International Monetary Fund Executive Board

Statement on behalf of the Southern Cone Chair

January 2007

1. Over the last years Peru has posted solid growth; responsible fiscal and monetary policies have been implemented; external and financial  vulnerabilities have diminished considerably; and progress has been made in structural reform. Nevertheless, the authorities that took office in July 2006 are not complacent and recognize the need to lay firmer foundations for  sustained medium-term growth and, crucially, reduce the still high poverty level by ensuring a more equitable distribution of the benefits of growth. They intend to make a decisive contribution to meeting these challenges by putting in place a set of wide-ranging policies aimed at locking-in  macroeconomic stability and deepening the reform process —mainly  enhancing the country’s physical and human capital, promoting  employment, improving the business climate, and further limiting financial vulnerabilities.

2. From past experience with Fund-supported arrangements, the authorities acknowledge the value of close collaboration with the Fund in resolving the problems facing the nation. In particular, they attach great importance to the sound advice provided by the staff, to whom they explicitly express their recognition, and believe that the greater credibility associated with Fund  endorsement will facilitate their goal of achieving investment grade status. In view of these considerations, they request a Stand-By Arrangement (SBA), covering the period through end-February 2009, in support of their policy agenda. The government intends to treat the requested arrangement as precautionary, keeping the Fund’s financial exposure in Peru at a minimum  —currently only 2.1 percent of quota.

Macroeconomic Policies

3. The Peruvian economy continues to show robust growth supported by a sound macroeconomic framework and a favorable international  environment. Preliminary estimates suggest that GDP growth in 2006 was  7.5 percent, well above initial expectations. The economy experiences persistent growth —its longest expansion on record. This growth was  achieved despite electoral uncertainties and after four years of annual  expansion of more than 5 percent. In 2006, private investment and  consumption were the main engines of growth, reflecting high market  confidence. Export growth —roughly 35 percent in dollar terms— was underpinned by favorable commodity prices and by a continuous expansion in the volume of industrial exports, mainly textiles and agricultural goods.  The external position has improved as well: at end-2006 the level of reserves reached 3.8 times short-term debt (residual basis) and around 100 percent of foreign currencydenominated deposits in the banking system. Meanwhile, sovereign spreads hit historic lows. Although the outlook for 2007 is one of soft deceleration, in line with expectations of a coolingdown of the global economy, macroeconomic policies and structural reforms will aim at sustaining growth and stability.

4. On the fiscal front:

  • The authorities will further strengthen debt sustainability, with public debt falling to almost 30 percent of GDP by end-2008 —from around 32 percent at end-2006 and 37½ percent at end-2005. They will continue to increase the share of local currency instruments to reduce exchange rate risks and extend the maturity of new placements abroad.
  • The overall public sector balance is foreseen to shift from a surplus of 1.6 percent of GDP in 2006, the highest in decades, to deficits not to exceed 0.8 percent in 2007 and 0.7 percent in 2008, due significantly to urgent increases in social and infrastructure spending. In particular, public investment would rise from around 3 percent of GDP currently to 4.5 percent over the next five years. To reinforce this strategy, the National System of Public Investment (SNIP), which has been instrumental in ensuring the quality of public investment, will be decentralized.
  • To remain consistent with fiscal discipline, the authorities will strive to create fiscal space by further improving tax collections and enhancing expenditure restraint, quality, and focus. In this regard, recently the authorities were granted temporary fiscal powers, which will facilitate their plans to enhance the efficiency and transparency of the tax structure and end several tax exemptions. Also, performance budgeting will be phased in; at least half of any excess central government revenue over programmed amounts will be saved; sanctions for noncompliance will be enforced under the Fiscal Responsibility and Transparency Law (FRTL); and the operations of subnational governments will be closely monitored.

5. The inflation targeting scheme adopted in 2002 aims at a 2.5 percent medium-term inflation target within a ±1 percent range, in the context of a floating exchange rate regime. Interventions in the foreign exchange market are limited to those needed to confront excessive exchange rate volatility or abrupt fluctuations, without an explicit or implicit commitment to any given exchange rate level (the domestic currency has appreciated around 1.5 percent in the last three months). In 2006, to improve its accountability, the central bank moved from a year-end basis to a rolling twelve-month inflation target, which was met until November. Towards the end of the year, supply shocks with a one-off effect brought twelve-month inflation below the target range, to 1.14 percent. Given the temporary nature of these shocks, inflation would start to converge towards the target range by mid-2007, and there is no reason so far to loosen the monetary stance. It should also be noted that core inflation, which provides a better picture of the true inflation trend, was heading towards the lower limit of the target range as of year-end, although it has been gradually increasing since December 2005.

Poverty Reduction and Structural Reform

6. The authorities aim at promoting rapid poverty alleviation and structural transformation to achieve high, sustainable, and balanced growth. To better target social expenditure, the Interministerial Committee for Social Affairs (CIAS) will present in March 2007 a plan for consolidating the existing social programs and optimizing their functioning (a performance criterion under  the program). Also, the significant resources generated through austerity measures and voluntary private sector contributions will be applied to programs aimed at resolving the most pressing social needs —mainly child malnutrition, access to clean water, and housing— and the cash transfer program launched in 2005 will be expanded. Critically, social recognition of the role of improved education standards in empowering the population is reflected in the strong support given by the National Accord —a multiparty assembly for the discussion of matters of national interest— to the government’s initiative to evaluate teachers and improve their skills through continuous training.

7. Peru’s infrastructure deficit continues to be an important bottleneck for industrial growth and the development of the rural economy. To help resolve it, the authorities plan to engage more actively in Public-Private Partnerships (PPPs). During 2007, the government envisages to initiate PPPs for a total of US$3 billion, especially in the areas of ports, highways, and sanitation. To  keep these operations in line with transparency and international best practice, a framework law —to be submitted to Congress by June 2007— will propose guidelines for project selection and approval, reporting requirements, conflict resolution, and adherence to accounting standards. Importantly, to ensure fiscal sustainability, a limit has been established on the net present value of future payments, firm and contingent, associated with PPPs.

8. The authorities are placing heavy emphasis on private sector growth to ensure sustained formal employment generation. In order to improve the business environment, they will press ahead with administrative  simplification for new businesses and exporters and, after a successful pilot program in the capital, will establish commercial courts in several other cities to expedite the resolution of business disputes. The fiscal regime will continue to be consistent with attracting investment, notably into the important mining and hydrocarbon sectors. In this regard, the authorities will not introduce measures that would result in the unilateral cancellation or modification of tax stability contracts. At the same time, they will aim at gradually reducing the persistently high number of informal jobs and  developing a more comprehensive social protection net.

9. The authorities are engaged in pursuing regional and bilateral free-trade agreements (FTAs). In particular, an FTA with the U.S. —currently pending ratification by the U.S. Congress— would make permanent the special access to the U.S. market currently enjoyed under the Andean Trade Promotion and Drug Eradication Act (ATPDEA). The FTA with the U.S. is expected to further encourage export growth and diversification, as well as accelerate critical  reforms that will attract investment into the country.

10. Financial system indicators remain sound as a result of a consistent strengthening of financial supervision and regulation. Going forward:

  • Measures to accelerate de-dollarization —including mortgage lending in domestic currency under the state-sponsored housing program— will be complemented by strengthened norms on loan classification, provisioning,  and capital requirements to face foreign currency credit risks.
  • Regarding the payments system, modified legislation will be introduced to entrust its surveillance and regulation to the central bank, and to ensure the latter’s seniority as a lender of last resort among creditors.
  • As part of the government’s strategy to promote small and medium-size enterprises, public banks will operate as second tier institutions. To facilitate access to the financial system in remote areas, Banco de la Nación —the government’s financial agent— will enter into infrastructure agreements with selected financial institutions. Also, it will continue to comply with a 25 percent annual growth limit on its consumer lending operations.
  • The authorities will implement additional measures aimed at improving the financial soundness and corporate governance of microfinance institutions and, recognizing the importance of private pension funds in the economy, they will seek to enhance their operating environment, including by  gradually raising the limits on their investments abroad.

11. Finally, the authorities believe that the policies described in their Memorandum of Economic and Financial Policies (MEFP) are adequate for meeting the objectives of the program, but stand ready to take any additional measures that may be needed for this purpose. They commit to maintaining the usual close and proactive dialogue with the Fund.



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