central Reserve Bank of Peru] by lowering rates.” 

Asset manager, Peru

The timing of interest rate cuts by the central bank “hinges on the El Niño phenomenon,” sited the economist. There is a prevalent fear among the populace that this event might turn into a catastrophic force akin to “Godzilla,” potentially devastating Lima. However, if this extreme scenario doesn’t materialise, “the overall sentiment will be very positive, leading to a very rapid recovery.” The true impact and the trajectory of recovery won’t be evident until “the conclusion of the first quarter of 2024.”

The BCRP’s decision-making process factored in various critical elements, including the monthly inflation rate for October (-0.32%), a discernible declining trend in year-on-year inflation rates. Although inflation indicators have showcased a downward trajectory since the commencement of 2023, they persistently hover above the stipulated target range. As the local economist warned, “there are still many uncertainties for 2024.” 

“there are still many uncertainties for 2024.”

Economist, Peru

Peru’s decision to join the trend of reducing interest rates follows similar actions taken by neighbouring countries such as Chile and Brazil, who initiated rate cuts in July and August respectively. Chile and Brazil “started with higher inflationary stress than Peru,” currently at 9% for Chile and 12.25% for Brazil, “but are reducing them faster,” explained the Peruvian based asset manager. “Chile quickly overcomes the problem because the Chilean state is more efficient, and the Chilean entrepreneur trusts in his country. In contrast, the Peruvian entrepreneur takes money out of the country.” 

Meanwhile, neighbouring countries like Colombia and Mexico, significant players in the region, have yet to make any interest rate cuts and remain at comparatively higher rates (13.25% and 11.25% respectively) set during the springtime. 

Financial institutions such as BBVA have predicted a further reduction in Peru’s interest rate to 6.75% by the year’s end. These forecasts coincide with an optimistic outlook for 2024, with expectations of inflation falling below 3%, signifying a consistent and controlled progression. “If we compare reserves, we [Peru] have 30% of GDP in reserves, while other countries do not. So, if you ask me if Peru will have possibilities of a fiscal problem or debt problem, I will say no,” replied the economist. Emphasising their commitment to closely monitor inflation-related data, the BCRP remains prepared to undertake additional measures necessary to steer inflation back within the target range of 1-3%. “The problem arises from investment,” the economist expanded, “we cannot grow at 1% because in 25 years, we will still have 20% poverty.” 

“The problem arises from investment, we cannot grow at 1% because in 25 years, we will still have 20% poverty.”

Political analyst, Peru

Peru’s recent strategic reduction in the benchmark interest rate reflects a concerted effort to address economic challenges amid a global trend of declining inflation rates. While the decision aims to stimulate economic activity and steer the nation toward recovery, it does so against a backdrop of cautious considerations, including potential risks stemming from climatic conditions and external financial dynamics. As highlighted by the political analyst, “The government is rolling out a plan of 23 measures in January to reactivate the payment chain. They are doing this with delays, and hopefully, it achieves its objective and helps those who really need it.” The coming months will be pivotal as Peru navigates its monetary policy decisions to steer its economy back on the path of stability and growth.

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