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MICROFICHE COPY bpwt No. P-5666-PE

Report No. P- 5666-PE Type: (PR)SHEPHERD, / X31912 / I7 051/ LAlCO

REPORT AND RECOMMNATION

OF THE

PR-SIDENT OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

TO THE

EXECUTIVE DIf 4- TORS

,'. ON APROPOSEED T1OADE POLICY REFORM LOAN

IN AN AMOUNT EQUIVALENT TO US$300 MILLION

TO THE

REPUBLIC OF PERU

JANUARY 10, 1992

This docnett has a resrictd dbutio and may be and by recip only in thLe perfomance ofthei:oficia s, ItsntetsmaY Mt otherw be disrelsed without Worl n thoriati

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MEN,CY EQUIVALENTS

(As of December 30, 1991)

Currency Unit Nuevo Sol (SI.)VUS$1.00 - S/.0.9SSI.1.00 = US$1.05

GOVERNMENTS FISCAL XEAR

January 1 - December 31

ABBREVIATIONS

ALADI - Asociacid6n Latino-Ametica de Inttegract6n (Latin Ameria Integration Asociation)CERTEX Certiricado de Reinte TnbutWat a ta Exportacl4n (Export Tax Reimbutement Certificate)CIF Cost, Insurance and FreightD.L - DecMo Lcgslatvo (Lgisatie Decree)D.S. - Decreto Supremo (Supreme Decree)ECASA - Empresa de Comercializacidn del Arroz SA (Rice Marketing Company)ENCI - Empresa Naciontl de Comercializaa6n de Insumos (National Inputs Marketing Company)FENT - Fondo de ExportaonOs No Tradiconales (Fund for Non-Taditional Exports)F.AR - Fondo latinoeicno de Reservas (latin America Reserve Fund)FONCODES - Fondo Nacional de Compensaci6o y De ollo Soial (National Fund for Socal Compensation and Development)GATT - General Agreement on Tariffs and TradeGDP - Gross Domestic Product

17T - Deutsche Gsldhft Mir Teclnisdhe Zusammenarbeit (German Company for Technical Cooperation)IFIs International Fnancial InstitutionsIBRD - International Bank for Reconstruction and DaelopmentICB - International Competitive BiddingICE - Instituto de Comermio Extior (Institute for Foreign Trade)IDB - Inter-American Development BankIMF - International MoUetaly FundMICm - Ministerto de Industria, Comercio Interior, Tuismo e Integracidn (Minitry of Industry, Commerce,

Tourism and Integmation)NOOs - Non-Governmental OrganiationsPETROPERU - Petrdleos del Perd, SA (Peru Oil)RAP - Rights Accutmulation ProgamSAL - Structural Adjustment LoanSUNAD - Supe utendencia Nacional de Aduanas (Customs Administration)SUNAT - Superintendencia Nacdonal do Admhtacdon Tributaria (Tax Administration)SDR ^ Special Drawing RightSOE - Statement of ExpenditureUNDP - United Nations Development ProgrammeUNICEF - United Nations International Chidren's Emegemy FundVAT - Value Added Tax

I/ On July 1, 1991, a new monetary unit, the Nuevo Sol (S/.), was introduced at a converaion factor of St.1.00 = I/m.1.00. The so-caUed Inti MillMn (EIm.) - equivalent to one million Intis (11.1,000,O0M) - was instituted on December 16,1990, as a devie, eliminatingthe last sx digits of any value in Intis, to simplify acounting and as a means of transition between the Inti and the Nuevo Sol.

FOR OFFICIAL USE ONLYPERU

TADE POLICY REFORM LOAN

Table of Contentspage

Loan and ProgramSummary ........................................ v

L The Project, the Debt Workout, and Country Strategy. 1

The Project Context .IThe Bank's Approach in a Countrywith Protracted Arrears1 . IThe Bank's Approach in Peru ...... .......................... 1

IL The Economy ........................................ 6

The Economy Inherited ................... 6The Economic Reforms of the Fujimori Administration. 7The 1991-1992 Macroeconomic Stabilization Program .10Risks and Assessment of the Stabilization Program .11Monitoring the Stabilization Program .13The Agenda for Structural Reforms .14The Medium-Term Outlook. 15

m. ExternalFinancing .16

The External Debt Problem . ................................ 16The External Financing Plan for 1991 and 1992 .16External Fiancing Beyond the Performance Period .20

IV. External Trade: Performance and Policies .21

V. Trade Policy Reform ........ ... 22

Actual and Planned Reforms .23The Expected Impact of Trade Policy Reform .26The Agenda for Trade Policy .26

|This report was prepared by Geoffrey Shepherd, based on the findings of a preappraisal misionto Peru In June, 1991, and appraisal in September. Contributors to the report were:Roberto Abusada, Carlos Rodriguez, and Katerina Taigasides (consultants and preappraisalmiseion members) i Valeriano ¢arcia (Senior Economist, contributing to "Part in: The Ecoaomynon the basis of a September, 1991, mission to Peru to preappraise a structural adjustrestloan); Janet Entwistle (Country Officer, contributlig to Part I: The Project, the DebtWorkout, and Country Strategy and Part IZII Esternal Fanancnlg) and Izumi Obno (CountryOfficer) and Cessx Burga (consultants statistical support). Angellca Silvero providedsecretarial support.

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclod without Worl Bank authorization.

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VL The Proposed Loan ......................................... . 28

History of the Loan ......................... 28Reforms to be Supported under the Loan ....................... 28The Loan ...................... 29Procurement, Disbursement, Audit, and Administration .30Technical Assistance .31Letter of Development Policy .32Conditions .32Monitornag ar4 Reporting. 35Cooperation with the IDB ................................... 36Project Benefits ...... 36Project Risks ..... 36The Social Impact ...... 37

VIL Recommendation ..... 38

Annexes

Annex 1 Economic Indicators ...................................... 39Annex 2 Trade Statistics ...... 51Annex 3 Trade Policy Reform Loan: Policy Matrix ..... 61Annex 4 Non-Tariff Barriers ...... 65Annex 5 Customs Action Plan ...................................... 75Annex 6 Letter of Development Policy .79Annex 7 List of Project Documents ............. 97Annex 8 Status of Bank Group Operations .99Annex 9 Technical Assistancew ............ 101Annex 10 Supplementary Data Sheet .............. 107

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Tables and Figues

Text Tabls

Table 1 Projected Ficl Accounts,1991and 1992 .......................... 10

Table 2 External Financng Requiementand Possible Sources of Funmcing, 1991and 1992 ................... 17

ADpen d 'rabies and Figs

Table 1.1 Peru: Balance of Payments Projectons: Current Account Ecluding Intest Payments,1990-99 ... 39

Table 12 Peru: Balmae of Payments Projections: Fmancing Requirements and Posuible Sources,1990-99 ... 40

Table 13 Peru: National AccountsProjections,1990-99 ...... ................ 41

Table1.4 Penru Projections of Key Economic Indicators, 1990-99 ..... .......... 42

Notesto Tables 1.1 to 1A .............................................. 44

Table 1.5 Peru: Eitnal Debt Outstanding(Stocks as ofDecember1990) .... .... 47

Table 1.6 Peru: Montbly Economic Indicators, July 1990-September 1 ...... .... 48

Fgue 2.1 Peru: Ratios ofTradeto GDP,1950-1990 ......................... 51

Figure 2.2 Peru: Effective Protection from Tariffs on Manufactures, 1990-1991 ..... 52

Fmre 2.3 Peru: Real Exchange Rate Index 1985-1991 ....................... 53

Figure 2.4 Peru Exports and Impots 1989-1991 ............................ 54

Fgmue 2.5 Peru: Black Market Exchange Rate Premium, 1985-1991 .............. 55

Figure 26 Peru: Production-Weighted Distnbution of Tariffs, 1990 and 1991 ....... 6

Figure 2.7 Per Export Subsidies 1980-1990 .... .......................... 57

Figure2.8 Peru: ExporTaTwsCollcted, 1980-1990 .......................... 8

Flge 2.9 Peru: Import Tas Coeoted, 1990-1991 .......................... 59

Table 4.i Peru: Non-Tariff Banrits, 1981-1990 (by Number of Tariff Categories) ... 65

.v.

PERU

TRAPE POLICY REFORM LOM

Loan and Program Summary

Republic of Peru

Executin, Agei:y Ministry of Economy anc Fmance

Amount USS300 million equiva'ent

Texms: Repayable in 20 years, including five yeas of grace,at the Banks standard variable interest rate.

Ln Obeves: The proposed loan would support the Government'smedium term program of trade polcy reform.

Lan Desription: The loan would recogn!ze the major trade reform measures takenbetween August, 1990, and September, 1991, and comprising: (i) areduction in tariff protection; (ii) the elimination of most non-tariffbarriers; (iii) the elimination of export subsidies ard impo t inschemes allowing exporters to recuperate indirect taxs; (iv) theabolition of the agency formerly administering trade controls and theinitiation of a reform of customs. The sectoral conditinns relatelargely to the maintenance of the current reforms, and measutes forfurther reform are generally considered a secondary issue, exceptinsofar as further action is felt necessary to secure the currentreforms.

First, trade reform can be expected to lead Peru to a more efficntuse of its resources through specialization in productive areas whereits comparative advantage is greatest and tbrough the compettivepressures that freely available imports wil exert on domesticproducers. The removal of non-tarff bariers should also enablethose resources previously used to acquire varous Inport pesmto be put to better uses. S the project wil also reae beeftthrough its contribution to Perus debt workut and reintegration intothe intemational financial community. In addition to providig somefreh eternal funds to Peru between now and the end of 1992, theworkout will open the door to resumption of a norma rela ipwith the Bank. The workout will allow Peem to normalize relationswith other multi- and bilateral donors even before the Bank itselfdisburses.

Ihe survival of the trade reform could be threatened by ( i) a failurein current efforts to stabilize the economy and a related failure tomaintain a real exchange rate providing sufficient incenties to theexport sector; (ii) pressures to reverse reforms fr m those adverewyaffected, inside and outside government, by the end of proteconistpractices; (iii) distortions that persist elsewhere in the economy (inspite of recent reforrAs) and which may inhbit a flexible responsefrom producesa, (iv) the polit!cal uncertainty generated by a still-weakgovernment capacity and the unstable security situation which couldadd risks to any reform movement in Peru; (v) the effect of socialunrest possibly delaying or arresting the reform process; and (vi) aweakening of the coordinated support for the internal reform processbeing providcL by the international financial community (a risk wbichhas recently diminished follwing the progress already made inimplementing the external financing plan). The trade reform processis part of a larger program of stabilization and adjustment which is notrisk-free, yet (like the trade reform) has strong political support.

Estimted Disbursement: The loan would be disbursed in one tranche. On Governmentfulfillment of effectiveness conditions, the Bank would simultaneouslymake the loan effective and release the tranche.

Staff Airraisal Renort: Not applicable.

REPORT AND RECOMMENDATION OF THE PRESIDENTOF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOANTO THE REPUBLIC OF PERUMOR TRADE POLICY REFORM

1. I submit the following report and recommendation on a proposed loan to the Republicof Peru for the equivale.-t of US$300 million. The proposed loan would support theGovernment's medium-term program of trade policy reform. The loan would be repayable over20 years on a fixed amortization schedule, including five yean grace, at the B"k'es standardvariable interest rate and charges.

I. The PmIecL the Workout ProEam and Countrr Strata!

The Project Context

2. This Report proposes a $300 million adjustment loan for trade policy reform. Iheimmediate objective of the loan is to encourage the current trade-reform process, whichrepresents one of the most far-reaching and rapid trade reforms carried out in the developingworld. The broader objective of this loan, as well as two proposed adjustment loans, is to allowthe Bank to participate in an internationall, supported approach to reintegrate Peru, which iscarrying out a bold program of stabilization and economic reform, into the international financialcommunity. This approach would provide Peru the opportunity to rehabilitate an economy muchdamaged by the actior_ of past governtments and would enable the Bank and other donors toresume a normal relationship of development assistance with Peru.

The Bank's Approach in a Country with P.-otracted Arrears

3. On May 2, 1991, the Board approved a new approach to support debt workoutprograms in countries with protracted arrears (Additional Support for Workout Programs inCountries with Protracted Arrears. R91-70, April 11, 1991). It allows strong-performing countrieswith large arrears to accumulate "contingent disbursements" during a pre-clearance 'performancepenod." Loans are presented to the Bank's Board dunng the performance perod, and once thearrears to the Bank are cleared, at the end of the performance period, loans are signed and madeeffective and all accumulated disbursements released. The new approach is analogous to theDIFs Rights Accumulation Program (RAP), and requires the following four conditions to be met:(a) the existence of an agreed financing plan; (b) an IM stabilization program; (c) a Bank-supported adjustment program; and (d) continued current debt service payments to the Bank.

The Bankts Approach in Peru

4. In order to assist Peru during the pe-arrears clearance performance period, expectedto last through December 1992, the Bank developed a country assistance strategy which conformswith this new approach. On July 30, 1991, the Board approved the application to Peru of thenew approach (Peru: The Bank's Approach to a Country with Protracted Arrears. R91-171, July12, 1991), opening the way for the implementation of this strategy. As a first step, the Bank

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participated in the formulation of an external financing plan agreed to by the IMF, IDB, bilateraldonors, and the Government (see Sect;on IR. Concurrently, the Bank has been preparing, withthe help of its economic and sector work, an adjustment program to support reform effortsunderway in Peru. As required under the new approach, loans approveu' under this program wilinot be disbursed until the end of the performance period.

5. The Bank also has been looking beyond the current period of protracted arrearsthrough FY95. During this period, the Bank expects to deepen its support of the adjustmentprogram through additional lending and econorr c and sector work, and also expects to presentinvestment loans now under preparation. These loans are lkely to take some time to prepare.Investment loans are inherently more time-consuming to prepare than adjustment loans. Theyrequire a complex mix of engineering, institutional, and human inputs and Peru's publicinstitutions, weak in part due to the past hiatus in Bank-Peix relations, are currently unable toundertake the necessary preparation themselves.

6. To counteract this weakness in public management, the Bank has launched a majorprogram of technical assistance, crucial for the successful implementation of the medima-termneconomic program. It has mobilized resources for these activities through the Japanese GrantFacility and the German GTZ, and is currently exploring other possible sources of financing.Thus, even before the Bank has been able to disburse, it has mobilized significant resources forPeru for project preparation and implementation. It has so far secured Japanese grants forapproximately $8.0 million for seven technical assistance projects, for structural adjustment,financial sector reform, debt statistics and management, social sector development, water andsanitation, energy and privatization, and German GiZ grants for about $1.0 million foragriculture, macroeconomic-stabilization and structural reforms, energy, mining and industry,infErastructure, and human resource development.

7. To assist the Government's efforts to reintegrate into the international financialcommunity, and subsequently to enhance and deepen the reforms undertaken during the periodof reintegration, the Banl's country assistance strategy is directed at four long-term strategicobjectives: (i) sustaining and accelerating the stabilization and adjustment process; (ii) fosteringprivate sector development and public sector reform; (iii) alleviating poverty and promotinghuman resource development; and (iv) rehabilitating key infrastructure.

& Sustaining and Accelerating the Stabilization and Adjustment Process. The Bank issupporting the reforms of the Fujimori Government, which assumed office in July, 1990, andimmediately initiated structural reforms to reverse the economic policies of previousadministrations and achieve a sustained eoDnomic recovery. Reforms have been announced intrade, monopoly rights and deregulation, privatization, ports, foreign investment, land reform,labor markets, social security, tax policy and adm atio and the financial sector (seeparagraphs 28-32).

9. The Government of Peru must sustain these reforms and undertake further measuresbefore it can fully reap the rewards. Bank lending operations in Peru are initialy focussing onthree adjustment loans to support the Government's effort. This loan is the first to be presentedto the Board, and the other two, a structural adjustment loan and a financial sector reform loan,wil be submitted in the remainder of FY92, assuming continued fulfillment of the four conditions

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described in paragraph 3. Later an agricultural sector loan wil be prepared to support reforms inagriculture.

10. The SAL will address balanced medium-term tonomic development needs through amulti-sector focus. It will aim at securing the Government's achievements and enhancing fartherreforms in the following areas: consolidaing the macroeconomic stabilization by maintaiing non-inflationary financing of government expenditure, improving tax collection and supporting the taxreform, redefining the functions of the government and reducing the number of public employees.laying out the general and sectoral strategies to privatize state-owned enterprises in varioussectors, increasing labor mobility, laying out the strategy for reform of official pension schemes,and reducing state intervention in agricultural markets. Ihe SAL would also help establish a clearpoicy and institutional framework for poverty alleviation identifying tatget groups and priorityprogram activities that refle the needs of the poor.

11. The financial sector reform loan will support the Government's efforts to liberalze thefinancial system and thereby promote efficiency in financial intermediation. The loan will focusspecif Alk on: implementation of the new, liberal banking law in an environment ofstrengthened banking supervision, a prograra of privatization of state-owned commercial banks,reform of the development banks, restructuring of the major public-sector bank, the Banco de laNacion, and improvements in the securities law and partial privatization of social security.

12. The groundwork for these adjustment loans was laid by economic and sector workundertaken in late 1990-early 1991 on public sector reform and investment, structural reform, thesocial sectors, and, in conjunction with UNDP, trade. The Bank is also undertaking firtherextensive studies on macroeconomic and structural reform, which will assist in maintainingdialogue with the government on monetary. financial-sector, and labor policies A study onmonetary policy will help the Government maintain a stable macroeconomic eniionment andsustain structural reforms. A financial sector report will analyze the status of financial institutionsand markets, and their inter-relatton with monetary and fiscal policies. A labor markets study willseek to strengthen the role of markets in supply and demand for labor services. In addition, astudy on agricultural incentives is currently under preparation to analyze the i'itial impact ofagricultural reforms which have been undertaken, and indicate areas for further reform.

13. Fostering Private Sector Development and Public Sector Refonn A number oflending operations are under preparation which wil broaden the Banks support, initiated in theSAL and iancial sector reform loan, for th Government's prvatization and publc sector reformefforts 'These loans wil fous on the reform of public sector policies that restrict private sectorparticipation, as well as the privatirstion of state-owned enterprises (SOEs) in energy, mining,manufcturing, fisheries, uansportation, and telecommunications.

14. In the energy sector, two loans are being prepared. An energy sector loan wilsupport reform of energy poicy and private setr devlopment, including priwatition of SOE.in the sector. In addition, in order to improve efficiency in production it will supportrehabilitation of facilities. Policy reforms wi include the establishment of tariff structures basedon economic principles, and of regulatory stuctures conducive to efficient use of energyources. he loan wil support privatization of Electrolima, one of the largest electricity

distribution companies, and foster private sector de%elopment in the oil exploration and extactionindustry. A subsequent power sector loan will build on the enerD sector loan to support

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continued sector reform, including tariff reform, institutional strengthening, and a kieview ofEtctroperu's functions. It wvl also include components to support privatization of regionalcompanies and to foster private sector power generation. A mining reform loan will improvesector efficiency through policy reforms and by closing uneconomic mines, shedding excess labor,strengthening support agencies, and addressing environmental issues. A privatization loan willsupport implementation of an agreed privatization program of SOEs in mining,telecommunications, oil, gas, and -- building on the financial sector reform loan -- banking. It willalso support policy reforms including elimination of excessive government controls, reform ofrestrictive labor practices, management strengthening, and further reforms to faster marketcompetition and private sector development.

1S. Economic and sector work will focus on privatization of SOEs and development of theprivate sector. An institutional artd pricing issues study will provide the basis for preparation ofloans in the energy sector. Several studies will be undertaken in preparation of the privatizationadjustment loan, which will include an examnination of the regulatory policies that govern naturalmonopolies and competitive industries, and a review of labor redundancy issues of publicenterprises. A planned study on industrid1 da.egulation will evaluate ways to further improve theconditions for private sector development. An environmental sector study will review problems ofsoil erosion, tropical deforestation, PCB pollution, and water pollution caused by mining.

16. Alleviating Poverty and Promoting Human Resource Development. The Bank'sprimary country assistance objectives in the area of human resources are to assist the Governmentin formulating and implementing an effective poverty alleviation strategy, and closely related tothat, promoting human resource development by supporting the Government's efforts to makeavailable basic social services, particularly for the poor, and improving the impact and cost-effect.iveness of those programs. The Bank's work in the social sectors will also contribute to theachievement of the other assistance objectives for Peru. Well-designed, sustainable programs toalleviate poverty and cushion vulnerable groups should increase the likelihood that the adjustmentprogram will be maintained. The dynamism and effectiveness of community organizations andother non-governmental organizations provide scope for decreasing reliance on the public sectorin some areas and encouraging a larger private sector role in the provision of social services. Theimpact of the past deterioration of the economy on provisions for operations and maintenance ofsocial infrastructure means that the requirements for rehabilitation are substaixtial.

17. In the lending program, the first S&ral Development Project will focus on support tobasic health services and nutrition interventions targeted to the poor in a few regions outside ofLima where most social programs are now concentrated. It will build on the SAL to support theGovernment in formulating a poverty alleviation strategy and identifying reforms in foodassistance programs. It will also include activities to strengthen institutional capacity at theregional and central levels, as well as to improve the Government's ability to monitor sceialdevelopment and poverty and to use that information more effectively in program design andevaluation. Ihe anticipated improvements in institutional capacity in the agencies responsible forhealth and nutrition, as well as the results of economic and sector work, would lay the base for amore comprehensive loan to strengthen primary health services in Peru. This loan would addresscritical rehabilitation needs and financial issues, including cost recovery, and, if feasible, it wouldextend to additional areas the programs and interventions which proved successful under the firstproject. The participation of non-governmental organizations is being incorporated in bothprojects. A subsequent operation in primary education is also planned to address rehabilitation

needs and quality enhancements, with special attention to the poor through improvements toprograms ard teacher training in rural areas and to consiO-stion of school feeding programs.

18. The emphasis of sector work is on the fundamentals -- primary health, basic education,and well-targeted nutrition interventions. Improvements in these sevices, together with aresumption of broad-based economic growth, are most critical to efforts to reduce poverty inPeru. The focus will be on identifying ways to broaden access by the poor to these programs, toenhance quality and to improve cost-effectiveness. In order to reduce the demands ongovernment agencies and to mobilize resources, mechanisms to enlarge the role of non-governmental organizations and community participation will be explored. An evaluationr ofpublic spending in the social sectors wiDl review government priorities in the light of thecontribution to poverty alleviation, the need for continued fiscal ramsterity, and a reduced role forpublic agencies. The Bank is also convening, at the Government's request, a series of donormeetings during 1992 to mobilize and channel external financing for priority programs andprojccts in the social sectors.

19. Rehabilitating Key Infrastructure. The Bankes strategy in this area is aimed at theimmediate rehabilitation of essential infrastructure in the transport and water sectors, whicia havesuffered from a lack of maintenance due to severe fiscal constraints, as well as the identificationof further rehabilitation needs and specific policy reforms. The goal is to simultaneously promotesustainable growth through an efficient use of resources within and across sectors, while relievingthe fiscal constraint and identifying public policies for the provision of infrastructure serviceswhich will help alleviate poverty. The Bank wi;l concentrate its rehabilitation efforts in the waterand sanitation, transport, urban, and irrigation sectors.

20. Initially, lending vwil focUs on high-priority rehabilitation needs. A water sector loanwfil involve emergency-type rehabiitaMion investments to address critical supply and qualityproblems, and health hazards (such as cholera) resulting from poor water qualty. A transportrehabilitation ?-nan, ftocussing primarily on highways, will finance emergency rebabilitationinvestments iu the transport sector. Given fiscal constraints in Peru, these loans will also supportpolicy and regulatory changes to promote private sector participation and investment (e.g. throughconcession arrangements). Over the medium-term, these emergency-type rehabilitation loans willbe supplemented with a municipal development loan to support basic urban infrastructure and awater sector loan to support further rehabilitation and sectoral reforms. An irrigationrehabilitation loan will be prepared to address irrigation infrastructure, which has been allowed todeteriorate es procedures anJ maintenance have been inadequate.

21. Given the constraints to immediate large-scale lending to Peru, and the institutionalweaknesses in the Peruvian Government, the Bank is seeking an immediate impact through theprovision of policy advice. Sector work related to infrastructure is emphasizing rehabilitation, aswell as institutional and pricing issues, including studies on the irrigation, telecommunications,transport and water supply, and general issues of policy reform in infrastructure. A study isunderway to examine the scope for deregulation, privatization, and decentralization in urbanservices.

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II. The Economy

Ihe Ticonomy Inherited

22. During the last two decades Peru developed a legal structure and policy environmentinimical to economic development. A state-led development strategy created a large publicsector, an intricate network of controls, and a largely inefficient state-owned-enterprise sectoroperating in virtually every sector of the economy. The tax code became complex and full ofloopholes, with tax administration ineffective and evasion high.

23. These policies seriously distorted most of the markets in the economy. Job security inthe formal sector was constitutionally protected, and strictly enforced. This, and very high taxrates on labor, helped shrink the formal sector. The land reform of the early 1970s severelyrestricted the marketability of land and its use as collateral. The trade policy of the last threedecades relied on an import-substitution strategy with very high tariffs and many non-tariffsbarriers, depriving the country of the benefits of comparative advantage. Domestic regulatorypolicies provided special privileges to incumbents. The financial sector was heavily regulated andburdened with direa government involvement. During the entire decade of the 1980s theGovernment wontrolled interest rates.

24. President Garcia's diagnosis of chronic inflation and low growth was that Peru was in a"debt trap": servicing the external debt would accelerate foreign exchange devaluation andinflation, erode domestic savings, and curtail investment. Consequently, his Administration (1985-90) put a ceiling on foreign debt service of 10 percent of the value of exports, and later stoppedpayments altogether. It instituted widespread foreign-exchange controls on current- and capital-account, with multiple exchange rates which were subject to frequent change. It increasedminimum wages, expanded directed credit and subsidies, reduced the tax rate on VAT, anddecreased public sector prices. This strategy led to a high and increasing fiscal deficit, financed byflat money. During the first two years of the Garcia Government this increase in the moneysupply had little effect on prices due to an increased demand for Intis generated by thePresident's widespread credibility among Peruvians. The initial results were excellent. Economicactivity expanded by 17 percent from 1985 to 1987, the rate of price increase fell, and real Intiliquidity experienced an unprecedented increase. This "boom", of course proved to beunsustainable. After 1987 the market lost confidence, the process of monetization sudde*lyreversed, inflation rebounded, and the economy deteriorated sharply.

25. In key productive sectors, such as petroleum and mining, the breakdown ofmanagement and finances led to a decline in production. Peru's per capita GNP declined sharplyand unemployment and poverty increased alarmingly. Relations with the international financialinstitutions (IFIs), bilateral lenders, and commercial institutions were suspended because of theaccumulation of large arrears. The government applied no effective remedy beyond the reductionof public investment to historically low levels, with the greatest relative reduction in health andeducation. Inflation continued out of control, further eroding tax revenues. In 1989 the pricelevel was 267 times higher than in 1987, output had contracted by 19 percent, and real wages hadcollapsed to under half their 1985 level

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26. Economic mismanagement reached a climax in 1989-90. The decade of the 1980switnessed a slow but steady process of dollarization due to the continuing weakness of thePeruvian Inti. Dollar-denominated deposits in the financial system doubled in the 1980s,exceeding all Inti denominated liquidity, which in this period was halved in real terms. TheGarcia Administration attempted to end this process by freezing all dollar deposits, and later eventried to nationalize the banking system. The market reaction was to rely even more on the dollar.

27. By late July, 1990, prices were already increasing at an annual rate close to 36,010percent (Table 1.6 of Annex 1). As a result, the country's fiscal base had almost vanished andmost public sector prices and tariffs were approaching zero in real terms. Economic activity wasextremely depressed, and investment even more so: the public sector had virtually abandonedmaintenance of its capital stockl The formal financial sector had shrunk and real domesticliquidity was down to about one-sixth the level of 1985. Exports were 40 percent below their1979 level, gross international reserves were low, and Peru's debt moratorium had led to itsisolation from the international community. Violence and terrorism were escalating. Seventy-fivepercent of the labor force was either unemployed or employed part-time and per capita incomeshad declined to the levels of 30 years earlier.

The Economic Reforms of the Fuiimori Administration

2X On assuming office at the end of July 1990, the Fujimori Government launched anorthodox and sweeping stabilization cum structural reform program. The progress achieved by theGovernment in both stabilization and structural reform is imnpressive. During the first stage ofeconomic reforms, the government took dramatic steps towards achieving macroeconomicstabilization and rebuilding ties with the intemational 3nancial community. The main componentsof the program launched in August, 1990 were:

(a) Tight controls over public sector wages and salaries, a 3000 percentincrease in fuel prices, and a 1,000 percent increase in the price ofelectricity, water, and telephone services.

(b) The elimination of numerous exemptions on import tariffs and salestaxes, and the introduction of a temporary tax of 10 percent on exportsand 1 percent on net wealth and insured assets.

(c) The introduction of a Cash Management Committee to manage CentralGovernment finances on a cash basis only (without recourse to CentralBank credit).

(d) The unification of exchange rates and the establishment of fullconvertibility in all current- and most capital-account transactions, witha managed floating exchange-rate system;

(e) A tight domestic credit policy;

(f) A significant reduction in price controls, including the de facto elimina-tion of ceilings on interest rates.

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These measures aimed at eliminating the main source of hyperinflation: the monetary financingof the fiscal deficit.

29. Further fiscal reforms. Foliowing the initial stabilization measures, the Governmenttook a number of steps, most of them in March, 1991, to reform the tax system, notably thefollowing.

(a) The tax regime was simplified. This implied the elimination ofnumerous taxes and their substitution by a system based principaly onfive types of taxes: a tax on income of individuals and corporations, atax on wealth of firms and individuals, a value added tax, a tax onz4lective consumption, and tariffs on imports.

(b) The income tax rate on firms was reduced from 35 to 30 percent andexemptions were reduced. The tax on net wealth of corporations wasunified at 2 percent and all exemptions eliminated. Both taxes willincorporate a system for adjustment to inflation beginning in fiscal year1992. The personal income tax rate was reduced from 45 to 37percent, and a 1 percent tax levied on the inflation-adjusted value of alist of assets replaced the previous tax on individuals' net wealth.Selective consumption tax rates -- excluding gasoline taxes -- werereduced to three, with a maximum of 50 percent.

(c) The emergency tax on insured assets, the 10 percent subsidy onnontraditional exports, and the 10 percent tax on exports (except forninerals) were eliminated. However, the emergency tax on checks and

the excise tax on interest wil be temporarily maintained until total taxrevenue collection increases by enough to justify their elimination.

30. The tax administration system has been subject to several reforms during 1991. Thetax administration office (SUNAT) has been reorganized; it was endowed with a budget of up to2 percent of total tax revenue collection, and an evaluation of its personnel to permit a carefulselection of new staff is currently in progress. SUNAT is also modernizing its computing facilitiesand inrducing reforms in its administrative procedures directed towards simplifying tax controls.

31. Since August, 1990 public utility prices have been subject to frequent adjustments,while public sector wages have remained under strict control. Wage indexation in publicenterprises was eliminated and wage increases require Central Government's approval In thefast four months of 1991, 50,000 civil servants resigned under a program that offered incentivesfor voluntary withdrawal.

32 Further structural reforms. A second stage of policy reform began when the initialeconomic measures were supported by a series of broad-based structural reforms announced fromMarch, 1991, onwards. These unprecedented measures were aimed at promoting domestic andextemal competitiveness and deregulation of economic activity. The major measures are asfollows.

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(a) Monopolies and deregulation. Monopoly rights of 12 public firms(including grain marketing, imports of fertilizers, gold trading,reinsurance, etc.) have been abolished.

(b) Financial sector. A new banking law strengthens prudential regulationsby redefining the capital requirements and credit concentration ratiosof banks, promoting universal banking, and opening commercialbanking to foreign investment. In addition, insurance has been partiallyderegulated by freeing premiums and abolishing some govermentmonopolies.

(c) Labor market. The rigid labor stability laws have been amended tobroaden provisions for layoffs and to establish a better regime tocapitalize the contnbutions towards compensation at the time oflayoff/retirement.

(d) Ports. With the elimination of the Controlling Commission ofMaritme Labor, which monopolized most loadingunloading activities,the cost of these services has been substantially reduced.

(e) Foreign investment. Foreign investors are now permitted to remitabroad all net profits and royalties. Foreign investment can now enterunder any corporate form or joint venture, and investors are allowed topurchase stock from residents and to invest in any sector except thoseotherwise resemved for nationals.

(f) Privatization. The Government is in the process of laying out thestrategy to privatize enterprises in the area of mining, fishing, banking,oil and gas, power, telecommunications, and transport.

(g) Land reform. Land property rights have been broadened andstrengthened. Corporations (including agrarian cooperatives) can nowlegally become private estates. Moreover, land is now freelytransferable and can be used as collateral.

33. The social progam. On implementing the adjustment program in August, 1990, theFujimori Government also began the Social Emergency Program to provide for direct food andhealth assistance during the five months from August through December. Although the Programinitially planned to disburse $415 million, it disbursed only $67.7 million of Treasury funds. Toestablsh a better focused program for a safety net, the government announced, in August, 1991,the creation of the National Fund for Social Compensation and Development (FONCODES).FONCODES is a temporary mechanism for channelling government and donor resources tolabor-intensive projects (mainly the rehabilitation of economic and social infrastructure) proposedby local government agencies, NGOs, and community-based organizations.

34. In addition, in an effort to set priorities and policies for the social sectors, theGovernment prepared a national short-term development plan in April, 1991. With UNICEFassistance, a Plan of Action for Child Welfare was also prepared and endorsed by the

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Government in June, 1991. The Plan diagnoses problems and sets goals for health, education,water and sanitation, nutriton, employment, and the problems of children in differentcircumstances.

The 1991-1992 Macroeconomic Stabilization Progam

35. To consolidate the process of economic stabilization, the Government has agreed to aRights Accumulation Program (RAP) with the IMF that identifies several targets formacroeconomic performance duing the period July 1991-December 1992. The Peruvianstabilization program, agreed with the IMF, envisages for 1992 an increase in fiscal revenues over1991 of roughly 2 percent of GDP as a result of better tax administration, a higher VAT rate of16 percent (up from 14 percent), and simplification of the tax regime. Privatization could alsoprovide some fiscal relief but the Government correctly acknowledges this to be temporary. Also,tight monetary policy would allow only for the purchase of international reserves by the CentralBank. The program envisages that inflation will be reduced steadily to achieve intemational levelsby the end of 1992. Table 1 summarizes the main fiscal indicators.

Table 1: PROJECTED FISCAL ACCOUNTS, 1991 AND 1992(Percentage of GDP)

1987 1988 1989 1990 1991 19

NFPS Primary Balance -5.1 -5.4 -5.1 -1.0 0.4 0.6Interest Accrued 2.8 3.8 2.8 4.4 3.5 3.6NFPS Total Balance 7.9 -9.2 7.9 -5.4 -3.1 -3.0Quasi-Fiscal Balance -5.4 -6.1 -2.8 -1.1 -0.5 -0.3

CPS Total Balance -13.3 -15.3 -10.7 _U 1 _

FinancingExtemal 2.4 4.3 2.9 3.2 3.1 3.3(interest Arrears) (1.7) (3.1) (2.5) (3.3) (0.0) (0.0)Intemal 10.8 11.0 7.8 3.3 0.5 0.0

Total 3 15.3 10.7 IA L 1

NFPS: non-financial public sector;CPS: consolidated pubfic sector.

Source: IMF Staff Report for the Article IV Consultation

36. The program also calls for substantial fiscal improvement over previous yeats. Whilethe primaty balance of the non-financial public sector showed deficits higher than S percent ofGDP during 1987489, the balance improved to a one-percent deficit in 1990 (the first year of the

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Fujimori Governtment) and it is planned to reach a surplus of 0.4 percent for 1991 and 0.6percent for 1992. The interest payments for those two years, of 3.5 and 3.6 percent of GDPrespectively, are expected to be financed through the primary surpluses plus voluntary externalcontributions of 3.1 and 3.3 percent of GDP for 1991 and 1992 respectively. The program, ascurrently stated, does not require any domestic financing of the non-financial public sector; infact, a small surplus of 0.3 percent of GDP is expected in 1992. In consequence, the only reasonsfor money creation during the 1991-92 program relate to either reserve accumulation or tiefinancing of the quasi-fiv_.al deficit.

37. The quasi-fiscal deficit is projected at 0.5 percent of GDP for 1991 and 0.3 percent for1992. For 1991, the quasi-fiscal deficit is expected to be fuly financed by domestic creditcreation. For 1992, external sources will finance this deficit. The program assumes an averagemonthly inflation rate of 5 percent for the second semester of 1991 and a monthly average of 2.7for 1992. This inflation projection is consistent with the projected increase in the money supplyrequired to buy foreign-exchange reserves and to service the external debt of the Central BankDuring the first semester of 1991, currency in circulation increased by 30 percent, solely forpurchases of foreign reserves and not for deficit financing. For the second semester of 1991, theprogram foresees a 55 percent increase in currency in circulation, of which 60 percent would bean increase in net domestic credit and the rest purchases of foreign exchange.

Risks and Assessment of the Stabilization Progam

38. The four risks to Peru's stabilization program are that: (a) the fiscal situation wouldremain precarious; (b) a continuing dollarization process would push up money velocity and fuelinflation; (c) market perceptions of the continuing overvaluation of the Sol would increasepolitical pressures on govemment officials to take unwarranted steps such as re-introducing capitalcontrols or making "excessive' (inflationary) purchases of foreign exchange; and (d) a growth interrorist activities would undermine business confidence and support for the Government.

39. The fiscal issue is most immediately worrying. As of September, 1991, the fiscaladjustment, in spite of gradual improvement, remains precarious. To maintain the budget cashbalance, suppliers are not fully paid, Administrative Regions do not receive fil transfers, foreigncreditors are not kept current, salaries of civil servants are at an all-time low, and net publicinvestment is practically zero, with little or no maintenance of physical infrastructure. Thisextremely low level of expenditure has created social unrest. Fiscal adjustment will be crucial forthe sustainability of the current stabilization effort. The Government expects extra tax revenuefor 1992 of 2 percent of GDP relative to 1991, bringing tax collections to a total of 9.2 percent ofGDP. However, this improvement depends on congressional approval of the tax reform andimprovement in tax admiistration. Nevertheless, this fiscal target is reasonable, gven thatinflation for 1992 is expected to be low, in 1985, by comparison, when annual inflation was 160percent ts collections were 15 percent of GDP.

40. TIhe process of dollarization -- that is, currency substitution in favor of the dolar -continues. It has steadily reduced the demand for Soles and has therefore made it increasingly

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difficult for the Government to collect the inflation tax.1' The experience for Latin Americancountries which have recently undergone dollarization is that successive stabilization efforts wereunable to return domestic cash balances to the pre-shock level, even when a lower inflation pathwas realized. It appears that the elimnination of all foreign exchange controls has facilitated Peru'sdollarization process and that the dollar has expanded its traditional store-of-value function inPeru to include those of unit of account and medium of exchangeY Were dollarization tocontinue, it could complicate the stabilization process; but as long as the fiscal accounts achieve asustainable equilibrium and the money supply grows within its targets, continued dollarizationshould not derail the stabilization process.

41. The Government has been concerned about the significant real appreciation of the Solin 1991.y In response to this concern, the 1991-92 program allows for the purchases of foreignreserves by the Central BankY The Government's economic team has gained popular supportas Peru has made a successful beginning to the process of reintegration into the internationalfinancial community, and the indicators are that, as interest rates have fallen in recent weeks,capital inflows have slowed and the real exchange rate has depreciated.

42. To sum up the stabilization effort, Peru's orthodox "shock' treatment succeeded inbringing hyperinflation to an abrupt halt: monthly inflation fell from 63 percent in July, 1990, to6 percent in November, having reached a historical high of 397 percent in August, 1990, themonth in which the public price and tariff adjustments were made (Table 1.6 in Annex 1).However, by the middle of 1991, inflation had increased to 7-10 percent per month. Inflation fellsteadily from 9 percent in July to 4 percent from October to December. The immediate causes ofthis higher inflation were increases in the monetary base by an average of 6-8 percent per monthand increases in the income velocity of money because of the dollarization trend. By August,1991, Peru's nonetary base was only $0.9 billion and its velocity of circulation almost 40 per year,

1. On July 1, 1991, a new monetary unit, the Nuevo Sol (S/.), was introduced at a conversion factor ofS/. 1.00 = I/m. The so-called Inti Mil16n (I/m.) - equivalent to one million Intis (I/. 1,000,000) - wasinstituted on December 16, 1990, as a device, eliminating the last six digits of any value in 1Itis, to simplifyaccounting and as a means of transition between the Inti and the Nuevo Sol.

2! Real Sol cash balances (currency plus demand deposits, deflated by the Consumer Prics Index) fel by 36percent between July, 1990 and July, 1991, in spite of the substantial reduction in inflation that took place.(CPI inflation was at a monthly rate of 45 percent in the three months May-July 1990, as compared with aoly8.7 for the same months in 1991). With a floating real exchange regime, a fall in the demand for Soles will leadto higher vaiability for prces denominaed in Soles t5an for prices in dolars. Nevertheless, by October, 1991,the fall in the real demand for Soles seems to have levelled off.

h/ According to the available measures, the currency has been appreciatng steadily since 1988. ITe rate at thebeginning of 1991 was one-quarter its 1988 level. The reasons for the long-tern appreciation in the realexchange rate are not clear; they are attributed by some to the rise of Peru's coca economy (now, by someestimates, equivalent to at least one-third of official exports).

4/ The net reserves of the Central Bank increased by US$277 willion during May-August, i991, in response toinreased purcbases-equivalent to 45 percent of the dollar value of Ml as of May, 1991, when the purchasesstrted. In spite of the significant purchases of foreign exchange by the Cental Bank, the prchasing power ofthe dolla in temns of domestic goods (measured by the CPI) fell 25 percent during the same penod.

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implying that even a small monetary financing of the deficit would have a large impact on prices.

43. The stylized economic cycle. By August, 1991, the rate of growth of the monetarybase explained, by and large, some 75 percent of the inflation experienced since October, 1990,the rest being due to the persistent dottarization of the economy, which increased the incomevelocity of money. The rate of growth of the monetary base was highly variable, but ovall,monetary policy was generally "tight! in the sense that the monetary base grew at a lower ratethan prices.

44. The following sequence appears to descnbe Peru's experience of cyclical fluctuationss of August, 1991: tight monetary policy increases interest rates on dollar and Sol financialassets. The high real rates attract capital inflows, which in turn appreciate the real exchange rate.The Central Bank, concerned about the 'low" level of the exchange rate, speeds up its rate ofmonetary creation by buying foreign exchange at a faster rate, and this in turn creates inflation.

45. Meanwhile, inflation reduces the eal level of those prices which are undergovernment control (gasoline for example). These prices are designed to include a large taxelement, and fiscal revenues therefore deteriorate. Worried about falling revenues, thegovernment then permits a large and immediate rise in public-sector prices which then causes aone-time rise in the price level. (This kind of adjustment should have no permanent inflationaryeffect.) The Central Bank, concerned about the surge in prices, tries to compensate by turning toa much "tighter" monetary policy (which involves buying less foreign exchange), thereby furtherincreasing interest rates and capital inflows. As these inflows appreciate the exchange rate, theCentral Bank loosens its grip, increasing the rate of growth of the money supply to buy foreignexchange. Tbis completes the inflationary cycle. The cycle has led to a highly volatile monetarypolicy which has increased uncertainty in an already uncertain environment.

46. In sum, Peru's Central Bank has been concerned with the same issues that concernmost Central Banks: inflation, foreign-exchange reserves, interest rates, unemployment, and theexchange rate. But Peru has been experiencing high inflation in an extremely demonetizedeconomy. This means that the government has little room for mistakes from inconsistent policyobjectives. Consequently, inconsistent objectives, or shifts among these, are another source ofmonetary volatility, contributing to the existing climate of uncertainty. These policy shifts,coupled with steady dollarization and a weak fiscal situation, help explain the current fragiemacroeconomic situation. The Central Bank should concentrate on targeting the rate of growthof the monetary base, thus providing a stable and predictable monetary framework This indeed isthe policy that the Government has followed since August, 1991. In addition, the provision of anefficient fiscal framework is an indispensable complement for a lasting stabilization.

Monitoring the Stabilization Program

47. The uncertainty related to a precarious tax base, increased doilarization, and realappreciation of the exchange rate makes it difficult to forecast the evolution of economic vari-ables. Therefore the Bank will assess the progress of the stabilization program with particularreference to the performance of a set of broad relevant indicators which are consistent with theIMF program. For 1992, we shall use the following set of indicators, with their correspondingvalues, to evaluate the economy's macroeconomic performance.

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(a) Central Government current tax revenue: about 9.0 percent of GDP:

(b) Primary balance of the non-financial public sector: It least 0.6 percentof GDP;

(c) Rate of creation of monetaty base (December,1991, toDecember,1992): up to 40 percent

(d) Stock of other Central BafA monetary liabilities in Soles: u' to 3.1times monetary base.

Within these broad indicators, the Bank will pay particular attention to measures of fiscal revenueenhancement and expenditure control which will contribute to efficiency, equity, and thesustainability of adjustment in the medium term. In monitoring the macroeconomic program, theBank will consult regularly with the IMF.

The Agenda for Structural Reforms

48. The structural reforms that Peru began in 1990 and 1991 are but the beginning of along and difficult path. The institutions of public management have to be rebuilt and publicconfidence in government restored. This must happen against an alarming backdrop of poverty, acholera epidemic, and the security problems that have fed on the country's econom . collapse.The Government has begun an ambitious program to modernize the economy through policies tomake it more efficient and competitive: the liberalization of agricultural, labor, and financialmarkets and trade will continue; the Government is detennined to provide public goods - health,education, justice, and so on - more efficiently; and a wide-ranging privatization process has beenlaunched.

49. Through its program of adjustment lending in FY92, the Bank will be working withthe Government in support of its agenda for structural reform. In addition to the trade reformsto be supported in this project, a SAL and a financial sector reform loan, both under -reparation,would support a variety of structural reforms (see paragraphs 10 and 11). This program ofadjustment lending will also contribute to stabilization objectives. Three components of theSAL -- supporting the non-inflationary financing of public expenditure, reform of taxadministration, and a reduction in public employment - have a direct and obvious impact. Butother components of the lending program support policy reforms with more indirect effects.

(a) If the prospects for structural reforms and for more efficient, lesscorrupt government are credible, people are more likely to pay theirtaxes. Thus structural reforms indirecdy increase fiscal revenues.

(b) The immediate fiscal contnbution of privatization is to provide a usefu,but only temporary, boost to revenues. Privatization's longer-termeffect is to eliminate the recurrng fiscal burden of state-ownedenterprises and to create a new tax base.

(c) The net impact of lower import duties combined with the eliminationof many preferential regimes is expected to lead to higher fisal

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revenues, a trend which has been apparent since the second quarter of191 (see paragraph 94).

(d) New labor laws will increase labor's mobility; this in turn will reducethe bankruptcies resulting from changes in relative prices caused by thetrade and other reforms. This should relieve short-term politicalpressures on the stabilization plan.

(e) The new banking law, by strengthening prudential regulation andproviding for deposit insurance, will help the bankdng system withstandthe recessionary effects of the stabilization.

The Medium-Term Outlook

50. Six major policy areas are likely to play an important role in determining the mediumterm outlook of the economy: (i) trade reform, (ii) fiscal adjustment, (iii) restoration of externaldebt serice, (iv) privatization, (v) increased reliance on market allocation mechanisms, and (vi)currnc convertibility and financial openness. GDP growth is eVpected to remain at 2.5 percentfor 1992 as the economy still has to adjust to the significant shock derived from the tight moneypolicy required to end the hyperinflation, the hardening of the fiscal budget, and the structuralchanges in telative prices. GDP is expected to start recovering in 1993 and its growth rate to risegradually to a sustainable level of 4.5 percent by the end of the decade (Table 1.4 of Annex 1).

51. A successful trade reform will increase the participation of exports and imports inGDP, once the short run disturbances associated with the end to the hyperinflation are washedout. We expect exports and imports of goods and non-factor services to gradually increase theirshare of GD? from 11 percent in 1990 to 17-18 percent by 1999, with exports rising slightly fasterthan imports, resulting in the emergence of a positive balance in the trade account towards theend of the decade (Table 1.4 of Annex 1).

52. Two conflicting forces operate on the current account: the fiscal adjustment shouldoperate towards improving the current account, while the restoration of normal debt service andthe financial hberalization will help generate additional capital inflows to finance a larger deficit.It is likely that for the rest of this decade the fiscal adjustment will dominate so that the cwu taccount balance will improve as Peru starts generating genuine resources to reduce the rate ofincrease in its foreign debt. The most likely scenario assumes the current account balance toremain in deficit during the decade, although it will be reduced from the high level of -5.2 percentof GDP reached in 1991 to below four percent by 1997 and thereafter (Table 1.4 of Annex 1).

53. The simultaneous achievement of GDP growth and current account improvementsdepends on a sustained fiscal adjustment and an increase in private savings that would bringdomestic savings up to 26 percent of GDP by 1999 (compared with 19 percent in 1991), a levelconsistent with an investment ratio of 25.5 percent and a Trade Surplus of 0.4 percent of GDP.The increased savings will be sustained by the positive interest rates allowed by the financialliberalization implemented in mid-1990.

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III. External Firancln

The External Debt Problem

54. Peru's arrears grew rapidly from 1983, whei ;ru adopted a best-effort-to-pay practiceon its foreign debt. Then, in July 1985, the Garcia Go- Anent announced that total foreign debtpayments would be capped at 10 percent of exports. Not until 1988, however, did actual debtservice fall to the 10 percent limit. Initially only payments from public creditors to private foreignbanks were targeted, but in 1987 Peru extended the moratorium to the IFWs and also bannedexternal debt-service payments by private debtors. In August 1986, Peru was declared ineligiblefor IMF lending and was placed on "non-accrual" status by the World Bank one year later. Inearly 1989, the IDB also took this last step. Threatened with expulsion, the Garcia Governmentresumed current debt servicing to the IMF at the end of August 1989.

55. The Fujimori government took prompt steps to rebuild Peru's ties with theinternational financial community by resuniing current debt service payments to the Bank and theDB: following discussions with the Bank, payments to cover current obligations were resumed inmid-October 1990, and to the IDB one month later, thus "freezing the stock of arrears with thesetwo institutions. Payments to the IFIs average about $41 million per month, equivalent to about14 percent of the central government's total fiscal revenues. Interruptions in the payment ofcurrent obligations to the Bank and thL IDB, but not the IMF, recurred in March 1991. By mid-September 1991 current debt service had been resumed to both of these institutions, and allarrears accumulated since mid-October 1990 paid.

56. Peru now faces an unprecedented overhang of external debt and arrears. At the endof 1990, it had almost $22 billion of external debt, with about one-third owed to private creditors,one-third to Paris-Club members, 10 percent to other official bilateral creditors, and 19 percent tolFIs (see Table 1.5 in Annex 1). Almost two-thirds of this was in arrears; arrears to the IWUalone totaled $2.2 billion. The secondary-market discount on commercial-bank claims on Peru isover 90 percent (down from 95 percent at the time the new Government took office).

The External Financing Plan for 1991 and 1992

57. Peru's external financing requirements for 1991 and 1992 could total $20.7 billion(Table 2). Taking account of disbursements already in the pipeline and private capital flows,external financing requirements are reduced to $18.7 billion. Most of the requirements are forthe financing of arrears; the rest is for public-sector debt-servicing, achieving a targeted level ofreserves, and supporting the non-interest current account deficit.

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ITa: EXTERNAL FINANCING REQUIREMENTSAND POSSIBLE SOURCES OF FINANCING, 1991 AND 1992

(in Millionsof U.S. Dollars)

1991 1992 1991-4'2

Financing Rea_rements

1. Non-Interest Cuffent 536 492 1,028Account Deficit

2. Debt Service Obligations 2,616 2,398 5,014

3. Total Afrears 12,055 1,800 13,855

4. Intease in Gross Reserves 454 303 757

S. Gross inacing Requirements (1 2+3+4) 15.661 4.993 20

6. Loan Disbursements in Pipeline 255 200 455

7. Private Capital Flows 908 545 1,453

8. Net Fimancing Requirements 14,498 4,248 18.746(5-6-7) ===.

9. Debt Rescheduling and Deferal 13,598 1,467 15,065Official Bilateral 6,352 769 7,121Private 7,246 698 7,944

10. Additional Disbursements 900 2,781 3,681Multilateral 654 2,328 2,982Official Bilatera 1/ 246 453 699

11. Additional Financing Required 0 0 0

12. Total Sources of Financing 14,498 4,248 18,746(8+9+10) === .m_

11 Additional disbursements of budgetazybalance of payments fromSuppott Group members.

SO=: Annex 1, Table 1.2

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58 To help cover these financing requirements, the donor community has sought todevelop a coordinated plan, which would help reintegrate Peru into the international financialcommunity. Rescheduling and deferral of debt to official bilateral creditors, and a cortinuedmoratorium on debt servicing to private creditors, are expected to cover most financingrequirements. Peru is not expected to receive any type of debt forgiveness in 1991 and 1992.The balance is expected to be provided by fresh disbursements from the three IFWb, the LatinAmerican Reserve Fund, and bilateral donors, coordinated through a "Support Group."

59. Debt rescheduling and deferral. Rescheduling negotiations have already beensuccessfully completed with the Pans Club of creditors, but negotiations are still underway withPeru's other bilateral creditors, notably some Latin American and Eastem European countries.The financing plan incorporates the agreement reached at the Paris Club, and assumes that Peruwill be able to secure similar terms from its other official bilateral creditors. It also assumes Peruwill be unable to service debts to private creditors during 1991-92; these debts will therefore berescheduled.

60. Paris Club Rescheduling. Per rescheduled part of its obligations to the Paris Club ofereditors on September 17, 1991. The Paris Club awarded the Government exceptional treatmentin the form of unprecedented cashflow relief between October 1, 1991 and December 31, 1992(the consolidation period). All current maturities due during the consolidation period on debtcontracted before the 1983 Paris Club rescheduling (pre-cutoff debt) and all arrears on pre-cutoffdebt were rescheduled on term; reserved for heavily indebted lower middle income countries Allmoratorium interest (interest due during the consolidation period on rescheduled debt) and allarrears on post-cutoff debt were deferred, the latter contingent on continued performance underthe IMFb RAP. (See the notes to Tables 1.1. to 1.4, in Annex 1, for more detail on the terms ofthe Paris-Club rescheduling).

61. Other Official Bilateral Reschedulings. Peru is seeking debt rescheduling from otherbilateral creditors on comparable terms to that received from the Paris Club of creditors, includigthe reprogramming of debt-for-export agreements with Eastern European creditors and therestructuring of medium-term obligations to Latin-American creditors that are currently beingserviced through the ALADI payments mechanism.

62. Existing Medium- and LonL=term Debt to Commercial Banks and UnauaranteedSuppliers. Although Peru will be unable to service debts to private creditors during 1991 and1992, the Government will continue discussions with these creditors. Unless an agreement can beconcluded without cash payments, the arrears on these debts will continue to grow during thisperiod. Following law suits brought by the commercial banks in 1989-90, the new Governmenthas negotiated an understanding with them under which it renounced recourse to statute-of-limitations provisions in return for a suspension of the default proceedings that were initiated inFebruary 1990.

63. Existing Short-Term Private Debt. Peru will continue to service short-term tradecredits. The suspension, since 1983, of amortization of short-term working-capital loans will

V/ The World Bank and the IMP would only disburse following clearance of Peru's areas to bothinstitutions, expectd in December 1992.

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continue. In addition, arrears that have emerged in recent ears on interest payments on workingcapital owed by some public-sector entities are likely to persist.

64. New disbureMents.The three IPIs and bilateral donors are committed to helpingPeru secure vitally needed external financing. However, their financial assistance is conditional onPeru's program of stabilization and economic reforms remaining in place. For the financing planto be successful Peru must abide by the conditions of the IMFs RAP and the Bank's conditionsfor lending to a country with protracted arrears during a specified period of time, expected to endin December 1992 As long as Peru adheres to the economic reforms in these programs until theend of the performance period, the Bank and the IF will be in a position to disburse to Peruupon clearance of arrears to both institutions. In order to clear Peru's arrears, a bridge loan,presumably from bilateral donors, wil need to be secured at the end of the performance period.Economic discipline throughout the performance period is also essential to ensure continuedlending by the IDB, and the release of funds pledged by a support group of bilateral creditors.

65. De International Monetary Fund. In January 1991, the IM management reached anagreement in principle with the Government of Peru on an economic program for 1991-92intended to form the basis for a request for a two-year Rights Accumulation Program (RAP). OnSeptember 12, 1991, the IMF Board, satisfied that Peru's external financing requirements couldbe met, and that Peru would maintain its payments on current obligations to the WIi, approvedthe RAP. Under the program, if Peru abides by LF performance criteria, and continues toservice current debt to all three IFM, it would accrue rights to future disbursements equivalent to188 percent of its quota, or SDR624 million, equivalent to Peru's current arrears to the WM.Rights would be disbursed once arrears to the IMF are cleared.

66. The World Bank. On May 2, 1991, the World Bank adopted a new 'debt workout"policy, analogous to the IMFs RAP (see paragraph 3). Under this program, three adjustmentoperations (expected to total $900 million) and other investment operations, if ready, would bepresented to the Board for approval, and disbursements would be released upon clearance ofarrears to the Bank.

67. The Inter-American Development Bank. The three IFIs agreed that Peru's arrears tothe IDB should be cleared first as they were smaller than those to the Bank or the NE. Thesearrears were cleared on September 13, 1991 with the help of a bridge loan of $325 million fromthe Latin American Reserve Fund (FLAR)Y With the clearance of its arrears, the IDB hasbegun to move ahead with a substantial program in support of Peru's rehabilitaton. OnSeptember 18, 1991 the MDB Board approved a $425 million loan for trade reform and is expectedto approve a $200 million loan for financial sector reform in early 1992. This adjustment lendigwil be followed up with disbursements on new projects in water/sanitation, and the reactivation ofexisting projects in the energy sector. Total disbursements in 1991 and 1992 are expected to beabout $839 million.

I/ FLAR, an institubon of the Andean Pact countries aeated to deal with balane-of-payments probles ithe ron through the provision of medium-term (up to three-to-four-year) fuding, has committed to makeavailale to Peru up to t78 million more in financing through the end of 1992.

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68. The Support Group. Following several meetings beginning in April 1991, a SupportGroup, led by the U.S. and Japan, was officially formed on June 7, 1991.!' At the time ofapproval of the RAP, the IMF estimated that the quick disbursing balance of payments supportrequired from the Support Group would be as much as $1.3 billion, but following the Paris Clubrescheduling, which was more favorable than initially expected, and an increase in expecteddisbursements from the IFIs, additional balance of payments support needed is now* timated atonly $0.7 billion. The Support Group has pledged to provide this amount, in additiu... to $326million earmarked for project aisistance. With the approval of the IMF RAP, which opened theway for the recent Paris Club agreement, bilateral donors are now in a position to disburse thesefunds.

External Financing Beyond the Performance Period

69. Peru's net external financing requirements would be between $2.5 billion and $3.5billion a year between 1993 and 1999 (Table 1.2 in Annex 1). These estimates are based on themacroeconomic scenario presented in Annex 1. Under this scenario, Peru would sustain non-interest 'urrent-account deficits through 1996; from 1997 a surplus is projected. In addition,these estimates are based on public debt-service obligations of between $2.5 to $4 billion a year,which are drawn from assumptions about expected disbursements. Finally, the estimates dependon assumptions ab: the volume of private capital flows, and Peru's ability to increase itsreserves. Yearly increases in reserves and positive private capital flows, including directinvestment related to the development of natural resource projects and renewed access to short-term trade credits, are assumed throughout the period. Because we recognize that many of theseassumptions are based on scant information, we emphasize that this financing scenario is highlytentative and should be interpreted wth caution.

70. If this scenario comes aeoout, significant increases in flows from the IPIs and officialbilateral donors are expected to account for most of the necessary fnancing. In addition, it isassumed that the Government will continue to reschedule private debt service 1, and pre-cutoff-date debt service to Paris-Club creditors due throughout the period. No debt reduction isassumed for either official bilateral or private creditors. Under these assumptions, a financing gapgenerally within the range of $200 million to $500 million annually would remainY This gapwould diminish by the amount of the IMF program that would have to be in place before afurther Paris Club rescheduling could take place. If Peru's access to IMF resources were to

7 / Bilateal donors who have pledged through the Support Group are: Belgium, Canada, France, Germany,Italy, Japan, the Netherlands, Spain, Sweden, Switzerland, and the United States.

_/ Given that financing gaps are likely to occur, even assuming a 100 percent rollover every year ofcommrcial bank debt, it will be difficult for the Government of Peru to enter into an agreement withcommeci banks requwtj a large cash payment. However, discussions have begun which may lead tonegotiations with the commercial banks as early as 1992 and a settlement on at least pant of the Governmen'sd4bt to commercial banks. Indeed, if the actual external financing scenario is more favorable than the onepresented here, and the Govemment were able to service or buy back its private debt, the external financing gpwould reflect the cost of any resources devoted to such transactions.

2/ he projections assume this financing gap would be met on commercial terms.

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average around 50 percent of current ninnual quota a year, the gap could be reduced by up to$200 million a year. Further reductions in the gap could come about if any variables prove to bemore favorable than assumed, for example if Peru were able to secure new flows on moreconcessional terms than in the past, if other exceptional treatment, such as debt reduction, wereoffered, or if faster GDP growth were to lead to higher government revenues.

71. Debt Servicing Capacity. Peru's current lack of creditworthiness originated with theGarcia Administration's unwillingness to service the government's debt. Peru's creditworthiness isexpected to improve following the repayment of its arrears to the World Bank and IMP inDecember 1992 and the earlier resumption of relations with the IDB and the Paris Club ofcreditors. The improvement in economic performance, in the coming decade, from a sustainedprogram of economic reform can be expected to underpin creditworthiness by improving Peru'scapacity to service its external debt.

72. Under the assumed scenario, the ratio of debt service to exports could fail quickly, to32 percent by 1999 from around 51 percent in 1993. However, the ratios of debt or interest toGDP, which better reflect the internal transfer problem, are projected to fail only slightly. Debtreduction would clearly lead to a greater reduction in the debt burden and contribute to thefuture recovery of Peru's creditworthiness. (See Table 1.4 in Annex 1, for a summary of Peru'sdebt and debt service indicators).

IV. External Trade: Performance and Polices

73. For the first decades of this century, Peru's was an open economy exporting a varietyof agricultural and mineral primary products. Industrialization owed much to the demand forcapital goods from the export sector. From 1959, the government adopted import-substitutionpolicies based on tariff protection and fiscal incentives. A military government in 1968 imposed astrategy of state-led development: job-protecting legislation and corporate forms of labor relationswere introduced; foreign-exchange controls and credit allocation were intensified, and tanff andnon-tariff protection came to be administered case-by-case. Industry became increasinglyoligopolistic, import-dependent, domestic-market-oriented, and inefficient. In spite of a landreform, industrial protection and cheap-food policies turned the terms of trade against agriculture.

74. Following a long period of currency overvaluation that culminated in a balance-of-payments crisis, a new economic team negotiated with industry a tariff structure sufficiently highto replace, in 1979, some non-tariff barriers. The government also introduced fiscal incentives toexports. With a return to civilian government in 1980 the administration deepened the trade-reforms, reducing the highest tariff from 155 to 60 percent and eliminating most non-tariffbarriers. The reform, however, left many tariff exemptions in place. Expansionary fiscal andmonetary policies in 1980-85, combined with a deteriorating terms of trade, an appreciating realexchange rate, and the natural disaster of 'El Niflow in 1983, led to large current-account deficits.Peru found it harder to borrow abroad to finance the deficits, especially after 1982. Rather thanadjust to all these shocks through the exchange rate, the Government chose to adjust throughtrade controls: reversal of the 1979-81 trade liberalization began in 1982 and, by 1984, much ofthe pre-1979 tariff structure had been restored and many imports once more required licenses(Table 4.1 of Annex 4).

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75. In 1985, the Government of Alan Garcia took to il-conceived, heterodox, expansionistpolicies in the hope of invigorating Peru's economy. The policies encouraged imports,discouraged exports, and, despite the limitations on debt servicing, led to a severe depletion ofreserves. Protection was strengthened: the Instituto de Comercio Exterior (ICE), created in late1986, was using foreign exchange allocations to control all imports by late 1987. By 1987 multipleexchange rates had become an additional tool to manage trade. From 1989 import licensing wascut back and used only for transactions enjoying a preferential exchange rate. Given the premiumthat preferential rates enjoyed over the market rate, this meant that the system remained highlyprotective and discriminatory: while only ten percent of tariff Unes required import licenses, amere five percent of lines protected an estimated 40 percent of manufacturing output. A host ofnon-tariff barriers - import monopolies, minimum-domestic-content rules, and bans on second-hand imports, for instance -- supplemented the official negative lists. Tariff remained high and avariety of preferential schemes -- allowing half of imports to enter duty-free -- benefitted selectedsectors and firms. To offset the heavy protection offered to import-substituting activities, non-traditional exports continued to enjoy heavy subsidies.

76. The most evident effect of protective policies since 1959 has been to close theeconomy: in 1961 exports and imports were 21 and 18 percent of GDP; by 1990 they were eightand seven percent (Figure 2.1 of Annex 2). At the same time, trade policies generated adistorted set of incentives to the tradable-goods-producing sector. For instance, effectiveprotection rates to manufacturing were typically high (averaging around 80 percent in early 1990)and variable (Figure 2.2 of Annex 2). The complexities of import protection and eWportpromotion - raised to an art during the Garcia regime - led to enormous discrimination anddiscretionality, not only between sectors but also between firms within sectors. The costs thatfirms spent seeking to gain or maintain these privileges were a completely non-productive use ofthe economy's resources and were passed on to consumers or taxpayers.

V. Trade PoliS1 Reform

77. In August, 1990, the Fujimori Government started a trade reform concurrently with astabilization policy that involved a float of the currency and a rapid correction of relative prices.Trade reform was intended to change the productive structure and eliminate economic privileges.By September, a substantial tariff reform had been achieved (keeping only three rates: 15, 25, and50 percent) and the import-licensing system had been suspended. A new Minister of Economyand Fmance, taking office in February, 1991, resumed the liberalization process by introducingnew measures in March, lowering the top tariff from 50 to 25 percent and removing almost allremaining non-tariff barriers and import monopolies. The trade reform achieved from August,1990, to March, 1991, has proven as rapid and deep as any other post-war reform, with thepossible exception of Bolivia's. It continues to have the support of a high proportion of Peru'sbusiness community.

X It is too early to assess the economic impact of trade reform. The economy remains inrecession (although there are some signs of industral recovery) and the demand for importsremains weak. By the available measures, the currency has been appreciating steadily since 1988(Figure 2.3 of Annex 2). This tendency continued after July, 1990, and the rate at the begnningof 1991 was one-quarter its 1988 leveL The reasons for the long-term decline in the realexchange rate are not clear; they are attributed by some to the rise of Peru's coca economy (now,

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by some estimates, equivalent to at least one-third of official exports). In the shorter term, thevalue of the (loating) currency has been influenced by the weakness of import demand and bythe capital inflows attracted by the relatively high real interest rates. Nonetheless, since March,1991, imports have grown, with consumer goods leading the way (Figure 2.4 of Annex 2).

Actual and Planned Reforms

79. The exchange-rate regime. In August, 1990, one of the first measures of the newGovernment was to liberalize the foreign exchange market. The exchange rate was unied, theInti floated, and convertibility restored. Convertibility permitted the abolition of the foreign.exchange controls which had been applied in the multiple-exchange-rate system prevailing untilJuly, 1990. Additional measures in March, 1991, completed the liberalization by freeing virtuallyevery capital account transaction. These measures eliminated the requirement for exporters tosurrender their foreign exchange earnings to the Central Bank, authorized banks to keep foreignexchange balances in correspondent accounts abroad, and eliminated a long-standing restrictionon maximum sales of foreign exchange for tourism. The black market m foreign exchange hasdisappeared (Figure 2.5 of Annex 2).

80. Imvort tariffs. The August, 1990, reform reduced the highest rate from 84 to 50percent, the number of rates from 38 to 22, and applied a minimum tariff of 10 percent to 39previously duty-free import regimes. In September, a further reform reduced the rates to three:15 percent for basic foodstuffs, medicine, some intermediate and capital goods, and some foods,25 percent for other producer goods, and 50 percent for other consumer goods. By this time,virtually every one of 139 preferential regimes (accounting for half of imports) had beeneliminated. In December, the Government announced a timetable to cut tariffs every six monthsto arrive at a flat 15 percent tariff by January, 1995.

81. In January, 1991, in a departure from the reform process, a five-percent tariff for theinputs of steel producers was introduced. But in March, the 50 and 25 percent rates werereduced to 25 and 15 percent. Over 70 percent of all tariff positions (weighted by production)now have the 15-percent rate (Figure 2.6 of Annex 2). In March the Government alsointroduced some protective specific tariffs for selected agricultural imports. These were replacedin May by a variable-surcharge scheme designed to lead to a landed price no higher than theprevious five-year average c.i.f. price plus a 15-percent tariff. The scheme covers: dried milk,wheat and wheat products (flour and pasta), corn and sorghum, rice, and sugar.

82. As a member of the Andean Group (along with Bolivia, Colombia, Ecuador, andVenezuela), Peru has since 1970 participated in a gradual and halting process of regional tradeintegration. Following the strong trade-reform movements in all these countries in recent yeas,the Group decided to accelerate the process. In December, 1991, the counties decided, inprinciple, to apply a common external tariff from January 1, 1992, and to move rapidly to feeinternal trade (which would apply to Peru from July, 1992). The proposed external tariff is low:initially, there would be no more than five rates, ranging from 0 to 20 percent; from the beginningof 1994, the top rate would fall to 15 percent, with only three or four rates. The actual tariffrates for specific products have yet to be negotiated, and these negotiations are likely to provedifcult given the different national philosophies on the optimal speed of trade reform. If thePeruvian Government judged these negotiations unlikely to succeed, it would maintain its presentobjective of achieving a flat 1'-percent tariff by 1995.

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83. In June, 1991, the Government passed aii anti-dumping and anti-subsidy code. Thecode permits duties to be levied on imports where dumping or subsidies could be demonstrated tohave caused injury, or the threat of this, to domestic producers. The implementing regulation forthe code has not yet been enacted.

84. Non-tariff import barriers.1 °' By September, 1990, all import prohibitions, historicallythe major import barrier, had been suspended. In March, 1991, new rules prohibited, in principleat least (with a few specific exceptions), a8l forms of discriminatory non-tariff barriers to importsand exports. Import prohibitions were permanently suspended. Preferential imports are nolonger subject to a test of whether local substitutes are available. Local-content regulations wereeliminated for assembly industries (notably vehicles and consumer durables). Several statemonopolies were eliminated, including import monopolies in rice (ECASA) and wheat, flour, andsugar (ENCI). In August, state-owned PETROPERU's internal and external trade monopoly inoil products was terminated. Imports of second-hand good. were completely banned untilNovember, 1990. From this time, many such imports were allowed, and in March, 1991, second-hand vehicle and machinery imports were permitted. Today, only clothing, shoes, and laundryitems are banned.

85. Quality controls on imports have been eliminated; some health controls on agriculturaland pesticide imports have been simplified (and some functions of these controls privatized), butcontrols remaining on food, drug, and cosmetic imports apparently continue to offer someprotection to local industry. In some cases -- for example, meat - such controls appear to havegrown in response to the loss of other instruments of protection. The Government is identifyingthe discriminatory content of such regulations and tackling them one after the other.

86. Exrort nolicies. In July, 1990, non-traditional exporters still enjoyed direct exportsubsidies, under the CERTEX scheme, ranging from 15 to 30 percent of the fo.b. value ofexports. In 1990, subsidies averaged 13 percent of the total value of non-traditional exports(Figure 2.7 of Annex 2). By November, the scheme had been abolished, along with a lessimportant scheme to subsidize interest rates for exporters (FENT). The new Governmentsubstantially increased the access of exporters to concessions on indirect taxes in March, 1991,liberalizing its temporary admission scheme and introducing a drawback scheme for traditionalexporters. Export restrictions were few, but the most significant of these have been removed andothers have been simplified (notably, health-related controls). Several traditional productscontinue to pay export taxes for fiscal reasons; the rate is now 5 percent (except for miningproducts where, at present, only copper is being taxed -- at 10 percent). Overall, export taxes areno longer quantitatively important: in 1990 they averaged 1.3 percent of the value of traditionalexports (Figure 2.8 of Annex 2), falling to an estimated ratio of only 0.3 percent by May, 1991.

87. Irade institutions. The executive branch of government has the general mandate fortrade policy. Within this branch, the main responsibility falls on the Ministry of Economy andFmance, which sets tariffs, is the major arbiter of non-tariff questions, and supervises theautonomous Customs Superintendency (SUNAD). The Ministry of Industry, Internal Commerce,Tourism, and Integration (MICITI) has held responsibility for integration (Andean Pact) policy

IQ/ Annex 4 briefly deswrbes Peru's progress in eliminating non-tarff barriers, listing the tange of barriersexisting in August, 1991, and the changes since then.

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and, in June, 1991, was given the responsibility for foreign-trade negotiations in general and forthe promotion of exports. Other ministries, notably Agriculture and Health, legislate on standardswhich can involve controls on foreign trade.

88. In August, 1990, the Govemment decided, in principle, to "de-activate" ICE, the focalpoint of discretionary import controls and export subsidies. It was not until June, 1991, that thisstep was finally achieved: ICE's assets and promotional functions were to be transferred toMICMTI and most of its staff were to be released. In September, the Government authorized thecreation of a joint public-private association for the commercial promotion of exports, to befinanced largely by the .eading trade associations (see Annex 9 for more details).

89. In March, 1991, the Government initiated a thorough reform of the Peruvian customs,having inherited a poorly -organized and -staffed service, with an ill-defined legal framework andan incoherent body of customs regulations. The inefficiency of SUNAD created obstacles totrade, reduced fiscal revenues, and gave cuptoms officials a high level of discretion. TheGovernment decreed a restructuring of the Superintendency and created the framework for a newstem of customs clearance that would simplify procedures and introduce the principle of bonafids This prnciple would be made operative through a procedure of "self-assessment' in wbichimporters or exporters (and their representatives) would determine and pay the taxes due withSUNAD's ex post verification. Tne Government further abolished the state monopoly in customswarehouses.

90. In August, 1991, the Government instituted a scheme for pre-shipment inspection, inthe port of origin, by qualifying international firms specializing in this process, of the quantity,quality, and price of goods to be imported into Peru. Importers would subsequently pay importduties based on the Certificate of Inspection thus issued, and the Customs Superintendency wouldclear goods after verifying the findings of the Certificate. The introduction of this nheme, whichhas not yet been put into effect, was not a part of the customs reform process; while it may, inthe shorter term, contribute to the valuation process, it also adds to the bureaucracy and costs ofimporting and potentially undermines the role that SUNAD must play in the longer term.

91. In September, 1991, under powers granted by Congress for promoting privateinvestment, the executive issued a Legislative Decree elevating to the status of a law many of thetrade reforms that had been carried out in the previous year. The new law guarantees freedom ofinternal and external trade and a free, unified foreign-exchange market. It makes the ban ondiscrminatory non-tariff barrers and tariff concessions permanent and guarantees the availabilityof anti-dumping protection and measures to exempt exports from indirect taxes.

92. Complementarv policies for trade reform. Trade reform is most effective if factors ofproduction are free to respond to market forces. The statist policies since the 1960s haveseverely restricted factor movements. Indeed, market rigidities were partly to blame for thefailure of the 1979-81 liberalization. While much remains to be done, the Government hassubstantially reduced inflexibilities, in particular through March, 1991, measures aimed atpromoting domestic and external competitiveness, private sector development, and deregulation.These measures were summarized above (paragraph 32).

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Dhe Epeted Impact of rrade Policy Reform

93. Trade reform can be expected to lead Peru to a more efficient use of its resourcesthrough specialization in productive areas where its comparative advantage is greatest and throughthe competitive pressures that freely available imports will exert on domestic producers. Theremoval of non-tariff barriers should also enable those resources previously used to acquirevarious import permissions to be put to better uses. For the longer term, Peru's greater role inthe international economy could be expected to be seen in larger imports and exports relative toGDP and a more diversified structure of imports and exports. Beyond this, it is fruitless to try topredict how trade reform will affect the structure of production.

94. The fiscal effects of the trade reform may be a little clearer. Lower average importtariffs, on their own, would reduce revenues, but the elimination of many preferential regimeswould act in the opposite direction, as too, probably, would the reduction in tariff variance and, inthe longer term, the expected faster growth of imports than GDP. Similarly, the elinmination ofexport subsidies has removed a drain on the budget. Effective import duties were 13 percent ofimport values in 1989 and fell to 9 percent by mid-1990 (Figure 2.9 of Annex 2). Preliminaryestimates suggest that the figure will rise to about 15 percent for 1991. The share of net revenuesfrom trade taxes (impcrt and export tax collections less export subsidies) in total central-government revcnues rose from around 11 percent in both 1989 and 1990 to 14 percent in thefirst six months of 1991.

95. Recent research has suggested that countries able to sustain their trade reform canusually expect to raise their imports after the reform, to raise their exports even faster, and thusto improve their balance of trade.1 ' This research also found the effects of trade reform onunemployment to be surprisingly small, even in rapidly reforming countries: after the reform,labor was largely reallocated within broad sectors, with far less disruption than might have beenfeared. Output tended to accelerate following a trade reform, often immediately for agricultureand with a more noticeable lag (in the first year) for manufacturing. These results cannot simplybe assumed for Peru, especially given the tenacity that inflation has shown and the continuing"low" real exchange rate. But the research strongly indicates that trade reform in itself,particularly when it is radical, does not need to disrupt the economy. This research did notestablish that lower-income groups gained or lost disproportionately from trade reform.

The Agenda for Trade Policy

96. The apparently high political acceptability of the trade reform so far owes much to thespeed of the reform, its transparency, and its removal of most of the inter-firm dicrminationwhich encouraged rent-seeking. The Government is comiritted to maintaining all the majoraspects of the reform so far achieved.

97. The exchange-rate regime. To maintain the convertibility of the Inti at a single ratefor current-account transactions, the Government will need to pursue appropriate monetary andfiscal policies.

I1/ See Demetrios Papageorgiou, Armeane M. Choksi, and Michael Michaely, Libealizinf PorMoan Thude inDeveloning Countries: the Lessons of Exnirience, the World Bank, Washington D.C., 1990.

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98. Import taniffs. The Government is committe o a policy of low tariff protection, butsome uncertainty has been introduced by the prospect of an Andean-Group common externaltariff. Peru's adoption of such a tariff, which envisages rates from 0 to 20 percent, could result inan increase in effective protection, as well as a fall in tariff revenues, to the extent that this tariffhad the highest rates on locally-produced goods and lowest rates on extra-regional imports.However, in conformity with the Andean Group's decision-in-principle to create a commonexternal tariff, the Peruvian Government's proposal is to assign tariff rates according to thedegree of processing incorporated in a product, which in turn would mean only a small degree oftariff escalation between processing stages. This approach, which would lead to a clustering ofmost items around the 10-, 15-, and 20-percent tariff positions, would not increase the currentlevel of effective protection.

99. If the Andean Group is unable to come to an agreement enabling implementation ofthe common external tariff, the Peruvian Government should take a more direct and simpleapproach to avoiding any increase in the level of tariff protection. This would mean notincreasing tariffs on any position or increasing the spread (defined in percentage points) betweenpositions. The most immediate further tariff change would then be to eliminate the 5-percenttariff on steel inputs introduced in January, 1991 (and to replace it by the 15-percent miimumtariff). Otherwise, this exceptional measure would continue to encourage other sectors to pushfor their own special rates. Eliminating the 5-percent tariff would smooth the way to the flat 15-percent tariff that the Government undertook (in December, 1990) to reach by Januaty, 1995.FmaRy, whatever justification may exist for the agricultural surcharges (price stability for Peruvianproducers and consumers of similar and substitute products), their continuation will encourage thepromotion of other forms of special protection. Therefore, the Government should consider waysin which it could reduce the scheme (for instance by reducing product coverage) or eliminate it.

100. Finally, the Government will need to implement the new anti-dumping and anti^subsidy code in such a way as to ensure that it does not become an instrument for protecting localproducers against legitimate import competition; this would require some revisions to the code, toinclude inter alia a procedure for fully documented, public hearings and a mechanism to ensurethat frivolous complaints are discouraged.

101. Non-tariff import barriers. To avoid the re-introduction of non-tariff barriers toimports and exports, the Government will need to pay particular attention to the border effects ofexisting and new health, safety, and technical regulations. It will need to develop consistentcriteria and corresponding regulations assuring that these regulations do not have the effect ofprotecting local productive sectors.

102. xport policies. Some traditional exporters -- particularly mines that face high fueltaxes and the mining and other sectors tnat pay export taxes -- still face considerable fiscaldiscdmination. While this is not a large distortion overall, the Government should act to removethese export impediments as soon as possible.

103. Trade institutions. The successful completion of the customs reform that has beenstarted is necessary in order that SUNAD become an efficient and impartial organ for theprocessing of trade, not only to maxdmize fiscal revenues, but also to secure public credibility inthe new trade system.

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104. Accompanying policies. The process of reform in policies that assure flexibility inproduct and factor markets is well underway (paragraph 32), but is nonetheless only in itsbeginning stages (and is less advanced than the trade-reform process itself). The consolidationand extension of these reforms is vital to the success of the trade reform

VI. The Propod loan

Histo[y of the Loan

105. Following tne discussions that led to Peru's resumption of current-debt servicing to theBank in October, 1990, three Bank missions visited Peru in late 1990. One mission prepared areport analyzing the country's reform and investment needs, particularly in the public sector(Peru: Sector Reform and Investment Review November, 1990). A second mission assessed theGovermnent's Social Emergency Program. A third looked at economic stabilization and strucwaladjustment issues (Peru: Economic and Sector Reforms to Sustain Stabilization and Lay theFoundations for Development June, 1991, white cover). This last mission proposed a range ofreforms to stabilize the economy and induce reforms in specific areas, including the labor market,public administration, the fiscal area, and the financial sector. Specific proposals in the area offoreign trade included: a rapid move to a low and uniform tariff; elimination of export subsidies;and the creation of a safeguard mechanism to adjudicate claims of import injury that balancedproducer and consumer interests. The mission also proposed a detailed plan for the reform of theCustoms Superintendency based on the principles of simplification, administrative rationality, bonaris, and devolution of some functions to the private sector.

106. Following this work on trade and customs, the Govermnent requested further helpfrom the Bank, and a mission, fuided undtr the joint UNDP-World Bank Trade ExpansionProgram, visited Peru in February, 1991. At the further request of the Government, the mission,before it left Lima, recommended a series of major measures to provide a new impulse to thereform process which had been started in August, 1990. It proposed: an immediate reduction intariffs to leave only three rates, 15, 20, and 25 percent, and the move to a flat 15 percent tariffwithin one year; an elimination of controls on second-hand imports of capital goods and motorvehicles; the permanent elimination of the main non-tariff import barriers and further eliminationand simplification of remaining technical barriers; the extension of the temporary admissionsystem to cover all exports; the preparation of a plan -o reform customs; the de-activation of ICE,the institution controlling imports and awarding export subsidies; the careful introduction of anti-dumping legislation; and the consideration of a scheme to provide internal price stability toselected agricultural products through a variable specific tariff. The Government has since actedconsistently with the mission's recommendations in all these areas.

Reforms to be Supported under the Loan

107. We propose a quick-disbursing (sectoral adjustment) loan in support of Peru's currenttrade reform program. This reform can be favorably compared to any of the major reforms inLatin America. For instance, Mexico took more than three years (from 1985) to make tarff- andnon-taiff-reform advances comparable to those Peru achieved in less than eight months. Chilewas two years in removing its non-tariff barriers and six years in arniving at a flat 15-percent tariff

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108. Specifically, the loan would recognize the major trade reform measures taken betweenAugust, 1990, and September, 1991. These measures, descnbed in paragraphs 80-91 i.-dpresented schematically in the Policy Matrix (Annex 3), can be summarized as follows:1

(a) I&rjff: the simplification of the structure and substantial reduction in the leveland variance of protection; the elimination of most special regimes allowingdiscrminatory preferences on the domestic market; the introduction of an anti-dumping code;

(b) non-tariff import barriers: the elimination of formally protective barriers,including prohibitions, minimum-local-content regulations, controls on mostsecond-hand imports, and state agricultural import monopolies; the reduction orsimplification of some technical/safety/health controls on imports;

(c) export regime- the elimination of fiscal and financial export subsidies; theimprovement of schemes to allow exporters to recuperate indirect taxes;reduction in non-tariff export barriers;

(d) trade institutions: the abolition of the Instituto de Comercio Exterior; initialreforms of the customs function; the passage of a legislative decree raising to thestatus of a law many of the trade reforms previously enacted.

109. The conditions proposed for this loan relate largely to the maintenance of thecurrent reforms: given the depth of the reform so far, measures for further reform are generallyconsidered a secondary issue, except insofar as further reform is felt necessary to secure thecurrent reforms. Thus, in the sectoral conditionality detailed below (paragraph 125), the emphasisis on 'conditions preventing policy reversal", rather than 'conditions for further reforms".

The Loan

110. A loan is proposed for $300 million under conditions consistent with the Bank's newpolicy of "Additional Support for Workout Programs in Countries with Protracted Arrears0(paragraph 3 above). Under this policy, the Board's approval would entitle Peru to the immediatedisbursement of the whole loan amount after loan signing and effectiveness. These would takeplace at the end of the performance period upon satisfactory implementation of the trade policyreform program, the economic stabilization progam, and the external financing plan (includingclearance of all Bank arrears). The performance perod, which started with the initial reforms ofAugust 8, 1990, would terminate in December, 1992, concurrently with the termination of theIMFs rights accumulation program. We do not propose any particular use of local counterpartfunds. The borrower would be the Government of Peru; the implementing agency would be theMinistry of Economy and Fnance.

1I P! ated efonns, not considered here, are the floaing of the currency (paragraph 79) nd various m_austo increase factor mobility and reduce costs (pawgaph 92). These reforms will be conidered under thefbaihoming SAL.

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111. Given that, under the workout program, effectiveness will not occur for at least tenmonths after Board presentation, the standard grace period will be calculated from the time ofloan signature, rather than Board presentation.

Procurement. Disbursement. Audit. and Administration

112. The proposed loan would be used in its entirety to finance 100 percent of the c iLcosts of eligible public and private sector imports. Eligible imports would be all goods andservices except those normally excluded under Bank policy-based lending, such as alcohol,tobacco, and armaments, as well as luxury, environmentally hazardous, or other goods specificallyprohibited in a negative list, and goods financed by other Bank loans or loans from official multi-or bilateral sources. The closing date of the loan would be June 30, 1993.

113. The proposed loan faces two particular circumstances affecting procurement anddisbursement. First, given the Bank's total proposed adjustment lending program for FY92 - anexpected sum of $900 million, all of it required to rapidly disburse in December, 1992 - and theexpected level of IDB adjustment lending and bilateral aid for the same years ($700 million and$1,300 million respectively), the amount of imports which are to be subject to Bank disbursementand procurement procedures will be substantial in relation to overall eligible Peruvian imports(total imports are currently almost $3 billion per annum). -

114. Second, effectiveness will fall well behind the policy reform process that the loansupports: the economic reform process began on August 8, 1990 (with the trade-reform processbeing substantively completed by April, 1991), Board presentation is expected in early 1992, butthe loan will not be signed before the end of 1992, that is, 28 months after the beginning ofeconomic reforms. Under these circumstances, retroactive financing of eligible imports for thewhole of the loan amount is recommended from August 8, 1990.

115. A Country Procurement Assessment Report prepared by the Bank on September 9,1991 noted that the laws and decrees governing the procurement procedures followed by bothpublic and private sector importers were in broad conformity with the World Bank's ProcurementGuidelines. In addition, the annual budget law provides that goods and works financed byinternational financial institutions will be procured in accordance with the requirements of theseinstitutions.

116. Trade policy reform since August, 1990 -- the wholesale reduction of tariff and non-tariff barriers, the elimination of fiscal privileges, the removal of controls on foreign-exchangetransactions, and the beginning of customs reforms - has immeasurably strengthened thecompetitive environment in which private purchasing decisions are made.

117. In view of the above-mentioned reforms, the following procurement procedureswould apply:

(a) Contracts for the procurement of imports made by public and private importersvalued at or exceeding $5.0 million would be procured under simplified ICBprocedures in accordance with Bank Procurement Guidelines. Imports of petroleumproducts and commodities such as wheat, corn, sugar, etc., would be purchased undercompetitive procedures acceptable to the Bank. In addition, direct contracting would

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be acceptable if it is in accordance with the requirements of paragraph 3,5 of theProcurement Guidelines. Contracts below $5,000 would not be eligible for Bankfinancing.

(b) Public sector imports valued at below $5.0 million and above $5,000 would beprocured in accordance with local norms which have been assessed as acceptable tothe Bank in the Country Procurement Assessment Report of September, 1991.

(c) Import contracts by private importers below $5.0 million and above $5,000 would beawarded in accordance with established commercial practices, which are acceptable tothe Bant These practices generally consist of inviting more than one quotation,except for importers of small amounts of consumer goods, who generally buy fromtraditional sources using direct negotiation.

118. Disbursements for contracts under $5.0 million would be made against Statements ofExpenditure (SOEs) for which the relevant procurement documentation would be kept locally forsupervision by the Bank staff in the field and for auditors whose terms of reference for auditingwould be acceptable to the Bank

119. The Ministry of Economy and Finance would administer the loan and be responsiblefor submitting the relevant documentation for disbursement. To fulfill this task, the Ministry hasestablished a Coordinating Unit to ensure compliance with loan conditions, prepare disbursementrequests, supervse consultancies, and flfill reporting requirements to the Bank.

120. To assist in the preparation of disbursement requests, the Ministry and the CentralBank have, in conjunction with the Customs Administration, created a Special Procurement Unitresponsible for the collection of relevant procurement documentation, ensuring that only eligibleand correctly procured imports are included in withdrawal applications. This documentation,would be retained for review, as required, by the Bank and the project auditors.

Technical Assistance

121. The technical assistance necessary to support Peruvian trade reforms wili be providedoutside this project The Customs Superintendency urgently requires technical assistance for itsrestructuring, and the IDB is providing a Technical Cooperation component of the trade policyloan it is financing in cooperation with the Bank. In addition, part of a Bank-administeredJapanese technical assistance grant to the Peruvian Govenment, which is in the final stages ofdiscussion, will be used to support the trade reform. This grant will be used to: help the Ministryof Economy and Finance undenake various studies to monitor the trade reforms and to fulfilproject conditionalities (studies on reforms in the anti-Jumping code, the agricultural surchargescheme, and the admuistration of non-tariff barriers); organize trade-policy seminars and training;develop commercial export support programs in the Ministry of Industry, and strengthen theCoordinating Unit (in handling disbursements, for instance). (See Annex 9 for details of thetechnical assistance to be offered through the Japanese grant.)

- 32 -

Letter of Development Policy

122. The basis for this loan is provided by a Letter of Development Policy (Annex 6).Given the context of Peru's workout, which envisages several adjustment projects and aperformance period that separates Board presentation from loan signature, this Letter goesbeyond the normal scope of a letter of sector policy and constitutes the understanding which theGovernment and the Bank will have at the time of Board presentation on the conditions andcriteria according to which the agreement for the proposed loan can be later signed and madeEective.W The Letter:

(a) sets out the Government's medium-term macroeconomic stabilization and adjustmentprogram;

(b) descnrbes the external financing plan for 1991 and 1992;

(c) sets out the process and timetable by which the loan is expected to be signed andbecome effective;

(d) describes the evolution, objectives, and guidelines of trade policy, setting out theprecise sectoral (trade-policy) conditions the Government undertakes to fulfill duringthe performance period and describing what further actions are intended in thelonger term; and

(e) indicates how the Government will report to the Bank during the performanceperiod.

Conditions

123. Conditions of Board presentation. Consistent with the Bank's new policy onAdditional Support for Workout Programs, the following Board presentation conditions have eonmet,

(a) a macroeconomic stabilization proram in place and agreed by the If and theBank, as described in paragraphs 35 to 37 above; this program would providethe common framework for this loan and the two subsequent adjustment loansproposed for Peru's workout; the Bank woul follow quantitative indicators ofmajor macroeconomic variables for 1992 (paragraph 47 above): within thesebroad indicators, the Bank would pay particular attention, in monitoring theprogram, to measures of fiscal revenue enhancement and expenditure controlwhich will contrbute to efficiency, equity, and the sustainability of adjustmentin the medium term;

3f/ it is envisaged that the subsequent two adjustment opeions in the debt workout would have a similLter of Developmet Policy, with common contents for the parts (a), (b), and (c) described below, excetwhr updating or changed cicumstces required specific, agreed changes.

- 33 -

(b) an external financing plan. agreed among the international financial institutionsand the Support Group, which would, as descnrbed in paragraphs 57 to 68above, provide for full clearance of arrears to the Bank and the normalizationof Peru's relations with the IMF and the IDB;

(c) agreement on sectoral conditions as outlined in paragraphs 125-126 below; and

(d) Peru remaining current on its servicing of debt to the Bank currently falingdue (other than debt covered under (b) above), on the terms already agreedwith the Government.

124. Conditions of loan signing and effectiveness. Consistent with the Bank's new policyon Additional Support for Workout Programs, loan signing and effectiveness conditions would beas follows:

(a) signing:

(i) prior clearance of arrears to the Bank;

(ii) compliance, during the performance period, with the IMF andBank-supported program of macroeconomic stabilization(paragraph 123(a) above), with particular reference to the Bank'squantitative indicators;

(iii) the continued viability of an external financing plan (paragraph123(b) above);

(iv) compliance, during the performance period, with the Bank'ssectoral conditionality as under paragraph 123(c);

(b) effectiveness:

(i) taking of all governmental actions required to authorize (or, ifnecessary, to ratify) signing of the loan agreement; and,

(ii) if a lapse of time occurred between signing and these actions,continued satisfactory implementation of the trade reform andmacroeconomic stabilization programs and the extetnal financingplan, in accordance with the provisions of the Letter ofDevelopment Policy.

125. Proposed sectoral conditions. The Government has agreed to the following conditions(for greater details, see the Policy Matrix, Annex 3, and Appendix A to the Letter ofDevelopment Policy, Annex 6).

A. Conditions preventing policy reversal. These will be monitorable conditions,based on the policies in force on July 5, 1991. (The policies then in force are:described in paragraphs 79 to 91 above; summarized in the third column of the

- 34 -

Policy Matrix (Annex 3); and detailed in paragraphs l(a), (b), (c), (d), (e), (f),(h), and (i) of Appendix A of the Letter of Development Policy, Annex 6.)Reversal of specific policies would be defined as follows:

(i) the reintroduction of foreigr-exchange controls on imports;

(ii) a rise in the level and variance of tariff Drmtection (whetherresulting from changes in specific rates or from tariffsurcharges);-II

(iii) the reintroduction of any tariff preference for the domestic market(except under international trade agreements);

(Ov) extension of coverage of the agricultural surcharge scheme;

(v) extension of free trade zones with the effect of selling, free ofimport taxes, imported goods on the domestic market;

(vOi) eintroduction of banned non-tariff barriers, including the use ofreference prices for protective purposes;

(vii) raising of export-duty rates or extension to new products orreintroduction of fiscal or financial subsidies to exports;

(viii) survival of any of the functions related to import or export controlsthat the now-extinct ICE fulfilled.

B. Conditions for further reforms. (These conditions are summarized in the fourthcolumn of the Policy Matrix, Annex 3, and detailed in Appendix A of the Letter ofDevelopment Policy, Annex 6.)W

(ix) agreement to replace, by March, 1992, the 5-percent rate on steelinnuts by a 15-percnt rate, unless the Goverment and the Bankagree that a new common external tariff is likely to be implementedin accordance with the recent decision-in-principle of the AndeanGroup;

(x) agreement, by March, 1992, on a terms of reference for a study toevaluate the icultural surcharge scheme agreement by June,1992, on guidelines for implementing the study's recommendations;

I If Peru implements a common extenul tariff which is in accordane with the tariff criteria establishd inthe recent denisin-in-priciple of the Andean Group of countres, this condition would no longer apply.

,I/ Tle March, June, and September, 1991, dates for compleding various actions, notioned in the rst of thisparagraph, ae meant to be target dates, rather than precise dates.

-35 -

and enactment, by September, 1992, of the reforms in line with theagreed guidelines;

(xi) carry out, under terms of reference which have been agreed withthe Bank, a study to develop consistent criteria, and proposecorresponding regulations, which minimize the protective features(Le. those that discriminate in favor of domestic producers) ofexisting (and any new) health. ohvtsanita. and technicalregulations; agreement, by March, 1992, on the guidelines andprinciples to be applied in implementing the study's finmdgs; andenactment, by June, 1992, of the reforms in line with the agreedguidelines;

(xdi) carry out, under terms of reference which have been agreed withthe Bank, a study to propose amendments to the Anfiumpggcod so that it does not become an instrument for protectionagainst legitimate import competition and it operates in antransparent manner; agreement to enact, by March, 1992,amendments to the code in line with the studys recommendations.

(xiii) implement the agreed Action Plan to restructure the CustomsSu2rtendency (see summary in Annex 5); compliance with therequired actions under the three phases of this Plan, by Boardpresentation (first phase), b5 March, 1992 (second phase), and byJune, 1992 (third phase).

126. In the Letter of Development Policy (Annex 6), the Government commits itself to thespecific sectoral measures outlined in paragraph 125 above. It also emphasizes its commitment tomaintaining current exchange-rate and trade policies as the basis for free trade and full private-sector participation in all economic activities. The Government intends to pass legislationensurng that non-tariff technical and health barriers to imports are non-d rminatory. It wilguarantee that protection against unfair competition from imports is not excessive. It will achievea uniform 15-percent import tariff by January, 1995, (unless a common external tariff has beenimplemented in accordance wMth the recent decision-in-pnnciple of the Andean Group) andeliminate export taxes and discriminatory effects of indirect taxation when the fiscal situationpermits.

Monitorinj and Repor

127. Ihe Bank and the Government have ageed on the information which the latter willprovide during and after the performance period on developments in macroeconomic policy andperormance, the external financing plan, trade poliy and performance, and the implementationof the restructuring of Customs. The information is listed in Appendix B to the Letter ofDevelopment Policy, Annex 6.

12& Consitnt with the Bank's new policy for Workout Programs, the management willsubmit each quarter to the Board a report on Peru's complince with the requirements of this andthe other adjustment loans in the workout. The report would assess the likelihood of a successl

-36-

workout by December, 1992, and recommend as necessary any modifications to the conditionalityor administration of the loan. Specifically, the report would cover the following topics.

(a) Peru's progress in fulfiling the obiectives of the macroeconomicstabilization program with particular reference to the risks that have beenidentified (paragraphs 39-46).

(b) Progress in fulfilling the conditions of the external financing plan i-cludingPeru's servicing of current payments due to the Bank; and any relateddevelopments (for example, negotiations with commercial banks).

(c) Progress in fulfilling the sectoral conditions of the workout loans, in thecontext of overall sectoral performance and policy and other developmentsaffecting fulfillment c! sectoral conditions and sectoral performance;

Coogeraion with the 1DB

129. On September 18, IDB's Board approved a fast-isbursing $425 million Trade SectorLoan, $325 million to be disbursed on effectiveness, with $50 million for each of a second andthird tranche. The loan covers five areas: (i) trade policy, (ii) customs reform; (iii) labor-marketreform; (iv) private-sector development in agricultural marketing; and (v) the social compensationfund. IlB and the Bank have developed their analysis and sectoral conditionality on trade andcustoms reform in close cooperation, in partcular through concurrent pre-appraisal missions inJune, 1991A In these two areas conditions in the two loans are virtually the same.

130. As a complement to its loan, IDB's Board also approved a $4.9 million reimbursableTechnical Cooperation component, of which $2.3 m illion is for funding the technical assistance forCustoms restructuring.

Project Benefits

131. The likely direct benefits of the trade reform supported by this loan - the expectedgains in economic efficiency - have been described elsewhere in this report (paragraphs 93 to 95)*The project will also realize benefits through its contnbution to Peru's workout and reintegrationinto the international financial community. In addition to providing some fresh external funds toPeru between now and the end of 1992, the workout will open the door to resumption of anormal relationship with the Bank, involving the financial and know-how transfers of investmentlending, economic and sector work, and technical assistance. Ihe workout wil allow Peru tonormalize relations with other multi- and bilateral donors even before the Bank itself disburses

kPwiec Risks

132. The Government is strongly committed to trade reform, as too - at the moment atleast - is a majority in the business sector. But the ability of the trade reform to survive and the

1I6/ Me odter tue ar will be covered by the B=ak in the SAL, and the Bank contius to work closely withe IDB in these anras.

- 37 -

opportunity for further reforms will depend on several factors. First, the survival of the reform isinseparable from the prospects for economic stabilization. Second, the real exchange rate remainsat a substantially appreciated level, and the Government has been under great pressure, especiallyfrom exporters, to reverse its policy and intervene heavily in the foreign exchange market. Butgovernments are relatively powerless to exert a direct effect, short of running a budget surplus. Athird source of pressure to reverse reforms can be expected to come both from businessmen withvested interests in a strategy of protected import substitution and from those within thegovernment who have lost power as discreonary import controls have been dismantled. Fourth,distortions elsewhere in the economy, although they have been reduced by measures taken by thenew Government, continue to inhibit a flexible response from producers. Fifth, the politicaluncertainty generated by a still-weak government capacity and the unstable security situation willcontinue to add risks to any reform movement in Peru. Sixth, there is an external risk: theinternal reform process depends substantiaDly on the coordinated support of the internationalfinancial community; this risk has diminished recently as a result of the progress made inimplementing the external financing plan. 'Te final risk is that social unrest could delay or arrestthe reform process: the Bank's second planned operation, the SAL, proposes to address this risk(see paragraph 135 below).

133. Whatever the risks that can be enumerated, the trade reform process must be seen aspart of a larger program of stabilization and adjustment. This larger program is not itself risk-free, but it still has strong political support; it is evident that, in Peru's straitened fiscalcircumstances, the Government has few choices.

The Social Impact

134. The policy mistakes that led up to the stabilization and economic reforms of 1990 alsocreated enormous social problems, and the new Government, facing a fiscal problem of enormousproportions, has had limited means to address these problems. It is not clear that trade-policyretorm, in itself, contributes to these problems, but in this case any effects of trade reform arewashed over by the broader stabilization and structural adjustment program of which it is part.

135. To address Peru's chronic poverty problem and to mitigate a recessive impact of thestabilization/adjustment program on the living standards of some of the poorest groups, thestructural adjustment loan (the Bank's second planned adjustment operation) calls for concertedaction to define and implement well-focused social measures designed to meet the most urgentneeds of the poorest social groups. These measures would include: (a) adoption of an explicitpoverty alleviation strategy; (b) elaboration of operational plans in basic health and educationwith priority project profiles; (c) elaboration of a national nutrition policy based on a review ofexisting food assistance pr.ograms; and (d) the initial implementation of this policy.

136. The Bank plans to assist the Government in implementing the above measuresthrough: a Japanese technical assistance grant, which wil be used to support the organization ofFONCODES and help develop priority social project profiles; preparation of a poverty report byJune, 199Z, outlining a poverty reduction strategy, and program and financial options; and a series,planned for the coming months, of donor meetings for the social sectors to present the povertyalleviation strategy and mobilize aeternal financing for priority programs and projects. The IDBand UNDP will also provide technical assistance to set up the adminstrative structure and

-38-

operational procedures of FONCODES. Action in this area is a high priority and is supported bya component (consistent with our views) under the IDB's Trade Reform Loan.

VII Recommendation

137. I am satisfied that the proposed loan would comply with the Articles of Agreement ofthe Bank and recommend that the Executive Directors approve the proposed loan.

Lewis T. PrestonPresident

Attachments

Washington, D.C.

January 10, 1992

TABLE 1.1 VWU : Batance of Payments Projectiens t Current Account Excluding---- Interest Pa_mnts, 1990-1999.

(S ml itt ilm)............ ...................... _,,............._. -.-......................................

Projected~~~~~~~~~.......... ----------------------------- _-_._------,-_.

1990 1991 1992 1993 1994 1995 196 199? 1998 1999.................... ....................................................................................................................

Nsrchandlse Trade Ac cnt 448 (25) 44 129 267 458 669 892 1.149 1,438Exports of Goods 3,333 3,240 3,758 4,091 4.578 5,252 6,015 6,863 7,83 8.975

ts dw tiami 745 725 840 91S 1.024 1.174 1.345 1,53S 1.754 24,0701tzer' tradJt1on t,"6U 1.602 1,858 2,023 2,264 2,597 2,974 3,394 3,8?8 4,438llen Traditional 940 914 1,060 1,154 1,291 1,481 1,696 1,935 2,211 2,531

1s4orts of Goods (2,885) (3,265) (3,714) (3,963) (4,312) (4,794) (5,346) (S,9n) (6,694) (7,537)

*FS Balance (610) (694) (769) (798) (833) (882) (939) (1,008) (1.089) (1.186)Exports of UFS 972 901 1,045 1,138 1,273 1t461 1,673 1,909 2,181 2,496laports of UFS (1,582) (1,595) (1,814) (1,936) M2M106) (2,342) (2,611) (2,917) (3.270) (3,682)

Resource Balne (162) (719) (725) (670) (566) (424) (269) (116) 60 252................ ............ .......... ..... ....... ..... ....... ----- ....... ----- ....... .. ........... ,.... .._... _.,-

fator ttce (120) (77) (36) (65) (74) (98) (11S) (128) (307) (446)Fector Receipts Net 74 105 127 142 160 176 194 204 211 218Private B Short-Term Interests aJ (146) (124) (120) (119) (116) (121) (118) (124) (130) (138) 0Other Factor Pa ments (48) (S8) (43) (88) (118) (153) (191) (208) 388) (S26)

Not Current Transfers 247 259 269 270 275 285 296 307 319 331

lln-Interest CurrenttAccmt a_ (35) (536) (492) (4S) (366) (236) (88) 63 n 137

... ....... .. .. V .. ..... .. ... .. .. ... .. ..... .. .. ... ..... ....... .... ... .. .. ... .... ... .. ..... .. .. ..... ..

eJ Does rot lncludc' Interest on ptMilc debt.

PIs

Teble 1.2 - PERU s Batance of Payments Projections : financing Requaremunts andPossible Sources of Financing, 1990-1999

(USS miltions).................................... *,,................. .................... .......................................... ............... ................................................. ....................................

1990 1991 1992 1993 1994 1995 1996 199? 1998 1999.................. .................................... _.. ....... _,. .. ..... ...... ,..................... ............................. .................................................. ..... .......... .............

Financ-in Requiremsnts.................. .................... ..

1. Non-tnterest Current Account Deficit 35 536 492 465 366 236 88 (63) (72) (137)

2. Pub41t Sector Debt ServiceObligatfons : 2,619 2,616 2,398 2,494 2,635 2,72? 2,890 3,192 3,406 3,642

buAtilaterat 650 513 530 625 688 708 749 889 933 987Bilateral 1,015 1,208 1,170 1.128 1,170 1,193 1,252 1,341 1,434 1,533Private 954 895 698 741 m 826 89 962 1,039 1,122

3. Arrears to be Settled inCurrent Year 0 12,055 1,800 0 0 0 0 0 0 0

Multilateral 0 379 1,800 0 0 0 0 0 0 0Bilateral 0 5,322 0 0 0 0 0 0 0 0Private 0 6,354 0 0 0 0 0 0 0 0

4. Change In Gross Reserves 290 454 303 223 225 200 198 100 100 122

5. Gross Finamcing Requdrements (1+2.3+4) 2,944 15,661 4,993 3,183 3.225 3.163 3,176 3,229 3,434 3,627...... ........ ..... ....... ..... ....... ..... ..... .. ..... ...... .............. .. .. .......

6. Pipeline Loan Disbursements 24S 255 200 80 68 51 3 0 0 0

7. Private Capital Flews 367 908 545 509 654 72 844 731 186 291

8. Increase inrrears 2,144 0 0 0 0 0 0 0 0 0

9. Other Lfabilities and Adjust. 188 0 0 0 0 0 0 0 0 0

10. FInancing Requfrements(S-6-7-8-9) (0) .4,498 4,248 2.594 2,503 2,385 2,329 2,498 3,248 3,336

== s ac= am= _ :"=_ n

Sources of Fifancing.....................

11. Debt Resdcedutis wnd Deferal 0 13.598 1,467 743 798 736 785 854 1,041 1,296Bilateral 0 6,352 769 2 21 (90) (102) (108) 2 174Private 0 7,246 698 741 m 826 887 962 1,039 1,122

12. Additional Disbursements 0 900 2,781 1,337 1,468 1.373 1,324 1,549 1,612 1,675Multitaterat 0 654 2,328 502 624 505 449 665 692 719

FUAR 0 170 200 0 0 0 0 0 0 0TORD ID, nd IMF 0 484 2,128 502 624 S05 449 665 692 719

Bilaterai 0 246 4S3 835 844 868 875 884 920 956

13. Additional Financing Required (0) A() 0 514 237 276 220 95 595 365 'II14. Totat Sourees of Financing (0) 14,498 4,248 2.594 2,503 2,385 2,329 2.498 3,248 3,336

(11.12+13) =u= v== _ =inu I Uu = a=== u== I# 3 u=u=

........................................................................................................................................................

Tabte 1.3 - PEII: Iatllat Accounts Projectians, 1990*1999.

.......... .................. _i**..........................................................................................................................

Prel. ProJected

1990 1Wt1 1992 1993 1994 1995 1996 1997 1998 1999

In Cmtmnt Prices (Niltlen 1919 Sles)

GDP ' 3.264 3.356 3,439 3,543 3.649 3,758 .S98 4,026 4,187 4.376

Total Cmnsuiptiln 2.429 2,537 2,547 2,583 2,64S 2,707 2,779 2,852 2.943 3,053Private Consuipion 2.151 2.271 2,264 2,295 2,33S 2,390 2,435 2,496 2.576 2,670Pubtle Consitale 278 266 283 288 310 317 344 354 367 383

Total Inwestent 627 6S0 658 667 661 657 675 698 725 760ol roes flied tIv. 594 618 652 664 6S8 654 672 694 722 56

Private Inwestmmnt 527 543 557 520 45S 404 414 429 446 469Puitc I.nstmnt 67 75 94 144 202 250 258 266 275 287

Chmna In Stocks 33 31 6 3 3 3 3 4 4 4

Gross Damotic Sawins 835 819 892 960 1,004 1,051 1,111 1,174 1,244 1,323

Exports 811 768 909 1.011 1,110 1,216 1,319 1.426 1,545 1,676Iiports 603 599 675 71 76 822 3 950 1t,026 1,113

................... ............................................. _...................................

.~~~~~~~~~~~~~~_

Tabe 1.4 - PERU : Projections of Key fEcmc irdicators, 190-1999.,.,............................ .. _......,. ,,.... ,.............................. ............................................................... __....

Pret. ------------------------------------- Projected -199 1991 . 1 1993 1994 1995 1996 997 `1998 1999

6rtbh Rates (prcent):.......................

MP -4.9 2.8 2.5 3.0 3.0 3.0 3.5 3.5 4.0 4.5MP per copito -7.4 0.3 0.1 0.6 0.6 0.7 1.2 1.3 1.8 2.3aT -5.0 -1.9 1.9 2.0 2.8 3.0 3.9 3.9 4.1 4.8on per cata- -7.5 -4.4 -0.5 -0.4 0.4 0.7 1.6 1.7 1.9 2.6Cors"tian -4.1 4.4 0.4 1.4 2.4 2.4 2.6 2.6 2.7 2.9Curumptien per capita -6.6 1.9 -2.0 -1.0 0.0 0.1 0.3 0.4 0.5 0.7

Exports OS (Uss) -6.3 -3.8 16.0 8.9 11.9 14.7 14.5 14.1 14.3 14.4Exports ePS (Ctanstt ust) -5.0 -S.4 18.5 11.2 9.8 9.6 B.5 8.1 8.3 8.5Exports of Goods (Constant Ust) -9.2 -2.3 19.4 11.8 9.8 9.4 8.0 7.6 7.8 8.0Exots VS -6.6 -15.4 14.9 8.5 9.8 10.6 10.3 9.9 10.1 10.3

Isports GNFS (USS) 25.9 8.8 13.7 6.7 8.8 11.2 11.5 11.7 12.1 12.6iqport GlfS (Comstant SO) 12.4 -0.7 12.7 6.4 6.8 7.2 7.4 7.6 8.0 8.Sltowts of goods (USS) 32.2 13.2 13.7 6.7 8.8 11.2 1. 11.7 12.1 12.6

1apwrt of goods (Constent USS) 24.4 3.3 12.7 6.4 6.8 7.2 7.4 7.6 8.0 8.S

Debt Indicators (percent) :...................... ......................... .

DebtExo GlrS 502.0 S60.8 524.5 510.3 484.3 445.0 407.5 374.3 344.S 317.858.2 5.T 63.6 63.8 63.0 61.9 60.S 59.0 17.5 55.9

IBD Debt / Total DMC 7.2 6.3 5.4 5.7 6.2 6.2 6.0 5.8 SJ. 5.4

Debt service/Exports WXS j 66.2 359.5 73.8 51.0 47.0 42.4 38.7 37.0 34.5 32.3Debt swrvic*Gd qJ 7.7 37.0 8.9 6.4 6.1 S.9 S.7 5.8 S.8 S.7

Interest /Exports GIrS 36.3 40.1 36.4 36.2 34.1 31.6 28.9 26.7 24.6 22.7Interest /GDP 4.2 4.1 4.4 4.5 4.4 4.4 4.3 4.2 4.1 4.0

1IM/ Caestry Puihle Debt 8.0 7.0 6.0 6.4 6.8 6.8 6.S 6.2 5.9 S.718RO1 Contry Pubtle Debt Serice aj 8.1 20.2 60.6 10.9 10.7 10.2 9.0 10.8 11.2 12.1EMD Debt Service I Exports WPS 4.8 5.1 22.8 3.4 3.0 2.8 2.3 2.6 2.4 2.2

Preferred Cred./Pubic Debt srwvice aj 24.8 83.1 78.4 33.5 33.0 31.3 31.1 32.8 34.4 37.2

tCuntry Share 1.7 .5 1.4 1.5 1.6 1.6 1.5 1.4 1.3 1.3

Total o (Slletion Us) 21.6 23.2 25.2 26.7 28.3 29.9 31.3 32.8 34.5 36.5...... _ .....................................................................................................................................

aJ P"btic debt service lncludes repasent of arrears to outtilaterats Institutions (1991 and 1992)and reesscwhatfng of arrear owed to bitaterats. comerclal bu*s, and supptiers.

(contiwmed)

table 1.4 (Ccnthuaxd) - PMR : ProJectians of Key EcnMic Idlectorw, 1990-1999................................... ''''.'''''''''.'''''................................................................................................. _Prel. ---------------------- Projected....................I.

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999-----............................ *-.-....... ....................................................

Shares In Current DP (percent) :..................... ................................

CeuEuapimfn 76.8 81.0 8019 80.8 81.0 31.2 80.8 80.4 9.7 78.7Private 70.8 n.5 71.9 71.8 71.5 71.7 70.6 70.4 69.7 68.?PuM I 6.0 8.5 9.0 9.0 9.5 9.5 10.0 10.0 10.0 10.0D_mmtic SavigU 23.2 19.0 19.1 19.2 19.0 18.8 19.2 19.6 20.3 21.3Total tIweteet 22.9 20.7 20.9 20.9 20.3 19.7 19.7 19.8 20.2 20.9Grew. Cepitot romtln ' 18.7 19.7 20.7 20.7 20.2 19.6 19.6 19.7 20.1 20.8as/ Private 16.2 16.2 16.7 16.7 16.2 15.6 15.6 15.7 16.0 16.5PubtIc 2.4 3.5 4.0 4.0 4.0 4.0 4.0 4.0 4.1 4.3Uhnqe in Stocks 4.2 1.0 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.1Resource Bateos 0.3 -1.8 -1.8 -1.6 -1.3 O.i -0.5 -0.2 0.1 0.4lt4crto GPs 10.9 10.3 12.1 12.5 13.0 13.9 14.8 15.8 16.7 17.6itperts GMS 10.6 12.1 13.9 14.1 14.3 14.8 15.4 16.0 16.6 17.2gatisisi Saings 19.0 15.6 15.6 15.5 15.3 15.1 15.5 1S.9 16.4 17.3Curren tAccount -3.9 -5.2 -5.3 -S.3 -5.0 -4.6 -4.2 -3.9 -3.8 -.. 6Tero of Trade (1906a 100) 165.7 96.0 92.4 89.7 89.7 90.8 92.7 94.7 96.7 98.7X_PRICE 132.4 131.8 128.0 124.6 127.0 133.2 141.3 149.8 1S8.7 166.1NJPRICE 125.3 137.3 138.5 138.9 141.6 146.8 1S2.4 156.2 164.2 170.4It=o -4.0 6.9 7.7 6.3 6.0 5.8 S.0 5.0 4.4 4.1LIB0 8.51 .S5 8.01 7.6X 7.11 7.03 6.41 6.4X 6.4X 6.41............................... ,.,.. .... ..... , . .... II

- 44 -

AN Page 6 of 11

Notes to Tables 1.1 to 1.4

Ihe ptojections in this Annex illustrate a feasible path for the economy under the stabilizationand stuctural reforms initiated by the Fujimori Government. These notes spell out some assumptionsbehind the projections and some definitions of items projected.

L Assumptions for Balance-ofPavments Items (Excluding Debt Servicing and the CapitalAccounta and National Accounts

The key country assumptions behind the forecasts in Tables 1.1, 1.3, and 1.4 are asfollows:

1. After three consecutive years of decline, Gross Domestic Product (GDP) is expectedto grow by 2.8 percent during 1991, the rate increasing steadily to reach 4.5 percentin 1999 (an average of 3.3 percent for the period).

2. Population is assumed to grow at 2.5 percent a year up to 1991, declining to 2.2percent by 1997.

3. Exports of goods and non-factor services are expected, because of the trade reforms,to be a major contributor to GDP growth. After an initial decline of 5.4 percent in1991, reflecting the appreciation of the real exchange rate, export growth will recoverto about 18 percent and 11 percent during 1992 and 1993, respectively. For the restof the period, exports are assumed to grow at an average of 9 percent per year,increasing their share in GDP from 11 percent in 1990 to about 18 percent in 1999(a level consistent with shares attained in the 1950s, 1960s, and early 1980s, wK - theeconomy was more open - see Figure 2.1 of Annex 2).

4. Similarly, imports of goods and non-factor services, after an initial increment of about13 percent in 1992, are assumed to grow at an average of about 7.5 percent between1993 and 1999, to reach a level of 17 percent of GDP in 1999 (up from 11 percentin 1990). The net movement of imports and exports would reduce the urent-account deficit from 52 percent of GDP in 1991 to 3.6 percent in 1999.

5. The ratio of investment to GDP is expected to increase from 19 percent in 1991 to21 percent in 1999, with an average ratio of 20 percent during this period, a levelcomparable to other middle-income economies. During the same period, public grosscapital formation would nse to 4.3 percent of GDP from 2.4 percent.

6. Between 1991 and 1999, contraction in demand would result in a growth inconsumption of only 2.4 percent a year, consistent with an average level of totalconsumption of 81 percent of GDP. In 1999, public consumption would recover to10 percent of GDP, similar to levels in other middle-income economies. However,growth in total consumption is expected to be enough to allow an incree in percapita consumption from 1995 onwards.

- 45 -

Page 7 of 11

7. For the period as a whole, these trends would result in an increase in domestic savinpfrom 19 to 21 percent of GDP. Similarly, national savings, because of the increasinglevel of investment and the improving current-account balance, would increase from15 to 17 percent of GDP.

IL Deription of Line Items in Table 1.2: Balance of Payments (Financing Requirements andPossible Sources of Financing)

1. Non-Interest Current Account Deficit: fom Table 1.1.

2. Debt Service Obligations; estimated publicly guaranteed debt service obligations tothe IBRD, IlDB, IMF, and bilateral and private aeditors.

3. Total Arrears: arrears outstanding to the IBRD, 1DB, IM, and bilateral and privatecreditors.

4. Increase in Gross Reseres: estimated targets for increase in Central Bank reserves.

6.i Loan Disbursements in Pipeline: estimated disbursements already in the pipeliefrom the 1DB, bilateral creditors, and unguaranteed private creditors.

7. Private Caidtal Flows: direct foreign investment and funds repatriated from abroad(includes errors and omissions).

9. Debt Reschgeuling and Deferral: in 1991 and 1992 all official bilateral debt isassumed to be rescheduled on the terms secured in the September 1991 Paris Clubnegotiations (see below). In 1993 and beyond, pre-cutoff debt service due to theParis aub of creditors is assumed to be rescheduled. Other official bilateral debt isassumed to be serviced. Private debt service is assumed to be rescheduled everyyear for 1991-99.

The terms of the September 1991 Paris Club agreemen. mre as follows.

Rescheduled:1

Current maturities due during the consolidation period2 and arrears on short, mediumand long-term debt on pre-cutoff debt,' including previously rescheduled debt.

ODA loans rescheduled at 20 years including 10 years grace, withconcessional interest rate.

'Rescedue on terms reserved for heavily iu ed lower middle income countries.

2Me consodation period is from October 1, 1991 to Decembe 31, 1992.

3 Pe-coff debt is debt conacted before January 1, 1983, te time of the first Paris Club resceduing.

- 46 -

AIPage 8 of 11

* Commercial credits rescheduled at 15 years including 8 year grace,with market interest rate.

Defer:

1) Moratorium interest due during the consolidation period on rescheduled debt:

* 30 percent to be repaid in four equal semi-annual installmentsbeginning November 15, 1992 and ending May 15, 1994.

* 70 percent to be repaid in six equal semi-annual instamentsbeginning May 15, 1995 and ending November 15, 1997.

2) Arrears on post-cutoff debt:

* 100 percent to be repaid in 12 equal semi-annual instalentsbeining June 30, 1993 and eng December 31, 1998 (defementcontingent on performance under the IMFs RAP).

Current maturities due durng the consolidation period on post cutoff debt.

o SDR15 million will be deposited into a special account monthly 4ritng1992.

In addition, it is assumed that pre-cutoff debt servce owed to Paris Club creditors wilcontinually be rescheduled through 1999.

10. Additional DisbusMents: estimated new disbursements from the IBRD, IDB, IME,and bilateral creditors.

11. Additional Fmancing Required: this residual figure is the financing gap.

- 47 -AtNNEXt

Page 9 of 11

Table 1.S: PERU: EXTERNAL OUJTANDNG DEBM at(STOCKS IN US$ MILLIONS AS OF DECEMBER 1990)

Stocks (of whichAr

I.MEDUM- AND LONG-TERM DEBT 20,341 13,414

1.1 Public Sector 19,965 13,414

a. Multilateral Creditors 3,972 2,156- 'World Bank 1.560 924

IMP 1,004 875- 1DB 1,077 357

Other 331b. Paris Club Creditors 6,839 4,835c. Other Bilateral Creditors 2,272 136d. Commercial Banks and

Unguaranteed Suppliers 6,882 6,287

1.2 Private Sector 376 n.a.

11. SHORT-T= DMT 1,366 58

m. TOTAL PM 21707 13472 bi

a/ Includes cufrent prncipal and arrears.bJ Excludes ears of MLT pivate sectr debt.

Sgg=: Central Bank, IMF, and Ministry of Economy and Finance.

ltae 1.6. * PM: Monthly cnwie tldicaters, uly 1990 * Octder 199-................ 19 -^---*----*--*-*-*-*----------------------------------- .................... .gtm -------...... ............ ,,,,,,,,,,,,,,,,,,,,,,,,......................................................................,,........

............................ .,,,........... .,,,,,,,........................ ..................--AJU Aug. Sept. Oct. NOv. one. Jan. Feb. fterd Aprit Nay June JUly AUPCt Sept. Oct.... ........................................... ............................................ ...................................... . .,....... ,,.................................. ... ..,,,,,,.,_,_,,, ,..................... "., fps (Augut 1109tOb) 20.1 100.0 113.5 124.? 132.1 163.4 192.5 210.6 2rA.0 239.9 256.2 28.2 307.9 330.0 346J 362.4S d ige eve ast month 63.2 397.0 13.6 9.6 S.9 23.7 17.8 9.4 r.r s.6 7.6 9.3 9.1 7.2 S.6 4.0sthlychange at RIrate () 35.591 9 372 200 99 1,184 614 194 14 97 141 191 154 130 92 60t dhe er last 12 mnths 3.040 12,375 It,1lb 9,045 8,271 7,639 6.924 5,78 4,663 3,585 2,686 2.189 1.430 230 206 19tReal %e irne (I $e "R0I0) 111.2 41.9 54.6 74.1 84.4 79.9 80.3 66.0 83.3 82.0 84.5 85.e n.e Me fl.* n.eEtchne Rote Ifrfet t

SIIUSS 0.12 0.3? O.4 O.4 0.43 O.S2 0.54 0.56 o.57 0.7o 0.83 0.64 0.60 0.79 0.83 0.96Ro tnlel Devltion bj.0m 204.82 19.1S .1.32 .0.92 20.6 3.12 3.72 1.6S 22.62 18." 1.82 -4.6S 1.92 5.71 15.1tReal Excdg Rate I c_/ 6.8 42.6 4S.0 40.9 38.7 38.1 33.4 32.1 29.4 33.7 37.0 33.9 29.8 27.s 27.$ 31.4Prodiution Indieators (1979%100)

GP idex 94.?7 82.9 76.7 o5.5 9.7 98.1 97.1 95.S 92.4 101.1 99.4 9.4 97.2 94.2 n." n.aInAtrile Sector Index 67.1 74.4 S9.1 74.7 91.5 88.9 94.4 91.9 89.3 97.2 97.2 93.1 94.6 90.6 n.e nMeRentimly lnteest ote. for DepositsSoles Accmmts :

R.ln,l Bates 35.6 3S.6 11.2 7.3 5.S 6.0 6.5 8.4 9.4 8.0 7.2 74 9.4 9.3 5.7 sr .Real Rttes .16.9 *72. -2.3 -2.1 -0.4 .14.3 -9.6 *0.9 1.6 2.1 -0.4 -I.? 0.3 2.0 0.1 n.Dollr Accouts swmint Rates 8J 0.7 0.7 0.7 o.? 0.r o.7 0.6 0.5 o.s 0.8 0.8 0.8 1.0 1.0 0.7 0.? 0lost Bate. -4.4 -38.3 5.3 -9.3 -5.8 -1.8 -12.0 -4.7 fS. 17.0 11.1 6.6 -.1. *7.6 0.6 11.4

rasd (Mllion 11w t) 260 239 161 207 196 m 187 212 19? 260 312 218 289 2 n.o n.oMerdawds Efxpwor 216 31s 310 271 88 296 251 281 m 290 266 312 300 300 n.e n.e0* : troditleal 196 234 235 184 203 210 178 208 n.e n.e n.e n.o n.e n.o n.e *. aNon-traditIonal n 76 74 87 85 e5 73 73 n.o n.e n.e e n.e n. n.o n.o

qteratln of Control 6 vermamut(In Millions tW0

On Acenul sis 2Ummet lo 141 22S 242 W 296 374 287 290 309 254 23? 322 317 36r n.euponditws fj 254 302 239 290 368 382 357 292 302 332 260 259 332 324 n.o n.obeficIt 147 161 14 49 29 85 -17 5 12 s57 6 23 I1 r n.o n.o

0h Cash ais:Remu l 1105 140 217 237 326 28 34S 252 269 3S9 242 234 302 296 n.o n.eEi pudtwefJ too 1 191 205 263 330 289 223 275 287 202 91 292 261 n.e n.eOeficlt 75 59 .26 -29 -64 43 -56 -29 6 .72 -40 -43 -10 -35 n.o n.o.............................................. ,,,,,,,, ,,,,,, ,, ,,,,,,.,,,.,,,,,,,,,,,,,,,,,.,,,,.,,,,,,.,.,,,,,,,,,..,,_. ............................................................................................................

.a_ In A_gt t9M0 mntly unalied Inflation rote oa 22,T13,113,069L (Cntimild)b_ Percata1e vrlItlon 0e previos nt./t a O O ar 1975M a 100.d- Aver, for alt 4 lt *cenatl In l Slettars. Stertfng In April 1991, It'. rate for saings dpsits.*_/ Stto sr Iy 19 the atbe is the Casta S2rlntedimny (SUM).j Incls marrant i sepital e1pndttures.

sone: ContrAl Sak ad lbtd _* estlmmotmo..... . O R~~~~~~~~I

tAble 1.6 (continued)- PMU t lonthly Economic Indicators. My 1990 - cttobe 91990...................... 19................., 19 . .

................................................................................................................................................................................. ..................................................................................

July Aug. Sept. oct. Ile. Dec. Jan. Feb. Owch April may am Jur at Sept. Oet............................................. ..................................................................................................................... .............. ..................................................................................

Central 8a t.et.te t.st e

etNIttlnM) Ibs 1U 42T 280 sn SS1 451 419 499 599 623 7M on02 900 944 n.5

In Nill isSS 11O2 420 66 886 949 821 m 819 913 m 661 714 804 872 8?0 n.eNomlnal Crowth late In illS -10.91 -61.2S 57.1S 34.32 7.1X -13.51 -3.21 3.1% 11.41 -1S.46 -14.42 8.02 12.7X 6.5S -0.22 n.eNomint Growth Rate In Sales 40.32 179.92 82.1X 33.22 6.32 2.32 1.22 6.92 13.41 3.92 1.4X 9.31 7.3X 6.42 5.52 n.aDomestic Credit

in eitlos USS 2,226 627 SS4 937 726 680 742 810 81S 662 562 526 601 606 629 n.ein Niltien Soles lie 240 246 413 31? 35 401 454 465 464 467 44 481 476 5220.lNmit Oreth Rote in USS 32.311 -71.20 -11.6 69.22 -22.6 -6.32 9.2X 9.12 0.7S -18.82 -15.1t 6.42 14.22 0.92 3.82 n.'Noinal Growth Rate in soles 106.32 102.92 2.5s 67.8X -23.21 10.9X 14.12 13.12 2.S *0.22 0.6X -S.2z 8.72 -1.02 9.7X n.eFinacisat Systm

lot Nilliari UlS$ 2.759 I 068 1t103 1 511 1.458 1.479 1.S21 1,570 I790 1.716 1.620 1.755 2 012 2.03 2.236neNinml Growth Rate In 115 -4.32 409 I eT.0% -3.52 1.42. 2.92 3.22 4.0 -4.11 oS.61 8.42 14.62 1.22z X9. n.81inat Growth Rate In slels 50.8s 184.32 17.2S 3S.92 -4.3X 20.02 7.52 7.0X 16.12 17.72 11.92 9.72 9.21 -0.7x 16.12 n.a

In Nittliona S 1.042 301 423 S87 648 741 6s 631 75s 703 627 670 743 724 767 n.alaminat Growth Rate In UIS 7.42 -71.12 40.62 38.72 10.42 14.42 -11.2X -4.01 19.6S -6.9s *10.81 6.91 10.82 -2.5S 6.02 n.5ominal Growt Rate in Soles 69.12 106.80 63.02 37.62 9.6X 35.42 -7.3S -O.SX 21.7X 14.42 S.7X .8.22 5.52 -4.32 12.12 n.aDeposits in US' 1391 1; t,7t 1.908 2,025 2I091tn.in 31i111mw US 674 663 697 83 934 1 032 1 160 1,219 1.273 *.9 I2 9.02 9.02 6.12 3.32 nNowmina Grout,Rst4i in U$2.42 -1.4 5.32 20.12 11.52C 10.42 12.4t 5.12 4.52 9.22 15.s3 90 .1 .X 33 .Breed Noney Sqipy 9ej

In 31t1t1m Il 2.585 1 228 1554 1 964 2 196 2.203 2,235 2.333 2 618 2,684 2.m 2.989 3 319 3,S49 3,676 n.eNminat rwtb late In U*6S -4.12 42.52 S 6.42 6 6.4S i1.8 0.32 1.52 4.42 12.2S 2.5X 1.42 9.82 i.1X 6.92 3.62 n.eNminal Groth Rate In Soles S1.0 242.42 46.7S 25.42 10.9X 18.72 6.01 8.3X 14.2X 25.92 20.2X 11.12 5.62 4.9X 9.52 n.eRatio IDeposlts In IS I Deposits In Soles 35.33 117.22 81.41 74.42 74.02 88.12 107.82 10g.42 94.7X 107.64 144.11 141.42 13S.1X 132.82 131.92 n.a........................................................................................................................................................

........................eJ Include al finwclat operatins dof fmal financil institutlems (bantsmid other nen-lbt N with IcIc agents, In Soles d US Dollat rs.

Surce t Central Satk ad owid Bark etimates...... ~~~~~~~~~~~~~~~~~~~~~~~~~~

I,

-51 -Page 1 of 10

Figure 2.1

Peru: Ratios of Trade to GDP,1950 - 1990

30.

25-

0Io 20-

~. 5

0~~~~1h

1 50 1 55 1 60 1 65 1 70 1 75 1 80 1 85 1 90

1 M Exports/GDP M Imports/GDP

Source: BCRP

-52 - AEPage 2 of 10

Figure 2.2

Peru: Effective Protection from Tariffson Manufactures, 1990 - 1991

Tr

Printing ui ________* Cloth ing oo . ._._-

Sted -bcc. =; ________.._______..____n 0i5 ~~ ~ ~~-----------------

M& Produts ^ __

0 20 40 so 80 100 120 140

Effective Protection Rate

I March 1991 December 1990 F--J July,ISS99

Source: Rossini (1991)

-53 -Page 3 of 10

Figure 2.3

Peru: Real Exchange Rate Index,1985-1991

160_

140

120

600-j$80-

1-60- . .'}

40-

20- ii.. hlJhhiIgIphihIlllllll ull-19 5 19,6 1997 19I8 1989 1990 19 1

Source: BCRP

Note: The real exchange rate index (RER) is defined as follows:

(nex of Rdevant teatonal Inflan for PeN) (Inde of NominalExhangp Rale)RER =

Index of CPI for Peru

The base for the index is December 1978. The exchange rate used through July1990 is trade-weighted; from August 1990 onwards it is the free market exchangerate. A rise in the index implies a depreciation.

-54 -Page 4 of 10

Figure 2.4

Peru: Exports and Imports,1989 - 1991

400

350-

300

2S-

020

5aa

}~~~~~~~~~~A' .i .9 .1 91

.t- Exports m Imports

Source: APOYO and Alerta Econ6mica

- 55 - Psgo S of 10

Figure 2.5

Peru: Black Market Exchange RatePremium, 1985- 1-991

800'1

700n

600

p500

400

0- 300

200-

*1*00

0BSource IIBC RP I I I I i 30 1 1

Source: BCRP

-56- A 2Page 6 of 10

Figure 2.6

Peru: Production-Weighted Distributionof Tariffs, 1990 and 1991

80

~70

:60°/

O50Q

40

~20-

10)

January 1990o 7March 1991

5% 15% 25% 50%Tariff Rates

Source: RossiDi (1991)

-57 - ARMPage 7 of 10

Figgure 2.7

Peru: Export Subsidies,1980 - 1990

25

20-

s/on-traditionol

rtc:l exports1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Source: BCRP

- 58- Pago 8 of 10

Figure 2.8

Peru: Export Taxes Collected,1980 -1990

1204

| 16-' l

12-

0 1,l A ttotal exports1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Source: BCRP

_59 _ AN=2Page 9 of 10

Fiure 2.9

Peru: Import Taxes Collected,1989 - 1991

30-

25-

020-

10

O 0

1 §89 t 9 1 §9 1Yeor and Month

l 1 taxes/imports _ taxes/revenue |

Source: BCRP

Note: The ratio of import taxes to imports is calculated using the parallelexchnge rate (PER). Given the high PER premium in the months through July1990 (see Figure 2.5), the use of the PER results in a larger ratio of import taxesto imports than would the use of t}e official exchange rate.

- 60 - AXNEaPage 10 of 10

APOYO S.A., Situacib E onWmia 1 em one mayo 1991.

Banco Central de Reserva del Perd (B3CRP), NotaSema. varous Issues.

Ministeric de Economfa y Finanzs, Eco No. 8, enero 1991.

Rossini, Renzo G., -Las Medidas Reclentes de Aperara Comercial-, LaMon2a, No.33, mazo 1991.

-61 -ARM 3Page 1 of 4

....

1-IMPORsT TARIFFS

1.1 STRUCTURE Range of 0484%; 38 By March, 1991, 3-rate Eliminate 5% rteo (steel-rates; u n weighted structure of 5, 15, 25%;. industry Inputs) byaverage of 45%; average of 17%; coeff. March 1992: unWsscoefficient of variation of variation of 23% lmpismentation duringof 55% 1992 of an Andear.-

Group common extenadtariff appears likely bythat time

1.2 PREFERENCES ON 139 regimes, accounting Elimination of mostTHE DOMESTIC for half of Imports regimes by September,MARKET 1990 (major exceptions

are educational &oultural Institutions;treaty agreements

1.3 SPECIFIC TARIFFS No specifio tariffs: some R e m o v a l of all Publicize, by BoardAND TARIFF surcharges surcharges by March presentation, theSURCHARGES 1991;vsriablesurchargs existing method of

on 5 agricultural setting the variableproducts, introduced in surcharge.May 1991 Reform of surcharge

scheme: agree studyTOR by March 1992,agree ImplementationguidelInes by June1992. enact reform bySeptember 1992

1.4 SAFEGUARD Cus toms use of Introduotion of an anti Reform of anti-dumpingMECHANISM reference p r ices dumping/subsidy code In code: agree study TOR

pertmitted to prevent June 1991 by Board Presentatondamage to the national enast refom by Marsheconomy OIn abeyance) 1992

- 62 -ANNEI

Page 2 of 4

W~~~~~~~~~~'2 .

2. NON-TARIFFIMPORT MRIAiS

2.1 FORMAL 10% of tariff lines All prohibitions/PROTECTiVE (affecting 40% of restrictions suspendedBARRIERS mnanuf a ctu ri ng) by September 1990,(NEGATIVE USTS) prohibited or restticted permanently lberaeiked

by March 1991

2.2 HEALTH, Technical standards & Various reforms from Reform of health andTECHNICAL. agrieolturel, health, and March to May 1991, p h V t o 8 a n I t a r ySECURITY, AND misc. controls removing or simplifying regulations & tochnicdMISCELLANEOUS controls; reintroduction standards: agree studyREGULATIONS of controls In a few TOR by Board

cases presentation, agreeImplementatlonguidelines by Moah1992, enact reforn byJune 1992

2.3 IMPORT In existence for oil All public-enterpriseMONOPOUES (Petroperul; wheat, monopolies removed in

flour, sugar (ENCI); rice principle in March 1991;(ECASA) ENCI & ECASA

monopolies removed inMarch *1991; Petroperumonopoly removed inAugust 1991

2.4 LOCAL-CONTENT Applied to motor-vehicle All lo cal-contentREGULATIONS production regulations eliminated In

March 1991

2.6 CONTROLS ON Ptohibition of all second- Imports of most second-SECOND-HAND handgoods hand goods allowed InIMPORTS November, 1990 and of

machinery and vehiclesIn March 1991; onlycontrols on clothing,shoes, and bath fixturesremain

-63- -Page 3 of 4

i.EX-PORT N REQ

3.1 TAXES ON Taxes ranging from 3% After 10% surchargeTRADmONAL to8% from August toEXPORTS November 1990, taxes

range from 0% to 10%by February 1991

3.2 SUBSIDIES FOR CERTEX: fob xport Reduction (Aug ).NON-TRADmONAL subsidy of 15.30%; then abolitionEXPORTS FENT (suspended): (November 1990) of

interest-rate subsidies CERTEX: abolition offENT In November 1990

8.3 INDIRECT TAX Temporary Admission A u t o m a t i o n o fTREATMENT scheme in operation, but Temp.Adm. scheme and

restricted scope and low its broadening to allautomatity expofters In March

1991; introduction ofdrawback scheme fornon-trod. exports InMarch 1991

3.4 EXPORT Duty-free capital-good No now contracts areCONTRACTS imlgrts against non- being issued and

traditional export scheo is defunctcontraots

3.5 FREE TRADE ZONE Two FTZs exist, butonly selling domesticallyand not developed forexpen industtis

3.8 NON-TARIFF Controls to preserve Removal of controls InEXPORT domestic-market supply March 1991CONTROLS

3.7 EXPORT Required for fish,CERTiFICATION mineral, agricultural

exports

-64- A MPage 4 of 4

S .. .. . .

4.,

4.1 NON-TARIFF ICE adrniinisters major ICE d-e setvated In JuneBARRIERS iTBS, as well as export 1P9O9L1, a Pn d I t.s

subsidies promotionsifunedons goto MiCTi

4.2 TARIFF Creation of Control Proosdums to ensureADMINISTRATION Cornmission for anti- open, irnartiai anti-,MEF) dumping rules dumping hestnga to be

tagreed by loannegodaton

4,3 CUSTONS Transfer of some AgraemnAnt by Board4 ERVICE funAtions to private prasentdEon on Aoteon

agents; monopoly an Plan; oornpliano w1thoustoms warehouses three phgo o Aotonretnoved Plan, by ea0rd

presontation (1). byM4rch 1992 Ce t2), b boJune 1992 (3)

4.4 EXPORT Function transoerred inPROMOTiON June 199n from ICE to

4.5 TRADE Creation in Jun1 199byNEGOTIATiON of an inter rninistsrial

comn-M1ted, wyth anOffice of TradJReprMseCtadve in MICTi

4.5 TRADELAW Augustt1991pssuge fa Legislative Decreeelevating to the statusof a law many of thetrade raforms passedsince August 1990

- 65 -

ANNEX4Page 1 of 10

NON-TABREW ARER

1. All countries apply health, safety, and technical regulations to many locally consumedproducts, and sometimes to exports. These norms are usually justified by a government's obligatto protect the population from risks to health and safety. But when these norms are also used to favordomestic producers at the expense of imports, they become discriminatory non-tariff barriers (NTBs).This type of barrier has tended to become more frequently used - in developed and developingcountries alike - when more conventional barriers (tariff and non-tariff) have fallen. It is oftendifficult to identify these instruments of the "new protecdonism" - they may exist as much inbureaucratic procedures as in formal legal instruments - and it is even more difficult to measure theirimpact.

Non-Tariff Barriers in Peru

2. In Peru during the 1980s "conventional" non-tariff barriers predominated: import prohibitionsand licenses constituted the majority of such barriers and were supplemented by foreign-exchangeconols, minimum-local-content regulations, import monopolies, and other controls. In 1987 and1988, formal import controls were at their height, with all imports subject to restriction or prohibition(See Table 4. 1). But even by the end of 1989, when controls had been eased, prohibitions on a merefive percent of all tariff lines protected an estimated 40 percent of manufacturing output.

Table 4.1: PERU: NON-TARIFFBARRIERS.1981 -_1990 (BY NUMBER OF TARF CATEGORIES

Dec Dec July Dec Dcc Dec Dec April Aug Sept1981 1953 1985 1985 1987 19889 19 1990 1990 1990

Fre 5,088 5,136 4,757 3,259 0 0 4,192 4,721 S,6 S2Rtriated 112 118 350 1,553 4,715 4,724 535 6 0 0Prohibited 7 a 8 525 539 539 539 539 13 0Temporarily Pohibited 0 0 188 0 0 0 0 0 0 0Tolal Tariff Categories 5,207 5,262 5,303 5,254 5,254 5,2 5W 5,269 5,269 5

Sgur: Abusada (1991)

3. Since assuming power in July, 1990, the new Government has made considerable progress inremoving protective non-tariff barriers. In August, 1990, Supreme Decree (DS) 228-90-EF reducedimport prohibitions to 13 tariff positions and suspended several technical norms which had adiscriminatory effect. In September, DS 257-90-EF eliminated the last fonnul "negative lists"(restrictions and most prohibitions) on imports. In March, 1991, DS 060-91-EF eliminated alladministrative restrictions on merchandise trade, including minimum-domestic-content regulations anddomestic-market-supply-related export restrictions, except for a prohibited list of exports, restricderived from foreign-exchange rules, health controls, defense of cultural patimony, conservation ofRota and fauna, and defense or security requirements. The elimination of cetain non-taiff barrierswas subsequently given the force of law by the passage of Decreto Legislativo 668 in Septer,1991.

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Page 2 of 10

4. The Appendix to this Annex lists all known non-tariff barriers, whether discriminatory or not,existing as of August, 1990, or November, 1991. Of the 45 non-tariff barriers thus identified, 22have been eliminated, eight seem to have been eased, and 15 remain in force. Three of these 15 wereinstituted XU August, 1990, in pat at least as a result of pressures from specific interest groups.

5. The non-tariff barriers eliminated include most of the restrictions that are more clearlydiscriminatory, such as state monopolies for import of foodstuffs, Register of Imports from AndeanGroup Countries, and the oil monopoly of PETROPERU. The Pre-Authorized Licence to Import(Licencla Previa de lmportacddn), required for imports financed with a preferential exchange rate, theclause of the Law of Industry (Ley de Industras) which protected national industry, and theAuthorization of No Competition (Dictdmen de No Competencla), a minimum-domestic-contentregulation, were also abrogated. Other non-tariff barriers eliminated were: quality controls on animalfeeds and canned and processed foodstuffs; import prohibitions for gold, printing and photocopyingmachines, ships, airplanes, and passenger vehicles; temporary suspension of imports of garlic andonions; and minimum-content regulations for products of industrial assembly.

6. Eight non-tariff barriers have been eased, either by the removal of procedures required priorto importing, or by an increase in the transparency of these procedures. The Certificate of Internment(Gertificado de Internamiento) from the Ministry of Health, needed prior to the import of medicines,perfumes, cosmetics, or medical equipment, is no longer required, and the receipt of a ProductRegistration (Registro Sanitarlo) for an imported product is now automatic if the importer'sapplication is not processed by the government within fifteen working days. Various inconsistent andcomplex procedures prior to the import of veterinary products and non-banned pesticides have beeneliminated; these imports can now enter the country after presentation of a single document (theDeclaracin Jurada) which describes them. The prohibition on imports of used industrial goods hasbeen loosened for the paper industry to allow for the import of paper and carton residuals, a key inputin the manufacture of paper and cardboard. The process for obtaining Quality Certifications(Certificaciones de Caldad) and a Product Registration from the National Istitute for Nutrition forimported and domestic processed foodstuffs has been made less complicated. Cotton importregulations have been eased such that only cotton imports from the American continent (with a fewexceptions) must undergo fumigatlon in special chambers. Used goods regulations have been relaxedto allow for the import of used machine parts, motors, automobiles, and engines.

7. Most of the non-tariff barriers not eliminated or eased are restrictions based on the need toprotect the safety, health, and security of the country. The non-tariff barriers which exist for safetyand health reasons are Technological Requirements for Meat Products (Reglamento Tecnoldgico deCames), Phytosanitary Permits (Permisos Fftosanltarios) for imports of vegetal origin, ZoosanitaryPermits (Permisos Zoosanltarlos) for imports of animal origin (i.e., milk, leather, skins, etc),packaging control of canned and boxed goeds, radiological control of canned goods (in place eversince the Chernobyl disaster), certification of fish products (though the need for this is questionable),the ban on organochloridic pesticides (such as DDT), and the restriction on imports of humanremains.

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AN=E 4Page 3 of 10

8. The restrictions on the import of maps, cartographic materials, cultural nnrifacts, arms, andcommunication equipment are of a non-economic nature. The prohibition of imports of used clothing,laundry and bathroom articles (i.e., towels, sinks, showerheads, tubs, etc) is clearly a discriminatorynon-tariff barrier which was not removed during the post-August trade liberalization.

9. Legislative Decree No. 653 established the "Law to Promote Investment in the AgriculturalSector" in August 1991. This decree reinforced two decrees (passed in June and July of 1991) whichprohibited the import of powdered mik products for use as inputs into the production of re-constiuted milk, butter, and other dairy-based products. This prohibition, and the required pre-inspection of goods at the port of origin (established by Legislative Decree No.659 in August 1991)weie put into effect after August 1990, and may be seen as reversals in the liberalization process.

Eyguation

10. On balance, Peru has made enormous progress in removing distortionary non-tariff barriers.In light of Peru's previous efforts at liberalization (1979-1981), the evolution of a new, freeenvironment for trade has advanced at a remarkably rapid pace, with support from most sectors of theeconomy. Conventional non-tariff barriers - negative lists, import monopolies, and the like - havenow been virtually eliminated and the less conventional barriers provided by technical, health, andsafety regulations now constitute the core of residual non-tariff protection.

11. With the passing of Legislative Decree No.668 in September, 1991, the Government renewedits committment tc liberalize trade and eliminate non-tariff barriers. The Government is banned fromengaging in monepolistic or oligopolistic activities in the private sector and the power of law is given,to certain articles of other regulations which eliminate minimum-domestic-content requirements forboth imported and domestically-produced goods. In this legislative decree the Government alsoundertakes to apply health and technical regulations in a non-discriminatory way. According toArticle 13, "the State will guarantee that future norms will not constitute obstacles to the free flow ofgoods and services and will allow for equitable treatment of imported and local goods." Ihis will intr require the Government to examine the way it applies its existing non-tariff barriers andsanctions new ones.

REFERENCES

Abusada, Roberto, m Comercial en el Perd, (mimeo), mayo 1991.

Abusada, Roberto, La Reforma dela Polftica Para-Arancelaria Peruana (1990-l9911, (mimeo), septlembre1991.

AfOYO, Es_ gue Afct la Eficlencia de la Indu=kManufacturera en el Perd (mimeo) octubre1990.

ECONSULT, S.A., Avance en la Desreeulacidn del omerclo Extir Peruano, (mimeo), agosto 1991.

Rossini, Renzo G., *Las Medidas Recientes de Apertura Comercial", La Mgn a, No.33, mawzo de 1991.

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AN=Page 4 of 10

AMEND TC ANNEX 4

PEU; NON-TARIFF BARRIS

NAME OF NTH SITUATION UNTIL CHANGES SINCEAUGUT 1990 ALM=S 1990

IRESTPJCIlONS 1T H1AUBEEN EURMAINAE

REGISTER OF IPORTING Importing firms had to be The Regis is no longeriFIRMS IN THE TRADE registered in the Trade Insttute. effectINSTTUTE (RtEGISRO DEEMPRESAS IMPORTADORASEN EL ICE)

STATE MONOPOLY IN Exclusive import rights granted to Import monopolies eliminated InFOODSTUFFS ENCI (wheat, wheat flour, white March 1991.

and cn^de sugar) and ECASA(rice).

IMPORT OF FOODSTUFFS Imports of foodstuffs other than The Certifcate Is no longerthose of ENCI and ECASA required, and the procedure forrequired a Certificate of acquiring a Product RegistrationInternment from the National has been simplified.Institute of Nutrition INN) andmust have received a registrationnumber before entering thecountry.

RESTRICTIONS ON SALE OF DS 053-85-AG required importer Sale and import of animal feodANIMA FEED registradon, feed approval, and healized completely.

Other restrictions.

WOOD PRODUCTS Could not be freely imported. DS 060-91-EF and DLeg 668may have diminated restrictions.

ITINTEC EVALUATIONS DS 055-84ITIIND required No long In effect.imported products to meet withtechnical norms established forsimilar domestic products.

ANNE 4

- 69 - Page S of 10

NAME OF NTB SITUATION UNTIL CHANGES SINCEA-UGUST 1220 AU=12

PHOTOCOPYING AND Could not be imported without Sale and Import of photoopyingPRINTING MACHINES authorization from the Ministry and priting machines freed.

of the Interior.

SPECIFIC IMPORT Ministry of Industr required No longer needed.AUTHORIZATION special documentation to import(DICTAMEN ESPECIFICO DE CKD packages, computers,IMPORTACION) domestic electric products, and

other products of industrialassembly.

CONSULAR REVIEW Restricted the import of Automobiles can be imported(VISACION CONSULAR) automobiles. freely.

PRE-AUTHORIZED LUCENCE Applied to imports under the No longer exists.TO IMPORT (LICENCIA MUC regime.PREVIA)

AUTHORIZATION OF NO Used to protect domestic No longer exists.COMPETITION (DICTAMEN producers from similar importedDE NO COMPETENCIA) goods.

GOLD IMPORT - State bad exclusive right to sell 'Me Importtexport of raw orRESTRICTIONS precious metals in raw or semi- semi-worked gold is totally

worked forms through the Banco freed.Mineral of Peru.

BOATS, SHIPS, AND Ministy of Defense needed to No longer In effect The GeneraFREGHTERS authorize import of ships, big and Office of Water Transport must

small. simply be notified after thebuying or selling of a ship.

REGISTER OF DECISION 200 No longer in effec.

LAW OF INDUSTRY (LEY DE Ley 23407 established restrictions Tle chapter which pvotedINDUSTRIAS) on Imports of industrial products national industry as abolished

also produced domestically. by DLeg 668 in September 1991.

ANDEAN GROUP Special document needed for No longer in effect.REGISTRATION imports originating in member

countries.

ANNUAL PRODUCTION PLAN Enterprises in the industrial sector DS4012-91-ICI1\IND removed(PLAN ANUAL DE were obligated to prepare an this obligation.PRODUCCION) annual production plan.

4- 70 - Page 6 of 10

NAME OFNTB SITUATION UNTIL CHANGES SINCEA1GIIS 1990 AlOS T IM

RESTRICTIONS ON THE Not in existence. In July 1991, impKs of ouionsIMPORT OF ONIONS AND and garlic from counties whereGARLIC certain plan diseases are preset

were prohibited. This restictionhas been lifted in September1991.

OIL MONOPOLY: PETROPERU exercised DLeg 655 elimnates thePETROPERU monopoly powers in oil monopoly privileges of

production, exploration rights, PETROPERU and its affiates.refining, distrib'ition, and imporof oil and petoleum.

PROHIBMON ON IMORTS Since 1984, imports of In August 1990 autombileOF AUTOMOBILES automobiles, except for import prohibitions wsre

diplomatic use, were prohibited. eliminated.

NATIONAL UNIONS (JUNTAS National Unions of Coffee, This power is eliminated alongNACIONALES) Wheat, Milk Products, and with any existing non-tarf

Hydrobiological Products restrictions.exercised power to restrictexports and imports through non-tariff barriers.

IMPORTING REGISTER Not in existence as of June 1991.(REGISTRO UNICO DEIMPORTACION)

aLnAVBEEN

LICENCE TO IMORT DS 164-82-AG and DS 018-86- The Imorti proes Is greatlyPESTICIDES (LICENCIA PARA AG established regulations for simplified; remang lboratoyINTERNAMEtNTO DE Import of pesticides. tests conform to itrnadonDPLAGUICIDAS) standads.

IMPORT CERTIFICATE FOR DS 124-81-AG established The ipotg process is gretyVETERINARY PRODUCTS various import regulations for simplified; remaining laboratory(CERTIFICADO DE veterinary products. tests conform to IntedonaINTERNAMIENTO POR standards.PRODUCTOS VETERINARIOS)

-71 - Page 7 of 10

NAME OF NTB STIUATION UNTIL CHANGES SINCEAUGUST 1990 ALGUST 1

MINISTRY OF HEALTH Restrictions on import of DS 003-91-SA eased manyRESMUCTIONS medicines, medical equipment, restrictions; import process more

perfumes, and makeup. transparent and efficient.

COlTON IMPORTS Not in existence In May 1991, RM 359-91-AGrequired that cowtton Imports beflmigated in special chambers,the scarcity of which implied avirtual prohibition of cottonimports. This decree wasmodified to submit only thoseimports from the Americancontinent, except Ecudor,Bolivia, and Argentina, tochamber fumigation.

IMPORTS OF NATURAL OR Imports of wastes, whether of DS 036-90-ICTND allowed theINDUSTRIAL WASTES natural or industri origin, were paper industry to import paper

prohibited. and carton residues as they are amajor input for industrWirecycling. The original law hasnot been changed and thus othersectors are seeking similartreatment.

QUALITY CERTIFICATIONS Imported or domestically DLeg 658 allows any qualifiod(CERTIFICACIONES DE produced goods needed public or private isitution toCALIDAD) certification of quality from a grant the certificadon.

state-authorized institution.

IMPORT OF USED Most used goods (imdustial parts, Most industrial used goods can beINDUSTRIAL GOODS motors, cars, equipment, etc.) freely Imported.

were on a list of prohibitedimports.

- 72 - Page8 of 10

NAMDE OFNTB SITUATION UNTIL CHANGES SINCEAUGUST 1990 AUUT199101

TECHNOLOGICAL DS 004-84-AG established More quality requients areREQUIREMENTS FOR MEAT sanity requirements for added in January 1991.PRODUCTS (REGLAMENTO imported meat.TECNOLOGICO DE CARNES)

PHYTOSAN1TARY PERMIS DS 016-76-AL established a Phytosanikuy requireme are(PE]WSOS FITOSANITARIOS) Sanitation Regulation made more general; on the oher

(Reglamento Sanitario) for hand, they are augmented.imports of vegetal origin.

ZOOSANITARY PERMITS RS 117-76-AG Qater modified by Zoosanitary requirements(PERMISOS ZOOSANITARIOS) RS 0122-86-DGAG), established amplified in RM 0231-91-AG.

that products with an animalorigin (such as milk, meats,leather, skins, etc) needed aZoosanitary Permit to beimported.

METEOROLOGICAL AND Canned and botded products had Standards have been made toCONTENT CONTROL to meet MTlNTEC standards. parallel international norms.

RADIOLOGICAL IPEN established maximum Restriction remains in force andCERTIFICATION FROM IPEN permissible levels of radioactive RM 00740-90-AG-DGA

contamination for imported reinforced the original law.foodstuffs.

GEOGRAPHIC TEXTS OR Could not be imported without Still In effect.CARTOGRAPHIC authorization from the MinistryPUBLICATIONS of Foreign Relations.

RADIO-COMMUNICATION Ministry of Transportation needed Still in effect.EQUIPMENT to authorize Import of radio-

communication gear.

SECOND-HAND CLOTHES imports of used goods were Other used good impots areAND LAUNDRY ARTICLES rrohibited. liberalized, but not clothing,

laundry or bathroom fixue;however, used-goods importsdestined fbr donation allowed.

_ 73 - Page 9 of 10

OEF B SITUATION UNTIL CHANGES SINCEAUGiST12990 AUQUST 1299

ARMS RESTRICTIONS Ministry of the Interior needed to Still in effecLauthorize import of arms,ammunition, and explosives forcivil use (not for war).

HEALTH CERTIFICATE Ministry of Health needed to Still in effect.authorize import of humanremains.

CULTURAL AUTHORIZATION National Institute of Culture Still in effect.needed to authorize import ofworks of art, replicas, and booksof more than 100 years of age.

SANITARY CERTIFICATE Sanitary requirements acted as Has not been specificallyFOR FISH PRODUCTS barrier to imports. Some export eliminated.(CERTIFICACION SANITARIA restrictions existed due to choleraDE CERPER) epidemic.

POWDERED, SEMI- Since 1965, no more than 30% of This domestic-content regulationPOWDERED MILK PRODUCTS the inputs, such as powdered or was eliminated by DS 060-91-EF

reconstituted milk, used in the of March 1991. However, afterdairy industry could come from August 1, 1991, imports ofsources outside Peru. powdered milk products for use

as inputs in the productio ofdairy-based products wereprohibited. The August 1991Law to Promote Investment in

the Agricultal Setor gaveforce of law to this prohibitioLTwo recent Legislative Decrees(668 in September and 757 inNovember) reinforce thisprohibition.

PRE-INSPECTION OF Not in existence. In August 1991 DL4g 659IMPORTED GOODS AT PORT required pwinspecion of importsOF ORIGIN at port of origin to confirm

quantty, quality, and mode ofpayment.

BANNED PESTICIDES A general regulation on pesticides Internationally banned pesticidesexisted. are prohibited entrance into Petu.

ANNEX-4- 74 - PAP 10 of 10

LIST OF ACRONYMS

CERPER La Empresa Piblica de Certificaciones Pesquers del PerdDLeg Decro LegislativoDS Decreto SupremoECASA Empresa Nacional de Comercializaci6n de ArrozENCI Empresa Nacional de Comercializacidn de InsumosICE Instituto del Comerclo ExteriorINN Instituto Naclonal de Nutrici6nIPEN Instituto Peruano de Energ(a NuclearITINTEC Insitito Nacional de TecnologfaLey Ley (Law)MUC Mercado Unico de CanbiosRM Resoluc.6n MinisterialRS Resoluci6n Suprema

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Page 1 of 4

THE CUSTOMS ACI_ON PLAN: A SUMMARY I/

C,ustoms Rorm

1. The Fujimonr Government imherited a Customs Superintendency (SUNAD) which was poorlyorganized, ineffectively operated, overstaffed, poorly trained, and under-paid. In addition, due to anil-defined and unstable legal framework, the body of customs regulations had developed incoherently:inefficient forms of control have led to obstacles to trade and a high level of discretion on the partof customs officials

2 In Mach, 1991, the Goverment initiated the process of reforming the customs service. Thisbegan wnth a reduction of more than 500 personnel, mainly through incentives and voluntaryrtirement The Goverment also introduced a reform to saphfy the proces inwvoed in thedifferent customs operations and tegulations. It authorized a new system of import and exportcustoms clearances, permitted the embarkation or disembarkation of goods by means of self-

assment, and instituted customs valuation based on documentary evidence and selective physicalamtion.

3. SUNAD has an important role in executing the Government's policy of trade reform whichincludes simplifying the remaining controls on trade. Thus, support aimed at increasing SUNAD'sefficiency wiU help consolidate these trade reforms. SUNAD's reoranizational efforts will need tobe supported by foreign advisory services which can bring new approaches to the tasks alreadyinitiated. In addition, computer equipment and systems must be strengthened to simpli5 operationalprocedures and obtain the information necessary for the efficient management of the customs system

4. Customs reform will encompass: (i) the orgational stucture of SUNAD, (ii) its operatingprocedures, (iii) the computer system, and (iv) human resources. An Action Plan for reform wasagreed between the MlB and the Peruvian Government, the three stages of the Plan coinciding withthe three tranches of the M)B's Trade Sector Loan. The Plan will be executed in the context of aprogram of Technical Cooperation, financed partly by the IDB and partly by the Government. TheWorld Bank was involved in the disussions leading to the agreement on the Action Plan and willsupport the fulfillment of the Plan in parallel to, and in consultation with, the IDB.

The Action Plan

A. The Fiust State

S. Thi will entail actions to be undertaken in SUNAD's organizational structure, including:

* preparation of a draft General Customs Law,

IL This Annex provides summay iniformtion frome Plan de Accidn p u d SSIom do Adumas de Pnt, AoIV of IDI document Pant hdsum Aidste del Sedo de Codmorio P1O3 : EdePon 10September, 1991.

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ANNEX-5Page 2 of 4

* preparation of a draft Legislative Decree to establish SUNAIYs ownregulations;

* identification and definition of SUNAD's top management levels; and

* definition of the functions of each section of SUNAD (and the size of itspersonnel) and its Administrative Units

6. The first stage will also include actions in the field of customs procedures and regulations,such as:

* approval of a procedure for export clearance;

* creation of a Group to analyze and monitor operative procedures;

* approval of a plan to review tax assessments of past imports declartions;

* initietion of a procedure to enforce bank guarantees for overdue debts;

* approval of the action plan to take inventory of, and auction off, goods leftunclaimed;

* establishment and implementation of a comprehensive guarantee system forin-transit goods and establishment of rules governing in-transit operations; and

* identification of personnel in charge of the review of import and exportdocumentation.

B. The Second Stage

7. The following steps will be carried out in the area of organizational structure:

* approval and publication of Legislative Decrees modifying the GeneralCustoms Law and providing regulations for SUNAD;

* formulation of a draft set of implementing regulations for the GeneralCustoms Law;

* approval and publication of the Statute of SUNAD;

* approval of the new organizational stnucture of SUNAD;

* naming of the employees for each division of SUNAD and of the units thatmake up SUNAD's organizational structure;

e the identification of personnel made redundant by the reorganization and ofmeans to carry out their separation; and

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Page3df4

* commencement of the purchasing process for the SUNAD building.

8 As for customs procedures and regulations, the actions will include the auctioning of goodsabandoned as of 30 June, 1991, the design and application of a system for monitoring manifests, andthe approial of the following:

* criteria to select the operations to be submitted to on-site inspection;

* procedure for adjusting settlements after assessing value;

* procedures for customs verification of operations to load and unload goodsand their subsequent implementation.

9. The processing of operations within the second stage will entail:

* creation of the computing center;

* defnition of general information needs and the configuration of the computersystem;

* selection and acquisition of the elements necessary for the computerequipment; and

* system design and development p!an.

10. In the area of human resources, the following steps will be taken:

* approval of the programs for the selection of new personnel and dtse forinternal promotion;

* approval of plans and proposals for short- and long-term training;* evaluation of the personnel and financial resources necessay for the Customs

School to operate; and* incorporation into the School of the training equipment envisaged in the

technical cooperation project

C. he Third Stage

11. Ihe acti as related to the organizational structure will include:

* equipping of the new customs facilities;* completion of the commiunications network of the Customs System; and* approval and publication of the implementing regulations of the General

Customs Law.

12. Actions for the reform of customs procedures and regulations will consist of

* preparation, approval and implementation of the Manuals for the new prcedures

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AM, SPage 4 of 4

o execution of the bi-annual Control Plan and the presentation of the resultsof this; and

* presentation of the figures for fiscal returns from the review of import andexport declarations.

13. In the area of processing of operations, the actions wil involve;

* deveOpment of computer files and sub-systems;* training of the users of the system; and* presentation of foreign trade statistics by tariff codes, countries, and economic

agents.

14. In the area of human resources, the actions will include:

* completion of the training courses set for this stage; and* inclusion in SUNAD's budget of the resources necessary for the operation of

the Customs School.

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Page 1 of 18

REPUBL1CA DEL PERUMMISTERIO DE ECONOMIA Y FINANZAS

DESPACHO MINISTERIAL

Oficio No. 206-91EF1O

Lima, Januaty 9th, 1992

Mr. Lewis T. Preston,President,The World Bank,1818 H Street N.W.,Washington, D.C 20433

Dear Mr. Preston,

1. To support the implementation of the trade refcnm that the GCrenment ofPeru has undertaken and the process of Peruvian reintegration into the international financialcommunitY, the Government is requesting from the International Bank for Reconstucton andDevelopment (IBRD) a Trade Policy Reform Loan of US$300 million equivalent.

2. In support of this request, this letter:

- describes the content and specific objectives of the Government's medium-termmacroeconomic-stabilization and medium-term adjustment program;

* descnbes the exernal financing plan that Peru has agreed with its majorcreditors;

* outlines the Govemnment's understanding of the process, conditions, andtimetable under which this Loan would be presented to the IBRD's Board, andthe loan agreement thereafter signed and made effective;

• describes the medium-term objectives and guidelines of trade policy, identifingspecific measures that will be undertaken by the time of signature of the loanagreement and furer measures the Government intends to undetabke ,fouwingloan signature; and

* descrs the Govements undeng as regards reporting to the Bank onprogress in the macconomic adjustment and tade-refom programs.

3. Once the proposed loan has been presented to, and apprved by, the Board ofthe World Bank, this letter (which we understand will become part of the loan do tation)will constitute an undetanding between the Goverment and the Bank on the conditions andcriteria according to which the agreement for the proposed loan can be siged and madeeffecive

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Page 2 of 18

L Governments Stabilization Efot and Medium Term Adjustment Program

4. On July 28, 1990, when the current administration assumed office, the countryonfronted a severe economic crisis and a serious institutional decay. Prices rose by 2,800 percent

in 1989 and accelerated to 60 percent per month by July 1990. GDP declined by 20 percent in1988-89 and declined further as 1990 advanced. The country's net international reserves weredepleted, and havnng pursued a confrontational extemal debt strategy, the country was vfrtuallyisolated from the international financial community. AU these factors contributed to make socialconditions increasingly difficult and led to intemal migration movements into major cities and to acontinued rise in polidcal violence and terrorism Further, the resulting growing poverty anddeterioration in the distnbution of income provided a breeding ground for drug traffickng andother criminal activities. Deep at the root of the crisis were massive fiscal and quasi-fiscal deficits,widespread wage and price controls and subsidies, a highly distorted exchange rate system,negative interest rates and multiple distortions in the trade system and labor market.

5. Faced vwth this dire situation, the Government, starting August 8, 1990, adopteda comprehensive stabilization program designed to curb inflation and achieve a sustainedeconomic recovery, along with the setting of conditions for progress towards a viable medium-term balance of payments situation and a reintegration into the global economy, including anexpansion of direct foreign investment. Further measures have been undertaken since thebeghiing of 1991 to strengthen the program and to accelerate the implementation of keystucturn reforms.

6. Throughout the implementation of the program, the Government has viewedfiscal and monetary discipline as critical to the stabilization effort. Thus, it undertook measuresaimed at eliminating the non-financial Public Sectores domestic borrowmg by means of combininglarge initial adjustments in gasoline and other public sector prices with the adoption of a taxrefrm (including several emergency taxes) and strict expenditure control, including the reductionof employment in the public sector through a voluntary program of withdrawals. In 1991, the aimis to achieve a primary budget surplus and a reduction in the current account deficit of the non-financial Public Sector from 3.4 percent of GDP in 1990 to 0.4 pe.rcent in 1991. Tis fiscal effort,if combined with expected foreigp financing flkws, would allow for a modest increase in publicivesatment.

7. The Government intends to continue pursuing strict fiscal discipline over themedium-term, and as a result, both the savings and the investment of the non-financial PublicSector are expected to increase further. However, to ensure the sustainability of the fiscal effort,the Govemment has embarked upon a major effort to restore tax revenues from the equivalent of7.6 percent of GDP in 1991 to 13 percent of GDP by 199.5. In line with this objective, theGovenment is proceeding with a number of reforms with a view to achieving before the end of1991 a simplified tax system based on a few broad taxes (the value added tax, selectiveconsumption taxes on gasoline and a few other products, personal and business income taxes, atax On gross assets of business enterprises, a local property tax, and a simplified import tariff). TosuppleAent the change in the tax system, the Government is also pursuing broad ranging refonmsin ta and customs adminiation. In addition, the Giovemment has resolved to maitain the taxcontribution of the petoleum secto in real terms and would seek to maintain the real level ofother publc sector taiff in line with expected inflation. Furthermore, before the year ends, the

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Page 3 of 18

Government plans to begin implementation of a public sector reform program which will enable itto redefine the scope of Government activities, reduce the size of the Public Sector, recruittrained personnel for seoior positions, and reassign or reduce personnel with appropriatecompensation. In the yeas to come, the Government also expcts to implement plans currentlyunder discussion for further reform public sector emoployment, the social security system, and thestate administration.

8. The adherence to strict fiscal discipline has been coupled by stem creditrestraint by the Central Bank in the pursuit of a lower inflation path and the attainment of astronger net international reserves position. Also within the tight credit ihnits, the Governmenthas looked for ways in which to rediect credit flows towards private sector activities by means ofa phased reduction in marginal reserve requirements and by reducing subsidized lending,particularly that of the Banco Agrario. These actions together with the establishment of market-determined interest rates, by lfting the ptevious interest rate ceilings to non-biwding levels, areexpeted to promote a faster growth of financial savings and their more efficient allocation. Toimprove monetary control, the Government will seek to widen the range of instruments to includeopen market operations before year end. The Govemment intends to maintain monetaryrestraint over the medium-term in line with the general objecdves of the program. Nevertheless,it wfll endeavor to increase the scale and efficncy of financial intermediation through furtherderegulation of financial markets and by further strengthening the framework of prudentialregulation and supervision. The Government also intends to reduce its participation in thef cial system by means of a more limited and precise delineation of the financial actmivtes ofofficial development banks and by engaging in an action plan to privatize public sectorcommercial banks.

9. The macroeconomic adjustment process has been accompanied by the beginnigof a far-reaching effort of modernization of the economy aimed at increasing its level ofcompetitiveness and efficiency. Important measures aimed at the hiberalization of differentmaets have been adopted while at the same time, the provision of public goods is begig tobe made more efficient, coupled with the launching of a wide ranging pmvatization proces. TheGovemment has alread issued three major Laws in the areas of land tenure and investment,labor relations, and the financial sector.

10. In the aaian sector the Govemment issued two decrees in March 1991, laterincoWrprted in the Law of Agrarian Investment Promotion of August 1991. The main objectiveof this legislation is to modify property rights, liberalizing previously existing limitations under the1969 Agrarian Reform Law, thus allowing farmers to freely dispose of their property andenhancing their access to credit markets. The new Law also promotes prvate corporate landowehp and investment and allows land cooperatives to become private estates. In addition,the Government decided to move away from massive subsidies by dereguating the domesticagriutural market and abolishing ENCIa import monopoly on wheat, corn, sugar, soybean-oil,powderd milk and ferls Moreover, the Government decreed the liquidation of ECASA andauthorized ENCrs reorganization with the purpose of reducing the scale and scope of itsactivities

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11. In the area of labor. the Government has recognized the need to reform the oldregime which rendered the labor market inflexble and caused the expansion of the informalsector. To this effect, the Goveament issued in March 1991 two Decrees regulating the existingemployment stabilit legilation by specifyg with greater clarity the cases for dmissal ofworkers. In addition, under the new legislation, workers and firms have been provided with abetter system for the financial treatment of contributions towards workers' severance payments.Fnally, firms have been offered wider possibilities for engaging workers on a temporary basis.

12. For the financial sector the Government has already begun to adopt measuresaimed at promoting greater efficiency and increased monetization of the economy. The purposeof the new Bankdng Law of April 1991, is to reduce the level of regulation in the sector. Itprovides incentives for lower intermediation costs, enhancing competition by allowing for universalbanking and opening the credit market to foreign investment. In addition, the Law strengthensprudential regulations specifying credit concentration ratios and new capital requirements. Also,the LAw includes new provisions for dereguating the insurance industry, premiums have beenfreed and the Govemment monopoly of the reinsurance business has been abolished.

13. Since March 1991, the Government has started to redefine its role in theeconomy, divesting itself of productive activity in order to redirect its scarce resources mainlytowards the provision of public goods and social infrastructure. A list of 23 public firms to beprivatized has already been published and the process of divestiture of some 180 firms is going tobe given special attention by the administration. Also, since July of 1991 the Government hasannounced plans to sell majority stakes in steel, mining, air transport and telewommunicationsenterprises Coupled with these efforts, the Government has proceeded to abolish the statemonopolies corresponding to ENCI, ECASA, gold trade, and PETROPERU's hydrocarbonproducts imports and commercialzation.

14. The Government is committed to encourage foreign investment in all sectors ofthe economy. The liberalization of the capital account of the balance of payments now allowsforeigp investors to remit abroad aU net profits and royalties. Foreign investment can now beunder any corporate form or joint venture, and investors are allowed to purchase stock fromresdents and to invest in any sector except those otherwise reserved for nationals. Also Peru hasbeome a member of the Multflateral Investment Guarantee Agency effective December 19, 1990,and is actively promoting the resolution of current contractual disputes in the mining and energysectom

IL Etea F cinu Plan

15. As of July 1990, about two-thirds of Peru's approximately US$22 billion extemaldebt was in arrears and Peruvian commercial debt traded at 5 cents on the dolar In the secondarymarkt The policy of slective default on external financial obligations followed by the previoGovernment had brought significant losses to Peru in the form of reduced aid flows, paralyzeddevelopment projects and foreign ivstment, increased vulnerability to trade restrictions increditor countries, and contributed to a major macroeconomic collapse. From the beginning, thenew Adminitration has made it clear that Peru would seek reintegration into the internationalfinanl commity. Payments of current obigatons falling due to the World Bank resumed in

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October 1990, and to the IIB a month later, thus "freezigM the stock of arrears with theseinstitutions at the respectie levels prevailing on those dates. (Current debt service payments tothe IMF had already been initiated in September 1989, durng the previous Admiitration.)Debt service payments to the three multilaterals, which average about US$41 milion per month,equivaent to 14 percent of fiscal revenues, represent a major effort by Peru, given the level ofunfulfiled social demands, the cholera epidemic, and the countrs current low ability to pay.IJterruptions in the payment of debt service to the IDB and the World Bank were registeredbegining in March 1991, but the Govemment deposited these funds in escrow and released themfollowing the IMFs appwval of its Rights Accumuiation Program (RAP) on September 12

16. The Government is committed to, and bas sought, support from its majorcreditors for a growth-oriented three-stage debt work-out. The first stage, comprising theclearance of arrears with multilateral creditors, has begun; the second stage, Peru's reschedulngof its official bilateral debt with the Paris Club, was completed on September 17; the third andfinal stage will consist of negotations to find a solution to Peru's debt overhang with commercialbanks The four conditions for the financing plan to be successful are that: (i) Peru comply withthe fisug-monetary targets unm/er the IMF program and implement a program of structurareform agreed with the IDB and the World Bank; (ii) the Support Group provide financing tocover a two-year gap estimated at US$0.7 billion; (iii) Peru comply with current debt serviceobligations to the multilaterals; and (iv) Peru abide by the terms of the rescheduling of Paris Clubdebts.

17. At the start of the debt worlout, arrears with the three mutilateral totaledUS$2.2 billon Under a financing plan agreed between Peru and the multflaterals, arres withthe IDB were cleared in September 1991, while arrears with the World Bank and the IMD wouldbe cleared by December 1992. Arreans clearance would be financed through a combination otbridge loans sgainst disbursements of multiateral institutions (which would be made immediatelyafter the clarance of arrears) and Peru's own balance of payments efforts.

18 The clearance of arrears owed to the = took place on September 13, 1991.Fiancing to clear 1DB arra was facilitated by the disbursement of a recently approved US$325million loan to Peru from the Latin American Reserve Fund (MFAR). On September 18, theIDB approved a trade sector adjustment loan, and we understand that IDB's resumed lending toPeru would consist of a further sector loan and four new project loans. The sector loan willsupport the Govement's reform efforts in the area of the Financial Sector. A third sector loan,posblly to support Agricultural refom and investment, is also foreseeable. In turn, the four newprojects cover the areas of Electricity, Health, Sanitation, and Roads. Total commitments underthese loans could reach up to US$1.1 billion, while disbursements prior to December 1992 couldtotal between US$700 to 800 million

19. The T approved a 16-month RAP in support of the Governmentsmacroenomic progm on September 1Z 1991. As you may recall, in 1990, the IMF establisheda new policy to dealwith countries in atrears with the MF. Under this policy, termed RightAccumulation Program (RAP), and upon satisfacury completion of the macroeconomic targets ofthe program, a country can build up 'rights towards a fuly back-loaded disbursement followingthe derance of arer At the end of the program, remaining arrears can be cleared with ashort-term bridge loan aginst the IM post-clearance disbursement. Total 'rights" to be

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accumulated during the program amount to SDR625 million, equal to total arrears owed to theIMF. The key performance targets under the IMP progrdm are: budget balance; zero flow ofCentral Bank domestic credit to the public sector; a ceiling on total arrears with all creditors and"frozen" arrears with multilaterals; and a US$225 mfllion increase in international reserves.

20. As regards the World Bank we would also expect to be beneficiaries of its newapproach which was approved early in 1991 for dealing with arrears of countries implementingstrong adjustment policies and whose arrears are large. Under this policy, the World Bank candevelop and process adjustment loans during a "performance period" in which the country wouldbuild a track record and establish a claim to future disbursements. Although these loans can bebrought to and approved by the World Bank Board, loan signing, effectiveness and disbursementsdo not take place until aU arrears to the Bank have been fully cleared and the country hasestablished a satisfactory track record on adjustment measures. The World Bank intends toprepare three such adjustment loans during the period from December 1991 to June 1992. Thesethree loans are expected to cover the areas of Trade, Structural Adjustment and Fmancial Sect.Disbursement claims to be accumulated could total about US$900 million. As in the case of theDMFs RAP, at the end of the performance period the country can mobilize a bridge loan to clearits arredrs.

21. As regards the situation with BilateraLs, the Government obtained arescheduling of Paris Club debt shortly after the RAP was approved by the IMF Board. The bulkof Peru's external debt is with bilaterals and suppliers (48 percent), most of it with Paris Clubcreditors. Peru received unprecedented cash-flow relief, during the consolidation period (October1991 to December 1992), from its Paris Club creditors, in the form of rescheduling, deferment ofmoratorium interest, and deferment of post-cutoff date arrears.

22. Per's debt with commercial banks totals US$5.6 billion, more than 90 percentof which is in arrear Followng law suits brought by the commercial banks in 1989-90, the newGovernment has negotiated an understandig with them under which it renounced recourse tostatute-of-limitations provisions in return for a suspension of the default proceedings that wereinitiated in February 1990. However, Peru's current and foreseeable low ability to pay would notappear to provide room for debt service payments to commercial creditors. In the context of acontinued strutural adjustment effort, Peru envisages the possibility of debt and debt semicereduction schemes (ie. buyback schemes and/or outright reductk%n with enhancements).

23. In order to cany out the strategy, outlined above, with each of Peru's majorcreditor groups, Peru would face financing requirements of about US$18.8 billion for the two-yearperiod 1991-1992. We would expect that US$15.1 billion would be debt relief, US$0.4 billionwould be provided by the FLAR, US$ 2.6 bilion by post-clearance renewed disbursements ofmultilaterals and US$0.7 billion by the Support Group. Financial support from FLAR wasdisbursed and the first D)B loan approved in September 1991. The first tranche of the 1DB loanhas already been disbursed. World Bank and IMF disbursements are expected in December 1992.The Support GToup was officially formed on June 7, 1991, under the co-ladesip of the U.S.and Japan, and comprsng inter j, Belgium, Canada, France, Germany, Holland, Italy, Spain,Sweden and Switzerlnd. By late August 1991, total commtments pledged by its members, in thefom of grants or soft loans, reached apprmately US$1.1 billion. However, of this total, onlyUS$673 million were in the form of pure balance of payments support while the rest was in either

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project that entailed additional non-programmed fiscal expenditures or grants channeled directlyto NGOs. Support Group disbursements are expected to take place through the end of 1992.

IIL The Process of Loan Preparation snd Peru's Clearance of its Arrears with the World Bank

24. Ihe Government understands that the Board presentation of the loan we arerequesting will require the following conditions to have been met:

(a) the Bank's agreement to the macroeconomic stabilization program presented inthis letter (which the Government has already agreed with the IMF);V'

(b) an External Fmancing Plan in place (as presented in this Letter), agreed amongthe intemational financial institutions and the Support Group, which wouldprovide for full clearance of arrears to the Bank and the normalization of Peru'srelations with the IMF and the 1DB;

(c) the Bank's agreement to the trade-reform program presented in this Letter, and

(d) Peru remaining current on its servicing of debt to the Bank currently falling due(other than debt covered under (b) above), on the terms already agreedbetween the Government and the Bank

25. The Goverment further understands that, after its approval by the WorldBank's Board, the loan would not at that point be signed. The loan would be signed and declaredeffective at the end of a 'performance penod" during which Peru would demonstrate thesustainabilit of its macroeconomic stabilization and trade-policy-reform programs and thecontinuing *iability of a Financing Plan agreed with the international financial institutions and theSupport Group. During this period, the Government would continue to follow the program ofmacreconomic stabilization agreed with the IB and the Bank and to carry out specific trade-policy measures agreed between it and the Bank. It would also undertake to supply the Bankwith relevant information on the progress of the macroeconomic-stabilization, trade-reform, andcustoms reform programs (as detailed in paragraph 45 below) to enable the Bank to reportregulrly to its Boa If, at the end of this period, the conditions governing this performanceperiod have been complied with, the loan would be signed. On effectiveness, it would then bedisbursed in its entrety, provided that the Bank has received and accepted the usualdocumentation for disbursement by that date. The performance perod for this loan would not

J/ The Sank milt monitor the macroecnomic-stabilization prograu in the light of the performmnce parametersset out in paragraphs x 6 to 8 above. The lank witl consult with the IMF on the progress of the program andmill pay particular attention in evaluating macroeconomic performance, to the following reasonable rangesfwr specific indicators In 192s

Central Government current tax revenue: at least 9.0 rercent of OOP

Primry Balance of the non-financial public sector: at least 0.6 percent of GOP

Rate of creation of monetary base (Decaiber, 19°1, to December, 1992): no mare than 40 percent

Stock of other Contral Bank monetary liabilities in Soles: uD to 0.1 x monetary base

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end before December, 1992, and would run concurrently with the period of the IMFs RightsAccumulation Program

26. During the performance° period, the Govemment is committed to continue toservice debt faling due to the Bank, undertaking to provide debt-servicing treatment to the Bankno less favorable than that provided to the IMF. Before loan signature, arrears to the WorldBank would need to have been completely cleared.

27. The Government further understands that (as will be reflected in the LoanAgeement), if a lapse of time onzurred between signing and effectiveness, effectiveness wouldrequire that during this period the Bank continue to be satisfied with the implementation of thetrade-reform and macroeconomic stabilization programs and the external financing plan, as setforth in this letter.

IV. The Govermen TiadReform Prom

28. The Government considers trade reform to be a key element of its efforts toreform the economy in order to modernize the productive structure and lay the groundwork forvigorous grwth based on the efficient use of resources. As well as hberalizing other markets andmaintaining a consistent macroecnomic framework, the trade reform is designed to shift theeconomy from inefficient production addressed mainly to the local marky t toward export activityand efficient import substitution. The long-term, comprehensive nature of the trade reformsundertaken by the Goverment will ensure the competitiveness needed by a small economy suchas Peru's in order to generate dynamic growth of production and employment through theexpansion of investment opportunities and active integration with the global economy.

29. The trade reforms have been implemented concurrently with the stabilizationeffort underken by the new administration to counteract one of the longest bouts with runawayinflation ever recorded in the world. The trade reforms were timed to provide support for thestabilization process Together with the exchange rate unification and float, the elimination ofprice contols and the drastic adjustment in prices and public utility rates, the trade reforms are tocontribute to restoring relative prices that are compatible with those prevailing on theinternational market, while at the same time helping to brng inflation down to world lavel

30. The exchange and tra systems inherited by the admnstration that took officein 1990 edhibited serious distortions owing to inconsistent discretional behavior by the State.Within a fixed exchange rate approach, multiple rates were established according to a system offoreign exchange allocation and differential payment for various export categories. The outcomeof such poicies was that Peru came to have at least ten exchange rates, and one of the leasttranpaet and most arbitAy exchange systems ever seen. This system generated enormousimplicit tanms on variou export sors and abnormal revenues on certain imports, therebypromoting speculation, leaving local production extremely vulnerable and giving rise to coruptionwithin the public ista

31. Simlarly, the tarff system showed a bigh level of nominal protection andfragmentation, with over SO differet tarif The tariff system was applied together with a broadrae of exemptions, bans, import monopolies, import permits, and a long list of non-tariff

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administrative controls designed to grant additional discretional protection to specific sectors. inspite of the high nominal protection, collections of import duties were low because of theproUfration of exemptions.

32. In August 1990, the exchange rate was unified and allowed to float with limitedCentral Bank intervention. Free converdtilty of the inti was established, and current and capitalaccount transactions on the balance of payments were hberalized. The obligation to surrender tothe Central Bank foreign exchange receipts from exports was eliminated, as well as theinnumerable restictions on foreign exchange holdings and use inside and outside the county.

33. One undesirable consequence of the stabilization program adopted by theGovernment to attack runaway inflation has been a revaluation of the currency, which has causedproblems in giving the productive apparatus a new export orientation and generating immediateimpetus for economic growth. The major economic adjustment of August 1990, in generatinghigh corrective inflation, had the effect of bringing about an abrupt drop in the money supply andan increase in real interest rates when inflation subsequently fell substantially. The greaterpreferene for local currency liquidity, together with the Central Bank's decision not to financethe non-financial public sector through currency issue, have caused the real exchange rate toappreate considerably. Ti situation became more acute with the recent repatriation of capitalheld by Peruvians aboad, motivated by high interest rates for local and foreign currency on thelocal capital market and the need for business to obtain worlkng capital given the prevailingrecession.

34. The return of capital has occurred despite a floating exchange rate system thatdoes not guarantee a particular nominal exchange rate. However, the revaluation process is nowshowing sdns of reversing itselL FSt, interest rates are already falling thanks to greatercnfiden tat inflation will be beaten. Second, the Central Bank has proposed that clearmonetary policy goals be set in combination with efforts to effect a sustainable rehabilitation ofthe public finances. In addition, the Central Bank has taken steps to raise miimum requiredreserves and has created new financial instruments to enhance its monetary control by allowinggreater mterenuon on the exchange market. The Government remains determined to keep afree exchange system, and is convinced that the current problem with local currency revaluationwil be resolved through a renewed attack against inflation by setting transparent monetary goalsand strengthening the fiscal situation.

35. The trade reform has evolved in three stages. In the fist, beginning in Augustl990, a maximum tariff of 50 percent was set while the exdsting system of tariff surcharges - whichin effect made the ceiling 76 percent - was maintained. Also in the first stage, a minimum tariffof 10 percent was set, which affected the system of exemptions, and the list of banned importswas drasticaly reduced to 13 tariff positions, eliminating the prior import permit During thesecond stage, begnng in late September 1990, tariffs were reduced to three, namely 15, 25, and50 percent while a 10 percetage point surchage was retained on the 25 and 50 percentcategories At this point, the Government announced its intention to continue lornng tarffs toa single rate of 15 percent by ijnuary 1995. In early 1991, however, it was clear that economicagents lackd confidence in the permanence of the tariff measures, mainly because of the delay inliftg the temporary 10 pcent surcharge and the establishment of a special reduced-rate importprocedure for iron and steel industry inputs. In this context, the Govemnment accelerated the

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process, eliminating in a third stage (in March 1991) the 50 percent tariff and applying the 15percent rate to the majority (81 percent) of tariff positions.

36. Also during this third stage of the trade reform, the Government eliminatedimport registers and state monopolies on imports of food commodities and inputs, and streamlinedhealth requirements for agricultural imports, sanitary requirements and quality control in thehealth sector, and technical quality standards for industrial products. It also eliminated non-tariffbarriers such as restrictions on he purchase and sale of vessels in the transportation andcommunication sectors, and the elimination of the state monopoly on the sale and import of fossilfuels and their byproducts in the energy and mining sectors. Also, to counteract the effects ofsubsidies applied by other countries to agricultural production and e;ports, compensatotysurcnarges were introduced on imports of dairy inputs, wheat, corn, rice, sorghum, wheat flour,sugar, and pasta. These surcharges act as specific duties that vary according to intemationalmarket prices. Also approved was a rule governing the application of countervailing andantidumping duties.

37. Under its new export policy, the Govemment lowered export subsidies(CERTEX) in August 1990 and eliminated both them and the subsidized interest rate forfinancing of nontraditional exports (FENT) in November 1990. In March 1991, exportrestrictions were eliminated, a simplified procedure was adopted for the reimbursement of indirecttaxes, and the temporary admission system was modified. For fiscal reasons, however, the tax onnon-traditional exports has been retained, at rates of 5 to 10 percent.

8. The trade reform that began in August 1990, has included the reform of theinstitutions that administer foreign trade. In August 1990, it was decided to dismantle the ForeignTrade Institute, formerly responsible for setting policy and applying controls on foreign trade, aprocess that was concluded in July 1991. Under the country's cnstitution, the executive branch isresponsible for Letting tariff levels and regulating trade in general, a task carried out by theMinistry of the Economy and Finance. However, the Ministry of Industry shares certain functionshaving to do with export promotion and trade negotiations, through an InterministerialCommission chaired by the President of the Cabinet Council or his delegate. The NationalCustoms Authority (SUNAD) is in the process of reorganization, having substantially modifiedprocedures for clearing imports and exports through customs. The new procedures are intendedto simplify and modernize customs through a better allocation of resources and a significantinvestment in training.

39. . he customs reorganization program also includes a staff reduction throughincentives for early separation and mandatory retirement. To date 500 of the 2,700 customsemployees have resigned voluntarily, while competitions have been held to hire some 100university graduates who must first pass a training program. Also as part of the reorganization,legiation has been passed to expedite clearing goods in customs warehouses, giving privatecustoms agents the authority to calculate duties and make payments, and leaving staff toconcentrate on reviewing documents and selective valuations. Fmally, there are new regulationson the administrtion of the temporary admission system to be used by the export sector. Underthe new system, payment of duties is suspended upon presentation by the exporter of anapplication to customs and to the ministry governing the sector concerned.

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40. In the area of ports and ocean transport, steps have been taken to reduce thecost of port activity substantially by elminating the monopoly on loading and unloading operationsand authorzng companies and cooperathes to carry out such operations from July 1991 at allPeruvian ports Also eliminated by legislative decree are all the administrative and legalrestrictions and obstacles that impeded free access to international ocean routes and xraffic.Shipments of export and import cargos have been freed and the cargo restriction in favor of shipsunder the national flag has been lifted.

41. Ihe Govemment intends to consolidate and advance the trade reform in orderto establish a permanent framework for dynamic trade development that will be consistent vinththe aim to promote greater efficiency and higher levels of economic growth Maintaining thecurret foreign exchange-rate policy and strengthening fiscal policy will serve in turn to shore upa stable economic policy over the long term, based on the principles of free trade, free access byeconomic agents to all kinds of trade activity without distinction as to the type of goods oreconomic sector, thus ensuring fiuI privatesctor participation in all economic activity. A vitalpart of the consolidation process was to pass into law, in September 1991, all tarifE, non-tariff andadmlnistratie reform measures, in the form of a legislative decree with the force of law, underspecal powers delegated by the legislative branch.

42. The legislation is intended also to ensure the permanence of the foreign tradereforms, in the spirit of the principles mentioned. Specifically, the trade system is prohibited fromdiciminating among productive activties, whether exports or imports. Export activities willpermanently enjoy rights to the drawbacks they currently have access to, and, as the fiscalsituation permits, these rights wil be etended to cover other indirect taxes which exporterscannot currently get back General surcharges and other taxes on imports are to be avoided bythe Governm t, as are other levies other than customs duties and the general sales tax It isobligatory to comply with technical standards, sanitary requirements and all regulations in such away that they do not function as non-tariff protective measures discriminating against imports.The State will ensure that protective measures against unfair competition (anti-dumping levies andcountervailing duties) are not used to introduce undue protection to local production. Fmally,furthe legislation will be pased to make permanent the ban on granting customs exemptions andreductions.

43. In December, 1990, the Government announced its intention to unify the tariffstructure at a single rate of 15 percent by January 1995. Since this time, substantial progress innegotiations betwee the member countries of the Andean Group has led to a decision inprinciple (on December 5 1991) of the Andean Presidential Council to create a customs union.This would require Peru to apply a common external tariff (which has not yet been negotiated)from January 1 1992. The tariff would have no more than five rates, ranging from 0 to 20pert, and the number of rates would fall to no more than four (ranging from 0 to 15 percent)by Januaty 1 1994. , for any reason, the steps necessary to implement the common externaltariff, as it has been ageed in pdnciple, do not appear likely to be taken within a reasonableperod, the Govenment intends to maintain its current objectve of a single tarff rate. Also, ifthe fiscal situation permits, the Government will eliminate export taxes and attempt to provideequitable scal tatment to all exports, both traditional a id nontraditional

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44. Consistent with the above reform program, the Government is committed tocarry out the schedule of trade-policy and customs-reform actions in Appendix A.

V. Monitoring of the Macroeconomic and Trade-Reform Programs and the Fmancing Plan

45. In order for the Bank to be kept informed of the progress of the trade reformand of the conditions that would govern the proposed loan and to form the basis for a continuingdialogue on trade and macroeconomic policy, the Government will provide information to theBank on the macroeconomic-stabilization, trade-reform, and customs-reform programs accordingto the schedule set forth in the attached Appendix B.

V. Conclusion

46. The Government will continue to exchange views with the World Bank in theareas covered by this project and to discuss the progress made in implementing the proposedreforms.

47. The trade policies described in paragraphs 28 to 44 above are those that theGoernment is now implementing, or plans to implement in the near future. These policies willalso be the basis for Peru's position in any international negotiation related to trade issues. Inthe event that these negotiations result in an international legal instrument, the PennianGovernment understands that the Bank could request the relevant information so as to decide ifthis instrument has, or could have, a significant negative impact on the program agreed in ftisLetter.

48. Fmaliy, I would like to reiterate that the Government is committed to carigforward its trade-policy reform program and to continuing its policy dialogue with the WorldBank. In consideration of the trade reforms already undertaken, within the context of Peru'soverall program of economic stabilization and reintegration into the international financialcommunity, the Government requests your favorable consideration of this request for a TradePolicy Reform Loan.

Yours sincerely,

/S/ Carlos Bolofia BehrMinister of Economy and Fmance

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ANNZ 6Page 13 of 18

bppondix A

b%2=IJL1 OETR E POLIC AND AI)MINSITRAONACIOLNS TC BE UNDERTAKEN

Polies to bt. Maintained. or Actions Undertaken. by Time of Board Presentation

(a) EVcha=ie ra= pogy. Maintenance of the convertibility of the local currency ata single rate of exchange for all external transactions.

(b) Tarff Not to increase the level of protection offered by the tariffsucture beyond tJat effective on July 5, 1991, unless and until a new tarff isimplemented in accordance with the December 5, 1991, statement ("Acta deBarahona") of the VI Andean Presidential Council

Not to increase the level of protection offered by the tariff structure beyondthat effective on July 5, 1991, will require the following:

(i) Maintenance of no more than three tariff rates;

(Ii) No tarff position currently at 25% to be assigned a tariff any higherthan 25% or ower than 15%;

(iii) No taiff position currently at 15% to be amigned a tariffany higher orlower than 15%;

(iv) The number and coverage of tariff positions now subject to the 5%rate not to be increased;

(v) No tarf position currently at 5% to be assigned a tariff rate any lowerthan 5%;

(vi) Not to utilize a possible reclassification of the tariff code from thecurent NABANDINAM nomenclature to any other, if such areclassification would have the effect of granting additional protectionto any product.

Aleratively Peru may tmplement a common external tarff under the aegis ofthe Andean Gtoup, prvided that it is substantially in accordance wMth theDecmber 5, 1991, statement of the VI Andean Presidential Council, whichprovides for no more than five rates, the highest at 20%.

Nommml/tum Anci de BUnssas pma el Gnpo Andio.

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ANNEX 6Page 14 of 18

(c) Tarif exemptio Not to reintroduce any exemption (frasauia orexonei) to the application of the tariff code except: those that result from

interational agreements; and those allowed in export-support programsestablished under D.S. 034-91-EF (temporary admission), and DS 052-EF(rawback), internamiento temporaL and replenishment of stocks.

(d) AgQFral surhar. The Goernment will not expand the surcharge schemebeyond the 18 NA3ANDINA positions listed in D.S. 0016-91 AG. In thecalculation of the minimum Eo.b. price for each of the 18 NABANDINA itemsunder the surcharge scheme, several guidelines will be followed: (i) the floorprice wBi be equal to the arithmetic average of the international price registeredin each of the 60 previous months; (ii) the relevant interiational reference fo.b.price for tariff items will be taken fi-om a recognized international publicationagreed upon with the Bank. The methodology for calculating minimum priceswill be published and strictly folowed thereafter. In addition, the GoenmentwM pubfish monthly. the minimum £o.b. price; the series of 60 previousmonthly recordings of the relevant international price; and the source of thelatter. Thi condition does not apply to the importation of powdered milk forwinch the surcharge should be specific and would have a ceiling of VS$496 perton for powdered milk and US$614 per ton for dehydrated mflk fat.

(e) Fet zones. Any new, or expanded existing, free trade zone will beauthorized to sell finished goods or inputs only within said zones or outside ofPeru. Any good or input coming from these free trade zones may be sold in thedomestic market if duties and other taxes are paid.

(*f) No~n-tariffiEi§n

(i) Refrain from using reference prices and mirnmum value(aforou) prices as a way of protecting domestic production.Mhis condition wfll not apply to the customs categoriesincluded in D.S. 0016-91 ACt.

(ii) Not to reintroduce non-taiff barriers on imports or exports(including hcensing, prohibitions, monopolies, quantitativeresictions, controls or prohibitions on second-handimports, national-content coefficients, prior-registrationrequirements), nor domestic trade restrictions further tothose that prevaied on July 5, 1991. TIis condition doesnot apply to the dipositions of Legislative Decree No. 653and the subsequent amendment to Legislative Decree No.668 regarding powdered milk within the context ofpromoting inhestment in the agricultural sector.

(iii) Agree with the Bank on tersw of reference for a study todevelop consistent criteria and corresponding regulationsassuring that health and fitosanitary regulations and

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Page 15 of 18

technical standards (particularly those administerd by theMinistries of Agriculture, Health and Industry) are appliedimpartially, without the aim of granting non-tadff protectonto local producers.

() AAnti-dumping code. Agree wit;i the Bank on terms of reference for a study torecommend amendments to the Code (D.S. 133-91-Er), and to propose a draftfor the Code's implementing regulations, in line with the Government'scommitment to amend several aticles of the Code so thzat it dons not becomean instrument of unjustified protection for domestic produces

(h) Exoort taxes and subsidies.

(i) Not to raise or increase the number of current export taxesor extend them to other products.

(ii) Not to introduce any fiscal or financial measures theeffect of providing direct export subsidies or providingexporters access to domestic credit - credit funded viadomestic savings - at below domestic interest rates for loansof comparable risk, maturity and co11ateraL

(I) InstittoZn,al rfurmt Ensure that the dismantling of all of the trade-regulatoiyfunctions of the Instituto de Comercio Exteric 'ICE) has been completed andthat those functions of ICE having been transm.ed to other governmentagnies do not include any related to the control of imports or exports in anyrpect, including the granting of .elective or global import duty exemptions forNy type of domestic activity or the establishment of export taxes, subsidies orselctive export probibitions

Uj) Qutma'(i) agree on an Action Plan to restructure the Customs Superintendency

(SUNAD) and to reform the legal framework of customs; and

(ii) comply with the first-phase conditions listed in the Action Plan forrestructung Customs.

21 lhs Acin Plan is conted in Plan do Accidn am el Sisde de Aduanas de Pwn' Anexo IV ofdo&wU of tla hta-Amwican Dw.dlmnt Dank, PerS: Pr o de Ajqst dd Scam de Com

g 10 S , 1991.

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ANNEXPage 16 of 18

2. Ac&ons to be Undtaken by Mabc 19S9

A goneral codition to be met by this tih'e is satisfactoty progress in the execution ofthe trade policy reform program, including the non-reersa of the policy actions previouslyrequired for Board presentation. Further conditions in each of the areas of the program arelisted below.

(a) Tag PElinination of the S% tariff rate and establishment of a two-tiertariff ucture. All tariff items thitt were previously subject to the 5% rate wMbe subject to the 15% rate.

IE, on or around March 1992, it appeas likely that a new tariff will beimplemented, during 1992, in accordance with the December 5, 1991, statementof the VI Andean Presidential Council, the Govemment and the Bank willconsult with a view to postponing or cancelling the elimination of the 5% tarffrate.

(b) AWcOtural surcharges. Agree with the Bank on the terms of reference for astudy to evaluate the surcharge scheme (paragraph l(d) above).

(c) Non-tfaia Agree with the Bank on the guidelines and principles to beapplied in implementing the results of the study of health md fitosanitaryregulations and technical standards agreed upon by Board presentation (para1(f)(ii) above).

(d) A W code, Enact the amendments to Decree D.S. 133-91-EF, basedon the recommendations of the study commissioned and agreed up on wth theBank, so that the Anti-dumping Code does not become an instrument ofunjustified protection (para l(g) above).

(e) oms. Implement second phase conditions of the Acion Plan forrestructung Customs.

3. Actions to be Undertaen by June. 1992#

A generd condition to be met by this time is satisfactory progress in the eaecution ofthe trade policy reorm program, including the non-reversal of the policy actions previouslyrequied. Further conditions in each of the areas of the program are listed below.

I/ This date is inkdictve, rather tha binding, as fart as furthr condition ar concerned.

41I Ths dae* is indicative, rather tha binding, as far as further conditions ar concerned.

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Page 17 of 18

(a) turil surthag Agree with the Bank on the guidelines for theimplementation of the recommendations of the study on the surcharge scheme(paragraph 2(b) above).

(b) No-ab . Appropnate implementation of reorms to health andphytosanitaiy regulations and technical standards in line with agreed guidelies(para 2(c) above).

(c) ms. Implement the third phase conitions of the Action Plan forrestruuring Customs.

4. Actions to be UndMert by September. 1992k

A geal condition to be met by this time is satisfactory progress in the execution ofthe trade policy reform program, including the non-reversal of the policy actions previousrequired. A further condition is as follows.

(a) Agical surcharges. Appropriate implementation of reforms to thesurcharge scheme in line with the agreed guidelines (para. 3(a) above).

5. Acions to be Undetakn by December. 1992

A genea condition to be met by this time is satisfactoty progress in the execution ofthe trade policy reform prognam, including the non-reversal of the policy actions previouslyrequired.

gI This ddai b dcatve, rtr ta bindin,t, as for as fwre conditn a

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Page 18 of 18

&Mpen. B

SCHEDULE OF REPORTW.Cv

1. dhe macroeconomic adjustment program: monthly povision of monthly dataon:

(i) Central Goernment current tax revenue;

(i) Primary Balance of the non-financial public sector (on av.guartcry basis);

(ii) Rate of creation of monetary base;

(iv) Stock of other Central Bank monetary lhabflities in Soles.

2. Trade Reform: quarterly prvision of

(i) all policy documents and customs communications relatngto: exchange-rate and trade and treuivalent measures(including health & fitosanitary regulations and technicalstandards which affect foreign trade, documents relatig tohearn of the Anti-dumping commission, documentsrelated to regional integration).

(il) monthly exchange-rate- and trade-related statistics:

(il) imports and exports by commodity (and advance customsstatistics relating to trade through Callao and JorBe Chavezairport);

(iv) import tax colnection (tariffi and IGV tax separately) andexport tax collection (by export commodity);

(v) for agricultural-surcharge products: reference pices andcomparable current world prices; value and volume ofimports (cif) and domestically-produced sales;

3. Cusoms : the Bank wil receive the same report, on the same schedule,as thoe to be sent to the Inter-Amercan Development Bank (as specified inParagraph 3.25 of Annex VM-A of Perd Pdstamo de Ajuste del Sector de

4 45QQ- 9): Pouet de, 10 Septmber, 1991).

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Page 1 of 1

LIST OF PROJECT DOCU4ENTS

Abusada, Roberto, La Reforma de la Polftica Para-Arancelaria Peruana (1990-1991). September,1991

Abusada, Roberto, El Comportamiento de los Precios Luego de la Apertura de la EconomfaPeruana October, 1991

Acta de Barahona Act of the VI Andean Presidential Council, 5 December, 1991

Ing. Jorge A Cavallotti, Procedimientos Recomendados para Aceterar los Desembolsos de losPr&stamos de Ajuste Propuestos para Perd. September 16, 1991

Ing. Jorge A. Cavallotti, Perdl: Informe de Evaluaci6n del Sistema de Adquisiciones de Bienes yServicios v Obras Civiles. September 16, 1991

ECONSULT, S.A., Avance en la Desregulacidn del Comercio Exterior Peruano. August, 1991.

Inter-American Development Bank, Perd: Prdstamo de Aiuste del Sector de Comercio (PE0029):Propuesta de Prdstamo September 10, 1991

PNUD - Banco Mundial - ?rograma de ExpLnsi6n del Comercio, Perd: Hacia una Economfa M-aAbierta draft, August, 1991

Rodrfguez, Carlos, Foreign Exchange Market, June, 1991

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Page 1 of 2

STAlUS OF BANK GROUP OPERATIONS IN PERU

A. SUMtkAR UA M O]EgR1F LOA0N(As of November 30, 1991)

Amount lesslM YAK ]mc E oseusI1on iluieakum1

(US$ Millions)Fifty-eight (58) loans fidly disbursed 1151.88

2091 1982 Republic of Peru Transpmt 93.0 50.392396 1984 Republic of Peru Rura Dev. 40.0 32.80

Total: 1284.88Of which has been repaid: 448.44

Total now outsanding: 836.44

Amount sold: 18.31of which has been repaid: iL31

Total now held by Bank: 818.13

Total undisbursed: 1L12

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Page 2 of 2

B. STAT3MN-T OF IFC INVESrYENTS(As of November 30, 1991)

Amount in US$ millionDate BoMrower Te of Busineys ln i in

1990 BUENAVENTURA Metal Ore Mining .00 1.01 1.011979 Non-Ferrous Ore Mining 2.00 .96 2.961983 4.00 .00 4.001986 .00 1.00 1.001986 CARISA Non-Ferrous Ore Mining 6.00 .50 6.501962 CEMENTO ANDINO Mfg of Cement Lime & Plaster 2.46 .20 2.661982 CONENHUA Mfg of Electric Light & Power 4.50 .00 4.501975 CUAJONE Non-Ferrous Ore Mining 15.00 .00 15.001960 DURISOL Mfg of Fabric Metal Products .30 .00 .301960 FERTILIZANTES Mfg of Fertilizers & Pesticides 3.19 .00 3.191962 .90 .00 .901960 LUREN Mfg of Non-Metallic Mineral PR .28 .00 .281985 MiNERA REGINA Non-Ferrous Ore Mining 6.08 .24 6.321986 ORCOPAMPA Non-Ferrous Ore Mining 9.00 .00 9.001964 PACASMAYO Mfg of Cement Lime & Plaster 1.60 .49 2.091967 .00 .01 .011983 PALMESA Mfg of Vegetable & Animal Oil 15.00 .00 15.001986 PODEROSA Non-Ferrous Ore Mining 3.30 .00 3.301960 REUNIDAS Mfg of Fabric Metal Products 25 .00 .251980 SIMSA Non-Ferrous Ore Mining 2.7 .50 3.201985 4.00 .00 4.001982 SOGEWIBSE Leasing CompaDies 3.00 .14 3.14

Total gross commitmen_ : 83.56 5.04 8&60Less cance1lations, terminations

and sales: 762252Q

Total commitments now held by IFC: 7.31 2.27 9.58

Total undisbursed:

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ANNEX9Page 1 of 5

TECHNICAL ASSISTANCE

1. bThe new liberalized trade regime requires procedures, skills, and institutions whichdiffer markedly from those applied under the previous dmitration. A technical assistance programis proposed to finance policy studies, seminars and training and institutional reforms to advance theGovernment's efforts in foreign trade liberalization.

2. lle cost of the technical assistance program is estimated at about $350,000, consistingof: (a) $150,000 for policy studies ard seminars and training; and (b) t*00,000 for support toMICITI's trade promotion and international negotiations activities.l/ . ;ese activities will befinanced from the Japanese Grant Facility for structural reforms. The Bank would act as executingagency for the technical assistance program. Both the MEF and the MICITI will assign counterpartsto coordinate the technical assistance program with the Band The program will be made effectivefollowing the finalization of the legal agreement for the Japanese Grant Facility between thePeruvian Government and the Bank.

A. Poliy Studies and Seminars/Training: $150,000

Study on Amendments to the Anti-Dumping Code

3. The study would recommend amendments to the recently established anti-dumpingand anti-subsidy code (D.S. 133-91-EF issued on June 13,1991) and for its implementing regulations,in line with the Government's commitment to amend the Code so that it does not become aninstrument of unjustified projection. This involves, inter alia. establishing: (a) the need for an 'injurytests in all anti-dumping claims; (b) penalties for claims that turn out to be unfounded; and (c)transparent procedures in which the interests of consumers and of other Peruvian firms are weighedagainst those of the applicant firm. The terms of reference for the study should be agreed by theBank and the Government by Board presentation of the Trade Policy Reform Loan, and amendmentsto the Code, based on study recommendations should be enacted by March, 1992.

Evaluation of the Scheme of Agricultural Tariff Surcharges

4. The study would review the objectives and functioning of the surcharge system ascreated under D.S. 0016-91-AG (and subsequent modifications). The study would also include theimpact of pviions, relevant to products falling under the system, contained in D.L 653, LegislativeDecree on Agricultural Investment. The study would ascertain the economic effects of the systemon Peruvian piJucts (including regional impact - on Costa, Sierra, and Selva) and on consumes(especially the poor) and recommend modifications to the system. Ihe terms of reference for thestudy should be agreed by the Bank and the Government by March, 1992, and guidelines forimplementing the study's recommendations should be agreed by June, 1992.

IL In addition, the Bank plans to asist Cae MICMI in developing local industries ($70,000) and promongtorism industry ($30,000) dtough the same Japaue Grant Facility.

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Page 2 of 5

Study on Policy for Non-Taiff Barriers

5. The study would develop criteria and corresponding regulations assuring that healthand phytosanitary regulations and technical standards (particularly those administered by theMinistries of Agriculture, Health, and Industty) are applied impartially, without the aim of grantingnon-taiff protection to local producersm The terms of reference for the study should be agreed bythe Bank and the Govemment by Board presentation, and guidelines and principles to be applied inimnlementing the results of the study should be agreed by March, 1992.

Study on Regional Economic Integration Options for Pegu

6 The objectives of the study is to help Peruvian policy makers evaluate the economicosts and benefits of regional-traa;ng options currently under di£ ¢r"n (particularly Andean Pact

propostis) and help them identify critical areas for negotiation. The study would be particularyconcemed about the compatibility of regirnal arrangements with the overall econonic reform process,including trade-policy refonn. It would be organized around the following topics: history of regionaleconomic integration arrangements in the Andean Group and within ALADI; current regional-economic-integration options; current and planned economic reforms; and the interactions of regionalintegration, overal economic reform, and gains from trade.

Trade Policy Sminar an dIrainint

7. Government officials, private executives, the press and the wider community wouldbenefit from a greeter understanding of the consequences of the Government's new trade policymeasures or of accession to GAIT. To facilitate an informed public debate, it is important toorganize public seminars on the implications for Peru of trends in international trade, trade policyteform and experiences of other nations, the GJATT system, and the Andean Pact The seminarwould feature speakers from relevant organizations and draw upon several lines of research andtechnical expertise of the World Bank. Funds would be also made available to provide training onthe above topics (both in Peru and abroad) for relevant Government officials

B. Institutnal Reforms: Support to the MICM for Export Promotion and InternationalTradc Negotiations: S2200.0

ackgound

& During the past decade, Peru's experience in the promotion of exports had mixedtesults. In the first attempt to liberalize Peru's foreign trade regime, the government created theFondo Promocion de Exportaciones (FOPEX) in 1979. FOPEX made important contributions todeveloping Peru's export capacity in close collaboration with the private sector. However, in late1986, under the previous Government, it was absorbed into the Ilstituto de Comercio Exterior(ICE). For various reasons, ICE was bureaucratized and became the focal point of discretionaryimport controls and export subsidies.

9. In a renewed attempt to advance foreign trade liberalization, the FujimondGoverment decided to de-activate ICE in August, 1990. In June, 1991, ICE's assets andpromotional functions were transferred to the MICITI, and most of its staff were released. With

103 -

Page 3 of S

participation from the private sector, the MICMTI plans to establish a small, but efficient group ofprofessionals in charge of export promotion and advisory services for international tradenegotiations. On September 14, 1991, D.L 684 was issued, authoring the constitution of a newassociation. The members of the new association (to be called Asociacion para la Promocion yDesarrollo de las Exportaciones del Peru - PROMOEX) would include both the Govenment(represented by the MICM) and leading industry associations: la Asociacion de Exportadores(ADEX), la Sociedad Nacional de Industriales (SNI), and la Sociedad Nacional de Exportadores(SNE). A Supreme Decree, which defines the organization and operative procedures ofPROMOEX, is being crafted, and its constitution is to be ratified by the end of September, 1991.

i "NOMOEx FunctiomnsI

10. The major objectives of PROMOEX are to: (a) promote and develop Peruvianexports in general; (b) enhance the quality and image of Peruvian products and services; and (c)promote domestic and foreign investments for export-oriented activities. To this end,PRO4OEX will: organize international trade fairs, trade and commercial missions, and otherevents; collect dataminfoans tion, undertake market research, and produce various publications forthe use of exporters; and provide technical advice on international negotiations. It will consist ofthree functional departments--information and studies, promotion and development, andintemational trade negotiations (see the appendix to this annex for its organization chart).PROMOEX's basic activities will be financed by the three private agencies, ADEX, SNI andSNE.

Technical Agsistance for the MICIT

11. Technical assistance for the MIClTI ($200,000) aims to foster the organization c'PROMOEX and its capacity for market research, compilation of data and statistics, andintemational trade negotiations. It will finance senior professional staff of PROMOEX and short-term consultants (both national and external) as follows:

(a) Support to PROMOEX's professionals: @$2,500/mo. x 48 = $1?A.000

* General Manager: responsible for overall administration, includingdevelopment of its work program, financial management, and coordinationwith el Consejo DirectivoL

* Manager for information and studies: responsible for market research,compilation and disseminatior of trade information/ statistics, and librahy,

2J PROMOEX will be govened by el Consjo Directivo, consting of two esetativ of dhe Govemetad _ ves of the member agences. El Cmose3o Directivo will met at least evey month. It willassum finald ponsibility for development of its anal work progrm., financial pusmndand ote key policies.

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Page 4 of S

* Manager for promction and development: organization of trade fairs andevents, development of design and fashion, promotion of sector activities,e.g., textile, foods, agro-fisheries, metal mining, chemicals, and art crafts;and

* Mianager for providing advisory services for international tradenegotiations: responsible for Latin American regional integration, bilateralnegotiations, and multilateral negotiations.

(bj Support to short-term national and external consultants: $8000_0 Consultantswould assist in planning and implementing the PROMOEX work program auAdprovide technical training for its staff.

12 The Bankes technical assistance would complement the support to be provided byother donors The IIDWs Trade Reform Loan (signed on September 18, 1991) includes a$400,000 technical assistance program to PROMOEX in supoort of short-term national andinternatioral consultants, purchase of computers, and other operational expenses. The Europeanliconomic Community and several bilateral donors (for instance, GTZ, the German Company fortechncial Cooperation, and JEIRO, the Japan Externa! Trade Organization) have indicated theirinterests in assisting in the organization of trade fairs and commercial missions.

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AMNX 9Page 5 of 5

GEREENTEGENERAL

GERENCIA DE GRRENCIA DE GERENCIA DEINFORMACION Y PROMOCION Y NEGOCIACIONESESTUDIOS DESARROLLO COWERCIALES

INTERNACIONALES

DEPARTANENTO DE 1DEPARTAMENTO DEL IGERENCIA DE.4 INVESTIGACION ICENTRO DE MODA _ INTEGRACION

DE MERCADOS IY DESENO LATINOAMERICANA

DRPARTAMENTO DEPARTAMENTO DE- GERENCIA D- DR INFORMACION LOWISTICA Y - NEGOCIACIONES

COMERCIAL E ORGA19ZACION BILATERALESIlFORMATICA J,E-EVENTOS

DEPARTANENTO DEL DEPARTAENTOS GERENCIA DECENTRO DE SECTORLELS NEGOCIACIOUES

DOCUMCION Y (TEXTILES, MULTlIATERALESORIENTACION BASICA COmECCIOnES Y

CUEROS, AGROPEC.,PESCA, METAL NEC.QUMICOS, ARTESA-NIAS, ETC.)

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ANNEX 10Page 1 of 3

PERU

TRADE POLICY REFORM LOAN

Supplementat Loan Data Sheet

Section I: Timetable of Key Events

(a) Tune Taken by the Governmentto prepare program: June 1991 - August 1991

(b) Program prepared by: Ministry of Economy and Fnance(c) Frst presentation to the Bank: June 1991(d) Appraisal: September 1991(e) Completion of Negotiations: January 1992(f) Planned Date for Effectiveness: December 1992

Section II: Special Bank Implementation Action

This is the first in a series of three proposed adjustment loans to effect a workout for Peruunder the Bank's new policy of Additional Support for Workout Programs in Countries withProtracted Arrears. The Bank's workout is part of, and contingent on, an extemal financing plan for1991 and 1992 agreed among the intemational financial institutions and a Support Group of bilateraldonors. It is also contingent on Peru's performance under a Bank - and IMF - supportedmacroeconomic stabilization program. Under the Bank's new policy, the Board's approval wouldentitle Peru to the immediate disbursement of the whole loan amount after loan signing andeffectiveness. These would take place at the erd of the performance period upon satisfactoryimplementation of the trade policy reform program, the economic stabilization program, and theexternal financing plan (including clearance of all Bank arrears). The performance period, whichstarted with the initial reforms of August 8, 1990, would terminate in December, 1992, concurrentlywith the termination of the IMFs rights accumulation program.

Section III: Special Conditions

1. The following conditions for Board Presentation have been met:

(i) a macroeconomic stabilization program in place and agreed by the IMW and the Bank;this program provides the common framework for this loan and the two subsequentadjustment loans proposed for Pe-ru's debt workout.

(ii) an external financing plan. agreed among the intemational financial institutions andthe Support Group, which provides for full clearance of arrears to the Bank and thenormalization of Peru's relations with the IMF and the IDB;

(iii) Peru remaining current on its servicing of debt to the Bank currently falling due(other than debt covered under (h) above), on the terms aleady agreed with the Govenment

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ANNEX 10Page 2 of 3

(iv) agreement on ectoral conditions some of which have been fulfilled by the time ofBoard Presentation (paragraph 2), others of which are to be fulfilled by Loan Signing(paragraph 3).

2. The following sectoral conditions for Board Presentaiion have been met:

(a) Some sectoral measures designed to prevent reversal of trade reform policies already in placehave been maintained. The following measures, if trAken, would have constituted a policyreversal:

(i) the reintroduction of foreign-xchange controls on imports;

(ii) a rise in the level and variance of tariff protection (whether resulting from changesin specific rates or from tariff surcharges);'

(iii) the reintroduction of any tariff preference for the domestic market (except underinternational trade agreements);

(iv) extension of coverage of the agricultural surcharge scheme

(v) extension of free trade zones with the effect of selling, free of import taxes, importedgoods on the domestic market;

(vi) reintroduction of banned non-tariff barriers, including the use of reference prices forprotective purposes;

(vii) raising of export-dutv rates or extension to new products or reintroduction of fiscalor financial subsidies to exports;

(viii) survival of any of the functions related to import or export controls that the now-extinct Foreign Trade Institute (ICE) fulfilled.

(b) Conditions for further sectoral reform that have been met are as follows:

(i) agreement to a terms of reference for a study to develop consistent criteria, andpropose corresponding regulations, which minimize the protective features (i.e. thosethat discriminate in favor of domestic producers) of existing (and any new) health.phytosanitary. and technical regulations;

(ii) agreement to a terms of reference for a study to propose amendments to the Anti-dumping code so that it does not become an instrument for protection againstlegitimate import competition and it operates in an transparent manner;

iIf Peru implements a common extemal tariff which is in accordance with the tariff crieria established m the recentdecision-in-principle of the Andean Group of countries, dl s condition would no longer apply.

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ANNEX 10Page 3 of 3

(iii) agreement to an Action Plan to restructure the Customs Superintendeny. andcompliance with the first phase of this plan.

3. Sectoral Conditions to be met between Board Presentation and Loan 'igning, in addition tocontinuing non-reversal of policies as defined in paragraph 2, are as follows:

(i) replacement of the 5-percent rate on steel inputs by a 15-percent rate, unless theGovernment and the Bank agree that a new common external tariff is likely to beimplemented in accordance with the recent decision-in-principle of the AndeanGroup;

(ii) agreement to a terms of reference for a study to evaluate the agricultural surchargescheme. agreement on guiidines for implementing the study's recommendations, andenactment of the reforms in line with the agreed guidelines;

(iii) agreement on the guidelines and principles to be applied in implementing the findingsof the study on health, phytosanitary, and technical regulations, and enactment of thereforms in line with the agreed guidelines;

(iv) enactment of amendments to the Anti-dumping code in line with the study'srecommendations;

(v) compliance with the required actions under the second and third phases of theCustoms Action Plan.

4. Conditions of loan signing are as follows:

(i) prior clearance of arrears to the Bank;

(ii) compliance, during the performance period, with the IMF and Bank-supportedprogram of macroeconomic stabilization, with particular reference to the Bank'squantitative indicators;

(iii) the continued viability of an external financing plan;

(iv) compliance, during the performance period, with the Bank's sectoral conditionality(paragraphs 2 and 3 above).

5. The following conditions would be fulfilled for loan effectiveness:

(i) taking of all governmental actions required to authorize (or, if necessary, to ratify)signing of loan agreement; and,

(ii) if a lapse of time occurred between signing and these actions, continued satisfactoryimplementation of the trade reform and macroeconomic stabilization programs andthe external financing plan, in accordance with the provisions of the Letter ofDevelopment Policy.