Peru - Trade Policy Reform and Structural Adjustment Loan Projects

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 14819 PERFORMANCE AUDIT REPORT PERU TRADE POLICY REFORM LOAN (LOAN 3437-PE) AND STRUCTURAL ADJUSTMENT LOAN (LOAN 3452-PE) JUNE 30, 1995 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Currency Equivalents (As of December 31, 1994) Currency Unit Nuevo Sol (S/.) US$1.00 = S/.2.17 S/.1.00 = US$ 0.46 Abbreviations and Acronyms AFP Pension Fund Administrator BN Banco Nacion CCD Democratic Constituent Congress EFF Extended Fund Facility, IMF ENTEL National Telecommunications Company FONCODES National Compensation and Development Fund FONAVI National Housing Fund FSAL Financial Sector Adjustment Loan IDB Inter-American Development Bank INDECOPI National Institute for the Defense of Free competition and Intellectual Property Rights MEF Ministry of Economy and Finance NFSP Non-Financial Public Sector Deficit RAP Rights Accumulation Program, IMF SAL Structural Adjustment Loan SUNAD Super Intendency of Customs SUNAT Tax Administration Institute TPL Trade Policy Reform Loan Fiscal Year January 1 - December 31 FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation June 30, 1995 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Performance Audit Report on Peru - Trade Policy Reform Loan (Loan 3437-PE) and Structural Adjustment Loan (Loan 3452-PE) Attached is the Performance Audit Report (PAR) for the Peru Trade Policy Reform (TPL) and the Structural Adjustment (SAL) Loans (Loan 3437-PE and Loan 3452-PE, approved in FY92), prepared by the Operations Evaluation Department. The TPL (US$300 million) and the SAL (US$300 million) were part of a package consisting of three adjustment loans, the third of which was a Financial Sector Adjustment Loan (not yet closed). The loans were intended to: (a) support the Governmentes comprehensive stabilization, rehabilitation, and structural adjustment program; and (b) allow the Bank to participate in an effort to reintegrate Peru into the international financial community by helping Peru clear its existing loan arrears. The reform program supported by the loans had been put in place starting in late 1990, and was doing well at the time of Bank approval of the loans. The Bank's new policy for dealing with countries with protracted arrears made possible the assemblage of the three-loan package that eventually cleared Peru's arrears to the Bank. The PAR found that the stabilization program was successful in eliminating hyperinflation and that the response to the Government's structural reform program in terms of economic activity has been impressive. In addition, capital inflows have more than covered the current account deficit in the balance of payment and have contributed to a sizable increase in foreign exchange reserves. These inflows, however, have also increased vulnerability to capital flow movements, which has led the Government to accelerate the implementation of aspects dealing with the solvency of the banking system. The main lesson derived from these operations is that when a window of opportunity exists, simultaneous implementation of a large package of policy reforms can have highly positive outcomes in terms of economic recovery and regaining financial equilibrium. In the case of Peru, all reforms were successfully initiated at the same time, and there were no problems related to sequencing. The outcome of the SAL and the TPL has been rated as highly satisfactory. Sustainability is rated as likely and institutional development as substantial. Bank and borrower performance are also rated as highly satisfactory. Attachment This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  FOR OFFICIAL USE ONLY Contents Preface........................................... ......... 3 Basic Data Sheet................. ................... ........ 5 Evaluation Summary ........................................... 9 1. Background ...................................... ....... 15 2. Project Objectives, Design and Relevance............... ......... 16 Objectives ....................................... ....... 16 Design of the Loans ........................................ 17 Loan Workout and External Financing Program ......... ............ 17 The Trade Policy Reform Loan ................................ 19 Structural Adjustment Loan................................. 19 Financial Sector Adjustment Loan ........................ ...... 20 Relation to Bank Assistance Strategy............................ 21 Relevance of Design ............................. ......... 21 Loan Workout and External Financing Program....................... 21 The Trade Policy Reform Program .............................. 23 The Structural Adjustment Loan ..................... ......... 25 Loan Disbursement Procedures ......................... ....... 26 Complexity ........................ ........................ 27 Riskiness........................ ...................... 27 Borrower Ownership ....................................... 28 Demands on Bank Resources ................ ................ 28 3. Project Outcome, Efficacy and Sustainability ............ .......... 28 Project Outcome ................................... ...... 28 Efficacy of Outcome........................................ 31 Loan Workout and External Financing Program..................... 31 The Trade Policy Reform ..................................... 32 Stabilization and Structural Adjustment............................... 33 Main Factors Affecting the Outcome ............................ 43 Assessment of the Outcome and its Efficiency ...................... 44 Sustainability ............................................ 44 4. Bank and Borrower Performance ............................. 45 Bank Performance .................................. ....... 45 Borrower Performance ............................... ....... 45 This report was prepared by Luis Ramirez, (Task Manager), Fernando Mendoza, (Staff) and Manuel Lasaga, (Consultant) who audited the project in January, 1995. Alejandra Sarmiento provided administrative support. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed wiLhout World Bank authorization. 5. Conclusions and Lessons of Experience .......................... 46 Conclusions ............................................. 46 Audit Ratings ........................................... 46 Lessons of Experience.............. .................. ..... 46 Overall .......................................... ........ 46 Trade Policy Reforms ....................................... 47 Structural Adjustment Program ................................. 47 Annexes ........................................... ...... 49 A. Tables ................................................ 49 B. Trade Policy Reform Loan: Policy Matrix .................. ....... 55 C. Structural Adjustment Loan: Policy Matrix ........................ 59 3 Preface 1. This is a Performance Audit Report (PAR) on the Trade Policy Reform Loan and the Structural Adjustment Loan to Peru. The Bank's financing consisted of two loans: (i) Loan 3437-PE in the amount of US$300 million equivalent which was signed on December 22, 1992, and became effective on March 18, 1993; and (ii) Loan 3452-PE in the amount of US$300 million equivalent which was signed on December 22, 1992, and became effective on March 18, 1993. 2. This PAR was prepared by the Operations Evaluation Department (OED). It is based on the President's Reports, the Loan Agreements, the Project Completion Report (for the two loans), official files of the projects and discussions with World Bank staff. In addition, an OED mission visited Peru in February 1995 and discussed the effectiveness of Bank assistance with Government officials and other participating individuals. Their kind cooperation and invaluable assistance during the mission is gratefully acknowledged. 3. The ratings of this PAR agree with those of the PCR with the exception that outcome for both operations is rated here as highly satisfactory instead of satisfactory as in the PCR. This assessment incorporates more recent information in terms of the program outcome. The PCR provides an extensive narrative of the programs' evolution and implementation. This PAR dwells on some additional design and implementation issues such as the loan workout, the pre-shipment inspection program, the agricultural sector reforms, and the social security system reforms. 4. A draft copy of the report was sent to the Borrower; however, no comments were received.  5 Basic Data Sheet Trade Policy Reform Loan (Loan 3437-PE) Loan Position Outstanding As of Original Disbursed Cancelled Repaid 1/31/94 Loan 3437-PE 300.00 300.00 0.00 0.00 300.00 Key Program Data Original Loan Dates Actual or Re-estimated Initiating Memorandum 07/12/91 08/22/91 A Letter of Development Policy 12/04/91 01/09/92 A Negotiations 08/26/91 11/15/91 A Board Approval 10/29/91 02/04/92 A Loan/Credit Agreement 11/27/91 12/22/92 A Effectiveness 03/18/93 03/18/93 A Loan/Credit Closing 06/30/93 06/30/93 A Actual Completion 12/30/93 06/31/94 Cumulative Loan Disbursement FY93 Planned $US300M Actual $US300M Actual as % of Planned 100% Date of Final Disbursement: March 18, 1993 March 18, 1993 (Arrears Clearance) 6 Staff Input (Manweeks) FY91 FY92 FY93 FY94 TOTAL Preparation 31.7 30.5 - 62.2 Appraisal - 18.5 - 18.5 Negotiations - 13.1 - - 13.1 Supervision - 12.7 7.1 2.0 21.8 PCR - - - 0.4 0.4 Sub-Total 31.7 74.8 7.1 2.4 116.0 Mission Data Month/Year No. of Weeks No. of Persons Staff Weeks Date of Report (staff & cons.) Preparation 06/91 2 12 31.7 06/04/91 Appraisal 09/91 2 18.5 Supervision I FY92 12.7 Supervision II FY93 7.1 Supervision III FY94 2.0 Completion 05/94 0.4 05/31/94 FOLLOW-ON ADJUSTMENT OPERATIONS SAL I, FSAL AND SAL II Operation: Structural Adjustment Loan I Loan No.: 3452-PE Amount: $300.0 million Board Date: 03/26/92 Operation: Financial Sector Adjustment Loan Loan No.: 3489-PE Amount: $400.0 million Board Date: 06/17/92 Operation: Structural Adjustment II Loan No.: 6PERPAl36 Amount: US$100.0 million Board Date: FY96 7 Structural Adjustment Loan (Loan 3452-PE) Loan Position Outstanding Original Disbursed Cancelled Repaid As of 1/31/94 Loan 3452-PE 300.00 300.00 0.00 0.00 300.00 Key Program Data Original Loan Dates Actual or Re-estimated Initiating Memorandum 10/10/91 10/10/91 A Letter of Development Policy 12/16/91 02/20/92 A Negotiations 12/02/91 02/10/92 A Board Approval 01/21/92 03/26/92 A Loan/Credit Agreement 12/22/92 12/22/92 A Effectiveness 02/15/93 03/18/93 A Loan/Credit Closing 06/30/93 06/30/93 A Actual Completion 12/30/93 06/31/94 Cumulative Loan Disbursement EY93 Planned $US300M Actual $US300M Actual as % of Planned 100% Date of Final Disbursement: March 18, 1993 March 18, 1993 (Arrears Clearance) Staff Input (Manweeks) FY91 FY92 FY93 FY94 TOTAL Preparation 77.4 61.2 - 138.6 Appraisal - 15.5 - 15.5 Negotiations - 18.9 - - 18.9 Supervision - 9.6 16.4 - 26.0 PCR - - - 0.3 0.3 Sub-Total 77.4 105.2 16.4 0.3 199.3 8 Mission Data Month No. No. of Persons Staff Date of /Year of Weeks (staff & cons.) Weeks Report Preparation 09/91 2 7 77.4 10/10/91 Appraisal 12/91 2 5 15.5 12/18/91 Supervision I FY92 11/92 1 1 9.6 11/10/92 Supervision II FY93 03/93 1 1 16.4 04/01/93 Completion (PCR) 05/94 05/31/94 FOLLOW-ON ADJUSTMENT OPERATIONS FSAL AND SAL II Operation: Financial Sector Adjustment Loan Loan No.: 3489-PE Amount: $400.0 million Board Date: 06/17/92 Operation: Structural Adjustment Loan II Loan No.: 6PERPA136 Amount: $100.0 million Board Date: FY96 9 Evaluation Summary Background 1. After three decades of increasing interventionism and instability in economic policy, Peru had reached, by the mid-1980s, a state of protracted economic decline and escalating incidence of terrorism. The economy had been mismanaged in many respects. The government determined key prices and owned important enterprises. Exports were subject to compulsory surrender of foreign exchange receipts to the Central Bank. Foreign trade was discouraged because of high tariffs and quantitative restrictions. And the regulatory framework prohibited the private ownership of agricultural land for commercial purposes, with minor exceptions, and prohibited the use of land as collateral for credit. In the late 1980s, an expansionist monetary policy, and an increase in money velocity as people substituted away from the domestic currency, led to hyperinflation. To repress inflation, successive governments had repeatedly imposed price controls and set up ceilings to interest rates at levels below inflation. Government finances were in a state of collapse, with high public deficits financed with money creation and accumulation of arrears. The Government stopped servicing foreign debts in 1985 and, by 1987, the Bank was forced to place Peru on "non-accrual" status. 2. In June 1990, Mr. Alberto Fujimori was elected president. Immediately after his election, a period of intense discussion ensued among his close advisors and with representatives of the Bank and the IMF, on a "shock" program to stabilize the economy. A few days after the new Administration took office, the Government introduced a radical and comprehensive program to reduce inflation and limit the role of the state, and to promote market oriented structural reforms. 3. Partly with the Peruvian case in mind, the Bank's Board approved in May 1991 a new policy of Additional Support for Workout Programs in Countries with Protracted Arrears (R91- 70). The new program enabled loans to be presented to the Board during a "performance period" but not disbursed. Once the country had cleared its arrears at the end of this period, loans could be signed and made effective and the accumulated disbursements released. This program was analogous to the IMF's Rights Accumulation Program (RAP) and required four conditions: (a) an external financing plan agreed with the country; (b) an IMF-supported stabilization program; (c) a Bank-supported adjustment program; and (d) continued payment of current debt service to the Bank. The Trade Policy Loan (TPL) and the Structural Adjustment Loan (SAL), approved in February and March 1992 respectively, and evaluated in this PAR were part of such a program for Peru. Project Objectives and Design 4. The TPL and the SAL were part of a package consisting of three adjustment loans, the third of which was a Financial Sector Adjustment Loan (FSAL). While the FSAL has not yet been closed, this report provides some information concerning its principal features in terms of objectives and design. The performance audit of the TPL and the SAL would have benefitted from a joint evaluation of the FSAL but, even before FSAL completion this audit assesses five years of experience with the reform process. The FSAL will be audited at a later date. 5. Overall Objectives. The loans were intended: (i) to support the Government's comprehensive stabilization, rehabilitation, and structural adjustment program and (ii) to allow 10 the Bank to participate in an internationally supported effort to reintegrate Peru into the international financial community, and to formulate an external financing plan, agreed to by the IMF, IDB, bilateral donors, and the Government, to clear existing loan arrears. Both loans recognized major reforms measures taken during "the performance period" between August 1990 and September 1991. 6. Trade Policy Reform Loan. This loan was aimed at supporting the Government's medium-term program of trade policy reforms, comprising: (i) a reduction in tariff protection; (ii) the elimination of most non-tariff barriers; (iii) the elimination of export subsidies and improvement in schemes allowing exporters to recuperate indirect taxes; and (iv) the abolition of the agency administering trade controls and the initiation of a reform of customs. 7. Structural Adjustment Loan. This loan was intended to support the Government's medium-term program of macroeconomic stabilization and broad-based reforms in the following areas: macroeconomic policy, fiscal policy, social sectors, privatization, agriculture, labor, and social security. The conditions in the above mentioned areas included maintenance of pre- existing reforms and measures for further reforms. 8. In addition, a few months later, the Financial Sector Adjustment Loan was approved to support Peru's medium-term program of structural reforms within the financial sector. The loan supported -he far-reaching reforms of the financial sector adopted by the Government since mid- 1990 and measures to be undertaken during 1992-1993 in the areas of development banking; reduction of the role of the large public banks, such as Banco de la Nacion; privatization of commercial banks; passage of banking legislation; strengthening of banking regulations and supervision; and development of the capital markets. Relevance of Design 9. The programs supported by the three loans constituted the core of Peru's stabilization and structural reform program. In view of the urgency of normalizing relations with the multilateral agencies, the loans were in large part disbursed immediately upon effectiveness, but only after program performance had been demonstrated. In effect, in accordance with the new policy for countries with protracted arrears, the Government had already started to comply with the TPL, SAL and FSAL loan conditional ities even before these were defined in the loan appraisal. With the benefit of hindsight, this new modality whereby loan effectiveness and disbursements were completed only after the end of a successful "performance period" resulted in a very effective loan design. Although it imposed some transitory extra sacrifices to the country, it helped to increase the awareness that commitment to reform was the only option to solve the acute problems of Peru at the time. External Financing Program 10. As part of the new policy to deal with external arrears, an external financing plan was agreed for 1991-1992 and carried out successfully, although with a few months delay. This delay was due to a temporary shortfall of funds that resulted from a halt of disbursements after the Government's partial suspension of the Constitution in April 1992. Overall, the External Financing Plan was realistic in terms of the financial requirements and their sources. In effect, the multilateral and the official bilateral lenders provided the crucial funds to close the gap between sources and uses of funds (See Table 2). The only weak link in the external financing 11 plan was the need to temporarily accept a moratorium on private medium- and long-term debt, which has become the last step to be solved for Peru's return to the international financial markets on a voluntary basis. The Trade Policy Reform Program 11. The structure of the TPL was responsive to the country's needs, with only a minor weak area regarding surcharges on agricultural imports. The PCR accurately described the variable surcharge scheme as potentially damaging to the overall thrust of trade reform because it could encourage other groups to seek similar protectionist measures. The Structural Adjustment Loan 12. The SAL was the principal component of the Bank support. Its design was comprehensive as well as compatible with the Government's goals and their capacity to implement the program. Only minor weaknesses were noted in the following areas: i. poverty alleviation: measures to shield the lowest income population from the immediate effects of restructuring were insufficient. ii. agricultural sector credit: the removal of credit subsidies through the elimination of Banco Agrario was necessary in order to correct financial market distortions and thus promote greater efficiency in the agricultural sector; however, the design of the project could have given some consideration to the creation of transitory alternative arrangements, since commercial banks were in general reluctant to provide credit to agriculture. Project Outcome 13. The overall outcome of the two operations, the TPL and the SAL, is rated as highly satisfactory. The stabilization program was quite successful in eliminating the hyper-inflation environment. The response to the Government's program was equally impressive in terms of economic activity. The most dynamic component of aggregate demand has been private investment, principally in construction. The improvement in the fiscal accounts has been noteworthy. The buoyancy of tax revenues improved considerably during 1993-94. In addition, an abundance of capital inflows has not only covered the imbalance in the current account deficit, but has also contributed to a sizable increase in foreign exchange reserves, which has helped to maintain currency stability. These inflows, however, have also increased vulnerability to capital flow movements. Loan Workout and External Financing Program 14. The loan package succeeded in normalizing Peru's relation with the IMF, the IDB, and the Bank. The Bank's decision to formulate a new policy for dealing with countries with protracted arrears made possible the assemblage of the three loan package that eventually cleared Peru's arrears. Peru's return to the international financial markets, on a voluntary basis, will now hinge on a successful restructuring of its commercial bank debts. 12 The Trade Policy Reform 15. The essence of the trade reforms was to move trade policy to a stance approaching neutrality, i.e. where there is minimal policy discrimination among economic activities, among firms, or between imports and exports. At the final program review in December 1992, the Bank concluded that the Government had observed all measures agreed, and continued to support an open trade regime. This assessment still holds at the time of this evaluation, with only minor qualifications regarding agricultural variable surcharges and non-tariff barriers related to health, technical, and security regulations. Stabilization and the Structural Adjustment 16. As demonstrated by the selected indicators on program results, the stabilization component of the SAL was quite successful. One of the more striking features of these results was that the improvements occurred in a relatively short period of time. However, some concerns have been expressed over the real exchange rate, domestic interest rates, and the persistently high level of dollarization. 17. The structural adjustment component of the SAL is rated as highly satisfactory. The reforms supported by the SAL have proven to be among the most important changes in the country's economic framework since 1968. All the goals set in the SAL were achieved, although minor weaknesses were noted in the areas of fiscal revenue collection and budget coordination, in the implementation of agricultural reforms, and in the social security restructuring. The Government liberalized economic activity throughout the country. It lifted barriers to domestic and international trade, opened activities to the private sector that were once reserved to the state, and, in general, very quickly fostered an environment of competition designed to promote a more efficient allocation of resources. However, sometimes a drastic solution can lead to other problems. The decision to disband all credit activities of the Banco Agrario, while necessary in order to eliminate excessive subsidies, but without prior studies of alternative arrangements or a suitable transition period, left a vacuum in the agricultural credit market with detrimental effects on agricultural producers. The assumption that commercial banks would move in quickly to fill the void may have been somewhat simplistic. The lack of an action plan to deliver credit to the agricultural sector might reflect a lack of clear vision by the Government regarding the difficulties of agricultural credit policy. Sustainability 18. Sustainability of the reform programs supported by the TPL and the SAL is likely. The current administration remains committed to the structural reforms and current economic policy. And the administration's recent re-election is strong indication that the voters favor a continuation of those reforms. Of course, there always exists some risk of backsliding after the end of the term of the current administration. Consolidation of the reforms will require a much longer period of time than the duration of the present regime. The measures contained in this loan package should be considered as a first phase of economic reforms, which were aimed at instilling discipline and credibility after decades of neglect and volatility. A second phase of reforms, possibly led by a follow-up SAL (in preparation) and other sectoral loans, needs to focus on the broader agenda of reforming the state and of creating a more efficient outward looking economy. 13 19. While the external financing plan proved to be very successful, some concern has recently arisen regarding the sustainability of the current short-term capital flows which have been an important factor in covering the external financing gap. At the same time, the strong success of the privatization program, which provided an additional impetus to capital inflows, means that it will soon have to be replaced by a more sustainable source of foreign capital. This increase in the vulnerability of the economy to capital flow movements has augmented the need to accelerate the implementation of aspects dealing with solvency of the banking system. Otherwise, structural weakness of the financial sector could undermine the sustainability of the stabilization program: i. the Central Bank has limited instruments to intervene in money markets in order to achieve monetary targets; ii. previous lax standards in terms of asset quality have contributed to an underestimate of non-performing assets; and iii. the introduction of universal banking could produce undesirable risk levels without appropriate regulatory experience. Therefore, government actions to strengthen the financial sector should be a top priority. In this context, continued implementation of the FSAL supported program is essential to achieve sustainability of the ongoing reform program. Bank Performance 20. Bank performance is rated as highly satisfactory. From the start, the Bank's staff played a proactive role in supporting the Government's own reform initiatives. The Bank sustained a high degree of cooperation with the senior government officials involved with the implementation of the loans. The Bank's analysis of the economic problems and the prognosis of needed action steps, were both in-depth and accurate. The Bank engaged in a fair amount of creative problem solving, first, by defining a new policy for dealing with a country with protracted arrears; second, by structuring a package of three loans around a common objective of arrears clearance; and third, by resolving the difficult procedural issue of disbursement and its associated documentation in a way that did not compromise the basic objectives of the loans. Borrower Performance 21. One of the outstanding features of the borrower's performance was the Government's exceptional commitment to the program. The highly successful stabilization and structural adjustment program was "owned" by the Government. One of the principal factors for this highly satisfactory outcome was the continuity of senior administration officials involved in the implementation of the loans. A special coordinating unit was set up in the Ministry of Economy and Finance (MEF) to facilitate implementation and to provide information on the status of the program. However, one apparent incidence of disagreement did arise between the MEF and the Ministry of Agriculture over the implementation of the agricultural component of the loans. This lack of coordination may have led to some weakness in the implementation and results of agricultural sector reforms. Nevertheless, the overall performance can be characterized as highly satisfactory. 14 Institutional Development 22. Institutional development impact is rated as substantial, specially because of the comprehensive nature of organizational reforms instituted in SUNAT, SUNAD, the implementation of a tightly controlled central government budget, and the effectiveness of the privatization program. Lessons of Experience 23. The main lessons of the TPL and the SAL are as follows: Overall * Once again, Borrower ownership of the reform program was a critical factor in its success. * Sometimes it may be necessary to put aside the issue of sequencing of reforms. In the case of Peru, when the Government assumed office in 1990, it encountered an exceptional window of opportunity to implement many reforms. It was felt that political support would have quickly dissipated for any reforms which would have been postponed. For this reason, the Government was convinced that the trade policy and other structural adjustments had to be implemented all at once. In retrospect this decision appears to have been the right choice. This also underscores the need for a case-by-case approach in the design and implementation of TPLs and SALs, since each country presents a set of unique challenges and opportunities. Trade Policy Reforms * The establishment of an independent body to deal with conflicts that may arise during the process of trade liberalization might be essential for the sustainability of the reforms. In the case of Peru, the establishment of INDECOPI as an independent body to decide on claims against non-competitive behavior, anti-dumping, and appropriateness of legislation on economic matters, was a very effective step on the part of the Government to deal with the threat of reforms reversals. The board of directors of INDECOPI is well-balanced with representatives from both the public and private sectors. Structural Adjustment Program * The design of a proactive poverty alleviation schemes in SALs cannot be overemphasized. In the case of Peru, the creation of FONCODES to finance employment creating projects in targeted areas was very relevant; however, in view of the dramatic deterioration of the economy during the 1980s, perhaps a broader social program might have been needed to complement the actions taken under the SAL. 15 1. Background 1.1 After three decades of increasing interventionism and instability in economic policy, Peru had reached, by the mid-1980s, a state of protracted economic decline and escalating incidents of terrorism. From 1985, it had begun to repudiate the servicing of its foreign debts, and in 1987, the Bank placed Peru on "non-accrual" status. With serious internal imbalances and no foreign financing, at the time of the 1990 presidential elections, the economy suffered a persistent hyper-inflation. 1.2 The economy had been mismanaged in many respects. The government determined key prices and owned important enterprises. Hyperinflation in the late 1980s was fueled by an expansionist monetary policy, and an increase in money velocity as people substituted away from the domestic currency. To repress inflation, successive governments had repeatedly imposed price controls. Interest rates had been constrained by ceilings which were significantly below inflation. Exports were subject to compulsory surrender of foreign exchange receipts to the Central Bank. Foreign trade was discouraged because of high tariffs and quantitative restrictions. Government finances were in a state of collapse, and depended heavily on inflationary finance. And the regulatory framework prohibited the private ownership of land for commercial purposes, with minor exceptions, and prohibited using land as collateral for credit. 1.3 In June 1990, Mr. Alberto Fujimori was elected president. Immediately after his election, a period of intense discussion ensued among his close advisors and with representatives of the Bank and the IMF, on a "shock" program to stabilize the economy. Shortly after the new Administration took office, the Government introduced a radical and comprehensive program to control inflation, limit the role of the state, and promote market oriented structural reforms. 1.4 In August of 1990, the Government introduced a Social Emergency Program safety net, which developed into a National Fund for Social Compensation and Development (FONCODES) in August 1991. This entity was to play a key role in the design of the social sector component of the SAL. 1.5 In March 1991, the Government launched a new and more aggressive phase of reforms covering many areas such as trade policy liberalization, the elimination of state monopolies, the liberalization of the financial system, and a revision of the labor code. 1.6 The Administration also sought to mend its ties with the international financial community, including the World Bank. To this end, it resumed the servicing of its debt to the Bank in October 1990. Discussions then ensued as to the most expedient way to reduce the Bank's arrears as part of an overall process of normalizing Peru's relations with the international financial community. At that time, Peru had the highest arrears in the Bank, accounting for 1.24 percent of the Bank's loan portfolio. 1.7 On September 12, 1991, the IMF Board, satisfied that Peru's external financing requirements could be met, and that Peru would maintain its payments on current obligations to the multilateral financial institutions, approved a Rights Accumulation Program (RAP) for Peru. Under the program, Peru's adherence to IMF performance criteria, and continued servicing of debt to the other multilateral lenders, would lead to the accrual of rights to future disbursements, which would then be released once arrears to the IMF had been cleared, as expected sometime 16 towards the end of 1992. A similar program with the Bank (para. 2.9) led to the preparation of three adjustment programs. 1.8 The Trade Policy Loan (TPL) and the Structural Adjustment Loan (SAL), were prepared during this period. The adjustment program initiated in August 1990 quickly produced impressive results in terms of lowering the fiscal deficit and sharply reducing inflation. Because of this, during loan preparation the Bank took the approach of focusing on conditionality that would help Peru to maintain its reforms, and to adopt additional complementary measures in other areas of the unfinished agenda. 1.9 Processing of the loans up to, and including, Board approval went smoothly until April 1992, when President Fujimori, in a "self-coup", dissolved the Congress and the judiciary, and suspended parts of the Constitution. The "self-coup" delayed the process of loan signature and eventual arrears clearance. By the end of 1992, Peru was making progress, at the urging of the international community, in returning to democratic rule. A Democratic Congress was elected in November. Within a month after these congressional elections, the twin processes of clearing arrears and loan preparation were back on track. 2. Project Objectives, Design and Relevance 2.1 The Trade Policy Loan (TPL) and the Structural Adjustment Loan (SAL) were part of a package consisting of three adjustment loans, the third of which was a Financial Sector Adjustment Loan (FSAL). While the FSAL has not yet been closed, this report provides some information concerning its principal features in terms of objectives and design. A second SAL is under preparation. Objectives 2.2 Overall Objectives: The three loans were intended: (i) to support the Government's comprehensive stabilization, rehabilitation, and structural adjustment program; and (ii). to participate in an internationally supported approach to reintegrate Peru into the international financial community, formulating an external financing plan, agreed to by the IMF, IDB, bilateral donors, and the Government, to clear existing loan arrears. This approach was expected to provide Peru with the opportunity to rehabilitate an economy much damaged by the actions of previous governments, and to enable it to resume a normal relationship with the Bank and other donors. These goals were consistent with the long-term strategic objectives of the Bank's country assistance strategy: (i) sustaining and accelerating the stabilization and adjustment process; (ii) fostering private sector development and public sector reform; (iii) alleviating poverty and promoting human resource development; and (iv) rehabilitating key infrastructure. 2.3 Trade Policy Reform Loan: The TPL aimed at supporting the Government's medium- term program of trade policy reforms. The loan recognized the major trade reform measures taken between August 1990, and September 1991, comprising: (i) a reduction in tariff protection; 1. For further discussion of the loans' objectives see the corresponding President's Reports for the TPL, Report No. P- 5666-PE; for the SAL, Report No. P-5714-PE; and for the FSAL, Report No. P-5791-PE. 17 (ii) the elimination of most non-tariff barriers; (iii) the elimination of export subsidies and improvement in schemes allowing exporters to recuperate indirect taxes; (iv) the abolition of the agency formerly administering trade controls and the initiation of a reform of customs. 2.4 The sectoral conditions of the TPL dealt principally with the maintenance of reforms already implemented, as well as additional reform measures which were felt necessary in order to secure existing reforms. 2.5 Structural Adjustment Loan. The SAL was intended to support the Government's medium-term program of macroeconomic stabilization and broad-based reforms. The loan recognized major reform measures taken between August 1990 and December 1991, and further reforms, to be implemented by December 1992, in the following areas: macroeconomic policy, fiscal policy, social sectors, privatization, agriculture, labor, and social security. The conditions in the above mentioned areas included both the maintenance of pre-existing reforms, and measures for further reforms. 2.6 Financial Sector Adjustment Loan. This loan was also intended to support Peru's medium-term program of macroeconomic stabilization and of structural reforms within the financial sector. The loan supported the far-reaching program of reform of the financial sector adopted by the Government since mid-1990. It also supported reforms to be undertaken during 1992-1993 in the areas of development banking; reduction of the role of the large public banks, such as Banco de la Nacion; privatization of commercial banks; passage of banking legislation; strengthening of banking regulations and supervision; and development of the capital markets. Design of the Loans 2.7 The loan package comprised three loans: the TPL for $300 million, the SAL for $300 million, and the FSAL for $400 million. The first two loans were disbursed in one tranche, upon effectiveness, and the FSAL in two tranches, the first tranche of $300 million upon effectiveness, and the second tranche of $100 million is still pending. While Board presentation dates for the three loans occurred during the first half of 1992, the three loans were disbursed simultaneously in March 1993, on the same day that arrears were cleared. Each loan underwrote the same macroeconomic stabilization program and external financing plan, while supporting separate sectoral adjustment programs. The signature of the loan agreements, in December 1992, came at the end of the performance period, and well after Board presentation. As explained in the PCR, the loan agreement, contrary to normal practice, was a simple document containing a recognition of what had been done, rather than a program of what was to be done. Loan Workout and External Financing Program 2.8 After several years of not serving its external debt, the Government resumed debt service and payments to the IMF in 1989, and payments to the Bank were resumed in October 1990, although new arrears to the Bank accumulated again during March through September 1991. The latter instance of arrears was resolved after the IMF made Board presentation of its program conditional on fulfillment of debt service payments to all multilateral lenders. 2.9 In parallel, also in 1990, the Bank initiated a review of its policies for dealing with countries with protracted arrears that were seeking to normalize their relationship with the Bank. 18 The Board approved a new policy on May 2, 1991.2 The Bank's new policy on loan workouts established eligibility once the following four conditions were met: (i) the country agrees to and implements a structural adjustment program agreed with the Bank; (ii) the country undertakes a stabilization rogram, if needed, endorsed and monitored by the Fund or supported by a Fund arrangement ; (iii) there must be an agreed financing plan for the country which provides for the full clearance of arrears to the Bank in the context of a medium-term growth-oriented adjustment program; and (iv) the country must continue to service Bank debt falling due during the performance period. It was agreed that the structural adjustment program should result in disbursements at least sufficient to clear arrears to the Bank. However, the signing, effectiveness and disbursement of these loans would not take place until arrears to the Bank had been fully cleared.4 2.10 In September 1990, the Bank and the IMF had agreed, at the urging of the Peruvian Government, to form a Support Group for Peru. The Group, which consisted of international donors as well as the Bank, the IMF and the IDB, first met in June 1991, co-chaired by the U.S. and Japan, with the IMF playing the leading coordinating role. The Group's purpose was to mobilize resources to fill Peru's external financing gap which was estimated at $1.3 billion. The actual Support Group contributions during 1991-1992 were only $595 million. The shortfall was partly the result of suspended disbursements after the "self-coup" of April 5, 1992, including concerns about human rights. 2.11 A Paris Club rescheduling in September 1991 and the resolution of the IDB arrears also in September 1991, further facilitated the process of return to normalcy in relations with the multilateral agencies. In September 1992, the IMF began preparing a successor arrangement to the RAP, in the form of an Extended Fund Facility (EFF) for 1993-95. 2.12 The Bank's three loans were signed on December 18, 1992. Finally, on March 18, 1993, a complex sequence of transactions completed the debt workout: Peru cleared its arrears with the Fund using two bridge loans; the IMF disbursed; the proceeds were used to clear the Bank's arrears; the Bank then disbursed the $900 million from the respective loans. 2. For a description of the debt workout process see the PCR; Additional Support for Workout Programs in Countries with Protracted Arrears, R91-70, April 11, 1991; The Chairman's Summing-up, M91-509, May 3, 1991; Peru: the Bank's Approach to a Country with Protracted Arrears, R91-171, July 12, 1991; and Review of IBRD Policy on Workout Programs for Countries with Protracted Arrears, JAC93-17, April 30, 1993. 3. In April 1990, the IMF Board had approved a similar loan workout policy known as the Rights Accumulation Program (RAP), whereby the country would adhere to IMF performance criteria and continued debt service payments to all multilateral lenders. Satisfactory performance under the program would earn the country rights to future disbursements once arrears to the IMF were cleared. 4. Due to procedural requirements that called for congressional approval of any loan agreements entered into by the Government, Peru became an exception to this policy with loan signing occurring prior to arrears clearance. This allowed the Government time to obtain the necessary approvals, and thus be in a position to qualify for disbursement immediately upon declaration of effectiveness. 19 The Trade Policy Reform Loan 2.13 The TPL sought to support the trade policy reforms already adopted by the Government. Of the 22 conditions agreed in the Trade Policy Reform loan, 16 were to maintain existing reforms, and six to achieve further changes. The principal actions supported by the loan were: a) foreign exchange regime: maintain a single freely convertible exchange rate for all transactions; b) tariffs: maintain a simplified tariff structure which had substantially reduced the level and variance of protection; maintain the elimination of most special regimes allowing discriminatory preferences on the domestic market; maintain the agricultural surcharges scheme as it was, with the possibility of revising it following a study; revise the anti-dumping code; c) non-tariff import barriers: maintain the elimination of formally protective barriers, including prohibitions, minimum-local-content regulations, controls on most second- hand imports, and state agricultural import monopolies; reduce or simplify some technical/safety/health controls on imports; d) export regime: maintain the elimination of fiscal and financial export subsidies; improve schemes to allow imports to recuperate indirect taxes when the fiscal situation permitted this; maintain the reduction in non-tariff export barriers; e) trade institutions: carry out a program for customs reforms. Structural Adjustment Loan 2.14 The SAL recognized the major reform measures taken by the Government between August 1990 and November 1991, and supported further reforms to be implemented by December 1992, in the following areas: macroeconomic policy, fiscal policy, social sector, privatization, agriculture, labor, and social security. The Government and the Bank agreed on a set of 45 sectoral conditions, of which 24 were aimed to prevent reversal of policy actions implemented prior to loan presentation to the Board, and the other 21 were conditions for further reform. The principal conditions were: a) Stabilization: the Government maintained its commitment to strict fiscal discipline, market determination of key prices, exchange rate, and interest rates, as well as the fulfillment of IMF targets. b) Fiscal Policy: Reforms included reducing the number of taxes; greater efficiency in tracking evasion; and the reorganization of SUNAT the tax administration institute. c) Labor: the labor stability law was relaxed by expanding conditions for layoffs and increasing the probationary period in specific cases; new labor contracts were allowed on a fixed-term basis. 20 d) Social Security: a new legal framework was established to allow workers to choose between a pension system managed by the State, or by private investment funds. e) Agriculture: implementation of the Agricultural Investment Promotion Law passed in 1991; implement land titling and registration program; eliminate State marketing monopolies; eliminate credit subsidies through Banco Agrario; and maintain liberalization of agricultural prices. f) Privatization: the legal and institutional framework for privatization was defined during 1991-1992. The Government would develop an overall action plan and implementation schedule for divestiture in banking, fishery, and mining sectors; and to develop divestiture strategy in all companies where the Government was a minority shareholder. g) Social Sector: Government designed a poverty alleviation strategy establishing a minimum safety net for the most vulnerable groups. One of the principal safety net schemes was to finance small labor-intensive projects for the rehabilitation of social and economic infrastructure, and for the provision of basic social services through FONCODES (National Fund for Social Compensation and Development), which was created in 1991. Financial Sector Adjustment Loan 2.15 The FSAL recognized the far-reaching program of reform of the financial sector adopted by the Government and the policy steps taken since mid-1990. A new banking law was enacted in July 1991, and, in 1992, the Superintendency of Banks initiated a program of updated prudential regulations. In addition, the loan supported reforms to be undertaken during 1992- 1993 in the areas of development banking; reduction of the role of the large public banks, such as Banco de la Nacion; privatization of commercial banks; implementation of banking legislation, supervision and regulation; and development of capital markets. The main components of this loan were: a) Development banks: liquidation of four development banks; limiting future development financing activities to second-tier institutions such as COFIDE; transferring of public sector deposits to commercial banks; b) Banco de la Nacion: removing the monopoly of BN over Government deposits; substantial downsizing of BN activities, and when appropriate, their transfer to private sector intermediaries; c) Privatization of Commercial Banks: initiate sale of Banco Popular and of shares held in Banco de Comercio; develop plan to sell Interbanc or Banco Continental and their subsequent sale; d) Prudential Regulations and Supervision: continue broadening of banks' scope of activities while maintaining abolition of directed credit; continuation of program of prudential regulations; implementation of program to conduct on- and off-site evaluation of the banks; 21 e) Capital Markets and Pension Funds: adopt action plan for implementation of the 1991 Capital Markets Law which strengthened the Securities Commission, and improved disclosure requirements; pass enabling legislation to develop a new pension system comprised of private pension funds; initiate work to make the Superintendency of Pension Funds operational. Relation to Bank Assistance Strategy 2.16 The Bank's country assistance strategy towards Peru was directed at four long-term strategic objectives; (i) sustaining the stabilization and adjustment process; (ii) fostering private sector development and public sector reform; (iii) alleviating poverty and developing human resources; and (iv) rehabilitating key infrastructure. The principal objectives of the TPL and the SAL were clearly consistent with the Bank's general objectives. Relevance of Design 2.17 The three loans embodied the essence of Peru's stabilization and structural reform program initiated in 1990. In view of the urgency of normalizing relations with the multilateral agencies, the loans were in large part disbursed upon effectiveness, but only after program performance had been demonstrated. In effect, the Government had already started to comply with the usual TPL, SAL and FSAL loan conditionalities even before these were first identified in the loan appraisal. This facilitated the process of design identification. The TPL was presented to the Board in February 1992, followed by the SAL in March, and the FSAL in June. Loan Workout and External Financing Program 2.18 The decision by the Government in the mid-1980s not to comply with its debt servicing obligations had resulted in serious arrears, which in some cases exceeded the original amount of the loan. As shown in Table 1, as of December 1990, 66 percent of the $20.3 billion debt was in arrears. The principal creditor groups were the commercial banks and suppliers representing 33.8 percent of total debt outstanding, the Paris Club creditors with 33.6 percent, and the multilateral creditors with 19.5 percent, with the Bank representing 7.7 percent of total debt outstanding. In the case of commercial banks and suppliers, arrears accounted for 91 percent of the outstanding debt, while for the multilateral lenders the corresponding figure was 67 percent, with the Bank at only 54 percent. These differences reflected in large part the operating structure of the lenders, with commercial banks focusing on the short-term range of the lending spectrum, and the Bank on the medium- to long-term range. Because of the magnitude of the Bank's exposure in Peru, the continuation of non-performing status was adversely impacting its financial performance. 22 Table 1 Peru: External Debt Profile as of December 1990 ($ millions, end-of-period) Debt by Creditor: Debt of which: Outstanding in arrears Medium and long-term $20,341 $13A4 Public Sector 19,965 13,414 Multilateral creditors 3,972 2,156 World Bank 1,560 924 IMF 1,004 875 IDB 1,077 357 Other 331 --- Paris Club 6,839 4,835 Other Bilateral creditors 2,272 136 Commercial banks & suppliers 6,882 6,287 Private Sector 376 n.a. Short-Term 1,366 JE TOTAL $21= Q$13Z472 Source: Central Bank, IMF and Ministry of the Economy. 2.19 One of the complications in the workout exercise was the Bank's policy not to reschedule interest or principal payments or to participate in debt rescheduling agreements with respect to its loans. In order to overcome these restrictions on the refinancing of a loan, the Bank had to design a new policy for countries with protracted arrears.5 One of the critical elements of this policy was that a country had to undertake a stabilization program as well as implement a structural adjustment program. In view of the extensive period of arrears since the mid-1980s, Peru's return to performing status had to be validated through concrete results in terms of economic stabilization and structural reforms. At the same time, the up-front performance period served to substantiate the Government's willingness and ability to resume debt service payments on a regular basis. It appears that the investment community looked favorably on the Bank's policy of requiring positive tangible results before approving a loan workout program. Probably the most salutary aspect of the Bank's workout process, from a creditworthiness perspective, was the emphasis on a coherent and effective up-front performance period. 2.20 While the loan workout accomplished its objectives in terms of normalizing Peru's relations with the multilateral banks, the structuring of the disbursements posed a formidable challenge. The Government had to first obtain a bridge loan to pay off the arrears, and then use the proceeds from the Bank's disbursements to repay the bridge loan. As the PCR explained, on 5. See Review of IBRD Policy on Workout Programs for Countries with Protracted Arrears, Joint Audit Committee Report, April 30, 1993. 23 March 18, 1993, within a 95 minute period, the U.S. and Japan disbursed funds as part of the bridge loan, which were then used to clear the arrears to the IMF, thus triggering IMF disbursements, which were subsequently used to clear the Bank's arrears, and finally, with the Bank's disbursements, Peru paid off the bridge loan. 2.21 The paramount objective of the loan workout was to rehabilitate Peru's creditworthiness within the international financial community. At the time of Board presentation of the three loans, which took place during the first half of 1992, it was expected that Peru's creditworthiness would improve following the repayment of its arrears to the Bank and the IMF, and the earlier reactivation of relations with the IDB and the Paris Club of creditors. In addition, it was expected that improved economic performance during the next decade would underpin creditworthiness by improving Peru's capacity to service its external debt. In this regard, the loan workout achieved its objectives. 2.22. As stated in the President's Report, the objective of the loan package was to "allow the Bank to participate in an internationally supported approach to reintegrate Peru into the international financial community."6 With respect to the goal of restoring creditworthiness in general, the Bank's actions were successful in normalizing Peru's relationship with the multilateral lenders; however, relations with other important players in the intentional financial community have yet to be normalized. Overall, the External Financing Plan was realistic in terms of the financial requirements and their sources. In effect, the multilateral and the official bilateral lenders provided the crucial funds to close the gap between sources and uses of funds (See Table 2). The Trade Policy Reform Program 2.23 The conditionality of the TPL was aimed at maintaining the trade policy reforms already implemented. In August 1990, the newly elected Fujimori government began a fundamental trade reform program concurrently with the introduction of a stabilization policy, and the initiation of a broad range of economic reforms. The stabilization component was keenly reliant on the currency market unification and liberalization. Trade policy reform was appropriately structured in three stages: (i) shift from quotas to tariffs; (ii) narrowing of the spread on tariff rates; and (iii) reduction in the average tariff rates. The most impressive aspect of the trade program was the speed with which it was implemented. About 90 percent of the program had been done prior to Board presentation. 2.24 Normally, a TPL should be designed as a follow up to a stabilization program." In addition, tax reform should precede trade liberalization if the reduction in tariff rates is expected to result in a revenue shortfall, unless these are compensated through other tax measures. Once again, the experience of Peru might be considered as an exception to these views. The Peruvian reform, through substantial reductions in rates and in exemptions, increased tax revenues. Also, in terms of timing, the reason why the TPL was prepared prior to the SAL and the FSAL was simply that at the time the Bank initiated discussions with Peru, work on trade reforms was already far advanced. 6.. See the President's Report for both the TPL and the SAL. 7. See Trade Policy Reforms under Adjustment Programs, OED,1992. 24 Table 2: Peri - External Financing 1991-93: Planned and Actual (US$ millions) 1991 a. 1992 a. 1991-1992 1993b. A. ESTIMATES: Financing Requirements: 1. Non-Interest Current Account Deficit 536 492 1028 1025 2. Debt Service Obligations 2616 2398 5014 2483 3. Arrears to be Settled in Current Year 12055 1800 13855 1799 4. Increase in Gross Reserves 454 303 757 324 5. Gross Financing Requirements (1+2+3+4) 15661 4993 20654 5631 6. Loan Disbursements in Pipeline 255 200 455 283 7. Private Capital Flows 908 545 1453 1445 8. Net Financing Requirements (5-6-7) 14498 4248 18746 3903 Sources: 9. Debt Rescheduling and Deferral 13598 1467 15065 1220 Official Bilateral 6352 769 7121 692 Private 7246 698 7944 528 10. Additional Disbursements 900 2781 3681 2682 Multi'ateral 654 2328 2982 2272 Official Bilateral 246 453 699 410 11. Additional Financing Required 0 0 0 0 12. Total Sources of Financing (9+10+11) 14498 4248 18746 3902 B. ACTUAL: Financing Requirements: 1. Non-Interest Current Account Deficit 877 1159 2036 1149 2. Debt Service Obligations 2925 2133 5058 2456 3. Arrears to be Settled in Current Year 4890 37 4927 1725 4. Increase in Gross Reserves 904 257 1161 275 5. Gross Financing Requirements (1+2+3+4) 9596 3586 13182 5605 6. Loan Disbursements in Pipeline 217 244 461 174 7. Private Capital Flows 1892 1898 3790 1698 8. Net Financing Requirements (5-6-7) 7487 1444 8931 3733 Sources: 9. Debt Rescheduling and Deferral 6352 1285 7637 1484 Official Bilateral 6352 777 7129 893 Private 0 508 508 591 10. Additional Disbursements 1135 159 1294 2249 Multilateral 698 64 762 2048 Official Bilateral 437 95 532 201 11. Additional Financing Required 0 0 0 0 12. Total Sources of Financing (9+10+11) 7487 1444 8931 3733 a. Estimates are from the beginning of 1992. b. Estimates are from the beginning of 1993; actual is preliminary figures. Source: PCR 25 2.25 During the identification and appraisal stages of the loan, several concerns were expressed regarding its design including: (i) whether some macroeconomic elements should have been built into the loan; (ii) whether fiscal measures such as tax collection and public employment be included; and (iii) a general concern that the program was under-funded, and that arrears would reappear. The first two concerns appear to have been directed at the TPL as if it was a stand alone operation. However, if the TPL was viewed as part of a loan package, which included the SAL and the FSAL, the aggregate of all conditions in the three loans more than adequately dealt with the fiscal and macroeconomic policy issues raised regarding the TPL. It would seem inappropriate to question the lack of macro-policy design in the TPL, when it was originally designed as one component of a three loan package to support the country's overall loan workout program. With respect to the risk of insufficient funding of the program, this has been a repeated source of concern for many of the Bank's adjustment operations. In this case the risk of underfunding was adequately avoided. 2.26 When President Fujimori assumed office in August 1990, the new Government encountered an exceptional window of opportunity to implement many reforms that had been abandoned for many years. Government officials interviewed for this report felt there was no time for sequencing, and that all the reforms had to be enacted at once. If they had not seized on the favorable public opinion early on, it would have been much more difficult to get approval once the crisis environment dissipated. On the other hand, the Government in 1990 inherited a public sector that had practically collapsed financially. For example, current revenues of the central government stood at 7.7 percent of GDP in 1989, of which import and export taxes represented a marginal 1.3 percent.8 These figures reflected a serious tax evasion problem, and under such circumstances it was justified to expect that with dramatic trade liberalization and sharp reduction in tariff rates, tax revenues would rebound; after all, revenues could not decline any further. The effective tax base was so small, that there was much upside potential, with only limited downside risk in terms of revenues. 2.27 While the structuring of the TPL was in general quite responsive to the country's needs, a potentially weak area of the program, although a minor one in relation to the overall excellent quality of the loan's conditionality, dealt with the condition of the surcharges on agricultural imports. The PCR accurately described the variable surcharge scheme as potentially damaging to the overall thrust of trade reform because it could encourage other groups to seek similar protectionist measures. The Structural Adjustment Loan 2.28 The SAL was the principal component of the three loan package. Its design was comprehensive as well as compatible with the Government's goals and their capacity to implement the program. As with the TPL, about 90 percent of the program had been done prior to Board approval, and the loan agreement became a document which recognized what was done rather than what was to be done, and required that those reforms be maintained. A concurrent IMF program further strengthened the SAL's stabilization objectives. 2.29 The stabilization program implemented by the Fujimori Administration was monetary- based, since it stopped domestic financing of the fiscal deficit and imposed targets on net 8. See Peru at the Crossroads: Building a Modern State, Report No. I 1943-PE, 1994, Statistical Annex. 26 domestic credit of the Central Revenue Bank. Drastic changes in tax legislation to simplify the tax code facilitated the design of the fiscal policy components of the program. The reorganization of SUNAT was an important initiative to buttress the buoyancy of the tax system. The institution of a cash budget for the Central Government was a very effective measure to control the deficit. Labor market liberalization addressed a critical problem holding back private sector investment. The re-introduction of private property guarantees in the agricultural sector was an essential step to promoting investment in that sector, although the land titling program has been slow in its implementation. The privatization strategy was instrumental in downsizing the public sector while contributing to the large inflow of capital. The social sector program, assigned to the National Social Compensation and Development Fund (FONCODES), dealt with the social cost of the adjustment program. 2.30 Only minor weaknesses were noted in the following areas: * poverty alleviation: the design of a proactive poverty alleviation scheme through FONCODES to finance employment creating projects in targeted areas was very relevant; however, in view of the dramatic deterioration of the economy during the 1980s, perhaps a broader social program, or a separate social sector rehabilitation loan might have been considered to complement the actions taken under the SAL; * agricultural sector credit: dismantling the Banco Agrario as a means of eliminating credit subsidies brought with it an almost total absence of credit in the sector with a negative impact on small producers, since the alternative sources of credit which were supposed to fill this gap did not materialize. Loan Disbursement Procedures 2.31 A complicated area in loan design and preparation was the disbursement mechanism. Arrears clearance was to be accomplished through the instantaneous disbursement of around $900 million from the three loans. Such disbursements, however, had to be made according to the Bank's rules, on the basis of documentation of payment for eligible imports. However, in view of the very large size of the loan disbursement that was to take place upon effectiveness, it was operationally impossible to satisfy the documentation requirements as normally specified. 2.32 The Bank acted expediently to find a solution to this problem. First, the Bank permitted an unusually long period of retroactivity of 28 months for purposes of qualifying imports. And second, the Bank made an exception to its normal rule of disbursing against proof of payment for imports. It accepted instead evidence of the act of importing contained in customs declarations as a proxy for evidence of payment. This report agrees with the PCR in describing the disbursement process for structural adjustment loans as contentious and arcane, specially since the project is balance of payments support, for which any import expenditure would qualify.' 9. Implicit financing of goods prohibited by the Bank could be avoided (for eligible countries) by certifying that the value of the loan (in the case of balance of payments financing) is less than the value of total imports minus prohibited goods during the period of retroactive financing. 27 Complexity 2.33 The loan package was a highly complex program consisting of three loans linked by the common objective of supporting Peru's debt workout to eliminate arrears to the Bank. Normally, these loans would have been timed in sequence starting with the TPL and followed by the SAL and FSAL. As explained in the previous section, years of policy neglect in almost all areas of the economy made it difficult to prioritize the reform agenda, and there was a window of opportunity for the Government to act before political opposition could organize and present an obstacle to further reforms. For these reasons, the Bank took a calculated risk in bunching many conditions into three simultaneous operations. In retrospect, the decision appears to have been well founded. 2.34 Despite its success, the SAL may have been somewhat ambitious in terms of the number of conditions, the areas covered, and the limited number of conditions in each area. At the time of loan appraisal some suggestions were made to restrict the SAL's conditions to the macroeconomic, fiscal, privatization and social sector areas. Government officials who were interviewed for this report also commented that there could have been fewer areas and conditions, with more emphasis placed on the agricultural sector, privatization, and social security. One of the suggestions was to have excluded conditions that were duplicated in other programs, such as the reform of tax administration which was already incorporated into a parallel IDB loan. 2.35 With 45 conditions covering seven areas, the SAL represented a complex program. At the same time, the package of the three loans contained 106 conditions. While such a large number of conditions would be considered burdensome under most circumstances, Peru's success story during the period of these loans is proof that the Government managed to accomplish much in a relatively short period of time. The two loans could afford to have more conditionality than most because the conditions were almost completely home-grown, largely implemented before they went to the Board, and completely implemented before they were disbursed. This experience underscores the importance of both the willingness and capacity (political and technical) of the borrower in determining the complexity of an adjustment program. In the case of Peru, about 90 percent of the conditions had already been implemented by the time of Board presentation. Bank analysis of structural adjustment lending has demonstrated that lending for prior actions enhances program performance because of a strong track record on the part of the borrower, which usually follows from the government's willingness to take unpopular actions.10 At the same time, during the initial phase of reforms, adjustment programs tend to be broader in scope and less intense in one particular area, and subsequently the follow up operations develop a tighter focus on additional reforms. Riskiness 2.36 The principal risks identified at the time of Board presentation were: (i) the fiscal situation would remain precarious; (ii) market perception of continuing overvaluation of the sol; (iii) continuing dollarization; (iv) pressures to reverse reforms; and (v) political uncertainty and a worsening of the security problems. The first three dealt with the overall risk of the stabilization program, while the latter two addressed concerns over the political will and ability to sustain the 10.. See V. Corbo, S. Fischer, and S. Webb, Adjustment Lending Revisited, The World Bank, 1992. 28 program, and the response of the private sector via investment. The fragile state of the economy and the political system at the time of loan appraisal could not be overstated. The urgency to clear Peru's arrears with its multilateral creditors called for an immediate response in terms of program support through the TPL and the SAL (as well as the FSAL). While more conditions could have been added to further guard against potential reversals, there was a need to make a trade off between reducing risks and adding to the already significant burden of conditionality. The best indication that these risks were manageable was the Government's strong positive response during the performance period prior to loan signing. 2.37 Some policy reversals occurred, mostly through congressional action, but most of them were subsequently corrected. Perhaps the most sensitive incident occurred in April 1992, when President Fujimori, in a "self-coup" dissolved the Congress and the judiciary, and suspended parts of the Constitution. This "self-coup" led to a delay in Support Group disbursements which in turn lead to delays in the Bank's own debt workout program. However, by the end of 1992, Peru was making progress in returning to democratic rule, and a Democratic Constitutional Congress was elected in November. Borrower Ownership 2.38 The success of the loans can in large part be attributed to the fact that the programs had been conceived and initiated by the Peruvian Government. Both the Bank and the Government were in synch from the beginning as to the reform program. While the Bank played an important role in providing economic policy advise, it was clear that the Government had both the will and the capacity to implement this highly complex package of loans. Demands on Bank Resources 2.39 The amount of Bank staff and resources devoted to the identification, appraisal, and implementation of the two loans seemed adequate. Most of the time was spent on the initial phase of identification and appraisal, particularly the structuring of the arrears clearance operation which was a novelty for the Bank. 3. Project Outcome, Efficacy and Sustainability Project Outcome 3.1 The overall outcome of the two operations, the TPL and the SAL, has been very positive. Because of the relatively short period of time since the implementation of these programs, this evaluation is based primarily on the medium-term results. 3.2 As shown in the Table 3, the stabilization program was successful in eliminating the hyper-inflationary environment. The sharpest decline in the inflation rate occurred in 1992, and inflation continued to fall through 1994. A more dramatic contrast of the pre- and post- adjustment periods is shown in Figure 1. During the 1980s, the minimum annual inflation rate was 64 percent, which occurred in 1982, and the maximum was 7,482 percent in 1990. 29 Table 3. Peru: Selected Indicators (percent, except where noted) 1986-90 1991 1992 1993 1994 1991-94 Inflation 822.2 410 73.3 48.6 23.7 100.8 GDP Growth (G) -1.5 2.8 -2.4 6.5 12.5 4.7 Investment / GDP (R) 22.0 23.8 23.7 24.9 29.6 25.5 of which: private (R) 15.4 16.8 17.9 18.3 22.6 18.9 NFPS - balance / GDP (R) -6.6 -1.5 -1.7 -1.2 2.5 0.5 Tax revenues / GDP (R) 9.2 9.2 9.1 10.8 12.4 10.4 Exports ($) (G) 1.6 3.0 4.6 -0.5 28.6 8.3 of which: non-traditional(G) 6.2 -1.5 6.5 11.5 18.1 8.4 Imports ($) (G) 9.9 20.9 15.9 -0.2 38.4 17.9 of which: capital goods / Total (R) 29.2 26.7 27.6 28.1 31.3 28.4 consumer goods /Total(R) 12.0 18.3 20.8 22.4 24.4 21.5 Foreign exchange reserves: months of imports (No.) 3.9 8.4 8.4 10.1 13.7 10.1 Note: G is growth rate and R is ratio (both expressed as percent), and No. is number (not percent). For the period 1986-90 and 1991-94, the figures are annual averages. 3.3 The response to the Government's program was equally impressive in terms of economic activity. During the five year period preceding the reform program, GDP declined by an average of 1.5 percent per annum; with the implementation of reforms, the average growth rate jumped to 4.7 percent per annum. The most dynamic component of aggregate demand has been private investment, principally in construction, both residential and non-residential. The investment to GDP ratio increased consistently throughout the initial and subsequent adjustment periods, which is in contrast to the average experience of a decline in this ratio in countries under a structural adjustment program. 30 Figure 1: Peru: Inflation (Percent per month) 40.0 - 35.0 30.0 25.0 20.0 G) 15.0 10.0 5.0 0.0 84 85 86 87 88 89 90 91 92 93 94 3.4 The improvement in the fiscal accounts has been noteworthy. The non-financial public sector (NFPS) deficit averaged 0.5 percent during 1991-94, which is substantially below the corresponding figure of 6.6 percent prior to the reform period. The buoyancy of tax revenues improved considerably during 1993-94. This had been cited as one of the major risks of the adjustment program, fearing that trade reforms would have a detrimental effect on customs revenues without an offsetting increase in other tax revenues. In view of the dire straits of fiscal finances at the time the reforms were initiated, especially widespread tax evasion, the three year delay in obtaining a revenue response should be regarded as a very positive response. 3.5 The trade reform program triggered a notable response in the balance of payments. Exports have been expanding at a faster pace, with non-traditional goods posting a robust performance. However, the response shown by imports has been much stronger, giving rise to a surge in the trade deficit. While the strong increase in imports may reflect a one-time pent-up demand effect from the dismantling of trade barriers, the share of consumer goods imports has been climbing since the beginning of the reform period. An abundance of capital inflows has not only covered the imbalance in the resource account, but has also contributed to a sizable increase in foreign exchange reserves. 3.6 One of the notable outcomes of the program was a strong vote of confidence by the private sector for the Government's results oriented strategy. Based on a Bank's private sector survey held in early 1993, the business community indicated that the reforms had positive effects in many areas." Great progress appeared to have been made in reducing regulations as an obstacle to enterprise growth. Figure 2 demonstrates that businesses rated most of the reforms as highly successful. The areas that show the greatest improvement are: (i) import and foreign exchange restrictions; (ii) labor regulations; (iii) inflation; and (iv) tax bureaucracy. The large scale privatizations were influential in instilling greater confidence. Nevertheless, businesses 11. World Bank, Peru: a Private Sector Assessment, 12096-PE, December 1993. 31 were concerned about a possible reversal of reforms, high costs of security, lack of financing, and a high tax burden. In terms of the unfinished agenda, emphasis in the private sector assessment was placed on greater commitment to reforms of the agricultural sector, greater support of the export sector, and strengthening of the administrative machinery of the public sector. Figure 2. Obstacles to Enterprise Growth High taxes Political/Policy Uncertainty Security Tax Bureaucracy Access to Bank Finance Access to Inputs Orders Renegotiated by Clients 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 no burden moderate burden severe burden Source: World Bank, Peru: A Private Sector Assessment, 12096-PE, December 1993. Efficacy of Outcome 3.7 The economic and financial programs supported by the TPL and the SAL were highly successful. Much of this had to do with the Government's unquestionable commitment to the implementation of the programs. The loan workout and external financing program achieved its goal of eliminating debt arrears and thus normalizing relations with the multilateral and bilateral lenders. The essence of the trade reforms was to move trade policy to a stance approaching neutrality, i.e. where there is minimal policy discrimination between different economic activities, between firms, or between imports and exports. The reforms supported by the SAL have proven to be among the most important changes in the country's economic framework since 1968. Loan Workout and External Financing Program 3.8 The loan package succeeded in normalizing Peru's relation with the IMF, the 1DB, and the Bank. The external financing program supported by the loan package achieved its objective. As shown by Table 2, the goal of reinforcing Peru's international reserves through a viable financing program was surpassed. While the non-interest current account deficit was significantly higher than the original estimates, a substantially higher inflow of private capital covered the current account gap, with additional capital flows accounting for the larger than expected buildup in reserves. 32 The Trade Policy Reform 3.9 At the final program review in December 1992, the Bank concluded that the Government had observed all measures it had agreed to undertake, and continued to support an open trade regime. This assessment still holds at the time of this evaluation, with only minor qualifications regarding the real appreciation of the exchange rate (see next section on the SAL), agricultural variable surcharges, non-tariff barriers related to health, technical, and security regulations, the development of exports, and the operations of customs. 3.10 The elimination of quantitative restrictions, followed by the simplification and subsequent reduction in the average tariff rates was completed as of September 1991, when two tariff rates of 15 and 25 percent were established. The reforms dealing with non-tariff barriers included the following: (i) in May 1992, the Government eliminated the use of reference prices for customs valuation, relying instead on the valuations provided by foreign-based pre-shipment inspection companies hired on a commission basis, although this initiative was independent of any Bank conditionality; (ii) a Government appointed commission (INDECOPI) was assigned to supervise the implementation of the anti-dumping code; and (iii) the Government implemented a thorough reform of the Customs Superintendency (SUNAD) with adoption of "self-assessment" declarations by importers, which put more ex-ante trust in the client.. 3.11 While the hiring of multinational firms to perform pre-shipment inspection has helped to reduce the problem of under-reporting of imports, this type of activity should eventually become the responsibility of SUNAD. As stated in the PCR, the use of outside inspection companies should serve only as a transitional aid to customs reform, and, for this reason, SUNAD needs to define a timetable to progressively take over customs valuation and inspection responsibilities. 3.12 The variable surcharges scheme is considered to be a potential source of protectionism, while the validity of its goal of providing a predictable return to producers has been questioned. The scheme, created in March 1991, provides for a variable surcharge in addition to the normal 15 percent tariff, based on the average of the previous five years' c.i.f. import price. As discussed in the PCR, this scheme has proven the most contentious part of the trade reform process. Frequent changes in the rules combined with other distortions which diverted the gains from the targeted producers, led to the Government's decision to scale back the coverage of the program to about 20 products. A study performed by GRADE pointed to the possibility that intermediaries have reaped the bulk of the gains from the higher tariffs, rather than the producers." This report agrees with the conclusions of the PCR that the variable surcharges have not generated satisfactory benefits. 3.13 The efficiency gains achieved through trade reforms usually arise from increased productivity and a shift in resources towards the more competitive sectors." However, the degree of supply response also depends on the adequacy of the infrastructure and transparency of the regulatory process. One of the issues brought out by the Bank's private sector survey was a less 12. Javier Escobal and Arturo Briceno, Una Altemativa al Actual Sistema de Sobretasas Agricolas en el Peru, GRADE, August 1992. 13. See Trade Policy Reforms Under Adjustment Programs. 33 than desired response of exports to the trade reforms. A recent analysis of obstacles to exporters points to the following factors: (i) high cost of financing with little long-term availability; (ii) lack of fiscal incentives due to restricted regime of temporary imports, absence of a drawback scheme, slow process for value-added tax credits, and no tax credit on the special fuels tax; (iii) continuing bottlenecks in customs, with exporters having to assume the cost of pre-shipment inspections for their imported inputs; (iv) high labor costs due to the FONAVI tax of 9 percent; and (v) insufficient infrastructure such as inadequate port facilities, high transportation costs, and elevated costs of public utilities." The conclusions of this analysis, as well as those of the Bank's private sector survey mentioned in the previous section, recommend that the Government take a more active role in supporting exporters. Its actions should include: greater efficiency in the processing of the value-added tax and the drawback for exporters; improvement of the infrastructure in ports, roads, and industrial parks; development of commercial intelligence and marketing support for exporters, such as the pooling of exporters for large contracts. Stabilization and Structural Adjustment 3.14 As demonstrated by the selected indicators on program results, the stabilization and structural adjustment components of the SAL were highly successful. One of the more striking features of these results was that the improvements occurred in a relatively short period of time. Inflation has declined dramatically from 410 percent in 1991 to 24 percent in 1994, with monthly inflation rates dipping below one percent during the fourth quarter of last year. However, some concerns have been expressed over the real exchange rate, domestic interest rates, the persistently high level of dollarization, and the presence of structural weaknesses in the financial sector. Real exchange rate: as shown in Figure 3, the Central Bank's index of the real exchange rate shows that as of the end of 1994, the sol had appreciated about 15 percent since 1990. While the appreciation of the sol may raise some concerns, its magnitude is not significant when considering potential sources of measurement error in the index, and other factors that are not reflected in relative prices of goods and services. Some exporters interviewed for this report, complained that the exchange rate was not favorable for exporting. However, a consultant study provided additional evidence of other non-price factors which were holding back exports. At the same time, the strength of capital inflows since 1991 would suggest that a purchasing power parity based index is not capturing all the relevant elements of market fundamentals. Perhaps a more important factor is the trend in the real exchange rate index since 1990. During 1991-92, the index exhibited sizable fluctuations (see Figure 3); however, since then, volatility has been reduced significantly. During 1994, the index was relatively stable, and as a consequence, exporters have benefitted from a more predictable exchange rate. 14. Grupo Apoyo, Factores que Afectan la Competitividad del Sector Exportador Peruano, Lima, June 1994. 34 Figure 3: Peru: Interest Rates vs. Inflation 8 7 56 0 E5 4 CL 0 0 CO Cu C 0 u u C 0 Cua u C z 2) ED U)~~ , c Z -> CO C14~ 0a)0 L 1ifiTion -- Iteres Domestic interest rates: through the management of monetary and exchange rate policies, interest rates are an important element of stabilization policy. In August 1990, the Government established the free determination of interest rates on deposits and loans. From Figure 4, it can be inferred that real interest rates on deposits have been positive since 1993 at what appears to be an acceptable level. To the extent that domestic interest rates influence investors' decision to hold domestic or foreign currency denominated assets, Figure 5 shows that rates on domestic deposits have exceeded the domestic currency equivalent rate on dollar deposits since the latter part of 1993. These indicators support the notion that the behavior of domestic interest rates is compatible with the Government's stabilization objectives. Figure 4: Peru: Interest Rates vs. Inflation 8 7 C 0 3 0 a C, a- > C > . > C3 0 0 Cu C C ) 0 Cu C u 4 0 CuCMu ) G Z --, c Z - 1 Z Cd C11C. 0)D M)0 35 Figure 5: Peru: Local vs Foreign Currency Deposit 160.0 140.0 120.0 100.0 -- Dom.curr V 800 Fgn.curr. 60.0 40.0 20.0 000 Dollarization in the financial system: A recent Bank report on the Peruvian economy pointed to the risks from dollarization of the local economy." The financial system has a high proportion of assets and liabilities in foreign currency - 65 percent of total deposits at end- 1992, although that proportion has remained stable through end - 1994. In view of the more favorable yields on domestic deposits since the latter part of 1993, it is likely that the proportion of dollar denominated deposits will decline. Nevertheless, the high degree of dollarization may be a symptom of an undesirable systemic risk of the financial sector. For example, to the extent that banks make dollar denominated loans to companies that rely exclusively on local currency revenues, the banks still carry the foreign exchange risk, although indirectly in the form of credit risk. The issue of dollarization needs further analysis, and more definitive conclusions are likely to be forthcoming once the ICR and Audit of the FSAL have been completed. 3.15 Despite the progress achieved in the reform program supported by the FSAL, the persistence of financial sector risk could put into question the sustainability of the stabilization program. While this Performance Audit does not evaluate the outcome of the FSAL, to the extent that recent trends and outlook of the financial sector could materially affect the continuity of the stabilization and structural reform programs supported by the TPL and the SAL, issues of financial sector weakness have a direct bearing on the performance of these two operations. 3.16 The origin of the problems currently faced by the financial sector can be traced back to the period prior to the present Government. In the past, banking legislation had been highly restrictive, denying the banks the opportunity of diversifying risk through different types of financing activities. By putting the banks practically in a straightjacket, the old banking code 15. Peru at the Crossroads: Building a Modem State, No, I1943-PE, March 1994. 36 frustrated financial innovations, deterred management initiative, and discouraged risk management as a result of weak asset quality standards. The remnants of this highly fragmented inefficient banking system are still prevalent today, although the dramatic opening of the economy has aggravated the vulnerability of the financial intermediaries to a sudden outflow of capital. 3.17 With the passage of a new Banking Law in 1991, Peru took important steps towards the modernization of the financial sector. The principal structural reforms initiated during the FSAL's performance period included: liberalization of the currency market, elimination of interest rate controls; phasing out of subsidized lending; near elimination of the state monopoly as provider of financial services; reinforcement of the regulatory environment; removal of excise taxes on bank debits and loans; and introduction of universal banking. 3.18 The financial reform program is a prerequisite for the consolidation of the stabilization and structural reforms supported by the SAL. However, the existence of certain deficiencies in the implementation of these reforms could undermine the overall macroeconomic framework. Three issues deserve special consideration: (i) the liberalization of interest rates has exposed an institutional weakness of the Central Bank in the management of monetary policy; (ii) previous lax standards in terms of asset quality have contributed to a serious underestimate of non- performing assets; and (iii) the introduction of universal banking, where there are practically no limitations to what activities bank can undertake, including the capital markets, in a system that had previously been subject to excessive controls, could produce undesirable risk levels without appropriate management techniques or regulatory experience to limit their exposure. 3.19 The implementation of monetary policy in an economy where interest rates are market determined hinges on the availability of effective instruments such as open market operations, and to a more limited extent, reserve requirements. In Peru, the Central Bank is prevented from holding Government securities for purposes of funds management. Because of this, its ability to intervene in the money markets in order to achieve certain monetary targets is severely constrained. 3.20 Recently issued regulations by the Superintendency of Banking regarding the classification of assets has tightened somewhat loan quality standards. Nevertheless, Peruvian banks still carry on their books a hefty de-facto non-performing loan portfolio dating back to the period of economic crisis during the 1980s. The banks have only partially recognized this problem in terms of loan loss provisions. A recent study by the Bank estimates that the banks need to make additional provisions, based on the new loan classifications, of about 40 percent of equity." The strong economic recovery since 1992 has improved the liquidity of the private sector, and may thus have diverted attention away from the loan portfolio problems. This asset quality problem could exacerbate the financial position of the banks in the event of a sudden sharp outflow of deposits. The solution to this problem may require a more aggressive bank capitalization program supported by the Government. 3.21 As stated above, the banking sector is excessively reliant on dollar deposits. The high reserve requirement rate on dollar deposits is acting, in effect, as a liquidity defense measure. Unfortunately there is no information on what proportion of dollar deposits in the banking 16. The World Bank, Financial Sector Reforms in a Stabilizing Economy-- the Case of Peru, September 1994. 37 system are from offshore sources. These could be considered as highly volatile deposits, which could be withdrawn very swiftly in the event of bank liquidity problems. For the above mentioned reasons, a financial sector crisis could undermine the recovery/stabilization program, and the possibility of such a scenario is significant. Government actions to strengthen the financial sector should be a top priority. In this context, continued implementation of the FSAL supported program is essential. 3.22 Fiscal Policy. The implementation of fiscal reforms was satisfactory, with emphasis placed on tax reform and continued reduction of the budget deficit. Some weakness was noted in the response of tax collections to the new measures, and in the reliance on earmarked funding, specifically the operations of FONAVI. 3.23 Drastic changes in tax legislation reduced to five the number of taxes collected by the central government, allowed for inflation adjustments to account for collection lags, and eliminated many exemptions and loopholes. The tax administration institution, SUNAT, reorganized its personnel and modernized its monitoring tools in order to improve its quality and effectiveness. Government expenditures as a percent of GDP were curtailed in order to achieve the deficit targets agreed with the IMF. One of the key measures was the utilization of a cash budget to manage the fiscal finances. Under this arrangement, cash outlays are basically matched with inflows, thus avoiding the use of inflationary financing of the deficit. 3.24 Despite the efforts to simplify the tax regime and to strengthen the enforcement process, tax revenues did not respond as expected during the first two years after the reforms. Nevertheless, estimates for 1994 reveal a significant increase in tax collections to 12 percent of GDP. This is surprising considering that the VAT rate of 18 percent is relatively high compared to other Latin American countries. The gap in VAT collections relative to other countries may imply a weak enforcement mechanism. SUNAT's efforts in actively monitoring a list of large taxpayers marks an important step in reducing tax evasion, however, much more needs to be done in this area, and in particular, in terms of the small- to mid-sized taxpayers. 3.25 The use of earmarked funds continues to impede efforts to attain greater control over the level and quality of public expenditures. The Bank's public expenditure review identified FONAVI as the most important and contentious fund, accounting for 5.7 percent of central government revenues and 70 percent of resources free from any Treasury control. FONAVI is funded through a 9 percent payroll tax, which in turn, hinders the competitiveness of local labor, and discourages employment creation in the formal sector. The sustainability of the fiscal reforms enacted during this phase of structural adjustment will hinge on more quality reforms, now that the quantity adjustments in terms of reducing the size of the deficit have been accomplished. 3.26 Labor Markets. Among the reforms supported by the SAL, the labor stability law was relaxed, expanding conditions for layoffs and increasing the probationary period in specific cases. In addition, new labor contracts were allowed on a fixed-term basis (up to three years), allowing for fluctuations in temporary employment to adjust for new market conditions. 3.27 Social Sector. The actions undertaken in the social sector have been satisfactory. The quick response to the structural adjustment program in terms of the recovery of economic activity has helped to alleviate the social costs of adjustment. Some questions have been raised regarding the adequacy of the Bank's overall commitment to the social sector (see section on 38 relevance of design). While GDP has grown strongly during the past two years, employment has not responded to the same extent. This can be attributed to continued downsizing in both the public and private sectors. Job training programs for displaced workers should be a priority. 3.28 The principal agency for implementation of the Government's social program was FONCODES. Initially there were long delays in activating FONCODES due to the search for a suitable director. Once the program got underway, it produced good results. 3.29 Privatization. The Government's privatization program has been very successful. It triggered a surge in private investment. While the main goal of the SAL was to develop privatization strategies, the Government went much beyond that objective, and, with the support of a subsequent Bank privatization loan, the sale of public enterprises went ahead of schedule. The positive response shown by private investors was a clear vote of confidence in the Government's policies. 3.30 From May 1992 to September 1994, 47 companies have been privatized. This process has accrued $ 2.6 billion in revenues based on the amount of the sales, and has helped the Government balance its budget. As shown by Table 4, the bulk of the funds from privatization are from sale of companies in the mining, telecommunications, and electricity sectors. Of particular note was the privatization of Empresa Nacional de Telecom unicaciones (Entel) and Compania Peruana de Telefonos (CPT), which were auctioned to a consortium led by Telefonica Internacional (Spain), for a total of $2 billion. However, the actual net amount of revenues from the privatizations is yet to be determined, since the Government, as part of the sales agreement, assumed all existing pension liabilities, the present value of which has not yet been determined. 3.31 In addition, investors in the privatized companies have committed to invest an additional $3.2 billion to upgrade their newly acquired operations. All the remaining major companies are expected to be privatized during 1995. These include the two main electricity companies, the national oil company, the water and sewerage company, and the remaining mining companies. 3.32 Agriculture. The agricultural component of the program was marginally satisfactory, with some areas in need of significant improvement. The loan conditions calling for the closure of the agricultural commodity marketing boards were complied with, and so were those involving the elimination of agricultural pricing controls and subsidies, (the exception of the variable surcharges, was part of the TPL). Overall, reforms in agriculture fell short of the program objectives; agricultural credit is now practically non-existent, security of land tenure is advancing at a very slow pace and extension services are still deficient. The Government still lacks a comprehensive agenda for agriculture that is widely supported by both public and private sector groups. 3.33 Agriculture is one of the most important sources of employment in the country. Agricultural and livestock activities absorb 35 percent of the economically active population, but contribute only about 12 percent of GDP and 8 percent of exports. Small producers are not considered real players in agriculture, even though about 80 percent of productive units are less than 5 hectares. Access to credit is very limited. According to GRADE estimates, about 10 percent of small producers received credit, 40 percent relied on family support or cost cutting measures, and 50 percent depended on money lenders (habilitadores). The principal impediments to development in this sector are: (i) inadequate sanitary standards; (ii) lack of land 39 rights; (iii) lack of water rights; (iv) low level of technology; (v) limited transportation infrastructure; and (vi) insufficient capital. Table 4. Peru: Results Of Privatization Program 1991 1992 No. of Amt. of Additional No. of Amt. of Additional Co. 's Sale Investment Total Co.'s Sale Investment Total (000s, US$s) (000s, US$s) Agriculture Fishing Mining 1 1,511 1,511 5 180,917 715,000 895,917 Manufacturing 1 6,565 6,565 Construction Telecommunications Electricity Transportation 2 11,873 2,000 13,873 Finance & Insurance 1 1,083 1,083 1 5,366 5,366 Commerce 1 4,100 4,100 0 Other TOTAL 2 2,594 2,594 10 208,820 717,000 925,820 Table 4 (Continued): Peru: Results Of Privatization Program 1993 Through September 1994 No. of Amt. of Additional No. of Amt. of Additional Co.'s Sale Investment Total Co. 's Sale Investment Total (000s, US$s) (000s, US$s) Agriculture 1 3,761 3,761 Fishing 1 1,002 1,002 Mining 2 237,000 550,000 787,000 8 76,733 871,728 948,461 Manufacturing 4 8,533 8,533 6 188,567 188,567 Construction Telecommunications 1 1,391,427 1,000,000 2,391,427 Electricity 2 388,610 388,610 Transportation 5 51,912 51,912 Finance & Insurance 1 6,150 6,150 1 51,000 20,000 71,000 Commerce 1 14,663 14,663 Other 2 2,063 2,063 Total 13 318,258 550,000 868,258 22 2,103,163 1,891,728 3,994,891 3.34 42 3.34 One of the basic pre-conditions for private sector investment in agriculture is the existence of a credible system of land and water property rights with reliable enforcement mechanisms. Unfortunately these basic rights had crumbled under the land reform movement in the 1960s. Now the Government needs to make some tough political decisions in returning to a system of private property rights. So far the issuance of land titles and water rights has moved very slowly. At the same time, the Constitution not only limits the size of an individual landholding, but gives the Government the authority to further restrict land tenure. A reform of the Constitution has been discussed, but so far, no definitive action has been taken. 3.35 The existence of an effective registration and land titling system is a prerequisite for viable financial intermediation in agriculture. In this regard, both the Government and the Bank need to be more proactive in updating and extending the process of land registration to include the extensive informal property holdings. A simplified but efficient method of land registration method, known as Registro Predial, was developed to collect information at the grass-roots level. The process of property regularization in the field was based on extensive community visits by attorneys and engineers. This method, known as PROFORM, was implemented as a Bank-financed pilot project in 1992. While it was very successful in terms of the number of properties registered, the project was never continued. Endorsement of this procedure by the judicial process would greatly facilitate its implementation, not to mention the potential benefits that this streamlining of judicial administration would generate by reducing the workload of the already overburdened courts. A recent law has approved the use of the Registro Predial method of registration for a five year period. Nevertheless, the Government as well as the Bank need to seize this window of opportunity to continue with the work started by the pilot project, but on a much broader basis.7 3.36 A Bank agricultural sector mission in November 1994, also identified the need for agricultural research and extension through technical assistance programs. According to their findings, both systems are in serious disrepair and in need of a proactive strategy on the part of the Government with private sector participation. 3.37 A frequently mentioned constraint to the development of agricultural production is the lack of financing. In this regard the closure of Banco.Agrario dealt a severe blow by eliminating credit to agricultural producers. Currently, commercial banks do not seem to be in a position to assume medium- to long-term credit risk in the agricultural sector, except for very few well known clients who would typically have no problem in obtaining un-secured short-term lines of credit. The lack of progress in land titling and registration has also deterred the availability of commercial credit. On the other hand, there is no objection to the policy that credit subsidies need to be eliminated. The issue in this case is that of timing of reforms. 3.38 The assumption that private sector financial intermediaries would simply fill in the vacuum created by the closure of inefficient public sector development banks was somewhat simplistic. The Government needs to develop a strategic plan for financial intermediation in agriculture, which avoids the use of direct credit subsidies. The Bank's Latin American Region is currently undertaking economic work to assist the Government in improving rural access to financing. 18. For additional discussion of this topic see Elena Panaritis, Peru: Evaluation of the Titling and Registration Component of the Irrigation Subsector Project, August 9, 1994; and Elena Panaritis and Geoffrey Shepherd, Background Paper for Policy Note on Land Property Rights, December 1994. 43 3.39 Social Security. In mid-1993, the Government revamped the social security administration from the previous pay-as-you-go system to a fully-funded private pension system to be introduced on a gradual basis. According to the Bank's Public Expenditure Review, the Government is committed to issuing "recognition bonds" for the accumulated contributions of workers shifting to the private pension system. These bonds are expected to create an unfunded liability of the Central Government, which is estimated at around $5 billion based on the life expectancy of existing workers. Because of the magnitude of these liabilities, it is important to further evaluate the fiscal implications of these commitments, which have so far been based on very sketchy information. At the time of this report, there was little information available on the potential balance sheet of the pension system according to: (i) assets, in the form of the current value of the fund, plus the present value of contributions for future employment; and (ii) liabilities, in the form of the present value of expected benefits for past employment plus the present value of expected benefits from future employment; and (iii) the net balance, in terms of a fund surplus or of an unfunded liability, with its consequent fiscal implications. 3.40 More time should have been dedicated to studying the financial implications of the new private pension system before embarking on the reforms. The fact that the previous system was in a state of disrepair, did not necessarily imply that it should be immediately replaced by another private sector managed fund. While the Chilean model is often cited as the source of Peru's new pension system, more careful analysis of the difference between the two countries, and the timing of these reforms is called for. In the haste to make the changeover some decisions could prove to be costly either for the Government or for the workers. In this context, it might have been more appropriate to have postponed the social security reforms to a subsequent SAL or sectoral adjustment loan. 3.41 The Capital Markets Law of 1991 set the stage for the development of the pension fund system. Under the new law, Private Pension Fund Administrators (AFPs) can be formed to manage the funds based on workers' contributions. Some financial sector and government representatives interviewed for this report mentioned that some AFPs had been loosing money due to high overhead, particularly advertising and commission expenses. At the same time, the AFPs have invested a good part of their funds as bank deposits given the limited availability of acceptable instruments in the capital market. Some of these problems may just be transitory, as these intermediaries go through the learning curve in their new business. However, a more definitive assessment of these issues may have to be deferred to the evaluation of the FSAL, since the financial sector support program contained a number of important measures dealing with the development of the AFPS. Main Factors Affecting the Outcome 3.42 The very positive outcome of these loans was influenced to a large extent by the Government's commitment to the program. During the performance period for the two loans, August 1990 through December 1992, the Government laid the basis for a dramatic economic reform program with a single-minded and pragmatic approach. The successful campaign against terrorist activities further enhanced the Government's credibility, and set the stage for a swelling of popular support for the program. External factors played a very limited role in the outcome of the programs. It was rather a strong Government performance in terms of macro policies, appointment of highly qualified individuals to key staff positions, and to the high quality of information generated within the implementing agency that contributed to the highly satisfactory outcome. 44 3.43 Once the Government demonstrated its unfaltering commitment to the economic reforms, a dynamic response by the private sector triggered a vigorous recovery led by investment activity. Assessment of the Outcome and Its Efficiency 3.44 The results of the two loans in terms of cutting inflation, strengthening the balance of payments, and fostering private sector investment, clearly exceeded expectations. The resources devoted to the design and implementation of the program were very effective. However, the loan workout process proved to be time consuming, in part because of the Bank's limitations regarding the treatment of past due loans. In particular, the need to structure a bridge loan in order to directly pay off arrears, complicated by the sizable amount of the arrears ($900 million), proved to be a long ordeal. Once arrears were eliminated in March 1993, Peru has continued to service its debt to the Bank on a timely basis. 3.45 The fact that the actual dates for preparation, negotiations, effectiveness, and loan closing were close to the original target dates, was reflective of the Bank's diligence as well as the Borrower's cooperation in meeting such tight deadlines. The amount of staff input dedicated to each loan was quite realistic, in particular the emphasis during the key year 1992. Sustainability 3.46 Sustainability of the reform programs supported by the TPL and the SAL is likely. So far, the pace of reform has been maintained, the current administration remains committed to the structural reforms and current economic policy, and its recent re-election is a strong indication that the voters favor a continuation of those reforms. However, the measures contained in this loan package should be considered as a first phase of economic reforms, which were aimed at instilling discipline and credibility after decades of neglect and volatility. A second phase of reforms, to be led by a follow-up SAL under preparation and other sectoral loans, needs to focus on the broader agenda of reforming the state and of creating a more efficient outward looking economy. 3.47 The external financing plan proved to be very successful and Peru's return to the international financial markets, on a voluntary basis, will now hinge on a successful restructuring of its commercial bank debts. At the same time, some concerns still remain regarding the sustainability of the current short-term capital flows which have been the principal factor in covering the external financing gap. At the same time, the strong success of the privatization program, which provided an additional impetus to capital inflows, will soon have to be replaced by a more sustainable source of foreign capital. 3.48 In the short-term, structural weakness of the financial sector could undermine the sustainability of the stabilization program. As explained in a previous section, a sudden outflow of capital could jeopardize the health of the financial sector. 3.49 The risks to the programs in the medium- and long-term continue to echo the issues raised in the President's Report: (i) the fiscal situation could remain tight; (ii) market perception of continuing overvaluation of the sol; (iii) continuing dollarization; (iv) pressures to reverse reforms; and (v) political uncertainty and the transition to the next administration. However, 45 these risks have diminished considerably from the time the programs were first implemented in 1990. 4. Bank and Borrower Performance Bank Performance 4.1 From the start, the Bank's staff played a proactive role in supporting the Government's own reform initiatives. Based on written communications, reports, and interviews during this audit mission, it appears that the Bank sustained a high degree of cooperation with the senior government officials involved with the implementation of the reforms (and the loans). The analysis of the economic problems and the prognosis of needed action steps, performed by the Bank, were both in-depth and of high quality. In this regard, the intensive discussions between the Bank and the Government produced valuable synergies not possible in a more unidirectional environment. 4.2 The Bank took many creative problem solving initiatives, first, by defining a new policy for dealing with countries with protracted arrears; second, by structuring a package of three loans around a common objective of arrears clearance; and third, by resolving the knotty procedural issue of disbursement and its associated documentation in a way that did not compromise the basic objectives of the loans. 4.3 Supervision of program performance was highly satisfactory. The Bank established a local monitoring unit, staffed by consultants, which provided regular reports. Quarterly reports were prepared during 1992, which provided detailed analysis of the program's implementation. In view of the importance of customs reform to the sustainability of an open trade regime, the Bank might have considered a more active role in customs reform. Nevertheless, the PCR cited a lack of internal Bank staff with expertise in management and operational issues affecting the restructuring of the customs administration. For example, the implementation of a pre-shipment inspection scheme, which was first proposed by the Government, was not included in Bank conditionality or supervision. Borrower Performance 4.4 One of the outstanding features of the borrower's performance was the Government's exceptional commitment to the program and the continuity of senior administration officials involved in the implementation of the loans. A special coordinating unit was set up in the Ministry of Economy and Finance (MEF) to facilitate the implementation and to provide information on the status of the program. However, one apparent incidence of disagreement did arise between the MEF and the Ministry of Agriculture over the implementation of the agricultural component of the loans. This lack of coordination may have led to some weakness in the implementation and results of agricultural sector reforms. Nevertheless, the overall performance can be characterized as highly effective. 46 5. Conclusions and Lessons of Experience Conclusions 5.1 The programs supported by the TPL and the SAL have been very successful. This success is largely attributed to the fact that the programs had been conceived and initiated by the Peruvian Government, and to the critical economic situation at the time which required strong and decisive action. The Bank's decision to formulate a new policy for dealing with countries with protracted arrears was also critical for the success of the program. Trade policy achieved substantial neutrality. The stabilization component of the SAL was also quite successful; however, some concerns were expressed over the persistence of structural weakness in the financial sector which could compromise the sustainability of the stabilization program. And, finally, the structural adjustment component of the SAL was highly satisfactory. All the goals set in the SAL were achieved, although minor weaknesses were noted in the areas of fiscal revenue collection and budget coordination, in the implementation of agricultural reforms, and in the social security restructuring. Audit Ratings 5.2 Both the TPL and the SAL as well as their participation in the normalization of Peru's relations with the Bank can be considered to have been very successful. While some weaknesses were noted, these are considered of minor significance in relation to the impressive results of the programs. The two loans are therefore rated as highly satisfactory. Institutional development impact is rated substantial, specially in terms of the comprehensive nature of organizational reforms instituted in SUNAT, SUNAD, the implementation of a tightly controlled central government budget, and the effectiveness of the privatization program. Finally, the sustainability of both the trade policy and the structural adjustment programs is rated as likely. Lessons of Experience 5.3 The main lessons of the TPL and the SAL are as follows: Overall * Once again, Borrower ownership of the reform program was a critical factor in its success. * Sometimes it may be necessary to put aside the issue of sequencing of reforms. In the case of Peru, when the Government assumed office in 1990, it encountered an exceptional window of opportunity to implement many reforms. It was felt that political support would have quickly dissipated for any reforms which would have been postponed. For this reason, the Government was convinced that the trade policy and other structural adjustments had to be implemented all at once. In retrospect this decision appears to have been the right choice. This also underscores the need for a case-by-case approach in the design and implementation of TPLs and SALs, since each country presents a set of unique challenges and opportunities. 47 Trade Policy Reforms * The establishment of an independent body to deal with conflicts that may arise during the process of trade liberalization might be essential for the sustainability of the reforms. In the case of Peru, the establishment of INDECOPI as an independent body to decide on claims against non-competitive behavior, anti-dumping, and appropriateness of legislation on economic matters, was a very effective step on the part of the Government to deal with the threat of reforms reversals. The board of directors of INDECOPI is well-balanced with representatives from both the public and private sectors. The Bank has concerns, however, about the authority, the resources, the accountability, and the sustainability of INDECOPI as an institution. Structural Adjustment Program * The design of a proactive poverty alleviation schemes in SALs cannot be overemphasized. In the case of Peru, the creation of FONCODES to finance employment creating projects in targeted areas was very relevant; however, in view of the dramatic deterioration of the economy during the 1980s, perhaps a broader social program, might have been needed to complement the actions taken under the SAL.  Table Al: Peru - Real GDP by Sector of Origin (Constant 1979 New Soles) 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Agriculture 403.3 414.8 431.4 453.5 480.2 462.7 421.4 433.6 401.4 425.7 479.8 Fishing 21.7 24.5 31.8 28.1 36.3 37.7 37.8 34.5 35.5 44.0 55.8 Mining 475.8 501.9 484.5 467.6 395.2 409.6 397.2 387.8 376.3 405.7 421.1 Manufacturing 747.9 794.2 937.0 1,067.9 931.0 750.5 731.5 781.1 749.8 799.9 929.5 Construction 195.7 179.1 227.0 261.8 251.6 210.5 216.9 216.1 225.7 256.2 342.5 Government 277.7 279.1 302.6 317.0 289.3 246.5 216.8 203.2 209.4 209.2 209.4 Other 1,425.7 1,454.4 1,597.0 1,751.6 1,581.6 1,386.3 1,333.3 1,393.7 1,370.7 1,445.5 1,595.8 Total GDP 3,547.8 3,648.0 4,011.3 4,347.5 3,965.2 3,503.8 3,354.9 3,450.0 3,368.8 3,586.2 4,034.0 Source: Central Bank Table A2: Peru - Real GDP by Sector of Origin (Growth rate in percent) 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Agriculture 9.3 2.9 4.0 5.1 5.9 -3.6 -8.9 2.9 -7.4 6.1 12.7 Fishing 66.9 12.9 29.8 -11.6 29.2 3.9 0.3 -8.7 2.9 23.9 26.9 Mining 5.7 5.5 -3.5 -3.5 -15.5 3.6 -3.0 -2.4 -3.0 7.8 3.8 Manufacturing 7.4 6.2 18.0 14.0 -12.8 -19.4 -2.5 6.8 -4.0 6.7 16.2 Construction -0.6 -8.5 26.7 15.3 -3.9 -16.3 3.0 -0.4 4.4 13.5 33.7 Government 7.6 0.5 8.4 4.8 -8.7 -14.8 -12.0 -6.3 3.1 -0.1 0.1 Other 2.4 2.0 9.8 9.7 -9.7 -12.3 -3.8 4.5 -1.7 5.5 10.4 Total GDP 5.1 2.8 10.0 8.4 -8.8 -11.6 -4.2 2.8 -2.4 6.5 12.5 Source: Central Bank Table A3: Peru - Real GDP by Sector of Origin (percent structure) 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Agriculture 11.4 11.4 10.8 10.4 12.1 13.2 12.6 12.6 11.9 11.9 11.9 Fishing 0.6 0.7 0.8 0.6 0.9 1.1 1.1 1.0 1.1 1.2 1.4 Mining 13.4 13.8 12.1 10.8 10.0 11.7 11.8 11.2 11.2 11.3 10.4 Manufacturing 21.1 21.8 23.4 24.6 23.5 21.4 21.8 22.6 22.3 22.3 23.0 Construction 5.5 4.9 5.7 6.0 6.3 6.0 6.5 6.3 6.7 7.1 8.5 Government 7.8 7.7 7.5 7.3 7.3 7.0 6.5 5.9 6.2 5.8 5.2 Other 40.2 39.9 39.8 40.3 39.9 39.6 39.7 40.4 40.7 40.3 39.6 Total GDP 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: Central Bank Table A4: Peru - Real GDP by Expenditure (Constant 1979 New Soles) 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Consumption 2,587.3 2,686.2 3,060.1 3,286.8 2,989.7 2,541.0 2,460.5 2,506.4 2,511.8 2,581.9 2,781.4 Private Consumption 2,239.3 2,324.0 2,669.1 2,872.8 2,640.7 2,266.0 2,156.5 2,250.4 2,236.8 2,308.9 2,484.4 Public: 348.0 362.2 391.0 414.0 349.0 275.0 304.0 256.0 275.0 273.0 297.0 Central Government 289.1 309.4 323.7 333.2 283.3 213.6 260.7 173.4 192.8 188.5 NA Other Public 58.9 52.8 67.3 80.8 65.7 61.4 43.3 82.6 82.2 84.5 NA Gross Investment 689.5 595.5 821.5 1,047.3 947.4 693.0 728.3 821.7 799.3 894.1 1,193.4 Gross Fixed Investment 712.2 614.3 762.3 906.1 782.1 653.0 698.3 691.7 728.7 800.9 1,096.9 Public 270.5 211.5 209.3 205.5 159.6 151.0 117.2 111.2 126.8 143.6 184.5 Central Government 123.8 101.7 131.8 129.5 93.2 68.6 56.8 54.4 69.8 76.5 NA Other Public 146.7 109.8 77.5 76.0 66.4 82.4 60.4 56.8 57.0 67.1 NA Private 441.7 402.8 553.0 700.6 622.5 502.0 581.1 580.5 601.9 657.3 912.3 Change in Stocks (22.7) (18.8) 59.2 141.2 165.3 40.0 30.0 130.0 70.6 93.2 96.5 Resource Balance 271.0 366.5 129.8 13.4 28.1 269.9 166.1 121.8 57.6 110.2 59.2 Exports 856.7 879.0 769.6 741.4 679.4 820.1 759.7 804.8 808.6 858.8 1,003.9 Imports 585.7 512.5 639.8 728.0 651.3 550.2 593.6 683.0 751.0 748.6 944.7 Total GDP 3,547.8 3,648.2 4,011.4 4,347.5 3,965.2 3,503.9 3,354.9 3,449.9 3,368.7 3,586.2 4,034.0 Source: Central Bank Table AS: Peru - Real GDP by Expenditure (Growth rate in percent) 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Consumption 1.4 3.8 13.9 7.4 -9.0 -15.0 -3.2 1.9 0.2 2.8 7.7 Private Consumption 2.9 3.8 14.8 7.6 -8.1 -14.2 -4.8 4.4 -0.6 3.2 7.6 Public: -7.2 4.1 8.0 5.9 -15.7 -21.2 10.5 -15.8 7.4 -0.7 8.8 Central Government -8.9 7.0 4.6 2.9 -15.0 -24.6 22.1 -33.5 11.2 -2.2 NA Other Public 2.3 -10.4 27.5 20.1 -18.7 -6.5 -29.5 90.8 -0.5 2.8 NA Gross Investment -7.9 -13.6 38.0 27.5 -9.5 -26.9 5.1 12.8 -2.7 11.9 33.5 Gross Fixed Investment -4.3 -13.7 24.1 18.9 -13.7 -16.5 6.9 -0.9 5.3 9.9 37.0 Public 3.6 -21.8 -1.0 -1.8 -22.3 -5.4 -22.4 -5.1 14.0 13.2 28.5 Central Government 22.6 -17.9 29.6 -1.7 -28.0 -26.4 -17.2 -4.2 28.3 9.6 NA Other Public -8.3 -25.2 -29.4 -1.9 -12.6 24.1 -26.7 -6.0 0.4 17.7 NA Private -8.6 -8.8 37.3 26.7 -11.1 -19.4 15.8 -0.1 3.7 9.2 38.8 Exports 7.4 2.6 -12.4 -3.7 -8.4 20.7 -7.4 5.9 0.5 6.2 16.9 Imports -18.8 -12.5 24.8 13.8 -10.5 -15.5 7.9 15.1 10.0 -0.3 26.2 Total GDP 5.1 2.8 10.0 8.4 -8.8 -11.6 -4.3 2.8 -2.4 6.5 12.5 Source: Central Bank M Table A6: Peru - Real GDP by Expenditure (percent structure) 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Consumption 72.9 73.6 76.3 75.6 75.4 72.5 73.3 72.7 74.6 72.0 68.9 Private Consumption 63.1 63.7 66.5 66.1 66.6 64.7 64.3 65.2 66.4 64.4 61.6 Public: 9.8 9.9 9.7 9.5 8.8 7.8 9.1 7.4 8.2 7.6 7.4 Central Government 8.1 8.5 8.1 7.7 7.1 6.1 7.8 5.0 5.7 5.3 NA Other Public 1.7 1.4 1.7 1.9 1.7 1.8 1.3 2.4 2.4 2.4 NA Gross Investment 19.4 16.3 20.5 24.1 23.9 19.8 21.7 23.8 23.7 24.9 29.6 Gross Fixed Investment 20.1 16.8 19.0 20.8 19.7 18.6 20.8 20.0 21.6 22.3 27.2 Public 7.6 5.8 5.2 4.7 4.0 4.3 3.5 3.2 3.8 4.0 4.6 Central Government 3.5 2.8 3.3 3.0 2.4 2.0 1.7 1.6 2.1 2.1 NA Other Public 4.1 3.0 1.9 1.7 1.7 2.4 1.8 1.6 1.7 1.9 NA Private 12.4 11.0 13.8 16.1 15.7 14.3 17.3 16.8 17.9 18.3 22.6 Change in Stocks -0.6 -0.5 1.5 3.2 4.2 1.1 0.9 3.8 2.1 2.6 2.4 Resource Balance 7.6 10.0 3.2 0.3 0.7 7.7 5.0 3.5 1.7 3.1 1.5 Exports 24.1 24.1 19.2 17.1 17.1 23.4 22.6 23.3 24.0 23.9 24.9 vn Imports 16.5 14.0 15.9 16.7 16.4 15.7 17.7 19.8 22.3 20.9 23.4 Total GDP 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: Central Bank Table A7 : Peru - Non-Financial Public Sector Operations (percent of GDP) 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Current Revenues Taxes 11.7 13.5 11.8 9.1 9.1 7 9.4 9.2 9.1 10.8 12.4 Social Security 1.6 1.7 1.9 2.1 1.3 1.3 0.8 1.6 1.7 Other Revenues 25 25.8 17.2 14.2 15.2 12.9 12.1 11.2 11.5 Transfers 0 0 0 0 0.2 0.1 0 0.2 0.3 Current Expenditures 37.5 38 31.3 28.5 30.4 24.8 24.1 21 21.1 Wages 9.5 8.4 8.9 9.2 8.3 7.9 5.3 5.4 5.6 Goods and services 15.9 18 12.5 10.5 11.9 8.8 8.5 7.9 7.1 Interest 5.9 6 3.7 3.1 4.6 3.5 4.6 3.3 2.7 Transfers 6.2 5.6 6.2 5.6 5.5 4.6 5.6 4.4 5.7 Current Balance Capital Revenues 0.6 0.5 0.3 0.3 0.2 0.3 0.1 0.2 0.3 Repayment of loans 0 0 0 0 0 0 0 0 0 Other 0.6 0.5 0.3 0.3 0.2 0.3 0.1 0.2 0.3 Capital Expenditures 8.1 6.3 5.6 4.7 4.1 3.9 2.7 2.8 3.5 Capital formation 7.9 6.2 5.2 4.2 3.5 3.6 2.6 2.4 2.5 Financial investment 0.2 0.1 0.1 0 0.3 0.1 0 0.1 0.1 Other 0 0.1 0.3 0.5 0.3 0.3 0.2 0.3 0.8 Overall Balance -6.6 -2.8 -5.6 -7.3 -8.5 -7.1 -4.5 -1.5 -1.7 -1.2 2.5 Financing (Net) 6.6 2.8 5.6 7.3 8.5 7.1 4.5 1.5 1.7 External 4.9 4.4 2.9 1.9 2.9 2.5 2.5 2.1 0.9 Long-term 5.5 4.6 2.5 2 2.9 2.2 2.5 2.1 0.9 Disbursements 12.4 11.9 7.9 5.5 7.3 5.2 6.3 4.4 2.5 Amortization 6.9 7.3 5.4 3.5 4.4 3 3.8 2.3 1.7 Short-term -0.6 -0.2 0.5 -0.1 0 0.3 0 0 0 Internal 1.7 -1.6 2.6 5.4 5.6 4.6 2 -0.6 0.9 Source: Central Bank Table AS: Peru - Balance of Payments (million USSs) 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Current Account (153) 118 (1,142) (1,637) (1,361) 3 (840) (1,284) (1,697) (1,776) (2,823) Trade Balance 1,007 1,172 (65) (521) (99) 1,197 340 (166) (567) (579) (1,143) ExportsofGoods(fob) 3,147 2,978 2,531 2,661 2,691 3,488 3,231 3,329 3,484 3,464 4,454 Traditional goods 2,421 2,264 1,886 1,952 1,944 2,509 2,265 2,378 2,471 2,334 3,119 Non-traditional goods 726 714 645 709 747 979 966 951 1,013 1,130 1,335 Imports of Goods (fob) 2,140 1,806 2,596 3,182 2,790 2,291 2,891 3,495 4,051 4,043 5,597 Consumer goods 265 129 378 409 272 251 338 639 841 907 1,367 Intermediate goods 924 824 1,242 1,462 1,586 1,089 1,332 1,597 1,783 1,849 2,291 Capital goods 771 558 761 976 729 666 886 934 1,120 1,136 1,754 Other 180 295 215 335 203 285 335 325 307 151 184 Services Balance (1,314) (1,152) (1,185) (1,270) (1,415) (1,355) (1,455) (1,484) (1,578) (1,638) (2,140) Financial (net) (1,088) (984) (861) (877) (1,004) (946) (1,041) (1,032) (910) (981) (1,522) Non-financial (net) (226) (168) (324) (393) (411) (409) (414) (452) (668) (657) (618) u Net Transfers 154 98 108 154 153 161 275 366 448 441 460 Long-Tern Capital 1,139 722 697 897 982 935 810 726 612 1,237 4,278 Public Sector 1,404 860 707 853 957 878 823 845 475 647 1,238 Disbursements 1,026 693 495 585 350 380 245 872 387 1,509 676 Refinancing 499 201 0 0 0 699 0 6,115 547 1,313 1,480 Interest 81 19 0 0 0 84 0 2,996 415 650 1,116 Principal 418 182 0 0 0 615 0 3,119 132 663 364 Debt forgiveness 0 0 0 0 0 0 0 63 9 7 138 Amortization 1,441 1,329 1,453 1,591 1,492 1,251 1,143 1,021 749 963 1,007 Other Long-term 1,320 1,295 1,665 1,859 2,099 1,050 1,721 (5,184) 281 (1,219) (49) Private Sector (265) (138) (10) 44 25 57 (13) (119) 137 590 3,040 of which: privatization 160 2,101 Short-Term Capital & Errors & Omissions. (739) (560) (72) (45) (19) (75) 166 1,809 1,576 1,037 1,664 Overall Balance 247 280 (517) (785) (398) 863 136 1,251 491 498 3,119 Source: Central Bank 55 Annex B TRADE POLICY REFORM LOAN: POLICY MATRIX ACCOMPLISHMENTS FROM MID-1990 TO CONDITIONS OF LOAN ISSUES AND OBJECTIVES BOARD PRESENTATION SIGNING STATUS IMPORT TARIFFS Structure By March, 1991, 3-rate structure of 5, 15, 25%; Eliminate 5% rate (steel-industry Completed. (D. Lg. No. average of 17%; coeff. of variation of 23%. inputs) by March 1992; unless 668) Increase neutrality of tariff structure. implementation during 1992 of an (The alternative Andean-Group common external tariff Andean-Group option appears likely by that time. has not been pursued.) Preferences on the Domestic Elimination of most regimes by September, 1990 No reintroduction of discriminatory Maintained. Marke (major exceptions are educational & cultural preferences. institutions; treaty agreements. Increase neutrality of tariff structure. Specific Tariffs Removal of all surcharges by March 1991; Publicize, by Board presentation, die Study completed and and Tariff Surchares variable surcharge on 5 agricultural products, existing method of setting the variable surcharge scheme introduced in May 1991. surcharge. Reform of surcharge revised (D. Ley No.. Increase transparency and efficiency of scheme: agree study TOR by March 25528.) agricultural protection. 1992, agree implementation guidelines by June 1992, enact reform by September 1992. Safeguard Mechanism Introduction of an and-dumping/subsidy code in Reform of anti-dumping code: agree Study completed and June 1991. study TOR by Board Presentation, code revised (D.S. No.. Minimize protective effect of enact reform by March 1992. 051-92-EF.) anti-dumping protection. NON-TARIFF IMPORT BARRIERS Formal Protective Barriers All prohibitions/ restrictions suspended by No reintroduction of non-tariff Maintained. September 1990, permanently liberalized by barriers. Increase neutrality of protection March 1991. structure. Health. Technical- Security. and Various reforms from March to May 1991, Reform of health and sanitary Study completed and Miscellnaneo Regulatiflo removing or simplifying controls; reintroduction regulations & technical standards: agricultural and of controls in a few cases. agree study TOR by Board phamaeutical import Reduce discriminatory effect of health presentation, agree implementation controls made more and technical regulation. guidelines by March 1992, enact flexible.(D.S. No.. 093- reform by June 1992. 92-EF and D. Ley No.. 25596). Imnort MononOlies All public-enterprise monopolies removed in No reintroduction of import Maintained. principle in March 1991; ENCI & ECASA monopolies. Increase neutrality of protection monopolies removed in March 1991; Petropenh structure. monopoly removed in August 1991. Loca-Contant Reigulations All local-content regulations eliminated in March No reintroduction of local-content Maintained. 1991. regulations. Increase neutrality of protection structure. Controls on Second-Hand Imports of most second-hand goods allowed in No reintroduction of controls in Maintained. IMBRU November, 1990 and of machinery and vehicles second-hand imports. in March 1991; only controls on clothing, shoes, Increase neutrality of protection and bath fixtures remain. structure. Annex B 56 TRADE POLICY REFORM LOAN: POLICY MATRIX ACCOMPLISHMENTS FROM MID-1990 TO CONDITIONS OF LOAN ISSUES AND OBJECTIVES BOARD PRESENTATION SIGNING STATUS EXPORT REGIME Taxes on Traditional Exports After 10% surcharge from August to November No raising of tax rates or application Maintained. Increase neutrality of export regime. 1990, taxes range from 0% to 10% by February of tax to new products. 1991. Subsidies for Non-Traditional Reduction (August), then abolition (November No re-introduction of export subsidies. Maintained. Exports 1990) of CERTEX; abolition of FENT in November 1990. Increase neutrality of export regime. Indirect Tax Treatment Automation of Temp. Adm. scheme and its No further action required. Letter of Development broadening to all exporters in March 1991; Policy undertaking to Reduce fiscal discrimination against introduction of drawback scheme for non- extend the drawback exports. traditional exports in March 1991. system has been signed and sent to the Bank. Export Contracts No new contracts are being issued and scheme is No further action required. Maintained. defunct. Increase neutrality of export regime. Free Trade Zone Any new or expanded zone may only Existing free trade sell to the domestic market if import zones not expanded Reduce unfair competition in the taxes are paid. domestic market. Non-Tariff Export Controls Removal of controls in March 1991. No reintroduction of non-tariffs export Maintained. controls. Increase neutrality of export regime. Exort Certification No further action required. Maintained. Increase neutrality of export regime. TRADE INSITIMMONS Non-Tariff Barriers ICE de-activated in June 1991, and its No further action required. Maintained. promotional functions transferred to MICTI. Eliminate institutional basis for non-tariff protection. Tariff Administration (MEF) Creation of Control Commission for anti- Procedures to ensure open, impartial Completed. dumping rules. anti dumping hearings to be agreed by (D.S. No.. 133-91-EF Minimize protective effect of anti- loan negotiation. and dumping legislation. D.S. No. 051-92-EF) Customs Serice Transfer of some functions to private agents; Agreement by Board presentation on Action Plan carried out monopoly on customs warehouses removed. Action Plan; compliance with three according to schedule. Improve efficiency in processing phases of Action Plan, by Board imports and raising revenue. presentation (1), by March 1992 (2), and by June 1992 (3). Exort Promotion Function transferred in June 1991 from ICE to No further action required. Maintained. 57 Annex B TRADE POLICY REFORM LOAN: POLICY MATRIX ACCOMPLISHMENTS FROM MID-1990 TO CONDITIONS OF LOAN ISSUES AND OBJECTIVES BOARD PRESENTATION SIGNING STATUS Shift emphasis from selective MICTI. promotion to commercial intelligence. Trade Negotiatio Creation in June 1991 of an inter-ministerial No further action required. No change. committee, with an Office of Trade Improve intergovernmental Representative in MICTI. coordination. Trade Law August 1991 passage of a legislative Decree No further action required. No change. elevating to the status of law many of the trade Provide legislative stability for reforms passed since August 1990. reformed trade regime. · & 떼 , & 1 59 Annex C STRUCTURAL ADJUSTMENT LOAN: POLICY MATRIX ISSUES AM OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN STATUS TO BOARD PRESENTATION SIGNING MACROECONOMIC ISSUE Exchange Rate Rearime Unification and float. Maintain domestic-currency Completed. convertibility for all external Improved resource allocation. transactions to a single type of exchange rate. Foreign Exchange Allocation Elimination of foreign exchange surrender Non-reversal of policy. Completed. requirements and all other controls on current and capital account transactions. Foreign Currency Holdin Removal of freeze on foreign exchange The use of foreign currencies in the Completed. certificates of deposit. Dollar deposits local financial system will continue. Keep a fluid payments system in increased 125 % between August 1990 and July the presence of a persistent 1991, up to a level of US$ 1814 million, trend of dollarization of the compared with US$ 1297 million in Sol- economy. denominated liquidity. External Debt Servic Resumed payments to all IFIs. Completed Maintain payment to all IFIs and Completed. negotiations with Paris Club. continue negotiations with all other Restore access to international creditors aiming for the fiill capital markets. restoration of service. Monetary Pofic Creation of monetary base mainly to finance the Non-reversal of Policy. Completed. quasi-fiscal deficit and increase foreign reserves Gradual achievement of price of the Central Bank. stability. Credit Marke Interest rates allowed to be market determined. Interest rates will be allowed to Completed. continue to be established by market Efficient allocation of credit. forces. Market Allocation Mechnnigms All price and wage controls lifted. Maintain market determination of Completed. prices and private sector wages. Efficient resource allocation. ELS92111AM Consolidated Public Sector Operational Deficit Adopt measures and an Completed. reduced to 6.5% of GDP in 1990 and an implementation schedule satisfactory Control of inflation. expected 3.6% in 1991. to the Borrower and die Bank aiming NFPS primary deficit reduced to I % of GDP in for a level of Tax Revenues for the 1990 and expected to reach a 0.4% surplus in Central Administration of about 9.0% 1991. of GDP. The primary deficit of the NFPS will not be larger than 0.6% of GDP (Jan.91-Dec.92) and there will be no domestic financing of the Consolidated Public Sector Balance, defined as the deficit of the primary balance added to the quasi-fiscal deficit, plus interest payment on internal and external debt. Deflell Financing Internal financing of the CPS reduced to 3.3 % Central Bank creation of domestic Completed. in 1990 and expected to reach 0. 5 % for 1991 credit consistent with IMF targets. Control inflation. Inflation reduced to 230% between August 1990-1991. Annex C 60 STRUCTURAL ADJUSTMENT LOAN: POLICY MATRIX ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN STATUS TO BOARD PRESENTATION SIGNING Macroeconomic Indicators Expected 1991 values: Performance indicators for 1992 Actual prformance (NOT CONDITIONALITIES): for first three quarters of 1992* These indicators should not be Central Administration Tax Revenue: 7.6% of Central Administration Tax Revenue interpreted as individual targets to GDP; about 9.0% of GDP; 9.1% of GDP. be met for loan compliance, but rather as the Bank's guidelines to Primary sur2]us of the non-financial public Primary deficit of the non-financial Surplus: 0.1% of evaluate macroeconomic sector: 0.4% of GDP; public sector no larger than 0.6% of GDP. performance. GDP; Rate of increase in monetary base: 320%. Rate of increase in monetary base less than or equal to 40%; 37.8% Stock of Central Bank of other monetary liabilities in Soles always 2.5%. less than 10% of monetary base. FISCAL ISSUES Drastic increase in price of public sector goods By October 31- 1992, the Government Completed. and services and frequent price adjustments and the Bank will jointly review taxes allow sharp recovery in tax revenues. on exports, and bank current account Simplification of tax system. Simplification of tax regime. New regime debits and interest to assess the Increase tax revenues and reduce based upon taxes on income, wealth, value prospects of phasing them out within a highly distortionary taxes. added, and selective consumption imports. specific timetable. Elimination of most exemptions. Reduction of some marginal tax rates. Simplification of tariff regime and reduction of tariff rates to three categories. Enactment of Legislative Decree 666 regulating VAT and selective excise taxes (September 11. 1991). Supreme Decree enacted to interpret the regulations created in Legislative Decree 666, by establishing procedures for their application (Supreme Decree 269-91-EF, November 21, 1991). Tax Aminirtn POLICY CHANGES BETWEEN MARCH e monitoring of large taxpayers Completed. 11I & DECEMBER 1991 will be expanded from 1,200 to 2,500 Reinforce independence of firms. SUNAT (the Peruvian tax collection Diagnosis and design of strategy for structural agency) and improve its efficiency as reform to be implemented with the support of By March 31 - I , SUNAT will Completed. measured by number of taxpayers International Technical Assistance. complete the process of personnel and level of tax revenues, selection at the national level. Legislative Decree 639 (March 18, 1991): Provides the legal framework for the By June 3 1992, the new Completed. reorganization of personnel and the acquisition infrastructure of computer information of basic (local) equipment. systems will be installed in Region I (primary taxpayers). Implementation of the program of voluntary resignation through incentives. The process of implementation of a Completed. new registration system for Personnel evaluation and selection with tax-payers will continue to be carried examinations in Lima. out on a priority basis. Definition of the organizational structure and Changes in the tax code, satisfactory Completed. structure of appointments to posts in the to the Borrower and to the Bank, will National Service Corps (Intendencias) and the be introduced to allow for greater Regional Service Corps I & II efficiency in the tracking of 61 Annex C STRUCTURAL ADJUSTMENT LOAN: POLICY MATRIX ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 ONDITIONS OF LOAN STATUS TO BOARD PRESENTATION SIGNING Legislative Decree 641 (June 26, 1991): infrinj,ements. Simplifies system of sanctioning so as to allow for implementation of moderate sanctions on a massive scale. Legislative Decree 673 (Sept. 24, 1991): Labor law which affects employees of the new SUNAT tax administration and made to correspond to Law 4916 (Private Sector Labor Law). Revise-and-purge process of the primary taxpayers' registry in existence and tax regime grants first priority to the VAT. Creation of a division for taxpayer account sanctioning and/or termination at SUNAT. charged with administering account closures and developing sanctioning systems for the Regional Service Corps (Superintendency Resolution 326-91-EF/SUNAT, November 6, 1991). SUNAT increased the number of primary taxpayers to 2,220 on December 6, 1991. Government Expenditure Tight controls upon public sector wages. No further action required. and Qual-Fiscal Deficit Reduction of public sector employment through incentives (Supreme Decrees 004-91-PCM & Increase the efficiency of 041-91-EF & Supreme Resolution 544-91- provision of public goods. INAP/J). Introduction of a CMC (Cash Reduction of administrative Management Committee), which spends only its discretionality. available cash (Supreme Decree 227-90-EF, Dec. 10, 1990 & General Public Sector Budget Law, December, 1991). Postponement of public investments. Limits to Banco Agrario subsidized credit. Elimination of subsidized credit to exporters. A draft law which incorporates agreement on substantive objectives satisfactory to the Borrower and the Bank was enacted, establishing the basis for reform of the Peruvian public sector, redefining the scope of government activities, and reforming personnel policies, including the tenure system (Supreme Decree 166-91-PCM, October 1Q91). SOCIAL SECTOR ISSUES Social Emergency Program (SEP) initiated to The Government will develop, by Completed. provide emergency food assistance and January z31, 1 9, a poverty Poverty Alleviation medicines, mainly through NGOs, for 5 months alleviation strategy and (8/90-12/90). implementation schedule, both Develop well-targeted social acceptable to the Bank, outlining safety net mechanisms and With UNICEF assistance, a Plan of Action for policies, and identifying priority provide the context for individual Child Welfare was prepared and endorsed by programs and target groups. The social programs and projects. the Goverment in June 1991. It diagnoses Government will adopt this strategy problems and sets goals in the area of health, by December 31. 1992. education, water and sanitation, nutrition, employment, and the problems of children in difficult circumstances. Annex C 62 STRUCTURAL ADJUSTMENT LOAN: POLICY MATRIX ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN STATUS TO BOARD PRESENTATION SIGNING In August 1991, a temporary National Social Compensation and Development Fund (FONCODES) was created (Legislative Decree 657, August 15, 1991) to finance employment- generating projects benefitting the population in extreme poverty. FONCODES's statute was approved through Supreme Decree 163-91- PCM, October 20, 1991. Health and Nutrition The Ministry of Health defined short-term The Government will develop profiles Completed (two objectives for 1991: reduce mortality associated for priority projects in primary health profiles). Improve the provision of low-cost with high-prevalence illness; expand health and nutrition acceptable to the Bank primary care to the poor. coverage in poor areas; rehabilitate social by April 30. 192. infrastructure; and upgrade the capacity of professional staff. Improve the cost effectiveness and Generalized food subsidies were abolished and The Government will prepare a Completed. impact of nutrition assistance to the monopoly positions of ECASA and ENCI national nutrition policy acceptable to the poor. were eliminated (Supreme Decree 066-91-EF y the Bank, based on a review of Supreme Decree 067-91-EF, March 27, 1991). existing food assistance programs, and will recommend reforms necessary to improve cost effectiveness by April 30. 1992. The Government will initiate the first stage of these reforms in food assistance programs, including streamlining the role of public agencies, by .une3Q. 192- Eduadwn The Ministry of Education defined broad short- The Government will develop profiles Completed (three term objectives for 1991 (to expand the for priority projects in pre-primary profiles). Increase internal efficiency of coverage and quality of primary education and and primary education acceptable to education and improve the quality link technical training to the job market) and the Bank by April 30. 1992. and coverage of pre-primary and medium-term priorities (to improve the quality primary education. of education, universalize education for 6-14 year old children, and upgrade the quality of teachers.) The Ministry of Education initiated an emergency program to feed schoolchildren one meal a day and use the school as a locus to introduce tuberculosis detection and improved health practices. PRIVATIZATION ISSUES The Government announced its intention to The Government will establish the Completed. Privatization of State reduce SEA and issued, on March 12, 1991, a institutional framework defined in Entrepreneurial Activity (SEA) Supreme Decree (No. 041-91-EF) authorizing Decree 674 by June 30- 1992. the privatization of 23 companies. Improve efficiency in allocation of resources through development The Government issued the Law for the of the private sector, avoiding the Promotion of Private Sector Investment in State possibility of fiscal drain. Enterprises, which called for (i) the creation of a commission, COPRI, to be responsible for the design and control of privatization, thus centralizing the decision making process, and (ii) the creation of Special Committees to implement the privatization of either one company or several within a sector (Legislative 63 Annex C STRUCTURAL ADJUSTMENT LOAN: POLICY MATRIX ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN STATUS TO BOARD PRESENTATION SIGNING Decree 674, September 27, 1991). The Government issued a law providing a legal framework for foreign investment, through guarantees on the stability of the fiscal regime (Legislative Decree 662, September 2, 1991). The Government issued a Legislative Decree which establishes rights, guarantees, and obligations applicable to national and foreign investors (Legislative Decree 757, November 13, 1991). The Government issued Legislative Decree 674 which defines the legal and institutional framework for privatization (September 27, 1991). SEA Privatization in Banking The Government abolished the Financial The Government will develop an Completed. System Nationalization Law and included Banco overall action plan and Popular del Peru in the list of 23 companies to implementation schedule acceptable to be privatized (DS no.041-91-EF). The the Borrower and the Bank for Government decided to restructure public divestiture in the sector by ,une.(L commercial banks with a new Banking Law in L92. April 1991 (General Law for Banking, Financial, and Savings Institutions: Legislative Decree 637). The Government sold its 15% share of Sogewiese Leasing on June 10, 1991. SEA Privatization in Fisheries The Government eliminated state monopoly of The Government will develop a policy Completed. fishmeal production in March 1991 and began a framework for the sector and a firm- partial sale of the assets of Pescaperu. by-firm divestiture strategy acceptable to the Borrower and the Bank, The Government issued a Law for the including an action plan and Promotion of Private Investment in the fishery implementation schedule for Flopesca, sector, prohibiting monopolistic practices and Pescaperu, Epsep, and CERPER by authorizing the Ministry of Fisheries to grant June 30. 1992. concessions to the private sector (Legislative Decree 750, November 13, 1991). SEA Privatization in Mining The Government sold its 19% stake in Minas The Government will develop a policy Completed. Buenaventura on July 19, 1991. framework for the sector and a firm- by-firm divestiture strategy acceptable The Government issued a Law for Private to the Borrower and the Bank, Sector Investment in the Mining Sector which including an action plan and creates conditions for the development of implementation schedule for Minero private investment (Legislative Decree 708, Peru, Centromin Peru, and Hierro November 14, 1991.). Peru by June 30. 1992. SEA Privatization in Oil and Petroperu increased the contracting-out of The Government will develop a policy Completed. -as exploration and development to the private framework acceptable to the sector. Borrower and the Bank, including an implementation schedule for private Petroperu monopoly eliminated (Legislative sector participation in exploration, oil Decree 655, August 7 1991). refining, distribution, and gas production and distribution by un 30, 1992. SEA Privatization in Powe In February 1991. The Government authorized The Government will develop a policy Completed. entrance of private investors to the power framework acceptable to the Annex C 64 STRUCTURAL ADJUSTMENT LOAN: POLICY MATRIX ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN STATUS TO BOARD PRESENTATION SIGNING sector; this included participation of Borrower and the Bank, including an autoproducers, co-producers, and implementation schedule for private concessionaires (Law 25304). sector participation in power generation, transmission, and On July 19 1991, The Government authorized distribution by J the sale of its participation in regional power companies (Legislative Decree 649). The Government issued a Law for the Promotion of Private Sector Investment in the Power Sector. Private investors will have access to the sector by means of a regime of concessions which will permit the generation and/or distribution and/or commercialization of electric energy (Legislative Decree 693, November 6, 1991). SEA Privatization in The Government enacted a new The Government will develop a policy Completed. Telecommunications Telecommunications Law enabling competition framework acceptable to the and private investment (Legislative Decree 702, Borrower and the Bank, including an November 8, 1991 and Legislative Decree 766, implementation schedule promoting November 15, 1991). private sector investment in the telecommunications sector by hm The Government created the Enterprise for 30L1992. Postal Services of Peru, S.A. (SERPOST) and declared that the incorporation of private investors in SERPOST is of national interest (Legislative Decree 685, November 5, 1991). SEA Privatization In Transport For ports, The Government transferred to the The Government will develop a Completed. private sector all stevedoring work, the loading strategy acceptable to the Borrower and unloading of cargo, and die maintenance of and the Bank, including an container-handling equipment, and issued implementation schedule to promote Supreme Decree 039-91-TC on November 5, private sector investment in railways, 1991, specifying actions to be taken for labor ports, airports, and air transport by reduction in CPV (shipping company). June 30. 1992. The Government liberalized urban transportation tariffs (Legislative Decree 651, July 25 1991). The Government liberalized air transport tariffs, authorized the entrance of new companies, and issued Legislative Decree 648 (July 17 1991), authorizing the privatization of AeroPeru. The Government also transferred part of the activities of CORPAC (airport authority) to the private sector (Legislative Decree 723, November 11 1991). The Government authorized the Ministry of Transports to grant concessions to private companies for rehabilitation and maintenance of highways (Legislative Decree 676, October 6 1991). The Government declared private sector investment in Enafer to be of national interest, prohibited any form of monopoly and restrictive practices, and authorized the Ministry of Transport and Commumcations to grant 65 Annex C STRUCTURAL ADJUSTMENT LOAN: POLICY MATRIX ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN STATUS TO BOARD PRESENTATION SIGNING concessions, through a public bidding process, to the private sector for rehabilitation and maintenance of portions of the railway lines. Tariffs and freights of service operators are market-determined according to supply and demand (Legislative Decree 690, November 6, 1991). SEA Privatization in Water and Sedapal began bidding process to delegate the The Government will develop a Completed. Sewrage task of billing in part of the city of Lima to an strategy acceptable to the Borrower external private firm. and the Bank, including an implementation schedule to promote The Government issued a Law for the private sector participation in the Promotion of Private Sector Investment in the sector by June 30. 1992. area of Water/Sanitation, specifically in the activities of exploration of potable water, sewage, waste disposal, recycling of water, and public cleaning (Legislative Decree 697, November 7, 1991). The Government authorized Senapa and Cortapa to undergo an economic and financial stabilization and an administrative rationalization, including staff reduction and a program of incentives for voluntary retirement (Supreme Decree 171-91-PCM November 7, 1991). SEA Privatization in Industry The Government announced its intention to The Government will develop a Completed. reduce SEA by including several industrial divestiture strategy acceptable to the companies on the list of 23 designated for Borrower and the Bank, including an privatization (Supreme Decree 041-91-EF, implementation schedule for the sale March 12 1991). of shares in all companies where the Government is a minority The legal and institutional framework shareholder. The Government should established by Legislative Decree 674 allows bring to the point of sale at least 6 of for privatization in all sectors of economic these companies. activity. AGRICULTURAL ISSUES Private Sector Development in Enactment of the Agricultural Sector No further action required. Agriculture Investment Promotion Law (Legislative Decree 653, August 1, 1991). Agricultural Comnmodity National rice-marketing monopoly (ECASA) By September 30. 1992: (i) liquidate Substantially Marketing abolished (Supreme Decree 066-91-EF, March ECASA: and (ii) implement Supreme Completed. While 27 1991). National input-marketing company Decree 148-90-PCM, authorizing ECASA has already Increased efficiency in trade and (ENCI) downscaled (Supreme Decree 148-90- ENCI's reorganization. ceased its operations, production. Reduction of public PCM & 084-91-PCM, April 17, 1991). laid-off its employees, sector involvement, and established a Freedom of entry for private sector (Supreme liquidation Decree 066-91-EF, March 27, 1991). commission, the process of liquidation is still underway. ENCI is being downsized. To date (6/2/94), ENCI's liquidation Annex C 66 STRUCTURAL ADJUSTMENT LOAN: POLICY MATRIX ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN STATUS TO BOARD PRESENTATION SIGNING commission is still in the process of selling the company's assets. Non-reversal of the elimination of Completed. State marketing monopolies established by Supreme Decree 066- 91-EF. Land Tenure/Registry and Restrictions removed: land freely transferable; Maintain all provisions reforming land Completed. 1tilng all regular rights of Peru's civil code extended tenure, agricultural labor, and to the agricultural sector; individuals and liberalizing agri-business activity in Improved resource allocation, corporations permitted to own land; size limit the "Ley de Promoci6n de las improved access to formal of individual agricultural estates increased; Inversiones del Sector Agricola" economy for small landowners. promotion of private investment in development (Legislative Decree 653). of uncultivated land. Speedy mechanism established to guarantee land ownership against expropriation and squatters. Agdcultural Credit Elimination of credit subsidies through Banco Non-reversal of policy liberalizing the Completed. Agrario (BA). Reduction of Central Bank use of land as collateral. Improved resource allocation, credit to BA. Abolition of BA's privileged improved access to credit for access to collateral of agricultural producers. Maintain legal framework allowing Completed. small producers, and expansion of agricultural-sector access to private access to commercial banks. Liberalization of use of land as collateral. commercial bank credit. Agrkultural Water Usaf Legislative Decree (No. 653, August 1, 1991: Maintain all provisions on water Completed. Agricultural Sector Investment Promotion Law) usage included in Legislative Decree Promotion of better water usage. provided legal framework allowing transfer of 653. irrigation network to private producer associations. Agrcltural TradePolcy Deregulation of all domestic and foreign trade Maintain trade liberalization Completed. of agricultural products and imports. provisions of Legislative Decree 653. Better resource allocation. Removal of anti- agricultural bias. Unified exchange rate eliminated bias against Consolidate macroeconomic agricultural exports and allowed foodstuff stability. imports without exchange rate subsidies. Elimination of exemptions for agricultural imports. Arultural Pricing Poliy Floating exchange rate remained and The Government will not introduce Completed. agricultural credit subsidies abolished. In any new mechanism for price control Maintain efficiency in resource March 1991, specific protective tariffs for of agricultural products and there will allocation, selected agricultural products were introduced. be no reversal in its policy of These were replaced in May 1991, by a abolishing interest rate subsidies. variable surcharge scheme designed to lead to a landed price which would not exceed the previous five-year average international price plus a 15% tariff. The scheme covers: wheat flour, pasta, corn, sorghum, rice, and sugar. Dried milk continued to receive a fixed surcharge. LABOR ISSUES Probmtioary Employmet Creation of a more flexible probationary period. Non-reversal of policy. Completed. 67 Annex C STRUCTURAL ADJUSTMENT LOAN: POLICY MATRIX ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN STATUS TO BOARD PRESENTATION SIGNING Initial period of three months extendable to a Improve quality of employee total of six months, provided the work requires screening and reduce turnover a training and adaptation period. In the case of costs. managerial and other positions of trust, the period is extendable to one year (Job Promotion Law, Legislative Decree 728, Art. 43, November 12, 1991). Tempory Employen Supreme Decree 077-90-TR issued, allowing Non-reversal of policy. Completed. longer fixed-term contracts for all sectors and Increase flexibility in labor under most circumstances (few relevant markets and reduce turnover restrictions exist). costs. Temporary employment authorized for initiation or increase in work load, changing labor market needs, or for retraining of employees (Legislative Decree 728, arts. 100-102, November 12, 1991). CTS (CompCnaion forllme Firms must now deposit semesterly the full Non-reversal of policy. Completed. and Services Rendered) amount due in special accounts for which financial institutions and firms compete. Improve administration of Worker specifies account to be held in national system. Reduce indexation or foreign currency and interest on these problems. Increase supply of accounts is exempt from income tax. CTS long-term funds to financial funds can be withdrawn by workers under intermediaries. specific circumstances (Legislative Decree 650, July 24, 1991). SOCIAL SECURITY ISSUES Creation of the framework for a Private System Non-reversal of policy and Completed. of Pensions (SPP), to complement the IPSS. presentation of an action plan and IPSS (Peruvian Social Security System) SPP benefits managed by the Administrators of implementation schedule, acceptable Pension funds (AFP) which will initiate to the Borrower and to die Bank, on activities to partially or totally privatize the the partial or complete privatization of system by July 28, 1992 (Legislative Decree the system by SepWamtr 30 1992. 724, November 11, 1991). Adminilstrstionof Heafth2nd Separation of accounts for revenue, but not Complete to separation of all health Completed. EmoniArm expenditures. and pension fund accounts (except administrative expenses) by June30- Improve financial management. t t. Colletionn.ofLContributions Collection system streamlined. Employers can Non-reversal of policy. Completed. complete form estimatt contribution due a Avoid losses from under-reporting make payment at any commercial bank. by contributors. dmnRstrMaingfcalt Fund deposits placed in official and private Non-reversal of policy. Completed. banks. Greater efficiency. Supervision and Control None. i me external audit of fiancial Substantially statements, involving income (pension Completed. Determine the administrative and and health) and expenditures (pension) In December 1992, financial situation of IPSS. accounts for 1991 will be completed the Government hired by losses fro uner. IPSS as fund the external auditors intermediator, will be subject to through Resolution of periodic independent auditing. Tese oe Controllers audits will include not only financial Office No. 345-92- control but also administrative and CG. operational diagnoses and Annex C 68 STRUCTURAL ADJUSTMENT LOAN: POLICY MATRIX ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN STATUS TO BOARD PRESENTATION SIGNING recommendations. IPSS Revenue Collection Contribution rates to IPSS were not increased. The total contribution rate to IPSS Completed. Collection ceilings and some deductions were will not be increased. Increase revenue and force eliminated. efficiency gains without increasing contribution rates. Physical Assets of IPSS New rental contracts and sale of property to Non-reversal of policy. Completed. reflect market prices. Greater efficiency. IPSS Personne No renewal of contracts for temporary Reduce number of employees by an Completed. IPSS personnel. additional 7,000. personnel reduced by Increased efficiency. 7,700 resignations through early retirement more than 18,000. incentives.    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