Index Trend Previous Quarterly Editions
Expropriation Risk: 2 52 ► Political Violence Risk: 59 ▲ Terrorism Risk: 33 ▼ Exchange Transfer and Trade Sanction Risk: 45 ► Sovereign Default Risk: 37 ▼
Overal Risk Temperature TREND ►
Special topic: Government's commitment on climate policy 2
Peru is exposed to climate change. One of the most visible examples is glacial melt, with Peru having among the world’s largest number of tropical glaciers, their extent diminishing greatly over the last 30 years. Once glaciers have fully disappeared, they no longer contribute to available water supplies. This is therefore likely to affect coastal cities, such as Lima, where river water accounts for much currently available supply. Climate change also appears to affect the El Niño phenomenon, a recurrent problem every few years which leads to both drought and flooding depending on the area concerned. The last El Niño year in 2018 caused major flooding on Peru’s northern coast, with infrastructure and urban settlements washed away. Patterns of agricultural
production are also affected by climate change, especially vulnerable highland peasant farms exposed to sudden climatic variation. Peasant farmers make up a large proportion of Peru’s poorest households.
The country’s main contribution to climate change is from deforestation in the Amazon. The rate of deforestation has accelerated in recent years, although more of the rain forest is still intact than in other Amazonian countries. Some 2.6 million hectares are believed to have been lost between 2001 and 2020. Expansion of the agricultural frontier, Illegal logging, mining and drug cultivation are major drivers of deforestation.
The state has shown itself ill-equipped to prevent this. Indeed, local authorities are often complicit.
Proposals to expand road communications in the Amazon are, if implemented, bound to accelerate the disappearance of the forest cover. As elsewhere in Latin America, deforestation leads to reduced rainfall which increases the likelihood of forest fires which, in turn, increase carbon levels in the atmosphere as well as lowering its natural absorption through trees. Among those most affected by climate change are Peru’s indigenous populations, but they lack a powerful political voice.
Policy towards preventing climate change has been erratic and largely ineffectual. The present government of President Pedro Castillo has afforded climate change scant importance, appointing environment ministers without relevant experience. The environment ministry wields little influence over overall development objectives -- promotion of extractive industries receives highest priority. Castillo did not attend the COP26 international climate meeting.
Peru lacks a strong ‘green’ movement. Only a handful of congressional members (mostly on the left) support a green agenda, though there are a number of non-governmental organisations which promote concern about the need for a stronger environmental agenda that protects the most socially vulnerable groups.
Policy goals have been set but are unlikely to be attained. In December 2020, the High-Level Commission for Climate Change updated the country’s Nationally Determined Contributions, committing to reduce greenhouse gas emissions by 40% by 2030, up from 30% previously. But this was contingent on promised external financing.
Deforestation and desertification are thought to be the source of 50% of emissions, followed by transport, industry and electricity generating. Peru lacks a medium-term plan for tackling climate change that brings together all relevant actors. In addition, the environment ministry and other regulatory bodies do not enjoy strong financial support.
Although targets have been introduced to shift electricity generation towards renewables (solar, wind, biomass and geo-thermal), the system of subsidies to traditional systems of generation does little to encourage this in practice.
Expropriation Risk 53 (Medium) TREND ►
Despite its initially radical agenda with threats to nationalise extractive industries, the Castillo government has sought to allay business fears, placing strong emphasis on the need to attract foreign investment, especially in the key mining sector. The resignation of Pedro Francke as minister of economy and finance in February and his replacement with Oscar Graham, a ministry technocrat, does not appear to have materially changed this policy orientation. Moreover, the reappointment of Julio Velarde, a conservative economist, as president of the central bank, reinforces the commitment towards the market economy and to orthodox fiscal and monetary policies.
However, the Castillo administration has done nothing to enhance political stability in Peru. Although Congress voted down attempts to initiate impeachment proceedings in December 2021, the threat remains active with three far-right parties – Fuerza Popular (Popular Force, FP), Renovacion Popular (Popular Renewal, RP) and Avanza País (Forward Country, AP) – all committed to bringing down Castillo when possible. Impeachment would need the approval of two-thirds of Congress. Opposition parties also seek to force out ministers identified as being on the left. On February 28, Transport and Communications Minister Juan Silva was obliged to resign over alleged irregularities in the award of tenders.
Political Violence Risk 67 (Medium-High) TREND ▲
Peru has long been afflicted by political violence arising from conflicts between communities and mining companies. These are the most common source of contention, according to the Ombudsman’s office. Restrictions and the impact of COVID-19 on communities led to reduced conflict. However, few cases of conflict have been resolved and new tensions have emerged especially in southern Peru, along the so-called ‘mining corridor’ linking mines in the highlands and port facilities on the Pacific.
In December 2021, MMG, the Chinese-owned company that extracts copper from Las Bambas, threatened to suspend production following repeated roadblocks along the corridor. Communities along the road have various grievances about Las Bambas ranging from environmental pollution to achieving more benefits from the mine at a time of high copper prices. The variety of interests between communities makes it difficult to agree on a common solution. At the end of February, MMG was again threatening a halt to production as new roadblocks were erected.
The Castillo government has outlined its criteria for siting new mining developments, known as ‘social profitability’. This involves limiting mining to areas where mining activity brings demonstrable and sustainable economic benefits to local communities. Despite past attempts to introduce policies to reduce conflicts over mining, these have had little practical effect. The state lacks the political ability to forestall protests, especially in more remote areas, as well as the ability to quell protests without risking a recourse to violence once they occur. Once violent conflict erupts, it becomes difficult to restore trust.
COVID-19 has led to increased unemployment and a rise in poverty, only partly mitigated by subsidies to vulnerable groups. This may result in increased social tension once restrictions on mobilisation are removed. Attempts to force Castillo out of the presidency could lead to similar protests.
Terrorism Risk 30 (Low) TREND ▼
The remnants of the Sendero Luminoso insurgency remain active in an area known as the Vraem, where the majority of Peru's coca is produced. The group is now primarily involved in drug trafficking. Though coca cultivation is not as widespread in Peru as in Colombia, it is rising. The government is trying to encourage a switch from coca to legal crops, but the lack of state presence on the ground makes progress difficult.
Exchange Transfer and Trade Sanctions Risk 45 (Medium) TREND ►
Faced with rising inflation due to increased import prices for fuel and grains, the central bank raised its reference rate to 3.5% in January 2022, having progressively raised it from 0.25% when the pandemic first struck in March 2020. Depreciation of the sol because of capital flight following Castillo’s election victory was also a factor in raising import prices, though by the beginning of 2022 the sol recovered much of its value to stand at 3.79 to the U.S. dollar at the end of February. Assuming fuel import prices stabilise, inflation should fall back from 5.7% at the end of February over the rest of the year. The central bank’s target ceiling for inflation is 3%.
Economic activity in 2022 is set to stabilise at around 3.5% in 2022, following its 11.2% contraction in 2020 and 13.3% recovery in 2021. The latter was faster than many had predicted, reflecting in part the strength of copper prices over much of the year. It was also a consequence of the rapid roll-out of an effective COVID-19 vaccination programme. The ‘third wave’ of COVID, still strong at the beginning of the year, is likely to tail off in 2022.
Sovereign Default Risk 27 (Low) TREND ▼
Peru’s dependence on China as the main market for its minerals has led to a sharp increase in exports of copper and other minerals. Most of Peru’s major mines were able to recover pre-pandemic output levels by the end of 2020, with the government moving early to release them from strict lockdown rules.
Improved trade performance is expected to lead to a balanced or even a surplus on current account in 2022. The government’s expansive COVID-19-related spending, coupled with a sharp drop in tax receipts, pushed up the fiscal deficit substantially in 2020 to 8.9% of gross domestic product, but this fell to 2.6% in 2021, aided by increased exports.
