Election of Pedro Pablo Kuczynski has been viewed by the private sector as the most bullish electoral outcome of the past quarter century.

BY FRANCO UCCELLI

Business sentiment has improved markedly. With the leftist threat out of the way, the choice between two pro-business candidates in the early June presidential runoff was welcome news for the private sector, and after market-favorite Pedro Pablo Kuczynski (PPK), who will be sworn in on July 28th, won the second-round vote, enthusiasm reached new highs. The positive sentiment is being supported further by the notion that Peru is about to transition from one pragmatic, free-market, export-oriented government to another, which means that not drastic changes are needed to keep the prevailing good story on track. By and large, the election of PPK has been viewed by the private sector as the most bullish electoral outcome of the past quarter century.

Legislative priorities are clear, though quite challenging. The new government’s legislative priorities/proposals are likely to focus on citizen security, tackling corruption, the economy, and infrastructure development. Given that it is the greatest source of concern for Peruvians today, showing tangible improvement fighting crime will be critical for the government to keep its popular support and approval rating high. So will be showing forceful action addressing public corruption and red tape, which many regard also as one of Peru’s most endemic problems and biggest obstacles limiting even better economic performance. While keeping economic growth at or above its current 4 percent potential will no doubt be a top policy priority, most pundits believe this will only be accomplished if the new administration is successful unblocking some pending mega-investment projects—including the Gasoducto Sur Peruano, Line 2 of the Lima Metro, the Chinchero (Cuzco) airport, and the expansion of Lima’s international airport—and launching new public infrastructure ones already in the pipeline.

Reform prospects are uncertain. One of the main concerns that most Peruvians share is that PPK’s economic proposals may face stiff opposition in a Congress dominated by the right-wing populist party of Keiko Fujimori, his runoff rival. Indeed, Fujimori’s party will control 73 seats in the 130-seat congress and PPK’s only 18. Since ruling out and alliance with PPK in her concession speech, Fujimori has said very little about her party’s political strategy going forward. That said, some members of her party have stated they will likely vote against PPK’s plans to lower the sales tax (gradually from 18 percent currently to 15 percent) and grant tax rebates to large corporations that reinvest profits, two of his principal reform proposals, as they would widen the fiscal deficit for the benefit of big business. Small congressional representation and bleak prospects of forming a legislative alliance with Fujimori’s dominant party make the outlook for PPK’s reform agenda uncertain at best.

Key policy proposals may have to be diluted to make them passable. Opposition in congress may force the PPK administration to tone down his campaign policy proposals to make them more approvable, perhaps making sales tax rate reductions subject to meeting specific tax collection targets and extending tax rebates to corporations of any size, not just large ones. While lacking a congressional majority may tempt PPK to ask congress for temporary powers to enact economic reforms, given that campaign wounds need time to heal, it is not at all clear if congress would be willing to grant him such powers. The bottom line is that the incoming government’s key policy proposals may have to be watered down to make them more palatable, something that could compromise their scope and hence their effectiveness.

Labor market rigidities and informality are limiting investment and growth. A common complaint among many Peruvian businesspeople is that unyielding labor laws and the lack of qualified workers hinder investment and hence growth in the country. The legacy of a series of populist governments, the current labor code is viewed as too rigid and therefore as generating disincentives to hire full-time workers and promoting informality. Not surprisingly, one of the new government’s key challenges will be to incorporate (i.e. formalize) large segments of the informal economy, which accounts almost two-thirds of the labor force, into the formal sector, particularly informal (or illegal) mining activities, as they have come under heavy criticism for their negative environmental impact (including mercury contamination) and have very rapidly grown in size and economic importance.

Impact of pension system changes may be significant, but not catastrophic. In early July, a series of changes directly affecting private pension funds (AFPs) went into effect. The key measures enable individuals having reached retirement age (65 years) to withdraw up to 95.5 percent of their pension contributions and individuals wishing to purchase a first home or pay off a mortgage loan to withdraw up to 25 percent of their existing contributions for such purposes. While retired individuals have full access to their funds, first time homebuyers would not receive the funds directly, but rather through a bank, which would first determine if the individual in question is a proper subject of credit and if the 25 percent of his/her retirement contributions would indeed cover the down payment on the new house. Only then would pre-qualified buyers be allowed to request the disbursement of their AFP funds. The same procedure would have to be followed to determine if an individual is apt to cancel a mortgage loan. Based on the new rules, it is estimated that as many as 60 percent of 600,000 private pension affiliates who are not homeowners could access 25 percent of their pension contributions. The central bank (BCRP) estimates that slightly more than $4.6 billion (2.4 percent of GDP) could potentially be withdrawn from the AFPs over the next 12 months, should all eligible affiliates choose to do so, a sizable amount, but not one that would break the bank. The withdrawals would inevitably have an impact on the Peruvian currency (PEN), as 65 percent of AFP assets under management are denominated in USD and affiliate funds would be disbursed in PEN. The incoming PPK government has indicated that it does not plan to eliminate the AFP recently-implemented measures.

Franco Uccelli is Executive Director of Emerging Markets Research at JP Morgan. This column is based on a recent trip report to Peru. Republished with permission. 

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