Peru is likely to be one of the region’s best performers in 2012, in terms of economic well-being, having shown resilience in weathering the global slowdown witnessed in late-2011, says a report by Capital Economics.

Should external conditions deteriorate again, Peru’s strong fiscal buffers will act as a cushion. Growth of 4.0 percent is expected this year, down from 6.9 percent in 2012. Nonetheless, if the recent global market recovery proves to be sustained, there is the potential for a faster pace of expansion and a growing risk of overheating.

The strength of domestic demand continues to be the main engine of growth, outpacing export-oriented sectors of the economy. Construction, in particular, has regained momentum following an election-related dip in mid-2011 and the real estate sector is booming. Rising capital inflows have stoked an equity market rally in 2012 and foreign reserves have increased to over $50 billion.

Capital Economics says that while policymakers will need to be vigilant about the potential for asset price bubbles, the biggest near-term challenge may be a political risk. Growing social unrest, particularly mining-related, has gradually eroded President Ollanta Moisés Humala Tasso’s traditional left-of-centre support base. By contrast, foreign investors remain confident on Peru, a fact evidenced by a strong post-election pick-up in planned FDI.

Capital Economics adds in order to appease the poorer, rural segments of society, and dampen the threat of further unrest, the government will continue to ramp up social and infrastructure spending. A relaxed fiscal stance will leave less space for monetary easing.

Capital Economics noted that although food price pressures should continue to ease, any rate cuts will not have a deep impact. Meanwhile, heavy intervention will limit large swings in the Peruvian currency nuevo sol. Capital Economics has forecast a slight depreciation to 2.75/$ by year-end, from 2.67/$ currently, predicted on a weaker global environment.