Economy

Peru and COVID-19

Latin America Takes a Stand

Peru and most Latin American countries are no strangers to severe crises, but governments and society as a whole have risen to the occasion.

Latin America is coping with an unprecedented severe external shock. Globally, the COVID-19 pandemic has had a gruesome toll so far; since early this year, there have been 15,000 deaths reported and over 350,000 confirmed cases in 159 countries.

Most analysts agree that this pandemic will most likely trigger a global recession. Healthcare experts predict that the human toll could exponentially rise if the contagion curve is not swiftly contained.

Even though Latin America has a long track record in dealing with external shocks and self-made crises, there is no direct experience to draw on in confronting such an unprecedented pandemic.

In the very short term, governments will have to deal with very significant economic losses from the strict social distancing measures that have been pursued. Recent reports indicate that there are currently over one billion people under quarantine in the world.

A further extension of social distancing measures in most countries in the region will certainly amplify the impact of a global economic recession, as payment chains in the economy could be broken.

In this situation, firms will cut their output given a fall in demand and consumers will be unable to spend as their income falls. The key challenges are to avoid bankruptcies, financial crisis, and major layoffs.

Unfortunately, this shock is hitting the region at a time in which economic growth has been negative or relatively flat for the past five years. The International Monetary Fund projects a -2% growth slump in the region in 2020, far from its original estimate of 1.5% for this year. This outlook may even worsen depending on the capacity to contain the contagion and on the outcome of countercyclical fiscal and monetary policies in a context in which macroeconomic fundamentals in the region are much weaker than those of the global financial crisis.

Moreover, this shock is happening in a particularly challenging context. Most Latin American countries are facing social discontent due to persistent structural problems, such as income inequality, citizen dissatisfaction with poor quality public services, insufficient pension benefits, rising citizen insecurity, just to name a few.

Aggravating this situation are ongoing demographic and technological trends that will introduce additional pressures on governments. Rapidly aging populations will stress even further overburdened healthcare systems.

Furthermore, changes in labor markets due to technological trends, such as the advent of the gig economy, will make a growing number of citizens more vulnerable to losing their jobs when struck by shocks without access to adequate social safety nets.

Effective policy responses and recovery plan for Peru

In the short-term, healthcare officials need to continue focusing on containing the contagion curve as they need to expand testing potential cases and deliver services to the sick and most vulnerable population groups. Economic policymakers are adopting quick and aggressive countercyclical policies.

On the fiscal policy front, given Peru’s very strong macroeconomic fundamentals (i.e. a fiscal deficit around 2% of GDP and a public-to-GDP ratio below 30%), the Finance Ministry is able to pursue an initial fiscal stimulus of around 2% of GDP, focusing on financing public healthcare needs during the emergency, granting tax breaks and guarantee funds for SMEs and delivering cash transfers destined to over 3 million vulnerable families. Additional measures are expected soon.

In turn, the Central Bank has reduced its interest rates by 100 basis points and is increasing liquidity via repo operations.

Excessive exchange rate volatility will also continue to be smoothed. Financial regulators, along with banks, are facilitating liquidity by reprogramming debt servicing for 1.5% of GDP so far. They are also pursuing countercyclical macroprudential measures and a surveillance plan especially targeted toward small financial intermediaries. It is essential to avoid a financial crisis at this juncture.

Notwithstanding this quick response, the main challenge is to avoid ruptures in payment chains to minimize bankruptcies and layoffs. This requires easing cashflow and financial burdens of consumers and firms.

Key actors in this effort are tax authorities, public utility firms, pension funds and financial services providers. Given Peru’s high reliance on commodity exports, which will face a significant slump, and prolonged disruptions in global supply chains, a recovery agenda must be quickly designed and pursued as the pandemic gets under control.

This agenda should include i) an aggressive public private infrastructure investment plan, ii) a publicly-supported financial plan to support the most affected economic sectors through, for example, first loss guarantees, and iii) structural reforms to curb high labor and firm informality and create a stronger and fiscally sustainable safety nets.

These endeavors demand bold policymaking, decisive political support and a new social pact.

Each time Peru, and most Latin American countries have faced severe crises, governments (and society as a whole) have risen to the occasion. These trying times undoubtedly provide a great opportunity to pursue reforms that will sustain growth and continue boosting social prosperity for all.

Dr. Luis Miguel Castilla holds a Ph.D. and M.A in Economics from Johns Hopkins University and a B.A in Economics from McGill University. He served in various capacities for the Government of Peru, including as Ambassador to the United States and Minister of Economy and Finance. He has over 20 years of professional experience at multilateral development banks, holding senior management positions at the Inter-American Development Bank, Development Bank of Latin America-CAF and the World Bank. He is a member of the Inter-American Dialogue and has held scholarly positions at MIT and several universities in the US and Peru. Dr. Castilla has written extensively on development, public finance, public policies and international affairs, and currently works as an international economics and public policy consultant based in Lima, Peru.

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