Aug. 27, 2015

Julio Velarde


Julio Velarde

Governor, Central Bank of Peru

TBY talks to Julio Velarde, Governor of the Central Bank of Peru, on inflation, the challenge of falling mineral prices, and quantitative easing.


Julio Velarde studied economics at the Universidad del Pacífico in Lima, Peru, in 1974, and went on to obtain an MA and a PhD at Brown University in the US in 1978. He has been Governor of the Central Bank of Peru since 2006, and prior to that he served as Executive President of the Fondo Latinoamericano de Reservas from 2004 to 2006. Before this he was Director of the Banco Central de Reserva del Perú from 1990-92 and from 2001-03. He has held senior academic positions in the department of economics at the Universidad del Pacífico, and been awarded as Governor of the Year 2010 by Emerging Market – Euromoney Institutional Investor, and BRAVO Award for Outstanding Services in Latin America 2012 by Latin Trade.

Peru is one of South America's top economic performers, but before this decade, it had experienced monitory woes. However, during your tenure the sol has seen stability and growth against the dollar. What role have the Central Bank's policies had in this transformation?

We have a highly turbulent monetary history. Back in the 1980s, both monetary and fiscal policies in Peru were very poor. Since 2001, when we adopted an inflation target regime to conduct monetary policy, we became the first country to adopt this regime with negative inflation rates. The credibility in the new regime allowed the central bank to adopt a more expansionary monetary policy, without affecting inflationary expectations. The second country to apply inflation targeting under negative inflation was Japan, in 2014. Since introducing inflation targeting, core inflation in Peru has been at 2%, and headline inflation at 2.6%, on average. That is the lowest in Latin America, which is consistent with fact that we have the lowest target of inflation in the region.

How is the bank acting to stimulate growth in the context of lower mineral prices, and what has led you to keep the rate constant over the past two months?

Inflation has been high, that is the main reason why we have been reluctant to cut rates. Instead, we reduced reserve requirements so that financial institutions can increase their lending at a faster pace. The Central Bank has adopted an expansionary policy stance since May 2013 when it started cutting reserve requirements. Since that time, we have also cut the policy rate three times up to 3%, which implies a real interest rate of less than 1%.

For many emerging economies the rise in the dollar, coupled with a fall in commodities, may come as a shock. How do you plan to insulate Peru from that trend?

In 2008, the emerging markets recovered quickly, because China was growing rapidly in 2009, which pushed commodity prices up. In addition, the Fed extended sub-lines to certain important emerging market economies like Brazil, Mexico, Korea, and Singapore. This allowed them to limit exchange rate pressures, whereby credit resumed flowing to emerging markets. Those conditions are not going to exist this time around, as commodity prices are falling, and the US is set to tighten its monetary policy. Expansionary policies will remain in place in Japan and Europe, which will partially compensate the impact of the FEDs tightening in emerging market economies. Last year Peru was the only country in the region with a fiscal surplus. Peru saved during good times and now we can use those savings to pursue a more aggressive counter-cyclical fiscal policy. We have a large level of international reserves, so if there is pressure on the currency, we can use a good chunk of those reserves to limit the risks of an abrupt depreciation of the sol. This gives us some leeway. The third important factor is that many important projects, particularly in the mining sector, will enter production in 2015-17, which will nearly double copper production over the next three years.

Do you have any thoughts about Peruvian debt markets and on the effects of quantitative easing?

We are the emerging economy with the largest participation of non-residents in the domestic-currency government bond market. This participation reached 58% in the past, nowadays is less than 40%. Besides this reduction, the yields of government bonds have not increased, reflecting the high demand for these bonds of domestic agents. Private Peruvian pension funds that had increased its investments abroad are moving it back to Peru. In the case of corporate bonds, the issuance in emerging markets have increased substantially recently, particularly in the last three years. Last year for example, we accounted for almost a fifth of total bonds issued in South America, Brazil, and Chile each one for 31%, and Colombia for the 14% of the total issuance during 2013. Those bonds have been typically been issued in dollars at a historically low interest rates. They are bullet bonds, typically issued with a maturity between seven and 10 years, therefore the rollover risk is relatively low. As part of policy to smooth the credit cycle in Peru, during the period of QE, we increased the reserve requirement in dollars, in the case of deposits up to 50%. This policy increases dollar lending rates, particularly for small and medium-sized firms (SMEs) and households, as corporates have access to international capital markets, this type of reserve requirement affects them less.