Peru - Country Assistance Strategy

Document of The World Bank FOR OFFICLAL USE ONLY Report No. 16796 PE MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ONA COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR PERU June 26, 1997 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  The last Country Assistance Strategy for Peru was discussed by the Executive Directors on November 14, 1994 (Report No. |12997-PE dated October 28, 1994). CURRENCY AND EOVIVALENTS Currency Unit: Nevus Sol (S/.) US$1.00 = S/.2.66 (May 1997) WEIGHTS AND MEASURES Metric System FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS ARPP Annual Report on Project Performance BOT BuildlOperatelTransfer CONAM Consejo Nacional del Ambiente (National Environmental Council) COOPOP Oficma Nacional para Cooperacion Popular (National Office for Popular Cooperation) COSUDE Swiss Agency for Development and Cooperation CPPR Country Portfolio Perfonnance Review DDSR Debt and Debt Service Reduction EDI Economic Development Institute ESMAP Energy Sector Management Assistance Programme ESW Economic and Sector Work FAO Food and Agriculture Organization FONAVI Fondo National de Vivienda (National Housing Fund) FONCODES Fondo Nacional de Compensacion y Desarrollo Social (National Social Compensation and Development Fund) GOP Govermnent of Peru GEF Global Environment Facility GTZ Gesellschaft fur Technische Zusanimenarbeit (German Technical Cooperation Agency) IDB Inter-Amencan Development Bank IDF Institutional Development Fund IFC International Finance Corporation IFI International Financial Institution rMAPRE Instituto del Mar del Peru (Ocean Institute of Peru) IMF International Monetary Fund MEF Ministry of Economy and Finance MIGA Multilateral Investment Guarantee Agency NGO Non-Governmental Orgamzation NLS Non-Lending Service OECF Overseas Economic Cooperation Fund (Japanese Aid Agency) PHRD Policy and Human Resource Development (Japanese grant fund) PROFONANPE Pro Fondo Nacional para Areas Naturales Protegidas por el Estado PROMCEPRI Comusion de Promocion de Concessiones Privadas (Commission for Promotion for Private Concessions) PRONAMACHCS National Project for the Management of Watershed Basins and Soil Conservation QAG Quality Assurance Group SME Small and Medium Enterpnse SUNAD Superintendencia Nacional de Aduanas (National Customs Superintendency) SUNAT Supenntendencia de Tnbutacion (National Tax Superintendency) UNDP United Nations Development Programme USAID United States Agency for International Development Managers and Staff Responsible for this CAS Vice President Shahid Javed Burki Director Paul Isenman Country Operations Chief Dan Morrow Task Manager Fred Levy  PERU FOR OFFICIAL USE ONLY COUNTRY ASSISTANCE STRATEGY Table of Contents SUMMARY ................................................................. 1. ECONOMIC, SOCIAL AND POLITICAL CONTEXT ............................................................... 1I A. The Situation in 1990 ...............................................................I1 B. Policies of the Fujimori Government ................................................................I C. Results of the Stabilization and Reform Programs: 1990-1996 .2 Macroeconomic Performance and Outlook .2 External Environment .3 Outlook.3 Poverty and Social Indicators .4 Political Developments .5 11. THE GOVERNMENT'S PROGRAM AND CHALLENGES FOR THE FUTURE. 5 A. Poverty and the Social Integration of Peru .5 Improving Access of the Poor to Economic Opportunities .6 Poverty Strategy and Institution .10 B. Institutional Reform.11 PriivatzaatoonI11 Financial Sector.11 Modernization of the Public Sector .12 C. Consultation and Participation: Selling the Program .13 lll. THE BANK GROUP ASSISTANCE STRATEGY .14 A. Progress Under the Last CAS ..14 B. ,Contextual Changes Since the Last CAS ..15 C. The Process of CAS Formulation ..16 D. The Bank Group Assistance Program .17 IBRD Assistance.18 Portfolio Management .21 Exposure and Risks .22 IFC and MIGA .23 Partnerships and Aid Coordination .24 ANNEXES Annex Al: Selected Indicators of Bank Portfolio Performance and Management Annex A2: Bank Group Program Summary, FY98-00 Annex A3: Summary of Nonlending Services Annex A4: Poverty and Social Indicators Annex A5: Key Economic Indicators Annex A6: Key Exposure Indicators Annex A7: Status of Bank Group Operations in Peru Annex Ag: CAS Program Matrix Annex A9: CAS Summary of Development Priorities Annex AI0: Peru at a Glance Annex B: Proposed IBRD Activities Related to Poverty Alleviation Annex C: Bank Portfolio Management MAP: 26572R This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  I  PERU COUNTRY ASSISTANCE STRATEGY SUMMARY i. Since taking office in July 1990, the Fujimori Government has restored public order; stabilized and radically reformed the economy, and reintegrated Peru into the global economy. Inflation was brought under control, and growth accelerated after 1992. Growth has been supported by high capital inflows, and net international reserves are now ample. In addition, the Government has introduced a broad range of programs intended to alleviate poverty and improve living conditions. Although poverty remains a serious problem, the poor appear to have benefited significantly from the economic reforms and Government social programs. Institutional reform has proven more complex and has not proceeded as rapidly as policy reform, and decision-making remains highly centralized. ii. The principal objective of the Government in its second term is the sharp reduction of poverty and extreme poverty. The Government recognizes that growth, macroeconomic stability, and the completion of economic reforms are essential but not sufficient conditions for poverty reduction. Its poverty program gives particular emphasis to raising the quality and improving the access of the poor to (a) education and health services, (b) effective property ownership and full enjoyment of property rights, and (c) basic infrastructure. Special attention is given to the more remote rural areas and to the advancement of women. iii. Because of Peru's improved access to other sources of financing, the desire to limit the growth of debt, concern for the public sector's absorptive capacity, and the diminishing role of the state in the economy, the Government has indicated its intention to reduce its annual borrowing to about US$ 200 million from the Bank, about half the level authorized in the previous CAS. Borrowing will be concentrated principally in those areas where the state will continue to play an important role. At the same time, a growing demand is foreseen for non-lending services, taking advantage of the Bank's analytical and advisory capacities for policy and program design, technical assistance, and distilling the lessons of experience. More active involvement is sought from the IFC and MIGA in the direct promotion of private sector development. iv. The overriding objective of the Bank's assistance program for Peru continues to be to support the Government's efforts to achieve the sustained, continuous reduction of poverty. The proposed program is focused in support of those fundamental elements of the anti-poverty program described above to raise the quality and improve the access of the poor to productivity-increasing human capital, market-integrating infrastructure, and the full rights and opportunities of private ownership. Infrastructure activities will continue to be important but will be more narrowly focused in support of poverty reduction. Private sector development will take on greater importance, with IFC playing a stronger role. Institution-building will be an important element in all of our activities.  ii v. The Government and the Bank agree on the need to maintain tight macroeconomic discipline, particularly as growth again accelerates, but, in view of the strong management of the past several years, this is expected to be less a focus of the Bank's program than in the past. The Bank will continue to support macroeconomic policy analysis through a series of issue-specific, quick-turnaround policy notes and the organization of policy seminars. A general objective of NLS will be to enrich the public dialogue and debate over economic and social development issues to assist in the consensus-building process. vi. Serious implementation delays have been experienced in several projects. Three problem projects were identified in the FY 96 ARPP, and Peru was included by the QAG in the list of 25 countries for special attention. Intensified supervision has resulted in observable progress. One project currently remains on the problem list, while another is listed as potentially at risk. CPPRs were completed in March 1996 and June 1997, resulting in the identification of a number of generic, as well as project-specific problems. Important steps have been taken toward their resolution, and a program of additional actions has been discussed with the Government. vii. The proposed program has three main risks: (a) institutional weaknesses could delay the preparation and implementation of projects and of NLS; (b) popular impatience with progress and increasing political pressures with the approach of municipal and national elections could divert attention from structural reforms and loosen overall macroeconomic management; and (c) macroeconomic stability could be threatened if the current account deficit again widens as recovery accelerates, and growth could be slowed ifforeign investment is less than expected. viii. This CAS has been prepared in consultation with the Government, which is in agreement with the overall strategy. The CAS has also benefited from discussions with other multilateral and bilateral assistance agencies, and from an extensive series of discussions with representatives of the private sector, NGOs, and other community organizations. ix. The following issues are suggested for Board discussion: * Is the emphasis given to poverty reduction through assistance to the social sectors, infrastructure aimed at areas of high poverty concentration, and the strengthening of property rights responsive to Peru's needs? * Is an adequate balance achieved between lending and non-lending services and the respective roles of the Bank, IFC, and MIGA in view of the Government's indicated priorities? * Is adequate attention given to other priorities, including macroeconomic management, institutional strengthening, and environmental protection? * In view of the reduction foreseen in the Bank's lending to Peru, should new forms of relationship be forged with other lenders to take advantage of the Bank's project identification, evaluation, and supervision capacities?  PERU COUNTRY ASSISTANCE STRATEGY I. Economic, Social and Political Context A. The Situation in 1990 1. As a result of decades of misguided economic policies and generations of socio-economic inequalities and institutionalized disenfranchisement of a large majority of the population, Peru entered the 1990s with a badly skewed income distributions and high incidences of poverty and extreme poverty. Years of terrorism, a mismanaged agrarian reform, nationalization of major sectors of the economy, huge public sector deficits, misdirected public investment, unclear property rights, a weak and distorted financial system, heavy subsidies, and high domestic market protection had resulted in hyperinflation, international bankruptcy, massive capital flight, badly deteriorated infrastructure, and inefficient and obsolete productive capacity. By the time of the change in Government in mid-1990, percapita income was below that of 1966; prices had risen by a factor of 27 million over three decades, including almost 7,700 percent in 1990 itself; tax collections had fallen to less than 5 percent of GDP; Peru was in default on most of its external debt; and political violence was claiming 3,000 lives per year. B. Policies of the Fujimori Government 2. The immediate priorities of the Government taking office in July 1990 were to reestablish political order, particularly in the countryside, to bring inflation under control, to restore a functioning market system, and to provide minimum protection to the most disadvantaged groups during the necessary adjustment process. 3. With the creation of a cash management committee to maintain public expenditure in line with tax collections and the elimination of Central Bank credit to the public sector, the combined public sector deficit was reduced from 7.6 percent in 1990 to 2.6 percent in 1995 and 1.1 percent in 1996, fully financed by external funds. High protection and heavy state intervention in resource allocation were replaced by reliance on market processes and openness to the international economy. Reforms included the elimination of controls on prices, interest rates, and foreign exchange transactions, the reduction of tariffs, the liquidation of state marketing agencies, the removal of administrative barriers to domestic and international trade, greater flexibility in labor market regulations, and the undertaking of a far-reaching program of privatization and strengthening of private property rights. Financial sector reforms included the liquidation of the public development banks, privatization of state-owned commercial banks, the elimination of state interventions in the allocation of credit, the strengthening of banking regulation, the opening of the financial system to private pension funds, and first steps toward covering unfunded public pension liabilities. Relations were reestablished with the IFIs, and the negotiation of debt reduction and restructuring agreements with the Paris Club creditors and the international commercial banks has virtually completed Peru's reintegration with the international financial community.  2 4. In addition, the Government introduced a broad range of programs intended to alleviate poverty and improve living conditions. Some of these programs were initially intended to create employment and improve living conditions of the poor in the face of the expected short-term negative impacts of the adjustment program. The central focus now is to improve the economic opportunities and raise the productivity of poor communities, largely through the creation of productive infrastructure. A program of social expenditures was also formulated to direct budgetary allocations to those programs in the Ministries of Health, Education, and Justice, which target the poorest segments of the population. C. Results of the Stabilization and Reform Programs: 1990-1996 Macroeconomic Performance 5. As a result of the stringent fiscal and monetary measures, inflation plummeted from over 7,600 percent in 1990 to 139 percent in 1991, and below 12 percent in 1996. Price stability encouraged a rapid remonetization of the economy--both in soles and dollars. Economic reforms had an immediate impact on international capital flows. Short-term capital inflows during 1991- 96 totaled over US$ 6.8 billion. Long-term capital inflows totaled about US$ 10.1 billion, largely associated with proceeds from privatization. Taken together, the long- and short-term (net) capital inflows averaged US$ 2.8 billion a year--about 5 percent of GDP. These high capital inflows boosted aggregate demand and sustained an economic recovery in the second half of 1992. GDP rose 6.4 percent in 1993, accelerating to 13.1 percent in 1994. Aggregate demand growth accelerated in the first half of 1995, and the deficit in the current account of the balance of payments widened. 6. The Government, confronted with the deterioration of the current account balance and an appreciation of the real exchange rate' sharply reduced the rate of growth of public spending in the second half of 1995. Nevertheless, credit to the private sector continued growing rapidly, and the current account deficit increased to 7.5 percent of GDP. Consequently, public spending remained tight in 1996, contracting almost 8 percent in real terms during the first nine months, compared to the same period of 1995. Private sector demand decelerated rapidly in spite of a 33 percent growth of credit. As a result, the rate of growth of GDP fell to 2.8 percent in 1996, and the deficit in the current account was reduced to about 5.5 percent of GDP. Recovery began in the last quarter of 1996, with GDP up about 5 percent in the first quarter of 1997, compared to the same period a year earlier. 7. Similar to what has occurred in other countries that have pursued trade liberalization policies, production activities in Peru have been restructuring along lines of comparative advantage. Real output in manufacturing grew 65 percent from 1990 to 1996, with large variations among subsectors. A strong effort is evident to modernize plant and equipment. Imports of capital goods to the industrial sector, which averaged about US$600 million annually The real exchange rate appreciated sharply (21 percent) from 1990 to 1992, depreciated temporarily in 1993, and has since remained fairly constant at about the 1992 level.  3 in 1990-93, increased to US$1,600 million a year in 1995-96, despite the slowdown of the economy. After declining in 1990-92, agricultural output rose by 35 percent between 1992 and 1996. External Environment 8. Imports have risen rapidly since 1990, reflecting income growth, pent-up demand released by trade liberalization, and rising investment demand. Exports were essentially flat in 1990-93, but rose rapidly (74 percent) in 1993-96. Traditional exports, mostly minerals and fishmeal, grew 81 percent over the latter period and still represent 70 percent of the total. Agricultural and agro- industrial exports rose 72 percent, albeit from a low base, to reach an all-time high. Differences over tariff levels and dispersion have led to the decision to withdraw from the Andean Pact. Meanwhile, Peru is looking to more active trade relations with NAFTA, Mercosur, and the countries of the Pacific. Principal markets are the U.S., Japan, and the European Union. Peru's largest Latin American export market is Brazil, which accounts for only 5 percent of the total. 9. The Government has successfully pursued steps to reintegrate Peru into the international financial market, clearing arrears with the IDB in 1991 and with the IMF and the World Bank in 1993. Peru's obligations to the Paris Club creditors were rescheduled in 1991, 1993 and 1996, and a debt and debt service reduction (DDSR) operation was closed with its commercial bank creditors in March 1997. As a result of the normalization of relations with external creditors and investors and its management of the external accounts, Peru now enjoys a strong international reserve position. The central bank's net international reserves totaled US$9.4 billion as of end- April 1997, or about 11 months of projected 1997 imports and 76 percent of total monetary liabilities. This strong reserve position and low short-term debt have been powerful deterrents to speculative capital movements and help to explain the minimal impact that the Mexico crisis had on Peru. Through these years, Peru has maintained close collaboration with the IMF, including two EFF arrangements. During 1996, Peru again fully complied with the targets agreed under the IMF program. Outlook 10. Domestic savings increased significantly (from 14.3 percent of GDP to 19.2 percent) during the 1993-95 recovery, but less than the increase in domestic investment (from 16.5 percent to 24.2 percent). If savings continued to lag, this could again lead to a widening current account deficit as recovery accelerated. However, the slower growth of domestic savings after 1993 was attributable to: (i) the initially low level of income, (ii) the wealth effect which accompanied the recovery; and (iii) the procyclical behavior of public spending. The importance of these factors is now likely to have diminished. Income is 32 percent above that of 1992, and much of the pent-up consumption demand of the earlier period has been accommodated. Moreover, the Government recognizes that the procyclical public spending of the second half of 1994 and first half of 1995 contributed to the higher deficit in the current account and forced a more severe cut in public spending in 1996 than would otherwise have been necessary.  4 11. Should the Government maintain its good 1990-96 track record of fiscal and monetary management, we project economic growth of 4-5 percent in 1997, and 5-6 percent in 1998-1999. The rate of growth of spending on consumer durables and residential construction will fall, with the satisfaction of previous pent-up demand, and as more realistic projections about the pace of future economic growth replace the bullish views of 1994-1995. Higher domestic savings will also result from improved fiscal performance. Higher productivity gains in the tradable goods sectors, compared to the rest of the economy, will boost exports. Consequently, the current account deficit is projected to fall to about 5.3 percent of GDP in 1997 and to continue falling in 1998-1999. Foreign direct investment will be particularly important in the mining and service sectors. 12. External public debt and debt service due will drop in 1997-2000 as a result of the DDSR agreement between the GOP and the commercial banks. Even though Peru remains a highly indebted country, and recent agreements with the Paris Club and the commercial banks have reduced flexibility to negotiate further debt restructuring in the event of external shocks, strong reserves and improved access to new longer-term borrowing provide greater room for proactive debt management. Moreover, the Government's ability to service its remaining debt should strengthen as reforms take hold and the economy improves. We project the debt service ratio falling from 35.0 percent of total exports in 1995 to about 27.3 percent in 2000, and the debt/GDP ratio declining from 56.2 percent in 1995 to 36.5 percent in 2000. Poverty and Social Indicators 13. Poverty remains a serious problem in Peru, but the poor appear to have benefited significantly from the economic reforms and social expenditure programs introduced by the Fujimori Government. An analysis of the results of nationwide household surveys carried out in 1991 and 1994 show substantial progress in all major sections of the country.2 Significant growth was noted in employment, earnings, and labor productivity, attributable both to market liberalization and to improved public order and security. Percapita household expenditures nationwide grew 29 percent during this period, with growth of 32 percent among those in the lowest income quintile. The greatest improvements occurred in the urban areas of the Sierra (47 percent) and the Coast (42 percent), with significant increases also realized in the rural Sierra (34 percent). The slowest growth (10 percent) occurred in Lima. Overall, the percentage of population below the poverty line fell from 55 percent in 1991 to under 50 percent in 1994, while those living in extreme poverty declined from 24 percent to 18 percent.3 2A similar survey carried out in 1996 suggests some deterioration between 1994 and 1996, probably related to the slowdown of the economy. At the same time, however, the access of the poor to basic social services is reported to have improved. Because of differences in sample size and coverage of this latest survey, closer analysis is required to compare its results to those of the earlier surveys. Nevertheless, strong relative performance in labor-intensive sectors of activity, particularly agriculture, construction, and services, suggest further employment gains. 3The poverty line is defined as the family percapita income required to purchase a minimum daily consumption basket meeting basic dietary requirements (2,250 calories and 63 grams of protein per person). Families in extreme poverty are those whose percapita expenditures cannot cover even the minimum dietary requirement.  5 14. Reinforcing the above information, the Demographic and Health Survey of 1996 revealed that access to health services had improved and that there had been a notable improvement since 1991 in some of the principal social indicators considered reliable proxy measures of living conditions. Infant mortality dropped from 53 to 43/1000 live births, and chronic malnutrition of children under five years of age was reduced from 36 percent to 25 percent. Nevertheless, the prevalence of poverty, particularly among the rural population, remains high. Almost two-thirds of the rural population lived in poverty in 1994, and 40 percent lived in extreme poverty. Political Developments 15. The Government's efforts to restore security in the country have been largely successful. Although still capable of occasional high-profile attacks, such as occurred recently at the residence of the Japanese Ambassador, militants of the two major terrorist groups are now few in number, enjoy little or no public support, and are geographically isolated in a few areas of the jungle. The Fujimori Government won strong political support in the 1995 elections, receiving two-thirds of the votes and majority control of the Congress. The Government's popularity suffered, however, during the economic slowdown of 1995-96. After a brief jump in the polls at the freeing of the hostages in April, ratings have again slipped in the context of legal and partisan debate over the constitutionality of the President running for reelection in 2000 and other political issues. The President has not indicated his own intentions in this regard. H. The Government's Program and Challenges for the Future 16. Despite the consistency and success of the policies and reforms implemented over the past six years, serious economic and social problems remain. Poverty remains deep and widespread with large disparities in incomes and in access to economic opportunities among regions, among social groups, and between genders. At the same time, institutional strengthening and reform are inherently more complex and have not proceeded as rapidly as policy reform. Several significant gaps also remain in the legal/regulatory framework needed to stimulate private investments on which sustained growth will depend. Finally, additional communications efforts are needed to strengthen the domestic understanding and support on which the continuity of the policy model that has guided Government policies over the past six years depends. A. Poverty and the Social Integration of Peru 17. Poverty reduction in Peru is necessarily a long-term task and depends on sustained increases in investments in human and physical capital. The Government has set out as a specific objective the halving of the proportion of the population living in extreme poverty by the year 2000. The Government recognizes that continued broadbased and sustainable growth with low inflation are essential, but not sufficient for further poverty reduction. To support such growth, the Government remains committed to the macroeconomic policies which have thus far served Peru so well. On the structural front, most key reforms are completed or well under way, and the Government is committed to the completion of the program. In addition to its macroeconomic  6 and structural reform efforts, the Government has put in place many of the critical elements of a comprehensive program to reduce poverty and improve the living conditions of the poor. Improving Access of the Poor to Economic Opportunities 18. Closely related to the sustained reduction of poverty is a theme that President Fujimori has used in a number of speeches--the social integration of Peru-and many of the programs in which he has taken a direct personal interest are consistent with this theme. In its pursuit of social integration, the Government's program has particularly emphasized improving the access of the poor, with special attention to the more remote areas of the country, to: (i) essential education and health services; (ii) the ownership of property and the enjoyment of property rights; and (iii) basic infrastructure. 19. Crosscutting these general issues of access are the special problems faced by specific groups--particularly women, the rural sector, and the indigenous population--and the overall issue of environmental sustainability. Education and Health. 20. The main objectives of the Government's Education Development Plan are to increase coverage at the preschool and primary school levels, to strengthen the management capacity of the education system, and to improve the quality of education at all levels, with increased private investment, particularly in higher education. As part of this strategy, the Government intends to raise teacher salaries gradually over the next ten years and to increase school managerial autonomy. Access to basic education and the level of educational attainment have improved in recent years. A 1995 survey of more than 18,000 rural communities indicated that more than 90 percent had a primary school. However, there are serious quality issues, and the resultant gap in educational attainment between urban and rural areas remains wide, with an average of 8.6 years of education completed in urban areas and 4.9 years in rural areas. Women remain at a disadvantage vis a vis men--in urban and rural areas, the number of years of schooling completed by women is on average more than one year less than for men. Women's enrollment is slightly behind that of men for all age groups except pre-primary, which suggests that more attention needs to be given to ensuring that girls, especially in rural areas, enroll and attend school. The illiteracy rate for women is more than three times that for men. In rural areas, more than a third of women over the age of fifteen are illiterate. Women with no education tend to have larger families and are less likely to use basic health and nutrition services for themselves and their children. 21. The guarantee of a basic health care package to all, with particular targeting of the high- risk, poor populations, is a central objective of the Government's strategy for the health sector. In rural areas, this strategy depends upon the ability of the health system to reach isolated areas of  7 the country and ensure the continuity and quality of programs. The Government's program of improved social expenditures has provided incentives for health workers in rural areas, equipment, supplies and medicines with the result that services have increased. In addition, investments in basic health infrastructure have restored services in areas which were affected by the political unrest of the 1980s and early 1990s. These efforts have begun to show results but they must be complemented by sector wide reforms which ensure the continuity of investments in programs and services targeted to the poor and underserved areas. The traditional concentration of resources in tertiary care in urban hospitals must be modified, if these programs are to be sustainable and access in rural areas is to improve. Also central to the Government's strategy is to attract private investment into the provision of care beyond the basic package and to stimulate the growth of private health insurance. Property rights. 22. The 1995 Land Law went a long way toward reestablishing clear and effective agricultural property rights after the mismanaged land reform of the 1970s. Passage of the implementing regulations for the law has been delayed, however, and is needed to give full effect to the Law and confidence to investors. Moreover, more than one million agricultural properties lack recognized and registered land titles. Among the questions to be resolved are the streamlining of process and clarification of institutional responsibilities for rural land titling and registry, the treatment of abandoned lands in the traditional comunidades campesinas, and the design of a rural arbitration system. In urban areas as well, more than one million properties are untitled. The result, particularly for the poor, has been the effective freezing of valuable assets, lack of access to credit and public services, and the undercutting of investment incentives for farmers and small entrepreneurs. Uncertain ownership also weakens the revenue base of local governments, and the capacities of the latter to satisfy local infrastructure needs. The Government has undertaken massive titling and registration programs for both rural land and informal urban properties and has introduced streamlined institutional arrangements and legal procedures for carrying it out. Administrative weaknesses have slowed the implementation of both programs, and a special political commitment and effort will have to be made if the established goals are to be met in significant degree. Infrastructure. 23. Peru's difficult geography presents a perennial challenge to the economic integration of the country, and many small communities in the mountains and the jungle, with high concentrations of poor and extremely poor families, have long subsisted on the margins of the national economy. These natural barriers were exacerbated during the 1980s, when terrorism directly destroyed roads, power and communications lines, etc., and threatened personal security, and lack of public investment and maintenance allowed existing infrastructure to decay. At the same time, urban infrastructure, including water and sewerage, power, transport, and telecommunications, were unable to keep pace with the heavy immigration caused by deteriorating economic and security conditions in the rural areas.  8 24. The Government has been making a major effort in the last five years to remedy the severe infrastructure deficit inherited from the past. Major programs of highway and rural road rehabilitation are being carried out by the Ministry of Transportation, PRONAMACHCS has undertaken water and soils management projects in the high sierra, and privatized telecommunications and power companies have begun major new investments in their sectors. In addition, a significant proportion of the expenditures of FONCODES and FONAVI have been directed to the rehabilitation of rural roads; irrigation and drainage systems; small town water and sewerage systems, power lines, etc., in areas of high concentration of poverty and extreme poverty. The armed forces have also participated extensively in this effort. Such investments offer immediate income returns by reducing the time and costs of moving goods to markets, traveling to available jobs, transferring information, cutting productivity losses due to illness, etc. 25. In the future, the Government intends that a growing proportion of large-scale infrastructure investments will be made by the private sector and has recently created PROMCEPRI as the agency responsible for promoting and regulating concession arrangements toward that end. Nevertheless, the public sector will necessarily remain the major source of infrastructure investment in the poorer and more remote areas. Rural Development 26. As noted in the foregoing paragraphs, poverty characterizes a high proportion of the rural population in Peru, and is explained and perpetuated by severe problems of access to education and health, property rights, and basic infrastructure and access to markets. Government revenue- sharing has shifted resources in the direction of rural municipalities, and many of the Government's social programs have given particular emphasis to rural needs. Key challenges for the rural sector include the reduction of rural poverty and the enhancement of agricultural competitiveness. Both must overcome problems of low productivity and poor natural resources management. Investment incentives will depend in part on solving the property titling and registration problem pointed out above. On a related property issue, the Government and Congress have been considering for several years a law to create tradable, private property rights for water and to allow the development of water markets. This development is crucial to encourage new investments in agriculture, in power, and in urban water systems, to protect the rights of small farmers, to improve the efficiency of water use generally, and in irrigated agriculture in particular, to facilitate efficient inter-sectoral transfers, and to realize Government plans to privatize the large public hydraulic schemes. 27. Of particular concern to the Government is the development of economically viable alternatives to coca production in the major areas of concentration. Intensive interdiction efforts over the past two years have succeeded in reducing the area planted and in causing a significant drop in the price of coca leaf, helping to make alternatives more attractive to the farmers. The high profits available from the coca trade will continue to challenge Peruvian and international efforts in this regard.  9 Status of Women. 28. The Peruvian Government is paying greater attention generally to the status of women, who suffer from a series of disadvantages, including unequal access to education and job opportunities and marginal participation in community affairs and political activities. Women constitute 77 percent of the illiterate population, and in rural areas, where many women speak only a native language, their social, political and economic isolation is reinforced. Unemployment and underemployment are higher and of longer duration among women. Controlling for education and other factors, women's earnings are on average a third below those of men in similar positions, and household survey data in 1991 and 1994 showed little progress in reducing that gap. Lower levels of educational attainment, lack of marketable skills, and exclusive responsibility for child care and other domestic chores contribute to the low status of women. Several of the programs in the newly created Ministry for the Promotion of Women and Human Development attempt to reduce illiteracy and train women to organize and manage microenterprises. A new law to prevent violence against women has been issued, and a hot line to deal with domestic violence has been established. Additional efforts to promote gender equity might focus on improved labor regulations, more and better child care facilities for working mothers, better access of women to higher education and public campaigns to overcome prejudices and misconceptions about women's capacities. 29. The health and well being of women and children is profoundly influenced by women's maternal role and their status in society. Poverty, especially in rural areas, is often associated with early marriage, high fertility, a high proportion of unwanted births, and limited access to health and nutrition services. The Peruvian Government has taken a strong international leadership position in favor of family planning and has launched extensive programs of sex education and improved access to alternative methods of contraception. Indigenous Peoples. 30. The indigenous peoples of Peru, defined as those who speak only Quechua, Aymara and other indigenous languages, are estimated to constitute about 11 percent of the total population. Indigenous populations, referred to as comunidades campesinas in the Sierra and comunidades nativas in the Selva, maintain many of their own social and political institutions. Two-thirds of the indigenous groups live in rural areas, and about half work in agriculture. Controlling for differences in education and other variables, the average earnings of indigenous workers were about 15 percent below those of non-indigenous workers in 1994, in comparison to a 29 percent differential in 1991. This marked improvement reflects in significant measure the impact of improved security in the rural areas that encouraged renewed economic activity and reopened the flow of goods to the market. A long-term strategy to improve the incomes and living conditions of the indigenous communities remains to be developed. Environmental Sustainability 31. Concern for the environment is relatively new and growing in Peru. In 1994, the Government created the National Environmental Council (CONAM) as a central policy and  10 coordinating agency. Although CONAM has gradually upgraded its capacity to play this role, its mandate remains unclear, and the policy instruments to be used to set and enforce environmental quality standards are largely undefined. Meanwhile, environmental offices in the various line ministries are proceeding at different speeds to set their own standards, sometimes with contradictory results. Among the principal environmental problems are high morbidity and mortality rates from exposure to untreated sewerage; water and air contamination from mining wastes; resource depletion, including uncontrolled logging in the jungle and improper agricultural practices that result in soil erosion in the sierra and desertification along the coast. 32. The fisheries sector is Peru's second most important earner of foreign exchange and a major source of employment for the coastal population. The current regime governing fishing rights leads to excess fishing capacity and, unless quotas are rigorously enforced, could result in over-exploitation and potential exhaustion of the resource. A recent census of sector capacity has demonstrated significant levels of overcapacity in the fishing and processing of anchovies and sardines, the two most economically important species. Consequently, the tendency has been for ever shorter fishing seasons and falling profitability, albeit buoyed in the past two years by high world prices. For the past several years, the Govermnent has been considering options for improving the effectiveness of controls and the efficiency of the fisheries regime. More independence is being given to IMARPE, responsible for determining the annual allowable catch, and private bids are currently being evaluated for providing monitoring and control services to regulate the catch. Improved controls are only part of the answer, however, and further action is needed to rationalize investment and ensure the long-term profitability of the sector. Poverty Strategy and Institutions 33. Results of the Government's anti-poverty efforts to date have been promising and demonstrate the consistency of the overall economic program with poverty reduction. Nevertheless, efforts are excessively diffused among a large number of loosely coordinated agencies and programs, strategy and objectives are not always clear, and the benefits of expenditures do not always reach the intended target groups. Extensive poverty and resource mapping are now making possible a more precise targeting of public expenditures and programs, and valuable work is also under way to identify the actual and potential market linkages of poverty areas to neighboring towns and cities. Analysis of the results can provide important guidance to investment priorities for roads, power, and other infrastructure. Community and beneficiary participation are also important to ensuring the sustainability of investments. Beneficiary assessments have played an important role in the design of programs to improve rural roads, basic health services and the management of natural resources in the Sierra, and efforts are being made to strengthen the capacities of local governments to identify, plan and execute small- scale investments in their communities.  B. Institutional Reform Privatization 34. Few countries have carried out privatization programs as ambitious, as swift, and as successful as has Peru over the past six years. As of end-May, 141 companies had been privatized, with sales proceeds totaling more than US$ 7 billion, and an additional US$ 2.7 billion of new investments committed through the bidding process. Major state enterprises in power, mining, telecommunications, air transport, fisheries, cement, banking and finance, trade, and the metallurgical industries have been transferred to private ownership in a well managed and open and transparent process. Major oil and gas investments have also been privatized, breaking up the state monopoly previously held by Petroperu, and the latter's remaining assets are scheduled for privatization over the next 12 months. Large new domestic and foreign investments have been encouraged as a result of privatization, with important benefits for productive efficiency, employment, and future exports. The Government currently is exploring opportunities for further privatizations, particularly in the infrastructure sectors--e.g., highways, ports, power transmission, and major irrigation projects--through concessions, under which full operating control and investment risks would be transferred to the concessionaires. Good progress has also been made toward the introduction of effective and efficient regulatory law and institutions in the infrastructure sectors, particularly for telecommunications, although a number of "loose ends" need to be tied. It is particularly important that the regulatory agencies maintain a high degree of professionalism and enjoy substantial autonomy and independence from the line ministries. 35. Uncertainties were raised by a slowdown in the rate of privatizations during 1995-96, owed principally to the political sensitivity of Petroperu and to concerns over price rises that had accompanied earlier privatizations. Although the process in general now appears to be reaccelerating, similar concerns are currently delaying decisions regarding the Mantaro power plant, which accounts for some 40 percent of Peru's generating capacity. While assuring a competitive environment will dispel concerns in most sectors--e.g., the oil and gas sector--a strong regulatory framework and effective, independent regulatory agencies are needed in sectors of necessarily high market concentration, such as telecommunications and power. Financial Sector 36. Peru's financial sector in 1990 was characterized by heavy state controls over interest rates, credit allocation, and foreign exchange; high intermediation costs and market segmentation; and large quasi-fiscal deficits generated by the state-owned development banks. Most institutions in the sector, including the state pension system, were insolvent. Since 1990, the state role in the financial sector has been substantially reduced. Markets have been fully liberalized, the state- owned banks have been liquidated or privatized,4 and the entry of foreign banks has increased competition. The capital market is growing and diversifying rapidly (equity market capitalization has risen more than ten-fold since 1991), but the size and range of instruments available are still 4Exceptions are COFIDE, which has been greatly downsized and limiited to second-tier operations, and Banco de la Naci6n, also downsized and operating largely as fiscal agent for the government.  12 relatively small. Both banking and securities market regulation and supervision have been greatly strengthened, incorporating internationally accepted regulatory principles, and the quality of bank loan portfolios has improved. Given the growing role of the commercial banks as intermediaries of external credit, it is important that their liquidity positions, and interest rate and foreign exchange risks be closely managed and supervised, and that Basle standards be strictly enforced. Modernization of the Public Sector Reform of the State 37. Peru's central government enjoys a core of effective ministries and autonomous agencies, a number of which, such as SUNAT, SUNAD, and the Central Bank, were made early focuses of reform. Nevertheless, most state institutions, including local governments and the judiciary, are weak and do a poor job of delivering public services. Decision-making is highly centralized, staff quality and morale in most agencies are low, funding for many activities is inadequate, and control over resources is highly bureaucratized and ineffective. The Government has been quite successful in carrying out the "first generation" of reforms, stabilizing the economy, and reducing state intervention, but continuation of the reforms and improving the quality of services to the population, and most particularly to the poor, will require increased efficiency throughout the public administration. Sustaining reform also requires the "institutionalization" of agencies and programs having clearly defined long-term roles and objectives and run by professional and honest public servants. 38. The Government has declared the modernization of the state a top priority. The actual implementation of a modernization program, however, poses a number of difficulties. In the first place, administrative reform in developing countries does not have obvious models to follow, and consensus on how to proceed has not been easy to achieve. Modernization also requires resources in competition with Peru's other vast development needs. A stable, technically qualified civil service is needed to replace much of the existing outmoded bureaucracy, and will require a significant improvement of salary levels. At the same time, administrative reform is necessarily a prolonged process, and a period of effective consultation with the public is needed to build consensus on priorities and directions. 39. In this light, it may make sense for the Government to consider the two-tier approach to broad institutional reform that has been adopted by several other Latin American countries. Under this approach, well functioning agencies, that have succeeded in significantly streamlining their procedures and bringing transparency and accountability to their decision making, can be given greater managerial autonomy in meeting agreed objectives, while others remain more tightly subject to the traditional controls. As the latter agencies are modernized, they can be "graduated" to the modern system of managing human and budgetary resources. Decentralization 40. Peru is one of the most centralized of Latin American countries in terms of control over public sector resources. Local governments account for only about 10 percent of total public  13 spending, including transfers they receive from the central government, and the direction of much of what they do spend is defined from the center.5 A history of wasteful spending and corruption at the local levels of government has not been encouraging to decentralization. Nevertheless, improving responsiveness, effectiveness, efficiency, and accountability in the delivery of public services will require a greater decentralization of decision-making and responsibility for program execution. With appropriate incentives, training, and modernized budgetary and administrative systems, local governments can assist the Government to improve public services and citizen access, particularly of the poor, to those services. An appropriate incentive framework can emerge from a clearer delineation of functional responsibilities among the levels of government and from placing on local governments a greater degree of responsibility for the mobilization of fiscal resources, with strengthened mechanisms for accountability to both the national government and to the local citizenry. Judicial Reform 41. For many years in Peru, the judiciary has been one of the weakest and least respected areas of the public sector. The resolution of disputes through the judicial system has been uncertain, lengthy, costly, and frequently corrupt and/or subject to political influence, thus raising the costs and risks of economic transactions and weakening property rights, particularly of the poor. Constitutional reforms in 1993 resulted in the establishment of a public Ombudsman's office, Constitutional Tribunal, Judicial Academy, and a Judicial Council. An emergency administrative reform program begun in 1996 was intended to significantly upgrade the training of both judicial and non-judicial personnel in the system; increase the accountability of judges; modernize case management and information systems, decentralize the court system to increase access to the system nationwide; improve the overall financial situation of the court system; and strengthen extra-judicial conflict resolution mechanisms. Recent references to a new constitutional amendment have raised questions about the institutional framework, which need to be resolved before reforms can go forward. C. Consultation and Participation: Selling the Program 42. The remarkable continuity of policies since 1990 has enjoyed the consistent support of President Fujimori and his willingness to take the necessary, frequently tough decisions associated with stabilization and the liberalization of the economy. Attacks on the economic program mounted in 1996 in the face of the economic slowdown, concerns about employment growth, the slow recovery of some traditional industries, and increasing competition from imports. Pressures grew to provide increased protection against imports and enhanced incentives for production and exports. In recent months, several measures have been introduced--e.g., a preferential tax regime and increased tariffs for agricultural products and extended terms for meeting tax arrears--which could create uncertainties about the future course of policy. The overall reform of the tariff structure introduced in April 1997 lowered most customs duties, consistent with the general tariff reduction policy, but the agricultural tariff hikes reversed the trend towards reducing tariff Comparable figures in Latin America are 20% for Chile, 33% for Colombia, 47% for Brazil, and 48% for Argentina.  14 dispersion, penalizing consumers (especially the poor) and potential investors in the processing of raw agriculture products, who will now face negative effective protection. What is needed is to stay the course. A stable policy framework is necessary to encourage the new investment that will expand the formal sector and create higher-productivity jobs. 43. Despite the success of the Government's policies over the past six years, public opinion about many of the program's essential elements remains vulnerable to wide swings in response to spot events and political criticism. The President himself is unusually active traveling around the country to meet with local residents and to assess and take actions to meet their needs, with particular emphasis on the poorest and remotest areas. Nevertheless, the style of many government agencies is still one of centralized decisions, with little or no consultation or sensitivity to local differences, or appreciation of the contribution that the participation of local organizations can make to the success of their programs and projects. This raises concern for the sustainability of the progress that has been made. A more active communications effort on the part of the Govermment to engage in and inform public dialogue could serve to both refine and build agreement around its programs and objectives. HI. The Bank Group Assistance Strategy 44. The Bank has been in active dialogue with the Fujimori Government since its beginning, and, along with the IMF and IDB, has made a major contribution to the design and implementation of the stabilization, reform and antipoverty programs, even though loan disbursement was not possible until the elimination of debt arrears in 1993. The Government views the Bank as an important partner in the analysis of development priorities, in the formulation of sectoral strategies, and in assuring the quality of the overall public investment program and portfolio. A. Progress Under the Last CAS 45. With poverty reduction as its central objective, the last CAS, presented to the Board in November 1994, focused on four principal strategic elements: (a) the maintenance of sound macroeconomic management; (b) infrastructure development; (c) social sector development, with particular attention to the improvement of primary education and health services for the poor; and (d) institution-building in conformance with the needs of a market economy. Attention was also given to private sector development, as the primary source of future growth, and to environmental concerns, but these were not proposed as areas of primary concentration in the near term. 46. In support of this strategy, combined adjustment, technical assistance, and investment lending averaged some $273 million per year in FY94-96, rising to almost $600 million (including a DDSR loan) in FY97. IFC investments totaling some $80 million in FY94-96 have focused on the mining and financial sectors, with important technical assistance to the privatization of the power sector and capital markets reform. MIGA approved $174 million in guarantees over this period in mining, manufacturing, and the financial sector.  15 47. The Bank's most important contribution to the success of Peru's program has been its technical and financial support of policy and structural reforms. As described in Section I, the Government has been steadfast in its adherence to sound macroeconomic policy, restoring growth and reducing inflation, increasing public sector savings, and reestablishing international financial credibility. Three major adjustment loans were made effective in 1993 in support of the program. Two of these have since been audited by OED, and the outcomes were rated as highly satisfactory.6 When the economy was in danger of overheating in 1995, the Govemment adopted appropriate stabilization measures in the face of strong political pressures to the contrary. Reforms have continued steadily since 1995, albeit at a somewhat reduced pace. These continuing efforts have been supported by disbursement of the last tranche of the Financial Sector Adjustment Loan and by two new quick-disbursing operations: the Debt and Debt Service Reduction Loan and the Pension Reform Adjustment Loan. Final tranche releases are still pending under the Privatization and Electric Sector Privatization Adjustment Loans. 48. Significant progress has also been made in the rehabilitation of infrastructure, with major financial support from the Bank, IDB, CAF, and OECF. Bank projects since 1994 have included the Lima Water and Sewerage Rehabilitation Project, Rural Roads Rehabilitation, and the Irrigation Subsector Project. The Government's commitment to poverty alleviation has not diminished, with efforts increasing to target infrastructure and social program spending to areas with the highest concentrations of poverty and extreme poverty. Efficient execution of the first FONCODES project enabled the Bank and IDB to move quickly to provide follow-up support. On the other hand, slow implementation of the Basic Health and Nutrition Project and of the Primary Education Project, and similar experience with the efforts of other lenders, slowed the preparation of new activities in these sectors. Institutional weaknesses generally and lack of familiarity with Bank procedures in the line ministries delayed new project preparation, with the result that, despite strong macroeconomic performance, Bank lending fell below the base case set out in the last CAS. The establishment of the Resident Mission in 1995 has facilitated more continuous supervision and is now showing positive results. 49. Slower progress has been made with respect to the more complex process of long-term institution-building. Line ministries have been appropriately reduced in size and function, but their new roles in a private sector-led development process have not been clearly defined, coordination among them is weak, many programs lack coherence and adequate staffing, and processes are often unduly bureaucratic. The tendency has been to create ad hoc agencies parallel to the line ministries, with staffs enjoying preferential salary regimes to manage programs accorded highest priority. This approach has worked well in the short term, but the transition to broader-based reform is not yet clearly defined. In general, decision-making and control tend to be highly centralized. B. Contextual Changes Since the Last CAS 50. The completion of the Brady deal with the private commercial banks and the restructuring of bilateral debt with the Paris Club countries is expected to improve Peru's access to normal 6 OED, Perfonnance Audit Report No. 14819, June 30, 1995.  16 channels of commercial financing and private direct investment. Along with the exceptional financing pledged by Japan, this will reduce the importance to Peru of financial flows from the multilateral institutions. Indeed, the Ministry of Economy and Finance (MEF) has indicated that concern for Peru's overali borrowing limits and public sector absorptive capacity, as well as the diminishing role of the state in the economy, will dictate a reduction in lending from the World Bank and the IDB, combined, to about $400 million per year7, concentrated in those areas-- principally the social sectors--where the state will continue to play an important role. At the same time, they envision a greater role for IFC in the direct promotion of private sector development across a broader array of sectors. 51. Although the importance of IFI financial assistance may be declining, the multilateral institutions will continue to have a vital role to play in Peru in the years ahead Peru's stabilization/structural reform program has benefited from extraordinary leadership, but the numbers of people actively involved in its design and implementation are few in number and highly concentrated in a few government agencies. Most line agencies have limited capacities for policy analysis, program formulation and implementation, and little exposure to the experiences of other countries. Crucially important to the sustainability of present policies will be the continued analytical, advisory, policy and project design, technical assistance and information distillation and dissemination capacities of the IFIs. In this regard, our policy dialogue continues to be excellent, and the Bank Group's advice is actively sought throughout the government. ESW, including informal, quick-turnaround policy notes, have had an important impact on policy decisions, the design of laws and regulations, and the revision of ongoing programs. Over the past year, a number of ministerial-level policy seminars were organized, and additional requests of this type can be expected.8 EDI assistance has been requested for the strengthening of the public investment evaluation and monitoring system. 52. Non-lending services will thus take on growing importance in our assistance program. In addition, the Government has expressed interest in exploring Bank Group loan and investment guarantees, assistance in the organization of concessions, BOTs, etc., as well as a closer working relationship with other donors, particularly the Japanese, in the identification, design, and supervision of projects. C. The Process of CAS Formulation 53. In the process of CAS preparation, we have had organized consultations with government officials, private businessmen, local UN agency heads, bilateral program directors, and the representatives of approximately 600 NGOs and community groups. To initiate the process of consultations with civil society, we invited interested groups and individuals to organize meetings for the purpose of advising the Bank on formulation of its assistance strategy for Peru. The 7IDB annual lending commitments to Peru in 1994-96 averaged US$463 million, including a DDSR loan in the latter year. s In two sectors-health and agriculture--Ministers have requested intensive advisory services, a "sector partnership" in the words of one, involving the presence of one or more Bank staff on a full-time basis during extended visits to Peru.  17 agenda, participation, and conduct of the meetings were left to the organizers. For a number of meetings which we were not able to attend outside of Lima, the organizers sent us written notes. The meetings varied somewhat in quality, but the response was uniformly positive, the discussions were lively and constructive, and many useful points and ideas coming from them have been incorporated into the CAS. 54. While the identification of priorities and recommendations for future action tended to reflect the specific interests of each group, there were many points in common. These have included a widespread appreciation for the major accomplishments of the Government and understanding of the need to maintain fiscal discipline and of the failures of past populist approaches. High priority was given to closing the great social and economic disparities between Peru's diverse social groups, with particular emphasis on raising health and education levels in the rural areas. Criticisms of the current situation focused on the perceived need for a more clearly articulated Government strategy, both sectoral and overall; accelerated reform of institutions and of attitudes in the traditional bureaucracies; and greater decentralization of decision-making and of control over program execution, with beneficiary and other stakeholder participation to assure greater attention to regional and local differences. D. The Bank Group Assistance Program 55. The overriding ob-jective of the Bank's assistance progam for Peru continues to be to support the Government's efforts to achieve the sustained, continuous reduction of poverty. The proposed program is focused in support of those fundamental elements of the anti-poverty program described above to raise the quality and improve the access of the poor to productivity- increasing human capital, market-integrating infrastructure, and the full rights and opportunities of private ownership. Many of the specific activities proposed build upon earlier Bank work in Peru and represent areas in which the Government has particularly sought Bank expertise. Moreover, in many of these areas, the Bank is playing a catalytic role in mobilizing assistance from other donors. Taking into account the strong and consistent macroeconomic management of the past several years, the successful restructuring of the external debt, and Peru's continuing excellent dialogue with the IMF, we expect that macroeconomic management will be less a focus of the Bank's program in the coming years. We will continue an active dialogue, however, and are prepared to consider a second-stage Pension Reform Adjustment Loan, if justified by program content and financial requirements. Infrastructure activities will continue to be important but will be more narrowly focused in support of poverty reduction. Private sector development will take on greater importance, with IEFC playing a stronger role. Institution-building will be an important element in all of our activities, and we are prepared to support major needed reforms--e.g., the modernization of the budgetary process and reform of the civil service--when the Government is ready to move forward in those areas. IFC will also continue to play an important role in financial sector development. As described above, financial sector reforms are well advanced. IMF and IDB continue to provide advice in this area, particularly as regards banking supervision.  18 JIBRD Assistance 56. As noted above, the program envisaged for the next several years will introduce a shift toward lower lending and increased non-lending services, as compared to the last several years. Consequently, the traditional scenario-building exercise of calibrating the Bank's lending program as a function of country performance has less relevance for the present CAS. The lending program now foreseen, on the order of $200 million per annum, consisting of 2-3 projects per year, will probably not exceed what might otherwise have been proposed for a low-case scenario, although failure to improve project implementation (see paras. 66-69) could result in further reduction. Annex A.8 shows, in matrix form, the WBG's assistance strategy for Peru, and Annex B describes IBRD program activities directly linked to poverty objectives Education and Health 57. Investments in human resources are central to the long-term reduction of poverty. Progress has been made difficult, however, by the weak administrative capacities of the traditional agencies involved. In the social sectors, intensified supervision of the Primary Education Project is contributing importantly to achievement of the Government's access and quality improvement objectives, and is coordinated with efforts underway and planned by the IDB in pre-school and secondary education and vocational training. GTZ is also active in the sector, recently launching a program in support of normal school education for teachers. EDI has begun work to incorporate Peru into the World Links program, and major Bank studies of education finance and of the special needs of rural education are planned to assist in designing the next stage of education reforms. The Bank-financed Basic Health and Nutrition Project under implementation is supporting maternal and childcare, nutrition, and family planning in local health posts in four poor departments, while IDB has concentrated on the upgrading of hospitals and institutional strengthening in the Ministry of Health. USAID has also been active, supporting health posts in other areas and institutional support to the Ministry. Under NLS, the Bank in the past year organized Cabinet-level serninars, with the participation of international experts, on education and health reform. The Bank is currently working closely with the Ministry of Health on issues of sector reform, which is expected to lead to lending support, and work is planned with the Ministry for the Promotion of Women and Human Development on the development of a national nutrition study and on a conference on women's issues and family planning. NLS, including ESW, will continue to support efforts to improve the targeting of social expenditures and, in collaboration with IDB and bilateral donors, to monitor and analyze progress toward achievement of the Government's anti-poverty objectives. An IDF grant will also be sought to provide assistance toward the preparation of an indigenous peoples development plan. Property Rights 58. Lack of clear ownership of the properties in which they live and work deprives millions of mostly poor Peruvians of access to credit and public services, thereby effectively freezing real assets into suboptimal uses and limiting income-earning potential. Building on a pilot effort supported by the Bank in the early 1990s, a Bank project in preparation will support the design and implementation of a national plan for the titling and registration of currently informal urban  19 properties, as well as financial reforms to improve the access of small titleholders to credit and other services. This project complements efforts supported by the IDB to accelerate the titling of rural properties, as well as programs of IDB and USAID to channel credit to microenterprises. The establishment of the property rights of small landholders complements support to governmental decentralization by strengthening the tax base of local governments, and is in turn complemented by the Judicial Reform Project under preparation, which will reduce the costs of dispute settlement and improve the access of the poor to the justice system. Infrastructure 59. Ongoing Bank projects in support of large infrastructure investments--i.e., Transport Rehabilitation and Lima Water and Sewerage Rehabilitation--with parallel projects and cofinancing from IDB and OECF, respectively, were essential to the restoration of economic activity after the serious deterioration of the 1980s, and are providing significant economy-wide benefits. Both projects include major institutional reforms and look toward a larger future role for the private sector in infrastructure investments. The Bank's Privatization and Electric Power Privatization Adjustment Loans have supported the transfer of major infrastructure investments to private ownership and management, with important benefits for operational efficiency and the mobilization of new investment, and the Privatization Technical Assistance Loan is supporting the development of the institutional and legal framework for infrastructure concession arrangements. IDB has also been active in supporting the development of an adequate regulatory framework for privatized utilities. Future strategy calls for greater concentration on small-scale infrastructure, particularly in mostly rural areas of high poverty concentration. A second FONCODES project, with parallel financing from IDB and support from bilateral donors, is now in implementation. The Rural Roads project, cofinanced with IDB, is also underway, and a follow-up operation is contemplated. Recently approved, with OECF cofinancing, is a project to channel resources to private water users' associations for on-farm irrigation rehabilitation. An Urban Transport Project for the Lima metropolitan area will combine some road rehabilitation with improvements in transport planning and traffic control to reduce the heavy economic and environmental costs of growing congestion. A transport sector strategy study will help to define the policy framework and investment priorities within the sector. The Bank is working with the Government to develop a strategy for cost recovery and subsidization, where justifiable, for rural power systems, and a new initiative for rural water systems is beginning with the support of the joint Bank/UNDP/COSUDE-financed Regional Water and Sanitation Group. As regards larger infrastructure projects, IFC assistance is available for the organization of concessions, and consideration can be given to the use of IBRD guarantees for private infrastructure development. Rural Development 60. As noted, much of the Government's anti-poverty effort, and of Bank support, have been concentrated in the rural areas. These activities need to be complemented with support to private efforts to increase the productivity and competitiveness of the agriculture sector. The Sierra Natural Resources Management and Poverty Alleviation Project will raise productivity in small- scale farming in the high Sierra via improvements in soil and water management, while the Water Management T/A Project will promote better water use in coastal agriculture. Under NLS, an  20 agricultural development strategy study will be carried out in joint collaboration with the Ministry of Agriculture and the Ministry of Economy and Finance, with the participation of IDB, FAO, and bilateral donors. This work follows up an earlier Cabinet-level seminar on rural development policy organized by the Bank. Among its expected outcomes is the preparation of a project to strengthen private sector-led agricultural research and/or extension. The Government's anti-drug and alternative development efforts have received significant direct support from UNDCP and from bilateral agencies. The Bank is supporting this effort indirectly through its education, rural roads, and FONCODES projects. Sustainable Development 61. Many of the above-mentioned activities have important environmental elements, most notably the Sierra Natural Resources, Lima Water, Irrigation Subsector, and Lima Transport projects, the work on rural water systems, and T/A projects for the development of a national water management policy and for the Mining and Energy Sector. A major project for the elimination of pollution of the ocean along Peru's central coast has been developed under a Bank- administered PHRD grant, and will be financed by OECF. A Bank-administered GEF grant is supporting a fund for the protection of national parks, and the Bank has helped to organize donors meetings to encourage debt swaps for that purpose. ESMAP funds are also being used to study alternative energy sources, as well as to support a Peruvian effort to elirninate lead from gasoline. Future NLS will support the formulation of a national environmental action program, supplementing assistance currently being provided by IDB and USAID. Institutional Reform 62. Although the Government is not seeking IFI financial support for a comprehensive program for modernization of the state, most Bank and other assistance activities in Peru have institutional strengthening as one of their objectives. In the past two years, the Bank has sponsored two high-level policy seminars covering various aspects of public sector reform. Grant funds have also been used to support improved debt management capabilities and policy analysis with the Ministry of Economy and Finance. Currently, the Bank and EDI are developing a program with the MEF to strengthen the system of public investment programming and management, complementing work in this area being supported by IDB. The Bank has also been collaborating closely with IDB in providing advice and technical assistance to the Government for the strengthening of the regulatory environment, in follow up of previous and ongoing support to the privatization process. 63. Crucial in our view to social integration over time, but less clear in the Government's program, is the decentralization of governmental responsibilities and accountability to the levels most sensitive to local needs and most efficient for allocation decisions, the delivery of services, and the fiscalization of both. The Urban Rehabilitation and Management Project will support a pilot program in several selected, medium-sized municipalities, combining the training of local officials, the modernization of administrative, budget and control systems with financial support for priority infrastructure investments under local responsibility. This project is complemented by the Urban Property Rights Project, which, among its other objectives, will help to strengthen  21 resource base of the local governments. FONCODES II is giving increased attention to working with and developing the capacities of local governments to assure the sustainability of its projects. Similarly, the Rural Road Rehabilitation program, cofinanced by the Bank and IDB, is demonstrating the feasibility and benefits of transferring road maintenance responsibilities to local governments, which in turn subcontract execution responsibility to local microenterprises. Such an approach could usefully be explored for other infrastructure investments. Portfolio Management Portfolio Status. 64. After a five-year hiatus, the Bank resumed lending in FY92, initially with a series of adjustment loans, followed by the first technical assistance and investment loans in FYs 93 and 94, respectively. Although the portfolio is thus young and relatively small (see Annex C), serious implementation delays have been experienced in some projects. Three problem projects were identified in the FY96 ARPP, and Peru was included by the QAG in the Bank's list of 25 countries for special attention. Important progress is now observable, and two projects (Transport Rehabilitation and Basic Health and Nutrition) have been fully removed from the problem project list. One project (Primary Education) remains on the list, and one project (Lima Water Rehabilitation) continues to be considered potentially at risk. 65. A first CPPR, conducted in March 1996, identified several generic implementation problems. A number of corrective actions have been taken, including improvements in the budget manage,ment system to give line ministries a more secure flow of funds, and the drafting of a new public procurement law. Steps were also taken toward the creation of a government-wide public investment programming and monitoring system centered in the MEF, and the Council of Ministers, concerned with slow disbursements and the absorptive capacities of the line ministries, has initiated regular discussions of the Bank and IDB portfolios. In parallel with this increased attention on the Government's side, more intensive, on-the-ground project supervision/implementation support has been provided by the Resident Mission in Lima. In response to these combined efforts, disbursements for investment operations are showing marked improvement in FY97. Portfolio Improvement Strategy 66. A second CPPR was carried out at the technical level in April 1997 and at Cabinet level in mid-June. Discussions included both generic and project-specific problems. Delays in counterpart funds, identified as a significant problem in the first CPPR, were found to have been largely resolved, but continuing problems were attributed to original project design and preparation (e.g., excessive number and complexity of project elements), weak administrative capacities and turnover of staff in executing agencies, and lack of familiarity with each other's procedures. Central elements of the proposed portfolio improvement strategy (see Annex C) include:  22 * Assuring readiness for implementation. Working closely with the new public investment system to assure quality at entry through simple project design, ensuring the readiness of the procurement and financial management systems and essential baseline studies, and resolving all issues at negotiations to avoid delays in effectiveness. Toward these ends, the investment programming units in the key line ministries are receiving training in project formulation under an IDB-financed program, and further assistance in the strengthening of project evaluation and management is being developed with EDI. * Project management. We are giving increased priority to project supervision in the country budget, with special attention to project launch workshops and an expansion of the supervision capacity of the Resident Mission to be able to cover additional sectors and to respond more quickly to the implementation issues raised by executing agencies. We have also proposed to the Government that more upfront attention be given to strengthening the administrative capacities and participation of the line offices within the rninistries as preferential to the creation of "enclave" project implementation units. * Regular, high-level monitoring of portfolio performance. We have also discussed initiating, in partnership with the Government, a quarterly ministerial-level portfolio review process, to consult on and find quick resolution to implementation issues. Government endorsement of this strategy and action program is pending. 67. Our immediate targets for FY98 are to maintain the weight of problem projects below 10 percent of the portfolio (6.7% as of June 1997); to reduce the average duration of a problem project prior to restructuring or closing to not more than 8 months; and the average time from Board approval to effectiveness to not more than 4 months; and to raise the disbursement ratio on investment loans to 20 percent in FY98 (from 15 percent in FY96). Exposure and Risks 68. Debt service to the Bank as a proportion of public debt service is projected to increase from about 8 percent in 1995 to 13.5 percent in 2000. Debt service to all preferred creditors is projected to rise from 17.3 to 38.4 percent. Debt service to the Bank as a fraction of exports and non-factor services is projected to decline from 2.6 to 2.3 percent between 1995 and 1998, and then rise again to 2.8 percent by 2000 (see Annex A.6). While total debt service to exports will fall over the next decade, it will remain high, and calls for continuous monitoring. Recent agreements between Peru and Paris Club creditors, and Peru and its commercial bank creditors have reduced the Government's flexibility to negotiate further restructurings of its external debt in the event of extemal shocks. However, these agreements, together with a strong intemational reserve position and the strengthening of the reform program, also contribute to broaden access to long-term credit, provide wider options for debt management, and create conditions to develop a domestic market for public debt. As a result, Peru's capacity to manage its debt has increased.  23 69. The proposed assistance program has three principal risks: (i) continued institutional weaknesses could delay the preparation and implementation of projects and of NLS; (ii) popular impatience with progress and increasing political pressures with the approach of municipal elections in 1998 and national elections in 2000 could divert attention from structural reforms and loosen overall macroeconomic management; and (iii) macroeconomic stability could be threatened if the current account deficit again widens as recovery accelerates, and growth could be slowed if foreign investment is less than expected. The first risk will be reduced by the intensified efforts and closer collaboration in monitoring and supervision by the Government and Bank, an effort now beginning to show positive results. The second risk will require careful monitoring but is acceptable in the context of the Government's demonstrated commitment to sound economic management and reform. In addition to our continuing dialogue and program support to the Government, we will give particular emphasis in our NLS to improving communication and dissemination to inform public dialogue and to strengthen the public consensus on reform. The third risk is closely related to the second. The Government can be expected to monitor the current account situation closely and react appropriately, as it did in 1996, and foreign investors can be expected to respond positively to strong economic management. IFC and MIGA will play catalytic roles in this regard. IFC and MIGA 70. Crucial to sustaining economic growth and declining poverty is the achievement of a dynamic response from the private sector to the trade liberalization policies and reduced role of the state explicit to the Government's economic model. Without that response, the economy will not achieve the investments, employment generation, and export expansion required to absorb the growing labor force, and the needed growth of domestic savings. Consistent with the Government's emphasis on broadly based, private sector-led growth, IFC foresees a significant increase and greater sectoral diversification in its gross investment program in Peru, rising from $80 million in FYs 94-96 to $200 million in FYs 97-99. The mining and financial sectors would continue to be areas of focus, given Peru's comparative advantage in the former and the importance of the latter to private sector development and broader popular participation. In the financial sector, particular attention will be given to modernization of the banking sector, providing long-term funds for intermediating to SMEs, along with access to new sources of medium and long-term funds, such as the U.S. commercial paper market, with institution-building services. IFC also expects to contribute to strengthening the contractual savings industry, starting with the privately managed pension system, and of the securities markets, through the development of private equity funds as well as of such ancillary institutions as rating agencies, credit bureaus, and investment research companies. IFC continues to assist in the design and implementation of the participacion ciudadana mutual fund program. Support to microenterprise finance will be provided through Profund. In infrastructure, IFC expects to continue support for the Government's efforts to further private participation, focusing on the development of concessions in more difficult sub-sectors. In agribusiness, substantial investments for rehabilitation and expansion may require IFC assistance. Opportunities will also be sought in tourism, petroleum, and possibly manufacturing.  24 71. MIGA currently has 24 guarantee applications pending and will continue to offer technical assistance for investment promotion, particularly in mining and tourism. Partnerships and Aid Coordination 72. Although the Bank may no longer be a crucial supplier of financial resources to Peru in the years ahead, it is still seen by both the Government and other members of the assistance community as an intellectual leader and the major source of advice on development policies and structural change. With resource mobilization no longer the principal focus of the Consultative Group, the traditional Paris meetings may no longer be needed, and the venue of future aid coordination and consultation activities will increasingly be in the field. The Bank maintains an active dialogue, particularly with regard to social sector programs, with other assistance agencies, including the UN and bilateral agencies, and with the NGOs, and Resident Mission staff participate actively in local sector or issues-oriented roundtables and working groups If the Government were interested, the Bank Group could play a more active role in promoting dialogue between the public and private (both foreign and domestic) sectors. This possibility remains to be explored. 73. Consultation and coordination with the IMF have been excellent and should continue to be so. We will continue to look to the IMF to play the leadership role in macroeconomic policy and will continue to advise them on the progress and content of structural reforms. There has also been close coordination in the field with UN and bilateral assistance agencies. Greater efforts will be made to assure close coordination and consultation with the IDB, where the quality of relationships in the past couple of years has varied among sectors. (Major IDB activities are indicated in Annex A.8.) A closer working relationship will also be sought with the Japan's assistance agencies, given the latters' increasingly heavy involvement in Peru and their limited staff resources for policy analysis and for project identification and supervision, particularly in the social sectors. James D. Wolfesohn President By Caio K. Koch-Weser Attachments Washington D.C. June 26, 1997  Annex Al PERU - Selected Indicators of Bank Portfolio Performance and Management Indicator FY 1994 FY 1995 FY 1996 FY 1997 (current) Portfolio Assessment Number of projects under implementationa 7 10 11 15 Avearage implementation period (years)b 1.01 1.58 2.40 2.37 Percent of problem projects a,c by number 0 10.00 27.27 6.67 by amount 0 3.49 23.23 13.16 Percent of projects at riska ,d by number NA NA NA 15.4 by amount NA NA NA 21.2 Disbursement ratio (%)C 30.89 17.16 14.95 19 11 Portfolio Management CPPR during the year (yes/no) no no yes yes Supervision resources (total US$ thousand) 942.61 706.06 769.06 733.25 Average supervision (US$thousand/project) 134.66 70.61 69.91 48.88 Number of projects in extended problem 0 0 1 1 staruse'F Memorandum item Since FY80 Last five FYs Projects evaluated by OED by number 26 2 by amount (US$millions)9 1,135.5 600.0 Percent rated U or HU by number 18 0 by amount (US$ millions)9 448.0 0 a. As shown in the Annual Report on Portfolio Performance (except for current FY). b. Average age of projects in the Bank's country portfolio. c. Percent of project rated U or HU on development objectives (DO) and/or implementation progress. (IP). d. As defined under the Portfolio Improvement Program. e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year: investment projects only. f Projects in problem status for 12 months or more. g. Net commitment amount.  Annex A2 Page 1 of 3 PERU - Bank Group Program Summary Proposed IBRD/IDA Base-Case Lending Program, FY98-O0a FY Project US$(M) Strategic Implementation rewards risks (H/MIL)b (Humm)b FY 98 Judiciary Reform 22 H H Urban Transport 100 M M Urban Property Rights 88 H L Water Resource Mgmt. TA 20 M L Subtotal 230 FY 99 Health Sector Reform 50 M M Urban Rehabilitation 100 H M Pension Adjustment Loan II 100 M L Subtotal 250 FY 00 Rural Roads 60 H L Rural Water 50 H L Ag. Research and Extension 50 M M Subtotal 160 Total FY 98-00 640 a. This table presents the proposed program for the next three fiscal years. b. For each project, indicate whether the strategic rewards and implementation risks are expected to be high (H), moderate (M), or low (L).  Annex A2 Page 2 of 3 Peru - Bank Group Program Summary Bank Group Fact Sheet IBRD/IDA Lending Program Past Current Planneda Category 1994 1995 1996 1997 1998 1999 2000 Commitments (US$m) 284.0 446.4 90.0 569.0 230.0 250.0 160.0 Sector (