Document of The World Bank For Official Use Only Report No. 37948-PE INTERNATIONAL BANK FOR RECONSTRUCTIONAND DEVELOPMENT PROGRAM DOCUMENT FOR A PROPOSED FIRST PROGRAMMATIC FISCAL MANAGEMENT AND COMPETITIVENESS DEVELOPMENT POLICY LOAN IN THE AMOUNT OF US$200 MILLION FOR THE REPUBLIC OF PERU November 15,2006 Poverty Reduction and Economic Management Bolivia-Ecuador-Peru-Venezuela Country Management Unit Latin America and Caribbean Region This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized
Transcript
Document of The World Bank
For Official Use Only
Report No. 37948-PE
INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT
PROGRAM DOCUMENT
FOR A PROPOSED
FIRST PROGRAMMATIC FISCAL MANAGEMENT AND COMPETITIVENESS DEVELOPMENT POLICY LOAN
IN THE AMOUNT OF US$200 MILLION
FOR
THE REPUBLIC OF PERU
November 15,2006
Poverty Reduction and Economic Management Bolivia-Ecuador-Peru-Venezuela Country Management Unit Latin America and Caribbean Region
This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not otherwise be disclosed without World Bank authorization.
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REPUBLIC OF PERU FISCAL YEAR January 1-December 3 1
APRA ATPDEA BCRF' CAF CPS CEM CFAA CFMS CGR CITES CND CONASEV CONSUCODE CPAR CRECER DCDPL DPL DFlD DNPP EITI ESSALUD EU FMCDPL FONAFE
FONCAM FONCOR FONCOMUN FSL I T A FY GDP GoP IADB IBRD ICT IFC IMF INEI ITF KfW LDF LPTF LRTF M&E MEF MFN MINCETUR MMM M O MSME N I T S NGO
CURRENCY EQUZVALENTS (Exchange Rate Effective: November 14,2006)
Currency Unit = Nuevos Soles 3.22 Nuevos Soles = US$1
WEZGHTS AND MEASURES Metric System
SELECTED ABBREVIATIONS AND ACRONYMS Alianza Popular Revolucionaria Americana (Popular Revolutionary American Alliance) Andean Trade Promotion and Drug Eradication Act Banco Central de Reserva del Peni (Central Reserve Bank o f Peru) Corporacidn Andina de Fomenro (Andean Development Corporation) Country Partnership Strategy Country Economic Memorandum Country Financial Accountability Assessment Country Financial Management Strategy Contraloria General de la Repu'blica (Comptroller General) Centros de Znnovacidn Tecnoldgica pechnological Innovation Centers) Consejo Nacional de Descentralizacidn (National Decentralization Council) Comisi6n Nacional Supervisora de Empresas y Valores (National Stock and Business Supervisory Commission) Consejo Superior de Conrraraciones y Adquisiciones del Esfado (National Procurement Council) Country Procurement Assessment Report Creating Conditions for Economic Revitalization Decentralization and Competitiveness Development Policy Loan Development Policy Loan Department for International Development (United Kingdom) Direcci6n Nacional de Presupuesro Pu'blico (National Office o f Public Budgeting) Extractive Industries Transparency Initiative Znsrituto Peruano de Seguridad Social (Health Social Institute) European Union Fiscal Management and Competitiveness Development Policy Loan Fondo Nacional del Financimienfo de la Acrividad Empresarial del Esfado (National Fund for Financing State-Owned Enterprises) Fondo Nacional de Camisea (National Camisea Fund) Fondo de Compensacidn Regional (Regional Compensation Fund) Fondo de Compensacidn Municipal (Municipal Compensation Fund) Fixed Spread Loan Free Trade Agreement Fiscal Year Gross Domestic Product Government o f Peru Inter- American Development Bank International Bank for Reconstruction and Development Information and Communications Technology International Finance Corporation International Monetary Fund Znstituro Nacional de Esradistica e Znform4tica (National Statistics Institute) Zmpuesto de Transacciones Financieras (Financial Transactions Tax) German Development Bank Ley de Decentralizacidn Fiscal (Fiscal Decentralization Law) Ley de Prudencia y Transparencia Fiscal (Law of Fiscal Prudence and Transparency Law) Ley de Responsabilidad y Transparencia Fiscal (Law o f Fiscal Responsibility and Transparency) Monitoring and Evaluation Ministry o f Economy and Finance Most Favored Nation Minisrerio de Comercio Exreriory Turismo (Ministry o f Trade and Tourism) Marco Marcroeconomico Multianual (Multiannual Macroeconomic Framework) Middle Office Micro, Small and Medium Enterprises Non-financial Public Sector Non-governmental Organization
OECD PCM PER PRODES PRODUCE PFM RENIEC ROSC RUC SBS SEACE SIAF SNIP SSEGP SUNARP SUNAT TAL TSA UCPS UPP USAID
Organization for Economic Cooperation and Development Presidencia del Consejo de Ministros (Office of the Prime Minister) Public Expenditure Review Program ProDecentralizacidn (Pro-Decentralization Program) Ministerio de la Produccidn (Ministry of Production) Public Financial Management Registro Nacional de Zdentidad y Estado Civil (National Identity and Marriage Registry) Report on Observance of Standards and Codes Registro l h i c o de Contribuyentes (Single Taxpayer Registry) Superintendencia de Banca y Seguros (Bank and Insurance Superintendent) Sistema Electrdnico de Adquisiciones y Contrataciones del Estado (Electronic System for State Parchases and Contracting) Sistema Integrado de Administracidn Financiera (Integrated Financial Management System) Sistema Nacional de lnversidn Pliblica (National Public Investment System) Sistema de Seguirniento y Evaluacidn del Gusto Pu’blico (Public Expenditure Monitoring and Evaluation System) Sistema Nacional de Registros Pliblicos (National System for Public Registry) Superintendencia Nacional de Administracidn Tributaria (Government Tax Agency) Technical Assistance Loan Treasury Single Account Unidad de Coordinaci6n de F’ri?stamos Sectorials (Sectoral Loans Coordination Unit) Unidn por el P e d (Union for Peru) United States Agency for International Development
Country Director: Marcelo Giugale Sector Director, PREM: Ernesto May Sector Manager: Mauricio Carrizosa Task Team Leader: Rossana Polastri
ACKNOWLEDGEMENTS
The World Bank Group greatly appreciates the close collaboration with Government o f Peru in the preparation o f this Development Policy Loan (DPL). The DPL team would l ike to express i ts gratitude to the entire country team for their contributions.
This DPL was prepared by an IBRD team composed o f Messrs/Mmes. Rossana Polastri, Fernando Rojas, Chris Humphrey, Henry Forero, Fernando Hernindez-Casquet, Antonio Velandia, Hela Cheikrouhou, Miguel Navarro- Martin, Luis Schwarz, Jeffrey Rinne, Alejandro Alcald Gerez, Jose Luis Guasch, Eduardo Urdapilleta, Linette Lecussan and Inks Thorne. Valuable assistance was provided Keith Mackay, Lisa Bhansali, Rosmary Cornejo, Juan Manuel Quesada; by staff from KfW including Peter Weinert and Markus Riihling; and from the IFC Technical Assistance Facility staff including Luke Haggarty, Javier Aguilar, and Giinther Schulz-Heiss.
The team was lead b y Rossana Polas.tri (LCSPE, Task Team leader) and Fernando Rojas (LCSPS, Co-Task Team leader) and worked under the general guidance o f Messrs. Marcelo Giugale (Director, LCC6C), Vicente Fretes- Cibils (Lead Economist and Sector Leader, LCC6C), Ernesto May (Director, LCSPR) and Mauricio Carrizosa (Sector Manager, LCSPE). Special thanks to Todd Crawford (LCOQE), Keith Mackay (IEGKE) for valuable comments, as well as LEGLA and LOAGI.
PERU
DEVELOPMENT POLICY LOAN FIRST PROGRAMMATIC FISCAL MANAGEMENT AND COMPETITIVENESS
TABLE OF CONTENTS Loan and Program Summary ..................................................................................................... i
I . Introduction ....................................................................................................................... 1
I1 . Country Context ................................................................................................................ 1 A . Political Developments ............................................................................................... 1 B . Economic Developments ............................................................................................ 2
The Government Program ................................................................................................. 6
B . Competitiveness ........................................................................................................ 19
I V . The Proposed Operation ................................................................................................. 26
B . Lessons Learned ........................................................................................................ 27 C . Design of DPL and Analytic Underpinnings ............................................................ 27 D . Programmatic Framework ......................................................................................... 28
C . Macroeconomic Outlook and Debt Sustainability ...................................................... 4
A . Efficiency and Quality o f Fiscal Management ........................................................... 7 111 .
A . Link to Country Partnership Strategy and Other Bank Operations .......................... 26
E . Co-Financing Arrangements, Institutional Coordination and Partnerships .............. 30
Operation Implementation .............................................................................................. 32 A . Poverty and Social Impact ....................................................................................... 32 B . Implementation, Monitoring and Evaluation ........................................................... 33 C . Fiduciary Arrangements ........................................................................................... 33 D . Disbursement and Audits ......................................................................................... 35 E . Environmental, Forest and Natural Resource Aspects ............................................. 36 F . Risks and Risk Mitigation ........................................................................................ 36
V .
Annexes Annex 1 Letter of Development Pol icy .......................................................................... 39 Annex 2
Annex 3 Annex 4 Annex 5 Annex 6
Bank-Supported Fiscal Management and Competitiveness Program Matr ix ................................................................................................ 52 Peru-IMF Relations .......................................................................................... 58 Peru At-A-Glance ............................................................................................ 59 Peru K e y Economic Indicators ........................................................................ 62 Debt Sustainability Analysis ............................................................................ 64
Tables Table 1 Table 2 Table A1 Table A2 Table A3
Key Economic Indicators ................................................................................... 2 Peru Financing Requirements and Sources 2003-2009 ..................................... 5 Peru Public Debt (US$ millions) ..................................................................... 65 Peru: Debt Determinants (% o f GDP) ............................................................. 67 Required Primary Balance 26% of GDP Public Debt in 201 1 ........................ 67
Table A4 Table A5
Required Primary Balance 20% o f GDP Public Debt in 201 1 ........................ 67 Debt Dynamics ................................................................................................. 68
Figures Figure 1 Central Government Tax Revenue (% o f GDP) ................................................ 3 Figure 2 Urban Employment in Firms of 10 or More Employees (monthly data) ........... 4
Boxes Box 1 Box 2
Natural Resource Income Transfers ................................................................. 14 IFC Technical Assistance to Baiios de Inca Municipality on the Mining Canon ...... 15
Map of Peru (IBRD #33465) ................................................................................... inside cover
REPUBLIC OF PERU FIRST PROGRAMMATIC FISCAL MANAGEMENT AND COMPETITIVENESS
DEVELOPMENT POLICY LOAN
LOAN AND PROGRAM SUMMARY
~~~
Borrower Implementing Agency Amount Terms
Tranching
Description
Benefits
Risks
ReDublic o f Peru Ministry o f Economy and Finance US$200 mil l ion Commitment-linked Fixed Spread Loan (FSL) in US$, with; repayment period o f 11.5 years, including 6.5 years o f grace and customized maturity profile; at six-month LIBOR plus fixed spread; with a front-end fee o f 1 percent on principal amount; commitment charge o f three-fourths o f one percent (3/4 of 1 percent) per annum on the undisbursed loan balances, less waivers as approved. The Borrower requested to maintain al l the embedded conversion options that FSLs currently offer. The loan i s expected to be disbursed in a single tranche o f U S $200 million. The proposed DPL i s the first in a series of possibly three or four loans supporting the GoP’s reform plan to improve the functioning o f Peru’s public sector institutions and business environment. The loan focuses on two broad areas o f policy reform:
Competitiveness Efficiency and Quality o f Fiscal Management
In each o f these areas, the GoP has begun to implement a detailed series o f important policy measures as part o f an integrated strategy to progressively reform fiscal administration, public spending and the business climate in ways that w i l l lead to specific results that have a broad impact on growth and w i l l be difficult to reverse. In the short term, the DPL w i l l have the twin benefits o f
Strengthening the GoP’s fiscal position with timely budget financing at reasonable terms; and Supporting the GoP’s public sector and competitiveness reform agenda.
In the medium and long term, reforms supported by the proposed loan series w i l l solidify Peru’s overall fiscal framework, improve the efficiency and quality o f public sector spending, and reduce bottlenecks to faster economic growth. This w i l l in turn result in budgetary savings that can be directed toward priority poverty programs; more and higher quality public services for the citizenry; and more sustainable and broad-based growth. Political Risks include a slowing o f reform momentum, especially if the November local elections are unfavorable to the administration and the divided Congress becomes less cooperative. Reforms to promote results-based management
Project ID Number
could generate opposition from politically active interest groups, such as public employee unions. President Garcia has launched a high-profile series o f actions for his first 180 days in government as a way to quickly demonstrate his determination to move forward on reform and mitigate political r isks. Government officials are re-engaging with the Acuerdo Nacional, a group o f political parties, civi l society and community groups, academics and NGOs who came together in 2002 to help generate a consensus on a broad national agenda.
Social risks relate principally to resource extractive industries, which have been accused by community residents near some mines and o i l wells o f polluting, leading to protests, particularly in remote areas with limited state presence. To address these problems, the new administration has for the f r s t time created a Conflicts Unit in the Presidential Council o f Ministers for negotiating conflicts as they arise which, together with the Defensoriu del Pueblo (Human Rights Ombudsman), w i l l create a space for dialogue with disaffected groups. A f i r s t result has been the peaceful negotiations with the Achuar indigenous group in Loreto in October 2006, which has protested pollution and lack o f social benefit from o i l production in their region. The work o f IFC’s Technical Assistance Facility on improving mining canon use around the Yanacocha gold mine has also been successful in illustrating how the industry can benefit local communities.
Economic risks include Peru’s vulnerability to a drop in the international commodity prices, in particular minerals, which form a large share o f exports. A slow-down in the U.S. economy or the failure for the U.S. Congress to ratify the Peru FTA could also impact exports. Political pressures could lead to a deterioration o f fiscal accounts should the GoP attempt to placate opposition with increased public spending. The high level o f dollarization o f the banking system could become a problem in the event o f currency devaluation. These risks are mitigated by growing non-traditional exports as well as a broadening o f export markets through trade agreements. The Government’s disciplined fiscal performance in the past several years has greatly reduced country risk and lowered interest rate spreads, meaning the cost o f rising international interest rates w i l l be lower than previously. To reduce vulnerabilities associated with dollarization, the authorities have tightened prudential regulations on foreign exchange credit r i sks and are promoting mortgage lending in domestic currency.
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I. Introduction
1. Peru’s evolution over the past several years and the country’s current political and economic context make clear that this middle-income country i s facing a unique opportunity to take a significant leap in its development. Following free and fair elections and an orderly transition between government administrations, coupled with a solid track record o f economic growth and macroeconomic stability, Peru i s putting behind i t s years o f instability and looking optimistically toward the future. Nevertheless, significant challenges remain. Hal f o f the population s t i l l lives in conditions o f poverty, the private sector faces numerous obstacles to greater economic activity, and many government institutions are riddled with inefficiencies and poor management. The new administration i s fully aware of these challenges, and has designed a comprehensive development plan to address them. During the past five years, the Government o f Peru (GoP) focused successfully on disciplined fiscal and monetary policies to solidify the economy. Now the challenge i s to move beyond the “bottom line” to the second generation o f reforms: strengthening fiscal management, public expenditure quality and competitiveness to achieve accelerated and broader-based economic growth. These goals form the core of the World Bank’s support to Peru in this proposed Fiscal Management and Competitiveness Development Policy Loan (FMCDPL) programmatic series.
2. In keeping with the relationship with Peru outlined in the Country Partnership Strategy (CPS) for the coming five years, this programmatic series was developed at the expressed request of the new administration and tailored to meet Peru’s specific needs. The GoP has a strong vision for how i t wishes to move forward, building on recent economic successes to achieve higher growth and better social outcomes; constructing a new contract between the government and citizens based on effective social development; and modernizing the institutions of the state. This FMCDPL, along with a series of social sector DPLs also proposed in the CSP, was designed in close partnership with GoP officials and in l ine with their vision. In keeping with the CPS’s strategy, the FMCDPL series builds in a degree of flexibility for the future operations to accommodate the evolving priorities and needs of the country.
11. Country Context
A. Political Developments
3. Peru i s strengthening and consolidating its democratic political system. Following the Fujimori regime and a brief transitional government, the administration o f former President Toledo governed a country at peace and with economic growth during 2001-2006. Despite many political difficulties and a generally low public approval rating, Toledo faced no major threats to his democratic authority, and was able to not only complete his mandate in office but also to muster enough support in Congress to undertake several reforms and to maintain disciplined control over economic policy. B y the end of Toledo’s term, i t appeared that a majority of Peruvians had come to see the benefits of a stable, democratic political system.
4. President Alan Garcia won the second round of presidential elections in June 2006 by 53 percent against 47 percent for Ollanta Humala, a former military officer. Humala failed to convince a majority o f voters, who preferred the platform o f Garcia, despite the
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memories o f his difficult first presidential term in the late 1980s. At the same time, the narrowness o f Garcia’s victory and the success o f Humala in Peru’s poorer regions--especially the southern Andes-points to dissatisfaction o f many Peruvians with the thus-far l imited improvements for the poor after recent years o f economic growth.
5. President Garcia faces a fragmented Congress, which will require building coalitions to pass legislation. H i s Alianza Popular Revolucionaria Americana (APRA) party has 37 seats, compared to 44 seats for Humala’s Unibn por el P e d (UPP) and 39 seats divided among five other parties. UPP has said i t w i l l strongly defend their candidate’s platform, meaning it wi l l l ikely form the core o f opposition to Garcia’s agenda, requiring APRA to seek coalitions wi th the other parties. Garcia’s cabinet, led by Prime Minister Jorge del Castillo and Finance Minister Luis Carranza, is a m i x o f APRA members and well-respected technocrats, wi th a record six women in ministerial posts. The latest po l l numbers show Garcia’s public support between 60 and 70 percent. The f i rs t major test for the new government wi l l be the November 19 elections for 26 regional presidents and all 1,832 municipal governments.
B. Economic Developments
6. In the past four years, Peru has had one of the best-performing economies in Latin America, surpassed only by Venezuela-an o i l exporting country-and Argentina-which i s coming out o f a deep recession. Based on sound macroeconomic policies and strong demand for Peruvian commodity exports, GDP grew 5 percent on average in the four years since 2002, and reached 6.4 percent in 2005. This growth has been all the more impressive considering the external shock o f the region in the early 2000s as well as the political instability that prevailed during the Toledo administration.
External Current AccounVGDP -2.9 -2.3 -2.0 -1.6 0.0 1.4 Source: Banco Central Reserva de Peru’ (BCRP), MEF (Revised Marco Macroecondmico Multianual2007-2
32.8
1.1 19).
7. Growth has been led by an upswing in exports, which rose 26 percent annually on average in 2002-2005, and the external current account posted a surplus of 1.4 percent of GDP in 2005. This increase was driven in good measure by the boom in commodity prices, particularly for mineral exports, as wel l as the coming on line o f new mining and hydrocarbon projects. Although mining production accounts for over half of al l Peruvian exports, non- traditional exports have grown rapidly, 20 percent on average annually since 2000, particularly specialized agricultural products such as asparagus, grapes and avocados. Other export sectors such as fisheries and textiles have also posted significant gains in recent years. Private investment, encouraged by the growing economy and sound policies, has also helped fuel growth, rising nearly 14 percent in real terms during 2005.
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8. Fiscal and monetary policy has been well-managed during recent years, with steady declines in public sector deficits and low, stable inflation rates. The combined public sector deficit has come down every year since 2001, falling from 2.5 percent o f GDP in 2001 to 0.3 percent o f GDP in 2005, lowering public debt from 46 percent o f GDP in 2001 to 38 percent o f GDP in 2005 (of which 28 percent was foreign and 10 percent domestic), and down to 32 percent of GDP by October 2006. These gains came from increases in revenue from mining taxes, as well as from cuts in public investment spending. Tax collection for the combined public sector w i l l reach 15 percent of GDP in 2006, low by international standards and below the 18 percent of GDP collected in the mid-1990s. This indicates that improvements in broadening the tax base and increasing collections remain needed. Year-end inflation for 2005 was 1.5 percent, at the low end of the target range o f 1.5-3.5 percent. Fiscal consolidation has continued in 2006, with the non-financial public sector expected to report a surplus o f 0.6-0.8 percent of GDP, only the second budget surplus in 40 years. Tax revenue i s estimated to reach 15 percent of GDP in 2006 (Figure l), pushed particularly by increases in income tax.
Figure 1. Central Government Tax Revenue (% of GDP)
14.9 3 K l6 I I"
a 14 0 (3 ae 13
12
11
10 2000 2001 2002 2003 2004 2005 2006
Source: BCRP and projections from MMM 2007-2009 MEF.
9. While Peru's macroeconomic performance has been very good in the past few years, poverty remains high. The national poverty rate dropped only two percentage points between 2002 and 2004, and half the population (51.6 percent) lives in conditions o f poverty. However, since 2003 per capita incomes o f the poor and the rates o f poverty and extreme poverty have started showing improvements, especially in rural areas, driven by broadening economic growth. Average incomes o f the poorest tenth of the population rose 33 percent between 2001 and 2004, while the incomes o f the wealthiest tenth of the population remained level over the same period. Growth has had the most impact on extreme poverty rates, especially in rural areas. Extreme poverty declined from 24 percent to 19 percent between 2001 and 2004 nationally, but rural extreme poverty fe l l from 50 percent to 40 percent over the period, while urban extreme poverty declined from 10 percent to 8 percent. Although no poverty numbers are available after 2004, recent improvements in employment in urban areas indicate that the growth of 2005 and this year (Figure 2) i s having further impacts on poverty. Income inequality also remains relatively high, with the Gini coefficient improving slightly from 0.52 to 0.50 during the same period.
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Figure 2. Urban Employment in Firms of 10 or M o r e Employees (monthly data)
I 8.0 1 6.0
4.0
- 8 2.0
0.0
Y
-2.0
lSource: Labor Mnistry.
C. Macroeconomic Outlook and Debt Sustainability
10. Economic activity for 2006 and 2007 i s expected to remain strong. GDP growth i s projected at 6.6 percent for this year and 5 percent for 2007-09. The projected deceleration o f economic growth for 2007 i s due in part to expected global economic slowdown and deteriorating terms o f trade. Nevertheless, i t i s expected that internal demand and tax revenues w i l l remain strong, supported by large investment projects planned in the mining and gas sectors and by the “public investment shock” program. Approval o f the recently-signed free trade agreement (FTA)’ wi th the U S may improve growth even more, stimulating greater trade and investment. Exports could be hampered if the U.S. Congress fails to approve the signed FTA with Peru before the end o f 2006, when the ATPDEA trade benefits granted by the U.S. to the Andean Countries expire. However, the new administration i s committed to continue implementing a trade policy conducive to global integration. The GoP i s already working in establishing free trade agreements with Chile, the European Union, Mexico, Singapore, India, China, Canada and Central America; as well as in expanding the current agreement wi th Brazil. At the same time, the GoP has developed an agenda o f competitiveness and a National Export Strategic Plan. The goal i s to increase non-traditional exports f rom 25 percent to 40 percent o f total exports by the end o f the current administration.
11. Based on sound fiscal policy and proactive debt management, Peru has reduced fiscal and debt vulnerabilities, and is expected to continue improving in coming years. The country’s debt service profile and i t s currency and interest r i sks exposures have improved significantly as a result o f Peru’s ample access to various funding sources, including multilateral banks, U.S. and European markets, and local markets. Re-profiling operations and pre-payments
’ The agreement, formally known as the US-Peru Trade Promotion Agreement, was signed by the two governments in April 2006 and was ratified by the Peruvian Congress on June 28,2006. For more details see http://www.ustr.govrrade_Agreements/Bilatera~eru-TP~Section-Index.html
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reduced public sector borrowing requirements by 2-3 percent in the medium-term, and provided amortization relief on average o f US$480 mi l l ion annually between 2006 and 2010. These transactions also improved the structure o f public debt, wi th domestic issues increasing f rom 15 percent o f total debt in 2004 to 23 percent in 2006, and local currency issues up f rom 10 percent o f total in 2004 to 17 percent in 2006. Assuming continued primary fiscal surpluses, favorable external conditions and a stable macro-economic environment, public debt i s projected to remain stable at i t s current level o f 32 percent o f GDP and possibly decline to as l o w as 26 percent o f GDP by 2011 (see Annex 6 for details on Peru’s debt sustainability, and Annex 5 for macroeconomic projections). Whi le this sustained reduction of public debt wi l l help the GoP achieve i t s goal o f investment grade status, dollarization in the financial system and i ts external debt structure should also be improved.
Table 2. Peru Financinp Reauirements and Sources. 2003-2009 2003 2004 2005 2006e 2007e 2008e 2009e
Memo item G D P growth Government Balance % of G D P - 1.7 - 1.1 -0.3 0.6 - 0.8 - 0.6 0.01
Source: BCRP, INEI and MEF projections.
3.9 5.2 6.4 6.6 5.5 5.0 5.0
12. Consolidation of Peru’s medium term fiscal stance relies on external financing. Under the assumption o f compliance with fiscal deficit targets and growth o f an average o f 5.5 percent during the period 2006-09, Peru’s financing needs are approximately US$8.6 billion. Projected external sources o f financing represent 55 percent (US$4.7 billion) o f total needs, o f which US$1.8 bi l l ion i s expected to be budget support. Peru’s debt management strategy under the revised Murco Mucroecondrnico Multianuul (MMM) and the recently published debt management strategy aims at minimizing the cost o f new borrowing, mitigating refinancing risk, increasing the share of domestic debt in soles, lengthening the maturities o f fixed-rate debt, and continuing to develop the market for international sovereign bonds. The medium-term plan i s to reduce the ratio o f public debt to 26 percent o f GDP at the end o f 2011, which coincides with Bank projections, and to reduce foreign currency participation to 69 percent (from 74 percent in 2005). A summary o f Peru’s net financing requirement flows are as shown in Table 2.
13. The recent 26-month Stand-By Arrangement with the IMF expired in August 2006 and the IMF i s currently negotiating a new arrangement covering the 2007-08 period. The
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IMF Executive Board recently completed the fourth and fifth reviews under Peru’s 26-month Stand-By Arrangement, in an amount equivalent to SDR 287 mi l l ion (about US$424 million), which expired in mid-August 2006. Discussions for the 2006 Article I V Consultation and negotiations for a new Stand-By Arrangement started in October 2006 at the request o f the Peruvian authorities. This arrangement, as with the previous one, i s l ikely to be treated as precautionary. A renewal o f a program with the IMF together with this proposed development policy loan w i l l bolster market confidence at the early stage o f the new government.
111. The Government Program
14. The GoP’s program for 2007-2011 intends to build on the solid macroeconomic framework to generate increased growth and ensure a more equitable distribution of the fruits of growth to poorer segments of the population. T o accomplish this, the GoP program (discussed in more detail in the CPS) aims to balance both human and economic development, and i s conceptually divided into three main areas o f action: accelerating and broadening economic growth; improving social development; and modernizing public sector institutions. The GoP’s priorities are reflected in the 2007 budget, which calls for an increase of 0.5 percentage points o f GDP in public investments, with a particular focus on key obstacles to growth, and with a strong emphasis on poorer regions o f the country. Measures are also underway to encourage private investment, which i s expected to grow by 20 percent in 2006. Key among these measures are finalizing the FTA with the U.S., offering concessions on regional airports, approving a timetable to put infrastructure projects out to bid, and unilaterally lowering tar i f fs on imported capital goods and intermediate inputs.
15. The GoP has made extensive efforts to establish a broad consensus on its policy program with the previous administration, the legislative branch and society at large, a process that the Bank has actively supported. During the transition in government after the elections, high level officials f rom the previous and current administration met together wi th the Bank’s country team to discuss the policy notes collected in Peni: La Oportunidud de Un Pais Diferente-Prbspero, Equitativo y Gobemable, and there was considerable agreement among on the principal areas o f reform needed in the country. The government plan and cabinet, presented by Prime Minister D e l Castillo, was approved in Congress by a large majority on August 24, 2006. At the initiative o f the Prime Minister’s Office, the National Accord (Acuerdo Nacional) has been reactivated as a forum for discussion o f long term objectives agreed among representatives of al l political parties, religious groups, unions and c iv i l society. The National Accord was f i rs t signed in 2002 and has served as the most important vehicle for developing a common vision for the future o f the country. Several working commissions on different sectors, such as health, transportation, and education, are formulating policies wi th input from government officials, specialists in the sector, and c iv i l society representatives.
16. T o achieve faster and more equitable economic growth, the GoP intends, on the one hand, to strengthen the efficiency and quality of fiscal management, and on the other, to improve competitiveness. On the fiscal side, this means continuing to strengthen control o f overall fiscal balances through a more efficient tax system and greater control over spending, and a better management o f public debt. But beyond the quantity, the GoP also w i l l focus on the
6
quality o f public accounts, implementing more rigorous monitoring and evaluation o f spending programs using results-based budgeting techniques and simplifying and rationalizing the tax system to reduce distortions. T o improve competitiveness, the GoP wil l enact policies to support private sector, such as key public investments, export promotion and greater credit to small and medium-sized companies. But just as important-if not more important-the GoP intends to get the public sector out o f the way o f private economic activity, by removing numerous obstacles in administrative procedures.
17. In the view of both the GoP and the Bank, these two areas are mutually reinforcing and, if reforms advance as planned, will offer a significant payoff in terms of economic growth, social development and poverty reduction. Strengthened fiscal management i s a desirable end in itself, to maximize l imited public resources, but i t also supports country competitiveness by generating private sector confidence in overall macroeconomic stability and the ability to undertake long-term investments and planning. As well, greater country competitiveness w i l l improve the fiscal situation by generating increased tax revenues and decreasing the need for government intervention to stimulate economic growth. Together, improvements in these two areas wil l strengthen the ability to achieve the GoP’s ultimate goal: accelerating and broadening economic growth to improve the standard o f living o f al l Peruvians, especially the poor. The fol lowing sections discuss the principal challenges and the administration’s plans in each o f these two areas.
A. Efficiency and Quality of Fiscal Management
18. A central element of the administration’s policy agenda i s to continue policies that strengthen macroeconomic stability and fiscal prudence, while improving the quality of public expenditure. The GoP has set a series o f clear targets related to that objective, which coincide with the outcome objectives o f this proposed loan series. Policy areas to achieve these goals include strengthening fiscal rules, public debt management and tax policy; improving the efficiency o f budgetary accounting; making the transfer system more equitable; and implementing efficient, performance-based budgeting.
Strengthening Fiscal Rules and Debt Policy
19. Fiscal policy has remained prudent in recent years and supported macroeconomic stability, although it has been moderately pro-cyclical. The deficit of the non-financial public sector has declined steadily in the last four years and w i l l record a surplus o f 0.8 percent o f GDP in 2006. The Fiscal Responsibility and Transparency L a w (LRTF), adopted in 2003, aims to guarantee fiscal sustainability using two rules: a deficit ceiling o f 1 percent o f GDP, with the principle o f a zero deficit over the cycle; and a 3 percent annual real growth limit on non- financial public expenditure. During periods o f strong economic growth, the 3 percent real increase in expenditure becomes binding, adding a countercyclical component to fiscal policy.2 However, since 2003 a waiver for the expenditure rule has been extended every year. The non- financial general government primary expenditure in 2005 increased by 8.3 percent in real terms, and by over 6.5 percent in 2006, above the 3 percent limit established in the LRTF. The
* This law also establishes that a deficit o f 2.5 percent o f GDP i s allowed if real GDP growth i s zero, and authorizes the use o f funds from a fiscal stabilization fund when revenues fall b y 0.3 percentage points o f GDP.
7
economy has institutional safeguards designed to ensure fiscal discipline while granting flexibility to manage economic shocks, but if these rules are not complied with, i t undermines fiscal credibility and makes the fiscal situation more vulnerable in the event o f an economic downturn.
20. Legislation to strengthen compliance and monitoring of the macro-fiscal rules at the national level has been approved by the Executive and submitted to Congress. This new legislation w i l l complement existing fiscal responsibility law by establishing sanctions for non- compliance with LRTF provisions. These rules w i l l be monitored by the recently-created Fiscal Policy Coordination Committee, which includes the Minister o f Economy and Finance (MEF), the two deputy MEF ministers, executive director o f the National Fund for Financing State- Owned Enterprises (Fondo Nacional del Financimiento de la Actividad Empresarial del Estado-FONAFE), director o f PetroPeru, and the ESSALUD president. The Committee w i l l define the objectives and fiscal targets included in the MMM, approve the annual fiscal program, review monthly budget execution, and verify the compliance with the LRTF fiscal rules. Committee members are responsible for the compliance o f two rules: (i) that the deficit o f the non-financial public sector deficit does not exceed by 0.1 percent or more of GDP the target established in the MMM; and (ii) that the growth o f non-financial general government expenditure does not exceed by 0.5 percent or more the limit established under the LRTF (3 percent in real terms). Sanctions to Committee members include their immediate removal f rom public office, with a four year prohibition o f participation in public appointments. Granting waivers to compliance wi th the fiscal rules (as was common in the past) are prohibited according to the new law.
21. Monitoring the reporting and compliance of the fiscal rules by sub-national governments has also been strengthened. The new legislation on sanctions establishes that sub-national authorities (governors, mayors, and legislatures) are responsible for complying with the fiscal rules. The L a w o f Fiscal Decentralization (LDF) established that regional and local governments must provide the central government wi th medium-term fiscal projections (including planned external and domestic debt issues), which must be consistent wi th the MMM. Also, sub-national governments must report on their quarterly fiscal performances and describe adjustment actions needed to comply with annual targets. The LDF required that by end-2005 local and regional governments wi l l provide the MEF a fiscal management report, including information on compliance wi th fiscal rules. The MEF has started a proactive pol icy o f providing institutional capacity to sub-national authorities, and has launched a series o f seminars to train local and regional authorities in report preparation. The strategy o f de-concentrating MEF offices to the regions w i l l also strengthen institutional capacity at the local level. MEF estimates that fiscal reports w i l l be submitted by 2008.
22. The administration intends to place more emphasis on public investment and social programs within a context of fiscal discipline. Redirecting public expenditure has been extremely difficult as the budget lacks flexibility. Fiscal rigidity has increased since the mid- 1990s as wages, interest, and transfers have increased to nearly 89 percent o f central government spending by 2005, f rom 78 percent in 1995. The ceiling for public expenditure growth under the LRTF w i l l be modified, wi th the 3 percent increase limit applying only to current expenditure, not investment, allowing for control over wage spending but more space for productive
8
expenditure. To further strengthen planning a multi-year program of public investment and maintenance has been adopted. The 2007 budget proposal recently submitted to Congress targets a deficit of 0.8 percent o f GDP and l i m i t s the growth of current expenditure to 3 percent in real terms. Public investment w i l l rise from 2.7 percent o f GDP in 2005 to 3.9 percent of GDP in 2007.
23. Declining public external debt and prudent debt management have reduced solvency and liquidity vulnerabilities, and led rating agencies to upgrade Peru’s sovereign rating, bringing it closer to investment grade.3 Steady improvement in Peru’s credit ratings has further reduced funding costs, made it easier to lengthen domestic bond maturities and facilitated access to markets and hedging instruments (see Annex 6 for details). Central to the modernization of debt management in Peru are the formulation and implementation o f a government debt management strategy. The strategy i s now contained in a formal document that was made public early in 2006 after being shared with Congress and the Comptroller. Peru i s one the few countries in Latin America that have a formal, published strategy, greatly enhancing the transparency and accountability o f the debt management process and illustrating the substantive progress in public debt management over the last four years. Such progress includes the revision of Credit0 Pliblico ’s organizational structure and division of responsibilities and the reorganization o f the middle office (MO) in 2005. The MO was expanded to strengthen the analytical work leading to the preparation of a borrowing strategy and to help promote debt market development
24. The debt management strategy aims to mitigate refinancing risk, increase the share of domestic debt in soles, lengthen the maturities of fixed-rate debt, and continue to develop the market for international sovereign bonds. Following these guidelines, Peru prepaid US$1.55 billion worth o f Paris Club debt in August 2005, reducing refinancing r i s k significantly for the period 2005-09. Similarly, the share of local currency debt rose from 8 percent to 16 percent in the last three years. An illustration of the GoP’s efforts in this regard i s the debt exchange conducted in 2005 which allowed the exchange of US$262 mill ion worth o f dollar- denominated bonds for bonds in soles (S/. 851 million), including a bond with a 10-year maturity; and an additional US$119 million exchange o f dollar-denominated bonds for inflation- indexed bonds maturing in 2024. There i s a consistent drive to increasing the share o f fixed-rate debt, not only using the new borrowing but also through interest rate swaps on existing debt4. Fixed-rate debt has increased from 47 percent of total debt in 2002 to 59 percent in 2005.
25. With approximately 80 percent of all public debt denominated in foreign currencies, Peru i s vulnerable to exchange rate risk, in particular if commodity prices decline or if the BCRP implements a monetary policy more oriented towards domestic goals’. As part o f i t s strategy to reduce this vulnerability, and as a result o f the very good fiscal and monetary policy track record of recent years, the MEF has begun issuing debt denominated in soles on a regular basis. The “market makers system” developed by the h4EF in 2003 has helped strengthen the
Standard and Poor’s upgraded Peru’s long-term foreign currency ratings to BB in June 2004 and i t s long term local currency rating to BB+ in July 2005. At end August 2006, Fitch raised Peru to BB+, the first adjustment by this agency since 2004. With this upgrade, Peru i s one step away from investment grade.
Such as swap transactions from floating to fixed interest rates on four IBRD loans and Brady Bonds. See Monetary and Exchange Rate Issues in Macroeconomics Policy Note.
9
market, allowing the MEF to gradually extend debt maturities (up to 15 years for fixed-rate paper and up to 30 years for variable rates) and consolidate the yield curve.
26. Peru i s one of the first countries to use IBRD Fixed Spread Loan (FSL) and has taken advantage of increased Bank flexibility to manage financial risks as part of i t s overall debt management strategy. Peru used the F S L f lexibi l i ty to customize the repayment terms o f their Third Programmatic Decentralization and Competitiveness Development Policy Loan (DCDPL), for US$ l50 million. This helped smooth the repayment profile and reduce refinancing r isks o f their overall debt. Also, Peru has used the embedded risk management options o f the fixed-spread loans by converting four o f the 18 existing F S L IBRD loans to f ixed rates, which correspond to 16 percent o f the total portfolio with the IBRD. This helped reduce the interest rate risk o f Peru’s overall debt.
27. Prior Actions for FMCDPL I: Presented legislation to Congress to strengthen monitoring and enforcement offiscal rules, including the Sanctions Law and the creation of a Fiscal Policy Committee; and published a public debt management strategy for 2006-2008 that provides guidance to the debt manager’s actions in funding and portfolio management, based on cost and risk analysis. The continuity o f the existing sound fiscal framework i s crucial in the f i rs t year o f the new administration, before moving on to tackling more dif f icult fiscal reforms in the future. The Sanctions Law and the Fiscal Policy Committee send a signal to al l levels o f government within the country, and to international markets, that the GoP i s committed to maintaining fiscal discipline, and that i t i s moving ahead with legal and institutional measures to ensure that. On public debt strategy, as noted above, by being one o f the f i rs t countries in the region to have a formal debt strategy, Peru i s making a strong statement that i t has a well- conceived plan for how i t w i l l manage i t s debt in the coming years, and that i t i s wi l l ing to make that plan public. The Bank policy note on public debt indicates that this i s a key signal to both domestic and international markets that the GoP intends to maintain a stable macroeconomic environment conducive to long-term investment and economic planning.
Policy Measures Going Forward: T o strengthen and enforce fiscal rules, fol lowing the approval o f proposed legislation, the GoP wil l next year begin applying sanctions to sectors and sub-national governments that violate fiscal rules, with the aim o f creating conformity wi th a single set o f national rules to tighten control over public spending. The following year, the GoP plans to begin issuing reports on compliance wi th fiscal rules by sub-national governments. External audits on the quality and content o f standard fiscal and financial reports are expected to star t in 2009, to improve the quality o f public accounting. Legislation w i l l be enacted to introduce sanctions for sub-national governments not complying with their fiscal rules or reporting requirements, and to make more precise the conditions under which the central government would intervene. By 2008, the MEF intends to begin publishing reports on sub-national fiscal management, and w i l l define incentives to encourage municipalities to pay over-due debt. By 2009, the MEF w i l l establish payment and fiscal sustainability agreements wi th four o f the 10 largest municipalities in the country. In the primary public debt market, challenges include creating a detailed strategy for domestic market development and a study o f investor demand for domestic issues;
10
exchanging fragmented, short-term bonds for longer-term issues to help consolidate the yield curve; and making the necessary pol icy changes to continue increasing the proportion o f f ixed-tern debt. The importance o f a viable and growing domestic debt market i s recommended in several Bank studies, including pol icy notes on the financial sector and public debt, as wel l as the Country Economic Memorandum. Increasing the share o f domestic debt i s a sound strategy that w i l l reduce Peru’s vulnerabilities to exchange rate risk, and it also i s an important catalyst for the private sector, particularly the highly-liquid pension funds in need o f high quality domestic investment instruments. Secondary debt market development w i l l require greater institutional coordination (through a formal committee) between the MEF, BCRP, Bank and Insurance Superintendent (Superintendencia de Bancas y Seguros-SBS) and National Stock and Business Supervisory Commission (Comisibn Nacional Supewisora de Empresas y Valores-CONASEV); unifying different valuation methodologies among different types o f investors; and creating well-functioning securities funding tools, such as repurchase agreement (repo) and securities lending systems.
0
28. Triggers for FMCDPL 11: Comply with fiscal rules-including a limit of 3 percent real increase annually on current spending-with a fully functioning Fiscal Policy Committee, and Comptroller is monitoring compliance with fiscal rules to all levels of government. This trigger i s intended to ensure a continued disciplined fiscal stance, which i s an essential precondition for Peru to achieve the levels o f growth it has targeted, as has been amply documented in numerous Bank studies, including the Country Economic Memorandum, the Bank thematic pol icy note on growth, and Bank policy notes on macroeconomics and the fiscal framework.
Making the Tax System More Neutral and Stable
29. The GoP intends to undertake tax system reforms to correct the relatively low collection as a percentage of GDP, excessive complexity in types of taxes and procedures, and numerous distortionary exemptions. Tax revenue collection o f the central government increased from 12.5 percent o f GDP in 2001 to an estimated 15 percent o f GDP in 2006, but i t remains below the 18 percent o f GDP o f the mid-1990s. The recent improvements in revenue collection are partly a result o f high commodity prices. The tax base i s l imited by a high level o f informality (about 60 percent o f the economy operates under informal system) and by a number o f sectoral and geographic exemptions (244 at last count), which cost an estimated 2 percent o f GDP. The GoP has tried in the past to eliminate tax exemptions without success. A further issue relates to the Financial Transactions Tax (Zmpuesto de Transacciones Financieras-ITF), which was introduced in April 2004, with a declining rate schedule and a December 2006 sunset clause. This tax was introduced as a temporary measure, but in the 2007 draft budget the authorities propose keeping the ITF one more year. Whi le the ITF is useful to track financial transactions, i t also negatively affects financial intermediation. On the administrative side, lengthy procedures to receive tax rebates limit the incentive for tax payers to fo l low the legal system, encouraging evasion. Poor coordination among different government institutions l imits the ability to pursue non-compliant citizens and companies.
30. The GoP strategy on reforms to tax policy and administration i s to involve the private sector in discussions on policy design. The MEF, with the support o f the Bank, has
11
organized a six-week consultation process wi th business associations, and w i l l submit proposals by December 2006. Technical assistance has been provided by the WIF in coordination wi th the Bank. Regarding exemptions, a cost-benefit analysis o f the existing exemptions has been finalized and wil l be used to define the road map for their elimination. The GoP has decided to reduce the ITF rate to a minimum level and credit i t against income tax. In this way i t could s t i l l be used as a tracking tool, but would not act as a disincentive to financial transactions. The GoP has already implemented administrative reforms to the tax system this year, including an overhaul o f the information o f the Internet-based Single Contributor Registry (Registro Unico de Contribuyentes-RUC), and also allowed the inscription o f individuals into the Registry for the first time.
31. Overall, the GoP intends to raise tax revenue to 16 percent of GDP by 2009. While this target i s not high, both the IMF and the Bank team concur that i t i s reasonable, considering the possibility o f revenue lost f rom lowering tariffs and reduced ITF, as wel l as the possibility o f declining commodity prices, which form a large share o f tax revenue. However, such a low target for tax revenue w i l l imply a greater need for prudence in spending to achieve the desired overall fiscal targets, as wel l as needed increases to investment in infrastructure and social programs. This reinforces the need to find savings through a more results-oriented, effective use o f scarce fiscal resources, and also to enforce fiscal rules to control the growth in spending on wages.
32. Prior Actions for FMCDPL I: Implementedfirst phase of tax reforms: prepared a cost- benefit analysis of eliminating existing sectoral and regional tax exemptions, enabled Internet registration for the single taxpayer identification number (RUC) and made updated RUC database available by Internet. This prior action i s intended to begin the process o f reducing the distortionary character o f the Peruvian tax system and facilitating the processes faced b y taxpayers, which as pointed out in the Bank’s fiscal pol icy note and the Country Economic Memorandum are key obstacles limiting the broadening o f the tax base and encouraging informality and non-compliance.
Policy Measures Going Forward: The administration w i l l implement several measures to rationalize the tax system and improve collections. One important step w i l l be to implement in 2007 a strategy to eliminate sectoral exemptions, and to continue negotiations to eliminate remaining regional exemptions. Also in 2007 the GoP w i l l reduce the ITF to a minimum level, and credit i t against corporate or personal income tax, and implement a broad-based minimum tax. Plans are being designed to facilitate the currently complex and time- consuming process o f tax refunds, which would encourage greater compliance. By 2008 the GoP intends to electronically integrate the tax collection agency (Superintendencia Nacional de Administracibn Tributaria-SUNAT) with the fiscal courts, to improve the ability to pursue non-compliant tax payers. By 2008 the GoP w i l l submit a law to devolve management o f specific taxes to the regions.
33. Triggers for FMCDPL 11: Implement the second phase of reforms to increase eficiency and neutrality of the tax system, for example ( i ) initiate a strategy to eliminate sectoral and
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regional exemptions based on a cost-benefit analysis, or ( i i ) reduce the effective rate of the ITF to a minimum level. The trigger on tax reform furthers the prior action noted above.
Improving the Efficiency and Transparency of Public Accounts
34. The GoP has taken actions towards strengthening transparency, accountability and efficiency through reforms in public sector financial management and accounting. Important steps towards these objectives include the recently approved Treasury System Law and the Accounting System Law. The Treasury L a w wi l l bring the budget classification system in l ine with international standards, budget classification w i l l be incorporated into the charts o f accounts, the integrated financial administration system (SIAF) wi l l be modernized according to external evaluation, and the coverage o f short-term debt under the General Public Debt L a w wil l be expanded.
35. Currently, the GoP i s pursuing a Treasury Single Account (TSA) to consolidate the availability of all public resources. There are roughly 5,000 accounts o f government entities in the Banco de la Nacibn, most o f them with balances. The build-up o f balances reduces the effectiveness o f an overall cash management strategy and also reduces the information and control over spending. A TSA system for each level o f government would promote greater transparency, better cash management, and allow for strategies to manage financial surpluses. All activities o f the three levels o f government would be programmed through the budget and only executed through the TSA, although the Treasury does not control the daily operations o f the individual correspondent’s accounts. Implementation needs to take into consideration the decentralization process, meaning regional and local governments need adequate systems to meet international standards with regard to information quality.
36. Prior Actions for FMCDPL I: Defined action plan and implemented first steps for adopting a TSA; aligned budget classification to international standards and with the chart of accounts, and automatic accounting by SIAF; and approved Treasury System Law and Accounting Law. A 2005 report by the IMF6 highlighted the problems occasioned by weaknesses in the budget classification system and SIAF accounting, and also pointed to the inefficiency and confusion caused by different government entities having multiple bank accounts. The actions taken here are al l fully in l ine with the recommendations considered most important by the IMF report. In particular, the report strongly recommended instituting a TSA to improve available information on government funds, strengthen appropriation authority and budget execution, and minimize the financing costs o f the budget.
Policy Measures Going Forward: The GoP w i l l initiate the first stage o f the action plan for implementing TSA and formalize the application o f a matrix to unify budgetary and accounting classification systems, and apply them in an integrated financial system.
37. Triggers for FMCDPL 11: Consolidate TSA in the Banco de la N a c i h , establish revenue and payments mechanism ensuring automatic conciliation, and unify budgetary and
Peru: Modernizing Budget Processes, Institutions and Information Systems (2005).
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accounting classification systems, including incorporation of the chart of accounts into the SIAF. This trigger follows directly on the prior actions in this area, and i s justified for the same reasons.
and Lima regions 18
Making the Transfer System Sustainable and Equitable
160 43
38. Peru has made a number of improvements to i t s system of transfers between different levels of government in recent years as part of the decentralization process. However, several problems remain to be addressed, most particularly: the high level o f sub- national dependence on transfers and a l o w level o f own-revenues; the difficulty in efficiently spending the growing public resources derived f rom natural resource income (Box 1); and a high and growing regional inequality accentuated by the transfer system.
Box 1. Natural Resource Income Transfers
Beginning with the creation of the petroleum canon for Piura and Tumbes in 1983, Peru has established a series of mechanisms to transfer income derived from natural resource exploitation to regional and local governments. By far the largest i s the mining canon and mining royalties, but the Camisea Development Fund (FONCAM) i s expected to grow significantly in coming years as well. The mechanisms are as follows:
Source of Funds
Distribution Formula
Total Amount in 2005 (US$
Mining Canon 50% of income tax paid by mining companies to gov’t
75% to municipal gov’ts in department o f resource, and 25% for regional gov’t
212
Mining Royalties
production value at int ’ l prices
1-3% o f
80% for municipal gov’ts in department o f resource; 15% for regional gov’t; and 5% to local universities
70
millions)
Gas Canon
50% o f income tax paid by gas companies, and 50% o f gov’t service contracts
Same as mining canon
91
3.3)
minus canon. sales by companies
Split between municipal and regional gov’ts and universities according to different formulas for Ucayali, Ayacucho, Huancavelica, Ica
Other Canons 50% of income tax/rights paid by hydro power, fishing and forestry companies to
canon mining canon
39. Natural resource-based transfers have increased sharply in recent years, driven by the commodity price boom. Efficiently and productively spending a substantial and largely unexpected amount o f revenue i s not an easy task. Utilization rates can be as l o w as 60 percent for sub-national governments receiving these types o f transfers. Canon and royalty resources are earmarked to investment, wi th 20 percent o f resources allowed for maintenance and another 3 percent for project preparation. The National Public Investment System (Sistema Nacional de Inversibn Pziblica-SNIP) evaluates investment projects according to standardized criteria.
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However, the SNIP office at the MEF does not count wi th the necessary human resources to fulfill demands for providing technical assistance to project-avid regions and municipalities. Pilot projects supported by the I F C Technical Assistance Facility in Cajamarca have helped improve this situation (see B o x 2), but more work i s needed. The GoP has begun to open regional offices o f the SNIP and other instances o f financial oversight in two regions, and plans to continue expanding this program.
Box 2. IFC Technical Assistance to Baiios de Inca Municipality on the Mining Canon
The IFC’s investment in the Yanacocha gold mine in Cajamarca, Peru has been extremely successful financially. However, local citizens have often felt that they are not benefiting from the wealth generated by the mine, despite the devolution o f a portion o f the mine’s income to local governments through the mining canon. In part this i s because many municipalities do not have the capacity to design effective investment projects, and as a result much of the canon remains in bank accounts instead o f being used productively in the region. To address this bottleneck, the IFC’s Technical Assistance Facility has been working with municipal governments in Cajamarca to improve the use o f canon resources. The rural, poor Baiios de Inca municipality has received millions of dollars in recent years from the mine, and the mayor committed to work with the IFC on how to best manage the canon. The IFC team worked closely with the municipality to improve the assessment of investments, speed their approval through the SNIP, and involve civil society in the entire process. This work was undertaken directly with the municipality on specific projects in an on-the-job style, rather then merely supplying standardized information on best- practice procedures. The results have been impressive. Municipal investment capacity increased five-fold from 2001-2003 (before the project started) to 2005, and i s on its way to surpass US$6 million by the end of FY 2006. This has translated into over 100 projects in 50 communities, with roughly half addressing health and education needs and more than 20 percent on productive infrastructure l ike roads and irrigation. As well, information on mining income and investment projects i s publicly available. While this work has not eliminated poverty in the municipality or social tensions around the mine, i t has increased awareness of the ability o f the project to improve the lives of local people, and also strengthened the ability o f the municipal government to address local needs.
40. The pro-cyclicality and volatility of these resource transfers could become a problem should commodity prices fall or if production falls f rom resource depletion or other reasons. For some municipalities, mining canon and royalties represent more than 90 percent o f their total annual budget. Sub-national governments receiving resources from the National Camisea Fund (Fondo Nacional de Camisea-FONCAM) and (to a lesser degree) other canons for fishing, hydrocarbon, and forestry face a similar situation. The previous administration proposed a stabilization fund to smooth out the transfer o f these resources, but the proposal remains in a congressional committee. As well, the l o w level o f own-revenue collection exacerbates the dangers in depending on transfers.
41. Wide divergences in natural resource endowments and economic concentration have the potential negative effect o f increasing “horizontal” inequalities, as has been the case in other countries. The amount o f per capita resources varies widely across regions, f rom a l ow o f 45 soles per capita in Lambayeque to a high o f 1,176 soles per capita in Moquegua in 2005. For example, in 2005 the department o f Ayacucho, with a poverty rate o f 65 percent, received 145 soles per capita in transfers, while Moquegua, wi th a poverty rate o f 37 percent, received 1,176 soles per capita. The revenue sharing arrangement for canon has exacerbated inequalities. These disparities can be mitigated by a well-designed system o f intergovernmental transfers.
Moreover, the variation o f transfers does not correlate strongly wi th poverty.
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However, although the formulas used to calculate the distribution o f canon resources and the Municipal Compensation Fund (Fondo de Compensacibn Municipal-FONCOMUN take poverty into account, this has not been sufficient to adequately offset high regional inequalities. The GoP has submitted a proposal to Congress to assign a portion o f mining canon to the Regional Compensation Fund (Fondo de Compensacibn Regional-FONCOR), a fund intended to help redress regional imbalances.
Policy Measures Going Forward: 0 Before the end o f 2006, the GoP w i l l undertake a thorough territorial mapping of all
transfers to the sub-national level, including FONCOMUN, canon, and public investment, as a f i rst step to building a coherent transfer system in pursuit o f national objectives.
0 The GoP i s seeking to reformulate the existing system of fiscal transfers, so regional governments that are not natural resource-endowed can also benefit f rom the current high cycle o f commodity prices. Changing the system o f transfers i s a challenging task and requires careful planning, in terms of objectives, impact and political economy. The GoP i s evaluating moving towards an equalization transfers system, which would be supported by potential future Bank operations, taking into account experiences in other countries that have s im i la r economic structure as Peru. The GoP intends to deconcentrate S N I P along with other instances o f the MEF to facilitate project evaluation, technical assistance, and approval at the sub-national level, and thus improve the f low o f investment spending f rom canon resources. T o reduce sub-national transfer dependence, the GoP plans to implement fiscal incentives to improve tax collection at the regional and local levels.
0
0
Implementing Performance-Based Budgeting
42. The GoP has decided to formally introduce the use of performance information (measures and evaluations) in the budgeting process and gradually implement a system of performance-based budgeting, with the objective o f improving the efficiency and effectiveness of public expenditure. The new administration i s placing strong emphasis in improving the quality and impact of public spending, and performance budgeting could be used a powerful tool for such objective. Performance results wi l l support better decision making, leading to improved performance and/or accountability for public spending. The authorities have decided to implement a gradual approach, by which they w i l l start utilizing performance information indirectly but systematically to enrich budget decisions, wi th as much coverage o f the budget as can be technically achieved. In this case, “indirectly” means that performance measures are systematically used during al l stages of the budget process: preparation, discussions, execution, evaluation and liquidation o f the government’s annual or multi-annual budget. Direct performance budgeting, which links performance results to budget allocations, w i l l come at a later stage. The performance budgeting system wil l be developed, implemented, managed and overseen by the MEF, and w i l l require close coordination wi th sectoral ministries.
43. The GoP has experimented in recent years with linking results to funds allocation. Examples o f these are the performance-based budgeting pilots in the agricultural extension program SENASA and the Seguro Integral de Salud (Integral Health Insurance), a public health
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insurance program that has a fee-for-service reimbursement and receives budget allocations based on the services rendered by health facilities. Additionally, two types of tools with bonudrewards for productivity have been widely used for improving quality and impact o f public expenditure. However, although some o f these efforts produced good results, these were not conceived under a coherent system for performance budgeting, and had l i t t le or no link with the budget formulation process.
44. A culture of performance measuring i s being fostered and the linkage between the MEF-based M&E system and the budget process has been formally established. The GoP has prepared an action plan for institutionalizing performance-based budgetin . The draft 2007 budget submitted to Congress includes performance indicators for 23 sectors$. These indicators have been prepared by the sector ministries and subsequently discussed and revised with the MEF, in order to jointly construct budget-relevant performance indicators that reflect government priorities and form the basis for a future M&E system. The design, implementation and institutionalization of an M&E system for performance-based budgeting i s a long-term task; in the meantime the GoP has proposed to use transitional M&E tools. The MEF has prepared technical terms o f reference for executive sector evaluations as a first step to introduce more independent evaluations linked to the planning and budget processes. These executive evaluations have the advantage o f being low cost, quick and provide the required flexibility to use the findings in the budgetary process', as opposed to other evaluation tools, that while providing more in-depth information, are more time consuming, more expensive, and require o f better information sources9 that are not yet available. Gradually, performance indicators and evaluations w i l l be used during the budget discussions and in some cases to directly determine resource allocation, particularly for priority programs. The emphasis during the first stages i s on identifying good outcome indicators and reliable information, before proceeding to use that information in budgeting.
45. A n important but challenging step i s to produce meaningful programmatic formulations to link budget cost data to outcomes. At this stage, performance budgeting relates resource allocation to measurable results in form of outputs/outcomes. While performance measures w i l l be used systematically to inform budget decisions along with other information on performance, macroeconomic situation, and policy priorities, at the initial stage only few programs w i l l link cost information to results. Ministries should identify four to five priority results, and specify the activities that they would need to undertake to achieve those results. In this phase, the goals w i l l not be overly ambitious. There wi l l be an effort to introduce this results orientation in three to four ministries and to have this approach account for perhaps 40 percent of total expenditure within a ministry. For this i s necessary to introduce programmatic formulation of budgets and identification o f targets at the sectoral level. This implies identifying meaningful programs and associating them to priority targets.
46. The performance-based system will be based at MEF and will operate in coordination with all sectors for identification o f sector-relevant indicators, advancing budget
' The f i rs t set o f indicators includes at least four indicators per sector, two for programs and two for projects and activities. * K.Kumar (1993). Rapid Appraisal Methods. The World Bank, Washington, D.C.
Roche, C. (1999) Impact Assessment for Developing Agencies: Learning to Value Change. Oxfam, Oxford
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programming, discussion and preparation o f evaluation reports, sector commitments to improve program structuring and performance, and reporting to Congress and civi l society. The GoP realizes that the impact and sustainability o f the system depends on its use and institutionalization. This project w i l l support policy decisions geared to ensuring installation o f a quality system, increased utilization and institutionalization. A social sector DPL under preparation wil l support the implementation o f M&E systems for social programs, focusing on standards and accountability in the social sectors. Working closely, in a collaborative manner, with committed sector entities i s an important element for the success o f the performance-based budgeting system, particularly at the early stages o f the development o f the M&E system. This w i l l help showcase to al l other government entities the value o f M&E.
47. Prior Actions for FMCDPL I: Enacted regulatory framework for pe$ormance measurement and reporting, linking the budget presentation cycle with performance indicators, by which all sectors and regional governments are required to generate output and pe$ormance indicators as part of their budget submission. The 2007 sector budget submission included sector pe$ormance indicators (programs, activities and projects), including for the environment. The need for improving the results focus o f Peru’s budgeting framework was noted as a key obstacle to obtain better results with scarce public resources in the 2003 Public Expenditure Review. The first prior action in this area initiates the required first stage of implementing a result-based budgeting system. This strategy for a phased implementation of performance-based budgeting i s validated by the experience o f numerous countries that have moved in that direction, as discussed in a 2005 OECD document surveying the experiences o f OECD countries in this area.”
Policy Measures Going Forward: Gradual implementation o f performance budgeting w i l l be defined in an action plan which wil l describe the sequencing strategy. The new performance indicators wil l be incorporated in the 2007 budget evaluation and progressively l inked to the financial management system (SIAF) with a view to enriching budget decisions. On the basis o f the budget performance indicators, the MEF w i l l begin a program to introduce M&E information in the budget cycle, through executive evaluations of programs, l inked to the budget cycle, beginning with four in 2007. Results w i l l be published and used to adjust goals for the following budget year starting in 2009. These executive evaluations w i l l be accompanied with the implementation and institutionalization o f an M&E system at the national and sub-national level that w i l l allow a gradual transition f rom desk evaluation to impact evaluations, and from these to formal evaluations and monitoring o f ministerial programs and presidential goals Performance measurement and monitoring w i l l cover key competences devolved to sub-national governments as part o f the decentralization program.
48. Triggers for FMCDPL 11: Review and launch action plan for institutionalizing results- based budgeting (performance measurement, reporting, and subsequently budgeting), managed and overseen by the MEF and based on the use of the government-wide M&E system and relating fund allocation to measurable results in the form of outputs andlor outcomes. Introduce
lo “Performance Information in the Budget Process: Results o f the OECD 2005 Questionnaire,” T. Curristine, OECD Journal on Budgeting, Vol. 5, No.2,2005.
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programmatic formulation of budgets at the sectoral level for key programs, and issue regulations to formalize executive evaluations as a component of the budget cycle, and undertake two pilot executive evaluations each in two diferent sectors. This next phase of performance budgeting implementation again responds to lessons learned in other countries, as discussed above. The usefulness o f executive evaluations i s noted in a World Bank overview o f rapid appraisal methods.
B. Competitiveness
49. The new administration bases its plans to improve development and reduce poverty in Peru on reforms to increase the private sector’s competitiveness in the world economy. Planned policy measures in this area include continuing to promote export-led growth, reducing transaction costs through procedure simplification and streamlined public-private sector interface, and strengthening the investment climate for micro, small and medium enterprises (MSMEs). Competitiveness and the investment climate w i l l benefit from several of the reforms noted in the previous section, in particular fiscal consolidation. However, a number of bottlenecks to private sector activity noted in the Investment Climate Survey (2004) w i l l be addressed by specific policies on competitiveness, which are part o f the program described below.
Promoting Export-led Growth
50. Peru’s export performance has shown impressive gains in recent years, with compound annual growth rates above 20 percent between 2001 and 2004, and 25 percent in 2005. However, the country s t i l l faces many challenges if i t wishes to reap greater gains from trade. Although non-traditional exports are growing fast, mining (which i s capital-intensive and hence generates relatively few jobs) s t i l l accounts for more than half of exports, and manufactured exports are low. As well, total exports in Peru s t i l l represent a low percentage of GDP, only 21 percent in 2005. This figure i s particularly striking when compared to other countries in Latin America such as Chile (34 percent), Venezuela (32 percent), Mexico (28 percent), and even Bolivia (24 percent).
51. The Garcia administration has stated clearly that it views international trade as a key engine for growth and poverty reduction in Peru. Peru signed and ratified the FTA with the U.S. in 2006, and the administration i s expecting the U.S. Congress to ratify the trade agreement. I t i s also pursuing other trade agreements with countries in the region and throughout the world. Undertaking the necessary competitiveness reforms to spur greater value-added exports i s a top priority, both to reduce dependence on volatile commodity prices, to encourage activities with a higher impact on employment and poverty, and to reap the opportunities of market access opened by the negotiated trade agreements. A major program to promote export development in the poor Andean region, Sierra Exportadora, i s one o f the administration’s flagship projects.
52. A crucial element in a pro-export strategy i s the reduction of costs of inputs used in the production process of exporters and the facilitation of trade-related processes. Tariffs
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have gradually been reduced since 1991, as have the levels o f dispersion. Currently, average nominal tariff i s 10.1 percent, close to average protection in Latin American and middle income countries, and the rate o f dispersion i s 6.3 percent. Average tariffs for 196 tariff l i n e s - o n inputs and capital goods not manufactured in the country-were reduced by the end o f 2005, falling to 4 percent, and resulting in a slight reduction (0.1 percent) in average nominal protection. Tariff dispersion has increased rather significantly wi th the tariff reductions in the 199Os, leading to economic distortions. Simplification, transparency and further reductions in the most favored nation (MFN) tariff, especially in intermediate and capital goods, would foster competitiveness, increase private investment, and reduce the cost o f trade deviation produced by bilateral trade agreements. T o this end the MEF has issued a Resolucidn Ministerial establishing the need to reduce protection and dispersion in order to foster competitiveness, and the Wor ld Bank w i l l provide technical assistance on modeling the impact o f such reforms. Regarding facilitation of processes to exporters, an agenda o f modernization o f customs and ports o f the GoP has already translated into reduction o f logistic and customs clearance costs. Among further actions envisaged in the country’s agenda are the improvement o f customs procedures in l ine with the commitments under the FTA and the creation o f a Ventanilla Unica (“single window”) establishing uniform procedures for the authorization and control o f imports and exports subject to non-tariff regulations.
53. Prior Actions for FMCDPL I: Signed the FTA with the US. and ratified by Peruvian Congress. Reduced from 7 to 3 percent tanfs on capital goods in 196 lines and published national guidelines for tarifSpolicy. Created Ventanilla Unica, one stop-shop with the objective of establishing uniform authorization and control of imports and exports subject to non - tan ! measures. The completion o f the FTA with the U.S. is a crucial sign that Peru i s committed to an export-led growth strategy, and that i t intends to integrate further into the wor ld economy by lowering constraints to trade. While the impact o f this action may be limited at first-pending ratification by the U.S. Congress-it nonetheless has a strong positive impact on how national and international markets view Peru, and acts as a catalyst to improve country competitiveness in advance o f lowering trade barriers, opening new market opportunities and consolidating existing preferences. Complementary measures envisaged by the GoP are the reduction o f MFN tariffs, particularly in capital and intermediate goods, to foster competitiveness and reduced trade deviation caused by bilateral preferences, and the pursuit o f an agenda to reduce costs for clearing import and export goods. Numerous Bank studies, in particular the Country Economic Memorandum, the thematic policy note on growth, and the pol icy note on trade, demonstrate clearly how far behind Peru i s compared to other developing countries in the region and the world on international trade, and how powerful trade can be as an engine to create faster, broader economic growth and poverty reduction.
Policy Measures Going Forward: 0 The current administration intends to continue negotiating and signing trade agreements
with other countries that offer strategic opportunities to Peru. Talks are underway with Mexico, Singapore, the E.U., Chile and Brazil, and future negotiations are being considered with Canada, India and China. An important component o f the GoP’s trade facilitation agenda i s to continue improving the institutions and regulations that govern trade transactions. The administration plans to integrate the different administrative units participating in customs clearance
0
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with the objective of simplifying the process of authorization, payment and control in compliance with non-tariff regulations. Additionally, and partly as a result of commitments assumed under the FTA, a strategy to improve customs procedures and times i s underway, covering issues l ike introducing express shipments, advance rule issuing, improving risk management.
0 To promote export growth in the regions, the GoP intends to open new export promotion offices, following on the experiences in Loreto, Chiclayo and Huancayo. As part o f the Sierra Eportadora project, the focus w i l l be to open these offices in the Andean region, to help small producers in poorer regions develop products that can be competitive in external markets. The Sierra Exportadora project w i l l also include measures to increase infrastructure and the flow o f credit to the Andean region, geared toward export growth.
0 To improve Peru’s low level o f technological innovation and quality accreditation for exporters, the GoP plans to evaluate the operations o f existing Centers o f Technological Innovation (Centros de Znnovacidn Tecnoldgica-CITES), public-private funded centers that provide technological support to f i rms in specific productive chains, including testing and certification, technical training, knowledge dissemination, and assistance in marketing strategies. Based on an assessment o f their impact, a plan for improvements and expansion w i l l be designed and implemented. As well, a program on science and technology w i l l be designed to provide financial incentives for the development of innovation and research and development projects in f i r m s and other institutions that demonstrate linkages and counterpart funding from the private sector.
54. Triggers for FMCDPL 11: Continue trade negotiations to expand market access to Peruvian exporters. Implement complementary measures to facilitate trade and customs clearance, for example implementing Ventanilla Unica or reducing average tarif and tarif dispersion. While the signing o f an FTA with the U.S. was a very important policy move, Bank analysis also highlights the importance for Peru to diversify i t s export markets to reduce the risk o f terms-of-trade shocks. As a result, the Bank i s supporting the GoP’s intention to move forward with negotiations to expand access to other markets for Peruvian products, such as the European Union, Canada, China, Chile and elsewhere. The complementary agenda to trade openness, including facilitating trade transactions, reducing the cost to access to inputs and capital goods in the production process, and reducing tariff dispersion, i s equally important as trade agreements to generate greater economic returns from trade, as noted in the Country Economic Memorandum, the Bank policy note on trade, and the 2004 study Peru: Microconstraints to Growth. The Bank i s also supporting the GoP with a Trade Facilitation and Competitiveness Technical Assistance Loan in improving the environment for trade related transactions in issues l ike logistic management, quality, innovation and promotion o f exports in developing regions.
Procedure Simplification and Streamlined Public-Private Sector Interface
55. As in many developing countries, bureaucratic procedures in Peru are time- consuming and costly, and act as a disincentive to greater economic activity. Particularly onerous and harmful to economic activity are the complex and lengthy procedures to open a new business, t it le land, and undertake international trade. There have been advances in procedure
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simplification at both the national and municipal levels in recent years. At the national level, the government has implemented a portal where processes and procedures for a number o f services are published. This effort wi l l continue to cover al l services.
56. At the municipal level, IFC, U S A I D and other donors have worked extensively on pushing the simplification agenda to ease bottlenecks to greater economic activity. The I F C Technical Assistance Facility and the local non-governmental organization (NGO) Ciudadanos al Dia have been integral in assisting the provincial municipality of L i m a simplify business permit and administrative procedures, starting in 2005 under a program called TrarniFaciZ. As a result o f the simplifications that went into effect in the beginning o f 2006, permits that formerly required 60 days to process are now finished in three days. Business owners formerly needed to visit government offices 11 times on average during the process, but now only have to go once or twice. Whi le previously a uniform process was required for al l companies, now risk categories help the municipality differentiate services. Importantly, the cost for undertaking these processes for small and medium enterprises has fallen by over half. The response has been impressive: while the municipality processed on average about 1000 licenses for commercial activities per year previous to the reforms, they processed over 5000 in the f i rs t seven months o f 2006. A “Toolkit for the Simplification o f Municipal Procedures” was developed out of this experience to extend these results to other provincial municipalities, which in turn can influence district municipalities to fol low suit.
57. Peru has developed a strategy for the inclusion of information and communication technologies (ICT) in the development agenda of the country. According to a United Nations E-Government Readiness Index, Peru ranked 56 out o f 179 countries in 2005, a drop o f three rankmgs f rom the previous year. This compares to 22 for Chile, 31 for Mexico, and 33 for Brazil. The index highlights e-governance infrastructure as a key area o f weakness in Peru. The GoP currently has a Digital Agenda and an e-government strategy, as wel l as an institutional structure and a legal framework that facilitates the coordination and execution o f activities in this area. There have been advances in the development and implementation o f the SIAF, and the GoP has put in place a web portal of public services, including tax administration and the c iv i l registry. The GoP has defined the rules for applying the e-Signatures Law, which w i l l promote the creation and implementation o f digital certification, an important step to facilitate the use o f electronic signatures, payments and exchange o f information. O n a broader level, there i s a need to begin the integration o f information platforms for all public sector institutions, to facilitate the f low o f data and improve communications. This process requires, first, the development o f an overall framework that different agencies can then adapt to.
58. Peru has initiated the development of an e-procurement system (Sisterna Electrdnico de Adquisiciones y Contratuciones del Estudo-SEACE). I t s development was planned in three modules: i) publication and dissemination o f government procurement; ii) small purchases under specific threshold; and iii) large purchases. The f i rs t module i s in operation and the results are positive. There are 5,862 users f rom 2,234 public entities already registered on the system. SEACE has become a tool of public consultation for procurement opportunities and processes. Recently, a tool to support small purchases was developed and applied as a pi lot in 25 organizations. The results were positive and the plan i s to scale up i t s use in the medium term.
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Also, there have been pilots for reverse bidding”, and the plan i s to make this possibly electronically via SEACE. While the design o f SEACE i s adequate, new technology that was not available when SEACE was f i rs t developed could greatly improve the system’s functioning. Another procurement issue i s to implement the framework needed to make corporate purchases, which would allow the public sector to take advantage o f economies o f scale and save significant public resources.
59. Prior Actions for FMCDPL I: Launched a strategy of e-government, including putting in place a web portal of public sewices such as tax administration and civil registry, and issued the National Digital Agenda. The gradual implementation of e-governance procedures i s essential to help improve the efficiency o f the public sector in Peru, as noted in the Bank pol icy note on e-governance. A key recommendation of that study was to publish the regulations to allow electronic signatures, which opens up a wide range o f possible transactions on the Internet, and also to move ahead quickly wi th placing important and useful government information on the Internet for public access and use. This recommendation i s also supported by the 2005 Country Procurement Assessment Report Update (CPAR Update).
Policy Measures Going Forward 0 The plan i s to extend procedure simplification to f ive additional provincial
municipalities during the coming years. Arequipa, Ica and Piura are already committed to begin simplification in the coming year, and at least two other provincial municipalities are expected to begin by 2007. On the national level, the GoP intends to develop and implement a “single window” for certain types o f procedures (foreign trade and land titling wil l l ikely be first).
0 In the area o f e-government, the GoP plans to scale up the electronic payment system, based on the results o f the current pilot. As a first step toward harmonizing e-government systems, an interface between SUNAT, business registry (Sistema Nacional de Registros Ptiblicos-SUNARP) and the National Identity and Marriage Registry (Registro Nacional de Zdentidad y Estado Civil-RENIEC) w i l l be developed in 2007, whereby data and processes are shared between the entities. A mechanism for periodic evaluation and update o f the e-government strategy wi l l be established, in order to take into account the technological and business advances. T o advance integration among government agencies, the GoP w i l l design by 2008 an overall framework for inter-operability among different government agencies, where platforms, communications, forms, catalogs, etc. are compatible. Regarding S E A C E and procurement, the GoP’s f i rs t priority for 2007 i s to migrate the f i rs t two modules o f SEACE to the new technological platform now available, and ensure the third module i s designed for this technology. At the same time, SEACE w i l l be integrated with S IAF at the process level (commitments, payments, etc.) and adopting the U N ’ s catalogue of goods and services, to ensure that the purchases are controlled by SIAF and published in SEACE. By 2008, an analysis o f public sector procurement and market opportunities w i l l allow the GoP to begin corporate purchases, which w i l l offer important savings to the public sector. In the longer term, it wi l l be important for SEACE
0
” Reverse bidding i s when vendors compete to offer their goods and services at the lowest price, as opposed to the auction process of selling to the highest bidder
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to continue expanding throughout the public sector and that other actors (NGOs, c iv i l society) are involved in monitoring tenders and purchases on the system.
60. Triggers for FMCDPL 11: Continue efSective promotion of e-government, for example ( i ) integrate SEACE with SIAF at the process level (e.g., commitments and payments) and at the catalogue level (adopting international accepted catalogue of goods and services), ( i i ) issue and implement the new regulation of Electronic Signatures, or ( i i i ) submit to Congress Draft Law on National Information System; and expand the TramiFacil program to reduce the time and cost of receiving a business operating licenses to at least three provincial municipalities. The importance o f integrating SEACE wi th S IAF i s essential to enable a better integration between public budget and procurement planning and execution tasks, and to provide a statistical information source for monitoring and measurement o f performance and management quality, and i s one o f the principal recommendations o f the CPAR Update. As discussed above, the time and cost o f obtaining a business license f rom municipal governments i s excessive in Peru. This sort of bureaucratic obstacle to greater private sector act ivi ty-especial ly on the part o f job- creating MSMEs-has been highlighted as a key constraint to growth by several Bank studies, including the Country Economic Memorandum, Microconstraints to Growth, and the annual Doing Business reports. The impressive results o f TramiFacil in L ima indicate that scaling up the program would l ikely have a significant impact on business activity and employment growth in the rest o f the country.
Promote Sustainable Financial Deepening and Improve Credit Access for MSMEs
61. While it has continued to grow, Peru’s financial system relative to GDP i s smaller than those of most large countries in Latin America. As o f end-2005, total financial sector assets were about US$42 billion, equivalent to 53 percent o f GDP. This ratio compares to about 100 percent o f GDP in Brazi l (2002) and Chile (2003), and 61 percent o f GDP in Colombia (2003). Financial deepening has slowed in Peru since 2001, and local companies lack adequate access to capital to grow and create jobs.
62. Banks’ soundness has substantially improved, although vulnerabilities remain. These vulnerabilities should be addressed strategically as banks are the backbone o f financial intermediation in Peru. Any meaningful deepening in the access to financial services w i l l include a major role o f local banks, which represent 65 percent o f the financial sector. As such, the following actions should be considered:
Strengthen the active regulatory and supervisory role o f the SBS Ro l l out an agenda for enhanced risk management Set up an effective framework for large bank resolution
0 Carefully weight the advantages and disadvantages o f increased credit activity by public banks, trying to limit it to second tier role.
63. Given the recent shift in banks’ portfolios to new areas, the lack of appropriate risk management tools and disclosure could lead to costly learning, or even disrupt existing practices. Credit risk models, tools and stress testing techniques are yet to be fully implemented in many banks. Moreover, banks (and other lenders) may lack the expertise to manage r isks involved in new types o f lending. As an illustration, a bank with purely corporate expertise
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which penetrates micro-credit segment by lending to good payers based on the credit information systems could inadvertently lead to over-indebtedness of micro-enterprises and default on pre- existing micro-credits from non-bank intermediaries. This i s because micro-lending techniques are based on motivating debtors to repay through the promise o f increased loan amount. The Bank w i l l support measures to ensure sound intermediation practices, in particular, the approval of regulations for sound management of growth in consumer and micro-loans, with the objective of reducing the risk o f over-indebtedness. Approving this regulation i s critical in an environment of high and growing liquidity.
64. Peru has a challenging agenda for improving access to credit by MSMEs, especially rural and agricultural sectors, through stronger lending infrastructure, releasing constraints to alternative lending tools and enhanced capacity of microfinance institutions. Impressive progress has been achieved in terms o f microfinance development, and Peru can boast advanced credit reporting systems, a pilot commercial courts program, fast-growing formal microfinance institutions, and growing leasing volumes. Yet further outreach and preservation of credit history i s needed, execution o f collaterals delays should be shortened, residual constraints to well developed leasing, factoring, warehouse and trade financing have to be eased, and enhanced governance and institutional capacity should be promoted in microfinance institutions.
65. The authorities have a catalytic role to play in creating the enabling environment for structured financing solutions to flourish, thus meeting the growing demands of institutional investors, while channeling much-needed financing to under-served sectors. A concerted, multi-agency effort-ideally spearheaded by a much stronger CONASEV-is needed. Regulatory clarity and taxation stability are pre-requisites to develop structured financial instruments, and tap the potential demand from the pension funds and other institutional investors. Structured finance helps pool small issuers and improves the creditworthiness of securities above that of the issuer. Deeper capital markets could aid development o f under- funded sectors such as housing, infrastructure projects and MSMEs, while providing more lucrative investment vehicles for emerging market investors seeking high yields.
66. As part o f Peru’s program to address bottlenecks hindering greater commercial activity, especially among MSMEs, the GoP intends to implement measures to facilitate sound credit expansion. This proposed operation w i l l support the adoption o f a regulation for sustainable widening of the scope o f financial services and operations by smaller financial institutions (mostly focused on micro entrepreneurs) by the SBS. The GoP wi l l conduct an analysis o f strategic policy options for more effective institutional setup in capital markets regulation and oversight. This analysis wi l l provide the basis for designing legal and regulatory changes to promote financial innovation for MSMEs, including reforms for a more efficient and agile capital market. Potential future operations w i l l support efforts to foster innovative financial deepening, such as innovative correspondent banking.
Policy Measures Going Forward The GoP wi l l implement legal reforms for more advanced risk management practices in the industry and a risk-based supervision approach, and consequently issue needed regulations for risk management and capital adequacy rules, allowing for flexibility in line with intermediaries’ level of sophistication.
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T o foster greater outreach by formal financial sector, the GoP wil l issue regulations to promote increased use o f banks in innovative ways, such as correspondent banlung; and in the longer term use grass-roots financial literacy initiatives to promote financial intermediation. The GoP wil l promote the setup o f institutional and technological infrastructure to implement the new collateral law, namely the consolidated and automated collaterals information system. I t w i l l also support legal and regulatory changes to promote financial innovation for MSMEs, including reforms for a more efficient and agile capital market regulatory and supervisory framework.
67. Triggers for FMCDPL 11: Adopt regulations for sound and sustainable deepening of micro and consumer lending, for example (a) regulation on widening o f the scope o f financial services and operations b y smaller financial institutions (mostly focused on micro entrepreneurs); or b) regulation for wel l managed growth in consumer and micro-loans, reducing over-indebtedness risk. The importance o f these actions to improve the climate for the growth o f MSMEs-and hence have a greater impact on employment growth and poverty reduction-is amply supported by Microconstraints for Growth study as wel l as the pol icy note on Peru’s financial sector.
IV. The Proposed Operation
A. Link to Country Partnership Strategy and Other Bank Operations
68. This programmatic series on improving fiscal management and competitiveness i s at the core o f the CPS’s proposed assistance program, and is envisioned as part of the country’s base-case lending scenario. The CPS foresees several thematic “clusters” forming the basis o f the Bank’s partnership wi th Peru, and this proposed loan series directly addresses aspects o f maintaining macro stability; accelerating growth and widening the base o f growth; and modernization o f institutions. Policies which form part o f the F M C D P L series include, among other reforms, simplifying and improving tax collection, controlling sub-national debt, implementing incentives for greater sub-national revenue creation and judicious use o f natural resource revenues, promoting performance-based budgeting, expanding e-governance procedures, streamlining administrative obstacles faced b y the private sector, and strengthening Peru’s ability to take advantage o f opportunities offered by international trade. Al l o f these directly promote the goals stated in the CPS.
69. The proposed operation also fits into a series of Bank operations that support the GoP’s reform agenda. I t was developed joint ly wi th another multi-year DPL series for the social sectors and a Health APL, which address issues o f improved service quality and performance-based management, as wel l as the on-going Accountability for Decentralization Technical Assistance Loan (TAL), which also focuses on the social sectors. The overall intention o f these loans i s to strengthen the focus o f public spending in areas o f greatest impact to the poor, particularly in health, education and social safety net support, and the performance- oriented management reforms that form part o f this F M C D P L w i l l be a critical tool to help ensure this occurs, b y allowing a more accurate assessment o f the impact o f priority programs throughout the public sector. Because o f the importance o f monitoring indicators in the social sectors, the Bank w i l l exploit synergies between these two series to ensure that the monitoring
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and evaluation component supported by this loan brings together both the overall budgetary and fiscal goals o f the MEF as wel l as the sectoral improvement goals in the l ine ministries. Actions under this loan w i l l be supported by the on-going Institutional Capacity for Sustainable Fiscal Decentralization TAL, designed to improve fiscal planning, expenditure efficiency, and decentralized public investment. The on-going Justice Reform Project wi l l help support implementation o f improvements in the conciliation system, which form part o f the competitiveness component o f this loan. In addition, the F M C D P L i s complemented by three IFC technical assistance projects, one in Cajamarca and a second under the Extractive Industries Transparency Initiative (EITI) in Cuzco, both o f which a im to build capacity at the municipal level for management o f natural resource-based revenues and investments, and a third on administrative simplification in provincial municipalities.
B. Lessons Learned
70. The experience of designing and implementing previous policy-based loans in Peru, in particular the three-stage Decentralization and Competitiveness DPL (DCDPL) series, provided important input in the design of this programmatic series. The aim of D C D P L programmatic series was to establish a conceptually coherent and fiscally sound foundation on which to build a decentralized system o f governance in Peru, a process that wi l l take a number o f years. The D C D P L series helped ensure that Peru began the process of decentralization in a deliberate, well-conceived manner, strengthening fiscal responsibility and administrative efficiency at al l levels o f government and avoiding the pitfalls seen in other countries o f deteriorating public services and confusion o f responsibilities. In parallel, significant legal, institutional and administrative initiatives were undertaken to enhance competitiveness, many with a strong focus on promoting growth in non-traditional exports and in economic activity outside the capital region. The results and pending agenda from the D C D P L series informed the design o f aspects o f this proposed loan series.
71. One key lesson from the DCDPL series i s the importance of choosing reform areas carefully and not pressing for the government to make too many changes too fast. Complex and technical processes l ike e-government and the devolution o f service delivery to the sub- national level need critical time for development and implementation, or capacity constraints w i l l impede progress. Moreover, time i s also needed to overcome the resistance o f groups that may feel threatened by the uncertainty brought about by changes and the accountability brought about by performance-oriented reforms. Because the GoP i s moving ahead with the devolution o f resources and service delivery to sub-national governments, this operation w i l l focus only on fiscal management aspects o f decentralization, and specific sectoral issues regarding oversight and service delivery wi l l be addressed in other operations.
C. Design of the DPL and Analytic Underpinnings
72. The proposed FMCDPL series responds to the GoP’s request for Bank support to i ts public sector institutions and competitiveness reform program. This operation i s intended as the first in a series o f possibly three or four loans, each marking progressively advanced stages in the reform program. The two broad areas addressed by the operation are (i) efficiency and quality o f fiscal management; and (ii) competitiveness. In view o f governmental
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priorities, the first proposed loan w i l l focus more on fiscal management, while later loans in the series w i l l be more weighted toward competitiveness.
73. This proposed DPL series takes into account lessons learned during past programmatic operations in Peru, as well as current best practices in policy-based lending to well-performing middle income countries. l2 As such, the FMCDPL emphasizes ownership and up-front actions based on a well-defined government reform program. This loan i s motivated by Peru’s laudable performance in recent years in consolidating i ts economy, and the clear desire o f the new administration to move into the next stage o f reform by improving the efficiency and impact o f governance institutions and public resources. The programmatic approach i s intended to support the government with a reliable source o f low-cost financing linked to i t s budgetary cycle.
74. The Bank team selected a sub-set of specific policies within the GoP’s program to support with the FMCDPL series which it considers will have the most impact, based on the Bank’s diagnostic work. Among the principal pieces o f research and analysis used in the preparation o f this loan are: the pol icy notes collection for the new administration collected in the volume Peni: La Oportunidad de Un Pais Diferente-Prbspero, Equitativo y Gobemable, Public Expenditure Review, Country Financial Accountability Assessment, Country Procurement Assessment Report, Investment Climate Assessment, Poverty Assessment, Country Economic Memorandum, and sector specific studies such as Municipal Debt, Microconstraints to Growth, and Environmental and Social Impact o f the Mining Sector. The links between these works and the specific policies supported by the FMCDPL series are outlined in each prior action and trigger description in the previous section o f this document.
D. Programmatic Framework
75. As discussed above, this DPL i s proposed as part of a programmatic approach that supports actions in the areas of: (i) efficiency and quality of fiscal management, and (ii) competitiveness. A Letter o f Development Policy i s attached (Annex 1) and the pol icy framework i s included in Annex 2. The key measures highlighted as prior actions for this DPL are listed below:
Efficiency and Quality of Fiscal Management 0 Presented legislation to Congress to strengthen monitoring and enforcement o f fiscal
rules, including the Sanctions Law and the creation o f a Fiscal Policy Committee. Published a public debt management strategy for 2006-2008 that provides guidance to the debt manager’s actions in funding and portfolio management, based on cost and risk analysis. Implemented first phase o f tax reforms: Prepared a cost-benefit analysis o f eliminating existing sectoral and regional tax exemptions, enabled Internet registration for the single taxpayer identification number (RUC) and made updated R U C database available by Internet.
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l2 Including Peru’s DECSAL and PSRL series, and the Development Policy Lending Retrospective, July 7,2006.
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0 Defined action plan and implemented f i rs t steps for adopting a TSA, aligning budget classification to international standards and with the chart o f accounts, automatic accounting by SIAF, and approved Treasury System Law and Accounting Law.
0 Enacted regulatory framework for performance measurement and reporting, linking the budget presentation cycle with performance indicators, by which al l sectors and regional governments are required to generate output and performance indicators as part o f their budget submission. The 2007 sector budget submission included sector performance indicators (programs, activities and projects), including the environment.
Competitiveness 0 Signed Peru-US FTA and ratified by Peruvian Congress. 0 Reduced from 7 to 4 percent tar i f fs to capital goods on 196 lines and published national
guidelines for tariff policy. 0 Created a Ventanilla Unica, one-stop shop, with the objective o f establishing uniform
authorization and control o f imports and exports subject to non-tariff measures. 0 Launched a strategy o f e-government, including a web portal o f public services such as
tax administration and c iv i l registry, and issued National Digital Agenda.
76. The key measures highlighted as triggers for the next DPL in the series are listed below:
Efficiency and Quality o f Fiscal Management Comply with fiscal rules-including a limit of 3% real increase annually on current spending-with a fully functioning Fiscal Pol icy Committee, and Comptroller i s monitoring compliance with fiscal rules to al l levels o f government. Implement the second phase o f reforms to increase efficiency and neutrality o f the tax system: for example (i) initiate a strategy to eliminate sectoral and regional exemptions based on a cost-benefit analysis, or (ii) reduce the effective rate o f the Financial Transactions Tax (ITF) to a minimum level. Consolidate TSA in the Banco de la Nacidn, establish revenue and payments mechanism ensuring automatic conciliation, and unify budgetary and accounting classification systems, including incorporation o f the chart o f accounts into the SIAF. Review and launch action plan for institutionalizing results-based budgeting (performance measurement, reporting -and subsequently- budgeting), managed and overseen by the MEF and based on the use o f the government-wide M&E system and relating fund allocation to measurable results in the form o f outputs and/or outcomes. Introduce programmatic formulation o f budgets at the sectoral level for key programs, and issue regulations to formalize executive evaluations as a component o f the budget cycle, and undertake two pi lot executive evaluations each in two different sectors.
Competitiveness 0 Continue trade negotiations to expand market access to Peruvian exports.
Implement complementary measures to facilitate trade and customs clearance, for example (i) the implementation o f the Ventanilla Unica or (ii) the reduction o f average tariff or tariff dispersion. Continue effective promotion o f e-government, for example (i) integrate SEACE wi th S IAF at the process level (e.g., commitments and payments) and at the catalogue level
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(adopting international accepted catalogue o f goods and services), (ii) issue and implement the new regulation o f Electronic Signatures, or (iii) submit to Congress Draft Law on National Information System. Expand the TrumiFuciZ program to reduce the time and cost o f receiving a business operating licenses to at least three provincial municipalities. Adopt regulations for sound and sustainable deepening of micro and consumer lending, for example (a) regulation on widening of the scope o f financial services and operations by smaller financial institutions (mostly focused on micro entrepreneurs); or b) regulation for wel l managed growth in consumer and micro-loans, reducing over-indebtedness risk.
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E. Co-Financing Arrangements, Institutional Coordination and Partnerships
77. The Bank has deepened partnership arrangements established for the DPL series for the previous administration. KfW, the German Development Bank, co-financed D C D P L I1 and 111, and plans to co-finance the first loan o f the proposed new programmatic series to the amount o f US$25 million. KfW participated in the Identification, Pre-Appraisal and Appraisal missions and worked with the Bank and the Government to develop the agreed pol icy matrix. The co-financing arrangement serves as an important step in improving donor cooperation in Peru. KfW i s preparing a program evaluation report for the German government, which w i l l make the final decision on co-financing F M C D P L I. Due to the excellent cooperation o f the two institutions during the previous programmatic series, a strong partnership has been established with KfW.
78. KfW has approved a related operation aiming to bolster the role of local governments in the Peruvian state organization and in the fight against poverty. The operation i s now awaiting the final approval f rom the GoP. Financing of social infrastructure at the local level in Lambayeque and the northern part o f Cajamarca wil l be combined with competitive and performance-oriented measures to stimulate good practices o f local governance, as wel l as training in several areas including the use o f SIAF. As well, the German Peruvian Fund-Debt for Development-was created in April 2003 with the mission o f financing small projects o f poverty reduction within the priority areas o f German cooperation with Peru, which are (i) democracy, c iv i l society and public administration, (ii) drinking water and sewerage, and (iii) sustainable rural development.
79. The FMCDPL series has been coordinated with other donors, and serves as an important reference for other donor activities in Peru related to fiscal management and competitiveness issues. GoP i s currently in discussions with the IADB on a three-year, US$600 mi l l ion policy-based operation. The Bank, the IADB, and the GoP have discussed both policy matrixes to ensure complementarity and avoid overlap. The IADB operation takes as its principal focus the management o f the pension funds (APPs) and public investment. A component o f the program addresses aspects o f results-based budgeting, as does the Bank operation. However, the IADB actions in this regard are focused specifically on public investment spending, rather than the entire budgetary framework. The init ial guidelines and pi lot supported in the IADB operation w i l l provide a useful test that can be employed as the GoP scales up results-based budgeting to the entire public sector, supported by this proposed series. U S A I D i s implementing three related technical assistance and grant programs: Pro- Decentralization Program (Programa Pro-DecentruZizuci6n-PRODES), which provides
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assistance to regional and municipal governments in budget planning and expenditure management in 537 municipalities in f ive regions (active until 2008); Participa Peni, which supports c iv i l society participation in the design and oversight o f the decentralization process (active until end-2006); and Creating Conditions for Economic Revitalization (CRECER), addressing issues o f administrative simplification for growth (active until 2008). The CRECER project i s proceeding with input from the IFC Technical Assistance Facility simplification project in L i m a (see below), and i s taken into account in this loan design.
80. IFC experiences in Peru have been instrumental in helping shape this proposed loan series. The IFC Technical Assistance Facility has been very active in Peru in two areas o f particular interest to this loan: use o f the sub-national resources derived f rom mining industries, and in administrative simplification on the municipal level. Regarding mining income, the IFC has considerable experience with municipalities in the area o f the Yanacocha mine in northern Peru, helping governments to manage the increasing resources f rom the mining canon and finding efficient and effective ways to put those resources to use. In administrative simplification, the IFC experience with the provincial municipality o f L i m a has been highly successful, and i s now being scaled up to other provincial municipalities. Bank-IFC dialogue on both o f these issues strongly informed the policies supported by this proposed loan series.
81. The World Bank and the IMF have engaged in a continuous dialogue on the World Bank’s country partnership implementation. F M C D P L has been coordinated with the IMF at al l stages. The dialogue has concentrated on the macroeconomic background, setting o f triggers, and risks, and estimation o f fiscal implications o f Bank’s operations. The IMF has provided technical assistance in the area o f tax policy and administration. Joint work in particular continues in the area o f fiscal decentralization and tax reform.
82. Regarding this operation, the GoP-via the Ministry of Finance (MEF), the operation’s main counterpart-led discussions with the Bank team and other relevant government agencies. The GoP involved al l sectoral ministries and the National Decentralization Council (CND) in the design o f this loan, as wel l as representatives o f sub- national governments. Issues related to this operation were also discussed in meetings held under government auspices for the preparation o f the CPS, including representatives o f small- scale farmers and businesspeople f rom the mountain region in Ayacucho, private sector representatives in Lima, regional and local government representatives, urban and rural businesspeople, and a mixed group with members o f community organizations, indigenous groups, academia, religious groups, and NGOs. The importance o f improved service delivery and strengthening the capacity o f sub-national governments was highlighted at several o f these meetings. On decentralization-related issues, the US AID-funded PRODES l3 has taken the lead in the last three years in organizing various forums for government officials and c iv i l society to discuss issues raised by the decentralization process. The Defensoria del Pueblo (Human Rights Ombudsman, elected by Congress) has participated in many o f these events. At the request o f the MEF, the Bank organized two workshops on October 24 and 25 o f this year on results-based budgeting, the first to give an overview o f the requirements and benefits o f the process for Peruvian legislators, and the second to outline international experiences on the issue to h4EF officials.
l3 For more information on PRODES, see their website at www.prodes.org.pe.
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V. Operation Implementation
A. Poverty and Social Impact
83. The proposed loan is expected to have significant poverty and social effects, mainly positive but some negative. Both the fiscal management and competitiveness components o f the loan are expected to reduce poverty. Reforms to improve the transparency and quality o f public spending and the provision o f public services wil l allow programs that promote human capital development and act as a social safety net for the poor have a greater impact on the targeted population, and overall public savings through better fiscal management wi l l allow the GoP to dedicate more resources to pro-poor programs. As well, steps to promote strengthened fiscal management at the decentralized level wi l l increase the effectiveness o f fiscal resources, devolving spending authority to lower levels o f government that are more aware of local needs. Policy actions to improve the distributional impacts o f fiscal transfers, including natural resource income, w i l l also help redress the large disparities between the coastal, mountain, and jungle regions. The competitiveness component o f the proposed loan i s also expected to have a largely positive and significant impact on poverty. Policies supported by the series involve removing existing obstacles to faster and broader economic growth. Changes l ike reducing the time and cost o f obtaining a business license or resolving a business dispute wi l l have a strong impact on the growth o f smaller and medium-sized businesses, which in turn w i l l have the greatest impact on employment. Likewise, policies to expand exports beyond commodities to non-traditional exports w i l l lead to greater employment growth and poverty reduction.
84. At the same time, Peru’s greater integration into the world economy-which i s supported by this loan-will provide greater opportunities for economic growth and lower consumer prices for the poor, but may also lead to economic dislocation in some sectors of production. The GoP i s working to minimize possible impact. One o f the flagship programs o f the new administration i s Sierra Exportadora, a package o f measures designed to promote greater economic opportunities through trade and market integration to poorer, heavily indigenous Andean mountain region. Proposals include directing significant technical assistance, infrastructure investment, and credit to boost export-oriented agriculture, forestry and artisan produce based on local knowledge and specialties. The Bank’s Sierra Development Project, proposed as part o f the CPS, would support aspects o f Sierra Exportadora. A study to review progress o f FTAs i s also planned under the CPS, which wil l provide information on impact o f trade opening on small producers and other vulnerable populations, among other things. This would complement studies done under the Peru CEM on the distributional impact o f FTAs, which based on strong assumptions o f elasticities and demand functions, found a possible short term negative effect o f trade liberalization mainly in populations and regions dedicated to traditional agriculture. The GoP intends to present to Congress a proposal o f compensatory measures to affected sectors, and they have requested assistance from the Bank to design and evaluate appropriate mechanisms. A pol icy package comprising compensations to affected segments o f the population, modernization o f agriculture, promotion o f exports o f the Sierra and incentives for the transfer o f resources towards higher value exportable agricultural should help mitigate short-term transition costs and distributional impact. As well, the GoP intends to precede these reforms with dialogue and negotiations among interested parties to smooth their implementation.
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B. Implementation, Monitoring and Evaluation
85. proposed operation using the different sources, among them:
The Bank wi l l monitor actions and review progress o f the implementation o f the
Fiscal Transparency Reports - MEF, www.mef.aob.pe Leading Indicators Reports - MEF, www.mef.aob.pe Central Bank o f Peru, Reports and Research Publications, www.bcrp.gob.pe SIAF - MEF, www.mef.aob.pe Instituto Nacional de Estadistica (INEI), www.inei.aob.pe Investment Climate Survey Credit Rating Agencies Reports - several sources World Bank Governance Indicators Doing Business Indicators Zndice de Gestibn Gubernamental - Universidad del Pacific0 Ciudadanos a1 Dia - Reports and Technical Notes, www.ciudadanosaldia.org Government Tax Agency SUNAT - www.sunat.pob.pe IMF and IADB reports
86. The GoP and the Bank have agreed to monitor progress in the DPL program regularly, including the annual reviews of CPS progress. The Sectoral Loans Coordination Unit (Unidad de Coordinacibn de Pre'stamos Sectoriales-UCPS) in the MEF i s the main counterpart agency for the proposed loan, which w i l l be in charge o f M&E for the loan and for collecting the appropriate data to follow the proposed indicators. The UCPS wi l l also coordinate with the Bank to collect baseline numbers for numerical indicators. Other important agencies are the BCRP, SUNAT, PCM and MINCETUR.
87. Semi-annual reviews will take place between the MEF and the Bank team aimed at identifying areas of strengths and weaknesses. The mid-tern review w i l l be made in the first quarter of 2007, when the GoP and the team wi l l jointly evaluate progress in achieving the outcomes laid out for the program. Indicative targets for this medium-term review include:
Fiscal deficit < 1 percent of GDP Real current expenditure growth <3 percent
0 Number o f executive evaluations of public expenditure 0 Execution of public investment by regional governments in the two regions with MEF
deconcentrated offices increases from 55 percent to 75 percent 0 Number of new exporting f i r m s located in developing regions increase by 20 percent
Number o f business with operating licenses in municipalities
C. Fiduciary Arrangements
88. The Bank reviewed the current status of the public financial management (PFM), and concluded that although progress has been made, many of the same issues identified in the 2001 Country Financial Accountability Assessment (CFAA) remain problems today. This conclusion i s supported by the draft Country Financial Management Strategy (CFMS)
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currently under preparation, as well as the conclusions o f the I M F ’ s 2004 Fiscal Transparency Report on Observance o f Standards and Codes (ROSC). The review looked at public sector financial accountability arrangements; the legislative framework; the application o f appropriate accounting standards and the reporting formats; the competence o f financial staff generally, and the adequacy o f financial management systems and practices, including cash management, planning, control, and supervision o f financial operations. Overall, Peru has made reasonable progress in financial management and transparency, particularly wi th the implementation o f the SIAF. However, a number o f problem areas remain, including: (i) lack o f comprehensive legislation governing financial administration; (ii) excessively complex regulations and overly- centralized control by the MEF; (iii) lack o f sufficient funding to the Comptroller General (Contraloria General de la Repziblica-CGR) to maintain i t s independence and do i t s job; (iv) improved but s t i l l insufficient information provision to Congress and the general public to properly oversee public expenditure; (v) the need to expand SIAF and harmonize i t s systems with other instances o f public finances; (vi) under-developed anti-conuption measures; and (vii) inadequate oversight o f spending by the Ministry of Defense.
89. A n update of the 2001 CFAA (or some proxy thereof) i s planned. The main activity that would fill the information gap w i l l be for the GoP to conduct (with Bank assistance) a PFM Systems Self-Assessment, using the Public Expenditure and Financial Accountability (PEFA) Framework. This exercise provides a common platform for assessing essential PFM systems and monitoring PFM performance. The assessment would include Peru’s oversight environment, accountability and transparency policies, and information systems. The self-assessment would also give the GoP and IBRD an opportunity to analyze together various fiduciary issues, and provide the government wi th a sense o f ownership that encourages addressing identified weaknesses. During the preparation o f each project the Bank wil l review the progress in addressing the issues identified through the PEFA self-assessment, which in turn would feed sector or project specific information into the country dialogue. In keeping with the new push toward decentralized fiscal management, the Bank w i l l also be encouraging two local governments to undertake self-assessments as well, l ikely the municipalities o f L ima and Arequipa.
90. Overall, reforms related to transparency in the public sector have been weak, and efforts to enforce anti-corruption laws even when auditor findings support enforcement have been limited. The current approach to ethics in government i s not supported by comprehensive legislation, funding or even a commitment to enforce an anti-corruption plan. The CGR developed and published a proposal for a national anti-corruption plan that would bring Peru’s approach and legislation in l ine wi th the practices applied in other countries in the region. This has been developed into the new CGR strategy document, “Lineamientos Estratkgicos”, but i t has not yet been formalized. Although the Fiscalia de la Nacibn (part o f the judicial branch) has financial specialists to investigate allegations o f corruption, CGR believes that there have been few successful prosecutions because o f the absence o f specialized courts to try these types o f offenses and the l imited resources available to the CGR for prosecution.
91. Due to the importance of fiscal management in this operation, the team closely assessed the performance o f SIAF, and noted several weaknesses that should be addressed, coinciding with the IMF R O S C conclusions in this area. Among the principal shortcomings noted were poor flexibility in report preparation and account details for project management, and lack o f reconciliation between the S IAF and other information systems that may create
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information gaps, involuntary errors or mistakes, and lack o f transparency on information management. Recommendations to address these problems include:
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Improve the SIAF software to allow i t s use on the Internet
Extend the use o f the SIAF to project implementing units
Use other information technology systems only when they are compatible wi th S IAF or could be interconnected with S IAF by the transfer o f archives
Record information on budget amendments
Al low the formulation o f monthly and quarterly budget allocations
Al low the record o f commitments
92. The Bank i s preparing a CFMS to cover the new CPS period that w i l l focus primarily on three main areas: a) improving the country’s disbursement ratio; b) promoting the anticorruption and governance agenda; and c) modernizing national and decentralized PF’M systems and practices.
93. The implementation of PFM reforms to increase the transparency o f processes i s likely to reduce transaction costs and generate of economies of scale. The Bank’s experience in other Latin American countries such as Chile, Brazi l and Mexico indicates that efficiency in public financial management generates savings that greatly exceed the government’s investment in reforms. Practical observations in the f ield on the implementation of integrated PFM systems clearly show that more reliable, transparent, accurate use o f data benefits the decision-making process. The Bank w i l l work closely wi th the Government to create the necessary tools to ensure the provision o f statistical information as part o f these CFMS objectives.
94. The IMF Fiscal ROSC of 2004 noted that the BCRP enjoys statutory autonomy in managing monetary policy, and i ts relations with the GoP are clearly defined by law. The BCRP has i t s own legal status and charter, and i t s sole responsibility i s to preserve monetary stability. The BCRP’s Board o f Directors i s appointed on an equal basis by the executive and legislative branches. The BCRP i s not allowed to provide financing to the Treasury or to off icial development financial institutions, or to extend collateral or guarantees. I t s activities are governed by Article 84 o f the Constitution and i t s own charter o f December 1992. I t i s subject to ex post control by the CGR and to supervision by the SBS. I t demonstrates fulfil lment o f i t s functions through publication o f an annual report (including audited financial statements) and reports on the performance o f the monetary program. A BCRP safeguard assessment update with regard to the new arrangement wi th the IMF i s currently underway and w i l l be ready by 2007.
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D. Disbursement and Audits
95. Disbursement arrangements will follow the procedures for DPL set out in OP 8.60: “Except as the Bank may otherwise agree (i) the single tranche withdrawal f rom the Loan Account shall be deposited by the Bank into an account designated by the Borrower and acceptable to the Bank which forms part o f the country’s foreign exchange reserves at the Central Bank o f Peru; and (ii) the Borrower shall ensure that upon deposit o f the Loan into said
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account, such amount or an equivalent amount i s credited in the borrower’s accounting system to an account, acceptable to the Bank, that finances budget obligations.” The Government w i l l be required to provide confirmation o f steps (i) and (ii) as soon as the tranche i s received. The proceeds o f the loan may not be used to finance expenditures typically excluded under the Loan Agreement.
E. Environmental, Forest and Natural Resource Aspects
96. The policies supported by this DPL operation are expected to entail significant effects on the environment, primarily positive but some negative. Some policies w i l l l ikely prove positive for environmental management, particularly aspects related to improved monitoring and evaluation for government expenditure, including environmental expenditure. This w i l l allow the GoP to set clear environmental priorities, to coordinate wi th environmental authorities on developing indicators to evaluate the impact o f spending on achieving these priorities, and to ensure that al l sectors fol low legal norms related to the environment. The fiscal space created through making the budget and expenditure process more efficient could also serve to strengthen under-funded environmental spending. As well, the decentralization o f S N I P offices and the capacity building program for investment-project preparation launched at the sub- national level should lead to improved environmental assessment o f investment projects. And lastly, this loan’s aim o f broadening exports to the non-traditional sectors w i l l work to reduce Peru’s dependence on resource extraction, which has significant environmental impacts.
97. However, in the medium and long term, further trade liberalization and economic activity in Peru-though desirable for growth and poverty reduction-will lead to greater infrastructure development and resource use that could negatively affect the environment. The Bank recently completed a Country Environmental Assessment, highlighting shortcomings in Peru’s institutional framework for environmental protection and sustainability. I t also pointed to the need to not only continue focusing on protection natural areas such as tropical forests, but also mitigating the serious health impacts and high costs o f environmental degradation, particularly related to air and water contamination. As a result o f this study and the ensuing dialogue with GoP, the Bank i s planning two environmental DPLs in coming years. Principal topics to be addressed in the loans w i l l be reordering the institutional and legal oversight for the environment, both at the national level-possibly through the creation of a new, single authority-and at regional and municipal levels. The Bank i s also exploring the possibility o f requesting an Institutional Development Fund grant or partnering wi th other donors interested in environmental issues to promote capacity building. Decentralized environmental oversight o f the mining sector w i l l be a priority, as wel l as adjusting spending priorities to achieve concrete results in reducing air and water contamination. In addition, the Bank w i l l explore wi th the authorities the possibility o f including environment and resource management as part of the desk evaluations pilots programmed for the next years.
F. Risks and Risk Mitigation
98. The most significant political risk i s if political momentum slows, especially if the November municipal elections are unfavorable to the administration, and the reform
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agenda i s scaled back. Although currently supportive, Congress i s divided and could make reforms difficult to push through. The administration must move quickly to demonstrate i t s ability to make changes and maintain growth, and to convince voters that President Garcia i s a different kind of leader than during his f i rs t government. I t w i l l be particularly important to undertake high-visibility programs in the poorer, highland regions, whose population voted strongly against President Garcia in favor of the more populist opponent Ollanta Humala. A weakening of support for the goals of the administration could be somewhat problematic for this first operation, but would be more so for future planned loans in this series, which call for more ambitious advances in policy reform. The process of decentralization and efforts to create a more equitable transfer system to reduce regional inequalities could be compromised if politicians opposed to the administration take power in local and regional governments. As well, the administration could move forward with decentralization more quickly than prudent for political reasons, possibly running up against local capacity problems or creating administrative confusion. Reforms to promote performance-based management could generate opposition from politically active interest groups, such as public employee unions.
99. President Garcia i s aware of the importance of creating and maintaining political momentum to move his program forward. H e has launched a high-profile series of actions for his first 180 days in government as a way to quickly demonstrate his determination to move forward and to take advantage of the political honeymoon following his election. Governance reform and decentralization are particularly high on this agenda. Also key i s the President’s proposed Sierra Exportadoru program, to boost economic activity in the Andean region where his support was low during the election. This i s a salutary change from the frequent practice withholding support from regions opposed to the victorious party during an election. Government officials are also reaching out by re-engaging in the Acuerdo Nacional, a group of political parties, religious and community groups, academics and NGOs who came together in 2002 to help generate a consensus on a broad national agenda. The Bank and IFC, as well as bilateral donors such as KfW and USAID, have also been active in meeting with civic groups and local governments in an effort to strengthen consensus behind the reforms embodied in this loan series. Regarding public employee opposition to results-oriented budget reforms, the GoP intends to implement these reforms gradually, starting with a few selected programs in three or four ministries. As well, the administration w i l l emphasize that newly-designed performance indicators wi l l not be used as a threat to reduce funding for certain programs, but rather as a way to ensure priority programs achieve desired outcomes, which in some cases may result in increased funding.
100. Social r isks relating to protests do exist in Peru, but they are generally isolated and limited to specific grievances, and have not had a major destabilizing impact on either the economy or the political system. One area of tension i s the resource-extraction industry, which has been accused b y community residents near some mines and o i l wells of polluting, leading to protests, particularly in remote areas with limited state presence. The new administration has for the f i rs t time created a Conflicts Unit in the Presidential Council of Ministers, a high-level office for negotiating conflicts as they arise. The unit works hand-in-hand with the Defensoria del Pueblo (Human Rights Ombudsman) to create a space for dialogue with disaffected groups. A first result has been the peaceful negotiations with the Achuar indigenous group in Loreto in October 2006, which has protested pollution and lack o f social benefit from o i l production in their region. The negotiations led to a decree mandating that a portion o f the o i l canon for Loreto be specifically dedicated to ethnic groups in the region, as a way to finance projects to
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improve their living conditions, and also commitments by the o i l company to undertake environmental rehabilitation. The work o f IFC’s Technical Assistance Facility on improving the use o f mining canon use around the Yanacocha gold mine has also been successful in illustrating how the industry can benefit local communities. As part o f the CPS, the Bank i s planning a series o f environmental DPLs to help strengthen the GoP’s ability to address the environmental impact o f resource extraction industries.
101. The most important economic risks relate to Peru’s vulnerability to changing international conditions and i ts ability to maintain fiscal discipline. If Peru’s economic stability were to be reversed, this could have a negative impact on the continuation of the reform program and on the country’s ability to service i t s loan obligations. The most serious threat to macroeconomic stability would come from a deterioration o f the currently favorable external economic conditions. A drop in the international prices o f Peru’s main traditional exports, in particular minerals, which has powered a good portion o f the country’s impressive export growth in recent years, would be a major blow to the export sector and the economy as a whole. As well, the U.S. economy-the largest market for Peruvian exports-could slow down, reducing demand, and the ending of preferential access to the U.S. in 2006 could hurt textile exports in particular i f the FTA i s not ratified in the U.S. Congress by the end o f this year. An increase in U.S. interest rates would impact the ability o f both the Government as wel l as the economy as a whole to access credit on reasonable terms. On the fiscal side, political pressures and increased government revenues could lead to a deterioration o f fiscal accounts should the GoP attempt to placate opposition with increased government spending. Whi le the financial sector is generally sound, Peru’s banks have a very high ratio o f dollar liabilities, while most o f their assets are in local currency, which could become a problem in the event o f a currency devaluation.
102. These economic risks are being mitigated in a number of ways. Most importantly, while non-traditional exports remain relatively low, they now comprise a significant portion o f total exports and are growing very rapidly, much faster than traditional exports. Further, the Government i s actively pursuing trade agreements, having completed and signed the Peru FTA with the U.S. and lobbying actively in the U.S. Congress for i t s ratification, and also branching out in search o f other export markets in Europe, Asia, and elsewhere in Lat in America. The combination o f these two trends-diversification o f products and o f markets-is reducing the risk o f major shifts in Peru’s terms o f trade due to exogenous factors. Regarding interest rate increases, the Government’s disciplined fiscal performance in the past several years has greatly reduced country r i s k and lowered interest rate spreads, meaning the cost o f rising international interest rates w i l l be lower than previously. Should current trends continue, Peru may soon be qualified as investment grade b y the major international rating agencies. As well, the increasing liquidity o f the local currency debt market for both sovereign and corporate debt-supported by a stable currency and low inflation-is easing the country’s dependence on external credit, and also reducing dollarization o f financial markets. A new regulation on credit r isks in dollar credits to uncovered borrowers implemented in 2005 i s a positive step to make banks internalize the credit risk associated with borrowers’ currency mismatches and reduce incentives for dollarization.
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A N N E X 1 Letter of Development Policy (English Translation Follows)
"AN10 DE LA CONSOLlDACldN o E M O C ~ T l C A *
MINJSTERIO DE ECONOMM Y FtNANZAS Despacho Ministerial
Luis Cnrranzi, Ugerte #Inisfro
CARTA DE POLlTfcA SECTORML
SpiEor Paul Wolfowitz Presidenfe Banco Mundial Presente.-
Referencia: Prbstamo ProgmmBlico de Apoyo a/ Foti8/ecimit?nto a la GestirSn Fiscal para el Cmim&nfo Ecan6mjco
Estimado seifor WolfowHr,
Mediante la presente b manifiesto el compromiso del Gobienio del Presidente Alan Garcia P&ez de consolider una pditics econ6mice y fiscal orientada a/ crecimiento sostenido con base en el aumento de la inversidn ptibtica y privsda, la reestructumcidn y eficienciia del gasto ptihljm, y la disminucicin de las hequidades existentes, de manere que 10s beneficios del crecimiento econhico y la descentrafizacibn seen empliamen fe canpartidm por /a poblaci6n.
En este marco, se he desamllado el "Pdstamo Pivgrarndtico de Apoyo a/ Fortalecirnienta de la Gestic513 Fiscal y Crecimiento Econcirnico" con el Banco Mundial (EM), soticitado por el monto de US$ 200 millones. que comprendera acciones especfficas en dos campos: (i) efktencia y celidad de la gestion fiscal y gasto pliblico y (/i) fotialecimiento de Is competitividad del pais. A contitwacih sa describe el contexto ewrn5mico del Per0 y posteriomente /os objetivos y las reformes restiradas y /as propuestas para el prestamo sdth5tarlo.
A. Context0 econ6tnico
Duranfe 10s Olt!mas aiios, /as indimdares econdmicos del Perti hon rnostrado un notable grad0 de estabilidad debida a1 consenso poli'tko sobre la irnportancia de msntener un confexfo mameconbrnico sostenible y una gestibn fmanciem responsable.
- - . __I - - . - Minrsterio de Economla y Finanrtls
Jr Junin 319, Lima - Pis0 4. lel&fonos (51 1) 428-9630
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Letter of Development Policy English Translation
Lima, November 9", 2006
Mr. Paul Wolfowitz President World Bank
Reference: Programmatic Loan for Fiscal Management and Competitiveness
Dear Mr. Wolfowitz,
Through th is letter I would like to express you the commitment o f the government o f President Alan Garcia to consolidate economic and fiscal policy to sustain growth through increasing public and private investment, restructuring public expenditure and making it more efficient, and reducing inequalities, in such a way that the benefits o f economic growth and decentralization are widely shared by the population.
The Programmatic Loan for Fiscal Management and Competitiveness was developed in th is framework with the World Bank (WB), asking for an amount o f US$200 million, which w i l l entail specific actions in two areas: (i) improving the efficiency and quality o f the fiscal policy and public expenditure, and (ii) strengthening country competitiveness. In the following paragraphs, we describe the economic context o f the country, the objectives and reforms carried out, and the proposals for the requested loan.
A. Economic Context
During recent years, Peru's economic indicators have shown a notable degree o f stability due to the politic consensus on the importance o f maintaining a sustainable macroeconomic framework and responsible financial management.
The Government w i l l continue implementing economic policies which allow sustainable growth on the basis o f an increase o f private and public investment, increased tax collection, the restructuring o f public expenditure, and a stable currency and national savings.
During year 2005, gross domestic product (GDP) grew 6.4 percent, thus consolidating four years o f continuous growth with an average o f 5.1 percent. The Government intends to maintain a stable economic framework to achieve growth of, initially, 6 percent, and then 7 percent o f GDP.
The growing economy wi l l allow an increase in investment expenditure-reducing current expenditure and increasing social expenditure-with the purpose of, principally, allocating resources to improve l i fe quality o f the poorer part o f the population. In five years, the goal i s to raise investment spending such that investment expenditure accounts for 25 percent o f total public spending and current spending 75 percent. At the same time, social, economic, political and judicial stability w i l l be promoted in order to
47
attract private investment, with a particular focus on encouraging strategic associations between public and private investment to generate the necessary infrastructure for the country.
On fiscal policy, tax collection i s expected to increase to 15 percent of GDP this year. In 2007, the fiscal deficit i s expected to be 0.8 percent o f GDP, and several actions w i l l be taken in order to improve public debt management and prevent unnecessary borrowing at all levels o f government. The goal i s to gradually reduce public debt from 32 percent o f GDP in 2007 to 26 percent o f GDP by 2011.
Regarding the monetary policy, the Government guarantees total independence o f the Central Bank, in order to maintain monetary stability. The inflation target i s not expected to surpass 2.5 percent annually, with a margin o f 1 percent.
Several measures w i l l be taken to promote national savings and reduce the dollarization o f the banking system from 56 percent to 40 percent by 2011. This w i l l reduce the financial risk to families and companies who have loans denominated in dollars while their income i s denominated in soles.
B. Reforms related to the Program
1. Efficiency and Quality of Fiscal Policy and Public Expenditure
Fiscal Policy
1.1
1.2
1.3
The Government’s economic program has as a central objective to maintain sustainable growth with low inflation, a controlled fiscal deficit and a level o f international reserves consistent with the sustainability o f foreign accounts. The final objectives o f th is policy i s reducing poverty, promoting the participation o f all the sectors of society in the productive process, and in th i s way improve the quality o f l i fe o f all Peruvians.
To ensure economic sustainability, the fiscal policy guidelines-established in the Law No. 27245, Fiscal Prudence and Transparency Law (LPTF), modified by the Law No. 27958, Fiscal Responsibility and Transparency Law (LRTF)-are aimed at assuring fiscal equilibrium or surplus in the medium term, accumulating fiscal surpluses in favorable periods and allowing only moderate but not recurrent deficits in periods o f lower growth.
Fiscal Rules. As part o f the reforms related to the program, with the goal o f guaranteeing adequate public finance management, several mechanisms and responsibilities have been established for the compliance o f fiscal rules contained in the Law. The Executive has presented to Congress the Draft Law which authorizes the creation o f a Fiscal Policy Coordination Committee and establishes sanctions for violating the fiscal rules contained in the LRTF. This law includes the rule by which the increase in current non-financial expenditure-excluding maintenance expenditure-cannot be greater than 3 percent in real terms. This restriction to the increase in current expenditure, and the application o f sanctions to the violation o f parameters contained in the LRTF, w i l l allow an improvement in budget reallocation and a gradual reversion o f the current bias against public investment. An important increase in investment i s expected, private and public o f at least 3 percentage points o f GDP by 2011 and 1 percentage point in the short term.
48
1.4
1.5
1.6
Public Debt. Public debt management constitutes a key element to attain fiscal sustainability. I t s goals should be to attract the necessary financing resources to cover the financing needs o f the public sector at reasonable costs and risks, to contribute to the adequate public debt market functioning and to seek mechanisms that w i l l allow a smooth payment profile in the coming years. The objective i s to smooth the repayment profile o f the public debt, extend maturities and favor domestic market issuances in soles as a mechanism not only to reduce financial vulnerability but also to strengthen the transmission channel o f monetary policy. Public debt management also has as a goal reducing public debt/GDP to a level that permits attaining investment grade qualification, which w i l l allow more credits and preferential interest rates.
As well, a significant effort i s being made to quantify the debt stock o f the principal municipalities o f the country in order to evaluate their fiscal sustainability, which has required coordinating with several suppliers, the Banking and Insurance Superintendent, and the Tax Agency, among others. In the medium term, mechanisms are being studied to reward municipalities which clear their debt stock.
Tax Policv. The principal guidelines in the short term are: a) continue with the improvement o f regulations and tax management in order to enhance efficiency and citizen service; b) continue with the elimination o f tax exemptions and other preferential treatments, and avoiding creating new ones; c) continue to combat the serious problem of tax evasion in Peru; d) avoid creating new taxes; and e) continue with the gradual elimination o f tari f fs as a mechanism for economic integration.
Public Expenditure Quality
1.7
1.8
1.9
One major goal i s a more efficient and effective use o f public resources, prioritizing to those who need it most. For this purpose, one important advance w i l l be the identification o f the high- priority results for the country, the connection between these results and the products and services that the public sector provides, and the quality standards that these products must fulfill to satisfy the needs o f the population. The present program develops mechanisms to link instruments and incentives to results-based management and the improvement o f accountable management o f public expenditure.
Government Transfers. During the last years, the transfers to regional and local governments from the mining canon have grown tremendously as a result o f an increase in the income tax paid by mining f m s . These resources, as established by the Canon Law and the Budget Law o f the Public Sector for each fiscal year, must be used by the regional and local governments to finance public investment projects. Nevertheless, despite the increase observed in transfers, regional and local governments have not been using much o f these resources. Among the main reasons limiting execution are weak managerial capacities on the part o f local governments, including a long term vision; the definition o f the source o f funds that assures the current expenditures needed to maintain the investment; and future income projection after the budgetary formulation.
With the purpose of improving regional and local capacities on multi-annual budget formulation, pre investment studies, and investment execution, technical assistance offices are being implemented as decentralized instances of the MEF. During this year, the f i r s t offices w i l l be implemented in the regions o f Ayacucho and Piura, and agreements o f inter-institutional cooperation between the MEF and the respective regional governments are being signed.
49
Results-based management. Traditional analysis o f the quality o f public expenditure has been limited to the financial effectiveness o f public institutions, disregarding the accomplishments or goals that were achieved with the public resources. The growth o f the state, the small size o f the public budget in relation to social needs, and increasing interest for accountability have led to a change in the approach, demanding more information on performance, in terms o f goals and accomplishments o f the public resources.
The Government considers i t necessary to promote results-based management in order to harmonize and complement policies and actions at the sectoral level and within al l three levels of government (national, regional and local); to link strategic and budgetary planning; to reduce budgetary inertia linking allocations to increases in products, services and results; to develop effective evaluations that generate adequate information for decision making; and to implement incentives to improve public administration. For this purpose, the Government has been working with different sectors to strengthen indicators formulation and information registration, so that the 2007 budget law includes clearly defined performance indicators, reflecting development policies. Also, during the f i rs t semester o f 2007 the Government w i l l have an Action Plan for results-based budget and rapid evaluations, and institutional management evaluations w i l l begin.
Additionally, the System o f Monitoring and Evaluation o f Public Expenditure (SSEGP) w i l l continue to be developed, expanding to the national and regional levels o f government. The SSEGP wi l l contribute to a better allocation o f public resources, improved administrative and accounting management, stronger oversight on whether different levels o f government conduct their actions with effectiveness, and greater transparency to civi l society and the public in general. In the medium term, the strategic and programmatic planning o f the sectors are being coordinated with the Comptroller General to institutionalize both the rapid and more in-depth institutional management evaluations.
Imulementation o f a Treasury Sinple Account (TSAZ. Today, there are more than 5,000 accounts from different organizations o f the public sector dispersed between the private banking institutions and the National Bank. This system i s inefficient inasmuch as it facilitates the accumulation o f large balances without use in the financial system and generates a banking intermediation cost. In addition, th i s prevents the consolidation o f the financial situation o f the entire public sector. The implementation o f a TSA has multiple advantages that w i l l solve these inefficiencies and w i l l fortify the management o f the fiscal policy.
2. Strengthening the Country Competitiveness
1.14 International Trade. Because Peru i s a small economy, i t s sustained development depends on the growth o f international trade and the access o f i t s exports to larger markets. Statistics indicate that Peru has great trade potential: in 2005 exports exceeded US$17 billion, with nearly US$1 bi l l ion in agricultural products. The Peruvian Government has been establishing commercial agreements with strategic countries l ike Chile-already signed-Mexico and Singapore-in process-and others, including the European Union. In particular, the U.S. Free Trade Agreement (FTA) offers an opportunity to sell products to a market with a purchasing power 180 times stronger than in Peru. Wi th the negotiations for the U.S. FTA agreement, and ratification by the Peruvian Congress, the country has taken an important step towards consolidating export expansion to give producers the external markets they need to grow.
1.15 Investment Climate Imurovement. The objective i s to support f i r m s by simplifying processes and costs, through the presentation to Congress o f the Framework Law o f the Construction License and the Framework Law o f the Firm Operation License, as well as continuing with procedure
50
1.16
1.17
simplification in several government institutions. Additionally, in order to support firm development, one-stop shop services w i l l be implemented to save time, money and human resources for entrepreneurs and public sector entities.
Institutionalize State Coruorate Purchases. The corporate purchase i s a management tool which allows the aggregation o f demand with the objective o f achieving significant savings through economies o f scale. B y the end o f this year, the number o f entities participating in corporate purchasing i s expected to increase nearly 50 percent, with estimated savings o f around 50 percent o f resources.
Transparency and Access to Information. The Government seeks to promote transparency in the routine action o f the state, in terms o f internal procedures and for the citizens. To this end, the Citizen and Firm Service Portal, which provides systematic information regarding the procedures required by citizens and f i r m s in one portal, w i l l be strengthened.
Conclusion
The Government continues making important actions to consolidate sustainable economic growth with the objectives o f achieving greater efficiency and fairness in the allocation of the public resources, within a fiscal framework based on responsibility and transparency.
The Government i s committed to continue advancing toward these goals, for which i t requires continued support by the World Bank in the indicated areas.
Hereby, the Peruvian Government asks for the approval o f the “Programmatic Loan for Fiscal Management and Competitiveness”.
Yours sincerely,
51
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L
ANNEX 3 Peru- IMF Relations
Press Release No. 06/170 August 1,2006
International Monetary Fund 700 lgth Street, NW Washington, D.C. 20431 USA
IMF Executive Board Completes Fourth and Fifth Reviews under Peru's Stand-By Arrangement
The Executive Board o f the International Monetary Fund completed the fourth and fifth reviews o f Peru's economic performance under a 26-month Stand-By Arrangement, in an amount equivalent to SDR 287.279 mi l l ion (about US$423.6 million), approved on June 9, 2004 (see Press Release No. 04/112). The completion o f the final reviews makes available for purchase the full amount o f the arrangement. The Peruvian authorities have been treating the arrangement as precautionary and indicated that they wil l not make any drawings before the arrangement expires on August 16,2006.
In completing the reviews, the Board granted a waiver o f applicability o f the June 30, 2006 quantitative performance criterion on the borrowing requirement o f the combined public sector, for which data were not available yet. Staff anticipates that this quantitative performance criterion w i l l be met wi th a margin.
Press Release No. 06/224, October 20, 2006
Statement by an IMF Staff Mission in Peru
"An IMF mission, led by Gilbert Terrier, has been in L ima the last two weeks to conduct the 2006 Article I V Consultation and discuss the new government's economic program that the authorities have requested to be supported by a Stand-By Arrangement f rom the Fund.
"The mission has been pleased to hold extensive discussions with government and central bank officials, and a broad spectrum o f representatives f rom the business community, financial institutions, academia, and c iv i l society. These discussions focused on the policy options for Peru to entrench i t s strong economic performance of the past several years and to give assurance that i t s benefits reach al l segments o f the population-key objectives o f the government. The IMF mission has been impressed by the strong consensus in society on the need for Peru to take advantage o f these favorable economic conditions to consolidate macroeconomic policies and pursue reforms that would enhance medium-term growth prospects and decisively reduce s t i l l high poverty levels.
"The discussions have been very productive. The WTt; mission supports the key elements o f the authorities' economic program for the period 2007-08. In the coming weeks, the authorities and Fund staff w i l l finish specifying the remaining elements o f the economic program. Both sides are working toward a timetable for presenting the program to the IMF Executive Board around the end o f the year.''
58
ANNEX 4
Peru a t a glance 8/11/06
Key Development Indicators
(2005)
Population. mid-year (millions) Surface area (thousand sq. km) Population growth (%) Urban population (Yo of total population)
GNI (Atlas method, US$ billions) GNI per capita (Atlas method, US$) GNI per capita (PPP, international $)
GDP growth (%) GDP per capita growth (“A)
(most recent estlmate, 2000-2005)
Poverty headcount ratio at $1 a day (PPP, O h )
Poverty headcount ratio at $2 a day (PPP, O h )
Life expectancy at birth (years) Infant mortality (per 1 ,OOO live births) Child malnutiiion (“h of children under 5)
Adult liieracy, male (% of ages 15 and older) Adult Iieracy, female ( O h of ages 15 and older) Gross primaryenrollment, male (“h of age group) Gross primaryenrollment, female (“h of age group)
Access to an improved water source (% of population) Access to improved sanitation facilities ( O h of population)
PeN
28.0 1,285
1.5 75
73.9 2,840 5,830
8.4 4.9
13 32 70 24 7
93 82
114 114
83 83
Latin America &Carib.
551 20,418
1.3 78
2,210 4,008 8,111
4.4 3.1
9 23 72 27 7
91 90
121 117
91 77
Lower middle income
2,475 39,948
1.0 49
4,746 1,918 8,313
8.9 5.9
70 33 12
93 85
115 113
82 57
Net Aid Flows
(US5 millions) Net ODA and official aid Top 3 donors (in 2004):
Exchange rate (annual average, local per US$) Terms of trade index (2000 = 100)
Population, mid-year (millions) GDP (US$ millions)
Agricutture Industry
Services
Household final consumption expenditure General gov’t final consumption expenditure Gross capital formation
Exports of goods and services Imports of goods and services Gross savings
Manufacturing
1980
202
53 11
1.0 12
59.1 65.9
0.0
17.3 20,861
11.7 42.8 23.5 45.5
57.5 10.5 29.0
22.4 19.4 28.1
1990 2000
400 40 1
79 92 40 192 E 19
1.6 0.8 18 15
7481.7 3.5 6,836.9 3.6
0.2 3.5 121 100
21.8 28.0 28,294 53,088
(% of GDP) 8.5 10.3
27.4 29.9 17.8 15.9 64.1 59.8
73.7 71.0 7.9 10.6
16.5 20.2
15.8 16.1 13.8 18.0 18.4 17.5
2005 a
487
178 90 56
0.7 18
1.5 3.4
3.3 108
28.0 79,283
7.2 34.6 16.3 58.0
66.1 10.2 18.5
24.8 19.4 19.6
Age distribution, 2005
Male Female
7074
8064 5054 4044 3(M4
2024
1014
0.4
15 10 5 0 5 10 15
carcent
I Under-5 mortality rate (per 1,OOO)
I’“1 I 75i n
50
25
0 lsw 1095 2Mo 2104
0 Peru B Latin America 8 the Caribbean
i rowth of GDP and GDP per capita (%)
15 I I
m e5 W
-GDP - GDP per capita
198C-90 1990-2000 200045 (averap annual growth %)
2.3 1.8 1.5 -0.1 4.8 4.2
3.0 5.5 2.8 0.1 5.0 5.5
-0.2 3.8 3.2 -0.4 4.2 3.5
0.7 4.0 3.5 -0.9 5.2 3.1 -3.8 7.4 3.8
-0.9 8.5 9.8 -3.2 9.0 5.7
Note: Figures in italics are for years other than those specified. 2005 data are preliminary estimates. .. indicates data are not available. a. Aid data are for 2 W .
Development Economics, Development Data Group (DECDG).
59
Peru
Ba lance of P a y m e n t s a n d T r a d e
(US$ millions) Total merchandise exports (fob) Total merchandise imports (cif) Net trade in goods and services
Workers’ remittances and compensation of employees (receipts)
Current account balance as a % of GDP
Reserves, including gold
Cen t ra l G o v e r n m e n t F inance
(x of GDP) Revenue
Expense
Cash surpiusldefin’t
Highest marginal tax rate (%)
Tax revenue
Individual Corporate
Ex te rna l D e b t and Resource Flows
(US$ millions) Total debt outstanding and disbursed Total debt service HlPC and MDRl debt relief (expected flow)
Total debt (% of GDP) Total debt service (% of exports)
Foreign direct investment (net inflows) Portfolio equity (net inflows)
2000 2005
6,955 17,336 7,366 12,076
-1,146 4,426
999 1755
-1,527 1,105 -2.9 1.4
8,180 14,097
14.9 15.7 12.2 13.6 18.0 16.5
-2.8 -0.7
20 30 30 30
24,241 22,279 2,117 4,995 - - 45.7 28.1 30.4 23.0
581 2,488 123 -47
Composition of total external debt, 2004
BBRD. 2 . w riDA;iME, iM
h
\ I - US$ millions
P r i v a t e Sec to r D e v e l o p m e n t
Time required to start a business (days) Cost to start a business (“h of GNI per capita) Time required to register property (days)
Ranked as a major constraint to business (“6 of managers surveyed who agreed)
Economic and regulatoly policy uncertainty Anti-competitive or informal practices
Stock market capitalization (% of GDP) Bank branches (per 1 W , W people)
Paved roads (% of total) Fixed line and mobile phone
High technology exports subscribers (per 1 ,000 people)
(Oh of manufactured exports)
E n v i r o n m e n t
Agricultural land (“h of land area) Forest area (“h of land area, 2000 and 2005) Nationally protected areas (% of land area)
Freshwater resources per capita (cu. meters) Freshwater withdrawal (% of internal resources)
CO2 emissions per capita (mt)
GDP per unit of energy use (2000 PPP $ per kg of oil equivalent)
Energy use per capita (kg of oil equivalent)
2000
13.4
115
3.6
17 54.1
1.1
9.8
483
2004
13.1
223
2.1
17 53.7 6.1
56,631 1.2
0.95
11.3
442
(US$ ml//ions)
IBRD Total debt outstanding and disbursed Disbursements Principal repayments Interest payments
IDA Total debt outstanding and disbursed Disbursements Total debt service
IFC (fiscal year) Total disbursed and outstanding portfolio
Disbursements for IFC own account Portfolio sales, prepayments and
repayments for IFC own account
of which IFC own account
MlGA Gross exposure
2,590 266
93 189
0 0 0
292 157 70
10
329
2,816 192 210 105
0 0 0
287 236
0
2a
65 0 New guarantees 40
R
Note: Figures in italics are for years other than those specified. 2005 data are preliminary estimates. 8/11/06 .. indicates data are not available. -indicates observation is not applicable.
Development Economics. Development Data Group (DECDG).
60
Millennium Development Goals Peru
With selected targets to achieve between 1990 and 2015 (estimate closest to date shown, +I- 2 years)
Goal 1: halve the rates for $1 a day poverty and malnutrition 1990 1995 2000 2004 Poverty headcount ratio at $1 a day (PPP, %of population) <2 6.9 18.1 12.5 Poverty headcount ratio at national poverty line (% of population) Share of income or consumption to the poorest qunitile (“A) 3.2 Prevalence of malnutrition (% of children under 5) 1 1 8 7
49.0
Goal 2: ensure that children are able to complete primary schooling Primary school enrollment (net, %) 98 97 Primary completion rate (%of relevant age group) Secondary school enrollment (gross, %) Youth literacy rate (% of people ages 15-24)
90 103 100 67 86 92 94 97
Goal 3: ellminate gender disparity in educatlon and empower women Ratio of girls to boys in primary and secondary education (“A) 96 97 100 Women employed in the nonagricuitural sector (“A of nonagricunurai employment) 29 32 33 37 Proportion of seats held by women in national parliament (%) 6 11 11 16
Goal 5: reduce maternal mortality by three-fourths Matemai mortality ratio (modeled estimate, per 100,000 live births) Births attended by skilled heanh staff (“A of total) 56 59 71
410
Goal 6: hait and begin to reverse the spread of HlVlAlDS and other malor dlseases Prevalence of HIV (%of population ages 15-49) Contraceptive prevalence (%of women ages 15-49) incidence of tuberculosis (per 100,000 people) Tuberculosis cases detected under DOTS (“A)
0.6 55 64 69
394 178 101 87 83
Goal 7: halve the proportion of people without sustainable access to basic needs Access to an improved water source (“A of population) 74 83 Access to improved sanitation facilities (% of population) 52 63 Forest area (% of total land area) 54.8 54.1 53.7 Nationally protected areas (% of total land area) 6.1 C02 emissions (metric tons per capita) 1.0 1.0 1.1 1.0 GDP per unit of energy use (constant 2000 PPP $ per kg of oil equivalent) 8.4 9.6 9.8 11.3
lntemet users (per 1,000 people) Personal computers (per 1,000 people) Youth unemployment (“1. of total labor force ages 15-24)
Goal 8: develop a global partnership for development Fixed line and mobile phone subscribers (per 1 ,000 people) 26 50 115 223
0 0 31 117 15 40 98
15.6 13.3 13.6 19.2
Education indicators (??)
:,1 --a 50 75 L 1998 2Mo 2w2 2004
+Primary net enrollment ratio
-0- Ratio of girls 10 boys in primary & secondary education
Jleasles immunization (%of 1-year olds)
125 7
m
75
50
25
0 1990 1995 2Mo 2004
0 Peru 0 Latin America & the Caribbean
CT lndlcators (per 1,000 people)
n 150
1w
Eo
0 xoo 2002 2w4
0 Fixed + mbtle subscribers B2 Internet users
Note: Figures in italics are for years other than those specified. .. indicates data are not available
Development Economics, Development Data Group (DECDG).
Public finance (as % of GDP at market prices)' Current revenues 14.2 Current expenditures 14.6 Current account surplus (+) or deficit (-) -0.3 Capital expenditure 2.0 Capital revenue 0.2 Overall Balance -2.1 Foreign financing 2.0
Monetary indicators M2lGDP Growth of M2 (%)
25.2 4.8
Price indices( YR94=100) Merchandise export price index 97.8 Merchandise import price index 178.2 Merchandise terms of trade index 54.9 Real exchange rate (US$/LCU)f 99.3
Real interest rates Consumer price index (W change) 1.5 GDP deflator (% change) 0.8
14.8 14.9 14.8 14.4 0.0 0.5 1.9 1.8 0.2 0.1
-1.7 -1.2 1.6 1.6
24.3 22.7 2.8 12.5
105.9 129.6 194.0 223.1 54.6 58.1
103.1 105.1
2.5 3.5 2.6 5.6
15.7 14.6 1.1 1.9 0.1
-0.7 -1.2
23.2 15.1
150.8 246.7 61.1
105.8
1.5 3.4
16.9 14.3 2.6 2.3 0.1 0.4
-0.3
22.6 13.4
204.6 262.0 78.1
106.0
1.5 1.6
16.0 14.1 1.9 2.8 0.1
-0.8 -0.2
23.1 9.4
198.5 267.8 74.1
105.1
2.5 2.1
16.0 13.7 2.3 3 .O 0.1
-0.6 -0.2
23.8 8.6
196.5 275.6
71.3 104.6
2.5 2.1
16.4 13.4 3.0 3.2 0.1
-0.1 0.0
24.2 8.6
197.9 283.0 69.9
104.0
2.5 2.3
a. GDP at market prices b. "GNFS" denotes "goods and nonfactor services." c. Includes net unrequited transfers excluding official capital grants. d. Includes use of IMF resources. e. Consolidated central government. f. "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation.
63
ANNEX 6 DEBT SUSTAINABILITY ANALYSIS
A. Debt Trends Peru’s debt levels have been on a declining trend. The total gross stock o f Peru’s public debt declined from over 63 percent o f GDP in 1993 to about 40 percent in 1997. The debt ratio increased to about 50 percent in 1999 and declined again to an estimated 32.8 percent o f GDP in 2006.19 These trends were mainly as a result o f improvements in fiscal balances at different levels o f government during the economic expansions o f 1995-97 and 2003-05, privatizations, and revaluation o f the local currency during 2001- 05. These outcomes are in l ine wi th a study on emerging market debt dynamics that finds that primary fiscal surpluses and real GDP growth were the main contributors to reductions in the debt-to-GDP ratio in a set o f 21 countries f rom the period 1991-02.20
The general government and the non-financial public sector ( N I T S ) have posted a series of improving balances, strengthening f rom -2.8 percent of GDP and -3.3 percent o f GDP respectively in 2001 to surplus o f 0.6 percent o f GDP in 2006. These balances reflect increases in revenues and to lesser extent declining expenditures. On revenues, tax collection improved since 2002 due to transitory factors such as the increase in Peru’s export prices, economic growth and the tax reform enacted in 2002. Total revenues for 2006 are estimated at 19.3 percent o f GDP, up f rom 17.4 percent in 2001. On the expenditure side, total general government expenditures decreased to an estimated 18.8 percent o f GDP in 2006 f rom an average o f over 21 percent o f GDP in 1999 and 2000.
Although the current debt-to-GDP ratio o f about 32 percent may be considered an acceptable level for Peru, research has shown that high levels o f debt can have significant negative impact on growth,21 and that countries with high inflation and default history have higher r isks o f a debt crisis even wi th l o w external debt levels o f 15 percent o f GNP.22 IMF research suggests that the conditional probability o f a crisis i s zero with debt levels o f less than 18.7 percent o f GDP and increases to 10 percent at debt levels above that threshold23. In Latin America, only Chile has reached levels o f debt to GDP below these levels. The recent crises in Argentina and the Dominican Republic illustrate the fact that debt to GDP ratios o f 40 and 27 percent cannot be considered as safe levels. In the case o f Peru, further declines in debt-to-GDP ratio would be beneficial. Ultimately, fiscal surpluses must be achieved according to the government lifetime budget constraint to ensure fiscal sustainability.
Debt Structure and Risk Analysis
The estimated 2005 total public debt in Peru stood at US$30 billion: US$22.5 bi l l ion (28.1 percent o f GDP) external and the remaining US$7.5 bi l l ion (9.7 percent o f GDP)
l 9 Net debt i s total gross debt minus domestic public debt held by al l public sector entities. The evolution o f debt aggregates in the last decade i s discussed with reference to gross aggregates because estimates o f net debt in Peru are not available.
2o Budina and Fiess (2005). 21 Patillo, Poirson and Ricci (2004). 22 Reinhart, Rogoff and Sevastano (2003). 23 International Monetary Fund (2002).
64
domestic (Table Al)24. External debt thus represents 75 percent o f the total, but the total funding raised in foreign currencies i s even higher since more than 22 percent o f the domestic debt i s denominated in dollars.
Table A l . Peru Public Debt (US$ million)
2000 200 1 2002 2003 2004 2005 2006e Total Public Debt 24,273 24,756 26,502 28,896 30,936 29,966 30,457 (% of GDP) 45.4 46.1 46.9 47.5 45.2 37.8 32.8
The issuance o f dollar-denominated liabilities in the local market i s a reflection of the financial dollarization process underway in the economy since the early 1990s. Conscious o f the increased vulnerabilities due to dollar-denominated public and private sector debt, the authorities have adopted a number of measures to gradually reverse this process, including actions to promote a broader and deeper local currency market for government securities. The greater use o f local currency instruments started in 2001 and has accelerated since 2003 (through the Programa de Creadores de Mercado), as evidenced by the greater size and longer terms o f local currency bonds. However, because o f the large debt stock relative to the borrowing flows, external debt in Peru i s s t i l l dominant.
Although the external debt i s mainly denominated in dollars, 36 percent o f external liabilities f rom official funding sources and the Paris Club are denominated in other currencies. Currently the debt unit at the MEF lacks a benchmark for the currency composition o f the overall portfolio. The portfolio structure by funding source i s changing rapidly as a result o f Peru’s greater access to the international capital markets and the refinancing and prepayment o f Paris Club loans wi th the proceeds o f bonds denominated in dollars and soles. Paris Club was the main government creditor in 2002, but in 2005 outstanding bonds and multilaterals were far more important. This trend i s expected to continue for the next 10 years, reflecting outstanding Paris Club loans coming due, and highlights the importance o f increasing the size o f the domestic market and the need to strengthen access to the international capital markets.
Refinancing exposure relates principally to maturing Paris Club loans. Fol lowing the pre- payment o f US$1.55 bi l l ion worth o f Paris Club debt in August 2005, refinancing risk has been reduced significantly for the period 2005-09. The stream o f annual repayments fluctuates around US$350 mi l l ion from 2006 to 2009; however, i t surpasses US$600 mi l l ion f rom 2010 to 2013, and these flows, combined with maturing bonds, produce an important hump o f repayments in 2012,2014 and 2015.
24 Information as reflected in the Marc0 Multianual Macroeconomico (updated to August 2006).
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With 84 percent o f the total debt denominated in foreign currencies, currency r i s k i s the authorities’ main concern. T o reduce currency risk, the debt management unit i s developing a market for securities in soles and i s gradually changing the portfolio’s currency mix. The share o f local currency debt has risen from 8 percent to 16 percent between 2003 and 2005. Issuance o f dollar-denominated debt in the domestic market was suspended since 2000, when dollar-denominated debt accounted for over 80 percent o f the domestic debt; by September 2005 this percent had fallen to under 25 percent. As well, a portion o f the external bonds i s being refinanced with local currency bonds. An illustration o f the Government’s efforts in this regard i s the debt exchange conducted in 2005 which allowed to redeem US$262 mi l l ion worth o f dollar-denominated bonds in exchange for bonds in soles (S/851 million), including a bond with a 10-year maturity; and an additional US$119 mi l l ion exchange o f dollar-denominated bonds for inflation- indexed bonds (VAC) maturing in 2024.
Of the total debt, 41 percent has a floating interest rate, while most o f the remaining 59 percent has f ixed rates2’. Floating-rate debt consists o f the external debt contracted with multilateral institutions. This percentage takes into account Paris Club loans refinanced with funding f rom the international and domestic capital markets.
Going forward, currency risk may increase if the Central Bank (BCRP) lessens i t s intervention in the exchange rate market and implements a monetary pol icy more oriented towards domestic goals. In addition, a downturn in commodity prices or a relaxation o f capital controls may result in net foreign currency outflows that would pressure the exchange rate. Given i t s currency structure, this clearly represents the debt portfolio’s chief exposure.
11. Debt Sustainability26
Public debt in Peru has improved considerably, decreasing to an estimated 32.8 percent o f GDP in 2006. The primary balance has steadily improved from a deficit o f 0.8 percent o f GDP in 2000 to a surplus o f 2.5 percent o f GDP in 2006, and the Government i s forecasting primary surpluses averaging 1.3 percent for the rest o f the decade. An analysis o f Peru’s debt determinant^^^ show the positive strong contribution o f real growth during periods o f economic expansions: from 2001-2005, the growth effect contributed to about a 9 percentage point decrease in the debt-to-GDP and to a decrease o f about 8 percentage points in the 1995-98 period. A revaluation effect contributed to about a 5 percentage point decrease in the debt-to-GDP ratio f rom 2001-05, whereas in the 1995-98 period, i t only contributed to about a 1 percentage point decrease. Privatization proceeds greatly contributed to the decrease in the debt ratio in 1995-98 by
25 A small percentage o f the domestic debt i s indexed to inflation. 26 The required primary deficits differ from the CPS, although the debt path i s the same. The differences result from using more up to date public debt information, which places the 2006 debt to GDP ratio at 33 percent. The debt sustainability exercise of the CPS assumes a starting point o f 38.5 percent o f GDP. In addition, for comparison purposes this section sets the target at 26 percent o f GDP in 201 1 which the GoP own target. The CPS section does simulations covering only until 2010. 27 The debt dynamics decomposition i s carried out following Craig Burnside methodology as described in Fiscal Sustainability in Theory and Practice (2005). Methodology i s described in Annex I of this note.
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transferring not only assets but liabilities to the private sector, but their impact has declined with the slowing o f the privatization program after 2000. Other factors captured by the residual o f the model accounted for a 4 percentage point decrease and a 5.6 percentage point decrease in 2005 and 1997, respectively, and could be attributed to the reduction of the Paris Club debt in September 2005 and the restructuring o f Brady Plan debt in 1997.
Source: Peru Policy Note Fiscal and Debt Sustainability, World Bank 2006.
Peru’s growth prospects are favorable in the medium term. Growth i s projected to hover around 5 percent per year in the next f ive years, inflation wi l l remain l ow at 2.5 percent per year and fiscal revenues w i l l continue strong. The GoP medium-term plan o f maintaining a fiscal surplus o f about 1.4 percent of GDP w i l l allow reducing the debt ratio to 26 percent o f GDP by 2011 the end o f the decade (Table A3). Compared to the primary surplus achieved in 2006 it is merely a 0.1 percent o f GDP effort. Debt scenarios simulations show that Peru’s debt ratios are robust to changes in the assumptions o f macroeconomic variables. If growth reverts to the long term rate o f 4 percent, lowering the debt to GDP ratio to 26 percent w i l l require a primary surplus o f 1.5 percent o f GDP, a fiscal effort o f 0.2 percent points o f GDP compared to 2006. A more ambitious target o f reducing the public debt to GDP ratio to 20 percent by the end o f the Garcia administration w i l l require a primary balance o f 2.6 percent o f GDP, or a fiscal effort o f 1.3 percentage points wi th respect to 2006.
Under a l ow case scenario o f 2 percent growth o f GDP annually and a real interest rate o f 6 percent, a primary surplus o f 1.8 percent o f GDP i s needed to bring public debt down to 26 percent o f GDP by 2011, or a primary surplus o f 3 percent to achieve public debt levels o f 20 percent o f GDP by 201 1 (Table A4)
Table A5 depicts the probabilities associated wi th the two scenarios, and shows that under a growth scenario o f 5 percent, even with shocks to the exchange rate, the debt-to- GDP ratio has a more than 50 percent chance to fa l l under 30 percent by the year 2010. However, under a l ow growth scenario o f 2 percent and lower primary surplus o f 0.5 percent o f GDP, the debt-to-GDP ratio i s more l ikely to increase, given the same shocks to the exchange rate.
Table A5. Debt Dynamics 2006 2007 2008 2009 2010
Prob. that debt is above 38 percent (base case) 12 4 2 1 1
Prob. that debt is below 30 percent (base case) 0 1 9 31 54
Prob. that debt is above 38 percent (low case) 61 62 68 73 78
Prob. that debt is below 30 percent (low case) 0 0 0 0 0
Source: Staff calculations based on Burnside (2005).
In conclusion, the official forecasts for the next five years o f an average o f primary surplus o f about 1.4 percent o f GDP2* and growth o f 5 percent o f GDP puts Peru’s debt- to-GDP ratio on a downward trend, and Peru could very wel l reach levels o f 26 percent o f GDP by 2011. Given the good external conditions, growth in the rest o f the decade could be as strong as it has been in the last two years. However, if global conditions should change, and the scenario turns less positive, leading to a slowdown in economic activity and lower primary surpluses, Peru’s debt path changes, and could lead to an increase in debt-to-GDP to over 35 percent.
’’ Primary balances are defined here with respect to the non-financial public sector. Although in the assumptions we do account for seigniorage, which in the case o f Peru has remained very low, and in 2005 our estimates have i t at around 0.2 percent o f GDP, and it i s expected that in the medium term i t remains at around that level.
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MAP SECTION
Andes M
tns.
NevadaNevadaHueascaránHueascarán(6768 m)(6768 m)
NevadaNevadaYerupajaYerupaja(6634 m)(6634 m)
NevadaNevadaSalcantaySalcantay(6271 m)(6271 m)
NevadaNevadaCoropunaCoropuna(6271 m)(6271 m)
NudoNudoAusandateAusandate(6384 m)(6384 m)
TUMBESTUMBES
HUANUCOHUANUCO
P A S CP A S C O
J U N I NJ U N I N M A D R EM A D R ED E D I O SD E D I O S
