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Reporl No. 3438-PE
PERU: Major Development Policy Issues and.Recommendations(In Two
Volumes) F COPYVolume 1: Main Report FILE OApril 27, 1981
Latin America & the Caribbean Regional Office
FOR OFFICIAL USE ONLY
Document of the World Bank
This document has a restricted distribution and may be used by
recipientsonly in the performance of their official duties. Its
contents may not otherwisebe disclosed without World Bank
authorization.
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CURRENCY EQUIVALENTS
The exchange rate is being adjusted daily roughly in linewith
the difference between domestic and international inflation.The
exchange rate and currency equivalents were as follows:
Currency Unit = Sol (SI.)
1979 1980
US$1 = S/.224.55 S/.289.2
c/.1000 - US$ 4.45 US$ 3.46
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FOR OFFICIAL USE ONLY
This report is based on the findings of an economic
mission,which visited Peru in June/July 1980; it basically reflects
theeconomic situation as of mid-1980. The mission was led byUlrich
Thumm and included the following members: David Franklin
and William Wadman (consultants, nutrition and related
healthaspects), Nathan Koenig (consultant, agriculture),
ConstantinoLluch (income distribution), Ricardo Martin (tax
incidence), andMirtha Pokorny (summer intern, income distribution).
The missionalso benefited from the parallel UNIDO industrial sector
missionas well as from background papers, provided by Bank staff,
onenergy, transport, and water.
The report was discussed with the Government in November 1980
andMarch 1981, and comments were incorporated. In the meantime,
theGovernment took vigorous policy action to address many of the
issuesidentified in this report. These recent policy measures are
brieflymentioned in the text. A more complete description is
presented inparas. xii-xx of the Summary and Conclusions.
This document has a restricted distribution and may be used by
recipients only in the performance oftheir official duties. Its
contents may not otherwise be disclosed without World Bank
authorization.
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TABLE OF CONTENTS(Volume 1)
Page No.
Summary and Conclusions .................................
i-vii
I. Recent Economic Performance .............................
1
1. Performance Under the Stabilization-Cum-Economic-Recovery
Program ....................... 1
2. Present Economic Situation in Perspective .......... 3
2.1 Growth and Employment ......................... 3
2.2 Financial Aspects ............................. 6
2.3 Income Distribution ........................... 10
II. Main Development Issues ............... .. ................
14
A. Macroeconomic and Financial Issues ....... .. ........ 15
1. Inflation ...................................... 15
2. Pricing, Interest Rate, Exchange Rate,and Trade Policies
............................. 19
3. Public Finance ............... .. ................ 23
B. Sectoral Issues .................................... 27
1. Social Aspects ............... .. ................ 27
1.1 Population and Employment ................. 27
1.2 Poverty, Nutrition, and RelatedHealth Aspects
............................ 32
2. Economic Aspects .............. .. ............... 38
2.1 Economic Infrastructure ................... 38
2.2 Industry ....... ........................... 44
2.3 Agriculture ............................... 48
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TABLE OF CONTENTS (Continued)Page No.
III. Medium-Term Financial Framework and Longer-TermDevelopment
Policies ................................ 55
A. Financial Framework Under Different Scenarios ....... 55
1. Present Situation and Past Experience .... ....... 55
2. Alternative Medium-Term Projections .... ......... 56
3. The "Preferred" Scenario and Its PolicyImplications
.................................... 58
B. Medium- and Longer-Term Development Policies ........ 63
ANNEXES
I. Technical Note on Income Distribution .... ...............
71
II. Inflation, Growth and Distribution, 1970-79 .... .........
77
III. Incidence of Changes in Government Budget 95
STATISTICAL APPENDIX (Volume 2)
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P4g 1 of 2
PBU - 3681C DATA
AREA AND Pop0!LATION
Total ane 1,285,W aq.b. Dsmity 13.5 par .q. .
(total)Agri-alt-ral 305,500 qa.tu 56.6 pa rq.kn. (n-n.)PapoPlatian
(mid 1979) 17.3 illion
POPULATION CltRACTERISTICS (1978) MUTH (1978)
Urban (pent of total) 65.6 Lif- .ap-etay at birth (yearn)
56.0Crude birth r (pa h...ad) 39r.0 tInfant ertality (pee thanmed)
13.0 (1970)Crude death arat (per thooaad) 12.0 Ate-a ta e-a. eater
(ymernt of PoPointion)POP IlcIOr growth ratr (percent) .lana
T6.0
Total 2.7 Urbtn 60.0Utban 4.5 torn) 25.0
PopulatIon ago ot`uctur- (pa-cent) Aeeae to anoata diapa-al
(pennant of pop1latitn)n-14 yro. 42.9 Totel 34.0
15-64 yr. 53.4 Urban 51.065 + 3.7 lornl
Poptlation per phymirian 1,556.0POOD ANT) NUTRITIOTN (1978)
Popylation per torms per-on 74350
POPlantLa per hbopital bad 547.0Calonit intake as penrent of
nequirnmatoa 97.0ProaLgn (fron per day) 59.0 EtCAT1O7 (1976)
of which: animral and poloc 24.0Ad1lt literary rate (parrent)
72.0
1NCO9 E DlSTRldUTIOS (1972)ACCESS TO OLECTZICITO (pere-t of
d-eilign.. 1972)
yrrcont of private locoe rerninad byhlgheoc 20 percent of
houae6oldn 61.0 Total 32.1Lo.e.t 20 percent of hoo.eboldo 1.9 Unbar
54,3L.o-ot 4D percent of hona..holds 7.0 Rgr-l 2.7
GNP PER CAPITA (USS, 1979) 730
(Wotld 1gnk AOlat Mnthodclogy)Anoa.l ame of arocib (ronet. 1973
vrine., 2)
NAT1ONAL ACC0UNTS, 1979 UiS nilli-o 2 1969-70 1970-75
1975-79
CDP on -ock-: prlte- 14774.2 IOO.0 3.0 4.6 1.1Conoceptlct
I1264.4 76.2 7.1 5.4 U.5Gno-- Icopatic Inveo-me.t 2067.8 14.0 0.1
14.5 - 11.3E.po.ro of c uod n .d NFS 4053.7 27.4 3.9 -6.l
1C.5Imports of Gcodt awd NFS 2611.7 17.7 8.4 6.4 - 0.0
OUTPUT, LABOR PORCE AND PRODUCTIVT (1970 prices
GDP by Sfctor Labor FPor Lbor PrdortinstnMtdillioc of 1970 S
Perreot of Tota1 roth tote Tbo o Paret of Total ireth ae7 Pea of
Aerage Genth Rate
1970 1979 1970 1979 1970-79 1970 1979 1970 1979 1970-79 1970
1979 1970 1979 1970-79
kgnlcculnrc 1,574.7 1,556.1 17.3 13.0 0 2,011.9 2,222.4 46.0
40.8 1.1 762.6 691.4 36.1 31.9 _1.1lodcocry 3,226.3 4,476.5 36.5
37.0 3.7 769.1 1.005.3 19.4 10.5 3.0 4,194.9 6,452.9 '98.6 205.4
0.7Services 4,084.8 5,760.6 46.2 49.0 3.9 1,407.6 2,212.9 33.6 40.7
5.2 2,902.0 2,612.2 37.4 i20.) - 1.2Totul.Avenone 8,645.3 11.793.7
100.0 1O0.1 3.2 4,100.6 5,440.6 l00.0 100.0 2.9 2.111.8 2,167.7
.0D.0 100.0 0.3
O2MERNtENT FINANCE
Gn.erol Consrro--n Cotr.l G-sroe-ntBililona of SI. P-r-en of GDP
Billioa of S/. Perac.t of GDP
1977 1978 197 1974 1977 1079 1977 1970 1979 1980 1974 1977 1979
1900Cunre- R-eveno.t 191.0 308.7 631.4 17.7 1b.7 19.0 154.1 263.7
552.2 1,013.4 13.8 13.5 16.6 10.4Cunnenr EopondInvent 220.7 343.4
542.0 15.7 20.0 16.3 193.1 291.0 448.7 954.0 12.6 16.9 13.5
17.Currnt Acocoont - 37.7 - 34.7 89.4 2.0 - 3.3 2.7 - 39.0 - 27.3
103.5 59.4 1.2 - 3.4 3.1 1.Cepitl geIeno- o - 0.5 1.I - - 0- - - -
- -Capital lope-di-nret 43.2 61.5 139.5 4.0 3.0 4.2 40.1 57.7 128.6
266.0 4.1 3.5 3.9 4.tlorrol1 Doficlc - B0.9 - 95.7 - 49.0 2.8 - 7.1
- 1.5 - 79.1 - 85.0 - 25.1 - 206.6 - 2.9 - 6.9 - 0.B - 3.7Eotnnool
Fln-c-iol 34.6 9.5 47.1 2.9 3.0 1,4 34.6 9.4 46.4 59.9 2.9 3.0 1.4
1.1
lrDNEf AND CREDIT L973 1974 1975 1976 1977 1978 1979 1980
(BlUlions of 57. o-ct-oeding no erd of period)
Money ooo Qoonl Money q) 98.3 120.0 141.8 166.3 220.5 321.2
615.7 1,177.1Bank 4nodit cv P.1kc S.ector a/ 27.2 26.9 49.7 101.4
198.9 207.7 212.1 350.2Bank Credit cc Private Sen,ot of 73.2 84.5
108.2 134.5 173.8 239.3 379.5 701.6
(Perceotagno or iodao oNuerermHorny aod qua--l mneay sa parrot G
of CDP 25.0 24.3 22.6 20.0 19.3 17.3 19.6 21.3Coreomr Pnr" e ldno
in lolen (1977 - 100) 37.9 c3.9 54.3 72.4 100.0 157.0 264.7
421.4dAnnual nhaogea In
Cener- Price Indeo 9.5 16.9 23.7 35.5 38.0 57.8 67.7 59.2Bank
Credit tO Poblin Stenor 53.7 - 1.2 84.0 105.0 96.1 44.7 - 26.3
66.1Saok C-edin to Prioare Sentot 27.7 15.5 28.1 24.3 29.2 37.7
58.6 86.9
a) et c-nent -oh-noa nato of each year.
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Sq. 2 of 2
BALANCE OF PAYMENTS (millions of US$) MERC8'ANDISE EXPORTS
(millions of US$)
1977 1978 1979 1980 1976-78 1979 1980
Espo-ts of Goods and NFS 2,137.8 2,399.9 4,065.9 4,554.4 Fishmel
182.8 237.0 191.8Imports of Goods and NFS 2,694.4 2,070.1 2.625.5
3.923.9 Other fish products 35.0 94.5 97.2Resource Balance - 556.6
329.8 1.440.4 630.5 Cotton 52.3 49.3 71.6Net Factor Servion boone -
426.4 - 577.7 - 44.9 - 777.9 S.ger 72.3 34.3 13.1Net transfers 56.8
56.0 122.0 132.9 Coffee 155.2 244.9 141.3Corrent Aooos-t - 926.2 -
191.9 617.9 _ 14.5 Cspper 342.6 667.5 712.6Dirnot Foregn
Investment, ne 54.1 25.0 71.0 - 64.2 Silver 174.8 389.2 636.3tNt
Psblio M I LT Loan a! 620.0 593.0 853.2 374.0 imo 162.7 171.
212.7
Sisborsemeor 1,026.4 S41.8 1,296.5 1,383 2 Other mimenseI 134 3
229.9 959.1Ornontizalton - 406.4 - 246.0 - 443.3 804.2 Petrole4a
93.1 605.7 809.8
Nlo Othnr M 4 LT Los-s - 0.1 - 11.2 _ 31.9 64.5 Other 248.1
710.6 783.7Olsboramennt 74.3 61.11 87.9 180.7 Total 1,675.2 3,474.0
3,863.3Amortleanloo - 74.4 - 73.0 - 119.7 - 116.2
Short-term Capital - 97.5 - 75.5 100.5 91.2Other Capitol, net 0
- 260.2 - 31.9 80.2 EXTERN7AL DEBT (aillions of US$ es of Dne.eher
31. 1979)fh.nge Sn Roseroe- (- I- .ncrese) o 349.7 - 92.0 - 1.578.9
- 731.2Net Re.erons (at the end of the period)o/ -705.0 - 623.0
955.9 1,687.1 Poblic Debt (intl. pnhlioly gseranteed) 5,931.5
Nan-GCar-nte-d Prinate Debt 1,307.8a/ Adjonted for
baleco-of-pay-ntn nopport oo n. and refinancing. lotal Ost.nteding
and Di-bureed 7,239.3
RATE OF EXCliANGE (Soles per US$) DEBT SERV1CE RATIO (peroen.t f
esp-etm of geed., NFS, 1979)
A-ega.e 1977 03.01 Phblin Debt (incl. psblicly sarnn-e-d)
22.6Overage 1979 156.34 Nom-Gsaranneed Pnin-te Dmbt n.e.Aver.e8
1979 224.55 Total n...Aesna.g 1980 289.2
IBRU/IDA LENDING (nillione of USS as of DOcetr 31, 1979)
O.tst.ndig end Dishbnred 234.7U.ndiabhned 353.1Osts tnding S
inl. sndihsbraed 587.8
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SUMMARY AND CONCLUSIONS
Present Economic Situation
i. Expansionary monetary and fiscal policies pursued during most
ofthe 1970s led to high public sector and balance of payments
deficits, par-ticularly during 1975-77, and to increased recourse
to foreign financing,mainly from commercial sources on relatively
short maturities. The situationwas exacerbated by a sharp
deterioration of Peru's terms of trade during1975-78. These
developments culminated in the severe economic and financialcrisis
of 1977-78.
ii. In 1978, the Peruvian Government embarked on a
stabilization-cum-economic-recovery program, which has been
implemented with relativesuccess during 1978-80. The new Government
that took office in July 1980has continued efforts begun under the
program and -- more recently -- hasadopted a series of far-reaching
additional measures at the macro and sectorallevels, which should
not only strengthen and complete economic stabilizationbut also
create an appropriate framework within which the recovery
processwould accelerate (see paras. xii-xx).
iii. The implementation of the
stabilization-cum-economic-recoveryprogram (1978-80), aided by
substantially improved terms of trade and refi-nancing of major
parts of the public sector's external debt, resulted ina strong
balance of payments performance during 1979 and 1980. The controlof
the public sector deficit, however, was less successful: after a
sharpreduction in 1979 it increased again in 1980, mainly because
of the resumptionof subsidies, generous wage increases, and
substantially increased defensespending. The program was again
relatively successful in laying the groundfor more efficient
resource use through import liberalization, export promo-tion, and
a more rational public investment program.
iv. In spite of these achievements, the present economic
situationremains highly volatile and is characterized by a long
list of acute problems:
- persistent high inflation, averaging 60 percent during
1980;
- high public sector deficit, equivalent to about 6 percent
ofGDP in 1980;
- high un- and underemployment, estimated at 11 and 44
percentrespectively of the urban labor force;
- stagnating agricultural production, as a result of
ill-conceivedagricultural policies during the past decade and
exacerbated bydrought;
- deteriorated pattern of income distribution, with increased
inci-dence of poverty and malnutrition, particularly in urban
areas;
- distortions of the whole system of incentives, with
deterioratedagricultural terms of trade, high food and petroleum
subsidies,and a tax system that is not conducive to employment
generation(notably through generous exemptions favoring capital).
The needfor adjustments is expected to result in substantial
adjustmentinflation for some time;
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- reduced government expenditures for economic and social
purposes(agricultural support services, road maintenance,
education, health)because of high outlays for defense and interest
payments andsome large projects of doubtful economic
justification.
Even the balance of payments, with high dependence on primary
exports, whichare subject to strong price fluctuations, and a high
debt burden, is lessstrong than it seems at present. The
medium-term prospects critically dependon efficient economic
management and particularly on petroleum sector policies.
v. To the above list of problems one has to add problems related
tothe longer-term development of the country. These are:
- widespread poverty, mostly concentrated in the rural areas
ofthe southern Sierra, but -- because of the recent decline inreal
household incomes -- now probably also affecting majorsegments of
the urban population;
- rapid population growth and rural-urban migration
exacerbatingthe pressure on the social and economic infrastructure
as well ason un- and underemployment;
- poor state of health and nutrition with high infant
mortalityand high incidence of communicable diseases;
- water and land resource constraints to agricultural
developmentrequiring major investment efforts in rehabilitating
existingirrigation systems and opening up new land;
- rapidly expanding demand for energy and potable water
alsorequiring urgent large-scale investments calling for
thoroughplanning and careful financial management, including
rationalpricing policies;
- need for better integration of the different regions of the
countryrequiring improvement and expansion of the transport
infrastructure.
Policy Recommendations
vi. These problems call for urgent corrective measures through
govern-ment programs and policy changes, some of which will be
mutually in conflict.It will be difficult to strike a balance and
to accomodate these programswithin overall resource availabilities,
particularly within the tight publicsector resource constraints. It
is crucial that these resource constraints(including a sustainable
volume of foreign savings in the form of net long-term capital
inflows) be taken into account to avoid a repetition in thefuture
of the disequilibria of the mid and late 1970s that required
drasticmeasures, which had strong negative side effects.
Stabilization must beconceived as a long-term effort to set a
framework of relative financialstability (in terms of sustainable
public-finance and balance of paymentssituation and decelerating
inflation), within which the government's longer-term development
goals will have to be effectively pursued.
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vii. The concept of "relative financial" stability is defined
through aset of macroeconomic projections (see tables 10.1-10.9,
Statistical Appendix).These projections, under a large number of
assumptions and with important
policy implications, delimit the overall resource availabilities
and particu-larly those of the public sector over the next five
years. This developmentpath of relative financial stability,
although by no means the only onepossible, will be relatively
narrow, and it will require vigorous economicmanagement to steer
the economy along these lines.
viii. Policy measures that are considered necessary to follow
thatpath (and thus provide a solid basis for medium- and
longer-term developmentpolicies) are summarized in table 23 and
evaluated with regard to theirimpact on the principal overall
socio-economic goals. The key measures arethe following:
- gradual reduction of public sector deficit through
-- tax reform to make better use of the taxation of incomes
and goods and services by improving tax administration
andreducing exemptions. The tax reform should, at least, beneutral
in terms of revenues, preferably have a positiveimpact and increase
the buoyancy of the tax system withregard to GDP growth over its
present level of about 1;
-- regular price adjustments for publicly supplied goods
andservices. For some products, there is still need forincreases in
real terms. Further adjustments would havejust to follow the
general price movements;
-- gradual elimination of food and petroleum subsidies and,
inthe case of food and possibly kerosene, partial replacementby
more specifically targeted interventions in favor of low-income
households;
-- rigorous scrutiny and tight control of government
expenditures,although there is now need for substantial increases
in out-lays for social (health, education) and economic
purposes(road maintenance, agricultural extension and
research)including selective adjustments of government salaries;
and
-- gradual reduction and restructuring of government
personnel;
- tight credit policies vis-a-vis the public sector,
includingthe improvement of the public sector's external debt
management;
- freezing or gradual reduction of Central Bank rediscount
ceilingstowards the rest of the financial system to have it
essentiallydepend on the mobilization of financial savings. To this
extent,reserve requirements could then be gradually relaxed;
- regular adjustment of the interest rate structure so that
deposit
interest rates would reach and maintain a positive level in
realterms and thus encourage financial savings;
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- iv -
elimination of distortions in the system of incentives
through
-- price decontrol, to be supplemented in the agricultural
sectorby the introduction of floor prices for non-perishable
goods;
-- progressive trade liberalization with further reduction of
importtariffs according to a pre-announced schedule. Exceptions
forinfant industries should be granted only on a very
selectivebasis for a small number of industries and with clearly
definedtime limits;
-- regular adjustment of credit interest rates to reach and
maintaina positive level in real terms;
-- maintenance of a constant real exchange rate; and
-- changes in the tax system eliminating payroll taxes, basing
taxexemptions for reinvestment on the number of jobs created,
andincreasing taxation of corporate property so as to reduce
therelative cost of labor and increase the relative cost of
capitaland thus make the tax system more conducive to
employmentgeneration.
ix. In view of the possible negative short-term impact of many
of therecommended policy measures (see table 23) it would be
indicated to supplementthis policy package by an appropriate
incomes policy. Such an incomes policy--for agriculture basically
in terms of pricing policies with gradual adjustmentstowards
longer-term levels of international prices and within the
urbaneconomy basically in terms of a gradually increasing labor
income share--should be designed within the overall macroeconomic
framework and backed bya social pact between Government, labor
unions, and trade associations.
X. Given the present state of Peruvian economy and society,
medium- andlonger-term development policies should aim at improved
use of resources,particularly in energy, water, transport,
industry, and agriculture as well asat better development of human
capital, particularly through improved healthcare, nutrition,
education, and family planning. The key measures are
thefollowing:
- employment generation as most effective long-term measure
toimprove income distribution and fight poverty, through revival
ofeconomic growth, change of relative factor costs in favor of
labor,higher use of labor in public investment projects wherever
feasible,and work-oriented adult education to enhance the
self-employmentpotential;
- specifically targeted interventions through the health system
toimprove the nutritional situation of low-income households to
becomplemented by the expansion of primary health care and
familyplanning;
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-v -
vigorous energy policy to develop the country's petroleum
andhydropower resources. In this context, it is crucial that
newforeign risk capital be attracted into petroleum exploration
andthat rational pricing policies be adopted to contain
domesticdemand growth and to generate appropriate savings. In the
case ofpower, the costly investment projects need thorough
evaluation andoptimization, and tariffs will have to be regularly
adjusted toallow a reasonable share of self-financing;
revival of agricultural development through adequate pricing
policy,improved marketing, strengthened support in the form of
extension,research, and credit, and more efficient use of water
resourcesthrough rehabilitation of existing irrigation schemes. In
thiscontext, the regular adjustment of water charges is important
toprovide for better operation and maintenance of the
irrigationsystems as well as a fair share of self-financing;
strengthening and expansion of the industrial sector
throughgeneral decontrol, continued trade liberalization and
exportpromotion, revision of the whole system of incentives,
includingthe treatment of foreign capital, and decentralization of
themanagement of public enterprises away from the Central
Government.
xi. The Government's awareness of both short-term problems and
longer-term development needs will have to be translated into a
balanced package ofpolicy measures, including development efforts
to strengthen the country'seconomic and social infrastructure and
its productive capacity. Many ofthese measures may have an
immediate negative impact on public sector financeseither through a
reduction in revenues or increased expenditures, althoughmost are
expected to contribute to improved public sector performance in
thelonger run. This has to be taken into account when designing the
measuresand planning the time frame for their implementation. This
requires skillfuleconomic management, for which adequate staffing
of key positions in thepublic sector is indispensable, supported by
adequate salary policies toattract and retain capable
personnel.
Latest Developments and Government Actions
xii. During the transition period of May-July 1980, the incoming
Govern-ment made a thorough assessment of Peru's economic and
social situation.An account of the state of the economy and an
outline of major policy actionswere given in the Prime Minister's
first major address in late August.Some of the conclusions were
immediately translated into policy action: somekey prices such as
for petroleum products and power were raised and pricecontrols
reduced and relaxed; the devaluation of the sol was no longer
pre-announced, and it was accelerated to fully compensate for the
differentialbetween domestic and international inflation; and --
perhaps most importantduring the first few months of the new
Government -- import liberalization wasgreatly advanced in
September when import licensing for virtually all but asmall number
of products was abolished and tariffs were cut from a maximum of150
percent to 60 percent (lowering the unweighted average by about
fivepercentage points to about 34 percent). Other measures had to
await congres-sional action or had to be delayed for political
reasons.
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- vi -
xiii. A major economic policy package was adopted at the end of
1980 andduring the first days of 1981. It comprised interest rate
adjustments, majorprice increases for goods and services supplied
by the public sector as wellas new petroleum legislation.
xiv. In November 1980, a law was enacted re-establishing the
CentralBank's control over interest rate policy, previously held by
the Ministryof Economy and Finance, and eliminating the 17 percent
tax on interest paymentsfor bank credits. Armed with this
authority, the Central Bank completelyrevised the interest rate
structure in January 1981. Deposit and lendingrates were increased
by about 20 percentage points to some 50-55 percent.Taking
commissions and discounting practices into account, the
effectivelending rates during the first quarter of 1981 were around
70 percent p.a.and, therefore, highly positive in real terms when
compared to expectedinflation of some 60 percent for 1981. The
Central Bank is closely monitor-ing the financial markets and
intends to maintain deposit and lending ratespositive in real
terms.
xv. The increased public sector deficit (equivalent to almost 6
percentof GDP in 1980) was tackled through substantial upward
adjustments of foodand petroleum prices as well as power and water
rates. Major increases --averaging about 40 percent with some of up
to 90 percent -- were implementedin early January 1981; another
round of adjustments, although less markedand limited to a smaller
number of products, took place in March. Theseprice increases,
which are scheduled to be followed by regular smaller adjust-ments,
will gradually eliminate all subsidies and help to bring down
thepublic sector deficit from its high 1980 level. Pricing policies
for some ofthe key public enterprises are now specifically
targeted: in the case ofpetroleum to reach approximately
international price levels over the nextthree years, in the case of
power and water to reach self-financing ratios ofabout 30 percent
of total investment also within the next three years.
xvi. With regard to trade policies, another round of tariff
reductionswas recently implemented lowering the average tariff by
another 3 percentagepoints. The ultimate goal is a tariff of some
25 percent with very littledispersion by 1984. The plan calls for
adjustments according to a schedulethat will be negotiated with the
different industries. Temporary relief toease the adjustment
process through higher tariff reductions for importedinputs and
thus higher effective protection is part of the Government'splan.
The export subsidy in form of tax certificates (CERTEX)was
revisedin February. Rates were reduced to 22, 20, and 15 percent,
and the eligibilitywas greatly rationalized by limiting it to a
relatively small number ofproducts defined according to the customs
code. These changes will help tolimit abuses and substantially
reduce the fiscal cost.
xvii. Important new policy initiatives with longer-term impact
weredirected at the agricultural, petroleum, and mining sectors. A
new Agricul-tural Promotion Law was enacted in November 1980. This
law provides specialfiscal incentives to agriculture and
agroindustries. It also opens theway for commercial banks and other
financial institutions -- in addition tothe state-owned
agricultural bank, wnich has virtually been the only sourceof
sector financing -- to extend credit to the agricultural sector by
eliminat-ing prohibitions on the mortgaging of land. The law also
concludes the
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- vii -
agrarian reform, which was the cause of great uncertainty. The
import
liberalization process also helps agriculture to the extent that
equipmentand inputs can be more easily imported at lower prices. In
addition, measures
are now under preparation to strengthen research, reestablish a
national
extension service, restructure the Ministry of Agriculture,
improveagricultural marketing, and to reorganize and improve
agrarian reform
enterprises. Particular attention will be given to
rehabilitating the sugarindustry.
xviii. The Government has also given high priority to increasing
oil
production and exploration. In December 1980, sector legislation
was modi-fied by opening secondary recovery, which had been the
exclusive preserve
of PETROPERU (the State petroleum company), to other domestic
and foreignfirms in association with PETROPERU. The new law also
improves the investment
climate by introducing a tax credit scheme that provides
additional incentivesfor investment. The foreign companies
currently operating in Peru havereacted favorably to these
incentives, and new foreign contractors concluded
negotiations with PETROPERU for several blocks in the northern
and southern
jungle areas. In addition, the sector benefits from the recent
change inthe export tax legislation phasing out the 17.5 percent
tax over a period
of two and a half years and replacing it by a 5 percent tax to
be creditedto income tax payments.
xix. The gradual elimination of the export tax also benefits the
mining
sector. (It is planned that the tax be also eliminated for
agriculturalexports so that this tax would eventually be fully
replaced by income taxation).
In addition, the general mining law was changed in several
important respects,especially as regards the role of the Government
and tax incentives for newinvestment. MINPECO, the state-owned
marketing organization for the miningsector, was dismantled of its
monopoly. It retains the right to be marketingagent for wholly
state-owned mining companies, while other companies can maketheir
own marketing arrangements. State participation in special
mining
enterprises was made more flexible by allowing public
enterprises other thanMINEROPERU and state-owned banks to hold the
State's share in equity capital.Finally, tax concessions were put
on equal footing for state-related andpurely private companies, and
investment tax redits were increased to make newventures
financially more attractive.
xx. To counteract the negative impact of the recent monetary and
fiscal
measures on the poorest population strata, the Government has
set up twospecial funds to finance specific food programs, mainly a
food stamp program,
and employment-intensive investment projects at the local level.
The Govern-ment is also committed to gradually improve real incomes
of the lower andmiddle income classes. In this respect, the
Government recently initiated a
broadly based negotiating process through the tripartite
commission (with
representatives of the Government, the unions, and the
entrepreneurs). While
the prime aim of the commission is to establish
stability-oriented incomes
policies, it may eventually play a more comprehensive role and
become the mainforum for negotiations of key economic policy
measures.
xxi. As evident from this brief account, the Government has
taken decisive
policy measures in many fields. However, a lot remains to be
done, particularlyin public sector finances and in the social
sectors, and it is of crucial impor-
tance that the initiated policies be consistently followed in
order to providea stable and financially viable framework for
longer-term development efforts.
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I. RECENT ECONOMIC PERFORMANCE
1. Performance Under the Stabilization-Cum-Economic-Recovery
Program
1. Throughout most of the 1970s, government policies in Peru
werenot conducive to the mobilization of savings and the efficient
use ofresources. The results were high public sector deficits
(averaging 6.5percent of GDP during 1970-78 and peaking at 9.3
percent in 1975), increas-ing savings-investment gaps (averaging
5.9 percent of GNP during 1972-78and peaking at 15 percent in
1975), and little response of production toinvestment. Inadequate
national savings were compensated by increased exter-nal borrowing,
which resulted in a total external debt equivalent to 56.8percent
of GDP in 1978 and public debt service equivalent to 31.2 percent
ofthe country's exports of goods and non-factor services. When in
additionanchovies, one of the major exports, virtually disappeared
and the country'sterms of trade were adversely affected after
1974/75, the external financialsituation got more and more out of
control. Beginning in 1975, successiveeconomic teams made several
efforts to cope with the mounting crisis. This,however, was not
done consistently over an extended period of time and was,therefore
without lasting success. By mid-1978, the economic crisis
hadreached grave proportions with a drop in real GDP, inflation
approaching 100percent, and the decline of the banking system's net
international reserves toa negative level of about US$1,200
million.
2. By mid-1978, the Government embarked on a
stabilization-cum-economic-recovery program that aimed at
strengthening public finances,stimulating exports, stemming the
loss of international reserves, andpromoting more efficient use of
private and public sector resources. Theprogram was supported by an
IMF stand-by arrangement, a program loan from theWorld Bank, and
was also greatly helped by rescheduling and refinancing oflarge
portions of the external debt. The relatively successful
implementationof this program together with increased petroleum
exports and a substantialimprovement of the country's terms of
trade helped to turn the financialsituation around and to begin the
process of economic recovery as reflectedby the financial and
economic indicators summarized in table 1.
-
Table 1: SELECTED FINANCIAL AND ECONOMIC INDICATORS, 1977-80
1977 1978 1979 1980 prel.
Net international reserves of the bankingsystem (US$ million)
-1,100.9 -1,025.0 553.9 1,285.1
Gross international reserves of thebanking system (US$ million)
457.4 592.4 1,858.2 2,556.4
(Equivalent to .. months of imports of goodsand non-factor
services) (2.0) (3.4) (8.5) (7.8)
Medium- and long-term external debt(in % of GDP) 44.4 56.8 49.0
40.5of which: public debt 34.5 45.6 40.1 33.4
Public debt-service ratio (in % of exportsof foods and
non-factor services) 30.6 31.2 22.6 a/ 31.3 a/
Overall public sector deficit (in % of GDP) 9.2 5.7 1.7 5.9
Domestic credit expansion to the publicsector (in % of GDP) 3.1
3.8 0.7 2.5
Savings-Investment gap (GNS - GDI in % of GNP) -7.5 -2.0 3.8
1.6
GDP growth (%) - Overall 0.0 -0.7 3.4 3.1- Per capita -2.6 -3.3
0.7 0.4
InflationLima CPI (annual percentage change) 38.0 57.8 67.7
59.2GDP deflator (annual percentage change) 37.7 63.3 73.1 57.9
a/ Including refinancing.
Source: Central Bank; ONE; Bank staff estimates.
3. While the Economic Recovery Program (ERP), by its nature,
hasbeen medium to long-term oriented, particularly with respect to
the openingup of the economy and the rationalization of the public
investment program,the thrust of the Government's economic policies
over the past two years wasmostly short-term oriented to improve
public finances and to overcome thebalance of payments crisis.
Besides the problem of the efficiency of resourceuse, which has
been tackled through import liberalization, export promotion,and a
more rational public investment program, the longer-term
developmentissues, particularly in the social sectors, have not
been effectively addressedduring the past two years. Even the
resource mobilization problem was addressed
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only with regard to the immediate problems of the public sector
and the finan-cial system through tax increases, measures to
improve tax administration,price adjustments, and raising interest
rates.
4. In spite of the generally successful implementation of the
ERP,many problems persist: high inflation; substantial distortions
of thewhole system of incentives (prices, interest rates, tax
incentives) witha high potential for further adjustment inflation;
widespread un- andunderemployment; low quality and effectiveness of
public expendituresvis-a-vis the country's needs, particularly in
the social sectors; sluggishagricultural development; weakness and
rigidity of public administration;and problems that have been
clearly beyond the ERP's scope such as rapidpopulation growth and
marked interregional and interpersonal inequalitiesof the
distribution of income and wealth. Some of the problems have
becomeeven more severe as a result of the recent recession and
stabilization effortsthat resulted in higher unemployment and
substantial cuts of public expendi-tures, particularly salaries and
outlays for socially oriented programs suchas education and health.
The following sections present a broader and morecomplete picture
of economic performance during the last few years.
2. Present Economic Situation in Perspective
2.1 Growth and Employment
5. GDP growth averaged 3.4 percent per year in real terms
during1970-79; it was higher during 1970-75, averaging 4.8 percent,
but droppedto a mere 1.1 percent during 1975-79 because of the
severe economic andfinancial crisis. The most dynamic sectors were
mining, power, transport,banking, and government with a combined
contribution to GDP growth of about52 percent during 1970-79,
compared to a share of 34 percent of GDP in 1970.Agriculture
virtually stagnated, and manufacturing and construction grew
onlyduring the first half of the 1970s (see table 2). On the demand
side, thegrowth of consumption of domestically produced goods and
services was the moststable element, persistently absorbing about
86 percent of GDP growth. Durin.,the first half of the 1970s,
investment growth was particularly high contribut-ing about 38
percent to GDP growth, while exports dropped and slowed downgrowth.
During the second half of the 1970s, however, exports
substantiallycontributed to the growth of GDP. During 1977-79, they
were the only dynamicelement of final demand (see table 3).
-
Table 2: GDP GROWTH BY SECTORS, 1970-79
(Percentages based on constant 1973 prices)
Average annual growth 1/ GDP Shares Contribution to GDP
growth1970-79 1970-75 1975-79 1970 1970-79 1970-75 1975-79
Agriculture 0.6 0.7 0.3 14.8 2.7 2.0 5.2
Fishing -4.4 -17.1 8.5 2.2 -2.7 -4.9 5.2
Mining 4.8 1.2 12.6 7.1 12.3 0.3 54.3
Manufacturing 3.2 5.7 -0.8 25.0 23.4 30.3 -0.7
Construction 3.2 11.0 -6.3 3.0 2.9 7.2 -12.1
Government 4.8 5.7 2.4 9.7 13.1 12.0 17.6
Others 4.1 6.3 0.8 38.2 48.1 53.1 30.5
Power 10.0 9.8 9.8 0.6 2.5 1.4 6.3Commerce 3.5 7.9 -2.2 12.8
14.2 23.7 -18.9Transport 6.3 8.7 2.1 5.0 10.0 9.6 11.0Fin. Inst.
4.0 5.0 2.6 11.2 13.8 11.7 21.1Services 3.4 4.1 1.7 7.2 6.9 6.2
9.3Others 2.0 1.8 2.2 1.4 0.7 0.5 1.7
Total GDP 3.4 4.8 1.1 100.0 100.0 100.0 100.0
1/ Trend rates based on least square estimate.
Source: ONE; Bank staff estimates.
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Table 3: GDP GROWTH BY DEMANDS COMPONENTS, a/ 1970-79
(Constant 1973 prices, percentages)
GDP Shares Contributions to GDP growth1970 1975 1977 1979
1970-79 1970-75 1975-77 1977-79
Consumption 72.8 75.5 80.3 76.0 86.4 86.4 86.3 -80.6
Investment 6.3 12.7 6.8 6.6 7.4 38.3 -122.6 -0.4
Exports 20.8 11.7 12.9 17.4 6.2 -24.7 136.3 181.0
GDP 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
a/ All demand components net of direct and indirect imports.
Source: ONE; Bank staff estimates.
6. The mediocre growth performance translated directly into
inadequateemployment generation and insufficient absorption of the
rapidly growing laborforce. During 1970-79, total employment grew
by 2.7 percent a year while thelabor force grew by 3.0 percent.
Open unemployment, therefore, increased from4.7 percent in 1970 to
7.1 percent in 1979. While employment in agriculturehas been
relatively stable and unemployment relatively low, open
unemploymentbasically is a non-agricultural or urban phenomenon.
During 1970-79, non-agricultural employment increased by 4.1
percent a year, the non-agriculturallabor force by 4.5 percent,
fueled by rapid natural growth and by rural-urbanmigration. As a
result, open unemployment in the non-agricultural sectorsincreased
from 8.3 percent in 1970 to 11.2 percent in 1979 (see table 4).Open
unemployment in a system without unemployment insurance is mostly
shortlived because people cannot afford to remain totally
unemployed for prolongedperiods and have to look for some
alternative source of income and employment.Inadequate employment
generation of the economy is mainly reflected by
highunderemployment in terms of low number of working hours and low
income. 1/Low-productivity employment is concentrated in the
agricultural sector. Itincreased, however, steeply in the
non-agricultural sectors during recentyears as a result of the
economic crisis and low economic growth.
1/ The Ministry of Labor classifies a person as underemployed if
weeklyworking hours are less than 35 and/or the income is less than
the 1967minimum wage adjusted for inflation.
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Table 4: UN- AND UNDEREMPLOYMENT, 1970-79
(Percent of Labor Force)
1970 1971 1972 1973 1974 1975 1976 1977 1978 1979
Unemployment 4.7 4.4 4.2 4.2 4.0 4.9 5.2 5.8 6.5 7.1
Agriculturallabor force 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3
0.3
Non-agriculturallabor force 8.3 7.7 7.3 7.1 6.6 8.1 8.4 9.4 10.4
11.2
Underemployment 1/ 45.9 44.4 44.2 41.3 41.8 42.4 44.3 48.1 52.0
51.4
Agriculturallabor force 64.3 63.6 67.0 65.4 65.4 68.2 68.8 62.1
65.4 63.5
Non-agriculturallabor force 30.9 29.0 26.6 23.3 25.0 24.8 32.7
39.2 43.7 44.1
1/ For definition, see footnote on preceding page.
Source: Ministry of Labor.
2.2 Financial Aspects
Public Sector
7. During most of the 1970s, the Government pursued
expansionary
expenditure policies, which were not matched by corresponding
efforts to
raise revenues. Moreover, inadequate pricing policies (including
subsidies
for food and petroleum imports) and inefficient management did
not allow
public enterprises to generate sufficient cash to make
reasonable contributions
to the financing of the investment program. The results were
steeply increas-
ing public sector deficits (see table 5) requiring excessive
recourse to
internal and external financing. The excessive public sector
demand spilled
over into the balance of payments with rising difficulties from
increasing
current account deficits and excessive debt service. Moreover,
the structure
of government expenditures did not really respond to the
country's needs:
expenditures for social and economic services, yielding place to
interest
payments and defense outlays, lagged substantially behind the
general trend of
current government expenditures and reached extremely low levels
at which
standards of service greatly suffered (see table 6); in
addition, investment
expenditures were heavily concentrated in large-scale projects,
some of which
are of doubtful economic justification such as the Majes
irrigation scheme,
with extremely long gestation periods and limited employment
creation.
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Table 5: PUBLIC SECTOR OPERATIONS IN RELATION TO GDP,
1971-80(Percentages)
1971 1972 1973 1974 1975 1976 1977 1978 1979 1980
Central Government
Current revenue 14.0 13.9 13.6 13.8 14.0 13.4 13.5 14.2 16.6
18.4Current expen-diture 12.5 12.9 13.4 12.6 14.4 14.8 16.9 15.7
13.5 17.3
Current account 1.5 1.0 0.2 1.2 -0.4 -1.4 -3.4 -1.5 3.1 1.1
Capital revenue - - - - - - - - - -
Investmentexpenditures 4.2 4.3 3.9 4.1 4.5 4.5 3.5 3.1 3.9
4.8
Overall deficit -2.7 -3.3 -3.7 -2.9 -4.9 -5.9 -6.9 -4.6 -0.8
-3.7
Total Public Sector
Current account 2.7 2.5 0.9 2.0 -0.9 0.0 -3.1 -0.5 3.8
0.9Capital revenue ... ... ... 0.6 0.0 0.0 - 0.0 0.0
0.0Investmentexpenditures 4.9 5.3 5.9 8.3 8.4 8.3 6.1 5.2 5.6
6.8
Overall deficit -2.2 -2.8 -5.0 -5.7 -9.3 -8.3 -9.2 -5.7 -1.7
-5.9
Source: Central Bank; IMF.
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-8-
Table 6: STRUCTURE OF CENTRAL GOVERNMENTCURRENT EXPENDITURE,
1972-78
(Percentages)
1972 1973 1974 1975 1976 1977 1978
General services 43.6 42.9 43.6 44.5 46.8 54.0 45.2of which:
defense (22.4) (24.1) (25.1) (28.1) (31.4) (40.0) (32.0)
Social services 36.3 35.8 34.7 35.5 34.0 25.4 22.7of which:
education (27.9) (28.3) (26.9) (24.5) (22.9) (18.1) (16.1)
health (7.1) (6.3) (6.6) (5.4) (6.2) (4.7) (6.0)
Economic services 7.6 8.0 7.1 7.9 7.0 4.5 6.1of which:
agriculture (3.6) (3.8) (2.6) (2.7) (1.8) (1.4) (3.4)
transport (2.6) (2.2) (2.2) (2.0) (2.0) (1.5) (1.5)
Other a/ 12.5 13.3 14.6 12.1 12.2 16.1 26.0
Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Total as % of GDP 12.9 13.4 12.6 14.4 14.8 16.9 15.7
a/ Mostly interest payments.
Source: Central Bank.
Money and Credit
8. Expansionary fiscal policies were supported by rapid credit
expansionand a rapid increase in overall liquidity. Credit to the
public sector expandedparticularly fast crowding out the private
sector. Low interest rates, whichhave been negative in real terms
for many years, additionally fueled thisprocess of monetary
expansion resulting in inadequate mobilization of financialsavings,
accelerating inflation, and increasing balance of payments
deficits(see table 7). Until 1978, the financing of the public
sector deficit was amajor source of inflation. During 1979 and part
of 1980, the monetization ofthe large increase in international
reserves played a major role. Substantialdevaluations, validated
through credit expansion and an acceleration of thevelocity of
circulation also contributed to the acceleration of inflation.
-
Table 7: MONEY AND CREDIT EXPANSION, 1972-80
(Annual percentage changes for money, credit and prices)
1972-73 1973-74 1974-75 1975-76 1976-77 1977-78 1978-79
1979-80
Money andquasi-money 20.1 22.1 18.1 17.3 32.6 45.7 98.4 78.1
Credit 31.8 10.9 41.8 49.4 57.9 41.4 16.0 62.0
Public sector 53.7 -1.2 84.8 104.0 96.1 44.7 -22.3 57.3Private
sector 27.7 15.5 28.1 24.3 29.2 37.7 61.9 77.5
Consumer prices 9.5 16.9 23.7 33.5 38.0 57.8 67.7 59.2(Lima
CPI)
Velocity ofcirculation 1/ 7.6 8.0 8.5 10.0 10.9 10.3 9.5
n.a.
Interest rates(Commercial banks,Lima)
Credit 12.0 12.0 12.0 12.0-15.5 15.5-17.5 17.5-31.5 31.5-32.5
31.5-32.5Savings deposits 5.0 5.0 5.0 5.0-9.0 9.0-11.5 11.5-29.0
29.0-30.5 29.0-30.5
1/ Based on Gross Output and M3
Source: Central Bank; IMF; ONE
Balance of Payments
9. Excess demand as measured by substantial savings-investment
gaps(that peaked at 15 percent of GNP in 1975) resulted in high
deficits ofthe current account of the balance of payments and --
after the sources ofexternal financing were gradually drying out
and gross capital inflows werealmost completely absorbed by debt
service -- in substantial losses of inter-national reserves. At the
height of the financial crisis in 1977/78, netinternational
reserves reached a negative level of about US$1,100 million
andgross reserves amounted only to about US$450 million, equivalent
to 2.0 monthsof imports of goods and non-factor services (see table
8). During 1979, thebalance of payments improved substantially as a
result of forceful demandmanagement, increased petroleum exports,
successful promotion of non-traditionalexports, an improvement of
the country's terms of trade, and debt reschedulingand refinancing.
This process continued in 1980, although vigorous
importliberalization resulted in a sharp increase of imports (56
percent over 1979)and in a minor current account deficit.
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Table 8: BALANCE OF PAYMENTS AND INTERNATIONALRESERVES, 1971-80
(% of GDP)
1971 1972 1973 1974 1975 1976 1977 1978 1979 1980
Current account 0.4 -0.4 -1.9 -6.3 -10.0 -8.2 -6.8 1.6 4.2
-0.1
Net long-term capital -0.4 1.7 4.2 7.3 7.6 7.1 4.9 5.1 6.0
3.0
Change in reserves 1.0 -0.6 0.1 -2.2 3.4 3.6 2.6 -0.7 -10.7
-3.8(increase - )
Reserve level, net 331.8 397.3 410.6 692.5 115.8 -751.7 -1100.9
-1025.0 553.9 1285.1(Us$ million)
Reserve level, gross 5.1 5.7 4.9 4.7 1.9 1.7 2.0 3.4 8.5
7.8(months of importsequivalent)
Source: Central Bank; IMF.
2.3 Income Distribution 1/
10. Reflecting the stabilization efforts and subsequent changes
inproduction, employment, and relative prices, income distribution
has undergonemarked changes during recent years. Functional income
distribution, ingeneral terms, is characterized by a drop of the
share of wages and salariesand contractual capital incomes (rent,
interest), relative constance of theshare of income from
self-employment, and an increase in the share of grossprofits (see
table 9). White-collar workers (salary earners) suffered alarger
drop of their share in national income than blue-collar workers
(wageearners). This larger drop, particularly during 1978 and 1979,
was partly dueto restrictions imposed on the salaries of government
employees. The averageremuneration of dependent workers declined by
14.2 percent in real termsduring 1970-79, the real wage of a
blue-collar worker in the Lima area by10.6 percent during the same
period, and that of a white-collar worker by36.4 percent 2/. By
comparison, the real average salary of a governmentemployee dropped
by an estimated 29.3 percent. Within the group of self-employed,
those working outside agriculture expanded their share
somewhat,while farmers suffered a substantial drop of their share
in domestic income,particularly during 1978 and 1979 as a result of
domestic policies and the
1/ For the method followed to estimate the different aspects of
incomedistribution, see Technical Note on Income Distribution,
Annex I.
2/ According to more recent data for the Lima metropolitan area,
realwages and salaries started to increase during the forth quarter
of 1979and throughout 1980.
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drastic deterioration of agricultural terms of trade. Continued
rapid rural-
urban migration helped the remaining self-employed farmers to
maintain a
higher share of domestic income; the demographically adjusted
share followed a
U-shape development, recovering towards the end of the 1970s
after gradual
decline during 1970-73 (see table 2.9, Statistical
Appendix).
11. Although the changing shares of different income sources
are
related to sectoral developments, especially in agriculture and
mining,
the general picture remains essentially the same -- drop of
wages and salaries,
increase in self-employed incomes and gross profits -- for the
non-agricultural
and non-mining activities together (see table 2.10, Statistical
Appendix). The
elimination of the net outflow of factor service incomes abroad,
which increased
rapidly during the past two years, does not fundamentally change
the picture
either. Factor income shares in national income closely followed
the lines of
shares in domestic income (see table 2.11, Statistical
Appendix).
Table 9: FUNCTIONAL INCOME DISTRIBUTION
AND REAL INCOMES, 1970, 1975, 1977-79
1970 1975 1977 1978 1979
Percentage Shares in Domestic Income
Wages and salaries 40.5 42.1 41.5 38.0 34.5
Wages 19.1 21.7 22.0 20.6 19.1
Salaries 21.4 20.4 19.5 17.4 15.4
Self-employed 23.8 21.8 21.6 21.8 21.7
Agriculture 10.4 8.1 7.4 6.3 5.8
Other 13.4 13.7 14.2 15.5 15.9
Contracted capital income 5.3 4.2 2.7 2.5 2.5
(rent, net interest)
Gross profits 30.4 31.9 33.2 36.7 40.3
Domestic income 100.0 100.0 100.0 100.0 100.0
Real Incomes, Index 1970 = 100
Wages and salaries 100 116.2 107.8 92.7 85.8
Wage, Lima Metropolitan Area 100 114.8 99.2 89.4 89.4
Salary, Lima Metr. Area 100 108.4 81.1 69.7 63.6
Source: Table 2.9, Statistical Appendix; Ministry of Labor;
ONE.
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- 12 -
12. The changes in the functional income distribution had
differenteffects on the household incomes of different income
groups. During 1971/72-79, the interpersonal distribution
deteriorated: real household incomes ofthe lowest income group
dropped by almost 18 percent, those of middle incomegroups by 10 to
17 percent, while those of the top income group increased byover 10
percent. During 1975-79 -- years of difficult adjustments and
economiccrisis -- the higher middle income groups (groups III and
IV, essentially blueand white collar workers) suffered the highest
drops (see table 2.12, StatisticalAppendix and Annex I).
13. The picture is regionally highly differentiated. Rural areas
andthe Sierra region fared relatively better than urban areas and
the Costaregion. The drop in real household income after 1977 was
less pronounced inrural areas than in urban areas, because the
decline in real incomes ofdependent workers (wages and salaries)
mostly affected urban jobs (see table 2.13,Statistical Appendix).
Tentative estimates show that the groups worst affectedby the
1975-79 adjustments were the middle and lower middle income groups
inurban areas, typically blue and white collar workers and some of
the self-employed engaged in subcontracting activities in the
informal sector. Rapidrural-urban migration helped to improve real
family incomes in rural areas,while, at the same time, they
contributed to exarcerbate the situationin urban areas. The ratio
of rural to urban household income went downslightly from 1 to 4.2
in 1971/72 to 1 to 3.6 in 1979.
14. While the real per-capita product, at the national level,
evolvedonly slightly during 1970-75, it dropped considerably during
1975-79. Thisdevelopment, however, was unevenly shared amongst the
different regions of thecountry. The Lima area experienced a fairly
stable increase in real per-capitaincome up to 1975, but suffered
the strongest decline thereafter. The otherregions followed an
S-pattern with declining income during 1970-73, followedby
increases during 1973-75 and sharp declines thereafter. In general,
theSierra -- depending more on agriculture than the rest of the
economy -- showedless fluctuations of the real per-capita income
than the other regions. This,to some extent, is also the result of
substantial out-migration. The Selva,in turn, with heavy
in-migration, was more subject to fluctuations in realper-capita
income than the rest of the country (see tables 2.14 and
2.15,Statistical Appendix). As was to be expected, the adjustment
process duringthe past few years imposed the heaviest burden on the
more advanced Lima areaand Costa region where most of the country's
modern sector activities arelocated.
15. The broad picture of functional income distribution in the
urbaneconomy (non-agricultural, non-mining GDP) throughout the
1970s is charac-terized by relative constancy of the share of
income from self-employment, arise of the wage and salary share
during the early 1970s, followed by relativeconstancy during the
mid-1970s, and a sharp decline thereafter. The capitalshare
followed the inverse pattern of the wage share, except for a marked
jumpin 1974. While this jump is associated with a substantial
increase in outputat the time when absolute protection through the
National Register of Manufac-tures took effect, the remaining
changes are associated with changes in theinternal terms of trade
between agriculture and the urban economy (that
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roughly followed a pattern of increase during the early 1970s,
relativeconstancy during the mid-1970s, and sharp decline after
1977) and acceleratedinflation. 1/
16. The changes in the internal terms of trade can be traced to
twosets of forces operating at different times. During the early
1970s, theinternal terms of trade followed the worldwide upward
trend of agriculturalcommodity prices relative to manufactured
products. Later on, particularlysince 1977, they changed through
the differential impact of domestic infla-tion on agricultural and
urban prices. This differential impact was broughtabout
particularly through the effects of massive currency
devaluations,which increased relative unit cost in the urban sector
(because of the rela-tively higher content of traded goods,
particularly traded inputs). Thedevaluations resulted partly in
reductions of urban output and partly inhigher inflation. Urban
profits (in terms of urban output) remained stable,while labor
incomes had to bear the full burden of adjustment and the
substan-tial increase in net indirect taxation. This process was
probably corroboratedthrough expectations and strategies by capital
income earners to maintaintheir incomes in dollar terms, which were
accomodated through substantialcredit expansion.
17. The observed shifts in income distribution were
exacerbatedthrough fiscal measures during the past four years
(revenues, expenditures,and price adjustments), whose incidence --
generally speaking -- tended to beregressive. 2/ The tax system
placed the highest burden on middle and lower-middle income
households for some time. The regressivity became even moremarked
during recent years, particularly because of the relative increase
inthe taxation of goods and services and the payroll taxes and the
reduction inthe taxation of personal income. While the average tax
rate for all householdsdeclined slightly during 1975-77, it
increased for the lowest three incomegroups. During 1977-79, the
overall tax burden increased, most markedly,however, for middle
income households (see table 10).
1/ For a broader discussion of possible explanations of the
observedchanges in income distribution, see Annex II "Inflation,
Growthand Distribution, 1970-79".
2/ For a more detailed assessment of the incidence of changes in
governmentrevenues and expenditures, see Annex III "Incidence of
Changes inGovernment Budgets, 1975-79".
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- 14 -
Table 10: AGGREGATE TAX RATES BY HOUSEHOLDS,
1975-79(percentages)
Household Income Groups 1/ AverageI II III IV V
(Low) (----- Middle ------) (High)
1975 9.73 13.30 14.38 12.95 13.31 13.30
1976 9.36 13.04 14.27 12.61 12.29 12.65
1977 10.32 13.70 14.74 12.57 11.33 12.18
1978 11.03 15.85 17.77 14.96 12.93 14.18
1979 12.34 17.84 20.06 16.49 14.57 15.86
1/ Definition of income groups according to table 2.12,
StatisticalAppendix.
Source: Bank staff estimates (For details see Annex 3: Changes
intax incidence, 1975-79).
18. With regard to the incidence of expenditures, the picture is
some-what less clear, since most of the expenditures are incurred
for non-attributablegeneral purposes like general services,
defense, and interest payments (whichtogether during 1975-78
accounted for two-thirds of government current expendi-tures). The
sharp decline in the share of expenditures for social purposesafter
1976, however, tended to be highly regressive, since lower income
house-holds depend on these public services to a larger extent than
higher incomehouseholds. The elimination of financial subsidies to
PETROPERU after 1976may have had some progressive impact, since it
mostly affected gasoline,which to a large extent is consumed by
middle and higher income households,while diesel and kerosene were
affected to a lesser degree. The maintenanceof food subsidies and
their sharp increase in 1980 may also have had someprogressive
impact, although the picture with regard to wheat is ambiguousto
the extent that higher income households may consume relatively
more wheatproducts and that wheat subsidies have a negative impact
on producer pricesfor other grains.
II. MAIN DEVELOPMENT ISSUES
19. During the past three years, the Government had to
concentrate effortson the solution of short-term problems to
overcome the financial and economiccrisis and keep the economy
afloat. At the same time, it initiated a processto make better use
of the country's resources by opening up the economy(through the
liberalization of imports and promotion of non-traditionalexports)
and rationalizing public investment (through reallocation of funds
to
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- 15 -
high-priority projects and postponement or elimination of
low-priority projects).The development of human resources and -- to
some extent -- that of thecountry's natural resources and physical
infrastructure were, however, neglected:current government
expenditures for social (education, health) and economicservices
(agriculture, transport) dropped in real terms to reach a point
whereservices are grossly inadequate as reflected by virtual
non-existence of agri-cultural extension, badly maintained roads,
or inadequate operation of hospitals;public investment continued to
be heavily concentrated in large-scale projects,generally with low
rates of return and, therefore, inadequate contribution toeconomic
growth and employment; population growth was left unchecked,
urbani-zation unstructured; and the distortions of the incentives
structure (prices,interest rates, tax exemptions, labor market
regulations) remained so as tofavor the use of (relatively scarce)
capital and to discourage the use of(relatively abundant) labor. At
the same time, while the acute balance ofpayments crisis was
overcome, the public sector deficit increased again in1980 after
having been reduced in 1979, and inflation with its strong
distor-tionary effects has continued at a high level. Moreover, its
temporaryrepression through price controls and its negative impact
on the internalterms of trade between agriculture and the urban
economy and thus on incomedistribution created a highly volatile
situation with the need for majoradjustments. In many fields, the
situation is critical, as reflected bysocial unrest during recent
years, and requires urgent corrective action.This section of the
memorandum concentrates on those issues that the WorldBank
perceives as the most critical ones. 1/
A. Macroeconomic and Financial Issues
1. Inflation
20. As in many other countries, high inflation in Peru basically
isa phenomenon of the 1970s. Prior to 1973, annual price changes
hoveredaround 6 to 7 percent, with the exception of the relatively
inflationary1963-68 period when annual price increases averaged
12.3 percent. Between1973 and 1979, there was an almost continuous
acceleration of inflation.First signs of decelerating inflation
were to be observed during the firsthalf of 1980, although this --
to some extent -- was the result of pricecontrols (see table 11).
With the exception of 1973-75, when acceleratinginternational
inflation certainly contributed to the acceleration of infla-tion
in Peru, inflation during the 1970s was mostly homemade: as a
result ofrapid credit expansion, mainly to the public sector,
averaging 32 percent peryear during 1972-78, total liquidity (money
+ quasi-money) increased by 26percent per year, fueling domestic
demand, spilling over into the balance ofpayments, and eventually
calling for the strong devaluations of 1976-78.Starting in
mid-1978, overall credit expansion was contained. However,liquidity
increased even faster, mostly because of the monetization of
thehigh balance of payments surplus (see table 7).
1/ In this context, we should mention again that this report
basicallyreflects the situation of mid-1980. The short-term
problems addressed inthe report prevailed for most of 1980. In the
meantime, however, theGovernment implemented a package of important
policy measures includingprice and interest rate adjustments that
will contribute to the solutionof some of the most pressing
financial problems (see Summary, paras.xii-xx).
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- 16 -
Table 11: ANNUAL PRICE CHANGES, 1973-80 (PERCENTAGES)
Import Price IndexLima Consumer Price Index Import Price Index
in US$ as Measured
Average Annual Quarterly in Soles 2/ in US$ 3/ by World Bank
IndexChanges Changes 1/ of International
Inflation
I 4.01973 II 9.5 8.6 14.1 15.8 20.3
III 12.0IV 13.3
I 15.51974 II 16.9 17.0 35.9 43.1 24.6
III 17.2IV 17.7
I 21.31975 II 23.6 21.2 36.0 24.3 15.3
III 26.0IV 25.6
I 27.7
1976 II 33.5 24.6 34.2 -2.3 -1.1III 36.8IV 43.1
I 39.8
1977 II 38.0 45.6 52.5 7.8 8.7
III 36.1IV 32.6
I 40.81978 II 57.8 53.4 105.1 6.5 15.3
III 61.3IV 72.1
I 72.61979 II 67.7 68.1 59.7 11.8 13.2
III 61.9IV 66.0
I 61.7
1980 II 59.2 56.8 44.7 12.8 12.5III 58.0
IV 58.8
1/ With respect to corresponding quarter of the previous
year.
2/ According to National Accounts.3! Converted at average
exchange rate, adjusted for changes in actual
import taxes.
Source: ONE, World Bank
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- 17 -
21. Inflation has caused major distortions in the economy:
markedchanges in relative prices of different goods and services
and erosion ofreal wages and salaries had a strong negative impact
on income distribution(see paras. 14-16); diversion of human and
capital resources towards infor-mation gathering and arbitrage to
take advantage of lags that occur in theprocess of general price
increases; financial repression through negativeinterest rates for
deposits resulted in inadequate mobilization of financialsavings;
and negative interest rates for credit was not conducive to the
bestuse of scarce resources. Available data do not provide clear
evidence of theimpact of negative real interest rates on financial
savings captured by thedomestic financial system. The share of the
increase in quasi-money (= proxyfor financial savings) in gross
national savings was subject to strong fluctua-tions. During the
past few years, however, the only dynamic element weredollar
denominated deposits, while the share of domestic currency
denominatedinstruments stagnated or even slightly declined (see
table 12). Inflation aswell as the interest rate and foreign
exchange policies prevented the financialsystem from playing an
increasingly important role of financial intermediation,as one
would expect in the process of economic development. To bypass
legalrestrictions with regard to interest rates and reserve
requirements, financialinstitutions may even have increasingly
promoted direct transactions betweensavers and investors on a
commission basis.
Table 12: GROSS NATIONAL SAVINGS -L/AND QUASI-MONEY,
-/1972-79
Billions of soles PercentagesGross nat. Quasi-money Quasi-money
Quasi-money (2) (3) (4)savings fin. system fin. system bank. system
(1) (1) (1)
w/o foreign w/o for. curr.curr. depos. deposits
(1) (2) (3) (4)
1972 41.9 7.3 7.3 4.5 17.4 17.4 10.71973 50.5 8.8 8.8 5.8 17.4
17.4 11.51974 58.0 8.8 8.5 4.8 15.2 14.7 8.31975 52.5 12.5 12.8 6.6
23.8 24.4 12.61976 81.1 11.9 11.7 5.4 14.7 14.4 6.71977 92.8 19.0
17.2 12.9 20.5 18.5 13.91978 248.3 67.0 29.9 18.9 27.0 12.0 7.61979
646.3 218.5 109.9 79.5 33.8 17.0 12.31980 866.1 n.a. n.a. 137.2
n.a. n.a. 15.8
1/ Including net private transfers from abroad2/ Annual increase
in stock
Source: Central Bank; IMF
22. Although fiscal and monetary policies pursued under the
stabiliza-tion-cum-economic-recovery program since mid-1978 were
relatively restrictiveas reflected by decreasing public sector
deficits and reduced overall credit
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- 18 -
expansion, they failed to check inflation effectively, mostly
because of highbalance of payments surpluses since early 1979,
which contributed to thesubstantial expansion of liquidity.
Accelerated import liberalization throughremoval of the remaining
non-tariff barriers, streamlining of administrativeprocedures, and
tariff reductions is critical to reduce inflation and
encouragehigher efficiency of resource use. The liberalization
measures taken by theGovernment in August/September 1980 and April
1981 should, in time, reap theexpected results. Since domestic
demand exceeds domestic supply, the gapcould be filled either
through price increases (which was the case untilrecently) or
through increased supply from imports with a dampening effect
onprices. Moreover, the structure of domestic supply, after years
of resourcemisallocation, is not in line with the structure of
demand so that increasedimports would also have to fill this
"structural gap". The dampening effecton domestic inflation from
increased imports may, however, be neutralized byoligopolistic
pricing policies in a highly concentrated commercial and
indus-trial sector. Therefore, specific action to foster
competition should betaken, e.g. in the form of "importaciones de
choque", through public and privateorganizations of articles whose
prices increase substantially faster thanaverage and through the
systematic spread of price information for importantconsumer
articles.
23. In addition, the Central Bank should continue to pursue its
re-strictive monetary policies, in particular the retention of
export earningsand the open market operations to absorb liquidity.
These measures should,however, be complemented by adjustments of
the interest rate and exchangerate policies (see paras. 27 and
28).
24. The present inflation also shows strong "cost push" signs in
theform of increased wages and mark-ups, fueled by still higher
inflationaryexpectations. A restrictive incomes policy, in line
with the expected growthof resource availabilities and backed by a
"social pact" between the Govern-ment, entrepreneurs, and unions,
could be an additional effective instrumentto fight inflation and,
at the same time, to promote employment. Whilethis task is
politically extremely difficult, it has high potential ina
conflict-prone situation like the Peruvian. The recent
establishment ofthe "Comision Tripartita" under the leadership of
the Ministry of Labor isa good start. The approach of a concerted
incomes policy had success for sometime in the United Kingdom and
Germany, also under politically and sociallydifficult
circumstances. Such a policy would in the short term have toaddress
particularly the entrepreneurs whose share in national income
hassubstantially increased over the past few years--mostly because
of pricemovements leading to increased profit margins, while output
shrank or stagnated.The need for some "re-alignment", however, does
not mean that the status quoante (say the 1975 situation) should be
re-established. The internationalcompetitiveness of Peruvian wages
and salaries (including the relatively highsocial benefits)
obviously is a major concern. The present level of totalhourly
labor costs (including all fringe benefits) for an unskilled
workerearning the Lima minimum wage, which is roughly US$1, is
about in line withthe economy-wide average labor productivity and
with wage levels in theCaribbean region (with the exception of
Haiti, where it is only about US$0.3)and somewhat lower than in
Mexico. In other countries, the minimum wage islower than the
economy wide average labor productivity, usually around 60 to70
percent. The higher ratio for Peru of almost 100 percent could
already
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- 19 -
indicate that the present minimum wage level 1/ might strain the
country's
potential. In any event, the question of the adequacy of the
wage level,
irrespective of the actual or assumed cost of living, deserves
careful study.
In the medium term, wage increases should be about in line with
increases in
labor productivity to avoid inflationary pressure from
increasing unit labor
costs. This medium-term orientation, which could be the guiding
principle of
the proposed negotiated incomes policy, irrespective of the
short-term need
for some re-alignment in income shares, would contribute to
dampen labor cost
and provide more equitable growth through higher employment
generation.
2. Pricing, Interest Rate, Exchange Rate, and Trade Policies
25. Prices, interest rates, and the effective exchange rate
(includ-
ing tariffs and export subsidies) are key signals for the
allocation of
resources. They have been subject to government control and
regulation in
Peru for many years resulting in serious distortions with
negative impact on
the efficiency of resource use. At the end of July 1980, prices
for about 40
different categories of goods and services were subject to
direct government
control through state-owned enterprises and prices for about
another 80 goods
and services, to a large extent supplied by private enterprises,
were subject
to government regulation. Although price controls seemingly
contain price
increases, they favor oligopolistic practices through concerted
action to
request periodic price increases. This applies particularly in
markets with
high effective protection, which is the case for most industrial
products--
even after the recent tariff cuts. Similarly, interest rates are
regulated.
Until recently, negative real deposit rates around -20 percent
(see table 7)
have resulted in inadequate mobilization of financial savings;
negative real
credit rates, also around -20 percent (see table 7) although
somewhat attenuated
through additional charges, have resulted in inefficient
resource use. Moreover,
the regulation, by preventing financial markets from reaching
equilibrium, may
have resulted in an excessive spread and, thus, excessive
profits of the banking
system. Finally, the exchange rate is managed by the Central
Bank, and the
"pace of the crawl" was at times determined by the targeted
rather than by the
actual domestic inflation rate as compared to international
inflation. Begin-
ning in the second quarter of 1979, this resulted in a gradual
appreciation of
the sol in real terms. During the third quarter of 1980, the sol
may have
been overvalued by about 15 percent with regard to the assumed
purchasing
power parity based on an estimate for 1978 by Williamson (see
table 13). 2/ If
one assumes that the free exchange rate of 1959 roughly
reflected purchasing
power parity, the actual nominal exchange rate of the sol in
1980 would have
been overvalued by about 25 percent with respect to the US
dollar.
1/ Although the minimum wage in many other parts of the country
is lower
than in Lima, the Lima minimum wage may be most representative
with
regard to the international competitiveness of the industrial
sector.
2/ During 1978 and 1979, the change in the nominal exchange rate
was very
close to that of the effective exchange rate, which takes
changes in
export and import taxes as well as export subsidies into
account. The
standard conversion factor changed from 0.9716 in 1978 to 0.9894
in 1979
or by 1.8 percent. The change from 1979 to 1980 must be similar
or
possibly somewhat lower so that the overvaluation argument based
on
nominal exchange rates basically holds.
-
- 20 -
Table 13: ACTUAL EXCHANGE RATE AND PURCHASING POWERPARITY OF THE
SOL, 1978-80
Actual ex- Domestic U.S. in- Inflation Purchasing
Deviationchange rate Inflation flation 2/ differential power parity
3/ (5)-(1)(%)SI. per $ (%) 1/ (%) (%) SI. per $ (1)
(1) (2) (3) (4) (5) (6)
I 130.30 - - - 132.7 1.81978 II 141.86 16.9 3.0 13.5 150.6
6.2
III 166.75 16.7 1.6 14.9 173.0 3.7IV 187.43 11.4 2.2 9.0 188.6
0.6
I 203.37 13.7 3.6 9.7 206.9 1.71979 II 218.60 13.9 3.5 10.0
227.7 4.1
III 232.22 12.3 3.2 8.8 247.8 6.7IV 244.01 14.2 3.5 10.3 273.4
12.1
I 257.29 10.7 4.5 5.9 289.7 12.61980 II 276.73 11.2 2.0 9.0
315.8 14.1
III 297.39 13.1 3.1 9.7 346.4 16.5
1/ Quarterly changes of the LIMA CPI2/ Quarterly changes of the
U.S. WPI3/ 1978 I estimate of the purchasing power parity based on
Denise Williamson:
Exchange rate policies in Peru, 1971-1979, paper prepared for
the con-ference on "The Crawling Peg: Past Performance and Future
Prospects",Rio de Janeiro, October 1979; 1977 II - 1980 II
projected on the basisof differential between domestic and U.S.
inflation.
Source: IMF; Bank staff estimates
26. Considering the distortions resulting from widespread
governmentinterventions, which in many state-owned enterprises
reached a degree thatleft management virtually without any
meaningful authority and financialresponsibility, the Government
should pursue a vigorous policy of decontrol,decentralization, and
devolution of economic decision making to the companylevel. Price
controls and regulations should be progressively dismantled
andprice formation left to the market subject to appropriate
anti-monopoly andanti-dumping safeguards. This will, however,
result in an additional infla-tionary push of short-term
adjustments. To moderate the impact, adjustmentscould be negotiated
within the framework of the proposed incomes policy (seepara. 24).
In case of oligopolistic market structures, additional
importsshould have a positive impact and, in addition, the state
could intensifycompetition through state enterprises without
imposing direct controls.Public enterprises would, however, have to
follow pricing policies that allowthem to be financially viable.
This principle should be gradually extended to
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- 21 -
all public enterprises including public utilities. Assuming
normal capacityutilization and efficient operation, prices should
be set at a level togenerate an internal cash flow sufficient to
meet a reasonable portion of thefinancial requirements of expansion
in line with demand growth. Low-incomeclasses could be helped
through cross-subsidization or direct consumer sub-sidies rather
than through control of producer prices. Substantial
progresstowards price decontrol has been made recently by lifting
price supervisionand by adjusting prices that are still subject to
state intervention.
27. Although decelerating inflation would in time result in
positivereal interest rates, there is a need for regular
adjustments in line withthe prevailing interest rate structure
abroad. The Central Bank's recentrevision of the interest rate
structure takes this into account. Higherdeposit rates are likely
to result in a higher capture of savings in thefinancial system
and, possibly, in a reduced spread between deposit andeffective
credit rates, particularly if the adjustment were supplementedby
freeing the access to the market (including foreign banks) and,
thus,increasing competition. However, given the pegged (although
crawling)exchange rate higher deposit rates may trigger additional
capital inflows,which would be inflationary. To protect the
external flank the speed ofdevaluation would have to be accelerated
to fully compensate the differentialbetween domestic and
international inflation and to make up lost ground(see table 12).
In addition, if necessary, an interest equalization taxcould be
introduced for non-resident capital owners.
28. As long as domestic inflation is substantially higher than
inter-national inflation, regular adjustments of the exchange rate
are crucial tomaintain international competitiveness. The
appreciation of the exchangerate in real terms observed during
1979-80 is an inadequate instrument tofight inflation. The
slow-down of the exchange rate depreciation should berather the
result of successful anti-inflationary policies. The exchange
ratepolicy should be defined with a view to the medium-term
requirements of domes-tic development, mainly economic growth and
employment generation. An over-valued exchange rate translates
directly into relatively high internationalprices for domestic
products and labor with damaging effects on the domesticeconomy
through declining exports and increased competitiveness of
imports.
29. The exchange rate has to be seen in the context of foreign
tradepolicies, together with import tariffs and the whole system of
export sub-sidies. The present system of highly differentiated
tariffs and exportsubsidies is equivalent to a system of multiple
exchange rates. Any changesof the different policy instruments have
to be closely coordinated andharmonized to eliminate distortions in
the overall structure of incentives.The present tariff structure,
even after the recent changes, provides rela-tively high effective
protection for the manufacturing sector. At the sametime, CERTEX
and subsidized export financing provide strong export
incentives.The present CERTEX system, however, based on gross value
of production ratherthan value added, discriminates against
products with high manufactured
-
- 22 -
content. 1/ Although the CERTEX, combined with more realistic
exchangerates, certainly helped to boost non-traditional exports
during the lastfew years, it has also to be recognized that the
strong export drive waspartly a response to the depressed domestic
market. If the real exchangerate continued to appreciate and the
other instruments were not changed,a re-orientation towards the
highly protected domestic market would haveto be expected,
particularly for products with high manufactured content,which from
a growth and employment point of view are the most desirable
ones.
30. To re-orient the industrial sector and to make better use of
thecountry's resource endowment, the level and structure of tariffs
and exportsubsidies would have to be revised. Lower tariffs and
lower export sub-sidies, combined with the pursuit of a rational
exchange rate policy, wouldprovide the same results in terms of
export promotion with less distortionaryeffect on domestic prices
and, probably, at a lower fiscal cost. The CERTEXshould be based on
value added (or some operational proxy that is easier tocalculate
and monitor) to eliminate discrimination against products with
highmanufactured content. Also tariffs should be less
differentiated to providea more uniform level of protection, which,
in time, would bring about thedesirable shift in the structure of
manufacturing production towards morelabor-intensive products and
higher degrees of processing. The recentlyadopted changes of the
tariff system are important steps in the right direction.While
trade liberalization as now pursued by the Government has its
greatmerits and will contribute to the containment of inflation and
-- in themedium run -- to more efficient resource use, there are
obvious risks involvedin terms of reduced economic growth and
employment, particularly if tariffsare cut too fast. To cushion the
impact of increased foreign competition,a gradual approach could be
advocated according to a negotiated and pre-announced schedule of
further tariff reductions, which allows entrepreneurstime to
adjust. Exceptions for infant industries should, however, be
grantedonly on a very selective basis for a small number of
industries and withinclearly defined time limits.
31. The new Government's trade, exchange, and interest rate
policiesare in line with the thoughts expressed in this report.
Non-tariff barriersagainst imports were removed and tariffs reduced
by an average of 8 percentagepoints (with the maximum rate set at
60 instead of 150 percent). Furthertariff reductions are being
considered with the ultimate goal of a rate ofsome 25 percent with
very little dispersion. The devaluation of the sol wasalso
accelerated in line with higher domestic inflation during the
second halfof 1980 and the first three months of 1981. Moreover,
the CERTEX system
1/ The manufactured content is defined as total domestic value
added bymanufacturing, either directly in the exporting sector or
indirectlythrough inputs from other manufacturing subsectors. Since
CERTEX isbased on gross value of production, products with low
value added, mainlyresource-based products, receive a relatively
higher subsidy per unit ofvalue added than products with high
manufactured content. In the caseof products that have a high
content of domestic manufactured inputs,the CERTEX may not even
compensate for the relatively high price of theseinputs.
-
- 23 -
underwent a thorough revision: rates were lowered, and the list
of eligibleproducts was reduced and specifically defined according
to the customs coderather than broad categories, which were subject
to widely varying interpre-tations. Finally, the Central Bank --
armed with new authority -- undertook athorough revision of the
interest rate structure and made substantial upwardadjustments of
both deposit and lending rates. More action is, however,
stilldesirable. It would be particularly important to make
additional effortstowards the gradual removal of administrative
controls of prices and interestrates. This obviously presupposes a
strengthening of competitive forces,particularly by facilitating
market access.
3. Public Finance
32. Although public sector finances improved substantially
during 1979and the first half of 1980 as reflected by a reduction
in the overall deficit(see para. 7), serious structural problems
remain to be solved. The financialdeterioration that took place
during the second half of 1980 exacerbated thesituation.
Improvements were previously achieved through cuts in
realexpenditures, mainly for social and economic services
(education, health,agriculture, transport) and salaries, and
through a substantial increase inrevenues. On balance, both groups
of measures tended to be regressive, andexpenditures in some fields
as well as salaries reached levels that aregrossly inadequate. For
example, per-capita expenditures for educationand health were about
$33 and $10 respectively in 1978 as compared to $75and $26 in
Panama or $69 and $12 in Costa Rica--two countries with
relativelyadvanced social services; 1/ outlays for highway
maintenance were $500 per kmin 1979 as compared to $1,100 that
would be considered adequate. There is anurgent need to step up
expenditures in these fields and for institutionalstrengthening,
particularly through more adequate salaries to attract andretain
capable staff. The recent salary increases for government
employeesand the announced policy of quarterly salary adjustments
in line with theincreasing cost of living may be adequate for a
period of overall adjustment.However, a more selective salary
policy with substantial increases at themanagerial level (in line
with improved productivity through additional workefforts and
training) would be required with a longer term view to
strengthenthe public administration.
33. To keep the public sector deficit manageable increased
expendituresin high priority fields should be matched by (i) cuts
of expenditures of lowerpriority; (ii) a trade-off between
recurrent and capital expenditures; (iii)increased revenues from
taxes and/or earnings of public enterprises or (iv) acombination of
all these offsetting measures. The tax burden of about 19percent of
GDP in 1980 is relatively high for a country of Peru's level
ofdevelopment. Thus, the scope for additional resource mobilization
throughincreased taxes is fairly limited, and the other possible
avenues have to beoxplored with priority.
34. With regard to cuts in low priority expenditures, subsidies
anddefense spending are the obvious candidates. Subsidies had been
sharplyreduced during 1979, but the reduction of wheat prices in
early 1980 as
1/ See BID - Progreso Economico y Social en America Latina,
Informe 1979.
-
- 24 -
well as the postponement of upward price adjustments for other
foodstuffs suchas rice and sugar and for petroleum products
resulted in the resurgence ofmassive subsidies amounting to S/.80
billion for foodstuffs and to S/.240billion for petrolem products.
It is only the sugar subsidy that comesdirectly out of the
Treasury, while the other subsidies are revenues foregoneby public
enterprises, ENCI, ECASA and PETROPERU. The immediate
financialburden is again somewhat lower than the economic subsidy
because of medium-termfinancing of most of the food imports. The
subsidization of gasoline tends tobe regressive, that of diesel may
be neutral, while that of kerosene andfoodstuffs may be slightly
progressive. While it is desirable to eliminateall subsidies to
improve the fiscal situation and the efficiency of resourceuse, a
gradual approach may be required to smoothen the social
impact.Subsidies could be progressively eliminated over a period of
say 12 to 18months. 1/ At the same time, s
