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Peru

Author(s):
International Monetary Fund
Published Date:
February 2009
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I. Background

1. The 2008 Article IV Consultation and Fourth (and final) review under the SBA takes place against a backdrop of strong macroeconomic performance but sharply deteriorating global conditions. With the Fund-supported program coming to an end, the consultation provided a good opportunity to highlight accomplishments in recent years, as well as the policy challenges and risks going forward.

  • Economic growth has been among the highest in the world. After reaching 10 percent in the first three quarters of 2008, recent indicators suggest that real GDP growth could decelerate to 7½ percent in the fourth quarter of 2008, and would end at around at 9.4 percent for the year as a whole. Growth has been led by private investment and consumption, as well as by a significant recovery of public investment.
  • Inflation has risen but remains low by regional standards. Headline inflation was 6.7 percent in 2008, above the 2 percent target (+/- 1 percent band), mostly driven by higher food and fuel prices. However, pressures broadened, with core inflation (excluding food and fuels) rising from 1.5 percent at end-2007 to 4¼ percent at end-2008.
  • Steady fiscal surpluses and declining public debt vulnerabilities. The nonfinancial public sector surplus is projected at 2.1 percent of GDP by end-year—entailing an expansionary fiscal stance, largely as a result of a significant increase in public investment and 0.6 percent of GDP in repayment of liabilities under the Fuel Price Stabilization Fund (FEPC). Fuel subsidies have been eliminated through adjustments to the band price and the sharp decline in imported fuel prices, while excise taxes on selected domestic fuel prices have been raised markedly (Box 1). Public debt has been reduced from about 33 percent of GDP in 2006 to 25 percent of GDP in 2008. The share of foreign currency denominated public debt has declined to almost 60 percent, the public sector has become a net external creditor, and the sovereign was granted investment grade by Fitch and Standard & Poor’s in April and July 2008, respectively (Box 2).
  • The economy is more open, with a better business climate and declining poverty. Peru has been liberalizing external trade through tariff reductions in recent years and has also been seeking enhanced market access through new bilateral agreements. To complement the approval of the Peru-U.S. FTA earlier this year, the authorities have continued negotiations with the EU and China, among others. There has been progress in simplifying administrative procedures and in enacting legislation to reduce labor market informality. Over the past two years, urban employment has risen by 9–10 percent, and poverty rates have declined from 44½ percent in 2006 to 39⅓ percent in 2007.

Real GDP per capita growth

Peru: Inflation decomposition

NonTradable Inflation

(excluding food)
Peru: Fiscal Performance 2007-08
20072008
Prel.CR 08/258Proj.
Total revenue of general government120.819.620.8
Total primary expenditure of general government116.016.017.1
Current expenditure12.912.213.0
Capital expenditure3.03.84.2
Public enterprises primary balance0.1-0.1-0.1
Overall balance of NFPS3.12.02.1
Central bank operating balance0.20.0-0.1
Overall balance of CPS3.32.02.0
Overall balance (including CRPAOs)2.21.41.3
Source: Peruvian authorities and Fund staff estimates.

Net of transfers to non-financial public sector (NFPS)

Source: Peruvian authorities and Fund staff estimates.

Net of transfers to non-financial public sector (NFPS)

Peru: Average effective tariff rate

2. The economy has been moderately affected by the global financial crisis thus far. Strong fundamentals, along with several measures implemented have helped limit the contagion from the global financial crisis, preserve adequate liquidity conditions in domestic financial and capital markets, and bolster domestic confidence in the economy. In particular:

  • Limited financial contagion. After tripling to above 620 basis points in late October, sovereign spreads have eased to around 455 basis points more recently and equity prices have recovered somewhat, but are still 60 percent lower than at end-2007. Following US$8.5 billion in foreign exchange purchases earlier this year, the central bank sold US$6 billion since September, to limit market volatility and contain pressures on the Nuevo Sol, which has depreciated by 5.8 percent against the U.S. dollar. Facing tight liquidity, reduced capital inflows, and a steepening of the government yield curve, the central bank has held policy rates unchanged since October, but eased reserve requirements and placed repos and swaps in Nuevo Soles and U.S. dollars. At the same time, the state-owned Banco de la Nación signaled its intention to repurchase government fixed-income securities in the secondary market. As a result of these measures, interbank and prime corporate rates in U.S. dollars, and the government yield curve are close to pre-crisis levels.
  • Banks have remained resilient, and a “credit crunch” is being avoided. After growing at about 30 percent in the year to September, credit to the private sector accelerated in October, particularly for the corporate sector, partly as a result of tighter financing faced abroad and in domestic capital markets. Large official reserves—which stood at $31 billion at end-December and strong financial soundness indicators for the banking system, along with banks’ limited reliance on external funding (at about 15 percent of total assets and two-thirds of long-term nature) have helped preserve stable liquidity conditions.
  • Dollarization has rebounded in recent months after declining markedly over the past two years. The share of dollar denominated deposits has risen markedly since September, reflecting portfolio shifts associated with concerns on the global financial crisis. Stress tests suggest that banks are better prepared to face a currency depreciation, while corporates and households also seem less exposed to currency-related risks (Box 2). Nonetheless, a potentially sudden and sharp depreciation could still bring strains to balance sheets and confidence, and revert the trend in dedollarization.
  • The authorities announced an “anti-crisis” plan to shield the economy from the global crisis and buttress business confidence. The government announced a “Plan for Sustaining Economic Growth, Employment, and Poverty Alleviation in a Global Crisis”, which presents a set of fiscal measures—equivalent to nearly 2½percent of GDP—that could be ready for implementation as conditions warrant. These include measures targeted to maintain a program of public investment and support construction, micro and small enterprises, exporters, and social programs, to be financed with public sector deposits. The government has also lined up access to contingent lines from official creditors that could amount up to $9¼ billion dollars.
  • Peru’s performance under the SBA has been good. All quantitative performance criteria for end-September were met, but inflation exceeded the upper limit of the program’s consultation band for end-September and end-December (see attached letter from the authorities). With data yet to be released and no evidence that the performance criteria will not be met, the authorities are requesting a waiver of applicability for the end-December 2008 quantitative performance criteria. End-June and end-September structural benchmarks were also met, except for the issuance of methodological guidelines to assess tax exemptions, the implementation of the Treasury Single Account (TSA) and the submission to Congress of amendments to the Decentralization Law to reconcile subnational government spending limits with those for the central government as presented in the Fiscal Responsibility and Transparency Law (FRTL). The timing of implementation of these reforms is uncertain.

Peru. Domestic Sovereign Yield Curve: Impact and Response to Crisis

Peru: Changes to Reserve Requirements (RR) in 2008-09
20082009
JanuaryJulyOctober 1/December 2/January
Minimum nonremunerated RR (both currencies)6997.56.5
Marginal RR for FX deposits3049353030
Marginal RR for NS deposits (residents)025000
Marginal RR for NS deposits (non residents)01201203535

The RR of 9 percent on long-term (more than 2 years) credit lines from foreign institutions established in August was eliminated in October. The marginal RR for foreign credit lines in both currencies were also removed in October.

Regarding local banks' short-term USD-denominated obligations, the BCRP established a 35 percent ceiling to the average RR.

The RR of 9 percent on long-term (more than 2 years) credit lines from foreign institutions established in August was eliminated in October. The marginal RR for foreign credit lines in both currencies were also removed in October.

Regarding local banks' short-term USD-denominated obligations, the BCRP established a 35 percent ceiling to the average RR.

Peru: Credit to the private sector 1/

1/ Based on latest available monthly data for 2008 for each country

Share of Credit and Deposits in Foreign Currency

The Anti-Crisis Plan: Fiscal Measures
Percent of
S/ millionGDP
Total10,0322.43
Support to construction sector3,1200.75
Mortgage financing guarantees2,9200.71
Access to drinking water2000.05
Support to SMEs and export sector1,3600.33
Public investment5,0021.21
Investment continuity initiative1,5000.36
Key new or accelerated projects (68)1,0080.24
FONIPREL2,2940.55
Other2000.05
Social programs and targeted support to workers5500.13
Memorandum items
Spending already in 2009 budget5500.13
Spending in baseline staff forecast1,7000.41
Nominal GDP413,550

II. The Medium-Term Outlook and Risks for 2008–2010

3. Medium-term prospects are favorable and require preserving prudent macroeconomic policies and dealing with long-standing structural challenges. With heightened risks stemming from the global economy, preserving the high quality of macroeconomic policies is necessary to sustain high growth, low inflation, external stability, and poverty alleviation. Peru has become a more open economy, and continued capital deepening should enhance productivity and potential output growth—estimated by staff at 6–6½ percent, to generate strong employment growth and higher real wages. These efforts need to be further complemented by reducing high labor market informality and improving the quality of public investment and social spending across all government levels to alleviate infrastructure and social gaps, and thus support ongoing export diversification and poverty alleviation. Strengthening public institutions, advancing administrative simplification and education attainment, would also help boost human capital and entrench high total factor productivity growth.

Peru: Contributions to Potential Output Growth and Output Gap 1/2/

1/ Calculations based on a laborshare of 32.3 percent, and a smoothed capital stock series

2/ Output gap expresed as a share of potential output.

Macroeconomic Framework, 2007–2013
Proj.
Prog.CR/08/258
CR/08/281/Proj.Proj.
2007200820092010201120122013
(Annual percentage change)
Real GDP growth8.96.58.29.46.06.86.56.56.5
Inflation (end-year)3.92.54.36.72.82.22.02.02.0
(In percent of GDP)
External current account balance1.4-0.7-0.6-3.3-3.0-2.9-2.6-2.0-1.6
Public sector balance (excluding CRPAOs3.32.03.02.00.60.60.50.30.1
Public sector balance (including CRPAOs)2.21.42.41.30.20.50.50.30.1
Total public debt (including CRPAOs)30.926.222.024.821.718.916.714.913.6
Gross official reserve coverage of:
Short-term debt (residual maturity)456489582443358363317383397
Source: Fund staff estimates and Peruvian authorities.

The public sector balance (excluding CRPAOs) equals 2 percent of GDP under the program CR/08/258.

Source: Fund staff estimates and Peruvian authorities.

The public sector balance (excluding CRPAOs) equals 2 percent of GDP under the program CR/08/258.

4. Against the backdrop of sharply deteriorating external conditions, the domestic economic outlook for 2009 still remains favorable, but with risks on the downside. The pace of economic growth is expected to slow to 6 percent in 2009—owing to the impact of the global slowdown, lower terms of trade, and tighter financial conditions on net exports and private investment. With global price disinflation already underway and imported food prices expected to decline by 3½ percent in 2009, inflation would decelerate to 2¾ percent by end-2009, within the 1–3 percent target range. While the economy is above potential, there is considerable uncertainty on these estimates and how domestic demand translates into inflation—particularly given the prominent role of private investment and surge in capital goods imports in recent years, as well as the still high levels of labor market informality.

Peru: Contribution to real GDP growth (y/y)
20082009
GDP9.46.0
Domestic demand13.07.1
Private Consumption5.93.7
Public Consumption0.30.2
Gross investment6.83.2
of which: private5.12.5
of which: public1.70.7
Net exports-3.6-1.1
Exports0.90.4
Imports-4.5-1.5
Source: Staff estimates
Source: Staff estimates

5. A more severe and prolonged global slowdown could also extend downside risks into 2010. With almost 50 percent of exports to the United States, Europe, and Japan, a deeper and more protracted global slowdown—especially if accompanied by a sharp deceleration in large emerging market economies in Asia, brings further downside risks. An illustrative staff scenario suggests that Peru would be vulnerable to a sharper-than-anticipated fall in external demand and commodity prices accompanied by a further tightening of financing conditions, lower foreign direct investment, and higher risk aversion. This could bring real GDP growth down to 4–5 percent. Moreover, under such scenario, a marked depreciation of the currency, could promote dollarization, strain the economy’s balance sheets and lower official reserves below comfortable levels. In these circumstances, the current adequate level of official reserves and the recently announced government plan would provide an important buffer to preserve significant economic growth, external stability, and poverty alleviation (Annex 1).

Peru: Official Reserves-to-Output Ratio 1/

1/ Optimal reserves calculated based on the methodology as in Jeanne and Rancierre (2006)

III. Policy Discussions

6. Discussions took place against a backdrop of heightened global uncertainty and with the economy showing incipient signs of deceleration. Discussions focused on the policies that could help shield the economy from a further deterioration in the global environment, while helping to preserve the strong economic performance over the medium term. In particular:

  • Achieving a “soft-landing”. The policies to respond to the global crisis and risks of a sudden and sharp slowdown to preserve macroeconomic stability.
  • Strengthening the financial system and sustaining an orderly deepening. The key reforms to ensure that financial deepening proceeds in an orderly manner and markets improve their resilience to external shocks.
  • Further solidifying the policy framework. Reforms to consolidate the fiscal framework, minimize fiscal risks, and strengthen the inflation targeting framework.
  • The poverty alleviation strategy and other structural reforms. Reforms to strengthen the effectiveness of social programs and further steps simplify business procedures and lessen regional disparities.

A. Achieving a Soft-Landing

7. The authorities stressed the need to preserve the prudent policy strategy of recent years.1 They recognized that the still strong economic underlying momentum provided an important buffer to face the global slowdown and financial crisis. However, they remained concerned that a sharp and sudden deceleration in domestic private demand—that could be precipitated by a sharp fall in commodity prices, domestic confidence, and potential disruptions in the financial system—could compromise a “soft landing”. Therefore, the conduct of fiscal policy in 2009 would be geared toward allowing for automatic stabilizers to operate in full, while several of the measures contemplated in the anti-crisis plan would be immediately implemented. Most notably, the authorities have extended the execution of public investment projects budgeted in 2008 through March 2009 and boosted resources under the Fund for Regional and Local Public Investment (FONIPREL), while public investment execution would be phased more evenly through the year to sustain some of the fiscal impulse during the first half of the fiscal year. As a result, the nonfinancial public sector surplus could reach 0.4 percent of GDP. This would still entail a tight rein on current spending (4 percent growth in real terms), while public investment would expand by about 20 percent in real terms. Staff noted that preserving a better balance between achieving a soft landing and addressing infrastructure and social needs would imply a more prudent expansion of public spending. This would entail achieving a neutral fiscal stance for the year as a whole—equivalent to an overall surplus of 0.7 percent of GDP. The authorities expected that some of the intrinsic difficulties in executing spending would likely bring fiscal policy close to a neutral stance.

Peru: Structural Fiscal Balance

8. In coordination with fiscal policy, monetary policy would continue to balance the disinflationary effects from the deteriorating external environment with the need to preserve adequate liquidity conditions. In the context of the inflation consultation (see attached letter), central bank authorities indicated their expectation that inflation would converge within the 2 percent target (+/- 1 percent band) by end-2009. They noted that inflation had begun to decelerate and that this trend was likely to intensify in the coming months, as declining global food and fuel prices had yet to be fully passed onto domestic prices.2 The authorities were confident that recent reductions in reserve requirements would preserve stable liquidity conditions and ward off the economy from a sharp and sudden slowdown in domestic demand. They also noted that disinflation dynamics could prove more severe, given some inventory build-up in specific sectors. Therefore, the authorities were committed to continue monitoring closely the path of domestic demand and inflation expectations, noting that, if needed, there could be scope for further easing of monetary policy by lowering reserve requirements. Staff agreed with this assessment and policy approach, and emphasized the importance of taking advantage of the expected global disinflation to bring domestic inflation promptly to the target. Staff also noted the risk that, with strong credit growth, the path of domestic demand could prove more resilient in the near term and delay somewhat the disinflation process.

Peru: Inflation Expectations and Target

9. Were the impact of the global crisis to intensify, the authorities and staff agreed that there would be some scope for cautious countercyclical policies. Staff stressed that the still strong underlying economic momentum and several of the measures implemented by the authorities seemed sufficient to buffer the economy from the global slowdown. However, should downside risks intensify and materialize, further reductions in reserve requirements and policy interest rates, along with further fiscal easing, reflecting automatic stabilizers, should be the first line of defense. The authorities and staff agreed that a prudent fiscal stimulus should be carefully considered and paced, if the impact of the crisis were to extend to 2010, and provided it could be financed with government savings accumulated in recent years.3 The authorities agreed with the need to proceed cautiously, as the scope for implementing countercyclical fiscal policy has traditionally been limited, and despite improved fundamentals in recent years, it could otherwise compromise the hard-won fiscal credibility. They stressed that such course of action would be consistent with the measures announced in the anti-crisis plan.

10. The authorities and the staff agreed that the Nuevo Sol was fairly valued in real effective terms, posing no risks to external stability.4

  • Assessment. Cross country panel estimates from the macroeconomic balance, external stability, and equilibrium exchange rate approaches suggest that the Nuevo Sol is undervalued by 2–7 percent (Annex 2). The underlying current account balance for 2009 would be a deficit of 2.8 percent of GDP, in line with the projected deficit of 3 percent of GDP adjusted for relative output gaps and commodity prices.
  • Discussions. The authorities stressed the uncertainty of these estimates associated with the considerable structural changes in the economy—such as the recent trade liberalization and labor market reform—and their implications for external stability going forward. Their own time series estimates suggested that the Nuevo Sol would be close to equilibrium, but ranging on average from an undervaluation of 4 percent to an overvaluation of 6 percent, reflecting the different impact of changes in terms of trade and labor productivity under different methodologies.

Peru: Real Effective Exchange Rate, 2000-08 1/

1/ An increase denotes appreciation. Last observation: September 2008.

B. Strengthening the Financial System and Sustaining an Orderly Financial Deepening

11. Financial soundness indicators show that banks are well-capitalized, liquid, and with provisions exceeding nonperforming loans for all credit segments.5 Recent stress tests conducted by the Superintendency of Banks (SBS) also confirmed that the banking system has gained resilience to market, credit, and exchange rate-related risks. Nonetheless, indicators vary between large (and stronger) banks compared to those for the small (and generally weaker) banks and microfinancial institutions, which would be potentially more vulnerable to a sharp deterioration of the economy and market risks.6 The authorities and staff agreed that banks’ provisions—at about $1 billion (25 percent of their capital) provided an important buffer to a potential significant slowdown in the economy and deterioration in asset quality, without significantly jeopardizing the comfortable level of capitalization.7

Financial Sector Indicators: Banks and Microfinance Institutions As of October 2008(in percent)
BanksCajas MunicipalesCajas Rurales
Capital Adequacy Ratio11.919.118.7
Nonperforming Loans/Total Loans1.24.14.4
Provisions/NPLs263.1142.3136.3
Nonperforming Loans/Total Loans 1/2.15.36.3
Provisions/NPLs 1/147.0111.495.4
Return on Equity30.724.613.7
Return on Assets2.64.22.1
Liquidity Ratio in Domestic Currency36.019.923.8
Liquidity Ratio in Foreign Currency53.940.662.2
Net Foreign Asset Position/Capital9.92.01.3

Including refinanced and restructured loans

Source: SBS

Including refinanced and restructured loans

Source: SBS

12. The authorities have also been implementing prudential measures to rein in buoyant credit growth. Staff noted that new entrants to the system—from the supply and demand side—posed unchartered risks to macroeconomic stability. Some had begun to manifest in rapidly growing nonperforming consumer and microenterprise loans, including in banks with stronger credit risk management practices.8 The authorities noted that banks had already begun to tighten lending standards, while the SBS established—effective 2009—more restrictive rules for granting credit card loans, as well as provisioning requirements for all consumer loans, and introduced procyclical provisioning effective December 1.9 As a result, they felt that risks to asset quality would be contained, particularly as banks were also expected to add most of their high profits expected for 2008 to their provisions. Staff welcomed these measures, noting that it would be important to continue monitoring the rapid expansion of nonperforming loans for consumer and microenterprise loans, particularly as the pace of economic growth slows.10

Peru: Banking System Non-performing loans, 2005-2008 1/

1/ Includes refinanced and restructured loans

13. The authorities noted that foreign-owned banks posed no systemic risks. They noted that while foreign banks represented almost half of the banking system’s assets, they continued to rely mostly on domestic funding. In addition, the SBS continued to monitor closely—through the provisions provided by memoranda of understanding with foreign supervisory agencies—the offshore operations of domestic financial conglomerates that could be more exposed to the global financial crisis. To address this risk and others related to large exposure to riskier operations (such as consumer and retail activities), staff encouraged the authorities to consider requiring financial institutions to increase their capital base, preferably with Tier-I contributions, as needed. The close monitoring of smaller banks and larger microfinancial institutions was also important, given their weaker risk management practices and potential contagion on other small financial institutions.

Peru: NPLs and capitalization, Oct 2008 1/

1/ Includes refinanced and restructured loans

Peru: External obligations and capitalization, Oct 2008 1/

1/ Includes refinanced and restructured

14. The authorities and staff agreed that the ongoing reform agenda should enhance the economy’s resilience to global financial shocks:

  • Crisis Preparedness. Intervention rules in cases where a bank experiences losses of 50 percent of capital have been clarified, with intervention triggered when such losses occur within a 12-month period. A Coordination Committee comprising senior officials from the Ministry of Finance, the Central Bank, and the SBS has been established to strengthen the framework for providing liquidity to all financial entities. The group has been exploring several mechanisms, including the possibility of establishing a trust fund that would allow private financial institutions to exchange high quality portfolio for a new credit-enhanced instrument issued by the trust fund, and potentially funded by the central bank. The authorities emphasized that such an instrument would facilitate access of smaller financial institutions to the central bank’s safety net. The authorities were also exploring the possibility of relying on the Deposit Insurance Fund (FSD) as a complementary mechanism of liquidity provision—via the acquisition of portfolio. For solvency issues, the legal framework of the FDS already allows the provision of assistance through credit lines from the Ministry of Finance. Staff noted that these measures would help minimize systemic risks, and needed to be complemented by a well-established mechanism to protect the central bank’s balance sheet. It would be important to recapitalize the FDS over the coming years through contributions by financial institutions.
  • Proceeding with the gradual implementation of Basel II as envisaged. Amendments to the General Banking Law and Organic Law of the SBS were approved by Congress on June 22, 2008. As a result, minimum capital requirements for credit, market, and operational risks will be introduced in line with Basel II. The minimum regulatory capital adequacy ratio will be raised from 9.1 percent to 9.5 percent in June 2009 and to 10 percent by 2011. Requirements for treating subordinated debt as Tier 2 capital have also been strengthened relative to standard international practice. Diagnostic Fund-World Bank missions confirmed that the authorities are well placed to implement Basel II gradually.
  • Strengthening and expanding the operations of micro-finance institutions (MFIs). The authorities submitted legislation to Congress in late August 2008 to increase minimum capital requirements for microfinance institutions (end-June structural benchmark).11 The new legislation was approved by Congress’ Banking Commission in mid-September and now awaits plenary approval. The authorities have recently passed legislation that allows these institutions to engage in securitization and fixed-income product operations, including the purchase of central bank securities (which could be used as collateral for LOLR support) permitting their direct participation in the payments system (subject to central bank approval). The authorities emphasized that they had enough flexibility to accommodate the expansion of these operations with minimal risk.
  • Aligning the supervisory framework of public banks with that of private banks. The market share of Peru’s public financial institutions has remained contained—mostly as a result of the growth of private sector participants. Staff encouraged the authorities to give full priority to bringing all public financial institutions fully under the supervisory umbrella of the SBS, as envisaged by draft legislation currently stalled in Congress.

15. The authorities agreed that promoting competition and strengthening the regulatory framework for domestic capital markets should help consolidate recent reforms. New financial instruments have begun to emerge—such as long-term, fixed-rate mortgage lending in domestic currency and mortgage securitization—while issuance of private fixed-income instruments in Nuevos Soles has increased. The authorities also raised the limits of pension funds’ investment abroad to 30 percent of total investments last May, paving the way for further diversification. Opening competition to other institutions, further streamlining their investment limits, and improving the coordination among public agencies, would best serve these goals. The authorities intend to continue implementing reforms related to the pension funds' minimum return guarantee and investment limits, and capital market supervision, with MCM TA during 2009.

Peru: Pension Fund Investment Abroad

Peru. Domestic Sovereign Yield Curve

C. Solidifying the Policy Framework

16. The authorities and staff agreed that the inflation targeting framework should remain focused on preserving low and stable inflation. They noted that their strategy in dealing with strong short-term capital inflows through higher reserve requirements earlier this year had been appropriate in buffering the inflation targeting framework from the risks to financial stability posed by large short-term capital inflows. The authorities felt that current global financial conditions were now more propitious to reduce reserve requirements and to rely on the policy interest rate as an instrument to control inflation. However, they stressed that they would not hesitate in relying on such instrument again, to contain excessive credit growth and risks posed by dollarization. Staff also encouraged them to prioritize Congressional approval of the constitutional amendment delinking the appointment of the central bank president and board members from the presidential cycle.

17. Some reforms would help establish conditions for greater exchange rate flexibility to help absorb shocks and better anchor expectations. Staff emphasized that stronger macroeconomic fundamentals, more resilient public and private sector balance sheets to exchange rate risks have provided more scope for exchange rate flexibility to act as a shock buffer. Staff and the authorities agreed that intervention has helped both build an adequate reserve buffer and contain the risks associated with large swings in the exchange rate. There was also agreement that in the current context of heightened global uncertainties, the timing for greater flexibility was less favorable given the risks of stimulating excessive volatility and dollarization.12 Staff encouraged the authorities to issue regulations for the tax treatment of derivatives, critical to bolster market incentives for hedging and to support a gradual increase in exchange rate flexibility.

Intervention and exchange rate variability

18. The authorities agreed on the need to strike a better balance between medium-term fiscal sustainability and cyclical factors. Staff encouraged the authorities to begin preparing for a structural fiscal rule that would formalize the broadly neutral fiscal stance of recent years and strengthen the credibility of fiscal policy by ensuring a balanced budget over the economic cycle. The formal adoption of such a rule could be gradual and brought explicitly into the budget process before it is formalized. Staff suggested establishing and independent expert panel to help alleviate the authorities’ concern on the difficulties in assessing the stage of the economic cycle when implementing such rule. Going forward, they agreed on the need to adopt a medium-term expenditure framework and remained committed to introducing multiannual budgeting in 2010.

19. Several reforms would also help strengthen the fiscal policy framework, particularly to minimize fiscal risks in the face of external shocks. Specifically:

  • Higher public expenditure quality. Staff emphasized the importance of maintaining an appropriate balance of risks between the public and private sector in initiatives involving private sector participation in the provision of public services, including infrastructure. In this context, staff highlighted the risks posed by the new Build and Transfer program13 and suggested close monitoring. Regional SNIP offices have been established (end-December 2008 benchmark), to provide further impulse to public investment in regions and municipalities. These efforts are being complemented with the expansion of performance budgeting to 9 sectors in 2009—from 5 in the 2008 budget. The authorities also agreed that further reforms to the FEPC—including an automatic price band—would help minimize fiscal risks of renewed subsidies. Staff also suggested the possibility of liberalizing fuel prices over the medium term.
  • Enhancing the budget coverage and accounting. It was agreed that new extrabudgetary funds, while still small in size, have proliferated in recent years and could be better integrated into the budget documents. Also, the new fiscal accounting rules for the PPPs have yet to be fully implemented. The fiscal accounting rules for the recently approved Build and Transfer program have yet to be defined as well.
  • Improving the consistency of the Fiscal Responsibility and Transparency Law (FRTL). There is a need to reconcile expenditure limits with those for subnational governments (SNGs) in the Decentralization Law (DL) (end-September structural benchmark), as well as to ensure that the granting of specific-exemptions to such limits are prohibited under the law and not subject to Congressional discretion. The authorities did not see scope to amend the DL in the near term and preferred to do so once a well-defined timetable for decentralization is agreed upon.

20. Despite significant progress, broadening the tax base remains a key challenge:

  • Tax revenue-to-GDP is at its highest since 1980. At 18.3 percent of GDP in 2007, this ratio remains below many countries in the region—and is still largely dependent on mining-related revenue, which represents a quarter of total central-government revenue. The authorities were in the process of implementing the 2007 tax reform, to begin taxing capital income and gains in 2009, although they did not rule out some delays. They recognized that recent reforms to simplify VAT procedures for small tax payers may undermine efficiency gains.14 The authorities agreed that it was also important to continue enhancing tax administration.15 The new Customs Law preserves its administrations at SUNAT, critical for exploiting synergies between customs and domestic tax collection. They also agreed that it was important to restore fuel excise taxes to 2004 levels in the period ahead, particularly for the most environmentally noxious.
  • Staff encouraged the authorities to proceed with the reform of tax exemptions planned for March 2009. Draft methodological guidelines for the assessment of all existing tax exemptions (end-June 2008 benchmark) under the new regime had been approved and the authorities intended to issue them shortly. However, they noted that advancing this reform may prove politically challenging. One particular example was the recent Congressional passage of a two-year-delay (to 2013) of the replacement of exemptions of VAT and fuel and excises with direct budget transfers in the Selva region.

Tax-to-GDP ratio for selected Latin American Countries 1/

1/ For the General Government

VAT Efficiency for selected Latin American Countries

21. The authorities and staff agreed that decentralization needs to proceed while carefully assessing fiscal risks. The authorities continued to assess the fiscal decentralization process, initiated in 2002. The devolution of functions to subnational governments proceeded in 2008 and pilot programs had been initiated for decentralizing primary health and primary education. However, the laws that would clarify responsibilities across government levels had yet to be issued to avoid duplication or loopholes in the provision of services.16 Staff stressed the need to evaluate the quality of public spending under the new National System of Public Investment (SNIP)

D. The Way Forward on Poverty Alleviation

22. While satisfied with the progress made in alleviating poverty, the authorities recognized the need to persevere with their efforts. They stressed that the strong economic performance and rising formal employment, along with more prioritized spending on social assistance programs, have been important contributing factors to the important gains on poverty alleviation. In this regard, they emphasized that continuing with the implementation of the strategy Crecer, and expanding the conditional cash-transfer program Juntos in the 2009 budget to more rural areas, would provide the basis for expanding the coverage and effectiveness of social assistance efforts.

Peru--Trends in Social Spending: Underlying Factors

23. Other important reforms are needed to sustain poverty alleviation. Despite the progress, social assistance programs—including those related to education and health (universal programs)—continued to face significant targeting challenges. The authorities were well aware of these problems, and noted that their effectiveness was also impaired by difficulties in ensuring an adequate supply of public services. Therefore, they decided to link 2009 budgetary allocations to concrete improvements in several large targeted social programs. For this, and to strengthen their effectiveness, they intend to finalize comprehensive reviews of such programs, including Glass of Milk, by March 2009. The conditional cash transfer program Juntos would also be subject to a review, with assistance from the Interamerican Development Bank and the World Bank, to better articulate its capacity to deliver public services. Staff encouraged the authorities to also assess and reform universal programs on health and education, in line with the strategy presented in the March 2007 poverty reduction strategy. While the authorities agreed with the need to reform universal programs, they indicated that it would be politically difficult, and emphasized that their efforts would continue to be focused on improving their quality through performance budgeting.

Peru: Beneficiaries of social programs, 2006-07(in percent)
Targeting
20062007Performance 1/
poornontotalpoornontotal20062007
Programpoorpoor
Glass of milk67.932.110061.138.91001.51.6
Public meals58.541.510053.846.21001.31.4
School breakfast75.424.610073.326.71001.71.9
Primary education66.133.910062.637.41001.51.6
Preventive health56.044.010052.847.21001.31.3
Curative health16.683.410014.785.31000.40.4
Source: Staff estimates based on National Household Survey (ENAHO), 2006-2007.

Targeting performance of a social program is calculated as the ratio of poor beneficiaries to total beneficiaries divided by the percentage of poor in the total population. Poor includes extreme poor and non-extreme poor households. Poverty rates were 44.5 in 2006 and 39.2 in 2007.

Source: Staff estimates based on National Household Survey (ENAHO), 2006-2007.

Targeting performance of a social program is calculated as the ratio of poor beneficiaries to total beneficiaries divided by the percentage of poor in the total population. Poor includes extreme poor and non-extreme poor households. Poverty rates were 44.5 in 2006 and 39.2 in 2007.

24. The authorities were also well aware of the risks posed by increasing regional disparities. Despite declining poverty, regional disparities were likely to increase, reflecting different resource endowments (in terms of economic structure and mining-related revenues) and ability to deliver public services. The authorities viewed the need to begin laying the ground for some form of equalization. As a first step, the 2009 budget increased the resources in the Fund for Regional and Local Public Investment (FONIPREL) by 0.5 percentage points of GDP so that the poorest regions could bid for resources to close their infrastructure gaps. Based on international experience, staff noted that further reforms would be needed to better help fill the gap between the subnational governments' expenditure needs, their revenue capacities, and the central government’s transfers.17

E. Enhancing the Business Environment, Institutions, and Competitiveness

25. Considerable progress has been made to enhance the business environment. The authorities recognized that, according to World Bank indicators, Peru continues to lag other investment grade economies on establishing a conducive business environment, particularly in view of existing costly procedures for opening and closing businesses and for construction permits, for tax payments, and external trade. They noted that, therefore, efforts have and will remain focused on advancing reforms in key three areas:

  • Promoting formal employment. The recently approved Micro and Small Business Law is an important step forward in reducing costs of formalization for small firms,18 while providing progressive access to social security and health benefits (Box 3). The authorities expected that the new law would begin to have considerable effects on formalization, helping entrench the rise in formal employment of recent years.
  • Modernizing and simplifying procedures. The Positive Administrative Silence Law has been in effect since 2008, and a one-step window for external trade is being implemented to facilitate the Peru-U.S. Free Trade Agreement. In addition, an e-government pilot project has been established that would allow the six more demanded procedures (including opening new businesses) to be completed electronically. Twelve commercial courts have been established across regions that have helped simplify and expedite conflict resolution.
  • Further trade liberalization. The authorities stressed that significant progress has been made in recent years in adding new external markets, with about two-thirds of external trade (exports) to be covered under bilateral free trade agreements. They stressed that these agreements should continue to provide the private sector with an important window to continue diversifying exports, particularly in light of the weakening global conditions.

Starting and Closing a Business

Source: Doing Business, World Bank

Peru: Composition of exports, 2000-2008

Peru: Composition of total trade

(Jan-May 2008)

Source: IMF-DOTS

1/ Includes: USA, EU, China, Chile, Canada, Mexico, EFTA

IV. Staff Appraisal

26. Peru’s strong economic performance owes much to prudent macroeconomic policies and reforms under the favorable external environment of recent years. Sustained fiscal surpluses have been the backbone of this success, supported by a prudent conduct of monetary policy, which while underpinned by inflation targeting, has also aimed at carefully balancing risks associated with high dollarization. Important structural reforms have been advanced to expedite public investment, reduce fiscal risks, enhance the resilience and depth of the financial system and capital markets, enhance the business environment and reduce poverty. These efforts have helped establish the basis for low inflation, reduced vulnerabilities, sustained high economic growth and a sustainable improvement in living standards, all of which have been recognized by the achievement of investment grade status.

27. Macroeconomic policies need to remain prudent and focused on achieving a soft-landing. This will entail the need to balance the risks associated with the global slowdown and the economy’s underlying growth momentum. In the staff’s view, achieving a neutral fiscal stance in 2009 would enhance macroeconomic stability and would provide room for implementing key elements of the authorities’ anticrisis plan, such as the decision to extend the execution of ongoing projects through March 2009, phase investment projects more evenly throughout the year and boost resources under the Fund for Regional and Local Public Investment (FONIPREL). This, along with the recent reductions in reserve requirements and steady growth in credit to the private sector, should help buttress business confidence and ward off the economy from a sharp and sudden deterioration in private investment and net exports. It will be important for monetary policy to re-anchor expectations and reduce inflation to the 1–3 percent range during 2009. At present, a more aggressive discretionary set of countercyclical policies risks delaying some needed slowdown in domestic demand and a potentially sharper deceleration later on, with an ensuing weakening of credibility and more limited progress in reducing inflation.

28. Were the global slowdown to be more severe and prolonged, the authorities would be in a position to implement cautious countercyclical measures in the second half of 2009. In particular, further reductions in reserve requirements and policy interest rates, along with some fiscal easing reflecting the use of automatic stabilizers, could be the first line of defense. The need for additional fiscal stimulus should be carefully considered and paced, and in the staff’s view, a prudent stimulus could be financed with government savings accumulated in recent years. This policy response would be consistent with the authorities’ intentions, as presented in their anticrisis plan.

29. The authorities’ focus on strengthening the financial system and sustaining an orderly financial deepening is timely. Given the risks stemming from still buoyant credit growth, staff welcomes the authorities’ decision to tighten prudential regulations on consumer loans and the implementation of new procyclical provisioning rules. Reforms to enhance the bank surveillance and intervention regimes, and to implement enhanced capitalization requirements in line with Basel II are also welcome. Going forward, it will be important to continue monitoring the growth in nonperforming loans, which may increase as a consequence of the slowdown in economic activity. Priority should be given in 2009 to enacting the increase in minimum capital requirements for microfinance institutions to protect their strong capitalization, including for new entrants. The continued close monitoring of foreign operations of domestic financial conglomerates is important in light of the recent experiences and risks posed by the global financial crisis. To address risks related to the large exposure of banks to riskier operations (such as consumer and retail activities), there may be a need to requiring financial institutions to increase their capital base, preferably with Tier-I contributions.

30. Staff welcomes the coordinated action among government entities to strengthen the framework for crisis preparedness. The ongoing actions and plans to ensure adequate liquidity to the financial sector and capital markets constitute a key step to minimize systemic risks. In the staff’s view, these actions need to be complemented by a well-established mechanism to protect the central bank’s balance sheet. Staff encourages the authorities to recapitalize the Deposit Insurance Fund over the coming years through contributions by financial institutions. In addition, the supervisory framework for public financial institutions should be aligned with that of private entities. It will be important to continue with reforms to enhance the depth and resilience of the domestic capital markets, including by improving the coordination for their oversight and enhancing competition for private pension funds.

31. There is scope to further solidify the policy framework and the economy’s ability to buffer shocks. To bolster the credibility of the inflation targeting framework further, priority could be given to enacting legislation that delinks the appointment of the central bank president and board members from the presidential cycle. In addition, the authorities’ decision to reduce reserve requirements to inject liquidity in the system would also help strengthen the signaling of the policy interest rate. Staff is of the view that the stronger macroeconomic fundamentals and improved balance sheets in the economy provide scope for greater exchange rate flexibility ahead, as external conditions permit. For this, it will also be critical to advance reforms that facilitate hedging in the economy, such as the issuance of regulations regarding the tax treatment of derivatives.

32. Efforts to strengthen the fiscal policy institutional framework have been significant and need to continue. Reforms to minimize fiscal risks, including through the issuance of a legal framework for Public-Private Partnerships (PPPs), and aligning the budget classification with international standards are to be commended. Going forward, it will be important to finalize the implementation of the TSA, implementing the recently approved fiscal accounting rules for PPPs and issue the pertinent accounting norms for the Build & Transfer program. It will also be important that the PPP framework and other initiatives involving the private sector maintain an adequate balance of risks between private and public sectors. Staff encourages the authorities to prioritize the alignment of the expenditure limits in the FRTL and the Decentralization Law, in line with commitments under the program. At the same time, the adoption of a structural fiscal rule would formalize the broadly neutral fiscal stance of recent years and strengthen the credibility of fiscal policy by ensuring a balanced budget over the economic cycle. The formal adoption of such a rule could be gradual and brought explicitly into the budget process before it is formalized. In addition, consideration should be given to making the price-band adjustment and settlement of liabilities of the Fuel Price Stabilization Fund automatic, or even liberalizing fuel prices over the medium term.

33. Broadening the tax base remains an important challenge ahead. With Peru’s tax system highly exposed to commodity revenues, it will be key to press ahead with reforms that broaden the tax base, including the taxation of capital gains. It is also critical to proceed with the 2007 reform of the tax exemptions planned for March 2009, including by issuing the recently completed methodological guidelines for the assessment of such exemptions, in line with program commitments. Staff supports the authorities’ intention to unwind fully the reduction in fuel excise taxes implemented since 2004 in line with environmental considerations. Efforts to protect the integrity of the tax administration and to strengthen procedures need to be sustained.

34. Sustaining poverty alleviation would require continued efforts to improve the effectiveness of social programs. Staff welcomes the commitment in the 2009 Budget to link allocated spending to concrete improvements in social programs, as well as the intention to assess the successful cash transfer program Juntos and other large social programs, to strengthen their effectiveness further. It will also be important to garner support to assess universal programs, in line with the poverty strategy of March 2007. Regional disparities remain a challenge, and the expansion of the Fund for Regional and Local Public Investment (FONIPREL) and the methodological changes to the allocation coefficients of Regional Compensation Fund (FONCOR) are welcome steps that need to be complemented by reforms toward institutionalizing an equalization scheme.

35. Much has been accomplished in enhancing the business environment, and further efforts are underway. Staff welcomes the implementation of the Micro and Small Business law, an important step towards reducing informality. Efforts to promote trade liberalization, could be complemented with further administrative simplification and reduced costs for the business environment.

36. Staff recommends completion of the fourth (and final) review and inflation consultation under the SBA, as well as the authorities’ request for a waiver of applicability of end-December performance criteria, given Peru’s strong performance under the program.

37. It is expected that the next Article IV Consultation will take place on the standard 12-month cycle.

Box 1.Fuel-Price Stabilization—Fiscal Cost and Social Distribution

With persistently rising international fuel prices, the Fuel-Price Stabilization Fund (FEPC) has stabilized domestic fuel prices over the past two years. Firms that keep prices within an official wholesale price band set by the authorities receive compensation for the gap between the band and an import-parity reference price formula. The authorities also reduced specific fuel excises to limit the pass-through to domestic retail prices.

The fiscal cost of the fuel-price subsidies reached a peak in July 2008, when the cost for the year was projected at 1.4 percent of GDP. Of this cost, 1.2 percentage points of GDP corresponded to the pure fuel-price subsidy, and 0.2 percentage points to ad-valorem tax revenue foregone due to lower retail prices. In addition, the annual fiscal cost of fuel excise tax cuts during 2004–08 was estimated at 0.5 percent of GDP, bringing the total 2008 cost of fuel-price stabilization policies to 1.9 percent of GDP. The average fuel-price increase required to eliminate the subsidy peaked at 45 percent (Table 1).

Table 1.Price Gaps: Required Fuel-Price Increases, July and December 2008(Percent)
July 2008December 2008Volume Share
Diesel43-1550
LPG69-1920
Gasolines9-3916
Industrial Petroleum60-4313
Kerosene33-21
Weighted Average45-23100
Source: Peruvian authorities and IMF staff calculations.Note: Table reports increase in official price band required to eliminate subsidy. Negative numbers indicate official price band above international reference price. Volume shares based on annual sales.
Source: Peruvian authorities and IMF staff calculations.Note: Table reports increase in official price band required to eliminate subsidy. Negative numbers indicate official price band above international reference price. Volume shares based on annual sales.

The rising cost of fuel subsidies and their poor targeting led the authorities to implement several measures. A Poverty and Social Impact Analysis (PSIA) concluded that fuel-price subsidies in Peru were poorly targeted, with the richest 20 percent of households receiving over eight times the subsidies received by the poorest 20 percent. The intuition for this finding was that richer households tend to consume a large share of fuel and final goods that use fuel as an intermediate good. In response, the authorities increased the official FEPC price band under in January, March, June and August 2008 by a cumulative 28 percent. They also made adjustments to the import-parity price formula to ensure that it did not overstate true import costs, and began unwinding the specific excise tax cuts in November, when these taxes were more than doubled. However, the weighted average of fuel excises would need to increase by a further 26 percent to reach end-2004 levels. With these measures, and the 50-percent fall in fuel import prices from their peak, subsidies have been eliminated, and the FEPC price band is now about 23 percent above the reference international price. With the FEPC now collecting payments from domestic firms, the cost of the pure fuel-price subsidies is projected at 0.7 percent of GDP in 2008, of which 0.6 percentage points of GDP has already been paid by the government.

Box 2.Balance Sheet Vulnerabilities

Peru’s overall external position has strengthened, but improvements differ across sectors. Between end-2006 and mid-2008, the economy’s net international liabilities fell from 26¼ percent of GDP (US$24.8 billion) to 23¼ percent of GDP (US$30.3 billion). Improvements were not uniform across all sectors—with the combined public sector recording the largest net increase in its international net asset position (by 17¼ percent of GDP), while private investment positions—other than FDI—experienced and increase in net liabilities of 13 percent of GDP.

Peru: International Investment Position, 2006:Q4-2008:Q2

(Millions of U.S. dollars)

The public sector became a net creditor. The authorities’ strategy involved public debt repayments, an increase in public debt maturity, and a decline in the share of FX denominated debt has fallen to about 60 percent. Potential vulnerabilities would be associated with the undercoverage of FX-denominated deposits protected under the Deposit Insurance Fund (DIF)—some US$9.2 billion—as DIF resources represent only 2 percent of total insured deposits.

Banks can better withstand currency-related shocks, but remain subject to dollarization risks. While credit dollarization remains high at 56 percent, the de-dollarization process has contributed to a reduction of the FX induced credit risk stemming from unhedged borrowers. However, with banks having reduced their net FX asset positions over the past year, a depreciation of the Nuevo Sol would have a slightly higher impact on the system’s capitalization than it would have had a year ago. Nevertheless, banks’ position is significantly stronger than at end-2005.

Table 1.Peru: Banking sector stress test to currency-related risks
Market Exchange Rate RiskForeign-Exchange Induced Credit Risk
2005 FSAP

Update 1/
June 2007August 20082005 FSAP

Update 1/
June 2007August 2008
Initial Banking System CAR13.512.112.413.512.112.4
New Banking System CAR11.812.012.29.910.211.2
Change in CAR (in percent)-12.6-0.8-1.5-26.7-15.7-9.9
Memorandum Items
Share of Loans in Foreign Currency (percent)75.765.058.9
Net Foreign Exchange Open Position / Capital24.228.610.8
Stress Scenario 2/20 percent depreciation
Source: Staff Estimates

Data as of December 2004.

Both the 2005 FSAP Update and the SBS methodology determined the 20 percent depreciation by the 99 percent confidence level of the normalized distribution of the monthly changes in the exchange rate in the period January 1997 to December 2004, and January 1991 to February 2006 respectively.

Source: Staff Estimates

Data as of December 2004.

Both the 2005 FSAP Update and the SBS methodology determined the 20 percent depreciation by the 99 percent confidence level of the normalized distribution of the monthly changes in the exchange rate in the period January 1997 to December 2004, and January 1991 to February 2006 respectively.

The corporate sector has improved its net foreign position in recent years, particularly at the short-end. Available data on 120 nonfinancial firms suggest that as of end-2006, the average firm held net total short-term FX-denominated assets for about US$3 million, compared to net short-term liabilities for US$6 million in 2003. Improvements were also reflected in the case of nonexporting firms.

The vulnerability of households’ balance sheets to exchange-rate shocks seems contained. Stress tests on mortgage-market debtors based on end-2006 data (latest available) suggested that a depreciation 20 percent of the Nuevo Sol against the U.S. dollar would have raised the amortization burden on low-income household by 5–6 percentage points—to nearly 35 percent.

Box 3.The Micro and Small-Sized Business Law

Peru’s strong economic performance has been accompanied by high levels of informality and limited access to social benefits among micro and small-sized enterprises (MSEs). Data from ENAHO 2006 shows that 60 percent of the Peruvian labor force works in enterprises with less than 50 workers, and many of these operate informally. High nonwage labor costs have been identified as one of the key factors driving the informal economy in Peru. Nonwage labor costs, which include mandated health and pension contributions, holiday bonuses, family assignments, and tenure bonuses amount to 72 percent of the basic wage in the general labor regime, compared to less than 30 percent in Chile and Mexico. Informality hinders competition, productivity and economic growth since informal enterprises do not benefit from trade liberalization or access to financing to invest in physical or human capital. Further, workers operating in the informal sector are excluded from the benefits and rights incorporated in the labor contracts and social systems.

Peru: Labor rights and access to benefits by workers across enterprises
Size of the enterpriseLacking labor contractAffiliation to healthAffiliation to a pension
(in percent)insurance (in percent)system (in percent)
1–10 workers57.99.813
10–50 workers53.332.434
More than 50 workers25 for medium- and69.469
14 for big-sized enterprises
Source: MEF based on ENAHO 2006.
Source: MEF based on ENAHO 2006.

The law for the promotion and formalization of MSEs approved in 2003 has not yielded the expected results. In particular, this law established a special labor regime that lowers nonwage labor costs of enterprises with less than 10 workers to 14 percent. However, this regime has not been attractive to workers or employers since the health contribution is compulsory and fully financed by the employer, while the pension affiliation is voluntary.

A legal reform to enhance the competitiveness, formalization and development of the small and medium-sized enterprises was approved in June. Although the reform entails a fiscal cost—S/. 1,987 millions per year (equivalent to 0.5 percentage points of GDP) according to the authorities’ estimates, it is expected that through formalization it raises the economy potential growth and lowers poverty. Key features of the reform are as follows:

  • More labor incentives for micro-enterprises (those with less than 10 workers). In particular, (i) affiliation to a health system will continue to be compulsory but cofinanced in equal amounts by the employer and the government; and (ii) it establishes a volunteer pension contribution to a portable individual pension account that will be managed by a private pension fund. Worker contributions into the individual accounts will be matched by government contributions up to a maximum, creating an incentive for voluntary savings. Affiliation to this pension scheme will also grant the right to a disability pension and a pension for survivors.
  • Reduced nonwage labor costs for small-enterprises (those with less than 100 workers). Small-enterprises will benefit from reduced nonwage costs of about 41 percent. Social security and pension affiliation are kept as compulsory, and other benefits such as life insurance, holiday bonuses, tenure bonuses, and the right to union are also maintained.

Figure 1.Peru: Real Sector Developments

Sources: Banco Central de Reserva del Peru and IMF staff estimates.

Figure 2.Peru: Fiscal Sector Developments

Sources: Central Reserve Bank of Peru; Ministry of Economy and Finance and IMF staff Estimates

Figure 3.Peru: External Sector Developments

Sources: Banco Central de Reserva del Peru, Ministry of Finance, JP Morgan and IMF staff estimates.

Figure 4.Peru: Banking and Financial System 1/

Sources: Bloomberg, SBS, World Federation of Exchange Rates and Fund staff estimates.

1/ Banking sector data corresponds to October 2008.

Figure 5.Peru: SBA Objectives and Outcomes, 2006–2008 1/

1/ Program performance in line with the fourth review under the SBA.

Table 1.Peru: Selected Economic Indicators
Prog.Proj.
CR/08/258Proj.CR/08/258Proj
200420052006200720082009
Social Indicators
Life expectancy at birth (years)70.7
Infant mortality (per thousand live births)22.8
Adult literacy rate87.887.9
Poverty rate (Total) 1/48.648.744.539.3
Unemployment rate9.49.68.58.4
(Annual percentage change; unless otherwise indicated)
Production and prices
Real GDP5.16.77.78.98.29.46.56.0
Real domestic demand4.05.710.311.811.012.87.16.8
Of which: Private sector4.45.99.011.411.212.46.47.7
Consumer Prices (end of period)3.51.21.13.94.36.72.82.8
Consumer Prices (period average)3.71.62.01.84.85.83.04.7
External sector
Exports40.935.637.017.418.512.83.5-17.7
Imports19.523.223.031.835.044.711.7-4.1
Terms of trade (deterioration -)9.25.928.33.6-1.8-9.5-5.8-10.6
Real effective exchange rate (depreciation -) 2/-1.6-0.5-1.3-0.6
Money and credit 3/4/
Liabilities to the private sector8.318.48.822.714.926.612.410.3
Net credit to the private sector-0.316.36.230.813.431.110.311.6
(In percent of GDP; unless otherwise indicated)
Public sector
General government current revenue17.018.019.820.720.320.719.219.6
General government noninterest expenditure16.216.716.216.016.017.116.217.3
Combined public sector primary balance1.01.64.15.14.53.52.92.0
Interest due2.01.91.91.81.51.51.31.5
Combined public sector overall balance-1.1-0.32.23.33.02.01.60.6
Combined public sector overall balance (including CRPAOs)-1.1-0.32.12.22.41.31.20.2
External Sector
External current account balance0.01.43.01.4-0.6-3.3-0.7-3.0
Gross reserves
In millions of U.S. dollars12,64914,12017,32927,74337,24330,74330,24330,243
Percent of short-term external debt 5/163.9311.4182.4456.1582.4442.8503.9358.1
Percent of foreign currency deposits at banks137.3125.9151.7208.5264.4165.8258.2158.0
Debt
Total external debt44.836.130.531.525.129.222.428.9
Combined public sector debt (including CRPAOs)44.337.733.130.922.024.819.021.7
Domestic9.29.79.211.07.38.26.57.4
External 6/35.128.023.919.914.716.512.614.4
Savings and investment
Gross domestic investment18.117.920.222.925.828.027.730.1
Public sector 7/2.82.92.83.14.14.44.94.8
Private sector15.315.117.419.821.723.622.825.3
National savings18.119.423.224.325.224.827.027.0
Public sector 8/1.72.65.16.47.26.36.45.4
Private sector16.416.818.117.918.018.520.521.6
External savings0.0-1.4-3.0-1.40.63.30.73.0
Memorandum items
Nominal GDP (S/. billions)238.0261.9302.8335.7382.9379.0414.3413.5
GDP per capita (in US$)2,6022,9203,3463,8264,8684,5505,5054,723
Sources: Central Reserve Bank of Peru; Ministry of Economy and Finance; ECLAC 2002-03; National Statistical Institute (INEI); and Fund staff estimates/projections.

Defined as the percentage of households with total spending below the cost of a basic consumption basket.

Based on Information Notice System.

Corresponds to the banking system.

Foreign currency stocks are valued at end-of-period exchange rates.

Short-term debt is defined on a residual maturity basis, and includes amortization of medium- and long-term debt.

Includes debt by the Central Reserve Bank of Peru.

Includes CRPAOs.

Excludes privatization receipts.

Sources: Central Reserve Bank of Peru; Ministry of Economy and Finance; ECLAC 2002-03; National Statistical Institute (INEI); and Fund staff estimates/projections.

Defined as the percentage of households with total spending below the cost of a basic consumption basket.

Based on Information Notice System.

Corresponds to the banking system.

Foreign currency stocks are valued at end-of-period exchange rates.

Short-term debt is defined on a residual maturity basis, and includes amortization of medium- and long-term debt.

Includes debt by the Central Reserve Bank of Peru.

Includes CRPAOs.

Excludes privatization receipts.

Table 2.Peru: Quantitative Performance Criteria and Inflation Consultation Mechanism for 2007-2008
20072008
Mar. 31Jun. 30Sept. 30Dec. 31Mar. 31June. 30Sept. 30
(Cumulative amounts from December 31, millions of Nuevos Soles)
Borrowing requirement of the combined public sector
Unadjusted limits 1/2/3/4/-1,396-4,190-2,7612,418-2,036-5,555-6,302
Adjusted limits-1,646-4,690-35111,418-2,486-6,455-6,302
Actual-4,194-11,749-14,181-13,176-3,001-8,320-10,983
Margin2,5487,05910,67014,5945151,8654,681
(Cumulative amounts from December 31, millions of U.S. dollars)
Net international reserves of the Central Reserve Bank,
excluding foreign-currency deposits of financial institutions
Unadjusted targets 5/6/-26044336350-645-404-437
Adjusted targets-635-478-8-1,691-1,446-1,185-1,310
Actual9484,1264,76187426,0426,6424,779
Margin1,5834,6044,76910,4337,4887,8276,089
Outstanding short-term external debt of the nonfinancial
public sector
Limits50505050505050
Actual0000000
Margin50505050505050
Contracting or guaranteeing of nonconcessional public
debt with maturity of at least one year
Unadjusted limits 7/8/9/7511,2371,6082,6361,5681,6732,354
Adjusted limits3,1463,6325,5066,9351,5681,6732,354
Actual2,7413,0284,6275,630254745857
Margin4056048791,3051,3149281,497
Of which: external debt of 1-5 year maturity
Limits100100100100100100100
Actual0011000
Margin1001009999100100100
External payments arrears of the public sector (on a
continuous basis)
Limits0000000
Actual0000000
NPV of future government payments associated with PPP
operations (on a continuous basis)
Unadjusted Limits 10/1,5001,5001,5001,5001,8601,8601,860
Actual585858680000
Margin1,4421,4421,4428201,8601,8601,860
(Consultation bands for the 12-month rate of inflation, in percent) 11/
Outer band (upper limit)5.55.55.55.55.05.05.0
Inner band (upper limit)4.54.54.54.54.04.04
Central point2.52.52.52.52.02.02.0
Inner band (lower limit)0.50.50.50.50.00.00
Outer band (lower limit)-0.5-0.5-0.5-0.5-0.5-0.5-0.5
Actual0.31.62.83.95.65.76.2
Sources: Staff estimations.

PIPP proceeds are included below the line.

In 2007, the limit on the borrowing requirement of the combined public sector will be adjusted downwards by the amount central government revenues net of mandatory transfers exceed program estimates of S/. 10,489 million at end-March, up to a ceiling of S/. 250 million; S/. 23,359 million at end-June, up to a ceiling of S/. 500 million; S/. 32, 807 million at end-September, up to a ceiling of S/. 750 million; and S/. 44,821 million at end-December, up to a total ceiling of S/. 1,000 million. In 2008, the limit on the borrowing requirement of the combined public sector will be adjusted downwards by the amount central government revenues net of mandatory transfers exceed program estimates of S/. 12,767 million at end-March, up to a ceiling of S/. 450 million; S/. 26,493 million at end-June, up to a ceiling of S/. 900 million. No adjustors will be applied to the end-September 2008 nor to the end-December 2008 data when assessing the performance of the PSBR.

The limit on the borrowing requirement of the combined public sector will be adjusted for the operating balance of the BCRP.

The limit on the borrowing requirement of the combined public sector will be adjusted upward by up to US$100 million for capital spending by Petroperu, over the $30 million already included in the program.

The target for net international reserves will be adjusted upward by the amount by which net foreign borrowing of the nonfinancial public sector exceeds '-US$15 million at end-March, -US$138 million at end-June, -US$274 million at end-September, and -US$148 million at end-December 2007. It will be adjusted downward for shortfalls from programmed net foreign borrowing. The amounts in excess will be deposited at the BCRP.

The target for net international reserves will be adjusted downward for withdrawals for portfolio management purposes of deposits held at the Central Reserve Bank by the Consolidated Pension Reserve Fund (FCR) and any other funds managed by the ONP. This downward adjustment will not exceed US$300 million at any time in 2007.

The limit will be adjusted upward by any amount of debt issued, and used in, debt-exchange operations, or for prefinancing of government operations.

The current debt limits do not include contracting of non-guaranteed debt by Petroperu and will be adjusted upward by up to US$300 million for debt contracted by Petroper during 2007.

The limit on contracting and guaranteeing of nonconcessional public debt will be adjusted upwards for guarantees contracted or extended by the government in relation to concessions, up to a ceiling of US$430 million for the year as a whole.

Discount rates to calculate the NPV of the future stream of payments will be the currency-specific commercial interest reference rates (CIRRs) published by the OECD and specified in the TMU.

Should inflation fall outside the inner band, the authorities will discuss with the Fund staff the appropriate policy response. Should inflation fall outside the outer band, the authorities will also complete a consultation with the Executive Board of the Fund on the proposed policy response before requesting further purchases under the arrangement.

Sources: Staff estimations.

PIPP proceeds are included below the line.

In 2007, the limit on the borrowing requirement of the combined public sector will be adjusted downwards by the amount central government revenues net of mandatory transfers exceed program estimates of S/. 10,489 million at end-March, up to a ceiling of S/. 250 million; S/. 23,359 million at end-June, up to a ceiling of S/. 500 million; S/. 32, 807 million at end-September, up to a ceiling of S/. 750 million; and S/. 44,821 million at end-December, up to a total ceiling of S/. 1,000 million. In 2008, the limit on the borrowing requirement of the combined public sector will be adjusted downwards by the amount central government revenues net of mandatory transfers exceed program estimates of S/. 12,767 million at end-March, up to a ceiling of S/. 450 million; S/. 26,493 million at end-June, up to a ceiling of S/. 900 million. No adjustors will be applied to the end-September 2008 nor to the end-December 2008 data when assessing the performance of the PSBR.

The limit on the borrowing requirement of the combined public sector will be adjusted for the operating balance of the BCRP.

The limit on the borrowing requirement of the combined public sector will be adjusted upward by up to US$100 million for capital spending by Petroperu, over the $30 million already included in the program.

The target for net international reserves will be adjusted upward by the amount by which net foreign borrowing of the nonfinancial public sector exceeds '-US$15 million at end-March, -US$138 million at end-June, -US$274 million at end-September, and -US$148 million at end-December 2007. It will be adjusted downward for shortfalls from programmed net foreign borrowing. The amounts in excess will be deposited at the BCRP.

The target for net international reserves will be adjusted downward for withdrawals for portfolio management purposes of deposits held at the Central Reserve Bank by the Consolidated Pension Reserve Fund (FCR) and any other funds managed by the ONP. This downward adjustment will not exceed US$300 million at any time in 2007.

The limit will be adjusted upward by any amount of debt issued, and used in, debt-exchange operations, or for prefinancing of government operations.

The current debt limits do not include contracting of non-guaranteed debt by Petroperu and will be adjusted upward by up to US$300 million for debt contracted by Petroper during 2007.

The limit on contracting and guaranteeing of nonconcessional public debt will be adjusted upwards for guarantees contracted or extended by the government in relation to concessions, up to a ceiling of US$430 million for the year as a whole.

Discount rates to calculate the NPV of the future stream of payments will be the currency-specific commercial interest reference rates (CIRRs) published by the OECD and specified in the TMU.

Should inflation fall outside the inner band, the authorities will discuss with the Fund staff the appropriate policy response. Should inflation fall outside the outer band, the authorities will also complete a consultation with the Executive Board of the Fund on the proposed policy response before requesting further purchases under the arrangement.

Table 3.Peru: Structural Benchmarks for June–December 2008
MeasureImplementationStatus
Clarify the tax treatment of securitization transactions in line with para. 11, bullet 4 of the LOI of December 5, 2007.June 30, 2008Not observed. As reported to the Executive Board at the time of the Third Review, the reform was put on hold, as it would entail amendments to the VAT law and a suspension of income tax withholding difficult to justify with Congress, as the authorities have been resisting introducing other tax exemptions in the recent period.
Issue methodological guidelines for ministries and public entities to assess tax exemptions in line with the new regime for tax exemptions.June 30, 2008Not observed. Draft methodological guidelines have not yet been issued by the authorities, although they have been approved by the Council of Ministers.
Submit to Congress amendment to the General Banking Law to allow the SBS the introduction of capital requirements for exchange-related risk in line with Basel II.June 30, 2008Observed.
Submit to Congress amendment to the General Banking Law to raise the minimum capital requirement for microfinance institutions.June 30, 2008Observed with some delay. The draft law was submitted to Congress in August.
Submit to Congress amendment to the Law of Pension Funds that would significantly raise the limit for foreign investment by private pension funds.June 30, 2008Observed.
2009 Budget to be prepared according to modernized budget classification system and incorporated into the chart of accounts.September 30, 2008Observed.
Implement the TSA, as described in para. 7 of the Letter of Intent of December 5, 2007.September 30, 2008Not observed. Earmarked funds (e.g., transfers of mining taxes to SNG, etc.) included in TSA but inclusion of revenues generated by agencies are still pending. The authorities are working on modifying the SIAF to generate outputs in a format that replicates that of a Treasury-General-Ledger.
Submit to Congress amendments to the Decentralization Law to reconcile subnational government spending with that for the central government as presented in the FRTL.September 30, 2008Not observed. Authorities are undertaking comprehensive review of decentralization process.
Expand the number of Technical Assistance Regional Offices from 16 to 28.December 31, 2008The authorities have established 24 regional offices, one per each region in the country.
Table 4.Peru: Fiscal Operations of the Combined Public Sector(In percent of GDP; unless otherwise indicated)
Proj.Proj.
CR/08/258ProjCR/08/258Proj.
2006200720082009
Central government primary balance3.23.43.43.52.62.4
Revenue17.518.317.618.217.017.2
Current17.418.217.518.116.917.1
Of which: Tax revenue15.015.715.315.514.814.8
Of which: Financial transaction tax0.30.40.40.30.30.3
Capital0.10.10.10.10.10.1
Noninterest expenditure14.314.914.214.814.314.8
Current 1/12.312.711.712.311.312.0
Wages and salaries4.13.93.73.73.53.6
Goods and services3.43.33.23.03.12.9
Transfers4.85.54.95.64.65.4
Capital2.02.22.62.53.02.8
General government primary balance3.74.84.43.73.02.4
Revenue19.920.820.420.819.219.7
Current19.820.720.320.719.219.6
Capital0.10.10.10.10.10.1
Noninterest expenditure16.216.016.017.116.217.3
Current13.512.912.213.011.812.9
Capital2.83.13.84.24.54.5
Public enterprise primary balance0.30.10.1-0.10.0-0.2
Nonfinancial public sector primary balance3.94.94.53.63.02.2
Overall balance2.13.12.10.7
Central bank operating balance0.20.20.0-0.10.0-0.2
Combined public sector primary balance4.15.14.53.52.92.0
Interest payments1.91.81.51.51.31.5
External1.41.30.90.90.80.9
Domestic0.40.50.60.60.60.6
Combined public sector overall balance2.23.33.02.01.60.6
Financing-2.2-3.3-3.0-2.0-1.6-0.6
External-0.5-0.9-1.0-0.30.50.7
Domestic-1.9-2.5-2.0-1.7-2.1-1.3
Privatization0.10.10.00.00.00.0
Memorandum items
Combined public sector overall balance (incl. CRPAOs2.12.22.41.31.20.2
Public sector debt (incl. CRPAOs)33.130.922.024.819.021.7
Nominal GDP (S/. millions)302,834335,730382,867378,997414,278413,550
Source: Peruvian authorities and staff estimates.

Figures since 2007 reflect the acceleration of transfers associated with income tax payments from the extractive industries to sub-national governments.

Source: Peruvian authorities and staff estimates.

Figures since 2007 reflect the acceleration of transfers associated with income tax payments from the extractive industries to sub-national governments.

Table 5.Peru: Fiscal Operations of the Combined Public Sector(In millions of Nuevos Soles; unless otherwise indicated)
Proj.Proj.
CR/08/258ProjCR/08/258Proj.
2006200720082009
Central government primary balance9,81611,53612,98013,20310,9639,949
Revenue53,07661,49867,51069,15370,28470,949
Current52,71561,11367,13168,74169,90070,520
Of which: Tax revenue45,55252,56958,60658,82461,42961,323
Of which: Financial transaction tax8431,4861,6671,1471,4061,191
Capital361385379412384429
Noninterest expenditure43,26049,96254,53055,95059,32061,000
Current37,25242,61344,73846,52346,78449,487
Wages and salaries12,55313,02013,98614,05214,68515,064
Goods and services10,19210,99412,14011,23712,86911,911
Transfers14,50618,59918,61221,23419,23022,513
Capital6,0087,3499,7919,42712,53611,513
General government primary balance11,09916,19016,88114,17012,4139,758
Revenue60,30369,84277,99278,80879,71581,372
Current60,05669,45677,72378,39779,43880,943
Capital247386269411278429
Noninterest expenditure49,20453,65161,11164,92467,30371,613
Current 1/40,83343,40746,74349,18048,79353,172
Capital8,37210,24414,36715,74518,50918,441
Public enterprise primary balance858285299-505-186-653
Nonfinancial public sector primary balance11,95716,47517,18113,66512,2279,106
Overall balance6,26410,4457,8293,040
Central bank operating balance47463211-249-144-694
Combined public sector primary balance12,43117,10717,19213,41712,0838,412
Interest payments5,6926,0305,7065,8375,5036,066
External4,3374,4403,5023,5473,1663,706
Domestic1,3551,5902,2042,2902,3362,359
Combined public sector overall balance6,73811,07711,4867,5806,5802,346
Financing-6,738-11,077-11,486-7,580-6,580-2,346
External-1,371-3,079-3,776-1,0732,2213,034
Domestic-5,671-8,448-7,746-6,544-8,829-5,409
Privatization30445037372828
Memorandum items
Combined public sector overall balance (incl. CRPAOs)6,3307,4839,0976,5515,139669
Public sector debt (incl. CRPAOs)100,245103,61084,05586,60278,88889,924
Nominal GDP (S/. millions)302,834335,730382,867377,899414,278413,550
Sources: Central Reserve Bank of Peru; Ministry of Economy and Finance; and Fund staff estimates/projections.

Figures since 2007 reflect the acceleration of transfers associated with income tax payments from the extractive industries

Sources: Central Reserve Bank of Peru; Ministry of Economy and Finance; and Fund staff estimates/projections.

Figures since 2007 reflect the acceleration of transfers associated with income tax payments from the extractive industries

Table 6.Peru: Public Sector Social Expenditure
Proj. 3/
20042005200620072008
(In millions of Nuevos Soles)
Total social expenditure and pensions23,52825,70827,71131,90533,041
Universal coverage (Education and Health) 1/10,26310,89212,28514,68514,123
Education7,2517,6828,2449,6489,409
Health3,0113,2104,0415,0374,714
Targeted programs (Extreme Poverty)3,0783,4533,5655,0276,024
Non-Targeted Social Programs10,18711,36311,86112,19312,894
(In percent of general government expenditure)
Total social expenditure and pensions60.958.656.359.550.9
Universal coverage (Education and Health) 1/26.624.825.027.421.8
Education18.817.516.818.014.5
Health7.87.38.29.47.3
Targeted programs (Extreme Poverty) 2/8.07.97.29.49.3
Non-Targeted Social Programs26.425.924.122.719.9
(In percent of GDP)
Total social expenditure and pensions9.99.89.29.58.7
Universal coverage (Education and Health) 1/4.34.24.14.43.7
Education3.02.92.72.92.5
Health1.31.21.31.51.2
Targeted programs (Extreme Poverty)1.31.31.21.51.6
Non-Targeted Social Programs4.34.33.93.63.4
Memorandum items
Total social expenditure and pensions
(annual percentage change, deflated by CPI)5.77.55.713.1-2.1
General government expenditure (S/. million)38,64143,84549,20453,65164,924
Source: Ministry of Economy and Finance.

Net of spending on education and health already included in the extreme poverty programs.

Includes expenditures for the targeted poverty-reduction program Juntos in 2006.

As per the 2008 approved budget.

Source: Ministry of Economy and Finance.

Net of spending on education and health already included in the extreme poverty programs.

Includes expenditures for the targeted poverty-reduction program Juntos in 2006.

As per the 2008 approved budget.

Table 7.Peru: Monetary Survey 1/
Prog.Proj.
CR/08/258Proj.CR/08/258Proj
200420052006200720082009
I. Central Reserve Bank
(In millions of New Soles)
Net international reserves2/41,43048,35355,27983,01796,69194,828107,69189,647
(In millions of U.S. dollars)12,63114,09717,27527,68937,18930,38930,38930,389
Net domestic assets-33,394-38,237-43,483-68,032-77,686-77,208-85,148-69,894
Net credit to nonfinancial public sector-12,930-13,770-19,925-28,933-34,821-35,376-44,260-38,143
Rest of banking system-19,191-21,585-22,158-39,175-54,243-35,841-56,481-33,199
Other-1,273-2,881-1,4007511,378-5,99115,5931,447
Currency8,03610,11611,79614,98519,00517,62021,94319,753
II. Banking System
(In millions of Nuevos Soles)
Net foreign assets40,90347,58256,05778,99391,70198,389103,14194,816
Net domestic assets16,19120,01717,50511,23411,94715,86613,40731,255
Net credit to nonfinancial public sector-12,970-14,254-20,601-34,822-41,422-42,937-50,456-45,796
Net credit to private sector43,68350,79953,94870,57480,01992,54688,287103,320
Other-14,522-16,528-15,842-24,518-26,650-33,744-24,424-26,269
Net credit to COFIDE-1,087-850-850-850-850-850-850-850
Other-13,435-15,678-14,992-23,668-25,800-32,894-23,574-25,419
Liabilities to the private sector57,09467,59973,56290,227103,648114,254116,548126,071
(12-month percentage change)
Base money25.325.718.328.229.021.814.712.0
Broad money8.318.48.822.714.926.612.410.3
Domestic currency28.119.518.034.530.223.514.513.5
Foreign currency-3.917.51.211.2-3.030.39.26.8
Net credit to private sector-0.316.36.230.813.431.110.311.6
Domestic currency11.934.829.043.131.244.114.522.0
Foreign currency-4.09.8-3.723.71.522.46.73.5
III. Financial System
(In millions of Nuevos Soles)
Net foreign assets40,77147,50456,03278,61088,04388,04395,08695,086
Net domestic assets42,06054,32267,29679,528101,672110,546119,680126,100
Net credit to the public sector-10,121-8,908-10,746-17,777-19,463-19,848-21,585-20,509
Net credit to private sector64,27174,94586,575111,218128,428146,417141,864164,929
Other-12,090-11,715-8,533-13,913-7,293-16,024-599-18,320
Liabilities to the private sector82,831101,825123,329158,138189,715198,589214,766221,187
(12-month percentage change)
Liabilities to the private sector12.522.921.128.220.025.613.211.4
Domestic currency23.529.130.414.530.223.514.513.5
Foreign currency0.114.46.714.4-3.030.39.26.8
Net credit to private sector4.716.615.528.515.531.610.512.6
Domestic currency17.926.038.240.128.340.113.220.0
Foreign currency-1.711.10.417.81.522.46.73.5
Memorandum item
End-of-period exchange rate (S/. per US$3.283.433.203.003.092.95
Sources: Central Reserve Bank of Peru; and Fund staff estimates/projections.

Stocks in foreign currency are valued at the end-of-period exchange rate.

Excludes subscriptions to the IMF and the Latin American Reserve Fund (FLAR), Pesos Andinos, credit lines to other central banks, as well as Corporacion Andina de Fomento (CAF) bonds, and foreign assets temporarily held by the BCRP as part of swap operations.

Sources: Central Reserve Bank of Peru; and Fund staff estimates/projections.

Stocks in foreign currency are valued at the end-of-period exchange rate.

Excludes subscriptions to the IMF and the Latin American Reserve Fund (FLAR), Pesos Andinos, credit lines to other central banks, as well as Corporacion Andina de Fomento (CAF) bonds, and foreign assets temporarily held by the BCRP as part of swap operations.

Table 8.Peru: Financial Soundness Indicators 1/(In percent; unless otherwise indicated)
Dec-04Dec-05Dec-06Dec-07Oct-08
Capital Adequacy
Equity capital to risk-weighted assets14.012.012.511.711.8
Regulatory Tier I capital to risk-weighted assets 2/13.111.210.68.88.4
Nonperforming loans net of provisions to capital-17.3-21.7-18.0-17.3-14.7
Asset Quality
Nonperforming loans to total gross loans 3/3.72.11.61.31.2
In domestic currency3.02.11.91.61.6
In foreign currency3.92.21.51.10.9
Nonperforming loans to total gross loans 4/9.56.34.12.72.1
In domestic currency6.14.23.22.52.4
In foreign currency10.67.14.62.81.9
Refinanced and restructured loans to total gross loans 5/5.84.12.41.40.9
Provisions to nonperforming loans 3/176.5235.3251.4278.4263.1
Provisions to nonperforming, restructured, and refinanced loans 4/68.780.3100.3131.6146.7
Sectoral distribution of loans to total loans
Consumer loans13.414.416.518.319.3
Mortgage loans14.214.814.012.311.6
Commercial loans68.165.864.263.963.1
Small business loans4.35.05.35.55.9
Earnings and Profitability
ROA1.22.22.22.52.6
ROE11.622.223.927.930.7
Gross financial spread to financial revenues71.970.567.666.666.5
Financial revenues to total revenues69.176.376.679.681.3
Annualized financial revenues to revenue-generating assets9.010.310.611.611.7
Liquidity
Total liquid assets to total short-term liabilities44.545.544.245.346.3
In domestic currency20.719.943.157.336.0
In foreign currency44.349.245.037.053.9
Foreign Currency Position and Dollarization
Global position in foreign currency to regulatory capital 6/24.223.117.116.825.9
Share of foreign currency deposits in total deposits67.167.262.759.357.2
Share of foreign currency loans in total credit75.771.565.561.858.6
Foreign currency deposits at commercial banks (in millions of U.S. dollars)9,59610,91311,85514,85718,353
Commercial banks’ short-term foreign assets (in millions of U.S. dollars)5477968788222,342
Commercial banks’ short-term foreign liabilities (in millions of U.S. dollars)7331,0857542,2382,105
Operational efficiency
Financing to related parties to capital 7/14.317.915.514.414.2
Nonfinancial expenditure to total revenues 8/35.933.331.330.128.4
Nonfinancial expenditure to total revenue-generating assets 8/4.74.63.44.54.3
Memorandum items
Number of Banks1614131518
Private commercial1412111316
Of which: Foreign-owned997912
State-owned2.02.02.02.02.0
Banks’ credit card loans to total loans6.46.98.19.29.6
Bank loans’ 12 month increase (in real terms)-1.919.014.027.730.7
Stock market index (U.S. dollars)11321400403258492284
Foreign currency debt rating (Moody’s)Ba3Ba3Ba3Ba2Ba1
EMBI+ PERU spread, basis points236186131175475
Sources: Superintendency of Banks and Insurance of Peru; Central Bank of Peru; and Fund staff estimates/projections.

These indicators correspond to private commercial banks.

Tier I regulatory capital is equivalent to share capital and reserves. Risk-weighted assets include market risk exposure. In year 2002, the Tier I considers a reduction on Banco Santander Central Hispano capital due to the valorization before its merger with Banco de Crédito.

Nonperforming loans are overdue loans after 15 days since the due date for commercial loans, after 30 days for small bussineses loans. In the case of mortgage, consumer and leasing loans, they are considered overdue after 30 days since the due date only for the non paid portion and after 90 days for all the credit. The overdue loans include credits under judicial resolution.

Includes restructured loans, refinanced loans, and arrears.

Refinanced loans refer to those loans subjected either term and/or principal modifications with respect to the initial debt contract. Restructured loans refer to those loans whose payments have been restructured according to the “Ley General del Sistema Concursal.”

Global position in foreign currency corresponds to those items in the balance sheet subject to exchange rate risk.

Financing to related parties corresponds to those loans to individuals and firms owning more than 4 percent of the bank.

Nonfinancial expenditures do not consider provisions nor depreciations.

Sources: Superintendency of Banks and Insurance of Peru; Central Bank of Peru; and Fund staff estimates/projections.

These indicators correspond to private commercial banks.

Tier I regulatory capital is equivalent to share capital and reserves. Risk-weighted assets include market risk exposure. In year 2002, the Tier I considers a reduction on Banco Santander Central Hispano capital due to the valorization before its merger with Banco de Crédito.

Nonperforming loans are overdue loans after 15 days since the due date for commercial loans, after 30 days for small bussineses loans. In the case of mortgage, consumer and leasing loans, they are considered overdue after 30 days since the due date only for the non paid portion and after 90 days for all the credit. The overdue loans include credits under judicial resolution.

Includes restructured loans, refinanced loans, and arrears.

Refinanced loans refer to those loans subjected either term and/or principal modifications with respect to the initial debt contract. Restructured loans refer to those loans whose payments have been restructured according to the “Ley General del Sistema Concursal.”

Global position in foreign currency corresponds to those items in the balance sheet subject to exchange rate risk.

Financing to related parties corresponds to those loans to individuals and firms owning more than 4 percent of the bank.

Nonfinancial expenditures do not consider provisions nor depreciations.

Table 9.Peru: Balance of Payments(In millions of U.S. dollars)
Prog.Proj.
CR/08/258Proj.CR/08/258Proj.
200420052006200720082009
Current account191,1492,7571,511-821-4,229-1,181-4,159
Merchandise trade3,0045,2868,9348,3536,6703,1634,744-1,244
Exports12,80917,36823,80027,95233,12431,52534,29025,950
Traditional9,19912,95018,37421,49024,96623,61824,65618,200
Nontraditional and others3,6114,4185,4266,4638,1597,9079,6347,751
Imports-9,805-12,082-14,866-19,599-26,454-28,362-29,546-27,195
Services, income, and current transfers (net)-2,985-4,137-6,177-6,842-7,491-7,392-5,924-2,914
Services-732-834-781-928-1,538-1,727-2,160-1,234
Investment income-3,686-5,074-7,581-8,409-8,534-8,439-6,441-4,393
Current transfers1,4331,7722,1852,4952,5812,7742,6762,713
Financial and capital account2,1551418478,90910,2827,4315,1543,632
Public sector988-1,440-599-1,272-1,512-534704829
Disbursements 1/2,5352,6567474,5882,1732,2611,7862,272
Amortization 1/-1,389-3,718-1,222-5,691-3,588-2,699-981-1,342
Other medium- and long-term
Public sector flows 2/-158-378-125-169-97-97-101-101
Capital transfers (net)00000000
Privatization313179000390
Private sector1,2881,78849110,18111,7947,9664,4112,803
Foreign direct investment (FDI) excluding
privatization1,5682,5483,3885,3436,7916,5256,2055,111
Other private capital-432-997-2,0204,8385,0031,441-1,794-2,308
Medium- and long-term loans-285-8401483,3351,9321,93727564
Portfolio investment-37779-1,5403231,640480296-1,323
Short-term flows 3/231-237-6281,1801,431-977-2,117-1,548
Net Errors and Omissions151238-877-8520-11700
Balance2,3261,5282,7269,5679,4613,0853,973-527
Financing-2,326-1,528-2,726-9,567-9,461-3,084-3,973527
NIR flow (increase -)-2,353-1,628-2,753-9,654-9,500-3,128-4,000500
Change in NIR (increase -)-2,437-1,466-3,178-10,414-9,500-3,000-4,000500
Valuation change-84162-425-760012800
Exceptional financing27100278639442727
Debt relief 4/27100278639442727
Change in arrears00000000
Rescheduling00000000
Memorandum items
Current account balance (in percent of GDP)0.01.43.01.4-0.6-3.3-0.7-3.0
Capital and financial account balance (in perce3.10.20.98.37.45.73.22.7
Export value (US$), percent change40.935.637.017.418.512.83.5-17.7
Volume growth13.915.0-0.13.111.56.67.82.0
Price growth23.717.937.213.96.25.8-4.0-19.3
Import value (US$), percent change19.523.223.031.835.044.711.7-4.1
Volume growth7.910.815.019.924.723.89.66.2
Price growth10.711.37.09.98.216.91.9-9.7
GDP (in billions of US$)69.779.593.0107.4138.8129.7159.3136.7
Sources: Central Reserve Bank of Peru; Ministry of Economy and Finance; and Fund staff estimates/projections.

Includes debt swap operations.

Includes portfolio flows of the pension reserve fund and subscription payments into international funds.

Includes COFIDE and Banco de la Nación.

Debt relief under existing operations.

Sources: Central Reserve Bank of Peru; Ministry of Economy and Finance; and Fund staff estimates/projections.

Includes debt swap operations.

Includes portfolio flows of the pension reserve fund and subscription payments into international funds.

Includes COFIDE and Banco de la Nación.

Debt relief under existing operations.

Table 10.Peru: External Financing Requirements and Sources(In millions of U.S. dollars)
Prog.Proj.
CR/08/258Proj.CR/08/258Proj
200420052006200720082009
Gross financing requirements7,2478,4344,96517,47519,56915,49512,74412,020
External current account deficit-19-1,149-2,757-1,5118214,2291,1814,159
(excluding official transfers)
Debt amortization4,9147,9564,9699,3329,2488,1387,5638,362
Medium- and long-term debt2,4005,2051,7836,3104,4563,2521,6042,058
Public sector1,3893,7181,2225,6913,5882,6999811,342
Multilateral 1/5716286479741,859960564894
Bilateral7422,1593942,200320329269307
Bonds and notes6690902,5131,3381,33800
Other108429247171148141
Private sector1,0111,486561619868553623716
Short-term debt 2/2,5142,7513,1863,0224,7924,8865,9606,304
Rescheduling and repayment of arrears00000000
Accumulation of NIR (flow)2,3531,6282,7539,6549,5003,1284,000-500
Change in gross reserves2,4431,4713,1779,5479,5001,9004,000-500
Payments of short-term liabilities incl. IMF-6-5186701,10000
Other-84162-425-760012800
Available financing7,2478,4344,96517,47519,56915,49512,74412,020
Foreign direct investment (net)1,5992,5793,4675,3436,7916,5256,2445,111
Privatization313179000390
FDI1,5682,5483,3885,3436,7916,5256,2055,111
Portfolio (net)-37779-1,5403231,640480296-1,323
Short-term assets (flow)163-434-1,276-1,536262-2,512-2,117-1,048
Of which: Errors and omissions151238-877-8520-11700
Debt financing from private creditors4,7535,5133,79012,2809,6259,6637,1648,288
Medium- and long-term financing2,0212,3288347,3943,6663,3591,2042,484
To public sector 3/1,2951,6821253,4408668695541,204
To private sector7266477093,9552,8002,4916501,280
Short-term financing2,7323,1852,9564,8865,9606,3045,9605,804
Official creditors 4/1,2409746231,1481,3081,3931,2311,067
Multilateral 1/1,0497624991,0051,0181,202822915
Of which: Balance of payments financing863581315854691887462713
Bilateral191212123143290191409152
To public sector191212123143290191409152
To private sector00000000
Other medium- and long-term public sector flows 5/-131-278-98-83-58-54-74-74
IMF00000000
Accumulation of arrears (exceptional)00000000
Sources: Central Reserve Bank of Peru; and Fund staff estimates/projections.

Excluding IMF.

Original maturity of less than one year. Equals stock at the end of the previous period.

Based on projections of no placements in external markets over the program period. Projections exclude possible external issuance for debt prepayments.

Includes both loans and grants. Breakdown not available as of 2008.

Includes debt relief and subscription payments to international organizations and changes in Banco de la Nación's long-term assets.

Sources: Central Reserve Bank of Peru; and Fund staff estimates/projections.

Excluding IMF.

Original maturity of less than one year. Equals stock at the end of the previous period.

Based on projections of no placements in external markets over the program period. Projections exclude possible external issuance for debt prepayments.

Includes both loans and grants. Breakdown not available as of 2008.

Includes debt relief and subscription payments to international organizations and changes in Banco de la Nación's long-term assets.

Table 11.Peru: Medium-Term Macroeconomic Framework
Proj.
20062007200820092010201120122013
(Annual percentage change)
GDP at constant prices7.68.99.46.06.86.56.56.5
Consumer prices (end of period)1.13.96.72.82.22.02.02.0
GDP deflator8.11.83.22.92.32.02.02.0
Merchandise trade
Exports, f.o.b.37.017.412.8-17.711.76.66.05.7
Imports, f.o.b.23.031.844.7-4.113.08.67.77.2
Terms of trade (deterioration -)28.33.6-9.5-10.6-1.4-0.60.0-0.2
(In percent of GDP; unless otherwise indicated)
External current account balance3.01.4-3.3-3.0-2.9-2.6-2.0-1.6
External current account, excluding interest obligations5.03.4-1.6-1.7-1.7-1.3-0.8-0.5
Total external debt service3.97.84.12.82.62.93.32.2
Medium- and long-term3.77.63.92.72.42.63.12.0
Nonfinancial public sector2.76.63.01.91.61.82.31.4
Private sector0.91.00.90.80.80.90.70.6
Short-term 1/0.20.20.30.20.20.20.20.2
Nonfinancial public sector0.00.00.00.00.00.00.00.0
Private sector0.20.20.30.20.20.20.20.2
External debt service 2/3.97.84.22.92.62.93.32.2
Interest2.02.01.71.41.21.41.21.1
Amortization (medium-and long-term)1.95.92.51.51.41.52.11.2
Combined public sector primary balance 3/4.04.02.91.61.91.91.61.3
General government revenue19.920.820.819.719.919.619.319.2
General govt. non-interest expenditure 3/16.216.017.117.317.617.317.417.5
Combined public sector interest due1.91.81.51.51.41.41.31.2
Combined public sector overall balance 3/2.12.21.30.20.50.50.30.1
Public sector debt 3/33.130.924.821.718.916.714.913.6
Gross domestic investment20.222.928.030.129.528.426.926.5
Public sector 3/2.83.14.44.84.84.95.05.0
Private sector17.419.823.625.324.723.522.021.5
National savings23.224.324.827.026.625.725.024.9
Public sector 4/5.16.46.35.46.35.45.35.1
Private sector18.117.918.521.620.320.319.719.8
External savings-3.0-1.43.33.02.92.62.01.6
Memorandum items
Nominal GDP (billions of Nuevos Soles)302.8335.7379.0413.5451.9490.9533.3579.3
Gross international reserves (billions of U.S. dollars)17,32927,74330,74330,24330,34330,99331,74332,593
Gross international reserves to broad money75.392.283.163.3663.363.564.265.5
External debt service (percent of exports of GNFS)13.826.915.412.911.813.816.711.9
Short-term external debt service (percent of exports of GNFS)0.80.91.00.80.71.01.01.0
Public external debt service (percent of exports of GNFS)9.622.610.98.47.48.511.87.5
Sources: Central Reserve Bank of Peru; Ministry of Economy and Finance; and Fund staff estimates/projections.

Includes interest payments only.

Includes the financial public sector.

Includes CRPAOs.

Excludes privatization receipts.

Sources: Central Reserve Bank of Peru; Ministry of Economy and Finance; and Fund staff estimates/projections.

Includes interest payments only.

Includes the financial public sector.

Includes CRPAOs.

Excludes privatization receipts.

Table 12.Peru: Financial and External Vulnerability Indicators(In percent; unless otherwise indicated)
Prog.Proj.
CR/08/258Proj.CR/08/258Proj.
200420052006200720082009
Financial indicators
Public sector debt/GDP44.337.733.130.922.024.819.021.7
Of which: in domestic currency (percent of GDP)6.98.29.211.08.08.27.57.4
90-day prime lending rate, domestic currency (end of period)3.84.45.25.6
90-day prime lending rate, foreign currency (end of period)2.65.56.16.4
Velocity of money 1/4.23.94.13.73.73.33.63.3
Net credit to the private sector/GDP 2/27.028.628.633.133.539.934.240.5
External indicators
Exports, U.S. dollars (percent change)40.935.637.017.418.512.83.5-17.7
Imports, U.S. dollars (percent change)19.523.223.031.835.044.711.7-4.1
Terms of trade (percent change) (deterioration -)9.25.928.33.6-1.8-9.5-5.8-10.6
Real effective exchange rate, (end of period, percent change) 3/-1.6-0.5-1.3-0.6
Current account balance (percent of GDP)0.01.43.01.4-0.6-3.3-0.7-3.0
Capital and financial account balance (percent of GDP)3.10.20.98.37.45.73.22.7
Total external debt (percent of GDP)44.836.130.531.525.129.222.428.9
Medium- and long-term public debt (in percent of GDP) 4/35.128.023.819.914.816.113.316.5
Medium- and long-term private debt (in percent of GDP)5.74.03.66.26.16.65.36.7
Short-term public and private debt (in percent of GDP)4.04.03.25.44.36.43.85.7
Total external debt (in percent of exports of goods and services) 4/212.2145.8107.4108.194.5106.993.2130.5
Total debt service (in percent of exports of goods and services) 5/26.135.013.826.917.515.49.412.9
Gross official reserves
In millions of U.S. dollars12,64914,12017,32927,74337,24330,74341,24330,243
In percent of short-term external debt 6/163.9311.4182.4456.1582.4442.8503.9358.1
In percent of short-term external debt, foreign currency deposits, and
adjusted CA balance 6/7/74.789.682.8143.1181.8120.6170.7110.9
In percent of broad money 8/72.771.675.392.299.183.198.770.8
In percent of foreign currency deposits at banks137.3125.9151.7208.5264.4165.8258.2158.0
In months of next year’s imports of goods and services10.09.38.79.812.511.312.99.8
Net international reserves (in millions of U.S. dollars)12,63114,09717,27527,68937,18930,18941,18930,189
Net international reserves (program definition; in millions of U.S. dollars) 9/9,3049,74813,96323,29231,28325,816
Net foreign exchange position (in millions of U.S. dollars) 10/6,9368,56411,31720,97030,47024,09834,47023,598
Sources: Central Reserve Bank of Peru; and Fund staff estimates/ projections.

Defined as the inverse of the ratio of end-period broad money to annual GDP.

Corresponds to the financial system.

End of period. Source: Information Notice System, IMF.

Includes Central Reserve Bank of Peru debt.

Includes debt service to the Fund. For 2002, excludes US$923 million of Brady bonds that were amortized in a debt exchange operation.

Short-term debt includes amortization of medium- and long-term loans falling due over the following year, including debt swaps.

Current Account deficit adjusted for 0.75*net FDI inflows; if adjusted CA balance>0, set to 0.

At end-period exchange rate.

Includes financial system's foreign currency deposits in central bank as reserve liability.

Includes public sector foreign currency deposits in central bank (e.g. pension reserve funds) as reserve liability.

Sources: Central Reserve Bank of Peru; and Fund staff estimates/ projections.

Defined as the inverse of the ratio of end-period broad money to annual GDP.

Corresponds to the financial system.

End of period. Source: Information Notice System, IMF.

Includes Central Reserve Bank of Peru debt.

Includes debt service to the Fund. For 2002, excludes US$923 million of Brady bonds that were amortized in a debt exchange operation.

Short-term debt includes amortization of medium- and long-term loans falling due over the following year, including debt swaps.

Current Account deficit adjusted for 0.75*net FDI inflows; if adjusted CA balance>0, set to 0.

At end-period exchange rate.

Includes financial system's foreign currency deposits in central bank as reserve liability.

Includes public sector foreign currency deposits in central bank (e.g. pension reserve funds) as reserve liability.

Table 13.Peru: Proposed Schedule of Purchases Under the Stand-By Arrangement, 2008–09 1/
Amount of PurchaseAvailability DateConditions Include
1. SDR 159.6 million 2/January 26, 2007Board approval of SBA.
2. SDR 1.596 millionJune 27, 2007Completion of the First Review and observance of end-March 2007 performance criteria.
3. SDR 1.596 millionAugust 15,2007Observance of end-June 2007 performance criteria.
4. SDR 1.596 millionDecember 19, 2007Completion of the Second Review and observance of end-September 2007 performance criteria.
5. SDR 1.596 millionFebruary 15, 2008Observance of end-December 2007 performance criteria.
6. SDR 1.596 millionJuly 7, 2008Completion of the Third Review and observance of end-June 2008 performance criteria.
7. SDR 1.596 millionAugust 15, 2008Observance of end-June 2008 performance criteria.
8. SDR 1.596 millionJanuary 28, 2009Completion of the Fourth Review and observance of end-September 2008 performance criteria.
9. SDR 1.596 millionFebruary 15, 2009Observance of end-December 2008 performance criteria.

Total access under the Stand-By Arrangement is SDR 172.368 million (27 percent of quota).

This amount is required to exhaust the first credit tranche which is not subject to phasing.

Total access under the Stand-By Arrangement is SDR 172.368 million (27 percent of quota).

This amount is required to exhaust the first credit tranche which is not subject to phasing.

Table 14.Peru: Capacity to Repay the Fund as of November 30, 2008 1/(In millions of SDRs; unless otherwise indicated)
Oct-Dec 2008200920102011201220132014Total
Obligations from existing drawings
Principal (repurchases)0.00.00.00.00.00.00.00.0
Charges and interest
GRA charges0.00.00.00.00.00.00.00.0
SDR charges0.00.90.90.90.90.90.95.4
Credit outstanding0.00.00.00.00.00.00.0
(percent of quota)0.00.00.00.00.00.00.0
Obligations from prospective drawings
Principal (repurchases)0.00.00.00.064.686.221.6172.4
Charges and interest 2/
GRA charges0.02.83.73.73.31.60.115.1
Service charge0.00.90.00.00.00.00.00.9
Credit outstanding0.0172.4172.4172.4107.721.50.0
(percent of quota)0.027.027.027.016.93.40.0
Cumulative (existing and prospective)
Principal (repurchases)0.00.00.00.064.686.221.6172.4
Charges and interest 2/
GRA charges0.02.83.73.73.31.60.115.1
SDR and Service charges0.01.80.90.90.90.90.96.3
Credit outstanding0.0172.4172.4172.4107.721.50.0
Percent of quota0.027.027.027.016.93.40.0
Percent of GDP0.00.20.20.20.10.00.0
Percent of exports of goods and services0.00.80.70.90.50.10.0
Percent of public sector debt service0.05.37.87.74.70.80.0
Percent of external public debt0.01.21.21.10.70.10.0
Percent of external public debt service0.07.011.510.36.21.10.0
Percent of gross foreign reserves0.00.90.60.90.50.10.0
Memorandum item
Purchases0.0172.40.00.00.00.00.0172.4
Sources: Fund staff estimates/projections.

Assuming all purchases are made when available. Repurchases assumed to be made under obligations schedule.

Projections are based on current rates of charge, including burden-sharing charges where applicable, for purchases in the GRA. The current SDR interest rate is assumed for net use of SDRs.

Sources: Fund staff estimates/projections.

Assuming all purchases are made when available. Repurchases assumed to be made under obligations schedule.

Projections are based on current rates of charge, including burden-sharing charges where applicable, for purchases in the GRA. The current SDR interest rate is assumed for net use of SDRs.

Attachment I. Inflation Consultation Letter

Mr. Dominique Strauss-Kahn

Managing Director

International Monetary Fund

January 7, 2009

Dear Mr. Strauss-Kahn,

During 2008 inflation was considerably influenced by international food and fuel supply shocks. In consequence, annual inflation reached 6.65 percent, above the upper limit of the target range (1–3 percent). It should be noted that the joint price increase for food, fuels, and electricity was 8.6 percent.

To prevent inflation expectations from affecting nonfood items, particularly in a context of robust domestic demand, the Central Bank reinforced its anti-inflationary stance to ensure a gradual return of inflation and inflation expectations to the target range. Accordingly, the Central Bank increased the reference interest rate by 200 basis points, from 4.5 percent in June 2007 to 6.5 percent in September 2008. This decision was complemented by increases in reserve requirements on obligations in both domestic and foreign currency.

The global financial crisis worsened in the second half of September, creating high volatility in international markets. Metal, fuel, and food prices dropped significantly; stock markets plunged in a context of deteriorating market expectations; and emerging market currencies experienced depreciation pressures. The resulting downward pressure on imported inflation is expected to translate into lower domestic prices over the next months.

As the main developed economies fall deeper into recession, the Peruvian economy is expected to decelerate. Growth is envisaged to decline from 9.3 percent in 2008 to 6.0 percent in 2009. At the same time, inflation expectations have started to ease, with a clear downward trend expected over the next two years.

Under these circumstances, the Central Bank has kept its policy interest rate at 6.5 percent. Additionally, in response to the financial system’s greater preference for liquidity in a context of considerable market uncertainty, the Central Bank has provided adequate liquidity through open market operations and reductions in reserve requirements. Official interventions in the foreign exchange market have continued to be confined to smoothing excessive exchange rate fluctuations in a context of financial dollarization.

The last Inflation Report envisages that inflation will return to the target range in 2009. Inflation is expected to drop from 6,65 percent in 2008 (one of the lowest of the region) to 2,8 percent (within the target range) in 2009, driven by lower imported inflation, GDP growth below potential (around 7 percent), and declining inflation expectations, in line with the Central Bank’s commitment to the 1–3 percent target range.

Sincerely,

/s/

Julio Velarde

President, Central Reserve Bank of Peru

Note: The fan chart shows the probability of various outcomes for inflation over the forecast horizon. The darkest band around the central forecast represents a 10 percent probability of occurrence, and all bands together represent a 90 percent probability of occurrence.

Attachment II. Impact of A Sharper and More Prolonged Global Slowdown
  • Real sector. Real GDP growth declines to 4 percent and 5 percent in 2009 and 2010, respectively (compared to 6 and 6.8 percent in 2009 and 2010 in the baseline). Real domestic demand growth decelerates by about 2 percentage points during 2009–2010 compared to the baseline, driven by weaker consumption and investment. Real GDP growth is expected to rebound to 7 percent in 2011, stabilizing at its potential level of 6.5 percent of GDP in 2012–13, as in the baseline.
  • Exchange rate and prices. The average nominal exchange rate is assumed to depreciate by an additional 6.2 and 8.4 percent in 2008 and 2009, respectively, relative to the baseline. Prices of major mineral commodities decline by 10 percent compared to the baseline, implying a reduction on traditional export prices of 25 percent. This contrast with a reduction of 19 percent in the baseline, which is in line with the WEO and authorities’ projections. End-of-year inflation is projected at 2.2 percent in 2009, reflecting a limited pass-through of commodity prices and the exchange rate depreciation. By 2010, inflation declines to 2 percent, at the mid-point of the inflation targeting range.
  • Fiscal policy. The decline in growth and the fall in mineral commodity prices lower government revenue by 0.8 percent of potential GDP relative to the baseline. Nominal government spending is assumed to remain unchanged, consistent with a neutral fiscal policy stance. The overall combined public sector fiscal balance-to-GDP ratio deteriorates by 0.8 percentage points from 0.6 percent of GDP in the baseline to -0.2 percent of GDP. The public debt-to-GDP ratio declines to 22.3 percent of GDP, versus 21.7 percent of GDP in the baseline.
  • Current account. The current account deficit narrows from 3.3 percent in 2008 to 3.2 percent of GDP in 2009–10, led by a strong decline in exports as a result of the decline in the price of mineral commodities, and significantly lower global real GDP growth and domestic demand compared to the baseline scenario. Imports decline in line with lower real GDP growth and oil prices. Foreign demand remains low in 2010 with a slow recovery towards the end of the year. The current account recovers to 2.5 percent in 2011, due to a rebound in foreign demand and despite a rebound in imports, led by the implementation of delayed expansion projects in the traditional sector.
  • Foreign direct investment. FDI is reduced on behalf of previously retained earnings now being repatriated to their home countries. Retained earnings are assumed to account for 60 percent of total FDI. In 2009, the crisis scenario assumes retained earnings to fall by 80 percent compared to the baseline. This drop would bring reinvested FDI in 2009 to about two times the 2001–03 average (which includes episodes of negative retained earnings). In the hard-lending scenario, the remainder is assumed to drop by 40 percent in 2009. FDI remain low in 2010 to recover to the baseline levels in 2011. The lower reinvested earnings and corresponding returns partly offset the decline in the trade balance during 2009–10.
  • Banks’ external medium- and long-term borrowing. It is assumed that US$200 million of the amortizations coming due in 2009 and 2010 are not rolled over.
  • Portfolio investment. In 2009, the crisis scenario includes around US$500 million in outflows compared to the baseline. This includes outflows in investment by private pension funds following the raise in their external investment limits. In 2010, portfolio outflows decline but remain $150 million higher than in the baseline.
  • Other short-term capital flows. In 2009, US$2.1 billion are withdrawn, including US$443 million of maturing CDs not rolled over; US$663 million of foreign deposits (5 percent of total FX deposits), and US$1 billion of other liabilities. Continued outflows for US$ 1 billion are assumed in 2010.
Table 1.Peru: Medium-Term Macroeconomic Framework under Alternative Scenario
Proj.
20062007200820092010201120122013
(Annual percentage change)
GDP at constant prices7.68.99.44.05.07.06.56.5
Consumer prices (eop)1.13.96.52.22.02.02.02.0
Consumer prices (average)2.01.85.83.82.32.02.02.0
GDP deflator8.11.83.22.52.51.51.92.0
Exchange rate (eop)3.23.03.13.33.12.82.82.8
Exchange rate (average)3.33.12.93.23.12.92.82.8
Merchandise trade
Exports, f.o.b.37.017.412.8-25.59.514.08.25.8
Volume growth-0.15.96.6-1.04.77.24.74.2
Price growth37.23.35.8-24.74.66.43.31.5
Imports, f.o.b.23.031.844.7-9.610.114.38.88.1
Volume growth15.015.723.83.94.77.16.56.3
Price growth7.03.916.9-13.05.16.72.11.7
Terms of trade (deterioration -)28.33.6-9.5-13.5-0.4-0.30.0-0.2
(In percent of GDP; unless otherwise indicated)
External current account balance3.01.4-3.3-3.2-3.0-2.5-2.0-1.7
External current account, excluding interest obligations5.03.4-1.6-1.7-1.7-1.1-0.7-0.6
Combined public sector overall balance2.23.32.0-0.2-0.10.00.00.0
Public sector debt 3/33.130.924.822.319.717.415.514.2
Gross domestic investment20.222.928.029.629.228.827.327.3
Public sector 3/2.83.14.44.95.05.15.25.2
Private sector17.419.823.624.724.223.722.122.0
National savings23.224.324.826.426.226.225.325.5
Public sector 4/5.16.46.34.75.85.15.25.2
Private sector18.117.918.521.720.421.120.120.3
External savings-3.0-1.43.33.23.02.52.01.7
Memorandum items
Nominal GDP (billions of Nuevos Soles)302.8335.7379.0404.1434.6472.0512.0556.2
Gross international reserves (billions of U.S. dollars)17,32927,74330,74327,69325,74326,39327,14327,993
External debt service (percent of exports of GNFS)13.826.915.414.026.9114.317.012.1
Short-term external debt service (percent of exports of GNFS)0.80.91.00.90.81.11.01.0
Sources: Central Reserve Bank of Peru; Ministry of Economy and Finance; and Fund staff estimates/projections.

1/ Includes interest payments only.

2/ Includes the financial public sector.

Excludes CRPAOs.

Excludes privatization receipts.

Sources: Central Reserve Bank of Peru; Ministry of Economy and Finance; and Fund staff estimates/projections.

1/ Includes interest payments only.

2/ Includes the financial public sector.

Excludes CRPAOs.

Excludes privatization receipts.

Attachment III. Surveillance Decision—External Sustainability Issues

In real effective terms, the Nuevo Sol has been recovering from its low level in recent years. In October, the real effective exchange rate (REER) was 3 percent below its 1991—2008 average. During 2004–07 the Nuevo Sol had been at its lowest level since it was introduced in 1991 following Peru’s recovery from the crisis of the late 1980s. This decline had been accompanied by a large accumulation of reserves. Nonetheless, since September, as a result of market pressures from the global financial crisis, reserves have declined by US$4 billion as the exchange rate depreciated by about 5 percent.

CGER-type analysis suggests that the exchange rate is undervalued (by about 2–7 percent). In particular, the macroeconomic balance approach shows an undervaluation of 7 percent in the real effective exchange rate, while the external sustainability approach suggests the Nuevo Sol is undervalued by about 6 percent. Finally, estimates under the equilibrium real exchange rate approach suggests an undervaluation of 2 percent.

CGER-type estimates are subject to considerable uncertainty. A sensitivity analysis shows the sensitivity of the misalignment measure to various assumptions in the macroeconomic balance approach. For instance, if the underlying medium-term current account deficit were underestimated by 1 percentage point of GDP in the baseline, Peru’s undervaluation would fall by 6 percentage points to only 1 percent. By contrast, if the current account norm were overestimated by 1 percentage point, the undervaluation would increase by 6 percentage points to 13 percent. The measure of misalignment is less sensitive to variances in the medium-term real exchange rate path underlying baseline projections and the current account elasticity to the real exchange rate.

Sensitivity of RER Gap to Assumptions
RER GapChange from

baseline
Baseline-70
MT current account balance
-1 p.p.-16
+1 p.p.-13-6
Current account norm
-1 p.p.-13-6
+1 p.p.-25
Elasticity (CA to RER)
+0.1-70
-0.1-8-1
Change in RER through 2013
+3%-10-3
-3%-43

Calculations based on an alternative methodology for countries with large stocks of nonrenewable resources confirm the CGER-type results. Using a stock approach (Thomas, Kim, Aslam, 2008) for Peru based on copper as the sole nonrenewable resources suggests an undervaluation of 7 percent. Uncertainties in this approach are linked to the estimate of the stock of copper reserves, assumptions on the return on investment and the discount rate, and the exclusion of other nonrenewable resources in the country.

Under the 2007 Surveillance Decision, the underlying current account balance is defined as the medium-term level of the current account stripped of temporary factors influencing the trade and income balances. The projected current account may differ from the underlying current account for several reasons, including:

  • Domestic output gap. Peru’s output above potential currently entails a higher level of imports—and lower trade and current account balances—than a closed gap.
  • Trading partner’s output gap. With output below potential abroad, Peru’s exports—and trade and current account balances—are lower than at a closed gap.
  • Commodity prices. Being a commodity exporter, if prices were to fall back to a smoothed average, Peru’s trade and current account balances would deteriorate.
  • Hydrocarbon prices. Being a net importer of hydrocarbon products, if prices did not fall back to a smoothed average, Peru’s current account would be higher.

Peru’s underlying current account deficit is estimated at 2.8 percent of GDP compared to a projection of 3 percent of GDP in 2009. With mining products representing two-thirds of goods exports, lower longer-term commodity prices have the strongest effect on Peru’s current account—some 0.9 percent of GDP. Nonetheless, this is more than offset by the closing of trading partner’s negative output gap and Peru’s positive output gap. Peru’s misalignment vanishes if this adjusted current account is used as the underlying current account in the macroeconomic balance approach.

Peru: Estimating the Underlying Current Account Balance in 2009
Current accountAdjustmentConceptExplanation
(billions of US$)(in percent of GDP)(billions of US$)(in percent of GDP)
Projection 2009
-4.16-3.040.680.50Output gap in PeruOutput is above potential. Reducing it to potential would lower imports.
0.600.44Output gap trading partnerForeign demand is growing below potential. Assuming the gap will be closed will benefit Peruvian exports.
-0.88-0.65Mineral PricesMineral prices are estimated above their long term level. If they fall, exports will be lower.
-0.09-0.06Hydrocarbon PricesOil are estimated slightly below their long term level. If they increase, net imports will be higher.
Underlying current account
-3.85-2.81
Attachment IV. Debt Sustainability Analysis19

Peru’s debt-to-GDP ratio is projected to decline considerably under the baseline debt sustainability scenario. Economic growth would average close to 7 percent a year in 2008–13 underpinned by a moderate fiscal surplus position. The public sector revenue-to-GDP ratio is expected to decline by a cumulative 1.6 percentage points, reflecting the decline in growth and mining government revenues. Under these assumptions, Peru’s public sector debt stock (including CRPAOs) would decline from 30.9 percent of GDP at end-2007, to 13.6 percent of GDP by 2013.

Given that nearly two thirds of total external debt is public, in the baseline scenario the projected drop in public debt largely determines the path of Peru’s total external debt. Private external debt rose in 2007 as banks sought long term loans abroad to expand their domestic business, but is projected to decline over the medium term as more financing becomes available domestically. Given the recent declines in public external debt, total external debt is projected to decline from 32 percent of GDP at end-2007 to 20 percent by 2013 (public external debt would decline from 20 percent to 10 percent over the same period).

Peru’s external and public sector debt ratios are robust to alternative assumptions about underlying macroeconomic variables. Sensitivity tests based on 10-year historical standard deviations to form alternative medium-term assumptions for real GDP growth and interest rates show that Peru’s debt dynamics are only moderately vulnerable to such changes.

Despite the increasing share of domestic currency in public sector debt, external and public debt ratios remain sensitive to changes in exchange rate changes, given the high foreign currency share of Peru’s debt. Specifically, under a one-off 30 percent real depreciation of the exchange rate, the external debt-to-GDP ratio would shift by 6 percentage points above the baseline projections in the medium term. This test assumes that the exchange rate would remain at its depreciated level permanently—a scenario that could only occur in case of the current exchange rate being significantly overvalued. Available data, however, do not point to such an overvaluation. Noninterest current account shocks (such as in the terms of trade) would have a moderate adverse impact on external indebtedness.

A similar pattern is observed under a 10 percent of GDP shock to the contingent liabilities of the public sector: The public debt-to-GDP ratio would rise sharply in the short run and, while declining over the medium term, would, by 2013 remain 9.3 percentage points above the debt levels projected under the baseline scenario.

Figure 1.Peru: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)

Sources: International Monetary Fund, Country desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

3/ One-time real depreciation of 30 percent occurs in 2009.

Figure 2.Country: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)

Sources: International Monetary Fund, country desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance.

3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2009, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

Table 1Peru: External Debt Sustainability Framework, Baseline, 2003-2013(In percent of GDP, unless otherwise indicated)
ActualProjections
20032004200520062007200820092010201120122013Debt-stabilizing
non-interest
current account 6/
Baseline: External debt48.244.836.130.831.529.228.926.123.621.319.5-3.4
Change in external debt-0.9-3.4-8.8-5.20.7-2.3-0.3-2.8-2.6-2.2-1.8
Identified external debt-creating flows (4+8+9)-2.1-7.4-9.0-9.6-10.2-2.7-0.6-1.6-2.6-2.5-2.3
Current account deficit, excluding interest payments-0.7-2.1-3.5-5.0-3.41.61.71.71.30.80.5
Deficit in balance of goods and services-0.1-3.1-5.6-48.4-51.4-53.5-46.1-45.5-43.5-41.6-40.2
Exports17.621.124.728.629.127.322.221.820.619.618.8
Imports17.518.019.1-19.8-22.2-26.2-24.0-23.7-22.9-22.0-21.4
Net non-debt creating capital inflows (negative)0.0-1.5-2.0-1.5-4.5-3.5-1.9-2.8-3.7-3.1-2.6
Automatic debt dynamics 1/-1.5-3.7-3.4-3.0-2.3-0.8-0.3-0.5-0.1-0.2-0.2
Contribution from nominal interest rate2.22.12.12.02.01.71.41.21.41.21.1
Contribution from real GDP growth-1.8-2.2-2.7-2.4-2.4-2.4-1.7-1.7-1.5-1.4-1.3
Contribution from price and exchange rate changes 2/-1.8-3.6-2.8-2.7-1.9
Residual, incl. change in gross foreign assets (2-3) 3/1.23.90.24.310.80.30.3-1.20.00.30.5
External debt-to-exports ratio (in percent)274.3212.2145.8107.8108.1106.9130.5119.8114.1108.9103.9
Gross external financing need (in billions of US dollars) 4/5.54.96.82.27.913.314.514.515.015.613.6
in percent of GDP9.07.08.62.47.310.210.69.38.68.16.5
Scenario with key variables at their historical averages 5/29.226.724.823.622.421.2-1.2
Key Macroeconomic Assumptions Underlying Baseline
Real GDP growth (in percent)4.05.16.77.78.99.46.06.86.56.56.5
GDP deflator in US dollars (change in percent)3.98.26.88.06.710.4-0.66.74.74.02.7
Nominal external interest rate (in percent)4.94.95.36.57.46.54.94.85.95.75.4
Growth of exports and services (US dollar terms, in percent)16.736.533.534.518.313.1-14.412.25.55.14.9
Growth of imports and services (US dollar terms, in percent)8.716.821.0-220.330.542.3-3.512.87.56.86.3
Current account balance, excluding interest payments0.72.13.55.03.4-1.6-1.7-1.7-1.3-0.8-0.5
Net non-debt creating capital inflows0.01.52.01.54.53.51.92.83.73.12.6

Derived as [r - g - ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, withr = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Derived as [r - g - ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, withr = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Table 2.Country: Public Sector Debt Sustainability Framework, 2003-2013(In percent of GDP, unless otherwise indicated)
ActualProjections
20032004200520062007200820092010201120122013Debt-stabilizing
primary
balance 9/
Baseline: Public sector debt 1/47.144.337.732.930.924.821.718.916.714.913.60.0
o/w foreign-currency denominated43.337.529.525.022.317.614.812.510.79.28.2
Change in public sector debt0.4-2.8-6.6-4.8-2.0-6.1-3.0-2.8-2.2-1.8-1.3
Identified debt-creating flows (4+7+12)-1.1-4.7-5.0-7.6-7.4-4.9-2.2-2.3-2.0-1.6-1.3
Primary deficit-0.4-1.0-1.6-3.9-4.0-2.9-1.6-1.9-1.9-1.6-1.3
Revenue and grants18.017.918.920.520.820.819.719.919.619.319.2
Primary (noninterest) expenditure17.617.017.316.516.817.918.018.017.717.817.9
Automatic debt dynamics 2/-0.7-3.6-3.3-3.6-3.3-2.0-0.6-0.4-0.10.00.0
Contribution from interest rate/growth differential 3/-0.9-2.8-2.1-3.4-1.3-2.0-0.6-0.4-0.10.00.0
Of which contribution from real interest rate0.8-0.70.6-1.01.40.60.80.91.01.00.9
Of which contribution from real GDP growth-1.8-2.2-2.7-2.4-2.7-2.6-1.4-1.4-1.1-1.0-0.9
Contribution from exchange rate depreciation 4/0.3-0.7-1.2-0.2-2.0
Other identified debt-creating flows-0.1-0.2-0.1-0.1-0.10.00.00.00.00.00.0
Privatization receipts (negative)-0.1-0.2-0.1-0.1-0.10.00.00.00.00.00.0
Recognition of implicit or contingent liabilities0.00.00.00.00.00.00.00.00.00.00.0
Other (specify, e.g. bank recapitalization)0.00.00.00.00.00.00.00.00.00.00.0
Residual, including asset changes (2-3) 5/1.51.9-1.62.85.4-1.2-0.8-0.5-0.2-0.20.0
Public sector debt-to-revenue ratio 1/261.7247.0199.2160.7148.4119.0110.594.985.476.971.0
Gross financing need 6/5.44.96.81.54.80.71.41.11.31.41.4
in billions of U.S. dollars3.33.45.41.45.11.01.91.72.32.73.0
Scenario with key variables at their historical averages 7/24.822.320.218.416.615.2-0.4
Scenario with no policy change (constant primary balance) in 2008-201324.819.916.112.89.86.90.0
Key Macroeconomic and Fiscal Assumptions Underlying Baseline
Real GDP growth (in percent)4.05.16.77.69.09.46.06.86.56.56.5
Average nominal interest rate on public debt (in percent) 8/4.84.84.85.86.05.66.57.18.08.48.6
Average real interest rate (nominal rate minus change in GDP deflator, in percent)2.0-1.31.7-2.44.92.43.64.86.06.46.6
Nominal appreciation (increase in US dollar value of local currency, in percent)-0.61.93.60.69.2
Inflation rate (GDP deflator, in percent)2.86.13.18.11.13.22.92.32.02.02.0
Growth of real primary spending (deflated by GDP deflator, in percent)4.11.38.92.810.616.96.86.74.37.17.1
Primary deficit-0.4-1.0-1.6-3.9-4.0-2.9-1.6-1.9-1.9-1.6-1.3

Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

Derived as [(r - π(1+g) - g + αε(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1 +g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

Derived as [(r - π(1+g) - g + αε(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1 +g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

1

A Selected Issues Paper presents an analysis of the role of fiscal policy in contributing to macroeconomic stability.

2

Domestic fuel prices remained 23 percent on average above their import parity as of mid-December 2008, in line with the FEPC mechanism, as its liabilities still amount to about ⅓ percent of GDP.

3

Government deposits amounted to 7¼ percent of GDP at end-October 2008.

4

Peru’s exchange system is free of restrictions on the making of payments and transfers for current international transactions.

5

Fitch’s October 2008 Banking System Risk Report, assessed the banking system potential vulnerability to macro-prudential risks as low (similar to Panama), with its intrinsic quality—which is derived from Fitch’s individual bank ratings—also deemed to be low, but typical of emerging markets.

6

Microfinance institutions account for 6 percent of total assets of the financial system and have a CAR of about 23 percent.

7

As of end-October, microfinance institutions provisions represented 29.6 percent, and 32.0 percent of capital for Cajas Municipales and Cajas Rurales, respectively.

8

In Peru, commercial loans past due 15 days are treated as nonperforming, compared with 30 days in most countries. In addition, the treatment of restructured loans—which payments have been rescheduled—has been aligned with international accepted practices in 2007.

9

With the implementation of procyclical provisioning, the authorities amended the accounting rules for financial institutions to avoid incompatibilities with the international accounting standards (IAS 39).

10

A Selected Issues Paper discusses the recent developments in private sector credit and policy options to ensure an orderly financial deepening.

11

Minimum capital for Cajas Rurales y Municipales would be raised to US$1.3 million (from US$0.3 million), and to US$ 0.8 million (from US$0.3 million) for Edpymes. All existing institutions will have 2 years to increase their capital to the new minimums once the law is approved by Congress.

12

A Selected Issues Paper explores empirically the central bank’s motives for intervention.

13

The program allows the subnational government to contract private companies for investment projects in exchange for credit certificates against future income tax liabilities. The ceiling for project contracts by each SNG is roughly equal to the aggregated canon transfers for concept of mining revenues of the last two years.

14

In particular, the new regime loosens the requirements to apply for VAT credit, while expanding the registration period to one year. These changes may create an incentives to request increased VAT devolutions and drawbacks during a economic slowdown, while delaying VAT receipts accruing to SUNAT.

15

Efforts should focus on streamlining audit procedures and quality, and setting noncompliance targets for tax audit and arrears collection.

16

The Organic Law of the Executive Power of December 2007 did not address the expenditure assignments among levels of governments, but instead, indicated that the shared responsibilities would be determined in the laws of organization and functions of each ministry.

17

A Selected Issues Paper discusses the impact of public transfers in regional disparities and the international experience in establishing equalization schemes.

18

Labor informality remains very high, partly reflecting still high costs of hiring and firing, notwithstanding labor force unionization of less than 10 percent.

19

The DSA includes standard sensitivity tests around the baseline medium-term scenario. The methodology used is in line with that endorsed in the Information Note on Modifications to the Fund’s Debt Sustainability Assessment Framework for Market Access Countries, dated July 5, 2005.

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