Abstract
This paper examines Peru’s Request for a Stand-By Arrangement (SBA). Performance under the 2002–03 SBA was satisfactory. This performance provides a solid basis for continuing with policies aimed at maintaining macroeconomic stability. The authorities are requesting a 26-month SBA covering the period through August 2006, when a new administration is scheduled to take office. They consider that continued IMF support for their program would help anchor economic policymaking and improve investor sentiment. To boost economic growth and promote employment, the authorities are committed to implementing a broad set of structural reforms.
1. Under the 2002-2003 Stand-By Arrangement (SBA), growth accelerated significantly, inflation was kept within the target, and there were considerable advances in fiscal consolidation and structural reform. Going forward, the authorities’ goals are to further diminish vulnerabilities, improve competitiveness, reinforce investor sentiment, and reduce the poverty level while maintaining macroeconomic stability. The Peruvian authorities recognize the importance of close collaboration with the Fund to successfully tackle these challenges; in particular, they value the sound technical advice, as well as the greater international credibility associated with Fund endorsement. In view of these considerations, the authorities see the convenience of requesting a successor SBA covering the period through August 16, 2006, also to be treated as precautionary. The authorities’ policy agenda is described in the Memorandum of Economic and Financial Policies (MEFP) and reflects broad-based consultation.
Macroeconomic Policies
2. The results as of the first quarter of 2004 confirm the positive trend in the main macroeconomic variables. Annual GDP growth was 4.6 percent, and is projected at 4 percent for the year. Export growth—roughly 30 percent in US$ terms—was underpinned by favorable commodity prices and by a continuous expansion in the volume of industrial exports, mainly textiles and agricultural goods. Growth in domestic demand is also sustained. While consumption increased at around 3 percent, growth in private investment accelerated, reaching 8 percent in the first quarter, the highest rate since end-1997. Moreover, preliminary information shows that during the first quarter Peru posted a fiscal surplus of 0.7 percent of GDP—and a primary surplus of 3.3 percent of GDP—which reflects the process of fiscal consolidation resulting from prudent policies. Monetary policy continues to meet the inflation target, while the level of reserves stood at a comfortable level—2.3 times short-term debt—and has since continued to increase. Overall, the medium-term outlook remains positive, supported by good prospects for the international environment and ample access to foreign financing. After reaching historical low levels at the beginning of the year, sovereign spreads have increased somewhat lately, due to a correction in expectations regarding international interest rates. However, end-May levels were similar to those in mid-2003, and remain among the lowest in Latin America.
3. The macroeconomic framework proposed for 2004-2006 is geared to strengthen the fiscal and external positions achieved under the 2002-2003 SBA, while locking in the growth momentum and the low inflation rate. On the fiscal front, the authorities will further strengthen debt sustainability, with public debt falling from over 47 percent of GDP last year to almost 40 percent of GDP at end-2006. Towards this goal, the overall public sector deficit is to be cut from 1.7 percent of GDP in 2003 to 1.4 percent in 2004 and to 1 percent in both 2005 and 2006. The authorities will persevere in enhancing revenues, exerting expenditure restraint and improving its quality and focus. Central government tax revenues are expected to rise, mainly reflecting higher income tax collections associated with buoyant export prices, the continuation of administration improvements, and the tax reform completed in early 2004.
4. As anticipated in the last Board meeting, for 2004 the Financial Transaction Tax (FTT) rate has been reduced from 0.15 percent to 0.10 percent, and will be gradually phased out, with rates falling to 0.08 percent in 2005 and 0.06 percent in 2006. The authorities also intend to devote revenues accruing from the FTT primarily to attend priority needs, including social spending in health and education, as well as infrastructure and security. Moreover, they will continue to work in coordination with regional governments and Congress to gradually eliminate sectoral and regional tax exemptions to generate additional resources for infrastructure and social services in the regions. The authorities will also explore financial mechanisms to enhance public investment, given its key role in social and productive development, in a way that is fully consistent with fiscal targets and debt sustainability.
5. Reflecting improved investor sentiment, Peru has maintained its access to international capital markets. Recently, Fitch international rating agency revised the outlook on Peru’s long-term foreign currency rating from Stable to Positive, in response to improved public and external finances and reduced public financing vulnerabilities. In April, the government launched a US$ 500 million 12-year global bond—including CACs—which completed its financing needs from the capital markets for 2004. This issue is also part of the government’s plan to improve medium-term fiscal sustainability by extending the term of Peru’s foreign debt profile. The strategy includes expanding placements in medium- and long-term local currency instruments to reduce rollover and currency risks. As previously reported, towards this end the authorities have successfully developed a primary dealer system since March 2003.
6. The inflation targeting scheme adopted in 2002 aims at a 2.5 percent medium-term inflation target within a ±1 percent range, in the context of a floating exchange rate regime. Recently, supply shocks, mainly weak agricultural crops and increases in world oil prices, generated a rise in inflation towards the upper end of target range. However, given the temporary nature of these pressures, inflation is expected to converge towards the center of the target band in the rest of the year and without the need of tightening monetary policy. The authorities stand ready to take the necessary steps to ensure the achievement of the inflation target.
7. Consistent with the inflation targeting framework, the Central Reserve Bank of Peru maintains a floating exchange rate regime, with interventions in the foreign exchange market limited to those needed to confront excessive exchange rate volatility or abrupt fluctuations, without any implicit or explicit commitment to any given exchange rate level. This flexibility allows the independent monetary policy—whereby the central bank adjusts domestic liquidity and the interest rate—to be directed to achieve the inflation target. This policy setting has been successful in meeting the inflation target and has also resulted in low interest rate volatility in the interbank market in domestic currency.
Structural Reforms
8. The authorities will continue their plans to implement key structural reforms aimed to ensure sustained and balanced growth. This year they relaunched their plans to promote private sector investment in infrastructure, and intend to step-up their efforts in this field through public-private partnerships (PPPs) and other arrangements. The government has recently signed a long-term management contract for a hydroelectric plant, sold its stake in an oil refinery, and completed the concession of an irrigation project. Their plans for the near future include granting in concession two major mining projects, as well as the operation and maintenance of a port terminal. With the aim of overhauling the road network, the government will award concessions or engage in PPPs for the construction and maintenance of at least two major roads by end-2004. All outlays or contingent liabilities associated with these arrangements will be reflected transparently in the budgetary and debt accounts. The authorities are confident in succeeding to muster support for the program, including by involving regional and local governments in the process.
9. In May, Congress concluded the first of two voting rounds needed for a constitutional amendment to close the preferential pension regime (Cedula Viva)—which has undergone modifications previously, but remains highly inequitable and requires heavy subsidization from central government current spending. The proposal, which enjoys broad political support, will include centralizing the administration of the system and eliminating the costly link between wage increases and pensions. Savings from the reform will contribute to more efficient expenditure allocation and support the reform of the state.
10. Within the reform of the state, the government is working to implement a computerized payroll, as well as a census of employees and pensioners. The authorities will continue to modernize procurement procedures and improve the regulation of domestic fuel prices. Increasing the effectiveness of social expenditure and improving the targeting of poverty-reducing programs, with the assistance of the Inter-American Development Bank (IADB) and the World Bank, remain at the core of the authorities’ agenda.
11. The authorities are engaged in actively pursuing regional and bilateral free-trade agreements (FTAs). In particular, Peru has started negotiations for an FTA with the U.S., which would make permanent the special access to the U.S. market currently enjoyed under the Andean Trade Promotion and Drug Eradication Act (ATPDEA). The FTA is also expected to encourage export diversification, as well as accelerate critical reforms that will attract investment to the region. At the same time, the authorities remain committed to participating in the FTAA initiative.
12. In this context, improving the business climate is a priority. Thus, the establishment of commercial courts modules to resolve commercial disputes and speed-up contract enforcement is an important part of the program to strengthen property rights.
13. The authorities are committed to complete the legal framework for decentralization to ensure that the devolution process is implemented in an orderly, gradual, and fiscally neutral manner. Fundamentally, by end-year the government will submit to Congress draft laws to establish the criteria to certify sub-national governments’ administrative capacity to deliver essential public services; clarify the distribution of functional responsibilities among the different levels of government; and specify remedial measures for sub-national governments that do not comply with the fiscal rules established under the Fiscal Decentralization Law.
14. Financial system indicators remain sound as a result of a consistent strengthening of financial regulation and supervision. In 2004, the authorities will further strengthen financial sector regulations and supervision, including in the context of the new Basle regulations, promote dedollarization, and support the development of domestic capital markets to increase the access and quality of credit, including through strengthening the basis for collateralization.
On the Program
15. The authorities are fully aware of the need to further advance the reform process, particularly in key areas including fiscal consolidation, financial de-dollarization, and growth-enhancing structural reforms. In their view, the proposed SBA, with the associated policy advice, direct dialogue, and explicit endorsement, would significantly contribute to achieving these goals.
16. Like previously, the authorities intend to treat the proposed SBA as precautionary, keeping the Fund’s financial exposure in Peru at a minimum—currently only 12.6 percent of quota. The proposed arrangement presents a more complete conditionality structure, including two structural performance criteria, with the aim of improving competitiveness and press forward with institutional reform. Also, the authorities underscore that the key policies that would be undertaken under the proposed program would pave the way for an exit strategy from Fund-supported programs.