This Selected Issues paper focuses on policies to promote high, sustainable growth in Peru, the risks posed by dollarization, and key medium-term fiscal issues of decentralization and social security reform. The paper identifies the main impediments to output and employment growth and proposes steps to remove them. It uses a balance sheet approach to analyze Peru’s highly dollarized economy, and finds that the factors explaining Peru’s relatively low international trade levels are related to the impediments to growth. The paper also looks at the main impediments to high, sustainable output, and employment growth in Peru.


This Selected Issues paper focuses on policies to promote high, sustainable growth in Peru, the risks posed by dollarization, and key medium-term fiscal issues of decentralization and social security reform. The paper identifies the main impediments to output and employment growth and proposes steps to remove them. It uses a balance sheet approach to analyze Peru’s highly dollarized economy, and finds that the factors explaining Peru’s relatively low international trade levels are related to the impediments to growth. The paper also looks at the main impediments to high, sustainable output, and employment growth in Peru.

III. Analyzing A Highly-Dollarized Economy From A Balance Sheet Perspective19

Main Findings and Recommendations:

  • Peru’s dollarization creates currency mismatches on residents’ balance sheets, which make them vulnerable to exchange rate shocks.

  • These currency mismatches vary significantly among different sectors: while the public sector has a large mismatch, the private financial sector’s foreign-currency assets and liabilities match.

  • The public sector’s vulnerability is mitigated by the long maturity of its liabilities and the high level of its liquid assets (official reserves).

  • The initial vulnerability to an exchange rate shock primarily lies within the private nonfinancial sector, where foreign-currency income and opportunities to hedge currency risk are often limited.

  • The shock would eventually be transmitted to the private financial sector, as the performance of foreign-currency loans extended to local borrowers would likely deteriorate.

  • In such a scenario, the private financial sector’s relatively high dollar liquidity is its first line of defense.

  • In addition, the public sector’s reserve holdings present a potential source of emergency dollar liquidity, should systemic risks arise.

  • Indeed, high official reserve levels seem a critical factor in explaining Peru’s resilience over recent years to the turbulence that affected other dollarized economies in the region.

A. Introduction

28. Peru’s vulnerability indicators have strengthened in recent years, bolstering the outlook for sustained growth and economic stability. Although the stock of public and external debt is relatively high, the fiscal and external positions are on a sustainable path.

29. At the same time, the still high level of doltarization in the economy is a source of vulnerability. 20 hi addition to the vulnerabilities associated with Peru’s sizeable public debt in foreign currency, the high share of domestic liabilities denominated in U.S. dollars exacerbates the currency mismatches on residents’ balance sheets. Consequently, balance sheets throughout the economy are sensitive to exchange rate changes, with a sharp depreciation potentially having severe effects on financial stability.

30. A closer examination of the economy from a balance sheet perspective—with a focus on currency mismatches—is key for an assessment of Peru’s vulnerabilities. This requires a systematic analysis of the asset and liability positions of the economy’s main sectors, including foreign currency liabilities between residents. The need to repay or roll over foreign-currency debt, even if between residents, can result in a drawdown of reserves and can potentially trigger a payments crisis—particularly when the capital account has been liberalized. Given the financial linkages among sectors, a problem that at first may only affect one sector can cascade into healthy sectors, causing a more widespread crisis.

31. The chapter is structured as follows. A simple analytical framework is introduced in Section B. Based on this framework, Section C assesses the vulnerabilities induced by Peru’s high dollarization. Currency mismatches on the balance sheets of the economy’s main sectors are measured. The risk associated with these mismatches is analyzed and evaluated in terms of other balance sheet characteristics (such as the maturity and capital structure) and non-balance sheet factors (such as off-balance sheet transactions and foreign-currency income flows). In Section D, the financial linkages and the related transmission mechanisms between sectoral balance sheets are explored. The chapter concludes (Section E) by pointing to the stabilizing elements in Peru’s sectoral balance sheet structure, which help to explain why Peru weathered recent regional turmoil despite its dollarization-induced vulnerabilities.

B. Analytical Framework And Methodology21

32. To explore balance sheet risks, the economy is decomposed into three sectors, along with their claims and liabilities vis-à-vis non-residents (external sector). The sectors are: public sector (PS),22 private financial sector (PFS), and the private nonfinancial sector (PNFS). A matrix of the sectoral asset and liability positions is presented in Table 1. From this matrix, the main balance sheet risks of the three sectors, their exposure to the external sector, and the country’s risk exposure as a whole can be identified. Each row shows the liability structure (currency, maturity, creditor) of a sector, from which exchange-rate and roll-over risk can be assessed. Each column provides information on a sector’s financial assets— its holdings of another sector’s liabilities—that might reveal a particular exposure to another sector or other asset-liability mismatches.

Table 1.

Sectoral Asset and Liability Positions in Peru

(As of end-December 2002. in millions of US$) 1/

article image

Data evaluated at 3.54 Nuevos Soles / U.S. dollar.

Nonfinancial public sector (central government, autonomous agencies, local and regional governments, fiduciary irusts, non-fiiianda! public enterprises) and the financial public sector (central ban!;. Banco de la Nacion, development banks and state-owned savings and loans).

Mainly commercial banks, insurance companies and private pension funds (AFRs).

Private enterprises and households.

Liabilities and assets with non-residents (International Investment Position).

According to residual maturity.

33. The analysis focuses on currency mismatches—the dominant concern in a highly dollarized economy—in combination with maturity and capital structure risks. Balance sheets in Peru typically have foreign-currency denominated liabilities and mostly local-currency assets (currency mismatch), which exposes them to exchange-rate risk. Furthermore, gaps between short-term liabilities and liquid assets (maturity mismatch) may create roll-over risk and also expose balance sheets to interest rate changes. Indeed, the combination of currency and maturity mismatches has often played a critical role in recent financial crises in emerging market economies. Finally, a heavy reliance on debt rather than equity financing (capital structure mismatch) could be problematic, as it generally makes balance sheets less resilient to any shock that reduces asset values.

34. In addition, off-balance sheet activities need to be considered. Guaranteeing of debt or trading with financial derivatives can significantly alter the risk exposure of a balance sheet, even if they are, by definition, off-balance sheet transactions. Hence, for a complete picture of risks, additional information on such transactions has to be considered (to the extent permitted by the limited availability of such data in Peru).

35. Some further conceptual issues and data limitations are to be kept in mind:

  • The matrix presents only a static snapshot of the asset and liability positions.

  • The matrix data does not include non-financial assets, which could play an important role, for example, for assessing solvency issues.

  • Assets are recorded at face value, following an accounting concept rather than a mark-to-market approach that takes into account the volatility of asset prices.

  • For the PNFS (mainly households and corporations) balance sheet, data is typically scarce and can often only be derived indirectly from the financial sector.

  • Risks in individual institutions or segments within a sector may not be revealed in the aggregated data of a sector; and the assets of one private entity may not be available to relieve the problems of another.

C. Assessing the Economy’s Vulnerability from Dollarization

Measuring the sectoral currency mismatches

36. The share of foreign-currency denominated debt is very high in each of the economy’s sectors. About 85 percent of the PS’ total liabilities are denominated in foreign currency, with half of its domestic liabilities being dollar-denominated. In the PFS the share of foreign-currency liabilities reaches 56 percent of total liabilities, and in the PNFS it is 83 percent. In total, over three-fourths of all debt in Peru is denominated in foreign currency; a high share even for an emerging market economy.


Share of foreign currency and external debt

Citation: IMF Staff Country Reports 2004, 156; 10.5089/9781451831047.002.A003


Foreign currency share in total debt

Citation: IMF Staff Country Reports 2004, 156; 10.5089/9781451831047.002.A003

37. Only slightly over half of the foreign-currency debt is external debt—reflecting the high degree of domestic liability dollarization. The total stock of foreign-currency debt in the Peruvian economy is close to 100 percent of GDP, while the economy’s external debt reaches only about 50 percent of GDP. The share of foreign-currency debt owed to external creditors varies widely among sectors; it is highest in the PS (72 percent of its debt is external debt), reflecting the government’s dependence on external financing, and lowest in the PFS (only 5 percent of its debt is external debt).


Foreign currency mismatch

(al matuldes, in billions US!)

Citation: IMF Staff Country Reports 2004, 156; 10.5089/9781451831047.002.A003

38. The balance between foreign-currency assets and foreign-currency liabilities varies widely across sectors. The currency mismatch in the public sector of US$13.8 billion is by far the largest, more than double than that in the PNFS (US$5.5 billion). On the other hand, the PFS has a positive position of US$7.1 billion (an important foreign-currency asset being its dollar loans to domestic borrowers).

39. This simple measure of currency mismatches implies that a depreciation of the local currency would affect the net present value of sectoral balance sheets quite differently. While the balance sheets of the PS and the PNFS would suffer net worth losses from an exchange rate depreciation, that of the PFS would theoretically gain net worth. However, as discussed below, if the negative balance sheet impact on the PNFS was so severe that loan repayments were to suffer, the PFS could also experience serious problems.

Including maturity structure in the risk assessment

40. The favorable maturity structure of the PS’ foreign-currency assets and liabilities greatly mitigates the risks associated with the currency mismatch on its balance sheet. While the currency mismatch between all assets and liabilities is ultimately relevant for the effect on a balance sheet’s net worth, it is the mismatch between liquid foreign-currency assets and short-term liabilities that creates immediate financial pressures. Peru’s PS, however, has liquid foreign-currency assets well in excess of its short-term foreign-currency liabilities—mainly owing to the central bank’s large international reserve holdings.


Maturity mismatch in foreign currency

(in billions US$)

Citation: IMF Staff Country Reports 2004, 156; 10.5089/9781451831047.002.A003

41. The PS’ position vis-à-vis the external sector is even more liquid than its overall foreign currency position, indicating a low roll-over risk. The bulk of the public sector’s short-term dollar liabilities are with the domestic banking system (banks’ dollar deposits at the central bank). At the same time, most of its external debt has long maturities (multilateral and bilateral debt), and almost all its liquid foreign-currency assets are external assets (official reserves). Taken together, this greatly reduces the government’s dependence on international markets to roll over its debt.


Maturity mismatch, in external position

(in billion US$)

Citation: IMF Staff Country Reports 2004, 156; 10.5089/9781451831047.002.A003

42. In contrast, the PFS faces a significant maturity mismatch in foreign currency, which, however, is much smaller than its overall maturity mismatch. While having a maturity mismatch on its balance sheet is normal for financial intermediaries, to have this mismatch in foreign currency exacerbates this risk.23 To address this vulnerability, the PFS has a high foreign-currency liquidity ratio (liquid foreign-currency assets cover 40 percent of short-term foreign-currency liabilities). For the commercial banks, this ratio is close to 50 percent—twice as high as the liquidity ratio in local currency—indicating the sector’s awareness of this particular vulnerability.

43. Importantly, the PFS has no maturity mismatch in its external asset-liability position, thus reducing its roll-over risk with external creditors. In principle, it should be irrelevant whether a mismatch exists vis-à-vis a resident or a nonresident; yet, in practice, maturity mismatches in external asset-liability positions in emerging markets carry the particular risk that external creditors may suddenly stop rolling over credit. Since the Russian and Brazilian crises in 1998, Peruvian banks reduced their foreign credit lines from close to US$4 billion to only about US$0.8 billion—an amount equal to their liquid foreign assets. As a result, over 90 percent of the financial sector’s short-term funding comes from residents, who thus far have proven to be a much less volatile funding source.


Peru: Domestic banks funding sources

Citation: IMF Staff Country Reports 2004, 156; 10.5089/9781451831047.002.A003

44. The PNFS has no maturity mismatch in foreign currency. 24 Owing to its dollar deposits in the domestic banking system (US$9.4 billion) there is ample foreign-currency liquidity in the PNFS. Even under the assumption that half of the dollar-denominated domestic loans must be rolled over in a given year, the balance between short-term foreign-currency assets and liabilities is still positive (US$1.8 billion).25

45. There is a maturity mismatch in the PNFS’ external position, albeit a manageable one. The mismatch of US$1.7 billion is mainly a result of trade credit, which is typically less likely to experience a sudden flow reversal, and the amount does not seem out of line with annual export and import flows of over US$8 billion each.

Including capital structure into the risk assessment

46. Based on the limited data available, excessive debt-financing does not seem a particular concern for Peru’s balance sheets. The higher a balance sheet is leveraged through debt, the higher the risk of default. Whereas dividend payments on equity are state-contingent, debt payments are due regardless of the financial situation of a firm. Equity capital can therefore be seen as a general buffer against balance sheet risks. While the concept of equity is not applicable for the government and the aggregation of equity over the PFS and the PNFS is problematic, it is possible to calculate debt-to-equity ratios for the banking system and Peru’s publicly registered enterprises. Neither have leveraging ratios that are particularly high.

47. The banking system is well-capitalized, and the significant share of foreign equity contributes to its strength. In 2002, equity capital reached US$1.8 billion, about 10 percent of commercial banks’ total assets. The risk-weighted capital-asset-ratio is 12.7 percent, well-above the BIS minimum requirement of 8 percent. About 45 percent of the banking system’s assets are under foreign control. The foreign ownership of banks generally seems to have improved the efficiency of the banking system and should permit a higher diversification of risk, in particular where banks are full subsidiaries of internationally operating banks.

48. Debt-to-equity ratios in the nonfinancial corporate sector are moderate on average (80 percent), although they vary strongly across industries. The above average leveraging in manufacturing and retail implies a lower equity buffer in these Peruvian industries, which are likely to have little foreign currency income. This said, their indebtness ratios are still much lower than, for example, those reported in many emerging Asian economies before the 1997/98 crisis (particularly in Korea and Thailand, where average debt-to-equity ratios of listed companies were about 400 percent at end-1996.)


Debt-to-equity ratios for corporations registered on the Lima stock exchange.

Citation: IMF Staff Country Reports 2004, 156; 10.5089/9781451831047.002.A003

Including financial hedging in the risk assessment

49. The hedging of currency risk with financial derivatives takes place almost exclusively through Peru’s forward market. Given the large share of dollar debt, the demand for dollar forwards from nonfinancial corporations is high, in particular during periods of increased exchange-rate volatility. Almost one third of the forward contracts are purchased by the largest telephone company, which typically receives local currency for its services while having to service U.S. dollar debt. The supply side is dominated by banks. In particular, the four international banks (which are only about 7 percent of the banking systems’ assets) hold close to 30 percent of the systems’ net stock of forwards. Their presence in international capital markets is likely to increase their capacity to manage risks within their institution, allowing them to take such comparatively large positions.


Peru: Foreign Exchange Forwards of Commercial Banks in 2002

(in million US$)

Citation: IMF Staff Country Reports 2004, 156; 10.5089/9781451831047.002.A003

50. The supply of forwards by domestic banks increases the PFS’ maturity mismatch in foreign currency to the extent that it lowers that of the PNFS. Adding the banking system’s net forward positions (US$0.9 billion by end-2002) to the matrix’s balance sheet data, the PFS’ mismatch increases by the same amount the PNFS reduces its exposure.26 As long as the external sector does not provide forwards—nonresidents willing to take local currency risk—any such hedging only shifts risk between domestic residents. Although this leaves the mismatch for the country as a whole unchanged, it might still help to allocate the risk to those domestic balance sheets that can best cope with the risk.

Including foreign-currency income flows in the risk assessment

51. A lack of foreign-currency income flows from real transactions (private sector) and revenue collection (government) might aggravate currency mismatches.

  • The absence of regular foreign-currency income for the government (its main revenue source is tax collections in local currency) exacerbates the PS’ large overall currency mismatch. This in part explains why the PS holds a high level of official reserves (which provides an ample liquidity cushion).27

  • Peru’s PFS creates foreign-currency income by lending in foreign currency to domestic clients and earns such income from its holdings of foreign assets. While this reduces currency risk on its books, it increases credit risk at the same time. If the PNFS cannot generate sufficient foreign-currency receipts, it will default, and the currency risk returns to the banks in the form of nonperforming loans.

  • Borrowers in the PNFS have to generate the foreign-currency income to service their dollar debt mainly through external transactions; in the domestic economy most real transactions are made in local currency.28


Maturity mismatch in foreign currency incl. forward position

(in billion US$)

Citation: IMF Staff Country Reports 2004, 156; 10.5089/9781451831047.002.A003

52. The composition of banks’ loan portfolios suggests that a significant their foreign-currency loans is extended to industries in the PNFS that have little export activity. Industries involved in construction, commerce and other local services mostly produce non-tradable goods and import-competing industries do not generate export earnings. Yet, they make up over half of the banking system’s loan portfolio.


Pent: Commercial banks’ loan portfolio

Citation: IMF Staff Country Reports 2004, 156; 10.5089/9781451831047.002.A003

Peru: Foreign-currency debt and foreign-currency income in the PNFS

article image

Using banking system’s loan portfolio classification.

Assuming MLT debt is owed by mining corporations, and allocating trade credit by export weight.

Intermediary goods and certain service imports (transportation, communication and insurance); weighted by export share where importing sector is unspecified.

53. A rough comparison of net exports and foreign-currency debt indicates that even some exporters might be adversely affected by a currency depreciation. The positive competitiveness effect of a depreciated exchange rate theoretically provides exporters with some natural hedge against the negative balance sheet effect caused by the foreign-currency debt. However, some industries’ current net export earnings (taking into account their need to import certain inputs) are relatively low compared to their stock of foreign-currency debt.

D. Links between sectoral balances and the possible transmission of risks

54. The PFS is central to the mechanisms by which the sectoral currency exposures are linked. In response to the demand for dollar deposits, the PFS creates dollar assets by extending dollar loans to domestic borrowers. Since overall the PFS’ dollar denominated assets exceed its dollar liabilities, a depreciation of the local currency would not directly reduce its balance sheet’s net worth, but would rather expose the mismatch in the quality of its assets and liabilities: Under a depreciated exchange rate domestic dollar assets’ performance is likely to deteriorate (credit risk) while dollar liabilities still have to be serviced. Once doubt arises about the PFS’ solvency, the risk of a run on dollar deposits rises, which in turn would expose the PFS to its maturity mismatch.

55. The PFS’ exposure to public sector assets is relatively small. The PFS’ holdings of foreign-currency denominated public-sector assets amounts to only about 5 percent of its total assets of over US$23 billion, and the ratio roughly doubles when local-currency instruments are included.29 This, however, is still a low overall exposure to the public sector in comparison with other emerging market countries (see chart below). Furthermore, as shown earlier, the public sector’s large liquid foreign-asset position reduces the risk of a default on its dollar debt, despite the lack of foreign-currency income.


Domestic banking sector’s claims on public sector

(in percent of its total assets)

Citation: IMF Staff Country Reports 2004, 156; 10.5089/9781451831047.002.A003

56. The PFS’ main vulnerability is credit exposure to the PNFS. The PNFS has a maturity mismatch between its foreign-currency assets and liabilities and therefore is more dependent on regular foreign-currency income flows. As shown, however, a significant share of these borrowers is not likely to have a reliable stream of foreign-currency receipts and, thus, would be adversely affected by an exchange rate depreciation. Moreover, the aggregation of asset and liabilities in the PNFS may conceal the fact that the financial positions in certain segments of the sector could be weaker than for the sector as a whole. For example, households may have ample holdings of liquid dollar deposits, while the highly dollar-indebted construction industry is heavily invested in illiquid, non-financial assets.

57. The PS’ ability to act as a lender of last resort in case of a run on dollar deposits is bolstered by its high foreign-currency liquidity. As mentioned earlier, NIR is high, and the fact that it matches the stock of PNFS dollar deposits in the domestic banking system significantly contributes to depositors’ confidence.

58. High official reserves also mitigate the risk of an external roll-over crisis. While the PFS’ liquid external assets almost exactly match its short-term foreign debt, the PNFS’ has a mismatch between liquid foreign assets and short-term external debt. The PS’ liquid foreign assets can in principle help bridge a temporary loss of access to credit from foreign creditors.

59. Under the extreme scenario of a simultaneous run on domestic dollar deposits and a shutdown of external credit, however, a gap could emerge between immediate dollar needs and available dollar assets. Short-term debt and domestic dollar deposits together exceed official reserves and the PFS’ liquid foreign assets. This would not change much even adding the PNFS liquid foreign assets, which most likely would be unavailable in a such a situation. At the same time, however, this static comparison of assets and liabilities does not take into account flow adjustment in the current account in response to a depreciated exchange rate under such a scenario.

E. Conclusions

60. Domestic liability dollarization presents a risk to the Peruvian economy. Although dollar liabilities among residents net out in principle, the systemic implications of a run on domestic dollar deposits would create pressures on official reserves as would a sudden loss of access to foreign credit.

61. The initial vulnerability to an exchange rate shock primarily lies with the PNFS’ currency mismatch, but would eventually be transmitted to the PFS through credit risk. Peru’s PFS has adjusted to the demand for dollar deposits by lending to residents in dollars; thus avoiding an overall currency mismatch on its books. This, however, effectively shifts the currency risk to the borrowers in the PNFS, many of whom have no significant foreign-currency income and only limited opportunity to hedge themselves. The adverse impact of an exchange rate shock on the PNFS would, thus, eventually hit the PFS in the form of nonperforming loans.

62. The PFS’ relatively high dollar liquidity is the first line of defense in such a scenario. In recognition of the higher credit risk of their dollar loans, Peruvian banks not only lend at short maturities but also maintain much higher liquidity ratios in dollars than in local currency. While low returns on assets throughout the banking system indicate that this dollar liquidity comes at a cost, it also provides the PFS with a comfortable cushion against the adverse effects of a sharp currency depreciation.

63. Ultimately, the high level of official reserves creates the potential for the PS to provide emergency dollar liquidity— a critical factor in explaining the economy’s resilience over recent years to the turbulence that affected other dollarized economies in the region. The PS has maintained international reserves at levels that could largely cover the economy’s foreign-currency liquidity needs.


External and financial vulnerability ratios

Citation: IMF Staff Country Reports 2004, 156; 10.5089/9781451831047.002.A003


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  • Banco Central De Reserva Del Perú: various editions of the weekly Nota Semanal.

  • Superintendencia de Banca y Seguros—SBS—Información Financiera de Banca Múltiple, Empresas Financieras y Empresas de Arrendamiento Financiero; al 31 de Diciembre de 2002.

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Prepared by Christian Keller (PDR).


Despite some downward trend since 2000, Peru has still one of the most dollarized banking systems in Latin America, with 70 percent of the deposits and 75 percent of loans denominated in U.S. dollars.


This follows the approach suggested by Allen (2002). All data for this analysis was provided by the Central Reserve Bank of Peru (BCRP) and the Superintendency of Banks and Insurance (SBS).


Comprising the nonfinancial and financial public sector.


It should be noted that this mismatch is measured taking into account only truly liquid assets. In the simplified matrix presentation, which defines assets as holdings of liabilities, it can be seen that the PFS holds US$5.9 billion short-term foreign-currency liabilities in the form of U.S. dollar loans to the PNFS that fall due over the next year (residual maturity); although these loans theoretically provide the PFS with a dollar cash flow over the short-term, they are not necessarily “liquid” assets.


This assumes that domestic U.S. dollar loans mature on average after only two years. About 20 percent of banks’ loan portfolios are mortgages, 20 percent are commercial credit with maturities beyond one year, and 60 percent are loans with maturities of less than one year. Assuming that the typical maturities in these categories are around 10, 2 and 0.5 years, respectively, the average maturity of the overall loan portfolio is conservatively estimated to be about two years.


As mentioned above, it must be kept in mind that this is true only for the PNFS in aggregate. It might well be that there are sectors or individual entities within the PNFS that have very low foreign-currency liquidity and a maturity mismatch.


Almost two-thirds of Peruvian forward contracts take the form of non-deliverable forwards (NDLs), which only require to settle the difference in the exchange rate value through a payment in local currency. While this avoids the need to deliver the foreign exchange, it implies the same exchange rate exposure in a regular forward contract.


At the same time, it underscores the importance of the government’s steps in recent years toward establishing a market for issuing bonds in local-currency. It will allow over time to better match the currency denomination of its debt with that of its revenue.


In Peru, financial dollarization—the use of the dollar as store of value—is widespread, while real dollarization—the use of dollars as a means of payment—is less prevalent. Most prices and wages are set in local currency. If real dollarization were dominant, it would be theoretically possible that some residents could earn foreign currency through domestic transactions. However, for the country as a whole, foreign currency can only be generated through external transactions.


By end-2002, the PFS held about US$0.9 billion of dollar-denominated financial-system support and debt-exchange bonds (issued during the 1998 bank restructuring), US$0.1 billion of exchange rate-linked central bank CDs and US$0.1 billion of Peruvian Brady bonds. In local currency it held about $0.6 billion of sovereign bonds and US$0.5 billion of central bank CDs.

Peru: Selected Issues
Author: International Monetary Fund