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Document of
The World Bank
FOR OFFICLAL UISE ONLY
RepoitNo. P-5714-PE
REPORT AND RFCO1MENDATION
OF THE
PRESIDENT OF THE
INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT
TO THE
EXECUTIVE DIRECTORS
ON A
PROPOSED STIRUCTURAL ADJUSTMENT LOAN
IN AN AMOUNT EQUIVALENT TO US$300 MILLION
TO THE
REPUbLIC OF PERU
MARCH 2, 1992
This document has a restricted distribution and may be used by recipients only in the performance ofdteir official duties. Its contents may not otherwise be disclosed without World Bank authorization.
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CURRENCY EOUIVALENTS
(As of December 30, 1991)
Currency Unit = Nuevo Sol (S/.)'US$1.00 = S/.0.9SS/.1.00 US$1.05 f
GOVERNMENT'S FISCAL YEAR
January I - December31
ABBREVIATIONS
ALADI Asociaci6n Latino-Americana de Integracion (Latin American Integration Association)BCRP Banco Central de Reserva del Peri (Central Bank of Potu)BPP Banco Popular del PerdCOPRI Corporacidn pama la Promoci6n de la Inversion Privada (Commission for the Pronmotion of Private-Sector Investments)CPI Consumer Price IndexCTS Compensaci6n por Tiempo de Servicios (Forced savings scheme for worker retirement)ECASA Eipresa de Comercializacion del Arroz (Rice Marketing Company)ENCI Empresa Nacional de Comercializacion de Insumos (National Input Marketing Company)FLAR Fondo Latinoamenricano de Roservas (Latin American Reserve Fund)FONCODES Fondo Nacional de Compensacion y Desarollo Social (National Fund for Social Compensation and Development)GDP Gross Domestic ProductCG Central GovernmentGOP Government of PewGTZ Deutsche GesellchafR fu-r Technische Zusammenarbeit (German Company for Technical Cooperation)IFIs International Financial InstitutionsIBRD Intetnational Bank for Reconsttuction and DoveloqmcntIDB Inter-American Development BankIMF Intnational Monetary FundINP htstituto Nacional de Planificaci6a (National Planning Institute)IPSS Instituto Peiuano de Seguridad Social (Peruvian Social Security Institute)*GF Japanese Grant FacilityLDP Loter of Development PolicyMEF Miniustio de Economia y Finaazas (Ministry of Economy and Finance)MLT Medium- and long-termNFPS Non-Financial Public SectorNGOs Non-Governmental AgenciesPETROPERU Pettoteos del Pen, S.A. (Pem Oil)RAP Rights Accumulation ProgramSAL Structural Adjustment LoanSBYS Superintendency of Banks and InsuranceSEA State Entrepreneurial ActivitiesSEP Social Emergency ProgramSPP Sistenta Privado de Pensiones (Private Pensions System)SUNAD Superintendencia Nacional de Aduanas (Customs Administration)SUNAT Superintendencia Nacional do Adminigraci6n Tributaria (Tax Administration)UNDP United Nations Development ProgrammeUNICEF United Nations Children's Emergency FundVAT Value Added Tax
'On July 1, 1991, a new monetary unt, the Nuevo Sol (SI.). was introduced at a converson factor of S/.1.00= Im.1.00. The so-calledInti Mill6n (I/m.) - equivalent to one million Intis (Vt.1,000,000)- was introduced on December 16 1990 to simplify accounting and asa means of transition between the Inti and the Nuevo Sol.
FOR OFFICUL USE ONLY
SMRUCTURAL ADJUSTMENT LOAN
Table gt Contents
Juoan and Progr Summ .ary . v
I. THE LOAN, THE WORKOUT PROGRAM, AND COUNTRY STRATEGY ............. I
A. Tbe Loan ........................................................ IB. The Bank's Approach to a Country with Protracted Arrears ........ 1........... C. Ihe Bank's Approach in Peru ................... ....................... 1
II. THE ECONOMY ............................................ 5
A. The Economy Inherited ............................................ 5B. The Economic Reforms of the Current Administration ....... ................ 12C. The 1991-1992 Macroeconomic Stabilization Program ....... ................. 15D. Risks and Assessment of the Stabilization Program ........ ................. 16E. Monitoring the Stabilization Progm ................................... 18F. The Agenda for Structural Reform ..................................... 19G. The Medium-Term Outlook ........................................... 20
M. EXTERNAL FINANCING ................................................ 20
A. The External Debt Problem ........................................... 20B. The External Financing Plan for 1991 and 1992 ............ ................ 21C. Externa Financing Beyond the Performance Period ........ ................. 25
Tis trpot wa prepared by Valeriano Garcia, based on the findings of a preappsl mission to Peru in Septemb.e199M, snd an apraisal mission in Dcmbr 1991. Contibutors to the report wer: Marcelo Anrnou (inanciaOfficer); Janet Eatt (Country Officer); Edgardo Favaro (Country Economist); Feliciano e (Sr. Economist);Polly lones (Sr. Economist); Chlh Kane (Economist); Izumi Ohno (County Officer); Geoffrey Sheped (Princ.pE30ono1st); Ch Yappaz (Reseauch Asistant); Robetto Abusada, Cesar Bu, Karen Cavan . AdJanOulssarTi, San Knaudt, Trwy Mincey, Mario Pasco Cosmopolis, Carlos Rodriguez, Saa Tboada de Coneila,Kateina Taiganide, Abel Viglione and Denise von Gersdorff (Consultants). Gabriela Huffman and Diana Sangesa=provided sectarial suppott.
IIs document has a resticted distibution and may bo used by recipients only in the performance of their officialdies. ts conten may not otherwise be disclosed wihout World Dank auton.aI
This documtent has a esticted distribution and may be wud by fe-ipients only in the performanceof their offlcial duties. Its contents may not otherwise be 6:sclosed without World Bank authorization.
* .~~~~~~~~~~~~~~ ii
IV. THE GOVERNMENT'S STRUCTURAL ADJUSTMENT PROGRAM .................. 26
A. PiscalPolicy .............................................. 26Background ............................................ 26Recent Reforms .......................................... 26An Agenda for Further Reform ................................ 27
B. Social Sectors .............................................. 27Background ............................................ 27Recent Reforms .......................................... 28
Pov-erty Alleviation .2............................ 28Health, Nutrition and Education ............................ 28
An Agenda for Further Reform .......................... .. 29
C. Privatization ............................ 29Background .............................. 29Recent Reforms ............................ 30An Agenda for Further Refortn .......................... .. 30
D. Agriculture ............................ 31Background .............................. 31Recent Reforms ...... ................................... 31An Agenda for Further Reform .......................... .. 31
E. Labor Reform ............................ 31Background . .............................. 31Recent Reforms ......................................... 32
Probationary Employment .................................. 32Temporary Employment ................................... 32Forced Savings Scheme for Worker Retirement (CTS) ................ 32
An Agenda for Further Reform ................................ 32
F. Social Security ............................................. 32Background ............................................ 32Recent Reforms ......................................... 33An Agenda for Further Reform ................................. 33
G. Prospects for the Structural Adjustment Program ........................ 33
V. THE PROPOSED STRUCTURAL ADJUSTMENT LOAN ......................... 34
A. TheLoan ................................................ 34Description ............................................ 34Policy Reforms to be Supported Under the SAL ...................... 34Proposed Sectoral Conditions ................................. 34
Conditions Preventing Policy Reversal .......................... 34Conditions for Further Reforms .............................. 36
Monitoring and Reporting .................................... 38
X jj; -
Pooperation with the IDB .................. 39Co-Financing .............. 39Technical Assistance ...................................... 39Procurement, Disbursement, Audit, and Administration ............... .. 40Letter of Development Policy ................................. 42Conditions for Board Presentation .............................. 42Conditions of Loan Signing and Effectiveness ....................... 43
B. Benefits .................................. 43
VI. RECOMMENDATION ................ 44
Annex I Economic Indicators. 45Annex 2 SAL Policy Matrix .56Annex 3 Supplementary Loan Data Sheet .70Annex 4 Letter ef Development Policy .76Annex 5 ListofProjectDocuments .92Annex 6 Status of Bank Group Operations in Peru ... 93Annex 7 Technical Assistance Program for Structural Adjustment .95Annex 8 Privatization Strategy by Sector .98
TABLES AND FIGURES
Texct Table
Table I Annual Percentage Rate of Inflation Over the Last Twelve Months. 6Table 2 Central Administration Tax Revenues as a Percentage of GDP. 9Table 3 Peru's Tax Revenue Ratios Compared to a Sample of Countries .10Table 4 Comparing VAT Revenues and Rates in Latin America .11Table 5 Fiscal Accounts (Percentage of GDP) ................................ 16Table 6 Peru: External Financing Requirements and Possible
Sources of Financing, 1991 and 1992 (US$ millions) .22
Text Figures
Figure I Real Stocks of Ml and M2 (Millions of 1979 Soles). 7Figure 2 Central Government Primary Deficit (Billions of 1990 US dollars). 9
Agpedix Tables
Table 1.1 Peru: Sumnmary Balance of Payments: Current AccountExcluding Interest Payments on Public MLT Debt (USS Millions) ..... ......... 45
Table 1.2 Peru: Summary Balance of Payments: Capital Account and FinancingRequirements (US$ Millions) ................. 46
Table 1.3 Peru: External Financing Requirements and Possible Sources ofFinancing (US$ Millions) ........................................ 47
Table 1.4 Peru: Projections of Key Economic Indicators .......................... 48
Notes to Tables 1.1 to 1.4 ....................................... 50
Table 1.5 Peru: Extenal Outstanding Debt (Stocks in USS Millions as of December 1990) .... . 53
Table 1.6 Peru: Monthly Economic Indicators, July 1990-September 1991 ..... I ........... 54
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PERUi
STRUCM AL ADJUSTME LOAN
L-oan and Program Summary
Borower Republic of Peru
Exeuing Agy: Ministry of Economy and Finance
US$300 million equivalent
1m: Repayable in 20 years, including five years of grace,at the Bank's standard variable interest rate.
I,oan Objestives: The proposed loan would support the Government'smedium-term program of macroeconomic stabilization and broad-basedstructural reforms.
Loan.Descrintion: The loan would recognize the major structural reform measures takenbetween August 1990 and December 1991, in macroeconomic policy, thefiscal sector, the social sector, privatization, agriculture, labor, and socialsecurity. The conditions in these abovementioned areas includemaintenance of current reforms and measures for further reform, and areset out in Appendix A of the Letter of Development Policy (Annex 4).
Bewnefhs: Stabilization is necessary for the success of the structural reformscurrently being implemented. Policies supported by this loan will reduceinflation to low levels, setting the framework for renewed growth. Iherevamping of fiscal administration and fiscal reforms should increaserevenues and make the fiscal adjustment sustainable. 'he trade reformshould mobilize resources toward Peru's competitive advantage and leadto an outward-oriented, and thus sustainable, growth. Labor marketreforms will improve the flow of labor inputs among sectors to adapt tochanges in relative prices caused by trade and fiscal reforms. Interestrates will continue to be set freely, thus improving resource allocation andmonetization. Land reformn has been extensive, strengthening propertyrights, crucial for agricultural development. Privatization will create alarger and more efficient private sector, and privatization of the socialsecurity system would be a new source for long-term financing.
The poor will gain in the long-rn from the liberalization of the labormarket, a wider distribution of employment opportunities, and thepotential benefit from agricultural reforms to use land as collateral, andimproved registration and titling of land. To protect the poor, in theshort-run, the Government is striving to mobilize external resources forpriority projects in basic social services. The Government will develop a
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national nutrition policy with a view to improving the eost-eveness,nutritional impact and targeting of food assistance programs. Therecently established social compensation fund (FONCODES) wIll channelfinancing (both domestic and external) to small, labor-intensive projectsfor the rehabilitation of the social and economic infrastructure, whichbenefit the poor.
The four risks to Peru's stabilization program are that: (a) the fiscalsituation would remain precarious; (b) a continuing dollarization processwould push up money velocity and fuel inflation; (c) market perptionsof the continuing overvaluatlon of the domestic currency would increasepolitical pressures on government officials to take unwanted steps suchas re-introducing capital cotrols or making 'excessive' (inflationary)purchases of foreign exchange; and (d) an increase in terroist activitieswould undermine business confidence and support for the Government.
Estimated Disbursement: The loan would be disbursed in one tranche. Upon fulfillment ofeffectiveness conditions, the Bank will make the loan effective and releasethe tranche.
REPORT AND RECOMMENDATION OF THE PENEOF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT
TO THE EXCUTIVE DIRECTORS ON A PROPOSED SIRUCTURAL ADJUSTMENT LOANTO THE REPUBLIC OF PERU
I. I submit the following report and recommendation on a proposed loan to the Republic of Peru forthe equivalent of US$300 million. Ihe proposed loan would support the Government's medium-termprogram of macroeconomic stabilization and broad-based structural reforms. The loan would be repayableover 20 years on a fixed amortization schedule, including five years of grace, at the Bank's standard variableinterest rate and charges.
I. THE ILAN, THE WORKOU PGRAM, AND COUN =Al=
A. he Loan
2. This Report proposes a US$300 million adjustment loan for a structural adjustment program. Theimmediate objective of the loan is to support Peru's macroecor.omic stabilization program and broad-basedstructural reforms, which represent one of the most far-reaching and rapid structural refc-ns carried out inthe developing world. The broader objective of this loan, as well as those of the previous trade policy reformloan and the following financial sector reform and privatization adjust.ment loans, is to allow the Bank toparticipate in an internationally supported approach to reintegrate Peru into the international financialcommunity. This approach would provide Peru the opportunity to rehabilitate an economy much damaged bythe actions of past governments and would enable it to resume a normal relationship with the Bank and otherdonors.
B. The Bank's Approach to a Country with mtrated A, s
3. On May 2, 1991, the Board approved a new approach to support debt workout programs incountries with protracted arrears (Additional Suptrt for Workout Proem in Countries with ProtractedArfars. R91-70, April 11, 1991). It allows strong-performing countries with large arrears to accumulate"contingent disbursemens" during a pre-clearance "performance period." Loans are presented to the Bank'sBoard during the performance period and, once the arrears to the Bank are cleared at the end of theperformance period, loans are signed and made effective and all accumulated disbursements released. Thenew approach is analogous to the IMF's Rights Accumulation Program (RAP), and requires the followingfour conditions to be met: (a) the existence of an agreed financing plan; (b) an IMP stabilization program;(c) a Bank-supported adjustment program; and (d) continued current debt service payments to the Bank.
C. The Bank's Approach in Peru
4. In order to assist Peru during the performance period, expected to last through December 1992,the Bank developed a country assistance strategy which conforms with this new approach. On July 30, 1991,the Board approved the application to Peru of the new approach (Peru: The Bank's Approach to a Countryœvith ProMacted Arrears, R91-171, July 12, 1991), opening the way for the implementation of this strategy.As a first step, the Bank participated *n the formulation of an external financing plan agreed to by the IMF,IDB, bilateral donors, and the Government (see Section II. Concurrently, the Bank has been preparing,based on its economic and sector work, an adjustment program to support reform efforts underway in Peru.As required under the new approach, loans approved under this program will not be disbursed until the endof the performance period.
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5. The Bank also has been looking beyond the current period of protracted arrears through FY95.During this period, the Bank expects to deepen Its support of the adjustment program through additionallending and economic and sector work, and also expects to present investment loans now under preparation.These loans are inherently more time-consuming to prepare than adjustment loans as they require a complexmix of engineering, Institutional, and human inputs, and Peru's public institutions are currently unable toundertake the necessary preparation themselves.
6. To counteract this weakness in public management, the Bank has launched a major program oftechnical assistance, crucial for the successful implementation of the medium-term economic program. It basmobilized resources for these activities through the Japanese Grant Facility and the German Company forTechnical Cooperation (GTZ), and is currently exploring other possible sources of financing. 'Tus, evenbefore the Bank has been able to disburse, it has mobilized significant resources for Peru for projectpreparation and implementation. It has secured Japanese grants for approximately US$8.0 million for seventechnical assistance projects, for reforms in the financial sector, debt statistics and management, the socialsector, water and sanitation, energy, and privatization, and has secured GTZ grants for about US$1.0 millionfor agriculture, macroeconomic stabilization and structural reforms, energy, mining and industry,infrastructure, and human resource development.
7. To assist the Government's efforts to reintegrate Peru into the international financial community,and subsequently to enhance and deepen the reforms undertaken during the period of reintegration, the Bank'scoury assistance strategy towards Peru is directed at four long-term strategic objectives: (i) sustaining andaccelerating the stabilization and adjustment process; (ii) fostering private sector development and publicsector reform; (iii) alleviating poverty and promoting human resource development; and (iv) rehabilitating keyinfrastructure.
8. Suining and Accelerating the Stabilization and Adjustment Process. The Bank is supporting thereforms of the current Government, which assumed office in July, 1990, and immediately initiated structuralreforms to reverse the economic policies of previous administrations and achieve a sustained economicrecovery. Deregulatory and other reforms have been announced in trade, monopoly rights, privatzation,ports, foreign invesunent, land tenure, labor markets, social security, tax policy and administration, and thefinancial sector (see paragraphs 44-56).
9. The Government of Peru must sustain these reforms and undertake further measures before thecountry can fully reap the rewards. Bank lending operations in Peru are initially focussing on threeadjustment loans to support the Government's efforts. The trade policy reform loan has been approved by theBoard in Febnrary 1992, and this structural adjustment loan (SAL) and the financial sector adjustment loanwill follow, assuming continued fulfillment of the four conditions described in paragraph 3. Later aprivatization adjustment loan will be prepared to support the privatization effort of the Government.
10. This loan will address balanced medium-term economic development reeds through a multi-sectorfocus. It aims at securing the Goverment's achievements and enhancing the fol' wing reforms:conwlidating the macroeconomic stabilization by maintaining non-inflationary fin cing of governmentexpenditure, improving tax collection and supporting the tax reform, redefining the functions of thegovermment and reducing the number of public employees, laying out the general and sectoral strategies toprivatize state-owned enterprises in various sectors, increasing labor mobility, laying out the strategy forreform of official pension schemes, and reducing state intervention in agricultural markets. The SAL will
3-
also hdp establish a clear policy and institutional framework for poverty alleviation, identifying target groupsand priority programs that reflect the needs of the poor.
11. The financial sector adjustment loan will support the Government's efforts to liberaize thefinancial system and thereby promote efficiency in financial intermediation. The loan will focus specificallyon: implementation of the new banking law in an environment of strengthened baning supervision, aprogram of privatization of state-owned commercial banks, reform of the development banks, restructuring ofthe major public-sector bank, the Banco de la Nacion, and improvements in the securities law as well asimplementation of the partial or full privatization of the social security system.
12. The groundwork for these adjustment loans was laid by eonomic and sector work undertaken inlate 1990-ely 1991 on public sector reform and investment, structural reform, the social sectors, and, inconjunction with UNDP, trade. The Bank is also undertaking further extensive studies on macroeconomicand structural reform which will assist in maintaining dialogue with the govemment on monetary, financialsector, and labor policies. A financial sector report will analyze the status of financial institutians andmarkets, and their inter-relation with monetary and fiscal policies. A labor markets study will seek tostrengthen the role of markets in supply and demand for labor services. In addition, a study on agriculturalincentives is currently under preparation to analyze the initial impact of agricultural reforms which have beenundertaken, and indicate areas for further reform.
13. Fostering Priate Sector Development and Public Sector Bform. A number of lendingoperations are under preparation which will broaden the Bank's support, initiated in this loan and in thefimancial sector adjustment loan, for the Government's privatization and public sector reform efforts. Theseloans will focus on the reform of public sector policies that restrict private sector participation, as well as theprivatization of state-owned enterprises (SOEs) in energy, mining, fisheries, transportation, andtelecommunications.
14. An energy sector rehabilitation loan will finance rehabilitation of facilities and support reform ofenergy policy and private sector development. Policy reforms will include the establishment of tariffs basedon economic principles, and of regulatory structures conducive to efficient production and use of energyresources. The loan will support privatization of Electrolima, the largest electricity distribution company inPeru, and foster private sector development in the oil industry. A privatization adjustment loan will supportimplementation of an agreed privatization program of SOEs in mining, oil, gas, telecommunications, and -building on the financial sector adjustment loan - banking. It will also support sectoral policy reformsnecessary for attracting the private sector, and permitting its efficient operation. These reforms will vary bysector: in utilities (power, telecommunications, etc.) the focus will be on regulatory and pricing policies; innaura resource-based sectors (mining, hydrocarbons, and fisheries) the focus will be on policies for grantingconcessions.
15. Economi. and sector work will focus on issues related to privatization of SOEs and developmentof the private sector, such as the regulatory policies to govern natural monopolies, financial restructuringrequirements, and labor redundancy. A planned study on industrial deregulation will evaluate ways to furtherimprove the conditions for private sector development. An environmental sector study will review problemsof soil erosion, tropical deforestation, PCB pollution, and water pollution caused by mining.
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16. Alleviating PoTh and ProngHUM R2W= Devlome. 'Me Bank's objectves in thearea of human resources are to assist the 5overnment in formulating and implementing a poverty alleviationstrategy, providing social services for the poor, and improving existing programs. The Bank's work in thesociW sector will contribute to the alleviation of poverty and will increase the likelihood that the adjustmentprogram will be maintained. The effectiveness of community organizations and other non-gwoernmentalorganizations will decrease reliance on the public sector and encourage a lareer private sector role in theprovision of social services. Howe% er, current requirements for rehabilitation are substantial due to thedeterioration of the economy.
17. In the lending program, the first Social Development Project will support basic health servicesand nutrition to the poor. It will build on the SAL to support the Government in formulating a povertyalleviation strategy and identifying reforms in food assistance programs. It will also include activities tostrengthen institutional capacity at the regional and central levels and improve the Governmen's ability todesign and monitor social programs. This improvement in institutional capacity, as well as the results ofeconomic and sector work, would lay the base for another more comprehensive loan to strengthen primaryhealth services in Peru. This future loan would address critical rehabilitation needs and financial issues,including cost recovery, and it would extend to additional areas the programs and interventions which provedsuccessful under the first project. The participation of non-governmental organizations is being incorporatedin both projects. A subsequent operation in primary education is also planned to improve programs andteacher training in rural areas, including school feeding programs.
i8. The emphasis of sector work in primary health, basic education, and nutrition is on thefundamentals. Improvements in these areas, together with a resumption of economic growth, are critical toefforts to reduce poverty in Peru. The focus will be on identifying ways to broaden access by the poor tothese programs, to enhance program quality, and to improve cost-effectiveness of programs. To reduce thedemands on government agencies, mechanisms to enlarge the role of non-governmental organizaons andcommunity participation will be explored. An evaluation of public spending in the social sectors will reviewgovernment priorities in light of the contribution to poverty alleviation, the need for continued fiscal :austerity,and a reduced role for public agencies. The Bank is also exploring the possibility, with the Government, ofconvening a donors meeting during 1992 to channel external financing for priority programs and projects inthe social sectors.
19. Rehabilitating Ky Infrasnucture. The Bank's objectives in this area are the rehabilitation ofessential infrastructure in the transport, sanitation, irrigation, urban, and water sectors, which have sufferedfrom a lack of maintenance due to severe fiscal constraints, as well as the identification of furtherrehabilitation needs and specific policy reforms. The goal is to simultaneously promote sustainable growththrough an efficient use of resources and identification of public policies for the provision of infrastructreservices which will help alleviate poverty.
20. Initially, lending will focus on high-priority rehabilitation needs. A water sector loan will involveemergency-type investments to address critical supply and quality problems, and health hazards (such ascholera) resulting from poor water quality. A rehabilitation loan, focussing primarily on highways, willfinance emergency investments in the transport sector. Given tight fiscal constraints in Peru, these loans willalso support policy and regulatory changes to promote private sector participation and investment. Over themedium-term, these emergency-type rehabilitation loans will be supplemented with a municipal developmentloan to support basic urban infrastructure and a second water sector loan to support further rehabilitation and
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secoral reforms. An irrigation rehabilitation loan will be prepared to address irrigation infrastructure, whichhas been allowed to deteriorate as procedures and maintenance have been inadequate.
21. Given the constraints to immediate large-scale lending to Peru, and the weaknesses of Peruvianinstitutions, the Bank is seeking immediate impact through the provision of policy advice. Sector workrelated to infrastructure is emphasizing rehabilitation, as well as institutional and pricing issues, includingstudies on irrigation, water supply, telecommunications, transport, and general issues of policy reform ininrastructure. A study is underway to examine the scope for deregulation, privatization, and decentralizationin urban services.
II. T ECONOMY
A. The Economy Inherited
22. During most of the last two decades Peru has had a legal structure and a policy environmentinimical to economic development. A state-led development strategy created a large public sector, anintricate network of controls, and largely inefficient state-owned enterprises in virtually every sector of theeconomy. The tax code was complex and full of loopholes, tax administration was ineffective, and taxevasion was widespread.
23. These conditions seriously distorted most markets in the economy. Job security in the formalsector was constitutionally protected and strictly enforced, and, together with very high tax rates on labor,helped shrink the formal sector. Land reform in the early 1970s severely restricted the marketability of landand its use as collateral. Trade policy relied on import substitution with very high tariffs and many non-tariffbarriers, depriving the country of the benefits of its comparative advantage in intemational trade. Domesticregulatory policies conferred special privileges on incumbents. The financial sector was heavily regulated andburdened by direct government involvement, including tight control of interest rates.
24. The Administration taking office in 1985 attributed chronic inflation and low growth to Peru'sexternal debt, declaring that debt-servicing was responsible for devaluation of the exchange rate, erosion ofdomestic savings, and curtailment of investment. Consequently, it put a ceiling on foreign debt service at 10percent of the value of exports and later stopped debt-servicing altogether. It instituted widespread foreign-exchange controls on current- and capital-accounts, and introduced multiple exchange rates that werefrequently changed. It increased minimum wages, expanded directed credit and subsidies, reduced the VATrate, and decreased public sector prices.
25. This strategy led to a severe fiscal deficit, financed by an unrestrained increase in the moneysupply. Between 1985 and 1987, this increase had little effect on prices, due to an increased demand for thedomestic currency generated by the Administration's initial credibility among Peruvians. Economic activityexpanded by 17 percent, the rate of price increases fell, and real domestic liquidity experienced anunprecedented growth. This "boom,* of course, proved to be unsustainable. After 1987 the market lostconfidence, the process of monetization was suddenly reversed, inflation rebounded, and the economydeteriorated sharply.
26. In key productive sectors such as petroleum and mining, the breakdown of management andfinances led to a decline in production. Peru's per capita GNP declined sharply and unemployment and
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poverty increased alarmingly. Relations with international financial Institutions (IFls), bilateral lenders, andcommercial institutions were suspended because of the accumulation of large arrears. The goverrment's onlyremedy was to reduce public investment to historically low levels, with the greatest relative reduction inhealth and education. Inflation continued out of control, further eroding tax revenues. In 1989, the pricelevel was 267 times higher than in 1987, output had contracted by 19 percent, and real wages had collapsedto less than half their 1985 level.
27. By early 1990, economic activity was extremely depressed and investnent even more so. Thepublic sector had virtually abandoned maintenance of its capital stock, the formal financial s- or had shrunk,and real domestic liquidity was down to about one-sixth the level of 1985.
Inflation
28. As shown in Table 1, the annual inflation rate (over the last twelve months) increased steadilyfrom 127 percent in January 1988 to 5,707 in August 1989. Thereafter, it fell to a new range between 2000and 3000 percent per year. The very high inflation of August and September 1990 was due to the strongadjustments that the new Government had to make on the price of public goods and services. Since August1990, one month after the current Administration assumed power, inflation decreased steadily from a peak of12,375 percent to a rate of 139 percent in December 1991.
Annual ftrc_ntAge Rae of Inflation Over the Last Twelve M'onths
January 127 2278 2436 6923February 140 2931 2222 5788March 180 3411 2069 4682April 209 4326 1904 3585May 217 5146 1969 2886June 229 5835 2297 2188July 302 5549 3040 1430August 355 5707 12375 230September 816 3342 11088 206October 1111 2918 9844 191November 1306 2952 8271 185Decenber 1721 2778 7639 139
Source: Consumer Price Index, from BCRP
29. Inflation during the period from 1988-1990 occ- * --d because the ge fiscal deficit was financedby printing money and because income velocity of money i- ased. Succes e controls and decontrol of
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wages and prices led to a considrable variation of the infladon ra and firther discouraged the demand fordomestic financial assets. At the same time, inlton eroded tax revenues because of collection lags and a falin he rel price of goods and serices ta ctibutd an important shae of taxes (e.g., gasoline tax), dtusadding to the fil deficiL
30. Ihese devdopments caused a high degree of dolarLzaion which, reinforced by the long bitoryof control over Interest and exchange rawes, reducd the demand for domestic currency to a ba miunmum.
Also, as the ncom velocity of money Increased, the nflatonary effects of deficit-financing via moneyreaton becam even grea.
31. Figur I shows the deci tread In the real quandty of narrow (MI) and broad (M2) domesdcmoey since 1980.Y The shorterm upward movement of the series reflects the temporary success of the1985487 ecottomic plan The monetary base reached a peak of USS4.3 billion in Novembaer 1987 but byDecember 1991 had dopped to about US$900 million.
Real Stocks of MI and M2(Milions of 1979 Soles)
200 - \
1001 -
1980 1981 1982 1983 1984 1ss 1986 1987 1988 1989 1990 1
- Ml -4-- M2
32. Price controls during the 1980s temporarily delayed increases in the price level but could notrepress the foreign exchange market even in the shortest-run. A recurrig sequence of events during the1980s was first a fall in the demand for money, followed by a foreign exchange crisis, and then an outburstof inflation. But ttie real culprit was always a weak and deteriorating fiscal front By July 1991, almost oneyear after the initi stabilization shock of the current Admhistraton, inflation was still relatively high at 9percen per month. Thereter it diminished steadily to 7 percent in August, 5.6 percent in September, 4percent in October, 3.9 percent in November, 3.7 percent in December, and 3.5 in January 1992.
ZI M is defincd as cy plus dcmsnd dcpoits. M2 u defind as MI plus savigsand &n dmposits.
8-
Doll1arizafti
33. The 1980s witnessed a slow but steady process of dollarization as the Peruvian currency continuedto weaken. Dollar-denominated deposits doubled, exceeding all domestic-denominated liquidity, which in thisperiod was halved in real terns. The previous Administration attempted to end this process by freezing alldollar deposits and later even tried to nationalize the banking system. The market reaction was to rely evenmore heavily on the dollar than before.
34. The functions of store of value, unit of account, and payment for transactions have beenincreasingly rendered by the dollar, which is held freely among the population. As of December 1991, thehighest denomination of domestic currency was worth US$10. Exchange houses have virtually been displacedby hundreds of unofficial exchange dealers who can be found at every conceivable public place and at anytime of the day or night. Furthermore, dollar deposits in the domestic financil system are estimated to besmall relative to Peruvian deposits held abroad. After the present Administration's stabilization shock, thedollarization process has continued at a slower pace and as of December 1991 it seems to have leveled off.
35. High inflation does not necessarily lead to dollarization. Countries like Brazil, which haveindexed their financial markets, have been able to sustain high inflation rates without experiencing a shifttowards the generalized use of foreign exchange as a substitute for the local currency. But Pem, likeArgentina and Bolivia, had repressed the financial market, the result being a steady process of currencysubstitution.
36. Despite general dollarization, domestic-price inflation remains relevant. For example, wages areset in the domestic currency, and thus unexpected changes in domestic inflation affect employment Also, ifdomestic-price inflation is higher than the devaluation of the exchange rate, the real exchange rate willappreciate. Consequendy, the wage bill of exporters will increase relative to the proceeds from exports,putting increasing strain on their competitive advantage.
EhcUsues
37. Fiscal Deficits. Mounting deficits were accompanied by rising inflation, frequently obscured bythe use of price controls and income policies that delayed required price adjustments and ended up incorrections far greater than needed in the first place. Econometric tests do not reject the hypothesis that, forPeru, there is a significant causal relationship between deficits, actual or expected monetary growth, and theinflation rate. Figure 2 shows the steady deterioration in Peru's fiscal condition:
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Central Government Primary Deficit(Billions of US Dollars)
12eflciv2 W
~~~~oJ
0.4t-0.6~~~~~1
MZ 44"at 11: ;:4t XoaB
38. Tax Revenues. Table 2 shows the structure of tax revenues as a percentage of GDP. Thedecline in tax revenues began in 1981 and accelerated after 1986, so that by the middle of 1990 total taxrevenues were very small and most public sector prices and tariffs were approaching zero in real terms.Most noteworthy was the decline in income taxes, both personal and business; which diminished from 4.4percent of GDP in 1980 to only 0.49 in 1990, and in import tariff revenues, which went from a peak of3.03 percent of GDP in 1981 to a low of 0.79 in 1990. Tariff revenues from increased imports in 1991and beyond ue expected to steadily increase, surpassing previous levels, notwithstanding the low importduties established by the recent trade liberalization.
Table 2 4'Centru Administration Tax Revenues as a Perce of GDP
1960 1981 19862 193 194 .1985 1986 1967 1988 1909 1990S 91J 01.1d U1 19926
Totd 15.70 13.00 12.90 10.70 11.50 13.30 11.20 8.33 6.60 5.24 7.47 7.23 6.88 6.94 9.20
hoome 4.40 2.25 2.13 1.39 1.36 1.40 2.67 1.75 1.35 0.92 0.49 .77 o.7 0.53 0.90Payroll 0.57 0.61 0.63 0.67 0.71 0.46 0.03 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Walth 0.55 O.S8 0.55 0.43 0.41 0.36 0.67 0.40 0.52 0.24 0.64 0.44 0.58 0.50 0.70mnpoer 2.55 3.03 2.73 2.27 2.58 3.01 2.40 1.88 1.25 0.92 0.79 0.68 0.66 0.75 1.10EImpots 2.05 1.09 0.68 0.31 0.12 0.31 0.18 0.00 0.07 0.08 0.05 0.02 0.00 0.00 0.01Prod & 6.31 5.93 6.72 8.16 6.55 8.32 5.82 4.70 4.51 2.90 4.28 4.85 4.51 4.65 5.70Con.VAT 4.88 4.35 4.41 3.58 2.99 2.57 1.43 1.07 1.08 1.49 1.26 NIA HIA N/A 2.00Ebals. 1.63 1.58 2.32 2.57 3.55 5.75 4.39 3.63 2.54 1.41 3.02 N/A NWA NIA 3.70
Fuds NIA N/A N/A N/A N/A N/A N/A N/A 0.97 0.49 1.99 N/A MIA N/A 2.10Rst N/A N/A N/A NIA N/A NIA N/A N/A 1.57 0.93 1.02 N/A N/A N/A 1.60
cohew 0.60 0.47 0.48 0.38 0.78 0.59 0.33 0.27 0.64 0.75 1.68 0.93 0.57 0.62 0.79A4ust *1.40 *0.90 -1.00 *0.90 -1.00 *1.10 40.80 40.70 4.0.0 40.70 0.50 *0.46 40.21 40.11 NA
* ProjeateN/A - Not Avaiable
-10.
39. Table 3 shows that, in countries at a similar stage of development (i.e., per-capita incomearound USS1,200), the average ratio of tax revenues to GDP is 17%. Peru's ability to reverse the seculardecline in tax revenues lies at the heart of the restoration of the fiscal balance. Such reversal is also vitalin order to guarantee the Government's ability to provide basic services in the long-run.
Table 3Peru's Tax Revenue Ratios CoMnared to a Sample of Countries
Countrygroup #Peru
Taxes(percent (year and percent of GDP)
_____ _____ ____ _____ _____ ____ of GDP) _ _ _ _ _ _ _
Taxes on: 1980 1991*
Income 5.8 4.40 1.95 0.53
Wealth and Property 0.5 0.5 0.52 0.50
Domestic Goods and Services 4.7 6.31 4.51 4.65- Value Added 2.8 4.68 1.98 NA- Excise 1.9 1.63 2.54 NA
Foreign Trade 5.3 4.60 1.32 0.75
Other 0.7 0.60 0.64 0.62
TOTAL 17.0 15.70 8.50 6.94
= third quarter of 1991# = countries with per capita income of US$1,200N/A = Not availableSources: Tanzi, V. 1987. "Quantitative Characteristics of the Tax Systems of Developing Countries." In
David Newbery and Nicholas Stern, eds., The Theory of Taxiaon for Developing Countries. NewYork: Oxford University Press.Ministry of Economy and Finance, Peru, 1991.
40. An eloquent testimony of the weakness of Peru's tax system is that over the period 197689no revenue from any tax increased pari-passu with income. As a result, the overall buoyanc of taxrevenues in the corresponding period was as low as 0.91, compared, for example, to 1.69 for Paraguay. Infact, over this period the VAT and the export taxes display a very significant negative annual trend
a1 Buoyancy is definod as the rdauive uise in tax revenues asscie with a I peent incrs in income.
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growth rate: -12% for the former and -31% for the latter. While less reliance on trade taxes is salutary,the persistent decline of VAT revenues is a serious matter of concern.
41. Column A of Table 4 shows that VAT revenues as a percentage of GDP in Peru were lowerthan all the Latin American countries included in the sample, with the excepdon of Panama. However,the VAT rate in Panama was three times lower than that of Peru. In fact, after adjusting for differencesin VAT rates across the countries included in the sample, Peru was ranked last and by a wide margin (thelast column of Table 4).
Table 4Comparing VAT Revenues and Rates in Latin America
Country 1989 Per capita Year VAT VAT (A)/(B)GNP Revenue Standard
(% of GDP) Rate(US$)
__ __ __ _ __ _ __ _ __ __ _ (A) (B) (% )Peru 1010 1990 1.26 16 7.9
Ecuador 1020 1988 2.66 6 44.3Bolivia 1099 1989 2.70 10 27.0Colombia 1200 1987 2.83 10 28.3Panama 1760 1988 1.08 5 21.6Chile 1770 1988 8.21 16 51.3Costa Rica 1780 1988 3.69 8 46.1Mexico 2010 1988 3.51 15 23.4Argentina 2160 1986 3.10 18 17.2Brazil 2540 1988 2.70 17 15.9Uruguay 2620 1988 6.98 21 33.2
Source: World Bank (1991), Bolivia: From Stabilization to Sustained GrowthWorld Bank (1989), Mexico: Trade Reform for Efficient Growth
42. The decline in VAT revenues prior to the period of high inflation indicates that ifationerosion is not the only culprit. Tax incentives have also affected VAT revenues. In 1989, the foregonetax revenues from these incentives reached 2% of GDP compared to actual collection of 1.5% of GDP.It should be noted, however, that it is tax evasion and avoidance that account for most of the gapbetween potential and actual revenues. For this reason, the temptation to rely on additional tax increasesto meet revenue requirements should be resisted. Furthermore, empirical evidence strongly suggests thatthe supply-side arguments about indirect taxes hold in Peru. The conjunction of all these factors proves
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that the answer, which the government is currently addressing, lies in strengthening enforcement,eliminating tax incentives, and reducing collection lags.
43. SUNAT, the new tax collection agency, was created in 1989 to arrest the steady decline in taxrevenues. It inherited a large number of employees without proper training and qualifications, anabsence of computing facilities, and inadequate controls and tax- auditing procedures. SUNAT'sperformance, though still inadequate, is improving steadily.
B. Tlhe Economic Reforms of the Current Administration
44. In August 1990, shortly after assuming office, the current Administration launched a sweepingstabilization cun structural reform program with bold steps towards achieving macroeconomicstabilization and rebuilding ties with the international financial community. The main components of theprogram, whose results so far have been impressive, were:
(a) Tight controls over public sector wages and salaries, a 3,000 percent increase in fuel prices,and a 1,000 percent increase in the price of electricity, water, and telephone services.
(b) The elimination of numerous exemptions in import tariffs and sales taxes, and the introductionof a temporary tax of 10 percent on exports and I percent on net wealth and insured assets.
(c) The introduction of a casb management committee to manage the finances of the CentralGovernment on a cash basis only (without recourse to Central Bank credit).
(d) The unification of exchange rates and the establishment of full convertibility in all current-and most capital-account transactions, with a managed floating exchange-rate system.
(e) A tight domestic credit policy.
(f) A significant reduction in price controls, including the de facto elimination of ceilings oninterest rates.
These measures aimed at eliminating the main source of hyperinflation: the monetary financing of thefiscal deficit.
45. Further Fiscal Reforms. Following these measures, the Govenment took a number of steps,most of them in March 1991, to reform the tax system:
(a) Numerous taxes were eliminated and a new system based on five types of taxes wasintroduced: on income of individuals and corporations, on wealth of firms and individuals, onvalue-added, on selective consumption, and on imports.
(b) The income tax rate on firms was reduced from 35 to 30 percent and exemptions wereredu.-d. The tax on net wealth of corporations was unified at 2 percent and all exemptionseliminated. Both taxes will incorporate a system for adjustment to inflation beginning in fisclyear 1992. The personal income tax rate was reduced from 45 to 37 percent, and a 1 percent
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tax levied on the inflation-adjusted value of a list of assets replaced the previous tax on anindividual's net wealth. Selective consumption tax rates - excluding gasoline taxes - werereduced to three, with a maximum of 50 percent.
(c) The emergency tax on insured assets, the 10 percent subsidy on nontraditional exports, andthe 10 percent tax on exports (except for minerals) were eliminated. Howvever, the emergencytax on checks and the excise tax on interest are being maintained until there are enough taxrevenues to permit their elimination.
46. Although the lowering of the average import tariff rate, on its own, would be expected toreduce revenues, the elimination of many preferential regimes would counteract this. The elimination ofexport subsidies has stopped a drain on the budget. Due to loopholes in customs procedures and taxevasion, import duties collected in 1989 were 13 percent of import values, and fell to 9 percent by mid-1990. Preliminary estimates suggest that the figure will rise to about 15 percent in 1991 because of bettercustoms administration and the removal of prohibitive tariffs. The share of net revenues from trade taxes(import and export tax collections JI export subsidies) in total Central Government revenues rose fromaround 11 percent in both 1989 and 1990 to 14 percent in the first six months of 1991.
47. Tax L minisation. The reorganization of SUNAT has been officially underway since March1991. The decree which created SUNAT gave it the authority to weed out unqualified employees andhire the best it could attract. It has now been permitted to increase its salary scalesf and its budget wasincreased to 2 percent of total tax revenues. Until recently it could not acquire even basic equipment. Itshares computing facilities with the Ministry of Economy and Finance, and some of its regional offices arewithout office equipment and furniture.
48. The institutional setup for tax collection has too many lags. The Banco de la Nacion acts asthe ultimate revenue collector for the Government, gathering taxpayers' deposits from private banks. Buttax collection procedures are difficult to control when the Banco de la Nacion delays in providing taxcompliance information to SUNAT. It is premature to speculate about the impact of reform on theactual collection of taxes, although the transformation of SUNArs administration to a smooth, efficientoperation will be facilitated by the design of a simple and easy-to-manage tax system and its subsequentimplementation. Consequendy, to improve tax administration, the IMF has set up a progtam of technicalassistance to overhaul the entire system of coverage and control.
49. Gavernment Expenditures. Strict control of the Central Government's cash flow was essentialto reduce monetary financing of the deficit and, consequently, the rate of inflation. However, a cashbudget does not guarantee a sustainable level of government spending, nor does it allow for any'budgetary policy" because payments are not based on budgetary appropriations but on available cash.The most important issue is the implemnentation of measures that ensure an inportant and permanentincrease in revenues to match the Government's minimum expenditures.
SO. Some public sector expenditures not under complete control of the Central Government cangenerate quasi-fiscal deficits, e.g.,the Central Bank's payment of interest on required reserves, its newdebt operations, and its purchases of foreign exchange. The IMF program placed a minimum target for
I/ Current monthly wages avcrage $50 for regular employees and S250 for supervisors.
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the increase in Net Inteniational Reserves (NIR) and a maximum target for the increase in Net DomesticAssets (NDA). This program also provided that any excess above the NIR minimum increment should becomplemented with a reduction In the program's ceiling for Net Domestic Assets so as to dampen themonetary effect of foreign exchange occumulation.
51. Currently, public sector projects are not subject to economic evaluation. The Governmentintends to change this by requiring that the agency initiating the investment evaluate the project and theMinistry of Economy and Finance rank the project according to economic criteria. This procedure willguarantee more economic efficiency in project planning. Similar economic project evaluation procedureshave been conducted with reasonable success in Chile, and are now implemented in Argentina.
52. Since August 1990, public sector wages have been under strict control. Wage indexation inpublic enterprises has been elimiated and wage increases now require Central Government approval. Inthe first four months of 1991, 50,000 civil servants resigned under a program that offered incentives forvoluntary resignations.
53. Deregulation. The Government has begun a process of drastic deregulation and extensiveprivatization, and, in this context, the Bank will prepare a privatization adjustment loan to set theframework for a small, but efficient, public administration. Since March 1991, sweeping measures haveeliminated regulations that limited the development of various sectors of the economy. In the fields ofhealth and agriculture, registration of firms and other procedures have been simplified with respect toimport and export activities. Administrative and legal restrictions that impeded domestic-market access toother than national shipping firms have been eliminated. Also, domestic firms are now allowed freeraccess to maritime loading or unloading activities for merchant ships.
54. The Government announced a program which would foster immigration by foreigners whowould bring in funds for investrnent. The Tariff and Transport Regulatory Commission was abolished,thus eliminating controls over tariff policy in transportation and price-setting for interregional publictransport systems. Restrictions and procedures impeding the development of civil aviation wereeliminated, facilitating the participation of private capital, national or foreign, in air transport activities.Water transport routes were opened to national traffic, and legal and administrative restrictionsprohibiting such traffic were eliminated.
55. All monopolistic and restrictive practices were eliminated to foster free competitionthroughout the economy. The steps for approval of contracting foreign workers were simplified, publicbidding procedures were modifted to allow for freer competition, and constraints that imitaed the work ofprofessionals were eliminated. Stipulations for official translating activities were eliminated, andadministrative procedures of local governments for the development of economic activities weresimplified.
56. Further Structural Reforms. During the second stage of policy reform launched in March1991, the Govermnent also announced several unprecedented measures aimed at promoting domestic andexternal competitiveness and deregulation of economic activity:
(a) Monopolies and deregulation. Monopoly rights of 12 public firms (grain marketing, import,of fertilizers, gold trading, reinsurance, etc.) were abolished.
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(b) EInnnailneI. A new banking law strengthened prudential regulations by redefining thecapital requirements and credit concentration ratios of banks, promoting universal banking,and opening commercial banking to foreign investnent. In addition, insurance was partiallyderegulated by freeing premiums and abolishing some government monopolies.
(c) Lar mikt. The rigid labor stability laws were amended to broaden provisions for layoffsand to establish a better system for the financial management of funds within the ForcedSavings Scheme for Worker Retirement (CTS).
(d) Pot The Controlling Commission of Maritime Labor, which monopolized mostloading/unloading activities, was abolished and the cost of these services was substantiallyreduced.
(e) Foreign investment. Foreign investors were permitted to repatriate all net profits androyalties. Foreign investment can now enter under any corporate form or joint venture, andinvestors are allowed to purchase stock from residents and to invest in any sector excepttelevision and radio.
(f) EPdatizatin. The Govermment announced an extensive privatization program in all sectors ofthe economy and designated the first batch of companies to be privatized. It is now workingon a strategy to privatize public enterprises in mining, fishing, oil and gas, power,telecommunications, banking, and transport.
(g) Land refbQr. Land property rights have been broadened and strengthened. Corporations(including agrarian cooperatives) can now legally become private estates. Moreover, land isnow freely transferable and can be used as collateral.
57. Tne Social Emergency Program. In August 1990, the Government also launched the SocialEnergency Program (SEP) to provide direct food and health assistance to the poor - principally throughNGOs. However, fiscal problems, a weak institutional framework, and changes in leadership within theSocial Emergency Program contributed to the failure to mobilize external support and sustain domesticfinancing for the SEP. From August to December 1990, the program disbursed only US$67.7 million, farbelow its original target.
C. The 1991-1992 Macroeconomic Stabilization Program
58. To consolidate the process of economic stabilization, the Government has agreed to a RightsAccumulation Program (RAP) with the IMF that identifies several targets for macroeconomicperformance between July 1991-December 1992. The program envisages an increase in fiscal revenues ofroughly 2 percent of GDP from 1991 to 1992 as a result of better tax administration, a higher VAT rateof 16 percent (up from 14 percent), and simplification of the tax regime. Privatization could also providesome fiscal relief but the Government acknowledges this to be temporary. Also, a tight monetary policywould dictate that any increase in the money supply would be from sources other than the deficit of theCentral Government. The program expects to reduce inflation to low levels by the end of 1992. Table 5summarizes the main fiscal indicators:
Table 5Eiscal Accounts
(Percentage of GDP)
I2L_ -M 12 2
NFPS Primary Balance -5.1 -5.4 -5.1 -1.0 0.4 -0.6Interest Accrued -2.8 -3.8 -2.8 -4.4 -3.5 -3.6NFPS TOTAL BALANCE -7.9 -9.2 -7.9 -5.4 -3.1 -4.1
Quasi-Fiscal Balance -5.4 -6.1 -2.8 -1.1 -0.5 -0.3CPS TOTAL BALANCE -13.3 -15.3 -1Q0 f A4.4
FinancingExternal 2.4 4.3 2.9 3.2 3.1 4.4(Interest Arrears) 11.7) (3.1) (2.5) (3.3) (0.0) (0.0)Intemal 10.8 11.0 7.8 3.3 0.5 0.0
TOTAL FINANCING 15.3 10.7 fi a6 4.4
= ProjectedNFPS: - Non-financial public sector;CPS: - Consolidated public sector.
Source: IMF Staff Report for the Article IV Consultation, August 21, 1991, and revision,November 1991.
59. Worthy of note is the reduction in the quasi-fiscal deficit from a peak of 6.1 percent of GDPin 1988 to 0.5 percent in 1991 and the projected decline to 0.3 percent of GDP in 1992. Furthermore,this and the NFPS deficit will be financed ondy by external resources.
60. The program also calls for substantial fiscal improvements. While the primary balance of theNFPS showed deficits higher than 5 percent of GDP during 1987-89, it improved to a 1 percent deficit in1990 (the first year of the current Administration) and to a 0.4 percent surplus during 1991. However,this balance is expected to show a deficit of 0.6 percent of GDP in 1992 because of planned expendituresin basic areas, including the social sector. These expenditures will be possible thanks to contributionsfrom the Support Group and consequently will be financed entirely with foreign funds.
D. Risks and Assessmwnt of the Stabilization Program
61. Peru's stabilization program faces four threats: (a) the fiscai situation could remain precarious;(b) a continuing dollarization process could push up money velocity and fuel inflation; (c) marketperceptions of the continuing overvaluation of the domestic currency could increase political pressures forthe reintroduction of capital controls or for excessive (inflationary) purchases of foreign exchange; and(d) a growth in terrorist activities could undermine business confidence and support for the Government.
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62. The fiscal situation gives cause for the greatest concern. As of December 1991, in spite ofgradual improvement, it remained precarious. To maintain the budget cash balance, suppliers are notfully paid, administrative regions do not receive full fiscal transfers, foreign creditors are kept waiting,salaries of civil servants remain low, net public investment is practically zero, and there is little or nomaintenance of physical infrastructure. This extremely low level of expenditure has created socialtension. Fiscal adjustment is crucial for the sustainability of the stabilization program. The Governmentexpects revenues for 1992 to increase by 2 percent of GDP relative to 1991, bringing tax collections to atotal of 9.2 percent of GDP. This target is reasonable, given that inflation for 1992 is expected to below; in 1985, by comparison, when annual inflation was 160 percent, tax collections were 13.3 percent ofGDP.
63. The process of dollarization continues, reducing the demand for domestic currency andmaking it increasingly difficult for the Government to collect the inflation tax. The experience of LatinAmerican countries that have recently undergone a high degree of dollarization is that successivestabilization efforts were unable to return domestic cash balances to the pre-stabilization level, even whena lower inflation path was realized. The elimination of all foreign exchange controls In Peru appears tohave facilitated the dollarization process, expanding the dollar's traditional store-of-value function toinclude those of unit of account and medium of exchange.y If dollarization continues, it couldcomplicate the stabilization process; but it should not derail it as long as the fiscal accounts achieve asustainable equilibrium and the money supply grows within its targets.
64. The Government has been concerned about the significant real apurecation of the domesticcurrency in 1991V and in response to this concern has permitted the purchase of foreign reserves by theCentral Bank.2' The indicators are that, as interent rates declined by the end of 1991, capital inflowshave slowed and the real exchange rate has started to depreciate.
65. To sum up the stabilization effort, Peru's orthodox shock treatment succeeded in bringinghyperinflation to an abrupt halt. Monthly inflation fell from 63 percent in July 1990 to 6 percent inNovember 1990 after reaching a historic high of 397 percent in August 1990 (Table 1.6 in Annex 1), themonth in which the public price and tariff adjustments were made. By December 1991, inflation was 3.7percent and steadily falling.
I/ Real domestic cash balances (currency plus demand deposits, deflated by the Consumer Price Index) fell by 36 percentbetween July 1990 and July 1991, in spite of the substantial reduction in inflation that took place. (CPI inflation was at smonthly rate of 45 percent in the three nwths May-July 1990, as compared with only 8.7 for the same months in 1991).Nevertheess, by the fourth quarter of 1991, the fall in the real demand for the domestic currency seems to have leveled off.
fi According to the available measures, the curmcy has been appreciating steadily since 1988. The rate at the begi_nof 1991 was one-quarter its 1988 level. The reasons for the long-term appreciation in the real exchange rate are not obvious;they are attributed by some to the rise of Peru's coca economy (now, by some estimates, equivalent to at least one-third ofofficial exports).
2/ Increased purchases of foreign reserves by the Central Bank increased net reserves by US$277 million during May-August1991, equivalent to 45 percent of the dollar value of Ml as of May, 1991 when the purchases started. In spite of thesignificant purchases of foreign exchange by the Central Bank, the purchasing power of the dollar in terms of domestic goods(meured by the CPI) fell by 25 percent during the same period.
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66. le tizd economic ctcle. By August 1991, the rate of growth of the monetary baseexplained about 75 percent of the inflation experienced since October 1990, the rest being due to thepersistent dollarization of the economy which increased the income velocity of money. The rate ofgrowth of the monetary base was highly variable but monetary policy was generally tight in the sense thatthe monetary base grew at a lower rate than prices.
67. The following sequence describes Peru's experience of cyclical fluctuations as of August 1991.Tight monetary policy increases interest rates on dollar and domestic currency flnancial assets. Theserates attract capital inflows, which in turn cause an appreciation of the real exchange rate. ITe CentalBank reacts by speeding up money supply creation through increased foreign exchange purchases, andthis in turn creates inflation.
68. Meanwhile, inflation reduces the real level of prices that are under Government control(gasoline, for example) and are designed to include a large tax elemert; fiscal revenues therefore decline.Worried about falling revenues, the Government then permits a large and immediate rise in public-sectorprices, which then causes a one-time rise in the price level. This kind of adjustment should have nopermanent inflationary effect. The Central Bank, concerned about the surge in prices, tries tocompensate by turning to a much tighter monetary policy (which involves buying less foreign exchange),thereby further increasing interest rates and capital inflows. As these inflows appreciates the Peruviancurrency, the Central Bank loosens its grip, increasing the rate of growth of the money supply bypurchasing foreign exchange. This completes the inflationary cycle. The cycle has led to a highly volatilemonetary policy which, particularly until August 1991, increased uncertainty in an already uncertainenvironment.
69. ?n sum, Peru's Central Bank has been concerned with the same issues that concer mostCentral Banks: inflation, foreign-exchange reserves, interest rates, unemployment, and the exchange rate.But Peru has been experiencing high inflation in an extremely demonetized economy, leaving theGoverment little room for mistakes from inconsistent policy objectives. Consequently, these objectives,or shifts - -ing them, are another source of monetary volatility contributing to uncertinty. Coupled withcontinuir. llarizatior -'d a weak scal situation, they help explain the current fragpile macoomicsituation. iien a floa: exchan4 ite, the Central Bank should target only the rate of growth of themonetary base to provi.. a stable ani predictable monetary framework. This indeed seems to be thepolicy that the Government has followed since August 1991. In addition, an efficient fiscal fraenworkwould be an indispensable complement for lasting stabilization.
L Monitoring the Stabilization Program
70. The uncertainty related to the precarious tax base, the process of dollarization, and theappreciation of the real exchange rate makes it difficult to forecast the evolution of economic variables.TIerefore the Bank will .ssess the progress of the stabilization program with particular reference to a setof broad relevant indicators which are consistent with the IMF program. For 1992, we shall use thefollowing set of indicators, with their corresponding values, to evaluate the economy's macroeconomicperformance:
(a) 'entral Governmnent current tax revenues: about 9 Jercent of GDP;
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(b) Pimary deficit of the non-financial public sector (NFPS): no larger thaM 0.6 percent of GDP.and no domestic financing of the NFPS total balance;
(c) Rate of creation of monetary base (December 1991 to December 1992): Ipto 40 percent;
(d) Stock of other Central Bank monetary liabilities in the domestic currency: up to 0.1 times thmone1trybas.
Within these broad indicators, the Bank will pay particular attention to measures of fiscal revenueenhancement and expenditure control which will contribute to efficiency, equity, and the sustainability ofadjustmet in the medium-term. In monitoring the macroeconomic program, the Bank will consultregulary with the IMF.
F. The Agenda for Structural Reform
71. The structural reforms that Peru began in 1990 and 1991 are but the beginning of a long anddifficult path. The institutions of public management have to be rebuilt and public confidence ingovernment restored. This must happen against an alarming backdrop of poverty, a cholera epidemic,and the security problems that have fed on the country's economic collapse. The Government has begunan ambitious program to modernize the economy through policies to make it more efficient andcompetitive: the liberalization of trade and agricultural, labor, and financial markets will continue; theGovernment is determined to provide public goods - health, education, justice, and so on - moreefficiently; and a wide-ranging privatization process has been launched.
72. Through its program of adjustment lending in FY92, the Bank will be working with theGovernment in support of its agenda for structural reform. In addition to the structural reforms to besupported in this project and the reforms of the preceding trade policy reform loan, a subsequentfinancial sector adjustment loan would support a variety of other reforms (paragraph 11). This programof adjustment lending will also contribute to stabilization objectives. Three components of the SAL -supporting the non-inflationary financing of public expenditure, reform of tax administration, and areduction in public employment - have a direct and obvious impact. But other components of thelending program will support policy reforms with more indirect effects:
(a) If the prospects for structural reforms and for more efficient government are credible, peopleare more likely to pay their taxes. Thus structural reforms indirectly increase fiscal revenues.
(b) The immediate fiscal contribution of privatization is to provide a usefil, but only temporary,boost to revenues. Privatization's longer-term effect is to increase efficiency, eliminate therecurring fiscal burden of state-owned enterprises, and create a new tax base.
(c) The net impact of lower import duties combined with the elimination of many preferentialregimes is expected to lead to higher fiscal revenues, a trend which has been apparent sincethe second quarter of 1991.
(d) New labor laws will increase labor mobility and thus facilitate the adjustment of inputsresulting from changes in relative prices caused by the trade and other reforms.
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(e) The new batiking law, by strengthening prudential regulation and providing for partial depositinsurance, wIll help the banking system withstand the recessionary effects of the stabilization.
G. keMediunm-TeIlQOgt"tk
73. Six major policy areas are likely to play an important role in determining the medium-termoutlook of the economy: (i) trade and financial sector reform, (ii) fiscal adjusttnent, (iii) restoration ofexternal debt service, (iv) privatization, (v) increased reliance on market allocation mechanisms, and (vi)currency convertibility and financial openness. GDP growth is expected to be at 2.5 percent for 1992 asthe economy still needs tight monetary policy (required to end inflation), the hardening of the fiscalbudget, and the structural changes in relative prices. GDP is expected to start recovering in 1993 and itsgrowth rate to rise gradually to a sustainable level of 4.5 percent by the end of the decade (Table 1.4 ofAnnex 1).
74. A successful trade reform will increase the participation of exports and imports in GDP, oncethe short-run disturbances associated with the end of the hyperinflation are washed out. We expectexports and imports of goods and non-factor services to gradually increase their share of GDP from 11percent in 1990 to 17-18 percent by 1999, with exports rising slightly faster than imports, resulting in theenergence of a positive balance in the trade account towards the end of the decade (Table 1.4 of Annex1).
75. Two forces operate on the current account: the fiscal adjustment should operate towardsimproving the current account while foreign debt service would tend to generate a deficit. The mostlikely scenario assumes the current account balance to remain in deficit during the decade, although itwill be reduced from the high level of 5.2 percent reached in 1991 to below 4 percent by 1999 andthereafter (Table 1.4 of Annex 1).
76. The simultaneous achievement of GDP growth and current account improvements depends ona sustained fiscal adjustment and an increase in private savings that would bring domestic savings up to 26percent of GDP by 1999 (compared with 19 percent in 1991), a level consistent with an investment ratioof 20.9 percent and a trade surplus of 0.4 percent of GDP (Table 1.4 of Annex 1). The increased savingsshould be sustained by the positive interest rates allowed by the financial liberalization begun in mid-1990.
Hi. EXTERNAL FINANCING
A. The External Debt Problem
77. Peru's arrears grew rapidly from 1983, when Peru adopted a best-effort-to-pay practice on itsforeign debt. Then, in July 1985, the Government announced that total foreign debt payments would becapped at 10 percent of exports. Not until 1988, however, did actual debt service fall to the 10 percentlimit. Initially only payments from public creditors to private foreign banks were targeted, but in 1987Peru extended the moratorium to the IFIs and also banned external debt-service payments by privatedebtors. In August 1986, Peru was declared ineligible for IMF lending and was placed on *non-accrualstatus by the World Bank one year later. In early 1989, the I1DB also took this last step. Threatenedwith expulsion, the Government resumed current debt-servicing to the IMF at the end of August 1989.
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78. The current Government took prompt steps to rebuild Peru's ties with the internationalflnancial community by resuming current debt service payments to the Bank and the IDB: followingdiscussions with the Bank, payments to cover current obligations were resumed in mid-October 1990, andto the IDB one month later, thus "freezing the stock of arrears with these two institutions. Payments tothe IWUs average about US$41 million per month, equivalent to about 14 percent of the CentralGovernment's total fiscal revenues. Interruptions in the payment of current obligations to the Bank andthe IDB, but not the IMF, recurred in March 1991. By mid-September 1991 current debt service hadbeen resumed to both of these institutions, and all arrears accumulated since mid-October 1990 paid.
79. Peru now faces an unprecedented overhang of external debt and arrears. At the end of 1990,it had almost US$22 billion of external debt, with about one-third owed to private creditors, one-third toParis-Club members, 10 percent to other official bilateral creditors, and 18 percent to IFls (see Table 1.5in Annex 1). Almost two-thirds of this was in arrears; arrears to the IFis alone totaled US$2.2 billion.The secondary-market discount on commercial-bank claims on Peru is over 90 percent (down from 95percent at the time the new Government took office).
B. The External Financing Plan for 1991 and 1992
80. Peru's external financing requirements for 1991 and 1992 could total US$20.7 billion (Table6). Taking account of disbursements already in the pipeline and private capital flows, external financingrequirements are reduced to US$18.8 billion. Most of the requirements are for the financing of arrears;the rest is for public-sector debt-servicing, achieving a targeted level of reserves, and supporting the non-nterest current-account deficit.
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Table 6 : External Financing Requirements andPossible Sources of Financing, 1991 nd 1992.
CUSS millions)
1991 1992 1991-1992........................................................... ..........................................................................................
Finanming Requirements.......................
1. Son-Interest Current Aooout Deficit 536 492 1,028
2. Public Seetor Debt Service Obligations : 2,616 2.398 5,014
3. Arrears to be Settled inCurrent Year 12,055 1.800 13,855
4. Change in Gross Reserves 454 303 757
S. Gross Financing Requirements (1C2+3+4) 15.661 46993 20.654
6. Pipeline Loan Disbursements 255 200 455
7. Private Capital Plows 90B 545 1,453
8. Increae in Arrears 0 0 0
9. Othetr Liabilities and Adjust. 0 0 0
10. Financing ReQuiriewnts(C56-7-8-9) 14.498 4.248 18.746
Sources of Financing.....................
11. Debt Rescheduling snd Deferral 13,598 1,467 15,065Bilateral 6.352 769 7,121Private 7.246 68 7.944
12. Additionat Disburseaments 900 2.?81 3,681Multilateral 6S4 2,328 2.982ailateral a- 246 453 699
13. dditional Financing Required (0) 0 0
14. Total Sources of Financing 14,498 4,248 18,746(11+12+13) a a -
.....................................................................................................
aj Additional disbursements of budgetary/ balance of payents from Support Grotq embers.
Source : Anex 1, Table 1.2
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81. To helpocover these financing requirements, the donor community has developed a coordinatedplan to help reintegrate Peru into the international financial community. Rescheduling and deferral of debt toofficial bilateral creditors, and a continued moratorium on debt servicing to private creditors, are expected tocover most financing requirements. Peru is not expected to receive any type of debt forgiveness in 1992.The balance is expected to be provided by disbursements from the three IFls, the Latin American ReserveFund, and bilateral donors, coordinated through a 'Support Group.'
82. Debt rescheduline and deferral. Rescheduling negotiations have already been successfillycompleted with the Paris Club of creditors, but negotiations are still underway with Peru's other bilateralcreditors, notably some Latin American and Eastern European countries. The financing plan incorporatesthe agreement reached at the Paris Club, and assumes that Peru will be able to secure similar terms from itsother official bilateral creditors. It also assumes Peru will be unable to service debts to private creditorsduring 1991-92; these debts will therefore be rescheduled.
83. Paris Club Rescheduling. Peru rescheduled part of its obligations to the Paris Club of creditorson September 17, 1991. The Paris Club awarded the Government exceptional treatment in the form ofunprecedented cashflow relief between October 1, 1991 and December 31, 1992 (the consolidation period).All current maturities due during the consolidation period on debt contracted before the 1983 Paris Clubrescheduling (pre-cutoff debt) and all arrears on pre-cutoff debt were rescheduled on terms reserved forheavily indebted lower middle income countries. All moratorium interest (interest due during theconsolidation period on rescheduled debt) and all arrears on post-cutoff debt were deferred, the lattercontingent on continued performance under the IMF's RAP. (See the notes to Tables 1.1. to 1.4, in Annex1, for more detail on the terms of the Paris-Club rescheduling).
84. Other Official Bilateral Reschedulings. Peru is seeking debt rescheduling from other bilateralcreditors on comparable terms to that received from the Paris Club of creditors, including the reprogramof debt-for-export agreements with Eastern European creditors and the restructuring of medium-termobligations to Latin American creditors that are currently being serviced through the ALADI paymentsmechanism.
85. Existing Medium- and Long-term Debt to Commercial Banks and Unguaranteed Suppliers.Although Peru will be unable to service debts to private creditors during 1991 and 1992, the Government willcontinue discussions with these creditors. Unless an agreement can be concluded without cash payments, thearrears on these debts will continue to grow during this period. Following law suits brought by thecommercial banks in 1989-90, the new Government has negotiated an understanding with them under which itrenounced recourse to statute-of-limitations provisions in return for a suspension of the default proceedingsthat were initiated in February 1990.
86. Existing Short-Term Private Debt. Peru will continue to service short-term trade credits. Ihesuspension, since 1983, of amortization of short-term working-capital loans will continue. In addition,arrears that have emerged in recent years on interest payments on working capital owed by some public-sectorentities are likely to persist.
I/ The World Bank and the IMF would only disburse following clearance of Peru's ears to both institutions, expectedin December 1992.
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87. New disbrsmet. The three MIs and bilateral donors are committed to helping Peru securevitally needed exteral financing. However, their financial assistance is conditional on Peru's program ofstabilization and economic reforms remaining in place. For the financing plan to be successful, Peru mustabide by the conditions of the IMF's RAP and the Bank's conditions for lending to a country with protractedarears during a speciftad period of time, expected to end in December 1992. As long as Peru adheres to the.economic reforms in these programs until the end of the performance period, the Bank and the IMF will be ina position to disburse to Peru upon clearance of arrears to both institudons. In order to clear Peru's arrears,a bridge loan, presumably from bilateral donors, will need to be secured at the end of the performanceperiod. Economic discipline throughout the performance period is also essential to ensure continued lendingby the IDB, and the release of funds pledged by a support group of bilateral creditors.
88. eIntrnat Fund. In January 1991, the IMF management reached an agreement-in-principle with the Government of Peru on an economic program for 1991-92 intended to form the basis fora request for a two-year Rights Accumulation Program (RAP). On September 12, 1991, the IMF Board,satisfied that Peru's external financing requirements could be met, and that Peru would maintain its paymentson current obligations to the IFIs, approved the RAP. Under the program, if Peru abides by IMFperformance criteria, and continues to service current debt to all three IFIs, it would accrue rights to futuredisbursements equivalent to 188 percent of its quota, or SDR624 million, equivalent to Peru's current arrearsto the IMF. Rights would be disbursed once arrears to the IMP are cleared.
89. Ihe World Bank. On May 2, 1991, the World Bank adopted a new "debt workout" policy,analogous to the IMF's RAP (see paragraph 3). Under this program, three adjustment operations (expectedto total around US$900 million) would be presented to the Board for approval, and disbursements would bereleased upon clearance of arrears to the Bank. On February 4, 1992, the Board approved the trade policyreform loan.
90. The Inter-American Develoment Bank. The three IFis agreed that Peru's arrears to the MDBshould be cleared first as they were smaller than those to the Bank or the IMF. These arrears were clearedon September 13, 1991 with the help of a bridge loan of US$325 million from the Latin American ReserveFund (FLAR).2 With the clearance of its arrears, the IDB has begun to move ahead with a substantialprogram .in support of Peru's rehabilitation. On September 18, 1991 the IDB Board approved a quick-disbursing US$425 million loan for trade reform. In November 1991, it approved a transportationrehabilitation investment loan for US$210 mi!tion and is expected to approve a quick-disbursing US$200million loan for financial sector reform in ea..y 1992. This lending will be followed up with disbursementson new projects in health, agriculture, energy, and water/sanitation, as well as the reactivation of existingenergy projects. Total disbursements in 1991 and 1992 are expected to be about US$839 million.
21 FLAR, an institution of the Andean Pact countries created to deal with balance-of-paymets problems in the regionthrgh the provision of medium-term (up to three-to-four-year) funding, has commited to make available to Peru up to $78million more in financing through the end of 1992.
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91. The S QuprGop. Following several meetings beginning in April 1991, a Support Group, ledby the U.S. and Japan, was officially formed on June 7, 1991 . At the time of approval of the RAP, theIMF estimated that the quick disbursing balance of payments support required from the Support Group wouldbe as much as US$1.3 billion but, following the Paris Club rescheduling, which was more favorable thaninitily expected, and an increase in expected disbursements from the IFIs, additional balance of paymentssupport needed is now estimated at only US$0.7 billion. The Support Group has pledged to provide thisamount, in addition to US$326 million earmarked for project assistance. With the approval of the IMF RAP,which opened the way for the recent Paris Club agreement, bilateral donors have now begun to disburse thesefunds.
C. External Financing Beyond the Performance Period
92. Peru's net external financing requirements would be between $2.6 billion and $3.3 billion a yearbetween 1993 and 1999 (Table 1.2 in Annex 1). These estimates are based on the macroeconomic scenariopresented in Section III of this report. Under this scenario, Peru would sustain non-interest current-accountdeficits through 1996; from 1997 a surplus is projected. In addition, these estimates are based on publicdebt-service obligations of between $2.5 to $4 billion a year, which are drawn from assumptions aboutexpected disbursements. Finally, the estimates depend on assumptions about the volume of private capitalflows, and Peru's ability to increase its reserves. Yearly increases in reserves and positive private capitalflows, including direct investment related to the development of natural resource projects and renewed accessto short-term trade credits, are assumed throughout the period. Because we recognize that many of theseassumptions are based on scant information, we emphasize that this financing scenario is highly tentative andshould be interpreted with caution.
93. If this scenario comes about, significant increases in flows from the IFIs and official bilatealdonors are expected to account for most of the necessary financing. In addition, it is assumed that theGovernment will continue to reschedule private debt service ', and pre-cutoff-date debt service to Paris-Club creditors due throughout the period. No debt reduction is assumed for either official bilateral or privatecreditors. Under these assumptions, a financing gap generally within the range of $200 million to $500million annually would remain. This gap would diminish by the amount of the IMP program that wouldhave to be in place before a further Paris Club rescheduling could take place. If Peru's access to IMFresources were to average around 50 percent of current annual quota a year, the gap could be reduced by upto $200 million a year. Further reductions in the gap could come about if any variables prove to be more
IQ/ Bilateml donors who have pledged through the Support Group are: Belgium, Canada, Ftance, Germany, Italy, Japan,the Netherlands, Spain, Sweden, Switzerland, and the United States.
11/ Given that financing gaps are likely to occur, even assuming a 100 percent rollover every year of commercial bankdebt, it will be difficult for the Government of Peru to enter into an agreement with commercial banks requiring a large cashpayment. However, discussions have begun which may lead to negotiations with the commercial banks as ealy as 1992 anda settlement on at least part of the Government's debt to commercial banks. Indeed, if the actual external financing scenariois more favorable than the one presented here, and the Govemment were able to service or buy back its private debt, theexternal financing gap would reflect the cost of any iesources devoted to such transactions.
12/ The projections assume this financing gap would be met on commercial terms.
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favorable than assumed, for example if Peru were able to secure new flows on more concessional terms thanin the past, if other exceptional treatment, such as debt reduction, were offered, or if faster GDP growth wereto lead to higher government revenues.
94. Debt Servicing Capacity. Peru's current lack of creditworthiness originated with the previousAdministration's unwillingness to service the government's debt. Peru's creditworthiness is expected toimprove following the repayment of its arrears to the World Bank and IMF in December 1992 and the earlierresumption of relations with the IDB and the Paris Club of creditors. The improvement in economicperformance, in the coming decade, from a sustained program of economic reform can be expected tounderpin creditworthiness by improving Peru's capacity to service its external debt.
95. Under the assumed scenario, the ratio of debt service to exports could fal quickly, to 32 percentby 1999 from around 51 percent in 1993. However, the ratios of debt to GDP and interest to GDP, whichbetter reflect the transfer problem, are projected to fall only slightly. Debt reduction would clearly lead to agreater reduction in the debt burden and contribute to the future recovery of Peru's creditworthiness. (SeeTable 1.4 in Annex 1, for a summary of Peru's debt and debt-service indicators).
IV. T GE G(OVERNMENT'S SRUCTURAL ADJUSTMENT PROGRAM
A. Fiscal Policy
Baehru=nd
96. 'he state of Peruvian public finances in June 1990 was chaotic. Fiscal difficulties wereaggravated by a plunge in Central Government revenues due to lags in adjusting public sector prices, theerosion of tax revenues caused by inflation, and increased tax evasion. A substantial quasi-fiscal deficitmerged as a result of the Central Bank's losses from its foreign exchange operations and subsidized lendingto Banco Agrario.
Recent Reffonn
97. The new Administration enforced tight discipline on public sector wages, reduced the number ofpublic employee; bhrough voluntary retirement, and postponed public sector investments. The financialperformance of public enterprises improved as a result of frequent adjustments in the level of public sectorprices and tight controls on wages. Consequently, the deficit of the Non-Financial Public Sector (NPPS)declined dramatically during the first two quarters of 1991 compared with the same period of 1990. ITelevel of the quasi-fiscal deficit declined as a result of a reduction in Central Bank lending to officWdevelopment banks. Real tax revenue increased 22 percent in the first half of 1991 compared with the sameperiod of 1990. Legislative Decree 666 regulating VAT and selective excise taxes was enacted in September1991 and, in October 1991, Supreme Decree 166-91-PCM established the basis for reform of the publicsector, redefining the scope of government activity, and reforming personnel policies and the tenure system.Supreme Decree 267-91-EF (November 21, 1991) was later enacted to interpret the regulations created inLegislative Decree 666 by establishing procedures for their applicason.
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98. The new tax system was simplified and is based on only five types of taxes:(a) a tax on the income of individuals and corporations;(b) a value added tax;(c) a tax on gross assets of firms and individuals;(d) tariffs on imports; and(e) a tax on selective consumption.
99. SUNAT, the tax administration agency, is undergoing a complete reorganization. A budget for itsreform has been provided with up to 2 percent of total tax revenues. Furthermore, the employees' tenuresystem has been eliminated, the number of employees reduced, and a careful selection process of theremaining staff has begun. On November 6, 1991 Supreme Resolution 326-91-EF/SUNAT established a newSUNAT division charged with administrating account closures and with developing sanctioning systems forthe Regional Service Corps. By December 6, 1991, SUNAT increased the number of primary taxpayers to2,200.
An Agenda for Further Reform
100. The Administration is starting a series of reforms of the public sector to redefine the scope ofgovernment activities, establish procedures allowing for the recruitment of skilled personnel for seniorpositions, and the reassignment of personnel throughout the public sector. The public sector labor force isbeing cut back with the use of voluntary retirement incentives.
101. The administration will make frequent adjustments in public sector prices, based on priceinflation. By October 31, 1991, the Government and the Bank wil; jointly review taxes on bank currentaccount debits, taxes on interest, and taxes on exports to access the prospects of phasing them out within aspecific timetable. Changes in the tax code allowing for greater efficiency in the tracking of infringementswill be introduced.
102. A revamped SUNAT will: implement new personnel selection processes which will operate in aprogram without tenure benefits; establish a modern information center which will be developed during thefirst semester of 1992 - the first stage will be the installation of modern computer facilities in the regionwhere primary taxpayers are concentrated; and expand the monitoring of large taxpayers to 2,500 firms bythe last quarter of 1992. This expansion will be crucial in boosting tax collection.
B. Social Sectoirs
103. Peru suffers from chronic poverty, the extent and depth of which have increased significantly overthe past decade. In Lima alone, in 1990, it was estimated that 44 percent of the population was living inpoverty (defined by consumption below the cost of a basic food basket). The available data also confirm thatPeru's child and infant mortality rates (119 and 84 per thousand live births, respectively) are more thandouble and its life expectancy rate (62 years) is ten percent lower than those of neighboring countries(Ecuador, Chile, and Colombia). Half of all children under age six are chronically malnourished. There is asharp disparity in the availability and quality of health, nutrition, and education services within the country.Activities are not well-integrated or targeted to the most vulnerable groups: infants, pregnant and lactatingmothers, and children under six. Although there are substantial contributions to food assistance programs by
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the Central Government and donors (totaling at least US$200 million in 1991), many programs do not reachtheir target groups or lack significant nutritional impact. Although the present Government has madeimpressive progress in restoring macroeconomic stability and establishing a more efficient incentive structureas a base for broad-based growth, it needs to attack Peru's deep-rooted poverty more vigorously and ensurethat the poor benefit from the increased economic opportunities. Such efforts will also increase the likelihoodthat the adjustment program will be sustained.
Recent RC&=
104. hEgty Allevialio. To protect vulnerable groups during the adjustment period, the Governmentlaunched the Social Emergency Program in August 1990. However, this program did not develop asplanned, and disbursements fell short of their original targets (paragraph 57). In a renewed attempt toalleviate poverty during the adjustment period, the Government created the National Fund for SocialCompensation and Development (FONCODES) in August 1991 to finance small labor-intensive projects forthe rehabilitation of the social and economic infrastructure (e.g., health posts, water and sanitation facility,schools, and rural access roads). Activities have begun on a small scale, mainly in the emergency zones inthe Andean region (where the incidence of poverty is high). Through its trade reform loan (which includes acomponent for FONCODES) and a US$4 million technical assistance grant, the IDB is assisting theseoperations and defining emergency programs. With funding from the Japanese Grant Facility, the Bank isalso providing technical assistance to strengthen the institutional capacity of FONCODES. Additional supportis being provided by UNDP.
105. Fiscal austerity will continue to severely limit government resources available for social programsin the medium-term. Furthermore, the Government faces a difficult task in coordinating the work of varioussocial sector institutions and setting priorities for their activities. As a first step in developing a frameworkfor poverty alleviation, the Government, with UNICEF assistance, prepared a Plan of Action for Children inlate 1991, which identifies problems and sets goals in health, education, nutrition, water and sanitation, andemployment. The Government is making this plan more effective by identifying priority projects and targetgroups, and clarifying the responsibilities of the various institutions concerned.
106. Health. Nutrition, and Education. With increased awareness of the need to reach vulnerablegroups more effectively, the social sector ministries recently have introduced several key programs. TheMinistry of Health has made special efforts to increase vaccination coverage (currently reaching 60 percent ofchildren 1 year old and under) and has begun to monitor child growth and promote breast feeding within itsbroad maternal and child health program. It has streamlined the logistics of food assistance by scaling downthe organization and personnel of ONNA, the National Food Assistance Office. It is forming a coordinatinggroup for nutrition programs to improve the effectiveness of food assistance through better linkages to healthand nutrition promotion, increased focus on 'regnant and lactating mothers and infants, and better impactevaluation. The Ministry of Education has introduced an emergency program, 'La Escuela Defiende laVida," which provides primary and pre-primary school children with a daily meal and uses the school as acenter for tuberculosis detection and other health services. In view of fiscal constraints, the Government nowplans to improve and expand these programs with resources from the NGO/private sectors and externadonors.
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An Agda for Furthr Reform
107. The SAL program calls for concerted actions to define and implement a series of social measuresto enable the poor to respond to income-earning opportunities arising from economic growth and to improveliving conditions. Under the program, the Government is committed to:
(a) developing a poverty alleviation strategy;
(b) developing profiles for priority projects in health, nutrition, and education;
(c) preparing a national nutrition policy based on a review of the existing food assistaceprogram; and
(d) implementing reforms in food assistance, based on the recommendations of the above-mentioned national nutrition policy.
108. The poverty alleviation strategy aims at establishing specific objectives and implementationmechanisms for targeted social programs as well as defining the roles of FONCODES, the social sectorministries, and the non-governmental sector. This strategy, together with the profiles for priority projects andthe national nutrition policy, will set the framework for the Bank-supported first Social Development Projectand serve as an important instrument for mobilizing external resources. Also, the first Social DevelopmentProject will expand the scale and geographical coverage of selected, well-defined programs currently operatedon a limited scale, e.g., maternal care, reduction of micronutrient deficiencies, and child development andgrowth monitoring (paragraph 106). The project will thus complement the activities of programs in whichother donors are taking the lead (for example, the IDB in the case of FONCODES). Reforms in foodassistance will address major weaknesses in the current food assistance program by integrating it with thepromotion of good health and nutrition practices and health services.
109. These actions are being supported by technical assistance under the Japanese Grant Facility andwill be strengthened by the Bank's program, including: (i) the preparation of a poverty assessment report; (ii)donor coordination through 1992; and (iii) a first Social Development Project and future lending to improvethe health and education infrastructure and the quality and coverage of services. Through the German GTZgrant, the Bank has also supported an update of the 1985/86 Living Standard Measurement Survey (includingselected rural areas) to construct a poverty profile, monitor changes in living standards over the past fiveyears, and establish a base for evaluating the effect of the Government's economic program on poverty.
C. Privatization
Ba&kgmond
110. State Entrepreneurial Activity (SEA), which includes those enterprises in which the Governmentis sole owner, majority, or minority shareholder, increased from 29 companies in 1968 to 177 in 1991. Theperformance of these enterprises has been adversely affected by lags in price adjustments, the high cost ofover-employment, and political interference. Since most of the companies comprising SEA operated at adeficit, the Government has not made the necessary investment for replacement, modernization, andexpansion of existing facilities. Political interference and poor economic performance of SEA firms have
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severely deteriorated the institutional framework of SEA, affecting the effectiveness of the companies'management as well as the Government agencies which control it.
&Mtfl Reforms
111. Faced with the reality of failing SEA companies, the Government decided to redefine and reducethe role of the public sector in the economy through the sale of public companies to the private sector. Theprocess began on March 12, 1991, when the President issued Supreme Decree 41 authorizing procedures forthe privatization of 23 companies. The strong public support for the first successful privatizations stimulatedthe Government to move forwardW. Technical assistance from the Bank, supported by Japanese GrantFunds, enabled the Government to proceed with a more comprehensive privatization strategy covering allsectors of economic activity, expressed in Legislative Decree 674 (September 27, 1991).
112. The Government's privatization strategy includes three main components:
(a) the development of a simple and flexible legal and institutional framework, as definedin Legislative Decree 674. Decisions on privatization will be taken by a centralprivatization commission (COPRI) under the direct supervision of the President.COPRI will be responsible for defining the companies to be privatized, ensuringconsistency throughout the privatization process, and resolving the cross-sectoraJissues affecting the privatization;
(b) the development of sector strategies and action plans for privatization in the areas ofeconomic activity where privatization should be preceded by changes in the regulatoryenvironment, and the development of action plans for privatization of companieswhich can be transferred to the private sector without any changes in the regulatoryenvironmentl-';
(c) an overall implementation plan to strengthen public support for the program. In theshort-term, COPRI will focus its efforts on a list of approximately '0 companieswhich can be privatized by December 1992 or early 1993.
An Agenda for Further Reform
113. Attention should be focussed at this stage on the conclusion of sector strategies and action plansfor privatization in the essential areas of banking, fishery, mining, oil and gas, power, telecommunications,transportation, and water and sewage. These strategies will be developed to ensure an organized andcomprehensive privatization, minimizing the risks and maximizing the efficiency of the process. Theimplementation of the privatization of the first batch of companies and subsequent privatizations will besupported by the Bank under the privatization adjustment loan and other Bank sector operations.
ill 'he Govemment sold its 15% stake in Sogewiese Leasing on June 10, 1991, and i% stake in Minas Bu _eaamon July 19, 1991.
JA/ To support the sectoral strategies, the Government also issued derees promoting private sector investmen in distitsectors of economic activity including fishery. mining. power, telecommunications, and transport.
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D. Agdcultur
114. For the last two decades, the agricultural sector was highly centralized. Credit was subsidizedand rationed by the State and agriculture was decapitalized under a system of incentives that favored cities.The state companies, ENCI and ECASA, created to import and market foodstuffs, became enormousbureaucratic organizations demanding large transfers from the goverment's budget. The Central Bankheavily subsidized their imports via access to the most subsidized exchange rates. The Banco Agrario ranlarge deficits and largely operated as a window for dispensing subsidies to a small portion of agriculturalproducers.
Rew ]Rehors
115. The newly established unified exchange rate eliminated the bias against agricultural experts, andimports of foodstuffs no longer received exchange rate subsidies. lTe trade reform also eliminated, thewidespread system of exemptions that discriminated against agriculture. Most significant have been theliberalization and deregulation of all domestic and foreign trade of agricultural products.
116. Decrees were enacted to abolish the National Rice-marketing Company (ECASA) and torestructure the National Input-marketing Company (ENCI); Banco Agrario credit subsidies were eliminatedand its privileged access to collateral offered by agricultural producers abolished; land and property rightswere strengthened, making land transferable and allowing it to be used as collateral. In promoting privatecorporate ownership of land, the Government began a long-term plan ensuring land-titling and registration;new agrarian policies dismantled the massive subsidization and regulatory system within the domestic market;and the personnel of the National Institute for Agricultural and Agroindustrial Research (INIAA) was reducedfrom 7,000 in 1987 to 4,000 in 1991.
An Agenda for Further Reform
117. Under the SAL program there will be no reversal of the provisions of the Agricultural SectorInvestment Promotion Law (Legislative Decree 653) which reform land tenure, agricultural commercializadonand credit, water usage, trade, and labor policy, and the final liquidation of ECASA and ENCI will becarried out according to liquidation guidelines set by the IDB Peru Trade Sector Loan (PE-029).
E. Labor Reform
gkgrouand
118. Labor market regulations of the last two decades were intended to protect worker stability andimprove wages, but worked in opposite ways. The formal labor market shrank, releasing resources to the*infbrmal* sector. Labor stability and fringe benefits significantly increased labor costs for employerswithout improving workers' incomes or employment conditions. In 1990 real wages in the formal market fellto 20 percent of their value at the beginning of the 1970s. Provisions for probationary employment in laborstability laws were rigid and limited probationary employment to a maximum of three months, and temporaryemployment was restricted to a limited number of sectors. Peru had a forced Savings Scheme for WorkerRetirement (CTS) by which businesses had to account for wcrkers' retirement in their balance sheets. The
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CTS served as a 13th month salary, accumulated yearly and withdrawn when job separation occurred. CTSfunds, proportional to tenure, were indexed to the inflation rate. However, severe problems existed in theimplementation of the CTS system.
119. The current Administration, recognizing the importance of reducing labor market rigidities, tookimportant steps to liberalize labor markets. Supreme Decree 76-90-TR permitted the formation of unionswith as few as twenty members and, where the Government had previously set the minimum wageunilaterally for the whole country without considering local differences, minimum wages are now set by aboard consisting of employers, employees, and government representatives, and are established byenployment sector, regional cost of living, and type of occupation (Supreme Decree 17-91-TR).
120. Probationary Employment The new Job Promotion Law created a more flexible probationaryemployment period. The initial employment period of three months can now be extended to a total of sixmonths, provided the work requires a training and adaptation period. In the case of managerial and otherpositions of trust, the period is extendable to one year (Legislative Decree 728, November 12, 1991).
121. Tepra Employme. Supreme Decree 077-90-TR allowed fixed-term employment contractsto be made for up to two years for all sectors and under most circumstances (few relevant restrictionsremain). Temporary employment was authorized for initiation or increase in work load, or for changinglabor market needs (Legislative Decree 728, November 12, 1991).
122. EPr_d Savings Scheme for Worker Retirement. In relation to the Forced Savings Scheme forWorker Retirement (CTS), the Administration made two reforms: the employee may now choose to depositthe funds in any financial institution and the firm now has ten years to deposit, in the institution chosen by theemployee, the balance of the CTS accumulated under the old regime. These changes have thus convertedCTS funds into a privately administered retirement cum unemployment fund.
An Agcn r Further Reform
123. The labor sector agenda for further reform is largely one of maintenance of current reformsthrough which the Government liberalized some distortionary regulations in the labor market, improvedoccupational mobility by increasing the term for labor contracts, and extended the probationary employmentperiod to one year.
F. Social Secudy
124. Peru's social security system, administered by the autonomous Instituto Peruano de SeguridadSocial (IPSS), was almost bankrupt in 1990 following a near total breakdown in its administration it the late1980s. Between 1985 and 1990, for example, IPSS boosted personnel from 31,000 to 45,000 in a massivebureaucratic expansion. It paid out generous pensions to employees with only five years of payments into thesystem and extended health coverage without concomitant increases in contributions. IPSS's real estate
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investments had been poorly managed, as revenues generated from rents did not cover costs. While this washappening, most firms, including most state-owned firms, stopped depositing funds withheld from employees.
Recen Reforms
125. The Govermnent took dramatic steps to improve the administration of IPSS. It abolished mostdeductions and reduced its staff by 30 percent. IPSS reorganized the management of its real estate assets andcommenced eviction procedures in order to rent and sell its properties under new market-based contractualarrangements. Also, the forced deposit and collection of IPSS funds at Banco de la Nacion was eliminated.Under the new system, official and private banks make monthly bids for tax collection of IPSS funds, basedon length of terms and interest rates. Furthermore, the Government has created the framework for a PrivateSystem of Pensions (SPP) to complement the IPSS. SPP benefits will be managed by the Administrators ofPension funds (AFP) which will initiate its activities to partially or totally privatize the system by July 28,1992 (Legislative Decree 724, November 11, 1991).
An Agenda for Further R_eform
126. The SPP framework will be established and will probably be based on a mixed-pension regimewith IPSS as the first layer (pay-as-you-go) and private companies as the second layer (capitalization). Thepolicy of partial or complete privatization of the pension system should not be reversed and an action planand implementation schedule will be agreed to by the Borrower and the Bank. Also, the separation of allhealth and pension fund accounts will be completed. The IPSS revenue collection rate will not be increased,the collection system will remain streamlined, and its personnel will be reduced by an addidonal 7,000employees.
127. IPSS will prepare quarterly action plans for the management of assets including the administradonof revenues from asset sales. As a control mechanism for its new collection procedures, IPSS intends tocontract a private company to conduct informational cross-referencing between the banking system's and itsown records. The independent audit of IPSS for 1991 will be completed by October 31, 1992. IPSS lastpresented financial statements in 1986; but the new administration will have a private organization prepareannual audits for IPSS beginning in 1992.
G. Prospects for the Structural Adjustment Program
128. The Administration has made important changes to reduce fiscal expenditures, initiate theprivatization effort, and deregulate the economy. The risk of a major reversal of these policies is slightbecause: (a) the strategy of emphasizing market forces is well in tune with regional and worldwide trends;and (b) a different strategy attempting to expand government expenditures would be constrained by the lowtax revenues and high income velocity of money.
129. Nevertheless, partial reversal cannot be ruled out, as policy objectives are far from having beenreached and cost always precedes the benefits. The reforms have just begun to make an impact: tradereform must hold against import-substitution lobbies; privatization has proven, in other countries, to be farmore difficult than first envisaged; and fiscal adjustment will be demanding due to the narrow tax base. Theentire stabilization effort will depend on the Government's determination to fight special interests.
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--M T E PRPQED SI*RUCURAL ADJUSTMENT LOAN
A. The loan
Descriptjo
130. A loan is proposed for US$300 million under the Bank's new policy for countries with protractedarrears (paragraph 3). The Board's approval would entitle Peru to immediate disbursement of the wholeamount after signing and effectiveness. These actions would take place at the end of the performance periodupon satisfactory implementation of the SAL reform program, the economic stabilization program, theexternal financing plan, and continued current debt-service payments to the Bank. The performance period,which began with the initial reforms of August 8, 1990, is expected to end in December 1992, concurrentlywith the termination of the IMF Rights Accumulation Program. We do not propose any earmarking of localcounterpart funds.
131. Under the workout program, the loan would be signed after Board presentation only after Peru'sarrears to the Bank are cleared (possibly by December 1992). The standard grace period will be calculatedfrom the time of loan signature, rather than Board presentation.
Policy Reforms to be Supported Under the SAL
132. We propose a quick-disbursing loan in support of Peru's current medium-term structuraadjustment program. It would recognize the major reform measures taken between August 1990 andDecember 1991 and further reforms to be implemented by December 1992 in the following areas:Macroeconomic Policy, Fiscal Policy, Social Sectors, Privatization, Agriculture, Labor, and Social Security.These measures are presented in the Policy Matrix (Annex 2).
PMrooosd Sectoral Co-ndiflons
133. We propose the following conditions for preventing reversal of policies recently implemented, andconditions for further reform. These conditions are also presented in the attached Policy Matrix (see Annex2) and in Appendix A of the Letter of Development Policy (Annex 4).
134. Conditions Preventing Policy Reversal. These conditions will be monitorable based on policies asof December 1991, and are arranged by sector:
A. Macroeconomic Policy:
* Maintain domestic-currency convertibility for all external transauctions to a single type ofexchange rate.
* The Government will not re-introduce foreign exchange surrender requirements or controls oncurrent- and capital-account transactions.
* Maintain the use of foreign currencies in the local financial system.
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* Maintain payment to all JETs and continue negotiations with all other creditors aiming for thefull restoration of debt service.
* Creation of monetary base mainly to finance the quasi-fiscal deficit and increase foreignreserves of the Central Bank.
* Maintain policy of market-determined interest rates.
* Maintain market-determination of prices and private sector wages.
B. Fiscal Policy:
* Maintain the process of implementation of a new registration system for taxpayers.
C. Agriculture:
* Non-reversal of the elimination of State marketing monopolies established by Supreme Decree066-91-EF.
* Maintain all provisions reforming land tenure, agricultural labor, and liberalizing agri-businessactivity in the "Ley de Promocidn de las Inversiones del Sector Agrfcolaw (Legislative Decree653).
* Non-reversal of policy liberalizing the use of land as collateral.
* Maintain legal framework allowing agricultural-sector access to private commercial bank credit.
* Maintain all provisions on water usage included in Legislative Decree 653.
* Maintain trade liberalization provisions of Legislative Decree 653.
* The Govermnent will not introduce any new mechanism for price control of agriculturalproducts and there will be no reversal in its policy of abolishing interest rate subsidies.
D. tabo:
* Maintain probationary employment reforms which lengthen the initial employment period formanagerial positions or for work requiring a training and adaptation period (Legislative Decree728).
* Maintain reforms which lengthen fixed-term contracts, as decreed in Supreme Decree 07790-TR.
* Maintain authorization for temporary employment for the purpose of initiation or increase inwork load, changing labor market needs, or for retraining of employees.
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* Maintain reform of CTS system including new semesterly deposit system, choice of currency inwhich to hold accounts, withdrawal conditions, and tax status of deposited funds.
E. SoilSeub
* Maintain the legislation (Legislative Decree 724) which initiates the privatization process for thepension system.
* Maintain streamlined collection system for social security contributions in which employers cancomplete a form to estimate contribution due and make payment at any commercial bank.
* Maintain the deposit of IPSS funds in public and private banks.
* The current social security contribution rate will not be increased.
* Maintain IPSS policy of forming new rental contracts and selling property to reflect marketprices.
135. Conditions for Further Reforms. These will be monitorable conditions based on policy changesmade between September 1991 and December 1992:
A. M nomic Policv:
* Adopt measures and an implementation schedule satisfacory to the Borrower and the Bankaiming for a level of Tax Revenues for the Central Administration of about 9 percent of GDP.The primary deficit of the NFPS will not be larger than 0.6 percent of GDP (January -December 1992) and there will be no domw c financing of the Consolidated Public SectorBalance, defined as the deficit of the prima balance added to the quasi-fiscal deficit, plusinterest payment on internal and external debt.
* Central Bank creation of domestic credit will be consistent with IMF targets.
B. Fiscal-Policy:
* By Qctober 31. 1992, the Government and the Bank will jointly review taxes on exports andbank current-account debits and interest t X assess the prospects of phasing them out within aspecific timetable.
* The monitoring of large taxpayers will be expanded from 1,200 to 2,500 firms.
* By March 31. 1992, SUNAT will complete the process of personnel selection at the nationallevel.
* By June 30, 1992, the new infrastructure of computer information systems will be installed inthe region of primary taxpayers.
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* Changes' in the tax regime code, satisfactory to the Borrower and to the Bank, will beintroduced to allow for greater efficiency in the tracking of infringements.
C. ocial Sectors:
* The Government will develop, by January 31. 1292, a poverty alleviation strategy and* imnplementation schedule, both acceptable to the Bank, outlining policies, and identifying
priority programs and target groups. The Government will adopt this strategy by December-3,1992.
* The Goverunent will develop profiles for priority projects in primary health and nutritionacceptable to the Bank by April 30IM.192.
* nThe Government will prepare a national nutrition policy acceptable to the Bank, based on areview of existing food assistance programs, and will recommend reforms necessary to improvecost effectiveness by April 30. 1992. The Government will initiate the first stage of thesereforms in food assistance programs, including streamlining the role of public agencies, by luu30, 1992.
* nThe Government will develop profiles for priority projects acceptable to the Bank in pre-primary and primary education by April 30,1992.
D. Privatization:
* The Government will implement policies defined in the institutional framework for privatlzation(established in Decree 674) by Junk 30. 1992.
* The Government will develop an overall action plan and implementation schedule acceptable tothe Borrower and the Bank for divestiture in the banking, fishery (including Flopesca,Pescaperu, Epsep, and CERPER), and mining sectors (including Minero Peru, Centromin Peru,and Hierro Peru) by June 30. 1992.
* The Government will develop a policy framework acceptable to the Borrower and the Bank,including an implementation schedule for private sector participation in: (i) oil exploration,refining, and distribution; (ii) gas production and distribution; (iii) power generation,transmission, and distribution; (iv) telecommunications; (v) transportation (railways, ports, andair transport); and (vi) water supply and sewage, by June 30. 1992.
* The Government will develop a divestiture strategy acceptable to the Borrower and the Bank,including an implementation schedule, for the sale of shares in all companies where theGovernment is a minority shareholder. The Government should bring to the point of sale atleast 6 of these companies by December 31, 1992.
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E. Agdl2tur:
* The Government will liquidate ECASA by Sptember 192. The liquidation will follow theAction Plan already agreed by the IDB and the Government for the IDB Trade Sector Loan(PR-1796: Annexes V and VI; September 10, 1991). The general objective of the Action Planis to help rapidly liquidate ECASA's assets with reasonable prices, thus allowing thecorporation to settle its liabilities and prevent continued costs which erode the state's fiscalresources. The liquidation steps are detailed in Annex 3.
* Implement Supreme Decree 148-90-PCM, authorizing ENCI's reorganization. Therestructuring of ENCI will also follow the steps agreed to by the IDB and the Governmententailed in the IDB Trade Sector Loan and detailed in Annex 3.
F. Social Securny:
* Pensionsysem: The Government has issued a decree allowing for partial or completeprivatization of the pension system. There will be no policy reversal regarding privatization ofthis pension system, and, by September 30. 1992, the Government will present an action planacceptable both to the Borrower and the Bank to implement the privatization decree.
* Complete the separation of all health and pension fund accounts (except administrative expenses)by Junlg30. 1992.
- IPSS, as fund intermediator, will be subject to periodic independent auditing. These audits willinclude not only financial control but also administrative and operational diagnoses andrecomnendations. The independent audit for 1991 will be completed by October 31. 1992.
* Reduce number of IPSS employees by an additional 7,000 by 12ecember 1992.
136. In all of the above areas the Bank and the Government of Peru will agree on a final timetable formeasures to be taken, monitoring criteria, and on procedures to be followed during the performance period.
Monitorint and Reporting
137. The Bank will, at negotiations, finalize an agreement on the information which the Governmentwill provide during and after the performance period on developments in macroeconomic policy andperformance, the external financing plan, and fulfillment of the conditions as set out in this loan. Theproposed information is listed in Appendix B to the Letter of Development Policy, Annex 4.
138. Consistent with the Bank's new policy for countries with protracted arrears (paragraph 3), themanagement will submit each quarter to the Board a report on Peru's compliance with the requirements ofthis and the c.ther adjustment loans in the workout. The report would assess the likelihood of a successfulworkout by December 1992, and recommend, as necessary, any modifications to the conditionality oradministration of the loan. Specifically, the report would cover the following topics.
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(a) Peru's progress in fulfilling the objectives of the macrgocnom1iC stabilizatjnmgrM, whparticular reference to the risks that have been identified (paragraphs 58-69).
(b) Progress in fulfilling the conditions of the external financing plan, including Peru's servicing ofcurrent payments due to the Bank, and any related developments (for example, negotiations withcommercial banks).
(c) Progress in fulfilling the gt rL ditiong of the workout loans, in the context of overallsectoral performance and policy and other developments affecting fulfillment of sectoralconditions and sectoral performance.
Cooperation with the IDB
139. On September 18, 1991, the IDB's Board approved a fast-disbursing US$425 million trade sectorloan, US$325 million to be disbursed on effectiveness, with US$50 million for each of a second and thirdtranche. The loan covers five areas: (i) trade policy; (ii) customs reform; (iii) labor market reform; (iv)private sector development in agricultural marketing; and (v) the social compensation fund. The IDB and theBank have developed their analysis and sectoral conditionality on trade and customs reform in closecooperation, in particular through concurrent pre-appraisal missions in June 1991 . In these last two areas,conditions in the two loans are the same.
C-o-Financing
140. As part of the German contribution to the Support Group, KfW (the German financial aid agencq)will provide DM50 million to Peru in the form of co-financing the SAL. Although details of co-financingarrangements are to be firmed up over the coming months, it is likely that Board approval of the SAL couldtrigger KfW disbursements to Peru.
Twhnital Assac
141. Technical assistance for implemnenting structural reforms proposed under the SAL will beprovided externally. Bank technical assistance will be principally supported by bilateral trust funds, i.e., theJapanese Grant Facility and GTZ (German Technical Aid Agency) grants, and will complement support beingprovided by other donors, including the IMF, IDB, and UNDP.
142. The Bank, as executing agency under the bilateral grants, will provide technical assistance totalingapproximately US$5.5 million in six areas (see Annex 7 for a description of the technical assistanceprogram):
151 Labor market reform, private sector development in agricultural marketing, and the social compensation fund will becovered by the Bank in this SAL. The Bank also continues to work closely with the IDB in the areas of trade policy andcustoms refonn.
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(a) budgjet planning and expenditure control, including development of criteria for national budgetplanning and expenditure monitoring, design of the public finance system, and formulation of apublic investment program (co-financing with IDB);
(b) pgyey aJeviat , including support to FONCODES and formulation of priorityprograms/projects in primary health care, nutrition, and basic education (co-financing with IDBand UNDP);
(c) PdYl xim andf restucripegf gulic enterpri3o, including development of overall and sectoralstrategies and a regulatory framework for privatization;
(d) ariculture sector reform, including development of a sectoral policy framework (e.g.,environment and water resources management) and implementation of urban and rural landtitling/registration;
(e) social security system, including development of an operational plan for privatization of theexisting pension system; and
(f) extern&I debt, including design of the debt information system and development of external debtnegotiation strategies (co-financing with UNDP).
143. Tb Bank will administer technical assistance funds to assist the Project Coordination Unit of theMinistry of E(onomy and Finance in collecting and preparing supporting documentation for disbursementrequests. This assistance to the Project Coordination Unit will be common to the Bank's three adjustmentloans. The UNDP also plans to support the Project Coordination Unit by financing personnel, equipment,and operational expenses. Furthermore, with the support of the German GTZ grants, the Bank will monitorclosely the implementation of the loan through the use of local consultants.
144. The IMF has been supporting tax reforms and restructuring SUNAT. The IDB plans to enhancethis effort through a US$5 million technical assistance grant. The IMF has been providing the Central Bankwith technical assistance for monetary policy. For agriculture marketing, the IDB will set aside US$528,000of technical assistance funds (from its trade sector loan) to develop and implement plans to liquidate ECASAand restructure ENCI. The IDB also plans to provide the US$4.5 million technical assistance loan to theMinistry of Ec-nomy and Finance in parallel with its financial sector adjustment loan.
145. Pcrement. Disbursement. Audit. and Administration. Arrangements for procurement,disbursement, audit, and administration will follow those of the preceding trade policy reform loan:
146. The proposed loan would be used in its entirety to finance 100 percent of the c.i.f. costs ofeligible public and private sector imports. Eligible imports would be all goods and services except thosenormally excluded under Bank policy-based lending, such as alcohol, tobacco, and armaments, as well asluxury, enviromentally hazardous, or other goods specifically prohibited in a negative list, and goodsfinanced by other Bank loans or loans from offtcial multi- or bilateral sources. The closing date of the loanwould be June 30, 1993.
147. Tle proposed loan faces two particular circumstances affecting procurement and disbursement.First, given the Bank's total proposed adjustment lending program for FY92 - arouna US$900 million, all
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of it required to rapidly disburse in December 1992 - and the expected level of IDB adjustment lending andbilateral aid for the same years (US$700 million and US$1,300 million respectively), the amount of importswhich are to be subject to Bank disbursement and procurement procedures will be substantial in relation tooverall eligible Peruvian imports (total imports are currently almost US$3 billion per annum).
148. Second, effectiveness will fall well behind the policy reform process that the loan supports: theeconomic reform process began on August 8, 1990 (with the trade-reforn process being substantivelycompleted by April 1991), Board presentation is expected in early 1992, but the loan will not be signedbefore the end of 1992, that is, 28 months after the beginning of economic reforms. Under thesecircumstances, retroactive financing of eligible imports for the whole of the loan amount is recommendedfrom August 8, 1990.
149. A Country Procurement Assessment Report prepared by the Bank in September 1991 noted thatthe laws and decrees governing the procurement procedures followed by both public and private sectorimporters were in broad conformity with the World Bank's Procurement Guidelines. In addition, the annualbudget law provides that goods and works financed by international financial institutions will be procured inaccordance with the requirements of these institutions.
150. Trade policy reform since August 1990 - the wholesale reduction of tariff and non-tariff barriers,the elimination of fiscal privileges, the removal of controls on foreign-exchange transactions, and thebeginning of customs reforms - has immeasurably strengthened the competitive environment in which privatepurchasing decisions are made.
151. In view of the above-mentioned reforms, the following procurement procedures would apply:
(a) Contracts for the procurement of imports made by public and private importers valued at orexceeding US$5.0 million would be procured under simplified ICB procedures in accordance withBank Procurement Guidelines. Imports of petroleum products and commodities such as wheat,corn, sugar, etc., would be purchased under competitive procedures acceptable to the Bank. Inaddition, direct contracting would be acceptable if it is in accordance with the requirements ofparagraph 3.5 of the Procurement Guidelines. Contracts below US$5,000 would not be eligiblefor Bank financing.
(b) Public sector imports valued at below US$5.0 million and above US$5,000 would be procured inaccordance with local norms which have been assessed as acceptable to the Bank in the CountryProcurement Assessment Report of September 1991.
(c) Import contracts by private importers below US$5.0 million and above US$5,000 would beawarded in accordance with established commercial practices, which are acceptable to the Bank.These practices generally consist of inviting more than one quotation, except for importers ofsmall amounts of consumer goods, who generally buy from traditional sources using directnegotiation.
152. Disbursements for contracts under US$5.0 million would be made against Statements ofExpenditure (SOEs) for which the relevant procurement documentation would be kept locally for supervision
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by the Bank staff in the field and for auditors whose terms of reference for auditing would be acceptable tothe Bank.
153. T`he Ministry of Economy and Finance would administer the loan and be responsible forsubmitting the relevant documentation for disbursement. To fulfill this task, the Ministry has established aCoordinating Unit to ensure compliance with loan conditions, prepare disbursement requests, superviseconsultancies, and fulfill reporting requirements to the Bank.
154. To assist in the preparation of disbursement requests, the Ministry and the Central Bank have, inconjunction with the Customs Administration, created a Special Procurement Unit responsible for thecollection of relevant procurement documentation, ensuring that only eligible and correctly procured importsare included in withdrawal applications. This documentation would be retained for review, as required, bythe Bank and the project auditors.
155. Letter of Development Policy. The basis for this loan will be provided by a Letter of Develop-ment Policy (Annex 4). Given the context of Peru's workout, which envisages several adjustment projectand a performance period that separates Board presentation from loan signature, this Letter goes beyond thenormal scope of a letter of sector policy and constitutes the understanding between the Government and theBank at the time of Board presentation on the conditions and criteria upon which the proposed loan agreementcan be signed and made effective. The Letter will:
(a) set out the Government's medium-term macroeconomic stabilization and adjustmentprogram;
(b) describe the external financing plan for 1991 and 1992;
(c) set out the process and timetable by which the loan is expected to be signed and become effective;
(d) describe the evolution, objectives, and guidelines of macroeconomic policy, setting out theprecise sectoral (macroeconomic stabilization and structural reform) conditions theGovernment undertakes to fulfill during the performance period and describing what furtheractions are intended in the longer term; and
(e) indicate how the Government will report to the Bank during the performance period.
156. Condidors fior Boad Presentation. Consistent with the Bank's new policy on AdditionalSupport for Workout Programs, the following Board presentation conditions have been met:
(a) a macroeconomic stabilization program in place and agreed to by the IMF and the Bank, asdescribed in paragraphs 58-60 above; this program would provide the common framework for thethree adjustment loans proposed for Peru's workout; the Bank would follow quantitativeindicators of major macroeconomic variables for 1992 (paragraph 70); within these broadindicators, the Bank would pay particular attention, in monitoring the program, to measures offiscal revenue enhancement and expenditure control which will contribute to efficiency, equity,and the sustainability of adjustment in the medium-term;
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(b) an external financing plan, agreed among the international financial institutions, which would, asdescribed in paragraphs 80-91, provide for full clearance of arrears to the Bank and the normal-ization of Peru's relations with the IMP and IDB;
(c) agreement on sectoral conditions to be undertaken and conditions preventing policy reversal(paragraphs 134-135 and Appendix A of Annex 4); and
(d) Peru remaining current on its servicing of debt to the Bank (other than debt covered underexternal financing above) currently falling due on the terms already agreed to with theGovernment.
157. Conditions of Loan Signine and Effectiveness. Consistent with the Bank's new policy onAdditional Support for Workout Programs, loan signing and effectiveness conditions would be as follows:
Signing*
(a) prior clearance of arrears to the Bank;
(b) compliance, during the performance period, with the IMF and Bank-supported program of macro-economic stabilization (paragraph 156(a) above), with particular reference to the Bank's quantita-tive indicators;
(c) the continued viability of an external financing plan (paragraph 156(b) above); and
(d) compliance, during the performance period, with the Bank's sectoral conditionality as underparagraph 156(c).
Effectiveness:
(a) taking of all Governmental actions required to authorize (or, if necessary, to ratify) signing of theloan agreement; and
(b) if a time lapse were to occur between signing and these actions, continued satisfactory imple-mentation of the trade reform and macroeconomic stabilization programs and the external financ-ing plan, in accordance with the provisions of the Letter of Development Policy.
B. Benefits
158. Stabilization is necessary for the success of the structural reforms currently being implemented.Policies supported by this loan will reduce inflation to low levels, setting the framework for renewed growth.Ihe revamping of fiscal administration and fiscal reforms should increase revenues and make the fiscaladjustment sustainable. The trade reform should mobilize resources toward Peru's competitive advantage andlead to an outward-oriented, and thus sustainable, growth. Labor market reforms will improve the flow oflabor inputs among sectors to adapt to changes in relative prices caused by trade and fiscal reforms. Interestrates will continue to be set freely, thus improving resource allocation and monetization. Land reform hasbeen extensive, strengthening property rights, crucial for agricultural development. Privatization will create a
- 44-*
larger and more efficient private sector, and pVivatization of the social security system would be a new sourcefor long-term savings.
159. The poor will gain in the long-run from the liberalization of the labor market, a wider distributionof employment opportunities, and the potential benefit from agricultural reforms to use land as collateral, andimproved registration and titling of land. To protect the poor, in the short-run, the Government is striving tomobilize external resources for priority projects in basic socW services. The Government intends to develop anational nutrition policy with a view to improving the cost-effectiveness, nutritional impact and targeting offood assistance programs. The recently established social compensation fund (FONCODES) will channelfinancing (both domestic and external) to small, labor-intensive projects to benefit the poor.
Vi. &ECOMMENDAION
I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bankand recommend that the Executive Directors approve the proposed loan.
Lewis T. PrestonPresident
Azrachments
Washington, D.C.March 2, 1992
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5. Grose Flouning Reqoreme (1h243#4 2,944 1S,61 4, 3.'1 3,2 3, us 3 ,3176 3229 3,434 3,627.~~~~~~~~~~~~~~~~~~ ... .. . . . . .
6. Pipeltri Lo 9emlarmw 245 25S 20no s0 60 1 3 0 0 0
7. PNate Capital flow 347 900 545 S11 654 m 7 WA 31 1ss 9
1t. tncse * er_ l 2.144 0 O0, 0 0 O 0 I t 0 0
9. Otbr ilabliltle s Adjust. la ° a 0 0 0 0 a 0
la. f1nmn top m *110. FInancing aiga reminte (0) 14,496 4,248 2594 2,53 2385 2329 2.4" 3.24 33
soues oef ItInin
o1 Deferra @ lt a 13.59" 1,46? 743 M 734 8 6r5 1,041 1,294*1. Debt Rs,eheebA In owl Deferral ~ 4.352 69 2 21 (90) (102) (18) 2 174
Privat 0 7,2U 69 741 nr 2 so 962 103" 1,122
12. Adeltlent 0idremaWt 0 900 2.8l 1,33 1,460 I3m 1.324 1,549 141 1.47SNultiast l,0 654 2,328 502 624 SOS 449 "S 92 9
21*3 0 fie 200 0 0 S 0 0 0 0ISI IoU, gm uiIf0 484 2,128 SU50 624 50S 449 4"5 692 719
SIltterel 0 246 453 635 644 an8 on5 a" 920 95
13. AMIttil Finwing R ired (0) 10) 0." 514 23 m 220 95 5S9 * 345
14. total uces of UlurJ_cIn (0) 14,490 4,240 2,594 2,503 2,35 2.329 2.49 3,2461 3,334
.. ... ...... . ...... .... ....... . . ,,,,. .... ,,,,,,,,.;.......
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" 9" 6t M to M c * s Is t *owle s" SamCu Oau 06 U9CU 113 S1 31 5. sip 1W9 Pl is ,
95 S&L m9 £9 CS9 £9 A" .I19 469 An *S2tII0sU *104
tot 19C 96t tic 9t5 Ott - 9 ZC* "I siUt uo* dMSUIU S1t,J013 1S UL'E 9CC 99£ 41 SIC' SO'R fOR 99'1 311' u34u *SI10L91t 951e 369't s191 "got s11 Sao? 99lft SSize t111 UPI IdMwuI3 00*484\UsIg Suez 1151 6L11 AU SW 199 1351 £9S1 LCC1g aw9 a13dS 30301
*lt *t* ga`* ON's out aloe 661 11 W o,4 wXwq 1
6461 0463 1461 961 5661 61 63U WH 7 146141661 0461,,,,,,,&, ~~~~~~~~~~~~~~~~~~~.. . .. . . ... ..... .
O" 4661.144 au ." a" a" *£1
;- ~ ~ ~ ~ ~ ~ ~ 041 a nu' ri-P
1e4 1.4 ^P t Pr.l.etIw of to Eemse lS^ed tg* 1996.1999.
*l**........... ..... **...**.**.*.** .. *...*******. .*n* X.. ,.* .... ..... n.....n.fa.
....................
U, -4.9 a.s 2.5 3.0 3.0 3.0 35 3. 4.0 4.50? pen aplI. t.14 6.3 0.1 0.6 0.6 0.7 1.2 1.3 t.0 2.3
? *5.0 -1.9 1.9 2.0 2.3 3.6 3.9 3.9 4.1 4.36n per pt 7.5 -4.4 -0.5 -4 0.4 0.7 1.6 1.7 1.9 2.6Ca_nMpm -4.1 4.4 0.4 1.4 2.4 2.4 2.6 2.6 2.7 2.9cwwptles pW e pite -6.6 1.9 '26 *I.0 0.6 0.1 0.3 0.4 0.5 0.7
tapte UPS OM) .6.1 .3A. 14.0 L. 11.9 14.7 14.3 14.1 14.3 14.4Imports 1WS ftcmtw* *I) -. 0 .S.4 10.5 1e.2 9.0 9.6 .5 6.1 6.3 6.5upnte ef SINe (cnswtmi M)l* .9.2 -2.3 19.4 11.6 9.6 9 .0 7.4 7.3 L.0Iutte 3 -6.6 -n.4 14.9 *.5 9.6 10.6 10.3 9.9 10.1 10.3
ste a" ( 25.9 0.3 1.7 6.7 6.3 11.2 11.5 1I.? 12.1 12.6Imprt US (Coutut Ml6) 13.4 -0.7 12W 6.4 6.6 Y.2 1.4 To 83.Ipats 1 ofsh OM) 32.2 13.2 13.r 6.7 g.0 11.2 11. ti 12.1 12.6lporte of eOf (Catit lIt$) 24.4 3.3 2. 6.4 6.a 7.2 7.4 7.6 *.0 8.S
................ 0ebt,to Sys 502.0 5".6 524.5 510. 4.3 "4.0 46.s 3743 344.5 317a
S:.2 SW. 4.6 430. "34.0 61.9 0.5 5$9.0 S.5 55.9
IM 0t V o*e l 7.2 *6.3 5.4 .t 4.2 6.2 6.0 .0 5. 5.4
*ebt "eenl wes IN" a 6.2 5.A 73.6 31.0 47.0 42.4 3..7 37.0 34.5 32.3Osbt wvI.IP Si 1.1 31.0 0.9 6.4 6.1 5.9 S.r 5-. 5.3 S.7
tatert Jqrte We 36.3 40.1 36.4 36.2 34t1 31.6 26.9 26. 24.6 22.7futeret lw 4*.2 4.1 4.4 4.5 4.4 4.4 4.3 4.2 4.1 4.0
3 Caatry h_ u hto km 6.0 7.0 6.0 6.4 4.3 6.0 6.5 6.2 5.9 5.7lass, c.atmy?hbtI 'a635 Sevie eJ 0.1 20.2 . 10.9 10.1 10.2 9. 10.0 11.2 12.1133 ebt DoIm .Ie I mat 6 4.2 5.1 22.6 3.4 3.0 2.6 2.3 2.6 2*4 2.2
rftre Crod. tI e SNM vIts eJ 24*.0 3.1 23.4 33. U3.S 313 31*1 32.0 34.4 37.2
emtry *MO 1.7 1.5 1.4 1. 1.6 1.6 15 1.4 1.3 1.3
i.t.t tottllIn AS 21.6 232 25.2 26.7 23.3 29.9 31.3 32.0 34.5 3.S....... , -.- * -.-- ------......... . .......... 00 ...............-------. -----........ -- ... ,
J Mle debt e.nlee tImtbd. rep"a of urnertt inattlitSr. lI"tlttl w 11 Ii wd 2) .. .9. *u rsch log of wr*r odar to bituterals, clot bus S st4de ( 1et
.~~ ~~~ ' , **.*
.At 1.4 tePtl _l KM t .sthtiep eI gay r er orle IrdMeaters, 1996-199.
~~~~~~~~~~~~~~.....O............ .................................. .................................................... s_
" m to curent) .....................
tCumuJwptimn 74.6 31.0 0.9 "0.6 61.0 31.2 6l.l 3e.4 79.7 7W.7PrIvate 76.5 725 1. 71.6 71..5 TI.? MAo 70.4 69.7 66.7publc L.a 0.5 9.0 9.6 . 9.5 9.s 1.6 10.0 1SA 10.6
Omut Is Savlsge 23.2 19.6 19.1 19.2 19.6 16.6 19.2 19.4 203 21t3
Total luwe"us 2n.9 26.7 20.9 20.9 20.1 19.7 19.7 19-.0 2.2 26.Urose Cipl*l lwmtlm MY 19.7 20.7 20.r 20.2 19.6 19.6 1.7 20.1 20.6
m,l ttlvw. 1.2 16.2 16.? 16.7 14.2 15. 1S.A IS.1 16.0 U.5P.b6ie 2.4 3.S 4.6 * 4.0 4.0 4.0 4.6 4.0 4.1 4.3
themu to Stcks 4.2 1.6 0.2 0.t 0.1 0*1 0.1 . 6.1 0.1 0.1
Iteseim. gt.1, *.3 -1.4 .1.3 -1.6 -1.3 O.i *.S 40.2 0.1 0.4taparts 6"is 16.9 10.3 12.1 12.S 13.0 1.it 14.8 1S.6 6.7 1A.lpern exIs 100. 12.1 13.? 14.1 14.3 14. 1S.4 16.0 16.6 1I3
3.t1mM Iw g "1. 15.6 15.6 1.S 15.3 1.1SJ 1.5 1.9 16.4 17.3
Current £2...t . -3.9 -S.2 .533 -5.3 .S.0 .4.6 .4.2 *-.9 .3.5 1.-A
team of trade (1166 160) 105.? 96.6 92.4 "I9 .7 39? 0. 92. 94.? 96.? 913.?3 Iresll 132.4 131.6. 124.0 124.6 1j7.0 133.2 141.3 19.A 10.7 1t6.1ujupics 125.3 137.3 136.5 136. 141.6 146. 152.4 156.2 164.2 1fl.4
0iU -4.0 6.9 7.7 6. 6.0 5. S.0 5.0 4.4 4.1
*uggg 6l *.51 6.51 3.61. 7.61 7.11 7.61 6.41 4.41 6.41 4.41~~~........ 0.0-".6.. .0.0..........00 . .0oe.. 0. .. .0.. 0. ... 041-4 6 ....
. . ~~~~~~* ... ., . .
* Based on 1990 Unified Survey projections.
* . ' * * , .- ;' ' , * ' S
*~~~~~~~~~ .. 4
- 50 -AN= 1
Page 6 of 11
Notes 3 Toles 1.1 to 1.4
The projecons in this Annex illusae a feasible path for the economy under thestabiliaton mad tural refbrms initiated by the Fujimori Govermen. These notes spell outsome assumptions behind the projections and some definitions of Items projected.
1. Assumdt for Balance.f-Pa =ment Itens dExcludine Debt Servicing and the CapitalAgout and National Accounts
lbe key coutry assumptions behind the forecasts in Tables 1.1, 1.3, and 1.4 are asfolows:
1. After three consecutive years of decline, Gross Domestic Product (GDP) is expectedto grow by 2.8 percent during 1991, the rate increasing steadily to reach 4.5 percentin 2000 (an average of 3.4 percent for the period).
2. Population is assumed to grow at 2.S percent a year up to 1991, declinig to 2.2percent by 1997.
3. Exports of goods and non-factor services are expected, because of the trade reforms,to be a major contributor to GDP growth. After an iiti increase of only 3.3percent in 1991, eflecting the appreciation of the real exchange rate, export growthwll recover to about 15 percent during 1992. For the rest of the period, exports areassumed to grow at an average of 8.3 percent per year, increasing their shae in GDPfrom 11 pecent in 1990 to about 19 percent in 2000 (a level consistent with sharesataned in the 1950s, 1960s, and early 1980s, when the economy was more open).
4. Similarly, imports of goods and non-factor services, after an iniial increment of about10.7 percent in 1992, are assumed to grow at an average of about 6.8 percentbetween 1993 and 2000, to reach a levd of 18 percent of GDP in 2000 (up fiom 11percent in 1990). The net movement of imports and exports would reduce thecurrent-account deficit ftom 4.6 percent of GDP in 1991 to 2.8 percent in 2000.
S. The ratio of investment to GDP is expected to increase from 20.7 percent in 1991 to25.3 percent in 2000, with an average ratio of 23.7 percent during this period, a levdcomparable to other middle-income economies. During the same period, public grosscapital formation would rise to 4.3 percent of GDP from 3.5 percent.
6. Consumption per capita is assumed to grow slowly due to increased investment andimprovement in the trde balance.
ANNEX 1
Page 7 oif 11
7. For the pod s as a wole, tuse trends would rsult in an Increase in domestic savnpfrom 19 to 21 percent of GDP. Similarly, nadonal savig, because of the ncasglevel of investment and the improving cuent-account balance, would increase fom15 to 17 percent of GDP.
IL dftdon of Line Item in Table 1J: Balnce of Payments Madg ,u enes andPosible Sources o£ inancing)
1. PJon-Intert Curet cunt Deficit from Table 1.1
2. Debt Service Obeptions: estimated publicly guaranteed debt service obligations tothe BRD, DB, DtF, and bDiate and private creditors.
3. Total Arrears: arrears outstanding to the IBRD, MDB, IthF, and bilatera and prvatecreditoms
4. In jsin GTss Re-se : estimated targu for increase in Central Bauk reseves.
6. L_an Disbursements in Pipeline: estimated disbursements alad in the p4pelinefrom the IDB, biateral creditors, and unguaranteed pnvate creditors.
7. Prfiate Capital lowe: direct foreig inve t and fuds repatiated from abroad(includes etrors and omisions).
9. Dcbt Rescbedulinu and Deferal: in 1991 and 1992 all official bilateral debt isassumed to be rescheduled on the terms secured in the September 1991 Pars aCubnegotiations (see biclow). In 1993 and bqyond, pre-cutoff debt service due to theParis Club of creditors is assumed to be rescheduled. Other oficdal bilater debt isassumed to be serviced. Private debt service is assumed to be rescheduled eveyyear for 1991-99.
Te terms of the September 1991 Paris Club agreement are as foUows.
Rescheduled:1
Current maturitides due during the consolidation period' and arrears on short, mediumand long-tem debt on pre-cutoEf debt,' including previously rescheduled debt
ODA oas rescheduled at 20 year incltudng 10 years gacc;, wihconcessional izterest rate.
%.hedW n ter resrved for heavly midteb lowr middle mcos comtze
'Me conOlidation peri is fom October 1. 1991 to December 31, 1992.
'P=uMtff debt is debt cotracted befor January 1, 1983. the time of the fit Paris Club rechduling.
.~~~~~~~~~~~~~~1
X 'r xJ { m .;~[ij kit .I* .. . .1..~~i ~~
-53-
AMO=-1Page T of 1l
Table 13: PERU: EXTERNA 0U rANDNG DBT aJ(STOCKS IN USS LUONS AS OF DECEBER 1990)
* StoXcs (of which
L MEDrUM- AND LONG-TERM DEBT 20,341 13,414
1.1 Public Sa:tor 19,965 13,414
a. Mullatead Creditors 3,9X 2,156- World Bank 1,560 924
1.004 875-* IDB 1,077 357.- Other 331 -
* b. Paris Club Credto 6,839 4,835c. Other Bilatal Credit 2,2 136d. Commerca Banks and
tUngaSranted Supplias 6,882 6,287
1.2 Pivate Sector 376 . La
IL SSHOTMERM .2 1,366 58
13L CTA DMB 21.707 13 -42 b/
a/ ludas cut principal ad aea.* bl Excludes arrears of WLT private sectr dbt.
* ~: Central Bnk, DO, ad Mistry of Economy and Fboie.
SH$le "so9331 VA 3 10as 63 S 33
9.~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~" ~~ ~ ~~ * ^ "ds n wum w q 1 . ;
-m at e m o n o ve 4 4 J O S' 0 1 s v .A u m * 3P6 1 6*~ ~ ~~~~~~~~~~~~~~~~~~~~~~33 644$ lPft J-_ 5asq-l-es '3666 ama *-*s" |lg |wp -, m$ 1-_ _l " u *.z1 Uz IlEdf " tlU *1" * li l jaqssie 3995 S
"~ ~ ~ ~~ ~~~~~~~~~~~~~~~~~~~~~~~~~~su" Jo *I tel Om ntaf t;t A"jt 'ntsg u as $VMS $$MPI sr je "X J $ I54iumst umwIts "As'M .~w % emiets OftUsW' C10
; ~~~:*s siv t e st to NgT nto 611 'u S 81N $ ,1*-S *O a t on &W t m * Su Alt " so w **=
~~~~~~~~~~~~ at 161 91" *ltt m 16 ^ Zs t m "t OK 44 sn m , , 96 =6'3 *.e i.e '.e 99* 31. *9 56* 41g OK a" 1 s 9 41 "9 U5 Su 45 5 swII,s-
lessee 3"3lo VI
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ws *'1 *+¢ er' + * ~~ ~~t 4K ut us ut rGa AnF w+X t" on AN 114 ttt on ::-a **- P
*r n *' l'> 8 s tJ ** *s t-15 511 *-1 545 55. 541 *9 06 -41 541s 9St (t JSWWid
g. t VI- res 515 915 t* 44 061 5'5 151 |. 9 `4- 51, 11,9 VW- 136934*3
re St. S rrt re* elf tU *U vs rz *" rne tre re re sU0 Al. f" a o """;Do
4..,... 6 ivre 1. W re I1- Us0 5. 3 43. V45 1.5 I's- 5- 9l 95ll 4,10 1131411 lost
"9. t3 r t g t*-l t vU * ru V 0 5 *4 re 4 r tVA C us Airelst PIs U Ollt-t * ehlse ri flu s
'*~ 3~3 4.5I re g* else n'- Vol 616 04$ 0. t5.t d*9* t o V1. 3t 1t4 a's 3'31- 41- e n '*3'.3 . *n 6.9 e.g u.* *; to ase ls. ms vs .u" 94. 191 t96 s . * 1' 91* 'ln "WWs _ r !
~~~~10 ssI" VI U I t6 t u VWZ VW a' t`1 *a '% I-S Vs rt e >t Wu A'"M$ _ l^1
*f 3') u t~ s' 14 94 tS 5£ 5 948 t5 5. 5 5 r ss Xs ti ,s 'su @ffw4mtg $stl8vtt o -t t*iv41 r'g %la ,_ * 1 5'66 i rig _*s 1_st *11Vro sY- r rt r ia ess* 60S93 -Iie
6r a " 164W*w 5.14 roe 5*$ 906 VW 44 .1 £54 i'm 55.4r5ts 59,5 114*u £*1 POSa Soft .59
us1 ru 101 sto rs * .Su %vt 411g 3.51 511 swis m55s w915 I'll 5*3. 4te sw 9.w.9 Swat 3'w9 'el,8 S "9 isisig S-*.* w VI VWg us all me w* 3 LO£6 95.6 91.r Al V& 90 11.6 5.96 9`9 Vi*M9, 999151MM$13 5.VI'II5
3"oWO 6S'S wan SW VI.e 55K 553 clo 053 Ilia glow SIM 4V4" Me .1,10 915.s VOOI else, 131434iI 3134 9u'e
.C....~~~~W....... ........ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~....................
3.. '...f................. ................... 4. .......................
Us34$ w I45 "a 064$ 1633*66 spo ISiia a39 AV""s tau4 9' N 53
*6~~~~~*w
sss PS103 I eJSas
..
W411 WWi won ari WUI IU'U Sri" 515W RVis w* U W444 WM SINo WU St 51S 5515 WittI 5.1 o' i't.*su tw
*U irS 555T wit ill ti as Isils 2555 WSS irs. Ir, nss tU." Ws isu 2&9s It WSt " IS SI' $I /1, %Y 1 1* '$ 3n61 .t -0 tU 19t " XrU ' 1-1 2I9tt U 03 I8WU -t U-91t tj t' I>,S1 U-10, >WSI w V-9N n t ls-s; U-V-s SO WS *41 li """
* silUWt &WS aU't mot at :*m s le- l Wsa a 1s Ur , 9669 I5Y 'AS t5 1l t a q w i' .AtxWs- P's =,I U-#.t U." £ 1W ISat XsrU wto U St *S' Il Itt's S ts a" *n" eaow
att't W || ta%lc* tt' Ug*t well ilstu " IX M; Ig eult 4 t walXsl a"s; 4; as I; m; MZ tW 9" UV$S Well*ll "s4 %#t $ia-ft
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:*~~g~~s u~s ass S stu is. isa ss iss mti itS StUS *1l ISt bU t ns0 uWWJttS*- IW
#e. U~~~t Ag w on An #t SU *to M1 SU I" M to ti an $wlll ,usw I
*s '1 XU'I "'l " F " nt 0 ZS "t "b~~le 555 558 tSi £5 sas t#5 lW* 539 .SItSUUItw s -J;@W
* 4$ ill e aa- as S u0 3It 5181- 501W s 3rt m WI * Wt illS War? a-*s no *s *40f SIin*4 lelvm*6 555 55n1& sd# $W& gas Mrs s Is VAe arW- %&s- W SaOt wai 1* ssm wW* t Is 155t NO I 1 1 S036Sli
sa eM "It in, Ul t" Ma as" M se lste a41 - tit ass v"s OH M, sans miollIwIv
las 45£ usea 58UW la 1M ?W o ofe M at s la Aus "Se ates ins ains eSe $sWI M% ima
-a IM as.$C. l. .0
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n. m"" 'SnJoIei5p pr S n3A IP am (po"131103) 9'5 1OWN
-56- P ANNEX 2- - 56 - ~~~~~~~~Pase T-of 1
".y'~ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~'.,( ' ~ ~ * f :. . . '_S :. ,,
MACBECINMl LM
dstwsubmama _ _ 1 _ * JR IsC_
AU"Stiauioau gsnmuk*fm m mhaoa*6uIp.o.m ft.1tpUp
fstmrn_. _ boIqlmn uus~ 4O4c- . - - -
lbl~~wg.em Dhki*ptsehm euIbm.di_dL Duhd_p h1ysw.aimus qiXPsamks iao"&S*ad258W 19t9 inM. mI u b iw. plukmt-
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awi k4iqaiMw Aunt si
hb.m fi- Ck ad WI (=ozsBtW ~in&%*M hwFbChu. eqs w"aan loUstcduu.bsk* huadodsaemiuvh
hioney Pbu s RcW &UlmaYisWaI mfs. 3qamh.t hsbmgtA N" Wfa Vof ass
1939).~~~~~~~~~~~~~~~~~~~~~~~
wdam~.g4w ~&sj Ogdof Mmasu tobha.a mV behb'w N.miatpdsm aQwdMAIaJofjwifs.ddsk. ~ ~ ~ mos%euud &alds6sWad has... hUI9
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wA_i .1991. of%t NffS sl am th hwGme 0.65of GDP ga.91.Dgs.92ad &ee siW he
* ae~sdsegfSeCwsasIl-as
ofSepei.wpmddei Squi
-~~~~~~~~~~~~~~~~~~~~~~Um d_ict _ hategpe_apl
Dd* hwata hssaSfolheof da CPS 4 defiit aaadi-soffSeCPS tOdomi 0 C.sdiw,-a, tarofdmwoe c-e hkis8_ 9.75 of GDP in 19c 9W. CSS_bOaS &d w A UsS 0.55 eResesUIWatu#W-" _ g:F 1|271 5 198 ad for 199.2771ilk I9691?WhUsds.aw4d = 60.3.. tedoud 2M0 bosAnst
pudb~~~~od . d 9NF0.1 AA91.lX 6
wA57_N 2*7 Page 2 of 14
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-59- Pag e f
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- 70 -
Page 1 of 6
PERU
STRUCTURAL AD.JUSMENT LOAN
Supplementaz Loan Data Sheet
Section I: Mmetable of Key Events
(a) Time Taken by the Govemnmentto prepare program: June 1991 - August 1991
(b) Program prepared by*. Mnistry of Economy and Fmance(c) Furst presentation to the Bank November 1991(d) Appraisal: December 1991(e) Completion of Negotiations: February 1992(f) Planned Date for Effectiveness: December 1992
Section MI SpeiaBank hMlemtaon Action
This is the second in a series of three proposed adjustment loans to effect a workout for Peruunder the Bankes new policy of Additional Support for Workout Programs in Countries withProtracted Aras. The Bank's workout is part o4 and contingent on, an extnal financing plan for1991 and 1992 agreed among the international financial institutions and a Support Group of bilateraldonors It is also contingent on Peru's performance under a Bank - and IMF - supportedmacroeconomic stabilization program Under the Bank's new policy, the Board's approval wouldentitle Peru to the immediate disbursement of the whole loan amount after loan sigming andefftieess These would take place at the end of the performance period upon satisfactoryimplementation of the structuil adjustment program, the economic stabilization program, and theexternal financing plan (including clearance of all Bank arreas). Ibe performance period, whichstarted with the initial reforms of August 8, 1990, would terminate in December, 1992, concurrentlywith the termination of the IMFs ights accumulation program.
Section IL Specal Conditions
1. The folowming conditions for Board Presentation have been met:
(a) a macroeconomic stabilization program in place and agreed by the IMF and the Bank; thisprogram provides the common framework for this loan and the trade policy reform andfinancial sector reform loans proposed for Peru's debt workout.
(b) an agn financng pla, azreed among the international financial institutions and theSupport Group, which provides for full clearance of arrears to the Bank and thenormazation of Peru's relations with the IMF and the IDB;
(c) Peru remaining current on its servicing of debt to the Bank currently faling due (other thandebt covered under (b) above), on the terms already agreed with the Government.
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ANNEX 3Page 2 of 6
(d) agreement on sectoral
2. Conditions of loan gjgiag are as folows:
(a) prior clearance of arrears to the Bank;
(b) compliance, dunng the performance perod, with the IBF and Bank-supported program ofmacroeconomic stabilization, with particular reference to the Bank's quantitative indicators;
(c) the continued viabiliy of an external financing plan;
(d) compliance, durng the performance period, with the Bank's sectorl conditionality (seeparagraph 4).
3. The following conditions would be fulfilled for loan effectiveness:
(a) taking of all governmental actions required to authorize (or, if necessary, to ratify) signingof loan agreement; and,
(b) if a lapse of time- occurred between signing and these actions, continued satisfactoryimplementation of the trade reform and macoeconomic stabilization programs and theeernal financing plan, in accordance with the provisions of the Letter of DevelopmentPolicy.
4. Some je g meas have already been taken and are to be maintained, whereas others areto be fulfilled during the performance period.
L Conditions Preventing Policv ReversaL These conditions will be monitorable based onpolicies as of December 1991, and are arranged by sector:
A. Macroeconomic Polis.
* Maintain domesticcurrency convertibility for all cternal transactions to a single tpcof exchange rate.
* Tbe Govenment will not re-introduce foreign exchange surrender requirements orcontrols on current- and capital-account transactions.
* Maintain the use of foreign curencies in the local financial system
* Maintain payment to all IFs and continue negotiations with all other creditors agfor the full restoration of debt senvice
* Creation of monetary base maimly to fimance the quasi-fiscal deficit and increaeforeign reserves of the Central Bank
- 72 -
Page 3 of 6
* Maitain policy of market-determined interest rates.
* Maintain market-determination of prices and private sector wages.
B. Hiscal noli.v:
* Maintain the process of implementation of a new registration system for taxpayers.
C. Agric3tuae:
* Non-reversal of the elimination of State marketing monopolies established by SupremeDecree 066-91-EP.
* Maintaim aU proviions reformig land tenure, agricultural labor, and liberalizing agri-business activity in the 'Ley de Promocifn de hs Inversiones del Sector AgrtcolaW(Legislative Decree 653).
* Non-revesal of policy hberaizing the use of land as collateraL
* Maintain legal framework allowing agricultural-sector access to private commercialbank credit.
* Maintain all prvisions on water usage included in Legislative Decree 653.
* Maintain trade l ation provisions of Legislative Decree 653.
* The Government will not introduce any new mechanism for price control ofagricultural products and there will be no reversal in its policy of abolishing interestrate subsidies.
D. Labor.
* Maitain probationary employment refonns whi^h lengthen the initial employmentperiod for managerial positions or for work requiring a training and adaptation period(Legislative Decree 728).
* Maintain reforms which lengthen fixed-term contracts, as decreed in Supreme Decree077-90-TR.
* Maintain authorization for temporay employment for the purpose of initiation orincrease in work load, changng labor market needs, or for retraining of employees.
* Maintain reform of CIS system including nw semesterly c. osit system, choice ofcurrency in which to hold accounts, wMthdrawal conditions, anu tax status of depositedfunds.
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ANNEX 3Page 4 of 6
E Social Scdy
* * Maintain the legislation (Legislative Decree 724) which initiates the pnvatizationprocess for the pension system.
* Maintain streamlined collection system for social security contributions in whichemployers can complete a form to estimate contrbution due and make payment at anycommercial bank
* Maintain the deposit of IPSS funds m public and private banks.
* The current social security contnrbution rate will not be increased.
e Maintain IPSS policy of formig new rental contracts and selling property to reflectmarket prices.
IL Conditions for Further Reforms These will be monitorable conditions based on policycianges made between September 1991 and December 1992:
A. Macroeconomic Polks.
* Adopt measures and an implementation schedule satisfactory to the Borrower and theBank aiming for a level of Tax Revenues for the Central Administration of about 9percent of GDP. The primary deficit of the NFPS wil not be larger than 0.6 percentof GDP (January - December 1992) and there wM be no domestic financing of theConsolidated Public Sector Balance, defined as the deficit of the primary balanceadded to the quasi-fiscal deficit, plus interest payment on intemal and extenal debt.
* Central Bank creation of domestic credit will be consistent with IMF targets.
B. Fuscal Polic.
* By October 31. 1992 the Government and the Bank will jointly review taxes onexports and bank current-account debits and interest to assess the prospet of phasingthem out within a specific timetable.
* The monitoring of large taxpayers will be expanded from 1,200 to 2,500 firms.
* By March 31. 1992 SUNAT will complete the process of personnel selection at thenational level
* By June 30. 1992. the new infastructure of computer information systems will beinstalled in the region of primary taxpayers.
* Changes in the tax regime code, satisfactory to the Borrower and to t!he Bank will beintroduced to allow for greater efficiency in the tracking of infigements.
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A-M Page S of 6
C Si S W,
* Ibe Government wil develop, by January 31. 1992 a poverty alleviation strategy andimpleentation schedule, both acceptable to the Bank, outlining policies, andidentifyg pdority programs and target groups. The Government will adopt thisstategy by December 31. l99Q
* The Government wDI develop profles for pnonty projects m primary health andnutition acceptable to the Bank by Apil 3-Q2 2
* The Government will prepare a national nutntion policy acceptable to the Bank, basedon a reiew of exAstig food assistance progams, and wil recommend reformsnecessary to improve cost effectiveness by Aprl 30 1992. The Government willinitiate the first stage of these reforms in food assistance programs, includingstreamining the role of pubL;c agencies, by June 30. 1992*
* The Govemment will develop profiles for priority projects acceptable to the Bank inpreprimary and prmary education by Aril 30. 1992?
D. Prvtzain
* The Government wil implement policies defined in the institutional famework forpfiatization (established in Decree 674) by June 30. 1992.
* The Goverment will develop an overall action plan and implementation scheduleacceptable to the Borrwer and the Bank for divestiture n the banking, fishery(incuding Flopesca, Pescaperu, Epsep, and CERPER), and mining sectors (includingMinero Peru, Centromin Peru, and Hierro Peru) by June 30.
* The Goverment will develop a policy framework acceptable to the Borrower and theBank, including an implementation schedule for private sector participation in: (i) oilexploration, refining, and distnbution; (ii) gas production and distribution; (iii) powergeneration, tramsmission, and distnbution; (iv) telecommunications; (v) transportation(raihays, ports, and air tansport); and (vi) water supply and sewage, by June 30. 1992Z
* The Government wDI develop a divestiture strateg acceptable to the Borrower andthe Bank, including an implementtion schedule, for the sale of shares in al companieswhere the Goernment is a minority shareholder. The Goverment shk. Ad bring to thepoint of sale at least 6 of these companies by December 31. 1992.
* ITe Government will liquidate ECASA by Stmber192. The liquidation wiUfollow the A.-tion Plan already agreed by the MDB and the Government for the IDBTrade Sector Loan (PR-1796: Annexes V and VI; September 10, 1991). Ihe generalobjective of the.Action Plan is to help rapidly liquidate ECASA's assets with
- 75 -
ANNEX 3Page 6 of 6
reasonable prices, thus ailowing the corporation to settle its liabilities and preventcontinued costs which erode the state's fiscal resources. The liquidation steps aredetailed in Annex 9.
* Implement Supreme Decee 148-90-PCM, authorizing ENCrs reorganization. Thestructuring of ENCI wm also follow the steps agreed to by the IDB and the
Government entailed in the 1DB Trade Sector Loan and detailed m Annex 3.
F. Social Seci4.
*Pension svstem: The Covernment has issued a decree allowing for partial or completeprivatization of the pension system. There wil be no policy reversal regardingprivatization of this pension system, and, by September 30. 1992 the Government willpresent an action plan acceptable both to the Borrower and the Bank to implementthe privatization decree.
* Complete the separation of all health and pension fund accounts (except administrativeexpenses) by June 3Q I9
* IPSS, as fund intermediator, wil be subject to periodic independent auditing. Theseaudits wil include not only financial control but also admimstrative and operationaldiagoses and recommendations. The independent audit for 1991 will be completedby Qctober 31. 1992'
0 Reduce number of IPSS employees by an additional 7,000 by December 1992.
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ANNEX4Page 1 of 16
REPUBLICA DEL PERUMINISTERIO DE ECONOMIA Y FINANZAS
DESPACHO MINISTERIAL
Oficio No. 206-91/EFlO
Lima, February 20, 1992
Mr. Lewis T. PrestonPresident,The World Bank,1818 H street N.W.Washinon D.C 20433
Dear Mr. Preston:
1. In order to support the on-going stabilization policy as well as address the longer-termfundamental causes of the economic crisis, the Government of Peru is requesting from the InternaticnalBank for Reconstruction and Development (IBRD) a Structural Adjustment Loan of US$300 miulionequivalent.
2. In support of this request this letter describes:
- the Government of Peu's medium-term macroeconomic stabilization and medium-termadjusment program;
- the external financing plan for 1991-92 that Peru has agreed with its major creditors;
- ithe process, general conditions and dmetable by which the loan would bepresented to the IBRD's Board, subsequendy signed and made effective;
- the evolution and objectives of all components of the Strucu Adjusment Loan,highlighting the precise sectoral conditions the Government is committed to fulfill duringthe adjustment period and additional actions to be taken in the longer-term; and
- the procedures through which the Government will be reporting to the Bank onmacro-adjustment and sectoral reforms during the performance period.
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ANNEX 4Page 2 of 16
3. This letter also reflects our understanding on the conditions and criteia according to which theagreement for the proposed loan can be signed and made efective after approval of the proposed loanby the World Bank's Board of Directors.
}. THvE RS-EHffl S MEIUM-TERM MACROSTABIIAZAIO AND AD1UMPROGRAM
4. In July of 1990, when the preceding government let office, Peru was confronted with a severeeconomic and social crisis. By the end of that month, prices were increasing 36,000 percent annually,exports were 40% below their 1979 level, and per-capita income reached a 30-year low. The severemacroeconomic disequilibria were compounded by an intsification of violence and teorism. Theeconomic crisis resulted from a combination of massive fiscal deficits, wage and price controls, verydistorted multiple exchange rate system, negative real interest rates. Recognizing the urgency of restoringa sound economy, the new government launched the first stage of very bold stabilization and structuralreforms in August 1990. Notable corrective measures are a tight control over public sector wages, anincrease in public sector prices, and the creation of a cash management committee to manage CentralGovernment finances on a cash-only basis. In March 1991, a second wave of structural measures wereadopted ranging from trade, financial, and labor market reforms to privatzation.
5. Under the Rights Acumuation Program (RAP) agreed with the International Monetary Fund(IMP), the Government is committed to restore fiscal and monetary discipline during the performanceperiod (July 1991 to December 1992). To this end, the primary balance of the non-financial publicsector, which reached annual deficits exceeding 5 percent of GDP during 1987-89, has been improvedto a one-percent deficit in 1990 and a 0.4 percent surplus in 1991. In addition, the quasi-fiscal deficitwill be limited to a deficit in the neighborhood of 0.5 percent of GDP in 1991 and 0.3 percent of GDPin 1992. In accordance with the projected increase of money supply required to purchase foreignexchange reserves and to service the extemal debt of the Central Bank, the program assumes an averagemonthly inflation rate of 5 percent for the second half of 1991, and a monthly average of 2.7 percent for1992.
6. The Government of Pew recognizes that the success of its stabilization policy requires not onlycuts in spending and a tightening of credit but also significant increases in tax revenues. To achieve thelatter objective, the Government has considerably simplified the tax system and taken drastic measuresto improve tax administration. The Government is also determined to maintain the tax contribution ofpetroleum sector in real terms, and adjust public sector prices in line with expected inflation.
7. In order to contain inflationary pressures, the curent stabilizationplan entails eliminatg the needto print money for purely fiscal reasons. The removal of interest rate controls is also expected to boostfinancial savings and improve the efficiency of its allocation. In general, the financial system willincreasingly be in the hands of the private sector. In this spirit, financial activities undertaken by officialdevelopment banks will be scrutinized and an action plan to privatize public sector commercial banksimplemented.
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ANNEX 4Page 3 of 16
I. TIRE ERNAL PNANCING PLAN
8. As of December 1990, as much as twothirds of Peru's approximately US$22 billion extnal debtwas in arrears. The biggest share of these arrears was owed to commerial baniks and unguaranteedsuppliers (32 percent) and by the Paris Club creditors (31 percet) followed by International FinancialInstuti (17 percent). The government took prompt steps to restore Peru's ties with the itrnationalcommunity by resuming current debt service payments to the Bank (October 1990) and the IDB(November 1990). The current debt service payments to the IM had already been started by theprevious adminision in September 1989. The total monthly debt service payments to all three IPIsis about US$41 million, or 14% of fiscal revenues.
9. The Government, with the support of its major creditors has put in place a threestage debt work-out. The first stage, which entails the clearance of arrears with multilateral creditors, has already started.The second stage was initiated in September 1991 with Peru's rescheduling of its official bilateral debtwith the Paris Club. The last stage covers the negotiations with commercial bans. Ihe success of thefinancing plan rests on four key ftors. FirEl Peru must comply with the fiscal-monetary targets underthe IMP program and Implement the structurd reforms agreed upon with the IDB and the World Bank.Second Peru must fulfill its current debt service obligations to multilateral creditors. Tibrd. the supportgroup should provide financing to cover the 1991-92 gap estmated at US$0.7 billion. EQJrth Peru mustabide by the terms of the rescheduling of Paris Club debts.
Muliltwl Crelms
10. In order to clear Its arrears to multilateral creditors, Peru will rely on bridge loans againstdisbursements bqy hese instdiu as well as its own balance of payments efforts. The learance ofars owed to the IDB took place on September 13, 1991. Ihe finaning of this clearance was madepossible by the disbursement of a US$325 million loan to Peru from the Latin American Resve Fund(FLAR). On septemter 18, the IDB approved a Trade Sector Adjustment Loan of US$425 milion.Furthermore, MIB's planned additional lending to Peru will consist of one sector loan and four projectloans. The former loan will support the fnancial sector reforms and the projects loans wIll cover theareas of Electricity, Healtg, Sanitation, and Roads. Total comminments under these loans could reachup to US$1.1 billion, while disbursements prior to the end of the performance period could total betweenUS$700 to 800 million.
11. On September 12, 1991 the IMP approved a 16-month Rights Accumulation Program (RAP) tosupport Peru's adjustment program. Provided the macroecnomic taugets of the program are met, thisscheme will allow Peru to build up rights towards a fully back-loaded disbursement following theclearance of arrears. At the end of the program, remaining arrears can be cleared with a bridge loanaganst the IMF post-clearance disbursement Total nghts to be acmulated during the program, which-ire equal to total arrears, amount to SDR625 million.
12. The World Bank's contribution to Peru's exteral financing will come through its newly adoptedpolicy for countries with proted arrears. Under this policy, which the World Bank Board hasapproved for Peru, countries are entited to *contingent disbursements" during a pre-clearance"performance" period. Accumulated disbursements are released after the clearance of ares. Thegovernment of Peru expects this sheme to be applied to three loans: Trade, Structural Adjustment andFinancial sector. The Trade Policy Refom Loan of US$300 million has already been presented to the
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ANNEX4Page 4 of 16
World Bank Loan Committee in December 1991. We expect the Structural Adjustment Loan to besubmitted to the Board by late March 1992, and the Financial Reform Loan in June 1992. Togetier,these three loans could generate disbursement claims of US$900 million.
lliEbra Credtors:
13. Following the IMF's approval of the RAP, Peru obtained a significant debt relief from its ParisClub credrs. As of Decembt 1990, arrears owed to these creditors accounted for 36 percent of thetotal. The debt relief granted to Peru took the form of rescheduling, deferment of moratorium interest,and deferment of post-cutoff date arrears. The cutoff date of January 1, 1983 was retained for the ParisClub agreement, and post-cutoff date arrears were deferred to te year 2002.
Cammercla Banks:
14. About 90% of Peru's US$5.6 billion debt owed to commercial banks is past due. In reaction tolaw suits brought by these banks, the Government has promised to renounce recourse to statute-of-limitations provisions in exchange for a suspension of default proceedings that were initiated in Febnry1990. We believe that under the current circumstances, debt service payments to commercial creditorsis not feasible. For this reason, the IMF program assumes that no payments on medium- and long-termdebt to these creditors will b3 made except for short-term trade credits and non guaranteed privatecreditors which Peru is expected to service fully.
iironmr.ent for Private Sector Avty
15. The PerAvin Govenment is determined to create a more favorable environment for private sectoractivity and is taking concrete steps to encourage the inflow of foreign private capital and technology asto accelerate the development of Peru's mineral and petroleum resources. To shis end, the Governmenthas decided to move expeditiously to resolve some of the oustanding problems in this area-such as, forexample, the payment of adequate and effective compensation to certain affected foreign enterprises andinvestrs-which have adversely affected the investment climate. In this connection, the Government hasalready negotiated the basic framework of an agreement with American International Group (AIG),representing a group of insurance compaes, which should resolve their claim against the property ofPETROMAR, and facilitate the association and involvement of a qualified foreign private company inthe efficient utilization and expansion of petroleum production. The Government intends to implementthis agreement - and similar agreements with other companies - expeditiously. The support ofmultlateral instiuons such as the World Bank Group and the Inter-American Development Bank forthese policies and initatives will be essential in order to create a more propitious environment for privatebusiness and investment
16. Given the scenario outlined above, Peru is confronted with financing requirements of aboutUS$18.8 billion for the two-year period 1991-1992. To meet these requirements, we expect debt reliefto account for US$ 15.1 billion, the rest being provided by the FLAR (USSO.4 billion), the support group(US$0.7 billion), and by multilarl creditors (US$2.6 billion) through post clearance reneweddisbursements. The FLAR component and the first tranche of the 1DB loan have already been disbursed.As far as the World Bank and the IM are conced, disbursements are expected in December 1992.
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ANNEX4Page 5 of 16
The support group was officially established on June 7, 1991, under the co-leadership of the U.S. andJapan. As of August 1991, commitmens pledged by this group totalled US$1.1 billion and disbursementsare expected to take place through the end of 1992. About 61 percent of these disbursements will be purebalance of payment support and the remaiing 39 percent are devoted to non-programmed fiscalexpenditures or grants channeled directy to NGOs.
m. =PROCESS OF LO ANARATZON miMD :U!S aEARANlCE IWllTE OIBANK
17. The Government of Peru recognizes that the presentation to the Board of the StucturalAdjustment Loan ha is requested requires that the following conditions have been met:
(a) the Bank's agreement to the macroeconomic stabilization program outlined in thisletter (and agreed with the If).
(b) the adoption of an Extenal Finaning Plan, endorsed by international financialinstitutions and the support group, which is consistent with the clearance of all arrearsto the Bank and the normalization of Peru's reltions with the IW and the IlB;
(c) the Bank's agreement with the structura reforms presented in this letter; and
(d) Pem remaining current or .ts servicing of debt to the Bank currently falling due (otherthan debt covered und. (b) above), on tems already agreed between theGovemment and the Banm
18. The Government of Peru acknowledges that in assessing the adjustment program, the World Bankwill be using the following indicators for 1992: Cental Government tax revenues should be about 9.0percent of GDPP; the primary deficit of the non-financial public sector should be about 0.6 percent of GDPand the domestic financing of the Consolidated Public Sector Balance should be negligible; fromDecember 30th, 1991 to December 30, 1992 the rate of creation of monetary base should be about 40percent of GDP and by December 30th, 1992 the stock of other Central Bank monetary liabilities in Solesshould not exceed 0.1 times the monetary base.
19. The Government of Peru is filly aware that the loan will not be signed right after its approvalby the World Bank's Board. The loan's signate and effectiveness will come only after the'performance period" and the World Bank's recogniton that Peru has successfully implementd themacroeconomic adjustment program as well as the Structural Adjustment Loan presented in this letter.The "performance" period would not end before December, 1992, and would follow the time span of theIW's RAP. In addition to implementing these reforms, the Government is committed to supply the Bankwith all the information required for the monioring of the program and its reporting to the Board. Thespecific information and the frequency at which it should be made available to the Bank are described inthe attached Appendix.B.
20. The Goverment of Pemu recognizes its commitmen to continue to ser Ace debt falling past dueto the Bank with an equal ntrea of the IMF and the World Bank regarding debt servicing. Prior tothe signature of the loan, arrears to the World Bank would need to be completely cleared. The
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ANNEX4Page 6 of 16
Government of Peru fuirther understands that, in the event a lapse of time occurred between signing andeffeciveness, effectiveness would require that during this period the Bank continue to be fully satisfiedwith the implementation of the macroeconomic adjustmet, the exteal finmcing plan, and the adjustmentprogram, as described by this letter.
IV. TM GOVERNM SMUC ADlUSNT REORMS
21. The Government of Peru considers that structr reforms will reinforce the credibility andeffectiveness of the stabilization program. We are therefore working very closely with the Bank indesigning a reform package which include international trade reform, fiscal adjustment, privatization andderegulation, and financial sector reform.
TheTde Reform Prgam
22. The foremost objectives of the trade reform program are to remove the import substitution biasand induce a more efficient use of domestic resources. This program is also expected to provide anwelcomed impetus to technical progress. The elimnation of multiple exchange rates has been a majorstep in this direction by eliminating import tariff implicit in differential exchange rates. In August 1990,the Government unified the exchange rate under a freely floating exchange rate regime and liberalizedboth current and capital account transactions. Under the World Bank Trade Policy Reform Loan, theGovernment of Peru has agreed to maintain the convertibility of local currency at a single rate. TheGovernment has also moved towards more uniform tariff structure by reducing considerably the numberof different rates. By March 1991, only two low rates of 15 and 25 percent were used, with the formerrate covering as much as 81% of tariff positions.
Fiscal
23. As of July 1990, the finances of the public sector in Peru were in tot disarray. One indicationof this is that tax revenues accounted for only 6.4 percent of GDP compared to 14 percent in the mid1970s and early 1980s. Because the decline in revenues was not matched a similar reduction inexpenditures the non-financial public sector deficit increased from 2.7 percent of GDP in 1985 to 7.9percent in the first semester of 1990. This was compounded by the operational losses of the Central Bankresulting from its financial subsidies. The current administration bas taken corrective measures tosimultaneously increase revenues and contain expenditures. On the revenue front, public sector priceswere adjusted and the tax system improved. Corrective measures taken to contain expenditures includea combination of tight controls upon public sector wages and the postponement of public investments.
24. Under the Structura Adjustment L , the Government has agreed to improve the efficiency ofits tax administration. By October 31,1992, the Government and the Bank will jointy review taxes onexports, and bank current account debits and interest to assess the prospects of phasing them out withina specific timetable. The tax administraton agency (SUNAI) will improve the quality of its personneland modernize its equipments. These changes will facilitate the envisaged monitoring of a larger sampleof taxpayers. The program is reforming the Peruvian public sector, redefining the scope of Governmentactivities and changing policies related to its personel management.
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AN=l 4Page 7 of 16
25. he cnsiderbl interest that the Govement of Peru places in the social mpont of thisprogram is due to the conjunction of two factors. Ei. sundards of living have deteriorated very fastin the past five years hence compoudgthe structu poverty and skewed income distibution. Atestimony to this worsening is the decline in the proportion of the population in Lima under the povertyline was 44 percent in 1990. Second the adjustment from an unsustable economic siuation, moreoften than not, has a significant sociad cost. For this reason, we understand the need to design policiesto ptct the most vulnerable groups. Furthemore, this will ensure the political sustainablity of thereforms. To this end, the Govenment has created the National Fund for Social Compensation andDevelopment (FONCODES) to chnd resources to labor iesive projects targeted to the poorestsegment of the population including in the areas of basic health and education services.
26. In the context of the requested Structural Adjustment Loan, the Govetnment will develop apoverty alleviation strategy and implementationschedule, outlinmgpolicies, identifying priorityprogramsfor arget groups. As far as primary health and mtition are concened, the Government will design andsubmit to the Bank profies for priority projects, prepare a national mntrition policy, and review theaesting food aid program in order to undertake the first stage of its reform. Priority projecls for basiceducation also need to be idendfied with a corresponding implementation schedule.
Privdzafon
27. This is a case in which stuctural roms are expected to direcdy conibute to the stabilizationprogram tough the tmporary revenue gains and the simplificatio of fiscal maagemn. In March1991, the president issued a Supreme Decree which authorized the procedure s for the prvatizaton of23 companies. Ibis was followed by a legislative decree defining the legal and instiutional frmeworkfor the overal privaion program. In order to facilite the privatization process, a Commission underthe direct supenrision of the President was created. Ihe additional reforms to be implemented under theWorld Bank Structural Adjustment Loan will consist of settng reglatoy frameworks for specific sectorswhich define the policies to be followed.
28. The agricutural sector has greatly benefitted from the unification of the exchange rate as well asthe liberalization and deregulation of all domesdc and foreign trade. In line with its commiment to relyon market meanisms, the Government of Peru has abolished a stateowned rice markeig monopolyand land has been allowed to be transferred and used as collateral. In addition, credit subsidies grantedby the Banco Agrario will be eliminated. Under the terms of the Strucral Adjustment ILan, theGovemen is committed not to reverse the provisions related to the refom of land tenure, agriculturalcommercialization and credit, water usage, trade and labor policy siroduced in Legisative Decree No.653. In addition, the Government plans to reform agricultural ibnitutons with more activities shiftedto the prvate sector. Other measures iclude specific wazr pricing studies to be conducted by theMinistry of agriculte.
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Page 8 of 16
29. In the context of the overal structr reorms, a more flexible labor regulaon is a prerequisitefor the pected gains in resource alocation in the goods market to materialize. Moreover, therestrictiveness of labor nmuket reulations in Peru has artificially raised the efective cost of labor in theformal sector hence cotruting to the shifting of reource towards the informal sector and impedingPerm's intrational competitiveness. In order to increase the flexibility of labor markets, the Governmenthas issued a Decree allowing, under most circum , for fixed-term conract for all sectors. Thecauses for jusdfied dismissals have also been redefed to facilitate justified dismissals. The Govermenthas also extended the probationary employment period from three month to one year. Under theStructural adjustment Loan, the Government is committed to maintain all policy changes described above.
Socal aSecuty
30. ln reaction to the difficlties facing the autonomous body (IPSS) which adminsters Peru's socialsecurity system, the new Government has initiated a reduction of the staff of IPSS, the removal of theceiling on taxable income, and the elimination of most deductions. The system of compulsory depositand collection of IPSS funds at Banco de la Nacion has also bee eliminated. Under the present system,official and private banks have to compete for these fimds by making monthy bids. In the spirit of theemphasis on privaization, the Government has already issued a Decree dtat would allow privaiuaton ofan important part of the social security system. Forthcoming policies include periodic independentauditing of the of the IPSS and a reduction of its staff by an additional 7,000.
V3. ONIDIUNGM OF THE ADJUSrNT AND SM UClTURAL wRultMS AND TEINANCING
31. The Goverment will provide to the Bank the information necessary to follow the evolution ofthe macroeconomic policy as well as all components of the Structural Adjustment Loan. The nature andfrequency of specific information to be transmitted are descnbed in Appendix B.
VI. OCSN
32. The structural reforms outlined in this letter have either been implemented, are beinimplemented, or will be implemented in the near future. The Government of Peru undestands that thesepolicies will be the basis for Peu's position in any international negotiation related to the componentsof the Stuctral Adjustment Loan. Furthermore, in the event these negotiations give rise to a legalinstument, the Government understands that the Bank could request the relevant inomation in order toassess its impact on the program agreed in this letter.
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ANNE 4Page 9 of 16
33. In light of all the structrl reforms already implemented and the Government's conmmitnent tocarr forad alU the measugreed with the World Bank that are described ithis letter, theGovement requests your favorable consideation of this request for a Structural Adjusment Lon.
Yours sincerely,
Carlos Bolofla BehrMinister of Economy and Finance
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AMpendix APage 10 of 16
SCHDL OF SIUCrURAL REFORMS TO BE UNDERTAKEN OR MAIQTAI
1. Ihe specific policies to be maintained or implemented in each sector of the economyae descrbed below. Unless stipulated otherwise, all polihy changes not yet in place will bave tobe implemented by December 30. 1992.
L MACROECONOMIC ISSUES
2. In order to assess the overall macroeconomic performance of Peru, the Bank willmonitor the following indicators:
(a) Central Government tax revenues should be about 9 percent of GDP.
(b) The primary deficit of the non-financial public sector should be about 0.6percent of GDP and the domestic financing of the Consolidated Public SectorBalance should be negligible.
(c) From December 30th, 1991 to December 30th, 1992 the rate of creation ofMonetary Base should be about 40 percent.
(d) By December 30th, 1992 the stock of other Central Bank monetary liabilites (inSoles) should not exceed 0.1 times the Monetary Base
3. The following are specific macroeconomic conditions:
(a) Exchange rate policy. Maintain Sol convertibility for all external transactions toa single tpe of exchange rate.
(b) oeign exchangfe alloation: Maintain the rent policy which eliminates thecompulsory surrender of expo receipts, and eliminates aUl controls on current-and capital-account transactions.
(c) Foreign currency holdings: Ihe use of foreign currencies in the local financialsystem will be maintained.
(d) External debt service: Maintain payments to all IFIs and continue negotiationswith all creditors aiming at the full restoration of service.
(e) Monetary polir. Money creation will be limited to financing the quasi-fiscaldeficit and increasing reserves of Central Bank.
(f) Credit markts: Maitain the market determination of interest rates.
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Page 11 of 16
(g) Mket allocation Mechanisms Maintain market determination of prices andprivate sector wages.
(h F) Lbalance: Adopt measures and an implementation schedule sadsfactoly tothe Bonrower and the Bank aiming for a level of Tax Revenues for the CentralAdministration of about 9% of GDP. The primary deficit of the NFPS wiI notbe larger than 0.6 percent of GDP (Januay - December 1992) and there wibe no domestic financing of the Consolidated Public Sector Balance, defined asthe NFPS balance added to the quas-fiscal deficit, plus interest payment oninternal and external debt
(i) Deficit financing: Ihe central Bank creation of domestic credits should beconsistent with IMF targets.
IL ISCALL
4. Ihe following fical conditions wil apply:
( Ta) regim: By October 31. 1 the Government and the Bank will jointlyreview taxes on exports, and bank current-account debits and interest to assessthe prospects of pbasig them out within a specfic timetable.
(b) Tax amnsrto
i) The monitoring of large taxpayers will be expanded from 1,200 to 2,500firms.
(ii) By Mrch 1992 SUNAT will complete the process of personnelselection at the nationa leveL
(ii) By June 30. 1992, the new infrastructure of computer informationsystems will be installed in Region I (primary taxpayers).
(iv) The process of implementaton of a new registration system for taxpayers will continue to be carried out on a priority basis.
(v) Changes in the tax code will be introduced to allow for greaterefficiency in the tracking of iningements
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&Mm&nd APage 12 of 16
Im SOCIAL SECTOR ISSUES
5. The following conditions will apply to the social sector.
(a) Pover alleviation: By anuar 31. 1992. the Government will develop a povertyalleviation strategy, acceptable to the Bank, outlining policies, and identifyngpnonty programs for target groups. The Governament will adopt this strategy byDecember 31. 1992.
(b) Health and Nutrition:
(i) Ihe Government will develop profies for priority projects in primyhealth and nutntion acceptable to the Bank, by April 30. 1992.
(ii) The Government will prepare a national nutrition policy acceptable tothe Bank, based on a review of existing food assistance progms, andWil recommend reforms necessary to improve cost effectiveness byApril 30, 1992? The Government will initiate the first stage of thesereforms in food assistance programs, including streamlning the role ofpublic agencies by June 30. 1992.
(b) Education: The Government will develop profiles for priority projects in pre-pimay and primay education acceptable to the Bank, by APIL3QJ9
1V. PRIVATIZATION ISSUES
6. Ihe Govemment has recently issued Legislative Decree 674 (September 27, 1991)defining the legal and institutional framework for privatization. Additional measures to beimplemented are summarized below.
(a) The Government wil establish the institutional framework defined in Decree674 by June 30. 1992'
(b) Bang To develop an overall action and implementation schedule acceptableto the bank for divestiture in the sector by June 30. 1992.
(c) Fisher. Develop a policy framework for the sector and a firm by firmdivestiture strategy acceptable to the Bank, including an action plan andimplementation schedule for Flopesca, Pescaperu, Epsep, and CERPER by Jun30. 199I
(d) Mgingg Develop a policy framework for the sector and a firm by firm divestiturestrategy acceptable to the Ban, including action plan implementation schedulefor Minero Peru, Centromin Peru and Hierro Peru by Jn 192
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Appendix APage 13 of 16
(e) Oil and gas: Develop a policy framework acceptable to the Bank, including animplementation schedule for private sector participation in exploration, oilrefinig, distribution, and gas production and distnbution by June 30 1992?
(f) P Develop a regulatory framework acceptable to the Bank, including animplementation schedule for power generation, transmission and distributionwith the view interalia of promoting private sector investments in the sector byJune 30. 1992.
(g) Telecommunications: Develop a regulatory framework acceptable to the Bankincluding an implementation schedule promoting private sector investment inthe sector by June 30. 1992.
(h) nsRiM Develop a strategy acceptable to the bank an implementationschedule to promote private sector inmestment in railways, ports, airports and airtransport by June 30. 199
(i) Wstaand sewagg Develop a strateV acceptable to the Bank including animplementation schedule to promote private sector participation in the sector byne 30. 1992.
(I) Ote economic sectors: Develop a divsiture strategy acceptable to the Bankincluding an implementation schedule for the sale of shares in all companieswbere the Government is a iminority shareholder. Ihe Govemment will bring tothe point of sale at least 6 of these companies.
V. AGRICULTURAL ISSUES
7. The following conditions wil apply to agriculture:
(a) Agricultural commodity marketing:
(1) The Goverment will liquidate ECASA by Setema 1992. Theliquidation will follow the Action Plan already agreed by the IlDB and theGovernment for the IDB Trade Sector Loan (PR-1796: Annexes V andVI; September 10, 1991). The liquidation steps have been agreed to bythe MDB and the Govment, and will be identical for the SAL.
(i) Implement Supreme Decree 148-PCM, authorizing ENCI'sreorganztion. * he re ruturing of ENCI will also follow the stepsagreed to by the 1DB and the Government in the IDB Trac; Sector Loan.
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Page 14 of 16
(lii) Mantain the elimination of State warketg monopolies established bySupreme Dec 066"91-EF.
(b) Imd nudaeis and titg Mainain all proions refoming land tenmre,agricultual labor, and liberalizing agri-business activity in the t Ley de Promocifnde las Inversiones del Sectr Agrfcola (Decreo Legislativo 653).
(c) :AgdcuIltur :
(1) Non-rweesal of provisions allowing tbie use of land as collateal.
(ii) Maintain legal framework allowing agrcultur sector access to prvatecommercial bank credit.
(d) Agricultural water usage: Maintin all provisions on water usage Included in DLNo 653.
(se) Agdaltu U& 1li:. Maintn trde liberlizaton provisions of D.L 653.
(f) AgriStural.j dgcing .. lly: The Government will n introduce any newme ism for price control of agricultural products and there will be no reversalin its policy abolishing interest rate subsidies.
VI. LABOR ISSUE
8. The following conditions will apply to labor:
(a) o,rbak= =WmnIQ mp =l: Maintain the one year probationary employmentprovisions in Legislative Decree 728.
(b) Inman mpyn
(6) No reversal of the policy allowing fixed trms contcs for all sectors.
(ii) Maintain authorization for temporary employment for the purpose ofiitiion or increase in workload, chmging labor marlet needs, or forretraining of employees.
(c) Comp ion for time and srvices: No reversal of policy (DL 650) regarding thecompetition between financial institutions and firms for the special accounts towhich funds have been deposited.
Vn SOCIAL SEC
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Appedix APage 15 of 16
9. In the area of socil scuriy, the flowing conditors wil apply:
(a) Peion systm: The Govemment has issued a decree allowing for partal orcomplete privatization of the penion system. There wil be nD policy revesregarding privatzation of this pension systm, and, by Senteber 30. 1992, theGovenment wil presen an action plan acceptable both to the Borrower and to theBank to implement the privatizatlon decree.
(b) Adminisont of health and ensign aMa: By n 3Q. 192. complete theseparation of a)l health and pension fund accounts (except for adminis veexpenses).
(c) Colln ofcotrbtio : Non reved of the current policy under whichemployers complete form esdmating conrition due and make payment at anycommercial bank.
(d) Resource : Maintain the current system allowing fiuds to be placed inboth official and private banks.
(*e) Supsrvsiol Ad cQMW':
0I) By Jun 30. 1992 the IPSS will be subject to periodic indepeadentauditng. These audits will include not only financial control but alsoadministrative and optional diagosis and re ons.
(H) The independent audit for 1991 will be completed by Octobsr 31 1992.
(t) 2P revenue collectiow: The total contbution rate to IPSS will not increase.
(g) IPSS h iol assets: Maintain the market determination of rental contracts.
Qi) IPSS Personnel: By December 30, 1992, reduce the nber of employees by anadonl7,000.
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Appendix BPage 16 of 16
SCHEDULE FOR REPORTING
1. For the monitoring of the macroeconomic adjustment
The Government will provide to the Bank on a monthly basis the followinginformation:
(i) Central Government current tax revenues;
(ii) Primaiy Balance of the non-financial public sector (on a quarterly basis);
(lii) Rate of creation of monetary base and source of creation of monetazy base;
(iv) Stock of interest bearing Central Bank liabilities in Soles;
2. For the monitoring of structural adjustment reforms
The Government will provide to the Bank all documents (Draft Laws, Decrees,reports.) pertaining to the measures that the government has agreed to implement or maintain underthe Structural Adjustment Loan descnbed in this letter. The provision of documents should be doneon a continuous basis no later than a month after the relevant policy has been in;plemented, butbefore the end of the 'performance' period.
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ANNE 5Page 1 of 1
LIST OF PROJECT DOCUJ=N
Jorge Vega, The Public enditure in Perd 1980-192, December 1991.
Edgardo Favaro, Perd-Fiscal Reyiew August 1991.
Abel Viglione, Social Securit in Perd (Spanish), July 1991.
Abel Viglione, Executive Renort-Perd Pension System (Spanish) September 1991.
Abel Viglione, *La Bqlsa de Comercio de Limp-Perl, July 1991.
Susana Knaudt, Pefdln of Social Secu d lPS) July 1991.
Carlos Rodriguez, b.flationin .Erg, May 1991.
Carlos Rodriguez, ecoeonomic NAlt es November 1991.
Mario Pasco, Labor Markets in Perd (Spanish), August 1991.
Eduardo Manciana, Perd: Agricultral Problems, September 1991.
Linda Van Gelder, Labor Leislation in Peri, August 1991.
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Pagel of 2
A. SUaARY STATEUME OF LOAN(As of December 31, 1991)
Amount lessLs X# Doug= £aarca UndskumE
(USS Millions)Fifty-nie (59) loans fuilly disbursed 1159.08
2091 1982 Republic of Peru Trasport 93.0 50.39
Total: 1,252.08of which has been repaid: 448.62
Tota now outtanding: 803.86
Amount sold: 18.31of which has been repaid: ILIt
Total now held by Bank:
Total undisbursed:
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Page 2 of 2
B. STAENLQT OFg IE (As of December 31, 1991)
Amount in USS millionBorrower~ ~~M Of BushmesLam FMEauitv
1990 BUENAVENTURA Metal Ore Mining .00 1.01 1.011979 BUENAVENTURA Non-Ferrous Ore Mining 2.00 .96 2.961983 BUENAVENTURA Non-Ferrous Ore Mining 4.00 .00 4.001986 BUENAVENTURA Non-Frous Ore Mining .00 1.00 1.001986 CARISA Non-Ferrous Ore Mining 6.00 .S0 6.501962 CEMENTO ANDINO Mfg of Cement Lime & Plaster 2.46 .20 2.661982 CONENHUA Mfg of Electric Light & Power 4.50 .00 4.501975 CUAJONE Non-Ferous Ore Mining 15.00 .00 15.001960 DURISOL Mfg of Fabric Metal Products .30 .00 .301960 FERTILIZANTES Mfg of Ferilizers & Pesticides 3.19 .00 3.191962 .90 .00 .901960 LUREN Mfg of Non-Metallic Mineral PR .28 .00 .281985 MINERA REGINA Non-Ferrous Ore Mining 6.08 .24 6.321986 ORCOPAMPA Non-Ferrous Ore Mining 9.00 .00 9.001964 PACASMAYO Mfg of Cement Lime & Plaster 1.60 .49 2.091967 .00 .01 .011983 PALMESA Mfg of Vegetble & Animal Oil 15.00 .00 15.001986 PODEROSA Non-Ferrous Ore Mining 3.30 .00 3.301960 REUNIDAS Mfg of Fabric Metal Products .25 .00 .251980 SIMSA Non-Ferrous Ore Mining 2.7 .50 3.201985 4.00 .00 4.001982 SOGEWIESE Leasing Companies 3.00 .14 3.14
Total gross commt : 83.56 5.04 88.60Less cancellations, terminations
and sales:
Total commitment now hdd by IFC: 6.56 2.27 8.83
Total undisbursed: 00 In1 3
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Page I of 3
TECNICL ASSISTANCE PROGM FOR SRU ADJUS
To help implement policy reforms included in the SAL, the Bank would providetechnical assitance totalling about $55 million in the six areas: (a) budget planming andexpenditure control; (b) poverty alleviation; (c) privatization and restructuring of publicentterprises; (d) agiculture sector reforms; (e) social securit system; and (f) external debt AUthese activies would be financed through the Japanese Grant Facilty -nd GTZ (GermanTecbnical Aid Agency) grants The Bank's tecbnical assitance program can be summarized asfollows:
L Budiet Plnuuinf and Exediture Control:
(a) Budget planning and expenditure monitorin:i.. to strengthen the capacity ofthe Direccion General de Presupuesto Publico (DGPP) of the Ministry ofEconomy and Fmance (MEF) for reviewing the budget structure anddeveloping criteria for national budget planning and expendituremonitoring (e.g., by sector, region, and program/ project);
(b) Development of the public finance system to conduct a diagnostic study ofpriority requirements for upgrading the DGPP's information technologyand design the public finance ifmation system. Funds would be alsomade available to purchase computers and software and provide technicaltraining with the DGPP staI
(c) Formulation and administration of the public investment program: to assistthe MEF, sector ministries and regional govrnents in reviewing theexisting public investment program and formulating a pipeline of newpriority projects for possible external financing (as well as re-evaluation ofseveral costly existing projects), based on the ground work done by theBank's Public Investment Review Mission in November 1990. Prioritywould be placed on agriculture, tansport, electricity, health, education, andsanitation; and
(d) Traming and seminars for public finance. public investment and projectplnning: to provide training and semmars (both in Peru and abroad) withstaff of the MEF and other pubLic agencies concerned, including sectorministries and regional governments.
2. Povert Aleati-on:
(a) Development of a Social Compensation and Development Fund(QNQDO ): to help the organization of FONCODES and assist indeveloping its management inormation system, geographic poverty-basedtareting mechanisms, and financial procedures; and
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ANNEX 7Page 2 of 3
(b) Formulation of pnonity social pMogmaprjec: to assist the Ministries ofHeal and Education in designing priority programs in primary healthcar nutrition, primary education to respond to the needs of the poor.
3. dirvatlzatlon
(a) Implementaion of the pnivatization pgram: to assist in developing theoverall privatization strategy, assessing the market value of the companiesto be privatized, designing an individual strateg for government divestiturein the selected sectors (e.g., financial, mining, power, oil, steel, fisheries,telecommunications, transportation, and water sewerage etc.), andestablishing an institutional framework for employee stock ownership plans;and
(b) Evaluation and reform of regulatoWy and institutional environment: to assistn developing a legal and regulatory environment that is conducive togreater private sector participation, and the eventual development ofcapital markets
4. Arilture Sector Reforms:
(a) Support to agicultural policy reforms: to assist the Ministry of Agriculturem establishing working groups to develop the sectoral and subsectoralpolicy famework and specif and implement necessary policy changes inenvironment and water resource management; and
(b) Urban and rural titling and registratio: to implement a pilot propertyregistry program for titling and registration of rural/urban real estate in themetropolitan Lima and selected rural arAs
S. bSodal Securit Sm
(a) Pevelopment of an operational plan for privatization: to assist the PeruvianInstitute of Social Security (IPSS) in developing an operational plan topartially privatize the existing pension fund system, based on theGovernment's decision in November 1991 (supreme decree No. 724).
6. Etn f
(a) Design of the debt information stem to conduct a diagnostic study toevauate the Govements specific needs for a debt information system
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ANNEX 7Page 3 of 3
and support the implementation of the system. Funds would be alsoavaiable to purchase computers and software and provide technicaltraining in the use of the system; and
(b) Developme . of an external debt strateg. to assist in development of adebt strategy and in preparation of Peru's debt negotiations with itscreditors through support to the debt negotiation office, Direccion Generalde Credito Publico of the MEF, and other relevant agencies
In addition, in colaboration with the UNDP, the Bank would assist the ProjectCoordination Unit in the MEF in coordinating compliance with the loan conditions, collecting andprepaing the supporting documentation for the disbursement requests, presenting disbursementrequests through a special procurement section to include representatives of Customs and theCentral Bank and fulfilling reporting requirements and coordination with the Bank.
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PRE ATJZATMON STRATEY 3Y SECTOR
1. SAL conditionality for privatization states that:
* The Government will implement policies defined in the institutional framework forprivatization (established in Decree 674) by June 30. 1992.
* The Government will develop an overall action plan and implementation scheduleacceptable to the Borrower and the Bank for divestiture in the banling, fishery(including Flopesca, Pescaperu, Epsep, and CERPER), and mining sectors (includingMinero Peru, Centromin Peru, and Hierro Peru) by June 30. 1992.
* The Government will develop a policy framework acceptable to the Borrower and theBank, including an implementation schedule for private sector participation in: (i) oilexloration, refining, and distribution; (ii) gas production and distribution; (iii) powergeneration, transmission, and distribution; (iv) telecommunications; (v) transportation(railways, ports, and air transport); and (vi) waxer supply and sewage, by June 3Q
* The Gmvermment will develop a divestiture strategy acceptable to the Borrower andthe Bank, including an implementation schedule, for the sale of shares in allcompanies where the Government is a minority shareholder. The Gwvernment shouldbring to the point of sale at least 6 of these companies by December 31. 199Q
2. The privatization strategy, outlined below by sector, was developed during preparation forthe SAL with the use of Japanese Technical Assistance funds, and is still evolving. This strategy,when completed and found acceptable to the Bank and the Borrower, will be implemented under thefinancial sector adjustment loan, the privatization adjustment loan (which will include the miningsector, ydcarbonsand the fishery sector), the transport sector rehabilitation project, the watersector rehabilitation loan, and the energy sector rehabilitation project.
L BANNG SECTOR
3. In the banking sector the state is involved in: (a) five development banks; (b) Banco deIa Nacon - created in the mid 1970s to handle: the financal operstions of international trade, forthe administration of the external debt, and the collecdon of taxes - a task previously handled by theprivate sector, (c) Inversiones Cofide - a second-tier bank to created to promote economic activitr,(d) seven commercial banks in which the state controls more than 99 percent of the shares and whichcolectively are referred to as the "Banca Asociada": Banco Popular del Pe, lanco Continental,Inteuc4 Banco Sur Medio y CaUao, Banco Nor-Peru, Banco Anazonico, aL anco de Los Andesand their subsidiaries; and (e) two commercial Banks with pnvate sector participaton but where thestate has a majcriiy control - Hipotecarlo and Banco de Comercio, which are referred to as the"Banca Mbcta
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4. Iu 1990, the state banb accounted fcr approximately 64 percent of the capital in thefinancial system, 70 percent of the credit, and 61 percent of the deposits At the end of 1989, theyemployed 72 percent of the employees in the sector. There is no reason for such extensiveparticipation in commercial banking when the relatively scarce fiacial and managerial talents of thestate could be better utilized elsewhere. The state banks cannot compete wth prvate sector banksdue to their discontinuity in management, overstaffing, and political influence in decision-making.They have been especily affected by the tecent economic crisi, which has caused a generaldeterioration in bank portfolios. To compensate for this deterioration, commercial banks have beenable to reduce their operational costs and increase their deposits through more aggresse competitionin the savings market. Tbe state-owned banks do not have the same flexibility to reduce costs andtheir operations are perceived as more risy by depositors These features have led the state banksto operate with higher interest-rate spreads allowing private commercial banks to increase theirprofitability. It is also important to emphasize that: (a) the higher operationa costs and interest ratesof the state-owned banks negatively affect aU economic activity through an unnecessary increase ininterest rates; and (b) the state is forced to make equity contnbutions or transfer subsidized depositsto these institutions to save them from bankriptcy when their revues canmot cover these costs.
5. The banks included in Banca Asociada are commercial bas expropriated foreconomic and nationalitic reasons in the 1970s and 1980s. The most important banks in this groupare: Banco Popular del Pe, formerly owned by Grupo Pardo; Banco Continental, the formerChase Manhattan Bank; Intrbanc, the former Chemica, Bank-, and their subsidianes. The BancaAsociada has 45.8 percent of the branches and 46.0 percent of the employees of the commercialbanking sector but accounts for only 26.3 percent of the deposits and 20.2 percent of the placementsInformaton provided by the Superintendencia de Bancos y Seguros (SBYS) - the govement agencyresponsible for the supervision of banking activities - indicates that in June 1991 4&0 percent of theportfolios of these banks were in difficulty.
6. The Banca Mixta includes Banco Hipotecarlo and Banco de Comerdo, in which thestate has a 74.2 percent and a 59.0 percent share, respectively. These banks have &1 percent of thebranches and 8.0 percent of the employees in the sector and account for 2.0 percent of the depositsand 13 percent of the placements Information from SBYS indicates that 21.5 percent of theirportfolios were in difficulty.
Reeent Reforms and GOP strte
7. GOP's commitment to the reform of the banking sector is evidenced by the inclusionof Banco Popular del Peru, among the 23 companies designated for privatization in the March 1991Presidential Decree No. 041, by the sale of the Government's 15 percent stake in Sopwlese Leasingin June 1991, and especial by the issuance, on April 26, 1991, of Legislative Decroe No. 637, "LAyGeneral de Istituciones Bancuias, Fnancieras y de Seguros to state commercial banks from theCentral Bank" also referred to as the New Banking Law. This law also includes important measuresto improve the efficiency of the sector, including: (a) enlarging the scope of operations of commercialbanks, especially in the acquisition of shares and the issuance of bonds; (b) increasing the fisaliZationpower of the SBYS; and (c) establishing rules for the autoizaton of new financial institutions Inaddition, the law cals for a restructunng of Banco de la Nacion and the Banca Asociada, to bringabout a downsizing and greater productivity and efficienc of these institutions in six months. On
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September 27, 1991 tie GOP issued the Legilative Decree No. 674 establishing the legal andinstitutional framework for privatization, and following that, the President of COPRI officially invitedthe IFC to implement the privatization of Baneo Popular del Peru. In February 1992, the GOPbegan the prepaatory procedures for the privatization of Banco de Comerdo.
Stratv for Reform
& The privatization of the Banca Asociada and Banca Mbcta, a major step inrestructuing the sector, should simutaneously reduce the fiscal burden on the state and enlarge GOPrevenues through the sale of assets.
9. The GOP will appoint a Special Committee for Banking Privatization in accordancewith the new institutional framework for privatization, since the restructuring cr privatization of onebank will affect all the others, and the portfolio of non-performing loans - the most important issuein bank privatization - could be minimized by global management. The committee should be headedby someone of prominence with the skdll to successfuly lead negotiations between the Govemnmentand the private banks The main tasks of the comiTittee will be to: (a) minimize losses by designingan effective mechanism for the collection of bad and doubtful loans; (b) minimize the social cost ofadjustment by softening the impact of employee reductions; (c) design and implement a strategy forthe privatization of each of the banks in Banca Asociada and Banca Mixta; (d) recruit consultants toaudit and appraise the banks; (e) renew the consultants valuations and set mnmum prices; (f)recruit legal advisers; (g) define criteria for the pre-qualification of potential buyers; (h) prepare althe necesay documents for the offer, (i) organize the auctions; and G) supervise the legal andadministrative procedures for the tasfer of the banks to their new owners.
10. The reason for the GOP's decision to start the privatization process in the bankingsector with Banco Popular del Peru (BPP), whose privatization was announced in the LegislativeDecree No.041 of March 1991, probably was BPP's poor financial performance and the imminentprospect of an equity contnrbution to save it from bankruptcy. With 199 branches, the bank operatesin almost every important city of the country, has 3,600 employees, and holds 3.2 percent of thedeposits. It has an operation in Bolivia with 18 agencies, and subsidiaries that should attract theprivate sector. Among these subsidiaries is Peruinvest, a non-bank financial institution, mainlyinvohled in leasing, which is to be granted a ful commercial bank license as part of the prvatizationprocess. Besides these few good assets, BPP has a bad portfolio, an eccessive iabor force, and atradition of a poor management made worse by recent exodus of qualified staff driven away by lowwages and uncertainty about the bank's future.
11. BPP should be trans&feed to the private sector in its entirety. If part of it remainsunder state control, there wfll certaily be continuing losses since it does not have the appropriatestaff or management to handle banking operations. The steps i BPP's pnvatzation should be: (a)the administrative supervision of BPP's management to ensure that the required reports forprivatation are prepared accurately and on schedule, and that the present monthly operational lossof more than US$2.0 million is stopped; (b) the transfer of the bad and doubtful loan portfolio toBanco de la Nacion; (c) the implementation of downsizing plan through the sale of some assets toprivate investors; (d) a guarantee that all the proceeds from GOP capitalization and the sale of assets
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will be used for risk-free operations and not to increase BPP's credits; and (e) the transfer to theprivate sector of the downsized BPP.
12. Since the privatization of BPP has no assurance of success a privatization failure ora pubhic impression of an underpiced sale could serously erode public support for pdvatization.Consequently, the privatization program should simultaneously include other banks more likely toattract private investorsm This will (a) give the committee some leeway to negotiate the transfer ofpart of the bad portfolio to private banis; (b) strengthen the credibility of the privatization programamong private investors by the transfer of banks that do not have cash problems; (c) speed up theprocess of improvmg the effciency of the financial sector; and (d) increase GOP's revenue in theshort run.
13. Prnvatization should proceed with the transfer of Banco de Comercio and Interbanu.GOP has 59 percent of the shares in Banco de Comerclo, a smaU bank with 1.3 percent of totaldeposits, 41 branches, 682 employees, and the best portfolio among the state-owned banks. The saleof GOP shares in Banco de Comerdo to the private sector should be designed with the sole objectiveof bringing in revenues. The case of Interbanc is somewhat different. Interbauc is fully owned byGOP, has 209 branches and 3,400 employees, and holds 42 percent of total deposits. The objectiveof Interbanc's privatization should not be solely to increase revenues for, in addition, privatizationpresents an important opportunity for the GOP to: (a) stimulate the development of the capitalmarket; and (b) increase competition by transforming Ilterbac into an independent bank owned notby a single group but by several investors. The committee should examine the feasibility of thisalternative with the help of consultants.
14. The privatization committee should determine, in discussions with private investors,the best timing for privatizing the remaining state-owned commercial banks - Banco Nor-Peru, Dancdel Sur Medio y Callao (Surmebanc), Baumo de los Andes, Banco Amazonico, and GOP's stake inBano H}potecario. These banks have a combined total of 170 branches and approximately 4,800employees. The main target of privatization here should be to increase the GOP's revenue.
15. As the final stage in the privatization of the Banca Asociada and Banca Mixta, theGOP should start the privatization of Banco Contntl, the largest state-owned bank, with 8.5percent of total deposits, 123 branches, and 3,300 employees. As in the case of Interbanc, the targetshould be not only a revenue increase but also the spread of ownership among many groups ofinvestors and the development of the capital market.
16. Once the strategy outlined has been approved by the GOP, implementation shouldproceed under the Special Committee for Banking Privatization. The Bank will support thecommittee with Japanese Grant Funds to recruit consultants to audit and appraise BPP; and preparespecific privatization strategies for Banco de Comerdo and Interbc. The Bank wil also advise theGOP in the analysis of alternative means to utlize debt-equity conversion in bank privatization andin the design and implementation of ESOP schemes.
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17. The maine waters off Peru are among the richest fhing grounds wn the world, and,prior to the 1970s, made Peru one of the world's top fishing nations. However, the sector hasdecHned sigificantly over the last 20 years as a result of increased state intervention and the advereeffects of El Nito, the warm water current of 1972-73 that decimated the important anchioveta catch.The sector, wich is export oriented, provided 15.8 percent of Peru's exports in 1989. Currently, itemploys 6.4 percent of the bbor force. The primary product is fishmeal, and the Governmentaccounts for 37 percent of the production. Despite its rich resource, Peru controls only 17 percentof the world market for fish products Overall efficiency in the sector is low, with an average fish tofishmeal ratio of 5.13:1, compared with the worldwide average of 4.7&1. Government involvementhas been one of the major obstacles in the sectoes development, particularly because of unfairompetition with private initiave and iefficient management, which has hurt competitveness in
international trade.
I& The state controls tve enterprses in the sector. The largest, Pemperu, was createdin the early 1970s and soon thereafter acqured a monopoly in the fishmeal industry through theakver of 99 fishmeal plants The company presently is losing US$140 for every ton of fishmealproduced. It produces lower quality products than Chile from the same raw materials, and thereforereceives 10 to 20 percent lower prices for its fishmeaL The company is highly inefficient, with over1,000 excess employees. It presently owns 20 operational prcesing units, 16 redundant units, 1guano fertilizer plant, and 4 oil referies. Seven of its plants coud bandlce 70 percent of its capacity.
19. Another major state-owned enterprise i Epsep, which was given the monopoly of fishdistution in 1970 to ensure the supply of fish, especially to low-income groups. The GOP hascontinued to support Epsep, despite its lsses, because of the company's social role. Audits from1980 to 1988 revealed nonprofitable investments, uncontroled expenses, and poor centralizedmanagement of the operational units. Epsps major source of supply was a Soviet fleet that turnedover 17.5 percent of its catch under a contract that was certaly unfavorable because it does notreflect the opporunity cost of the catch. Epsep is overstaffed, with 1,100 worbers where 400 areestimated to be adequate. In the mid 1980s, the GOP set up Eopescs, as a subsidiary to Epsep, witha fleet of fishing boats that wud supply the domestic market with rozen fish. Ti company hasnever generated a profit and is now in liquidation. Copes, a mixed company, was created in 1974between Epsep, rep ing the Government, and Star Kist, a private tuna canning company. It hasbeen managed unilateraly by Epsep during the lst five years, when it has suffered severe losses; in1988 these totalled US$7.8 million. The fifth state enterprise is Cerper, a priately owned firm
xpropriated in 1970 and given a monopoly over fisr- product certification. Its manageral andfinancial condition has steadily deteriorated over the lasL few years
Recent Reforms and GOP Sratm
20. The GOP recently has made some important changes in the sector, putting an endto Epsep's monopoly of fish distributon and Pescperls monopoly of fishmeal production. It has
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also begun a partial selling off of the assets of Pescaperp, and authorizd the liquidation of Flopescsm Supreme Decree 002-92, on January 29, 1992. Epsep has cancelled the contract with the Sovietfleet. Maitime work has been liberalized, allowmng for a decrease in the cost of port sennces whichhave been among the most expensive in the world. A new fisheries law has been drafted. Many ofthe Goverment's broad reforms, including liberalization of exports and foreign imnestmentopportunities and the abolition of export taxes, have encouraged the development of pnvate sectorparticipation. However, continuing privatization will depend on a resolution of the following issues:(a) LIabo - Fishing crews, chosen by fishemen's unions rather than boat owners, are entitled to 40percent of the value of the catch, a practice certain to deter new vessels carrying heavy financialobligations Another problem is that plant employment is considered permanent rather than seasonal,resulting in ecess costs for the plants. (b) Regaatory Framework - Development is inhibited bycumbersome regulations and adminstrative units that slow the process of issuing iicenses to theprivate sector. The Ministry, ighbly overstaffed with 6,000 employees, 60 percent of whom work inLima, needs to be streamlined. Succsful privatization will require the establishment of the SpecialCommittee for Fshery Pvatation and a regulatory fmeork that can control overfishing and thegranting of fihing concessions so as to ensure equitable competition among private investor
Stoately for Reform
21. Ihe GOP's privatization strategy covers the following plans: (a) Pescaperu will betransferred to the private sector through an employee buyout that wM give the workers anopportumty to manage the compaWn, (b) Flopea is being liquidated and its fishing boats are beingsold to private investors, (c) the privatization of Copes wil depend upon an agreement with theprivate co-owner, who holds 45 percent of the capital; (d) Epsep will be reorganized and its activitieslimited to a market regulatory role, with most of its commercial activities, presently performedinefficiently and at a loss, turned over to privt initativeu The company wll be divested of its fishingvese and about 90 percent of its transport fleet, which will be sold to its employees Thealternative of liquidating this company will also be assessed. Cerper will lose its monopoly overcertification, particularly for exports, and retain only its role of inpection and quality controL TheBank and the GOP will develop a firm-by-firm divestiture strategy, including action plans andtimetables for their implementation.
m MDIMG
22. The mining sector is a major component of the Peruvi economy, contnbuting 12percent of GDP and 50 percent of total exports, and its poor performance in recent years thereforehas had a significant impact. The three principal state-owned companies - Minero Pru, Centomnd,Hiervo Pe-u, and their subsidiaries - are responsible for 93 percent of copper concentrate production,40 percent of lead production, 38 percent of zinc production, and 100 percent of iron ore production.Production declined by 25 percent in the second half of the 1980s, during which time the overal netinvestment was negative Inadequate investment has inhibited the expansion of production and
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Page 7 of 17
exploration as well as the ability to repair and replace equipment. At present, the major miningcompanies are operatig at an average of 75 percent of their installed capacity.
Recent RefrMs and GOP Strategy
23. The GOP has recognized that the immediate revival of the sector is essential and willonly be possible with the involvement of the private sector. On July 13, 1991, the GOP issuedLegative Decee No. 647 authizing private sector ownership of a minimum of 51 percent of theshares in Miner. Pero, CeStromI and Hierro Peru through an mcrease of capital that wouldprovide pnvate investors with the majority stake. This decree was recently rejected by Congress, butptivatizaton program in mining is continuing under Legislative Decree No. 674, which establisbeda broader legal and institutional framework for the overal privatization.
24. Reiulatory Framework- Te GOP has taken several steps to attract private mvestors.A new mining law, issued by Decree No. 708 in November 1991, provides for equal treatment ofpublic and prvate enterprses, support of market forces to encourage economic efficiency, eliminationof mechanims that inhibit investors, allowance of joint ventures, and the free commercialization andownership of gold. A new investment law includes guarantees that foreign investors will be able toremit diviends abroad.
25. Institutional Structure- INGEMMET, the public research and technology agency, hasbeen reorganized to investigate and generate basic information for the sector, as recommended bythe Bank. More than two million hectares of land previously reserved for the public sector have beenreleased to the private sector. Over the next six months the total reserves are to be reduced by 18percent. The General Directorate of Mines (DGM) has begun a process of reform but has not yetachieved much progress. The personnel have been reduced from 150 to 60, but DGM is in need ofsignificant streamlining and modernization, to more efficiently fulfill its role as the regulatory bodyin charge of supervision, planning, and promotion in the sector. It has acquired computer informationsystems, without proper planning that do not adequately match its needs.
Stratefy for Reforn
26. Rapid prwatization is essential, given the deterioration of the mIning companies, andthe Special Committee for Mining Privatization should be created as soon as possible, in accordancewith the Privatization Decree. To ensure that they are operatie when privatized, the companiesshould immediately transfer to the private sector services that are not essential; drastically reduceadministrative costs; layoff of redundant workers, with compensation; consolidate the activities ofMhpeco, which provides marketing sertices to the state mining companies, with Centromn andMinero Peru; and examine the liabilities of Mipeco to determine which obligations wil betransferred to the private sector and which wil be assumed by the Central Government. Potentialinvestors will require information on each enterprise in a form consistent with international staniardsto include: financial statements prepared by auditors; a professional opinion on the legal proceduresrequired for privatization; and details of geological reserves, present state of mining operations,envronmental impact of operations, and mmimum potential of the mines In the final stages, theactual transfer will require the assistance of an investment banker.
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27. Although the GOP has made significant progress in developing an adequate regulatoryframework for private sector mvestment, a number of changes are still required. Among these arethe removal of all distinctions between small, medium, and large companies; and the establishmentof a tax package that will eliminate excessive dependence on indirect taxes and promote efficiency.DGM should be restructured as a modern and efficient organization for allocating, directing, andcontrolling mining nghts. It should acquire adequate software and hardware support for the cadastreand related activities of control and statistics to ensure prompt and smooth attention to all requestsand transfers. INGEMMEr should focus on reducing the size and complexity of its organizationalstructure and improving the ratio of technical personnel to administrators from the present 70:30 to90:10 or 85:15.
28. Environment - Mining is a major source of pollution in Peru, which the regulatoryframework and the practices of the companies do little to address. The privatization strategy shouldinclude environmental audits as part of the technical preparation for transfer. Based on these audits,the sales agreements should contain provisions for cleaning up major environmental problems andan understanding that new environmental standards with which the new owners would be expectedto comply may be introduced.
29. Centromin - is company should be privatized as rapidly as possible, since itsfinancial situation is alarming as demonstrated by the growth of its current debt to US$74 million in18 months. Priority should be given to the transfer of the company and to keeping it in operationuntil then. Centromind should not be sold as a whole but in distinct segments attractive to the privat-sector. These should have a solid economic base, and should be flexible enough for successfulnegotiation with potential investos Once it has been privatized, Centromin should take on thefunctions of a holding company that would eventually combine with an equivalent holding companyto be developed for Minero Peru. Although the privatization program should attempt to mini miesocial costs, it should be made clear from the beginning that some plants will have to be closed andothers wil have their operations suspended until they can meet international enwronmental standards.
30. Minero Peru - This company did experience a slight economic recovety in 1991, andhas embarked on a plan to reduce costs and augment production. Both local and foreign investorshave been invited to participate in the development of its projects. In accordance with theGovernment decision to privatize Minero Peru, with Bank support, initiated the recruitment ofconsultants to appraise the company.
31. Hierro Peru - The privatization of Hierro Peru is underway. An internationalconsultant who commenced work in January 1992 is scheduled to provide a valuation of the companywithin four months. The recent Bank mission reviewed the consultant's proposal and contract andapproved the scope of work In accordance with Bank guidelines, Hierm Peru has also selected thebank that will assist in identifying buyers and preparing sales documents.
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ANNEX 8Page 9 of 17
IV. OIL AND GAS
32. The major state enterprse in this sector, Petrperu, is responsible for 54 percent ofPeruvian oil production and for supervising the remang 46 percent by foreign companies underconcesson agreements Pe1or is also responsible for 100 percent of refining and distribution.As a result of the GOP's insbility to provide sufficient capital investment, the reserves and productionof hydrcarbons are presently at 50 percent and 65 percent of their respective 1982 levels and Peruhas become a net importer.
Recent Reforms and GOPrat
33. The GOP has taken some significant steps to initiate the privatization process.Petropers 84 gasoline stations have been proposed for sale to the private sector, and the contractingout of exploration and development has been increased. In addition, a money-losing fertilizer planthas been closed and 1,500 eccess Petroperu employees have been laid off.
Slraltq for Reform
34. The revWal of this sector will depend on the establisment of a regulatory frameworkthat will attract private sector partcipation in the refining and distribution of oiL The first area ofreform wil have to be the revision of the pricing policy for petroleum products Ex-refinerypetroleum prices need to be increased to reach parity with international border prices. The presentsystem in which the GOP subsidizes Pecboes operating deficits will have to be changed. A secondarea of reform must be the resruucuing and deregulation of the hydrocarbon sector that will require:(i) legislation to remove barriers to the entry of the private sector, (ii) sale of 25 percent of thestorage capacity of Peropeu to the prvate sector, (iu) freeing of exports and imports of crude oiland petroleum products and of refining, and (*v) rationalization of taxation policies and insurance.
35. The third area of reform is a divestiture strategy for Petropu. If the GOP decideson a partial divestiture, it must defie the core business to be retained and the non-core business tobe spun off or divested. Among the functions that should certainly be removed are the regulatoryresponsibilities for exploration and development - which should be transferred to the Directorate ofHydrocarbons within the Ministry of Energy and Mines. An adequate regulatory framework forprivate sector participation in gas production and distnbution is necessary for the privatization ofSoAP
36. Petrma has presented for Bank review bidding documents for consultants to conductthe valuation and an invetment bank to assist in the transfer of the company to the private sector.However, it is unclear what the GOP is planing to do with Petromars liabilities and employees.Pe_trmar, which operates the offshore oil fields in the Talara region, was created in 1986 when Belcowas nationalized.
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ANNEX8Page 10 of 17
37. Solgas, which controls about 40 percent of the LPG distrbution market and competeswnth three prvate firms, has selected firms to conduct a valuation. The success of privatization willdepend on the adjustment of ex-refinery LPG prices, as mentioned above.
38. Petrolen Transoceca, a shipping company fully owned by Petroperu, has themonopoly of oil transport, with four petroleum-product tankers. The strategy agreed upon by theBank and the GOP entails the sale of the company as a whole, with a provision that Petroperu wouldcontinue to use the tankers for another year under terms to be included in the bidding documentsinviting offers from private investors. The next step will be the recruitment of consultants to preparethe valuation of the company.
V. POM
39. There are 11 state-owned companies in the power sector. Electroperu, itssubsidiaries, and the provncial government enterprises account for 70 percent of electricityproduction and distribution. (The rest is accounted for by private firms.) The power sector is facingits deepest crisis in decades. The standard of service has deteriorated noticeably in the last few year,with frequent and lengthy intenruptions in supply, low reliability, and a high level of losses. Theinstalled capacity of 2,785 MW is far short of the increasing demand. Since nationalization of allprivate concessionaires in 1972, the generation and distribution of power has been placed under theauthority of Electropem Efficient operation has been inhibited by. monopolistic and centraliedoperation; the absence of an independent regulatoty body, pricing policies inconsistent with economicprinciples; and a lack of corporate autonomy and accountability.
Recent Reforms and GOP Strateg
40. In February 1991, the GOP passed Law No. 25304 authorizing the participation ofprivate investors in the power sector, as autoproducers, coproducers, concessionaires, BOT schemeinvestors, etc. In July 1991, Legislative Decree No. 649 authorized the sale of the GOP's stake inregional power companies. This legislation became effective in December 1991, and the GOP willissue the relevant regulations by March 15 1992. Although the new legislation, which the Bankreviewed prior to issuance, still requires some improvements, it does provide important changes andallows for modenuzation of the sector.
Strategv for Reform
41. The privatization strategy begins with Electrolima, the largest power distnbutor andthe second largest generator after Electroperu. The functions of Electroperu will be redefined in theEnergy Sector Reform and Rehabilitation Loan under preparation by the Bank Among the projectsof private sector investment to be evaluated and supported by the Bank are: (i) the privatization ofE:lectrolia (iC) the seling of the Federal Govemment's minority stake in the regional powercompanies; and (iii) a Build-Own-Operate scheme for power generation for the Ima area proposed
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ANNEX 8Page 11 of 17
by a private group of investors In the power sector, as in telecommuncatons, water and sewerage,and eventually transport, the establishment of a regulatory agency will be necessary. Because of thescarcity of human and fiancial resources m the country, the Bank will analyze the altemative of uinga single regulatory agency for all these sectors.
VL TELECOMMUNICATIONS
42. Two companies provide telephone serce in Peru: Entel, which controls all regionalphone operations as well as all long-distance and international services; and CPT, which manages theLima metropolitan area. Entel, which is 100 percent state-owned, was created in 1969 to absorbservices previously provided by Government commissions or foreign companies that were nationalized.CPT, which was created in 1970 when IT&T was nationalized, is mainly subscnrber owned (69 percentof shares), with the Govemnment holding 21 percent of the remaining shares and private shareholdersholding 10 percent. Recently, cellular phone serce has been introduced as a joint venture betweenCPT and the private sector. The service provided by the state-owned companies compares verypoorly with semce in other countnes. There are presently 2.6 telephone lines per 100 of thepopulation, compared with 10.2 per 100 in Argentina and 9.1 in Venezuela The GOP has set atarget for increasing the number of telephone lines to 10 per 100 citizens by the year 2000, a projectthat would cost US$35 billion over the next 9 years and require the services of expenencednternational telephone operators.
Rent Reforms and GOP Strat
43. The GOP is proposing to sell its 21 percent interest in CPT and a controlling interestin Entel, to ensure new investments and improve efficiency. The Bank supports this plan and hasprovided three alternatives which the GOP is presently analyzing. (a) the sale of a controllinginterest in Entel and CPT separately to a consortium of private and/or foreign investors; (b) themerger of Entel and CPT or alternatively offering a controlling interest in Entel and CPT jointly toa consortium of private and/or foreign investors; (c) the creation of tw'v separate operating companies- one including the northern part of Lima and the northern hin land provinces and a secondincluding the southern part of Lima and the southern hinterland provinces - and the offer of sharesto two different sets of private and/or foreign investors. The GOP has appointed a new presidentof Entd to implement the privatization. In an attempt to overcome the opposition of CPT, theremaining obstacle to pnvatization, the GOP has issued new by-laws for CPT under which a newboard will be elected in February.
44. The GOP has recently issued a new Telecommunications Law, prepared with Banksupport, which will allow and stimulate private sector participation in telecommunications service.
45. On November 5, 1991, the GOP issued Legislative Decree No. 685 to create a stateenterprise, Serpost, to replace the General Directorate of Correspondence as the body responsiblefor postal service. The decree also prohibited monopoly of postal service and declared privateinvestment in the shares of Serpost to be of natonal interest.
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ANNEX8Page 12 of 17
Stategy for Reform
46. A key element of the telecommunications legislation should be the establishment ofan independent regulatory agency to minimize political interference in the sector, to exercise publicoersight over private supply, to enforce the telecommunications law, and to promote theGovernment's objectives in telecommunications. Because of the scarcity of human and financislresources in Peru, the Bank is analyzing the alternative of using a single regulatory agency fortelecommunications, power, transport, and water and sewerage. Another important legal aspect willbe the implementation of an equitable and clearly defined pricing policy.
47. In the privatization of CPT and Entd, the main issue is the ability of the Ministry tocontrol CPT, whose President is withholding support for the program. The Government stake inCPT is only 21 percent, which does not give it clear control. The next step to facilitate the processwill be the formation of the Special Privatization Committee for Telecommunications. Once thecommittee is established, it wil be advisable to send a mission to discuss the sector strategy.
VIOL TRANSPORTATION
adcround
4Q Peru's transportation system is a Government monopoly in all areas except airtransport, where the state-owned airline, Aeroperu, operates in a highly competitive environment thatrewards the quality of management. The airline carries 20 percent of international passengers andfor 44 percent of the domestic load. The entire transportation sector is in dire need of rehabilitation.The railroads, marine fleet, and port infrastruture are operating at levels below that of five yearsago. About 88 percent of the roads are in disrepair, and 70 percent of the railroads are in adeplorable state.
Recent Reforms and GOP Strate
49. The GOP has begun the implementation of a policy conducive to private sectorinvestment in the sector.
(a) Airlines - To create an enabling environment for private sector investment,the GOP in July 1991 authorized the operation of new companies to transportpassengers and freight Three new companies providing regular passengerservice, seven companies providing charter flights, and four maintenancecompanies have stared business in the last five months. Continuing thisliberaliztion process, the GOP issued a new Civil Aeronautics Law inSeptember 1991, that removes tariffs in the sector, and that followed theLegislative Decree of July 13 authorizing the privatization of Aeroperu. Aninternational consultant has been selected by Aeroperu to: (-l review andupdate its financial statements; (ia) catalog its assets; and (iii) assess the valueof the company for privatization.
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(b) Highways - Although the GOP will continue to own the nation's roadways,a proper strateg for private sector development is essential for rehabilitationand maintenance. An estimated 30 percent of the roads are to be toll roadsoperated by private companies through concessions. The remaining 70percent can be serviced by private sector contracts paid for by a HighwayFund suppled by a portion of the revenues raised from gasoline tax TheGOP issued Supreme Decree No. 006 in April 1990 designating the Mistryof Transport and Communications as the sole authority to establish tolls, thuscreating the conditions for a national Highway Transport Policy. The 1991budget for the public sector permits the toll system for federal highways to beoperated by private ;nvestors under concessional agreements. Two bids fromprivate toi operators are being reviewed.
(c) Ports - The GOP has taken the following measures to encourage increasedprivate sector involvement in port services: (i) Supreme Decrees Nos. 026,027, and 054 have eliminated the monopoly of the Comision Controladora deTrabajo Maritimo on stevedoring services, bringing about an immediatereduction of the 40 percent tariffs; (ii) the state-owned company, Euapu,which is responsible for adntering and managing all major ports, has beengiven icreased decision-making power, has reduced its work force by morethan 3,000 employees, and has transferred to the private sector all stevedoringwork, the loading and unloading of cargo, and the maintenance of containerhandling equipment; (iii) Legislative Decree No. 644 has fuly liberalizedmarine transport routes, as well as the rules governing the purchase and leaseof new ships In addition, Supreme Decree of July 1991, has eliminated thereserve of 50 percent of cargo transport for Peruvian ships. As a consequenceof these two measures, new companies have been created and new routeshave been established by existing companies.
(d) Railroads - Ihe state-owned rairoad, Eoafer, which dominates railtransportation, is in dismal condition with most of its tracks and cas indisrepair, and an operating deficit of US$26.3 million. The GOP is clearlyaware that rehabilitation will require private sector involvement.
(e) Urban Transport -The improvement of urban transportation services requiresthe reform of the reglatoxy environment to permit the private sector tofunction freely. Import policy has resticted the adequate procurement ofparts, cars, etc. and fares are not commall viable. Liberalizing measuresin this area are (i) Legisltve Decre No. 640 of June 1991 eliminating allrestrictions on routes and operations in the interprovincial transport ofpassengers; (ii) Legislative r ree No. 642 of June 1991 reducing the tariffsin the incial transpL . and (iii) the completing opening up of routes,operations, and tariffs for uroan transport throughout the countty in July1991.
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Sa for Reform
50. Ihe next recommended steps for private sector development and prvatization in thetransportation sector are as follows:
(a) Airlines - Establishment of the Special Pnvatization Committee for Acroperuand the hiring of an airline expert to assist the committee in identifying andnegotiating with potential buyers Aeroper. should prepare thepre-qualifcation bidding documents for privatization
(b) Highways - The GOP must outline a clear policy and reorganize the GeneralDirectorate for Roads to handle concessions and contracts.
(c) Ports - The folowing measures are necessary. continuing the prtvatization ofport operations, including the handling of general cargo, at the port of Callao;priatizing the handling of general cargo at aU ports; privatizing the receiving,storing, and loading of minerals; developing a program for the transfer oflarger structural and civil works projects to private industry, and establinga format for attracing the private sector to the tug boat operations in the portOf Callao.
(d) Urban Transport - Once the GOP has created an enabling environment forprivate sector participation, the next step should be the privatization ofEnatr, the national bus company, through an employee buyout.
(e) Railroads - Several possibilities offer the GOP a choice for the developmentof Euafer. (i) a large section of the railway, the Linea Central, could betransferred to its primary client, Centromin, the state-owned mining company,but this will depend on the GOP's divestiture strategy for the mining sector,(ii) Enafer could be transferred to the private sector by means of aconcession; (iii) the GOP could retain responsibility for the upkeep of theinfirastructure and turn over operations to the private sector, either on aconcession basis or to a joint public/private operator, or (iv) the GOP couldissue several contracts for select railway operations. Regardless of whichoption is chosen, the following reforms should be undertaken by Enaferimmediately: (i) 1,500 excess employees should be laid off, withcompensation; (ii) radio train control and communications should beintrduced; (ii) all less than wagon-load traffic should be discontinued; and(iv) documents should be prepared for the contractig out of special servicesto the private sector.
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Vm. WATER SUIPLY AND SEEGE
Raround
51. Through a system of 13 state-owned municipal companies, the GOP controls 100percent of water and sewerage operaions and distrbution. At present, only 73 pcent of the urbanpopulation has access to water and 50 percent to sanitation. In the rural areas, only 22 percent hasaccess to water and 6 percent to sanitation. Average annual investment in the sector from 1985-1989was approximately 0.15 percent of GDP, one of the klwest in Latin America.
Recent Reforms and GOP StMAteW
52. As a first step to private sector participation in the sector, Sedapal has begun thebidding process to delegate the task of biing to a private firm. Eight firms are already pre-qualifiedto install and maintain 120,000 meters in SedapaPs west region and bil customers. The Bank andthe GOP have agreed on the utilization of the Japanese grant approved last May for theimprovement and rehabilitation of the water and sewerage infrstructure.
Sratev for Reform
53. The existing rehabilitation program being administered by LAIIN, with a Japanesegrt is designed to be implemented by the public sector, however, a major issue to be discussed isthe role that the private sector can play. The Minister of Housing recently informed the Bank thatthe GOP plans to transfer as many aspects of water and sewerage management as possible to theprvate sector and is preparing an overall strategy and the regulatoty framework for this purpose.
DC S
Backexound
54. The State Entrepreneurial Activity includes approxiately 77 industrial companieswhere the GOP has either minorty or majority control and which do not require any changes in theregulatory enviroment prior to privatization. The companies in which the GOP has a minonty stakeinclude Cementos Lima - and its subsidiaries Nisa, Sia, and Larcabon; Quimlca del Paclco, Enata;and Fertisa. The two most important companies in which the GOP has a majority stake areParamouga and SideVer
55. Parmonga, natiazed in 1974, controls 60 percent of the market for paperproducts and is also one of the country's most important manufacturers of chemical products. Itsinstalled capacity can produce approximately 250 million metric tons of paper products andapproximately 25 million metrc tons of chemical products. It uses the kalag and malaz from sugarcane for the production of its paper products. Paramonga is the second largest consumer ofpetroleum in Peru and one of the major consumers of electricity. Its situation has become difficultas import duties for paper products have been reduced by SO percent and for chemical products by
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Page 16 of 17
25 percent. The situation will worsen when the import taiffs for the Andean countnes areeliminated in January 1992, since Pamamong cannot compete without them. Exacerbating theproblems of increased competition is a declining demand for Paramongas products, as a result of theeconomic crisis.
56. Siderpero, the major steel producer, supplied about 60 percent of domestic demandin 1989 and operates the only integrated steel mill in Peru, with an annual installed capacity of450,000 tons of crude steeL Its mill is located at Chimbote on the Pacific Coast about 420km. northof Lima. Throughout the 1980s, Siderperu operated in a privileged environment protected both byits status as priority supplier and by high import tariffs which averaged 50 percent. Under the presentGovernment, Siderperu lost its privileged status and consumers began to import steel products freely.Since March 1991, import tariffs for most steel products have been lowered to 15 percent. Due toincreased competition, production this year is expected to be less than 200,000 tons.
Recent Reorms and GOP Stratenv
57. On March 12,199'., the present administration signed a Presidential Decree (DecretoSupremo No. 041-91-Er) authorizing a legal framework and procedures for privatization and listing23 state-owned companies as the first batch designated for prnvatization. COPRI is doing thepreparatory work for the privatization of these companies, some of which can be brought to the pointof sale before June 1992. Tle main companies in this list are: Cementos LAma - with a GOP shareof 49 percent, 418 employees, total assets of US$107 million, and total income of US$43 million in1990; Fertss - fully owned by GOP, with 382 employees, total assets of US$5.4 million, and totalincome of US$10.7 million in 1990; and Enata - fully owned by GOP, with 221 employees, total assetsof US$3.3 million and total income of US$2.2 million in 1990.
58. The GOP has requested the Bank's support for the privatization of Paramonga andSiderperu, although it has not made an official announcement because of the anticipated oppositionof the local communities of Paramonga and Chimbote. A mission visited Siderpers and concludedthat privatization could proceed rapidly.
Strateg= for Reform
59. The primary consideration must be a reliable valuation of assets. To ensure this, itis recommended that a reputable firm be recruited, with Japanese grant funds, to: (i) assist thecompanies in the preparation of the TOR for the valuations; (ii) supervise the valuation proceduresdeveloped by auditors selected through a bidding process; and (iii) review the final valuation reportsThis strategy would permit local firms to participate in the valuations, under the supervision of theexternal consultant.
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ANNEX 8Page 17 of 17
X JUDIWDA-MONS
Backwound
60. The GOP has drawm up a preliminary list of 28 small state-owned companiesconsidered to be non-viable and therefore prime candidates for liquidation.
Recent Reforms and GOP Stratefv
61. Legislative Decree No. 674 issued in September 1991, outlined rules for theliquidation of state-owned companies. Consistent with this, the GOP presented the Bank with aprelimnay list of ten companies that would require US$89,640.00 in Japanese grant funds for theirliquidation. These are: Grope TAS, Negocldon Avicola El Cencerro, Alambresa, Min Agula,Iquitos Plywood, Fundacdon Aulna del Peru, Tractoes Andluos, Maqulnaia y HermmnutasMoraveco, End, and Ecasa.
StrateU for Reform
62. It is recommended that funds be disbursed in tranches The frst disbursement wouldbe made when the GOP presents the first list of companies with a timetable for their liquidation.The second disbursement will be made only after the first has been concluded.
