At a Glance: 2001-02

COUNTRY REPORT

Peru At a glance: 2001-02

OVERVIEW While away on an official trip to Asia, Alberto Fujimori resigned from the presidency of Peru. Valentín Paniagua, the president of Congress, was sworn in to succeed Mr Fujimori after his vice-presidents, Francisco Tudela and Ricardo Márquez, stepped aside. To build confidence in his new adminis- tration, Mr Paniagua appointed Javier Pérez de Cuellar as his prime minister. Both president and prime minister have the experience and standing to ensure free and fair elections as well as an orderly transition of power to a new regime in 2001. The next president is likely to be a centre-right member of the opposition to Mr Fujimori, given the former president's high disapproval rating and the public's preference for stability following the upheaval of the past several months. Politics will overshadow and obstruct policy initiatives until July 2001. Peru is unlikely to achieve its fiscal targets. The EIU expects GDP growth for 2001 to decline to 1.5% as a result of the uncertainty engendered by a second consecutive year of elections. The risk of a constitutional crisis will remain until the new president is elected on April 8th 2001. Consumer price inflation will remain below 4% and Peru’s strong reserves position and generally good macroeconomic fundamentals should keep the currency at around Ns3.55:US$1. Key changes from last month Political outlook • Mr Paniagua, president of Congress, was designated president of Peru following the resignation of Mr Fujimori. Economic policy outlook • The resignation of Carlos Boloña, Mr Fujimori's finance minister, has generated high levels of uncertainty over near-term policy direction. Economic forecast • Mr Paniagua's announcement that Peru is not in a position to service its debt in 2001 will drive funding costs higher.

December 2000

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Outlook for 2001-02

Political outlook

Domestic politics Alberto Fujimori resigned from the presidency on November 20th while in Japan on an official trip to Asia. After a generally successful decade in office, Mr Fujimori is now suspected of having illegally enriched himself and of being involved in bribing public officials. Rather than accept his resignation, Congress voted to remove him from office on the grounds of being “morally unfit”. Having been voted out on these grounds, the former president is prevented from running for elected office in the future. Rumours had surfaced at the beginning of November that he might attempt to run for Congress on April 8th 2001 in order to gain the protection of legislative immunity. Even though such immunity would probably not be available for protection against crimes committed while president, the rumours of a congressional run persist, thanks to ambiguous statements being made by Mr Fujimori from Japan. The fall of the former president led to a scramble to decide who would succeed him. The first vice-president, Francisco Tudela, and the second vice-president, Ricardo Márquez, were first and second in line to replace Mr Fujimori according to the 1993 constitution. Both men, however, removed themselves from consideration by resigning their positions.

As next in line, the president of Congress—Valentín Paniagua, of Acción Popular (AP)—was sworn in as interim president of the country on November 22nd. Because of recently passed reform legislation, Mr Paniagua is prevented from running for the presidency in the election next April. As a member of a party with only three congressmen in the 120-seat legislature, Mr Paniagua is unthreatening to other members of the former opposition, and is seen as a pair of “safe hands” to guide the country through this difficult period. In his 37- year political career he has served as minister of education (1965); president of the Chamber of Deputies (1980), and again as minister of education (1984). Fortuitously, he is also a constitutional expert. The president’s first appoint- ment was that of Javier Pérez de Cuellar as prime minister. Mr Pérez de Cuellar gives the new government instant international credibility thanks to his experience as secretary-general of the UN in 1982-92. Both the president and the prime minister have the experience and credibility to ensure free and fair elections as well as an orderly transition of power to a new regime in 2001.

Election watch Presidential and congressional elections will be held on April 8th 2001, with the next five-year government inaugurated on July 28th. Since September, when Mr Fujimori called for new elections following a bribery scandal involving his security adviser, Vladimiro Montesinos, several reforms have been passed which increase the likelihood that the next elections will be conducted in a more open and fair manner than the highly controversial two- round election of April-May 2000. The electoral bodies have new, more independent leadership, the Constitutional Tribunal has been reinstated, media freedom has increased, and the armed forces and judiciary are steadily being purged of those with close ties to Mr Montesinos. Congressional lists and

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presidential candidates must be registered by January 8th. Given the uncertainty suffered by the electorate over the past several months, the new president is likely to be a moderate member of the opposition to Mr Fujimori. High levels of public outrage should help the parties that have been in opposition during the past decade win control of Congress. In a recent poll, a record 89% of the public disapproved of the ex-president’s performance in office.

Although Alejandro Toledo, of Perú Posible, came close to winning the presidency this year, having received 37% of the vote in the first round, he is unlikely to be successful in uniting the opposition behind his candidacy in 2001, as his supporters have become concerned by his actions in the past several months. A protest led by Mr Toledo against the government in July resulted in violence and the deaths of several security personnel. In addition, he urged the armed forces to consider supporting him instead of Mr Fujimori after the latter’s election to a third term of office. About a dozen opposition members have expressed interest in running for the presidency, and polls show that several have higher approval ratings than Mr Toledo, including Fernando Olivera of the Frente Independiente Moralizador (FIM); Jorge Santistevan, currently the human rights ombudsman; and Lourdes Flores of the Partido Popular Cristiano (PPC). In addition, other well-known figures such as the economist Hernando de Soto are considering entering the race.

The Perú 2000 coalition has disintegrated rapidly following Mr Fujimori’s departure. The coalition was always united more by government patronage than by common ideas and programmes. Mutual dislike between the leaders of Cambio 90-Nueva Mayoría and Vamos Vecino, two major parties in Perú 2000, will keep what is left of the coalition from easily agreeing on a common congressional list. Of the potential presidential candidates who formed part of the Fujimori government, only Mr Tudela would have any realistic chance thanks to his perceived independence. Mr Tudela, however, has announced that he will not seek the presidency in the next election. Carlos Boloña, the former minister of finance, may run, but a lack of political experience at the popular level will hamper his chances of success.

The military The probability of a military coup occurring in the forecast period is low. The armed forces have undergone several drastic changes in the command structure in recent weeks as civilian officials seek to reduce Mr Montesinos’s influence on the institution. After each change, the remaining military officers have reaffirmed their commitment to obeying the constitutionally elected authorities. Although the armed forces have declared their support for Mr Paniagua and his cabinet, wariness does exist about any move towards the creation of a “truth commission” to investigate human rights abuses by the military. The next government will need to strike a delicate balance between cleaning up corruption and maintaining stability with the support of the armed forces.

International relations No external threats to Peru’s stability are likely to materialise during the forecast period. On the contrary, the US and neighbouring Latin American countries are eager to coax Peru back to a more stable position. To accomplish this goal, these countries, as well as multilateral organisations, will provide

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economic and political support as requested. Following its experience with Mr Fujimori, the international community wants to help rebuild the country’s democratic institutions and strengthen political stability by encouraging domestic political co-operation and, ultimately, national reconciliation.

Economic policy outlook

Policy trends The resignation of Mr Fujimori’s finance minister, Mr Boloña, combined with the uncertainty over next year’s presidential election has made the outlook for policy over the forecast period unclear. In a blow to stability, Mr Paniagua used his inauguration message to announce that the government would not be able to pay its full debt service next year. The new finance minister, Javier Silva Ruete, rushed to clarify that Peru would honour its obligations, although an adjustment in the country’s debt maturity profile is seen as necessary. If successful negotiations were held to lengthen the maturity of Peru’s debt, the country’s risk premium would fall. However, calling for such a negotiation in an overtly public and political forum creates unnecessary uncertainty with regard to the country’s willingness to pay, reminding many of the “can’t pay, won’t pay” attitude that prevailed in the 1980s. On privatisation, policy is likely to be more constructive. Mr Silva Ruete has committed to the completion of the already-agreed concessions for the development of the Camisea gas deposit and the upgrading of Lima’s Jorge Chávez Airport. Planned privatisations in the mining sector will also continue.

Fiscal policy Commitment to the Fiscal Prudence and Transparency Law is uncertain, given the coming change in government. The law, originally passed in 1999, calls for the elimination of the fiscal deficit by 2003. The first goal—that of an overall deficit equal to 2% of GDP in 2000—will be missed by a wide margin, with the EIU estimating a deficit for 2000 of 2.8%. The period 2001-02 is likely to show improvement in the fiscal deficit as the new government is forced to hold its costs down to satisfy its creditors. By the end of the forecast period, the deficit will narrow to 1% of GDP. Such an improvement from the current level would increase investor confidence and improve Peru’s risk rating in the international financial markets. A reduction in risk would facilitate further improvements in the fiscal deficit, as interest rates charged on government debt would decline.

Monetary policy The Banco Central de Reserva del Perú (the central bank) will persist in its goal of bringing Peruvian inflation to levels similar to those experienced by OECD countries, a goal we expect to be achieved within the forecast period. The central bank will also maintain its flexible exchange-rate regime to help cushion the economy from the effects of internal and external shocks. The monetary authority’s most pressing near-term concern is to shore up the banking system, which has suffered balance-sheet damage in the past three years from the triple shock of the El Niño weather pattern’s effect on the economy; the collapse in emerging market bond prices following the 1998 Russian devaluation; and now the resignation of Mr Fujimori. Past-due loans have reached 10% of total loans, which has put enormous pressure on the capital of smaller banks as required provisions for this questionable debt flow

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through the income statement. Forced mergers between good banks and bad banks is one policy option, but in the end the government will probably foot most of the bill for any bank that must be taken over.

Economic forecast

International assumptions The global economy will slow in 2001-02 to growth of just above 4%, from much higher growth of 4.9% in 2000. The slowdown is not a cause for excessive concern, as it is relative to the world’s most buoyant performance since 1984. Signs show that global growth peaked in mid-2000, with the US economy slowing sharply in the third quarter. There have also been increasing signs that growth in the euro zone peaked at mid-year and is now weakening. These two regions account for about 50% of global output and their slowdown will hamper global growth. Having rebounded to 4.4% GDP growth in 2000, Latin America will slow slightly, to 4% growth in 2000. The two largest economies in the region, Brazil and Mexico, will both perform well in 2001-02, with Brazil rebounding after two years of weakness and Mexico benefiting from the continued strength of the US economy. By 2002 GDP growth for the region will begin to climb again to 4.3% as Argentina recovers from its current stagnation. With commodity prices, particularly those for copper, trending upwards in the forecast period, the prices of Peru’s exports should improve.

International assumptions summary (% unless otherwise indicated) 1999 2000 2001 2002 Real GDP growth World 3.5 4.9 4.2 4.1 US 4.2 5.2 3.2 2.6 EU 2.3 3.4 3.0 2.6 Exchange rates (av) ¥:US$ 113.9 107.3 104.0 102.0 US$:¤ 1.07 0.92 0.95 1.05 SDR:US$ 0.731 0.766 0.775 0.738 Financial indicators US$ 3-month commercial paper rate 5.18 6.32 6.38 5.25 US$ 3-month Libor 5.42 6.55 6.61 5.48 Commodity prices Gold (US$/troy oz) 278.8 283.2 275.0 270.0 Oil (Brent; US$/b) 17.9 28.8 23.5 18.8 Food, feedstuffs & beverages (% change in US$ terms) –18.6 –7.1 4.7 11.5 Industrial raw materials (% change in US$ terms) –4.3 14.9 8.7 2.3

Note. Regional aggregate GDP growth rates weighted using purchasing power parity (PPP) exchange rates.

Economic growth Economic activity has decelerated through the course of 2000, with consumer confidence slumping since mid-September, when the Montesinos bribery scandal erupted. GDP contracted by 0.1% year on year in September, ending 11 consecutive months of growth. Private investment has declined sharply, which appears to have slowed output further in the fourth quarter. We expect GDP growth of 3.6% in 2000, decelerating to 1.5% in 2001. Thanks to improved export prospects, 2002 should register a brisk recovery to 5.5% GDP growth, although the achievement of this recovery depends on continued responsible handling of fiscal policy.

Forecast summary (% unless otherwise indicated) 1999a 2000b 2001c 2002c Real GDP growth 1.4 3.6 1.5 5.5 Industrial production growth 0.3 7.0 1.5 5.0 Gross fixed investment growth –11.9 –1.1 0.0 5.2 Unemployment rate (av) 7.2 7.1 10.1 10.3 Consumer price inflation Average 3.5 3.8 3.2 3.4 Year-end 3.7 4.1 3.1 3.0 Short-term interbank rate 30.8 32.7 30.5 26.7 NFPS balance (% of GDP) –3.0 –2.8 –1.8 –1.0 Exports of goods fob (US$ bn) 6.1 7.2 7.7 8.9 Imports of goods fob (US$ bn) 6.7 7.5 8.1 9.1 Current-account balance (US$ bn) –1.8 –1.6 –1.9 –1.8 % of GDP –3.5 –3.0 –3.5 –3.0 External debt (year-end; US$ bn) 30.7b 31.2 31.6 32.2 Exchange rates Ns:US$ (av) 3.40 3.50 3.55 3.56 Ns:US$ (year-end) 3.51 3.56 3.55 3.58 Ns:¥100 (av) 2.98 3.26 3.41 3.49 Ns:BrR (av) 1.87 1.93 1.94 1.91

a Actual. b EIU estimates. c EIU forecasts.

Inflation Consumer price inflation reached 4.2% in the 12 months to October 2000, up from a year-end rate of 3.7% in 1999, because of a sharp rise in international oil prices in 2000. Year-end inflation rate is likely to reach 4.1% in 2000, slightly above the central bank’s 3-4% indicated range, despite depressed domestic demand. However, international fuel prices are likely to trend firmly downwards in 2001 and 2002, which will help cut Peru’s consumer price inflation to just over 3% in 2001 and 2002.

Exchange rate Peru’s currency will remain stable during the forecast period thanks to strong fundamentals and US$8.6bn in net international reserves—enough to finance ten months of merchandise imports—and will be bolstered by large foreign investment inflows in coming years related to Camisea and the US$2.3bn Antamina mining project.

The external sector Peru’s current-account deficit will remain near US$2bn over the forecast period, equal to around 3% of GDP. Over the past five years, this deficit had been as large as US$3.6bn. A sharp contraction in domestic demand in 1999 cut the deficit to US$1.8bn, a level that has persisted into 2000. Export earnings, which have continued to rise at a faster rate than the import bill, have kept the trade deficit on a narrowing trend, but this has been offset by a deterioration in the services and income balances.

Editors: Brian Pearl (editor); Martin Pickering (consulting editor) Editorial closing date: December 1st 2000 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule