Recent Economic Developments

This paper describes economic developments in Peru during the 1990s. During 1990–92, real GDP growth was negative by 0.9 percent a year on average, reflecting in part deterioration in the terms of trade and adverse weather conditions. During that period, growth in the construction, manufacturing, and fishing sectors was more than offset by a contraction in the agricultural and mining sectors. Gross domestic investment rose from about 15½ percent of GDP in 1990 to 16½ percent in 1992 mainly on the strength of public sector investment.


This paper describes economic developments in Peru during the 1990s. During 1990–92, real GDP growth was negative by 0.9 percent a year on average, reflecting in part deterioration in the terms of trade and adverse weather conditions. During that period, growth in the construction, manufacturing, and fishing sectors was more than offset by a contraction in the agricultural and mining sectors. Gross domestic investment rose from about 15½ percent of GDP in 1990 to 16½ percent in 1992 mainly on the strength of public sector investment.

I. Recent Economic Developments and Structural Reforms

In early 1990 the Peruvian economy was facing a severe economic crisis characterized by hyperinflation and a sharp drop in output resulting from large fiscal imbalances, negative real interest rates, widespread wage and price controls and subsidies, and a highly distorted exchange rate system. In addition, the social environment had deteriorated with the escalation of terrorism. The administration that took office in July 1990 began implementing a program of macroeconomic and structural adjustment, aimed at drastically reducing inflation, creating the conditions for sustained economic growth, and ensuring the progressive return to external viability while re-establishing relations with the international financial community. The initial adjustment program has been followed by the continuous implementation of sound financial policies, comprehensive structural reforms, and pacification of the country which have permitted to make significant progress towards the achievement of the objectives mentioned above.

1. Economic developments and policies

a. Background

During 1990-92 real GDP growth was negative by 0.9 percent a year on average, reflecting in part a deterioration in the terms of trade and adverse weather conditions (Table I.1). During that period growth in the construction, manufacturing, and fishing sectors was more than offset by a contraction in the agricultural and mining sectors. Gross domestic investment rose from about 15 1/2 percent of GDP in 1990 to 16 1/2 percent in 1992 mainly on the strength of public sector investment. Over the same period national savings declined by 0.7 percentage points of GDP to 11 1/2 percent. The 12-month rate of inflation dropped from 7,650 percent by end-1990 to 56.7 by end-1992 reflecting the implementation of tighter financial policies and the virtual elimination of restrictions to trade.

Table I.1.

Peru: Selected Economic Indicators

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

New soles per U.S. dollar; end-of-period data.

12-month percentage change; end-of-period data.

Includes debt to the Fund.

During 1990-92 the authorities were successful at broadening the tax base and improving the overall efficiency of the tax system while keeping the growth of expenditure under tight control. As a result, the combined public sector deficit was reduced from 7.6 percent of GDP in 1990 to 2.7 percent in 1992 (Table I.2). Following improvements in tax administration through a major reorganization of the National Superintendency of Tax Administration (SUNAT) and the adoption of revenue-enhancing measures, central government current revenue rose from 9.9 percent of GDP in 1990 to an average of 10.4 percent of, GDP in 1991-1992. Public sector expenditure (excluding interest payments) rose from 11.3 percent of GDP in 1990 to close to 12 percent in 1992, largely on account of stepped up capital outlays as current expenditure declined somewhat as a share of GDP during the period. Quasi-fiscal losses declined from 1.1 percent of GDP in 1990 to 0.3 percent in 1991-92 1/

Table I.2.

Peru: Combined Public Sector Operations 1/

(In percent of GDP; unless otherwise indicated)

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

Nominal GDP series have been revised and ratios to GDP have been adjusted based on revised GDP data.

Includes collections of the payroll tax earmarked to the housing agency and 2 percentage points of VAT receipts earmarked to municipalities.

Includes cash losses of the Central Reserve Bank.

Domestic financing includes statistical discrepancy and variation in domestic arrears.

Includes wages, salaries, pensions, and goods and services of military personnel.

Includes wages and salaries of civil servants, interior personnel, and military personnel, but excludes pensions.

During the 1991-92 period the main objective of monetary policy was to reduce the rate of inflation by keeping the growth of base money in line with the needs of the economy while allowing interest rates to be determined by market forces (Table I.3). Monetary policy shifted away from the use of direct instruments, including credit allocation schemes and interest controls, to that of indirect tools of monetary management. The reduction of inflation and a turnaround in confidence resulted in an increase of bank intermediation that was reflected in a decline in money velocity from 17 1/2 in 1990 to 10 1/2 in 1992. In an effort to promote bank intermediation in domestic currency, the authorities lowered the marginal reserve requirement on domestic currency deposits from 40 percent in 1990 to zero in March 1992; the marginal reserve requirement on foreign currency deposits was left at 50 percent. However, the share of foreign currency denominated deposits in total deposits with commercial banks remained high, at about 80 percent as of December 1992. Commercial bank credit to the private sector increased by an average of 42 percent a year in real terms.

Table I.3.

Peru: Banking System Indicators 1/

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

Figures may differ from staff report inter alia because net domestic assets are defined here as the difference between liabilities to the private sector, net international reserves, and medium- and long-term foreign assets. In addition, flows denominated in foreign currency are valued at average actual exchange rates, not at program exchange rates. Finally, reserve requirements in foreign currency are recorded as liabilities to the banking system and not as a reserve liability in accordance with the program definition.

Flows denominated in foreign currency are valued at the average official exchange rate during the corresponding period.

Percent change in relation to Central Reserve Bank liabilities to the private sector at the beginning of period.

Reserve requirements on foreign currency deposits are treated as liabilities to the banking system.

Percent change in relation to M2 at beginning of period.

Nominal GDP divided by the average of the stock of money and quasi-money during the period.

The external current account deficit widened from 3.3 percent of GDP in 1990 to an average of about 3.9 percent in 1991-92 reflecting in part a deterioration in the terms of trade over the period (Table I.4). Private foreign capital inflows responded favorably to the reform efforts and the pacification of the country, increasing from US$101 million in 1990 to an average of about US$1.4 billion a year between 1991-92. The net international reserves of the Central Reserve Bank rose tenfold between 1990 and 1992, and by end-1992 gross reserves amounted to US$2.9 billion, equivalent to about 6 1/2 months of imports of goods and nonfactor services. The strong capital inflows resulted in upward pressures on the currency and the new sol appreciated by almost 16 percent in real effective terms from end-1990 to end-1992.

Table I.4.

Peru: Summary Balance of Payments

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Sources: Central Reserve Bank of Peru; and Fund Staff estimates.

Excludes cash grants from the Support Group.

Project loans, including from multilateral sources.

From 1993 includes portfolio investment.

Includes reserve requirements on foreign currency deposits.

Includes rescheduling, debt foregiveness, and cash disbursements for balance of payments support.

b. Developments during 1993-1995

In contrast with the preceding years, the Peruvian economy experienced a rapid rate of growth during 1993-95, while inflation declined further. During this period there was a further accumulation of net international reserves of the Central Reserve Bank reflecting continued large private capital inflows, including from privatization. The external current account deficit widened significantly in the second half of 1994 and the first half of 1995 following a strong growth in imports.

During 1993-95 real GDP grew by about 9 percent a year on average, led by investment and external demand. The fastest average rates of growth in 1993-94 were recorded in construction (24 percent), fishing (22.1 percent), and agriculture (9 1/2 percent). Real GDP growth continued at about the same rate in the first half of 1995 with a strong expansion in construction and commerce, and a decline in fishing output reflecting a temporary ban on the exploitation of certain species. Gross domestic investment grew from 16 1/2 percent of GDP in 1992 to 24 1/2 percent in the first half of 1995. Gross national savings rose by close to 5 percentage points of GDP during the same period, to about 17 percent of GDP in the first half of 1995, with improvement both in public and private sector savings. The 12-month rate of inflation declined from 39 1/2 percent in December 1993 to 15.4 percent in December 1994, and to 10.3 in October 1995.

Public finances remained tight during 1993 and the first half of 1994, but weakened during the second half of 1994 and the first half of 1995, reflecting stepped-up social and capital outlays as well as wage increases granted in the second half of 1994. The overall balance of the combined public sector (excluding privatization receipts) turned from a surplus of 0.3 percent of GDP in the first half of 1994 to a deficit of 2.8 percent of GDP in the first semester of 1995.

Current revenue of the Central Government increased from 11.3 percent of GDP in 1992 to 13.0 percent of GDP in 1994. During the first half of 1995 central government current revenue rose further to the equivalent of 13.7 percent of GDP, mostly on account of strong import-related revenue associated with the increase in imports. Total expenditure (excluding interest payments) rose from 11.8 percent of GDP in 1992 to 13.6 percent in 1994 and 14.8 percent in the first half of 1995. Privatization receipts of the nonfinancial public sector amounted to 0.4 percent of GDP in 1993, 4.5 percent of GDP in 1994, and 1.3 percent of GDP in the first half of 1995.

In December 1993 the Government adopted a package of tax measures aimed at further simplifying the tax system, broadening the tax base, and increasing revenue yield. The income tax brackets were reduced from five in 1991 to three; the income tax was modified by taxing business income at a flat rate of 30 percent; dividend income was excluded from the tax base; and the net wealth tax was eliminated. The 2 percent minimum income tax, based on gross assets, was maintained but several exemptions (particularly for machinery and equipment) were added. The bases for the value added and excise taxes were broadened and exemptions eliminated. Also the tax code was modified to enhance the ability of SUNAT to audit taxpayers, increase fines and penalties, simplify administrative procedures and strengthen tax courts. Additional legislation approved by Congress during the first half of 1994 reinforced the fight against smuggling. During 1994 the bases for the income and value-added taxes were broadened further.

During the 1993-95 the Central Reserve Bank increased its intervention in the foreign exchange market in an attempt to mitigate the pressures on the currency to appreciate because of the large capital inflows; it also stepped up its open market operations to sterilize partially the attendant monetary effects. The stock of Central Reserve Bank certificates of deposit rose from S/. 12 million in December 1993 (0.7 percent of base money) to S/. 350 million in December 1994 (13 percent of base money) and S/. 1085 million in September 1995 (35 percent of base money). In November 1993 the Central Reserve Bank also established a minimum nonremunerated reserve requirement of 9 percent on both domestic and foreign currency deposits with the banking system. At the same time it reduced from 50 percent to 45 percent the marginal reserve requirement on foreign currency deposits and lowered the remuneration on such requirements from the rate paid on foreign currency deposits in the domestic financial system to LIBOR. In real effective terms, the new sol appreciated by 12.3 percent during 1993-94 but it depreciated by 6.1 percent between December 1994 and June 1995, reflecting in part the nominal depreciation of the U.S. dollar vis-à-vis other major currencies during that period.

The deepening of Peru’s financial markets continued during 1993-95, with money velocity reaching 6.8 in June 1995, down from 8.3 at end-1993. In real terms the 12-month rate of growth of credit to the private sector steadily rose from 24 1/2 percent at end-1992 to 31 1/2 percent at end-June 1995 financed with large borrowing abroad by commercial banks and increases in foreign currency deposits.

The external current account deficit widened significantly during the second half of 1994 and the first half of 1995 (7.5 percent of GDP), reflecting mainly an acceleration in the rate of growth of imports of intermediate and capital goods. Also, export volume rose by 13.5 percent a year in 1993 and 1994, but slowed to 4.9 percent in annual terms in the first half of 1995, reflecting lower fishing exports. The external current account deficit was largely financed by private capital inflows. Excluding privatization receipts, private inflows amounted to US$2 billion a year on average in 1993-94 and were US$1.7 billion in the first half of 1995. Privatization receipts from nonresident investors are estimated at US$2.5 billion during the January 1993-June 1995 period, with most proceeds remaining unspent. The Central Reserve Bank gross official reserves increased from US$2.9 billion at end-1992 to about US$6.8 billion at end-June 1995 (equivalent to close to 8.7 months of imports of goods and nonfactor services).

The strategy that Peru has pursued since the early 1990s to normalize relations with foreign financial creditors is reviewed in Chapter III.

2. Structural reforms

During the 1990-95 period the Government has been implementing wide ranging structural reforms aimed at restoring the conditions for sustained growth. Several measures have been adopted since 1990 to restructure the role of the Government in economic activity. In an effort to streamline its operations, the public sector offered in early 1991 incentives for voluntary retirement. Also that year certain public sector monopolies were eliminated and the Government developed a program to divest state holdings in all public enterprises (Box I.1). In December 1992 a private pension system based on individual capitalization was created to supplement the pay-as-you-go public system, which is described in Chapter II.

Reforms were undertaken to strengthen the financial system and to adapt it to a market economy. A new banking system law was adopted in March 1991 which redefined the role of the Superintendency of Banking and Insurance (a new law of the Superintendency was enacted in 1992), extended the supervisory and regulatory framework to nonbank financial intermediaries, reinforced capitalization requirements for commercial banks making them similar to those of the Basle agreements, and established a system of deposit insurance. This law was modified in 1993 to strengthen the prudential regulations that apply to banks, intensify on site inspections, pursue a strong provisioning policy for nonperforming assets, and promote the capitalization of the financial system. In December 1992 a modern Central Bank Charter was enacted (Box I.2). Subsidized lending was eliminated in September 1990 and in 1992 the development banks were closed. At the same time, the activities of the government investment bank (COFIDE) were scaled down and limited to those of a second-tier financial institution. In January 1994 the Government issued a new charter for the Banco de la Nación which specifies that the bank’s operations as agent for the Treasury are to be limited to administering public accounts and that the Bank is not to engage in commercial activities with the private sector or in operations in the interbank market.

The Superintendency of Banks has continued to strengthen prudential regulations and bank supervision which has resulted in a decline in the ratio of nonperforming loans to total outstanding loans from 11.7 percent in 1993 to 7.7 percent in 1994 and to 6.1 percent in June 1995. Also, the ratio of bank provisioning to total outstanding nonperforming loans increased from 60 percent at end-1992 to close to 80 percent in June 1995.

To enhance efficiency in the labor market, between 1990 and 1993 the Government enacted legislation aimed at reducing rigidities in the market. On August 18, 1995, a new labor code was enacted that increases the flexibility of labor contracts and eases the hiring process for young workers under the apprenticeship regime. With respect to labor contracts, the law increases labor mobility by greatly simplifying the layoff process and reducing its costs. On apprenticeship, the maximum age increased from 21 to 25 years and the maximum duration of contracts was lengthened from 18 months to 36 months.

During 1991-92 the exchange and trade systems experienced deep reforms. In the area of foreign trade, the maximum import tariff was reduced from 50 percent to 25 percent in March 1991, and most transactions were made subject to the tariff rate of 15 percent. At the same time, a variable surcharge was adopted for some 18 basic food imports to protect the agricultural sector. Also, a temporary export tax and subsidies were eliminated and the system of temporary duty-free admission of imported inputs was made more flexible. In 1993 the list of products subject to a 25 percent tariff was further reduced, leaving only 3 percent of the total value of imports subject to this tariff level. On December 18, 1994, the Peruvian Congress approved the Agreements under the Uruguay Round and the charter establishing the World Trade Organization.

In the exchange system most remaining restrictions on private sector current and capital transactions were eliminated in 1991 as well as limitations on remittances on direct investment income and capital. At the same time, the previously frozen foreign currency deposits in the banking system were freed and the opening of accounts abroad was authorized. Also, the export surrender requirement and the system of official registry of exchange transactions were eliminated.

Poverty is widespread in Peru and it is most severe in the rural sierra. Since 1990 the Government has implemented a series of reforms aiming at reinforcing its anti-poverty strategy. In that year the Social Emergency Program (PES) was launched in order to tackle urgent health and nutrition needs. In 1991 the fight against poverty took a larger dimension as the National Fund for Compensation and Development (FONCODES) was established as an agency under the supervision of the Ministry of the Presidency to finance temporary employment generation projects, and health and education programs. Social expenditure through FONCODES increased from 0.1 percent of GDP in 1991 to 0.4 percent in 1992. During 1993-94 the Government continued to reinforce its efforts through the creation of the Basic Social Expenditure program. This program aims at coordinating the efforts of various public institutions in order to improve the effectiveness of social spending particularly in the areas of health, nutrition, education, and justice. Financing for these programs has come both from privatization receipts, and from grants and loans from multilateral institutions. Social spending through FONCODES amounted to about 0.7 percent of GDP a year in the 1993-94 period.

The Privatization of Public Enterprises

During the second half of 1991 the Government started implementing a major program to divest its holdings in some 180 public enterprises. The privatization modalities included: direct sale through auctions; sale through the stock market; participation agreements; and service agreements (Table I.5)

Table I.5.

Peru: Privatization of Public Enterprises, 1991-95

(In millions of U.S. dollars)

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Source: Central Reserve Bank of Peru.

Debt for equity operations.

Investment commitments that are included as part of the sale contract.

Payment of exploitation rights.

Includes participation in Cervecera del Sur, Inversiones Centenario, Financiera San Pedro, Aceros Arequipa and Banco de Credito.

Includes the sale of fixed assets in ENAFER, ENTURPERU, EPSEP, and Pesquera Samanco.

Includes the sale of fixed assets in ENTURPERU and FERTISA.

In September 1991, a high level Commission for Privatization (COPRI) was created with the authority to design and implement the privatization program. Also, new legislation established the principle of equal treatment of domestic and foreign investors. In the context of the revised regulatory framework supporting privatization, legislation (including tax regimes and pricing policies) was enacted in 1993, in the areas of energy, telecommunications, fisheries, banking, transport, water, and mining. In February 1994, the Government issued regulations on the use of debt for equity swaps in selected privatization cases.

In practice, the privatization procedures differ depending on the characteristics of the firm to be privatized. Typically the COPRI appoints a special commission for the privatization of a specific firm (CEPRI) which organizes the privatization procedures. The CEPRI usually contracts the services of an investment bank (local or foreign) to assess the value of the enterprise, makes available all information on the firm to interested bidders, and determines the privatization modality to be taken. Once a company is sold, the buyer usually has taken 45 days to complete the transaction. The Government deposits the proceeds from the privatization in the Central Reserve Bank and/or the Banco de la Nación. In some cases, the privatization agreement is complemented with an investment commitment from the buyer.

In 1992, the Government sold ten enterprises for a total of US$209 million and with receipts to the Treasury amounting to US$46 million (0.1 percent of GDP) during that year. In 1993, 15 firms were sold including Aeroperu, the airline company, Petromar, the off-shore oil exploration company, Transoceanica, a shipping company, and the Cerro Verde mining company for a total of US$317 million. For the year, a total of US$166 million in cash receipts were paid to the Treasury (0.4 percent of GDP). The privatization process gathered momentum in 1994, when privatization receipts to the Treasury amounted to US$2.2 billion and in addition there were associated investment commitments for US$2.7 billion. Although 32 firms were privatized in 1994, the bulk of the receipts accrued from the sale of part of the equity share of the telecommunication companies (US$1.4 billion), the Lima electricity distribution company (US$388 million), the Tintaya mine (US$277 million, of which US$55 in debt-equity swaps), and the Cajamarquilla refinery (US$193 million, of which US$40 million in debt-equity swaps). During the first half of 1995, privatization receipts amounted to US$308 million (excluding US$100 million in debt-equity swaps), of which US$189 million came from the privatization of the remaining commercial bank (Banco Continental).

The 1992 Central Reserve Bank Charter

A new Central Reserve Bank charter was enacted in December 1992 and came into effect in 1993 (Decree 26123). The main changes introduced by the new law are the following:

a. Under the new law, the objective of the Central Reserve Bank is to preserve the value of the currency. The previous law established three main objectives: to keep monetary stability; to provide credit and exchange conditions consistent with an orderly development of economic activity; and to promote high growth rates of output and employment. Also, the Central Reserve Bank was previously in charge of fostering the development of the banking system.

b. In accordance with the new charter the Central Reserve Bank cannot provide financing (either directly or indirectly) to the public sector. The Central Reserve Bank can only purchase treasury bonds in the secondary market up to 5 percent of the outstanding stock of base money at the end of the previous year. The previous law allowed Central Reserve Bank financing of the public sector to offset temporary discrepancies between revenue and expenditure. Also, there were no limits on the holding of treasury bonds and other public sector financial Instruments.

c. Under the new law, the Central Reserve Bank is banned from financing public sector development banks, or to create special funds to promote economic activity. Also, the Central Reserve Bank can no longer impose sectoral or geographic allocation requirements on the portfolio of financial institutions. The previous law included direct credit control mechanisms, and allowed the Central Reserve Bank to establish special funds to promote development of economic activities or regions.

d. The Central Reserve Bank is impeded from establishing multiple exchange rates.

e. The Central Reserve Bank promotes market-determined interest rates.

f. Finally, the new law provides for the recapitalization of the Central Reserve Bank by the Treasury in order to attain a level of capital of S/. 50 million.

g. Directors are appointed for a five-year term and can not be dismissed unless they commit serious fault. Three Directors are appointed by Congress, three by the Executive, and the President of the Central Reserve Bank is appointed by the President of the Republic, and his nomination ratified by Congress.

II. Reform of the Pension System

1. Introduction

Since the mid-1980s, several countries in Latin America, including Argentina, Chile, and Peru have carried out far-reaching pension system reforms. While these reforms differ in the specific details, they share as a common objective the establishment of a fully funded, privately managed pension system, either in place of or alongside a pre-existing public pension system. In Peru, the decree law of December 6, 1992 introduced a fully-funded private system, which operates alongside the pay-as-you-go public pension system. 1/

The introduction of a fully-funded private pension system embodies a number of important benefits. First, the new pension system should enhance the development of the financial markets and contribute to an increase in private savings. Second, the direct link between contributions and benefits in the private system should increase labor market incentives, as workers are unlikely to view these contributions as taxes. Third, the fact that the pension funds are privately managed implies that investment decisions are less likely to be influenced by political factors, resulting in a more efficient allocation of funds. The public pension system in Peru, which is comprised of four pension regimes, was generally considered as not being viable over the medium term, particularly the cédula viva regime, which provides employees of the public sector with generous pensions in relation to their contributions. 2/

The current section successively reviews the 1992 reform; the problems remaining after this reform and the additional measures adopted in July 1995; and the fiscal costs of the transition.

2. The 1992 pension reform

When the operations of the private pension system in Peru began in June 1993, the public pension system was faced with serious difficulties. Its coverage had become progressively smaller; the payment of contributions was lagging due to evasion; and pensions had been severely eroded by inflation. During the hyperinflation period of 1990, total revenue had been reduced to less than 1 percent of GDP, and the financial position of the social security system had been preserved only through a drastic reduction of pension payments in real terms.

Decision was taken to create a private pension system that would operate alongside the pay-as-you-go public system. 1/ Contributors to the public system at the time of reform, as well as new entrants into the labor market, were given the option of choosing either the private or the public pension plan. The private system is a fully funded, defined-contribution pension plan based on individual capitalization accounts, administered by specialized private financial institutions (AFPs), and regulated by the Government through a Superintendency of the AFPs.

Participants in the private system contribute a fixed percentage of their salary to a pension fund administered by the AFP of their choice. Each AFP charges a commission comprised of a flat fee and a percentage of salaries. The pension is determined by the accumulated value of contributions plus the return on the financial instruments in which they are invested. A participant retiring at age 65 would be able to use the accumulated value of his account to buy a life annuity, purchased either from the insurance companies or the AFPs themselves under terms set by the Superintendency.

A contributor who switches from the public to the private system is to receive a pension bond representing the value of his pension rights accumulated in the public system. The precise value of the bond is a function of the contributor’s age and the salary earned during the 12-month period prior to the move to the private system. In order to determine the amount of the bond, each contributor must present to the ONP documentation regarding his work history; the ONP has then up to three years to verify each request and issue the pension bond. 2/

3. Problems facing the new pension system

While the transition to the new pension system has been generally smooth, the number of individuals switching to the private system was lower than anticipated. A total of 640,000 persons joined the private pension plan during the first year of operations but the number of new entrants subsequently abated significantly. By June 1995 the number of contributors had levelled off at about one million, significantly below expectations (the potential number of participants is estimated at 2.5 million). This slowdown in the rate of transfer to the private pension system reflected several shortcomings.

First, pension contributions paid by employees in the private pension system were substantially higher (at about 15 percent of wages) than in the public pension system (3 percent). The contribution in the private system included a payment of about 4 percent for insurance and charges of the AFPs, and a 1 percent solidarity tax used to finance health services of the public pension system. Also, the employer paid a contribution of 6 percent in the public pension scheme but none in the private one (Table II.1). Second, the retirement age in the private system was set at 65 for all contributors, whereas the retirement age in the public pension plan was 55 for women and 60 for men.

Table II.1.

Peru: Charges and Taxes on Wages and Salaries

(In percent of wages and salaries)

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Source: Peruvian authorities.

Third, there were delays in the issuance of the pension bonds, largely due to administrative difficulties associated with the computation of each individual bond, on the basis of the work and contribution histories of contributors. These delays may have hampered the full growth of the private pension system, particularly in the initial stages when it had to establish its credibility with the general public.

Fourth, the operating costs of the AFPs were high, reflecting in part the amortization of large marketing and advertisement costs initially incurred by the AFPs. Since their initiation, the AFPs have drastically reduced the number of sales agents and the system has experienced significant restructuring, including through a reduction in the number of branches and the merging of four AFPs into two. At present, there are six AFPs, with the two most important accounting for close to half of total assets of the system.

The private pension funds also have strengthened efforts to improve the collection of contributions. In practice, private sector workers who switch jobs often do not inform their new employer of their pension status, and he may mistakenly contribute to the public sector. To improve collections, delinquent contributors have been offered since November 1994 the possibility of settling overdue amounts without fines or penalties over a four month period.

Finally, the positive impact of the pension reform for the economy has been limited by the lack of financial instruments for the AFPs to invest in. At end-October 1995 the total assets of the private pension system amounted to about S/. 1.2 billion (about US$530 million). Over three fourths of these assets were deposited with the domestic financial system, with 44 percent with commercial banks, 26 percent in the form of Central Reserve Bank certificates of deposit, and 9 percent with nonbank financial institutions. Other investments included equity shares (15 percent), government bonds (3 percent), and private corporation bonds (3 percent). 1/ The average yearly rate of return for the AFPs through mid-1995 has been close to 8 percent in real terms.

4. Reform of July 1995

The Government passed legislation in July 1995 in order to address the above-mentioned shortcomings and to encourage the migration to the private pension plan. The main aspects of the reforms consisted in the harmonization of the contribution and retirement ages.

In July 1995 the Government equalized the contribution rates paid by employees in the private and public pension schemes at about 11 percent. 2/ To that effect, contributions paid by employees in the public pension system were increased from 3 percent to 11 percent. However, the actual increase in all charges and taxes paid by employees was significantly lower, as two other contributions (to the health plan and FONAVI) totaling 6 percent of wages and salaries were shifted from the employee to the employer (see Table II.1). Thus, in net terms total contributions paid by employees in the public system were increased by 2 percent, which was compensated by an equivalent increase in their wages. In addition, effective July 18, 1995, the retirement age in the public system has been increased to 65 for all workers, as in the private pension system.

In the private system the contribution channeled to the individual account was temporarily reduced (through end-December 1996) from 10 percent to 8 percent. In addition, the 1 percent solidarity tax on contributors to the private system was eliminated and the value-added tax on AFP commissions and insurance was removed. On January 1, 1997, the contribution channeled to the individual account is scheduled to rise by 2 percentage points, to return to 10 percent. At the same time, the contributions in the public system also would be raised by 2 percentage points, thus maintaining equality between the two systems. 3/

In order to increase competition among the AFPs, employees have been free to move between AFPs since November 1, 1995. However, in order to discourage excessive movement which would be costly to administer, the law requires the affiliate to request the change in person, rather than in writing, and a fee is charged for the switch. New entrants into the labor market continue to have the option of joining either the public or private system. However, if a new worker does not inform the employer of his preference, he will be automatically placed by the employer into the AFP to which most employees belong. 1/

Finally, the new legislation contemplates a minimum pension for those in the private system whose pension falls below a threshold, either because of a short period of contributions or a low wage base. However, the modalities and the financing of the scheme have not been specified yet.

While the changes introduced in 1995 have made the private system more attractive, it is too early to assess their impact on the functioning of the private pension system. In July and August 1995, during public debate on the pension legislation, each month some 20,000 workers switched to the private system, compared with only a few thousand each month earlier in the year. In most recent months the number of new entrants has continued to increase at a similar pace and the total number of contributors in the private pension system amounted to close to 1.1 million at end-October 1995.

5. Fiscal costs of transition

The transition from an unfunded pay-as-you-go system, in which current contributions by workers finance benefits of current retirees, to a fully funded scheme, involves transition costs. From an inter-generational point of view, current workers, in their role as taxpayers, must finance both their own retirem it savings through the private pension system and that of current retirees. This cost can be spread over time to the extent that the transition is financed by bonds.

Operationally, the fiscal costs are of two basic types. In the short run the public pension system will forego payroll contributions due to the switch to the private pension system by some contributors. Over the medium term, however, government outlays will increase when pension bonds are encashed, at the time of retirement. 2/ There are some offsetting savings to the public sector, in the form of reduced pension payments to those leaving the public system, although these savings are relatively small.

There are a number of important characteristics of the current situation which tend to lessen the fiscal cost of the reform in Peru. First, the Peruvian private pension system is optional for all workers, including new entrants to the labor force. Second, the public pension system in Peru covers a relatively small fraction of the working population, reflecting the large relative size of the informal sector. Third, those moving to the private system in Peru have tended to be quite young, with about three fourths of individuals migrating to the private plan between the ages of 20 and 40. This implies both that the reduced pension payments for the public sector will remain small over the next decade or so, and that the cost of the “cashing in” of the pension bonds will take place, for the most part, only over the long term. However, those switching have generally been relatively high-wage workers, which tends to increase the loss in contributions.

The pension reform of July 1995 has potential fiscal implications, although the size and direction of this effect are not clear. On the one hand, the contribution rate to the public system has increased from 9 to 11 percent, tending to increase the revenues of the public system. On the other hand, the more rapid movement of workers to the private system would imply lower contributions to the public system, and so the need for increased transfers from the Central Government. As noted, the wages of contributors in the public system have been adjusted to offset the higher pension contribution.

To date, the costs of the transition to a fully funded pension system have been manageable. The public pension system receives about S/. 57 million a month in contributions and pays out approximately S/. 67 million. In 1994 losses of the public system were covered by accumulated surpluses. In 1995 the central government transfer to the public pension system to cover the operating losses (including administrative and financial costs) of the public pension system is projected to amount to approximately S/. 280 million, or 0.2 percent of GDP. The total cost, including transfers to the public pension system and cashing in of pension bonds, is projected to increase gradually to 0.7-0.9 percent of GDP by 2005.

6. Conclusion

The reform of the pension system in Peru is an important part of the overall reform of the public sector and the economy. Over time it is expected to have a sizable positive effect on the functioning of the labor and capital markets. To date the impact has been limited by a number of specific characteristics of the Peruvian reform, as well as by the large size of the informal sector in the economy. At the same time this has moderated the fiscal costs of transition.

The transition has faced a number of difficulties, and the legislation of July 1995 represents an important step in overcoming these problems and in making the private system more attractive. Important problems remain, however, in both the private and public pension systems. Contribution evasion remains high in both pension systems. For the AFPs, administrative costs remain high and investment instruments limited. Finally, the special pension system for many public employees (“cedula viva”) continue to require large budgetary transfers. These difficulties will need to be addressed in the coming years if the reform is to have its full benefit.

III. External Debt Developments

This chapter reviews the strategy that Peru has pursued since the early 1990s to normalize relations with its foreign financial creditors in the framework of an ambitious program of stabilization and structural reforms. The success of this strategy greatly contributed to bring inflation down from hyperinflation levels to about 10 percent in 1995, while fostering the environment for sustained growth and the resumption of private sector financing. As the program called for a reduction in fiscal imbalances while avoiding domestic financing, the mobilization of adequate external financing became important to support the authorities’ fiscal adjustment. Given that Peru was in arrears with most foreign creditors, an initial step to secure renewed access to financing was the restoration of orderly financial relations with them.

The chapter is organized as follows: section 1 reviews Peru’s medium-and long-term public debt situation at end-1990; section 2 presents an overview of debt restructuring with creditors, including through a description of the steps taken to obtain bridge financing to clear arrears to multilateral creditors; and section 3 surveys the debt contracted since 1991 and the fiscal impact of the debt relief obtained.

1. Debt situation as of end-1990

The public sector medium- and long-term external debt (excluding the debt of the Central Reserve Bank) amounted to US$18.5 billion at end-1990, equivalent to 57 percent of GDP, of which US$12.2 billion was in arrears (Tables 43 and 44). 1/ Debt to multilateral institutions accounted for 15 percent of the total, while official bilateral creditors and private creditors were owed 47 percent and 37 percent of total, respectively. The accumulation of arrears resulted from the implementation of unsustainable fiscal and monetary policies in the second half of the 1980s. 2/

Peru suspended debt-service payments to the Fund in August 1985 and started accumulating arrears with the World Bank in 1985 and with the Inter-American Development Bank in August 1988. As of end-1990 more than 90 percent of the debt to commercial banks and 70 percent of the debt to unguaranteed suppliers was in arrears, accumulated since the second half of 1983. More than 97 percent of the arrears to official bilateral creditors outstanding by end-1990 were with Paris Club participants. Debt to Latin American creditors was serviced through the Latin American Integration Association (LAIA) clearing agreement which provided for the automatic debit of commercial bank operations through the central banks of its members. From 1983 to mid-1990, debts to former socialist countries were serviced mostly in kind, in the framework of counter-trade agreements. 1/

2. Debt restructuring

The administration that took office in July 1990 undertook to redress Peru’s large domestic and external macroeconomic imbalances. A centerpiece of this strategy was the restoration of normal relations with the international financial community. This strategy was to be carried out in several steps by restoring relations with multilateral institutions, Paris Club creditors, and other bilateral and private creditors.

a. Multilateral creditors

With regard to the Fund, the previous administration had resumed the payments in full of maturities falling due starting from the third quarter of 1989. The new administration extended this policy to the World Bank and the IDB in October and November 1990, respectively. Nevertheless, a total of US$2.1 billion of arrears to the multilateral institutions were still outstanding by end-1990. A key step in resolving this matter was the endorsement by the Executive Board of the Fund of a 15-month Fund-monitored Rights Accumulation Program (RAP) on September 12, 1991, once satisfactory financing assurances were secured with pledges made by the Support Group. 2/ Under the program, rights to purchase SDR 623.7 million (188.5 percent of quota at that time), corresponding to the outstanding stock of arrears, were to be accumulated by Peru upon observance of quarterly performance criteria and completion of quarterly program reviews. Under the RAP, arrears to the IDB were to be cleared in the last quarter of 1991, and those to the Fund and the World Bank upon completion of the program. 1/

Arrears to the IDB amounting to US$434 million were cleared in September 18, 1991. 2/ The process of arrears clearance was supported by a drawing from a short-term facility available to the Central Reserve Bank of Peru in the Latin American Reserve Fund (LARF). On the same day the IDB approved and disbursed the first tranche of the US$425 million Trade Sector Loan.

Peru successfully completed the RAP with the observance of the September 1992 performance criteria accumulating all the rights available under the program. These rights were cashed under the three-year extended arrangement that was approved by the Executive Board on March 18, 1993 in an amount equivalent to SDR 1,018 million (218.4 percent of quota) following Peru’s clearance of arrears to the Fund. Bridge financing from the U.S. Treasury and the Eximbank of Japan (JEXIM) was arranged to the effect. On the same day the Executive Board lifted Peru’s ineligibility and the country made a SDR 642.7 million purchase allowing it to repay the money borrowed earlier in the day. On the same day US$867 million in arrears to the World Bank were cleared also with bridge financing from the U.S. Treasury and JEXIM. Following this action, the World Bank disbursed US$900 million under the three adjustment loans, which allowed Peru to repay the bridge financing also on the same day.

b. Official bilateral creditors

Under the RAP Peru also was to seek comprehensive rescheduling agreements with Paris Club bilateral creditors covering arrears and maturities falling due during the program period. Almost 80 percent of Peru’s US$7.4 billion debt to Paris Club creditors was in arrears by end-September 1991, including US$1.0 billion in post-cutoff date debt arrears. On September 17, 1991, Paris Club creditors granted debt relief to Peru on lower-middle income countries terms, providing for the exceptional treatment of moratorium interest on consolidated eligible debt and arrears on post-cutoff date debt. 1/ In making such a decision creditors took into account the constraints imposed by the large size of arrears and the limited payment capacity of the country (the BCRP’s gross reserves were equivalent to about 4 months of imports of goods and nonfactor services by end-1990).

The consolidation period extended from October 1, 1991 to December 31, 1992, in line with the RAP. The public or publicly guaranteed debt consolidated included pre-cutoff date debt (i.e. contracted before January 1, 1983) not previously rescheduled, and principal and interest resulting from the November 1978 and July 1983 rescheduling agreements. 2/ Official Development Aid (ODA) loans in arrears and maturities due in the consolidation period were rescheduled over 20 years including a ten-year grace period, while arrears and maturities on commercial loans were rescheduled over 15 years, including an eight-year grace period. In both cases Peru received the maximum available grace period. Notably, moratorium interest on rescheduled amounts that accrued during the consolidation period was capitalized; repayments were to be effected over a five-year period starting on November 15, 1992. Paris Club creditors granted an exceptional treatment of arrears on post-cutoff date debt, both on principal and interest (including late interest). These arrears were deferred beyond the period of the RAP, with repayments extending over a six-year period starting on June 30, 1993. The exceptional treatment was contingent upon the completion of reviews under the RAP. Total debt relief amounted to US$5.5 billion in 1991 and US$0.6 billion in 1992.

In support of the extended arrangement from the Fund, Paris Club creditors granted Peru a new rescheduling agreement on May 4, 1993 covering eligible maturities falling due from January 1, 1993 to March 31, 1996, in line with the period of the EFF arrangement. The maturity and grace period for ODA and commercial debts were as in the 1991 agreement; this agreement also featured an exceptional treatment of accrued moratorium interest. Half of the moratorium interest accrued from January 1, 1993 to December 31, 1994 was capitalized; repayments were to be effected over a five-year period starting on September 30, 1996. The debt relief granted was in excess of US$0.6 billion a year over the 1993-95 period.

In the framework of these two rescheduling agreements, Peru has benefitted from debt forgiveness amounting to US$275 million, including arrears and maturities, granted by various bilateral creditors. In exchange, the Government was asked to provide counterpart funds in local currency for the equivalent of 19 percent of this total, to be used in funding a variety of undertakings in social areas, support for small enterprises, and the preservation of the environment.

In the context of the RAP, and later the EFF, and given the debt relief granted by Paris Club creditors under the two rescheduling agreements, the Government was to seek debt relief on comparable terms from other bilateral non-Paris Club creditors. However, little progress has been achieved regarding the restructuring of debts to other bilateral creditors not participating in the Paris Club.

c. Private creditors

In the context of the RAP, Peru was to service only short-term nonguaranteed trade credits provided by banks and suppliers, but no cash payments were programmed on medium- and long-term debt owed to commercial banks and suppliers. In the context of the extended arrangement, Peru was expected to conclude a debt and debt-service reduction (DDSR) operation with commercial banks and to approach nonguaranteed suppliers with a view to seek comprehensive agreements. In this context, in March 1993 Peru concluded a US$0.7 billion debt rescheduling agreement with Japan Peru Oil Company (JAPECO), its main unguaranteed supplier. The agreement provides for repayment over a 25-year period, including a 14.5-year grace period. 1/

Moreover, in late October 1995 the Peruvian Government announced an agreement in principle reached between the Government of Peru and the Bank Advisory Committee (BAC) on a Brady-type deal. On a preliminary basis, the principal covered is estimated at US$4.4 billion, which includes medium- and long-term commercial bank, short-term commercial bank, and unguaranteed suppliers debt. Preliminary estimates indicate that the reduction of principal could reach about 67 percent, including the impact of a buyback of about one third of eligible debt. The agreement provides for a simplified method to calculate past due interest, and for Peru to make quarterly partial payments of interest until final closing, at which time a downpayment on the stock of PDI will be made. The menu of options for principal exchange includes 30-year par and discount bonds, a 20-year front loaded interest reduction bond (FLIRB), and a debt buy-back to be effected through a Dutch auction.

This announcement signals the initiation of the final stage of a long process of negotiation. Peru started to accumulate arrears to commercial banks in the second half of 1983, when it failed to pay in full commissions related to a debt restructuring agreement that had been signed on July 13, 1983. 2/ Following the unilateral moratorium declared by Peru in 1985, no further discussions were held with banks until late 1990 and virtually no payments were effected during this period. 1/ First progress in the negotiations came with an agreement in November of 1991 (Tolling Agreement) under which Peru dropped the enforcement of a six-year statute of limitations on legal claims (formally included in Law Decree No. 25848 of November 23, 1992) in exchange for the lifting of default proceedings initiated by banks in February 1990. Meetings were held with the BAC during September and November 1993 on the restructuring of the outstanding debt, including short-term debt. A law approved on November 19, 1993 (law No. 26250) extended the possible use of debt instruments in the privatization process from certain short-term debt to all bilateral and private debt not affected by a pending suit. 2/ Following the approval of legislation recognizing the claims of two banks that had been excluded since November 1985, all pending lawsuits against Peru were lifted in December 1994. Following informal meetings with banks held in New York and Europe in February 1995, the authorities met with the BAC on a number of occasions since May until they reached the agreement in principle in October.

3. Results of the strategy

The unilateral moratorium declared by Peru, and the accumulation of arrears curtailed Peru’s access to foreign financial markets. New public sector medium- and long-term debt contracted between 1985 and 1990 averaged US$356 million a year, with only one fourth of that amount with a maturity of more than 15 years. By contrast, between 1991 and 1994, the annual average grew to US$1.2 billion, or to US$0.8 billion excluding World Bank’s and IDB’s new loans extended immediately after the clearance of arrears to these institutions (Table III.1). 3/ The average maturity of these loans has exceeded 20 years, including a grace period of about 5 years. Most of the new contracting has been with multilateral institutions, and with a lag this has been reflected in the composition of actual disbursements (see Table III.1). Nevertheless, it appears that contracting with (and disbursements from) official bilateral creditors is also on the increase.

Table III.1.

Peru: Selected Indicators of Medium- and Long-Term External Public Sector Debt Management 1/

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Sources: Central Reserve Bank of Peru (BCRP); and Fund staff estimates.

Excludes transactions with the Fund, and interest payments made by the BCRP.

Corresponds to the July-December period.

Corresponds to the January-June period.

The public sector is defined to include the nonfinancial public sector, COFIDE, and the official banking system (BCRP, Banco de la Nación, and development banks). It excludes loans classified as reserve liabilities of the BCRP.

The debt covered excludes: (i) consolidation of short-term credits into medium-term loans; (ii) any bilateral lending mobilized multilaterally (e.g., via Support Group); (iii) any new loans extended in the context of debt reschedulings; (iv) loans from the World Bank and the Inter-American Development Bank; and (v) concessional loans.

Includes payments of arrears.

Annual disbursements displayed a declining trend from 1985 to 1990, reaching only US$250 million in 1990, the lowest level in 20 years. In 1991, by contrast, there was a dramatic surge in disbursements, of which three fourths was in support of the RAP with almost an equal split between the IDB and Japan (a member of the Support Group). The IDB disbursed US$325 million in connection with the arrears clearance. Disbursements in 1992 declined to US$387 million, of which about 40 percent were for program support. Disbursements from the Support Group amounted to US$54 million in loans and US$84 million in grants, mostly in kind. Disbursements increased to US$1.5 billion in 1993, the first year of the extended arrangement, mostly in program support, reflecting World Bank disbursements of US$975 million in connection mostly with the arrears clearance. Loan disbursements from a second Support Group created to mobilize financing for the EFF-supported program amounted to US$174 million. Disbursements in 1994 came down to US$630 million, of which only one third was for program support.

The debt relief granted by Paris Club creditors, along with the deferral of maturing obligations to most private creditors and the accumulation of arrears with other bilateral creditors, is reflected in the large difference between the cash payment and accrued debt-service ratios reported in Table III.1, most notably as it relates to the relief granted on current interest charges. Even though in recent years the accrued interest debt-service ratios, at an average of 27.6 percent of exports of goods and nonfactor services and 26 percent of the central administration current revenue, have been relatively high, actual interest debt-service ratios on current maturities are only one fourth of those levels. On average, cash payments on current maturities are about one third of the debt-service charges falling due.

Peru: Summary of the Tax System, 1995

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UITs (tax units) are accounting units used by the Government to assess tax deductions and liabilities. The Ministry of Economy and Finance has the authority to set UITs.

The general sales tax (IGV) operates as a value-added tax.

Table 1.

Peru: Aggregate Supply and Demand

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

Goods and nonfactor services.

Includes investment by nonfinancial public enterprises, and excludes other net public sector capital expenditures.

Weighted by the contribution to domestic expenditure in the previous year.