Peru - Policies to stop hyperinflation and initiate economic recovery (Vol. 2 of 2) : Annexes and statistical appendix

Report No. 7460-PE Peru Policies to Stop Hyperinflation and Initiate Economic Recovery (In Two Volumes) Volume Il: Annexes and Statistical Appendix December 15, 1988 Country Department IV Latin America and the Caribbean Regional Office FOR OFFICIAL USE ONLY U.,~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Document of the World Bank This report 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 Currency Unit = Inti (I/.) Official Exchange Rate (Effective December 1, 1988) I/. 1.00 = US$0.002 US$ 1.00 = I/. 500 FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY PREFACE This report was prepared and drafted prior to the announcement of two packages of economic measures by the Peruvian Government, first in September 1988 and then in November 1988. A description of these measures as well as an update on the current state of the economy is contained in the Addendum provided in the last section of Volume I. This report is based on findings and analysis of Bank economic missions which visited Lima in October 1987, November/December 1987, and March/April 1988. Support for the Bank work with the Government was provided by the United Nations Development Programme (UNDP). Participation in the missions, which varied in size and composition, was as follows: William Tyler (Mission Chief); Ricardo Lago (Deputy h.tCsion Chief ani principal author); Ulrich Lachler (trade and exchange rate policies); Daniel Oks (consultant, macroeconomics); Jeno Malatinszky (public enterprises); Ricardo Martin (projections); Fernando Rezende (consultant, taxation); Javier Escobal (consultant, agriculture); Bruce Herrick (consultant, labor markets); Cesar Burga (projections, statistical annex, and research assistance). Pedro Mercader (UNDP Lima Representative) accompanied the work of the missions in Lima and provided valuable guidance and overall support. Valuable comments on an earlier draft were provided by Rudiger Dornbusch. Michel del Buono provided a short note on the state of the energy sector. Brian Wesol provided research assistance in one of the missions. Dorothy Jenkins provided secretarial work throughout the cycle of the report. Milagros Aquino-Divino provided secretarial assistance in the final stage of the report. This report was discussed in great detail with the Government's economic team in Lima during October/November 1988 by Messrs. Tyler and Lago. While there was general agreement between the Bank and the Government's economic team as to the diagnosis and analysis of the situation, the Government's economic team stressed political and social constraints to taking strong policy action to forestall hyperinflation and indicated the need for a more gradual policy approach. 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.  PERU - POLICIES TO STOP HYPERINFLATION AND INITIATE ECONOMIC RECOVERY TABLE OF CONTENTS VOLUME I: THE MAIN REPORT Page No. COUNTRY DATA EXECUTIVE SUMMARY i RESUMEN EJECUTIVO xvi CHAPTER I. THE EVOLUTION OF THE PERUVIAN ECONOMY .............. 1 A. Background ............., 1 B. Recent History ................................. 1 C. The Diagnosis of the Economy in 1985 and Strategy of the Incoming APRA Government ...... 3 D. The Implementation of the Policies, July 1985 to December 1986 ................... 4 E. The Results in 1986: Reactivation and Disinflation ................................. 9 F. Economic Policy in 1987 ........................ 12 G. Economic Perfor.mance in 1987: Stagnatio4i of Production and Intensification of Inflationary Pressures ....................... 19 H. Economic Policy during January-August 1988 ..... 21 CHAPTER II. THE ECONOMIC PROSPECTS IN THE ABSENCE OF MAJOR POLICY REFORMS . ....... .. ........... 23 A. The Diagnosis of the Current Crisis ............ 23 B. The Likely Evolution of the Economy without Major Corrective Measures ............ 28 CHAPTER III. THE MAIN ECONOMIC ISSUES AND POLICY RECOMMENDATIONS 38 A. Public Finance ..... ...... ............... 39 1. The Tax System: Evolution, Structure, and Recommendations ...................... 41 2. Prices and Tariffs of State Enterprises: Evolutions, Structure, and Recommendations .......................... 47 3. Public Investment: Recent Trends and Recommendations .......................... 54 4. The Central Bank's Quasi-Fiscal Deficit: Definition, Measurement, and Recommendations .......................... 56 B. Externial Sector Policies .. 60 1. Exchange Rate Policy: Evolution, Structure, and Recommendations ........... 60 2. Import Restrictions: Structure, Assessment, and Recommendations .......... 68 3. Export Incentives: Structure, Assessment, and Recommendations .......... 76  - ii - C. Other Resource Allocation Issues . . ............. 80 1. Financial Policy: Main Issues and Recommendations . . 80 2. Price Controls: Structure and Recommendations .......................... 85 3. Agricultural Pricing and Subsidies: ?olicies, Assessment, and Recommendations .......................... 87 4. Labor Market Issues and Recommendations .... 92 5. The State Enterprise Sector ................ 96 CHAPTER IV. ECONOMIC POLICY TO STABILIZE INFLATION AND SET THE CONDITIONS FOR MEDIUM-RUN GROWTH ........... 99 A. The Preconditions for Stabilization ............. 99 B. Resumption of Growth and the Foreign Debt Problem ...................................... 100 C. Overall Macroeconomic Strategy ................. 103 D. Illustrative Evolution of the Economy under Stabilization and Structural Adjustment ...... 112 ADDENDUM - AN UPDATE ON RECENT DEVELOPMENTS .. .. . 120 VOLUME II: ANNEXES AND STATISTICAL APPENDIX A;NNEXES* .... ........................................................... 1 Annex 1. Inflation and Inflationary Finance ....... 1 Annex 2. The Inflation Tax: Theoretical Derivation and Calculation for 1980-87. .. . 4 Annex 3. The Central Bank's Quasi-Fiscal Defieit.. 17 Annex 4. Main Characteristics of the Peruvian Tax System ..... ................. 28 Annex 5. Misalignment of Prices and Tariffs of State Enterprises: A Preliminary Calculation ............................ 38 Annex 6. The Working of the "Mesa de Negociacion" of Foreign Exchange Certificates ........................... 41 Annex 7. The Financial System: Institutional Characteristics ........................ 42 Annex 8. Population, Income Distribution, and Labor Market Segmentation .............. 47 Annex 9. The State Enterprise Sector .............. 58 Annex 10. The Interaction of Fiscal and Monetary Policy ................................. 79 Annex 11 Reserve Requirements and their Remuneration ........................... 92 Annex 12 Brief Background on the Agricultural Sector ................................. 93  - iii - STATISTICAL APPENDIX ...... ............................... ....... 95 I. POPULATION AND EMPLOYMENT ... ...... ......................, 95 1.1 Total Population Distribution . . 95 1.2 Demographic Indicators . . 96 1.3 Enployment and Labor Productivity ............ 97 1.4 Un- and Under-Employment .................... 98 II. NATIONAL ACCOUNTS ...................... . . 99 2.1 GDP by Sectoral Origin (Constant Intis) ...... 99 2.1(A) Real GDP Average Growth Rates (Percentages).. 100 2.2 Nominal GDP by Sectoral Origin (Current Intis) ............................ 101 2.2(A) GDP: Percentage Distribution ................. 102 2.2(B) GDP Deflators ................. 103 2.2(C) GDP Deflators: Yearly Percentage Changes ..... 104 2.3 GDP by Expenditures (Constant Intis) ......... 105 2.4 GDP by Expenditures (Current Intis) .......... 106 2.5 Domestic Irncome .............................. 107 2.5(A) (PerceLatage Distribution) .............. 108 2.6 Gross Capital Formation by Goods and Origin-.. 109 2.7 Real GDP Per Capita ......................... . 110 2.8 Per Capita GDP by Departments . .11....... i III. BALANCE OF PAYMENTS ............................. .... 112 3.1 Summary Balance of Payments . ......... 112 3.1(A) (As a Percent of GDP) ............. 113 3.2 Merchandise Exports by Commodities (Current Dollars) .................................. 114 3.3 Merchandise Exports by Commodities (Constant Dollars) .115 3.4 Merchandise Ii.tports (Current Dollars) 116 3.5 Merchandise Imports (Constant Dollars) 117 3.6 Export, Import ar.A Terms of Trade Indexes... 118 IV. EXTERNAL DEBT .................. e-..**e... .......... 119 4.1 Total External Debt Outstanding and Disbursed ................................. 119 4.2 Service Payments, Disbursements and Outstanding Amounts of External Public. Debt ...................................... 120 V. PUBLIC FINANCE ......................... 121 5.1 Non-Financial Public Sector Operations ....... 121 5.1(A) (As a Percent of GDP) ........................ 122 5.2 Central Government Operations ................ 123 5.2(Al (As a percent of GDP) ........................ 124 5.3 Non-Financial Public Enterprise Operations ... 125 5.3(A) Non-Financial Public Enterprise Operations ... 126 5.3(B) Non-Financial Public Enterprise Operations by Company ................................. 127  - iv - 5.4 Current Revenue of the Central Government by Source . . 128 5.4(A) (As a Percent of GDP) .. 129 5.5 Current Expenditures of the Central Government ....... 130 5.5(A) (As a Percent of GDP) .............. 131 5.6 Fiscal Cost of Exemptions on Import Tariffs by Sectors . . 132 VI. MONETARY STATISTICS ................................. ..... 133 6.1 Summary Accounts of the Consolidated Financial System ...............,...... 133 6.2 Summary Accounts of the Consolidated Banking.. System .................................... 134 6.3 Summary Accounts of the Central Reserve Bank.. 135 VII. PRODUCTION STATISTICS ........ .......... . 136 7.1 Agricultural Production ....................... 136 7.2 Volume Index of Manufacturing Production ...... 137 'VIII. PRICES AND EXCHANGE RATE .................................... 138 8.1 Consumer Price Indexes for Metropolitan Lima.. 138 8.2 Exchange Rates ................................ 139 8.3 Real Exchange Rate Index ...................... 140 COUNTRY MAP  GLOSSARY OF ACRONYMS Spanish English APRA - Alianza Popular Revolucionaria American Popular Revolutionary Anericana Alliance BAP - Banco Agrario del Peru Agricultural Bank of Peru BC.R - Batnco Central de Reserva del Peru Central Reserve Bank of Peru BOP - Balanza de Pagos Balance of Payments CD - Certificados de Deposito Certicates of Deposit CRB - Blnco Central de Reserva del Peru Central Reserve Bank of Peru CENTROMIN - Empresa Minera del Centro Central Peruvian Mining Enterprise CERTEX - C.ertificado de Reintegro Export Tax Reimbursement Tributario a la Exportacion Certificate COFIDE - Corporacion Financiera de Development Finance Corporation Desarrollo CONADE - Corporacion Nacional de National Development Corporation Desarrollo CPI - Indice de Precios al Consumidor Consumer Price Index ECASA - Empresa de Comercializacion Rice Marketing Enterprise del Arroz ELECTROPERU - Empresa Electrica del Peru Peruvian Electricity Enterprise ENCI - Empresa Nacional de Inputs Marketing Enterprise Comercializacion de Insumos FENT - Fondo de Exportaciones Fund for Non-Traditional Exports 14o Tradicionales FRASA - Fondo Naciornal para la National Fund for Agrarian Reactivacion del Agro Reactivation and Nutritional y Seguridad Alimentaria Security GDP - Producto Bruto Interno Gross Domestic Product GNP - Producto Nacional Bruto Gross National Product HIERROPERU - Empresa Minera del Hierro del Peru Peruvian Iron Mining Enterprise ICE - Instituto de Comercio Exterior Institute of Foreign Trade IDB - Banco Interamericano de Inter-Ameri-an Development Bank Desarrollo INE - Instituto Nacional de Peruvian Statistical Institute Estadistica IGV - Impuesto General a las Ventas Sales Tax IMF - Fondo Monetario Internacional International Monetary Fund LIBOR London Inter-Bank Offer Rate MEF - Ministerio de Economia y Ministry of Economy and Finance Finanzas MINEROPERU - Empresa Minera del Peru Peruvian Mining Enterprise MN - Mesa de Negociacion Negotiation Table MUC - Mercado Unico de Cambios Official Exchange Market OCN - Otras Cuentas Netas Net Unclassified Assets PAIT - Programa Nacional de Apoyo al Temporary Income Support Program al Ingreso Temporal PETROPERU - Petroleos del Peru Peruvian Petroleum Company PROEM - Programa de Empleo Temporal Temporary Employment Program PSBR - Requerimientos Financieros del Public Sector Borrowing Rights Sector Publico QFD - Deficit Quasi-Fiscal Quasi-Fiscal Deficit QRs - Restricciones Cuantitativas Quantitative Restrictions TINTAYA - Empesa Estatal Minera Asociada Tintaya S.A. WPI - Indice de Precios al por Mayor Wholesale Price Index  ANNEX 1 INFLATION AND INFLATIONARY FINANCE 1. The purpose of this annex is to study the relationship between the inflation rate and the real resources from inflationary finance (seigniorage). In particular, the focus is placed on identifying the shape of the trade-off between the inflation rate (as a tax rate) and the amount of real resources that can be transferred to the government from a given demand for money (as a tax base). This trade-off can be termed as a Laffer curve, in analogy with the theory of taxation. From analyzing this trade- off it can be calculated the inflation rate that maximizes revenues from inflationary finance. It is found that in the case of Peruvian economy, that inflation rate is between 500 percent and 600 percent per annum, and the maximum revenue from inflation is just over 10 percent of GDP. 2. The demand for money utilized here is the simple Cagan formulation: M/p = A exp (-anl) y (1) Where M/p = real broad money; n = inflation rate: y = real GDP Since in Peru interest rates on Bank deposits are very low compared to inflation and the share of deposits in broad money is declining rapidly, it is assumed for simplicity that the nominal return of all broad money is zero. 3. The government's rea'l revenue from irnflation (R) is: R = (M/kp) n1 = [A exp (-%l)Y 1]/k (2) Where k = money supply multiplier. To maximize inflationary revenues: d R/dfl = A [exp (-&ll) y -anl exp (-al) y ]/k = 0 This can be written as: (A exp (-dl)y/k) (1-5U) - 0 The maximum revenues are reached at n (max) = I/a (3) Also when n = o or f = w ==) R (Min) = 0 4. To infer the value of the parameter "a'. the following convenient expression of (1) can be used: (M/p)/y = A exp (-acl) or y/(M/p) = exp (fIa)/A Since V = py/M = income velocity of money; therefore: V = exp (Ia)/A (4) Taking logs and then derivatives: d log V ldH = a or (dV/V)/dll = a (5)  5. The variables of expression (5) can be proxied by the growth rate of velocity and the increase in inflation trom the second semester of 1987 to the first semester of 1988. Thus: d V/V t Av/v = 1163/bO9 = 0.44 Since: M/P (at Dec. 1987) = 1163; Real GDP (average July-Dec. 1987) = 121; and M/p (at June 1988) = 809; Real GDP (average Jan.-May 1988) = 121 In addition: AH = 3.62 - 1.38 = 2.24 Since: n (July to Dec. 1987) = 138 (annual rate) I (Jan. to June 1988) = 362 (annual rate) Therefore the estimate of "a" is: (AV/v) /An = 0.44/2.24 = 0.196 and, as a result, the inflation rate that maximizes inflationary finance is: n (max) = I/a = 1 / 0.196 = 5.1 or 510 percent per annum Chart 1-1 I ' ! 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