Peru - Current economic position and prospects

FILE COPY DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Not For Public Us Report No. 1364E CURRENT ECONOMIC POSITION AND PROSPECTS OF PERU May 10, 1973 Latin America and the Caribbean Regional Office This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsbility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS* Currency Unit - Sol (S/.) US$1 = S/. 38.70 S/. 1 = US$0.026 S/. 1,000,000 = US$25,8h0 US$l,0oo,ooo = S/. 38,700,000 GLOSSARY OF ABBREVIATIONS COFIDE - (Corporacion Financiera de Desarrollo): the public develop- ment finance corporation. ELECTROPERU - the public enterprise for power sector development. EMADI - (Empresa Nacional de Puertos): the public enterprise for the management and development of ports. ENTEL - (Empresa Nacional de Telscommunicaciones): the public enter- prise in the field of telecommunications. EPCHAP - (Empresa Publica de Comercializacion de la Harina y Aceite de Pescado): the public enterprise for the marketing of fishmeal and fishoil. EPSA - (Empresa Puiblica de Servicios Agropecuarios): the public enterprise for importing foodstuffs and agricultural inputs and for the internal marketing of agricultural products. EPSEP - (Empresa Publica de Servicios Pesqueros): the public enter- prise for research and development in the field of fisheries. INDUPERU - (Industrias del Perui): the public enterprise for developing industries. INP - (Instituto Nacional de Planificacion): the national planning board. MINEROPERU - the public enterprise for the development of mining. PETROPERU - the public enterprise for the development of hydrocarbon resources. SAIS - (Sociedades Agricolas de Interes Social): organization embracing agricultural cooperatives and indian Communities. SIDERPERU - (Empresa Sider6rgica de Peru): the public enterprise for steel. GOVERNMENT OF PERU FISCAL PERIOD January 1 to December 31 of following year (a biennium), starting from January 1, 1971. * Above rate a pplies to some 85 percent of total foreign exchange transactions (largely trade) and is used normally for conversions in this report. There is also a draft market rate of US$1 = S/. 43.38 which covers some 15 percent of foreign exchange transactions. ** For a complete list of state enterprises, see list preceeding Table 5.9(a) of the Statistical Appendix.  CURRENT ECONOMIC POSITION AND PROSPECTS OF PERU TABLE OF CONTENTS Page No. COUNTRY DATA MAP SUMMARY AND CONCLUSIONS I. INTRODUCTION ................................ 1 The Socio-Economic Setting .... ......... 1 II. )EVELOPMENT TRENDS ...... ..................... 4 Population Trends .................. 4 Labor Force and Employment ............. . 5 Productivity and Incomes ................ 7 The Productive Sectors ... . 10 A Perspective on the Mlacro-Economy ...... 12 III. DEVELOPMENT APPROACH AND STRATEGY .... ........ 14 Institutional Aspects ................... 15 Policies Towards the Private Sector 17 Reforms in Industry and Agriculture 18 IV. RECENT ECONOMIC DEVELOPMENTS .... ............. 20 The General Growth Experience ........... 20 Production Developments ................. 24 Resource Use and Savings ......... * ...... 25 Central Government Finances ............ . 28 The Consolidated Public Sector .......... 31 Credit Policies .............. .......... . 35 External Accounts ...... .......... 37 Public Capital and External Debt ........ 42 This report is based on the findings of a mission which visited Peru in November-December 1972, and again in January 1973. The mission was com- posed of Messrs. Percy Bargholtz, Michel Devaux, Jose A. Guerra (chief), Guillermo Rossel, Miguel Schloss, Kenji Takeuchi, and Alberto Yanez of the Bank, Mr. George M. Pigott, consultant to the Bank, and Mr. Gonzalo Ruiz Ballivian, OAS. Miss Myriam Suarez was secretary to the mission.  T'ABLE OF CONTENTS (Cont'd) Page No. V. SECTORIAL ISSUES AND POLICIES .... ........... 46 A. Agriculture ............................ 46 The Agrarian Reform ............... 48 B. Industry and Mining .................... . 52 Manufacturing ..................... 52 Mining ....... ..................... 54 C. Fishing Processing ..................... 56 D. Transport and Electric Power ........... 58 Transport ......................... 58 Electric Power .................... 60 VI. THE BIENNIAL PLAN AND BUDGET 1973-74 :62 A. The 1972-74 Development Plan .63 The Objectives of the Plan 63 The Programmed Public Investment by Sectors . ........-.. 66 B. The 1973-74 Public Sector Budget 69 The Central Government Budget 69 The New Revenue Measures in the Budget . .72 The Budgets of Other Public Sector Agencies . .75 The Budget and thle Investment Program ..77 Financing of the Budgeted Public Investment . .80 C. Financing a Total Investment Program ... 82 Slippage and Substitution of Projects . . 82 Availability of Domestic Credit ... 85 Conclusion ............. 86 Vii. BALANCE OF PAYMENTS AND EX'j'ERNAL CAPITAL REQUIREMENTS 1973-76 ........................ 89 Foreign Exchange Constraint ............ 89 '-alor nt ' . ................... 90 General Assumptions for the Projection . 92 Current Account Proiections ............93 Capital Requirements ...... ............. 98 External Debt ....... ................... 104 Conclusion .......... ................... 105 STATISTICAL APPENDIX  Page 1 of 2 COUNTRY DATA - PERU AREA I/ DENS ITY 2 1,280,219 km2 l44il/ ion (mid-1972) 11.2 per Ie n te of Growth: 3.1% (from 1965 to 1972) 500 per km of arable POPULATION CHARACTERISTICS (1971)1/ HFALTH (1970) Crude Birth Rate (per 1,000) 42 Population per physician 2,070 Crude Death Rate (per 1,000) 11 Population per hospital bed 435 Infant Mortality (per 1,000 live births) 75 INCOME DISTRIBUTION DISTRIBUTION OF LAND OWNERSHIPV! 70 of national income, lowest quintile .. 7 owned by ton 107. of owners highest quintile .. 7. owned by smallest 10 of owners ACCESS TO PIPED WATER (1971) ACCESS TO ELECTRICITY % of population - urban 60 % of population - urban - rural 14 - rural NUTRITION (1970) EDUCATION (1970) Calorie intake as % of requirements 94 Adult literacy rate % 66 Per capita protein intake 58 grams/day Primary school enrollment 7. 82 GNP PER CAPITA in 19724/: US $476T GROSS NATIONAL PRODUCT IN 1972 ANNUAL RATE OF GROWTH (%. constant prices) US $ Mln. % 1961-675/ 1969-19725/ 1972 GNP at Market Prices 7,692 100.0 5.9 6.2 5.5 Gross Domestic Investment 915 11.9 9.4 4.5 3.0 Gross National Soving 873 11.2, 4.0 ._/ -2.8 Current Account Balance -101 2T-.3-08 Exports of Goods, NFS 1,126 14.6 2.77/ -0.8 2.5 Imports of Goods, NFS 1,129 14.7 12.9 4.7 4.5 OUTPUT, LABOR FORCE AND PRODUCTIVITY IN 1971 Value Added Labor Force!8/ V. A. Per Worker Us $ Mln. % Thous. 7 ___ % Agricultue 1,199 17.7 1,961 44.4 ilO 40 Industry- 2,356 34.8 872 19.8 2,700 175 Services 3,221 47.5 1,440 32.6 2,240 145 Unallocated . 142 3.2 Total/Average 6,776 100.0 4,415 100.0 1,535 100 GOVCRNMENT FINANCE General Government Central Government (Soles Bn. ) % of GDP (Soles Bln.) 7% of GDP 1971 1971 1969-71 1971 1971 1969-71 Current Receipts 50.3 19.2 19.3 41.0 15.6 15.9 Current Expenditure 42.0 16.0 16.0 35.9 13.7 13.8 Current Surplus 8.3 3.2 3.3 5.1 1.9 2.1 Capital Expenditure 14.8 5.6 4.9 12.7 4.8 4.0 External Assistance (net) -0.1 - 0.0 0.3 - 0.2 - 0.1 0.3 I/ Projected figures, based on 1961 census. 2/ "Arable" defined as actually cultivated plus areas officially given as "cultivable but not used". 3/ Latest fi.,ures are from 1961; in view of the very significant Agrarian Reform going on in Peru these are thought irrelevant today. 4/ The Per Capita GNP estimate is at 1970 market prices, calculated by the same conversion technique as the 1972 World Bank Atlas. All other conversions to dollars in this table are at the average exchange rate prevailing during the period covered. 5/ As there was a severe economic crisis in Peru 1967-68, it would not be meaningful to show the usual period 1965-70. Instead the chosen periods are "before the crisis" and "since the crisis". 6/ Nc trend discernible after the crisis. A record export surplus brought about a sharp peak in 1970; for other years savings have fallen shore of the earlier trend. 7/ R, -rs to 19f--68. 7,' Tela) labor force: unemployed are allocated to nector of their normal occupation. "Unallocated" consists Ln nly of unemployed workers seeking their first job. a/ Cr-prises Manufacturing, Construction and Mining. All 1 )7" data are preliminary estimates .. not available not applicable  Page 2 of 2 CaWlERY DATA - PERU ONEY, CREDIT _and PRICES 1965 1970 1971 1972 (Billion Sales outstanding end period) Money and Quasi Money 26.5 55.9 63.1 74.8 Bank Credit to Public Sector (net) 4.4 12.2 18.1 21.1 Bank Credit to Private Sector 20.8 39.8 48.1 58.9 (Percentages or Index Numbers) Money and Ouasi Money as % of GDP 23.0 23.7 24.1 24.9 General Price Index (1963 - 100) 12R 219 229 248 Annual Percentage Cbanges in: General Price Index 13.4 6.8 4.8 8.4 Bank Credit to Public Sector 51.3 5.4 47.8 l .6 Ban" Crec.t to Private Sector 25.6 16.2 20.6 .5 BALANCE OF PAYMENTS MERCHANDISE EXPORTS (AVERAGE 1970-72) 1970 1971 1972 US $ Mlc S (Million US $1 Fish prodtucts 320 8 33.7 Exports of Goods, NFS 1.223.8 1,081.0 1.126.4 Copper 203.5 21.4 Inports of Goods, NFS 971.6 1.042.2 1,129 6 Sugar 67.5 7.1 Resource CGp (deficit -) 252.2 38.8 - 3.2 Iron ore 6'.1 7.0 1/ ~~~~~~~~~~~ ~ ~~~~~~~~~Silver 57.3 6.0 Interest Payments (net)- -34.o -50.4 -33.9 Zink S3 2 5.6 Other Factor Payments (net) -98.7 -54.3 -97.2 All other comodities i82.0 19.2 Net Transfers 82.0 39.1 33.3 Total 951.4 lO0.0 Balance on Current Account 201.5 -26.8 -101.1 EXTERNAL DEBT, DECEMBER 31. 1972 Direct Foreign Investment -69.6 17.0 38.9 Net MET Borrowing US $ Mln Disbursements 242.3 250.2 323.0 Amortization 191.3 226.7 216.9 Public Debt, incl. guaranteed 1,018.4 Subtotal 51.0 23.5 106.1 Mon-Guaranteed Private Debt Total Outstanding and Disbursed SDR-allocation 14.3 14.2 14.1 Other items n.i.e. 59.q -80.5 -16.0 DEBT SERVICE RATIO FOR 19722/ Increase 'n Reserves (+) +257.1 -61.6 i Gross Reserves (end year) 496 470 521 Net Reserves (end year) 409 347 389 Public Debt, incl. guaranteed 17,8 Non-Guaranteed Private Debt Total Outstanding and Disbjrsed RATE OF EXCT!AMGE TBRD/IDA LENDING, (March '1, 197)-~ 1li CS i lJS $ 1.00 = SI. 38.70- IBRD IDA SI. 1.00 = US $ 0.0258 Outstanding and Disbursed i32.2 Undisbursed 4.C Outstanding incl. lndisbursed 166I 1/ Public sector only, interest on private debt included in "Otber Factor Payments." 2/ P.atio of debt service in foreign currency to exports of goods and non-factor services. 3/ This is the main rate (certificate rate); there is also a secondary rate (draft rate '29 1.00 SI. 43.38) at which about 15% of transactions are concluded. All 1972 data are preliminary estimates. not available not applicable Apr- 14;, 1973  IBRD 10440 _N; % T
= % on 171 tf t Lli 11 11
jll   CURREBNT ECONOMIC POSITION AND PROSPECTS OF PERU SUMMARY AND CONCLUSIONS 1. The developments in the Peruvian economy during the past two years represent essentially the continuation of the process f;f growth chat started in1Z970, when the economy was reactivated after the 1968-69 stabili_ation period. In 1970 favorable developments in commodity prices brought about an export boom, which decisively strengthened the country's international re- serves, increased fiscal revenues and made it possible for the Government to adopt an expansionary policy, which rapidly stimulated the growth of out- put. This very good record could not be fully maintained during 1971, when copper export prices slumped, as did prices for other metals and fishmeal. In addition, the volumes available for export decreased as a result of pro- longed strikes at several of the important mines. Total commodity export earnings dropped by some 16 percent, while imports continued their expansion. The result was a sharp deterioration of the current account and a loss of re- serves in 1971. Despite these unfavorable balance of payments developments, an overall real growth of close to 6.percent was achieved. 2. During 1972 the economy was affected by further adverse circumstances. Thus domestic consumption agriculture suffered from particularly unfavorable climatic conditions, and there was a severe - 54 percent - drop in the anchovy catch. Despii:e these developments, GDP is estimated to have grown by 5.9 per- cent, as in the previous year. Overall growth was mainly sustained by the increase in exports, the high level of construction due to the continuing housing boom, and the further expansion of public investment; there was, how- ever, a slowdown in the growth of manufacturing production as capacity prob- lems were encountered. The severe reduction of the anchovy catch forturately affected fishmeal exports only moderately due to the earlier accumulation of large stocks that could be drawn down. Copper exports more than recovered from the loss experienced in 1971, while exports of other minerals, sugar, coffee and wool expanded, more than compensating the reduction in fish prod- ucts and cotton exports; on the whole, earnings from commodity exports in- creased by 4.6 percent. In summary, the general level of economic activity slowed down only slightly, external financial stability was maintained, and inflation, though at a somewhat higher annual rate than in the preceding years, was still kept under control. 3. The developments of 1971, showed not only the vulnerability of the economy to an adverse export performance, but also the inadequacy of the exist- ing tax structure to sustain fiscal revenues in such a situation. Zhe fact that in 1972 Central Government revenues increased only slightly in real terms, despite the recovery of income tax collections, illustrated again the inelas- ticity of the tax system. The result has been a lag in public savings after the peak in 1970 when they amounted to some 4 percent of GDP; in 1972 they may have been equivalent to only about 3 percent. Meanwhile, aggregate sav- ings, which remained constant in real terms from 1971 to 1972, would have  - ii - shown a significant improvement if it had not been for the drop in fishmeal nroduction, which caused abnormal stock disinvestment. The determined expan- sion of public investment has continued, with an increase of some 20 percent in 1972, bearing witness to the increasing project preparation and execution capacity of many public sector agencies. 4. In the light of the experience of the past three years it seems reasonable to foresee that, as the demand for food and manufactured goods grows and the public sector investment capacity continues to increase, the negative effects of the constraints represented by the slow growth of private industriat investment, the lagging agricultural sector and the low elasticity of the tax system, will be felt more strongly. Adequate agricultural pro- duction promotion policies and greater effort of domestic resource mobiliza- tion will be required to overcome these constraints over a number of years. Meanwhile, careful economic management is necessary during the next few years, when the s'ow growth of exports and 'he heavy external debt service may other- wise raise problems for maintaining external equilibrium. 5. During the four years it has been in power, the Government has pur- sued a development approach in which economic growth is directly linked to a transformation of the society to achieve broader popular particiaption in the country's economic, social, and political life. This approach assigns to the state an active and much increased role in the economy, raising a number of basic issues of a general character. These concern, first, the need to re- concile the expansion of the direct eoconomic activity of the state with the preservation of outlets for and incentives to private investment and initia- tive. The private sector in the past accounted for four-fifths of total in- vestment and virtually all investment in the productive sectors, and its alienation would involve a risk of a slowdown in growth, at least for several years. Secondly, as Peru's growth prospects in the medium-term future depend largely on increased mineral exports there is an evident need to reconcile the aspirations of national ownership and control over the country's basic productive resources with the need of attracting the hutie amounts of foreign capital which are indispensable for developing the country's mineral resources. A third set of issues arises out of the trade-offs involved in the Government's attempt to pursue simultaneously economic growth and structural reform objec- tives. 6. The Government's policies during the last three years indicate that - is quite awar2 of these basic issues, and capable of adapting its policies to the realities and constraints of specific situations withlout sacrificing its goals. Faced initially with the problem.s arising from a heavy debt serv- ice and low level of reserves, and by a stagnation of private investment arising in part from the uncertainties created by the socio-economic reforms, the Government has succeeded in reactiviating the economy, expanding public investment and considerably raising the level of external reserves. These achievements have been helped by the exceptional export performance of 1970 and by ample excess capacity after the 1968-69 stabilization, which made possibl.e the expansion of industrial output though little new private in- vestment was taking place.  - iii - 7. Perhaps the key element of the Government's development strategy is the decision to assign to the state exploitin& the countrY's basic Productive resources. During the past rour years the Government has laid the institutional basis for carrying out this policy through the creation of public enterprises in the mining, petroleum and heavy industry fields, and of aguncies for marketing an increasing num- ber of agricultural products for domcstic consumption as well as the basic export products. It has also strengthened its position in the financial field through the creation of a public development financing institution and the acquisition of three large commercial banks. In addition, it has strengthened and broadened the control over imports. 8. The institutional base having been laid, there are two important requirements for success in the state's entrance into the productive sectors of the economy: a rapid increase in the availability of trained manpower and a greater resource mobilization through, especially, increased public sector savings. The Government has made significant progress in improving its capability for preparing infrastructure and social service investment projects, but in addition it will soon face the need of recruiting and 'rain- ing technical and managerial personnel for operating and administering the industrial projects now in the planning or construction stage. Until now the expansion of public investment could be financed without greatly in- creased public savings. This cannot continue, however, if the Government is to attain its goals, and thus an increased savings effort will be required. The urgency of this is strengthened b.1 the fact that the public investment program comprises many large projects in the mining, power and industrial fields with long gestation periods, requiring the immobilization of large amounts of resources before production begins to generate funds to recover the investments and eventually produce surpluses. Finally, the considerable expansion of public sector agencies will require a closer monitoring of their operations by the Central Government than has been the case in the past. 9. The Government's efforts to spread the fruits of economic growth to the masses of the population and improve the country's very skewed dis- tribution of wealth and incomes are embodied in the reforms adopted in the industrial field, and in the acceleration and deepening of the agrarian re- form initiated by the preceding government in 1964. Here those problems of trade-offs between social objectives and economic growth - at least in the short-term - that the Government is attempting to solve, are raised explic- itly. Thus the reforms in industry, which provide for profit-sharing by the employees and their gradual acquisition - up to 50 percent - of the equity capital of industrial firms, initially resulted in near complete stagnation of private investment. To reactivate it, the Government has given strong fiscal incentives through generous tax exemptions for profits which are reinvested; these are in addition to the duty exemptions on capi- tal and intermediate goods imports under the general industrial promotion legislation. 10. To some extent the tax exemptions are proving successful, which is a most timely development in view of the now urgent need to expand capacity in industry. Private investment from other funds, however, continues to be  - iv - negligible, reflecting probably a feeling of uncertainty in the private sec- tor that is still not fully overcome regarding the ultimate role that the Government will allow for private initiative. In fact, the Government's avowed policies, while placing a heavy responsibility on the State, leaves to the Private sector a very broad field of initiative within the industrial sector. If the Government succeeds in persuading the business co,munity that the reforms it has adopted and the role assigned to private enterprise in Peru do represent the established "rules of the game", it would be reasonable to expect an early resumption of private investment. 11. The Government has also adopted measures designed to attract direct foreign investment in particular sectors, and to make possible the continuing operation of important existing foreign enterprises. To these effects it modified at the end of 1971 the earlier legislation to facilitate foreign participation in state-private joint ventures for industrial projects. Further, the Government availed itself of a provision of the Andean Group regulations concerning the operation of foreign enterprises in member countries in order to allow them continuing access to domestic credit. Finally, it has entered into contract arrangements with (so far) eight groups of foreign firms for petroleum exploration and development. These arrangements provide for specific ..ommitments of investment in exploration and development by the coi1panies, and, in case of success, the sharing of production between them and the government in agreed proportion over an extended period of years, at the end of which production facilities will be transferred to the state. 12. In the field of agriculture, the outstanding policy measure, which affects the development of the sector both in the short and in the long run, is the widening of the scope of the agrarian reform started by the previous Government in 1964, and the acceleration of its implempntation. Faced with the acute shortage of agricultural land, the Government has increasingly oriented the reform towards cooperative forms of farm organization and manage- ment; even so it is estimated that there will remain, after full redistribution, some 300,000 landless rural families. Both expropriation and settlement 1/ is proceding at a much faster rate than before. During the last two years the number of families settled in reformed areas increased by about 50 percent over the number settled since the start of the reform in 1964, and the area settled more than doubled. It now seems likely that by 1975 all larger hold- ings will have been expropriated, but the implementation of the reform over the whole area will take longer. 13. Aware of the negative effects that the uncertainty caused by the orgoing agrarian reform expropriations is having on agricultural inve3tment 1/ This refers to the legal process including the final transfer of titles to the land (adjudicacion); the lands concerned are settled, in the sense of used in production, throughout the reform process.  - v - and on the demand for credit by private farmers, the Government has recently begun to issue "certificados de no afectacion", with the purpose of guarantee- ing the present title to the land to those farmers whose holdings are in con- formity with the provisions of the law. It is not clear yet to what extent this measure has been successful. Restoring the confidence of the farmers is very important, however, for though the reform does not appear to have adversely affected production so far, a continuing stagnation of private investment could not fail to have negative effects. n fact, to remove as quickly as possible the grounds for this insecurity, it may be worthwhile for the Government to concentrate available technical resources on zhe expropria- tion process, even at the price of a slower pace of settlements for a certain period. 14. For the biennial plan 1973-74 the Government has adopted a global target of 7.5 percent real growth per year. This would equal the performance of the exceptional year 1970, and would mean a significant increase over the achievement in 1971 and 1972, estimated at 5.9 percent. The increase i-s ex- pected to come from a renewed upsurge in manufacturing, the gradual return to normal of the fishing sector, and better performance of mining and agri- culture. Individually, such better results in several of the important sec- tors appear entirely reasonable, but several of them depend on circumstances beyond the Government's control, e.g., the return to normal of the ecological conditions for the anchovy, and also climatic conditions that are at least fair for agriculture. More successful incentive and production promotion policies are called for in agriculture, while the Government's labor policies will be put to a test by the need to avoid a repetition of the past losses due to strikes in the mining sector. The higher growth rate in manufacturing may be difficult to realize in view of the rather sluggish investment during the last few years. On balance, it appears realistic to expect an actual growth rate somewhat lower than the targeted one, although above the 1971-72 figures. 15. Fixed investment is assumed in the plan to grow by about 12.5 per- cent annually in real terms, with public investment growing on the average about twice as rapidly as private, 18 and 9 percent annually respectively. This is an ambitious target for public investment, and well above the 1971- 72 average, but is in line with the actual achievement during 1972. In view of the growing experience of the project preparation and implementation agencies, an overall public investment growth of the order envisaged may thus be physically feasible. For private fixed investment the assumed rate implies only a moderate increase over the past two years, as a reflection of the hopes for a somewhat greater success in stimulating private investment. Direct foreign investment is expected to be significant in mining and petro- leum exploration. 16. The public investment program is heavily concentrated in four sec- tors - transport and communications, agriculture, industry, and power - which together account for over half of the total. In transport and communications, the largest increases fall on the public enterprises (ports, telecommunicaticns, ships) where the proposed target may be possible to achieve. The power sec- tor has demonstrated in the past good ability to realize its program, and the new program does not appear to be out of line with executing capacity. The  - vi - more ambitious sectorial targets, where shortfalls in actual execution are 'lkely to occur, are industry and agriculture. The program in industry, even allowing for the fact that it contains some large projects (such as the fer- tilizer plant and the copper refinery) which are likely to be carried out, is nevertheless too large given the relative inexperience of most sector agencies in project implementation; substantial slippage will probably occur. The same general comment applies to agriculture, where shortfalls in execution in the past two years have been considerable, and where a major part of the investment contemplated is in large irrigation and colo- nization projects, the execution of which is necessarily slow. 17. In financial terms, the 1973-74 public sector investment program calls for a total investment of SI. 58.6 billion ($1.5 billion) in the bien- nium, including projects which are to be started, but for which no provision was made in the original budget as the external financing had not yet been secured. As the target for public investment which could be considered the upper limit of an administratively feasible program is probably about SI. 50 billion ($1.3 million), which is the financial equivalent of 18 percent real growth per year, the adjustment or rephasing required is SI. 8-9 billion, or about one-sixth of the total. This proportion does not seem unreasonably .arge, and it may well be that slippage in actual implementation will give that margin so that no major adjustment or rephasing of the formal program will prove necessary; in fact, a larger relative slippage has been experienced in the past biennium. 18. In order to help meet the financial requirements of the investment program, the Government in December 1972 adopted a number of tax measures, which together are expected to yield an additional revenue over the biennium of over S/. 7 billion. The most importait of the new measures is the sub- stitution of a general sales tax for a large number of stamp taxes which existed previously; among the others are changes in the property tax and increased automobile licensing fees. Further, the Government has indicated in the budget that additional revenue measures will b2 taken during 1973 with an estimated revenue effect of SI. 3.0 billion in 1974. The total to be raised by new taxes during the 1973-74 biennium would thus amount to over Sf. 10.0 billion, close to 12 percent of total government revenues in the past biennlum. With this, total public sector savings, including an in- creased surplus of enterprises and social security agencies, are expected to be about S/. 29.5 billion in 1973-74, compared with SI. 17.5 billion in ,971-72. These projected public savings would be equivalent to some 4 percent of GDP. 19. Total public sector capital expenditures in the 1973-74 biennium are estimated at SI. 73.2 billion ($1.9 billion), and the financial resources likely to be available from identified sources amount to some SI. 70.0 bil- lion ($1.8 billion), distributed as follows:  - vii - Required funds Fixed capital formation 50.0 Financial investments 7.U5 External debt amortization 14.3 Expenditures in liquidation period of 1971-72 biennium 1.1 Identified sources 70.0 Public sector savings in budget 29.5 Disbursements from existing external loans as of December 31, 1972 3.8 Disbursements from new external project loans 5.8 Non-project external assistance 3.9 Domestic borrowing from banking system 10.0 Bond placements outside banking system 4.0 Additional government revenue 3.0 /1 Of which S/. 4.8 billion as capital transfer to government banks. The uncovered difference of SI. 3.2 billion ($85 million) even after counting on S/. 3.0 billion of public savings in addition to those estimated in the 1973-74 budget, though small given the margin for variations in the projec- tions, indicates that the proposed investment program is ambitious not only in real te-rms, but also from the point of view of the financial requirements. It underlines the importance of a strong savings effort and tight fiscal man- agement by the Government. 20. Peru's economic growth has in the past been heavily dependent on imports of investment goods, and also on imports of raw materials and inter- mediate goods for the manufacturing sector. This pattern is likely to con- tinue, at least in the medium-term, and thus the development of the capacity to import will remain a crucial factor for the country's growth prospects. This capacity is likely to be constrained by a relatively slow growth of ex- port volume through 1976. Even if the fishing crisis is assumed to be a temporary phenomenon, and the Cerro Verde copper mine is expected to begin production in mid-1975, a significant increase in Peru's export supply ca- pacity will not come until 1977, when the impact of the large Cuajone mining development is likely to be felt. Export volume in 1976 is only projected to be some 20 percent above the 1972 volume. The constraint on import ca- pacity would be alleviated if Peru's export prices were to be substantially higher than in the past. At the time of writing, prices were increasing; but given the experience with commodity markets, it would not be prudent to count on a major sustained improvement in Peru's terms of trade as a solution to its balance of payments problem. Also, no large-scale petroleum development is assumed; while the signs are most promising, commercial reserves are not yet proven, and it would not be prudent to count upon their existence. It is clear, however, that if major petroleum reserves indeed confirmed, the pro- jections would be appreciably affected. With respect to fishmeal, the pro- jection appears to be on the optimistic side at least for 1973 and 1974, judging from the results of the fishing up to the end of April 1973.  - viii - 2'. Supply capacity being limited, commodity exports have been projected to grow in the 1973-76 period by about 9 percent annually in nominal terms, with about equal contributions from increases in volumes and prices. Imports, meanwhile, are projected at an average annual growth of 12.3 percent in no- minal terms (9.8 percent in real terms). This more rapid growth of imports, mainly on account of the capital goods required to sustain the economy's growth, results in a shift of the trade balance to a moderate deficit; after taking interest payments, profits and other remittances into account, there will be a substantial current account deficit, estimated at $1,150 million over the four-year period. In addition, amortization on new borrowing and m'scellaneous outflows would raise the total to $855 million. 22. Total gross external capital requirements are thus estimated at about $2,005 million during 1973-76. On an annual average basis for a compa- rable period (1973-74), they are quite close to the estimate in the 1972 IBRD report (WH 212a). Of the projected amounts, direct foreign investment is projected to contribute about $415 million, mainly for the Cuajone and Marcona m1ning projects and petroleum exploration and development, while disbursements from public and publicly guaranteed loans signed by the end of 1972, will contribute about $535 million. The overall level of possible new external project borrowing (commitments) during the four years is seen as rising from an initial $295 million in 1973 to $470 million by 1976, a target which, though ambitious compared to the level of about $260 million in 1972, cou'.d still be achieved provided a sufficient effort at project preparation is made in Peru. The list of Projects for External Financing 1973-75 proposes commitments aggre- gating $1,593 million over the three years. 1/ This should make it possible to actually commit the $1,115 million projected here, allowing for a slippage of about one third. Allowing for realistic disbursement rates, disbursements from such new project loans are projected at about $810 million over the period. This would then leave about $245 million uncovered, despite the _fcct that local cost financing equivalent to some 11 percent of total project cost has been assumed. In order to avoid the need to draw heavily on reserves initially, when this would not be advisable in view of the major uncertainty surrounding the fishing sector, the projection foresees non-project assistance of $100 million during the 1973-74 period. The $145 million left to be covered by reserves represent a considerable reduction of the level of reserves - they would be reduced by 1976 to a level equal to about two months' imports - and it might thus prove necessary to utilize instead some further non-project assistance and increase domestic resource mobilization further. The end-1972 level of net reserves was $389 million, equivalent to some five months of .lmports. 23. While the projection thus indicates the need for utilization of reserves and/or non-project assistance, this may be substantially reduced. The export projections (particularly copper) are based on price assumptions 1/ Excluding the $340 million included for the trans-Andean pipeline, on whiich the final decision to go ahead has not yet been taken.  - ix - that the very recent developments may eventually prove to be too low. Given the uncertainty surrounding the exports of fishmeal as well as the difficulty in making now a judgement as to how the currency realignments may affect worid trade and commodity prices over the projection period, it has seemed prudent to maintain the projections in this report on the basis presented. If prices do stay at a higher level, the increased export earnings could provide an off- set to a possible substantial shortfall in fishlneal export. I/ In any case, the possible gains from higher prices would not be sc high as to reduce the need for project borrowing from the level projected. 24. With the high levels of commitments required to achieve a sufficient capital iflow over the period 1973-76, external debt outstanding (including undisbursed) is projected to increase by about 60 percent - from $1,500 mil- lion in 1972 to some $2,400 million at the end of 1976. The debt service payments would rise from an estimated $201 million in 1972 to $304 million in 1976; the service of debt already contracted will still amount to over $200 million by then. Expressed in terms of export earnings, the debt serv- ice would remain at about 19 percent over the period compared to 18 percent in 1972. Looking beyond 1976, export earnings are expected to be increased by some $120 million with the full coming into production of the Cuajone mine (in 1977). This would immediately ease the debt service burden and moderate the further requirements for capital inflow, which emphasizes the importance of assuring the timely completion of this project and related arrangements. Assuming tha other mining projects will be developed accord- ing to current plans, the external position can be expected to remain stable, with debt service as a percentage of export earnings remaining at or below the 1972 value of 18 percent through the first half of the next decade. Should significantly higher copper prices than assumed prevail, or a major petroleum development occur, this figure would become considerably lower; alternatively a higher income growth rate could be sustained. Conclusion 25. While the above projections do indicate that the period through 1976 will pose problems for Peru in terms of the external balance and debt management, these problems should not be insurmountable given reasonable external support. The Peruvian Government has up to now shown such flexi- bility in its economic management and willingness to take necessary steps to meet problems as they arise, that it must be considered capable also of coping with those that lie ahead. To sustain over the next few years an adequate growth rate, and to make it possible for the Government to continue its ambitious program of social transformation with economic development, fairly large amounts of external borrowing will be needed. Despite some recent improvements, Peru's debt structure remains unfavorable, with 80 per- cent to be repaid within 10 years, and with service of comparatively short- term loans a substantial part of the total for the next few years. An urgent task for Peru and its creditors must be to find ways to improve on this situation by increasing the share of longer-term loans extended. Lenders should also give consideration to the already high debt service burden during the first few years, and to the need to extend the grace periods, so that 1/ Judging from developments until early May 1973, this is a likely result; see attachment to Table 3.2 of the Statistical Appendix.  x amortization does not begin until the foreseen additional export earnings begin to accrue. On the side of Peru, further measures to increase domestic resource mobilization are indicated to supplement those already taken, as well as continuing efforts to secure external support for activities leading to a susta4ned strengthening of the balance of payments.  CURRENT ECONOMIC POSITION AND PROSPECTS OF PERU I. INTRODUCTION 1. When it came to power in October 1968, the present Peruvian Govern- ment announced plans for a fundamental transformatic- of the pattern of devel- opment in the country: the excessive dominance of foreign capital and enter- prise would be broken, the very unequal distribution of wealth and income would be changed, and a genuine popular participation in the national devel- opment would be promoted; new exports would be developed, and as rapid an economic growth would be sought as would be compatible with the structural transformation goals (which clearly have first priority). To achieve this transformation, the role of the State in the economy would be greatly expanded, going into the production sectors, while the private sector would be actively influenced and directed along a new path. The Government has; now had a little over four years to implement its program, and, it is possible to draw some preliminary conclusions about what has been achieved and which areas need particular attention for the future. 2. It may be useful to give first a sketch of Peru's historic develop- ment and the social and economic situation that has evolved. Only against such a background is it possible to properly appreciate the challenge which the country presents to any governument which wishes to pursue an active policy of social and economic transformation, and thus to understand the Government's approach to development. While it is true that many of Peru's problems also exist in other Latin American countries, the combination and intensity of the negative factors are quite pronounced. The Socio-Economic Setting 3. Peru's development history is dominated by one pattern: great wealth is produced, but only by small segments of the population and for the benefit of even more limited groups. The rest of the population has been left largely untouched by development, securing its livelihood from a subsistence agriculture and having litttle contact with the money economy. At first, during colonial and early republican days, there was the extrac- tion of precious metals and a plantation-type agriculture, with labor being provided largely by conscripted indians. Then Peru found itself in posses- sion of a veritable treasure in the form of vast guano deposits, which were exploited almost in "gold-rush" fashion as the international demand for fer- tilizers grew. Intensive, irrigated agriculture for export crop production in the coastal valleys provided another new avenue of expansion at the same time as Peru's large deposits of copper and other megals began to be sys- tematically exploited at the beginning of this century. The latest addi- tion to the resource base was finally the anchovy, the great abundance of which in the waters off the Peruvian coast gave rise to yet another boom during the late 1950's and early 1960's.  - 2 - 4. Significant economic development has taken place along the coast, and at some .isolated mining enclaves in the Andes, but practically nowhere else. The country's extreme topography and difficult climate make transport and communications very difficult and costly, thereby further limiting the effect which development at one place has had on other parts of the country. These circumstances have had the effect of increasing the attractiveness of the coast for other productive investments - in industry and related trans- portat-ion, power and commercial services - thus reinforcing the geographical concentration of economic activity. In turn this, by drawing to Llma and other coastal urban centers almost everybody with initiative and aspirations to improve his lot, may have staved off the effective pressures for economic and social change in the Peruvian highlands, the Sierra. 5. At the same time, it is notable how much of this modern development has been carried out by foreign enterprises. Among Peru's export industries all the large-scale and most medium-sized mines are foreign-owned. This is also the case with many of the larger firms in the fishmeal industry; until the recent agrarian reform the same applied to the sugar estates. But foreign initiatives were not restricted to the export sector. While the Government's drive towards Pe'iuvianization is now rapidly changing the pattern of owner- ship in some industries, foreign domination has been strong in the fields of petroleum development, power, telephones, railways and commercial banking. It is generally the case that most larger firms in modern sectors of manufac- turing are tied to foreign interests. 6. This pattern of development has proven its capacity to achieve a respectable rate of overall global economic growth, but, coupled with rigid and outdated social institutions, it has also led to wide disparities in productivity, employment opportunities, income levels, and welfare. between the modern and the traditional sectors, between the coast and the rest of the country, between the urban and the rural population. Peru has a modern sector comprising highly specialized export agriculture, a Aimited manufac- turing sector, their related transport, trade, electr4- power and financial services and large scale production of minerals for cxport. Coexisting with this modern sector is the traditional agricult,.re sectur in the Sierra which, until the advent of agrarian reform, was dominated by peasant-type, small farm units and indian communities, on the one hand, and large plantation- type "haciendas" raising most'ly livestock on the other. Comparatively speaking, the modern sector is characterized by intensive use of capital, a relatively modern technology and organization of production, and conse- cuently, relatively high productivity. In contrast, the traditional agri- cultural sector exhibits a low level of investment and uses few tezhnologi- cal inputs and modern production practices. The general economic ,ackward- ness of this agriculture with very low levels of productivity per worker and per unit of land, and the severe scarcity of arable land in the Sierra - the average arable land per inhabitant is only about .3 ha. - result in low l7evels of income both in absolute terr.s and relative to the population engaged in other economic activities. 7. *t must be concluded that the difficulties in successfully attack- ing the hirstoric problems and initiating a development process capable of  - 3 - reaching the broad masses of the population and of transforming the whole country into a modern society, are serious. It would also be too simplistic to explain the limitations of past development only by reference to shortcom- ings of the private sector. The character and the location of Peru's modern economic sector have been dictated by the nature and the geographical dis- tribution of the country's basic productive resources, and the development of such resources in the areas and at the times it took place, probably represented the most efficient utilization of those resources to meet a given pattern of foreign and domestic demand. In addition, the special dif- ficulties posed by the country's physical structure, and the relatiije scarc- ity of agricultural land combined with a high rate of population growth can- not be overrated. 8. Despite such difficulties, the present Government is committed to bring about a major transformation of Peruvian society. It views the economic development of the country as an all-embracing process in which the objective of economic growth is intimately linked to social transformation goals. This is a commendable and ambitious program though fraught with enormous difficul- ties. It is bound to give rise to problems of trade-off between economic and social objectives with regard to specific policy measures, programs and proj- ects, and face the authorities with difficult choices. This report, concerned with reviewing Peru's recent developments, is intended as a contribution to better understanding the country's current problems and policies and its short and medium-term prospects, against the background of the country's longer-term development problems, efforts and goals.  II. DEVELOPMENT TRENDS 9. In any discussion of developments during a period of only a few years, it is necessary to keep constantly in mind the underlying medium- term trends and larger problems they pose. The danger is that too much at- tention to short-run detail will obscure the basic issues. Similarly, there are basic factors in any economy, which change only slowly, but which funda- mentally affect the courses of action open to the Government, whatever its priorities. These include the growth rate and composition of the country's population, the available natural resources, and major features of the pro- ductive structure. As background for the discussion of the new Government's development approach and recent economic trends, this chapter will give a slhort summary of the major developments in the past decade and point to some of the basic problems suggested by them. Population Trends 10. Peru does not yet have population statistics which give accurate data on actual changes from year to year; hence analysis is limited mainly to information from the censuses. The final results from the most recent one, in 1972, are not yet available, but preliminary figures suggest that the average annual growth rate since the 1961 census has been about 3 per- cent, I/ in comparison with the average of 2.1 percent experienced between the 1940 and 1961 censuses. Peruvian demographers are of the opinion that the most important cause for this acceleration of growth is the reduction in mortality at all ages. They also feel that, as there will be further such reductions accompanying the improvement of liealth services available to the population outside the major urban centers, the population growth r.ate during the coming decade may very well increase slightly. Th