Peru - Structural Adjustment Loan Project

Document of The World Bank FOR OFFICLAL UISE ONLY RepoitNo. P-5714-PE REPORT AND RFCO1MENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED STIRUCTURAL ADJUSTMENT LOAN IN AN AMOUNT EQUIVALENT TO US$300 MILLION TO THE REPUbLIC OF PERU MARCH 2, 1992 This document has a restricted distribution and may be used by recipients only in the performance of dteir official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EOUIVALENTS (As of December 30, 1991) Currency Unit = Nuevo Sol (S/.)' US$1.00 = S/.0.9S S/.1.00 US$1.05 f GOVERNMENT'S FISCAL YEAR January I - December31 ABBREVIATIONS ALADI Asociaci6n Latino-Americana de Integracion (Latin American Integration Association) BCRP Banco Central de Reserva del Peri (Central Bank of Potu) BPP Banco Popular del Perd COPRI Corporacidn pama la Promoci6n de la Inversion Privada (Commission for the Pronmotion of Private-Sector Investments) CPI Consumer Price Index CTS Compensaci6n por Tiempo de Servicios (Forced savings scheme for worker retirement) ECASA Eipresa de Comercializacion del Arroz (Rice Marketing Company) ENCI Empresa Nacional de Comercializacion de Insumos (National Input Marketing Company) FLAR Fondo Latinoamenricano de Roservas (Latin American Reserve Fund) FONCODES Fondo Nacional de Compensacion y Desarollo Social (National Fund for Social Compensation and Development) GDP Gross Domestic Product CG Central Government GOP Government of Pew GTZ Deutsche GesellchafR fu-r Technische Zusammenarbeit (German Company for Technical Cooperation) IFIs International Financial Institutions IBRD Intetnational Bank for Reconsttuction and Doveloqmcnt IDB Inter-American Development Bank IMF Intnational Monetary Fund INP htstituto Nacional de Planificaci6a (National Planning Institute) IPSS Instituto Peiuano de Seguridad Social (Peruvian Social Security Institute) *GF Japanese Grant Facility LDP Loter of Development Policy MEF Miniustio de Economia y Finaazas (Ministry of Economy and Finance) MLT Medium- and long-term NFPS Non-Financial Public Sector NGOs Non-Governmental Agencies PETROPERU Pettoteos del Pen, S.A. (Pem Oil) RAP Rights Accumulation Program SAL Structural Adjustment Loan SBYS Superintendency of Banks and Insurance SEA State Entrepreneurial Activities SEP Social Emergency Program SPP Sistenta Privado de Pensiones (Private Pensions System) SUNAD Superintendencia Nacional de Aduanas (Customs Administration) SUNAT Superintendencia Nacional do Adminigraci6n Tributaria (Tax Administration) UNDP United Nations Development Programme UNICEF United Nations Children's Emergency Fund VAT Value Added Tax 'On July 1, 1991, a new monetary unt, the Nuevo Sol (SI.). was introduced at a converson factor of S/.1.00= Im.1.00. The so-called Inti Mill6n (I/m.) - equivalent to one million Intis (Vt.1,000,000)- was introduced on December 16 1990 to simplify accounting and as a means of transition between the Inti and the Nuevo Sol.  FOR OFFICUL USE ONLY SMRUCTURAL ADJUSTMENT LOAN Table gt Contents Juoan and Progr Summ .ary . v I. THE LOAN, THE WORKOUT PROGRAM, AND COUNTRY STRATEGY ............. I A. Tbe Loan ........................................................ I B. The Bank's Approach to a Country with Protracted Arrears ........1........... C. Ihe Bank's Approach in Peru ................... ....................... 1 II. THE ECONOMY ............................................ 5 A. The Economy Inherited ............................................ 5 B. The Economic Reforms of the Current Administration ....... ................ 12 C. The 1991-1992 Macroeconomic Stabilization Program ....... ................. 15 D. Risks and Assessment of the Stabilization Program ........ ................. 16 E. Monitoring the Stabilization Progm ................................... 18 F. The Agenda for Structural Reform ..................................... 19 G. The Medium-Term Outlook ........................................... 20 M. EXTERNAL FINANCING ................................................ 20 A. The External Debt Problem ........................................... 20 B. The External Financing Plan for 1991 and 1992 ............ ................ 21 C. Externa Financing Beyond the Performance Period ........ ................. 25 Tis trpot wa prepared by Valeriano Garcia, based on the findings of a preappsl mission to Peru in Septemb.e 199M, snd an apraisal mission in Dcmbr 1991. Contibutors to the report wer: Marcelo Anrnou (inancia Officer); Janet Eatt (Country Officer); Edgardo Favaro (Country Economist); Feliciano e (Sr. Economist); Polly lones (Sr. Economist); Chlh Kane (Economist); Izumi Ohno (County Officer); Geoffrey Sheped (Princ.p E30ono1st); Ch Yappaz (Reseauch Asistant); Robetto Abusada, Cesar Bu, Karen Cavan . AdJan OulssarTi, San Knaudt, Trwy Mincey, Mario Pasco Cosmopolis, Carlos Rodriguez, Saa Tboada de Coneila, Kateina Taiganide, Abel Viglione and Denise von Gersdorff (Consultants). Gabriela Huffman and Diana Sangesa= provided sectarial suppott. IIs document has a resticted distibution and may bo used by recipients only in the performance of their official dies. ts conten may not otherwise be disclosed wihout World Dank auton.aI This documtent has a esticted distribution and may be wud by fe-ipients only in the performance of their offlcial duties. Its contents may not otherwise be 6:sclosed without World Bank authorization.  * .~~~~~~~~~~~~~~ ii IV. THE GOVERNMENT'S STRUCTURAL ADJUSTMENT PROGRAM .................. 26 A. PiscalPolicy .............................................. 26 Background ............................................ 26 Recent Reforms .......................................... 26 An Agenda for Further Reform ................................ 27 B. Social Sectors .............................................. 27 Background ............................................ 27 Recent Reforms .......................................... 28 Pov-erty Alleviation .2............................ 28 Health, Nutrition and Education ............................ 28 An Agenda for Further Reform .......................... .. 29 C. Privatization ............................ 29 Background .............................. 29 Recent Reforms ............................ 30 An Agenda for Further Refortn .......................... .. 30 D. Agriculture ............................ 31 Background .............................. 31 Recent Reforms ...... ................................... 31 An Agenda for Further Reform .......................... .. 31 E. Labor Reform ............................ 31 Background . .............................. 31 Recent Reforms ......................................... 32 Probationary Employment .................................. 32 Temporary Employment ................................... 32 Forced Savings Scheme for Worker Retirement (CTS) ................ 32 An Agenda for Further Reform ................................ 32 F. Social Security ............................................. 32 Background ............................................ 32 Recent Reforms ......................................... 33 An Agenda for Further Reform ................................. 33 G. Prospects for the Structural Adjustment Program ........................ 33 V. THE PROPOSED STRUCTURAL ADJUSTMENT LOAN ......................... 34 A. TheLoan ................................................ 34 Description ............................................ 34 Policy Reforms to be Supported Under the SAL ...................... 34 Proposed Sectoral Conditions ................................. 34 Conditions Preventing Policy Reversal .......................... 34 Conditions for Further Reforms .............................. 36 Monitoring and Reporting .................................... 38  X jj; - Pooperation with the IDB .................. 39 Co-Financing .............. 39 Technical Assistance ...................................... 39 Procurement, Disbursement, Audit, and Administration ............... .. 40 Letter of Development Policy ................................. 42 Conditions for Board Presentation .............................. 42 Conditions of Loan Signing and Effectiveness ....................... 43 B. Benefits .................................. 43 VI. RECOMMENDATION ................ 44 Annex I Economic Indicators. 45 Annex 2 SAL Policy Matrix .56 Annex 3 Supplementary Loan Data Sheet .70 Annex 4 Letter ef Development Policy .76 Annex 5 ListofProjectDocuments .92 Annex 6 Status of Bank Group Operations in Peru ... 93 Annex 7 Technical Assistance Program for Structural Adjustment .95 Annex 8 Privatization Strategy by Sector .98 TABLES AND FIGURES Texct Table Table I Annual Percentage Rate of Inflation Over the Last Twelve Months. 6 Table 2 Central Administration Tax Revenues as a Percentage of GDP. 9 Table 3 Peru's Tax Revenue Ratios Compared to a Sample of Countries .10 Table 4 Comparing VAT Revenues and Rates in Latin America .11 Table 5 Fiscal Accounts (Percentage of GDP) ................................ 16 Table 6 Peru: External Financing Requirements and Possible Sources of Financing, 1991 and 1992 (US$ millions) .22 Text Figures Figure I Real Stocks of Ml and M2 (Millions of 1979 Soles). 7 Figure 2 Central Government Primary Deficit (Billions of 1990 US dollars). 9 Agpedix Tables Table 1.1 Peru: Sumnmary Balance of Payments: Current Account Excluding Interest Payments on Public MLT Debt (USS Millions) ..... ......... 45 Table 1.2 Peru: Summary Balance of Payments: Capital Account and Financing Requirements (US$ Millions) ................. 46  Table 1.3 Peru: External Financing Requirements and Possible Sources of Financing (US$ Millions) ........................................ 47 Table 1.4 Peru: Projections of Key Economic Indicators .......................... 48 Notes to Tables 1.1 to 1.4 ....................................... 50 Table 1.5 Peru: Extenal Outstanding Debt (Stocks in USS Millions as of December 1990) .... . 53 Table 1.6 Peru: Monthly Economic Indicators, July 1990-September 1991 ..... I ........... 54  .-. PERUi STRUCM AL ADJUSTME LOAN L-oan and Program Summary Borower Republic of Peru Exeuing Agy: Ministry of Economy and Finance US$300 million equivalent 1m: Repayable in 20 years, including five years of grace, at the Bank's standard variable interest rate. I,oan Objestives: The proposed loan would support the Government's medium-term program of macroeconomic stabilization and broad-based structural reforms. Loan.Descrintion: The loan would recognize the major structural reform measures taken between August 1990 and December 1991, in macroeconomic policy, the fiscal sector, the social sector, privatization, agriculture, labor, and social security. The conditions in these abovementioned areas include maintenance of current reforms and measures for further reform, and are set out in Appendix A of the Letter of Development Policy (Annex 4). Bewnefhs: Stabilization is necessary for the success of the structural reforms currently being implemented. Policies supported by this loan will reduce inflation to low levels, setting the framework for renewed growth. Ihe revamping of fiscal administration and fiscal reforms should increase revenues and make the fiscal adjustment sustainable. 'he trade reform should mobilize resources toward Peru's competitive advantage and lead to an outward-oriented, and thus sustainable, growth. Labor market reforms will improve the flow of labor inputs among sectors to adapt to changes in relative prices caused by trade and fiscal reforms. Interest rates will continue to be set freely, thus improving resource allocation and monetization. Land reformn has been extensive, strengthening property rights, crucial for agricultural development. Privatization will create a larger and more efficient private sector, and privatization of the social security system would be a new source for long-term financing. The poor will gain in the long-rn from the liberalization of the labor market, a wider distribution of employment opportunities, and the potential benefit from agricultural reforms to use land as collateral, and improved registration and titling of land. To protect the poor, in the short-run, the Government is striving to mobilize external resources for priority projects in basic social services. The Government will develop a  -vi- national nutrition policy with a view to improving the eost-eveness, nutritional impact and targeting of food assistance programs. The recently established social compensation fund (FONCODES) wIll channel financing (both domestic and external) to small, labor-intensive projects for the rehabilitation of the social and economic infrastructure, which benefit the poor. The four risks to Peru's stabilization program are that: (a) the fiscal situation would remain precarious; (b) a continuing dollarization process would push up money velocity and fuel inflation; (c) market perptions of the continuing overvaluatlon of the domestic currency would increase political pressures on government officials to take unwanted steps such as re-introducing capital cotrols or making 'excessive' (inflationary) purchases of foreign exchange; and (d) an increase in terroist activities would undermine business confidence and support for the Government. Estimated Disbursement: The loan would be disbursed in one tranche. Upon fulfillment of effectiveness conditions, the Bank will make the loan effective and release the tranche.  REPORT AND RECOMMENDATION OF THE PENE OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXCUTIVE DIRECTORS ON A PROPOSED SIRUCTURAL ADJUSTMENT LOAN TO THE REPUBLIC OF PERU I. I submit the following report and recommendation on a proposed loan to the Republic of Peru for the equivalent of US$300 million. Ihe proposed loan would support the Government's medium-term program of macroeconomic stabilization and broad-based structural reforms. The loan would be repayable over 20 years on a fixed amortization schedule, including five years of grace, at the Bank's standard variable interest rate and charges. I. THE ILAN, THE WORKOU PGRAM, AND COUN =Al= A. he Loan 2. This Report proposes a US$300 million adjustment loan for a structural adjustment program. The immediate objective of the loan is to support Peru's macroecor.omic stabilization program and broad-based structural reforms, which represent one of the most far-reaching and rapid structural refc-ns carried out in the developing world. The broader objective of this loan, as well as those of the previous trade policy reform loan and the following financial sector reform and privatization adjust.ment loans, is to allow the Bank to participate in an internationally supported approach to reintegrate Peru into the international financial community. This approach would provide Peru the opportunity to rehabilitate an economy much damaged by the actions of past governments and would enable it to resume a normal relationship with the Bank and other donors. B. The Bank's Approach to a Country with mtrated A, s 3. On May 2, 1991, the Board approved a new approach to support debt workout programs in countries with protracted arrears (Additional Suptrt for Workout Proem in Countries with Protracted Arfars. R91-70, April 11, 1991). It allows strong-performing countries with large arrears to accumulate "contingent disbursemens" during a pre-clearance "performance period." Loans are presented to the Bank's Board during the performance period and, once the arrears to the Bank are cleared at the end of the performance period, loans are signed and made effective and all accumulated disbursements released. The new approach is analogous to the IMF's Rights Accumulation Program (RAP), and requires the following four conditions to be met: (a) the existence of an agreed financing plan; (b) an IMP stabilization program; (c) a Bank-supported adjustment program; and (d) continued current debt service payments to the Bank. C. The Bank's Approach in Peru 4. In order to assist Peru during the performance period, expected to last through December 1992, the Bank developed a country assistance strategy which conforms with this new approach. On July 30, 1991, the Board approved the application to Peru of the new approach (Peru: The Bank's Approach to a Country