Peru - Country assistance strategy

Documet of The World Bank FOIt OFFICLAL USE ONLY RportN0 12997 PE EORANDUN OF THE PRESIDENT OF THE InTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BAW GROUP FOR PERU OCTOBER 28, 1994 Country Department III Latin America and the Caribbean Region This document has a esticted ditibution and may be used by reiets ony in th pefomanc of their official duties Its contents may not otherwis be diclosed without WoM Dan& authoriation.  DATE OF LAST CAS April 20, 1993 CURRENCY EOUIVALENTS (As of August 31, 1994) Currency Unit - Nuevo Sol (S/.) US$1.00 - S/.2.25 S/.1.00 - US$0.44 WEIGHTS AND MEASURES Metric System FISCAL YEAR January 1- December 31 ABBREVIATIONS AND ACRONYMS AEROPERU - Empresa de Transpone Aereo del Perd (Arine Company) AFPs - Adminisadoras de Fondos de Pensiones (Private Pension Funds) CORPAC - Corporacin Nruana de Aeropuertos y Aviaci6n Comercial S.C. (Comercial Aviation Corporation) C*PT - Compafa Perana de Telefonos (Penivian Telephone Company) CPV - Conpafifa Penana de Vapores (Peuvian Shipping Company) DDSR - Debt and Debt Service Reduction ECASA - Empresa de Comercializaci6n de Arroz S.A. (Agricultural Marketing Company) ELECTROLIMA - ELECTROLIMA (Lima Electric Company) BLECTROPERU - ELECTROPERU (Perd Elctric Company) ENAFER - Empress Nacional de Ferrncarriles (National Railrad Company) ENCI - Empresa Nacional de Comercializaci6nde lnmos (National Inputs Marketing Company) ENTEL - Empresa Nacional de Telecomunicaciones (National Telecommuniations Company) ESW - Economic and Sector Work FONCODES - Fondo Nacional de Compensaci6n y Desarrollo Social (National Social Compensation and Development Fund) FSAL - Financial Sector Adjustment Loan GDP - Gross Domestic Product GTZ - Gesellschaft fir Technische Zusammenarbeit (German Technical Cooperation Agency) IBRD - International Bank for Reconstmction and Development IDA - International Development Association IDB - Inter-American Development Bank IFC - International Pinance Corporation IFls - lnternational Financial Intutions IMF - International Monetaty Fund INDECOPI - Inshduto Nacional de Defensa de la Competencia y de la Propiedad ItelectuW (Instiute for the Defence of Intellectual Property and Free Competition) MDB - Multilateral Development Banks MIGA - Multilateral Investment Guarantee Agency NGOs - Non-Govermmental Organiations PEs - Public Enterprises PESCAPERU - PESCAPERU (Peruvian Fishing Company) PETROMAR - Petr6leos del Mar S.A. (Offshore Oil Exploration Company) PETROPERU - PETROPERU (Peruvian Oil Company) SAL - Stuual Adjustment Loan SEDAPAL - Servicios de Agua Potable y Alcantarillado de Lima (Water Supply and Sewerage Agency) TPRL - Trade Policy Reform Loan  FOR OFFICIAL USE ONLY Table of Contents Recent Economic and Social Performance ......................................... I A. Historical Perspective . .................................1...... B. Economic Developments Since July 1990 ........ ..................... 2 C. Macroeconomic Assessment: Three Years of the Economic Program . ..................................... 6 External Environment ............................................. 8 Peru's Development Objectives and Policies . ...................................... 10 Bank Group's Country Assistance Strategy . ........................................ 14 (a) Infrastructure Development . .................................... 15 (b) Income Disribution/Poverty Alleviation ............................ 17 (c) Institution Building . ........................................ 17 (d) Macroeconomic Sustainability ............. ...................... 17 Agenda for Board Discussion ............................................. 21 Annexes Annex Al: Peru: Selected Indicators of Bank Portfolio Performance and Management ............... ........ 23 Annex A2: Peru: Bank Group Fact Sheet, FY91-97 EBRD/IDA Lending Program, FY91-97 ........................ 24 Annex A3: Peru: Priority Poverty Indicators Supplementary Poverty Indicators Resources and Expenditures .25 Annex A4: Peru: Key Economic Indicators .28 Annex A5: Peru: Key Exposure Indicators .31 Annex A6: The Status of Bank Operations in Peru Statement of IBRD Loans and IDA Credits .32 Tables Table 1: The Changing Role of the State in the Economy. 3 Table 2: Peru: External Financing Requirements .12 Table 3: Bank Group's Country Assistance Strategy .16 Boxes Box 1: Peru: A Snapshot. 1 Box 2: Peru: Key Structurd Reform Measures .2 Box 3: Poverty and Indigenous Population .5 ox 4: Peru: E Nifio .7  MEMORANDUM OF THE PRESIDENT OF THE NTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCES1RATEGY OF THE WORLD BANK GROUP FOR PERU Recent Economic and Social Performance I. Peru is generously endowed with minerals, fish and hydrocarbons. Yet, despite its richness, it has heretofore failed to achieve a stable political, social and economic enviromnent capable of promoting social and economic development. Over the last thirty years Pern's economy has had a dismal performance and it is today Box Per: A Snapshot one of Latin America's poorest Box_1____A_Snapshot countries (see Box 1). By 1992, per capita income had fallen to levels Populatioui: According to the 1991 census, Peru's popuation is simiiar to that of 1960. Welfare about 23 million, of which 28.9 penent five in Limn. The average annual, growth rate since 1981 has been 2.2 percen indicators for Perd are among the The costa is the most populated area with 53 percent of toal worst in Latin America. It has the population, followed by the sierra wift 35 percent, the seva- second worst life expectancy at with 12 percent. About 70 percent of the population lv in birth, just above that of Bolivia, and urban areas. Per capita inconme is US$1,490. the sixth worst infant mortality rate. Age Distribution: Peru is a country of young people. About 31 Its income distribution is highly percent of Peruvians are below 15 years old; onl 4 perce a$e skewed, with the poorest fifth older than 64 years. earning only 4.1 percent of the Povry Profge: Natonwide it is esaed that about.20 income, while the wealthiest tenth percent of all households are extremely poor and about 50 receive 35 percent of income. percent are poor (uing adjustd poverty lines). Extremewpov is concentated in the mral sierra where 50 percent of the housebolds are extremely poor. In Lima, 10 percent of households are extremely poor. A. Hstorical aPesp tive Lngse: 'me predominant language bs Spanish, but Quecdu,- 2. During the past 40ya and other ie l es are also spoken. years, the Peruvian economy has moved from feast to famine. Throughout the 1950s, when government intervention was limited, there was a steady increase in per capita income. Economic activities were mostly unregulated and the economy was open to foreign trade. Nevertheless, economic wealth and social status were tightly concentrated in a small elite, mostly located in Lima. 3. Pardy in reaction to this concentration, these outward market-oriented policies were gradually abandoned, starting in 1963, and increasingly reversed by subsequent civilian and military governments. A poorly administered agranan reform, frequent changes in property rights, administered prices and overexpansion of state participation in the economy replaced prior economic po icies. Policy makers looked inward, the economy was partially closed to foreign trade and foreign corporations were natonalized. All these strategies were fueled by expansionary monetary and fiscal policies. The public sector deficit expanded, inflation accelerated and foreign debt grew rapidly.  4. By the 1980s, the results for both economic growth and poverty alleviation were devastating. PoliLdes aimed at social reform only worsened and perpetuated poverty. Frequent experiments in social engineering created economic and institutional uncertainty and a prolonged deterioration in governance. These, in turn, undermined productivity, fostered anarchy and public turmoil, and ultimately made poverty reduction impossible. The steady deterioration of the economy and the sociopolitical situation paved the way for terrorism. Attacks of Perd's terrorist movements and drug traffickers were responsible for a drop of 8 percent in per capita income between 1983 and 1990. 5. By the time President Alberto Fujimori took office in mid-1990, political violence was claiming more than 3,000 lives each year; tax collection was less than 6 percent of GDP, down from around 14 percent in 1985; real wages had declined by 60 percent since 1985; and the country was under hyperinflation. Prices had increased by a factor of 27 million over the previous three decades. B. Economic Develonments Since Julv 1990 6. In July 1990, Box 2 PerM: Key Structura Reform Measures the new administration inherited a government Fhm,6a incapable of providing basic * ltberaaon of inerest and exchange raes. services, including health, * elbmnaon of public developmen banks and stae inteveion in the allocation of crdi education and security; a . establishment of a framework for a private pension fund system. collapsed economy; badly . improvement of banking laws, as well as regulatoy and damaged infrastructure; and supervision functio. severe social inequality Trade exacerbated by hyperinflation. ompesv lbeian of the foreign trade sector. The new Government elimination of barriers to domesti trade. implemented the most liabor comprehensive program of refrm of labor ruls eliminaig labor sabit and establishing economic reforms in the more flexible regulation r ing the probationary peio d country's history, aimed at fixed-em contracts. reducing inflation, stabilizing the economy and radically F privatzaion program dtat includes the sale of all PEs to eiher changing the state-dominated national or foreign buyers. economy into a market- oriented one (see Box 2). scuring property rights faciliating land transctios. These reforms have been in grengdt the capacity of the state as a regulator of some large part embodied in the economic activities. Constitution ratified by a close * elmtion of pdoe ons and public monopolies. margin in an October 1993 * creation of the lute for the Defence of Intellectual Property popular referendum (see n Fe C Table 1).  -3 - TABLE 1: THE CHANGING ROLE OF THE STATE IN THE ECONOMY A COMPARISON OF THE 1979 AND 1993 CONSTITUliONS 1979 Constitution 1993 Constitution Art. 111: The state formulates the economic policies and No equivalent exists. Eliminates the concept of central social development plans that regulate the actvities of the planning. public sector. Art. 112: The state guarantees economic pluralism. Art. 60: The state recognizes econonic pluralism. Only when authorized by a specific law, and in case of high public interest can the state became involved in subsidiary business activity. Art. 116: The state promotes and protects the free No equivalent exists. Eliminates the promotion of development and autonomy of businesses and cooperatives. cooperatives. No equivalent exists. Art. 65: The state defends the interest of consumers and guarantees the right to information on goods and services provided by the market; ir. particular for the health and security of the population. Art. 122: The state sthmulates mining activity. No equivalent exists. Mining is no longer subject to special treatment. Art. 138: Economic and financial administradon of the Art. 77: The budget guides the activity of the state. Its cental government is guided by the annual budget programming and execution respond to criteria of approved by Congress. Local and regional governments efficiency, basic social needs, and decentralizaion. The have their own budgets. budget is consolidated. 7. The program included stringent fiscal and monetary measures and radical macroeconomic reforms. A cash management committee has maintained public expenditure in line with tax collection, and credit from the Central Bank to the public sector was eliminated. The tax system was reorganized and interest rates and foreign-exchange transactions were liberalized. Structural reform also called for deregulation at both national and sectoral levels, including the elimination of state monopolies. The program strengthened the role of market mechanisms in the allocation of resources, and implicitly defined a subsidiary role for the state in the economy with the privatization of all public enterprises (PEs). Policy, legal, and regulatory reforms were introduced in virtually all sectors of the economy to promote competition, private sector participation and efficiency. Under the program, Peru made the initial steps to reintegrate into the international financial community by reestablishing relations with multilateral financial institutions and the Paris Club. However, a debt deal with commercial banks is still pending (para. 26). 8. Agriculture. In the agriculture sector, the Government implemented a fundamental reform. It moved quickly to liberalize product, financial and land markets and  to reduce the budgetary drain caused by subsidies and price guaantee mechanisms. Price controls were removed while price guarantees were replaced by a price floor mechanism for essential agricultural products. ECASA, the agricultural marketing agency, was liquidated, while ENCI, the agricultural import monopoly agency, was restructured and its monopoly removed. Preferential interest rates in agriculture were eliminated and the unprofitable state agricultural bank liquidated. Land can now be more easily traded, leased or mortgaged. Maximum land holding limits were raised and land registration procedures simplified. A land titling agenda for small holders is being developed. The Government has also made progress in the liberalization of water markets. Management and operation of public irrigation networks is being transferred to user groups while water tariffs are being adjusted to ensure cost recovery for operations and maintenance. It is expected that existing water rights will be vested in existng users and rew water rights will be auctioned to create a water market, where farmers will assume full financial and technical responsibility for rehabilitation of water works. 9. Ener and Industrv. In the energy and industry sectors, the Government implemented a wide-ranging structural reform program aimed at establishing market-based policies, a transparent legal and regulatory environment, and a radically reduced role of the public sector. Competition and private investment were promoted by comprehensive privatization. More than 30 companies have been privatized in the last two years, yielding roughly $2.6 billion in cash proceeds plus $700 million in future investment commitments. Of the major privatizations remaining, the Government plans to privatize: (a) electricity generation, (b) PETROPERU, the oil company, (c) CENTROMIN, a major mining complex, and, (d) Banco Continental, the second largest bank. A new hydrocarbons law became effective in November 1993, liberalizing the sector, eliminating PETROPERU's monopoly rights, deregulating petroleum product prices and establishing new procedures for contractua arrangements between the govemment and petroleum companies. The tax regime for petroleum products was brought in fine with the general tax system and PETROPERU's privatization was initiated with the sale of its subsidiaries. In mining, a leading export sector, the 10 percent export tax was removed. A new mining law was enacted as well as regulations to foster private investnent. By early 1994, five state-owned mining companies were privatized, resulting in US$172 million in cash and US$635 million in investment commitments. In power, a new electricity law and accompanying regulations were enacted during 1992-93, to open the sector to private investment, and promote competition via the separation of generation, transmission and distribution activities. The distribution network of ELECTROLIMA, one of the two largest power PEs, has been privadzed, and its generation and transmission are being prepared for privatization. ELECTROPERU, the other large power PE, is being prepared for privatization. In fisheries, the second most important export sector, the monopoly rights of the state-owned fish marketing and distribution agencies were eliminated. The sector was opened to foreign investment and a new fisheries law enacted. The Government is currently developing a fisheries management regime consistent with this law to prevent depletion of the resource. PESCAPERU, the fish processing PE, is being prepared for privatization. In telecommunications, a new telecom law was enacted in November 1991, and ENTEL and CPT, the telephone companies, were privatized in February 1994.  - 5 - 10. Infrastructure. The Government has taken bold steps to restructure the physically deteriorated and grossly mismanaged infrastructure sector. Early on, it removed all price, entry and route regulations affecting the provision of transport services, including trucking, intercity bus, urban and air transport. Major transport PEs were privatized, including the shipping company (CPV), the national airline (AEROPERU) and the urban bus companies in Lima, Trujillo and Arequipa. Privatization of others, such as the railroad company (ENAFER) and the civil aviation authority (CORPAC), are underway. S-veral profit-making ports are under preparation for privatization and cargo handling was transferred to the private sector. As a result of these measures, transport costs have declined, services have increased and transport options multiplied. Subsidies to loss-making enterprises were eliminated and the role of the private sector enhanced. In the water sector, the Government is preparing the privatization of the Lima water company (SEDAPAL), along with a regulatory framework to ensure water quality wLlle promoting private sector participation. In housing, the government has withdrawn from direct provision of housing in favor of the private sector. 11. Poverty Alleviation. In the face of overwhelming problems in the social sectors, particularly for the indigenous community (see Box 3), the Government established in 1990 a social emergency program to provide direct food and health assistance to the poor. This program was replaced in August 1991 by FONCODES, the National Fund for Social Compensation and Development, a mechanism for channeling government and donor resources to labor-intensive projects. Since its creation, FONCODES has become the Box 3 IPar Pveoty and the g Iblpdaton The indigenous population, defined by individuals that speak ony Quedwa, Aymara or another indienu language represent about 11.3 pcrcent of the total popuadon. Pem is a mesio county, however, sad Ibis. definion understates the share of the indigenous population by not coumng individuals that speak bot anish and an ifdigenous language. The indigenous populaton mostly resides in the rural sierra, the poorest aea of tan country. According to a 1991 household srvey: * poverty and language are highly correlated: 79 percent of nonpanis-speaking households are poor ai:d 55 percent are extremely poor. Morwver, the non-spanish-speakig poulaion is 1.3 times nore eiiy.: to be poor than the rural spanish-speakig populto; * the educational gap between the spanish-speaking and non-spanish-spe population is dcinin but the survey shows that non-spanish-speaking men still average 3.3 years of schooling o les an-aiS-' speaking men. The educaional gap is greater for women; * unemnployment is higher in the non-spanish-speakingpopultion (46 percet than it is in toe sp;:sh speaking population (36 percemnt). The smuvey also reports that the non-spanish-speaking populaton primarily employed in frming; * average income for the spanish-speaking population is more tban double the average inome of-the mu- spanish-seaking population; * the non-span-speakigpopulation has less access to public servces like runnmg water, sewe electricity. In rual areas only 4 percent ca no-speaking-people have access to pbli seweiv Y -aciities; * non-spanish-speakcing infant mortality is more ta double infant notli~yi pns-paig am ilie^  - 6 - Government's main instrument to achieve its goal of reducing extreme poverty, located primarily in Per6's rural areas, from 20 percent to 15 percent by 1995. FONCODES encourages close involvement of community representatives, and responds to demands from poor communities for rehabilitating social and economic infrastructure, and improving access to basic social services. 12. In early 1993, the Government prepared its first poverty alleviation strategy. This strategy seeks to promote broad based economic growth and to improve the living conditions of the extreme poor through FONCODES as well as through food assistance, health, and education programs coordinated through the Ministries of Health and Education. In health, the Government is seeldng to enhance the quality of primary health services, particularly for maternal and child health. In education, the Governuent has sought to lay the basis for education reform widh improved participation of the private sector. Resources for managing educational services would be shifted to local communities. The Government seeks to increase the efficiency and quality of primary education and to improve literacy and job skills among non-literate adults. A national nutrition program is providing food to vulnerable groups to meet their nutritional requirements. 13. Environment. In late 1990, Perd adopted an environmental code, which took the critical steps of abolishing legislation that provided incentives for colonizing the Amazon region and requiring the preparation of an environmental impact statement for any activity in the Amazon-public or private. From 1993 to 1994 additional legislation was passed requiring environmental impact studies for investments in the development of mining, industry and fishing. Parallel to these legislative efforts, the Government has taken steps to strengthen the institutions responsible for the naural environment. In 1990, the National System of Natural Areas Protected by the State (SINANPE) was established, creating a national park system. This was followed by the creation in 1993 of the National Institute of Natural Resources (INRENA), which principally coordinates the management and conservation of Perd's natural parks, and establishes and monitors standards for pollution associated with agricultral activities. C. Macroeconomic Assessment: Three Years of the Economic Program 14. The Peruvian economy has reacted positively to the stabilization and structural reform program. Inflation dropped from 7,650 percent in 1990 to 40 percent in 1993. However, economic growth has been more erratic. GDP increased in 1991 by 2.7 percent but declined in 1992 by 2.8 percent, largely as a consequence of the occurrence of "el Nifno" (see Box 4). El Niuo caused a severe drought that reduced Perd's capacity to generate electricity. It also was responsible for output declines in fishing, agriculure, manufacturing, and mining. On top of el Niub, fish exports were also hurt by the cholera epidemic that struck Perd in 1992, which was a result of the deterioration of the state's capacity to maintain and provide public services such as sanitation and clean water.  15. The economy recovered Box4 Ps* ElNiI strongly in 1993. The driving force of the econonic growth was not government El Niflo is a phenomenon that strikes Peru about spending, but the participation of a buoyant every four to eight years. changing sea current private sector. Peru's GDP grew by 7 and weather conditions. Its intensity is irregular, percent, with labor productivity in the but the strongest occur about eveiy fifty years. manufacturing sector growing by about 21 During this century, el Nlfto has returned to Peru percent. Productivity has increased at an in 1914, 1925126, 1931/32, 1941/42, 1953a54, 1957/58, 1965, 1972/73, 1975/76, 1982/83 and annual rate of 11 percent since 1990. The 1992. The strOngeSt were in 1925 and 1982. source of this increase in productivity has been a lower and more stable rate of The effects of el Nifio on Peru's most important inflation, maintenance of stuctural reforms, export sectors cm be devastating. Fishing and including deregulation and trade agriculture can collapse due to its effects on sea liberalization, and the reestablishment of currents and weather conditions. Manufacturing and mineral extraon can be severely slowed public order. Part of the GDP growth in down by el Nifno's effects on the weather, which 1993 was the result of the recovery of reduces the capacity of Peru to generate sectors affected by the 1992 drought. electicity. Fishing grew by 24 percent, with the -___ fishmeal industry setting output records. Agriculture production was up by 10.3 percent and mining by 7.8 percent. The construction sector picked up in 1993, growing by 14 percent during the year. Since August 1990, construction has more than doubled. 16. With accelerated economic activity, the current account deficit increased from 2 percent of GDP in 1989 to 6 percent in 1993. This increase reveals a growing gap between aggregate investment and national savings. While high, the deficit is sustainable in the near-term given the trend in capital inflows. These have increased greatly since 1990, because of high real interest rates and a reduction of the perceived country risk. Part of the inflow is foreign in origin, mostly in portfolio investment and proceeds from privatizations, while part is the return of domestic flight capital and the proceeds from the illegal drug trade. These flows of private capital have not only sustained a growing current account deficit, but also increased net intemational reserves at the Central Bank (excluding reserve deposits in U.S. dollars) by US$819 million during the 1990-93 period. As the stabilization program consolidates, significan: capital inflows are expected to continue. 17. The fiscal discipline and tight monetry policy maintainedd during the past three years provide a strong indicatian of the Government's commitment to reform. As a consequence of these sound pclicies, the primary fisal balance moved from a deficit of 2 percent of GDP in 1990 to a surplus of 0.1 percent of GDP in 1993, while the consolidated public sector deficit declined from 6.5 percent of GDP in 1990 to 3.1 percent in 1993 (both before privatization revenues). Revenue collected by the central government, including tax collections and other sources of revenue, increased from 9.5 percent of GDP in 1990, to 10.5 percent of GDP in 1993. Nevertheless, tax collection remains a problem. It declined from 10.2 percent of GDP in 1992 to 9.6 percent of GDP in 1993 due to lower excise taxes  - 8 - and continued tax evasion. The tax collection rate, although increasing in the first eight months of 1994, remains low compared to other Latin American countries and to Perd's levels during the 1970s and early 1980s. 18. Adjustment of the fnancial sector continues. The main elements of the reform are: (a) a modern banking famework which encourages competition among banking institutions; (b) the privatization of state-owned commercial banks; (c) the downsizing of Banco de !a Naci6n, the state-owned Bank that offers services exclusively to the public sector; (d) a new capital markets framework that redefines the role of security brokers; (e) the introduction of the private sector in the pension fund system; (f) strengthened banking supervision; and (g) the liquidation of the development banks. The new rules of the game are forcing private financial institutions to re-think the way business is conducted, restructuring portfolios and changing lending strategies. The remaining major risk to the financial sector is its high concentration: the two largest commercial banks account for 46 percent of total assets--one of the largest concentrations in the world. For this reason, interest rates are defined by these two institutions. Other serious problems include the lack of long-term financing, high interest rates, low intermediation levels, and the high number of financial conglomerates, which represent an impediment to effective regulation and supervision. 19. Following the economic reforms introduced in mid-1990, the real exchange rate appreciated until it stabilized in the second quarter of 1994. In spite of this appreciation, there is little evidence of exchange rate overvaluation. The appreciation of the real exchange rate has been caused by domestic policies congenial with long-te.n economic expansion, and by changes in the international financial community's perception of the region in general, and Perd in particular. These domestic and external effects have generated conditions for the capital inflows which have supported the real appreciation. Nevertheless, prudent economic policies have offset, in part, the effects of capital inflows on the real exchange rate. Moreover, any negative impact of the appreciation of the sol on COmpetitiveness has been compensated by increases in productivity (paragraph 15). Exteral Environment 20. Peru's economy remains highly vulnerable to exogenous factors and changes in its external environment. Besides climatic shifts, recent external events that have had a significant impact on the country's economy and the Bank Group's assistance strategy Tnclude: (a) foreign trade; (b) external debt; and (c) privatization. 21. Foreign Trade. Peru's traditional exports are concentrated in minerals, commodities and hydrocarbons. Exports of goods and non-factor services declined in real terms at an average rate of 1.4 percent during 1980-91. This decline reflects both the policies of the 1980s as well as adverse external factors. Perd's terms of trade declined by 65 percent during 1980-92. Severe macroeconomic instability, misallocation of resources  and appreciation of the Peruvian currncy during the 1980s also adversely affected export performance. Terrorist activities, moreover, contributed to the decline of mining and tourism. 22. The Govenmment has implemented a full-scale trade liberalization as part of its program of stabilization and structural reforms. It included the elimination of most non-tariff barriers and the reduction of the Pumber, level and dispersion of tariffs. Perd now has two import tariffs (25 and 15 percent), and is moving towards unification at 15 percent and the elimination of the remaining non-tariff barriers. Overall, exports in dollar terms have expanded modestly-by 6 percent-since 1990, masing an important shift. Non-traditional exports have grown rapidly, increasing as a percent of total exports from 30 percent in 1990 to 36 percent in 1993. In 1993, traditional exports declined by 7 percent while non- traditional exports expanded by 19 percent. The poor performance of traditional exports stemmed from: the low internatonal prices of most traditional exports from Per6, antiquated and poorly maintained infrastructure and facilitating services, the cholera epidemic of 1992, and recurrent natural disasters such as el Nifio. 23. Future - cts are brighter; exports are forecast to grow by 7 percent anually on average d ^994-96, reflecting expected trends in the external environment. These growth rates can be sustained because: (a) the structural reform program--particularly the privatization of mineral and other PEs--is expected to expand Perd's capacity to export; (I) world growth and world trade are expected to pick up; (c) terrorist activities have declined; (d) changes in Perd's terms of trade are expected to be minor; (e) Perd's small share in world trade and the mix of its exports makes it unlikely to be targeted for protectionist or retaliatory measures; and (f) Peri, along with other Andean Group members, is reducing regional trade barriers and thus expanding regional trade. Peru is planning to fully rejoin the Andean Group when commercial policies between members are compatible. In the meantime, it will expand bilateral agreements with Andean Group members. 24. Externl Debt. Perd's remains heavily indebted; total external debt outstanding was US$21.4 biLlion at the end of 1993, representing 500 percent of exports of goods and services and 47 percent of GDP. Total debt service iu 1993 was US$5.5 billion, equal to 129 percent of exports Lf goods and services, up from 24 percent in 1992, due in part to the debt workout arrangements with IFIs and the Pans Club. Total debt to commercial banks in 1993 was US$7 billion, more than half of which is past due interest. The accumulation of interest arrears to commercial banks during 1993 alone increased interest past due by US$400 million. 25. Perd is addressing this heavy debt burden in stages. The Govermnent of President Fujimori has made significant progress in reintegrating PerG into the international financial community. The overall external debt strategy has involved agreements with IFls and the Paris Club, and first steps to solve the commercial bank debt problem. Perd cleared arrears with the IDB in September 1991, and with the IMF and the World Bank in March  - 10- 1993. The Government rescheduled its official bilateral debt with Paris Club creditors in September 1991 and May 1993. The current agreement expires in March 1996, and will need to be renewed. 26. Perd is moving forward to resolve its commercial bank debt arrears. In November 1992, the Government issued a tolling declaration to the Bank Advisory Committee representing foreign commercial banks, paving the way for the first negotiations between Perd and commercial banks. Several meetings have followed, and Perd has offered the use of a debt-for-equity conversion program, attached to the privatization of PEs, as a way to advance negotiations. Legal issues which had blocked further negotiations have recently been resolved, and an agreement may follow in 1995. 27. Privatization Revenues. Perd's privatization program, a source of considerable foreign interest and capital inflows, has netted about US$2.6 billion in cash, US$1 billion more than expected. The Government earned this windfall, which represents approximately 3 percent of GDP and 32 percent of tax revenues in 1993, mainly from the sale in Febnrary 1994 of Per6's telephone system to the Spanish telephone company. With several large privatizations still in the works, it is likely that revenues could reduce further the squeeze on the budget and give the Government an opportunity to improve its social progrms, within the limits of its absorptive capacity. At the same time, the exceptional revenues could contribute to driving up the price of resolving Peru's arrears with foreign commercial banks. The Government should not jeopardize the stabilization program by spendig beyond its capacity, but instead should use some of the privatization revenues to resolve its extensive unfunded liabilities, such as domestic debts pending to the public pension fund and left behind by the liquidated development banks, and/or its foreign obligations. These unfunded liabilities are estimated to be over US$4 billion. Peri's Development Objectfves and Policies 28. Perl's economy has improved remarkably due to firm fiscal discipline and an equally firm commitment to economic reforms. However, resuming growth and reducing poverty on a sustainable basis after 30 years of stagnation are difficult tasks; many challenges lie ahead. On the social and political front: (a) poverty, a skewed income distnrbution, and ethnic alienation continue to divide the country; (b) terrorism and drug trafficking drain scarce resources, and weaken the efforts to integrate the country; and (c) political instability remains a risk; if it increases, fundamental economic reforms could be slowed down or even reversed. On the institutional front: (a) government institutional capacity remains weak, government decision-makimg is highly centalized, and the government has yet to design and implement its decentralization agenda; (b) weak sectoral ministries and central government officials' distrust of NGOs and local administations hinder the implementation of an ef.icient anti-poverty program; and (c) fragmentation of environmental responsibility among ministries remains, and Peri has not yet followed the lead of other countries which have created a national planning agency or ministry specifically for the environment. On the economic front: (a) infrastucre remains badly deteriorated  - 11 - from years of neglect and mismanagement, creating bottlenecks which inhibit economic growth; and (b) the fiscal situation remains precarious, especially because of low tax collection and unfunded obligations of the central government, including external debt and pension liabilities. 29. To meet these challenges, the Government's present strategy is to concentrate on two broad strategic objectives: the promotion of a free market system integrated with' he global economy; and the development of a state centered on the capacity to provide basiL public services, including social services, infrastructure, public security, environmental protection, and a stable environment for economic growth and poverty alleviaton. 30. The Government's 1993-95 program, supported by an External Financing Facility (EFF) of the IMF, reflects the Government's intention to stay the course in terms of maintaining economic stability and to continue to implement the program of structral reforms. In 1994, the GDP growth target will be substantially exceeded-reaching at least 10 percent--while inflation will be reduced from 40 percent in 1993 to about 20 percent. The fiscal situation, although still fragile, is expected to improve. Foreign investors are responding positively to the privatization program, the surplus in the capital account of the balance of payments has been increasing, and international reserves have grown. Nevertheless, the reserves position requires further strengthening in the near term. Nefting out short-term liabilities of the central bank to residents and likely use of privatization proceeds to meet unfunded liabilities', available reserves are equivalent to about 3 months of imports, and further reserve accumulation is justified to protect against the potenial variability of capital flows. 31. In the medium-term, given the favorable policy environment and improved security situation, gross domestic investment is expected to increase to 20 percent of GDP by 1995, up from 16 percent in 1992. This should make possible sustained GDP growth rates of 5-6 percent per year. (See Annex 4.) Exports are expected to grow at an average of 7 percent, with non-traditional exports gaining a higher share of the total. (Although the real exchange rate may appreciate further if good economic management and improved security continue to attract capital inflows, the governmevt's clear commitment to tight fiscal and monetary policy will help maintain Per6's external competitiveness). Given rising imports fueled by strong investment and GDP growth, the cufrent account deficit in the next few years is projected to be in the range of 5 percent of GDP. Taking into consideration the need for principal repayments and additional reserve accumulation, the financing needs over the medium-term would average about 6.4 percent of GDP. Assuming a base case lending scenario for IBRD (see paragraph 45), it is estimated that PerG can expect about 1.6 percent of GDP from net MLT disbursements from official sources. The remaining gap of 4.8 ' Out of the grmss internafional reseres of about US$6.5 billion in mid-1994, more than US$3.8 bilion constiue the resere requirements against dollar deposits in dte banking system, i.e., shortterm liabilities of die central bank to rdents. And over US$2.4 billion are ptoceeds from die privatiaon, which are assets of the treasury that should be used in part to resolve its subsUntial unfided habities, including external debt (see paragraph 27). It is reasonable to assume t at least US$1 billion is allocated in the near term for that purpose.  - 12 - debt from private sources, and short-term capital inflows. Reliance on substantial short-term capital inflows is too risky, and Perd must take furither steps to complete its reintegration into the international financial community. Toward this end it is essential to conclude a debt and debt service reduction agreement with its commercial bank creditors. Under this scenario of continued good economic management, efficient private sector-led investment and high GDP growth would lead to sustainable external debt ratios. TABLE 2: PERU - EXTERNAL FINANCING REQUIREMENTS US$ billions 1994 1995 1996 1 19,7 1998 Fmancing Needs 5.0 2.8 3.6 4.3 4.6 1. Current Account Balance 2.6 2.5 2.7 3.2 3.4 a. Non-Iterest Current Account 1.7 1.6 1.6 2.1 2.3 b. Interest Payments Due 0.9 0.9 1.1 1.1 1.1 2. Principal Repayments Due 0.5 1.4 0.7 0.8 0.8 3. Reserve Changes 2.0 (1.1) 0.2 0.3 0.3 Finning Sources 5.0 2.8 3.6 4.3 4.6 1. Net MLT Disb. from Official Sources 1.2 0.8 0.8 0.8 0.8 2. Net Foreign Direct Investment 3.1 0.7 0.8 0.8 0.9 3. Official Grants 0.1 0.1 0.1 0.2 0.2 4. Other Private Sector* 0.7 1.2 1.9 2.5 2.7 Me; o, Items: i Reserves** 2.7 1.6 1.8 1.9 2.0 Months of Imports 6.0 3.0 3.0 3.0 3.0 * Including net short term capital flows. **Reserves are calculated as follows: total liquidity minus international short-term liabilities minus resident short-term liabilities (mostly required reserves of commercial banks). 32. While the economic program has achieved remarkable results and laid the foundatior for growth, key constaints to sustainable development remain. Perd's tax collection remans low due to a large informal sector, continued tax evasion and a small tax base; this restricts the government's capacity to provide basic services and reduce poverty. The effectiveness of Perd's public expenditures can still be improved. There are large expenditure needs in social security and infrastructure, a weak civil service organization and administrative practices, and continuous tension between central and local governments. In  - 13 - addition, the Government must absorb significant costs in its continuing efforts to defeat terrorism. Recognizing its low implementation capacity, the Goverunent has restricted public investment. This could prove unsustainable in the long-term given Perd's needs in the social and infrastructure sectors. Perd's poor and deteriorated infrastructure limits its capacity to compete abroad and inhibits economic growth. Pervasive poverty and ethnic tensions hinder economic development. Degradation of the natural environment jeopardizes Peri's tourism potential, the availability of potable water, and the sustainability of investments to exploit Peri's natural resources, in particular timber, petroleum, natural gas, gold and fisheries. And finally, a weak judicial system for contract enforcement and the legacy of two decades of state intervention have imposed limits on the speed of private sector adjustment. It will take time to rebuild social and economic institutions in Perd and generate the human capital needed to ensure sustained development. 33. The Govermment is addressing these constraints through its reform policies. It is broadening the tax base, eliminating tax exemptions, refomiing tax laws and enforcing them. This in turn will improve tax collection and reduce the tax burden on the formal sector. The Government is planning to privatize most of the remaining PEs by the end of 1995, which will continue to reap major efficiency gains, increased tax collection, reduction in transfers and substantial direct eamings. The authorities plan to strengthen budgetary and accounting procedures and develop a unified information system to control efficiency in public spending. 34. The Government has begun to rehabilitate basic inftructure-especially in tansportation, water supply and sanitation and urban and rural services-both to improve conditions of the poor and to promote growth. Infrastructure rehabilitation concentrates on areas where the poor live. To reduce poverty and ethnic tensions, the Govermnent will also coninue to use targeted intervention programs in areas of extreme poverty, like the rural sierra, and in urban pueblos jovenes, via FONCODES. It will also use part of the privatztion earnings to advance its social agenda. The Government will continue to take important steps to improve the natural environment, including strengthening management of its national parks, improving sanitation, and completing and enforcing environmental legislation and regulation in the energy, mining and fisheries sectors. A key action will be the Government's effort to restore public order, especially in areas previously controlled by terrorism, to better integrate all elements of the country. 35. Finallv, the Government plans to deregulate capital, labor, and land and water markets to increase productivity, reduce costs in reallocatng resources in the economy and elimnate distortions that obstruct the development of these markets. Deregulating the labor market will help to integrate the informal sector into the formal economy. Developing a market for land and water rights will require an efficient mechanism for titling and registering land and water ownership rights and an efficient judicial system capable of enforcing contracts. However, before appropriate laws can be enacted, the Government still has to overcome the strong opposition to labor, land, and water markets reforms, and build consensus among all sectors of society on the long-term benefits of these reforms.  - 14 - Bank Group's Counpry Assstance Strateg 36. After Peri resumed debt servle payments to the Bank in October 1990, our initial lending strategy, presented to the Board in July 1991, was to support the Govermnent's macroeconomic stabilization and strucural reform program through a series of adjustment loans. These loans contributed to Pern's multilateral debt work-out and were consistent with the Bank's policy for countries with protracted arrears. The policy reforms supported by these loans, two of which were fully disbursed upon arrears clearance in March 1993, have dramatically changed the orientation of the economy from the state to the private sector, and have been largely achieved2. 37. The last Country Assistance Strategy, presented to the Board on April 20, 1993, initiated a shift toward investment lending intended to help the Government achieve its long-term objectives of growth and poverty reduction. It introduced the elements that we plan to pursue over the long-term: poverty alleviation, mfrastructure development, and institution building. Based on that strategy, while stdll focussing on structural reforms -th gh adjustment lending and policy advice, during FY94 we supported the fight against poverty with targeted investment programs for health and nutrition and FONCODES. Likewise, we began supporting infrastructure development, with loans of an emergency nare, for long-neglected maintenance and rehabilitation of the transport system, especially highways. In institution building we continued to provide technical assistance in support of the institutions responsible for privatization and the complementary regulatory and legal framework. This strategy was also fully reflected in the ESW program which included a Poverty Assessment Report (May 1993), a Country Economic Memorandum (March 1994), and a Public Expenditure Review (to be released). 38. The proposed strategy for FY95-97 will continue to pursue the long-term objectives of poverty alleviation, infrastructure development, institution building and macroeconomic sustinability as set forth in the previous CAS but will make a more pronounced shift to address these long-term challenges and will more fully reflect the following considerations: Poverty reduction is the central objective of the Bank's involvement in Perd. This must be achieved through both private sector-led and environmentally- sustainable growth and investments in public goods and services which directly benefit the poor. Given that much has already been achieved in creating a policy environment for overall growth, increasing attention must be given to investment in public goods needed for growth and poverty reduction while sustaining good macroeconomic management. TIe reform progtam in the finanal sector is sdll ongoing, and the final tranche of one of the loans, the Financial Sector Adjusmen Loan, is still pending the compleion of the program. Likewise, tie privadzaion program condnues at full speed, anth ie third tanche of the Pdvtizaion Adjusm Loan, approved immediatey aftr the debt workout, is also pending.  - 15 - * In pursuing this central objective of poverty reduction, the Bank must be selective, concentrating its attention and resources to ensure its effectiveness and relying on partnerships with other institutions to pursue other essential objectives. The roles envisioned by the IDB and IMF are discussed in paragraphs 52-53 below. * Given that PerG has completed or will soon complete the core agenda of structural reforms, our strategy involves a further shift from adjustment lending to investment lending. Following the Electricity Privatization Adjustment Loan which is presented to the Executive Directors together with this CAS, we would consider only one additional adjustment loan if needed to support public sector reforms and provide financing for a possible Brady deal with commercial bank creditors. 39. With these considerations in mind, the Bank will concentrate its efforts during FY95-97 primarily on investment lending in the infrastructure and social sectors, including support for the corresponding public institutions, and on sustaining good macroeconomic management. Given Peru's stage of development, we believe that concentrating our efforts in these areas will maximize the Bank's contribution to poverty reduction. The following paragraphs provide more detail about our proposed involvement in these four areas of concentration, and Table 3 provides a summary of the planned lending operations and ESW program consistent with the proposed strategy. (a) Infrastucture Development 40. In the infrastructure sector, the Bank's long-term objective is to improve the performance of infrastructure services--focussing on roads and highways, urban, intercity and rural transport, water supply, sewerage, and urban and rural services--so as to provide the basis for robust economic growth, particularly in the private sector, and to increase the effectiveness of infrastructure services in addressing poverty in both rural and poor urban areas. To achieve this strategy, the Bank will support the Government's efforts to rehabilitate greatly deteriorated infrastructure, restructure institutions in the subsectors mentioned above to open the way for private sector involvement, and at the same time, strengthen public sector institutions at the central and local level to assume their role in the restructured environment. In particular, we will assist the Government in defining and implementing a strategy to redirect expenditure on infrastructure to directly benefit low income populations. Other key elements in this strategy will be to address the resource mobilization issues in the infrastructure sectors, both at the central and local level, to improve the effectiveness of expenditure through better programming and budgeting processes, and to ensure appropriate environmental impact assessments.  - 16 - TABLE 3: BANK GROUPS COUNTRY ASSISTANCE STRATEGY Policy Priorities Proposed Bank ActivMtes ObJective Objective_______________ _ _ Lending Economic and Sector Work Infrastructure * Improve performance of Electricity Privatization Adjustment Loan (FY95) Water Resource Management (FY95) Development infrastructure services, particularly Lima Water Rehabilitation and Management Project Provision and Regulation of Urban Transport (FY97) urban, intercity, and rural transport, (FY95) water supply, sewerage, and urban Irrigation Subsector Project (FY95) services. Rural Roads Rehabilitadon and Maintenance Project (FY96) Municipal Finance and Management Project (FY96) Land-Water Management Project (FY97) l Social Sector * Promote human resource Primary Education Project (FY95) Poverty and Income Distribution (FY96) Development development and encourage targeted Primary Health (FY97) measures that reach poorer groups. Institution Building * Improve effectiveness of public Lima Water Rehabilitation and Management Project Assessing Local Government Investment Capacity agencies and redefine the role and (FY95) (FY95) structure of both local and central Irrigation Subsector Project (FY95) Public SRector Reform (FY96) Government institutions. Municipal Finance and Management Project (FY96) Primary Education Project (FY95) Primary Health (FY97) Mining Envircnment Project (FY97) Macroeconomic * Sustain fiscal and monetary policies Electricity Privatization Adjustmnent Loan (FY95) Economic Policy Notes (annually) Sustainabilily and continuation of key reforms. Country Economic Memorandum: the Reform Experience (FY97)  - 17 - (b) Social Sector Development 41. To help the govermnent develop Perd's most important resource, its people, the Bank will assist in designing and implementing programs to improve primary education and health services. Priority will be given to improving the efficiency and sustainability of expenditures, strengthening both central and local instutions, and deliveing these services to the poor. This will involve financing both infrastructure investments in these sectors and technical assistance. Considering the particular relevance to social sector policies, we will analyze poverty and income distribution based on the results of the 1994 LAving Standards Measurement Survey fmanced by GTZ and th- IDB. This work should provide useful information about the effects of recent economic policies on the distribution of income and on poverty and also provide a better basis for targeting of public expenditures toward the poor. (c) Insitu&ion Buildng 42. The Bank's strategy is to assist the Government in redefming the role and structure of both central and local Governmen institutions to (a) conform with the needs of a market economy and a reduced role for the state, (b) improve capacity to design and implement public policy, and (c) provide more effective service delivery. The Bank will assist the Government with reforms aimed at strengthening the weak institutional base in the social and infrastructure sectors, which inhibits the implementation of programs in these areas. We will also assist the Government in designing public sector reform to improve government efficiency in virtually all sectors. To supplement our lending and sector work, and due to the Government's reluctance to borrow for technical assistance, we will continue to seek grant financing to assist the Govermment in this area. (d) Macroeconomic Sustainabiy 43. Despite the very significant progress in the last four years, Perd's macroeconomic situation remains fragile. Therefore, we will conime to provide support for good macroeconomic management in several ways, thereby complementing the likely continued involvement of the IMF. First, the Electricity Privatization Adjustment Loan will require maintenance of a satisfactory macroeconomic program. Second, if needed to support a Brady deal with commercial bank creditors which would reduce the debt overhang and thereby contribute to the credibility of the macroeconomic program, we would consider an additional adjustment loan (particularly focussed on further public sector reforms) and/or a free-standing DDSR lending operation. And third, part of our economic and sector work program-particularly short policy notes responding to policymakers' concerns--would deal with topical issues of economic management.  - 18 - 44. Environment and Private Sector Development. Although environment and private sector development issues will not be areas of Bank concentration in the near-term, we will be involved selectively, taking into consideration the roles of partner institutions. In addition to providing urban water and sanitation, our program will include attention to environmental sustainability in key extractive sectors which are essential for private sector- led growth. Specifically, through the on-going Privatization Adjustment Loan, we remain involved in the development of a sustainable policy regime for fisheries. Also, as a follow- up to the on-going technical assistance loan on mining and the environment, we anticipate a lending operation to fully establish and promote good environmental practices in the mining sector. The planned involvement in land and water management would be directly primarily at preventing soil and water degradation in rural areas and hence serve the complementary objectives of rural poverty alleviation and environmental protection. Finally, we are now preparing a GEF grant which would provide support for the protection of national parks in the Peruvian Amazon. Our principal involvement in private sector development will be continuing support for the privatization program and associated legal and regulatory reforms. In addition to the Privatization Adjustment Loan and the Technical Assistance Loan for privatization, the two new lending operations presented to the Executive Directors at the same time as this CAS--the new Electricity Privatization adjustment Loan and Lima Water Rehabilitation and Management Project-will support the privatization in these key sectors. Finally, we will continue to be involved in the reforms of the financial sector through the completion of the on-going Financial Sector Adjustment Loan. 45. Lending Levels and Composition. Under a base case lending scenario, new IBRD commitments to Perd are expected to average about US$425 million annually during FY95-97. This level of lending would be contingent on a continuation of good macroeconomic management (including tight fiscal and monetary policies which prevent a resurgence of inflation) and continued progress in the structural reform programs already initiated by the government (including privatization and development of a policy environment conducive to private sector development). Under this base case scenario the Bank's lending program includes the Electricity Privatization Adjustment Loan (amounting to 30 percent of planned lending in FY95) and investment loans for infrastructure development (water, irrigation, and transport), education, health, and municipal development. 46. Under less favorable developments, Bank lending during FY95-97 would be reduced from the base case level. The scope and size of the lending program will depend upon the Government's performance in three areas: (a) macroeconomic policy; (b) policy dialogue with the Bank in key sectors; and (c) implementation and absorptive capacity. A deterioration in macroeconomic policy, particularly a loss of fiscal discipline, and/or important reversals of structural reforms would trigger a reduction in the lending program. Likewise we would lower lending in the case of strong disagreement with the Government on policies and strategies in key sectors. In particular we would lower our lending levels in the event that the Government does not demonstrate a serious poverty reduction effort. Also if implementation and absorptive capacity prove to be lower than currently expected in key sectors, we would reduce lending levels to those specific sectors in order to avoid inefficient  - 19 - use of Bank resources. Under such adverse circumstances, lending could fall to an average of about US$200 million annually, which would constitte a core program focused on institution building and poverty alleviation. 47. If, in addition to the conditions required for the base case scenario, there is a need for Bank support for a Brady deal with commercial bank creditors, average lending could increase to about $500 million annually, and the program could include an additional adjustment operation, focussed on support of public sector reform, and/or a free-standing DDSR operation. 48. Portfolio Implementation. Implementaton of the initdal series of adjustment loans progressed well and the portfolio is rated satisfactory. However, given the five-year hiatus in Bank lending for Peru and the prior poor performance of the portfolio, there is a pronounced need to familiarize Per6's officials with Bank operating procedures. To avoid portfolio problems before they redevelop, we are holding project launch workshops and seminars to train officials in Bank procurement, disbursement, fmancial reporting, auditig and debt servicing requirements. In addition, we are keeping project design simple and involving local participation in design and implementation of projects. To facilitate project supervision, we have taken steps to open a Resident Mission in Lima in FY95. 49. Creditworthiness and Exposure. Under the base case lending scenario, the Bank's exposure to Perd is projected to increase from US$1.5 billion in 1994 to US$2.3 billion in 2000. Given the good macroeconomic management required for the base case scenario, Per4's capacity to service debt would increase substanially. Hence, debt service to IBRD as a percentage of exports would average about 3.5 percent over 2000-2003. However, assuming a significant lending program by IDB and relatively modest growth of non-preferred debt, the share of public debt service to preferred creditors would increase at the end of the decade to around 35 percent. 50. IFC and MIGA Activides. Since beginning operations in Perd in the late 1960s, IFC has approved 28 investments. Mining has been the most important sector. Although IFC processed an average of two projects amnuafly in the past, no new project was processed between FY86 and FY92 due to the poor investment climate and macroeconomic policies. However, in March 1990, IFC participated in the capital increase of Compafifa de :Ainas Buenaventra S.A. by exercising its preemptive rights and purchasing additional shares, raising IFC's shareholding from 5 to 6 percent. Since 1992, IFC has made loans worth US$26.3 million (including syndications) and equity investments worth US$7.6 million in capital markets, oil and mining. As of June 30, 1994, IFC held US$19.8 million in outstanding loans, and US$11.96 million in equity investments in 19 companies. Total exposure (outstanding investments plus undisbursed commitments) represents about 0.2 percent of IFC's total portfolio. Currently, IFC is advising the Govermnent in the privatization of Electrolima. Over the next few years, IEC will continue its involvement in mining in view of Peri's comparative advantage, but will also diversify its activities to other sectors, including infrastructure, consumer goods, and agro-industries.  - 20 - 51. Perd became a member of MIGA in December 1991. MIGA guarateed its first investment in Peru in August 1993, a US$45 million investment in a gold mine, Mineral Yanacocha S.A. A second project involving investment by Citibank in Profuturo, a private pension fund, was insured by MIGA in early September 1993. MIGA's total exposure in PerG is currently US$38 million. MIGA anticipates a large volume of continuing business in Peru, based on the number of preliminary applications it bas received. 52. Cooperation with Other Institudons. The proposed concentration of our efforts in the coming years in infrastructure and the social sectors takes into consideration the complementary roles played by the IDB, the IMF and bilateral donors. During the multilateral debt workout, the Bank and the IMF worked together to assist Perd in preparing and implementing the Government's stabilization and structural reform program. The 1MP is currently supporting Perd through an Extended Fund Facility that will close in 1995, and the Bank is continuing to work with the IMF in monitoring the macroeconomic program and securing the external fmancing agreed under this facility. The Govemment observed all prograim performance criteria for end-1993, and is on track to meet the 1994 targets. The IMF also is providing, in coordination with the IDB, long-term technical assistance to assist the Government to improve tax administration, gain better control over public expenditures, and to reorganize and strengthen the Central Bank. Because of the strong involvement of the IMF and IDB, the Bank has chosen not to be involved in these areas. 53. The Bank will contnue coordination with the IDB on policy reforms and project design. The IDB's assistance strategy in Perd focuses on supporting the consolidation of stabilization and structural reforms and promoting medium- and long-term development. It emphasizes: (a) economic recovery and sustainable growth; (b) poverty alleviation and the social sectors; (c) public sector efficiency; and (d) basic infasre bilitation. Like the Bank, the IDB program includes mostly investment lending and technical cooperation; however the program may also include a small share of quick-disbursing loans. The two institutions coordinate programs in the same sectors closely, sometumes cofinancing and other times dividing responsibilities within sectors. Currently, in preparing a rural roads project we are undertaking joint missions, sharing background studies and will jointly finance a commonly identified investment program. In education, the Bank is financing primary education whereas the IDB will focus on preschool and technical education. In the water sector, the Bank is achieving synergies and cost savings by sharing IDB financed studies. However, the IDB pursues a number of programs in sectors without a strong presence by the Bank. For example, the IDB is directly involved in governance issues, including reform of the judicial system and the Congress. Also, through a special program the IDB is involved in support to micro enterprises. Besides the technical cooperation activities discussed in paragraph 52, the IDB is financing an environmental assessment and the design and implementation of a national environment framework, as well as activities linked to a second phase of financial sector reform, including strengthening capital markets and the second-tier financing institution.  - 21 - 54. The Bank has taken a leading role in aid coordination, and will continue working closely with bilateral donors to ensure the successful implementation of the Government's medium-term economic and structural refonn program, and to help ensure funding for priority programs and technical assistance. Given the magr'+ude of Peri's resource needs, we are encouraging cofinancing with concessional loans and grants. The Bank held an Informal Consultative Group meeting for Peri in June 1993, where donors discussed the Government's economic program, poverty alleviation strategy, and the profiles of priority social projects. A second Consultative Group meeting was held in May 1994, where donors reviewed the Government's stabilization and structural reform program and its progress with respect to poverty alleviation, and evaluated the Government's public expenditure program. Agenda for Board Discusson 55. Economic and Social Prospects. Since 1990, Perd has undertaken an ambitious macroeconomic stabilization and structural reform program. Pragmatism and a clear commitment to reform have generated steady progress, resulting in improved economic performance. Inflation has steadily declined, productivity has increased, fiscal discipline has been unbroken, government effectiveness is slowly increasing and Peru has taken decisive steps toward reintegration into the international financial community. Public order is gradually being restored and terrorism has abated. Notwithstanding these important accomplishments, the Peruvian economy remains fragile. Resuming growth and reducing poverty on a sustaiable basis after 30 years of economic stagnation and social instability, while ensuring equitable access to the benefits of such growth to all its people, will take time. It will depend on the consolidation of the macroeconomic stabilization and structural reform program and on a contied effort for broad-based economic and social development. 56. Perd's problems remain both serious and mumerous, imposing risks both to its development program and to t!ie Bank's assistance strategy. The Government's insdtutional capacity remains weak, since there has been little progress in reforming the public administration and the civil service. Lack of institutional mechanisms to control efficiency in public spending and low tax collection constrain the production of public goods and services, as well as government effectiveness. Basic infrastructure remains badly deteriorated and needs to be rehabilitated. Poverty and ethnic tension continue to divide the country and residual terrorism and drug trafficking drain scarce government resources. Moreover, Perd's economic prospects and its ability to service external obligations will depend on a favorable external environment. Peri is broadening its export base to reduce its vulnerabilty to exogenous shocks; nevertheless, a heavy debt service burden and the lack of a solution to commercial bank debt arrears constrain long-term growth and development. 57. The Government's focus has recently shifted from economic reforms and long-term development toward a short-term political agenda, and some reforms are being slowed or postponed unil after the presidential elections in April 1995. As an element of  - 22 - this short-term strate, part of the privatization revemnes will feed increased government spendig. This might weaken the economic program if it increases inflaton and reduces the credibility of some administrative and strucural reforms. 58. Bank Asistance. The Bank's strategy for FY9S-97 is to promote poverty reductdon primarily through investment lendig focussed on inrAstructure, socil sectors, and instition building and through connued support for good macroeconomic management. This strategy recognizes and builds on Perd's achievements to date in terms of macroeconomic stability and stuctural reforms and takes into account the roles of partner institutions. In developing a pipeline of investment loans, we plan to keep projects simple and use ESW and policy dialogue exensivcly to support improved economic and social policies. This parallel-track approach will facilitate project implementation, given Perd's weak institutions and constaints. Under the base case program, Bank lending to Peru will average about US$425 million annuaLly for FY9S-97. The Bank will continually monitor and revise its program according to economic policy and portfolio performance. Lewis T. Preston President c:i  -23 - Aum= Al PERU - Selected Indicats of Bank Portfolo Performance ad Maagement Idicator 1nW FM2 fl03 FMW (Curent) Potfolio Performance Number of projects under implemention 7.0 8.0 6.0 7.0 Average implemenation peod (years)' 7.4 5.3 6.1 0.8 Avetge ratiUs Development objectivesP 2.9 2.9 1.0 1.0 Overall stas 3.4 3.5 1.0 1.8 Percent of projects raed 3 or 4 Development objectivee S7.2 25.0 0.0 0.0 Overal staes 71.4 62.5 0.0 0.0 Canceled during FY 2.0 5.0 0.0 0.0 Diburemt rtio (%)Y 0.0 0.0 0.0 120.0 Disbursement lag (%y 0.0 0.0 100.0 13.0 Memorandum item: % completed projects rated unusatistor' - - 0 Porfolio Management Supervision resources (total staff-weeks) 22.8 26.8 82.7 143.0 Average supevision (staff-weeks/project) 3.3 3.4 13.8 23.8 Supervision resources by locaton (in %) 100.0 100.0 100.0 100.0 Percent headquarters 100.0 100.0 100.0 100.0 Percent resident mission Supervision resources by rating category (staff-weeks/project) Projects rated I or 2 1.4 7.7 13.8 23.8 Projecs rated 3 or 4 4.3 1.2 - Memotandum item: Next CPPR: May 1995 a. Average age of projects in the Bank's counuy potfoo. b. Extent to which the project will meet its developmet objctives (see OD 13.05, Annex D2). c. Assessment of overall perfomanxeof the prto,c bed on the radigs gin to inva aspects of project implemenaon (e.g., mmgemem, availabilty of funds, compliance with legal covenanis) and to delopment objeces (aem OD 13.05. A=nex D2). Ihe overall sus is not given a better rating than that given to project deveont objelv. d. Ratio of dibursem during the year to tho umbed banc of th Dks potfolio at the begning of the year's investme projes oy. e. For aDl projects comprisng the Bank's county pordoli, the pementaped ce between actual cumulative dis eme and the cumulative disbursements estimaes as given in the Orginal S R PocaatW or, if the loan amoun have been modified, in the 'Revised Forecast'. The country portfolio dibrsm lag is effively dte weighte avetage of dibusement lags for projects compisig the Bank's country pordblio, where the weights used are the respective ptoject shares in dth total cumulaive disbrse esmiates. f. For current PY only: from the OED databse.  - 24 - Annex A2 Page 1 of 2 PERU - Bank Group Pact Sheet, PY91-97 IBRD/IDA Leading Progam, PY91-97 AW Qureat Planned' Category FY91 FY92 FM93 FY94 FY9S FY96 FY97 Commibnes (US$m) 0.0 1,000.0 291.8 284.0 475.0 300.0 425.0 Sector (%)b Agricur 0.0 0.0 o .0 0.0 16.0 0.0 40.0 lbdustry and finance 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Ery 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Power 0.0 0.0 0.0 0.0 32.0 0.0 0.0 hubbk sector manag_et o0.0 0.0 0.0 0.0 0.0 0.0 0.0 hfrasucr and urban development 0.0 0.0 0.0 52.8 32.0 100.0 0.0 Hman resouces 0.0 0.0 0.0 47.2 20.0 0.0 20.0 Enironme 0.0 0.0 0.0 0.0 0.0 0.0 20.0 Mining and olher extacive 0.0 0.0 0.0 0.0 0.0 0.0 20.0 Mu_sector 0.0 Q2Q nu 0 0LQ