Peru Looks to Sustain Growth in Wake of the Commodities Bust

Oil and mining investments still flow but inequality fuels resentment and opposition; can consumerism be the new driver?


Whenever elections loom in Peru, presidential hopefuls distance themselves from the mines and energy projects that form the backbone of the country’s economy. Ollanta Humala, the current president, won in 2011 by attacking the mining industry for failing to consult with local communities and turn over more benefits to them. And that was at the height of a commodities boom that supercharged Peru’s growth rate. Pedro Pablo Kuczynski, an early favorite in the race to succeed Humala, doesn’t even mention mining in his campaign literature for the 2016 presidential election. “People don’t like mines, and there’s no getting around that,” says Kuczynski, a longtime politician and former Wall Street investment banker.

This antipathy is surprising given that Peru is riding out the slump in global commodity prices better than most other Latin American nations (see “Commodities Bust Continues to Depress Latin American Economies”). The International Monetary Fund and the World Bank, which will hold their annual meetings in Lima in October, predict that Peru will grow by 2.5 to 3 percent this year, compared with just 0.5 percent for Latin America as a whole. The country is benefiting from $60 billion in mining investments already in the pipeline, a third of which have come from China. By next year Peru will have moved up a notch to become the world’s second-largest copper producer after Chile. “Thanks to cheaper energy and labor, Peru’s costs in bringing its mineral resources to market are much lower than Chile’s,” a key factor at a time when copper prices are under pressure, says Axel Christensen, BlackRock’s Santiago, Chile–based chief investment strategist for Latin America.

Yet despite the relative strength of the Peruvian economy, inequality remains a pervasive problem, especially in rural communities near the country’s mines and oil and gas wells. These increasingly high-tech projects require nomadic armies of skilled workers who are moved by companies from one site to another. “This leads to complaints that most benefits are going to outsiders,” says Lisa Viscidi, a researcher at the Inter-American Dialogue, a Washington-based think tank.

Peru enjoyed one of the highest growth rates in the region over the decade that ended in 2013, and the ranks of the country’s middle class — defined by the World Bank as those with per capita income of $10 to $50 a day — more than doubled over that period, to 35 percent of the population. In Lima and other cities, newly middle-class consumers with recently opened bank and credit card accounts crowd into modern shopping centers.

Little of this consumerism reaches the rain forests and the Andean mountain regions, where most of Peru’s mineral resources are found. Average incomes in large swaths of this vast interior are barely 5 percent of those in the capital. Not a week goes by without reports of new conflicts over mining and energy projects. In fact, the end of the commodities supercycle has brought an escalation of protests from Peruvians demanding a greater voice in the development of copper, oil and gas resources in their regions, and a larger share of their revenue.


Government officials express frustration at the media attention these conflicts draw, and at the failure of carefully established negotiating frameworks to assuage irate communities. “Some of these processes are new and cumbersome,” Economy and Finance Minister Alonso Segura tells Institutional Investor. The protests — and falling commodity prices — have discouraged the flow of capital into mining and energy. Investment in oil and gas projects fell by 18 percent between 2013 and 2014, while mining investment declined by 11 percent.

Policymakers are trying to find growth drivers besides mineral exports, which account for more than 60 percent of Peru’s foreign revenue. One option, advocated by Kuczynski, is to add value to those exports by smelting ore — a process well suited to the country because of its hydrocarbon reserves. “Peru will also have to look more toward renewable resources,” says Ana Corbacho, the IMF’s chief economist for Peru. Like Chile, the country can ratchet up exports of fish, fruit, vegetables and forestry products.

The Peruvian economy stands to get a boost from increasing government and private spending on highways, public transportation, water supplies and other infrastructure. Another promising avenue is the rapid expansion of modern retailing — supermarkets, department stores and home improvement centers — that is replacing informal street markets with cheaper, higher-quality products that can help raise living standards.

But it will take years, if not decades, for these changes to lift incomes enough in the interior to defuse popular resentment over inequality. In the meantime, rising political tensions are likely to lead to more-frequent delays or outright cancellations of mining and energy projects. “Government must accept the reality that if the local people oppose a mine, it may never be built,” says Kuczynski.

Fortunately for Peru, there is a broad consensus among the three most likely candidates for the presidency — Kuczynski, former president Alan García and Keiko Fujimori, daughter of another former president, Alberto Fujimori — in favor of continuing the current economic policy framework. The election will be held in two rounds, in April and June 2016.

Kuczynski, the only declared candidate thus far, served as prime minister, Economy and Finance minister and minister for Energy and Mines in a variety of governments dating to the early 1980s. Between public service stints he had a lucrative financial career in the U.S.: chairman of First Boston International from 1982 to 1992 and then partner in the Latin American Enterprise Fund, a Miami-based private equity fund he co-founded for investments in Mexico and South America. “Kuczynski is very well respected by the markets, but his main challenge is to broaden his appeal among poorer Peruvians,” says María Luisa Puig, a Peruvian analyst for Eurasia Group, a political risk consulting firm.

The former prime minister, García and Keiko Fujimori hold similar investor-friendly views in support of freer trade, reasonably low business taxes, a reduction in bureaucratic red tape and equal treatment of foreign and domestic investors. That’s not surprising given that foreign investors dominate the businesses of natural-resource extraction and consumer retailing, and hold close to half of Peru’s banking assets.

“Regardless of who wins in 2016, we can expect these policies will continue,” says Finance Minister Segura. He should know. His boss, President Humala, is a former army officer who ran on a populist, left-wing platform in 2011, then quickly shifted course in office to pursue free-market policies that have drawn record foreign investments. Under Peruvian law he cannot run for a consecutive term.

Peru’s embrace of the private sector came after many years of economic failure that left the country among the poorest in the region. In the 1970s a left-wing military dictatorship imposed state control over large portions of the economy, spurring prominent politicians, intellectuals and businesspeople — including Kuczynski — to flee abroad and causing the economy to stagnate. In the 1980s the murderous Maoist movement known as Shining Path wreaked havoc in the provinces while economic mismanagement sparked hyperinflation. In the 1990s then-president Fujimori crushed Shining Path and brought an end to hyperinflation, but he was later convicted of corruption and human rights violations.

Though Fujimori remains in prison, Peru emerged from his years in office with a stable economy that allowed the country to take advantage of the commodities boom. From 2004 to 2013, Peru’s gross domestic product expanded at an average rate of 6.4 percent a year, much faster than the 3.8 percent average for Latin America as a whole. “And it did so with low inflation, solid banks and huge improvements in social indicators,” says the IMF’s Corbacho.

The fall in commodity prices has cooled the economy sharply, prompting authorities to take modest measures to stimulate growth.

At a time when many Latin central banks have been raising rates to quell inflation and defend their currencies, Banco Central de Reserva del Perú shaved interest rates by 25 basis points, to 3.25 percent, in January. Among major Latin economies only Mexico and Chile — both at 3 percent — have lower benchmark rates. To encourage lending, Peru’s central bank eased reserve requirements for commercial banks.

The government, meanwhile, began 2015 by shaving the corporate tax rate to 28 percent from 30 percent and slashing the income tax rate for low-income workers to 8 percent from 15 percent. The cuts, together worth some $1.6 billion, along with $2.3 billion in increased spending on infrastructure projects, including a subway system for Lima, will provide an economic stimulus equivalent to 1.9 percent of GDP.

Economists don’t see the fiscal deficit — projected to rise to 2 percent this year from 0.1 percent in 2014 — as a constraint, but neither do they expect the fiscal moves to return the economy to the strong growth rates of yesteryear. “The Peruvians have created significant fiscal and monetary room to accommodate the end of the commodities supercycle,” says Alberto Ramos, Goldman Sachs Group’s senior economist for Latin America, based in New York. “They are waiting for better external conditions to bring back high-growth levels, but we don’t expect to see that happen any time soon.”

According to Finance Minister Segura, infrastructure spending will overtake the mining sector next year as the biggest driver of investment. He contends that Peru is less vulnerable than other regional countries to a rise in U.S. interest rates because it is tied with Mexico for the second-highest credit rating in Latin America, after Chile: an A3 from Moody’s Investors Service. “We have ample access to capital markets and have been able to fund significant infrastructure projects without any difficulty,” Segura says.

None of the government’s stimulus policies, however, offers a clear blueprint for bridging the economic chasm between Lima and Peru’s interior.

More than a quarter of Peru’s 30 million people live in the capital. Lima’s economic transformation is most evident in San Isidro and Miraflores, upscale neighborhoods sitting on cliffs overlooking the Pacific. Here high-walled shopping malls rise like Inca fortresses. The most luxurious is the Jockey Plaza, where Chilean retailer Falabella has its biggest-selling department store in Latin America. It’s built in the same mold as Falabella stores back in Chile, occupying vast space over three floors.

The shelves are stocked with consumer electronics and clothing from some of the world’s leading brands, from Apple and Sony to Mango and Aeropostale. Falabella provided many middle-class Peruvians with their very first credit cards. In 20 years the number of active Falabella cardholders in Peru has mushroomed to 1.4 million. About 40 percent of store sales are financed with Falabella’s own credit and debit cards, part of a larger financial services operation. “Basically, we are a consumer finance company focused on retail clients,” says Juan Xavier Roca, the company’s CEO in Peru. “We use the credit knowledge gained from our clients to offer them other services.” As in all Falabella stores, a Banco Falabella branch is located on the third-floor financial center in the Jockey Plaza. It offers savings and deposit accounts, as well as loans for cars and home improvements. Next to the tellers, Falabella has made space for its insurance brokerage and its travel agency.

Since arriving in Peru in 1995, Falabella has expanded to 131 sites, including department stores, hypermarkets, supermarkets, home improvement centers and shopping malls. Peru accounted for 26 percent of the company’s $12.4 billion in revenue last year.

Falabella was lured to Peru by the country’s consumer demand, pent up after decades of stagnation. “The main attraction is that the Peruvian market has a lot of catching up to do by comparison with more-developed countries,” Roca says.

The commodities export boom, led by copper sales to China, fed a consumer spending explosion. Successive governments reduced import taxes on the whole range of goods sold at department stores like Falabella and Ripley, another big Chilean retailer.

For institutional investors, buying shares in the major Chilean retail companies — like Falabella, Ripley and supermarket behemoth Cencosud — is the surest way to profit from the Peruvian consumer boom. “Locally listed companies are few and usually have low liquidity,” says Adam Kutas, Boston-based portfolio manager for the Fidelity Latin America Fund. He invests in Peru through Chilean companies.

Banks are a significant exception to the shortage of attractive locally listed companies. “There are some interesting liquid investments in Peruvian financials because the banking system is very consolidated and loan penetration is still low,” says Verena Wachnitz, London-based manager of T. Rowe Price’s Latin America Fund. The top four banks — Banco de Crédito del Perú, BBVA Continental, Scotiabank Perú and Banco Internacional del Perú (Interbank) — claim more than 80 percent of banking assets. Loan penetration to the private sector is only about 35 percent of GDP, compared with 62 percent in Brazil and 90 percent in Chile.

Interbank has been Peru’s fastest-growing bank over the past decade. Its controlling shareholder is Carlos Rodríguez-Pastor, a billionaire whose assets also include insurance firm Interseguro, supermarket chain Supermercados Peruanos, Real Plaza shopping malls and InkaFarma drugstores. Rodríguez-Pastor is the biggest financial backer of Kuczynski’s presidential campaign.

Last October the billionaire listed his Intercorp Financial Services (IFS), combining Interbank and Interseguro assets, on the New York Stock Exchange in a $400 million IPO. Today, Interbank is Peru’s fourth-largest bank by loans, with an 11.7 percent market share; Interseguro, known mainly for its annuities, is the third-largest insurer by assets. Last year net income for IFS, including banking and insurance, was 964 million nuevos soles ($302 million), up from 745 million soles in 2013.

“The growing middle class has always been the target for Rodríguez-Pastor’s whole group of companies,” says Alonso Aramburú, a New York–based analyst for Brazilian investment bank BTG Pactual. Interbank is more focused on retail than are other Peruvian lenders, with a 50-50 split between its business and retail loans, compared with a 65-35 ratio at the three other big banks. Interbank has built the largest distribution network by installing its ATMs in Supermercados Peruanos. It has also used the supermarket chain to become the market leader in credit cards, with a 25 percent market share.

The strongest headwind facing Peruvian banks, including Interbank, is the more than 13 percent depreciation of the sol versus the dollar over the 12 months to August 20. “This is creating a mismatch for the banks,” Aramburú says. Allowed to save in either currency, Peruvians are opting for more dollar deposits. At the same time, banks, pressured by the country’s central bank, are trying to cut their dollar risks by lending more in soles. Until now Peruvian banks have used deposits to cover about 75 percent of their funding. But with deposit costs rising as the sol continues to fall against the dollar, banks may be forced to find other, more expensive sources of funding.

Ever since the arrival of Francisco Pizarro and his conquistadores in 1532, a chasm has existed between the Pacific capital created by the Spaniards and the interior, whose Indian-owned lands provided the riches that built Lima. The divide persists after nearly half a millennium and continues to stir resentment against largely middle-class Lima by denizens of the interior, who feel left behind both in boom times and in periods of slower economic growth.

An eight-hour overnight bus from the coastal capital to the central jungle town of Pichanaki covers 223 miles, climbing 11,000 feet into the frigid Andes and then descending by hairpin curves into the steamy Amazon rain forest. The economic contrasts are even starker than the shifting landscapes. According to the World Bank, the poverty rate in the region including Pichanaki is more than 50 percent; the average Lima resident earns 20 times as much as these rain forest dwellers. Yet when Pichanaki had an opportunity to become a major natural-gas producer, the community of just over 50,000 inhabitants exploded in rage and chased out Argentina’s Pluspetrol, the largest private oil and gas company in Peru.

Peru isn’t a significant hydrocarbon exporter, but its energy supplies help make its copper mines globally competitive, especially compared with those in neighboring Chile. The country’s biggest natural-gas project is in Camisea, 130 miles east of Pichanaki. Supplying energy to Lima and the copper mines in the country’s southern Andes, the field went into production in 2004 with Pluspetrol as the operator and largest partner, with a 27.2 percent stake.

Fresh from its Camisea success, Pluspetrol won the Pichanaki concession in an auction a decade ago. Last year it finally announced plans to launch exploration. But Pluspetrol was linked to some of the most environmentally damaging projects in the northern Amazon province of Loreto; the company, along with state-owned Petróleos del Perú, was blamed for the pollution of four main Amazon tributaries.

Loreto became an issue in Pichanaki as a result of a new era of Catholic Church activism and the spread of social media. “Initially, the residents of Pichanaki and the nearby rain forest communities were completely in the dark about Pluspetrol,” says Carlos Chavarría, a stocky farmer who has led local opposition to the company. “But that changed thanks to Father Richie.”

Ricardo (Richie) García, a bearded Spanish priest who has headed a Pichanaki parish since 2008, heard rumors of environmental devastation in Loreto, traveled to the zone and interviewed tribal and community leaders. He later disseminated their testimonials in Pichanaki through YouTube and Facebook. The priest denounces “the lies and grave pollution committed by Pluspetrol, even if the company denies it,” in Loreto. His parishioners “became aware of the serious environmental dangers that future exploitation could bring,” says García, whose strong stands on environmental issues and income inequality echo the pronouncements of Pope Francis on his visit to South America in July.

In the second half of last year, local protesters blocked roads into Pluspetrol headquarters in Pichanaki and at sites that were marked for gas exploration. A violent demonstration in February ended with police firing on protesters. One person was killed, and 40 others were hospitalized with gunshot wounds.

Such incidents have become commonplace around new mining and hydrocarbon developments. According to the Inter-American Dialogue’s Viscidi, there are more than 160 conflicts tied to energy and mining projects in Peru. “The government has discovered ways to somewhat reduce the violence,” she says. “But they don’t always work.”

Under President Humala the government has established a prior-consultation process with local communities, as well as a tax program, known as the “canon,” intended to steer portions of mineral and hydrocarbon profits back to these communities. But there is no agreement on what prior consultation means. The government insists communities have a right only to be informed about a project and to offer comments; community leaders assert they are empowered to veto a project.

In Pichanaki government officials and Pluspetrol did in fact hold consultations with residents, but to no avail. “We felt that there were no guarantees of environmental protection, nor that we would receive benefits from the project,” says Chavarría, who heads the regional environmental defense group. “Institutions in this country are weak, and politicians are easily corrupted.”

Some analysts agree with his cynicism. “If regional and local governments used the canon money as they are supposed to, there would be fewer conflicts,” says Cynthia McClintock, a political science professor at George Washington University. “Unfortunately, local political leaders get bribed, and only about half of the money ever gets spent on the communities.”

After the fatal confrontation in February, Pluspetrol announced it was pulling out of Pichanaki. The minister of Energy and Mines stepped down — the third to resign in Humala’s four years as president. “Ministers lose credibility because they are in office so briefly,” Viscidi says. “It definitely hinders the government’s ability to have a clear, consistent policy.”

Efforts to short-circuit local opposition to natural-resources projects don’t always succeed. Consider Tía María, a $1.4 billion copper mine in the southern Peruvian Andes owned by Southern Copper Corp., a unit of Mexican mining and rail operator Grupo Mexico. Shortly after his election Humala gave Southern Copper a green light to proceed with the project, bypassing the newly created community consultation process because a previous government had authorized the project back in 1994.

The approval marked an about-face for the president, who had backed community protests against mining projects during his campaign. His stance angered local farmers, who contended that Tía María would pollute nearby agricultural valleys. Backed by labor unions, university students and political groups in the region’s capital, Arequipa, the farmers have blocked initial construction efforts on the project for the past four years. The government sent more than 1,000 soldiers to support 4,000 police officers in keeping roads and bridges open between Arequipa and the mine site, 56 miles south. But increasingly violent protests in April and May of this year left three people dead and led Southern Copper to suspend efforts to begin development of the mine.

Muddying the situation even more are accusations of corruption against a powerful local opponent of the project. The activist, Pepe Julio Gutiérrez, allegedly was caught on an audiotape requesting $1.5 million from a man who identified himself as a Southern Copper negotiator. In exchange, Gutiérrez offered to bring an end to the protests. The tape, broadcast by a local radio station in May, led to the arrest of Gutiérrez and caused dismay among his followers.

Government officials insist that stalled projects like Tía María are the exception rather than the norm. “Successful projects don’t make the news,” says Finance Minister Segura. He cites as examples three large, mainly copper-mining projects in Peru’s southern Andes that recently went into operation: $1.5 billion Constancia, owned by Canada’s Hudbay Minerals; $3.5 billion Toromocho, owned by Aluminum Corp. of China, also known as Chinalco; and $5.85 billion Las Bambas, owned by MMG, an Australian-Chinese company.

Still, mining is not popular in Peru, even though it remains the source of almost two thirds of the country’s export income. One problem is that mining projects are located far away from the seat of government power. “So local communities expect the mining companies to fulfill roles, like road building and the supply of electricity, that the state would normally undertake,” says Eurasia analyst Puig.

Water is a flash point as well. “The big issue with mining is that most of it is done high up in the Andes, and that’s where water used by the agricultural valleys below comes from,” Kuczynski says. Rather than press ahead with controversial new mining projects, he says, Peru can better sustain its economic development by creating a smelting industry that would add value to copper exports. “If we can get China to invest in smelters in Peru, we can raise our export mining revenue by 25 percent,” Kuczynski says. “Of course, we will still be dependent on mining. That’s not going to change.”

It’s also unlikely that the bleak outlook for commodity prices will change significantly. That means no return to a 6 percent growth rate any time soon. “Whoever comes in will face a tougher economic environment,” predicts Segura.

Never one to mince words, Kuczynski agrees. “It’s going to take somebody with cojones,” he says. •

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