Statement by Guillermo Le Fort, Executive Director for Peru, and Carlos E. Pereyra, Senior Advisor to the Executive Director

Peru showed commendable economic performance under the Stand-By Arrangement, owing to its strong fundamentals, prudent macroeconomic policies, and progress with structural reforms. Executive Directors commended these developments, and stressed the need to strengthen fiscal prudence, transparency, debt management, and monetary policy stance. They emphasized the need to implement tax and pension plan reforms, and improve the public sector operations and banking sector indicators. They agreed that Peru has successfully completed the third review under the Stand-By Arrangement.


Peru showed commendable economic performance under the Stand-By Arrangement, owing to its strong fundamentals, prudent macroeconomic policies, and progress with structural reforms. Executive Directors commended these developments, and stressed the need to strengthen fiscal prudence, transparency, debt management, and monetary policy stance. They emphasized the need to implement tax and pension plan reforms, and improve the public sector operations and banking sector indicators. They agreed that Peru has successfully completed the third review under the Stand-By Arrangement.

November 3, 2003

Recent Developments

1. We would like to thank the staff for a concise and well-written report. Peru has continued to perform well under the Stand-by Arrangement (SBA), with rapid growth, low inflation, and limited external vulnerabilities. All end-September performance criteria were observed, and the authorities’ commitment to implementing prudent macroeconomic policies and structural reforms is expected to further improve investor confidence, ensure sustained growth, and pave the way for significant poverty reduction. In particular, specific steps have been taken to deepen the reform process, and the new cabinet appointed in mid-year has shown the ability to muster political support for the authorities’ agenda.

2. The Peruvian economy has been undergoing a sustained recovery over the past twenty-six months, and the projected GDP growth rate of 4 percent for 2003 is among the highest in Latin America. It is important to highlight the more balanced sectoral growth registered in 2002 and the first half of 2003, with the more labor-intensive sectors, like non-primary manufacturing, construction and services, showing important expansions. Furthermore, after two years of slowdown, private investment picked up vigorously, growing at a 4 percent annual rate in the second half of 2002, with a 5 percent increase projected for 2003. The recovery in private investment is mostly associated with the dynamic behavior of the construction sector, the expansion of corporate profits, and a positive shift in business sentiment.

3. In 2002, Peru’s trade balance moved into surplus for the first time since 1990 based on the dynamism of exports, which are projected to increase further in 2003. Several large-scale mining projects implemented in recent years and the growth of non-traditional exports are at the center of this process. In particular, apparel exports, Peru’s fourth largest export item, has increased 25 percent in the first eight months of this year, a direct effect from the Andean Trade Promotion and Drug Eradication Act (ATPDEA) agreement with the U.S. Additionally, FDI prospects, associated mainly with the mining sector and the Camisea gas project, remain promising. Regarding the latter, an agreement concluded in September to export gas destined to the U.S. market will result in further growth of investment and exports.

4. The floating exchange rate regime and a sound international reserve level—$9.8 billion as of end-September, equivalent to 2.1 times short-term external obligations and 15 months of imports—place Peru in a good position to weather external shocks. This has been recognized by international markets, as evidenced in recent debt issues and by the reduction in sovereign bond spreads to historically low levels.

Macroeconomic Policies

5. The authorities are committed to fiscal sustainability and the continuation of economic reforms. Achievement of the deficit target of 1.9 percent of GDP for the overall public sector in 2003 will be underpinned by the administrative enhancements and tax measures introduced in 2002. They also put in place a set of austerity and rationalization measures; and additional reforms were introduced in the state pension system to level the two existing regimes. The authorities will persevere in their efforts to reduce tax evasion by broadening the coverage of the withholding schemes introduced in 2002 and intensifying tax audits. These actions will be supported by increased use of computing systems and streamlined auditing and collection processes. Control operations will emphasize the VAT and the income tax.

6. Moreover, with the aim of strengthening public sector finances, responding to pressing social needs—mainly in the areas of education, health, and domestic security—and enhancing the equity, efficiency, and collection potential of the tax system, a comprehensive tax reform was launched in October. This reform, which figured prominently in the new cabinet’s agenda, was expedited by the special powers granted by Congress to legislate on tax matters, reflecting a finer coordination between the government and the legislative branch. The reform would include administrative improvements, a widening of the tax base of the corporate and personal income taxes, the elimination of sectoral tax benefits, and a financial transactions tax (FTT). Since the FTT would be complemented with the obligation to perform financial operations above a threshold through the banking system, the authorities argue it would be instrumental in improving tax control. At the same time, they are giving due consideration to the staff’s suggestions in this regard. The authorities’ decision will be announced shortly.

7. The authorities emphasize that, together with enhanced revenues, strict expenditure control is crucial to ensure medium-term fiscal sustainability. They also underscore that fiscal discipline would create room for priority spending aimed at raising the living standards of the population and improving productivity performance, thus providing a favorable environment for growth and facilitating the continuation of the reform process. The fiscal deficit is expected to decline from 2.2 percent in 2002 to 0.4 percent of GDP in 2006, and the debt-to-GDP ratio from 47 percent in 2002 to 41 percent in 2006.

8. The authorities continue to strengthen the conduct of monetary policy within the inflation targeting scheme. The low inflation forecast—close to the lower band of the target range—has allowed the Central Bank to adopt a more accommodative monetary stance. Since July, the Board of the Central Bank has reduced its policy interest rate, which has been followed by market-determined interest rates. Thus, both the level and volatility of the interbank interest rate have continued their falling trend.

9. The new primary dealer system, launched in March to improve debt management, reduce the exchange rate risk, and promote de-dollarization through the development of a fixed-income market in domestic currency, has been very successful, with demand exceeding supply by over 100 percent in all auctions. Maturities have become longer, reaching up to five years, and yields have decreased significantly, reflecting greater confidence in the domestic currency and providing a reference for longer-term financial instruments. This context has also favored a reduction of dollarization in the banking system, from 67 percent of deposits in 2001 to 65 percent in 2002 and to 63 percent in September 2003. In addition, the quality of the loan portfolio is improving, past-due loans have been decreasing in the past months, and provisioning has strengthened.

Structural Reforms

10. As informed in previous reviews, the authorities are working in a gradual elimination of regional and sectoral tax exemptions, and continue to coordinate with the regional authorities the phasing out of exemptions in exchange for investment in infrastructure and social programs. Concerning the legal framework for decentralization, by year’s end the authorities intend to enact the draft fiscal decentralization law, and another law will further regulate the devolution process, with emphasis on social programs and infrastructure. Additionally, the draft budget law for 2004 is consistent with the decentralization process and considers a greater participation of regional and local governments in the distribution of fiscal resources, notably for investment.

11. Bank supervision continues to be strengthened, with stress on exchange rate risk management and monitoring of dollar lending. Also, a new regulatory body, effective since October, was introduced to unify previous legislation on bank debtor evaluation and classification, refine provisioning with the aim of reducing the cost of credit, and make banks’ boards of directors more accountable for credit risk management. Furthermore, the authorities intend to press forward for an early passage of legislation granting legal protection to bank supervisors in the discharge of their duties.

12. Trade policy aims at increasing openness and widening export markets. In August, Peru signed an agreement with Mercosur, which allows bilateral negotiation of a free-trade list of products with each member of that trade bloc. Additionally, in October, Thailand and Peru signed an agreement to set up a free trade area, and the authorities have expressed their interest in negotiating trade agreements with the U.S. and the E.U. At the same time, the authorities remain committed to participating in the FTAA initiative.

Relations with the Fund

13. The current SBA, which will expire in end-February 2004, has served Peru well in providing an adequate policy framework for its longer-term objectives. In particular, (i) it has helped to better define the commitment to fiscal sustainability, evidenced in Peru’s medium-term fiscal consolidation plans; (ii) it constitutes an invaluable endorsement with the international community and has proved helpful in greatly improving investor sentiment, as reflected in the significant decrease in Peru’s country-risk and the ability to regain access to international capital markets, floating sovereign bonds for the first time in several decades; (iii) it provides comfort to the other multilateral organizations—the World Bank and the Inter-American Development Bank—whose disbursements are an essential financing component geared to support key reform initiatives, especially poverty alleviation, the reform of the state, and the decentralization process.

14. At the same time, despite Peru’s ability to deliver under the SBA, the authorities are far from complacent, and acknowledge that substantial work remains to be done to fulfill their reform plans and, in particular, to reinforce investor confidence. The authorities believe that this process can be substantially underpinned by Fund endorsement. As previously underscored by this chair, the Fund is in a unique position to inform international markets about member countries’ economic performance, and therefore plays a crucial role in promoting investor discrimination.

15. Our Peruvian authorities are giving strong consideration to requesting a successor arrangement in the form of a precautionary SBA. As explained in the staff report, such possibility would have to be discussed on the basis of an assessment of the Fund’s extended financial engagement with Peru, in accordance with the recently approved policy on prolonged use of Fund resources. We take the opportunity to recall that this and other chairs have expressed the view that precautionary arrangements should be excluded from that definition. In particular, Peru would not fall into the classification of “prolonged user” since it has not relied continuously on Fund resources, having generally treated arrangements as precautionary (that is, mainly as a framework for consistent macroeconomic and reform policies), with a Fund exposure continuously falling to less than 15 percent of quota. Also, the Operational Guidance for Assessments of Countries with Longer-Term Program Engagement includes considerations regarding precautionary arrangements, namely that they should not be evaluated as if they were indistinct from a standard program, and that the framework should not entail a new bias against them. Quite importantly, the authorities also see the desirability of seeking a smooth transition to a successor arrangement to ensure continuous investor confidence and access to multilateral financing through Fund endorsement.

16. Following past practice, the authorities consent to the publication of the staff report.