Peru: El Niño Still on Economic Radar

Earlier this year, many expert climatologists sounded alarm bells about the possibility of another devastating episode of the weather phenomenon known as El Niño. Peru is one of Latin America’s most vulnerable countries to the economic impacts of El Niño and the Peruvian government and investors in the region should be on high alert. In fact, Peru’s fishing industry, agricultural sector and domestic infrastructure have all been severely damaged by previous episodes, such as the catastrophic El Niño of 1997–1998.

Earlier this year, many expert climatologists sounded alarm bells about the possibility of another devastating episode of the weather phenomenon known as El Niño. Peru is one of Latin America’s most vulnerable countries to the economic impacts of El Niño and the Peruvian government and investors in the region should be on high alert. In fact, Peru’s fishing industry, agricultural sector and domestic infrastructure have all been severely damaged by previous episodes, such as the catastrophic El Niño of 1997–1998.

Climate forecasters have indicated that it is highly probable that this weather system will develop in the coming months, although they are now predicting that the impact will be much more moderate than previously anticipated. In a report published on 10 July, the Climate Prediction Center, an agency of the U.S. National Weather Service, predicted that, “El Niño will peak at weak-to-moderate strength during the late fall and early winter.” While the risk of a major El Niño episode and the subsequent harmful effects has faded since early warning signs were spotted at the beginning of the year, a high element of uncertainty remains. Given the irregularity of this weather phenomenon and the complexity of climate forecasting, it is impossible to know whether El Niño will die down or amplify in scale and cause damage and economic losses in Peru.

El Niño refers to the periodic warming in ocean temperatures across the equatorial Pacific. Under normal conditions, warm surface water is pushed westward away from the Americas and towards Asia by prevailing ocean winds and currents. As a result, the water closer to the Americas is typically much cooler. During an El Niño event, the westward winds weaken and warm water travels in the opposite direction: from the Western Pacific towards the South American coastline. This reversal in dynamics and the consequent buildup of warm water in the Eastern Pacific causes major disruptions to ocean ecosystems and weather patterns, often with devastating effects.  

El Niño typically occurs once every three to seven years, but it does not follow a regular cycle. The last episode of El Niño occurred in 2009–2010, and, while it caused temperatures to rise and disrupted climate patterns, it was relatively moderate. The last extreme event took place in 1997–1998, and it is considered the most intense manifestation of this phenomenon in the 20th century. The change in conditions led to torrential rain, flooding and landslides in Latin America’s west coast, while several Asian countries were battered by severe droughts, poor harvests and forest fires. The 1997–1998 episode of El Niño is reported to have caused 23,000 deaths worldwide along with more than USD 33 billion in damages.

Peru and its economy are particularly vulnerable to El Niño. The 1997–1998 event caused deadly flooding and mudslides, and the government calculated that damage to infrastructure amounted to about USD 3.5 billion, or about 4.5% of GDP. The Ministry of Economy and Finance had warned that if this year’s El Niño were to hit strongly, economic growth would be limited to 3.5% rather than the expected 5.0%. Similarly, the consulting firm Apoyo Consultoria has said that a repeat of the 1997–1998 El Niño would generate USD 2 billion in losses. However, forecasts of a more moderate El Niño as well as the government being better prepared, suggest that a major disaster will be avoided this year at least. Most economic analysts surveyed by FocusEconomics remain optimistic about Peru’s economic outlook in the near term. For this year, private sector analysts expect economic growth to rise to 4.7% and then to pick up to 5.6% in 2015*.

The altered weather patterns brought on by El Niño can have an impact on many sectors, damage infrastructure, and lead to spillover effects throughout the economy. Peru’s coastal regions are important for agricultural production. Warmer ambient temperatures and higher rainfall resulting from El Niño are a threat to the production of a variety of crops, including avocados, mangos, bananas, grapes, asparagus, and sugarcane. Peru’s association of exporters (ADEX) reported a strong first semester, but have also noticed that the moderately altered weather brought by El Niño has been dragging on agricultural production since then. Peru’s agricultural producers could see a significant decline in harvest volumes in the second half of this year if average temperatures rise further above normal. Moreover, the high prevalence of small-scale farmers whose livelihood depends on these crops means that reduced output can have widespread consequences on the population. In addition to lower incomes, reduced economic activity and damaged infrastructure would likely result in higher price inflation throughout the country. Inflation in Peru rose notably in the first three months of 1998, but declined in April as the effects of El Niño subsided.

While El Niño typically brings torrential rains and mudslides to the coast, the opposite often happens in more elevated mountain regions. A shortage of rain in these regions can reduce power generation capacity at hydroelectric plants. However, the potential impact of El Niño on hydroelectric energy production is less significant today as Peru relies on hydroelectric power for about 45% of its energy need and also has significant backup energy reserves. Fifteen years ago hydroelectric power represented more than 80% of total national energy output. The biggest threat to the energy sector posed by El Niño is not so much on the production side as it is on distribution. The avalanches and flooding caused by El Niño can seriously damage the infrastructure for transmitting energy throughout the country. Peru’s hydroelectric plants are integrated in a large national distribution network known as the Sistema Electrico Interconectado Nacional, which has been seriously damaged during previous el El Niño episodes. However, experts have predicted that in the event of a weak-to-moderate El Niño, such as the one that is expected this year, there is not likely to be a need for energy rationing nor will there be a big jump in prices for consumers.

Peru’s fishing industry is the most vulnerable to El Niño. Today, Peru has a vibrant fishing industry that represents roughly 2% of GDP, 7% of exports and 220,000 jobs. The stock of anchovies off the coast of Peru represents the world’s largest fishery, and Peru is by far the largest producer of anchovies in the world. Moreover, Peru is the world’s number one exporter of fishmeal, producing roughly a third of total global supply. Fishmeal is a protein-rich byproduct made by drying and grinding up small fish, with anchovies used as the key ingredient. Fishmeal is used as animal feed and in fertilizers around the world. According to the FAO, the total catch by weight of the Peruvian anchovy exceeds that of any other fish species in the world. Catches of Peruvian anchovy vary considerably across years and El Niño is identified as one of the main causes behind the large fluctuations. The intrusion during El Niño chokes off the normal supply of cold nutrient-rich water and the otherwise highly productive ecosystem struggles. Ultimately, fish either die due to the lack of nutrients or migrate to other areas, putting pressure on the fishing industry. During the 1997–1998 event, Peru’s fishing industry took a massive hit, with anchovy catches plummeting 80% and exports dropping by 66% as fish migrated away from the abnormally warm waters.

In July, ENFEN, the Peruvian institution in charge of tracking El Niño, reported that this year’s system has lost strength after sparking concerns just a few months ago about a potentially devastating buildup later this year. Despite the weakening, anchovy stocks have already been reduced due to warmer ocean water temperatures during the past months. The impact is compounded because fish often move to the south and close to the shore, where industrial scale fishing is banned by government decree. The combination of El Niño and government quotas is a double edged sword for the Peruvian fishing industry.

A special report by Moody’s published in July emphasized that output in the fishing and agricultural sectors could fall in the event of a strong El Niño. However, the credit rating agency also reported that Peru’s government and banks are well positioned to confront any issues. Peru’s government is fiscally much stronger than in previous years, and, according to Moody’s, “the sovereign has accumulated assets in its Fiscal Stabilization Fund, which are now equivalent to 4.2% of GDP, and can be used in case of a national emergency.” In addition to such reserve funds, the government has actually set aside money specifically for contingency purposes. In May, the government announced the budgeting of more than USD 1 billion, which is about 0.5% of GDP, for spending throughout different sectors of the economy to minimize damage in the case of natural disasters such as El Niño.

Peru is undoubtedly exposed to the effects of El Niño. Previous versions of the weather phenomenon have inflicted significant damage and the specter of an episode like that of 1997–1998 still weighs heavily on the national conscience. While forecasters now suggest that the risk of a major El Niño hitting this year has diminished, there still is uncertainty as to how the system will develop in the coming months. Scientists are predicting that global climate change will facilitate the underlying process that generates El Niño, and perhaps even increase the frequency and magnitude of this weather phenomenon in the years to come. Peruvian authorities and investors in the region must continue to monitor the progression of El Niño, not only through the end of this year, but also in the future.

*Note: In addition to macroeconomic analysis, FocusEconomics produces the LatinFocus Consensus Forecast, a monthly forecast based on 29 individual projections from investment banks, consultancies and think tanks. For more information, please contact us via www.focus-economics.com.

Author: Carl Kelly, Economist

Date: August 19, 2014


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