World Bank Document€¦ · through higher taxes, better tax administration, expenditure restraint,...

Document of

The World Bank

FOR OFICAL USE ONLY

Report No. 14157

PROJECT COMPLETION REPORT

PERU

TRADE POLICY REFORM LOAN(LOAN 3437-PE)

AND

STRUCTURAL ADJUSTMENT LOAN 4(LOAN 3452-PE)

MARCH 29, 1995

Country Operations I DivisionCountry Department III

l Latin America and the Caribbean Regional Office

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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CURRENCY EQUIVALENTS

(As of March 31, 1994)

Currency Unit = Nuevo Sol (S/.)US$1.00 = S/.2.17S/.1.00 = US$ 0.46

GOVERNMENT'S FISCAL YEAR

January 1 - December 31

FOR OMCIL USETHE WORLD BANK

Washington, D.C 20433U. S. A

Office of Director-General March 29, 1995Operations Evaluat'on

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Project Completion Report on PeruTrade Policy Reform Loan (Loan 3437-PE)and Structural Adjustment Loan (Loan 3452-PE)

Attached is the Project Completion Report on two loans to Peru-Trade Policy Reform Loan(Loan 3437-PE) and Structural Adjustment Loan (Loan 3452-PE)-prepared by the Latin America andthe Caribbean Regional Office, with Part II contributed by the Borrower.

The Bank's Board of Directors approved in May 1991 a new policy of "Additional Support forWorkout Programs in Countries with Protracted Arrears." Under this new policy a Trade PolicyReform Loan to Peru in the amount of US$300 million was approved on February 4, 1992 and aStructural Adjustment Loan in the amount of US$300 million was approved on March 26, 1992. Atthe end of the performance period-December 1992-the loans were signed and they became effectiveand were disbursed on March 18, 1993 as part of an arrears clearance operation. Both loans supporteda far-reaching program of macroeconomic stabilization, structural adjustment and trade reform as wellas an external financing plan for Peru.

The PCR describes the well designed and comprehensive programs and the remarkableperformance of the Government in meeting its commitments under the loan agreement. All 67conditions in the two loans were met satisfactorily. This success was largely due to the firm belief ofthe Government in the soundness of the program and in the perceived need to act promptly, firmly andin agreement with the external sources of finance.

Based on the analysis in the PCR, the outcome of both projects is rated as satisfactory both interms of sustaining and extending Peru's economic reform program and in terms of effecting a debtworkout for the country and reintegrating it to the international financial community. Institutionaldevelopment is rated as substantial. Sustainability is rated as likely given the degree of commitment ofthe Government to the program. Long term sustainability is also likely, but ultimately will depend onthe political and financial support which it continues to receive from the Government.

An audit is planned. JJ , J

Francisco guii-SacasaActing Director General

Attachment.

This document has a restricted distribution and may be used by recipients only in the performance of their omdial duties. Its contentsmav not otherwise be disclosed witbout World Bank authorization.

Project Complation Report: TPRL and SAL

PERU

TRADE POLICY REFORM LOAN (LOAN 3437-PE)STRUCTURAL ADJUSTMENT LOAN (LOAN 3452-PE)


TABLE OF CONTENTS

Page No.

PREFACE ................................ .i

EVALUATION SUMMARY .. ii

PART I: THE PROJECT REVIEW FROM THE BANK'S PERSPECTIVE ... 1

I. Project Identity .1

II. Introduction. 1

III. Policy Reform: The Historical Background. 3

IV. The Debt Workout for Peru. 4

V. The Two Projects. 7

The Structure of the Loans. 7Stabilization and the Structural Adjustment Program 8The Trade Reform Program .10The External Financing Plan .14

VI. Implementing and Monitoring the Loans ................ 16

The Borrower ............................ 16Project Monitoring ......................... 17Disbursement ........ .................... 17The Arrears Clearance Process ................. 18

VII. Conclusions . ............................... 18

Issues in Project Design and Preparation .... ........ 19The Structural Adjustment Loan ...... ........... 22The Trade Policy Reform Loan ...... ........... 23

Project Completion Report: TPRL and SAL

TABLE OF CONTENTS (continued)Pa-eNo.

References ................................ 25

Annex 1: Trade Policy Reform Loan: Policy Matrix ................. 27

Annex 2: Structural Adjustment Loan: Policy Matrix ................ 31

Annex 3: The Structural Adjustment Loan ....................... 42

Historical and Economic Context ..................... 42The Adjustment Program .......................... 45Preparation and Design of the SAL ................... 49Program Results ............................... 53Overall Evaluation .............................. 63Sustainability ................................ 66Conclusions and Lessons from the SAL ................. 67

Annex 4: The Trade Policy Reform Loan ........................ 69

Trade Policy Reform and the Loan .................... 69Implementation of the Reforms ...................... 71Recent Developments in Foreign Trade ................. 77Conclusions ................................ 79

PART Il: THE PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE 81

I. Introduction ................................ 81

II. Performance of the Bank .......... ................ 81

Trade Sector ............................. 82Structural Adjustment ............................ 83

III. Performance of the Borrower ....... ................ 83

IV. Trade Policy Reform Loan Objectives ..... ............. 83

a. Trade Policy ............................. 83b. INDECOPI ............................. 85


TABLE OF CONTENTS (continued)Page No.

c. Customs Reform ............................. 85d. Ports ................................ 86e. Tariff Surcharges .87f. ENCI (National Input Marketing Company) .87g. ECASA (Rice Marketing Company) .87

V. Objectives of the Structural Adjustment Loan .88

VI. Lessons Learned .90

VII. Bank and Borrower Relations During Loan Implementation 91

PART III: STATISTICAL INFORMATION ...................... 92

Trade Policy Reform Loan ......................... 92Structural Adjustment Loan ........................ 94

Project Completion Report: TPRL and SAL i

PERU



PREFACE

1. This is the Project Completion Report (PCR) for the US$300 million Trade PolicyReform Loan and the US$300 million Structural Adjustment Loan (SAL) to the Republic ofPeru. The Board approved the Trade Policy Reforrn Loan on February 4, 1992, and theSAL on March 26, 1992. At the end of the performance period -- December 1992 -- theparties signed the loans. The loans became effective and were disbursed on March 18, 1993as part of an arrears clearance operation.

2. The Japanese Grant Facility and the German Company for Technical Cooperation(GTZ) provided technical assistance for the preparation and implementation of the SAL.

3. Geoffrey Shepherd was task manager of the Trade Policy Reform Loan and ValerianoGarcia task manager of the Structural Adjustment Loan. Armeane Choksi was the Directorand Demetris Papageorgiou the Division Chief responsible for the two loans.

4. Parts I and III of this PCR were prepared by Geoffrey Shepherd and ValerianoGarcia. Michael Fabricius (summer intern) provided assistance on the historical record ofthe workout. Annex 3 was prepared by Valeriano Garcia, with the assistance of JorgeCanales (consultant), and Annex 4 by Geoffrey Shepherd. This PCR is based on thePresident's Reports for the two loans (Reports No. P-5666-PE and P-5714-PE), informationgathered during supervision missions and collected through a monitoring unit in Peru, andother cited documents.


PERU



EVALUATION SUMMARY

Introduction

1. After three decades of increasing interventionism and instability in economic policy,Perui had reached a state of virtual economic collapse and hyper-inflation by 1990. From1985 it had begun to repudiate the servicing of its foreign debts, and in 1987 the Bank placedPeru on "non-accrual" status.

2. In 1990, a new Administration, under President Alberto Fujimori, introduced aradical "shock" program to control prices, limit the role of the state, and promote market-oriented structural reforms. The Administration also sought to mend its ties with theinternational financial community, including the World Bank. To this end and followingdiscussions with the Bank, it resumed the servicing of its current debt to the Bank in October1990.

3. With the Peruvian case in mind, the Bank's Board approved in May 1991 a newpolicy of Additional Supportfor Workout Programs in Countries with Protracted Arrears(R91-70). The policy would assist strong-performing countries with large and protractedarrears to the Bank in mobilizing sufficient resources to clear their arrears and to support asustainable growth-oriented adjustment program over the medium term. The new WorkoutProgram enabled loans to be presented to the Board during a "perfornance period" but notdisbursed. Once the country had cleared its arrears at the end of this period, loans could besigned and made effective and the accumulated disbursements released. The WorkoutProgram, analogous to the IMF's Rights Accumulation Program (RAP), required fourconditions: (a) an external financing plan agreed with the country; (b) an IMF-supportedstabilization program; (c) a Bank-supported adjustment program; and (d) continued paymentof current debt service to the Bank. The adjustment program should result in Bankdisbursements at least sufficient to clear arrears to the Bank. However, the signing,effectiveness, and disbursement of these loans would not take place until arrears to the Bankhad been fully cleared.

4. This report covers two loans to Pern, a Trade Policy Reform Loan, presented to theBoard in February 1992, and a Structural Adjustment Loan, presented to the Board in March1992. The two loans, along with a Financial Sector Adjustment Loan, were part of a Bankprogram to effect a debt workout for Peru and thereby contribute to reestablishing a normaloperational relationship between the Bank and Peru and to help the country return to theinternational financial community. The three loans were among the first projects presented

Project Completion Report: TPRL and SAL iii

to the Board (in February and March of 1992) under the Bank-'s new Workout ipolic). Bothloans supported a drastic program of macroeconomic stabilization and an external financingplan for Pern. The first loan also supported a Peruvian program of rapid and far-reachingtrade reform, while the second supported deep structural reforms in several areas, as well asa social program.

Objectives

5. Under a Rights Accumulation Program agreed with the IMF, a macroeconomicstabilization program for 1991 and 1992 set budgetary targets that were to be achievedthrough higher taxes, better tax administration, expenditure restraint, and monetary controls.

6. An external financing plan for 1991 and 1992 was agreed between the PeruvianGovernment and a Support Group consisting of the international financial institutions andmajor bilateral donors. The plan envisaged that rescheduling Peru's public debt (mostlythrough the Paris Club) and a continued moratorium on private medium- and long-term debtwould cover most of the country's financing requirements. In addition, the IDB wouldresume lending (following Peru's clearance of its arrears to that institution) as soon aspossible, and the Bank and the IMF would resume operations following arrears clearance andat the end of a "performance period", in December 1992. Finally, a Support Group ofbilateral donors pledged to provide additional balance-of-payments support in 1991 and 1992.

7. In terms of sectoral conditionality relating to structural adjustment, the SALundertook to recognize the major structural reformns taken between August 1990 andDecember 1991 in: macroeconomic policy; the fiscal sector; the social sector; privatization;agriculture; labor; and social security. A total of 45 sectoral conditions covered themaintenance of current reforms (24 conditions) and measures for further reform (21conditions).

8. In terms of sectoral conditionality relating to trade policy reform, the Trade PolicyReform Loan undertook to recognize the major measures taken between August 1990 andSeptember 1991 and comprising: a reduction in tariff protection; the elimination of mostnon-tariff barriers; the elimination of export subsidies and improvement in schemes allowingexporters to recover indirect taxes; the abolition of the agency formerly administering tradecontrols and the initiation of a reform of customs. Of a total of 22 sectoral conditions, theemphasis (16 conditions) was on the maintenance of already existing reforms, with measuresfor further reform (six conditions) generally being considered secondary.

Implementation Experience

9. The macroeconomic stabilization program. The stabilization program met thetargets of the IMF. The program implemented by the Government was orthodox andmonetary-based, since it stopped domestic financing of the fiscal deficit and imposed targetson expansion of the monetary base. The Government maintained its commitment to strictfiscal discipline. A cash management committee managed central government finances on acash basis only. The Government also maintained its commitment to the market

Project Completion Report: TPRL and SAL ij

determination of key prices, including wages, as well as exchange and interest rates. Withno foreign exchange surrender requirements, all external transactions were convertible to asingle exchange rate. Monetary growth was limited to financing the quasi-fiscal deficit andincreasing foreign reserves of the Central Bank, at rates consistent with IMF targets.

10. The external financing plan. In September 1991, after the IMF's Board approvedthe RAP. the plan achieved two major objectives with: the Paris Club rescheduling, onexceptional terms, for the period October 1, 1991, to December 31, 1992; and the debtworkout with the IDB (followed by the IDB's resumption of normnal lending). During 1991the Support Group gave $370 million in balance-of-payment support and another $128million in 1992. These amounts were well below the original pledge. The shortfall waspartly the result of suspended disbursements after the Government's partial suspension of theConstitution in April 1992. Arrears with the Bank and the IMF were finally cleared inMarch 1993, three months behind schedule.

11. Structural adjustment. The Government fulfilled all the agreed conditions.

12. Trade policy reform. The Government fulfilled all the agreed conditions.

13. The Workout. Following Board presentation of the two loans covered in this report,the Bank closely monitored project implementation, partly through local consultants. Itreported the results of its supervision in three reports to the Board during 1992. The finalreport in December, at the end of the performance period, noted that the Government hadfulfilled the requirements of the two loans (and first-tranche requirements of the thirdadjustment loan) and that it had also maintained its servicing of current debt to the Bank. Inthe final report to the Board, Final Review of the Bank's Workout Program (R92-226), theBoard's approval was sought, and obtained, to allow the signing of the loan agreements, butnot their effectiveness and disbursement, prior to arrears clearance as an exception to thepolicy established in the paper Additional Support for Workout Programs in Countries withProtracted Arrears (R91-70). In March 1993, in an intricate arrears clearance procedurealso involving the IMF and bridge-financing institutions, the Trade Policy Reform, StructuralAdjustment, and Financial Sector Adjustment Loans were, following Perui's clearance of itsarrears, made effective and disbursed. (The first two loans were fully disbursed, along withthe first tranche of the Financial Sector Adjustment Loan.) Arrears clearance then enabledthe Bank and Peru to resume a normal relationship.

Results and Lessons Learned

14. Between August 1990 and December 1992 (the date when the performance period setby the Bank and the IMF ended), a new Administration laid the basis for one of the mostfundamental and rapid economic reforms witnessed in any country. These reforms may takea long time to bear fruit, if the experience of other radical reformers such as Chile and NewZealand is anything to go by. The economic situation remains fragile, but the resumption ofgrowth -- so far sustained -- since the end of 1992 and a palpable revival in investorconfidence augur well.

Project Completion Report: TPRL and SAL V

15. The macroeconomic stabilization program. The program was successful incurtailing hyperinflation, but it has not yet abated high inflation. The monthly inflation ratedeclined from an average of 40 percent per month through mid-1990 to a figure around twopercent per month by the end of 1993. Notwithstanding the largle improvement. Peru is stilla high inflation country. In addition, domestic real interest rates both in soles- and dollar-denominated operations, though still high, have dwindled from post stabilization levels. In1990-92 there was a strong perception that the real exchange rate was over-valued. therebypenalizing the production of tradable goods. In 1993, the real exchange rates depreciatedsomewhat, enhancing the competitiveness of exports.

16. Peru's experience contains some lessons about the course of stabilization of a highlvrepressed economy.

* In a scenario of historical instability and persistent dollarization, the increase in thedemand for domestic real balances will be small despite a reduction in the inflationrate.

* In this framework, the efforts of the Central Bank to depreciate the real exchange ratethrough direct purchases of foreign exchange will generate inflation.

* Financial intermediation in dollars reduces the effectiveness of monetary policy butdeepens financial intermediation more generally and provides a "strong" currencywhich facilitates trade and exchange.

* Real interest rates may remain high despite the opening of the capital account,reflecting a combination of country risk, expectations of a real exchange depreciation,and the level of taxation. In turn, this may attract foreign capital and further affectthe real exchange rate.

17. Structural adjustment. The reforms supported by the SAL have proven to be amongthe most important changes in the country's economic framework since 1968. The reformprogram encompasses a change in development strategy from an inward-oriented, importsubstitution scheme to a market-oriented open economy. The program aims to limit the long-run role of the Government to those activities in which it will be most efficient. Inparticular, the State is abandoning its role as producer and planner. It is concentratinginstead on providing a stable legal framework for property rights, health, education, securityand basic infrastructure and fostering an environment of competition designed to promote amore efficient allocation of resources.

18. Trade policy reform. The essence of the reform was to move trade policy to astance approaching neutrality, i.e. where there is minimal policy discrimination betweendifferent economic activities, between firms, or between imports and exports. Peru's tradereform was in general as radical and rapid as that observed in any other country, includingChile and Bolivia. The reforms have been completely effective in moving trade operations toa more market-oriented system of incentives and greater integration with the world economy.While the Peruvian economy has now begun a strong recovery from decades of stagnation


and a subsequent period of recession (induced by the stabilization). it is as \-e difficult to

fully measure changes in the structure or level of trade (beyond a rapid growth in importsand some change in their composition), hence to measure the gains from trade reforllls.Nevertheless, a recent Bank report found Peruvian firms now listed trade regime problemsc asthe least of their worries (it had been their ereatest before). and noted the herinninms olimproved industrial efficiency. If these economic reforms are maintained. measurablebenefits are soon likely to be apparent.

19. The experience of the Trade Policy Reformn loan contains some lessons ol a narrowver.more technical kind.

* The Loan provided support to an agrictultural surcharges scheme. The scheme has,in the event, operated most unsatisfactorilv, neither stabilizing prices nor benefittingfarmers, and it stands as a precedent encouraging other sectional interests to lobby forprotection.

* As more and more Bank member countries undertake fundamental trade reforms,Bank expertise needs to encompass new sets of issues. The Loan supported a custon7sreform program. The Bank relied heavily on the IDB in the design and supervision ofthis component, which appears to have been very effectively implemented. The Bankcould have made a better contribution if it had its own expertise in this area.Similarly, the Bank needs to develop more expertise to deal with the public-health andadministrative issues associated with residual non-tarif barriers imposed for health,safety. and security reasons.

20. The external financing plan for 1991 and 1992. The success of this plan wasrealized with the achievement of Peru's final arrears clearance with the IMF and the Bank.

21. The Workout. Some of the discussion preceding the establishment of a Bankworkout program centered on issues of sequencing between the international financialinstitutions and of sharing the burden in the clearance process. In the case of the Peruworkout, it is not easy to come to firm conclusions. but some relevant points can be made.

* Burden sharing. Lending to Peru6 is risky, though the perceived risks have fallen asPeru has sustained its recovery efforts. In the case of Peru's debt workout for theBank (as for the IMF), disbursements were approximately the size of arrears. In fact.the Bank's disbursements were US$33 million larger than Per-u's arrears of US$867million. Thus the rise in the Bank's country exposure (i.e. the sum of principal andinterest outstanding) was minimal, and it incurred little new direct risk. On the otherhand, any new lending to Perui associated with arrears clearance posed a risk to theBank's standing in capital-markets. This in itself might provide a reason to lend aslittle as possible. Support Group disbursements in 1991 and 1992 allowed Peru todefray the costs of servicing its debt to the Bank and the IMF. These countries thusbore a greater burden of risk.

Project Completion Report: TPRL and SAL vii

Timing and sequencing of clearance. By waiting to clear late -- at the end of theperformance period and 18 months later than IDB -- the Bank postponed theresumption of its lending. It thus temporarily forewent part, but not all, of itsdevelopmental role. But it can be argued that the Bank (like the IMF) reapedfinancial advantages. First, the Bank was the recipient of net transfers from October1990 to February 1993. During this period Pern paid the Bank over US$200 millionin current debt servicing. Second, the discipline which the Bank encouraged in Peru -

- in terms of economic policy and debt servicing -- cannot in itself have had anegative impact on capital markets. The later clearance lowered the risk of the Bankbeing associated with a failed reform and being perceived to have rolled over Peru'sdebt. In the event, the indicators are that the arrears clearance operation has notjeopardized the Bank's standing on capital markets.

* The effect of later clearance on Peru. As a development institution, the Bank mustbe as much concerned with its development impact as its financial standing. TheBank's late clearance imposed an immediate cost on Pern inasmuch as Peri spenttwo-and-a-half years servicing its current debt without receiving any developmentassistance. Against this, it may, of course, be argued that the discipline of theperformance period provided its own benefits to Peri.

22. Procurement and Disbursement procedures. Since the debt workout aimed at Bankdisbursements roughly equivalent in size to the arrears that Pern owed, there was in realitylittle net transfer of funds from the Bank to Peru. Nonetheless, the Bank's rules requiredthat disbursements be made against import expenditures. This imposes a burden onborrowers -- albeit minor compared to the size of the loan -- without any effect on theprocurement of imports from Bank member countries. A Country Procurement AssessmentReport (CPAR) prepared by the Bank correctly identified the issues related to reimbursementof funds when no evidence of payment can be obtained, which permitted a broad discussionand prompt resolution of the issue in the Bank. As a result of problems with documentationof imports in Peru, the Bank changed its disbursement policy for structural adjustment loans,somewhat simplifying the Bank's documentation requirements. But it might be preferable, ifthis could be done consistently with the Bank's Articles of Agreement, to simplifydisbursement procedures even more for adjustment loans, especially for those carried out inthe context of an arrears clearance.

Sustainability

23. The current Administration remains committed to the structural reforms and to currenteconomic policy, and is expected to maintain that position until the end of its term.Furthermore, the Administration has signed a three-year Extended Fund Facility Programwith the IMF, that has defined an economic program for the period, setting goals and targetsconsistent with increased stability.

24. However, inflation and real interest rates are very high relative to internationalstandards. The exchange rate remains appreciated relative to historic levels, and financialintermediation remains limited. There are still concerns about the sustainability of the

Project Completion Report: TPRL and SAL viii

economic program beyond 1995. On the macroeconomic side, the fears are based on thefragile situation of the fiscal balances over the medium term, unless there is an increase inthe level of tax revenues and an increase in the efficiency of public expenditure.

25. In addition, some positive economic achievements are required to fully consolidate thestabilization program. In particular, the recent recovery in growth must be sustained and thebanking system must recover its health. The long-term sustainability of the broad structuralreforms and economic improvement implemented by the Fujimori Administration will dependon long-term political support. Maintaining democratic procedures, given the politicalturmoil of recent years, while providing continuity in economic policy is a large challenge.On the other hand, after a quarter-century of economic mismanagement and decline, manypeople share a stake in, and hope for, Peri's economic reforms.

PERU

TRADE POLICY REFORMI LOAN (LOAN 3437-PE)STRUCTURAL ADJUSTMENT LOAN (LOAN 3452-PE)


PART 1. THE PROJECT REVIEW FROM THE BANK'S PERSPECTIVE

I. Project Identity

Operation Trade Policy Reform LoanLoan number P-3437-PE

Operation Structural Adjustment LoanLoan number : P-3452-PE

Region : Latin America and the CaribbeanCountry Republic of PeruSector Non-project Lending

II. Introduction

1. This report covers two loans to Perui, the Trade Policy Reform Loan and theStructural Adjustment Loan. The first supported a Peruvian program of rapid and far-reaching trade reform, while the second supported a drastic program of macroeconomicstabilization, as well as a social program and deep structural reforms in several areas. Thetwo projects were also part of a Bank program to effect a debt workout for Peru and therebycontribute to reestablishing a normal operational relationship between the Bank and Peru andto help the country return to the international financial community.

2. These were among the first projects presented to the Board (in February andMarch of 1992) under a new approach to address the problem of arrears to the Bank ofcountries in non-accrual status. To address the problem, the Board adopted a policy, on May2, 1991,1 to assist members with protracted arrears to the Bank in mobilizing sufficientresources to clear their arrears, and to support a sustainable growth oriented adjustmentprogram over the medium term. For strong-performing countries with large arrears, thisnew Workout Program enabled loans to be presented to the Bank during a "performanceperiod" but not disbursed (hence the "shadow adjustment program"). Once the country hadcleared its arrears at the end of this period, loans could be signed and made effective and theaccumulated disbursements released. The Workout Program, analogous to the IMF's RightsAccumulation Program (RAP), required four conditions: (a) an external financing planagreed with the country; (b) an IMF-supported stabilization program; (c) a Bank-supported"shadow" adjustment program; and (d) continued payment of current debt service to the

'Additional Supportfor Workout Programs in Countries with Protracted Arrears, R91-70, April 11, 1991.

Project Completion Report: TPRL and SAL 2

Bank. The Board agreed that the adjustment program should result in Bank disbursements atleast sufficient to clear arrears to the Bank. However, the signing, effectiveness. anddisbursement of these loans would not take place until arrears to the Bank had been fullycleared.

3. Perfi had gone into arrears with the Bank in 1987 and resumed the servicin- ofits current debt to the Bank in October 1990. On July 30, 1991, the Board approved theapplication to Peru. of the new Workout Program (see Peru. the Bank's Approach to aCountry with Protracted Arrears, R91-171, July 12, 1991). The Bank thereafter participatedin formulating an external financing plan with the government, the IMF, the IDB. andbilateral donors. This involved the formation, in 1991, of a Support Group of donors. InSeptember 1991 the IMF's Board approved a RAP for Perui. The Bank's Board approvedthree adjustment loans in the first half of 1992 (the Trade Policy Reform Loan, the SAL, anda Financial Sector Adjustment Loan). Thus Bank staff requested permission to sign the threeadjustment loans prior to arrears clearance, with effectiveness of the loan agreements anddisbursements conditioned upon arrears clearance. This change allowed the Government tocomplete expeditiously the legal steps required to ensure the validity of the loan agreements.The performance period was completed, and the three loans signed with the Bank, inDecember 1992. Peru repaid its arrears in March 1993, using two bridge loans, and theBank immediately disbursed an equivalent amount, made up of the single tranche of the tradeloan and the SAL and the first of two tranches of the third loan, the Financial SectorAdjustment Loan. After the completion of the Workout, the Bank then resumed normallending to Pern.

4. This report considers the two first projects of the Peruvian Debt Workouttogether because of their shared objectives, common background, and contemporaneouscompletion. The report describes the application of the Workout Program to Peru, but itdoes not comment on the Program itself, which has been evaluated in a paper of the JointAudit Committee.2 During the period of implementation of the project, the Bank made threereports to the Board.3 The last of these asked the Board to approve certain amendments. Itincluded the request to sign the three adjustment loans prior to arrears clearance, witheffectiveness of the loan agreements and disbursements conditioned upon arrears clearance.That approval was critical to the arrears clearance operation. In addition, this last report(R92-226) analyzes the evolution of the macroeconomic situation in this period, describes theevolution of sectoral policy covered by the three adjustment loans in the workout (providingthe details of fulfillment of conditionality in matrix form -- reproduced as Annexes 1 and 2 tothis Project Completion Report), and describes the fulfillment of the external financing plan.Annexes 3 and 4 to this Project Completion Report provide a more detailed account of theimplementation of the two projects.

2joint Audit Committee, Review of IBRD Policy on Workout Programs for Countries wvith Protracted Arrears,JAC93-17, April 30, 1993. The paper concludes (para. 15) that 'The policy has worked well, and hassupported both country and Bank objectives. ... there is no need for any change to the policy".

3Peru: QuarterlN Reviest' of Progress in the Bank's Workout Program, SecM92-697, May 28, 1992; Peru:Quarterlh Review of Progress in the Bank's Workout Program, SecM92-1310, October 1, 1992; and Peru:Final Review of the Bank's Workout Program, R92-226, December 10, 1992.


III. Policy Reform: The Historical Background 4

5. After an orthodox pro-market, export-oriented regime in the 1950s, Pernexperienced almost three decades of increasing interventionism and instability in economicpolicy (1962-90) -- interventions in pricing, interest rates, exchange rates, trade, creditallocation, land and labor markets, and so on. This had profound effects: economicstagnation (per capita GDP in 1990 at 72 percent of its 1980 level), the withering of the stateas an effective governing force, the growth of a huge informal sector, repudiation of foreigndebts and isolation from the international community, and the growth of a vicious brand ofterrorism. The culmination of these trends was, at the end of Alan Garcia's presidentialregime in 1990, economic collapse and hyper-inflation (inflation at 36,000 percent per annumin late July 1990). By any standards, this was a brutal collapse of a country.

6. In June 1990, Mr. Alberto Fujimori was elected President. He had run foroffice as a political outsider and on a platform of populist economic policies. His electionwas followed by a period of intense debate among his advisers and with representatives ofthe World Bank and the IMF on the need for a shock program to stabilize the economy. (OnJune 29, he met the heads of the World Bank, IDB, and IMF in New York to discuss hiseconomic reform program and the possibility of help from the international financialinstitutions.)

7. On August 8, a few days after the new Administration took office, PrimeMinister Hurtado Miller announced a radical and orthodox program to control inflation,adjust prices, and free markets. On the fiscal side this included management of the budgeton a cash basis, public-sector wage controls, a drastic rise in public sector prices, and theelimination of most fiscal incentives and subsidies. On the monetary side it included a policyof tight money, tight domestic credit, freeing of the exchange rate, and elimination ofexchange-rate controls. Most price controls were removed. The Government also began aprocess of reforrning the structure and administration of taxes and it took the first measuresin trade reform (including tariff reductions, a preliminary elimination of most non-tariffbarriers, and the elimination of export subsidies).

8. In March 1991, when a new Minister of Economy and Finance, Carlos Bolofiatook office, the program of economic reform entered a new and powerful phase, coveringmany areas.

* In trade, most remaining non-tariff barriers were eliminated (including those on mostsecond-hand goods), a two-tier tariff was introduced, as were variable tariffs tostabilize the prices of leading agricultural products, and a customs reform was begun.

* In the regulatory area, most state monopolies were eliminated, the ports and urbantransport were deregulated, and, from late 1991, a huge privatization program wasinitiated.

* The financial system was liberalized.

4 See Annex 3.

Project Completion Report TPRL and SAL 4

* The labor regime was made more flexible (through easier layoff provisions andcompensation for lavoffs).

* Foreign investment was liberalized.

* Steps were taken to improve private propert a rights in land.

9. In August 1990 the government also introduced a Social Emergency Programsafety net, which developed into a National Fund for Social Compensation and Development(FONCODES) in August 1991.

IV. The Debt Workout for Peru

10. The Peruvian Government had resumed servicing debt to the IMF in 1989. Inthe aftermath of President Fujimori's election, the Bank and the Goverrnment entered intodiscussions on the resumption of a normal relationship. The Goverrnent wished thereby notonly to gain access to the Bank's capital and technical assistance but also to take a step thatwould facilitate the normalization of its relations with the international financial community.To this end, on October 14, 1990, the Government resumed servicing its current debt to theBank.5 This cleared the way for two large Bank missions which prepared and discussedreports in the field. One report (Perti: Sector Reform and Investment Review, November 14,1990) analyzed the country's reform and investment needs, particularly in the public sector.The other (Economic Reforms to Sustain Stabilization and Lay the Foundations forDevelopment, December 8, 1990) proposed a range of reforms to stabilize the economy andinduce reforms in specific areas, including the labor market, public administration, the fiscalarea, trade, and the financial sector.

11. In mid-1990, Board discussion of debt workout exercises with Guyana andHonduras gave expression to some dissatisfaction with the lack of an agreed Bank workoutpolicy and to the view that the Bank had played an insufficient role vis-a-vis the IMF andhad taken too large a share of the risk. Perni was the first case of a non-IDA country forwhich arrears clearance came under discussion. It had the highest arrears in the Bank,accounting for 1.24 percent of the Bank's portfolio in July 1990. Thus it became the catalystfor a more widely applicable workout instrument. Actually, discussions within the Bank on

5Between March and September 1991, the Govemment began once more to accumulate arrears on the currentdebt service to the Bank and the IDB. This action represented the Government's private dissatisfaction with asituation in which the servicing of current debt to the Bank and the IDB was consuming about one tenth of thebudget, a situation which would not improve until after the workout with these two institutions. In this delicatesituation, the Bank consulted with the IMF, who made it a condition of its Board presentation (in September1991) that arrears on current debt service to the other international financial institutions would be settled, andthe problem was thus solved.

'The reports were later combined, in shortened, slightly updated form, as Peru: Economic and SectorReforms to Sustaini Stabilization anid Lay the Foundations for Development, Green cover, February 18, 1992.The combined report added little, existing mostlv to fulfill a bureaucratic requirement for a formal Bankdocument on which to base adjustment lending.

Project -Completion Report: TPRL and SAL 5

various options to deal with Peril's arrears had been ooing on since Peru resumed its debtservicin2 to the IMF in 1989. From 1990, various Bank- departments cooperated to produceproposals for a Bank debt workout policy, with the idea that Peru would be the first countryto have this policy applied.7 As a result, a paper was submitted to the Board in April.receiving Board approval on May 2, 1991. This paper (Additional Support for Wnor/-'itPrograms in Countries with Protracted Arrears, R91-70) provided the basis for the Bank'snew workout policy, hence the framework for the adjustment operations in Pern (see sectionV below).

12. In April 1991, a Bank mission to Lima met with the gov.rnment and laid thebasis for a series of three adjustment loans to effect such a workout for Peru. 1 July tb-Board approved the application of the new workout policy to Peri by giving its blessinm .July 12 paper, Perfi: the Bank's Approach to a Country wiith Protracted Arre,-rs. R91-171.The preparation of these loans began thereafter. The Japanese Grant Facilitt and theGerman Company for Technical Cooperation (GTZ) provided technical a- -`tance in 1991 forpreparing and implementing the SAL.

13. Following the Bank-Fund Annual Meetings in September 1990, the Bank andthe IMF agreed, at the urging of the Peruvian Government, to form a Support Group forPern.8 The leading donor countries were at first reluctant to make large scale commitmentsto Peri, and it took some time for the Group to form. The Group, consisting ofinternational donors and the three international financial institutions, first met in June 1991,co-chaired by the U.S. and Japan, with the IMF playing the leading "secretarial" role. TheGroup's purpose was to mobilize resources to fill the US$1.3 billion external financing ga.-that had been identified (mostly on the analysis of the IMF), in addition to quick-disbursingsupport from the international financial institutions, for 1991 and 1992. By September, theSupport Group had pledged US$1.1 billion. Following the formation of the SunporL Group,the Bank took a secondary role in mobilizing donor support through the Group, concentratinglater on mobilizing support, through a Consultative Group, formed in 1993, for Pern's socialsectors.

14. On September 12, 1991, the IMF Board, satisfied that Peru'~ externalfinancing requirements could be met and that Perd would maintain its payments on currentobligations to the international financial institutions, approved a Rights AccumulationProgram (RAP) for Peru.9 Under the program, Peru's adherence to IMF performancecriteria and continued servicing of debt to the international financial institutions would lead tothe accrual of rights to future disbursements once arrears to the IMF had been cleared at theend of 1992.

7This notably involved the LA4 Country Department and the Risk Management & Financial PolicyDepartment. In January 1991, following a reorganization in the Latin Ai !rica and Caribbean Region,responsibility for Pern shifted from LA4 Department to LAI. Some key country personnel were transferred tothe new Department.

8 Support Groups, usually chaired by the IMF, have been established when extraordinarily large amounts ofexternal financing are to be mobilized quickly. Consultative Groups, usually chaired by the Bank, are formedto address longer-term resource requirements.

9The RAP had been adopted by the IMF Board in April 1990.


15. The agreement with the IMF led the way to Peru's clearance of its arrearswith the IDB on September 13. (After some initial hesitation, the international financialinstitutions agreed that the IDB should lead the way on clearance as it had the smallestarrears outstanding). On September 18, the IDB's Board approved a Trade Sector Loan toPeru for USS425 million, a first tranche of which (for US$325 million) was disbursed onSeptember 25. The IDB was then able to undertake an active program of adjustment andinvestment lending (including a financial sector adjustment loan in 1992) and resumedisbursement on existing projects.

16. In their September 1991 meeting Peru's Paris Club creditors agreed onexceptional terms for the country in the form of cash-flow relief from October 1991 to theend of 1992.

17. On February 4, 1992, the Bank's Board approved a US$300 million TradePolicy Reform Loan (3437-PE). On March 26, 1992, its approved a US$300 millionStructural Adjustment Loan (SAL -- 3452-PE). On June 17, 1992, it approved a US$400Financial Sector Adjustment Loan (3489-PE).

18. In early 1992, the Bank and the Peruvian Government discussed the possibilityof bringing forward the arrears clearance to June 1992. Discussions were quite advancedwhen President Fujimori, in an April 5 "auto-golpe" ("self-coup"), dissolved the Congressand the judiciary, and suspended parts of the Constitution. Disbursements by Support Groupcountries and the IDB were suspended. The auto-golpe scuttled the idea of early arrearsclearance with the Bank. Bank staff requested permission to sign the three adjustment loansprior to arrears clearance, with effectiveness of the loan agreements and disbursementsconditioned upon arrears clearance. This change allowed the Government to completeexpeditiously the legal steps required to ensure the validity of the loan agreements. By theend of 1992, Perui was making progress, at the urging of the international community, inreturning to democratic rule. A Democratic Constitutional Congress (CCD) was elected inNovember. The performance period was completed, and the three loans signed with theBank, in December 1992.

19. At the Government's request, the Bank made first contacts with financialinstitutions to arrange two bridge loans in March 1992. There was a positive reaction on thepart of various banks, but the Government was, in the end, unable to come to an agreement.The US Treasury and the Japanese Export-Import Bank then agreed to provide the bridgeloans.

20. In early 1992, the IMF had to consider a successor arrangement to the RAP.In September 1992, it started preparing an Extended Fund Facility (EFF) for 1993-95. TheIMF estimated that a new Support Group would need to raise US$410 million to cover theexpected external funding shortfall of 1993. But only US$270 million was pledged.

"'The loan was among the first that IDB made under a new policy permitting it to undertake adjustmentlending without having to co-finance with the Bank.

Project Completion Report. TPRL and SAL 7

21. The Bank's three loans were signed on December 18. 1992. Nonetheless, ittook a further three months before the arrears could be cleared and the loans made effectiVe.One reason for this was that, following the Bank's requirement that the loans receivecongressional ratification, Per-Ci's political timetable did not allow ratification before mid-January. In addition, the IMF had difficulties in coming to an agreement with theGovernment on its 1993 economic program, and this held up the finalization of the EFF fromthe last few months of 1992 onwards. Given that the External Financinc Plan envisagedconcurrent clearance of Bank and IMF arrears, the Fund did not want the Bank to disburseon the adjustment loans until it was ready to do so (which happened in early 1993)."

22. Finally, on March 18, 1993, a complex sequence of transactions completed thedebt workout: Peri cleared its arrears with the Fund using the two bridge loans; the IMFdisbursed; the proceeds were used to clear the Bank's arrears; the Bank then disbursed thefull proceeds of two adjustment loans and the first tranche of the Financial Sector AdjustmentLoan; and Peru paid back the bridge loans.

V. The Two Projects

The Structure of the Loans

23. The three adjustment loans contributing to the Peruvian debt workout had acommon structure reflecting the peculiarities of the workout. Each loan underwrote the samemacroeconomic stabilization program and external financing plan, while supporting separate"sectoral" adjustment programs. (In the discussion below that covers the sectoral adjustmentprograms of the two loans covered by this report, the macroeconomic stabilization programis considered along with the structural adjustment program.)

24. For each loan the Letter of Development Policy played a particularly importantrole. The signature of the loan agreements came (in December 1992) at the end of theperformance period, well after Board presentation (10 months later, in the event, for theTrade Policy Reform Loan and 9 months later for the SAL). Under these circumstances, theloan agreement, contrary to normal practice, was a simple document containing a recognitionof what had been done, rather than a program of what was to be done. It was the Letter ofDevelopment Policy which, effectively, detailed the understanding that the Bank and theGovernment reached during loan negotiations. This understanding covered the process andconditions under which the loans would be presented to the Board and thereafter signed andmade effective. This included the conditions covering the macroeconomic stabilizationprogram and the external financing plan, the requirement for PerI to remain current on itsdebt servicing, and the precise details of sectoral conditionality. Thus the loans wereimplemented (and supervised) before they were signed.

"The resignation of the Minister of Economy and Finance, Carlos Bolofia, on January 4, 1993, did not initself appear to slow the clearance process. The new US Administration that came into office in January 1993sought assurances on several human-rights issues from the Fujimori Administration. Assurances were promptlygiven (shortly before arrears were cleared), and this did not appear to add any delays to the clearance.

Project Completmon Report: TPRL and SAL 8

Stabilization and the Structural Adjustment Program'2

25. For tCe SAL, the Government of Perna agreed with the Bank on a set of 45sectoral conditions covering macroeconomic and structural reforms. Twenty four of theseconditions prevented reversal of policy actions implemented prior to loan presentation to theBoard. The other 21 were conditions for further refonn.

26. Stabilization. The 6. )ilization program implemented by the FujimoriAdministration can be characterized as orthodox and monetary-based, since it stoppeddomestic financing of the fiscal defi t and imposed targets on money base expansion. TheGovernment maintained its commitment to strict fiscal discipline. A cash managementcommittee managed State finance, -,n a cash basis only. The Government also maintainedits commitment to the market determination of key prices, including wages, as well as the.xchange and interest rates. With no foreign exchange surrender requirements, all externaltransactions were convertible to a single exchange rate, at the time considered convenient tothe exporter or importer. Monetary growth was limited to financing the quasi-fiscal deficitand increasing foreign reserves of Central Bank, at rates consistent with IMF targets. Theprogram was succezsful in curtailing hyperinflation,'3 but it has not yet abated highinflation. The monthly rate declined from an average of 40 percent per month through mid1990 to a filurc iround two percent per month by the end of 1993. Notwithstanding thelarge improvement, Perd is still among high inflation countries. In addition, domestic realinterest rates both in soles and dollar-denominated operations, though still high, havedwindled from post-stabilization levels. In 1993, the real exchange rates depreciatedsomewhat, enhancing the competitiveness of exports.

27. Fiscal policy. Drastic changes in tax legislation reduced to five the number oftaxes collected by the central government, allowed for inflation adjustments to account for

12See also Annex 3.

13The Bank's new workout policy required the presence of an IMF-supported stabilization program. The IMFduly supported Peru's stabilization program through its RAP, and, at the end of 1992, pronounced allperformance criteria under the RAP observed. The Bank also chose to monitor the stabilization planindependently by reference to the performance of a set of relevant indicators for 1992. The purpose of thisapproach was not to set up alternative indicators -- they were consistent with the IMF program -- but to enablethe Bank to emphasize those indicators it thought were most important. These indicators, not in themselvesstrict performance conditions vould help support the Bank's own judgements on the progress of stabilization.1992 performance under the i,idicators was as follows.

(a)Central Government current tax revenue: target of about 9.0 percent of GDP; actual was 10.2percent.

(b)Primary balance of the non-financial public sector: target of at least 0.6 percent of GDP; actual was0.1 percent

(c)Rate of creation of monetary base (December 1991 to December 1992): target was up to 40 percent;actual was 71 percent.

(d) Stock of other Central Bank monetary liabilities in Soles: target was up to 0. 1 times monetarybase; actual was 0.

Prolec Comp/etlon Reporn. TPRL and SAL 9

collection lags, and eliminated many exemptions and loopholes. The Government introduceda new tax code allowing more efficiency in the tracking of infrinoements. and stricterpenalties (including prison terms) for certain infractions. The modification of statutory ratesincreased the share of the value added tax in total collections, reducing the level of moredistorting taxes. The institutional framework for the implementation of the law wasimproved, providing the basis for higher tax enforcement compliance. The tax adminis-tration institution, SUNAT, reorganized its personnel and modernized its monitoring tools inorder to improve its quality and effectiveness. These changes in the fiscal system permnittedthe central administration to collect about nine percent of GDP in tax revenues in 1992, fivepercentage points higher than when the new Administration took office. But with taxcollections still at a low level, the Government was obliged to continue restrictingexpenditure in order to achieve a negligible deficit of the consolidated non-financial publicsector in 1992. It was obliged to postpone public sector investment, to observe tightdiscipline on public sector wages, and to reduce the number of employees through voluntaryretirement. However, the Government managed to resume payment to all internationalfinancial institutions.

28. Labor. Among the reforms supported by the SAL, the labor stability law wasrelaxed, expanding conditions for layoffs and increasing the probationary period in specificcases. In addition, new labor contracts were allowed on a fixed-term basis (up to threeyears), allowing for fluctuations in temporary employment to adjust for new marketconditions. Finally, the Compensation for Time and Services Rendered (CTS) became afully-funded severance-cum-retirement mandatory savings scheme, managed by financialinstitutions. This change has improved labor mobility, because it provided workers withguaranteed savings available in case of severance while they search for a new job. TheGovernment also redefined the framework for collective negotiations and the rules thatgovern a strike.

29. Social security. The Government has redefined the nature of the mandatorysaving for retirement. A new legal framework will allow workers to choose between joininga pension system managed by the State and one handled privately. The new system maysignificantly increase the saving rate and improve income distribution. It has also eliminateddiscriminatory treatment favoring some pressure groups and changed the legal requirementfor indexation of the pension to periodic rises to account for inflation depending on thefinancial resources available to the managing institution.

30. Agriculture. In 1991, the Government passed a new Agricultural InvestmentPromotion law which abolished the earlier Agrarian Reform Law and strengthened the basisfor private property rights and market freedoms in land and water usage. Significant stepshave been taken toward the full implementation of the law. However, some difficultiesremain for land titling and registration. Most rural land has not been registered yet. Titlingwill enable peasants to use their land as collateral for credit. State participation inagriculture -- through price-setting, credit and subsidies, trading monopolies -- is being cutdrastically.

31. Privatization. The legal and institutional framework for privatization wasdefined in 1991 and 1992. Perd's bold program aims to privatize about 224 companies,


leaving the State to concentrate on basic infrastructure, health, education, and justice. Aspart of the effort to promote investment, the Government has made its foreign investmentlegislation among the most liberal in the world. Foreign investors now have the same rightsand obligations as Peruvians. There are no restrictions on capital remittances in any form.

32. From May 1992 to April 1994, 33 companies have been privatized. This processhas accrued US$ 2.07 billion in revenues, and has helped the Government balance its budget.Of particular note was the privatization of Empresa Nacional de Telecomunicaciones -Entel/Compania Peruana de Telefonos - CPT - Telecommunications. On February 28, 1994,a control package of 35% of Entel and CPT--including a capital increase in CPT--, wasauctioned to a consortium led by Telefonica Internacional (Spain), for a total of US$2 billion.Out of this amount, the State will receive US$1.39 billion, while US$0.61 billion will be theadditional capital in CPT. Up to 10% of Entel's shares will be offered to Entel's workersand the remaining shares will eventually be offered in the market. All the remaining mayorcompanies will be privatized by early 1995. These include the two mayor electricitycompanies (ELECTROLIMA and ELECTROPERU), the national oil company(PETROPERU), the water and sewerage company (SEDAPAL) and the remaining miningcompanies (CENTROMIN and MINEROPERU).

33. The social sector. To alleviate poverty, the Government will promote thegeneration of wealth as much as the redistribution of income. The process of labor marketderegulation, the elimination of the regressive inflation tax, and the promotion of otherstructural reforms should both improve real wages and expand the number of people informal occupations. In addition, the Government will concentrate on the provision,rehabilitation, and expansion of basic public services in health, education, and water andsanitation. This will require considerable improvement in the Government's administrativecapacity. As a short-term response to critical poverty, the Government designed a povertyalleviation strategy establishing a minimum safety net for the most vulnerable groups in thesociety. It began with an outline of policies in health, nutrition, education, and employment;the identification of vulnerable sectors and priority programs; and an institutional frameworkfor the implementation of social programs. One of the principal safety net schemes,FONCODES (the National Fund for Social Compensation and Development), created in1991, finances small labor-intensive projects for the rehabilitation of social and economicinfrastructure and for the provision of basic social services, identified by poor localcommunities. Since it started, it has achieved notable improvements in efficiency andmanagement. It relies on both internal and external resources.

The Trade Reform Program'4

34. In August 1990, the newly elected Fujimori Government began a fundamentaltrade reform concurrently with the introduction of a stabilization policy and the initiation of abroad range of economic reforrns. The exchange rate was immediately unified and floated,and almost all rationing of foreign exchange was eliminated. Many non-tariff barriers, mostimport tariff preferences, and all export subsidies were eliminated in short order. By March

14See also Annex 3.


1991, virtually all remaining non-tariff barriers had been eliminated. At that time, a two-ratetariff (15 and 25 percent) was introduced (with a few exceptions for steel products). Asystem of variable tariff surcharges was introduced for a limited number of agriculturalproducts in an effort to provide greater price stability in the domestic market. In mid-1991an anti-dumping code was passed. By this time, the Government had eliminated most of theactivity of the Instituto de Comercio Exterior (ICE -- the public body that had formerlyadministered import controls and export subsidies), and begun a program of reforming thecustoms service. In September, the Government gave the strength of law to many of thedecrees that had achieved these policy changes.

35. The Bank -- more than satisfied with the amount and quality of reform alreadyhaving taken place -- was concerned to agree on conditionality which would require Peri toundertake to maintain all its actual reforms and undertake only a few remaining reforms ithad already announced (notably tariff unification by early 1993), rather than to seek newpolicy concessions. In this respect, the Bank sought to defend the trade policy positionsalready established by the Government and enjoying substantial public support against anyfuture opposition that might arise. Of the 22 conditions agreed in the Trade Policy ReformLoan (see Annex 1), 16 were to maintain existing reforms and six to achieve further changes.The main actions under the Loan can be summarized as follows:

(a) the exchange regime: maintain a single freely convertible exchangerate for all transactions;

(b) tariffs: maintain a simplified tariff structure which has substantiallyreduced the level and variance of protection; maintain the elimination of mostspecial regimes allowing discriminatory preferences on the domestic market;maintain the agricultural surcharges scheme as it is (that is, not expanding orchanging it), with the possibility of revising it following a study; revise theanti-dumping code (with the help of a study of the issue);

(c) non-tariff import barriers: maintain the elimination of formallyprotective barriers, including prohibitions, minimum-local-content regulations,controls on most second-hand imports, and state agricultural importmonopolies; reduce or simplify some technical/safety/health controls onimports (with the help of a study of the issue);

(d) export regime: maintain the elimination of fiscal and financial exportsubsidies; improve schemes to allow imports to recuperate indirect taxes whenthe fiscal situation permitted this; maintain the reduction in non-tariff exportbarriers;

(e) trade institutions: carry out a program for customs reform.

36. The loan was prepared between June and December 1991. From thebeginning, the Bank worked in close cooperation with the IDB, which presented its ownTrade Sector Loan to its Board on September 18, 1991. The Bank and IDB agreed on


virtually identical trade conditionality. IDB took the lead in designing the project componenton customs reform. (IDB also provided a US$2.3 million component of a TechnicalCooperation project to fund technical assistance for the customs reform.)

37. The Board document Perni: Final Reviewv of the Bank's Workout Program(R92-226, December 10, 1992) reported that the Government had observed all measuresagreed (see Annex 1, reproduced as Annex 1 in this report, for details) and that itscommitment to an open trade regime had not wavered during the performance period."5

This is still the case more than one year later. In some cases, however, the trade reformencountered temporary reversals or other problems of implementation.

38. Tariff reform and the Andean Pact. Shortly before Board presentation, thePresidents of the Andean Pact committed themselves to create a customs union. This hadtariff implications for Peru in conflict with the loan conditionality initially proposed by theGovernment and acceptable to the Bank. To solve the conflict, the Bank and theGovernment then agreed on "either/or" conditions for tariff reform, depending on whetherthe Government opted to maintain the tariff strategy announced in early 1991 (first a two-tiertariff, then a low single rate) or opted to negotiate a common external tariff within theAndean Group (which was likely to be a multi-tier tariff, with higher average rates). In theevent, the Government, wishing to avoid raising the level of protection, has not agreed acommon external tariff with its Andean-Group partners, and the Government's tariff policycontinues to be to move to a flat 15-percent tariff. This outcome bodes well for maintainingthe momentum of Perd's trade reforn process.

39. The agricultural surcharges scheme, created in March 1991, provides for avariable surcharge, in addition to the normal 15-percent tariff, based on the average of theprevious five years' c.i.f. import price. Much of the revenue from these tariffs providesresources for the Ministry of Agriculture. The Government agreed not to extend the schemebeyond the 18 products originally specified and to undertake a study to evaluate the scheme.This study, completed in August 1992, found that, had the scheme been consistentlyimplemented as originally intended, greater price stability would have brought welfare gains,particularly for sugar."6 But the frequent changes in the rules -- changes in productscovered and in methodology -- led instead to welfare losses. Moreover, the presence ofclose substitutes and apparently imperfect competition in food distribution meant that thesurcharges were not translated into increased farm-gate prices. The study recommended the

15 The procedure in this loan, as in other Bank adjustment loans, was to require the fulfillment, withoutexception in principle, of a list of conditions. Formally, this gives the Bank little flexibility, short of seeking aBoard waiver: if one condition remains unmet while 19 are met, the conditionality is deemed not having beenfulfilled, even if some of the other 19 are fulfilled beyond expectations. In this Loan, there were undoubtedlysome minor cases of backtracking, but on balance conditionality was amply fulfilled. The Loan further requiredthe Government to prepare studies in three areas (the anti-dumping code, tariff surcharges, and non-tariffbarriers), the Bank and the Government to agree on further reforms based on these studies, and the Governmentto implement these. This kind of conditionality does not always make sense: it is sometimes unwise forgovernments and the Bank to commit themselves to agreeing and acting on a study whose findings they do notknow in advance.

16 Javier Escobal and Arturo Brisceno, El Sistenma de Sobretasas Agricolas en el Peru: Ev'aluacion YRecomendaciones, GRADE, 28 de Agosto de 1992.


direct provision of budgetary resources to improve farmer welfare, measures lo-increasecompetition in distribution, and a flat 10-percent ad valoremn tariff surcharge.

40. The variable surcharge has been potentially damaging to the overall thrust oftrade reform because it provides the thin end of the wedge for protectionist interests. Thecurrent situation is that the scheme, now covering 20 products, has been more or lessbrought back to its September 1991 situation. Given opposition within the Government tothe flat-10-percent-tariff recomrnendation, and the view that evolved in the Bank that thescheme should be changed wholesale (preferably eliminated) or not at all, the Bank hasaccepted the scheme in its present form, but has undertaken to keep the matter under reviewin its policy dialogue with the Government.

41. Non-tariff barriers related to health, technical, security, and miscellaneousregulations. The Government agreed to undertake a study to improve import procedures inthis area. A study, completed in March 1992, analyzes procedures for importing agriculturalgoods and inputs, and proposes criteria and measures for non-discriminatory healthcontrols. 17 It criticizes the protectionism of pre-Fujimori measures, but also suggest thathealth risks may be posed by the extent of liberalization associated with some of the post-Fujimori reforms. The study was originally intended as the basis for Bank-Governrmentagreement on new policy measures to be taken. However, the complexities of the public-goods problems involved in health and safety controls suggest that thorough-going reformswill require more study.

42. Nonetheless, the Government has been assiduous in fighting the lingeringbureaucracy of some of its ministries. In the area of certifying agricultural andpharmaceutical imports, it has made progress -- at times slow and halting -- in establishingprocedures allowing private agents to certify imports. Surveillance of non-tariff barriers isnow the responsibility of a new National Institute for the Maintenance of Competition andDefense of Intellectual Property (INDECOPI). INDECOPI continues to be active in studyingmethods ol reducing the discriminatory impact of non-tariff barriers, and may take overaccreditation responsibilities for health and quality certification from the Ministries ofAgriculture and Health.

43. Customs Reform. The Government agreed to formulate and carry out anAction Plan to restr-ucture the Customs Superintendency (SUNAD) and reform the legalframework lolr customs. The Action Plan has been carried out, and SUNAD has madeimpressive progress in changing its structure and practices. Customs bureaucracy has beenredluced, and imports are now processed more rapidly: it now takes less than a day, onaverage, to clear customs. There has been a dramatic increase in revenue collection: from1990 to 1992 the value of imports increased by 40 percent while revenues doubled. But thepresent reform may not go htr enough. There is, for instance, further scope for privatizingcustoms clearance, leaving a streamlined SUNAD to issue rules and to supervise. TheGovernment has been considering further reformn along these lines.

17 Hcriiogeines Pinedo R., Criterios y Nortmas de Imporracion: Eliminacion de Barreras No Arancelarias alConlercio Exterior: Inventario iv Criterios para Mejorar la Aplicacion de las Normas de Control Sanitario en lalnporlacion tie Producros e Insumos Agrarios, Lima, Marzo 1992.


44. A pre-shipment inspection (PSI) scheme, designed to increase tfie efficiencyand honesty of collecting tariff revenue, has been working since March 1992. The Bank hadno conditionality in this area. Indeed, the President's Report was equivocal about thebenefits of the scheme (para. 90). (In general, the Bank has embraced such schemes morepositively than this.) Few have been caught cheating, but the services of PSI companiesmust have played a significant role in the increase in tariff revenues. The Government hasexplained that the PSI scheme is intended to last for no more than one to two years, bywhich time customs will have a decent customs valuation data bank. A Bank study haslooked at the Peruvian PSI scheme in the context of a broader research project on the costsand benefits of PSI schemes.'8 The study acknowledges the benefit of the scheme as atransitional aid to customs reform by removing the valuation process from customs andgiving the service a breathing space to concentrate on other aspects of reform. But the netbenefit is likely to decrease over time as customs and trade reform reduces the returns tofalse declarations. Thus, SUNAD must begin to take over progressively customs valuationresponsibilities from the PSI companies.

The External Financing Plan

45. Peru's arrears grew rapidly from 1983 onwards. In July 1985, theGovernment announced that it would cap total foreign debt payments at 10 percent ofexports. It had achieved this by 1988, by which time it had also extended its moratorium tothe international financial institutions. Thus Peri became largely uncreditworthy ininternational financial markets.

46. With the Fujimori Government's announced intention of reintegrating Peri intointernational capital markets, the international community sought to develop a coordinatedapproach to address the problems of Peru's arrears and the heavy debt-service obligations ithad undertaken (in spite of a fragile fiscal situation) by resuming current debt-servicing to theinternational financial institutions. Given that, at the beginning at least, international donorswere skeptical of Peru's capacity for recovery, the approach taken was step-wise. Thedonors and the Government adopted a 1991-92 external financing plan that addressed theissues of rescheduling Peru's arrears to bilateral official creditors and accomplishing thenormalization of Peru's standing with the three international financial institutions."J Theresolution of arrears to private creditors was to be unilaterally deferred.

47. The IMF took the lead in the forecasts on which the plan was based, and theBank adopted these forecasts. As is traditional in the approach of donor groups andagencies, the "bottom line" of these forecasts is an estimated financing gap which donors arecalled on to fill. This kind of analysis is, of course difficult; some of the items projected areresiduals, and flexible exchange rates (as is Perui's case), reduce, ex-post, the projected gaps.Nonetheless, the projection serves the purpose of justifying aid levels.

18 Geoffrey J. Bannister, The Peruvian Pre-Shipmnent Inspection Program, International Trade Division,World Bank, July 1993.

'9See paras. 54-72 of Report and Recommendation of the President of the International Bank forReconstruction and Development to the Executive Directors on a Proposed Trade Polic) Reformri Loan in anAmount Equivalent to US$300 Million to the Republic of Peru, P-5666-PE, January 10, 1992.


Table 1: Peru - External Financing 1991-93: Planned and Actual(US$ millions)

1991 a. 1992 a. 1991-1992 1993 b.

A. ESTIMATES:

Financing Requirements:

1. Non-Interest Current Account Deficit 536 492 1028 10252. Debt Service Obligations 2616 2398 5014 24833. Arrears to be Settled in Current Year 12055 1800 13855 17994. Increase in Gross Reserves 454 303 757 3245. Gross Financing Requirements (I +2+3+4) 15661 4993 20654 5631

6. Loan Disbursements in Pipeline 255 200 455 2837. Private Capital Flows 908 545 1453 14458. Net Financing Requirements (5-6-7) 14498 4248 18746 3903

Sources:

9. Debt Rescheduling and Deferral 13598 1467 15065 1220Official Bilateral 6352 769 7121 692Private 7246 698 7944 528

10. Additional Disbursements 900 2781 3681 2682Multilateral 654 2328 2982 2272Official Bilateral 246 453 699 410

11. Additional Financing Required 0 0 0 012. Total Sources of Financing (9+10+ 11) 14498 4248 18746 3902

B. ACTUAL:

Financing Requirements:

1. Non-Interest Current Account Deficit 877 1159 2036 11492. Debt Service Obligations 2925 2133 5058 24563. Arrears to be Settled in Current Year 4890 37 4927 17254. Increase in Gross Reserves 904 257 1161 2755. Gross Financing Requirements (I +2+3 +4) 9596 3586 13182 5605

6. Loan Disbursements in Pipeline 217 244 461 1747. Private Capital Flows 1892 1898 3790 16988. Net Financing Requirements (5-6-7) 7487 1444 8931 3733

Sources:

9. Debt Rescheduling and Deferral 6352 1285 7637 1484Official Bilateral 6352 777 7129 893Private 0 508 508 591

10. Additional Disbursements 1135 159 1294 2249Multilateral 698 64 762 2048Official Bilateral 437 95 532 201

11. Additional Financing Required 0 0 0 012. Total Sources of Financing (9+ 10+ 11) 7487 1444 8931 3733

a. Estimates are from the beginning of 1992.b. Estimates are from the beginning of 1993; actual is preliminary figures.


48. In September 1991, after the IMF's Board approved the RAP' the planachieved two major objectives with: the Paris Club rescheduling, on exceptional terms, forthe period October 1, 1991, to December 31, 1992; and the debt workout with IDB(followed by IDB's resumption of normal lending).20 During that year the Support Groupgave US$370 million in balance-of-payment support and another US$67 million in projectsupport (see Table 1). The Support Group contributed US$128 million of balance-of-payment support in 1992 and another US$50 million in project support. In September 1991,the Support Group had sought to raise US$1.3 billion for 1991-92. By the time that theBank presented its three adjustment loans to the Board (first half of 1992), this figure hadbeen revised down to US$700 million. The actual Support Group contribution for the twoyears (balance-of-payments support only) totalled US$595 million. The shortfall was partlythe result of suspended disbursements after the "auto-golpe" of April 5, 1992, includingconcerns about human rights. Of the two largest contributors (and co-chairs of the SupportGroup), Japan, less affected by these concerns, gave more than it had initially pledged, whilethe US gave far less.2 ' Postponing the arrears workout for the Bank and the IMF from theend of 1992 to the beginning of 1993 meant that the final result of the 1991-92 externalfinancing plan was achieved a little behind schedule.

49. Once Peru had normalized its relations with official bilateral creditors and theinternational financial institutions, the Government in 1993 began negotiations with itscommercial bank creditors. In May 1993, Perfi also benefitted from a further Paris Clubrescheduling which reduced Peru-'s debt service due to Paris Club countries by aboutUS$1.88 billion for 1993 to 1995. The success of this settlement was deemed to virtuallyeliminate the need for a Support Group in 1994 and 1995. The Support Group met for thelast time in March 1993, pledging US$265 million for 1993.

VI. Implementing and Monitoring the Loans

The Borrower

50. The President appointed well-qualified professionals to design and manage thereform and stabilization programs. Two Ministers of Economy held office during theperformance period, but the reforms followed a single direction. Moreover, many of theadvisors remained at their positions, giving continuity to the economic policy. The principalMinistries responsible for the Structural Adjustment Program were Economy and Finance,Labor, Agriculture, Health, and Education. In addition, the Central Bank and theCommission for the Promotion of Private Sector Investment in State Enterprises (COPRI)had a direct participation in the SAL. The Bank worked closely with a special coordinatingunit set up in the Ministry of Economy and Finance to monitor the specific targets agreed onboth loans and to report on their status to the Bank. A special unit was set up in the CentralBank to prepare disbursement documentation.

20The Latin American Reserve Fund (FLAR) also contributed a bridge loan of $325 million in connectionwith the IDB workout, but the Central Bank repaid this almost immediately.

21This was made up as follows: $20 million from the US; $422 million from Japan; $16 million fromFrance; $25 million from the Netherlands; $5 million from Sweden; and $10 million from Switzerland.

Pro1ect Completion Report: TPRL and SAL 1 7

Project Mlonitoring

51. The Bank supervised the maintenance and implementation of measures agreedunder both loans not only through supervision missions, but also by establishing a localmonitoring unit, staffed by consultants, which provided regular and detailed reports to theBank on policy changes and the fulfillment of project conditionality. The monitoring unitwas extremely valuable in providing accurate and timely information over a broad range ofpolicy areas and in the timely detection of any problems that might arise in the fulfillment ofconditionality. The Bank also consulted closely with IDB on common concerns arising fromthe conditionality of its loans (mostly in issues related to trade).

52. As the Bank's workout policy requires, the Bank reported regularly to theBoard on the implementation of these two projects, as well as the Financial SectorAdjustment Loan, in the context of the Peru workout program. Three reports weresubmitted to the Board after the Trade Policy Reform Loan and SAL had been presented tothe Board, in May, October, and December of 1992. The final report, indicating asuccessful conclusion to the "performance period", sought the Board's approval for arrearsclearance and permission to sign the three adjustment loans prior to the arrears clearance,with effectiveness of the loan agreements and disbursements conditioned upon arrearsclearance. The permission to sign allowed the Government to complete expeditiously thelegal steps required to ensure the validity of the loan agreements.

Disbursement

53. One of the biggest problems in loan preparation -- and one internal to the Bank-- was the disbursement issue. Arrears clearance was to be accomplished through theinstantaneous disbursement of around US$900 million from three projects. This required,according to the Bank's rules, documentation of payment for eligible imports; and it poseddifficulties on two fronts. First, US$900 million (about 30 percent of Peru's annual imports)was a large amount to document, especially given that an estimated US$1.4 billion of IDBand Support-Group financing due by the end of 1992 also needed to disburse against similardocumentation. Second, obtaining evidence of payments for imports would be veryproblematic: the very reforms that our loans were supporting had eliminated the need forimport transactions to go through the Central Bank, while bank secrecy laws made itpotentially difficult for the Bank to obtain evidence of payment for imports from commercialbanks. These difficulties have also to be understood in the particular context of the Peruworkout: Bank disbursements were to be more or less equivalent in size to the arrears thatPeru would pay the Bank. In the event, there was a net transfer of funds from the Bank toPeru of US$33 million.

54. Notwithstanding this, the solution to these difficulties maintained the principleof disbursing against imports. The solution had two principal elements. First, the Bankpermitted an unusually long period of retroactivity. The performance period for Peru wasdefined, with some logic, to begin when Peru's reforms began, i.e. in August 1990. Thisjustified an expected 28-month period (that is, until December 1992) of imports eligible fordisbursement. Second, for the first loan to go to the Board (the Trade Policy Reform Loanin February 1992), the Bank made an exception to its normal rule of disbursing against proof

Project Completlon Report: TPRL and SAL 78

of payment for imports. It accepted instead evidence of the act of importing contained incustoms declarations as a proxy for evidence of payment. The issue of disbursing adjustmentloans had been recently raised elsewhere in the Bank, and as a result of the new Peruprecedent, the Bank quickly established a new policy for disbursement of adjustment loanswhich accepted proof of importing as the basis for disbursing adjustment loans. By the timethe SAL went to the Board, it was covered by the new policy.22

55. The disbursement issue constituted a costly, contentious, and arcane part ofproject preparation. Even though the Bank solved its difficulties and the loans weredisbursed smoothly, the Peruvian Govermment, through its special unit in the Central Bank-,was still involved in considerable expense in compiling the necessary documentation.

The Arrears Clearance Process

56. Arrears were finally cleared on March 18, 1993, in a complex, multi-partytransaction which, in order:

3 provided bridge financing from the U.S. Department of the Treasury and the Export-Import Bank of Japan (both via the Federal Reserve Bank of New York) to permitIMF arrears clearance;

* aused the proceeds of the IMF disbursement (plus a small, additional amount of fundsfrom the Peruvian Government and the US Treasury) for clearing the arrears of theBank; and

* ldisbursed Bank funds to the bridge financiers who, once they had taken back theamount of the bridge financing, disbursed the remainder to the Peruvian Government.

The transaction needed to be fast and minutely planned to minimize the cost of the bridgeloan and the chance of the process going wrong. To this end, a Bank inter-Departmentalarrears clearance team, formed in April 1992 (and modelled on a team approach to theearlier clearance of arrears for Zambia), had been meeting regularly to prepare the clearance.In the event, the above three steps were completed in 95 minutes -- including a record 33minutes from clearance of the Bank's arrears to Bank instructions to disburse to Peru.

VII. Conclusions

57. The Trade Policy Reform and Structural Adjustment Loans had a doubleobjective: first, to sustain and extend Peru's economic reform program; and second, toeffect (along with the Financial Sector Adjustment Loan) a debt workout for the country,thereby helping reintegrate it into the international financial community. The operationappears so far to have been a complete success.

22ln disbursing its Trade Reform Loan (first tranche in September 1991) the IDB had already adopted asimilar approach.


58. Between August 1990 and December 1992, the performance period set by theBank and the IMF, a new Administration laid the basis for one of the most fundamental andrapid economic reforrns witnessed in any country. These reforms may take a long time tobear fruit, if the experience of other radical reformers such as Chile and New Zealand isanything to go by. Moreover, the economic situation remains fragile: a still-delicate fiscalbalance translates into obstinately high inflation and interest rates, though they have beenfalling. But the resumption of growth -- so far sustained -- since the end of 1992 and apalpable revival in investor confidence augur well.2 3 The success of the reform programbenefitted from the single-mindedness and pragmatism of the Peruvian Government.

59. Peru has now cleared its arrears with the Bank and the other financialinstitutions. The Bank's arrears were cleared, and an equivalent amount disbursed inadjustment lending, only after a performance period during which the Bank carefullymonitored: Peru's compliance with macroeconomic stabilization program and structuraladjustment programs; the execution of an internationally coordinated external financing plan;and Peru's continued servicing of its current debt to the Bank. The indicators are that thearrears clearance operation has not compromised the Bank's standing on capital markets.The Peruvian case had the added benefit of having catalyzed a Bank-wide workout policy.

Issues in Project Design and Preparation

60. The project timetable. The preparation and implementation of both projectssuffered various delays, although these delays may in the end not have been too costly.

* The Bank first started discussing a Bank-wide workout policy in 1989 and took until1991 to put one in place. This could perhaps have been achieved a year earlier, andit took developments in Peru to bring the matter to a conclusion.

T he Bank took 16 months from Peru's resumption of debt servicing (in October 1990)to present its first adjustment project to the Board (in February 1992). The Bank hadmaintained its economic work on Peru after it stopped lending in 1987 and was quickto establish contacts with, and offer advice to, the new Administration in 1990. Thetransfer of responsibility for Peru from one Department to another at the beginning of1991 may have cost a little momentum. Once the Bank had decided to go ahead withthe clearance exercise and prepare three projects, the first two were presented to theBoard a few months later than initially projected (the Trade Policy Reform Loan wasthree months late, the SAL two months). Most aspects of project preparation wentvery smoothly, because of the good knowledge base and the virtual absence ofdisagreement with the Government. Coordination within the Bank proved moredifficult. In particular, the disbursement issue and the normal bureaucratic clearance

23Peru's political ups and downs have affected investor confidence. The "auto-golpe" of April 1992 harmedthe recovery, but progress in returning to democratic institutions, as well as the considerable damage that theGovernment has inflicted on Sendero Luminoso, the terrorist movement, have been positive developments. Thecommercial success of the privatization program is one indicator of the new confidence.

Project Comp/etion Report: TPRL and SAL 20

requirements consumed a large amount of time.24 Board presentation was animportant political signal, and earlier Board presentation would have been beneficial.

61. The debt workout. Some of the discussion preceding the establishment of aBank workout program centered on issues of sequencing between the international financialinstitutions and of sharing the burden in the clearance process. In these discussions theremay have been something of an implicit presumption in the Bank that bearing a smallerburden and earlier clearance were better. This is not necessarily so. The Bank's financialhealth may not necessarily be best served in this way, while the Bank's financial concernsmay often conflict with its development role. In the case of the Peru. workout, it is not easyto come to firm conclusions, but some points can be made.

* Burden sharing. In the case of Peru's debt workout for the Bank (as for the IMF)disbursements were approximately the size of arrears. In fact, the Bank'sdisbursements were US$33 million larger than Peri's arrears of US$867 million.Thus the rise in the Bank's country exposure (i.e. the sum of principal and overdueinterest outstanding) was minimal, and it incurred little new direct risk. On the otherhand, any new lending to Peru associated with arrears clearance posed a risk to theBank's standing in capital-markets. This in itself might provide a reason to lend aslittle as possible, while the developmental impact of lending (for policy reforms, forexample) would presumably stand in direct relation to loan size. The IDB's firstdisbursement on its arrears clearance (the first tranche of its adjustment loan) wasslightly less than its arrears. Support Group disbursements in 1991 and 1992 allowedPeru to defray the costs of servicing its debt to the Bank and the IMF. Lending toPeru is risky -- though the perceived risks have fallen as Peru has sustained itsrecovery efforts -- and official bilateral lenders or donors thus bore a greater burdenof risk than the international financial institutions.

* Timing and sequencing of clearance. By waiting to clear late -- at the end of theperformnance period and 18 months later than IDB -- the Bank postponed theresumption of its lending. It thus temporarily forewent part, but not all, of itsdevelopmental role. But it can be argued that the Bank (like the IMF) reapedfinancial advantages. First, the Bank was the recipient of net transfers from October1990 to February 1993. During this period Peru paid the Bank over US$200 millionin current debt servicing.25 Second, the discipline which the Bank encouraged inPeru -- in terms of economic policy and debt servicing -- cannot in itself have had anegative impact on capital markets. The later clearance lowered the risk of the Bankbeing associated with a failed reform and being perceived to have rolled over Peri's

24The IDB began to prepare an adjustment loan at the same time as the Bank -- and with less expenise onPeri -- and got to its Board by mid-September 1991.

251n 1991-92, the Support Group disbursed a similar amount to Peru. Officials from some of the SupportGroup governments privately complained, at the beginning of the process at least, that the international financialinstitutions expected bilateral aid to shoulder a large burden.


debt. 26

* The effect of later clearance on Peru. As a development institution, the Bank mustbe as much concerned with its development impact as its financial standing. TheBank's late clearance imposed an immediate cost on Peru inasmuch as Penr spenttwo-and-a-half years servicing its current debt without receiving any developmentassistance. Against this, it may, of course, be argued that the discipline of theperformance period -- and the public record of prompt debt service payments --provided its own benefits to Peru.

62. Procurement and Disbursement procedures. The debt workout required, asa minimum, Bank disbursements equivalent in size to the arrears that Per6 owed, and therewas in reality only a modest net transfer of funds (US$33 million) from the Bank to Peru.Nonetheless, the Bank's rules required that disbursements be made against importexpenditures. This imposes a burden on borrowers -- albeit minor compared to the size ofthe loan -- without any effect on the procurement of imports from Bank member countries.A Country Procurement Assessment Report (CPAR) prepared by the Bank correctlyidentified the issues related to reimbursement of funds when no evidence of payment can beobtained, which permitted a broad discussion and prompt resolution of the issue in the Bank.The loans to Peru did succeed in somewhat simplifying the Bank's requirements in respect ofimport documentation. But it might be preferable, if this could be done consistently with theBank's Articles of Agreement, to simplify disbursement procedures even more for adjustmentloans, especially for those carried out in the context of an arrears clearance.

63. The Bank's relationship with the IMF and EDB. Peru resumed its currentdebt servicing to the IMF earlier than it did to the Bank or the IDB, while only the Bank andthe IDB, not the IMF, suffered interruptions in current debt servicing in the course of 1991.(The IMF, through of its power of expulsion, enjoys leverage that the Bank does not have.)In spite of this differential treatment, all three international financial institutions came tocooperate in encouraging the Government to maintain current debt servicing to the threeinstitutions equally.

64. The Bank had an exceptionally close working relationship with the IDB, theresult largely of the transfer of a Bank staff member to the IDB in mid 1991 to spearheadIDB's own arrears clearance exercise with Peru. The Bank also enjoyed a close workingrelationship with the IMF. A division of labor emerged between the two institutions. TheIMF took the lead, as it normally does, in agreeing on a macroeconomic stabilization planwith the Government, and the Bank sought to emphasize those policy aspects of the plan itconsidered most vital. The IMF also coordinated the external financing plan (leaving theBank, after the conclusion of the debt workout, to coordinate aid in the social sectors). TheBank took the main role on structural reforms, sharing this with the IDB in the area of trade(and, later, financial sector reform).

26Early on in the process of formulating a coordinated international approach, the international financialinstitutions were keen not to be last in the clearance process. There were obviously political gains to be madefrom being the first to clear, not least with the Peruvian Government. The financial gains are less clear.

Project Completion Report. TPRL and SAL 22

The Structural Adjustment Loan

65. The reforms supported by the SAL have proven to be among the mostimportant changes in the country's economic framework since 1968. The reform programencompasses a change in development strategy from an inward-oriented import substitutionscheme to a market-oriented open economy. The program aims to limit the long-run role ofthe Government to those activities in which it will be most efficient. In particular, the Stateis abandoning its role as producer and planner. It is concentrating instead on providing astable legal framework for property rights, health, education, security and basicinfrastructure and fostering an environment of competition designed to promote a moreefficient allocation of resources.

66. The current Administration remains committed to the structural reforms and tocurrent economic policy, and is expected to maintain that position until the end of its termn.Furthermore, the Administration has signed a three-year Extended Fund Facility Programwith the IMF, that has defined an economic program for the period, setting goals and targetsconsistent with increased stability.

67. However, inflation and real interest rates remain high relative to internationalstandards, and financial intermediation remains limited. There are still concerns about thesustainability of the economic program beyond 1995. On the macroeconomic side, the fearsare based on the fragile situation of the fiscal balances over the medium term, unless there isan increase in the level of tax revenues and an increase -- very difficult to achieve -- in theefficiency of public expenditure.

68. In addition, some positive economic achievements are required to fullyconsolidate the stabilization program. In particular, the recent recovery in growth must besustained, real interest rates must fall further, perhaps the real exchange rate must stilldepreciate further, and the banking system must recover its health. The long-termsustainability of the broad structural reforms and economic improvement implemented by theFujimori Administration will depend on long-term political support. Maintaining democraticprocedures, given the political turmoil of recent years, while providing continuity ineconomic policy is a large challenge. On the other hand, after a quarter-century of economicmismanagement and decline, many Peruvians share a stake in, and hope for, the economicreforms.

69. Peru's experience contains some lessons about the course of stabilization of ahighly repressed economy.

* In a scenario of historical instability and persistent dollarization, the increase in thedemand for domestic real balances will be small despite a reduction in the inflationrate.

* In this framework, the efforts of the Central Bank to depreciate the real exchange ratethrough direct purchases of foreign exchange will generate inflation.

* Financial intermediation in dollars reduces the effectiveness of monetary policy but


deepens financial intermediation and provides a "strong" currency which facilitatestrade and exchange.

* Real interest rates may remain high despite the opening of the capital account,reflecting a combination of country risk, expectations of a real exchange depreciation,and the level of taxation. In turn, this may attract foreign capital and further affectthe real exchange rate.

The Trade Policy Reform Loan

70. The Trade Policy Reform Loan was based on a sweeping and simple reformprogram which took place within a broader and supporting program of macro- andmicroeconomic reforms. The essence of the reform was to move trade policy to a stanceapproaching neutrality, i.e., where there is minimal policy discrimination between differenteconomic activities, between, firms, or between imports and exports. Peru's trade reformwas in general as radical and rapid as that observed in any other country, including Chile andBolivia. The relative roles of the Peruvian Government and World Bank (and IDB) inmaking the case for and designing the reform are hard to distinguish. In the very early daysof the Government, the Bank's advice was important, but from early 1991 onwards, theinitiative in design was clearly that of the Government. There is no doubt of Peruvian"ownership".

71. The trade reforms have been completely effective in moving trade operationsto a more market-oriented system of incentives and greater integration with the worldeconomy. While the Peruvian economy has now begun a strong recovery from decades ofstagnation and a subsequent period of recession (induced by the stabilization), it is as yetdifficult to identify measurable changes in the structure or level of trade (beyond a rapidgrowth in imports and some change in their composition), hence to measure the gains fromtrade reforms. If the economic reforms are maintained, measurable benefits are soon likelyto be apparent.

72. There are several features of Peru's trade reform that augur well for itssustainability. First, the program was bold and rapid. This made it politically convincing.Second, the rapid and virtually complete elimination of quantitative restrictions further addedto its credibility. Third, Peru has maintained a stable macroeconomic environment. If thereis a feature of the reform that bodes less well, it is that the reform took place without anyapparent real depreciation of the currency. Indeed, the perception among economic agentswas especially prevalent in 1991-92 that the currency was overvalued. There is no evidencethat, under the circumstances, the currency could have been much more depreciated, if onlybecause there was a strong inflow of short-term capital over which the Government did have(and could have) only limited control. On the other hand, a more depreciated currencywould undoubtedly have helped in the "political economy" of trade reform by raising theprofitability of exporting and thereby more rapidly creating a new political constituency fortrade reform. The currency has depreciated in real terms since 1992, so that the problem ofperceptions has receded and the opportunities for profitable exporting have grown. Moregenerally, domestic politics are likely to be the main determinant of the sustainability ofPeru's economic reforms, including trade reform.


73. The experience of the Trade Policy Reform loan contains some lessons of anarrower, more technical kind.

The Loan provided support to the agricultural surcharges scheme on the argumentthat food price stabilization could benefit the economy. The scheme (providing aprice floor, but not a ceiling) was never the best design to stabilize prices. It has, inthe event, operated most unsatisfactorily, neither stabilizing prices nor benefittingfarmers. And it has threatened to open a protectionist breach that might be exploitedin attempts to reverse other measures of the trade reform. In retrospect, the Bank'sefforts should have been applied to fundamentally changing the scheme (a flatsurcharge, for instance, but preferably a complete elimination). Failing this, the Bankshould have left the scheme alone.

As more and more Bank member country undertake fundamental trade reforms, Bankexpertise needs to encompass, in addition to the "why" and "how" of trade reform, anew set of issues which, broadly speaking, come under the heading of "tradefacilitation". Prominent among these are issues such as customs reform (including therole of pre-shipment inspection), port reform, and implications of reform for transportinfrastructure. The Loan supported a customs reform program. IDB provided themajor input, negotiating project conditions with the Government and closelysupervising implementation. The Bank relied heavily on the IDB in the design andsupervision of this component, which appears to have been very effectivelyimplemented. This may have been a somewhat too passive stance for the Bank. TheBank could benefit from its own expertise in customs issues.

Perul, having eliminated a large array of clearly protectionist non-tariff barriers, nowhas to deal with residual non-tariff barriers imposed for health, safety, and securityreasons. Many of these barriers respond, in theory at least, to valid problems ofpublic health and so on. The issue is to be able to distinguish justifiable cases ofpublic-good barriers from unjustifiable cases and to design an efficient and non-discriminatory mechanism. The Bank has played a leading role in identifying, anddeveloping techniques to measure, non-tariff barriers. It could now benefit fromdeveloping its own expertise in regulations that minimize the costs and discriminatorynature of health and safety controls.


REFERENCES

The World Bank-, Perti: Sector Refonn and Investment Review. November, 1990

Economic Reforms to Sustain Stabilization and Lay the Foundations for Development,December 8. 1990

Demetris Papageorgiou, Armeane M. Choksi, and Michael Michaely, Liberalizing ForeignTrade in Developing Countries. the Lessons of Experience, Washington, D.C.: the WorldBank, 1990

Additional Support for Workout Programs in Countries with Protracted Arrears, R91-70,April 11, 1991 and Chairman's summing-up remarks

Peru: the Bank's Approach to a Country with Protracted Arrears, R91-171, July 12, 1991

Report and Recommendation of the President of the International Bank for Reconstructionand Development to the Executive Directors on a Proposed Trade Policy Reform Loan in anAmount Equivalent to US$300 Million to the Republic of Perui, P-5666-PE, January 10, 1992

The World Bank, Peru: Economic and Sector Reforms to Sustain Stabilization and Lay theFoundations for Development, green cover, 10361-PE, February 18, 1992

Pinedo R., Hermogenes, Criterios y Normas de Importacion. Eliminacion de Barreras NoArancelarias al Comercio Exterior: Inventario y Criterios para Mejorar la Aplicacion de lasNormas de Control Sanitario en la Importacion de Productos e Insumos Agrarios, Lima,Marzo 1992

Report and Recommendation of the President of the International Bank for Reconstructionand Development to the Executive Directors on a Proposed Structural Adjustment Loan in anAmount Equivalent to US$300 Million to the Republic of Perul, P-5714-PE, March 2, 1992

Peru: Quarterly Review of Progress in the Bank's Workout Program, SecM92-697, May 28,1992

Escobal, Javier, and Arturo Brisceno, El Sistema de Sobretasas Agricolas en el Peru.Evaluacion y Recomendaciones, GRADE, 28 de Agosto de 1992

Peru: Quarterly Review of Progress in the Bank's Workout Program, SecM92-1310, October1, 1992

Per.: Final Review of the Bank's Workout Program, R92-226, December 10, 1992

Bolofia Behr, Carlos, Cambio de Rumbo: el Programa Econ6mico para los '90, SegundaEdici6n, Lima: Instituto de Economia de Libre Mercado, 1993


Cooperacion Tecnica a Superintendencia de Aduanas (SUNAD): Supervision de la TerceraFase: Informe de Mision, IDB, 1993 (mimeo)

Joint Audit Committee, Review of IBRD Policy on Workout Programs for Countries wvithProtracted Arrears, JAC93-17, April 30, 1993

The World Bank, Perua at the Crossroads. Building a Modern State, Green Cover, 11943-PE, June 30, 1993

Geoffrey J. Bannister, The Peruvian Pre-Shipment Inspection Program, International TradeDivision, World Bank, July 1993

World Bank, Peru: a Private Sector Assessment, Green Cover, 12096-PE, December 20,1993

- 27 -

Annex 1: TRADE POLICY REFORM LOAN: POLICY MATRIX

ISSU'ES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN STATUSTO BOARD PRESEN'TATION SIGNING

INIPORT TARIFFS

Structure By March, 1991, 3-rate structure of 5, 15, 25%; Eliminate 5% rate (steel-industry Completed. (D. Lg.average of 17%; coeff. of variation of 23%. inputs) by March 1992; unless No. 668)

Increase neutralitv of tariff structure. implementation during 1992 of an (The alternativeAndean-Group common external tariff Andean-Group optionappears likely by that time. has not been pursued.)

Preferences on the Domestic Elimination of most regimes by September, No reintroduction of discriminatory Maintained.Market 1990 (major exceptions are educational & preferences.

cultural institutions; treaty agreements.Increase neutrality of tariff structure.

Specific Tariffs Removal of all surcharges by March 1991; Publicize, by Board presentation, the Study completed andand Tariff Surcharges variable surcharge on 5 agricultural products, existing method of setting the variable surcharge scheme

introduced in May 1991. surcharge. Reform of surcharge revised (D. Ley No..Increase transparency and efficiency of scheme: agree study TOR by March 25528.)agricultural protection. 1992, agree implementation

guidelines by June 1992, enact reformby September 1992.

Safeguard Mechanism Introduction of an anti-dumping/subsidy code in Reform of anti-dumping code: agree Study completed andJune 1991. study TOR by Board Presentation, code revised (D.S. No..

Minimize protective effect of enact reform by March 1992. 051-92-EF.)anti-dumping protection.

- 28 -

Annex 1: TRADE POLICY REFORNM LOAN: POLICY MIATRIX

ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF 10).4N STAsT1ISTO BOARD PRESENTATION SIGN ING

NON-TARIFF IMPORTBARRIERS

Fornmal Protective Barriers All prohibitions/ restrictions suspended by No reintroduction ot non-larnl Mdannined.September 1990, permanently liberalized by barriers.

Increase neutrality of protection March 1991.structure.

Health, Technical. Security, and Various reforms from March to May 1991, Reform of health and sanitary Studv completed andMiscellaneous Regulations removing or simplifying controls: reintroduction regulations & technical standards: agricultural and

of controls in a few cases. agree study TOR by Board pharmaceutical importReduce discriminatory effect of health presentation, agree implementation controls made moreand technical regulation. guidelines by March 1992. enact flexible.(D.S. No..

reform by June 1992. 093-92-EF and D. LeyNo.. 25596).

Inmort Monopolies All public-enterprise monopolies removed in No reintroduction of import Maintained.principle in March 1991; ENCI & ECASA monopolies.

Increase neutrality of protection monopolies removed in March 1991; Petroperustructure. monopoly removed in August 1991.

Local-Content Regulations All local-content regulations eliminated in March No reintroduction of local-content Maintained.1991. regulations.

Increase neutrality of protectionstnucture.

Controls on Second-Hand Imports of most second-hand goods allowed in No reintroduction of controls in Maintained.Imoorts November, 1990 and of machinery and vehicles second-hand imports.

in March 1991; only controls on clothing, shoes,Increase neutrality of protection and bath fixtures remain.structure.

- 29 -

Annex 1: TRADE POLICY' REFORM" LOAN: POLICY NtATRIX

ISSUES AND OBJECTIVES ACCOMPLISHMEENTS FROM N MIID-1990 CONIDITIONS OF LOAN STATUSTO BOARD PRESENTATION SIGNING

EXPORT REGIME

Taxes on Traditional Exports After 10% surcharge from August to November No raising of tax rates or application Maintained.Increase neutrality of export regime. 1990, taxes range from 0% to 10% by February of tax to new products.

1991.

Subsidies for Non-Traditional Reduction (August), then abolition (November No re-introduction of export Maintained.Exports 1990) of CERTEX; abolition of FENT in subsidies

November 1990.Increase neutrality of export regime.

Indirect Tax Treatment Automation of Temp. Adm. scheme and its No further action required. Letter of Developmentbroadening to all exporters in March 1991; Policy undertaking to

Reduce fiscal discrimination against introduction of drawback scheme for non- extend the drawbackexports. traditional exports in March 1991. system has been signed

and sent to the Bank.

Export Contracts No new contracts are being issued and scheme is No further action required. Maintained.defunct.

Increase neutrality of exportregime.

Free Trade Zone Any new or expanded zone may only Existing free tmdesell to the domestic market if import zones not expanded

Reduce unfair competition in the taxes are paid.domestic market.

Non-Tariff Export Controls Removal of controls in March 1991. No reintroduction of non-tariffs Maintained.export controls.

Increase neutrality of export regime.

Export Certification No further action required. Maintained.

Increase neutrality of export regime.

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Annex 1: TRADE POLICY REFORMI LOAN: POLICY MNATRIX -

ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN STATUSTO BOARD PRESEN'TATION SIGNING

TRADE INSTITUTIONS

Non-Tariff Barriers ICE de-activated in June 1991, and its No further action required. Maintained.promotional functions transferred to MICTI.

Eliminate institutional basis fornon-tariff protection.

Tariff Administration (MEF) Creation of Control Commission for anti- Procedures to ensure open, impartial Completed.dumping rules. anti dumping hearings to be agreed by (D.S. No.. 133-91-EF

Minimize protective effect of anti- loan negotiation. anddumping legislation. D.S. No. 051-92-EF)

Customs Service Transfer of some functions to private agents; Agreement by Board presentation on Action Plan carried outmonopoly on customs warehouses removed. Action Plan; compliance with three according to schedule.

I;.prove efficiency in processing phases of Action Plan, by Boardi:nports and raising revenue. presentation (1), by March 1992 (2),

and by June 1992 (3).

Export Promotion Function transferred in June 1991 from ICE to No further action required. Maintained.MICTI.

Shift emphasis from selectivepromotion to commercial intelligence.

Trade Neaotiation Creation in June 1991 of an inter-ministerial No further action required. No change.committee, with an Office of Trade

Improve intergovernmental Representative in MICTI.coordination.

Trade Law August 1991 passage of a legislative Decree No funher action required. No change.elevating to the status of law many of the trade

Provide legislative stability for reforms passed since August 1990.reformed trade regime.

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Annex 2: STRUCTURAL ADJUSTMEN!T LOAN: POLICY MIATRIX

~~~~~~~~~~~~~~~~~~- -.ISSUES AND OBJECTIVES ACCOMPLSHMENTS FROM MID-1990 CONDITIONS OF LOAN SIGNING STATUS

TO BOARD PRESENTATION

MACROECONOMIC ISSUES

Exchange Rate Reeime Unification and float. Maintain domestic-currency Completed.convenibility for all external

Improved resource allocation. transactions to a single type ofexchange rate.

Foreisn Exchange AUocation Elimination of foreign exchange surrender Non-reversal of policy. Completed.requirements and all other controls on currentand capital account transactions.

Foreign Currency Holdings Removal of freeze on foreign exchange The use of foreign currencies in the Completed.certificates of deposit. Dollar deposits local financial system will continue.

Keep a fluid payments system in increased 125% between August 1990 and Julythe presence of a persistent 1991, up to a level of US$ 1814 million,trend of dollarization of the compared with US$ 1297 million in Sol-economy, denominated liquidity.

External Debt Service Resumed payments to all IFIs. Completed Maintain payment to all IFMs and Completed.negotiations with Paris Club. continue negotiations with all other

Restore access to international creditors aiming for the fullcapital markets. restoration of service.

Monetary Policv Creation of monetary base mainly to finance Non-reversal of policy. Completed.the quasi-fiscal deficit and increase foreign

Gradual achievement of price reserves of the Central Bank.stability.

Credit Miarkets Interest rates allowed to be matket determined. Interest rates will be allowed to Completed.continue to be established by market

Efficient allocation of credit. forces.

Market Alocation Mechanisms All price and wage controls lifted. Maintain market determination of Completed.prices and private sector wages.

Efficient resource allocation.

Fiscal Balance Consolidated Public Sector Operational Deficit Adopt measures and an Completed.reduced to 6.5% of GDP in 1990 and an implementation schedule satisfactory

Control of inflation. expected 3.6% in 1991. to the Borrower and the Bank aimingNFPS primary deficit reduced to 1% of GDP for a level of Tax Revenues for thein 1990 and expected to reach a 0.4% surplus Central Administration of about 9.0%in 1991. of GDP. The primary deficit of the

NFPS will not be larger than 0.6% ofGDP (Jan.91-Dec.92) and there willbe no domestic financing of theConsolidated Public Sector Balance,defined as the deficit of the primarybalance added to the quasi-fiscaldeficit, plus interest payment oninternal and external debt.

Deficit Financina Internal financing of the CPS reduced to 3.3% Central Bank creation of domestic Completed.in 1990 and expected to reach 0.5 % for 1991. credit consistent with IMF targets.

Control inflation. Inflation reduced to 230% between August1990-1991.

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Annex 2: STRUCTURAL ADJUSTMENT LOKN: POLICY MATRIX

ISSUES AND OBJECTIVES ACCOMPLISHNIENTS FROM MMI-1990 CONDITIONS OF LOAN SIGNING STATUSTO BOARD PRESENTATION

Macroeconomic Indicators Expected 1991 values: Performance indicators for 1992 Actual performance(NOT CONDITIONALITIES): for first three

quarters of 1992:These indicators should not be Central Administration Tax Revenue: 7.6% of Central Administration Tax Revenueinterpreted as individual targets to GDP; about 9.0% of GDP: 9.1% of GDP.be met for loan compliance, butrather as the Bank's guidelines to Primary surplus of the non-financial public Primary deficit of the non-financial Surplus: 0. I% ofevaluate macroeconomic sector: 0.4% of GDP: public sector no larger than 0.6% of GDP.performance. GDP;

Rate of increase in monetary base: 320%. Rate of increase in monetary baseless than or equal to 40%: 37.8%

Stock of Central Bank of othermonetary liabilities in Soles always 2.5%.less than 10% of monetary base.

FISCAL ISSUES Drastic increase in price of public sector goods By October 31. 1992, the Completed.Tax Regime and services and frequent price adjustments Government and the Bank will jointly

allow sharp recovery in tax revenues. review taxes on exports, and bankSimplification of tax system. Simplification of tax regime. New regime current account debits and interest toIncrease tax revenues and reduce based upon taxes on income, wealth, value assess the prospects of phasing themhighly distortionary taxes. added, and selective consumption imports. out within a specific timetable.

Elimination of most exemptions. Reduction ofsome marginal tax rates. Simplification oftariff regime and reduction of tariff rates tothree categories.

Enactment of Legislative Decree 666 regulatingVAT and selective excise taxes (September 11,1991).

Supreme Decree enacted to interpret theregulations created in Legislative Decree 666.by establishing procedures for their application(Supreme Decree 269-91-EF, November21,1991, .

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Annex 2: STRUCTURAL ADJUSTMEN'T LOAN: POLICI' MATRIX

ISSt ES AND OBJECTIVES ACCOMIPLISHNMENTS FRONI MID-1990 CONDITIONS OF LOAN SIGNING STATU'STO BOARD PRESENTATION

Tax Administration POLIC} CHANGES BETVEEN MARCH The monitoring of large taxpayers Completed1991 & DECEMBER 1991 will be expanded from 1,200 to 2.50()

Reintorce independence of firms.SUNAT (the Peruvian tax collection Diagnosis and design of strategy for structural

agency) and improve its efficiency as reform to be implemented with the support of By March 31, 1992, SUNAT will Completed.measured by number of taxpayers Intemational Technical Assistance. complete the process of personneland level of tax revenues. selection at the national level.

Legislative Decree 639 (March 18, 1991):Provides the legal framework for the By June 30. 1992, the new Completed.reorganization of personnel and the acquisition infrastructure of computerof basic (local) equipment. information systems will be installed

in Region I (primary taxpayers).Implementation of the program of voluntaryresignation through incentives. The process of implementation of a Completed.

new registration system forPersonnel evaluation and selection with tax-payers will continue to be carriedexaminations in Lima. out on a priority basis.

Definition of the organizational structure and Changes in the tax code, satisfactory Completed.structure of appointments to posts in the to the Borrower and to the Bank, willNational Service Corps (Intendencias) and the be introduced to allow for greaterRegional Service Corps I & 11 efficiency in the tracking of

infringements.Legislative Decree 641 (June 26, 1991):Simplifies system of sanctioning so as to allowfor implementation of moderate sanctions on amassive scale.

Legislative Decree 673 (Sept. 24, 1991): Laborlaw which affects employees of the newSUNAT tax administration and made tocorrespond to Law 4916 (Private Sector LaborLaw).

Revise-and-purge process of the primarytaxpayers' registry in existence and tax regimegrants first priority to the VAT.

Creation of a division for taxpayer accountsanctioning and/or termination at SUNAT,charged with administering account closuresand developing sanctioning systems for theRegional Service Corps (SuperintendencyResolution 326-91 -EF/SUNAT, November 6.1991).

SUNAT increased the number of primarytaxpayers to 2,220 on December 6, 1991.

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Annex 2: STRUCTURAL ADJUSTMEN'T LOAN: POLICY NIATRIX

ISSUES AND OBJECTIVES ACCONIPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN SIGNING STAI't'STO BOARD PRESENTATION

Government Expenditure Tight controls upon public sector wages. No further actinn rcquiredand Ouasi-Fiscal Deficit Reduction of public sector employment through

incentives (Supreme Decrees 004-91-PCM &Increase the efficiency of 041-91-EF& Supreme Resolution 544-91-provision of public goods. INAPII). Introduction of a CMC (CashReduction of administrative Management Comminee), which spends onlydiscretionality. its available cash (Supreme Decree 227-90-EF,

Dec. 10, 1990 & General Public Sector BudgetLaw, December, 1991). Postponement ofpublic investments. Limits to Banco Agrariosubsidized credit. Elimination of subsidizedcredit to exporters.

A draft law which incorporates agreement onsubstantive objectives satisfactory to theBorrower and the Bank was enacted,establishing the basis for reform of thePeruvian public sector, redefining the scope ofgovernment activities, and reforming personnelpolicies, including the tenure system (SupremeDecree 166-91-PCM, October 1991).

SOCIAL SECTOR ISSUES Social Emergency Program (SEP) initiated to The Govemment will develop, by Completed.provide emergency food assistance and January 31, 1992, a poverty

Poverty AUeviation medicines, mainly through NGOs, for 5 alleviation strategy andmonths (8/90-12/90). implementation schedule, both

Develop well-targeted social acceptable to the Bank, outliningsafety net mechanisms and With UNICEF assistance, a Plan of Action for policies, and identifying priorityprovide the context for individual Child Welfare was prepared and endorsed by programs and target groups. Thesocial programs and projects. the Government in June 1991. It diagnoses Government will adopt this strategy

problems and sets goals in the area of health, by December 31, 1992.education, water and sanitation, nutrition,employment, and the problems of children indifficult circumstances.

In August 1991, a temporary National SocialCompensation and Development Fund(FONCODES) was created (Legislative Decree657, August 15, 1991) to finance employment-generating projects benefitting the population inextreme poverty. FONCODES's statute wasapproved through Supreme Decree 163-91 -PCM, October 20, 1991.

Health and Nutrition The Ministry of Health defined short-term The Government will develop profiles Completed (twoobjectives for 1991: reduce mortality for priority projects in primary health profiles).

Improve the provision of low-cost associated with high-prevalence illness; expand and nutfition acceptable to the Bankprimary care to the poor. health coverage in poor areas: rehabilitate by April 30, 1992.

social infrastructure; and upgrade the capacityof professional staff.

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Annex 2: STRUCTIJItAL ADkJUST'MENT LOAN: POLICY MATRIX

ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN SIGNING STATUSTO BOARD PRESENTATION

Improve the cost effectiveness and Generalized food subsidies were abolished and The Government will prepare a Completed.impact of nutrition assistance to the monopoly positions of ECASA and ENCI national nutrition policy acceptable tothe poor. were eliminated (Supreme Decree 066-91 -EF y the Bank, based on a review of

Supreme Decree 067-91-EF, March 27, 1991). existing food assistance programs,and will recommend reformsnecessary to improve costeffectiveness by April 30. 1992. TheGovernment will initiate the firststage of these refortns in foodassistance programs, includingstreamlining the role of publicagencies, by June 30. 1992.

Education The Ministry of Education defined broad short- The Government will develop profiles Completed (threeterm objectives for 1991 (to expand the for priority projects in pre-primary profiles).

Increase internal efficiency of coverage and quality of primary education and and primary education acceptable toeducation and improve the quality link technical training to the job market) and the Bank by April 30, 1992.and coverage of pre-primary and medium-term priorities (to improve the qualityprimary education, of education, universalize education for 6-14

year old children, and upgrade the quality ofteachers.)

The Ministry of Education initiated anemergency program to feed schoolchildren onemeal a day and use the school as a locus tointroduce tuberculosis detection and improvedhealth practices.

PRIVATIZATION ISSUESThe Govemment announced its intention to The Government will establish the Completed.

Privatization of State reduce SEA and issued, on March 12, 1991, a institutional framework defined inEntrepreneurial Activity (SEA) Supreme Decree (No. 041-91-EF) authorizing Decree 674 by June 30. 1992.

the privatization of 23 companies.Improve efficiency in allocationof resources through development The Government issued the Law for theof the private sector, avoiding the Promotion of Private Sector Investment inpossibility of fiscal drain. State Enterprises, which called for (i) the

creation of a commission, COPRI, to beresponsible for the design and control ofprivatization, thus centralizing the decisionmaking process, and (ii) the creation of SpecialCommittees to implement the privatization ofeither one company or several within a sector(Legislative Decree 674, September 27, 1991).

The Government issued a law providing a legalframework for foreign investment, throughguarantees on the stability of the fiscal regime(Legislative Decree 662, September 2, 1991).

The Government issued a Legislative Decreewhich establishes rights, guarantees, andobligations applicable to national and foreigninvestors (Legislative Decree 757, November13, 1991).

The Government issued Legislative Decree 674which defines the legal and institutionalframework for privatization (September 27,1991).

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Annex 2: STRUCTURAL ADJUSTMENT LOAN: POLICY MATRIX

ISSUES AND OBJECTIVES ACCOMPLISHMEN'TS FRONI MID-1990 CONDITIONS OF LOAN SIGNING STATUSTO BOARI) PRESENTATION

SEA Privatization in Bankine The Government abolished the Financial The Government will develop an Completed.System Nationalization Law and included overall action plan andBanco Popular del Peru in the list of 23 implementation schedule acceptablecompanies to be privatized (DS no.041-91-EF). to the Borrower and the Bank forThe Govemment decided to restructure public divestiture in the sector bv June 30.commercial banks with a new Banking Law in 1992.April 1991 (General Law for Banking,Financial, and Savings Institutions: LegislativeDecree 637). The Government sold its 15 %share of Sogewiese Leasing on June 10. 1991.

SEA Privatization in Fisheries The Government eliminated state monopoly of The Government will develop a Completed.fishmeal production in March 1991 and began policy framework for the sector and aa partial sale of the assets of Pescaperu. firm-by-firm divestiture strategy

acceptable to the Borrower and theThe Govemment issued a Law for the Bank, including an action plan andPromotion of Private Investment in the fishery implementation schedule forsector, prohibiting monopolistic practices and Flopesca, Pescaperu, Epsep, andauthorizing the Ministry of Fisheries to grant CERPER by June 30. 1992.concessions to the private sector (LegislativeDecree 750, November 13, 1991).

SEA Privatization in Minine The Govemment sold its 19% stake in Minas The Govemment will develop a Completed.Buenaventura on July 19, 1991. policy framework for the sector and a

firm-by-firm divestiture strategyThe Govemment issued a Law for Private acceptable to the Borrower and theSector Investment in the Mining Sector which Bank, including an action plan andcreates conditions for the development of implementation schedule for Mineroprivate investment (Legislative Decree 708, Peru, Centromin Peru, and HierroNovember 14, 1991.). Peru by June 30, 1992

SEA Privatization in Oil and Petroperu increased the contracting-out of The Government will develop a Completed.Gas exploration and development to the private policy framework acceptable to the

sector. Borrower and the Bank, including animplementation schedule for private

Petroperu monopoly eliminated (Legislative sector participation in exploration, oilDecree 655, August 7 1991). refining, distribution, and gas

production and distribution by June30, 1992.

SEA Privatization in Power In February 1991, The Govemment authorized The Govemment will develop a Completed.entrance of private investors to the power policy framework acceptable to thesector; this included participation of Borrower and the Bank, including anautoproducers. co-producers, and implementation schedule for privateconcessionaires (Law 25304). sector participation in power

generation, transmission, andOn July 19 1991, The Govemment authorized distribution by June 30. 1992.the sale of its participation in regional powercompanies (Legislative Decree 649).

The Govemment issued a Law for thePromotion of Private Sector Investment in thePower Sector. Private investors will haveaccess to the sector by means of a regime ofconcessions which will permit the generationand/or distribution and/or commercialization ofelectric energy (Legislative Decree 693,Novembert6, 1991).

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Annex 2: STRUCTURAL ADJUSTMENT LOA-N: POLICY NMATRIX

ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID1990 CONDITIONS OF LOAN SIGNING STATUSTO BOARD PRESENTATION

SEA Privatization in The Govemnment enacted a new The Govemnment will develop a Completed.Telecommnunications Telecommunications Law enabling competition policy framework acceptable to the

and private investment (Legislative Decree Borrower and the Bank. including an702, November 8, 1991 and Legislative Decree implementation schedule promoting766, November 15, 1991). private sector investment in the

telecommunications sector by JuneThe Govemment created the Enterprise for 30 1992Postal Services of Peru, S.A. (SERPOST) anddeclared that the incorporation of privateinvestors in SERPOST is of national interest(Legislative Decree 685, November 5, 1991).

SEA Privatization in Transport For ports, The Government transferred to the The Government will develop a Completed.private sector all stevedoring work, the loading strategy acceptable to the Borrowerand unloading of cargo, and the maintenance of and the Bank, including ancontainer-handling equipment, and issued implementation schedule to promoteSupreme Decree 039-91-TC on November 5, private sector investment in railways,1991, specifying actions to be taken for labor ports, airports, and air transport byreduction in CPV (shipping company). June 30. 1992.

The Govemment liberalized urbantransportation tariffs (Legislative Decree 651,July 25 1991).

The Govermnent liberalized air transpontariffs, authorized the entrance of newcompanies, and issued Legislative Decree 648(July 17 1991), authorizing the privatization ofAeroPeru. The Government also transferredpart of the activities of CORPAC (airportauthority) to the private sector (LegislativeDecree 723, November 11 1991).

The Govemment authorized the Ministry ofTransports to grant concessions to privatecompanies for rehabilitation and maintenanceof highways (Legislative Decree 676, October6 1991).

The Govenument declared private sectorinvestment in Enafer to be of national interest,prohibited any form of monopoly andrestrictive practices, and authorized theMinistry of Transpon and Communications togrant concessions, through a public biddingprocess, to the private sector for rehabilitationand maintenance of portions of the railwaylines. Tariffs and freights of service operatorsare market-determined according to supply anddemand (Legislative Decree 690, November 6,1991).

- 38 -


ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN SIGNING STATllSTO BOARD PRESENTATION

SEA Privatization in Water and Sedapal began bidding process to delegate the The Government will develop a Completed.Seweraze task of billing in part of the city of Lima to an strategy acceptable to the Borrower

extemal private firm. and the Bank, including animplementation schedule to promote

The Govemment issued a Law for the private sector participation in thePromotion of Private Sector Investment in the sector by June 30, 1992.area of Water/Sanitation, specifically in theactivities of exploration of potable water,sewage, waste disposal, recycling of water, andpublic cleaning (Legislative Decree 697,November7, 1991).

The Govemment authorized Senapa andCortapa to undergo an economic and financialstabilization and an administrativerationalization, including staff reduction and aprogram of incentives for voluntary retirement(Supreme Decree 171-91-PCM November 7,1991).

SEA Privatization in Industry The Government announced its intention to The Govemment will develop a Completed.reduce SEA by including several industrial divestiture strategy acceptable to thecompanies on the list of 23 designated for Borrower and the Bank, including anprivatization (Supreme Decree 041-91-EF, implementation schedule for the saleMarch 12 1991). of shares in all companies where the

Govemment is a minorityThe legal and institutional framework shareholder. The Govemment shouldestablished by Legislative Decree 674 allows bring to the point of sale at least 6 offor privatization in all sectors of economic these companies.activity.

AGRICULTURAL ISSUES

Private Sector Development in Enactment of the Agricultural Sector No further action required.Agriculture Investment Promotion Law (Legislative Decree

653, August 1, 1991).

Azriculttral Commoditv Natinnal rice-marketing monopoly (ECASA) By September 30, 1992: (i) liquidate SubstantiallyMarketinz abolished (Supreme Decree 066-91-EF, March ECASA; and (ii) implement Supreme Completed. While

27 1991). National input-marketing company Decree 148-90-PCM, authorizing ECASA has alreadyIncreased efficiency in trade and (ENCI) downscaled (Supreme Decree 148-90- ENCI's reorganization. ceased its operations.production. Reduction of public PCM & 084-91-PCM, April 17, 1991). laid-off itssector involvement. employees, and

Freedom of entry for private sector (Supreme established aDecree 066-91-EF, March 27, 1991). liquidation

commission, theprocess of liquidationis still underway.ENCI is beingdownsized. To date(6/2194), ENCI'sliquidationcommission is still inthe process of sellingthe company's assets.

Non-reversal of the elimination ofState marketing monopolies Completed.established by Supreme Decree 066-91 -EF.

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Annex 2: STRUCTURAL ADJUSTMENT LOA.N: POLICY' MIATRIX

ISSUES AND OBJECTIVES ACCOM_LISHMENTS FROM NID-1990 CONDITIONS OF LOAN SIGNING ST_ _LSTO BOARD PRESENTATION

Land Tenure/Registrv and Restrictions removed: land freely transferable; Maintain all provisions retforming Completed.Titling all regular rights of Peru's civil code extended land tenure, agriculrural labor, and

to the agricultural sector; individuals and liberalizing agri-business activirs inImproved resource allocatiotn, corporations permitted to own land; size limit the "Ley de Promoci6n de lasimproved access to formal of individual agricultural estates increased; Inversiones del Sector Agricola"economy for small landowners. promotion of private investment in (Legislative Decree 653).

development of uncultivated land. Speedymechanism established to guarantee landownership against expropriation and squatters.

Agricultural Credit Elimination of credit subsidies through Banco Non-reversal of policy liberalizing Completed.Agrario (BA). Reduction of Central Bank the use of land as collateral.

Improved resource allocation, credit to BA. Abolition of BA's pnvilegedimproved access to credit for access to collateral of agricultural producers. Maintain legal framework allowing Completed.small producers, and expansion of agricultural-sector access to privateaccess to commercial banks. Liberalization of use of land as collateral. commercial bank credit.

Agricultural Water Usage Legislative Decree (No. 653, August 1, 1991: Maintain all provisions on water Completed.Agricultural Sector Investment Promotion Law) usage included in Legislative Decree

Promotion of better water usage. provided legal framework allowing transfer of 653.irrigation network to private producerassociations.

Agricultural Trade Policy Deregulation of all domestic and foreign trade Maintain trade liberalization Completed.of agricultural products and imports. provisions of Legislative Decree 653.

Better resource allocation.Removal of anti- agricultural bias. Unified exchange rate eliminated bias againstConsolidate macroeconomic agricultural exports and allowed foodstuffstability. imports without exchange rate subsidies.

Elimination of exemptions for agriculturalimports.

Agricultural Pricing Policy Floating exchange rate remained and The Government will not introduce Completed.agricultural credit subsidies abolished. In any new mechanism for price control

Maintain efficiency in resource March 1991, specific protective tariffs for of agricultural products and there willallocation. selected agricultural products were introduced. be no reversal in its policy of

These were replaced in May 1991, by a abolishing interest rate subsidies.variable surcharge scheme designed to lead to alanded price which would not exceed theprevious five-year average international priceplus a 15 % tariff. The scheme covers: wheatflour, pasta, corn, sorghum, rice, and sugar.Dried milk continued to receive a fixedsurcharge.

LABOR ISSUES

Probationary EmDloyment Creation of a more flexible probationary Non-reversal of policy. Completed.period. Initial period of three months

Improve quality of employee extendable to a total of six months, providedscreening and reduce turnover the work requires a training and adaptationcosts. period. In the case of managerial and other

positions of trust, the period is extendable toone year (Job Promotion Law, LegislativeDecree 728, An. 43, November 12, 1991).

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ISSUES AND OBJECTIVES ACCOMPLISHMENTS FROM MID-1990 CONDITIONS OF LOAN SIGNING STATB'STO BOARD PRESENTATION

Temworarv Emplovment Supreme Decree 077-90-TR issued, allowing Non-reversal of policy. Completed.longer fixed-term contracts for all sectors and

Increase flexibility in labor under most circumstances (few relevantmarkets and reduce turnover restrictions exist).costs.

Tempoiary employment authorized forinitiation or increase in work load, changinglabor market needs, or for retraining ofemployees (Legislative Decree 728, arts. 100-102, November 12, 1991).

CTS (ComDensation for Time Firms must now deposit semesterly the full Non-reversal of policy. Completed.and Services Rendered) amount due in special accounts for which

financial institutions and firms compete.Improve administration of Worker specifies account to be held in nationalsystem. Reduce indexation or foreign currency and interest on theseproblems. Increase supply of accounts is exempt from income tax. CTSlong-term funds to financial funds can be withdrawn by workers underintermediaries. specific circumstances (Legislative Decree 650,

luly 24, 1991).

SOCIAL SECURITY ISSUES Creation of the framework for a Private Non-reversal of policy and Completed.System of Pensions (SPP), to complement the presentation of an action plan and

IPSS (Peruvian Social Security System) IPSS. SPP benefits managed by the implementation schedule, acceptableAdministrators of Pension funds (AFP) which to the Borrower and to the Bank, onwill initiate activities to partially or totally the partial or complete privatizationprivatize the system by July 28, 1992 of the system by September 30,(Legislative Decree 724, November 11, 1991). 1992.

Administration of Health and Separation of accounts for revenue, but not Complete the separation of all health Completed.Pension Areas expenditures. and pension fund accounts (except

administrative expenses) by June 30

Improve financial management. 1992.

Collection of Contributions Collection system streamlined. Employers can Non-reversal of policy. Completed.complete form estimating contribution due and

Avoid losses from under-reporting make payment at any commercial bank.by contributors.

Resource Manayement Fund deposits placed in official and private Non-reversal of policy. Completed.banks.

Greater efficiency.

Supervision and Control None. The extemal audit of financial Substantiallystatements, involving income Completed.

Determine the administrative and (pension and health) and expenditures In December 1992,financial situation of IPSS. (pension) accounts for 1991 will be the Govemment hired

completed by October 31. 1992. the external auditorsIPSS, as fund interFnediator, will be through Resolution ofsubject to periodic independent the Controller'sauditing. These audits will include Office No. 345-92-not only financial control but also CG.administrative and operationaldiagnoses and recommendations.

N'SS Revenue Collection Contribution rates to IPSS were not increased. The total contribution rate to IPSS Completed.Collection ceilings and some deductions were will not be increased.

Increase revenue and force eliminated.efficiency gains without increasingcontribution rates.

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Annex 2: STRUCTURAL ADJUSTMENT LOAN: POLICY' MIATRIX

ISSUES AND OBJECTIVES ACCOMIPLISHMIENTS FROMI MID-1990 CONDITIONS OF LOAN SIGNING STATUSTO BOARD PRESENTATION

Phvsical Assets of IPSS Newk rental contracts and sale of properry to Non-re%ersid of polics Completedreflect market prices.

Greater efficiency

IPSS Personnel No renewal of contracts for temporary Reduce number of employees by an Completed. IPSSpersonnel. additional 7,000. personnel reduced by

Increased efficiency. 7,700 resignations through early retirement more than 18,00().incentives.

Annex 3 The Structural Adjustment Loan42

ANNEX 3

THE STRUCTURAL ADJUSTMENT LOAN

Historical and Economic Context'

1. An environment of increasing political and economic instability prevailed inPeru over the three decades that ended in 1990. Expansionist policies produced creepinginflation and periodic balance of payment crises, followed by a series of unsuccessfulstabilizations. In this period, economic policy varied widely through the different regimes,but concurred, by and large, in an inward-oriented development strategy and an escalatingintervention of the State in the economy. The model of import-substitution predominatedthroughout, characterized by tariff protection and eventual quantitative restrictions to trade.

2. The govermnent deternined key prices and owned important enterprises. Thenumber of state enterprises increased from 29 in 1968 to more than 200 by the end of 1989.Most of these companies operated at a deficit, were state monopolies, and were plagued withpolitical interference. This period was also characterized by economic mismanagement,resulting in hyperinflation, financial repression, multiple exchange rates, stagnation andhigher level of absolute poverty. The economy "survived" by substituting the dollar for thedomestic currency and enlarging the "informal" sector.

3. By the end of the 1980s, there was hyperinflation, fueled by an expansionistmonetary policy and an increase in velocity as people substituted away from the domesticcurrency. Monetary growth was used primarily to finance government expenditures ortransfers, especially to provide tax credit to the agricultural sector and to non-financial publicenterprises.4. To repress inflation, successive governments repeatedly imposed pricecontrols. By the end of 1989, all products were subject to some kind of governmentregulation. Basic staples and public services were fixed by the Government, but had to berevised periodically to account for inflation. The direct participation of the State in thedetermination of prices was reinforced by the fact that the government-controlled publicenterprises monopolized various areas of activity.

5. Interest rates were constrained by binding ceilings which were significantlybelow inflation. Lacking indexed financial instruments and faced with significant restrictions

See also: World Bank, Peru: Economic and Sector Reforns to Sustain Stabilization and Lay theFoundations for Developmnent, green cover, 10361-PE, February 18, 1992; and World Bank, Peru at theCrossroads: Building a Modem State, Green Cover, 11943-PE, June 30, 1993.

Annex 3 The Structural Adjustmenr Loan43

on capital mobility, the dollar became first a store of value and unit of account, and then amedium of exchange. By the end of the decade, only petty transactions were made in soles.

6. Exports were subject to compulsory surrender of receipts to the Central Bank,in exchange for domestic currency at one of the multiple sets of government-determinedexchange rates. Those were adjusted to compensate for inflation, but with protracted delays.The disparity in exchange rates, which were fixed arbitrarily, generated black markets andrent-seeking activities to gain access to a better rate. In addition, the existence of illegalexport activities (drug dealing and smuggling) precipitated the emergence of a parallel"black" exchange rate market.

7. Foreign trade was discouraged because of high tariffs and quantitativerestrictions. Imports were severely restricted, with explicit bans on some final products,quantitative restrictions, and licenses, among others. On the other hand, capital goods andindustrial inputs not only were permitted, but received preferential treatment. Together theyaccounted for 79 percent of total imports for the period covering 1988-1990. In order togenerate the necessary foreign exchange, exports were encouraged through a promotionscheme based on credit subsidies, but which was inconsistent with the implicit taxation of therequired surrender of foreign exchange at one of the appreciated exchange rates. Overall,exports accounted for about 15 percent of GDP for the period covering 1988-1990. Themain source of export revenues was mining products, copper in particular. Other traditionalexports included oil, fishmeal, coffee, and cotton. In addition, a diversified set of non-traditional export increased its share over time, contributing about US$ 1.0 billion to exportearnings.

8. Capital-outflows restrictions to restrain capital flight were consistent withdomestic financial repression. Profit remittances, royalty and interest payments weretemporarily prohibited. In 1985-90, the Garcia Administration unilaterally announced that itsdebt service would be limited to only ten percent of exports. Debt service to the multilateralinstitutions was stopped and large arrears accumulated to these entities. This position forcedthe IMF to declare Peru as ineligible for funding and the World Bank to declare loans toPeru in iion-accrual. Consequently, Peru was isolated from international capital markets. In1990, total external debt amounted to more than US$ 20 billion, most of which was inarrears.

9. Capital inflows were welcome but understandably very scarce. The countrydid not attract direct foreign investment, in part, because of its explicitly adverse legislation.Investors were subject to discriminatory treatment by nationality, had strict regulations fordividend remittances, and had difficulty gaining access to certain activities.

10. Government finances were in a state of collapse and depended heavily oninflationary finance. Tax pressure, measured by the ratio of tax collection to GDP reachedits historic low record at about 5 percent in 1990, as a result of an inadequate tax system as

Annex 3 The StructuralAdjustment Loan44

well as lax administration of the tax collection authority. The tax system was extremelycomplex, exhibiting numerous taxes, high dispersion of marginal tax rates, and manyexemptions. The legislation, besides being complicated and unstable, was plagued withloopholes, and there were no appropriate provisions against inflation to protect from latepayments. Indirect tax revenues were low due to controlled prices and poor collectionprocedures. The tariff system exhibited a high dispersion and resulted in an extremely highaverage rate which provided protection to the domestic industrial sector. In addition, lack ofsupervision and control from the tax administration allowed widespread tax evasion.

11. Dwindling government revenues were accompanied by a halt in publicinvestment. However, public employment increased significantly in the period, at wagelevels which although low, were subject to periodic indexation. This was possible withCentral Bank direct transfers that took the form of credit at no interest.

12. Government regulation of labor and agricultural markets adversely affected theefficient allocation of resources, hampered the development of new working opportunities,and blocked the progress of agriculture. To "protect" workers, the regulations promotedstrict labor stability, under which the worker gained tenure after a three-month probationaryperiod. Temporary contracting of personnel was very limited. This regulation increased the(fixed) costs of operating firms and magnified their exposure to fluctuations in demand. Theresult of the drastic reduction in labor mobility was that the fornal labor market shrank, andthe "informal" economy gained momentum.

13. Also to "protect" workers against health, accident, old-age and layoff risks theregulatory framework enacted mandatory health and pension insurance with the NationalSocial Security Institute (IPSS) and mandatory severance payments for laid-off workers underthe "Provision for Social Benefits". This latter scheme can also be understood as amandatory savings program that the company managed on behalf of the worker. Both thepension plan and the severance provision behaved as unfunded schemes, one managed byIPSS and the other by the company itself.

14. Furthermore, the severance provision provided an additional income tax shieldas changes in the nominal provision were charged to labor costs and could be deducted fromtaxable income. Nevertheless, the scheme put the company under financial pressure as, inthe macroeconomic scenario depicted above, it did not have the means of accumulating inreal terms (or at least was not efficient in doing so) the resources needed to meet severancepayments when they were to mature, and not all could manage to get subsidized financing.

15. The Social Security system became unviable. Its management was deplorable,employment increased five-fold, and the accounting system was unauditable. The collectionsystem was slow and inefficient. The Institution had become, by the end of the 1980s, oneof the most important real estate owners in the country, but rental fees charged were farbelow market levels. Besides, the pension plan, which became a benefit-defined pay-as-you

Annex 3 The StructuralAdjustmenr Loan

45

go system, became financially unviable, at the given contribution rate and level of evasion.with the aging of the population structure of the country, aggravated by the practice ofgranting pensions with only five years of contributions. Firms considered contribution toSocial Security as taxes to finance the government, and avoided depositing funds withheldfrom employees.

16. Finally, the regulatory framework prohibited private ownership of land forcommercial purposes, with minor exceptions, and prohibited using land as collateral forcredit. As a result, farmers were rejected for commercial credits and had to resort tosubsidized credit from the state development bank (which in turn received its funding fromthe Central Bank). In addition, agricultural exports received one of the lowest exchangerates available, and Peruvian staples in the domestic market had to compete with foodstuffsimported at preferential exchange rates by the state import monopoly.

The Adjustment Program

The Government's Economic Program

17. The present Administration implemented, shortly after assuming office in lateJuly 1990, the first stage of a bold stabilization-cum-structural reform program, with thepurpose of achieving macroeconomic stability and reintegrating the country into theinternational financial community. In March 1991, additional reforms were implemented intrade, financial, and labor markets.

18. The measures adopted implied a drastic change with the past. The newAdministration shifted from a multiple-exchange crawling peg to a unified floating exchangerate system. Compulsory surrender of export receipts and all controls on current- andcapital-accounts transactions were abolished. In addition, most price controls wereeliminated, including a defacto elimination of interest rates ceilings.

19. Monetary expansion was limited mainly to purchases of foreign currency bythe Central Bank to accumulate foreign reserves. Central-Bank financing of the centralgovernment was explicitly prohibited. A cash management committee managed Statefinances on a cash basis only. In order to sustain this situation, the Government undertookfurther fiscal reforms aimed at increasing tax revenues and improving governmentexpenditure management.

20. To increase tax revenues, the Government redefined the Peruvian tax systemand reorganized the tax administration authority, SUNAT, and the customs bureau, SUNAD.The new system was based on five types of taxes covering income of individuals andcorporations, wealth of firms and individuals, value-added, selective consumption (excise),and import duties.

Annex 3 The StrucruralAdjustment Loan46

21. Based on the premise that collections were low because of tax evasion andnumerous exemptions, not necessarily because of low marginal tax rates, most exemptionswere eliminated. In addition, the income tax rate on firrns was reduced from 35 to 30percent, the tax on net equity of corporations was unified at two percent, and the highestbracket of personal income tax rate was reduced from 45 to 37 percent. For corporations,the Government instituted a minimum income tax, set at two percent of total assets net ofdepreciation, of which the two percent net equity tax could be deducted. Selectiveconsumption (excise) tax rates -- except fuel and gas oil taxes-- were reduced to three with amaximum of 50 percent. Fuel and gas excise taxes remain one of the most important taxes,accounting for about 15 percent of government revenues. Rates are set above 80 percent,and the tax base (fuel prices) is constantly adjusted for inflation to avoid its erosion in realterms. Finally, import tariffs were initially reduced to a three-tier -- and later to a two-tier --

system, with rates set at 15 percent and 25 percent.

22. However, the value added tax rate was increased from 14 percent to 16percent, temporary taxes of 10 percent on exports, (of one percent on net wealth and insuredassets) were imposed, and emergency taxes on current-account debits and the excise tax oninterests were instituted. Through the process, numerous taxes were eliminated. At differentstages of the program, including the temporary taxes of 10 percent on exports and of onepercent on net wealth and insured assets. Prior to the SAL Board presentation, anemergency tax on current-account debits and the excise tax on interests were beingmaintained, but were eliminated immediately after?.

23. The approach to strengthen SUNAT was to improve the quality of thepersonnel and equipment employed at tax collection. To achieve this, SUNAT laid offredundant personnel, and increased its salary scales to attract more qualified professionals.To fund the program, SUNAT was endowed with a budget of up to two percent of total taxrevenues.

24. On the government expenditure side, public sector wages were under strictcontrol and a sweeping reduction in personnel took place. Wage increases had to beapproved by the central government, after wage indexation was eliminated.

25. Finally, to consolidate the process of economic stabilization, the Governmentagreed to a Rights Accumulation Program (RAP) with the IMF in September 1991, settingseveral macroeconomic targets to be achieved during the performance period betweenJanuary and December 1992 that complemented the efforts made by the Govermnent on itsown.

Changes in the Legal and Regulatory Framework

26. Together with the stabilization program and policy reforms, a process ofdrastic deregulation was developed. The Government abrogated all monopolistic and

Annex 3 The StructuralAdjustmenr Loan47

restrictive practices throughout the economy, including the monopoly rights of 12 publicfirms.

27. In the financial sector, the Government passed a new banking law whichpromotes universal banking, accompanied by stronger prudential regulations. This legislationabolished the nationalization of the banking system passed by the previous Government. Thelaw allowed financial intermediation to take place in US dollars. However, dollar-denominated accounts were subject to higher marginal reserve requirements. It also createda limited deposit insurance scheme to reduce the possibilities of runs during banking crises.In addition, other insurance premiums were allowed to be market determined, and insurancemonopolies were abolished.

28. Air transport activities were opened to private capital, without regard tonationality, but without committing to an open skies policy. Foreign shipping firms weregiven access to the domestic market, and the port loading/unloading monopoly wasabolished. Finally, the commission in charge of setting transport tariff policy was dismissed.

29. The Government started an extensive privatization program in all sectors of theeconomy. To attract foreign investors, the Government permitted dividend and royaltiesremittances, eliminated any kind of discrimination on local investors, and announced aprogram of immigration for foreigners who bring in funds for investment. In this manner,Peruvian treatment of foreign investment became one of the most open in the world.

30. To improve the efficiency of labor markets, the tenure law was made moreflexible, expanding provisions for layoffs and increasing the probationary period from threeup to six months. In the case of managerial and other positions of trust, this period is nowextendable to one year. Also, regulations for contracting foreign workers were simplified.In addition, the Government allowed fixed-term contracts for all sectors and, under mostcircumstances, with few exemptions. Companies were allowed to hire workers temporarilyfor new or increased work loads, changing labor market needs, or retraining of employees.

31. Finally, the severance savings scheme was completely reformed from a pay-as-you-go company-managed scheme to a fully-funded financial institution-managed one, underthe name of Compensation for Time and Services Rendered (CTS). The severance-cum-unemployment saving scheme has become a source of long-term funds to financialintermediaries. Under the new program, firms must deposit the full amount due everysemester in a special account of the financial institution designated by the worker. Thecurrency denomination of this account (national or foreign) is also chosen by the worker.Interest received on these accounts is exempt from income tax. Even though the nature ofthe scheme is one of mandatory savings to cover the worker from an unexpected lay-off,workers can withdraw their CTS funds under some circumstances.


32. In 1991, the Government enacted the Agricultural Sector InvestmentPromotion Law, which wiped out the Agrarian Reform Law of 1969. The new legislationredefined the framework in which trade, price settlement, and credit practices related toagriculture should take place. It determined a major role for the private sector in thedevelopment of agriculture.

33. All rights under Peru's Civil Code were extended to the agricultural sector.Moreover, individuals and corporations were free to own land, relaxing size-limit restrictionsfor individual agricultural estates. Thus land can now be freely traded and leased to anyindividual or legal entity, whether Peruvian or foreign, with some minor exceptions.Property rights were also defined on water usage for agricultural purposes, by modifying thelegal framework to allow the transfer of irrigation networks to private producers'associations. To guarantee land ownership against expropriation and third-party claims, theAdministration simplified the registry and titling mechanism for rural property, although thenew system remains to be implemented.

34. All domestic and foreign trade in agricultural inputs and products wasderegulated and state participation in foodstuff trading was severely reduced. ECASA, thenational rice-marketing monopoly, was declared to be in the process of liquidation. ENCI'sgrain and fertilizer import monopoly was removed, and ENCI began a process ofreorganization to make it self-financed. Moreover, the company scheduled its privatizationfor 1994. Also, the procedures for verifying the quality of agricultural products andmedicines were considerably relaxed, allowing for certificates to be issued by privatelaboratories.

35. The Government also removed price controls on agricultural products. Theprice support scheme adopted for some selected staples was replaced in May 1991, by avariable surcharge scheme designed to lead to a landed price equivalent to the previous five-year average international price plus the correspondent 15 percent tariff. The staples coveredare dried milk, wheat and wheat-derived products, corn, sorghum, rice, and sugar.

36. Finally, the Government abolished directed credit policies, including thosedirected at agriculture, and modified the legal framework to allow the use of land ascollateral, to facilitate access to private commercial bank credit to the agricultural-sector.Farmers were allowed to mortgage their land holdings in excess of five hectares. Inaddition, the Government abolished the privileged access to the collateral of agriculturalproducers that Banco Agrario (BA) used to enjoy. In the new environment of fiscaldiscipline, subsidized credit from Banco Agrario was eliminated.


Preparation and Design of the SAL

37. The Bank's operations in Peru were suspended in 1987, when the Boarddeclared the country in non-accrual status, after the Government of Peri was six monthsoverdue in payments. The last loan to the Republic of Peru was granted in 1984.

38. The Structural Adjustment Loan (SAL) was the second of three policy loanswithin the Bank's new approach to debt workout problems with Peri, as a country withprotracted arrears. Arrears clearance permitted the Bank to restart large lending operationsin Pern consistent with its long-term objectives for the country.

39. However, even before arrears clearance, the Bank channeled resources for amajor program of technical assistance for project preparation and implementation. Thefinancial resources were obtained through the Japanese Grant Facility and a grant from theGerman Company for Technical Cooperation (GTZ).

40. To evaluate the major structural reforms under the Fujimori Administration,several missions visited Peri beginning in October 1990. The first mission prepared a reportentitled Perui: Sector Reform and Investment Review, while the second mission prepared thereport Peru: Economic Reforms to Sustain Stabilization and Lay the Foundations forDevelopment. Several background papers on labor, agriculture, privatization, social security,social sectors, and macroeconomic issues were also written during that period in preparationfor the SAL.

Program Description and Objectives

41. Long-Term Objectives. The long-term objectives of the Bank's strategy inPeru are to help the Peruvian governments lay the foundations for growth, improve theefficiency of resource allocation, and improve the situation of the poor.

42. A most important element to foster growth is to promote investment byexpanding the stock of capital, thereby incorporating technological progress. The marketallocation of investment generates productivity gains and also improves the situation of thepoor. Appropriate means of attracting investment, besides profitable opportunities, are tostrengthen property rights, promote law and order, and establish a sound macroeconomicpolicy.

43. To improve the efficiency of resources, the Bank supports the role of marketmechanisms, in keeping with regional and worldwide trends. Consistent with this is thegradual reduction in the direct participation of the state in productive activity and aredefinition of the role of the state in the economy.

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50

44. In the social area, the long-term goal is to provide the means for upward socialmobility through public investment in education and health and through a competitiveenvironment. These means should enable the poor to respond to income-eamingopportunities arising from structural market-oriented changes.

45. Loan Objectives. The SAL was part of the Bank's debt workout program inPeru, as a country with protracted arrears. As such, the immediate objectives of the loanwere to: (a) resume large scale lending operations in Peru, reversing the country's non-accrual status; and (b) support policies to foster growth and alleviate poverty in Peru throughthe liberalization and deregulation of key markets, in particular, labor, capital andagricultural markets.

46. Reforms in the labor market aspired to enhance labor mobility and improve thescheme of forced-savings for retirement. Reforms in social security aimed at a bettermanagement of the corresponding institution and a better allocation of pension savingsthrough an alternative private system, which would have direct impact in the development ofPeruvian capital markets. Finally, reforns in agriculture had the objective of eliminatingprice distortions and legal and regulatory restrictions to credit and trade.

47. The process of privatization was intended to reduce the direct participation ofthe government in productive activities, thus improving resource allocation in the futurewhile providing a respite from fiscal problems in the present.

48. Finally, the loan assisted the Government to formulate a poverty-alleviationstrategy, which outlines policies, target groups, priority programs, and the role of variousorganizations involved. It also assisted in preparing profiles of priority social projects andestablished the basis for imnproved food-assistance programs and a national nutrition policy.The strategy recognizes that poverty alleviation calls for revitalization of the economythrough stabilization and liberalization, increased and more efficient social spending, andclose coordination with community representatives.

49. Program Description. The Structural Adjustment Loan (SAL) supported a setof reformns in macroeconomic and fiscal policy, agriculture, and social security. In addition,it included a social sector component and fostered the divestiture of government-ownedenterprises through a broad program of privatization.

50. In these areas, the Governmnent agreed with the Bank on a set of 45 sectoralconditions (Annex 2). Twenty-four of these aimed to prevent reversal of policiesimplemented prior to loan presentation to the Board. The other 21 were conditions forfurther reform.

51. Macroeconomic Policy. The macroeconomic policy component stressedmarket determination of prices, exchange rates, private sector wages, and interest rates. In

Annex 3 The Structura/ Adjustment Loan51

addition, it limited monetary base expansion to IMF targets, and restricted its growth to thefinancing of the quasi-fiscal deficit and foreign exchange purchases by the Central Bank.Also, it supported a unified floating exchange rate system and accepted the use of foreigncurrencies in the local financial system. All foreign exchange surrender requirements wereexplicitly prohibited.

52. Finally, there were quantitative "performance indicators" related to taxrevenues, and government deficit and financing: tax revenues were to reach about 9 per centof GDP, the primary deficit of the non-financial public sector would not be larger than 0.6percent of GDP, and the consolidated public sector balance would not be financeddomestically.

53. Fiscal Policy. The fiscal policy component stressed the need to reduce taxevasion to improve tax collection, strengthening the tax administration authority, SUNAT.The conditions envisaged the installation of new computerized information systems, as wellas the selection of new personnel at a national level. SUNAT also committed itself toexpand from 1,200 to 2,500 the list of large taxpayers monitored.

54. The Government agreed to introduce changes in the tax code to allow forgreater efficiency in the tracking of infringements. Finally, in order to simplify the taxstructure, the Government pledged to assess the phasing out of taxes on exports, bankcurrent-account debits, and interest paid.

55. Labor. The changes in labor legislation supported by the SAL took placeprior to loan design. The conditionality was intended to prevent policy reversals in this area.In particular, the longer probationary period, the extended fixed-term contracts, and theauthorization for temporary employment to accommodate work load increases, changes inmarket needs, or retraining of employees were to be maintained. Moreover, the reform ofCTS from an unfunded provision for severance payment to a fully-funded one was to bepreserved. Every semester, the company was to deposit in a worker's bank account theequivalent of a yearly wage.

56. Social Security. In the area of social security, the Government adopted thedecision to establish the legal framework for the partial or complete privatization of thepension system. The SAL conditionality required improved management of the nationalsocial security institution, IPSS. This entity agreed to an action plan to significantly reducepersonnel, improve its accounting system, separate health and pension fund accounts, andpresent an independent audit of its financial statements by the end of 1992. Furthermore, theplan envisaged the streamlining of the collection system, aimed at increasing revenues for theinstitution without resorting to raising the social security contribution rate. Finally, IPSScommitted to deposit its reserves (funds) in public and private banks, and to issue new rentalcontracts or sell its real estate investment.


57. Agriculture. The SAL conditions for agriculture were intended to preservethe changes introduced in the legal, regulatory and judicial framework that governs thesector. In particular, policies related to the use of land as collateral, the liberalization oftrade, the elimination of price controls, the abolition of interest rate subsidies, and thereforms in land tenure strengthening property rights were to be maintained.

58. Further, state marketing monopolies were to be dismantled. ECASA, the staterice marketing entity, was to be totally liquidated and, ENCI, formerly the state foodstuffsand fertilizer import monopoly, was to be downsized, reorganized and lose its marketmonopoly.

59. Privatization. The Government promised to launch the privatization processfollowing the regulatory framework defined prior to loan presentation. The conditionalitywas expressed in terms of action plans, implementation schedules, policy frameworks anddivestiture strategies. This component required a Government commitment to undertakecomplete divestiture in the banking, fishery, and mining sectors. Furthermore, it requiredprivate participation in public utilities (power generation, water supply and sewerage), publicservices (transportation), and even in politically sensitive activities (oil exploration, refiningand distribution; and telecommunications).

60. Social Sector. In the social sector, the Government was to delineate a povertyalleviation strategy, a national nutrition policy, and profiles for priority projects in primaryhealth and nutrition, and pre-primary and primary education. The poverty alleviationstrategy, with its corresponding implementation schedule, was to outline policies and identifypriority programs and target groups. The Government was to adopt the strategy by the endof the performance period. The national nutrition policy was to improve existing foodassistance programs, enhancing cost effectiveness. The Government was to implement thispolicy during the performance period.

61. Role of the Bank and IMF. The Bank's new approach to support debtworkout programs in countries with protracted arrears required, among other things, theadoption of an IMF stabilization program and a Bank-supported adjustment program.

62. The IMF recognized the efforts of Peruvian authorities and agreed with theGovernment of Peru on a Rights Accumulation Program (RAP) which prescribed fiscal andmonetary discipline during the performance period (January-December 1992). Furthermore,the macroeconomic component of the SAL reinforced the goals set in the IMF RAP, andsupported additional policy decisions.

Annex 3 The Srructural Adjustment Loan

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Program Results

Macroeconomic and Fiscal Policv

63. All the goals set in the SAL were achieved. In macroeconomic policy, theGovernment maintained its commitment to strict fiscal discipline and to the marketdetermination of key prices, including wages, as well as the exchange and interest rates.With no foreign exchange surrender requirements, all external transactions were convertibleto a single exchange rate.

64. Monetary growth was limited to financing the quasi-fiscal deficit andincreasing foreign reserves of Central Bank, at rates consistent with IMF targets. The netinternational reserves of the entire financial system increased US$500 million from US$2,425million by the end of December 1992 to US$2,925 million by the end of 1993.

65. Drastic changes in tax legislation reduced to five the number of taxes collectedby the central government, allowed for inflation adjustments to account for collection lags,and eliminated many exemptions and loopholes. Moreover, the Government introduced anew tax code allowing more efficiency in tracking infringements, and stricter penalties (inclu-ding prison terms) for certain infractions. The modification of statutory rates increased theshare of the value added tax in total collections, reducing the level of more distorting taxes(the levies on exports). Bank current account debits (turnover of bank deposits) and interestson loans were eliminated.

66. Moreover, the institutional framework for the implementation of the law wasimproved, providing the basis for better tax enforcement. The tax administration institution,SUNAT, reorganized its personnel and modernized its monitoring tools in order to improveits quality and effectiveness. SUNAT completed a process of personnel selection andevaluation at the national level to attract capable professionals and reduce redundantpositions. Moreover, the institution had installed a new computer information system, whichallowed it to expand from 1,200 to 2,500 the number of large taxpayers monitored.

67. In 1992, the central govermnent's tax revenue reached a level of about 9percent of GDP, up five percentage points since the new Administration took office.However, the level of tax collection is still low, both relative to a sample of 15 countries inLatin America with analogous levels of per capita income (14.8 percent), and to historicalexperience.

68. The level of government expenditures was in line with tax collection revenues.In 1992, the deficit of the consolidated non-financial public sector (NFPS) was negligible.This was the result both of deliberate policy and lack of access to credit from the CentralBank, the domestic financial sector, or international markets. Shortage of funds, given therelatively low level of government revenues, forced the Administration to postpone public


sector investment. Over the period, the Government observed tight discipline on publicsector wages and accomplished a reduction in the number of employees through voluntaryretirement. However, the Government managed to resume debt servicing to all internationalfinancial institutions and began negotiations with its Paris Club creditors aimed at the fullrestoration of service.

69. Consistent with this persistently lower level of government deficit, theperformance of the main macroeconomic variables has improved. In particular, inflationhas abated from its hyperinflationary levels, domestic real interest rates both in nuevo sol-and-dollar denominated operations have dwindled from their elevated post-stabilization levels,and the real exchange rate depreciated somewhat during 1993, enhancing the competitivenessof exports. However, macroeconomic stability is still fragile, and inflation and real interestrates are very high relative to international standards.

70. Inflation at the end of the "performance period" was at an annual rate of about60 percent, and continues to decline. It does not appear to have reached a floor. In April1994, inflation was at about 1.5 percent. The real exchange rate, as measured by the ratioof an external price index (adjusted for devaluation) and the domestic consumer price index,was about 40 percent of the level prevailing on average in 1985, even after depreciatingabout 10 percent in 1992. On the other hand, despite the high level of capital mobility, realinterest rates were higher in Peru than abroad, both on dollar-denominated and on nuevo sol-denominated accounts. Furthermore, the spread between interest rates on loans and interestrates on deposits was high, even after accounting for inflation, reserve requirements andother taxation. It should be pointed out, however, that real interest rates and spreads wereconsistently higher for domestic currency-denominated loans than for dollar- denominatedones.

71. In the financial system, the amount of demand deposits grew, but at a veryslow pace. A bank run on deposits in the months of April and May of 1992, after theclosing of Congress, was reversed in the following months. The market has continued toprefer dollar deposits, albeit at a decreasing rate. The participation of dollar denominatedaccounts in total

deposits increased from about 60 percent at end-1990 to almost 80 percent at end-1992. As aresult, loans granted were also increasingly denominated in dollars.

72. During 1992 and subsequently, the quality of the portfolio of the bankingsystem, measured as a percentage of non-performing loans, deteriorated significantly. Insome financial institutions, the level of insolvency reached such a degree that the Superinten-dency of Banks had to order their liquidation. The grade of uncertainty in the stability of thebanking system redirected deposits to the most solvent institutions, increasing the degree ofconcentration in the industry. As of the end of 1992, four institutions received more than 70percent of all the deposits in the banking system.


Labor Markets

73. Given the magnitude and scope of the structural change, the Peruvian economyneeded a more flexible labor market to permit a more efficient reallocation of labor. Amongthe reforms supported by the SAL, the labor stability law was relaxed, expanding conditionsfor layoffs and increasing the probationary period in specific cases. In addition, new laborcontracts were allowed on a fixed-term basis (up to three years), allowing for fluctuations intemporary employment to adjust for new market conditions. Finally, the Compensation forTime and Services Rendered (CTS) became a fully-funded severance-cum-retirementmandatory savings, managed by financial institutions. This change has improved labormobility, because it provided workers with guaranteed savings available in case of severancewhile they search for a new job.

74. The Government also redefined the framework for collective negotiations andthe rules that govern a strike. Previously, most collective labor negotiations were agreed byindustrial sector, instead of company by company. Given the hyperinflationary scenario,labor agreements usually included indexation clauses. Strikes were decided in assemblieswithout a quorum, and there were no periodic votes to decide on the continuation of thestrike. With the changes, workers are free to organize in unions, but the law requires aminimum number of 20 members per company. Moreover, collective labor negotiations cannow be agreed on a company by company basis. However, if firms and workers assent, thescope could be broadened to an industry basis. Even though inflation remains high, periodicindexation has been ruled out in most collective agreements, allowing fluctuation in realwages to reflect market conditions. On the other hand, strikes now require a quorum: morethan half of the workers have to decide in an assembly, in a direct, secret, individual anduniversal vote, to start a strike in order for it to be valid, and this has to be certified by anotary public.

75. Even though minimum wages were required by the old Constitution, the Go-vernment has set them at non-binding levels. In addition, new legislation now requires aboard of employers, employees and government representatives to set the different minimumwages, taking into consideration the sector, cost of living, and type of occupation.

76. Finally, a significant gap still exists between the cost of labor for firms andtake-home wages for workers, the difference being compensation for time of service, socialsecurity contributions, and a tax to the National Housing Fund. The first of these is not atax, but a forced savings scheme. The second is a mandatory health and old-age insurancescheme which has been significantly improved (see below). The last used to be a housinglottery, but is currently an earmarked tax used for the construction of basic infrastructure inlow-income urban areas.


Social Security

77. In the area of social security, the Government redefined the nature of themandatory saving for retirement. The National Pension System (SNP), currently managedby the Peruvian Social Security Institution (IPSS), has been revised, and new financialintermediaries will be allowed to compete for the administration of the mandatory pensionlevy. Furthennore, a new law expanding private sector participation in the administration ofmandatory health insurance has been passed, but has not been implemented yet.

78. The National Pension System was legally defined in 1973 as a benefit pensionscheme, where the initial retirement income was estimated on the bases of a formula whichtook into consideration years of contribution, number of family members, and average wagein the prior 12 months. Later, the legal framework required the pension, thus defined, to beindexed to inflation every three months to maintain its purchasing power.

79. This system assumed the obligations from prior mandatory pension programs.However, the number of workers close to retirement age who had contributed to the systemwas small relative to the number of workers being levied. Thus, the system generated, up to1988, significant cash surpluses and could comply with the benefit formula mandated in thelaw. This formula was extremely generous relative to other legislations in the world.

80. Given the important cash surpluses, and the nature of the pension scheme, theadministration of the program should have built significant reserves from the amount leviedon workers and firms. However, this was not possible, basically because the governmenttook those funds in exchange for bonds yielding negative interest rates.

81. Having virtually no reserves, the system collapsed to a pay-as-you go plan,where benefits were, defacto, estimated on the basis of the available resources. Moreover,the transition to an effective pay-as-you-go system was accelerated by giving access to apartial pension with only five years of contribution. With the outbreak of hyperinflation,indexation was abandoned, and retirement income dropped significantly in real terms.

82. The prospects for the system were bleak, with projected reductions in theratios of contributors to beneficiaries to account both for the natural maturity of the system(tending toward the age structure in Peru) and the observed long-term trend in the aging ofthe population. This raised questions about its financial feasibility at the given contributionrate and level of evasion. In addition, a deficient administration of the pension plan wascharacterized by redundant personnel, an inefficient collection system, and financialmismanagement that was concealed by an obscure, unauditable accounting system.

83. The Government decided to reform the nature of the pension system in Peru.The new legal framework will allow workers to choose between joining a pension systemmanaged by the State and one handled privately. A massive transfer of workers to the new

Annex 3 The Structural Adjusrment Loan57

system is expected, since the benefits of the former have been reduced significantly and aredecided arbitrarily. The pension provided by the private system will depend on the amountof contributions of the individual during his working life, and the evolution of the realinterest rate over the period; thus it is a fully-funded scheme instead of pay-as-you-go. Thissystem promotes competition because the worker can choose the intermediating institution tomanage its funds, whereas the other scheme acted on a monopoly basis. Finally, financialinstitutions in charge of managing the funds are private instead of State-owned institutions.

84. In summary, the modification may significantly increase the saving rate andimprove income distribution. It also eliminated all favorable discriminatory treatment forsome pressure groups and changed the legal requirement for pension indexation to periodicrises to account for inflation depending on the financial resource available to the managinginstitution.

85. The National Pension system has been operating on a pay-as-you-go basis.Consequently, a massive transfer of contributors to the alternative system will significantlyaffect the system's finances. Because of this, the Government has offered to guarantee, overthe transition period, the pensions of retired workers. In the meantime, the Governmentinproved the administration, accounting and financial management of the social securityinstitution (IPSS).

86. The reforms imply a partial privatization of the administration of the socialsecurity institution, as many of its former duties have been delegated to the private sector.Consistent with this reduced scope of work, the Government has trimmed redundantpersonnel from a level of 45,000 to 22,000 across the nation.

Agriculture

87. This sector is one of the most important sources of employment in the country.Agricultural and livestock activities absorb 35 percent of the economically active population,but contribute only about 12 percent of GDP and 8 percent of exports. Nevertheless, thelevel of production is enough to provide a significant amount of the food consumed byPeruvians. The balance is provided by imports. Imports are especially important when theeconomy suffers from adverse supply shocks, such as the El Nifio current phenomenon whichrepeats itself about every 10 years.

88. Agricultural production is widely diversified. The most important staples involume, are rice, maize, potatoes, coffee, cotton and sugar. The latter three havetraditionally provided most of the foreign revenue generated by agriculture. The abrupttopography and difficult geography of the country mean that croplands are broadly scatteredand segmented. This inhibits large-scale operations and increases transportation costs. Inaddition, farmers have to face the problem of cultivating land in sloped areas, for which they


have developed their own technology. Pasture area is relatively small, restricting large-scaleanimal raising activities in the country.

89. Despite Peru's sizable territory, agricultural land is relatively scarce. Only2.9 percent of the land mass of the country can be used for agriculture, most of it to befound in the highlands. However, this resource has not been appropriately managed throughtime, and much of it has been severely damaged or completely wasted for agriculturalpurposes. Salinization is a prevalent problem in the coastal region, while soil erosion is amajor issue in the highlands. Deforestation and overgrazing affect large agricultural andanimal raising areas through the country. Furthermore, lack of official concern for theenvironment has contributed to land degradation and ecological disruption.

90. Land is subject to a high degree of climatic uncertainty, exhibiting a highvariance of temperature and availability of water and energy. This environmental factorincreases the risks associated with the activity in the country. A large number of ruralfarmers, who are close to a subsistence level, take this as given and adjust their behavior byfollowing risk-averse practices and diversifying their production, even though on a smallscale. Over the years, farmers have arranged risk-pooling agreements to reduce theirindividual exposure.

91. Water availability depends on the precipitation in the mountains, either directlyor indirectly. Most of the agriculture in the coast takes place in the scattered river valleyslocated along the large desert strip. In this region, farmers depend on irrigation systemswhich gather the seasonal rise in the level of the rivers during the rainfall period, whileagriculture in the highlands depends directly on the amount of rainfall. In the 1970s, theGovernrnent developed very important irrigation projects which have proved to be badlydesigned and managed. Despite the high cost of these projects, which aimed at providingwater supply for agriculture, successive governments set water charges at levels so low thatthey were not worth collecting. Cheap water tariffs promoted the overuse and waste ofwater.

92. Urban centers are the natural markets for agriculture. However, local peasantsface competition from imports. Protection is now limited to tariff barriers and, for somestaples, a temporary surcharge scheme. Nevertheless, these may not compensate the higherroad transportation costs that domestic production has to bear to reach the market. Thisreflects many factors, among them a government budget that depends on fuel taxes, thedeterioration of the road network and infrastructure in general, and the environment ofpolitical violence that has prevailed in the country. Rural insecurity caused by terrorism anddrug trafficking activities have increased both the costs of production and distribution.

93. Finally, the amount of investment in agriculture is extremely low. The levelof under-capitalization can be explained, in part, by the mistakes contained in the Agrarian

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Reform Law passed in 1969. This law denied full property rights to the beneficiaries of thereform and threatened them permanently with expropriation.

94. In August 1991, the Government instituted a new Agricultural InvestmentPromotion Law which abolished most of the negative aspec.s of the earlier Agrarian ReformLaw. The new policy framework is based on strengthened property rights and lower tariffsfor agriculture inputs. The basis of agricultural progress is to be well-defined property rightsfor land and water usage, under which land may be owned, leased, mortgaged (if in excessof five hectares), and traded without restriction by or to any individual or legal entity,whether Peruvian or foreign.

95. Nevertheless, a vast array of farmners, are not yet covered by the law, and thuslack a proof of their property rights. Urgent reorganization of the rural registration systemneeds to be achieved since most of the land has not yet been registered. Once titling andregistration of rural properties is undertaken peasants will be able to use their land ascollateral for credit. (Peasant communities -- "comunidades campesinas" -- do not have thisfreedom, though their freedom to dispose of their land has increased under the new 1993Constitution.)

96. State participation in agriculture is being cut drastically. The State hasrefrained from setting price controls, providing inflationary credit subsidies, or supportingprivileged access to collateral. In foodstuff trading the role of the State has beensubstantially reduced. ECASA, the national rice-marketing monopoly, has already ceasedoperations and is completing the process of liquidation. The monopoly on imported grainsand fertilizers that ENCI formerly had was removed, and the company has begun a processof reorganization.

97. To temporarily provide funds for agriculture, the central government budgethas allocated limited amounts for credit since Banco Agrario is no longer a source of creditand commercial credit to agriculture has remained low. Unfortunately, the improvedeconomic framework for agriculture has not been reflected in greater production, because ofbad climatic conditions. In this scenario, banks, which face a difficult financial situation,have not been willing to increase their risk by lending to clients that are unknown to them.Faster procedures to call on guarantees and swifter solutions for legal disputes must beimplemented if banks are to increase their stake in agriculture.

Privatization

98. The bold privatization program of the Fujimori Administration aims atdivestiture of about 224 companies. The State will concentrate on providing basicinfrastructure, health, education, justice, and public goods.

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99. The legal and institutional framework for privatization was defined inLegislative Decree 674 of September 1991, as amended in December 1992. This decreecreated an executive agency in charge of the privatization program, the Commission for thePromotion of Private Investment (COPRI). This inter-ministerial commission is directlysupervised by the President. For the privatization of each public company, COPRInominates a Special Committee (CEPRI) which draws up the plan and conditions of sale on acase by case basis. Each CEPRI monitors the privatization by overseeing consultantscontracted under competitive bidding to carry out the technical and financial studies.

100. As part of the effort to promote investment, the Government has transformedforeign investment legislation into one of the most liberal in the world. Foreign investorsnow have the same rights and obligations as Peruvians. Foreign investors may organizethemselves into any corporate form provided for in corporate law, including joint ventureswith domestic investors. There are no restriction on any form of capita] remittance, whetherdividend, interest, or royalty payments. For the transfers, investors need only channel theresources through the banking system without needing any type of approval from thegovernment. Finally, Peru acceded to the Multilateral Investment Guarantee Agreement(MIGA) in December 1991. In addition, the country has become a member of the Internatio-nal Center for the Settlement of Investment Disputes (ICSID) and has signed bilateralagreements to protect investments with Switzerland, Thailand, and recently with the UnitedStates (through the Overseas Private Investment Corporation).

101. From May 1992 to April 1994, 33 companies have been privatized. Thisprocess has accrued US$ 2.07 billion in revenues and has helped the Government balance itsbudget. Of particular note was the privatization of Empresa Nacional de Telecomunicaciones- Entel/Companiia Peruana de Telefonos - CPT - Telecommunications. On February 28,1994, a control package of 35% of Entel and CPT--including a capital increase in CPT--,was auctioned to a consortium led by Telefonica Internacional (Spain), for a total of US$2billion. Out of this amount, the State will receive US$1.39 billion, while US$0.61 billionwill be the additional capital in CPT. Up to 10% of Entel's shares will be offered to Entel'sworkers and the remaining shares will eventually be offered in the market. All theremaining mayor companies will be privatized by early 1995. These include the two mayorelectricity companies (ELECTROLIMA and ELECTROPERU), the national oil company(PETROPERU), the water and sewerage company (SEDAPAL) and the remaining miningcompanies (CENTROMIN and MINEROPERU).

Social Sector Issues

102. A large segment of the Peruvian population suffers from chronic poverty,defined as a level of consumption below that represented by a basic food basket. There areserious problems in health, nutrition, sanitation, and education. Under the new economicpolicy, the government will promote wealth-generating activities rather than redistribution ofincome. The new economic strategy is intended to improve real wages. Crucial in this


effort is the process of labor market deregulation and the elimination of the regressiveinflation tax.

103. In addition, the Government will concentrate on the provision, rehabilitation,and expansion of basic social infrastructure and essential public services: health, water andsanitation and education services. In order to do so, the Government will have to improveits administrative capacity and reform key institutions, as duplication of functions remains inkey areas like health provision.

104. However, as a short-term response to critical poverty, the Government hasdesigned a poverty alleviation strategy establishing a minimum safety net for the mostvulnerable groups in society. It began with outlining policies in health, nutrition, education,and employment, identifying vulnerable sectors, priority programs, and the institutionalframework for the implementation of social programs. Identification of target groups impliesa significant change in policy relative to the prevalent generalized food subsidies of the past.

105. One of the principal safety-net schemes in the program is FONCODES, theNational Fund for Social Compensation and Development, created in August 1991. Itfinances small labor-intensive projects for the rehabilitation of social and economicinfrastructure and for the provision of basic social services, identified by the poorer localcommunities. After its formative period during 1992, there have been notable improvementsin its efficiency and management. To fund the program it relies on both internal andexternal resources.

Health

106. The most common health problems in Peru, and among the main knowncauses of mortality, are pollution-related respiratory illnesses and water-borne diseases suchas diarrhea. Diarrheal diseases arise from the use of contaminated water and lack of accessto a public sewerage service. The precariousness of the sanitary conditions of the countryexplains the degree of prevalence of water-borne diseases and the speed with which thecholera epidemic spread in the country in 1991.

107. Infant mortality is very high, especially in the rural areas, where it is doublethe rate of urban areas. Correspondingly, the number of children per mother in rural areasis twice that of mothers in urban areas. Average life expectancy is about 64 years, but aftersurviving the first two years of life, life expectancy increases to above 70 years old. Themost dramatic fact, however, is that more than 80 percent of the infant deaths could be easilyavoided with proper care. Moreover, it is estimated that around 40 percent of children undersix suffer some sort of nutritional deficiency.

108. There are in Peri almost the same number of public and private hospitals.However, private hospitals have a much lower number of beds per institution. The Ministry


of Health is the main provider of hospital infrastructure in the public sector, followed by thcSocial Security Institution, which provides health care to its contributors and their families.Unfortunately, because of lack of funds and mismanagement, public hospitals aresignificantly limited in their ability to provide health services to the population. There areabout than 27,000 physicians, about one for every 3,000 people. The ratio is much lower inLima: about one for every 436. In general, health care is much better in urban than in ruralareas.

109. The Ministry of Health intends to reduce infant mortality, expand healthcoverage in poor areas, rehabilitate social infrastructure, and upgrade the capacity ofprofessional staff. Concurrently, the Ministry of Education initiated an emergency programto feed schoolchildren one meal a day and use the school as a locus to introduce tuberculosisdetection and improved health practices.

110. With UNICEF assistance, a Plan of Action for Child Welfare was prepared bythe Government. It sets goals in the area of health, water and sanitation, nutrition,employment, and the problems of children in difficult circumstances. Moreover, theGovernment prepared a national nutrition policy based on a review of existing food assistanceprograms, which were reformed to improve cost effectiveness and nutritional impact. Inaddition, the Government prepared a list of priority projects and project profiles in primaryhealth and nutrition.

Education

11. The illiteracy rate is 11 percent, although the underlying distribution exhibitshigh variance associated with geographical area and sex. For men, the average rate is only 5percent, while for women it is 18 percent. The illiteracy rate is 5 percent for urban areasand 30 percent for rural areas. In the Andean valleys, a significant portion of the populationbarely speaks Spanish, Quechua being the main language. Finally, the rate of illiteracy ismuch lower for younger than older people, reflecting the effort at universal educationundertaken by the State in the last decades.

112. About 70 percent of children receive school education, 90 percent of them inpublic schools. Of the 47,000 schools in the country, about 41,000 are public. Thepresence of the State at the university level is lower. It manages 33 of the 56 universities inthe country. However, public schools perform very poorly. The degree of educationalattainment, although improving, remains very low. Repetition rates are about 10.2 percentin primary school and 8.5 percent in secondary school. The attrition rate is currently about6.2 percent, being somewhat higher in secondary schools.

113. The Government developed a list of priority projects and implementationschedules with the objective to increase internal efficiency of education. The Ministry ofEducation aims at expanding the coverage and quality of primary education and linking

Annex 3 The Srruc tural A djus tmen t L oan63

technical training to the job market. Over the medium-term, the objectives are to improvethe qualitv of education, universalize education for 6-14 year old children, and upgrade thequality of teachers in the public system. Over time, the investments in human capitalachieved through education will be the most valuable tool to emerge from poverty.

Overall Evaluation

114. Reforms introduced by the Fujimori Administration in Peru have proven to bethe most important changes in the country's economic framework since 1968. The revolutionin the structure of the economy encompasses a change in development strategy from aninward-oriented import-substitution system to a market-oriented open economy. The long-run role of the government has been limited to those activities in which it will be mostefficient. In particular, the State is abandoning its generalized intervention as producer andplanner, and concentrating on providing a stable legal framework for property rights andservices for health, education, security and basic infrastructure.

115. The achievements are encouraging. As described in the prior sections, thestructural adjustment has pervaded most activities in Peru. In particular, the Governmentliberalized economic activity throughout the country. It has lifted barriers to tradedomestically and abroad, opened activities to the private sector that were once reserved to thestate, and, in general, fostered an environment of competition designed to promote a moreefficient allocation of resources. In general, the scope of the structural changes in Peru isone of the boldest and most far reaching ever seen in Latin America.

The Stabilization Program

116. The stabilization program implemented by the Fujimori Administration can becharacterized as orthodox and monetary-based, since it has stopped domestic financing of thefiscal deficit and imposed targets on money base expansions. Liberalization programs havecomplemented this effort, laying the foundations for growth and increasing confidence in thesustainability of the stabilization.

117. The program was successful in curtailing hyperinflation, but it has not yetabated high inflation. The monthly rate declined from an average of 40 percent per monththrough mid 1990 to a figure around two percent per month by the enid of 1993.Notwithstanding the large improvement, Peru is still among the high inflation countries.

118. The observed increase in the consumer price index over the period wasconsistent with the growth of the monetary base, despite the fact that the Central Bank didnot finance any budget deficit. This shows that equilibrium in the fiscal accounts is anecessary, but not a sufficient condition to maintain price stability. Inflation is a monetaryphenomenon, and there are many reasons why the Central Bank might increase the quantityof money, besides funding the government. For instance, expansion in the money supply


may arise from purchases of foreign reserves. direct credit policy, or open market operationsof the monetary authority.

119. The expansion of high-powered monev can be explained mainly by CentralBank purchases of foreign exchange with the double objective of increasing internationalreserves and trving to depreciate the real exchange rate. Some additional intervention of theCentral Bank in the exchange rate market was on behalf of the government, acting as anintermediary in acquiring foreign exchange to service debt. The behavior of the CentralBank was consistent with the yearly monetary expansion targets and credit ceilings agreedwith the IMF under the Rights Accumulation Program. The Govemrnent and the IMFagreed on a gradualistic attack on inflation.

120. Although not to the standards of developed countries, inflation has beenreduced drastically, thus curtailing the depreciation rate of real money balances. This effectshould have boosted, cetenis paribus, the demand for domestic currency. On the other hand,the opportunity cost increased with the elimination of repression in the financial system.Market determined interest rates reached levels previously unknown to the country, anddollar deposits in the financial system provided a low risk financial asset that enhanced thepossibilities of inter-temporal substitution which for a large majority of the population waspreviously restricted to the dollar bill.2

121. Since the Fujimori Administration took office, domestic real interest rates havebeen above both international and historical levels. At the beginning of the stabilization,interest rates in soles and dollars skyrocketed, due to a liquidity effect increasing demand forcredit and higher expected growth.

122. High risk also explains the higher real interest rates observed in the economy.Depending on the denomination of the type of asset, deposits reflected: the lack ofconfidence in the financial system (the risk of expropriation and bankruptcy); the devaluationand inflation tax premium; and the country risk. The latter arises from the frequenthistorical changes in economic policy and in the legal and regulatory framework that haveaffected the business environment.

123. The economy suffered a contraction in GDP as a result of the adjustmentprocess to the new set of market prices and external competition. In addition, other supplyshocks were also present, such as bad weather and the presence of the El Nino current thataffected agriculture and fishing. This also caused a drought in the Andes that reducedproduction through a lack of electricity.

2 Domestic nominal interest rates in Peru's financial system prior to 1990, did not reflect the cost of holdingcurrency. Because of financial repression, deposits at the financial system were not the best alternative (andtherefore the opportunity cost) of holding purchasing power. Hence, people resorted to dollar bills as store of value.

Annex 3 The S truc tura/ A dus trmen r L oan65

124. Inflation would have been lower if money demand had responded to lowerinflation. One of the possible explanations of the sluggish increase in real domestic moneybalances is that the reduction in monetary growth rate was not perceived to be permanent.Under this hypothesis, the fact that the current inflation rate was lower did not necessarilymean that people expected it remain that way in the future. Drastic policy changes havebeen common in the country and Peri has had a long experience with surprise unsuccessfulstabilization programs. Those came together with periodic drastic once and for all increasesthat dramatically shrank the real money balances of those who maintained them.

125. Lack of confidence in the government's ability to lower inflation may beexplained with the observation that the inflation forecasts published by the governmentconsistently underestimated actual results. Moreover, the implicit expected devaluation rateobserved from interest rate differentials suggests that those forecasts were never believed.

Currency Substitution

126. Domestic currency has to compete with foreign exchange to provide monetaryservices to the Peruvians. The economy uses the US dollar a as means of payment for largedomestic transactions, a store of value and a unit of account. Petty exchanges are mostlycarried out in local currency. Thus, the dollar coexists with the domestic currency, whichlost its monopoly as the domestic means of payment with the outbreak of uncontrolledinflation.

127. The explanation of this substitution is that the foreign currency is cheaper andmore reliable than the domestic currency. The user cost of domestic currency is stillsignificantly higher than the user cost of dollars, and transaction costs of exchange are verylow. The existence of dollarization in the economy may improve net welfare since itincreases the number of options available to consumers.

128. Dollarization of transaction services is still the most efficient way that societyhas to keep its payment system going, in a scenario of still high inflation rates. Ifdollarization could be prohibited, economic agents would have to resort to another lessefficient means, and probably some mutually beneficial exchanges would not take place.

129. The allowance of dollar deposits has reduced significantly the seignorage paidby the Peruvian Economy as a whole. Before dollar deposits were permitted, seignorage wasbeing paid on dollar bills kept for both uses: transaction and store of value purposes. Withthe introduction of dollar deposits, the dollar "base" has declined accordingly. Indeed, eventhough banks must hold reserves at the Central Bank, this institution may deposit thoseresources abroad and earn interest. Thus, the cost of holding dollar deposits to the societyfor store of value purposes--the loss of seignorage--is about equal only to the bills incirculation.

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Real Exchange Rate

130. The real exchange rate has been appreciating since 1988, but has appreciatedat a much lower rate since the beginning of the stabilization. Nonetheless, there is a strongperception of real exchange rate appreciation, especially when the ratio is compared to priorhistoric levels. Moreover, there is a prevalent expectation that the real exchange rate willcontinue to appreciate. This expectation is consistent with domestic real interest rates ofdollar denominated deposits being higher than real interest rates abroad.

131. The Central Bank tried to depreciate the exchange rate to promote export-ledgrowth in the country. It seems that it made a small dent in this rate, but at the cost of asizable inflation tax.

132. With the liberalization of capital markets came an increase in the supply ofdollars in the economy. Capital inflows were attracted to the country by the high interestrates, either to earn a high yield or to avoid paying one. In addition, capital inflowsfinanced the remonetization of the economy, which took place to a significant degree indollar-denominated liquidity.

133. Many factors have affected the real exchange rate since the launching of thestabilization plan. The reduction in tariffs decreased the price of tradable goods, theelimination of subsidies boosted the price of non-tradable goods and, finally, the increase inthe price of energy and public services may have affected the price of non-tradable goodsmore than that of non-tradable goods. It is difficult to assess the final net result of theseopposing effects.

Sustainability

134. The current Administration remains committed to the structural reforms andcurrent economic policy, and is expected to maintain that position until the end of its term.Furthermore, the Administration signed a three-year Extended Fund Facility Program withthe IMF in March 1993 that has defined an economic program for the period, setting targetsconsistent with greater macroeconomic stability.

135. However, there are some concerns about the sustainability of the economicprogram beyond this Administration. On the macroeconomic side, the fears are based on thefragile fiscal situation over the medium term unless there is a significant increase in the levelof tax revenues. In particular, two factors could affect the current equilibrium. The first isthe level of external debt, the servicing of which would be unsustainable at current taxcollection rates. Conservative projections forecast that medium- and long-term public debtcould reach a level in excess of total exports in 1996. Peru would have to negotiate areduction in its debt with its creditors, because even if revenues increase enough to cover

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debt service, the opportunity cost is very high since the State needs financial resources toprovide for social spending and basic infrastructure.

136. The second factor is related to the redefinition of the social security system. Ifthe introduction of the new system is successful!, the government would assume a significantinternal debt on behalf of the current pensioners and contributors (in principle all workers inthe formal system) estimated at US$ 1.9 billion, assuming a discount rate of 4%. That debtwould have to be paid over the next 50 years, but could be financed over time in order toredistribute the cost of the transition to a better pension system to the future generations whowill benefit from it.

137. Over the shorter run, some macroeconomic progress is required to consolidatethe stabilization program. In particular, growth must be resumed and inflation reduced.Inflation continued to fall after 1992, while a promising recovery growth began at the end of1992. The economic situation of the banking system gives rise to concern. A banking crisiswould be a serious setback for the stabilization program.

138. The long-term sustainability of the broad structural reforms andmacroeconomic improvement implemented by the Fujimori Administration will depend on thepolitical support that they will be able to retain over time. The Government has enjoyedhigh approval rates, but it must secure political support from the most vulnerable groups. Inthis sense, the poverty alleviation scheme implemented by the Government is of utmostimportance.

Conclusions and Lessons from the SAL

139. The Structural Adjustment Loan (SAL) was the second of three policy loanswithin the Bank's new approach to debt workout problems with Peru, as a country withprotracted arrears. Arrears clearance reversed the country's non-accrual status, and hasallowed the Bank to restart large lending operations in Peru.

140. The SAL was instrumental in supporting the reforms that will sustain long-term growth. To improve allocation of resources the loan has fostered the development ofthe private sector by supporting the liberalization and deregulation of key markets andpromoting the privatization of state enterprises, thus directly reducing the participation of thegovernment in productive activities. It has been the Government's decision, supported by theSAL, to limit its scope to those activities in which it will be most helpful for society:providing a more stable legal and regulatory framework, social welfare programs, and basicinfrastructure.

141. Reforns in the labor market have enhanced labor mobility and improved thesystem of forced savings for retirement. Those in social security have achieved a bettermanagement of the corresponding institution and the introduction of a superior alternative


which will foster Peruvian capital markets. Finally, reforms in agriculture have eliminatedprice distortions and broadened property rights in land, abolishing most legal and regulatoryrestrictions to credit and trade.

142. In addition to the structural reforms, the Peruvian economy has made afundamental change in economic policy. This includes a change in development strategyfrom an inward-oriented import-substitution scheme to a market-oriented open economy.The new Administration shifted from a multiple-exchange crawling peg to a unified floatingexchange rate system. Compulsory surrender of export receipts and all controls on current-and capital-accounts transactions were abolished. In addition, most price controls wereeliminated, including a defacto elimination of interest rates ceilings. Monetary expansionwas limited mainly to purchases of foreign currency by the Central Bank to accumulateforeign reserves. Central-Bank financing of the central government was explicitly prohibited,and a cash management committee managed State finances on a cash basis only. In order tosustain this situation, the Government undertook further fiscal reforms aimed at increasingtax revenues and improving the management of public expenditure.

143. However, macroeconomic stability is still fragile and there is still much toachieve. Inflation and real interest rates are very high relative to international standards.Finally, Peru still has a sizable labor force working in the "informal" sector.

144. The lessons that can be drawn from the structural adjustment loan are relatedto the stabilization program implemented by the Government. First, in a scenario of lack ofcredibility and persistent dollarization, an increase in the demand for domestic real balancescannot be expected despite the reduction in the inflation rate. Second, in this framework, theefforts of the Central Bank to depreciate the real exchange rate through direct purchases offoreign exchange will generate inflation. Third, financial intermediation in dollars mayreduce the seignorage paid by the economy. Fourth, real interest rates may be higher in thecountry even though it is open to foreign capital, as a result of a combination of country risk,expropriation risk, expectations of future real exchange depreciation, and the internal level oftaxation.

Annex 4 The Trade Policy Reform Loan 69

ANNEX 4

THE TRADE POLICY REFORM LOAN

Trade Policv Reform and the Loan

1. In August, 1990 the newly elected Fujimori Government began a fundamentaltrade reform concurrently with the introduction of a stabilization policy and the initiation of abroad range of economic reforms. The exchange rate was immediately unified and floated,and rationing of foreign exchange largely eliminated. Many non-tariff barriers, most importtariff preferences, and all export subsidies were eliminated in short order. By March 1991,virtually all remaining non-tariff barriers had been eliminated. At this time, a two-rate tariff(15 and 25 percent) was introduced (with a few exceptions for steel products). A system ofvariable tariff surcharges was introduced for a limited number of agricultural products in aneffort to provide greater price stability in the domestic market. In mid-1991 an anti-dumpingcode was passed. By this time, the Government had eliminated most of the activity of theInstituto de Comercio Exterior (ICE -- the public body that had formerly administered importcontrols and export subsidies), and begun a program of reforming the customs service. InSeptember, the Government gave the strength of law to many of the decrees that hadachieved these policy changes.

2. The early reforms of the new Administration were not part of any clearblueprint for trade reform. They may have responded to informal policy advice from theinternational financial institutions, but many of them were also a necessary part of thestabilization. A Bank mission at the end of 1990 made specific proposals in the area offoreign trade including: a rapid move to a low and uniform tariff; elimination of exportsubsidies; and the creation of a safeguard mechanism to adjudicate claims of import injurythat balanced producer and consumer interests.' The mission also proposed a detailed planfor the reform of SUNAD, the Customs Superintendency. After this, a Bank trade mission(funded under the joint UNDP-World Bank Trade Expansion Program) arrived just after theFebruary 1991 appointment of a new Economy and Finance Minister. Carlos Boloiia, forwhom radical micro-economic reform, particularly in trade, was a top priority. The radicalmeasures the Government took from March onwards were consistent with the mission'srecommendations (though not always identical), and reflected a unanimity of views ratherthan any new conviction on the Government's part.2

' Economic Reforms to Sustain Stabilization and Lay the Foundations for Development, December 8, 1990,World Bank, mimeo.

2 The mission proposed: an immediate reduction in tariffs to leave only three rates, 15, 20, and 25 percent,and the move to a flat 15 percent tariff within one year; an elimination of controls on second-hand imports ofcapital goods and motor vehicles; the permanent elimination of the main non-tariff import barriers and furtherelimination and simplification of remaining technical barriers; the extension of the temporary admission systemto cover all exports; the preparation of a plan to reform customs; the de-activation of ICE, the carefulintroduction of anti-dumping legislation; and the consideration of a scheme to provide internal price stability toselected agricultural products through a variable specific tariff. See also the subsequent report: UNDP-WorldBank Trade Expansion Program, Peru: Towards a More Open Economy, Trade Policy Division, Country


3. The loan was prepared between June and December 1991. Preparing thetrade-policy-related part of the loan proved straightforward. No new analytical work wascarried out: even if there had been more time for this, the two missions mentioned inparagraph 2 above had laid a solid basis, while the reform was by and large so classical andstraightforward that it did not warrant any complex data manipulation to justify or design it.From the beginning, the Bank worked in close cooperation with the lDB, which presented itsown Trade Sector Loan to its Board on September 18, 1991. The close cooperation wasfacilitated by the fact that the IDB loan was managed by a former Bank staff member whohad led the December Bank mission mentioned in paragraph 2 and had recently transferred tothe IDB. The Bank and IDB agreed on virtually identical conditionality (with the exceptionthat IDB handled the restructuring of two state enterprises, ENCI and ECASA, in its TradeSector Loan, while the Bank handled this in its SAL). IDB took the lead in designing theproject component on customs reform. (IDB also provided a $2.3 million component of aTechnical Cooperation project to fund technical assistance for the customs reform.)

4. The Bank -- although quite pleased with the amount and quality of reformalready having taken place -- was concerned to agree on conditionality which would requirePeru to undertake to maintain all its actual reforms and carry out only a few remainingreforms it had already announced (notably, eliminating a residual 5-percent tariff rate byearly 1993), rather than to seek new policy concessions. In this respect, the Bank sought todefend the policy positions already established by the Government and enjoying substantialpublic support against any future opposition that might arise. Bank-Government negotiations(in December 1991) were straightforward and uneventful.

5. The loan conditions agreed between the Bank and the Government emphasizedthe maintenance of the reforms achieved between August 1990 and September 1991, ratherthan new measures to be taken. Of the 22 conditions agreed (see Annex 1), 16 were tomaintain existing reforms and six to achieve further changes. The main actions under theLoan can be summarized as follows:

(a) the exchange regime: maintain a single freely convertible exchange rate forall transactions;

(b) tariffs: maintain a simplified tariff structure which had substantially reducedthe level and variance of protection; maintaining the elimination of mostspecial regimes allowing discriminatory preferences on the domestic market;maintaining the agricultural surcharges scheme as it is (i.e. not expanding orchanging it), with the possibility of revising it following a study; revising theanti-dumping code (with the help of a study of the issue);

(c) non-tariff import barriers: maintain the elimination of formally protectivebarriers, including prohibitions, minimum-local-content regulations (except onmilk), controls on most second-hand imports (notably excluding clothing), andstate agricultural import monopolies; reduce or simplify sometechnical/safety/health controls on imports (with the help of a study of the issue);

Economics Department, the World Bank, October 1992.


(d) export regime: maintain the elimination of fiscal and financiaL exportsubsidies; improve schemes to allow inports to recover indirect taxes when thefiscal situation permnitted this; maintain the reduction in non-tariff exportbarriers;

(e) trade institutions: carry out a program for customs reform.

Implementation of the Reforms

6. The Board document Perui: Final Review of the Bank's Workout Program(R92-226, December 10, 1992) reported that the Government had observed all measuresagreed (see Annex 1, reproduced as Annex 1 in this report, for details) and that itscommitment to an open trade regime had not wavered during the performance period.' Thisis still the case. But this is not to say that the trade reform has been entirely without its upsor downs or problems. This section reports on developments in Peruvian trade policy sinceBoard presentation of the Trade Policy Reform Loan (February 1992).

7. Exchange Rate Policy. The Government has maintained a unified, freelyconvertible exchange rate for all transactions, with no change in the floating-rate regime.

8. Tariff Policy. At the last moment (while the project was actually beingnegotiated, in December 1991), the Presidents of the Andean Pact (of which Peru is amember) made a commitment, in the Acta de Barahona, to create a customs union. This hadtariff implications for Peru in conflict with the loan conditionality initially proposed by theMinistry of Economy and Finance (which represented the Government at negotiations) andacceptable to the Bank. To solve the conflict, the Bank and the Government then agreed on"either/or" conditions for tariff reform, depending on whether the Government opted tomaintain the tariff strategy announced in early 1991 (first a two-tier tariff, then a low singlerate) or opted to negotiate a common external tariff within the Andean Group (which waslikely to be a multi-tier tariff, with higher average rates).

9. In the event, the Government has not agreed a common external tariff with itsAndean-Group partners. In a succession of negotiations from the end of 1991 onwards, theGroup was unable to find a unanimous position on a common external tariff, largely becausethe countries were at different stages in the trade-reform process or had different ideas on theoptimum speed of trade reform. The Peruvian Government did not wish to be part of aarrangement that would compromise its strategy of radical and rapid trade liberalization. OnAugust 25, 1992, the Commission of the Cartagena Agreement acceded to Peru's request tosuspend its commercial obligations until December 31 1993 and permitted Peru to seek

I The procedure in this loan, as in other Bank adjustment loans, was to require the fulfillment, withoutexception in principle, of a list of conditions. Formally, this gives the Bank little flexibility, short of seeking aBoard waiver: if one condition remains unmet while 19 are met, the conditionality is deemed not having beenfulfilled, even if some of the other 19 are fulfilled beyond expectations. In this Loan, there were undoubtedlysome minor cases of backtracking, but on balance conditionality was amply fulfilled. In the Letter ofDevelopment Policy, the Government committed itself to prepare studies in three areas (the anti-dumping code,tariff surcharges, and nontariff barriers), to agree with the Bank on further reforms based on these studies, andto implement them.

Annex 4 The Trade Po/icy Reform Loan 72

commercial agreements with its Andean-Group partners. This suspension has since beenrenewed for 1994. Perul has since signed limited preferential agreements offering zero dutieson the most important items in bilateral trade with its Andean-Group partners. Thesedevelopments (and earlier official speculation that Peru might even leave the Andean Group)now make Peruvian agreement on a common external tariff unlikely, and the Government'stariff policy continues to be to move to a flat 15-percent tariff. This outcome bodes well formaintaining the momentum of Peru's trade reform process.

10. Thus the Goverrnent has kept to the conditionality on tariff structure agreedas the alternative to the Andean Group tariff. In February 1992 the Government officiallydecided that the 5-percent tariff on steel inputs, established in January 1991, had beensuperseded by legislation of September 1991. From this latter date, therefore, Peru has hadonly two tariff rates, 15 and 25 percent.4 In 1992 and 1993, 850 items (13 percent of alltariff items) were removed from the 25-percent rate to the 15-percent rate.

11. Tariff exemptions. Several measures related to tariff exemptions have beenintroduced.

(a) In March 1992, small producers were permitted to pay IGV (the value added tax)under the simplified regime at 5 percent (normally 18 percent). The purpose of thiswas not to provide a preference for existing tax-payers but to get some tax from firmswhich normally evaded it.

(b) Under the pressure of recession, the Government in 1992 introduced several schemesthat now allow many private capital-goods importers to spread their import dutypayments over 24 months, with interest payable at a local market rate for deposits.Thus, the loan represents a subsidy to the extent of the spread between deposit andlending rates. In the particular case of private electricity-generating machinery aconcession granted in July 1992 amounts to a 24-month interest-free loan (payableover 18 months, with six months' grace). This measure reflected an emergencysituation resulting from a drought which reduced the public electricity supply (whichis mainly hydroelectric) by one-third after about May 1992. It is noteworthy that, forthe first time, the Government has not resorted to a full tariff exemption. There areno domestic producers of large generators, hence the measure has no discriminatoryeffect. However, these schemes allowing importers to spread out their import dutypayments involve a subsidy -- which is close to representing a tariff preference -- andshould be discontinued.

12. Agricultural surcharges. The scheme, created in March 1991, provides for avariable surcharge, in addition to the normal 15-percent tariff, based on the average of theprevious five years' c.i.f. import price. Much of the revenue from these tariffs providesresources for the Ministry of Agriculture. The Government agreed not to extend the scheme

' In March 1992, a system of tariffs reclassified according to the harmonized system (NANDINA) wasintroduced. As a result, 27 percent of tariff positions came to enjoy the higher rate (25 percent ad valorem),compared to 18 percent under the previous classification. There is no evidence, however, that if these figureswere import-weighted, there would be a rise in protection.


beyond the 18 products originally specified, to apply and publish an agreed methodology forcalculating the surcharge, and to update the surcharge regularly. For two of the 18 products(powdered milk and dehydrated milk fat), a fixed, specific surcharge was permitted.

13. The Governrnent also agreed to undertake a study to evaluate the scheme and,by about September 1992, to implement reforns to the scheme agreed with the Bank. Thestudy was completed in August 1992.5 This study found that, had the scheme beenconsistently implemented as originally intended, greater price stability would have broughtwelfare gains, particularly for sugar. But the frequent changes in the rules led instead towelfare losses. Moreover, the presence of close substitutes and apparently imperfectcompetition in food distribution meant that the surcharges were not translated into increasedfarm-gate prices. The study recommended the direct provision of budgetary resources toimprove farmer welfare, measures to increase competition in distribution, and a flat 10-percent ad valorem tariff surcharge. (This last recommendation presumably reflects thebelief that a technically optimal scheme -- with variable rates -- would inevitably lead to, andbe frustrated by, rent seeking.)

14. The surcharge has proven the most contentious part of the trade reformprocess. It has been potentially damaging to the overall thrust of trade reform because itprovides the thin end of the wedge for protectionist interests. The revenue from thesurcharge has also been used in part to reintroduce discretionary programs of agriculturalsupport. The scheme has been changed on a number of occasions: the number of itemscovered has been increased and then reduced; the methodology has been changed. All thisreflected struggles among agricultural, processing, and importing interests. The currentsituation is that the scheme, now covering 20 products, has been more or less brought backto its September 1991 situation (with two of the products, maize and sorghum, now reflectinga flat 10-percent surcharge).

15. Given opposition within the Government (mainly from the Ministry ofAgriculture) to the flat-10-percent-tariff recommendation, and the view that evolved in theBank that the scheme should be changed wholesale (preferably eliminated) or not at all, theBank has accepted the scheme in its present form, but has undertaken to keep the matterunder review in its policy dialogue with the Government. If only because the scheme hasbeen so clearly revealed as a vehicle for rent-seeking and a dangerous precedent encouragingcreeping protection in other fields, it has revealed itself as thoroughly undesirable,notwithstanding the technical merits that price stabilization schemes could theoretically have.

16. Free-trade zones. Perui has two free-trade zones which process or re-sellimports for the internal market. Imports from these zones into the rest of Peru pay fulltaxes, except on some goods where a uniform 10 percent duty is charged. The Ministry ofIndustry is promoting the introduction of twelve industrial free-trade zones, but the Ministryof Economy and Finance is less enthusiastic about this.

5 Javier Escobal and Ariuro Brisceno, El Sisiena de Sobretasas Agricolas en el Peru: Evaluacion yRecomendaciones, GRADE, 28 de Agosto de 1992.


17. Non-tariff Barriers. The Government has agreed: to ban the use ofreference prices and minimum values for protective purposes; not to introduce new non-tariffbarriers beyond those existing on July 5, 1991; and to undertake a study which would lead tothe implementation, about June 1992, of regulations assuring non-discrimination in health andsanitary regulations and technical standards.

(a) Reference prices. Although the use of reference prices for protective purposes hadbeen eliminated, the customs service (SUNAD) continued until 1992 to applyreference prices to imports of steel, Chilean wine, and automobiles. In May 1992 theGovernment eliminated the use of reference prices for customs valuation, turninginstead to reliance for customs purposes on the valuation provided by pre-shipmentinspection companies (see below). Since September 1992, SUNAD has usedreference prices for imports that fall outside the pre-inspection scheme (principallyconsignments of less than $2 million). Reference prices do not appear to have beenused in a protective manner (and have not, for instance, been deliberately set atabove-world prices).

(b) Non-tariff barriers.

An August 1991 measure prohibited the import of milk inputs, in powder andother forms, for commercial reconstitution or combining. (This measure hadbeen exempted from the provisions of the Bank's Loan.) This measurereplaced a de facto non-tariff barrier limiting the share of imported inputs to30 percent of the dairy industry's inputs, a barrier enforced through a publicmonopoly of such imports. (The public monopoly no longer has legalstanding, but the state enterprise, ENCI, is still the only importer.) Producersof evaporated milk and milk producers agreed in early 1992 to a timetable forincreasing the proportion of fresh Peruvian-produced milk in evaporated milkfrom 70 percent in mid-April 1992 to 100 percent from the beginning of 1994.

Since the end of 1991 cotton imports from Brazil and Colombia have beensubject to controls on health grounds: the requirement of vacuum-chamberfumigation for such imports in their country of origin has a discriminatoryaspect. The Government has not yet been able to solve this problem.

In January 1992, a Lima court mandated the suspension of imports of plasticproducts from Colombia on the grounds of dumping. However, the customsservice did not accept the court's authority in this matter and has not appliedthe measure.

* In August 1992 quarantine treatment was required for fruits and vegetablessuffering from fruit flies originating from neighboring countries. This wasalso thought to have a discriminatory aspect.

(c) Certification of agricultural imports. There have been halting moves toward theliberalization of procedures in this area. Various ministerial-level decrees have been


issued to reduce the monopoly that the Ministry of Agriculture has enjoyed in issuingQualitv Certificates for agro-livestock products. The Ministrv resisted thesemeasures, but progress is being made in establishing agreed procedures to allowcertified private firms to issue the certificates.

(d) Certification of pharmaceutical imports. Registering with the Registro Sanitario isindispensable for production, import, and trade in pharmaceuticals, cosmetics, andmedical goods. There has been a similar halting progress towards partial privatizationof the issue of Health and Quality Certificates to that observed in agriculturalcertification. Health legislation relating to imports is now contained in one law.

18. Bank conditionality required a study on non-tariff barriers related to health,technical, security, and miscellaneous regulations. A study of import procedures foragricultural goods and inputs, completed in March 1992, provides and analyzes an inventoryof these measures, and it proposes criteria and measures for non-discriminatory healthcontrols.6 The study criticizes the protectionism of pre-Fujimori measures, but also suggestthat health risks may be posed by the extent of liberalization associated with some of thepost-Fujimori reforms. The study was originally intended as the basis for Bank-Governmentagreement on new policy measures to be takeii. However, the complexities of the public-goods problems involved in health and safety controls suggest that thorough-going reformswill require more study.

19. Undoubtedly, non-tariff barriers have now been largely eliminated in Peru, andthe most important remaining task is to perfect an efficient system of health and safetycontrols that addresses public health needs while minimizing the discrimination this causesagainst imports. In practice the Government has been assiduous in fighting the lingeringbureaucracy of some of its ministries. Surveillance of non-tariff barriers is now theresponsibility of a new National Institute for the Maintenance of Competition and Defense ofIntellectual Property (INDECOPI). INDECOPI continues to be active in studying methodsof reducing the discriminatory impact of non-tariff barriers, and may take over accreditationresponsibilities for health and quality certification from the Ministries of Agriculture andHealth.

20. Anti-dumping code. The Government agreed to undertake a study on furtherrefonn of the existing anti-dumping code to make sure that it did not give unjustifiedprotection to domestic producers and to enact, by around March 1992, appropriateamendments to the code. Prior to Board presentation, expert commentary had been made onthe code, both from within the Bank and from outside.7 This commentary fulfilled the loanrequirement for a study. The Government then amended the code in March 1992. This

6 Hermogenes Pinedo R., Criterios y Normas de Impornacion: Elimninacion de Barreras No Arancelariasal Comercio Exterior. Inventario y Criterios para Mejorar la Aplicacion de las Normas de Control Sanitario enla Importacion de Productos e Insumos Agrarios, Lima, Marzo 1992.

7 See July 25, 1991, memorandum from Patrick Low to Geoffrey Shepherd and the memorandum ofAugust 28, 1991 from Horlick and Shea (representing a Washington law firm) to Mr. Johnson, IDB.


amendment follows most of the expert reconunendations, and the revisions reasonablsaddress the issues of guarding against unjustified protection.

21. INDECOPI has also assumed responsibility for administering the anti-dumpingcode. The Institute has so far taken a strongly pro-free-trade line in its actions, dismissincmost cases. Out of 24 applications for anti-dumping subsidies from 1991 to the end of 1993,only one saw the imposition of anti-dumping duties. Even the best written anti-dumpingcodes allow enough discretion to enable them to be used as surrogate instruments ofprotection. While INDECOPI has so far applied the code in a manner consistent with theGovermnent's free-trade philosophy, the Government needs to be vigilant that this willcontinue.

22. Export taxes and subsidies. The Government has agreed not to raise existingtaxes, extend them to other products, or introduce any fiscal or financial subsidies to exports.It also promised to extend the drawback as and when the fiscal situation permits.

23. The Government has taken various measures to reduce the burden of indirecttaxes on exporters through duty-drawback and temporary admission schemes (these areconventionally permitted measures to equalize international competitive conditions, not exportsubsidies). These measures have somewhat improved the situation, but these schemes arestill largely ineffective. It appears that the Government still hesitates for budgetary reasonsto move to a clear and transparent drawback system.

24. Customs Reform. The Government agreed to formulate and carry out anAction Plan to restructure the Customs Superintendency (SUNAD) and reform the legalframework for customs. The reform plan was based on principles of: bona fide (through thedevolution of duty-assessment functions to private agents and the move to ex-post verificationon a sample basis); the reorganization of customs; and strengthening of the Customs Schooland the computer system.

25. The Government has continued to observe the agreed timetable of actions, andthe progress that SUNAD has made in changing its structure and practices is impressive.8Customs clearance has become more efficient: bureaucracy is less and average processingtime faster (it now takes less than a day, on average, to clear customs). Meanwhile, therehas been a dramatic increase in revenue collection: from 1990 to 1992 revenues doubledwhile the value of imports increased by only 40 percent (the services of pre-shipmentinspection companies are no doubt also part of the explanation -- see below). But the presentreform may not go far enough. There is, for instance, further scope for privatizing customsclearance, leaving a streamlined SUNAD to issue rules and to supervise. The Governmenthas been considering further reform along these lines.

26. Pre-shipment inspection. The Bank had no conditionality in this area.Indeed, the President's Report was equivocal about the benefits of the scheme (para. 90). (Ingeneral, the Bank has embraced such schemes more positively than this.) A pre-shipment

I See Cooperacion Tecnica a Superintendencia de Aduanas (SUNAD): Supervision de la Tercera Fase:Informe de Mision, IDB, 1993.


inspection (PSI) scheme, legislated in August 1991, has been working since March 1992.Four companies have been qualified by SUNAD. The inspection fee is 0.5 percent for"commodities" (and not all consignments need an inspection certificate) and one percent forother imports. Consignments of less than $2 million are not subject to PSI.

27. The Government has explained that the PSI scheme is intended to last for nomore than one to two years, by which time customs will have a decent valuation data bank(indeed, the main value of PSI is to assist with customs reforn). Few have been caughtcheating, but tariff revenues have risen. A Bank study has looked at the Peruvian PSIscheme in the context of a broader research project on the costs and benefits of PSIschemes.9 The study acknowledges the benefit of the scheme as a transitional aid to customsreform by removing the valuation process from customs and giving the service a breathingspace to concentrate on other aspects of reform. While costs and benefits are difficult toassess, the net benefit is likely to decrease over time as customs and trade reform reduces thereturns to misdeclarations. Thus, according to the study, SUNAD must begin to take overprogressively customs valuation responsibilities from the PSI companies.

Recent Developments in Foreign Trade

28. There is no doubt that the trade reform measures have fundamentally changedthe trade regime that Peruvian producers face. A recent Bank report on Peru, Peru: aPrivate Sector Assessment, surveyed a range of private firms in Lima to gauge the currentbusiness climate and the changes in this since 1990. Of 14 obstacles to growth that firmswere surveyed on (pertaining to the tax regime, inflation, bureaucracy, finance, laborregulation, and so on), import and foreign-exchange restrictions and export regulations hadbeen among the severest before the reformns and had become the least severe by 1990. Thereport characterized the changed climate as follows (paragraph 57).

"The trade reform appears to have been one of the great successes of the reformprogram. From being one of the most severe of the constraints to doing business, itbecame of much lesser concern. Imports of capital goods have risen substantiallysince 1990, indicating that restructuring is beginning to occur. Furthermore there isan indication that many firms that were hitherto producing goods in the previouslyheavily protected environment have stopped manufacturing and have started importingand distributing the same products. For them in particular, trade reform hasimproved allocative efficiency. Many complained about competition from smugglers,however. With an 18 per cent VAT rate on top of the import duty, incentives forsmuggling are substantial and there is a lot of anecdotal evidence that it is stillwidespread. There have been great efforts on the part of senior officials in thecustoms administration to make sure that the new rules are being applied. At lowerlevels, however, customs officials have not welcomed the change in their authority tointerpret the rules regarding importation in a way that is less than transparent .......However, all companies interviewed indicated that problems connected with importshad declined sharply and that there were now few problems with exporting."

9 Geoffrey J. Bannister, The Peruvian Pre-Shipmenr Inspection Program, International Trade Division,World Bank, July 1993.


29. But this radically changed climate for trade has not yet been translated into ameasurably different role for trade in the Peruvian economy. This reflects above all broaddevelopments in the economy. The economy is still in the process of stabilization. From ahigh point of 43 percent a month on average in 1990, inflation has continued to fall. It hasremained below two percent a month for most of the time since September 1993. Real GDPat best stagnated from 1990 through 1992, but began a vigorous recovery from the lastquarter of 1992. The overall growth of the economy in 1993 was seven percent. The signsof recovery of confidence in the economy, on the part of local and foreign business, areevident.

30. Since 1990 imports and exports (of goods and non-factor services) have bothgrown in dollar terms, thus reversing the absolute decline of the 1980s. In recent yearsexports have grown in line with the growth of the economy as a whole, and there is as yet noclear change in the commodity structure of exports, except for a slow increase in the share ofnon-traditional exports. In the years 1990-92, terrorism, weather conditions, and the choleraepidemic contributed to a sluggish export performance, especially in mining, fishing, andtourism. Imports grew faster than the economy, until 1992 at least. The structure ofimports is changing in two dimensions. First, consistent with the removal of statemonopolies and the recent process of privatization, there has been a strong fall in the shareof the public sector in imports (though the trend appears to have started before mid-1990).The public sector now accounts for about 16 percent of imports (third quarter of 1993),compared to 45 percent in 1989. Second, since the initial trade reform measures in 1990,the share of consumer goods has grown steadily (from 11 percent of all imports in 1989 toover 20 percent in 1993). Nowhere is this development reflected more dramatically than onthe streets. A couple of years ago, most cars on the road looked as if they should be inmuseums or junkyards. Imports of new and second-hand cars (especially the latter) havesince completely changed the picture.

31. The faster growth of imports than exports reflected a large growth in thecurrent-account deficit of the balance of payments, which doubled to $2 billion from 1990 to1992 (but remained unchanged for 1993, according to preliminary estimates). This deficitwas the result of a sharp growth in short-term capital flows following the capital-accountliberalization of 1990-91. The earlier period of the reform -- 1990-92 -- coincided withsubstantial complaints from the private sector about the effect of an overvalued exchange rateon their ability to compete. There are substantial problems in measuring Peru's realexchange rate, prior to 1991 at least. According to the most frequently used measure (that ofthe Central Bank), the real exchange rate appreciated steadily after the mid-1980s. From1990 to 1992 it appreciated by 25 percent, but depreciated 16 percent in 1993.

32. Notwithstanding the apparent appreciation, it is difficult to argue that theexchange rate is misaligned: the Central Bank has continued to accumulate reserves in recentyears; the current account deficit, though high, is considered sustainable from anindebtedness point of view; the price of non-tradable goods in Peru is probably not excessiveby international standards; and the recent productivity gains Peru has enjoyed are a reasonfor a real appreciation. The appreciation that followed stabilization in Peru is consistent withthe experience of other countries eliminating high inflation (for instance Argentina in 1991and Israel in 1985): the stabilization removes the artificial scarcity of foreign exchange,


while economic reforms encourage the repatriation of savings. In addition, the. fall ininterest rates in world markets has encouraged financial flows to Peru.

Conclusions

33. The Trade Policy Reform Loan was based on a sweeping and simple reformprogram which took place within a broader and supporting program of macro- andmicroeconomic reforms. The essence of the reform was to move trade policy to a stanceapproaching neutrality, i.e. where there is minimal policy discrimination between differenteconomic activities, between, firms, or between imports and exports. Peru's trade reformwas in general as radical and rapid as that observed in any other country, including Chile andBolivia. In the very early days of the Government, the Bank's advice was important. Fromearly 1991 onwards, the initiative in design was clearly that of the Governrment. There is nodoubt of Peruvian "ownership".

34. The trade reforms have been completely effective in moving trade operationsto a more market-oriented system of incentives and greater integration with the worldeconomy. While the Peruvian economy has now begun a strong recovery from decades ofstagnation and a subsequent period of recession (induced by the stabilization), it is as yetdifficult to identify measurable changes in the structure or level of trade (beyond a rapidgrowth in imports and some change in their composition), hence to measure the gains fromtrade reforms. If the economic reforms are maintained, measurable benefits are soon likelyto be apparent.

35. Is the reform sustainable? The essence of the conventional wisdom -- whichstill has much to learn -- on this can perhaps be expressed in the following conclusion from aBank research project that studied 36 liberalization episodes in 19 countries.

".... for reform to succeed, a small group of factors -- each entirely within thegovernment's control -- appears to really count: The program should be bold and itshould start with a bang. Any quantitative restrictions should be rapidly dismantled.Where appropriate, the program should begin with a substantial real depreciation ofthe currency. And there must be a stable macroeconomic enviromnent. Almostevery program that has followed these four simple rules has succeeded. "l0

The Peruvian reform is, by the above criteria, classically sustainable, with the proviso thatthere was not a "substantial real depreciation". The latter has not apparently occurred inPeru: the perception among economic agents was especially prevalent in 1991-92 that thecurrency was overvalued. There is no evidence that, under the circumstances, the currencycould have been much more depreciated, if only because there was a strong inflow of short-term capital over which the Government did have (and could have) only limited control. Onthe other hand, a more depreciated currency would undoubtedly have helped in the "politicaleconomy" of trade reform by raising the profitability of exporting and thereby more rapidlycreating a new political constituency for trade reform. The real exchange rate has

'° Page 41 of Demetris Papageorgiou, Anmeane M. Choksi, and Michael Michaely, Liberalizing ForeignTrade in Developing Countries: the Lessons of Experience, Washington, D.C.: the World Bank, 1990.


depreciated since 1992, so that the problem of perceptions has receded and the opportunitiesfor profitable exporting have grown. More generally, domestic politics are likely to be themain determinant of the sustainability of Perii's economic reforms, including trade reform.Maintaining democratic procedures, given the political turmoil of recent years, whileproviding continuity in economic policy is a large challenge. On the other hand, after aquarter-century of economic mismanagement and decline, many people share a stake in, andhope for, Peru6's economic reforms.

36. The experience of the Trade Policy Reform loan contains some lessons of anarrower, more technical kind.

* The Loan provided support, if less than enthusiastically, to the agriculturalsurcharges scheme on the argument that food price stabilization could benefit theeconomy. The scheme (providing a price floor, but not a ceiling) was never the bestdesign to stabilize prices. It has, in the event, operated most unsatisfactorily, withfrequent changes in rules in response to private rent-seeking initiatives. The schemehas therefore not stabilized prices and certainly not benefitted farmers. And it hasthreatened to open a protectionist breach that might be exploited in attempts to reverseother measures of the trade reform. With great effort -- and largely thanks topressure applied by the IDB -- the scheme was more or less returned to its originalshape. In retrospect, the Bank's efforts should have been applied to fundamentallychanging the scheme (a flat surcharge, for instance, but preferably a completeelimination). Failing this, the Bank should have left the scheme alone.

- As more and more Bank member country undertake fundamental trade reforms, Bankexpertise needs to encompass, in addition to the "why" and "how" of trade reform, anew set of issues which, broadly speaking, come under the heading of "tradefacilitation". Prominent among these are issues such as customs reform (including therole of pre-shipment inspection), port reform, and implications of reform for transportinfrastructure. The Loan supported a customs reform program. IDB provided themajor input, negotiating project conditions with the Government and closelysupervising implementation. The Bank relied heavily on the IDB in the design andsupervision of this component, which appears to have been very effectivelyimplemented. This may have been a somewhat too passive stance for the Bank. Itreflects the fact that the Bank does not have the expertise to form an independent viewof the customs reform process (without a minimum expertise, it is often not profitableto employ expert consultants). The Bank needs to acquire its own expertise incustoms issues (as it is already beginning to do in the area of pre-shipmentinspection).

* Perui, having eliminated a large array of clearly protectionist non-tariff barriers, nowhas to deal with discriminatory elements in residual non-tariff barriers imposed forhealth, safety, and security reasons. The issue is not necessarily one of getting rid ofthese barriers; they respond, in theory at least, to valid problems of public health andso on. The issue is to be able to distinguish justifiable cases of public-good barriersfrom unjustifiable cases and to design an efficient and non-discriminatory mechanism.Again, the Bank could benefit from developing its own expertise in this area.


PERU



PART II. THE PROJECT REVIEWFROM THE BORROWER'S PERSPECTIVE

(Report No.022-94-EF/UC-PS)

I. Introduction

1. The objective of this report is to evaluate both the Borrower's and the Bank'sperformance during the evolution and implementation of the project, with an emphasis on thelessons which may be relevant for the future.

II. Performance of the Bank

2. Since the inauguration of the Fujimori administration, one of theGovernment's main objectives has been the reintegration of Peru into the internationalfinancial community. To achieve this goal, the clearance of protracted arrears to the threeInternational Financial Institutions (IFIs) -- IMF, IBRD, IDB -- was sought. Thereestablishment of the government's relations with the IFIs would enable Peru to gain accessto loans in support of the program of economic reform which it was implementing.

3. To enable the clearance of the arrears to the IBRD, given that the US$ 900million disbursement from the Bank's Trade Policy Reform Loan, Structural AdjustmentLoan, and Financial Sector Reforn Loan were contingent upon this clearance, a bridge loanwas arranged for Peru from the United States Treasury and Japan's Eximbank.Disbursement of the three Bank loans occurred once arrears were cleared and once thecountry had complied with several other loan conditions tied to the execution of theGovernment's structural adjustment reform program.

4. These structural reforms performed the dual role of consolidating thestabilization process and laying the basis for sustainable growth. In a market-based economysuch structural reforms make up the country's medium-term economic policy program. Theyfocus on the elimination of the state interventionist policies that characterized Peri's previousadministrations through public sector reform, privatization, dismantlement of barriers to thefunctioning of competitive markets, and an effective assault on problems of poverty andsocial backwardness.

5. The maintenance and implementation of measures agreed under the loansprovided by the IFIs were overseen by the Government through the Coordination Unit for


Sectoral Loans in the Ministry of Economy and Finance (MEF). The unit wNas firstconceived as part of the design of the IDB's loans to Peru and was financed throughtechnical cooperation loans tied to the IDB structural adjustment operations.

6. The Coordination Unit acts as the technical entity responsible for maintainingconstant communication with the Bank and the IDB to ensure adequate coordination of jointactions. In this context, it serves as the Ministry of Economy and Finance's officialrepresentative during meetings between Bank and IDB staff visiting the country onsupervision missions. In fulfilling its role, the Coordination Unit relies upon the Bank forthe technical advice required to monitor progress in the achievement of the objectives of thestructural reform program.

7. In the particular case of the Bank, it is important to note the need to identifyalternate joint actions to improve the execution of investment loans. This process could leadto overall improvement in the design of future Peru projects. In the same way, it is crucialthat the present level of coordination with the Bank be maintained so that the government,through its various offices, and the Bank are in a position to agree on appropriate positionsand courses of action. Coordination will contribute to strengthened relations between theGovernment and the IFIs and, more importantly, to fully consolidating the stabilizationprogram now being implemented in the different sectors of the Peruvian economy.

Trade Sector

8. Reform of the trade sector has established the basis for an open-economydevelopment strategy. Foreign trade liberalization, reduction of the number of customstariffs and the move towards a uniform tariff, unification of several types of exchange rates,the opening of capital markets, and the reintegration of Peru into the international financialcommunity have enabled the country to enjoy the benefits of an open economy exposed tointernational competition. These measures have provided the foundation for sustainableeconomic growth.

9. The primary objective of the new tariff policy was to improve the efficiency ofresource allocation and to increase fiscal revenues through the unification of tariff rates andthe elimination of tariff exemptions.

10. As stated earlier, Peru resumed relations with the Inter-American DevelopmentBank through the initiation of the structural adjustment program. The first step was tonegotiate a Trade Policy Reform Loan with the IDB, signed in September 1991. Once thefirst tranche of this loan was disbursed, Peru cleared its arrears to the IDB. Subsequentlythe remaining tranches of this loan, as well as funds from other IDB adjustment loans, weredirected towards supporting the country's balance of payments.

11. In December 1992, the Bank confirmed Peru's full compliance with theconditions set forth in the Trade Policy Reform Loan (3437-PE). In this context, the Bankand the IDB worked in close cooperation to coordinate their analyses, proposing commonsolutions to the problems arising during the reform process.


Structural Adjustment

12. The objectives of the Structural Adjustment Loan called for reform in the areasof macroeconomic and fiscal policy, the social sector, agriculture, privatization, socialsecurity, and the labor markets. These objectives were fulfilled on November 30, 1992. Asa result, loan signing took place on December 22, 1992.

III. Performance of the Borrower

13. At the inception of the reform program, monitoring and execution wereconcentrated on the Ministry of Economy and Finance. To an extent this explains the lack ofstrategic coordination with the other institutions involved in the program. This resulted in asituation where many government entities were ignorant of the agreements that theGovernment of Peru had reached with the Bank. The reform program suffered as a result.

14. Once infornation dissemination improved, mainly by means of theCoordination Unit, these entities became active participants in the program. This allowed theestablishment of coordinated processes and measures for effective implementation.

IV. Trade Policy Reform Loan Objectives

15. We indicate below the most important elements of the sectoral reform processand the status of reform at the date of writing.

a. Trade Policy

Several reforms were enacted to facilitate foreign trade procedures. Amongthe most significant was D.S. No. 033-91-EF which established a two-tier tariff system, withrates at 15 percent and 25 percent. D.S. No. 060-91-EF eliminated foreign trade barriersand Import and Export Registries, as well as other restrictions.

Legislative Decree No. 668 enacted in September 1991 gave the force of lawto some of the trade reforms that had been implemented in March of that same year. ThisDecree guaranteed rights to free commerce, both inside and outside the country, as afundamental condition for the country's development. The decree consolidated the new tariffpolicy, eliminated state monopolies, and gave the private sector access to the infrastructure ofthe state.

For the purpose of disbursement conditions for the IDB's Trade Policy ReformLoan, the provisions of these decrees gave palpable fonn to a set of policies necessary toguarantee the consolidation of the reform process.

In addition, Decree Law No. 25789, enacted on October 21, 1992, reversedprevious prohibitions and restrictions on the import of second-hand goods with the exceptionof used clothing and shoes.


In order to unify the tariff structure, Supreme Decrees Nos. 027-92-EF, 125-92-EF and 100-93-EF were enacted to establish an almost flat 15-percent tariff. This leavesonly 13 percent of the universe of tariffs subject to the 25 percent ad valorem rate.

Once Decree Law No. 25629 (July 22, 1992) was then passed, the Ministry ofEconomy and Finance was required to endorse all trade policy legislation. In the same vein,Decree Law No. 25909 (December 1, 1992) stipulated that only this Ministry had the right totake measures to restrict the free flow of imports and exports of goods.

Thereafter, Decree Law No. 25988 (December 24, 1992) led to the adoptionof the Law for the Simplification of the National Tax System and for the Elimination ofConcessions and Surcharges. This Law allowed the reorganizing of the country's taxregime.

Among the Legislative Decrees that Congress empowered the Executive toenact was a set of Decrees passed on December 31, 1993, to establish a new national taxsystem. These included the following:

- Legislative Decree No. 771, establishing the legal framework for the NationalTax System, stipulated the following Central Government taxes: income tax,general sales tax, selective consumption tax, customs tariffs, and rates forpublic-sector services.

- Legislative Decree No. 775 approved the new text of the Law for the GeneralSales Tax and the Selective Consumption Tax (IGV and ISC). This decreeratifies the drawback of the IGV and rescinds the drawback on the ISC onfuels.

* Legislative Decree No. 779 modifies the Free Trade Zones Law bysubstantially restricting its application.

* Legislative Decree No. 781 elevates to the status of a law ExtraordinarySupreme Decree (DSE) No. 159-PCM/93 which establishes the regulationsdesigned to facilitate the ground servicing of airplanes.

Complementary measures in Supreme Decree No. 101-93-EF eliminated theSelective Consumption Tax for certain categories of services and reduced it for others sincecollection rates for this tax are low and administrative costs high. These measures havereduced incentives to smuggle by reducing the profitability of this activity.

Finally, the Government will continue to simplify the tariff structure until aflat 15-percent ad valorem rate is reached. The expected fiscal impact will becounterbalanced by an increase in the volume of imports. The policy will enable greatercustoms efficiency. It will discourage smuggling and encourage a rise in consumption levelsas a result of falling prices.


b. INDECOPI

The National Institute for the Defense of Competition and the Protection ofIntellectual Property Rights (INDECOPI) was established through Decree Law No. 25868(November 24, 1992). It is the governmental entity responsible for applying legal measuresto protect the market from: 1) monopolistic and restrictive activities in the production andsale of goods and services; 2) activities which may produce unfair competition: and 3)activities which can harn economic agents and consumers. INDECOPI is also the entityresponsible for the protection of all forms of intellectual property rights.

The law which established INDECOPI empowered it, among its otherfunctions, to ensure compliance with the laws maintaining free trade. The law also requiresINDECOPI to assess how measures allowing non-tariff barriers are being implemented andwhether these measures contravene the provisions of Legislative Decree No. 668 and DecreeLaw No. 25629.

Decree Law No. 26122 (December 30, 1992) set forth rules to prevent,discourage, and punish actions contrary to good faith in business and to open competition ineconomic activity.

INDECOPI issued the Resolution of the Commission on Supervision ofTechnical Rules, Metrology, Quality Control and Non-Tariff Barriers (No. 004-94-INDECOPI/CNM, April 24, 1994. This Resolution declared the inapplicability of SupremeDecree No. 004-93-AG which established non-tariff measures violating the conditionsrequired for MEF to approve new rules that create an interference in the free flow of goods.

In the same way, INDECOPI vetoed Supreme Decree No. 0015-93/RE whichapproved the implementing regulations for Law No. 26219 covering the distribution ofgeographical, cartographical, and historical texts and/or publications. INDECOPI did thisbecause the legislation did not meet with the approval of the Ministry of Economy andFinance under the provisions of Decree Law No. 25629. This veto has led to a draftSupreme Decree to correct the matter.

c. Customs Reform

Legislative Decree No. 722 (November 11, 1991) put into practice the NewGeneral Customs Law. This was put into effect on March 28, 1992 with the issue of theimplementing regulations (Supreme Decree No.058-92-EF). This law has undergone somemodifications in an effort to match customs regulation with the reform process in this sector.

To facilitate the application of the law, Supreme Decree No. 45-94-EF (April26, 1994) was enacted to unite all the legal rules that modified the original law within aCodified Text of the General Customs Law.

Various legal measures have been enacted to simplify and expedite customsprocedures and regimes. Among the most important modifications to the General CustomsLaw are the following:


e Decree Law No. 26014 (December 1992) which established the principle of "goodfaith" and the presumption of veracity as the fundamental basis for all foreign-tradeprocedures and delegated more functions and responsibilities to the private sector.This decree also specified the concepts of physical inspection and documentaryverification, requiring random physical inspection for a maximum of 15 percent of thetotal number of import declarations presented in any one day.

* Extraordinary Supreme Decree No. 013-93/PCM (March 1993) established the InwardProcessing Regime (Regimen de Trafico de Perfeccionamiento Activo) to expedite andsimplify the regimes for Temporary Admission and Replenishment of Stocks forDuty-Free Goods.

* In addition several Procedural Manuals and Directives were approved in mid-1993,notably covering Exports, Imports, Industrial Free Trade Zones, Manifests,Temporary Admission of Goods, and Withdrawal of Goods from Bond.

* Within the group of Legislative Decrees establishing the new taxation system inDecember 1993 was Legislative Decree No. 778. It revised the definition of importsfor domestic consumption, improved the temporary export regime, clarified groundsfor the suspension of customs agents and the sanctions to be applied in these cases,and improved the regimes for temporary admittance and withdrawal of goods frombond.

In terms of institutional reform, Legislative Decree No. 26020 (December 28,1992) approved the new Organic Law of the customs administration, while Supreme DecreeNo. 073-93-EF (1 May, 1993) approved its Statute. The latter decree also established itsnew organizational structure, as well as the functions associated with each level of the newstructure. The customs administration now has a new, remodeled headquarters building andis currently completing the implementation of its computer network system.

d. Ports

The process of privatizing the ports, which began with the port of Ilo, isunderway.

The new policy for ports provides for a fundamental separation of portoperations from administration, requiring the state to design and execute the new regulatoryframework for ports.

The new policy for the sector will modify the regulatory framework to redirectthe operation and administration of ports towards the private sector, within the context of apolicy of long-term territorial concessions and/or the award of special operating licenses.This new policy will increase the possibilities for competition on prices, will be able toreduce charges that are not related to services, and will block the formation of portmonopolies. At the same time, some time will be required to enable the rehabilitation,modernization, and expansion of specialized facilities.


The execution of this program will guarantee that investment in the port sectorwill effectively reflect market needs. In this context, the State will have a minority share insome of these investments, while the private sector will be exclusivelv responsible foridentifying and executing future investments.

e. Tariff Surcharges

The Government simultaneously agreed with the IDB and the Bank on therevision of the tariff surcharge formula with respect to the standard deviation which will beprogressively reduced in accordance with a schedule ending in 1997. The scheme's objectivewas to reduce the fluctuation in import costs, hence in domestic prices, so that domesticproducers could make their decisions under conditions typical of competitive markets.Therefore protection would only be required in those cases where international prices fell tolevels below their long-term trends.

In this context, Supreme Decree No. 114-93-EF (28 July, 1993) up-dated thesurcharges and customs schedule for imports of products to be made subject to variablespecific tariff rates, as covered by D.S. No. 016-91-AG and its amendments.

The Central Reserve Bank of Perui was charged with the revision and updatingof the tariff surcharge tables on a semi-annual basis. Accordingly the reference prices forthe imported products subject to the surcharge scheme are updated and published on a weeklybasis. The scheme is under constant review in order to ensure that it fulfills the objectivesfor which it was created.

f. ENCI (National Input Marketing Company).

The Government has revised the method it will employ in the privatizationprocess for ENCI. It has established that the company's privatization will be implementedby transferring to the private sector all or a part of the company's shares or assets. Inaccordance with the Letter of Intent sent to the IMF, the privatization process will beconcluded by December 1994.

g. ECASA (Rice Marketing Company).

To expedite the process of dismantling and liquidating ECASA, EmergencyDecree No. 30-94 (July 8, 1994) was enacted to establish measures to restructure iteconomically and financially through the transfer of company assets to public enterprises.This would enable the settlement of ECASA's debts.

Once the company's liquidation process is completed, alternative measures willbe proposed to enable private sector marketing of production.


V. Objectives of the Structural Adjustment Loan

16. Effectiveness of the Structural Adjustment Loan was subject to compliancewith objectives in the following areas: macroeconomic, fiscal, social, agriculture,privatization, social security, and the labor markets.

17. Conditions in the macroeconomic area included: a free market in foreignexchange, resumption of foreign debt service payments, a stable monetary policy, and marketdeterminiation of interest rates, prices and salaries. In tune with the policy of an openeconomy, these macroeconomic measures have been gradually and irrevocably implemented.

At the end of May of this year the Peruvian Government's Letter of Intent wassubmitted to the International Monetary Fund. 1994 targets included: reduction and gradualstabilization of inflation to a level between 15 and 20 percent, real growth of GDP in excessof five percent, and the deepening of structural reforms to improve efficiency and domesticsavings.

18. Loan objectives for fiscal policy aimed at eliminating poorly designed taxes,simplifying the tax system, and improving tax administration. The new tax system has beenrevised, with effect from January 1, 1994, through the Framework Law for the National TaxSystem (Legislative Decree No. 771). Under this, the Central Government is now entitled tocollect the following taxes: income tax, sales tax, selective consumption tax, customs tariffs,and rates for public-sector services.

19. In the area of social policy the Government drew up, with the Bank'sassistance, a poverty alleviation strategy. This strategy was later presented to Peru'sConsultative Group for Social Support in June 1993. At this meeting, the internationalcommunity was informed that the National Fund for Social Compensation and Development(FONCODES) was the Governmental entity charged with handling social welfare resources.

This first meeting of the Consultative Group for Social Support enabled Peruto receive bilateral and multilateral aid commitments of approximately US$ 900 million. Themeeting also led to further meetings to designate aid to Peru in the social sphere. Thisresulted in grant agreements with Switzerland, Germany, and Canada. A secondConsultative Group Meeting, in May 1994, was presented with an updated social-sectorstrategy, including the steps necessary for social stability.

This second Consultative Group Meeting was held with representatives of tensupporting countries and nine international organizations. It mobilized resources in theamount of US$ 1,100 million, of which US$ 250 million were pledged to Peru throughdonor grants and US$ 850 million were pledged through loans. Of the total US$ 1,100million pledged, US$ 90 million will be utilized for technical assistance and the remainingamount will fund investment projects of multilateral organizations.

From its inception in 1991 to June 1994, FONCODES has channelled US$ 374million in financial aid funds through the approval of 10,764 projects. In additionFONCODES has obtained two loans, each of US$ 100 million, from the IDB and the Bank.


20. Another social sector loan objective was the preparation of project profiles inhealth, nutrition, and education. The Government is now developing a Program of Focus onSocial Expenditures. The program aims at directing funds towards the areas of health,education, and justice through a reform of the budgetary process aimed at achieving specificobjectives as a result of identifying the needs of each sector.

In addition, the Government has received support from the Bank through theBasic Health and Nutrition Loan in the amount of US$ 34 million.

21. Peru is implementing an aggressive, accelerated program of privatizationaimed at transferring to the private sector every one of its roughly 140 state-owned-enterprises by 1995. The privatization program will generate sales and investmentsrepresenting billions of dollars.

Among the objectives achieved by the Structural Adjustment Loan was theestablishment of an institutional framework for Peni consistent with the Privatization Law.Other objectives included an action plan and policy frameworks for the privatization of thefollowing sectors: banking, fisheries, mining, oil and gas, electricity, telecommunications,transport, water and sewerage, and industry.

The privatization strategy for each sector was presented in the form of a letterfrom the official in charge of that sector describing the measures to be taken. This formedthe basis for the privatization component of the structural adjustment loan and for thetechnical assistance in the area of privatization.

In April 1993 the Bank's Board approved a US$ 250 million PrivatizationAdjustment Loan and a US$ 30 million Technical Assistance Loan. The TechnicalAssistance Loan and the Japanese Grants to which it was linked represent an importantsupport mechanism for the Government's privatization program.

Finally, it should be noted that so far 39 companies have been privatized. Thetotal price paid was U$ 2,172 million, equivalent to around 6 percent of Peru's GDP. In1991 two companies were sold for U$S 1.7 million, in 1992 ten companies were sold forUS$ 209 million, in 1993 13 companies were sold for US$ 318 million, and so far during1994 another 14 have been privatized for a total price of US$ 1,643 million. These figuresrepresent the net income for the Treasury.

22. The loan objectives in the agricultural sector include the liquidation of ECASAand the implementation of ENCI's reorganization. ECASA's liquidation process is beingaccomplished gradually, and Emergency Decree No. 30-94 has been enacted to carry out thedissolution and liquidation of the company. ENCI is being restructured through aprivatization process involving the partial or total transfer of its assets by December 1994.

23. The labor market, which was excessively protectionist in the past, hasundergone reforms to make labor relations more flexible and guarantee, among other things,freedom to contract and to negotiate labor contracts. The objective of these measures is toreduce the costs and risks of contracting and to promote employment in the long term.


The specific loan objectives in the labor area included greater flexibility inprobationary employment procedures, greater flexibility in labor markets, reduced costsassociated with personnel turnover, and improvement in the compensation for time of service(CTS) scheme. These reforms are irreversible.

24. Finally, loan objectives for social security included the creation of a PrivatePension System, thereby strengthening Peru's capital markets, and improvements inprocedures to collect social security contributions. The objective requiring an audit of theaccounts of the Peruvian Social Security Institute (Instituto Peruano de Seguridad Social-IPSS) led to the declaration that the institution's accounts were in a state of emergency.

IDB financing under a technical assistance loan, has enabled the Governmentto proceed with the process of separation of IPSS accounts. This laid the basis for thecreation of an Office for the National Pension System (Oficina de NormalizacionPrevisional).

VI. Lessons Learned

25. As previously indicated, during the process of fulfilling loan objectives severalpublic institutions involved in the reform program failed to receive timely information aboutthe commitments that the Government had made and in many cases did not give thecommitments the priority they required. Therefore, it is vital that the Government continueto promote the participation of the agencies involved in the reforms by having letters ofdevelopment policy signed not only by the Minister of Economy and Finance but also bythose in charge of these agencies. This has recently become the practice.

26. When the loan conditionality of both the IDB and the Bank is similar or inthose instances when action plans and procedures are identical, there should be a bettercoordination between both institutions so that they can reach the common objective ofeffective benefits for the borrower. At the same time, it would be useful if the differentdivisions of the Bank could move towards agreeing on a procedure for creating a unifiedposition which, in turn, would allow a unified Bank negotiating position to be established.

27. In the case of the IDB's sectoral loans to Peru, the amount devoted to arrearsclearance was matched by an amount devoted to balance-of-payments support. Although it istrue that the arrears owed to the Bank were three times those owed to IDB, the Bank'ssupport of the reform implementation process could have been completed earlier had therebeen greater balance-of-payments aid to Peru.

28. Finally, loans in support of Peri's balance of payments are of greatimportance as they serve to relieve the pressures on the Government's budget, therebyproviding support to the structural reform process.


VII. Bank and Borrower Relations During Loan Implementation

29. Through the relationship established between the Bank and the borrower, thepursuit of the objectives of the sectoral loans enabled the development of important areassuch as capital markets. Likewise, the Bank's assistance was instrumental in bringing aboutPeru's complete reintegration into the international financial community.

30. Similarly, it is also important to recognize the valuable support the Bank gavein different sectors of the Peruvian economy throughout the reform process initiated by theGovernment in 1990. In this context, although it is evident that the country has significantlyimproved its economic outlook, it is precisely now that Peru must look to the continuedsupport of the Bank, given that the country is currently launching the final phase of itsstructural adjustment process. Economic stabilization and sustained economic growth dependon the successful conclusion of this process.

The sectoral adjustment loans have not only been a vital source of financing insupport of the country's balance of payments, but have also played the catalytic role offacilitating negotiations and agreement on actions designed to advance the reform program.Quite apart from the stabilization program and the strategy for Peru's reintegration into theinternational financial community, it is essential to be able to rely on these types of loans sothat the Government can guarantee fulfillment of sectoral commitments and the reformprogram can therefore be maintained.

- 92 -

PART III: STATISTICAL INFORMATION

TRADE POLICY REFORM LOAN(LOAN #3437-PE)

BASIC DATA SHEETAmounts (US$ million)

LOAN POSITION

OutstandingOriainal Disbursed Cancelled Repaid As of 1/31/94

Loan 3437-PE 300.00 300.00 0.00 0.00 300.00

KEY PROGRAM DATA

Original Loan Dates Actual or Re-estimated

Initiating Memorandum 07/12/91 08/22/91 ALetter of Development Policy 12/04/91 01/09/92 ANegotiations 08/26/91 11/15/91 ABoard Approval 10/29/91 02/04/92 ALoan/Credit Agreement 11/27/91 12/22/92 AEffectiveness 03/18/91 03/18/93 ALoan/Credit Closing 06/30/93 06/30/93 AActual Completion 12/30/93 06/31/94

CUMULATIVE LOAN DISBURSEMENT

FY93

Planned $US300MActual $US300MActual as % of Planned 100%Date of Final Disbursement:

March 18, 1993 (Arrears Clearance)

STAFF INPUT(Manweeks)

FY91 FY92 FY93 FY94 TOTAL

Preparation 31.7 30.5 - - 62.2Appraisal - 18.5 - - 18.5Negotitations - 13.1 - - 13.1Supervision - 12.7 7.1 2.0 21.8PCR - - - 0.4 0.4

Sub-Total 31.7 74.8 7.1 2.4 116.0

-93 -

MISSION DATA

Month/Year No. of Weeks No. of Persons Staff Weeks Date of Report(staff & cons.)

Preparation 06/91 2 12 31.7 06/04/91Appraisal 09/91 2 18.5Supervision I FY92 12.7Supervision II FY93 7.1Supervision III FY94 2.0Completion 05/94 0.4 05/31/94

FOLLOW-ON ADJUSTMENT OPERATIONSSAL I, FSAL AND SAL II

Operation: Structural Adjustment Loan ILoan No.: 3452-PEAmount: $300.0 millionBoard Date: 03/26/92

Operation: Financial Sector Adjustment LoanLoan No.: 3489-PEAmount: $400.0 millionBoard Date: 06/17/92

Operation: Structural Adjustment IILoan No.: 6PERPA136Amount: US$100.0 millionBoard Date: 07/15/95 (estimated date)

-94-

PART III: STATISTICAL INFORMATION

STRUCTURAL ADJUSTMENT LOAN(LOAN #3452-PE)

BASIC DATA SHEETAmounts (US$ million)

LOAN POSITION

OutstandingOriginal Disbursed Cancelled Revaid As of 1/31/94

Loan 3452-PE 300.00 300.00 0.00 0.00 300.00

KEY PROGRAM DATA

Original Loan Dates Actual or Re-estimated

Initiating Memorandum 10/10/91 10/10/91 ALetter of Development Policy 12/16/91 02/20/92 ANegotiations 12/02/91 02/10/92 ABoard Approval 01/21/92 03/26/92 ALoan/Credit Agreement 12/22/92 12/22/92 AEffectiveness 02/15/93 03/18/93 ALoan/Credit Closing 06/30/93 06/30/93 AActual Completion 12/30/93 06/31/94

CUMULATIVE LOAN DISBURSEMENT

FY93

Planned SUS300MActual SUS300MActual as % of Planned 100%Date of Final Disbursement:

March 18, 1993 (Arrears Clearance)

STAFF INPUT(Manweeks)

FY91 FY92 FY93 FY94 TOTAL

Preparation 77.4 61.2 - - 138.6Appraisal - 15.5 - - 15.5Negotiations - 18.9 - - 18.9Supervision - 9.6 16.4 - 26.0PCR - - - 0.3 0.3

Sub-Total 77.4 105.2 16.4 0.3 199.3

- 95 -

MISSION DATA

Month/Year No. of Weeks No. of Persons Staff Weeks Date of Report(staff & cons.)

Preparation 09/91 2 7 77.4 10/10/91Appraisal 12/91 2 5 15.5 12/18/91Supervision I FY92 11/92 1 1 9.6 11/10/92Supervision II FY93 03/93 1 1 16.4 04/01/93Completion (PCR) 05/94 05/31/94

FOLLOW-ON ADJUSTMENT OPERATIONSFSAL AND SAL II

Operation: Financial Sector Adjustment LoanLoan No.: 3489-PEAmount: $400.0 millionBoard Date: 06/17/92

Operation: Structural Adjustment Loan IILoan No.: 6PERPA136Amount: $100.0 millionBoar o: 09/27/94 (estimated date)

GLOSSARY

CCD Congreso Democratico Constituyente(Democratic Constituent Congress)

CERTEX Certificado de Reintegro Tributario a la Exportaci6n(Export Tax Reimbursement Certificate)

COPRI Comisi6n para la Promoci6n de la Inversi6n Privada(Commission for the Promotion of Private Investment)

CTS Compensation for Time and Services

ECASA Empresa de Comercializaci6n del Arroz S.A.(Rice Marketing Company)

EFF Extended Fund Facility

ENCI Empresa Nacional de Commercializaci6n de Insumos(National Inputs Marketing Company)

FENT Fondo de Exportaciones No Tradicionales(Fund for Non-Traditional Exports)

FLAR Fondo Latinoamericano de Reservas(Latin American Reserve Fund)

FONCODES Fondo Nacional de Compensaci6n y Desarrollo Social(National Fund for Social Compensation and Development)

GDP Gross Domestic Product

GTZ Gesellschaft fur Technische Zusammenarbeit(German Company for Technical Cooperation)

IBRD International Bank for Reconstruction and Development

ICE Instituto de Comercio Exterior(Foreign Trade Institute)

IDB Inter-American Development Bank

IFIs International Financial Institutions

IMF International Monetary Fund

INDECOPI Instituto Nacional de Defensa de Competencia y de la Propriedad Intellectual(National Institute for the Defense of Free Competition and IntellectualProperty Rights)

MEF Ministerio de Economfa y Finanzas(Ministry oF Economy and Finance)

MICTI Ministerio de Industria, Comercio Interior, Turismo e Integraci6n(Ministry of Industry, Commerce and Integration)

NGOs Non-Governmental Organizations

RAP Rights Accumulation Program

SAL Structural Adjustment Loan

SUNAD Superintendencia Nacional de Aduanas(Customs Administration)

SUNAT Superintendencia Nacional de Administracion Tributaria(Tax Administration)

TPRL Trade Policy Reform Loan

UNICEF United Nations International Children's Emergency Fund

VAT Value Added Tax

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