Fitch Affirms Peru's FC IDR at 'BBB+'; Outlook Stable

Fitch Ratings has affirmed Peru's long-term foreign and local currency IDRs at 'BBB+' and 'A-', respectively, with a Stable Outlook. The issue ratings on Peru's senior unsecured foreign- and local-currency bonds are also affirmed at 'BBB+' and 'A-', respectively. The country ceiling is affirmed at 'A-' and the short-term foreign-currency IDR at 'F2'.

KEY RATING DRIVERS

Peru's IDRs reflect the following key factors:

Peru's creditworthiness is supported by its established track record of policy credibility, consistency and flexibility which has delivered strong macroeconomic and financial stability. Strong external liquidity and manageable external financing requirements mitigate risks from short-term international capital market volatility. Strong external and fiscal balance sheets underpin the sovereign's fiscal financing flexibility.

These credit strengths are balanced by the country's high commodity dependence, low government revenue base, financial dollarization and structural weaknesses such as low per capita income, weak social indicators and institutions.

The sovereign balance sheet is among the strongest in the 'BBB' category supported by robust external buffers and low debt. Peru's international reserves--at 31% of GDP last year, resulting in a liquidity ratio of 346% for 2015--provide the country with the capacity to adjust to lower commodity prices and tightening global financial conditions. The external buffers also smooth foreign-exchange market volatility and mitigate risks posed by significant participation of non-residents in the domestic financial market and high financial dollarization (40% of deposits). Prudent fiscal policies and high growth have reduced general government debt to 19.4% of GDP in 2014.

Peru's current account deficit, 4% in 2014, is forecast to remain wider than those of 'BBB' peers over the rating horizon. Private external debt has also increased in recent years. These vulnerabilities are mitigated by foreign direct investment (FDI) flows, continued access to external markets, relatively manageable external financing requirements (near 20% of international reserves in 2015-2016) and Peru's position as the third-strongest net sovereign external creditor in the 'BBB' category.

Supply-side mining and agricultural shocks and lower-than-expected public capital outlays lowered growth to 2.4% in 2014. Despite continuing low metal prices, Fitch forecasts economic growth of 4% in 2015 and 5% in 2016, driven by expanded mining production and infrastructure investment, as well as monetary and fiscal policy stimuli. Downside risks to our forecast could materialize from a sharp decline in terms of trade, under-execution of capital spending by subnational governments, and weak business confidence.

The general government ran a deficit of 0.1% of GDP in 2014 and it will likely use fiscal space to run 1.7% of GDP overall deficits in 2015-2016, financed principally with government deposits and local-currency issuance and international capital markets. Hence, government debt could rise above 20% in 2015-2016. With the implementation of the Strengthened Fiscal Responsibility Law, the general government is required to record a maximum 1% of GDP structural deficit in 2016. The government could request a waiver to ease the fiscal consolidation trajectory without curtailing infrastructure investment and growth.

Peru's fiscal financing flexibility is underpinned by substantial government deposits in addition to the well-established Fiscal Stabilization Fund (estimated at 4.7% of GDP in 2014), proven access to international financing sources, and development of the domestic capital market. Although non-resident holdings of local-currency public-sector debt have decreased, this has not inhibited the central government from issuing long tenors in local currency.

Inflation, averaging 3.3% in 2014, is currently on a downward trend and inflation expectations remain anchored within the central bank's inflation target range. In spite of PEN depreciation pressures and dollarization, the central bank has provided monetary stimulus through interest rate cuts and differentiated FC and LC reserve requirements. The central bank continues to implement measures to reduce risks from financial dollarization, especially on the credit side.

Fitch expects Peru to maintain prudent and pragmatic policymaking direction throughout the 2016 electoral cycle given increased consensus over the direction of economic policy and the strengthened macroeconomic and fiscal policy frameworks since 2001. Nevertheless, the early start of the electoral season combined with the confrontational stance between Congress and the Humala administration could increase political noise, detract from government's effective implementation of the stimulus measures and, if prolonged, weaken investor confidence.

RATING SENSITIVITIES

The Stable Outlook reflects Fitch's view that upside and downside risks to the rating are broadly balanced. The main risk factors that, individually or collectively, could trigger a rating action are:

Negative:

--A sustained decline in the price of Peru's main commodity exports resulting in weaker macroeconomic performance and deterioration in the sovereign's balance sheet;

--Sharp decline in external liquidity;

--Policy choices that result in macroeconomic and financial instability, and reduce investment and growth prospects.

Positive:

-- Sustained growth, especially of the non-mineral sector, that reduces Peru's income gap and improves social indicators relative to higher-rated sovereigns;

--Strengthened institutional capacity that improves the effectiveness of economic and social policy implementation;

--Significant improvements in Peru's fiscal and external balance sheets and material reduction of financial dollarization.

KEY ASSUMPTIONS

The ratings and outlooks are premised upon a number of assumptions:

--Fitch assumes China's real GDP growth with decelerate to 6.8% in 2015 and 6.5% in 2016. This will maintain weakening pressures on international commodity prices.

--Fitch assumes copper production broadly begins to increase over 2015-2017 as expanded and new mines come online and social protests will not obstruct development.

Additional information is available on www.fitchratings.com

Applicable Criteria and Related Research:

--'Sovereign Rating Criteria' (Aug. 13, 2012).

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=982026

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