Road to Lima

IMF projections for Latin America’s GDP forecast a growth rate of 1% for this year and around 3% for the next five years. At the same time, projections for Peru estimates that rate around 3,8% for 2015 and around 5% until 2020. It’s the economic dynamism that Christina Lagarde has referred to as “one of the brightest economy in the whole world”. For the first time in almost five decades Latin America will be one of the locations for the International Monetary Fund and World Bank Group’s annual meeting. Lima will be an international meeting point for governors and leaders from 188 countries, attracting a lot of attention around the world. How did Peru become one of the most dynamic economies in the word and what does it means for the country to host a world summit of such an importance?

I believe that having learned about our mistakes in the past has a lot to do with that. We’ve had hyperinflation and irresponsible fiscal policies with huge deficits. We were one of the few countries where the economy has been stagnant for almost 30 years. Only by 2006, we’ve recovered 1975’s per capita income. The Sol, our actual currency, equals 1,000 million of old Soles and the reason for that is the magnitude of the problems we’ve faced. But actually, because of those problems, we could also learn. In the last 25 years we’ve adopted prudent, sensible macroeconomic policies that let us maintain monetary stability and deal successfully with the effects of the worldwide financial crisis. Therefore, as soon as fiscal or monetary policies are regarded to be going beyond prudency, government’s popularity starts going down.

There are many other countries that suffered hyperinflation, but our advantage is that we’ve learnt from that; other countries have not always done that. I consider we’ve created an essential basis for growth -macroeconomic stability- which encourages investors, providing them with clarity and transparency at the markets they want to invest in. Once the idea of a transparent market is generated, the economy grows. We were a very close economy, where importing any product locally produced was nearly banned. Nowadays, we are one of the most open economies in Latin America. We are absolutely opened to capital markets; Peru is probably the Latin American country with the largest opening-up. I believe all these elements have helped our sustainable growth.

Do you think this growth and economic dynamism was reflected in the choice of Lima to host an event that has not taken place in South America in the last half century? What other countries had to compete with Peru to host the Summit?

I abstain on answering that question because it implicates talking about other countries. Three countries were summoned and we were chosen to host the Summit.

What financial lessons do you expect to come out from this forum?

I believe this forum will be very important, because it’s going to be held in a context where the most important central bank’s monetary policies are different. While interest rate is going up in the US, European Central Bank is undergoing a expansionary phase. That rarely happens. The world’s two most important central banks have completely different monetary policies. On one side, the FED, after it stopped purchasing assets is starting to raise its interest rate and consequently, reducing its monetary stimulus.  On the other side, the ECB has adopted unique expansive measures. Regarding that situation, I think this meeting will help the discussion around this scenario. For my point of view, debates in Lima around these policies would be really useful. Hopefully, a scenario that enables to start with IMF’s reform can be created, because it’s the American Congress that is not approving the American vote at the IMF. The result is that increasingly big economies have yet a very low weight at the IMF. Obviously, this is the case of China. Regarding votes, even Brazil has the same weight as Belgium at the IMF. All this represents an old-dated structure, like the one existing after Second World War, 70 years after Bretton Woods. If reforms aren’t made, IFM will lose legitimacy. We should not be surprised by the emergence of new institutions where the weight of emerging countries is better represented.

One element that was highlighted was the good management of the reference rate. Not only the Central Reserve Bank of Peru was awarded but also your person received the distinction of best central bank governor in 2014. What aspects of you financial governance would like to highlight? Can your governance model be extrapolated to the region?

A particular feature of Peru, shared with other emerging markets in Eastern Europe, Asia, Africa and the rest of Latin America, is that a huge part of the credit was in foreign currencies. For e.g. in Poland there are 600,000 families with mortgages taken in Swiss francs. Now that Swiss francs shot up, we see that it’s complicated for the Polish families to pay for their mortgages. Therefore, handling monetary policies in a scenario where the biggest part of credits are in dollars it’s a difficult issue, but main bankers from emerging countries should face it. Fortunately, the Central Reserve Bank of Peru could apply quite expansionary policies when needed, we lowered the interest rate in 2009 to 1.25% and the economy recovered quickly. Not only GDP growth did not fall in 2009, but it also grew that year and also in 2010 it grew more than 8%. We also faced a mega financial recession, that seemed to be at the beginning a grand depression. Because of the actions of world's central banks, like the FED or the European Central Bank, it ended up being "The great recession", but when it started, in November and October 2008, most of the people expected a terrible situation, like the one in the 30's.

On many occasions you’ve stated that the impact of the closure of the Fed’s economic stimulus program was already interiorized. What were the mechanisms that gave impermeability to the Peruvian financial market and bank system against measures taken by the Fed or global financial turbulences?

In Peru, financial supervision is not a direct responsibility of the Central Bank, it’s separated, but we’ve taken measures to strengthen it. We’ve adopted Basel III agreements before European countries had adopted them or even before we were obliged to do so.  We have introduced liquidity requirements and cyclical provisioning, like the ones that were introduced in Spain. When the Russian Crisis occurred, in 1998, many banks were affected. After that, limitations on short-time foreign indebtedness capacity were introduced to the banks.  I believe those measures helped us to remain strong in times of crisis.

Peru continues to progress in the path of inclusive growth and diversification of its economy; however, economic growth is not the same as in 2010. Some say that this dynamic comes from external factors such as the rise in the United States or falling price of gold and oil. Others that there are still many bottlenecks in Peru that prevent investment or institutional uncertainty. Do you look outside or inside of Peru to respond to these dynamics, Mr. Velarde?

A fall in the price of exportable products affects the investment in sensitive sectors. Our investment in mining fell around 8% last year and it’s expected to fall again this year. Obviously, this implied implications. Secondly, when you observe your prices falling 25%, 30% you look for adjusting you costs and if it’s possible to lay off employees, you’ll do so; if you can adjust your providers, you’ll adjust them. This obviously had a depressing effect on the demand so certainly, we were affected by the international situation. I think that the most important factor was the fall due to external factors, because you’ll always have internal ones.

As soon as the country stars growing, many barriers and excessive regulations are introduced. You don’t realize how this affects private invertors’ decisions or companies’ activities. If you are growing strongly, you don’t perceive the same way the possible beginning of an economic slowdown of the fall of investments. In Europe, while economy was growing, it was possible to be very generous, with employment benefits and other policies that seemed to be costless. It’s when the economy holds back when you realize about the costs.

What does the USA represent for Peru?

It’s our largest market for exports of non-commodities. It’s a market that allowed the increase of our non-traditional exports. That market was growing significantly before the 2008 crisis. Probably, the market that grew the most and contributed the most to national employment was the textile market, products were bought by the US.  We’ve been one of the first countries in the region to sign a free-trade agreement with the US and now we are one of the five countries that participate in the Trans-Pacific Partnership (TPP), along with Mexico, Chile and Canada. We don’t only have a free-trade agreement but also we are deepening it with the TPP.

You are fully aware of the importance of the image that a country projects to the rest of the world, facing the investors, business partners, entrepreneurs or citizens. Not surprisingly you hold hands and travel with major private sector players to many countries through inPERU. You visited Brazil just last March. What is the current image of Peru?

I believe Peru’s image is positive, although the growth rate of the economy experienced was a slowdown. Being members of the Pacific Alliance is something that distinguishes us from the rest of the countries of the region. The Pacific Alliance is integrated by four countries, which strong macroeconomic fundamentals: Mexico, Colombia, Chile y Peru, countries with autonomous central banks, the lowest tariffs among the biggest countries of the region, and totally opened to the market capitals.

Each one has free-trade agreements with Europe. Chile, Mexico y Peru are part of Asian-Pacific Economic Cooperation (APEC) but they also have commercial agreements with China and Japan. They are the countries with the greatest number of free trade agreements all along the region.

How important is the presence of the President of the Central Reserve Bank of Peru to the Peruvian businessman who comes to events like inPERU? How important is to the Peruvian corporative and banking sectors that Peru has been selected as a venue for these meetings and that its growth model has been praised by the IMF and the WB?

If you are making reference to inPERU, an association between the local financial sector and the public sector (Central Bank and Ministry of Economics and Finances) it’s because financial investors are addressed directly.
There are many concerns around economic growth, financial issues, central bank, etc.

How would you like this Summit of governors of the IMF and the Central Bank to be remembered?

I hope that important decisions will be taken in spite of the fact that, strictly talking, decisions are not taken. It’s a frame, discussions, more than anything else. In fact, when you are a governor, you can vote by mail when your country should vote.  I believe it can be an interesting debate because of the particular moment we are going through. A moment with divergent elements, as I said before. It’s a moment when we are even discussing if worldwide long-term growth is lower than the year before. This is the discussion on the table. I believe that the new horizon opened for the next years will be more positive due to technological advances.

If we had to choose a title for this interview to show the banking and financial sector of Peru to the world. What would it be?

The name of the conference, as all those the Fund has organized, is “Road to Lima” like “Road to Santiago.”