Peru - The economy

FILE CC-PY ~ ~~w.H. 22-a FILE COPY RES 1 E This report is restricted to use within the Bank. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT THE ECONOMY OF PERU March 24, 1954 Department of Operations Western Hemisphere  Currency No official parity; from 1950 to March 1953 the rate fluctuated between 15 and. 16 soles to the U.S. dollar; from April 1953 to January 1954 it went up from 16 to 22, but had again gone down to 18 at the end of February. In this report conversions have been made on the basis of: I U.S. $ = 20-soles 1 sol (s/0) = 5 cents, 1 million soles = U.S. $50,000  TABLE OF CONTENTS PAGE Basic Data Summary and Conclusions i - iv I. Economic Development 1-5 Growth of Output and Income 1 Investment and Savings 1- 3 Prospects 3 -5 II. Agriculture 6 -10 Production and Consumption 6 -7 Obstacles to Production 7- 8 Government Policy 9 Prospects 9 -10 III. Mfining 11 - 12 IV. Petroleum 13 V. Industry 14 - 15 VI. Domestic Finance 16 - 21 Inflation 16 - 17 Government Finances 17 - 19 Prospects 19 - 21 VII. Balance of Payments 22 - 24 Past Trends 22 Prospects 22 - 24 VIII. Creditworthiness 25 - 26 Over-all Creditworthiness 25 Dollar Creditworthiness 25 - 26 STATISTICAL APPE?DIX Table 1. Summary of External Public Debt Table 2. Estimated Contractual Interest and Amortization Payments on External Public Debt Table 3. Public Expenditures and Revenue Table 4. Public Investment Table 5. Exports by Mdain Commodities and Areas Table 6. Exports, Imports and Terms of Trade Table 7. Indices of Real Net Domestic Product and its Components Table 8. Investment and Savings Table 9. Increases in Bank Lending and in Hsoney Supply  BASIC DATA Area 482,300 square miles Population - 1952 8.9 million National Income - 1952 16,200 million soles (At factor cost) U.S.Q 1,000 million 4115 per capita Balance of Payments - 1952 Exports (f-.o.b.) 228 Imports (f.o.b.) 23 Trade balance Services -71 Total Goods and Services :Z Direct Investment 32 Other capital movenents, errors and omissions1! 30 Tbtal Capital o2ements Deficit {_) _:C l/ Mainly increases in short-term credit granted by foreign exporters to Peruvian importers. Net Foreign Exchange Reserves of As of Dec. 31, Central Bank 1953 In U.S. $Tp mnillion 39.2 As % of 1952 imports 16 Principal Exports - 1952 (in U.S.4 million) ($ of total) Cotton 79 33 Sugar 33 1L Wool, skins and hides 9 4 Copper 17 7 Lead 22 10 Zinc 15 6 Gold 5 2 Silver 12 5 Trade by Areas - 1952 Exports Imports (7). U.S. and Canada 30 63 Latin America 31 7 Europe 35 26 Other Continents 2 2  -i- SUMMARY AND CONCLUSIONS Econoric Development 1. Output increased little in ?eru in the two decades prior to 1950. Old mineral resources were gradually being exhausted and there was little development of new ones. Agriculture on the coast was impeded by lack of irrigated land and in the interior by lack of transportation, credit and extension services. Domestic savings and investment were inadequate and there was little inflow of foreign capital. Moreover, private investment went to a large extent to residential construction and accumulation of in- ventories, while public expenditures for roads, irrigation and promotion of agriculture and industry were low. However, in spite of the low increase in output, Peru achieved after the war substantial gains in real income, because prices of Peruvian exports increased much more than prices of imports. 2. Since 1242 basic changes in economic policy at home and price rises abroad have encouraged output and directed investment to more productive fields than previously. Devaluation and the establishment of a free exchange market have stimulated investment in the export industries, and the adoption of new legislative codes has opened the gates for foreign investment in min- ing and petroleum. Rising Goveniment revenue has made possible a great expansion of public investment. Agriculture 3. Agricultural production in Peru has long failed to keep up with consumption. Growth of population and income has increased consumption of agricultural products rapidly. Production has, on the other hand, been impeded by lack of suitable land, lack of capital and knowledge, lack of transportation and lack of positive measures to overcome these obstacles. As a result, rural areas in the Sierra (Andean uplands) have been left be- hind in the country's economic development, agricultural exports have stag- nated and food imports have risen. However, in recent years improved irrigation, better agricultural methods and changed government policy have helped to raise production substantially. 4. During the next decade there are great possibilities of raising agricultural production by irrigation on the coast, by cultivation of new lands in the Sierra and the M-lontana (eastern slopes of the Andes) and by improvement of agricultural methods throughout the country. The realization of these possibilities requires, however, sustained government action on irrigation, road construction, and agricultural credit and extension services. Imiining 5. After a long period of stagnation, Peruvian mining has in recent years progressed rapidly. The maintenance of a free and stable exchange rate,  political stabilization and the enactment of a new mining code have been powerful inducements to production and investment. So have better metal prices abroad. Capacity of lead and zinc mining has been expanded, a zinc refinery is under construction and exports of iron ore have recently begun. As a result of investments already being made, output of refined lead and zinc will increase greatly, and total export value is likely to increase in spite of falling metal prices. Petroleum 6. Stimulated by low prices, oil consumption in Peru has increased rapidly. Production has, on the other hand, been impeded by the depletion of old oil fields and the failure to develop new ones. As a result, petro- leum exports fell by one half in ten years. However, the enactment of a new petroleum code in March 1952 made it possible to grant new concessions to oil companies, Successful explorations in the Sechura IDesert, where drill- ing started in 1953, might after a few years lead to important increases in oil exports. Industry 7. In the last decade there has been a considerable expansion of Peruvian manufacturing industries. These are mostly consumer goods indus- tries with textiles holding the first place and food processing the second. A continued industrial expansion is of the greatest importance for economic development, and will help to raise national income and keep down imports. Domestic Finance 8. In recent years there has been considerable inflation from credit expansion and public deficits. owing to the great rise in export receipts in 1950-51, and the increase in capital inflow, this inflation did not im- mediately endanger balance of payments stability. When, however, inflation continued, while at the same time exchange receipts from exports and capital inflow leveled off, a fall in the value of the sol began in April 1953 and became acoelerated towards the end of the year 1953 and in January 1954. 9. Towards the end of January a new Minister of Finance was appointed, and on February 18 a stabilization credit of $30 million was obtained from the International ilonetary Fund (412.5 million), the U. S. Treasury ($12.5 million) and the Chase National Bank ($5 million). A few days later the President and the Prime Minister announced the governmentTs plans to continue the policy of free trade and free exchange and end inflation by cutting government investment, increasing revenue and checking credit expansion. At the end of February the so4 had appreciated to s/o 18 per dollar, suggest- ing that confidence was being regained.  Balance of Payments 10. Stagnating output of minerals, cotton and sugar, and rising domestic consumption have for a long time kept Peruvian exports down. Nevertheless, since the end of the war, imports have been able to rise due to improved terms of trade. In the last three years mineral and agricultural exports have expanded and inflow of long-term capital has been resumed. This, together with substantial short-term commercial credits, made possible an increase in imports to unprecedented levels in 1950-1953. 11. Export prices have now fallen and further commercial debt cannot be incurred. Peru will therefore have to reduce its imports substantially, in spite of a rising export volume and high long-term capital inflow. This can be accomplished by curbing inflation and allowing the rate of exchange to find a new equilibrium level appreciably above that of recent years. This is the object of present government policy. 12. Over the next five to ten years foreseeable development of mining and agriculture wiUl bring about some increase in export volume. A substan- tial increase would result from oil discoveries and from the realization of the Toquepala copper project. However, the gains from these increases will partly be offset by increased investment service and reduced capital inflow when the projects are completed. Therefore, barring important oil discoveries, Peruvian imports will even in the longer term have to remain below the high levels of recent years, although they could be appreciably higher than imports in 1947-1950. 13. If under these conditions a satisfactory rate of economic growth is to be achieved at the same time as the balance of payments is safeguarded, agricultural and industrial production will have to substitute for imports. This will be easier because most Peruvian imports can be substituted, because fuel will probably not have to be imported, and a significant increase in food imports can be avoided. Economic policy can help by preventing infla- tion and promoting appropriate agricultural and industrial production. Creditworthiness 14. In the next ten years.Peru should be able to obtain a substantial rise in output. The effects of this rise upon real income will, however, probably be reduced by worsened tenrs of trade. Increased population growth will also make it more difficult than previously to obtain gains in per capita income. Nevertheless, Peru should be able to attain a satisfactory rise in per capita income through the judicious uae of her own resources and with the help of foreign capital. If, moreover, savings do not fall in relation to national income, Peru should after ten years be able to carry on her economic development without substantial new capital imports, and at the same time be able to service a substantial foreign debt.  -iv- 15. The prospects are favorable that inflation in Peru will be stopped during this year and the rate of exchange stabilized. In this case, no sub- stantial part of the stabilization credit of February 1954 will be utilized, and it will not reduce Peru's creditworthiness for other lending. 16. The service of Peru's present foreign debt (excluding the stabiliza- tion loans) will in 1956-1959 be about $8 million. The five Bank loans presently under consideration would add a maximum service of about 'p2.5 million. This would be well within Peru's payment capecity and leave scope 'for additional lending. 17. So long as European currencies remain inconvertible, Peru's dollar creditworthiness will be lower than her over-all creditworthiness. This difference is, however, reduced by prospective increases in exports to the United States, by the likelihood that Peru will continue to earn dollars from exports to other countries than the United States, and by the possibili- ties for shifting imports from the United States to Europe. Although it would be desirable if new loans were partly made in non-dollar currencies, the Bank could make all the loans preaently under consideration in dollarS8  THE SCOlCIVE OF FERtU I. ECON,OMIC DEVVCREiV'f Gronrth of outPut and Income 1. Output increascd little in ?eru in thze two decades prior to 1950. Comprehensive proiuctiorn and national inc-ne date are available only since 1942. Such data as are available indicate that there was only a small increase of oultput in most fiseds fromq the late 1920' s to the early 1940's. From 1942 to 1949 there rsas hardly any increace in outpu2t per capita. In 1950-1952, however, basic changes in economic rolicy at home and price rises abroad cobined to encourage output. The voluMe of m-dineral orduction increased by over 502 from! 149 to 1952 and that of agricultural rroduction by afLoat 20% in th.e same period. Nevertless, growth of output in the postwar period as a whole was slower than ia most other Latin American countries. The Peruvian annual average increase of net domestic nroduct in 1945-1952 of less than 4% con;pares ',ith tne rates estimated by SOfA of over 5: for Brazil and Yexicci a,nd betwjeer I and 5% Cc-r the whole of Latin .acerica (excluding Arentina) in thze same interval. 2. However, great wm..-ror.menets rir the terns of trade allowed Peru to obtain substantial gains in real income in spite of the smll increase in output. After reimaining largely unchanged during thae -mao, the terms of trade sharply improved in 194, an., remained up to 1949 about 40% higher than in 1940. In 1950 and 1951 a new improvement took place, Ahich brought the terms of trade up to a level 67% higher than in 1940. This was corsiderabl-y above the aversage improvernent in tems cf trade for Latin Azserica as a wdhole. Als a. result of these changes _n the terms of trade, real ineomle increased an average 4% annually from 1942 to 1952, and per capita income 4%. Inve stenta Savings 3. Investinent and savings in Peru have been substantial for a country with its per capita income. Fevertheless, they have been lower than rfor many other Latin American countries, and this partly explains Periats relatively slow ecoromic growth. The ratio of gross savings to gross rnatilonal product was about 229 for tDx perIod 1943-1952, and that of gross investment to gross niational product (excluding inventories) about 13%. This is appreciably lower than the average rates Df savings and investnent for Latin Anerica as a whole in 1945-1951, 15.2% and 15.8%, respectively. 4. TMhe slow growth in. outpu-t w.sas, nowever, also lue to lc-w yialds fror, inestment. From 1945 to 1951 annual iasrease in output in Peru Aas l'ttle ztore than 30% of annual irvest-ment, while in Bruzil, 3ol-oabia and MIexi<co it w!as 5OC, and ih Latin America on the average 40%-4 These Thlle investment-oitput ratio (the ratio of net domestic investient to the increase iln real net domestic prodiuct in the same -eriod) was about 3 for Perna comoared to about 2 for the other three countries and 2.4 for Latin mnerica on the average.  - 2 - differences in average investment yields are explained by the patterns of investment. In Peru a relatively large part of investment has been in resi- dential housing and in public buildings, and a relatively small part in machiinery, vehicles, and in such public facilities as roads and irrigation. When the investment pattern changed in recent years, yields increased. 5. Inventories, which are not taken into account in the above esti- mates, were depleted during the war but have risen sharply every year since 1947. This increase, which has been in excess of the needs of the economy, has been induced by aiticipation of foreign price rises or of devaluation, and made possible by credit expansion. 6. Private construction--of which residential hcusing is the main part--was until recently the biggest item in Peruvian investment. From 1943 to 1952 private construction accounted for almost one-third of investment (excluding changes in inventories), compared to less than one-fifth in Mexico from 1939 to 1950. It declined, however, substantially after 1947. On the other hand, imports of machinery, equipment and vehicles were only about 30% of investment in 1943-1947. Their increase to over 50% of investment in 1950-52 reflects partly the effects of the devaluation upon import prices and partly a change in the investrment pattern. 7. Public investment was relatively low in Peru up to 1952 and much of it was of social importance primarily and did not have immediate or sub- stantial effects upon output. Its yields were also lowered sizeably by expenditures on some costly projects (notably the Santa Corporation and the Pucalpa Railroad) which so far have not given any returns. The roads were also, until recently, built to unnecessarily highl specifications and some of them were of little economic significance. 8. Since before the war and until 1950 there was little inflow of foreign capital. Private foreign investment was low and official loans insignificant. This lack of foreign capital not only limited investment, but also over-all investment yields because many of the most productive investments (especially in mining and petroleum) could not be undertaken by domestic capital. 2. The prevailing pattern of investment in Peru has to a large extent been a consequence of official policies. When these were changed after 1948, substantial changes in the investment pattern followed. Low government receipts and high expenditures for defense, administration and food subsidies had 'kept public investment down, and created uninterrupted budgetary deficits from 1935 to 1948. The unsettled foreign debt prevented the Government from complementing its own low investment resources by foreign loans. The infla- tion that resulted from the public deficits helped, on the other hand, to direct private investment to residential construction and accumulation of inventories. Domestic inflation and rigid exchange rates limited invest- ment in the export industries, and so did the lack of a determined govern- ment policy towards foreign investment in mining and petroleum.  10. The devaluation and the establishment of a free exchange market in 1949 stimulated investment in the export industries, and the adoption of the new mining and petroleum codes in 1950 and 1952, respectively, opened the gates for foreign investment in these fields. Increased export earnings and capital inflow facilitated the imports of investment goods. At the same time rising government revenue made an expansion of public investment possible. As a result investment in mining and petroleum in- creased and further investment in these fields is under way. Imports of capital goods expanded greatly and public investment in roads and irriga- tion gained momentum. In spite of these changes the Peruvian investment pattern has to some extent retained its former features. Although lower than previously, private construction is still rather high, accumulation of inventories has continued, and expenditures for public buildings were in 1953 almost as high as expenditures for roads and irrigation combined. Prospects 11. In the next ten years Peru should be able to obtain a substan- tial rise in output. The effects of this rise on real income may, how- ever, be reduced by worsened terms of trade. Increased population growth will also make it more difficult than previously to obtain gains in per capita income. Nevertheless, Peru should be able to attain a satisfactory rise in per capita income throlugh the judicious use of her owin resources and with the help of foreign capital. 12. In 1943-1952 private savings were quite high and showed a sub- stantial increase. Public savings, on the other hand, were extremely low up to 194S and in spite of a great increase since then, they are still relatively low in relation to national income. The increase in both pri- vate and public saving after 1948 was stimulated by growth of earnings in the export industries. It will be more difficult in the face of falling export prices to achieve a sLmilar increase in the future. Nevertheless, it is reasonable to expect that private savings will not fall below the average level of 1944-52 (12% of gross national product) and public savings below that of 1947-52 (3%). In addition to domestic savings, Peruvian economic development will in the next decade on all present forecasts be supported by substantial amounts of foreign capital. 13. It is likely that increases in output in the next decade can be achieved at a lower investment than in the past. If inflation is avoided and favorable conditions maintained in agriculture and industry, private capital could find productive opportunities in these fields, and invest- ment in residential construction and inventories could be reduced. i'iore- over, yields from public investment could be enhanced by giving higher priority to roads, irrigation and promotion of agriculture and industry and less to public buildings. Increased investment in mining and, if oil is struck, in petroleum, would also contribute to higher investment yields. In recent years the investment pattern has already changed in these direc- tions.  - a - i. If the expected savings and capital imports are realized, and there is a moderate increase in investment yields, Peru can achieve a substantial groworth of output in the next decade. An annual average rate of increase in output of about b% (or slightly above the 19)2-1952 aver- age) appears to be well within the limits of reasonable expectations. Hovrever, the terms of trade are likely to move against Peru. The prices of many of Peru's leading export articles such as lead, zinc, copper, cotton, sugar and wool, have already fallen sharply from the high levels of recent years. A further fall of copper and cotton prices has been assumed in making calculations for this report. On the other hand, there has so far only been a slight fall in Peru's import prices and their future decline will no doubt fall much short of the drop in export prices. On these assumptions an annual growth of output of L% could not be expected to lead to an increase in real income of more than 312%. 15. Peru's population has been increasing at a rate of about 2% per annum. There is every prospect that a sharp fall in the death rate will occur in the next decade, while it is not likely that there will be any significant fall in the birth rate. As a result, population will grow faster than before, and the rate of increase in population might be expected to reach 2.55