Peru - Current economic position and prospects

~~~~~~~~~-R E S T R I C T E D RETURN TO REPORTS DESK R e p o r t N o. WH-70a WITHIN AL 3 ONE WEEK W i This,teport was prepared fbr use within the Bank. In making it available to others, the Bank assumes 'no responsibility to them for the -accuracy or completeness o.f the information contained herein. INTERNATIONAL BANK FO:R RECO:NSTRUCTION AND DEVELOPMENT, THE CURRENT ECONOMIC POSITION AND PROSPECTS OF PERU i)Februa1rgy 26, 1958 Department of Operations Western Hemisphere  CIJRRENCY Since January 23, 1958 the exchange rate has moved from 19 soles to 21 soles per dollar. 1 U.S. $ = 21 soles 1 sol = 5 cents, approximately 1 million soles = U.S. $47,500  TABLE OF CONTENTS I. SUtMARY IT. BASIC TRENDS Agriculture Mining and F'uel Industry and Power Transportation Regional Development and Decentralization Financial Aspects of Development III. RBC.bT FTNINCIAL DEVELOPMENTS L. :lor Situation Commercial Bank Credit The Puhiic Sector Balance of Payments IV. RaIEDIAL ACTION AND m OSPECTS FOR FINANTCIAL STABIlITY V. CREDITWORTHINESS  BASIC DATA Area 182,300 square miles Population 9.9 million Average annual rate of increase, 1950-57 2% Gross National Product, 1956 32.4 billion soles Average annual increase, in real 6-1/4% terms, 1950-56 % originating in agriculture (1955) 28 % devoted to gross fixed investment (1955) 24 Cost of Living Average arinual increase, 1950-56 7% Balance of Payments, 1956 Millions of U.S. dollars Exports 321 Imports, f.o.b. 341 Balance of trade -20 Invisibles -78 Balance on current account -9 Financed by: Direct investments 40 Long-term capital 37 Other 22 Commodity Exports, 1956 Millions of % of total U.S. dollars exports Meajor agricultural products (cotton & sugar) 119 37% Major mineral products (petroleumn,copper, silver, lead, zinc, iron) 1314 141% All other exports 69 22% 321 100% Foreign Exchange Reserves of Central Bank, December 1957 MLillions of U.S. dollars 33.5 % of 1956 imports, c.i.f. 9% Government Finances, 1955 Millions of soles Revenues 4R590 As % of G.N.P. 16.5% Expenditures 4,881 % of expenditures for investment 41% % of expenditures for investment, 1951-1954 26%  - 1 - I. SUMITARY The general background against which the present economic position is to be appraised is contained in the February 1057 Economic Reiport on Peru (W.H. 53 a). The main conclusions of that report still stand. The basic long term economic prospects of Peru remain favorable and her creditworthiness remains at a high level, providing reasonable financial stability prevails and foreign short-term credits are kept within moderate limits. However, the immediate financial position has deteriorated sharply in the course of the last year, and it was only after heavy losses of exchange reserves that remedial action was taken. The Peruvian au-thorities now appear to appreciate the need for such action and in the closing months of 1957, they instituted firmer ccntrol on bank credit while taking fiscal measures also designed to close the inflationary gap. More recently they demonstrated their firm intention to have the Peruvian economy livre within its means by permitting the exchange rate to find its own level. In addition, future wage and salary increases will have to be kept within reasonable limits. It wil:L not be easy for the Administration to carry out its pro- gram for maintaining stability. While it may not be able to avoid some further deterioration there are good grounds for expecting that instability will not reach the point where it counteracts the favorable long-term trends in the Peruvian economy.  - 2 - II. BASIC TRENDS IN THE ECONOMY ln Peru possesses abundant and diversified natural resources. Since its exports are well diversified and well balanced between mineral and agricultural products, the country has good protection from adverse developments in foreign markets; this was well illustrated in 1957 when the fall in the prices of non-ferrous metals was offset by an increase in the price of sugar. Peru has had a high growth of output in recent years. From 1949 to 1955 Gross National Product increased in real terms at an annual average rate of about 6%; this rate may have been exceeded in 1956 although the severe drought which reduced agricultural output in the south offset in part some of the rapid gains made elsewhere Growth continued to be well balanced between the mAjor sectors of the economy. It has been sustained by a high rate of -.Lvestment ercl of foreign capital inflow. Prospects for a continuatJi-n of these trends are good; Peru. offers good opportunities for investment; its s;atutes are favorable to private capital and provide special incentives in the form of -ax adv-antages to foreign capital. Large inv-estment projects now under construction will, within a fFew years, add substantially to productive capacity. On a geographical basis, howeV-,er, growth has been 'opsided; in the field of agriculture development has taken place mostly on the coast; industrial development has concentrated in the Lima area where it has been accompanied by high activity in commercial and residential construction. Agriculture 2. Agricultural production continues to increase; production of cotton in the 1956/57 season reached a record of 2.5 million quintals as compared with half this amount in 19h9/50; sugar production also reached a record high of 718,000 metric tons in 1956 (472,000 tons in 1949/50). Several irrigation projects now under construction, including the Bank financed second stage of the Quiroz-Piura project, the Choclococha project and the La Joya project will probably add 70,000 ha. to the cultivable area on the coast. Farm credit from the Agricultural Development Bank continues to provide vital assistance to agriculture. A second IBRD loan of US%5 million was made to supplement the Agricultural Bank's resources in March of 1957. On the other hand, agriculture in the Sierra remains backward; production of wheat and corn has declined since 1953; the seriousness of the problem was emphasized by the severe drought of the last two years which reduced production further and made it necessary to import large quantities of wheat. 3. The basic problems of agriculture - lack of water on the coast,  - 3 - inadequacy or lack of transport facilities, and backwardness of agricultural technology in the Sierra - are still being dealt with in an uncoordinated fashion, without adequate background studies. Recently the Government has shown its awareness of the situation and discussions are in progress for the organization of a mission of experts to make a general survey of agriculture. Meanwhile the Government is contemplating the re-organization of the Ministry of Agriculture and has already set up an Office of Agricultural Planning in that Ministry which will deal with the agricultural aspects of irrigation projects, a responsibility hitherto entirely left to the Ministry of Public Wiorks. Mining and Fuel 4. In 1956 mining output continued to rise steadily in response to favorable market conditions abroad and as a result of investments made in recent years. In 1957 the fall in prices of non-ferrous metals forced some small mines to close, but prospects are for a continuation of increase in output of both refined metals and concent-ates. Worlk on the Toquepala copper project in the south is proceed-i:g and ft is expected to quadruple yearly copper production in Peru after 1961. 1Eron ore production will continue to increase; the Marcona Mvining Company which is nouT exploiting dreposits on a long term contract with the Peruvian Santa Corporation has initiated a USY20 million expansion prcgra-m. Financing was also arranged recently to develop the Acari iron ore deposits. Present plans for Acari contemplate the production of 1 million tons a year after 1959. The coal industry has received some stimulus, the result of a contract providing for the export to France of up to 300,000 tons yearly of anthracite. 5. Petroleum exploration in the Selva has continued to be disappoint- ing. The major producer insists that unless petroleum prices are increased it will be unable to continue expensive "secondary recovery" methods; if this occurred production of crude oil would actually decrease. A bill was introduced in Congress raising the gasoline tax by about S/.0.30 per gallon, which will be earmarked to finance part of the highway program. It is also understood that at the same time the Government would increase the price paid to the producer by an equal amount. Industry and Power 6. All available data point to the continuation of the steady growth of recent years. The Bank financed Pacasmayo Cement Plant is now in production and the country's production capacity is now sufficient to cover its needs. The opening of the new Goodrich tire plant provides  excess capacity for some time to come. The completion of the "Fertisaf' fertilizer plant in 1958 will substantially reduce the imports of synthetic fertilizers. Whlile there are many other encouraging developments in the field of consumer goods, Peruvian industry is not without problems. The textile industry continues to be a trouble spot. While some sectors of the industry are highly efficient and are developing rapidly, others suffer from a complex of problems ranging from technology, marketing practices, labor relations, and other deficiencies resulting from weak management. As an immediate step the Government provided immediate but temporary relief by increased duties and financial help through the Industrial Bank. The Government has already established a joint labor management council to deal with some of the problems of the industry. 7. As a measure to help finance industrial development, the capital resources of the Industrial Bank are to be increased progressively over the years from S/.40 million to S/.4oo million. An Industries Law, prepared with a view to creating new incentives for the development of industry, is now under discussion in Congress. The Electricity Law which was passed in 1955 has been regarded as successful in creating incentives for investments and some important private prcjects are going forward within its frameworrk the procedure for regulation of rates i3 well conceived and F'o far has worked well. An overall electricity survey was co.pleted by the Electicite de France in the surnrmer of 1957, and is intended to provide major gidelines for government action in this field. Transportation 8. Some imoortant developments have taken place in that field in recent months. In addition to the project of rehabilitation of the Central and Southern Railroad nOw under consideration, other transpor- tation projects are in preparation. A report on the overall need for port facilities in Peru is now being prepared by consultant engineers. The Bank has been asked to consider a project for the expansion of the Port of Callao. Work on the construction of a breakwater in Salaverry will soon be completed and the Government is considering the initiation of the second stage of the project. Consulting engineers are now completing a preliminary report on the expansion of the Port of Paita. 9. In 1957 road construction proceeded at a somewhat slower rate than in the past, partly due to financial difficulties. During the year the outline of a National Roads Program for the next five years was prepared by the Highway Department and the Government. The overall size of the program does not seem excessive in relation to levels of investment in the past and in relation to the country's requirements. The program provides for the construction and improvement of a net of roads at a cost estimated by the roads department at one billion soles over five years. While some of the priorities from an economic stand- point and some of the cost estimates may be open to question, the program represents an effort to plan investments taking into account financial resources which might become available. Half of the cost of the program  represents roads of penetration to the Eastern Selva. The other half covers the construction of links between existing roads and the improvement of main highways. Maintenance work has been improved in the last two years as a result of the program initiated with the Bank's loan made in August 1955. The Roads Department is now spending on maintenance one third of total expenditures on roads as compared with one fourth before the program was initiated. In absolute amounts expenditures for maintenance have been raised from S/.2h.b million in 1953 to S/.80 million in 1957 (in addition to Bank financed expenditures). Regional Development and Decentralization 10. The uneven character of economic development in Peru has become more evident in recent years. Economic growth on the coast and in the metropolitan Lima area has been rapid, but growth in other parts of the country has lagged behind. Perhaps the most sericus long- term structural weakness in the economy is the continued stagnai-Ion of the subsisten.ce economy of the highlands, which includes a large. portion of tnie countryJs pooulation, growing at a rapid rate. Another aspect of unevenness and weakness has been the excessive centralization of responsibility for public development activity in the Central Government in Lima. Efforts to solve these problems are only in their be-innings, btut some important steps have been taken in the recent past. The Southern Peru Development Commission, a regional public body, has been completing its plan of organization, and is beginning a program of studies of how to deal with the economic problems in Southern Peru in a coordinatedl manner. The channelling of drought relief through the Commission was a stimulus to such activity. In 1957 the Cuzco Reconstruction and Development Corporation was established to deal with the economLic problems of that important section of the highlands. It has substantial revenues (some 68 million soles in 1958) whose effective application could do much to develop the economic activity of a popula- tion numbering some 700,000 persons. Important progress was also irade in beginning and carrying on studies and construction on several pene- tration roads which would open up new areas for economic development, including those adjacent to the highly populated highland regions. These roads continue to figure in the new 5-year National Roads Program. 11. The Cuzco Corporation also evidences an attempt to decentralize responsibility for development. If it is successful in formulating and implementing a constructive program it could well influence the adoption of a similar pattern for public development activities in other regions. 12. On a national scale, the Economic Development Fund, referred to in the last report, began its operations. Endowed with special portions of national public revenues (budgeted for 1958 at 280 million soles) it distributes these funds for expenditures on development activities in each of the political Departments of the country, for programs to be  departmentally developed and implemented, under procedures established by a national council. In its first year, the application of the funds, while showing regard for the needs of the social sector, has concentra- ted very largely on water supply and sei-ernge,local roads, electric power distribution, and small irrigation works, all of high priority among Peruvian development needs. Local development on these lines could help in some measures to balance the unevenness of development activity, and to stimulate local interest in the proper choice and execution of productive works and perhaps lead eventually to some local financing. Financial Aspects of Development 13. The growth of the Peruvian economy has been sustained in the last years by a high level of capital formation. As pointed out in the last economic report,, the high statistical rates of gross domestic investment probably overstate realities but the direction and th-- magnitude of the changes have been si,nificant. Tne rate of grr ss investment in fixed capital increased f-rom 21% of t4le gross nationial product in 1950 to 2i4,8% in 1955. WThiLe public investments represented only 11% of g.- ;s domestic investments in 1950, the proportion increased steadily to 2- . in 1.955. Another aspect is increasing recourse to foreign borrowing; thus whi].e in 1950 public investment was carried ou7t with the country's c;yn resources, foreign loans acco.nted for a L-rge par-G3 of public investment after 1953; by 1955 more than a third of public investment was financed with foreign loans. 14. The highr ate of gross domestic private investment was also sustained by an increase in foreign private investments which rose from less than 3% of gross private domestic investment in 1950 to about 15% in 1955. As was also pointed out in the previous economic report, foreign investment has played a very important role as a catalyzer by mobilizing domestic funds. This fact continued to be demonstrated by the establishment of new subsidiaries of foreign companies with large participation of local financial groups and also by the success of two large security issues of IT and T of the Swiss Electricity group with local investors. Such progress underlines the need for a well organized Local capital market whose absence is increasingly an obstacle to the mobilization of domestic savings. Traditionally in the past small savings have been deposited in savings accounts; these have more than doubled in the last five years; large savings found their way largely in real estate. 15. The authorities and the business community have become increasingly aware of the necessity of taking steps to help organize a capital market. The Director of the Marketing Department of the Bank visited Lima in the spring; his visit was followed by that of the President of the New York Stock Exchange; as a result, the interest of the community has grown steadily and a project f6r reorganization of the  - 7 - Lima Stock Exchange is being prepared. 16. The lack of a capital market also makes it more difficult for the Government to place bonds with the public and to finance development by non-inflationary internal borrowing. Until 1952 almost all public investments were financed with current revenues. In 1952 the highway construction program was greatly expanded and in the following years a large part of new construction was financed by contractors and by commercial banks on a short term basis. In 1955 large borrowing was undertaken abroad on a short term basis to finance a wide range of expenditures. Most of these loans were disbursed in 1955 and 1956; repayment now represents a large share of current revenues. In 1957 more than 80% of the funds earmarked for road construction and almost half of those earmarked for port development were allocated to loan service. As a result of these policies and in order to carry ouc- needed investments the Government is now faced with the need to increase taxes and/or to have recourse to borrowing, Otherwise p ublic investments would have to be considerably curtailed to a le 7el which would not provide an adequate basis for a sound and balanced growzth of the economy. 1L7. Available indicators such as percentage of revenues collected tlr. -.gh taxes to National Income (17% estimated for 1958) seem to indi- cate that there is some margin for increasing revenues. There is little doubt also that stricter enforcement of existing income taxes would yield substantial additional revenues. An increase in the gasoline tax which presently sells at a relatively low price would help finance a larger road program. Greater financial contribution of the ultimate user to the cost of irrigation projects also seems advisable. These additional revenues, together with long term financing of invest- ments, would allow the Government to carry a sizeable invrestment program in the course of the next five years. 18. Im -the past, financing of investments by borrowing was done in a haphazard manner. Peru's ability to arrange financing abroad for investment projects has been limited mainly by deficiencies in the selection, study and presentation of projects for financing. Lack of planning and coordination in public investments continues to be a major weakness in the economic development of the country. The establishment of an adequate mechanism of coordination with adequate technical staff to prepare programs and execute studies would be a major step in this direction. III. RF,CENT FTP-(PIY-L DEVELOPMENTS 19. The last eighteen months have been marked by an intensification of the inflationary pressures which have been present in the Peruvian economy for many years. In the past, these pressures were absorbed  - 8 - by a rapid rate of growth of output and of foreign exchange income. This was still true in 1956 when output and foreign exchange income were the highest on record. In 1957, however, foreign exchange income was tapering off while many of the pressures generated in 1956 continued to be felt. The} main developments centered on three fronts: 1) large increases in wages and salaries, accompanied by intensified labor union activity and more frequent strikes; 2) continuation of the commercial bank credit expansion to the private sector of the economy; 3) large deficits of the public sector financed by Central Bank credit. Labor Situation 20. Since the middle of 1956, labor union activity intensified with an increase in claims for higher wages and salaries. In recent years, the cost of living kept creeping upwards while wages and salaries lagged behindv, This resulted in pressures for wage adjust- ments and in 1956, on the eve of the elections, massive wage and salary increases were v:-en across the board representing average increases of 25 to 30%. In some cases the increase represented 60% of the payroll; considered in the light of the very favorable retirement rights these increases represented a heavy charge to many industries. In 1957, further substantial raises were granted0 At the same time, there were signs of increased activity of the labor movement on a wide range of issues which in some cases led to a direct interference with the functions of management proper. Meanwhile, the Government's labor policy was hesitant, changing from indecision to firmness, Commercial Bank Credit 21, The rate of monetary expansion in Peru in recent years has been considerably in excess of growth of real output. In 1956, commercial bank credit expansion exceeded 14% while the increase in real output is estimated not to have much exceeded 6%. In September and October of 1956 more stringent reserves requirements were introduced, but the expansion of credit continued unabated; commercial banks increased their rediscounts with the Central Bank and simply did not comply with the newly established reserve requirements. The deficit of reserves of the banking system grew steadily. In late March 1957, more stringent restrictions were imposed by raising the marginal reserve ratio on both sight and time deposits which brought the average reserve requirements for all deposits for all banks to about 24%. However, no really serious effort was made to enforce the regulations; fines were set at a level which did not constitute a deterrent; they were paid by the banks which nevertheless continued to circumvent the regulations. As a result, commercial bank credit expanded during the first 9 months of 1957 by almost 15%, compared with less than 14% during the same period in the previous year. The expansion of bank credit in 1957 was supported not by rediscounts with the Central Bank, which were actually lower than in 1956, but by increasing deficiencies in reserve accounts with the Central Bank.  - 9 - This meant that the regulations put into force in March had not been successful in achieving their main purpose which was to prevent the primary Central Bank Credit expansion used to cover the budget deficit - the main cause of monetary expansion in 1956 and 1957 - from spilling over and permitting a secondary credit expansion on the part of commercial banks. The Public Sector 22. Moderate budget deficits have been the rule in the past. On a cash basis government operations for calendar year 1955 resulted in a small surplus. In 1956 there was a deficit of S/.h97 millions covered in part by using S/.121 mrillions of Treasury balances and S/.354 millions from the consolidation loan of S/.900 millions which the Government obtained from the Central Bank in the fall of 1956. The loan was to be used to consolidate all unpaid debts contracted by the past government in the form of Treasury Bills (there were S/.421.5 million outstanding as of December 31, 1955) and to cover the deficit of the 1956 budget. As of December 31, 1956, S/.775.5 million of the S/.900 million loan had been disbursed leaving S/.124.5 million to be used in 1957. 23. In 1957, the fiscal situation deteriorated further. The Govern- ment financed S/.200 million of public works by a loan from the commercial banks (rediscountable with the Central Bank up to 75%); also the Corporacion del Santa received Central Bank credits for S/.130 million to carry on the construction of the steel mill in Chimbote and the hydroelectric plant of the Canon del Pato. In addition, the current budget continued to run a large cash deficit. For calendar 1957 the Public Sector used S/.770 million of new credit from the Central Bank and the Commercial Banks. By far the largest part came directly or indirectly from the Central Bank. Balance of Payments 24. The large expansion of credit to the public sector and the excessive credit expansion of the commercial banks have been the two factors of expansion of means of payments in 1957. This expansion has stimulated demand for both locally produced and imported goods. The cost of living is estimated to have increased at an annual rate of 10% this year - the highest rate since 1951 - and imports reached an all time high.  Foreign Trade (Millions of US.) Jan.-Oct. 1957 Jan.-Oct. 1956 Imports 336.2 295.3 Exports 265.1 260.1 - 71.1 - 35.2 25. Import demand increased sharply for most items. At the same time the value of exports remained at more or less the same level as last year. There were lower receipts from non-ferrous metals du.e to a fall in the price of copper, lead and zinc; the Tanguis cotton crop was bad and in the second semester stocks accumulated due largely to market conditions; consequently, foreign income from cotton declined. These declines were offset by the high prices received for the good sugar crop and by a higher volume of exports of iron ore, wool and petroleum. For the year 1957 as a whole exports are estimated to reach US$ 330 million, and imports about US$ 400 million leaving a trade deficit of about US'y 70 million as compared with US$ 23.6 million in 1956. 26. Inilow of capital continued at a high level in 1957 but as repayment of foreign debt also remained high and imports continued to increase, much pressure was brought to bear upon the exchange rate. The Peruvian exchange system provides for two separate rates of exchange, the draft rate which has been allowed to fluctuate and had risen slowly from 19.02 soles to the dollar to 19.11 in the early summer, then rising rapidly to 29.60 in late September; and the certifi- cate rate, used for most commercial transactions, which has been pegged at S/.19 per US dollar since 1954. As the demand for foreign exchange increased the Central Bank maintained the certificate rate by selling exchange from its reserves, which declined from US$ 41.7 million equi- valent as of December 31, 1956, to US$ 34.6 million at the end of May and US$ 27.0 million at the end of August. By September speculation started; it was in large part motivated by the continuous loss of reserves, and by the feeling that inflationary pressures were gathering momentum. The large credit expansion, the growing budget deficit and the confusion which accompanied the presentation of the 1958 budget added to the uncertainty. In turn speculation was made possible by a large commercial bank credit expansion which took place in the latter half of September. Reserves dwindled to a low of US$ 8 million equi- valent at the end of October, recovering slightly to a level of about USt 10 million at the end of December.  - 11 - IV. REIEDIAL ACTION AND PROSPECTS FOR FINANCIAL STABILITY 27. As a result of these various developments, by October 1957 the Government was faced with need for remedial action. Prospects for 1958 indicated the total exchange earnings including capital inflow would probably not exceed the 1957 level; since foreign exchange reserves had reached a record low it was clear that exchange stability could only be achieved if inflationary pressures were brought to a halt. After consultation with staff members of the International Monetary Fund the general lines of a stabilization program were drawn. Action was considered in the field of credit policy, public finance and labor policy. 28. In the field of Bank credit the program called for a reduction of loans from commercial banks by maintaining and enforcing strictly existing legal reserves requirements, by reducing Central Bank rcdis- counts of commercial paper, and by progressively trarsferring Government deposits in commercial banks to the Central Bank. The first step wzas to eliminate pi:cgressively the deficit of legal reserves. In two months the net reserves deficit was reduced from S/.320.9 million on October 31, 1957 to S/.206.9 million on Movember 30, and S/.90.2 million on December 31, 1957., As of that date only one Bank had a large defic;> accounting for more than the total of net deficit. On January 13 the fine for the non-observance of reserves requirements was raised from 10% to 18%. Central Bank commercial rediscounts were also reduced from a peak of S/.206.6 million on October 15 to S/.133.4 million on December 31. Finally the decision was made to deposit 20% of future tax collections in the Central bank while drawing only on deposits in commercial Banks to cover expenditures. To comply with the new directives commercial Banks reduced their loans outstanding by S/.156 million in November and by an additional S/.104.4 million in December. As a result total commercial banks credit expansion for the year declined to S/.413.0 million, thbt is an increase of 8.5% for the year as compared with 14.2% in the same period of 1956, and 19.4% in 1955. Despite strong protests from many quarters against credit restrictions, the Government stood firm. 29. In the field of public finance the 1958 budget as sent to Congress contained a deficit which may be estimated at about S/.350 million, i.e. about 10% of the budget estimates. Furthermore no real resources were provided for financing investment expenditures Which may be conservatively estimated at no less than S/.200 million. Since in addition much of the deficit of 1957 is to be covered in early 1958, the prospective gap for 1958 on this basis would be as high as in 1957 (S/.750 million) a situation hardly consistent with the maintenance of stability.  - 12 - 30. Pleasures were taken slowly however. It was not until the end of November that the awareness that stability could not be maintained by commercial credit restrictions alone led the authorities to re-examine the position. Their program developed along the following lines. 31. As an immediate step in order to deter further speculation and in anticipation of the seasonal requirements for the early part of the year, the Government initiated negotiations for the renewal and increase in standby credits abroad. In the meantime in order to exercise stricter control of foreign expenditures of the public sector, the Minister of Finance was given the power to pass upon requests for foreign exchange from the Ministries and Public Agencies. In order to reduce the prospective inflationary gap in the public sector further measures were proposed. Congress approved a limitation of expenditures on special accounts transferring 8% of the yield (about S/.l0O million) to the ordinary budget to readjust deficitary accounts. A bill wars introduced in Congress raising the tax on gasoline by 40%; it would yield about S,'.60 million and would be used for roads construction, thereby reducing the amount of borrowing which the Government proposed to undertake to carry forward the Acministration one billion soles road program. The Ministry of Finance also is making p'ans to accelerate the collection of back income taxes and enforce future collection more strictly. Executive decrees are being issued changing the system and procedure for collection. It is also attempting to secure the coopera- tion of the other ministries to reduce expenditures by 10% from their budgeted level. The Government has been preparing a bill to introduce in Congress increasing import duties on a wide range of items. It is important to note that this stabilization program is based on the continuation of policies of free exchange and free trade which the Government has declared it is firmly determined to maintain. 32. As regards labor, several serious strikes had developed in late summer, violence and bloodshed occurred, and labor agitation assumed alarming proportions. The authorities, after trying a temperate policy, met the situation by suspending on November 8 for a period of 30 days certain constitutional guarantees, including the right of assembly, throughout the country. Thereupon, the labor unions ordered their members back to work; with the exception of the postal workers' strike, since settled, there has been tranquility, with negotiation being used to solve at least one important issue. 33. To the extent that the Government proves unable to carry out a stabilization program along these general lines, the ability of Peru to take full advantage of its material resources and the present favorable attitude of domestic and foreign investors would be seriously hampered. Inflation in Peru could quickly gather momentum, given the fact that the exchange market is small and sensitive, that the rate of investment depends heavily on inflow of foreign capital, and that under  the present political structure wage pressures are difficult to resist. A severe and continuous depreciation of the exchange rate would be inevitable, and under the circumstances it would be only a prelude to cumulative difficulties, including a wage-price spiral of substantial proportions, further difficulties in balancing the budget and restraining expansion of bank credit, discouragement of the inflow of foreign capital and further weakening of the balance of payments position. To avoid these consequences, a stabilization program dealing with the major causes of difficulty will need to be effectively and consistently implemernted. 34. The Administration has had and probably will continue to have difficulties in implementing such a stabilization program. Effective cooperation from the Banks, from the Labor Unions and from the Congress is required. A determined stand on the part of the Government to push its stabilization program in the public sector which it now appears willing to do, should help materially to assure that cooperation. In recent weeks, most tanks have been showing their cooperation in -espect of the measures to curtail credit, but pressures are mounting and concessions are likely to be made by the Government. Action on the 1958 Budget is complete. The Administration's proposals for restraining expenditures have been adopted, and action remains tc be taken on7 pro- pozals for obtaining new rev'enues to reduce the deficit. Perhaps the greatest uncertainty is that with respect to wage increase. Even if the Administration makes efforts to restrain excessive demands, some increases in wages early in 1958 appear inevitable. In these circum- stances it appears that it will be difficult to avoid some depreciation of the rate of exchange. In fact, on January 22 tv.e Central Bank ceased intervening in the exchange market, thus allowing the rate to reach new levels, a process not yet completed. 35. This action reflects the importance which the Peruvian authorities attach to protecting the balance of payments under diffi- cult circunstances. It reflects also a realistic appreciation by the government authorities of what could be accomplished at the present time in the stabilization effort. As long as the devaluation of the exchange rate is not used actually to justify a weakening of the stabilization effort, it can be interpreted as an adjustment to economic reality which will not weaken the economy over the long term. V. CREDITWORTHINESS 36. The performance of Peru in the past year serves in general to reinforce the view expressed in the last economic report: t'In a free and open economy like Peru, improper fiscal and monetary policies are soon reflected in pressures in the exchange reserves and the exchange rate, and require quick remedial action." While policies to avoid such pressures have not been as firm or as quickly applied as was hoped, action was taken first to restrict credit to the private sector, and then, with some delay, to reduce the deficit in the government budget.  Most important was the fact that the government has stopped supporting the exchange rate and is permitting the rate to be determined by market force!s. While complete financial stability is not assured, there are good grounds for expecting that financial instability will not reach the point where it counteracts the favorable long term trends in the Peruvian economy. 37. The country's natural and manpower resources are abundant and it has considerable entrepreneurial talent; its basic economic policies of freedom of controls and its favorable legislation for investments offer strong incentives for private enterprise. Its current rate of capital formation is high; its exports are well diversified and place the country in an advantageous position to adjust itself to adverse trends in world markets. While immediate prospects for an increase in exchange earnings are uncertain, the future outlook is more promising. The increase in production of export commodities expected in the next few years should be more than sufficient to offset those declines :n export prices which have recently taken place. The country wil' also begin to reap the be;nefits of the large investments now taking place in the economy. 38. Consiclered in the light of its present balance of payments and immediate prospects -Er exchange earnings, Peru's present official debt service is high, about US$29 million annually, but is scheduled to fall rapidly to IJS$11 mil'ion in 1962 and US$9 million in 196h. Since the last appraisal the new administration has contracted only one small direct foreign cbligation. It has guaranteed only one loan made by the IBRD in MIarch 1957 to the Agricultural Development Bank. Recent requests for Government guarantees have been channelled through a Coordinating Commission which appraises the project and makes recommendations on the proposed borrowing. In view of the country's long term prospects, a sizeable margin therefore remains for additional service on long-term debt, provided short-term credits are undertaken with moderation and financial stability is maintained.  Table 1 STNMARY OF EXTERThAL PUBLIC DEBT OUTSTANDING, JUNE 30, 1957 (Amounts in thousands of U.S. dollar equivalents) Debt Outstanding Amount 1% Total Debt Outstanding, June :30, 1957 1 208,608 100.00 Disbursed and still outstanding 193,314 92.67 Undisbursed 15,294 7.33 U.S. Dollar Debt 176,919 84.81 Disbursed and, still outstanding 161,625 77.48 Undisbursed 15,294 7.33 Publicly-issued bonds 60,628 ?9.o6 Privately-placed debt 62,10 ?9.79 Disbursed and still outstanding 61,047 .S 26 Undisbursed 1,101 0,53 Participation in and guaranteed sales of IBRD loans 3 688 1.77 Disbursed and still outstanding 2,1.24 Undisbursed 1,101 O.53 Suppliers' and bank credits 58,460 28.02 Loans held by IBRD Z 35 877 17.20 Disbursed and still outstanding 11.52 Undisbursed 11, 849 5.68 U.S. Government loans 18,266 8.76 Disbursed and still outstanding 15,922 Undisbursed 2,344 1.13 Sterling Debt 24,803 11.89 Publicly-issued bonds 11,265 5.40 Privately-placed debt (supplierst credits) 13,538 6.49 Argentine Peso Debt (Government loan) 6,2 2.99 Swiss Franc Debt (suppliers' credit) 304 0.15 Danish Krone Debt (suppliers' credit) 341 0.16 1/ Does not include the following stand-by credits for currency stabilization: a) $25,000,000 purchase from the International Monetary Fund. b) $17,500,000 from the U.S. Treasury. c) $17,500,000 from U.S. banks. Also excludes $11,750,000 of ICA loans from the U.S. Government payable in dollars or soles at the option of Peru. / U.S. dollar debt is overstated since all IBRD loans are shown here as dollar ddet despite the fact that they are being disbursed in several currencies.  Maab1e 2 ESTIMATED CONTRACTUAL INThTEIST AND AIAORTIZATION PAYMENTS 1958-1972 ON EXT7PLTAL PUPLIC DEBT AS OF JUNE 30, 1957 n thou ands c' U.S. dollar equivalents) Serv'ice payments re Total Debt __ by tyvpe of loan Service Payments bY cu rency-V Debt out- Payments during Year Suppliers' standing Amor- baii; U.S. Pounds Argentine Swiss Jan. 1 tization Interest Total credits Other dollars sterling pesos francs 1958 201,886 23,263 5,918 29,181 17,269 11,912 23,552 4,475 1,052 102 1959 168,610 22,242 5,303 27,545 14,623 12,922 21,604 4,839 1,000 102 1960 143,154 18,786 4,667 23,453 10,906 12,547 20,189 2,214 1,000 50 1961 123,101 15,554 4,076 19,630 7,521 12,109 17,415 1,215 1,000 1962 106,222 13,241 3,562 16,8C3 5,117 11,686 15,400 403 1,000 1963 91,696 11,065 3,120 14,185 3,054 11,131 12,782 403 1,000 1964 79,083 6,595 2,756 9,351 1,818 7,533 8,759 403 189 1965 70,972 4,438 2,459 6,897 1,042 5,855 6,494 403 1966 64,947 4,240 2,232 6,472 1,254 5,218 6,o69 403 1967 59,834 -3,085 2,022 5,107 5,107 4,704 403 1968 55,849 2,866 1,900 4,766 4,766 4,373 393 1969 51,271 3,012 1,745 4,757 4,757 4,373 384 1970 47,515 3,009 1,615 4,624 4,624 4,240 384 1971 43,730 3,005 1,487 4,4i72 4,492 4,108 384 1972 39,915 3,133 1,358 4,491 4,491 4,107 384 1 Includes all the debt shovm on Table 1 except the eciuivalent of $6,722,000 of suppliers' credits on which we do not have repayment terms, 2/ Dollar payments since all IBRD loans are included in dollar debt in Table 1.  Table 3 ESTIMATED INTEREST ANTD AMORTIZATION PAYIENTS 1946-1957 ON EXTERNAL PUBLIC DEBT (Amounts in thousands of U.S. dollar equivalents) Total debt Suppliers' credits Other debt Debt out- Payments during year Debt out- Debt out- standing Amor- standing Service standing Service Jan. 1 tization Interest Total Jan, 1 pa,vments Jan. 1 -pvments 1946 98,441 418 205 623 1,464 403 96,977 220 1947 102,956 969 334 1,303 6,167 1,005 96,789 298 1948 106,o76 2,022 1,125 3,147 5,354 999 100,722 2,148 1949 99,147 2,985 1,088 4,073 4,523 958 94,624 3,115 1950 113,280 4,784 1,205 5,989 3,708 556 109,572 5,433 1951 104,023 5,748 1,330 7,078 572 1,153 103,451 5,925 1952 110,947 3,277 2,295 5,572 13,675 1,221 97,272 4,351 1953 117,432 6,212 1,955 8,167 14,032 3,638 103,400 4,529 1954 120,794 6,644 2,706 9,350 21,932 3,663 98,862 5,687 1955 120,923 12,397 3,478 15,875 20,313 10,698 100,610 5,177 1956 222,oo6 25,555 4,663 30,218 89,222 24,941 132,784 5,277 1957 203,673 20,664 4,877 25,541 74,667 17,159 129,oo6 8,382  Table 4 AGRICULTURAL PRODUCTION, 1945-1956 (000 nmetric tons) Principal Average Commodities 1945-46 19h9-50 1951 1952 1953 1954 1955 1956 Sugar 410 472 490 494 626 638 678 717 Cotton 71 71 84 96 97 114 109 115 Rice, Millet 116 92 138 176 185 172 165 157 Wheat 101 136 157 162 169 163 152 123 Corn 524 264 299 321 319 30)4 297 265 Potatoes 653 1,9242 1,325 1,313 1,385 1,453 1,389 1,013 Barley 145 216 202 217 226 226 208 159 Coffee 5.2 5.6 60o 8.9 9.6 9.6 10.3 12.O Tea 0.07 02 o.6 o.,6 o.6 0.7 0.7 0.9 Cacao n.a, 4.1 5.0 4.3 4.1 4.1 4.2 4.3 Rubber 2.6 1.5 2.1 2.0 3.3 3.0 3.1 2.6 good (million 14 31 61 62 62 66 n.a. square feet) Source: Central Bank. Ministry of Agriculture  Table 5 AREA UNDER CULTIVATION, 19h5-1956 (1000 hectares) Average Commodity 1945-46 1949-50 1951 1952 1953 1954 1955 1956 Sugar 51 52 55 52 55 56 57 62 Cotton 138 135 165 188 205 220 217 226 Rice 55 5 51 89 66 69 62 67 w,heat 98 1,4 162 170 172 166 .159 139 Corn 326 177 207 231 226 232 236 234 Potatoes 227 214 242 242 238 246 235 224 Barley 143 186 182 189 191. 194 185 169 Coffee 6 11 11 17 16 15 22 26 Source: Central Bank. Ministry of Agriculture.  Table 6 YIELDS OF AGRICULTURAL CROPS, 1945-1956 (metric tons per hectare) Average Commodity 1945-46 19)49-50 1951 1952 1953 1954 1955 1956 Sugar 8.o 9.1 8.9 9.5 11.4 11.4 11.9 11.6 Cotton 0.5 OS 0.5 0.5 0.5 0.5 0.5 0.5 Rice 2.1 2.0 2.7 2.0 2.8 2.5 2.7 2.3 Wheat 1.0 0.9 1.0 1.0 1.0 loO 1.0 0.9 Corn 1.6 1.5 1.4 1 1,4 1,3 1.3 1.1 Potatoes 2.9 5.8 5.5 5.4 5.8 5.9 5.9 4.5 BariLey 1.0 1.2 1.1 11 1.2 1.2 1.1 0.9 Coff'ee 0.5 0.5 0.5 0.5 o.6 o.6 o.5 0.5 Source: Central Bank. I'linistry of Agriculture.  Table 7 MINERAL PRODUCTION, 1945-1956 (1000 metric tons) Average Major minerals 1945-h6 1949-50 1951 1952 1953 1954 1955 1956 Copper 29 29 32 31 35 38 43 46 Lead 49 64 83 98 115 111 119 129 Zinc 62 80 102 128 139 159 166 175 Silver (1000 394 375 5l1t 597 611 635 7114 715 kilos) Iron __ __ __ __ 854 1,282 1,056 1,771 Petrolewn 1,875 2,020 2,139 2,343 2,126 2,279 2,302 2,543 Gold ('000 4 5 4 4 5 5 kilos) Coal 216 182 186 225 210 206 84 loh Source: Central Bank data.  Table 8 EXPI'1DITURES ON GROSS NATIONAL PRDDUCT, 1948-1955 (millions of soles) Expenditures ]948 1949 195o 1951 1952 1953 1954 1955 Consumption 7,449 9,795 12,108 14,145 16,147 18,107 19,439 21,633 - Private 6,711 8,870 10,815 12,789 14,488 16,170 17,202 19,327 - Government 738 925 1,293 1,356 1,659 1,937 2,237 2,306 Gross fixed invest- merit 1,105 1,645 2,700 4 373 5,044 5,224 5,351 6,967 - Private 973 1,367 2,368 3,670 4,090 ,142 4,L460 5,203 - Government 132 278 332 703 954 1,082 882 1,7(4 Inv,entories 199 721 395 707 506 4o8 52.3 665 Gross available resources 8,753 12,161 15,203 19,225 21,697 23,739 25,313 29,265 Less net purchases abroad (-) -100 29 -56 -518 -733 -1,093 -231 -725 Gross national product 8,654 12,189 15,148 18,706 20,965 22,647 25,082 28,5h0 Source: Central Bank data.  Tabl e 9 ORIGIN OF GROSS NhATIONAL PRODUCT (percentages) Sector 1942 1948 1951 1954 1955 Agriculture 32 35 37 31 28 iining 12 8 12 13 13 Industry 13 17 13 16 15 Services 12 6 5 5 5 Commerce 14i 18 16 16 17 Finance 3 2 2 3 3 Governa-.>e,' 10 10 11 12 14; Other 14 4 14 4 5 100 100 100 100 100 Source: Central Bank data.  Table 10 OCCUPATIONAL DISTRIBUTION OF LABOR FORCE (percentages) Sector 1942 1948 1951 1954 1955 Agriculture 62.5 62.5 62,14 62.5 62.5 Mining 1.8 1.8 1.8 1.9 1.9 Industry 17,5 17.5 17.5 17.5 17.5 Services 3e4 3.4 3.4 3.4 3.4 Commerce 4.4 4.4 14.14 4.5 4.5 Finance 01 0.2 0.3 0.3 o0,4 Goverrznm -nt 2.3 3.6 3.6 3.5 365 Other 7.9 6.6 6.6 6.3 6r3 100 100 100 100 100 Source: Central Bank data.  Table 11 PUBLIC INVESThENT EXPENDITURES, 1948-1956 (millions of soles) Purpose :L948 1949 1950 1951 1952 1953 1954 1955 1956 Agriculture 6 52 41 127 184 157 119 296 351 Industry, Mining and Power 32 52 61 92 108 87 104 219 164 Transportation 35 58 79 165 321 3