Peru Business Forecast Report Q4 2008

Sound Fundamentals, But Challenges Ahead
While the Peruvian economy will likely face a period of moderating growth over the coming years, we note that strong demand will maintain the economy buoyed. Prudent macroeconomic policies further support our view of improving fundamentals, which notwithstanding a significant rise in investor risk aversion, should keep investment flows into the Andean country anchored for the foreseeable future. While we believe that market friendly policies of the Alan Garca administration are set to continue through to at least 2011 (the year of the next general election), in the Q408 Peru Business Forecast Report we revisit the theme that political risk - as in many parts of Latin America - is growing increasingly acute. To be sure, growing opposition to investment-friendly policies in Perus remote areas could see autonomist movements among indigenous communities gain prominence over the next few years.

The popularity of President Alan Garca continues to slide as Perus voters grow increasingly frustrated with government efforts to attract greater foreign investment into the countrys remote areas. Moreover, promises of a prompt reconstruction of severely damaged areas hit by a Magnitude 8 earthquake in August 2007 have failed to materialise one year later. President Garcas approval ratings fell to just 22% in August, according to an Ipsos/Apoyo poll published in local newspaper El Comercio, down from 26% back in July. Indeed, the president and his ruling Partido Aprista Peruano (PAP) were dealt a significant blow in congress on August 22, when legislators rejected two decrees signed off by the president by a vote of 66 to 29.

Notwithstanding a recent upward revision to our 2008 real GDP growth forecast for Peru (to 8.5% from 7.0%), we see the economy entering a challenging four-year period, which will see growth moderate towards a trough of 3.6% by 2012. Capacity constraints caused by still underdeveloped physical infrastructure and high inflation - partly as a result of the countrys supply bottlenecks and capacity constraints - will likely weigh on the overall performance of the economy over the next several years. Moreover, with global commodity prices on a downward spiral as key markets get hit by slowing economic growth, Peruvian exporters could be hit by lower global demand for their commodity exports (metals in particular). Perus mining sector, which accounts for some 15% of GDP, will therefore contribute to slower economic growth going forward.

The government agency overseeing Perus state companies, FONAFE, recently announced plans to list shares of more than 20% of up to 36 companies with a combined annual revenue of some US$6bn. Companies earmarked for this extensive privatisation initiative will be announced in early 2009, and will cover water, energy and transportation companies. We believe that the largest companies could include Petroperu, Electroperu and water utility Sedapal, which would mark the largest privatisation effort in Peru since the 1990s. The move would increase investment options for Peruvian pension funds and likely attract greater foreign investment into the country, which recently acquired investment grade status.