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

REPORTAND RECOMMNATION

OF THE

PR-SIDENT OF THE Public Disclosure Authorized INTERNATIONALBANK FOR RECONSTRUCTIONAND DEVELOPMENT

TO THE

EXECUTIVEDIf 4- TORS

,'. ON A PROPOSEEDT1OADE POLICY REFORMLOAN

IN AN AMOUNTEQUIVALENT TO US$300 MILLION

TO THE Public Disclosure Authorized REPUBLICOF PERU

JANUARY10, 1992 Public Disclosure Authorized

Thisdocnett has a resrictddbutio and may be and by recip onlyin thLeperfomance of thei:oficia s, ItsntetsmaY Mt otherw be disrelsedwithout Worl n thoriati MEN,CY EQUIVALENTS (As of December30, 1991)

CurrencyUnit NuevoSol (SI.)V US$1.00 - S/.0.9S SI.1.00 = US$1.05

GOVERNMENTS FISCAL XEAR

January 1 - December31

ABBREVIATIONS

ALADI - Asociacid6nLatino-Ametica de Inttegract6n (Latin Ameria IntegrationAsociation) CERTEX Certiricado de Reinte TnbutWat a ta Exportacl4n(Export Tax Reimbutement Certificate) CIF Cost, Insurance and Freight D.L - DecMo Lcgslatvo (Lgisatie Decree) D.S. - Decreto Supremo (Supreme Decree) ECASA - Empresa de Comercializacidndel Arroz SA (Rice Marketing Company) ENCI - Empresa Naciontl de Comercializaa6nde 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 Compensaci6oy De ollo Soial (National Fund for Socal Compensationand Development) GATT - General Agreement on Tariffs and Trade GDP - Gross Domestic Product 17T - Deutsche Gsldhft MirTeclnisdhe Zusammenarbeit(German Companyfor Technical Cooperation) IFIs International Fnancial Institutions IBRD - International Bank for Reconstruction and Daelopment ICB - International CompetitiveBidding ICE - Instituto de ComermioExtior (Institute for Foreign Trade) IDB - Inter-AmericanDevelopment Bank IMF - International MoUetalyFund MICm - Ministerto de Industria, Comercio Interior, Tuismo e Integracidn (Minitry of Industry, Commerce, Tourism and Integmation) NOOs - Non-GovernmentalOrganiations PETROPERU - Petrdleos del Perd, SA (Peru Oil) RAP - Rights AccutmulationProgam SAL - Structural AdjustmentLoan SUNAD - Supe utendenciaNacional de Aduanas (Customs Administration) SUNAT - SuperintendenciaNacdonal do Admhtacdon Tributaria (Tax Administration) SDR ^ Special DrawingRight SOE - Statement of Expenditure UNDP - United Nations DevelopmentProgramme UNICEF - United Nations International Chidren's Emegemy Fund VAT - ValueAdded Tax

I/ On July 1, 1991,a new monetary unit, the Nuevo Sol (S/.), was introduced at a converaionfactor 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, eliminating the last sx digits of any value in Intis, to simplifyacounting and as a means of transition between the Inti and the Nuevo Sol. FOROFFICIAL USE ONLY PERU TADE POLICYREFORM LOAN Table of Contents page Loan andProgramSummary ...... v L The Project,the Debt Workout,and CountryStrategy. 1 The Project Context .I The Bank'sApproach in a Country with Protracted Arrears1 . I The Bank's Approach in Peru ...... 1 IL The Economy...... 6 The EconomyInherited ...... 6 The EconomicReforms of the FujimoriAdministration. 7 The 1991-1992Macroeconomic Stabilization Program .10 Risks and Assessmentof the StabilizationProgram .11 Monitoringthe StabilizationProgram .13 The Agendafor StructuralReforms .14 The Medium-TermOutlook. 15 m. ExternalFinancing.16 The ExternalDebt Problem ...... 16 The ExternalFinancing Plan for 1991and 1992.16 ExternalFiancing Beyondthe PerformancePeriod .20 IV. ExternalTrade: Performanceand Policies.21 V. Trade PolicyReform ...... 22 Actual and PlannedReforms .23 The ExpectedImpact of Trade PolicyReform .26 The Agendafor Trade Policy .26

|This report was prepared by Geoffrey Shepherd, based on the findings of a preappraisal mision to Peru In June, 1991, and appraisal in September. Contributors to the report were: Roberto Abusada, CarlosRodriguez, and Katerina Taigasides (consultants and preappraisal miseion members) i Valeriano ¢arcia(Senior Economist, contributing to "Part in: The Ecoaomyn on the basis of a September, 1991, mission to Peru to preappraise a structural adjustrest loan); Janet Entwistle (Country Officer, contributlig to Part I: The Project, the Debt Workout, and Country Strategy and Part IZII Esternal Fanancnlg) and Izumi Obno (Country Officer) and Cessx Burga(consultants statistical support). Angellca Silvero provided secretarial support.

This documenthas a restricteddistribution and maybe used by recipientsonly in the performance of their officialduties. Its contents may not otherwisebe disclod withoutWorl Bankauthorization. -il-

VL The Proposed Loan ...... 28

History of the Loan ...... 28 Reforms to be Supported under the Loan ...... 28 The Loan ...... 29 Procurement, Disbursement, Audit, and Administration.30 Technical Assistance.31 Letter of Development Policy.32 Conditions .32 Monitornagar4 Reporting. 35 Cooperation with the IDB ...... 36 Project Benefits ...... 36 Project Risks ..... 36 The Social Impact ...... 37

VIL Recommendation ..... 38

Annexes

Annex 1 Economic Indicators ...... 39 Annex 2 Trade Statistics ...... 51 Annex 3 Trade Policy Reform Loan: Policy Matrix ..... 61 Annex 4 Non-Tariff Barriers ...... 65 Annex 5 Customs Action Plan ...... 75 Annex 6 Letter of Development Policy.79 Annex 7 List of Project Documents ...... 97 Annex 8 Status of Bank Group Operations .99 Annex 9 Technical Assistancew...... 101 Annex 10 Supplementary Data Sheet ...... 107 .-ii- Tablesand Figues Text Tabls Table 1 ProjectedFicl Accounts,1991and1992 ...... 10 Table 2 ExternalFinancng Requiement and PossibleSources of Funmcing,1991and 1992 ...... 17 ADpend 'rabies and Figs Table 1.1 Peru: Balanceof PaymentsProjectons: Current AccountEcluding Intest Payments, 1990-99... 39 Table 12 Peru: Balmae of PaymentsProjections: Fmancing Requirements and PosuibleSources, 1990-99 ... 40 Table 13 Peru: NationalAccountsProjections,1990-99 ...... 41

Table1.4 PenruProjections of KeyEconomic Indicators, 1990-99 ...... 42

Notesto Tables 1.1 to 1A ...... 44 Table 1.5 Peru: Eitnal Debt Outstanding(Stocksas ofDecember1990) ...... 47 Table 1.6 Peru: MontblyEconomic Indicators, July 1990-September 1 ...... 48

Fgue 2.1 Peru: RatiosofTradeto GDP,1950-1990...... 51 Figure 2.2 Peru: EffectiveProtection from Tariffs on Manufactures,1990-1991 ..... 52 Fmre 2.3Peru: Real ExchangeRate Index 1985-1991...... 53 Figure2.4 Peru Exportsand Impots 1989-1991...... 54 Fgmue2.5 Peru: BlackMarket ExchangeRate Premium,1985-1991 ...... 55 Figure 26 Peru: Production-WeightedDistnbution of Tariffs,1990 and 1991 ...... 6 Figure 2.7Per Export Subsidies1980-1990 ...... 57 Figure2.8 Peru: ExporTaTwsCollcted,1980-1990 ...... 8 Flge 2.9 Peru: ImportTas Coeoted, 1990-1991...... 59

Table 4.i Peru: Non-TariffBanrits, 1981-1990(by Numberof TariffCategories) ... 65 .v.

PERU TRAPEPOLICY REFORM LOM Loan and ProgramSummary Republicof Peru Executin,Agei:y Ministryof Economyanc Fmance Amount USS300million equiva'ent

Texms: Repayablein 20 years,including five yeas of grace, at the Banks standardvariable interest rate. LnObeves: The proposedloan wouldsupport the Government's mediumterm programof trade polcy reform. Lan Desription: The loan wouldrecogn!ze the majortrade reformmeasures taken betweenAugust, 1990, and September,1991, and comprising:(i) a reductionin tariff protection;(ii) the eliminationof most non-tariff barriers;(iii) the eliminationof exportsubsidies ard impo t in schemesallowing exporters to recuperateindirect taxs; (iv) the abolitionof the agencyformerly administering trade controlsand the initiationof a reformof customs. The sectoralconditinns relate largelyto the maintenanceof the current reforms,and measutesfor further reformare generallyconsidered a secondaryissue, except insofaras further action is felt necessaryto secure the current reforms. First,trade reformcan be expectedto lead Peru to a more efficnt use of its resourcesthrough specialization in productiveareas where its comparativeadvantage is greatest and tbroughthe compettive pressuresthat freelyavailable imports wil exert on domestic producers. The removalof non-tarff bariers should also enable those resourcespreviously used to acquirevarous Inport pesm to be put to better uses. S the projectwil also reae beeft throughits contributionto Perus debt workut and reintegrationinto the intemationalfinancial community. In additionto providig some freh eternal funds to Peru betweennow and the end of 1992,the workoutwill open the door to resumptionof a norma rela ip with the Bank. The workoutwill allow Peem to normalizerelations withother multi-and bilateraldonors even before the Bank itself disburses. Ihe survivalof the trade reform could be threatened by ( i) a failure in current efforts to stabilize the economy and a related failure to maintain a real exchange rate providingsufficient incenties to the export sector; (ii) pressures to reverse reforms fr m those adverewy affected, inside and outside government, by the end of proteconist practices; (iii) distortions that persist elsewhere in the economy (in spite of recent reforrAs)and which may inhbit a flexible response from producesa, (iv) the polit!cal uncertainty generated by a still-weak government capacity and the unstable security situation which could add risks to any reform movement in Peru; (v) the effect of social unrest possiblydelaying or arresting the reform process; and (vi) a weakening of the coordinated support for the internal reform process being providcL by the international financial community (a risk wbich has recently diminishedfollwing the progress already made in implementing the external financing plan). The trade reform process is part of a larger program of stabilization and adjustment which is not risk-free, yet (like the trade reform) has strong political support.

Estimted Disbursement: The loan would be disbursed in one tranche. On Government fulfillmentof effectiveness conditions,the Bank would simultaneously make the loan effective and release the tranche.

Staff Airraisal Renort: Not applicable. REPORT AND RECOMMENDATIONOF THE PRESIDENT OF THE INTERNATIONALBANK FOR RECONSTRUCTIONAND DEVELOPMENT TO THE EXECUTIVEDIRECTORS ON A PROPOSEDLOAN TO THE REPUBLICOF PERU MORTRADE POLICYREFORM

1. I submitthe followingreport and recommendationon a proposedloan to the Republic of Peru for the equivale.-tof US$300million. The proposedloan wouldsupport the Government'smedium-term program of trade policyreform. The loan wouldbe repayableover 20 yearson a fixedamortization schedule, including five yean grace,at the B"k'es standard variableinterest rate and charges.

I. The PmIecLthe WorkoutProEam and CountrrStrata! The ProjectContext

2. This Report proposesa $300 millionadjustment loan for trade policyreform. Ihe immediateobjective of the loan is to encouragethe current trade-reformprocess, which representsone of the mostfar-reaching and rapid trade reformscarried out in the developing world. The broader objectiveof this loan, as well as two proposedadjustment loans, is to allow the Bank to participatein an internationall,supported approach to reintegratePeru, whichis carryingout a bold programof stabilizationand economicreform, into the internationalfinancial community.This approach would provide Peru the opportunityto rehabilitatean economymuch damagedby the actior_of past governtmentsand wouldenable the Bank and other donorsto resumea normalrelationship of developmentassistance with Peru. The Bank'sApproach in a Countrywith P.-otractedArrears 3. On May 2, 1991,the Board approveda new approachto support debt workout programsin countrieswith protractedarrears (Additional Support for WorkoutPrograms in Countries with Protracted Arrears. R91-70, April 11, 1991). It allowsstrong-performing countries with large arrears to accumulate"contingent disbursements" during a pre-clearance'performance penod." Loans are presentedto the Bank's Boarddunng the performanceperod, and once the arrears to the Bank are cleared,at the end of the performanceperiod, loans are signed and made effectiveand all accumulateddisbursements released. The new approachis analogousto the DIFs Rights AccumulationProgram (RAP), and requiresthe followingfour conditionsto be met: (a) the existenceof an agreed financingplan; (b) an IM stabilizationprogram; (c) a Bank- supportedadjustment program; and (d) continuedcurrent debt servicepayments to the Bank. The BanktsApproach in Peru 4. In order to assistPeru duringthe pe-arrears clearanceperformance period, expected to last throughDecember 1992, the Bank developeda countryassistance strategy which conforms with this new approach. On July 30, 1991,the Board approvedthe applicationto Peru of the new approach(Peru: The Bank's Approachto a Countrywith ProtractedArrears. R91-171, July 12, 1991),opening the way for the implementationof this strategy. As a first step, the Bank -2- participatedin the formulationof an externalfinancing plan agreed to by the IMF, IDB, bilateral donors,and the Government(see Sect;onIR. Concurrently,the Bank has been preparing,with the help of its economicand sectorwork, an adjustmentprogram to support reformefforts underwayin Peru. As requiredunder the new approach,loans approveu' under this programwili not be disburseduntil the end of the performanceperiod.

5. The Bank also has been lookingbeyond the current periodof protracted arrears throughFY95. During this period,the Bank expectsto deepen its support of the adjustment programthrough additional lending and econorr c and sectorwork, and also expects to present investmentloans now under preparation. These loansare lkely to take some time to prepare. Investmentloans are inherentlymore time-consumingto prepare than adjustmentloans. They require a complexmix of engineering,institutional, and humaninputs and Peru's public institutions,weak in part due to the past hiatusin Bank-Peixrelations, are currentlyunable to undertakethe necessarypreparation themselves. 6. To counteractthis weaknessin publicmanagement, the Bank has launcheda major programof technicalassistance, crucial for the successfulimplementation of the medima-termn economicprogram. It has mobilizedresources for these activitiesthrough the JapaneseGrant Facilityand the GermanGTZ, and is currentlyexploring other possiblesources of financing. Thus, even before the Bank has been able to disburse,it has mobilizedsignificant resources for Peru for projectpreparation and implementation. It has so far securedJapanese grants for approximately$8.0 millionfor seventechnical assistance projects, for structuraladjustment, financialsector reform,debt statisticsand management,social sector development,water and sanitation,energy and privatization,and GermanGiZ grants for about $1.0million for agriculture,macroeconomic-stabilization and structuralreforms, energy, mining and industry, infErastructure,and humanresource development. 7. To assistthe Government'sefforts to reintegrateinto the internationalfinancial community,and subsequentlyto enhanceand deepen the reformsundertaken during the period of reintegration,the Banl's countryassistance strategy is directed at four long-termstrategic objectives:(i) sustainingand acceleratingthe stabilizationand adjustmentprocess; (ii) fostering privatesector developmentand publicsector reform; (iii) alleviatingpoverty and promoting humanresource development; and (iv) rehabilitatingkey infrastructure. & Sustainingand Acceleratingthe Stabilizationand AdjustmentProcess. The Bank is supportingthe reformsof the FujimoriGovernment, which assumed office in July, 1990,and immediatelyinitiated structural reforms to reversethe economicpolicies of previous administrationsand achievea sustainedeoDnomic recovery. Reformshave been announcedin trade, monopolyrights and deregulation,privatization, ports, foreign investment, land reform, labor markets,social security, tax policyand adm atio and the financialsector (see paragraphs28-32). 9. The Governmentof Peru mustsustain these reformsand undertakefurther measures before it can fullyreap the rewards. Bank lendingoperations in Peru are initialy focussingon three adjustmentloans to support the Government'seffort. Thisloan is the first to be presented to the Board,and the other two, a structuraladjustment loan and a financialsector reform loan, wil be submittedin the remainderof FY92,assuming continued fulfillment of the four conditions 3 - describedin paragraph3. Later an agriculturalsector loan wil be prepared to support reformsin agriculture. 10. The SAL willaddress balanced medium-term tonomic developmentneeds througha multi-sectorfocus. It willaim at securingthe Government'sachievements and enhancingfarther reformsin the followingareas: consolidaingthe macroeconomicstabilization by maintaiing non- inflationaryfinancing of governmentexpenditure, improving tax collectionand supportingthe tax reform,redefining the functionsof the governmentand reducingthe numberof publicemployees. layingout the generaland sectoralstrategies to privatizestate-owned enterprises in various sectors,increasing labor mobility,laying out the strategyfor reformof officialpension schemes, and reducingstate interventionin agriculturalmarkets. Ihe SALwould also help establisha clear poicy and institutionalframework for povertyalleviation identifying tatget groupsand priority programactivities that refle the needs of the poor. 11. The financialsector reformloan willsupport the Government'sefforts to liberalze the financialsystem and thereby promoteefficiency in financialintermediation. The loan willfocus specif Alkon: implementationof the new, liberalbanking law in an environmentof strengthenedbanking supervision, a prograraof privatizationof state-ownedcommercial banks, reformof the developmentbanks, restructuring of the majorpublic-sector bank, the Bancode la Nacion,and improvementsin the securitieslaw and partialprivatization of socialsecurity. 12. The groundworkfor these adjustmentloans was laid by economicand sectorwork undertakenin late 1990-early1991 on publicsector reformand investment,structural reform, the socialsectors, and, in conjunctionwith UNDP, trade. The Bank is also undertakingfirther extensivestudies on macroeconomicand structuralreform, which will assist in maintaining dialoguewith the governmenton monetary.financial-sector, and labor policies A studyon monetarypolicy will help the Governmentmaintain a stable macroeconomiceniionment and sustainstructural reforms. A financialsector report willanalyze the status of financialinstitutions and markets,and their inter-relattonwith monetaryand fiscalpolicies. A labor marketsstudy will seek to strengthenthe role of marketsin supplyand demandfor labor services.In addition,a studyon agriculturalincentives is currentlyunder preparationto analyzethe i'itial impactof agriculturalreforms which have been undertaken,and indicateareas for further reform. 13. FosteringPrivate SectorDevelopment and PublicSector Refonn A number of lendingoperations are under preparationwhich wil broadenthe Banks support,initiated in the SAL and iancial sectorreform loan, for th Government'sprvatization and publc sector reform efforts 'Theseloans wil fous on the reformof publicsector policies that restrictprivate sector participation,as wellas the privatirstionof state-ownedenterprises (SOEs) in energy,mining, manufcturing,fisheries, uansportation, and telecommunications. 14. In the energysector, two loansare being prepared. An energysector loan wil support reformof energypoicy and privatesetr devlopment, includingpriwatition of SOE. in the sector. In addition,in order to improveefficiency in productionit willsupport rehabilitationof facilities.Policy reforms wi includethe establishmentof tariff structuresbased on economicprinciples, and of regulatorystuctures conduciveto efficientuse of energy ources. he loan wil support privatizationof Electrolima,one of the largestelectricity distributioncompanies, and foster privatesector de%elopment in the oil explorationand extaction industry. A subsequentpower sectorloan willbuild on the enerD sectorloan to support -4- continuedsector reform,including tariff reform,institutional strengthening, and a kieviewof Etctroperu's functions. It wvlalso includecomponents to support privatizationof regional companiesand to foster privatesector powergeneration. A miningreform loan willimprove sector efficiencythrough policy reforms and by closinguneconomic mines, shedding excess labor, strengtheningsupport agencies,and addressingenvironmental issues. A privatizationloan will support implementationof an agreed privatizationprogram of SOEs in mining, telecommunications,oil, gas, and -- building on the financial sector reform loan -- banking. It will also support policyreforms including elimination of excessivegovernment controls, reform of restrictivelabor practices,management strengthening, and further reformsto faster market competitionand privatesector development. 1S. Economicand sectorwork will focus on privatizationof SOEs and developmentof the privatesector. An institutionalartd pricing issues study will provide the basis for preparationof loansin the energysector. Severalstudies will be undertakenin preparationof the privatization adjustmentloan, whichwill include an examninationof the regulatorypolicies that governnatural monopoliesand competitiveindustries, and a reviewof labor redundancyissues of public enterprises. A plannedstudy on industrid1da.egulation will evaluate ways to further improvethe conditionsfor privatesector development.An environmentalsector study will review problems of soil erosion,tropical deforestation, PCB pollution,and water pollutioncaused by mining. 16. AlleviatingPoverty and PromotingHuman Resource Development. The Bank's primarycountry assistance objectives in the area of humanresources are to assistthe Government in formulatingand implementingan effectivepoverty alleviation strategy, and closelyrelated to that, promotinghuman resource development by supportingthe Government'sefforts to make availablebasic social services, particularly for the poor, and improvingthe impactand cost- effect.ivenessof those programs.The Bank'swork in the socialsectors will also contributeto the achievementof the other assistanceobjectives for Peru. Well-designed,sustainable programs to alleviatepoverty and cushionvulnerable groups should increase the likelihoodthat the adjustment programwill be maintained.The dynamismand effectivenessof communityorganizations and other non-governmentalorganizations provide scope for decreasingreliance on the publicsector in some areas and encouraginga larger privatesector role in the provisionof socialservices. The impactof the past deteriorationof the economyon provisionsfor operationsand maintenanceof socialinfrastructure means that the requirementsfor rehabilitationare substaixtial. 17. In the lendingprogram, the first S&ral DevelopmentProject will focus on support to basic health servicesand nutritioninterventions targeted to the poor in a few regionsoutside of Limawhere most socialprograms are now concentrated.It willbuild on the SAL to support the Governmentin formulatinga povertyalleviation strategy and identifyingreforms in food assistanceprograms. It willalso includeactivities to strengtheninstitutional capacity at the regionaland central levels,as well as to improvethe Government'sability to monitorsceial developmentand povertyand to use that informationmore effectivelyin programdesign and evaluation. Ihe anticipatedimprovements in institutionalcapacity in the agenciesresponsible for health and nutrition,as well as the resultsof economicand sectorwork, would lay the base for a more comprehensiveloan to strengthenprimary health servicesin Peru. Thisloan wouldaddress criticalrehabilitation needs and financialissues, including cost recovery,and, if feasible,it would extend to additionalareas the programsand interventionswhich proved successful under the first project. The participationof non-governmentalorganizations is being incorporatedin both projects. A subsequentoperation in primaryeducation is also plannedto addressrehabilitation needs and qualityenhancements, with special attention to the poor through improvementsto programsard teacher trainingin rural areas and to consiO-stionof school feedingprograms. 18. The emphasisof sectorwork is on the fundamentals-- primaryhealth, basic education, and well-targetednutrition interventions. Improvements in these sevices, togetherwith a resumptionof broad-basedeconomic growth, are mostcritical to efforts to reduce povertyin Peru. The focuswill be on identifyingways to broaden accessby the poor to these programs,to enhancequality and to improvecost-effectiveness. In order to reduce the demandson governmentagencies and to mobilizeresources, mechanisms to enlargethe role of non- governmentalorganizations and communityparticipation will be explored. An evaluationrof publicspending in the socialsectors wiDl review government priorities in the light of the contributionto povertyalleviation, the need for continuedfiscal ramsterity, and a reducedrole for publicagencies. The Bank is also convening,at the Government'srequest, a series of donor meetingsduring 1992to mobilizeand channelexternal financing for priorityprograms and projcctsin the socialsectors. 19. RehabilitatingKey Infrastructure.The Bankesstrategy in this area is aimedat the immediaterehabilitation of essentialinfrastructure in the transportand water sectors,whicia have sufferedfrom a lack of maintenancedue to severefiscal constraints, as wellas the identification of further rehabilitationneeds and specificpolicy reforms. The goal is to simultaneouslypromote sustainablegrowth through an efficientuse of resourceswithin and acrosssectors, while relieving the fiscalconstraint and identifyingpublic policies for the provisionof infrastructureservices whichwill help alleviatepoverty. The Bankwi;l concentrate its rehabilitationefforts in the water and sanitation,transport, urban, and irrigationsectors. 20. Initially,lending vwil focUs on high-priorityrehabilitation needs. A water sectorloan wfilinvolve emergency-type rehabiitaMion investments to addresscritical supply and quality problems,and health hazards(such as cholera)resulting from poor water qualty. A transport rehabilitation ?-nan,ftocussing primarily on highways,will finance emergency rebabilitation investmentsiu the transportsector. Givenfiscal constraints in Peru, these loanswill also support policyand regulatorychanges to promoteprivate sector participationand investment(e.g. through concessionarrangements). Over the medium-term,these emergency-typerehabilitation loans will be supplementedwith a municipaldevelopment loan to support basic urban infrastructureand a water sector loan to support further rehabilitationand sectoralreforms. An irrigation rehabilitationloan will be preparedto addressirrigation infrastructure, which has been allowedto deterioratees proceduresanJ maintenancehave been inadequate. 21. Given the constraintsto immediatelarge-scale lending to Peru, and the institutional weaknessesin the PeruvianGovernment, the Bank is seekingan immediateimpact through the provisionof policyadvice. Sectorwork related to infrastructureis emphasizingrehabilitation, as well as institutionaland pricingissues, including studies on the irrigation,telecommunications, transportand water supply,and generalissues of policyreform in infrastructure.A studyis underwayto examinethe scope for deregulation,privatization, and decentralizationin urban services. - 6- II. The Economy Ihe TiconomyInherited

22. During the last two decades Peru developed a legal structure and policy environment inimicalto economic development. A state-led development strategy created a large public sector, an intricate network of controls, and a largely inefficient state-owned-enterprise sector operating in virtually every sector of the economy. The tax code became complex and full of loopholes, with tax administrationineffective and evasion high.

23. These policies seriouslydistorted most of the markets in the economy. Job security in the formal sector was constitutionallyprotected, and strictly enforced. This, and very high tax rates on labor, helped shrink the formal sector. The land reform of the early 1970s severely restricted the marketability of land and its use as collateral. The trade policy of the last three decades relied on an import-substitutionstrategy with very high tariffs and many non-tariffs barriers, depriving the country of the benefits of comparative advantage. Domestic regulatory policies provided special privilegesto incumbents. The financial sector was heavilyregulated and burdened with direa government involvement. During the entire decade of the 1980s the Government wontrolledinterest rates.

24. President Garcia's diagnosisof chronic inflation and low growth was that Peru was in a "debt trap": servicing the external debt would accelerate foreign exchange devaluation and inflation, 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 stopped payments altogether. It instituted widespread foreign-exchangecontrols on current- and capitalaccount, with multiple exchange rates which were subject to frequent change. It increased minimumwages, expanded directed credit and subsidies,reduced the tax rate on VAT, and decreased public sector prices. This strategy led to a high and increasing fiscal deficit, financed by flat money. During the first two years of the Garcia Government this increase in the money supply had little effect on prices due to an increased demand for Intis generated by the President's widespread credibilityamong Peruvians. The initial results were excellent. Economic activity expanded by 17 percent from 1985 to 1987, the rate of price increase fell, and real Inti liquidityexperienced an unprecedented increase. This "boom",of course proved to be unsustainable. After 1987 the market lost confidence, the process of monetization sudde*ly reversed, inflation rebounded, and the economy deteriorated sharply.

25. In key productive sectors, such as petroleum and mining,the breakdown of management and finances led to a decline in production. Peru's per capita GNP declined sharply and unemploymentand poverty increased alarmingly. Relations with the international financial institutions (IFIs), bilateral lenders, and commercialinstitutions were suspended because of the accumulation of large arrears. The government applied no effective remedy beyond the reduction of public investment to historically low levels, with the greatest relative reduction in health and education. Inflation continued out of control, further eroding tax revenues. In 1989 the price level was 267 times higher than in 1987, output had contracted by 19 percent, and real wages had collapsed to under half their 1985 level - 7 -

26. Economic mismanagementreached a climax in 1989-90. The decade of the 1980s witnessed a slow but steady process of dollarization due to the continuing weakness of the Peruvian 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. The Garcia Administration attempted to end this process by freezing all dollar deposits, and later even tried 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 36,010 percent (Table 1.6 of Annex 1). As a result, the country's fiscal base had almost vanished and most public sector prices and tariffs were approaching zero in real terms. Economic activitywas extremely depressed, and investment even more so: the public sector had virtually abandoned maintenance of its capital stockl The formal financial sector had shrunk and real domestic liquiditywas down to about one-sixth the level of 1985. Exports were 40 percent below their 1979 level, gross international reserves were low, and Peru's debt moratorium had led to its isolation from the international community. Violence and terrorism were escalating. Seventy-five percent of the labor force was either unemployedor employed part-time and per capita incomes had declined to the levels of 30 years earlier.

The Economic Reforms of the Fuiimori Administration

2X On assumingoffice at the end of July 1990, the Fujimori Government launched an orthodox and sweeping stabilizationcum structural reform program. The progress achieved by the Government in both stabilization and structural reform is imnpressive.During the first stage of economic reforms, the government took dramatic steps towards achievingmacroeconomic stabilization and rebuilding ties with the intemational 3nancial community. The main components of the program launched in August, 1990 were:

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

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

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

(d) The unification of exchange rates and the establishment of full convertibilityin all current- and most capital-account transactions, with a managed floating exchange-rate system;

(e) A tight domestic credit policy;

(f) A significantreduction in price controls, includingthe de facto elimination of ceilingson interest rates. -8- These measuresaimed at eliminatingthe main sourceof hyperinflation:the monetaryfinancing of the fiscaldeficit. 29. Further fiscalreforms. Foliowingthe initialstabilization measures, the Government took a numberof steps, mostof them in March,1991, to reformthe tax system,notably the following. (a) The tax regimewas simplified. This implied the eliminationof numeroustaxes and their substitutionby a systembased principalyon fivetypes of taxes:a tax on incomeof individualsand corporations,a tax on wealthof firmsand individuals,a valueadded tax,a tax on z4lectiveconsumption, and tariffson imports. (b) The incometax rate on firmswas reduced from 35 to 30 percent and exemptionswere reduced. The tax on net wealthof corporationswas unifiedat 2 percent and all exemptionseliminated. Both taxeswill incorporatea systemfor adjustmentto inflationbeginning in fiscalyear 1992. The personalincome tax rate was reducedfrom 45 to 37 percent,and a 1 percenttax leviedon the inflation-adjustedvalue of a list of assetsreplaced the previoustax on individuals'net wealth. Selectiveconsumption tax rates -- excludinggasoline taxes -- were reducedto three, with a maximumof 50 percent. (c) The emergencytax on insuredassets, the 10 percentsubsidy on nontraditionalexports, and the 10 percenttax on exports(except for ninerals)were eliminated. However,the emergencytax on checksand the excisetax on interestwil be temporarilymaintained until total tax revenuecollection increases by enoughto justifytheir elimination. 30. The tax administrationsystem has been subjectto severalreforms during 1991. The tax administrationoffice (SUNAT) has been reorganized;it wasendowed with a budgetof up to 2 percent of total tax revenuecollection, and an evaluationof its personnelto permit a careful selectionof new staff is currentlyin progress. SUNATis also modernizingits computingfacilities and inrducing reformsin its administrativeprocedures directed towards simplifying tax controls. 31. SinceAugust, 1990 public utility prices have been subjectto frequentadjustments, while publicsector wages have remainedunder strict control. Wageindexation in public enterpriseswas eliminatedand wageincreases require CentralGovernment's approval In the fast four monthsof 1991,50,000 civil servants resigned under a programthat offered incentives for voluntarywithdrawal. 32 Further structuralreforms. A secondstage of policyreform began when the initial economicmeasures were supportedby a seriesof broad-basedstructural reforms announced from March, 1991,onwards. These unprecedentedmeasures were aimedat promotingdomestic and extemalcompetitiveness and deregulationof economicactivity. The majormeasures are as follows. - 9 - (a) Monopoliesand deregulation.Monopoly rights of 12 publicfirms (includinggrain marketing,imports of fertilizers,gold trading, reinsurance,etc.) have been abolished. (b) Financialsector. A new bankinglaw strengthensprudential regulations by redefiningthe capitalrequirements and creditconcentration ratios of banks,promoting universal banking, and openingcommercial bankingto foreigninvestment. In addition,insurance has been partially deregulatedby freeingpremiums and abolishingsome goverment monopolies. (c) Labor market. The rigidlabor stability laws have been amendedto broadenprovisions for layoffsand to establisha better regimeto capitalizethe contnbutionstowards compensation at the timeof layoff/retirement. (d) Ports. With the eliminationof the ControllingCommission of Maritme Labor,which monopolized most loadingunloadingactivities, the cost of these serviceshas been substantiallyreduced. (e) Foreigninvestment. Foreign investors are now permittedto remit abroadall net profitsand royalties.Foreign investment can now enter under any corporateform or joint venture, and investorsare allowedto purchasestock from residentsand to investin any sectorexcept those otherwiseresemved for nationals. (f) Privatization.The Governmentis in the processof layingout the strategyto privatizeenterprises in the area of mining,fishing, banking, oil and gas, power,telecommunications, and transport.

(g) Land reform. Land propertyrights have been broadenedand strengthened. Corporations(including agrarian cooperatives) can now legallybecome private estates. Moreover,land is now freely transferableand can be used as collateral. 33. The socialprogam. On implementingthe adjustmentprogram in August,1990, the FujimoriGovernment also began the SocialEmergency Program to providefor direct food and health assistanceduring the five monthsfrom August through December. Althoughthe Program initiallyplanned to disburse$415 million,it disbursedonly $67.7 million of Treasuryfunds. To establsh a better focusedprogram for a safetynet, the governmentannounced, in August, 1991, the creation of the NationalFund for SocialCompensation and Development(FONCODES). FONCODESis a temporarymechanism for channellinggovernment and donor resourcesto labor-intensiveprojects (mainly the rehabilitationof economicand socialinfrastructure) proposed by localgovernment agencies, NGOs, and community-basedorganizations. 34. In addition,in an effort to set prioritiesand policiesfor the socialsectors, the Governmentprepared a nationalshort-term development plan in April, 1991. With UNICEF assistance,a Plan of Actionfor ChildWelfare was also preparedand endorsedby the - 10-

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 different circumstances.

The 1991-1992Macroeconomic StabilizationProgam

35. To consolidate the process of economic stabilization, the Government has agreed to a Rights Accumulation Program (RAP) with the IMF that identifies several targets for macroeconomicperformance duing the period July 1991-December1992. The Peruvian stabilization program, agreed with the IMF, envisagesfor 1992 an increase in fiscal revenues over 1991 of roughly 2 percent of GDP as a result of better tax administration,a higher VAT rate of 16 percent (up from 14 percent), and simplificationof the tax regime. Privatization could also provide some fiscal relief but the Government correctly acknowledgesthis to be temporary. Also, tight monetary policywould allow only for the purchase of international reserves by the Central Bank. The program envisages that inflation will be reduced steadily to achieve intemational levels by 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

NFPSPrimary Balance -5.1 -5.4 -5.1 -1.0 0.4 0.6 InterestAccrued 2.8 3.8 2.8 4.4 3.5 3.6 NFPSTotal Balance 7.9 -9.2 7.9 -5.4 -3.1 -3.0 Quasi-FiscalBalance -5.4 -6.1 -2.8 -1.1 -0.5 -0.3 CPSTotal Balance -13.3 -15.3 -10.7 _U 1 _ Financing Extemal 2.4 4.3 2.9 3.2 3.1 3.3 (interestArrears) (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: consolidatedpubfic sector. Source: IMFStaff Reportfor the ArticleIV Consultation

36. The program also calls for substantial fiscal improvement over previous yeats. While the primaty balance of the non-financial public sector showed deficits higher than S percent of GDP during 1987489,the balance improved to a one-percent deficit in 1990 (the first year of the - 11 - FujimoriGoverntment) and it is plannedto reach a surplusof 0.4 percent for 1991and 0.6 percent for 1992. The interestpayments for those two years,of 3.5 and 3.6 percent of GDP respectively,are expectedto be financedthrough the primarysurpluses plus voluntaryexternal contributionsof 3.1 and 3.3 percent of GDP for 1991and 1992respectively. The program,as currentlystated, does not require any domesticfinancing of the non-financialpublic sector; in fact, a smallsurplus of 0.3 percent of GDP is expectedin 1992. In consequence,the only reasons for moneycreation during the 1991-92program relate to either reserveaccumulation or tie financingof the quasi-fiv_.aldeficit. 37. The quasi-fiscaldeficit is projectedat 0.5 percentof GDP for 1991and 0.3 percent for 1992. For 1991,the quasi-fiscaldeficit is expectedto be fuly financedby domesticcredit creation. For 1992,external sources will finance this deficit. The programassumes an average monthlyinflation rate of 5 percentfor the secondsemester of 1991and a monthlyaverage of 2.7 for 1992. This inflationprojection is consistentwith the projectedincrease in the moneysupply requiredto buy foreign-exchangereserves and to servicethe externaldebt of the CentralBank Duringthe first semesterof 1991,currency in circulationincreased by 30 percent,solely for purchasesof foreignreserves and not for deficitfinancing. For the secondsemester of 1991,the programforesees a 55 percent increasein currencyin circulation,of which60 percentwould be an increasein net domesticcredit and the rest purchasesof foreignexchange. Risks and Assessmentof the StabilizationProgam

38. The four risksto Peru'sstabilization program are that: (a) the fiscalsituation would remainprecarious; (b) a continuingdollarization process would push up moneyvelocity and fuel inflation;(c) marketperceptions of the continuingovervaluation of the Sol wouldincrease politicalpressures on govemmentofficials to take unwarrantedsteps such as re-introducingcapital controlsor making"excessive' (inflationary) purchases of foreignexchange; and (d) a growthin terroristactivities would undermine business confidence and support for the Government. 39. The fiscalissue is mostimmediately worrying. As of September,1991, the fiscal adjustment,in spite of gradualimprovement, remains precarious. To maintainthe budgetcash balance,suppliers are not fullypaid, AdministrativeRegions do not receivefil transfers,foreign creditorsare not kept current,salaries of civilservants are at an all-timelow, and net public investmentis practicallyzero, with little or no maintenanceof physicalinfrastructure. This extremelylow level of expenditurehas created socialunrest. Fiscaladjustment will be crucialfor the sustainabilityof the current stabilizationeffort. The Governmentexpects extra tax revenue for 1992of 2 percentof GDP relativeto 1991,bringing tax collectionsto a total of 9.2 percent of GDP. However,this improvementdepends on congressionalapproval of the tax reformand improvementin tax admiistration. Nevertheless,this fiscaltarget is reasonable,gven that inflation for 1992 is expected to be low, in 1985, by comparison, when annual inflation was 160 percent ts collectionswere 15 percent of GDP. 40. TIheprocess of dollarization-- that is, currencysubstitution in favorof the dolar - continues. It has steadilyreduced the demandfor Solesand has therefore made it increasingly - 12-

difficult for the Government to collect the inflation tax.1' The experience for Latin American countries which have recently undergone dollarization is that successivestabilization efforts were unable to return domestic cash balances to the pre-shock level, even when a lower inflation path was realized. It appears that the elimninationof all foreign exchange controls has facilitated Peru's dollarization process and that the dollar has expanded its traditional store-of-value function in Peru to include those of unit of account and medium of exchangeY Were dollarization to continue, it could complicate the stabilization process; but as long as the fiscal accounts achieve a sustainable equilibriumand the money supply grows within its targets, continued dollarization should not derail the stabilization process.

41. The Government has been concerned about the significant real appreciation of the Sol in 1991.y In response to this concern, the 1991-92program allows for the purchases of foreign reserves by the Central BankY The Government's economic team has gained popular support as Peru has made a successfulbeginning to the process of reintegration into the international financial 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 in bringing hyperinflation to an abrupt halt: monthly inflation fell from 63 percent in July, 1990, to 6 percent in November, having reached a historical high of 397 percent in August, 1990, the month in which the public price and tariff adjustmentswere made (Table 1.6 in Annex 1). However, by the middle of 1991, inflation had increased to 7-10 percent per month. Inflation fell steadily from 9 percent in July to 4 percent from October to December. The immediate causes of this higher inflation were increases in the monetary base by an average of 6-8 percent per month and 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 monetaryunit, the NuevoSol (S/.), was introducedat a conversionfactor of S/.1.00 = I/m. The so-calledInti Mil16n(I/m.) - equivalentto one millionIntis (I/. 1,000,000) - was institutedon December16, 1990,as a device,eliminating the last sixdigits of any valuein 1Itis,to simplify accountingand as a meansof transitionbetween the Inti and the NuevoSol.

2! Real Solcash balances (currency plus demand deposits, deflated by the ConsumerPrics Index) fel by 36 percentbetween July, 1990and July, 1991,in spiteof the substantialreduction in inflationthat tookplace. (CPI inflationwas at a monthlyrate of 45 percentin the threemonths May-July 1990, as comparedwith aoly 8.7 for the samemonths in 1991).With a floatingreal exchangeregime, a fall in the demandfor Soleswill lead to highervaiability for prces denominaedin Solest5an for pricesin dolars. Nevertheless,by October,1991, the fall in the real demandfor Solesseems to havelevelled off. h/ Accordingto the availablemeasures, the currencyhas beenappreciatng steadily since 1988. ITe rate at the beginningof 1991was one-quarterits 1988level. The reasonsfor the long-ternappreciation in the real exchangerate are not clear; theyare attributedby someto the rise of Peru's cocaeconomy (now, by some estimates,equivalent to at leastone-third of officialexports). 4/ The net reservesof the CentralBank increased by US$277willion during May-August, i991, in responseto inreased purcbases-equivalentto 45 percentof the dollarvalue of Ml as of May, 1991,when the purchases strted. In spiteof the significantpurchases of foreignexchange by the Cental Bank,the prchasing powerof the dolla in temnsof domesticgoods (measured by the CPI)fell 25 percentduring the samepenod. - 13 - implyingthat even a smallmonetary financing of the deficitwould have a large impacton prices. 43. The stylizedeconomic cycle. ByAugust, 1991, the rate of growthof the monetary base explained,by and large,some 75 percent of the inflationexperienced since October,1990, the rest beingdue to the persistentdottarization of the economy,which increased the income velocityof money. The rate of growthof the monetarybase washighly variable, but ovall, monetarypolicy was generally"tight! in the sense that the monetarybase grew at a lowerrate than prices. 44. The followingsequence appears to descnbe Peru's experienceof cyclicalfluctuations s of August,1991: tight monetarypolicy increases interest rates on dollarand Sol financial assets. The high real rates attract capitalinflows, which in turn appreciatethe real exchangerate. The CentralBank, concernedabout the 'low"level of the exchangerate, speeds up its rate of monetarycreation by buyingforeign exchange at a faster rate, and this in turn createsinflation. 45. Meanwhile,inflation reduces the eal levelof those priceswhich are under governmentcontrol (gasolinefor example). Theseprices are designedto includea large tax element,and fiscalrevenues therefore deteriorate. Worriedabout fallingrevenues, the governmentthen permitsa large and immediaterise in public-sectorprices which then causesa one-timerise in the price level. (Thiskind of adjustmentshould have no permanentinflationary effect.) The CentralBank, concerned about the surge in prices,tries to compensateby turningto a much "tighter"monetary policy (which involves buying less foreignexchange), thereby further increasinginterest rates and capitalinflows. As these inflowsappreciate the exchangerate, the CentralBank loosensits grip,increasing the rate of growthof the moneysupply to buy foreign exchange.Tbis completesthe inflationarycycle. The cyclehas led to a highlyvolatile monetary policywhich has increaseduncertainty in an alreadyuncertain environment. 46. In sum, Peru's CentralBank has been concernedwith the same issuesthat concern mostCentral Banks: inflation,foreign-exchange reserves, interest rates, unemployment,and the exchangerate. But Peru has been experiencinghigh inflation in an extremelydemonetized economy.This meansthat the governmenthas little room for mistakesfrom inconsistentpolicy objectives. Consequently,inconsistent objectives, or shiftsamong these, are another source of monetaryvolatility, contributing to the existingclimate of uncertainty.These policyshifts, coupledwith steady dollarization and a weakfiscal situation, help explainthe current fragie macroeconomicsituation. The CentralBank shouldconcentrate on targetingthe rate of growth of the monetarybase, thus providinga stableand predictablemonetary framework This indeedis the policythat the Governmenthas followedsince August,1991. In addition,the provisionof an efficientfiscal framework is an indispensablecomplement for a lastingstabilization.

Monitoringthe StabilizationProgram 47. The uncertaintyrelated to a precarioustax base,increased doilarization, and real appreciationof the exchangerate makesit difficultto forecastthe evolutionof economicvari- ables. Thereforethe Bank willassess the progressof the stabilizationprogram with particular referenceto the performanceof a set of broad relevantindicators which are consistentwith the IMF program. For 1992,we shalluse the followingset of indicators,with their corresponding values,to evaluatethe economy'smacroeconomic performance. - 14-

(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 percent of GDP;

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

Within these broad indicators, the Bank will pay particular attention to measures of fiscal revenue enhancement and expenditure control which will contribute to efficiency,equity, and the sustainabilityof adjustment in the medium term. In monitoring the macroeconomicprogram, the Bank 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 a long and difficult path. The institutions of public management have to be rebuilt and public confidence in government restored. This must happen against an alarming backdrop of poverty, a cholera 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 to make it more efficient and competitive: the liberalizationof agricultural,labor, and financial markets and trade will continue; the Government is detennined to provide public goods - health, education, justice, and so on - more efficiently;and a wide-rangingprivatization process has been launched.

49. Through its program of adjustment lending in FY92, the Bank will be working with the Government in support of its agenda for structural reform. In addition to the trade reforms to 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 of adjustment lending will also contribute to stabilization objectives. Three components of the SAL -- supporting the non-inflationaryfinancing of public expenditure, reform of tax administration, and a reduction in public employment - have a direct and obvious impact. But other components of the lending program support policy reforms with more indirect effects.

(a) If the prospects for structural reforms and for more efficient, less corrupt government are credible, people are more likely to pay their taxes. 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-term effect is to eliminate the recurrng fiscal burden of state-owned enterprises and to create a new tax base.

(c) The net impact of lower import duties combined with the elimination of many preferential regimes is expected to lead to higher fisal - 15- revenues,a trend whichhas been apparentsince the secondquarter of 191 (see paragraph94). (d) New labor lawswill increase labor's mobility; this in turn willreduce the bankruptciesresulting from changesin relativeprices caused by the trade and other reforms. Thisshould relieveshort-term political pressureson the stabilizationplan. (e) The new bankinglaw, by strengtheningprudential regulation and providingfor depositinsurance, will help the bankdngsystem withstand the recessionaryeffects of the stabilization. The Medium-TermOutlook 50. Sixmajor policy areas are likelyto playan importantrole in determiningthe medium term outlookof the economy:(i) trade reform,(ii) fiscaladjustment, (iii) restorationof external debt serice, (iv) privatization,(v) increasedreliance on marketallocation mechanisms, and (vi) currnc convertibilityand financialopenness. GDP growthis eVpectedto remainat 2.5 percent for 1992as the economystill has to adjustto the significantshock derived from the tight money policyrequired to end the hyperinflation,the hardeningof the fiscalbudget, and the structural changesin telative prices. GDP is expectedto start recoveringin 1993and its growthrate to rise graduallyto a sustainablelevel of 4.5 percent by the end of the decade (Table 1.4 of Annex 1). 51. A successfultrade reformwill increase the participationof exportsand importsin GDP, once the short run disturbancesassociated with the end to the hyperinflationare washed out. We expect exportsand importsof goodsand non-factorservices to graduallyincrease their share of GD? from 11 percentin 1990to 17-18percent by 1999,with exports rising slightly faster than imports,resulting in the emergenceof a positivebalance in the trade accounttowards the end of the decade (Table 1.4of Annex 1). 52. Two conflictingforces operate on the current account: the fiscaladjustment should operate towardsimproving the current account,while the restorationof normal debt serviceand the financialhberalization will help generateadditional capital inflows to financea largerdeficit. It is likelythat for the rest of this decadethe fiscaladjustment will dominate so that the cwu t accountbalance will improve as Peru starts generatinggenuine resources to reduce the rate of increasein its foreigndebt. The most likelyscenario assumes the current accountbalance to remainin deficitduring the decade,although it willbe reducedfrom the high levelof -5.2percent of GDP reached in 1991to belowfour percentby 1997and thereafter (Table 1.4of Annex 1).

53. The simultaneousachievement of GDP growthand current accountimprovements dependson a sustainedfiscal adjustment and an increasein privatesavings that wouldbring domesticsavings up to 26 percent of GDP by 1999(compared with 19 percent in 1991),a level consistentwith an investmentratio of 25.5 percent and a Trade Surplusof 0.4 percent of GDP. The increasedsavings will be sustainedby the positiveinterest rates allowedby the financial liberalizationimplemented in mid-1990. - 16-

III. External Firancln

The External Debt Problem

54. Peru's arrears grew rapidly from 1983, whei ;ru adopted a best-effort-to-pay practice on its foreign debt. Then, in July 1985, the Garcia Go- Anent announced that total foreign debt payments would be capped at 10 percent of exports. Not until 1988, however, did actual debt service fall to the 10 percent limit. Initiallyonly payments from public creditors to private foreign banks were targeted, but in 1987 Peru extended the moratorium to the IFWsand also banned external debt-service payments by private debtors. In August 1986, Peru was declared ineligible for IMF lending and was placed on "non-accrual"status by the World Bank one year later. In early 1989, the IDB also took this last step. Threatened with expulsion, the Garcia Government resumed 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 the international financial communityby resuniing current debt service payments to the Bank and the DB: followingdiscussions with the Bank, payments to cover current obligationswere resumed in mid-October 1990, and to the IDB one month later, thus "freezing the stock of arrears with these two institutions. Payments to the IFIs average about $41 million per month, equivalent to about 14 percent of the central government's total fiscal revenues. Interruptions in the payment of current obligationsto 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 all arrears accumulated since mid-October 1990 paid.

56. Peru now faces an unprecedented overhang of external debt and arrears. At the end of 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 to lFIs (see Table 1.5 in Annex 1). Almost two-thirds of this was in arrears; arrears to the IWU alone totaled $2.2 billion. The secondary-marketdiscount on commercial-bankclaims on Peru is over 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 for the financingof arrears; the rest is for public-sectordebt-servicing, achieving a targeted level of reserves, and supporting the non-interest current account deficit. - 17-

ITa: EXTERNALFINANCING REQUIREMENTS AND POSSIBLESOURCES OF FINANCING,1991 AND 1992 (in Millionsof U.S. Dollars)

1991 1992 1991-4'2 FinancingRea_rements 1. Non-InterestCuffent 536 492 1,028 AccountDeficit 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 Disbursementsin Pipeline 255 200 455

7. Private Capital Flows 908 545 1,453 8. Net FimancingRequirements 14,498 4,248 18.746 (5-6-7) ===.

9. Debt Reschedulingand Deferal 13,598 1,467 15,065 OfficialBilateral 6,352 769 7,121 Private 7,246 698 7,944 10. AdditionalDisbursements 900 2,781 3,681 Multilateral 654 2,328 2,982 OfficialBilatera 1/ 246 453 699 11. AdditionalFinancing Required 0 0 0 12. Total Sourcesof Financing 14,498 4,248 18,746 (8+9+10) === .m_

11 Additionaldisbursements of budgetazybalanceof paymentsfrom Suppott Group members.

SO=: Annex 1, Table 1.2 - 18-

58 To help cover these financingrequirements, the donor communityhas soughtto developa coordinatedplan, whichwould help reintegratePeru into the internationalfinancial community.Rescheduling and deferralof debt to officialbilateral creditors, and a cortinued moratoriumon debt servicingto privatecreditors, are expectedto cover mostfinancing requirements.Peru is not expectedto receiveany type of debt forgivenessin 1991and 1992. The balanceis expectedto be providedby fresh disbursementsfrom the three IFWb,the Latin AmericanReserve Fund, and bilateraldonors, coordinated through a "SupportGroup." 59. Debt reschedulingand deferral. Reschedulingnegotiations have alreadybeen successfullycompleted with the Pans Clubof creditors,but negotiationsare still underwaywith Peru's other bilateralcreditors, notably some Latin Americanand Eastem European countries. The financingplan incorporatesthe agreementreached at the Paris Club,and assumesthat Peru willbe able to securesimilar terms fromits other officialbilateral creditors. It also assumesPeru willbe unableto servicedebts to privatecreditors during 1991-92;these debtswill therefore be rescheduled. 60. Paris Club Rescheduling.Per rescheduledpart of its obligationsto the Paris Clubof ereditorson September17, 1991. The Paris Clubawarded the Governmentexceptional treatment in the formof unprecedentedcashflow relief between October 1, 1991and December31, 1992 (the consolidationperiod). All current maturitiesdue duringthe consolidationperiod on debt contractedbefore the 1983Paris Club rescheduling(pre-cutoff debt) and all arrears on pre-cutoff debt were rescheduledon term; reservedfor heavilyindebted lower middle income countries All moratoriuminterest (interest due duringthe consolidationperiod on rescheduleddebt) and all arrears on post-cutoffdebt were deferred,the latter contingenton continuedperformance under the IMFb RAP. (See the notes to Tables1.1. to 1.4,in Annex 1, for more detail on the terms of the Paris-Clubrescheduling). 61. Other OfficialBilateral Reschedulings. Peru is seekingdebt reschedulingfrom other bilateralcreditors on comparableterms to that receivedfrom the Paris Club of creditors,includig the reprogrammingof debt-for-exportagreements with Eastern European creditorsand the restructuringof medium-termobligations to Latin-Americancreditors that are currentlybeing servicedthrough the ALADIpayments mechanism. 62. ExistingMedium- and LonL=termDebt to CommercialBanks and Unauaranteed Suppliers. AlthoughPeru willbe unableto servicedebts to privatecreditors during 1991and 1992,the Governmentwill continue discussions with these creditors. Unlessan agreementcan be concludedwithout cash payments, the arrears on these debtswill continue to growduring this period. Followinglaw suits broughtby the commercialbanks in 1989-90,the new Government has negotiatedan understandingwith themunder whichit renouncedrecourse to statute-of- limitationsprovisions in return for a suspensionof the defaultproceedings that were initiatedin February1990. 63. ExistingShort-Term PrivateDebt. Peru willcontinue to serviceshort-term trade credits. The suspension,since 1983,of amortizationof short-termworking-capital loans will

V/ TheWorld Bank and the IMP would only disburse following clearance of Peru'sareas to both institutions,expectd in December1992. - 19- continue. In addition,arrears that have emergedin recent ears on interestpayments on working capitalowed by some public-sectorentities are likelyto persist. 64. NewdisbureMents.The three IPIs and bilateraldonors are committedto helping Peru secure vitallyneeded externalfinancing. However, their financialassistance is conditionalon Peru's programof stabilizationand economicreforms remaining in place. For the financingplan to be successfulPeru must abideby the conditionsof the IMFs RAP and the Bank'sconditions for lendingto a countrywith protractedarrears during a specifiedperiod of time, expectedto end in December1992 As long as Peru adheres to the economicreforms in these programsuntil the end of the performanceperiod, the Bank and the IF willbe in a positionto disburseto Peru upon clearanceof arrears to both institutions.In order to clear Peru's arrears, a bridgeloan, presumablyfrom bilateraldonors, wil need to be securedat the end of the performanceperiod. Economicdiscipline throughout the performanceperiod is also essentialto ensure continued lendingby the IDB, and the releaseof fundspledged by a support groupof bilateralcreditors. 65. De InternationalMonetary Fund. In January 1991,the IM managementreached an agreementin principlewith the Governmentof Peru on an economicprogram for 1991-92 intendedto form the basis for a request for a two-yearRights AccumulationProgram (RAP). On September12, 1991,the IMF Board,satisfied that Peru'sexternal financing requirements could be met, and that Peru wouldmaintain its paymentson current obligationsto the WIi, approved the RAP. Under the program,if Peru abidesby LF performancecriteria, and continuesto servicecurrent debt to all three IFM,it wouldaccrue rights to future disbursementsequivalent to 188percent of its quota, or SDR624million, equivalent to Peru's current arrears to the WM. Rights wouldbe disbursedonce arrears to the IMF are cleared. 66. The WorldBank. On May 2, 1991,the WorldBank adopted a new 'debt workout" policy,analogous to the IMFs RAP (see paragraph3). Under this program,three adjustment operations(expected to total $900million) and other investmentoperations, if ready,would be presentedto the Board for approval,and disbursementswould be releasedupon clearanceof arrearsto the Bank. 67. The Inter-AmericanDevelopment Bank. The three IFIs agreed that Peru's arrears to the IDB should be clearedfirst as theywere smallerthan those to the Bankor the NE. These arrears were clearedon September13, 1991with the help of a bridgeloan of $325million from the Latin AmericanReserve Fund (FLAR)Y With the clearanceof its arrears,the IDB has begun to move aheadwith a substantialprogram in support of Peru's rehabilitaton. On September18, 1991the MDBBoard approveda $425million loan for trade reform and is expected to approvea $200million loan for financialsector reformin early 1992. This adjustmentlendig wil be followedup with disbursementson new projectsin water/sanitation,and the reactivationof existingprojects in the energysector. Total disbursementsin 1991and 1992are expectedto be about $839million.

I/ FLAR,an institubonof the AndeanPact countries aeated to dealwith balane-of-payments probles i the ron throughthe provisionof medium-term(up to three-to-four-year)fuding, has committedto make availale to Peru up to t78 million more in financingthrough the end of 1992. - 20 -

68. The Support Group. Followingseveral meetings beginning in April 1991, a Support Group, led by the U.S. and Japan, was officiallyformed on June 7, 1991.!' At the time of approval of the RAP, the IMF estimated that the quick disbursingbalance of payments support required from the Support Group would be as much as $1.3 billion, but following the Paris Club rescheduling,which was more favorable than initiallyexpected, and an increase in expected disbursements from the IFIs, additional balance of payments support needed is now* timated at only $0.7 billion. The Support Group has pledged to provide this amount, in additiu...to $326 million earmarked for project aisistance. With the approval of the IMF RAP, which opened the way for the recent Paris Club agreement, bilateral donors are now in a position to disburse these funds.

External Financing Beyond the Performance Period

69. Peru's net external financing requirements would be between $2.5 billion and $3.5 billion a year between 1993 and 1999 (Table 1.2 in Annex 1). These estimates are based on the macroeconomicscenario 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 obligationsof between $2.5 to $4 billion a year, which are drawn from assumptionsabout expected disbursements. Finally,the estimates depend on assumptions ab: the volume of private capital flows, and Peru's ability to increase its reserves. Yearly increases in reserves and positive private capital flows, includingdirect investment 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 these assumptions are based on scant information,we emphasize that this financingscenario is highly tentative and should be interpreted wth caution.

70. If this scenario comes aeoout,significant increases in flows from the IPIs and official bilateral donors are expected to account for most of the necessary fnancing. In addition, it is assumed that the Government will continue to reschedule private debt service 1, and pre-cutoffdate debt service to Paris-Club creditors due throughout the period. No debt reduction is assumed for either official bilateral or private creditors. Under these assumptions, a financinggap generally within the range of $200 million to $500 million annually would remainY This gap would diminishby the amount of the IMF program that would have to be in place before a further Paris Club reschedulingcould take place. If Peru's access to IMF resources were to

7 / Bilatealdonors who have pledged through the SupportGroup are: Belgium,Canada, France, Germany, Italy, Japan,the Netherlands,Spain, Sweden, Switzerland, and the UnitedStates.

_/ Given that financinggaps are likelyto occur, even assuminga 100 percent rollover every year of commrcial bank debt, it will be difficultfor the Governmentof Peru to enter into an agreementwith commeci banks requwtj a large cash payment. However,discussions have begun which may lead to negotiationswith the commercialbanks as early as 1992 and a settlementon at least pant of the Governmen's d4bt to commercialbanks. Indeed, if the actual externalfinancing scenario is more favorablethan the one presentedhere, and the Govemmentwere able to serviceor buy back its private debt, the externalfinancing gp would reflect the cost of any resourcesdevoted to such transactions.

2/ he projectionsassume this financinggap would be met on commercialterms. -21. averagearound 50 percentof current ninnualquota a year, the gap could be reducedby up to $200 milliona year. Further reductionsin the gap couldcome about if any variablesprove to be more favorablethan assumed,for exampleif Peru were able to secure new flowson more concessionalterms than in the past, if other exceptionaltreatment, such as debt reduction,were offered,or if faster GDP growthwere to lead to highergovernment revenues. 71. Debt ServicingCapacity. Peru's current lack of creditworthinessoriginated with the Garcia Administration'sunwillingness to servicethe government'sdebt. Peru's creditworthinessis expectedto improvefollowing the repaymentof its arrears to the WorldBank and IMP in December1992 and the earlier resumptionof relationswith the IDB and the Paris Clubof creditors. The improvementin economicperformance, in the comingdecade, from a sustained programof economicreform can be expectedto underpincreditworthiness by improvingPeru's capacityto serviceits externaldebt. 72. Under the assumedscenario, the ratio of debt serviceto exportscould fail quickly,to 32 percent by 1999from around 51 percentin 1993. However,the ratios of debt or interest to GDP, whichbetter reflect the internaltransfer problem, are projectedto fail onlyslightly. Debt reductionwould clearly lead to a greater reductionin the debt burden and contributeto the future recoveryof Peru's creditworthiness.(See Table 1.4in Annex1, for a summaryof Peru's debt and debt serviceindicators).

IV. ExternalTrade: Performanceand Polices 73. For the first decadesof this century,Peru's was an open economyexporting a variety of agriculturaland mineralprimary products. Industrializationowed much to the demandfor capitalgoods from the exportsector. From 1959,the governmentadopted import-substitution policiesbased on tariff protectionand fiscalincentives. A militarygovernment in 1968imposed a strategyof state-leddevelopment: job-protecting legislation and corporateforms of labor relations were introduced; foreign-exchangecontrols and credit allocationwere intensified,and tanff and non-tariffprotection came to be administeredcase-by-case. Industry became increasingly oligopolistic,import-dependent, domestic-market-oriented, and inefficient.In spite of a land reform,industrial protection and cheap-foodpolicies turned the terms of trade againstagriculture. 74. Followinga long periodof currencyovervaluation that culminatedin a balance-of- paymentscrisis, a new economicteam negotiatedwith industrya tariff structuresufficiently high to replace,in 1979,some non-tariffbarriers. The governmentalso introducedfiscal incentives to exports. With a return to civiliangovernment in 1980the administrationdeepened the trade- reforms,reducing the highesttariff from 155to 60 percent and eliminatingmost non-tariff barriers. The reform,however, left manytariff exemptions in place. Expansionaryfiscal and monetarypolicies in 1980-85,combined with a deterioratingterms of trade, an appreciatingreal exchangerate, and the naturaldisaster of 'El Niflowin 1983,led to large current-accountdeficits. Peru foundit harder to borrowabroad to financethe deficits,especially after 1982. Rather than adjustto all these shocksthrough the exchangerate, the Governmentchose to adjustthrough trade controls: reversalof the 1979-81trade liberalizationbegan in 1982and, by 1984,much of the pre-1979tariff structurehad been restored and manyimports once more requiredlicenses (Table 4.1 of Annex4). -22 - 75. In 1985,the Governmentof Alan Garciatook to il-conceived,heterodox, expansionist policiesin the hope of invigoratingPeru's economy.The policiesencouraged imports, discouragedexports, and, despitethe limitationson debt servicing,led to a severedepletion of reserves. Protectionwas strengthened: the Institutode ComercioExterior (ICE), created in late 1986,was usingforeign exchange allocations to control all importsby late 1987. By 1987multiple exchangerates had becomean additionaltool to managetrade. From 1989import licensing was cut back and used onlyfor transactionsenjoying a preferentialexchange rate. Given the premium that preferentialrates enjoyedover the marketrate, this meant that the systemremained highly protectiveand discriminatory:while only ten percentof tariff Unesrequired import licenses, a mere five percentof lines protectedan estimated40 percentof manufacturingoutput. A host of non-tariffbarriers - import monopolies,minimum-domestic-content rules, and bans on second- hand imports,for instance-- supplementedthe officialnegative lists. Tariff remainedhigh and a variety of preferential schemes -- allowinghalf of imports to enter duty-free -- benefitted selected sectorsand firms. To offset the heavyprotection offered to import-substitutingactivities, nontraditionalexports continued to enjoyheavy subsidies. 76. The mostevident effect of protectivepolicies since 1959has been to closethe economy:in 1961exports and importswere 21 and 18 percentof GDP; by 1990they were eight and sevenpercent (Figure2.1 of Annex2). At the same time,trade policiesgenerated a distortedset of incentivesto the tradable-goods-producingsector. For instance,effective protectionrates to manufacturingwere typicallyhigh (averagingaround 80 percent in early 1990) and variable(Figure 2.2 of Annex2). The complexitiesof import protectionand eWport promotion- raisedto an art duringthe Garciaregime - led to enormousdiscrimination and discretionality,not onlybetween sectors but also betweenfirms within sectors. The costs that firmsspent seekingto gain or maintainthese privilegeswere a completelynon-productive use of the economy'sresources and were passedon to consumersor taxpayers.

V. Trade PoliS1Reform

77. In August, 1990,the FujimoriGovernment started a trade reformconcurrently with a stabilizationpolicy that involveda float of the currencyand a rapid correctionof relativeprices. Trade reformwas intendedto changethe productivestructure and eliminateeconomic privileges. By September,a substantialtariff reformhad been achieved(keeping only three rates: 15, 25, and 50 percent) and the import-licensingsystem had been suspended. A new Ministerof Economy and Fmance,taking office in February,1991, resumed the liberalizationprocess by introducing new measuresin March,lowering the top tariff from 50 to 25 percentand removingalmost all remainingnon-tariff barriers and import monopolies.The trade reformachieved from August, 1990,to March,1991, has provenas rapid and deep as any other post-warreform, with the possibleexception of Bolivia's.It continuesto have the support of a highproportion of Peru's businesscommunity.

X It is too early to assessthe economicimpact of trade reform.The economyremains in recession(although there are somesigns of industral recovery)and the demandfor imports remainsweak. By the availablemeasures, the currency has been appreciating steadilysince 1988 (Figure2.3 of Annex 2). Thistendency continued after July, 1990,and the rate at the begnning of 1991was one-quarterits 1988leveL The reasonsfor the long-termdecline in the real exchangerate are not clear;they are attributedby some to the rise of Peru'scoca economy(now, - 23 - by someestimates, equivalent to at least one-thirdof officialexports). In the shorter term, the valueof the (loating) currencyhas been influencedby the weaknessof import demandand by the capitalinflows attracted by the relativelyhigh real interest rates. Nonetheless,since March, 1991,imports have grown,with consumer goods leading the way(Figure 2.4 of Annex 2). Actualand PlannedReforms

79. The exchange-rateregime. In August,1990, one of the first measuresof the new Governmentwas to liberalizethe foreignexchange market. The exchangerate was unied, the Inti floated,and convertibilityrestored. Convertibilitypermitted the abolitionof the foreign. exchangecontrols which had been appliedin the multiple-exchange-ratesystem prevailing until July, 1990. Additionalmeasures in March,1991, completed the liberalizationby freeingvirtually everycapital account transaction. These measureseliminated the requirementfor exportersto surrendertheir foreignexchange earnings to the CentralBank, authorized banks to keep foreign exchangebalances in correspondentaccounts abroad, and eliminateda long-standingrestriction on maximumsales of foreignexchange for tourism. The blackmarket m foreignexchange has disappeared(Figure 2.5 of Annex2). 80. Imvort tariffs. The August,1990, reform reduced the highestrate from 84 to 50 percent,the number of rates from38 to 22, and applieda minimumtariff of 10 percent to 39 previouslyduty-free import regimes. In September,a further reformreduced the rates to three: 15 percentfor basicfoodstuffs, medicine, some intermediateand capitalgoods, and somefoods, 25 percentfor other producergoods, and 50 percentfor other consumergoods. By this time, virtuallyevery one of 139preferential regimes (accounting for half of imports)had been eliminated. In December,the Governmentannounced a timetableto cut tariffsevery sixmonths to arriveat a flat 15 percenttariff by January,1995. 81. In January,1991, in a departurefrom the reformprocess, a five-percenttariff for the inputs of steel producerswas introduced. But in March,the 50 and 25 percent rates were reducedto 25 and 15 percent. Over 70 percentof all tariff positions(weighted by production) now have the 15-percentrate (Figure2.6 of Annex2). In March the Governmentalso introducedsome protectivespecific tariffs for selected agriculturalimports. Thesewere replaced in May by a variable-surchargescheme designed to lead to a landed price no higherthan the previousfive-year average c.i.f. price plus a 15-percenttariff. The schemecovers: dried milk, wheat and wheatproducts (flour and pasta),corn and sorghum,rice, and sugar. 82. As a memberof the AndeanGroup (alongwith Bolivia, Colombia, Ecuador, and Venezuela),Peru has since 1970participated in a gradualand haltingprocess of regionaltrade integration. Followingthe strongtrade-reform movements in all these countriesin recent yeas, the Group decidedto acceleratethe process. In December,1991, the counties decided,in principle,to applya commonexternal tariff fromJanuary 1, 1992,and to moverapidly to fee internaltrade (whichwould apply to Peru fromJuly, 1992). The proposedexternal tariff is low: initially,there wouldbe no more than fiverates, rangingfrom 0 to 20 percent; from the beginning of 1994,the top rate wouldfall to 15 percent,with only three or four rates. The actualtariff rates for specificproducts have yet to be negotiated,and these negotiationsare likelyto prove difcult giventhe differentnational philosophies on the optimalspeed of trade reform. If the PeruvianGovernment judged these negotiationsunlikely to succeed,it wouldmaintain its present objectiveof achievinga flat 1'-percent tariff by 1995. -24 -

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

84. Non-tariff import barriers.1 °' By September, 1990, all import prohibitions, historically the major import barrier, had been suspended. In March, 1991, new rules prohibited, in principle at least (with a few specific exceptions), a8lforms of discriminatorynon-tariff barriers to imports and exports. Import prohibitions were permanently suspended. Preferential imports are no longer subject to a test of whether local substitutes are available. Local-content regulations were eliminated for assemblyindustries (notably vehicles and consumer durables). Several state monopolieswere eliminated, includingimport monopoliesin rice (ECASA) and wheat, flour, and sugar (ENCI). In August, state-owned PETROPERU's internal and external trade monopoly in oil products was terminated. Imports of second-hand good. were completely banned until November, 1990. From this time, many such imports were allowed, and in March, 1991, second- hand vehicle and machineryimports were permitted. Today, only clothing, shoes, and laundry items are banned.

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

86. Exrort nolicies.In July, 1990, non-traditional exporters still enjoyed direct export subsidies,under the CERTEX scheme, ranging from 15 to 30 percent of the fo.b. value of exports. In 1990, subsidiesaveraged 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 less important scheme to subsidize interest rates for exporters (FENT). The new Government substantiallyincreased the access of exporters to concessionson indirect taxes in March, 1991, liberalizingits temporary admissionscheme and introducing a drawback scheme for traditional exporters. Export restrictions were few, but the most significantof these have been removed and others have been simplified (notably, health-related controls). Several traditional products continue to pay export taxes for fiscal reasons; the rate is now 5 percent (except for mining products where, at present, only copper is being taxed -- at 10 percent). Overall, export taxes are no longer quantitatively important: in 1990 they averaged 1.3 percent of the value of traditional exports (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 for trade policy. Within this branch, the main responsibilityfalls on the Ministry of Economy and Fmance, which sets tariffs, is the major arbiter of non-tariff questions, and supervises the autonomous Customs Superintendency (SUNAD). The Ministryof Industry, Internal Commerce, Tourism, and Integration (MICITI) has held responsibilityfor integration (Andean Pact) policy

IQ/ Annex4 brieflydeswrbes Peru's progressin eliminatingnon-tarff barriers, listing the tange of barriers existing in August, 1991, and the changessince then. -2S5- and, in June, 1991,was given the responsibilityfor foreign-tradenegotiations in general and for the promotionof exports.Other ministries,notably Agriculture and Health, legislateon standards whichcan involvecontrols on foreigntrade. 88. In August, 1990,the Govemmentdecided, in principle,to "de-activate"ICE, the focal point of discretionaryimport controlsand exportsubsidies. It was not until June, 1991,that this step wasfinally achieved: ICE's assetsand promotionalfunctions were to be transferredto MICMTIand mostof its staff were to be released. In September,the Governmentauthorized the creation of a joint public-privateassociation for the commercialpromotion of exports,to be financedlargely by the .eadingtrade associations(see Annex9 for more details). 89. In March,1991, the Governmentinitiated a thoroughreform of the Peruviancustoms, havinginherited a poorly-organized and -staffedservice, with an ill-definedlegal framework and an incoherentbody of customsregulations. The inefficiencyof SUNADcreated obstaclesto trade, reducedfiscal revenues, and gavecuptoms officials a high levelof discretion. The Governmentdecreed a restructuringof the Superintendencyand created the frameworkfor a new stem of customsclearance that wouldsimplify procedures and introducethe principleof bona fids Thisprnciple wouldbe madeoperative through a procedureof "self-assessment'in wbich importersor exporters(and their representatives)would determine and pay the taxesdue with SUNAD'sex post verification.Tne Governmentfurther abolishedthe state monopolyin customs warehouses. 90. In August,1991, the Governmentinstituted a schemefor pre-shipmentinspection, in the port of origin,by qualifyinginternational firms specializing in this process,of the quantity, quality,and price of goodsto be importedinto Peru. Importerswould subsequently pay import dutiesbased on the Certificateof Inspectionthus issued,and the CustomsSuperintendency would clear goodsafter verifyingthe findingsof the Certificate.The introductionof this nheme, which has not yet been put into effect, wasnot a part of the customsreform process; while it may,in the shorter term, contributeto the valuationprocess, it also adds to the bureaucracyand costs of importingand potentiallyundermines the role that SUNADmust play in the longerterm. 91. In September,1991, under powersgranted by Congressfor promotingprivate investment,the executiveissued a LegislativeDecree elevatingto the status of a law many of the trade reformsthat had been carriedout in the previousyear. The new lawguarantees freedom of internaland externaltrade and a free, unifiedforeign-exchange market. It makesthe ban on discrminatorynon-tariff barrers and tariff concessionspermanent and guaranteesthe availability of anti-dumpingprotection and measuresto exemptexports from indirecttaxes. 92. Complementarvpolicies for trade reform. Trade reform is most effectiveif factorsof productionare free to respondto marketforces. The statistpolicies since the 1960shave severelyrestricted factor movements.Indeed, marketrigidities were partlyto blame for the failure of the 1979-81liberalization. While much remainsto be done, the Governmenthas substantiallyreduced inflexibilities, in particularthrough March, 1991,measures aimed at promotingdomestic and externalcompetitiveness, private sector development, and deregulation. These measureswere summarizedabove (paragraph 32). -26-

Dhe Epeted Impactof rrade PolicyReform

93. Trade reform can be expected to lead Peru to a more efficient use of its resources throughspecialization in productiveareas where its comparativeadvantage is greatest and through the competitivepressures that freelyavailable imports will exert on domesticproducers. The removalof non-tariffbarriers should also enable those resourcespreviously used to acquire variousimport permissions to be put to better uses. For the longer term,Peru's greaterrole in the internationaleconomy could be expectedto be seen in largerimports and exportsrelative to GDP and a more diversifiedstructure of importsand exports. Beyondthis, it is fruitlessto try to predicthow trade reformwill affect the structureof production.

94. The fiscal effects of the trade reform may be a little clearer. Lower average import tariffs, on their own, would reduce revenues, but the elimination of many preferential regimes wouldact in the oppositedirection, as too, probably,would the reductionin tariff varianceand, in the longerterm, the expectedfaster growthof importsthan GDP. Similarly,the elinminationof export subsidieshas removeda drain on the budget. Effectiveimport duties were 13 percent of importvalues in 1989and fell to 9 percentby mid-1990(Figure 2.9 of Annex2). Preliminary estimatessuggest that the figurewill rise to about 15 percent for 1991. The share of net revenues fromtrade taxes (impcrtand export tax collectionsless exportsubsidies) in total central- governmentrevcnues rose from around11 percent in both 1989and 1990to 14 percent in the first sixmonths of 1991.

95. Recent researchhas suggestedthat countriesable to sustaintheir trade reformcan usuallyexpect to raise their importsafter the reform,to raise their exportseven faster,and thus to improvetheir balanceof trade.1 ' Thisresearch also found the effectsof trade reform on unemploymentto be surprisinglysmall, even in rapidlyreforming countries: after the reform, labor waslargely reallocated within broad sectors,with far less disruptionthan mighthave been feared. Output tended to acceleratefollowing a trade reform,often immediatelyfor agriculture and witha more noticeablelag (in the first year) for manufacturing.These resultscannot simply be assumedfor Peru, especiallygiven the tenacitythat inflationhas shownand the continuing "low"real exchangerate. But the researchstrongly indicates that trade reformin itself, particularlywhen it is radical,does not need to disruptthe economy.This research did not establishthat lower-incomegroups gained or lost disproportionatelyfrom trade reform. The Agendafor Trade Policy 96. The apparentlyhigh politicalacceptability of the trade reformso far owes much to the speed of the reform,its transparency,and its removalof most of the inter-firmdicrmination whichencouraged rent-seeking. The Governmentis comirittedto maintainingall the major aspectsof the reformso far achieved. 97. The exchange-rateregime. To maintainthe convertibilityof the Inti at a singlerate for current-accounttransactions, the Governmentwill need to pursue appropriatemonetary and fiscalpolicies.

I1/ See DemetriosPapageorgiou, Armeane M. Choksi,and MichaelMichaely, Libealizinf PorMoanThude in DeveloningCountries: the Lessonsof Exnirience,the WorldBank, Washington D.C., 1990. - 27 - 98. Import taniffs.The Governmentis committe o a policyof low tariff protection,but some uncertaintyhas been introducedby the prospectof an Andean-Groupcommon external tariff. Peru's adoptionof such a tariff,which envisages rates from0 to 20 percent,could result in an increasein effectiveprotection, as wellas a fall in tariff revenues,to the extent that this tariff had the highestrates on locally-producedgoods and lowestrates on extra-regionalimports. However,in conformitywith the AndeanGroup's decision-in-principleto create a common externaltariff, the PeruvianGovernment's proposal is to assigntariff rates accordingto the degree of processingincorporated in a product,which in turn wouldmean onlya smalldegree of tariff escalationbetween processing stages. This approach,which would lead to a clusteringof mostitems around the 10-, 15-,and 20-percenttariff positions,would not increasethe current levelof effectiveprotection. 99. If the Andean Group is unableto come to an agreementenabling implementation of the commonexternal tariff, the PeruvianGovernment should take a more direct and simple approachto avoidingany increasein the level of tariff protection. This wouldmean not increasingtariffs on any positionor increasingthe spread (definedin percentagepoints) between positions. The most immediatefurther tariff changewould then be to eliminatethe 5-percent tariff on steel inputsintroduced in January,1991 (and to replaceit by the 15-percentmiimum tariff). Otherwise,this exceptionalmeasure would continue to encourageother sectorsto push for their own specialrates. Eliminatingthe 5-percenttariff would smooth the wayto the flat 15- percent tariff that the Governmentundertook (in December,1990) to reach by Januaty, 1995. FmaRy,whatever justification may exist for the agriculturalsurcharges (price stability for Peruvian producersand consumersof similarand substituteproducts), their continuationwill encourage the promotionof other formsof specialprotection. Therefore,the Governmentshould consider ways in whichit could reduce the scheme(for instanceby reducingproduct coverage) or eliminateit.

100. Finally,the Governmentwill need to implementthe new anti-dumpingand anti^ subsidycode in such a wayas to ensure that it does not becomean instrumentfor protectinglocal producersagainst legitimate import competition;this wouldrequire some revisionsto the code, to includeinter alia a procedurefor fullydocumented, public hearings and a mechanismto ensure that frivolouscomplaints are discouraged. 101. Non-tariffimport barriers. To avoidthe re-introductionof non-tariffbarriers to importsand exports,the Governmentwill need to pay particularattention to the border effectsof existingand new health,safety, and technicalregulations. It willneed to developconsistent criteria and correspondingregulations assuring that these regulationsdo not have the effect of protectinglocal productive sectors. 102. xport policies. Some traditionalexporters -- particularlymines that face highfuel taxesand the miningand other sectorstnat pay exporttaxes -- still face considerablefiscal discdmination.While this is not a large distortionoverall, the Governmentshould act to remove these export impedimentsas soon as possible.

103. Trade institutions.The successfulcompletion of the customsreform that has been started is necessaryin order that SUNADbecome an efficientand impartialorgan for the processingof trade, not only to maxdmizefiscal revenues, but also to securepublic credibility in the new trade system. -28 - 104. Accompanyingpolicies. The processof reformin policiesthat assureflexibility in productand factormarkets is wellunderway (paragraph 32), but is nonethelessonly in its beginningstages (and is less advancedthan the trade-reformprocess itself). The consolidation and extensionof these reformsis vitalto the successof the trade reform

VI. The Propod loan Histo[yof the Loan 105. Followingtne discussionsthat led to Peru's resumptionof current-debtservicing to the Bank in October,1990, three Bank missionsvisited Peru in late 1990. One missionprepared a report analyzingthe country'sreform and investmentneeds, particularly in the publicsector (Peru: SectorReform and InvestmentReview November,1990). A secondmission assessed the Govermnent'sSocial Emergency Program. A third lookedat economicstabilization and strucwal adjustmentissues (Peru: Economicand SectorReforms to SustainStabilization and Lay the Foundationsfor DevelopmentJune, 1991,white cover). This last missionproposed a range of reformsto stabilizethe economyand inducereforms in specificareas, includingthe labor market, publicadministration, the fiscalarea, and the financialsector. Specificproposals in the area of foreigntrade included: a rapid moveto a low and uniformtariff; elimination of exportsubsidies; and the creationof a safeguardmechanism to adjudicateclaims of importinjury that balanced producerand consumerinterests. The missionalso proposeda detailedplan for the reformof the CustomsSuperintendency based on the principlesof simplification,administrative rationality, bona ris, and devolutionof somefunctions to the privatesector. 106. Followingthis work on trade and customs,the Govermnentrequested further help fromthe Bank, and a mission,fuided undtr the joint UNDP-WorldBank Trade Expansion Program,visited Peru in February,1991. At the further request of the Government,the mission, before it left Lima,recommended a seriesof majormeasures to providea new impulseto the reformprocess which had been started in August,1990. It proposed:an immediatereduction in tariffsto leave onlythree rates, 15,20, and 25 percent,and the move to a flat 15 percent tariff withinone year; an eliminationof controlson second-handimports of capitalgoods and motor vehicles;the permanentelimination of the mainnon-tariff import barriers and further elimination and simplificationof remainingtechnical barriers; the extensionof the temporaryadmission systemto cover all exports;the preparationof a plan -o reformcustoms; the de-activationof ICE, the institutioncontrolling imports and awardingexport subsidies; the carefulintroduction of anti- dumpinglegislation; and the considerationof a schemeto provideinternal price stabilityto selectedagricultural products through a variablespecific tariff. The Governmenthas since acted consistentlywith the mission'srecommendations in all these areas. Reformsto be Supportedunder the Loan 107. We proposea quick-disbursing(sectoral adjustment) loan in support of Peru's current trade reformprogram. This reformcan be favorablycompared to any of the majorreforms in Latin America. For instance,Mexico took more than three years(from 1985)to make tarff- and non-taiff-reformadvances comparable to those Peru achievedin less than eight months. Chile was two years in removingits non-tariffbarriers and sixyears in arnivingat a flat 15-percenttariff -29 - 108. Specifically,the loan wouldrecognize the majortrade reformmeasures taken between August, 1990,and September,1991. Thesemeasures, descnbed in paragraphs80-91 i.-d presentedschematically in the PolicyMatrix (Annex 3), can be summarizedas follows:1 (a) I&rjff: the simplificationof the structureand substantialreduction in the level and varianceof protection;the eliminationof most specialregimes allowing discrminatorypreferences on the domesticmarket; the introductionof an anti- dumpingcode; (b) non-tariffimport barriers: the eliminationof formallyprotective barriers, includingprohibitions, minimum-local-content regulations, controls on most second-handimports, and state agriculturalimport monopolies;the reductionor simplificationof some technical/safety/healthcontrols on imports;

(c) exportregime- the eliminationof fiscaland financialexport subsidies; the improvementof schemesto allowexporters to recuperateindirect taxes; reductionin non-tariffexport barriers; (d) trade institutions:the abolitionof the Institutode ComercioExterior; initial reformsof the customsfunction; the passageof a legislativedecree raisingto the status of a law manyof the trade reformspreviously enacted. 109. The conditionsproposed for this loan relate largelyto the maintenanceof the current reforms: giventhe depth of the reformso far, measuresfor further reformare generally considereda secondaryissue, except insofar as further reformis felt necessaryto secure the current reforms. Thus, in the sectoralconditionality detailed below (paragraph 125), the emphasis is on 'conditionspreventing policy reversal", rather than 'conditionsfor further reforms". The Loan 110. A loan is proposedfor $300 millionunder conditionsconsistent with the Bank'snew policyof "AdditionalSupport for WorkoutPrograms in Countrieswith ProtractedArrears 0 (paragraph3 above). Under this policy,the Board'sapproval would entitle Peru to the immediate disbursementof the wholeloan amountafter loan signingand effectiveness.These would take place at the end of the performanceperiod upon satisfactoryimplementation of the trade policy reformprogram, the economicstabilization progam, and the externalfinancing plan (including clearanceof all Bank arrears). The performanceperod, whichstarted with the initialreforms of August8, 1990,would terminate in December,1992, concurrently with the terminationof the IMFs rightsaccumulation program. We do not proposeany particularuse of localcounterpart funds. The borrowerwould be the Governmentof Peru; the implementingagency would be the Ministryof Economyand Fnance.

1I P! ated efonns,not consideredhere, are the floaing of the currency(paragraph 79) nd variousm_aus to increasefactor mobility and reducecosts (pawgaph 92). Thesereforms will be conideredunder the fbaihomingSAL. - 30 - 111. Given that, under the workoutprogram, effectiveness will not occur for at least ten monthsafter Board presentation,the standardgrace periodwill be calculatedfrom the time of loan signature,rather than Board presentation. Procurement.Disbursement. Audit. and Administration 112. The proposedloan wouldbe used in its entiretyto finance100 percent of the c iL costs of eligiblepublic and privatesector imports. Eligibleimports would be all goodsand servicesexcept those normallyexcluded under Bank policy-basedlending, such as alcohol, tobacco,and armaments,as well as luxury,environmentally hazardous, or other goodsspecifically prohibitedin a negativelist, and goodsfinanced by other Bank loansor loans from officialmulti- or bilateralsources. The closingdate of the loan wouldbe June 30, 1993. 113. The proposedloan faces two particularcircumstances affecting procurement and disbursement.First, giventhe Bank's total proposedadjustment lending program for FY92 - an expectedsum of $900 million,all of it requiredto rapidlydisburse in December,1992 - and the expectedlevel of IDB adjustmentlending and bilateralaid for the same years($700 million and $1,300million respectively), the amount of importswhich are to be subjectto Bank disbursement and procurementprocedures will be substantialin relationto overalleligible Peruvian imports (total importsare currentlyalmost $3 billionper annum). - 114. Second,effectiveness will fall well behindthe policyreform process that the loan supports: the economicreform process began on August8, 1990(with the trade-reformprocess being substantivelycompleted by April, 1991), Board presentation is expectedin early 1992, but the loan willnot be signedbefore the end of 1992,that is, 28 monthsafter the beginningof economicreforms. Under these circumstances,retroactive financing of eligibleimports for the whole of the loan amount is recommendedfrom August 8, 1990. 115. A CountryProcurement Assessment Report preparedby the Bank on September9, 1991noted that the laws and decreesgoverning the procurementprocedures followed by both publicand privatesector importers were in broad conformitywith the WorldBank's Procurement Guidelines. In addition,the annualbudget law providesthat goodsand worksfinanced by internationalfinancial institutions will be procuredin accordancewith the requirementsof these institutions. 116. Trade policyreform since August,1990 -- the wholesalereduction of tariff and non- tariff barriers,the eliminationof fiscalprivileges, the removalof controlson foreign-exchange transactions,and the beginningof customsreforms - has immeasurablystrengthened the competitiveenvironment in whichprivate purchasing decisions are made. 117. In viewof the above-mentionedreforms, the followingprocurement procedures wouldapply: (a) Contractsfor the procurementof importsmade by publicand privateimporters valued at or exceeding$5.0 million would be procuredunder simplifiedICB proceduresin accordancewith Bank ProcurementGuidelines. Imports of petroleum productsand commoditiessuch as wheat,corn, sugar, etc., wouldbe purchasedunder competitiveprocedures acceptable to the Bank. In addition,direct contractingwould - 31 -

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

(b) Public sector imports valued at below $5.0 million and above $5,000 would be procured in accordance with local norms which have been assessed as acceptable to the 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 be awarded in accordance with established commercial practices, which are acceptable to the Bant These practices generally consist of inviting more than one quotation, except for importers of small amounts of consumer goods, who generally buy from traditional sources using direct negotiation.

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

119. The Ministry of Economy and Finance would administer the loan and be responsible for submitting the relevant documentation for disbursement. To fulfill this task, the Ministry has established a Coordinating Unit to ensure compliancewith loan conditions, prepare disbursement requests, supervse consultancies,and flfill reporting requirements to the Bank.

120. To assist in the preparation of disbursement requests, the Ministry and the Central Bank have, in conjunction with the CustomsAdministration, created a Special Procurement Unit responsible for the collection of relevant procurement documentation, ensuring that only eligible and correctly procured imports are included in withdrawal applications. This documentation ,wouldbe 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 provided outside this project The Customs Superintendency urgently requires technical assistance for its restructuring, and the IDB is providing a Technical Cooperation component of the trade policy loan it is financing in cooperation with the Bank. In addition, part of a Bank-administered Japanese technical assistance grant to the Peruvian Govenment, which is in the final stages of discussion,will be used to support the trade reform. This grant will be used to: help the Ministry of Economy and Finance undenake various studies to monitor the trade reforms and to fulfil project conditionalities(studies on reforms in the anti-Jumping code, the agriculturalsurcharge scheme, 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 the Coordinating Unit (in handling disbursements,for instance). (See Annex 9 for details of the technical 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 a performance period that separates Board presentation from loan signature, this Letter goes beyond the normal scope of a letter of sector policy and constitutes the understanding which the Government and the Bank will have at the time of Board presentation on the conditions and criteria according to which the agreement for the proposed loan can be later signed and made Eective.W The Letter:

(a) sets out the Government's medium-termmacroeconomic stabilization and adjustment program;

(b) descnrbesthe external financing plan for 1991 and 1992;

(d) describes the evolution, objectives,and guidelinesof trade policy, setting out the precise sectoral (trade-policy) conditions the Government undertakes to fulfill during the performance period and describingwhat further actions are intended in the longer term; and

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

Conditions

123. Conditions of Board presentation. Consistent with the Bank's new policy on Additional Support for Workout Programs, the followingBoard presentation conditions have eon met,

(a) a macroeconomicstabilization proram in place and agreed by the If and the Bank, as described in paragraphs 35 to 37 above; this program would provide the common framework for this loan and the two subsequent adjustment loans proposed for Peru's workout; the Bank woul follow quantitative indicators of major macroeconomicvariables for 1992 (paragraph 47 above): within these broad indicators, the Bank would pay particular attention, in monitoring the program, to measures of fiscal revenue enhancement and expenditure control which will contrbute to efficiency,equity, and the sustainabilityof adjustment in the medium term;

3f/it is envisagedthat the subsequenttwo adjustmentopeions in the debtworkout would have a simil Lter of DevelopmetPolicy, with common contents for the parts(a), (b), and (c) describedbelow, excet whr updatingor changedcicumstces requiredspecific, agreed changes. - 33 -

(b) an external financingplan. agreed among the international financial institutions and the Support Group, which would, as descnrbedin paragraphs 57 to 68 above, provide for full clearance of arrears to the Bank and the normalization of Peru's relations with the IMF and the IDB;

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

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

(a) signing:

(i) prior clearance of arrears to the Bank;

(ii) compliance,during the performance period, with the IMF and Bank-supported program of macroeconomicstabilization (paragraph 123(a) above), with particular reference to the Bank's quantitative indicators;

(iii) the continued viabilityof an external financing plan (paragraph 123(b) above);

(iv) compliance, during the performance period, with the Bank's sectoral conditionalityas under paragraph 123(c);

(b) effectiveness:

(i) taking of all governmental actions required to authorize (or, if necessary, to ratify) signingof the loan agreement; and,

(ii) if a lapse of time occurred between signing and these actions, continued satisfactoryimplementation of the trade reform and macroeconomicstabilization programs and the extetnal financing plan, in accordance with the provisionsof the Letter of Development Policy.

125. Proposed sectoral conditions. The Government has agreed to the followingconditions (for greater details, see the Policy Matrix, Annex 3, and Appendix A to the Letter of Development 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; summarizedin the third column of the - 34 - PolicyMatrix (Annex 3); and detailedin paragraphsl(a), (b), (c), (d), (e), (f), (h), and (i) of AppendixA of the Letter of DevelopmentPolicy, Annex 6.) Reversalof specificpolicies would be definedas follows: (i) the reintroductionof foreigr-exchangecontrols on imports;

(ii) a rise in the leveland variance of tariff Drmtection(whether resulting from changes in specific rates or from tariff surcharges);-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 of import taxes, imported goods on the domestic market;

(vOi) eintroduction of banned non-tariff barriers, includingthe use of reference prices for protective purposes;

(vii) raisingof export-duty rates or extension to new products or reintroduction of fiscal or financial subsidiesto exports;

(viii) survivalof any of the functions related to import or export controls that the now-extinctICE fulfilled.

B. Conditions for further reforms. (These conditions are summarized in the fourth column of the Policy Matrix, Annex 3, and detailed in Appendix A of the Letter of DevelopmentPolicy, Annex 6.)W (ix) agreementto replace,by March,1992, the 5-percentrate on steel innutsby a 15-percnt rate, unlessthe Goverment and the Bank agree that a new common external tariff is likely to be implemented in accordance with the recent decision-in-principleof the Andean Group;

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

I If Peru implementsa commonextenul tariff which is in accordanewith the tariffcriteria establishd in the recentdenisin-in-priciple of the AndeanGroup of countres,this condition would no longerapply.

,I/ Tle March,June, and September,1991, dates for compledingvarious actions, notioned in the rst of this paragraph,ae meantto be targetdates, rather than precise dates. -35 - and enactment,by September,1992, of the reformsin line with the agreedguidelines; (xi) carryout, under terms of referencewhich have been agreedwith the Bank,a studyto developconsistent criteria, and propose correspondingregulations, which minimize the protectivefeatures (Le.those that discriminatein favorof domesticproducers) of existing(and any new) health. ohvtsanita. and technical regulations;agreement, by March, 1992,on the guidelinesand principlesto be appliedin implementingthe study'sfinmdgs; and enactment,by June, 1992,of the reformsin line withthe agreed guidelines; (xdi) carryout, under terms of referencewhich have been agreedwith the Bank,a studyto proposeamendments to the Anfiumpgg cod so that it does not becomean instrumentfor protection againstlegitimate import competition and it operates in an transparentmanner; agreement to enact, by March,1992, amendmentsto the code in line withthe studys recommendations. (xiii) implementthe agreed ActionPlan to restructurethe Customs Su2rtendency (see summaryin Annex 5); compliancewith the requiredactions under the three phasesof this Plan,by Board presentation(first phase),b5 March,1992 (second phase), and by June, 1992(third phase). 126. In the Letter of DevelopmentPolicy (Annex 6), the Governmentcommits itself to the specificsectoral measures outlined in paragraph 125above. It also emphasizesits commitmentto maintainingcurrent exchange-rateand trade policiesas the basisfor free trade and full privatesector participationin all economicactivities. The Governmentintends to pass legislation ensurng that non-tarifftechnical and health barriers to importsare non-d rminatory. It wil guaranteethat protectionagainst unfair competition from imports is not excessive.It willachieve a uniform15-percent import tariff by January,1995, (unless a commonexternal tariff has been implementedin accordancewMth the recent decision-in-pnncipleof the AndeanGroup) and eliminateexport taxes and discriminatoryeffects of indirecttaxation when the fiscalsituation permits.

Monitorinj and Repor 127. Ihe Bankand the Governmenthave ageed on the informationwhich the latter will provideduring and after the performanceperiod on developmentsin macroeconomicpolicy and perormance, the external financingplan, trade poliy and performance,and the implementation of the restructuring of Customs. The information is listedin Appendix B to the Letter of DevelopmentPolicy, Annex 6. 12& Consitnt with the Bank's new policyfor WorkoutPrograms, the managementwill submiteach quarter to the Board a report on Peru's complince with the requirementsof this and the other adjustmentloans in the workout. The report wouldassess the likelihoodof a successl -36-

workout by December, 1992, and recommend as necessary any modifications to the conditionality or administration of the loan. Specifically,the report would cover the followingtopics.

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

(b) Progress in fulfillingthe conditions of the external financing plan i-cluding Peru's servicing of current payments due to the Bank; and any related developments (for example, negotiations with commercialbanks).

(c) Progress in fulfillingthe sectoral conditions of the workout loans, in the context of overall sectoral performance and policy and other developments affecting fulfillmentc! sectoral conditions and sectoral performance;

Coogeraion with the 1DB

129. On September 18, IDB's Board approved a fast-isbursing $425 million Trade Sector Loan, $325 million to be disbursed on effectiveness,with $50 million for each of a second and third tranche. The loan covers five areas: (i) trade policy, (ii) customs reform; (iii) labor-market reform; (iv) private-sector development in agricultural marketing; and (v) the social compensation fund. IlB and the Bank have developed their analysis and sectoral conditionalityon trade and customs reform in close cooperation, in partcular through concurrent pre-appraisal missionsin June, 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 reimbursable Technical Cooperation component, of which $2.3 million is for funding the technical assistance for Customs restructuring.

Project Benefits

131. The likely direct benefits of the trade reform supported by this loan - the expected gains 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 reintegration into the international financial community. In addition to providingsome fresh external funds to Peru between now and the end of 1992, the workout will open the door to resumption of a normal relationship with the Bank, involvingthe financial and know-howtransfers of investment lending, economic and sector work, and technical assistance. Ihe workout wil allow Peru to normalize 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 at least - is a majority in the business sector. But the ability of the trade reform to survive and the

1I6/Me odtertue ar will be coveredby the B=akin the SAL,and the Bankcontius to workclosely wi the IDBin theseanras. - 37 - opportunity for further reforms will depend on several factors. First, the survivalof the reform is inseparable from the prospects for economic stabilization. Second, the real exchange rate remains at a substantially appreciated level, and the Government has been under great pressure, especially from exporters, to reverse its policy and intervene heavily in the foreign exchange market. But governments are relatively powerless to exert a direct effect, short of running a budget surplus. A third source of pressure to reverse reforms can be expected to come both from businessmenwith vested interests in a strategy of protected import substitution and from those within the government 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 the new Government, continue to inhibit a flexible response from producers. Fifth, the political uncertainty generated by a still-weakgovernment capacity and the unstable security situation will continue to add risks to any reform movement in Peru. Sixth, there is an external risk: the internal reform process depends substantiaDlyon the coordinated support of the international financial community;this risk has diminished recently as a result of the progress made in implementingthe external financingplan. 'Te final risk is that social unrest could delay or arrest the 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 as part 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 fiscal circumstances,the Government has few choices.

The Social Impact

134. The policy mistakes that led up to the stabilization and economic reforms of 1990 also created enormous social problems, and the new Government, facing a fiscal problem of enormous proportions, has had limited means to address these problems. It is not clear that trade-policy retorm, in itself, contributes to these problems, but in this case any effects of trade reform are washed 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 the stabilization/adjustmentprogram on the livingstandards of some of the poorest groups, the structural adjustment loan (the Bank's second planned adjustment operation) calls for concerted action to define and implement well-focusedsocial measures designed to meet the most urgent needs of the poorest social groups. These measures would include: (a) adoption of an explicit poverty alleviation strategy; (b) elaboration of operational plans in basic health and education with priority project profiles; (c) elaboration of a national nutrition policy based on a review of existing food assistance pr.ograms;and (d) the initial implementationof this policy.

136. The Bank plans to assist the Government in implementing the above measures through: a Japanese technical assistance grant, which wil be used to support the organization of FONCODES and help develop priority social project profiles; preparation of a poverty report by June, 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 poverty alleviation strategy and mobilize aeternal financing for priority programs and projects. The IDB and UNDP will also provide technical assistance to set up the adminstrative structure and -38- operationalprocedures of FONCODES. Actionin this area is a high priorityand is supportedby a component(consistent with our views)under the IDB's Trade ReformLoan.

VII Recommendation 137. I am satisfiedthat the proposedloan wouldcomply with the Articlesof Agreementof the Bank and recommendthat the ExecutiveDirectors approve the proposedloan.

LewisT. Preston President

Attachments Washington,D.C.

January 10,1992 TABLE1.1 VWU: Batanceof PaymentsProjectiens t CurrentAccount Excluding ---- Interest Pa_mnts, 1990-1999. (S mlitt ilm) ...... _,,...... _. -.-...... Projected ~~~~~~~~~...... ------_-_._------,-_. 1990 1991 1992 1993 1994 1995 196 199? 1998 1999 ......

NsrchandlseTrade Accnt 448 (25) 44 129 267 458 669 892 1.149 1,438 Exports of Goods 3,333 3,240 3,758 4,091 4.578 5,252 6,015 6,863 7,83 8.975 ts dwtiami 745 725 840 91S 1.024 1.174 1.345 1,53S 1.754 24,07 01tzer'tradJt1on t,"6U 1.602 1,858 2,023 2,264 2,597 2,974 3,394 3,8?8 4,438 llenTraditional 940 914 1,060 1,154 1,291 1,481 1,696 1,935 2,211 2,531 1s4ortsof 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 2,496 laportsof 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 74 105 127 142 160 176 194 204 211 218 Private B Short-TermInterests aJ (146) (124) (120) (119) (116) (121) (118) (124) (130) (138) 0 Other 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-InterestCurrenttAccmt a_ (35) (536) (492) (4S) (366) (236) (88) 63 n 137

...... V ...... eJ Doesrot lncludc' Interest on ptMilc debt. PIs Teble 1.2 - PERUs Batance of PaymentsProjections : financing Requaremuntsand Possible 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. Pub41tSector Debt Service Obligatfons : 2,619 2,616 2,398 2,494 2,635 2,72? 2,890 3,192 3,406 3,642 buAtilaterat 650 513 530 625 688 708 749 889 933 987 Bilateral 1,015 1,208 1,170 1.128 1,170 1,193 1,252 1,341 1,434 1,533 Private 954 895 698 741 m 826 89 962 1,039 1,122 3. Arrears to be Settled in Current Year 0 12,055 1,800 0 0 0 0 0 0 0 Multilateral 0 379 1,800 0 0 0 0 0 0 0 Bilateral 0 5,322 0 0 0 0 0 0 0 0 Private 0 6,354 0 0 0 0 0 0 0 0 4. ChangeIn 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 wndDeferal 0 13.598 1,467 743 798 736 785 854 1,041 1,296 Bilateral 0 6,352 769 2 21 (90) (102) (108) 2 174 Private 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 1,675 Multitaterat 0 654 2,328 502 624 505 449 665 692 719 FUAR 0 170 200 0 0 0 0 0 0 0 TORDID, 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 FinancingRequired (0) A() 0 514 237 276 220 95 595 365 'II 14. Totat Soureesof 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. Prel. ProJected ...... _i**...... 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 3,053 Private Consuipion 2.151 2.271 2,264 2,295 2,33S 2,390 2,435 2,496 2.576 2,670 Pubtle Consitale 278 266 283 288 310 317 344 354 367 383

Total Inwestent 627 6S0 658 667 661 657 675 698 725 760 ol roes flied tIv. 594 618 652 664 6S8 654 672 694 722 56 Private Inwestmmnt 527 543 557 520 45S 404 414 429 446 469 Puitc 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 1,676 Iiports 603 599 675 71 76 822 3 950 1t,026 1,113 ...... _......

.~~~~~~~~~~~~~~_ Tabe 1.4 - PERU: Projections of KeyfEcmc 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 4.5 MP per copito -7.4 0.3 0.1 0.6 0.6 0.7 1.2 1.3 1.8 2.3 aT -5.0 -1.9 1.9 2.0 2.8 3.0 3.9 3.9 4.1 4.8 on per cata- -7.5 -4.4 -0.5 -0.4 0.4 0.7 1.6 1.7 1.9 2.6 Cors"tian -4.1 4.4 0.4 1.4 2.4 2.4 2.6 2.6 2.7 2.9 Curumptien 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 14.4 Exports ePS(Ctanstt ust) -5.0 -S.4 18.5 11.2 9.8 9.6 B.5 8.1 8.3 8.5 Exports of Goods (ConstantUst) -9.2 -2.3 19.4 11.8 9.8 9.4 8.0 7.6 7.8 8.0 Exots 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 12.6 iqport GlfS (Comstant SO) 12.4 -0.7 12.7 6.4 6.8 7.2 7.4 7.6 8.0 8.S ltowts of goods (USS) 32.2 13.2 13.7 6.7 8.8 11.2 1. 11.7 12.1 12.6 1apwrtof goods (ConstentUSS) 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 317.8 58.2 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 32.3 Debt 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 22.7 Interest /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.7 18RO1Contry Pubtle Debt Serice aj 8.1 20.2 60.6 10.9 10.7 10.2 9.0 10.8 11.2 12.1 EMDDebt 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 (1991and 1992) and reesscwhatfngof arrear owedto bitaterats. comerclal bu*s, andsupptiers. (contiwmed) table 1.4 (Ccnthuaxd)- PMR : ProJectians of KeyEcnMic Idlectorw, 1990-1999...... ''''.'''''''''.'''''...... Prel. ------Projected...... I. _ 1990 1991 1992 1993 1994 1995 1996 1997 -----...... *-.-...... 1998 1999 SharesIn Current DP (percent) : ...... CeuEuapimfn 76.8 81.0 8019 80.8 81.0 31.2 80.8 80.4 9.7 78.7 Private 70.8 n.5 71.9 PuM 71.8 71.5 71.7 70.6 70.4 69.7 68.? I 6.0 8.5 9.0 9.0 9.5 9.5 10.0 10.0 10.0 10.0 D_mmtic SavigU 23.2 19.0 19.1 19.2 19.0 18.8 19.2 19.6 20.3 21.3 Total tIweteet 22.9 20.7 20.9 20.9 20.3 19.7 19.7 19.8 20.2 20.9 Grew. Cepitotromtln ' 18.7 19.7 20.7 20.7 20.2 19.6 19.6 19.7 20.1 20.8 as/ Private 16.2 16.2 16.7 16.7 16.2 15.6 15.6 15.7 16.0 16.5 PubtIc 2.4 3.5 4.0 4.0 4.0 4.0 4.0 4.0 4.1 4.3 Uhnqe in Stocks 4.2 1.0 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Bateos Resource 0.3 -1.8 -1.8 -1.6 -1.3 O.i -0.5 -0.2 0.1 0.4 lt4crtoGPs 10.9 10.3 12.1 12.5 itperts 13.0 13.9 14.8 15.8 16.7 17.6 GMS 10.6 12.1 13.9 14.1 14.3 14.8 15.4 16.0 16.6 17.2 gatisisi Saings 19.0 15.6 15.6 15.5 15.3 15.1 15.5 1S.9 16.4 17.3 tAccount Curren -3.9 -5.2 -5.3 -S.3 -5.0 -4.6 -4.2 -3.9 -3.8 -.. 6 Tero of Trade (1906a 100) 165.7 96.0 92.4 89.7 89.7 90.8 92.7 94.7 96.7 98.7 X_PRICE 132.4 131.8 128.0 124.6 NJPRICE 127.0 133.2 141.3 149.8 1S8.7 166.1 125.3 137.3 138.5 138.9 141.6 146.8 1S2.4 156.2 164.2 170.4 It=o -4.0 6.9 7.7 6.3 6.0 5.8 S.0 5.0 4.4 4.1 LIB0 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

Notesto Tables 1.1to 1.4

Ihe ptojectionsin this Annexillustrate a feasiblepath for the economyunder the stabilization and stuctural reformsinitiated by the FujimoriGovernment. These notes spell out someassumptions behindthe projectionsand somedefinitions of itemsprojected. L Assumptionsfor Balance-ofPavmentsItems (ExcludingDebt Servicingand the Capital Accountaand NationalAccounts The key country assumptionsbehind the forecasts in Tables 1.1, 1.3, and 1.4 are as follows: 1. After three consecutiveyears of decline,Gross Domestic Product (GDP) is expected to growby 2.8 percent during 1991,the rate increasingsteadily to reach 4.5 percent in 1999(an averageof 3.3 percent for the period). 2. Populationis assumedto grow at 2.5 percent a year up to 1991,declining to 2.2 percentby 1997. 3. Exportsof goodsand non-factorservices are expected,because of the trade reforms, to be a majorcontributor to GDP growth. After an initialdecline of 5.4 percentin 1991,reflecting the appreciationof the real exchangerate, exportgrowth will recover to about 18 percent and 11 percentduring 1992and 1993,respectively. For the rest of the period, exportsare assumedto grow at an averageof 9 percent per year, increasingtheir share in GDP from 11 percent in 1990to about 18 percent in 1999 (a levelconsistent with shares attained in the 1950s,1960s, and early 1980s,wK - the economywas more open - see Figure 2.1 of Annex2). 4. Similarly,imports of goodsand non-factorservices, after an initialincrement of about 13 percentin 1992,are assumedto growat an averageof about 7.5 percentbetween 1993and 1999,to reach a levelof 17 percentof GDP in 1999(up from 11 percent in 1990). The net movementof importsand exports would reduce the urent- accountdeficit from 52 percent of GDP in 1991to 3.6 percent in 1999. 5. The ratio of investmentto GDP is expectedto increasefrom 19 percentin 1991to 21 percent in 1999,with an averageratio of 20 percent during this period, a level comparableto other middle-incomeeconomies. During the same period,public gross capitalformation 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 in consumptionof only 2.4 percent a year, consistentwith an average level of total consumptionof 81 percent of GDP. In 1999,public consumption would recoverto 10 percent of GDP, similarto levelsin other middle-incomeeconomies. However, growth in total consumptionis expectedto be enough to allow an incree in per capita consumptionfrom 1995onwards. - 45 -

Page 7 of 11 7. For the periodas a whole,these trends would result in an increasein domesticsavinp from 19 to 21 percentof GDP. Similarly,national savings, because of the increasing levelof investmentand the improvingcurrent-account balance, would increase from 15 to 17 percentof GDP. IL Deription of Line Items in Table 1.2: Balanceof Payments(Financing Requirements and PossibleSources of Financing) 1. Non-InterestCurrent AccountDeficit: fom Table 1.1. 2. Debt ServiceObligations; estimated publicly guaranteed debt serviceobligations to the IBRD, IlDB,IMF, and bilateraland privateaeditors. 3. Total Arrears: arrearsoutstanding to the IBRD,1DB, IM, and bilateraland private creditors. 4. Increasein GrossReseres: estimatedtargets for increasein CentralBank reserves. 6.i Loan Disbursementsin Pipeline: estimateddisbursements already in the pipelie from the 1DB,bilateral creditors, and unguaranteedprivate creditors. 7. Private CaidtalFlows: direct foreigninvestment and funds repatriatedfrom abroad (includeserrors and omissions). 9. Debt Reschgeulingand Deferral: in 1991 and 1992 all official bilateraldebt is assumedto be rescheduledon the terms securedin the September1991 Paris Club negotiations(see below). In 1993and beyond,pre-cutoff debt servicedue to the Paris aub of creditorsis assumedto be rescheduled.Other officialbilateral debt is assumedto be serviced. Private debt serviceis assumedto be rescheduledevery year for 1991-99. The termsof the September1991 Paris Club agreemen. mreas follows.

Rescheduled:1

Current maturitiesdue duringthe consolidationperiod 2 and arrearson short,medium and long-termdebt on pre-cutoffdebt,' includingpreviously rescheduled debt. ODA loans rescheduledat 20 years including10 years grace, with concessionalinterest rate.

'Rescedue on termsreserved for heavily iu edlower middle income countries.

2Me consodation period is from October 1, 1991 to Decembe 31, 1992. 3 Pe-coff debt is debt conacted beforeJanuary 1, 1983,te timeof the firstParis Clubresceduing. - 46 - AI Page 8 of 11 * Commercialcredits rescheduled at 15 years including8 year grace, with marketinterest rate. Defer: 1) Moratoriuminterest due duringthe consolidationperiod on rescheduleddebt: * 30 percent to be repaid in four equal semi-annualinstallments beginningNovember 15, 1992and endingMay 15, 1994. * 70 percent to be repaid in six equal semi-annual instaments beginningMay 15, 1995and endingNovember 15, 1997. 2) Arrearson post-cutoffdebt:

* 100 percent to be repaid in 12 equal semi-annualinstalents beining June 30, 1993and eng December31, 1998 (defement contingenton performanceunder the IMFs RAP).

Currentmaturities due durng the consolidationperiod on post cutoffdebt. o SDR15million will be depositedinto a specialaccount monthly 4ritng 1992. In addition,it is assumedthat pre-cutoffdebt servce owedto Paris Clubcreditors wil continuallybe rescheduledthrough 1999. 10. AdditionalDisbusMents: estimatednew disbursements from the IBRD,IDB, IME, and bilateralcreditors.

11. AdditionalFmancing Required: this residualfigure is the financinggap. - 47 - AtNNEXt Page 9 of 11

Table 1.S: PERU: EXTERNALOUJTANDNG DEBMat (STOCKSIN US$MILLIONS AS OF DECEMBER1990)

Stocks (of which Ar

I.MEDUM- ANDLONG-TERM DEBT 20,341 13,414 1.1 PublicSector 19,965 13,414 a. MultilateralCreditors 3,972 2,156 - 'WorldBank 1.560 924 IMP 1,004 875 - 1DB 1,077 357 Other 331 b. Paris ClubCreditors 6,839 4,835 c. OtherBilateral Creditors 2,272 136 d. CommercialBanks and UnguaranteedSuppliers 6,882 6,287 1.2 PrivateSector 376 n.a.

11. SHORT-T= DMT 1,366 58 m. TOTALPM 21707 13472 bi

a/ Includescufrent prncipal and arrears. bJ Excludes ears of MLTpivate sectr debt.

Sgg=: CentralBank, IMF, and Ministryof Economyand 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 S d ige eve ast month 63.2 397.0 13.6 28.2 307.9 330.0 346J 362.4 sthlychange 9.6 S.9 23.7 17.8 9.4 r.r s.6 7.6 9.3 9.1 7.2 S.6 at RIrate () 35.5919 372 200 99 1,184 614 194 14 97 4.0 t dhe er last 12mnths 3.040 12,375 It,1lb 9,045 141 191 154 130 92 60 8,271 7,639 6.924 5,78 4,663 3,585 2,686 2.189 1.430 230 206 19t Real%e irne (I $e "R0I0) 111.2 41.9 54.6 74.1 84.4 79.9 80.3 66.0 83.3 82.0 84.5 85.e n.e Me fl.* n.e Etchne RoteIfrfet t SIIUSS 0.12 0.3? O.4 O.4 0.43 Ro Devltiontnlel bj.0m O.S2 0.54 0.56 o.57 0.7o 0.83 0.64 0.60 0.79 0.83 0.96 204.82 19.1S .1.32 .0.92 20.6 3.12 3.72 1.6S 22.62 18." 1.82 Real Excdg RateI c_/ 6.8 42.6 4S.0 40.9 -4.6S 1.92 5.71 15.1t 38.7 38.1 33.4 32.1 29.4 33.7 37.0 33.9 29.8 27.s 27.$ 31.4 ProdiutionIndieators (1979%100) GP idex 94.?7 82.9 76.7 o5.5 9.7 98.1 97.1 95.S 92.4 101.1 InAtrile Sector Index 67.1 74.4 S9.1 99.4 9.4 97.2 94.2 n." n.a 74.7 91.5 88.9 94.4 91.9 89.3 97.2 97.2 93.1 94.6 90.6 n.e nMe Rentimlylnteest ote. for Deposits Soles 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 Real Rttes .16.9 *72. -2.3 -2.1 -0.4 .14.3 -9.6 5.7sr . Dollr Accouts s *0.9 1.6 2.1 -0.4 -I.? 0.3 2.0 0.1 n. wmint 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 lost Bate. -4.4 -38.3 5.3 -9.3 -5.8 1.0 1.0 0.7 0.? 0 -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.o Merdawds Efxpwor 216 31s 310 271 0* : troditleal 88 296 251 281 m 290 266 312 300 300 n.e n.e 196 234 235 184 203 210 178 208 n.e n.e Non-traditIonal n 76 74 n.e n.o n.e n.o n.e *. a 87 85 e5 73 73 n.o n.e n.e e n.e n. n.o n.o qteratln of Control vermamut6 (In Millions tW0 On Acenul sis 2 Ummet lo 141 22S 242 W 296 374 287 uponditws fj 254 290 309 254 23? 322 317 36r n.e 302 239 290 368 382 357 292 302 332 260 259 beficIt 147 161 14 49 29 332 324 n.o n.o 85 -17 5 12 s57 6 23 I1 r n.o n.o 0hCash ais: Remu l 1105140 217 237 Ei pudtwefJ 326 28 34S 252 269 3S9 242 234 302 296 n.o n.e too 1 191 205 263 330 289 223 275 287 202 Oeficlt 75 59 .26 -29 91 292 261 n.e n.e ...... -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 . b_ Percata1evrlItlon 0e previos nt. (Cntimild) /t O a O ar 1975Ma 100. d- Aver, for alt 4 lt *cenatl In l Slettars. Stertfng In April 1991, It'. rate for saings dpsits. *_/ Stto sr 19Iy the atbe is the Casta S2rlntedimny (SUM). j Incls marrant i sepital e1pndttures. sone: ContrAlSak ad lbtd _* estlmmotmo...... OR~~~~~~~~I tAble 1.6 (continued)- PMU t lonthly EconomicIndicators. My 1990 - cttobe 9 1990...... 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.e Nomlnal Crowthlate In illS -10.91 -61.2S 57.1S 34.32 7.1X -13.51 -3.21 3.1% 11.41 Nomint GrowthRate In Sales -1S.46 -14.42 8.02 12.7X 6.5S -0.22 n.e 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.a DomesticCredit in eitlos USS 2,226 627 SS4 937 726 680 in Niltien Soles 742 810 81S 662 562 526 601 606 629 n.e 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 Noinal GrowthRate in soles 0.7S -18.82 -15.1t 6.42 14.22 0.92 3.82 n.' 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.e Finacisat Systm

lot NilliariUlS$ 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 2.236ne Ninml GrowthRate In 115 -4.32 409eT.0% I -3.52 1.42. 2.92 3.22 4.0oS.61 -4.11 8.42 inatGrowth Rate In slels 50.8s 14.62 1.22zX9. n.81 184.32 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.a laminat GrowthRate In UIS 7.42 -71.12 40.62 38.72 10.42 14.42 -11.2X -4.01 19.6S -6.9s ominalGrowt Ratein Soles 69.12 *10.81 6.91 10.82 -2.5S 6.02 n.5 106.80 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.a Deposits US' in in 31i111mwUS 1391 1; t,7t 1.908 2,025 2I091tn. 674 663 697 83 934 1 032 1 160 1,219 1.273 *.9 NowminaGrout,Rst4i in U$2.42 -1.4 I29.02 9.02 6.12 3.32 n 5.32 20.12 11.52C 10.42 12.4t 5.12 4.52 9.22 15.s3 90 .1 .X 33 . Breed NoneySqipy 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.e Nminat rwtb late In U*6S -4.12 42.52S 6.426 6.4S i1.8 0.32 1.52 4.42 12.2S 2.5X Nminal Groth Rate In Soles 1.42 9.82 i.1X 6.92 3.62 n.e 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.e RatioI DeposltsIn 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 (bants mid other nen-lbt Nwith IcIc agents, In Soles d USDollat rs. Surce t Central Satk ad owid Bark etimates ...... ~~~~~~~~~~~~~~~~~~~~~~~~~~ I, -51 - Page1 of 10 Figure 2.1

Peru: Ratiosof Tradeto GDP, 1950- 1990

30.

25- 0I o 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 - AE Page2 of 10 Figure 2.2

Peru: Effective Protectionfrom Tariffs on Manufactures, 1990 - 1991

Printing ui ______* Clothing oo . ._._-

n Sted0i5-bcc. ~~ =; ~______..______..____ ~~------

M&Produts ^ __

0 20 40 so 80 100 120 140 EffectiveProtection Rate

I March1991 December1990 F--J July,ISS99

Source: Rossini(1991) -53 - Page3 of 10 Figure 2.3 Peru: Real ExchangeRate 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 exchangerate index(RER) is definedas follows: (nex ofRdevant teatonal Inflan forPeN) (Inde of NominalExhangpRale) RER = Indexof CPIfor Peru The base for the indexis December1978. The exchangerate used throughJuly 1990is trade-weighted;from August 1990 onwards it is the free marketexchange rate. A rise in the indeximplies a depreciation. -54 - Page 4 of 10 Figure 2.4

Peru: Exportsand Imports, 1989- 1991

400

350-

300

2S- 020 aa5

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

.t- Exports m Imports

Source: APOYO and Alerta Econ6mica - 55- PsgoS of 10 Figure 2.5

Peru: Black MarketExchange Rate Premium, 1985- 1-991 800'1

700n

600 p500

400

0- 300

200-

*1*00

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

Source: BCRP -56- A 2 Page6 of 10 Figure 2.6

Peru: Production-WeightedDistribution of Tariffs, 1990 and 1991

~70 :60°/

O50Q 40

~20-

10) January1990 o 7March 1991 5% 15% 25% 50% TariffRates

Source: RossiDi(1991) -57 - ARM Page7 of 10 Figgure2.7

Peru: ExportSubsidies, 1980- 1990

20-

s/on-traditionol rtc:l exports 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Source:BCRP - 58- Pago8 of 10 Figure 2.8

Peru: ExportTaxes Collected, 1980 -1990

1204

| 16-' l

12-

0 1,l A ttotal exports 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Source: BCRP _59 _ AN=2 Page 9 of 10 Fiure 2.9

Peru: Import TaxesCollected, 1989- 1991

30-

25-

020-

O 0

1§89 t 9 1 §9 1 Yeor and Month

l 1 taxes/imports _ taxes/revenue|

Source: BCRP

Note: The ratio of import taxes to imports is calculatedusing the parallel exchnge rate (PER). Given the high PER premiumin the monthsthrough July 1990(see Figure2.5), the use of the PER results in a larger ratio of import taxes to importsthan would the use of t}e officialexchange rate. - 60 - PageAXNEa 10 of 10

APOYOS.A., Situacib E onWmia1 em one mayo1991. BancoCentral de Reservadel Perd (B3CRP),NotaSema. varous Issues. Ministericde Economfay Finanzs, Eco No.8, enero 1991. Rossini,Renzo G., -Las MedidasReclentes de Aperara Comercial-,LaMon2a, No.33, mazo 1991. -61 -ARM 3 Page 1 of 4

....

1-IMPORsTTARIFFS 1.1 STRUCTURE Range of 0484%; 38 By March,1991, 3-rate Eliminate5% rteo (steel- rates; u n weighted structureof 5, 15, 25%;. industry Inputs) by average of 45%; averageof 17%; coeff. March 1992: unWss coefficientof variation of variationof 23% lmpismentationduring of 55% 1992 of an Andear.- Group commonextenad tariff appearslikely by that time

1.2 PREFERENCESON 139regimes, accounting Elimination of most THE DOMESTIC for half of Imports regimesby September, MARKET 1990 (majorexceptions are educational & oultural Institutions; treatyagreements 1.3 SPECIFICTARIFFS Nospecifio tariffs: some Re m o v a l of all Publicize, by Board AND TARIFF surcharges surchargesby March presentation, the SURCHARGES 1991;vsriablesurchargs existing method of on 5 agricultural setting the variable products,introduced in surcharge. May 1991 Reform of surcharge scheme: agree study TOR by March 1992, agree Implementation guidelInes by June 1992. enactreform by September1992

1.4 SAFEGUARD Cus toms use of Introduotionof an anti Reformof anti-dumping MECHANISM reference p r ices dumping/subsidycode In code: agreestudy TOR pertmittedto prevent June 1991 by Board Presentaton damageto the national enast refom by Marsh economyOIn abeyance) 1992 - 62 -ANNEI Page 2 of 4

W~~~~~~~~~~'

2 .

2. NON-TARIFF IMPORTMRIAiS

2.1 FORMAL 10% of tariff lines All prohibitions/ PROTECTiVE (affecting 40% of restrictions suspended BARRIERS mnanuf a ctu ri ng) by September 1990, (NEGATIVEUSTS) prohibitedor restticted permanently lberaeiked by March 1991

2.2 HEALTH, Technical standards & Various reforms from Reform of health and TECHNICAL. agrieolturel,health, and March to May 1991, p h V t o 8 a n I t a r y SECURITY,AND misc. controls removingor simplifying regulations & tochnicd MISCELLANEOUS controls; reintroduction standards: agreestudy REGULATIONS of controls In a few TOR by Board cases presentation, agree Implementatlon guidelines by Moah 1992, enact reforn by June 1992

2.3 IMPORT In existence for oil All public-enterprise MONOPOUES (Petroperul; wheat, monopoliesremoved in flour, sugar (ENCI);rice principlein March1991; (ECASA) ENCI & ECASA monopoliesremoved in March*1991; Petroperu monopoly removed in August 1991

2.4 LOCAL-CONTENT Appliedto motor-vehicle All lo cal-content REGULATIONS production regulationseliminated In March 1991

2.6 CONTROLSON Ptohibitionof all second- Importsof most second- SECOND-HAND handgoods hand goods allowed In IMPORTS November,1990 and of machinery and vehicles In March 1991; only controls on clothing, shoes,and bath fixtures remain -63- - Page 3 of 4

i.EX-PORTREQ N

3.1 TAXES ON Taxes ranging from 3% After 10% surcharge TRADmONAL to8% from August to EXPORTS November 1990, taxes rangefrom 0% to 10% by February1991

3.2 SUBSIDIES FOR CERTEX: fob xport Reduction (Aug ). NON-TRADmONAL subsidy of 15.30%; then abolition EXPORTS FENT (suspended): (November 1990) of interest-ratesubsidies CERTEX: abolition of fENT In November1990

8.3 INDIRECTTAX Temporary Admission A u t o m a t i o n o f TREATMENT schemein operation,but Temp.Adm.scheme and restrictedscope and low its broadening to all automatity expofters In March 1991; introduction of drawback scheme for non-trod. exports In March 1991

3.4 EXPORT Duty-free capital-good No now contracts are CONTRACTS imlgrts against non- being issued and traditional export scheo is defunct contraots

3.5 FREETRADE ZONE Two FTZs exist, but only sellingdomestically and not developedfor expen industtis

3.8 NON-TARIFF Controls to preserve Removal of controls In EXPORT domestic-marketsupply March 1991 CONTROLS

3.7 EXPORT Required for fish, CERTiFICATION mineral, agricultural exports -64- A M Page 4 of 4

S ......

4.,

4.1 NON-TARIFF ICE adrniinisters major ICEd-e setvated In June BARRIERS iTBS,as well asexport 1P9O9L1, a d PnI t.s subsidies promotionsifunedonsgo to MiCTi 4.2 TARIFF Creation of Control Proosdums to ensure ADMINISTRATION Cornmission for anti- open, irnartiai anti- ,MEF) dumpingrules dumping hestnga to be tagreed by loan negodaton

4,3 CUSTONS Transfer of some AgraemnAntby Board 4ERVICE funAtions to private prasentdEonon Aoteon agents; monopoly an Plan; oornpliano w1th oustoms warehouses three phgo o Aoton retnoved Plan, by ea0rd presontation (1). by M4rch1992 Cet2), b bo June 1992 (3) 4.4 EXPORT Functiontransoerred in PROMOTiON June 199nfrom ICEto

4.5 TRADE Creationin Jun1 199by NEGOTIATiON of an inter rninistsrial comn-M1ted,wyth an Office of TradJ ReprMseCtadvein MICTi 4.5 TRADELAW Augustt1991pssugef a Legislative Decree elevating to the status of a law many of the trade raforms passed sinceAugust 1990 - 65 - ANNEX4 Page 1 of 10 NON-TABREWARER

1. All countriesapply health, safety, and technicalregulations to many locally consumed products, and sometimesto exports. These norms are usuallyjustified by a government'sobligat to protect the populationfrom risks to health and safety. But when these norms are also used to favor domesticproducers at the expense of imports, they becomediscriminatory non-tariff barriers (NTBs). This type of barrier has tended to become more frequentlyused - in developedand developing countries alike - when more conventionalbarriers (tariff and non-tariff)have fallen. It is often difficult to identifythese instrumentsof the "new protecdonism"- they may exist as much in bureaucraticprocedures as in formal legal instruments- and it is even more difficultto measure their impact.

Non-TariffBarriers in Peru

2. In Peru during the 1980s "conventional"non-tariff barriers predominated:import prohibitions and licenses constitutedthe majorityof such barriers and were supplementedby foreign-exchange conols, minimum-local-contentregulations, import monopolies, and other controls. In 1987 and 1988, formal import controls were at their height, with all importssubject to restrictionor prohibition (See Table 4. 1). But even by the end of 1989, when controlshad been eased, prohibitionson a mere five percent of all tariff lines protected an estimated40 percentof manufacturingoutput.

Table4.1: PERU:NON-TARIFFBARRIERS.1981 -_1990 (BYNUMBER OF TARF CATEGORIES

Dec Dec July Dec Dcc Dec Dec April Aug Sept 1981 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 S2 Rtriated 112 118 350 1,553 4,715 4,724 535 6 0 0 Prohibited 7 a 8 525 539 539 539 539 13 0 TemporarilyPohibited 0 0 188 0 0 0 0 0 0 0 TolalTariff Categories 5,207 5,262 5,303 5,254 5,254 5,2 5W 5,269 5,269 5

Sgur: Abusada(1991) 3. Since assumingpower in July, 1990, the new Governmenthas made considerableprogress in removingprotective non-tariffbarriers. In August, 1990, SupremeDecree (DS) 228-90-EFreduced importprohibitions to 13 tariff positionsand suspendedseveral technicalnorms which had a discriminatoryeffect. In September,DS 257-90-EFeliminated the last fonnul "negativelists" (restrictionsand most prohibitions)on imports. In March, 1991, DS 060-91-EF eliminatedall administrativerestrictions on merchandisetrade, includingminimum-domestic-content regulations and domestic-market-supply-relatedexport restrictions, exceptfor a prohibitedlist of exports, restric derived from foreign-exchangerules, health controls, defenseof cultural patimony, conservationof Rota and fauna, and defenseor security requirements. The eliminationof cetain non-taiff barriers was subsequentlygiven the force of law by the passageof Decreto Legislativo668 in Septer, 1991. - 66 - ANNEX 4 Page 2 of 10 4. The Appendixto this Annex lists all known non-tariffbarriers, whether discriminatoryor not, existingas of August, 1990, or November, 1991. Of the 45 non-tariffbarriers thus identified, 22 have been eliminated,eight seem to have been eased, and 15 remain in force. Three of these 15 were instituted XU August, 1990, in pat at least as a result of pressuresfrom specificinterest groups.

5. The non-tariffbarriers eliminatedinclude most of the restrictionsthat are more clearly discriminatory,such as state monopoliesfor importof foodstuffs,Register of Imports from Andean Group Countries, and the oil monopolyof PETROPERU. The Pre-AuthorizedLicence to Import (LicenclaPrevia de lmportacddn),required for imports financedwith a preferentialexchange rate, the clause of the Law of Industry (Ley de Industras) whichprotected national industry,and the Authorizationof No Competition(Dictdmen de No Competencla),a minimum-domestic-content regulation, were also abrogated. Other non-tariff barriers eliminatedwere: qualitycontrols on animal feeds and canned and processedfoodstuffs; import prohibitionsfor gold, printing and photocopying machines,ships, airplanes,and passengervehicles; temporarysuspension of importsof garlic and onions; and minimum-contentregulations for productsof industrialassembly.

6. Eight non-tariffbarriers have been eased, either by the removalof proceduresrequired prior to importing,or by an increasein the transparencyof these procedures. The Certificateof Internment (Gertificadode Internamiento)from the Ministry of Health, neededprior to the importof medicines, perfumes, cosmetics,or medicalequipment, is no longer required, and the receipt of a Product Registration(Registro Sanitarlo) for an importedproduct is now automaticif the importer's applicationis not processedby the governmentwithin fifteenworking days. Various inconsistentand complexprocedures prior to the import of veterinary productsand non-bannedpesticides have been eliminated; these imports can now enter the country after presentationof a single document (the Declaracin Jurada) whichdescribes them. The prohibitionon imports of used industrialgoods has been loosened for the paper industryto allow for the importof paper and carton residuals, a key input in the manufactureof paper and cardboard. The process for obtainingQuality Certifications (Certificacionesde Caldad) and a Product Registrationfrom the NationalIstitute for Nutritionfor importedand domesticprocessed foodstuffs has been made less complicated. Cotton import regulationshave been easedsuch that only cotton importsfrom the Americancontinent (with a few exceptions)must undergo fumigatlonin special chambers.Used goods regulationshave been relaxed to allow for the import of used machineparts, motors, automobiles,and engines.

7. Most of the non-tariffbarriers not eliminatedor eased are restrictionsbased on the need to protect the safety, health, and security of the country. The non-tariffbarriers which exist for safety and health reasons are TechnologicalRequirements for Meat Products (ReglamentoTecnoldgico de Cames), PhytosanitaryPermits (PermisosFftosanltarios) for imports of vegetal origin, Zoosanitary Permits (PermisosZoosanltarlos) for imports of animalorigin (i.e., milk, leather, skins, etc), packagingcontrol of canned and boxed goeds, radiologicalcontrol of canned goods (in place ever since the Chernobyldisaster), certificationof fish products(though the need for this is questionable), the ban on organochloridicpesticides (such as DDT), and the restrictionon imports of human remains. - 67 - AN=E 4 Page3 of 10 8. The restrictionson the importof maps,cartographic materials, cultural nnrifacts, arms, and communicationequipment are of a non-economicnature. The prohibitionof importsof used clothing, laundryand bathroomarticles (i.e., towels,sinks, showerheads, tubs, etc)is clearlya discriminatory non-tariffbarrier which was not removedduring the post-Augusttrade liberalization. 9. LegislativeDecree No. 653 establishedthe "Lawto PromoteInvestment in the Agricultural Sector"in August1991. Thisdecree reinforced two decrees (passed in June and July of 1991)which prohibitedthe importof powderedmik productsfor use as inputsinto the productionof re- constiutedmilk, butter, and otherdairy-based products. This prohibition, and the requiredpre- inspectionof goodsat the port of origin(established by LegislativeDecree No.659 in August1991) weie put intoeffect after August1990, and maybe seenas reversalsin the liberalizationprocess. Eyguation 10. On balance,Peru has madeenormous progress in removingdistortionary non-tariff barriers. In light of Peru's previousefforts at liberalization(1979-1981), the evolutionof a new, free environmentfor tradehas advancedat a remarkablyrapid pace, with support from most sectors of the economy. Conventionalnon-tariff barriers - negativelists, importmonopolies, and the like- have now beenvirtually eliminated and the less conventionalbarriers provided by technical,health, and safetyregulations now constitute the coreof residualnon-tariff protection. 11. Withthe passingof LegislativeDecree No.668 in September,1991, the Governmentrenewed its committmenttc liberalizetrade and eliminatenon-tariff barriers. The Governmentis bannedfrom engagingin monepolisticor oligopolisticactivities in the privatesector and the powerof law is given ,to certainarticles of otherregulations which eliminate minimum-domestic-content requirements for both importedand domestically-producedgoods. In this legislativedecree the Governmentalso undertakesto applyhealth and technicalregulations in a non-discriminatoryway. Accordingto Article13, "the Statewill guarantee that futurenorms will not constituteobstacles to the free flowof goodsand servicesand will allowfor equitabletreatment of importedand localgoods." Ihis willin tr requirethe Governmentto examinethe way it appliesits existingnon-tariff barriers and sanctionsnew ones.

REFERENCES

Abusada,Roberto, m Comercialen el Perd, (mimeo),mayo 1991. Abusada,Roberto, La Reformadela PolfticaPara-Arancelaria Peruana (1990-l9911, (mimeo), septlembre 1991. AfOYO, Es_ gue Afct la Eficlenciade la Indu=kManufactureraen el Perd (mimeo)octubre 1990. ECONSULT,S.A., Avanceen la Desreeulacidndel omercloExtir Peruano,(mimeo), agosto 1991. Rossini,Renzo G., *LasMedidas Recientes de AperturaComercial", La Mgna, No.33,mawzo de 1991. - 68 - AN= Page 4 of 10

AMEND TC ANNEX4 PEU; NON-TARIFFBARRIS

NAMEOF NTH SITUATIONUNTIL CHANGESSINCE AUGUT 1990 ALM=S 1990

IRESTPJCIlONS1T H1AU BEEN EURMAINAE REGISTEROF IPORTING Importingfirms had to be The Regis is no longeri FIRMSIN THETRADE registeredin the Trade Insttute. effect INSTTUTE(RtEGISRO DE EMPRESASIMPORTADORAS EN EL ICE)

STATEMONOPOLY IN Exclusiveimport rights grantedto Import monopolieseliminated In FOODSTUFFS ENCI (wheat,wheat flour, white March 1991. and cn^desugar) and ECASA (rice).

IMPORTOF FOODSTUFFS Importsof foodstuffsother than The Certifcate Is no longer thoseof ENCI and ECASA required, and the procedurefor requireda Certificateof acquiringa ProductRegistration Internmentfrom the National has been simplified. Instituteof Nutrition INN)and musthave received a registration numberbefore entering the country. RESTRICTIONSON SALEOF DS053-85-AG required importer Sale and importof animalfeod ANIMA FEED registradon,feed approval,and healized completely. Otherrestrictions.

WOODPRODUCTS Couldnot be freely imported. DS 060-91-EFand DLeg 668 may have diminatedrestrictions.

ITINTECEVALUATIONS DS 055-84ITIIND required No long In effect. importedproducts to meetwith technicalnorms established for similardomestic products. ANNE 4

- 69 - Page S of 10

NAMEOF NTB SITUATIONUNTIL CHANGESSINCE A-UGUST1220 AU=12

PHOTOCOPYINGAND Couldnot be importedwithout Sale and Importof photoopying PRINTINGMACHINES authorizationfrom the Ministry and priting machinesfreed. of the Interior.

SPECIFICIMPORT Ministryof Industr required No longerneeded. AUTHORIZATION specialdocumentation to import (DICTAMENESPECIFICO DE CKDpackages, computers, IMPORTACION) domesticelectric products, and other productsof industrial assembly. CONSULARREVIEW Restrictedthe importof Automobilescan be imported (VISACIONCONSULAR) automobiles. freely. PRE-AUTHORIZEDLUCENCE Appliedto importsunder the No longerexists. TO IMPORT(LICENCIA MUCregime. PREVIA)

AUTHORIZATIONOF NO Usedto protectdomestic No longerexists. COMPETITION(DICTAMEN producersfrom similarimported DE NO COMPETENCIA) goods.

GOLDIMPORT - State bad exclusiveright to sell 'Me Importtexportof raw or RESTRICTIONS preciousmetals in raw or semi- semi-workedgold is totally workedforms through the Banco freed. Mineralof Peru.

BOATS,SHIPS, AND Ministy of Defenseneeded to No longerIn effect The Genera FREGHTERS authorizeimport of ships, big and Officeof WaterTransport must small. simplybe notifiedafter the buyingor sellingof a ship.

REGISTEROF DECISION200 No longerin effec.

LAWOF INDUSTRY(LEY DE Ley 23407established restrictions Tle chapterwhich pvoted INDUSTRIAS) on Importsof industrialproducts nationalindustry as abolished also produceddomestically. by DLeg668 in September1991.

ANDEANGROUP Specialdocument needed for No longerin effect. REGISTRATION importsoriginating in member countries.

ANNUALPRODUCTION PLAN Enterprisesin the industrialsector DS4012-91-ICI1\INDremoved (PLANANUAL DE wereobligated to preparean this obligation. PRODUCCION) annualproduction plan. 4 - 70 - Page 6 of 10

NAMEOFNTB SITUATIONUNTIL CHANGESSINCE A1GIIS 1990 AlOS T IM

RESTRICTIONSON THE Not in existence. In July 1991, impKs of ouions IMPORTOF ONIONSAND andgarlic from counties where GARLIC certainplan diseasesare preset wereprohibited. This restiction has been liftedin September 1991. OIL MONOPOLY: PETROPERUexercised DLeg655 elimnatesthe PETROPERU monopolypowers in oil monopolyprivileges of production,exploration rights, PETROPERUand its affiates. refining,distrib'ition, and impor of oil andpetoleum. PROHIBMONON IMORTS Since 1984,imports of In August1990 autombile OF AUTOMOBILES automobiles,except for importprohibitions wsre diplomaticuse, wereprohibited. eliminated. NATIONALUNIONS (JUNTAS NationalUnions of Coffee, This power is eliminatedalong NACIONALES) Wheat,Milk Products, and withany existingnon-tarf HydrobiologicalProducts restrictions. exercisedpower to restrict exportsand imports through non- tariff barriers.

IMPORTINGREGISTER Not in existenceas of June 1991. (REGISTROUNICO DE IMPORTACION)

aLnAVBEEN LICENCETO IMORT DS 164-82-AGand DS 018-86- The Imorti proes Is greatly PESTICIDES(LICENCIA PARA AG establishedregulations for simplified;remang lboratoy INTERNAMEtNTODE Importof pesticides. tests conformto itrnadonD PLAGUICIDAS) standads. IMPORTCERTIFICATE FOR DS 124-81-AGestablished The ipotg processis grety VETERINARYPRODUCTS variousimport regulations for simplified;remaining laboratory (CERTIFICADODE veterinaryproducts. tests conformto Intedona INTERNAMIENTOPOR standards. PRODUCTOSVETERINARIOS) 71- - Page 7 of 10

NAMEOF NTB STIUATIONUNTIL CHANGESSINCE AUGUST1990 ALGUST1

MINISTRYOF HEALTH Restrictionson importof DS 003-91-SAeased many RESMUCTIONS medicines,medical equipment, restrictions;import process more perfumes,and makeup. transparentand efficient. COlTON IMPORTS Not in existence In May 1991,RM 359-91-AG requiredthat cowttonImports be flmigatedin specialchambers, the scarcityof whichimplied a virtualprohibition of cotton imports.This decree was modifiedto submitonly those importsfrom the American continent,except Ecudor, Bolivia,and Argentina,to chamberfumigation. IMPORTSOF NATURALOR Importsof wastes,whether of DS 036-90-ICTND allowedthe INDUSTRIALWASTES naturalor industri origin,were paper industryto importpaper prohibited. and cartonresidues as they are a majorinput for industrWi recycling.The originallaw has not been changedand thus other sectorsare seekingsimilar treatment.

QUALITYCERTIFICATIONS Importedor domestically DLeg 658 allowsany qualifiod (CERTIFICACIONESDE producedgoods needed publicor privateisitution to CALIDAD) certificationof qualityfrom a grant the certificadon. state-authorizedinstitution. IMPORTOF USED Most used goods(imdustial parts, Most industrialused goodscan be INDUSTRIALGOODS motors,cars, equipment,etc.) freely Imported. were on a list of prohibited imports. - 72 - Page8 of 10

NAMDEOFNTB SITUATIONUNTIL CHANGESSINCE AUGUST1990 AUUT199101

TECHNOLOGICAL DS 004-84-AGestablished More qualityrequients are REQUIREMENTSFOR MEAT sanity requirementsfor addedin January1991. PRODUCTS(REGLAMENTO importedmeat. TECNOLOGICODE CARNES) PHYTOSAN1TARYPERMIS DS 016-76-ALestablished a Phytosanikuyrequireme are (PE]WSOS FITOSANITARIOS) SanitationRegulation mademore general;on the oher (ReglamentoSanitario) for hand,they are augmented. importsof vegetalorigin.

ZOOSANITARYPERMITS RS 117-76-AGQater modified by Zoosanitaryrequirements (PERMISOSZOOSANITARIOS) RS 0122-86-DGAG),established amplifiedin RM 0231-91-AG. that productswith an animal origin (suchas milk,meats, leather, skins, etc) needed a ZoosanitaryPermit to be imported.

METEOROLOGICALAND Cannedand botdedproducts had Standardshave been madeto CONTENTCONTROL to meet MTlNTECstandards. parallelinternational norms.

RADIOLOGICAL IPEN establishedmaximum Restrictionremains in forceand CERTIFICATIONFROM IPEN permissiblelevels of radioactive RM 00740-90-AG-DGA contaminationfor imported reinforcedthe originallaw. foodstuffs.

GEOGRAPHICTEXTS OR Couldnot be importedwithout StillIn effect. CARTOGRAPHIC authorizationfrom the Ministry PUBLICATIONS of ForeignRelations.

RADIO-COMMUNICATION Ministryof Transportationneeded Stillin effect. EQUIPMENT to authorizeImport of radio- communicationgear.

SECOND-HANDCLOTHES importsof used goodswere Otherused good impots are ANDLAUNDRY ARTICLES rrohibited. liberalized,but not clothing, laundryor bathroomfixue; however,used-goods imports destinedfbr donationallowed. _ 73 - Page9 of 10

OEF B SITUATIONUNTIL CHANGESSINCE AUGiST12990 AUQUST 1299

ARMSRESTRICTIONS Ministryof the Interiorneeded to Still in effecL authorizeimport of arms, ammunition,and explosivesfor civiluse (not for war).

HEALTHCERTIFICATE Ministryof Healthneeded to Still in effect. authorizeimport of human remains.

CULTURALAUTHORIZATION NationalInstitute of Culture Stillin effect. neededto authorizeimport of worksof art, replicas,and books of more than 100years of age. SANITARYCERTIFICATE Sanitaryrequirements acted as Has not been specifically FOR FISHPRODUCTS barrier to imports.Some export eliminated. (CERTIFICACIONSANITARIA restrictionsexisted due to cholera DE CERPER) epidemic.

POWDERED,SEMI- Since 1965,no morethan 30% of This domestic-contentregulation POWDEREDMILK PRODUCTS the inputs, such as powderedor was eliminatedby DS 060-91-EF reconstitutedmilk, used in the of March1991. However,after dairy industrycould come from August1, 1991, importsof sourcesoutside Peru. powderedmilk products for use as inputsin the productio of dairy-basedproducts were prohibited. The August1991 Law to PromoteInvestment in the Agricultal Setor gave force of law to this prohibitioL Two recent LegislativeDecrees (668 in Septemberand 757 in November)reinforce this prohibition.

PRE-INSPECTIONOF Not in existence. In August1991 DL4g 659 IMPORTEDGOODS AT PORT requiredpwinspecion of imports OF ORIGIN at port of origin to confirm quantty, quality,and modeof payment.

BANNEDPESTICIDES A generalregulation on pesticides Internationallybanned pesticides existed. are prohibitedentrance into Petu. ANNEX-4 - 74 - PAP 10 of 10

LIST OF ACRONYMS

CERPER La Empresa Piblica de CertificacionesPesquers del Perd DLeg Decro Legislativo DS Decreto Supremo ECASA Empresa Nacionalde Comercializaci6nde Arroz ENCI Empresa Nacionalde Comercializacidnde Insumos ICE Institutodel ComercloExterior INN InstitutoNaclonal de Nutrici6n IPEN InstitutoPeruano de Energ(a Nuclear ITINTEC Insitito Nacionalde Tecnologfa Ley Ley (Law) MUC MercadoUnico de Canbios RM Resoluc.6nMinisterial RS Resoluci6nSuprema - 75 -

Page 1 of 4 THE CUSTOMSACI_ON PLAN: A SUMMARYI/

C,ustoms Rorm

1. The FujimonrGovernment imherited a CustomsSuperintendency (SUNAD) which was poorly organized,ineffectively operated, overstaffed, poorly trained, and under-paid.In addition,due to an il-definedand unstablelegal framework, the bodyof customsregulations had developedincoherently: inefficientforms of controlhave led to obstaclesto trade and a highlevel of discretionon the part of customsofficials 2 In Mach, 1991,the Goverment initiatedthe processof reformingthe customsservice. This began wnth a reduction of more than 500 personnel,mainly through incentivesand voluntary rtirement The Goverment also introduceda reform to saphfy the proces inwvoedin the differentcustoms operationsand tegulations. It authorizeda new systemof import and export customsclearances, permitted the embarkationor disembarkationof goods by means of self- assment, and institutedcustoms valuation based on documentaryevidence and selectivephysical amtion. 3. SUNADhas an importantrole in executingthe Government'spolicy of trade reformwhich includessimplifying the remainingcontrols on trade. Thus,support aimed at increasingSUNAD's efficiencywiU help consolidatethese trade reforms. SUNAD'sreoranizational efforts willneed to be supported by foreign advisoryservices which can bring new approachesto the tasks already initiated. In addition,computer equipment and systemsmust be strengthenedto simpli5operational proceduresand obtainthe informationnecessary for the efficientmanagement of the customssystem 4. Customsreform will encompass: (i) the orgational stucture of SUNAD,(ii) its operating procedures,(iii) the computersystem, and (iv) human resources. An Action Plan for reformwas agreedbetween the MlBand the PeruvianGovernment, the three stagesof the Plan coincidingwith the three tranchesof the M)B'sTrade SectorLoan. The Plan willbe executedin the contextof a programof TechnicalCooperation, financed partly by the IDB and partlyby the Government.The WorldBank was involvedin the disussions leadingto the agreementon the Action Plan and will support the fulfillmentof the Plan in parallelto, and in consultationwith, the IDB. The ActionPlan A. The FiustState S. Thi willentail actionsto be undertakenin SUNAD'sorganizational structure, including: * preparationof a draft GeneralCustoms Law,

IL ThisAnnex provides summay iniformtion frome Plande Accidnp u d SSIomdo Adumas de Pnt, Ao IV of IDI documentPant hdsum Aidstedel Sedo de CodmorioP1O3 : EdePon 10 September, 1991. - 76 -

ANNEX-5 Page 2 of 4 * preparation of a draft LegislativeDecree to establish SUNAIYs own regulations; * identificationand definitionof SUNAD'stop managementlevels; and * definitionof the functionsof each section of SUNAD (and the size of its personnel)and its AdministrativeUnits 6. The first stage willalso includeactions in the field of customsprocedures and regulations, such as:

* approvalof a procedurefor exportclearance; * creationof a Group to analyzeand monitoroperative procedures; * approvalof a plan to reviewtax assessmentsof past importsdeclartions; * initietionof a procedureto enforce bank guaranteesfor overduedebts; * approvalof the actionplan to take inventoryof, and auctionoff, goodsleft unclaimed; * establishmentand implementationof a comprehensiveguarantee system for in-transitgoods and establishmentof rulesgoverning in-transit operations; and

* identificationof personnelin charge of the review of import and export documentation.

B. The SecondStage 7. The followingsteps willbe carriedout in the area of organizationalstructure: * approval and publicationof LegislativeDecrees modifyingthe General CustomsLaw and providingregulations for SUNAD; * formulationof a draft set of implementingregulations for the General CustomsLaw; * approvaland publicationof the Statute of SUNAD; * approvalof the new organizationalstnucture of SUNAD; * namingof the employeesfor each divisionof SUNADand of the units that makeup SUNAD'sorganizational structure;

e the identificationof personnelmade redundant by the reorganizationand of meansto carryout their separation;and - 77 -

Page3df4 * commencementof the purchasingprocess for the SUNADbuilding. 8 As for customsprocedures and regulations,the actionswill include the auctioningof goods abandonedas of 30 June, 1991,the designand applicationof a systemfor monitoringmanifests, and the approial of the following:

* criteriato select the operationsto be submittedto on-siteinspection; * procedurefor adjustingsettlements after assessingvalue; * proceduresfor customsverification of operationsto load and unloadgoods and their subsequentimplementation. 9. The processingof operationswithin the secondstage willentail: * creationof the computingcenter; * defnition of generalinformation needs and the configurationof the computer system;

* selection and acquisitionof the elements necessary for the computer equipment;and

* systemdesign and developmentp!an. 10. In the area of humanresources, the followingsteps willbe taken: * approvalof the programsfor the selectionof new personneland dtse for internalpromotion; * approvalof plans and proposalsfor short- and long-termtraining; * evaluationof the personneland financialresources necessay for the Customs Schoolto operate; and * incorporationinto the Schoolof the training equipmentenvisaged in the technicalcooperation project

C. he Third Stage 11. Ihe acti as related to the organizationalstructure will include:

* equippingof the new customsfacilities; * completionof the commiunicationsnetwork of the CustomsSystem; and * approvaland publicationof the implementingregulations of the General CustomsLaw.

12. Actionsfor the reformof customsprocedures and regulationswill consist of * preparation,approval and implementation of the Manualsfor the newprcedures - 78 - AM, S Page 4 of 4

o executionof the bi-annualControl Plan and the presentationof the results of this; and * presentationof the figuresfor fiscalreturns from the reviewof import and exportdeclarations. 13. In the area of processingof operations,the actionswil involve; * deveOpmentof computerfiles and sub-systems; * trainingof the usersof the system;and * presentationof foreigntrade statisticsby tariffcodes, countries, and economic agents. 14. In the area of humanresources, the actionswill include: * completionof the trainingcourses set for this stage;and * inclusionin SUNAD'sbudget of the resourcesnecessary for the operationof the CustomsSchool. - 79 -

Page 1 of 18 REPUBL1CADEL PERU MMISTERIODE ECONOMIAY FINANZAS DESPACHOMINISTERIAL

OficioNo. 206-91EF1O Lima,Januaty 9th, 1992 Mr. LewisT. Preston, President, The WorldBank, 1818H Street N.W., Washington,D.C 20433

Dear Mr. Preston, 1. To support the implementationof the trade refcnmthat the GCrenment of Peru has undertakenand the processof Peruvianreintegration into the internationalfinancial communitY,the Governmentis requestingfrom the InternationalBank for Reconstucton and Development(IBRD) a Trade PolicyReform Loan of US$300million equivalent.

2. In support of this request,this letter: - describesthe content and specificobjectives of the Government'smedium-term macroeconomic-stabilizationand medium-termadjustment program; * descnbesthe exernal financingplan that Peru has agreedwith its major creditors; * outlinesthe Govemnment'sunderstanding of the process,conditions, and timetableunder whichthis Loan wouldbe presentedto the IBRD's Board,and the loan agreementthereafter signed and made effective; • describesthe medium-termobjectives and guidelinesof trade policy,identifing specificmeasures that willbe undertakenby the timeof signatureof the loan agreementand furer measuresthe Governmentintends to undetabke,fouwing loan signature;and

* descrs the Govements undeng as regardsreporting to the Bank on progressin the macconomic adjustmentand tade-refom programs. 3. Once the proposedloan has been presentedto, and apprved by,the Board of the World Bank,this letter (whichwe understandwill become part of the loan do tation) willconstitute an undetanding betweenthe Goverment and the Bank on the conditionsand criteria accordingto whichthe agreementfor the proposedloan can be siged and made effecive - 80 -

Page 2 of 18 L GovernmentsStabilization Efot and MediumTerm Adjustment Program 4. On July 28, 1990,when the current administrationassumed office, the country onfronteda severeeconomic crisis and a seriousinstitutional decay. Prices rose by 2,800percent in 1989and acceleratedto 60 percentper monthby July 1990. GDP declinedby 20 percent in 1988-89and declinedfurther as 1990advanced. The country'snet internationalreserves were depleted,and havnngpursued a confrontationalextemal debt strategy,the countrywas vfrtually isolatedfrom the internationalfinancial community. AU these factorscontributed to makesocial conditionsincreasingly difficult and led to intemal migrationmovements into majorcities and to a continuedrise in polidcalviolence and terrorism Further, the resultinggrowing poverty and deteriorationin the distnbutionof incomeprovided a breedingground for drug traffickngand other criminalactivities. Deep at the root of the crisiswere massivefiscal and quasi-fiscaldeficits, widespreadwage and price controlsand subsidies,a highlydistorted exchange rate system, negativeinterest rates and multipledistortions in the trade systemand labor market. 5. Facedvwth this dire situation,the Government,starting August 8, 1990,adopted a comprehensivestabilization program designed to curb inflationand achievea sustained economicrecovery, along with the setting of conditionsfor progresstowards a viablemedium- term balanceof paymentssituation and a reintegrationinto the globaleconomy, including an expansionof direct foreigninvestment. Further measureshave been undertakensince the beghiing of 1991to strengthenthe programand to acceleratethe implementationof key stucturn reforms. 6. Throughoutthe implementationof the program,the Governmenthas viewed fiscaland monetarydiscipline as criticalto the stabilizationeffort. Thus, it undertookmeasures aimed at eliminatingthe non-financialPublic Sectores domestic borrowmg by meansof combining large initialadjustments in gasolineand other publicsector priceswith the adoptionof a tax refrm (includingseveral emergency taxes) and strictexpenditure control, including the reduction of employmentin the publicsector througha voluntaryprogram of withdrawals.In 1991,the aim is to achievea primarybudget surplusand a reductionin the current accountdeficit of the non- financialPublic Sector from 3.4 percentof GDP in 1990to 0.4 pe.rcentin 1991. Tis fiscaleffort, if combinedwith expected foreigp financing flkws, would allow for a modestincrease in public ivesatment. 7. The Governmentintends to continuepursuing strict fiscaldiscipline over the medium-term,and as a result,both the savingsand the investmentof the non-financialPublic Sectorare expectedto increasefurther. However,to ensure the sustainabilityof the fiscaleffort, the Govemmenthas embarkedupon a majoreffort to restoretax revenuesfrom the equivalentof 7.6 percentof GDP in 1991to 13 percent of GDP by 199.5.In line with this objective,the Govenment is proceedingwith a numberof reformswith a viewto achievingbefore the end of 1991a simplifiedtax systembased on a few broad taxes (the value addedtax, selective consumptiontaxes on gasolineand a few other products,personal and businessincome taxes, a tax On grossassets of businessenterprises, a localproperty tax, and a simplifiedimport tariff). To suppleAentthe changein the tax system,the Governmentis also pursuingbroad rangingrefonms in ta and customsadminiation. In addition,the Giovemmenthas resolvedto maitain the tax contributionof the petoleum secto in real terms and wouldseek to maintainthe real levelof other publc sector taiff in line with expectedinflation. Furthermore,before the year ends, the - 81 -

Page 3 of 18 Governmentplans to begin implementationof a publicsector reformprogram which will enable it to redefinethe scope of Governmentactivities, reduce the size of the PublicSector, recruit trainedpersonnel for seoior positions,and reassignor reducepersonnel with appropriate compensation.In the yeas to come,the Governmentalso expcts to implementplans currently under discussionfor further reformpublic sector emoployment, the socialsecurity system, and the state administration. 8. The adherenceto strict fiscaldiscipline has been coupledby stem credit restraintby the Central Bankin the pursuitof a lowerinflation path and the attainmentof a strongernet internationalreserves position. Alsowithin the tight credit ihnits,the Government has lookedfor waysin whichto rediect credit flowstowards private sector activitiesby meansof a phasedreduction in marginalreserve requirements and by reducingsubsidized lending, particularlythat of the BancoAgrario. These actionstogether with the establishmentof market- determinedinterest rates, by lfting the pteviousinterest rate ceilingsto non-biwdinglevels, are expeted to promotea faster growthof financialsavings and their more efficientallocation. To improvemonetary control, the Governmentwill seek to widenthe range of instrumentsto include open marketoperations before year end. The Govemmentintends to maintainmonetary restraintover the medium-termin line withthe generalobjecdves of the program. Nevertheless, it wfllendeavor to increasethe scale and efficncy of financialintermediation through further deregulationof financialmarkets and by further strengtheningthe frameworkof prudential regulationand supervision.The Governmentalso intendsto reduceits participationin the f cial systemby meansof a more limitedand precisedelineation of the financialactmivtes of officialdevelopment banks and by engagingin an action plan to privatizepublic sector commercialbanks. 9. The macroeconomicadjustment process has been accompaniedby the beginnig of a far-reachingeffort of modernizationof the economyaimed at increasingits levelof competitivenessand efficiency.Important measures aimed at the hiberalizationof different maets have been adoptedwhile at the same time, the provisionof publicgoods is begig to be made more efficient,coupled with the launchingof a wideranging pmvatization proces. The Govemmenthas alread issuedthree majorLaws in the areas of land tenure and investment, labor relations,and the financialsector. 10. In the aaian sector the Govemmentissued two decrees in March 1991,later incoWrprtedin the Lawof AgrarianInvestment Promotion of August 1991. The main objective of this legislationis to modifyproperty rights, liberalizing previously existing limitations under the 1969Agrarian Reform Law, thus allowingfarmers to freelydispose of their propertyand enhancingtheir accessto credit markets. The new Law also promotesprvate corporateland owehp and investmentand allowsland cooperatives to becomeprivate estates. In addition, the Governmentdecided to move awayfrom massivesubsidies by dereguating the domestic agriutural marketand abolishingENCIa importmonopoly on wheat,corn, sugar,soybean-oil, powderd milkand ferls Moreover,the Governmentdecreed the liquidationof ECASAand authorizedENCrs reorganizationwith the purposeof reducingthe scale and scope of its activities - 82 -

Page 4 of 18 11. In the area of labor. the Governmenthas recognizedthe need to reformthe old regimewhich rendered the labor marketinflexble and causedthe expansionof the informal sector. To this effect, the Goveament issuedin March 1991two Decrees regulatingthe existing employmentstabilit legilation by specifyg with greaterclarity the casesfor dmissal of workers. In addition,under the new legislation,workers and firmshave been providedwith a better systemfor the financialtreatment of contributionstowards workers' severance payments. Fnally, firmshave been offeredwider possibilities for engagingworkers on a temporarybasis. 12. For the financialsector the Governmenthas alreadybegun to adopt measures aimedat promotinggreater efficiency and increasedmonetization of the economy.The purpose of the new BankdngLaw of April 1991,is to reduce the level of regulationin the sector. It providesincentives for lowerintermediation costs, enhancing competition by allowingfor universal bankingand openingthe credit marketto foreigninvestment. In addition,the Law strengthens prudentialregulations specifying credit concentrationratios and new capitalrequirements. Also, the LAwincludes new provisionsfor dereguatingthe insuranceindustry, premiums have been freed and the Govemmentmonopoly of the reinsurancebusiness has been abolished. 13. Since March 1991,the Governmenthas started to redefine its role in the economy,divesting itself of productiveactivity in order to redirectits scarceresources mainly towardsthe provisionof publicgoods and socialinfrastructure. A list of 23 publicfirms to be privatizedhas alreadybeen publishedand the processof divestitureof some 180firms is goingto be givenspecial attention by the administration.Also, since July of 1991the Governmenthas announcedplans to sell majoritystakes in steel, mining,air transportand telewommunications enterprises Coupledwith these efforts,the Governmenthas proceededto abolishthe state monopoliescorresponding to ENCI, ECASA,gold trade, and PETROPERU'shydrocarbon productsimports and commercialzation. 14. The Governmentis committedto encourageforeign investment in all sectorsof the economy. The liberalizationof the capitalaccount of the balanceof paymentsnow allows foreigpinvestors to remit abroad aUnet profits and royalties.Foreign investment can nowbe under any corporateform or joint venture,and investorsare allowedto purchasestock from resdents and to investin any sectorexcept those otherwisereserved for nationals. Also Peru has beome a memberof the MultflateralInvestment Guarantee Agency effective December 19, 1990, and is activelypromoting the resolutionof current contractualdisputes in the miningand energy sectom

IL Etea F cinu Plan 15. As of July 1990,about two-thirdsof Peru's approximatelyUS$22 billion extemal debt was in arrears and Peruviancommercial debt traded at 5 cents on the dolar In the secondary markt The policyof slective defaulton externalfinancial obligations followed by the previo Governmenthad broughtsignificant losses to Peru in the formof reducedaid flows,paralyzed developmentprojects and foreignivstment, increasedvulnerability to trade restrictionsin creditorcountries, and contributedto a majormacroeconomic collapse. From the beginning,the new Adminitrationhas made it clear that Peru wouldseek reintegrationinto the international finanl commity. Paymentsof currentobigatons fallingdue to the WorldBank resumed in - 83 - ANN 6 Page 5 of 18 October 1990,and to the IIB a monthlater, thus "freezigM the stockof arrearswith these institutionsat the respectie levelsprevailing on those dates. (Currentdebt servicepayments to the IMF had alreadybeen initiatedin September1989, durng the previousAdmiitration.) Debt servicepayments to the three multilaterals,which average about US$41milion per month, equivaent to 14 percentof fiscalrevenues, represent a majoreffort by Peru, giventhe levelof unfulfiledsocial demands, the choleraepidemic, and the countrs current low abilityto pay. IJterruptionsin the paymentof debt serviceto the IDB and the WorldBank were registered begining in March 1991,but the Govemmentdeposited these fundsin escrowand releasedthem followingthe IMFs appwvalof its RightsAccumuiation Program (RAP) on September12 16. The Governmentis committedto, and bas sought,support fromits major creditorsfor a growth-orientedthree-stage debt work-out. The first stage, comprisingthe clearanceof arrears with multilateralcreditors, has begun;the secondstage, Peru's reschedulng of its officialbilateral debt with the Paris Club,was completedon September17; the third and final stage willconsist of negotations to find a solutionto Peru's debt overhangwith commercial banks The four conditionsfor the financingplan to be successfulare that: (i) Peru complywith the fisug-monetarytargets unm/erthe IMF programand implementa programof structura reform agreedwith the IDB and the WorldBank; (ii) the SupportGroup providefinancing to cover a two-yeargap estimatedat US$0.7billion; (iii) Peru complywith current debt service obligationsto the multilaterals;and (iv) Peru abideby the terms of the reschedulingof Paris Club debts. 17. At the start of the debt worlout, arrearswith the three mutilateral totaled US$2.2 billon Under a financing plan agreed between Peru and the multflaterals,arres with the IDB were clearedin September1991, while arrears with the WorldBank and the IMDwould be clearedby December1992. Arreansclearance would be financedthrough a combinationot bridgeloans sgainstdisbursements of multiateralinstitutions (which would be madeimmediately after the clarance of arrears) and Peru's ownbalance of paymentsefforts. 18 The clearanceof arrearsowed to the = took place on September13, 1991. Fiancing to clear 1DBarra was facilitatedby the disbursementof a recentlyapproved US$325 millionloan to Peru from the Latin AmericanReserve Fund (MFAR).On September18, the IDB approveda trade sectoradjustment loan, and we understandthat IDB's resumedlending to Peru wouldconsist of a furthersector loan and four new projectloans. The sectorloan will support the Govement's reformefforts in the area of the FinancialSector. A third sector loan, posblly to support Agriculturalrefom and investment,is also foreseeable.In turn, the four new projectscover the areas of Electricity,Health, Sanitation,and Roads. Total commitmentsunder these loans could reach up to US$1.1billion, while disbursements prior to December1992 could total betweenUS$700 to 800 million 19. The T approveda 16-monthRAP in support of the Governments macroenomic progm on September1Z 1991. As you mayrecall, in 1990,the IMF established a new policyto dealwith countriesin atrearswith the MF. Under this policy,termed Right AccumulationProgram (RAP), and upon satisfacurycompletion of the macroeconomictargets of the program,a countrycan build up 'rights towardsa fuly back-loadeddisbursement following the derance of arer At the end of the program,remaining arrears can be clearedwith a short-termbridge loan aginst the IM post-clearancedisbursement. Total 'rights"to be - 84 - ANN-EX6 Page 6 of 18 accumulatedduring the programamount to SDR625million, equal to total arrears owedto the IMF. The key performancetargets under the IMP progrdmare: budgetbalance; zero flow of CentralBank domesticcredit to the publicsector; a ceilingon total arrearswith all creditorsand "frozen"arrears with multilaterals;and a US$225mfllion increase in internationalreserves. 20. As regardsthe WorldBank we wouldalso expect to be beneficiariesof its new approachwhich was approvedearly in 1991for dealingwith arrears of countriesimplementing strongadjustment policies and whosearrears are large. Under this policy,the WorldBank can developand processadjustment loans during a "performanceperiod" in whichthe countrywould build a track record and establisha claimto future disbursements.Although these loanscan be brought to and approvedby the WorldBank Board,loan signing,effectiveness and disbursements do not take place until aUarrears to the Bankhave been fullycleared and the countryhas establisheda satisfactorytrack recordon adjustmentmeasures. The WorldBank intends to prepare three such adjustmentloans during the period fromDecember 1991 to June 1992. These three loans are expectedto cover the areasof Trade,Structural Adjustment and FmancialSect. Disbursementclaims to be accumulatedcould total about US$900million. As in the case of the DMFsRAP, at the end of the performanceperiod the countrycan mobilizea bridgeloan to clear its arredrs. 21. As regardsthe situationwith BilateraLs, the Governmentobtained a reschedulingof Paris Club debt shortlyafter the RAP wasapproved by the IMF Board. The bulk of Peru's externaldebt is withbilaterals and suppliers(48 percent),most of it with Paris Club creditors. Peru receivedunprecedented cash-flow relief, duringthe consolidationperiod (October 1991to December1992), from its Paris Club creditors,in the form of rescheduling,deferment of moratoriuminterest, and defermentof post-cutoffdate arrears. 22. Per's debt withcommercial banks totals US$5.6billion, more than 90 percent of whichis in arrear Follownglaw suits broughtby the commercialbanks in 1989-90,the new Governmenthas negotiatedan understandig with them under whichit renouncedrecourse to statute-of-limitationsprovisions in return for a suspensionof the defaultproceedings that were initiatedin February1990. However,Peru's current and foreseeablelow abilityto pay wouldnot appear to provideroom for debt servicepayments to commercialcreditors. In the contextof a continuedstrutural adjustmenteffort, Peru envisagesthe possibilityof debt and debt semice reductionschemes (ie. buybackschemes and/or outright reductk%n with enhancements). 23. In order to cany out the strategy,outlined above, with each of Peru's major creditor groups,Peru wouldface financingrequirements of about US$18.8billion for the two-year period 1991-1992.We wouldexpect that US$15.1billion would be debt relief,US$0.4 billion wouldbe providedby the FLAR,US$ 2.6 bilion by post-clearancerenewed disbursements of multilateralsand US$0.7billion by the SupportGroup. Financialsupport fromFLAR was disbursedand the first D)Bloan approvedin September1991. The first tranche of the 1DBloan has alreadybeen disbursed.World Bank and IMF disbursementsare expectedin December1992. The SupportGToup was officiallyformed on June 7, 1991,under the co-ladesip of the U.S. and Japan, and comprsng interj, Belgium,Canada, France, Germany, Holland, Italy, Spain, Swedenand Switzerlnd. Bylate August 1991,total commtmentspledged by its members,in the fom of grants or soft loans,reached apprmately US$1.1billion. However,of this total, only US$673million were in the form of pure balanceof paymentssupport while the rest was in either - 85 - ANNEX6 Page 7 of 18 project that entailedadditional non-programmed fiscal expenditures or grantschanneled directly to NGOs. SupportGroup disbursementsare expectedto take place throughthe end of 1992.

IIL The Processof Loan Preparationsnd Peru's Clearanceof its Arrearswith the WorldBank 24. Ihe Governmentunderstands that the Boardpresentation of the loan we are requestingwill require the followingconditions to have been met: (a) the Bank'sagreement to the macroeconomicstabilization program presented in this letter (whichthe Governmenthas alreadyagreed with the IMF);V' (b) an ExternalFmancing Plan in place (as presentedin this Letter), agreed among the intemationalfinancial institutions and the SupportGroup, which would providefor full clearanceof arrears to the Bank and the normalizationof Peru's relationswith the IMF and the 1DB; (c) the Bank'sagreement to the trade-reformprogram presented in this Letter, and (d) Peru remainingcurrent on its servicingof debt to the Bank currentlyfalling due (other than debt coveredunder (b) above),on the terms alreadyagreed betweenthe Governmentand the Bank 25. The Goverment further understandsthat, after its approvalby the World Bank's Board,the loan wouldnot at that point be signed. The loan wouldbe signedand declared effectiveat the end of a 'performancepenod" during which Peru woulddemonstrate the sustainabilit of its macroeconomicstabilization and trade-policy-reformprograms and the continuing*iability of a FinancingPlan agreedwith the internationalfinancial institutions and the Support Group. Duringthis period,the Governmentwould continue to followthe programof macreconomicstabilization agreed with the IB and the Bank and to carry out specifictrade- policymeasures agreed betweenit and the Bank. It wouldalso undertaketo supplythe Bank withrelevant informationon the progressof the macroeconomic-stabilization,trade-reform, and customsreform programs(as detailedin paragraph45 below)to enable the Bank to report regulrly to its Boa If, at the end of this period, the conditionsgoverning this performance periodhave been compliedwith, the loan wouldbe signed. On effectiveness,it wouldthen be disbursedin its entrety, providedthat the Bank has receivedand acceptedthe usual documentationfor disbursementby that date. The performanceperod for this loan wouldnot

J/ The Sank milt monitor the macroecnomic-stabilization prograu in the light of the performmnceparameters set out in paragraphs x 6 to 8 above. The lank witl consult with the IMF on the progress of the program and mill pay particular attention in evaluating macroeconomicperformance, to the following reasonable ranges fwrspecific indicators In 192s Central Governmentcurrent 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 - 86 - ANNEX6 Page 8 of 18 end before December,1992, and wouldrun concurrentlywith the periodof the IMFs Rights AccumulationProgram

26. During the performance° period, the Govemment is committed to continue to servicedebt faling due to the Bank,undertaking to providedebt-servicing treatment to the Bank no less favorablethan that providedto the IMF. Beforeloan signature,arrears to the World Bank wouldneed to have been completelycleared. 27. The Governmentfurther understandsthat (as willbe reflectedin the Loan Ageement), if a lapse of time onzurredbetween signing and effectiveness,effectiveness would require that duringthis periodthe Bankcontinue to be satisfiedwith the implementationof the trade-reformand macroeconomicstabilization programs and the externalfinancing plan, as set forth in this letter.

IV. The Govermen TiadReform Prom 28. The Governmentconsiders trade reformto be a key elementof its efforts to reform the economyin order to modernizethe productivestructure and lay the groundworkfor vigorousgrwth based on the efficientuse of resources. As well as hberalizingother marketsand maintaininga consistentmacroecnomic framework, the trade reformis designedto shift the economyfrom inefficientproduction addressed mainly to the localmarky t towardexport activity and efficientimport substitution. The long-term,comprehensive nature of the trade reforms undertakenby the Goverment willensure the competitivenessneeded by a smalleconomy such as Peru's in order to generatedynamic growth of productionand employmentthrough the expansionof investmentopportunities and activeintegration with the globaleconomy. 29. The trade reformshave been implementedconcurrently with the stabilization effort underken by the new administrationto counteractone of the longestbouts with runaway inflationever recordedin the world. The trade reformswere timed to providesupport for the stabilizationprocess Togetherwith the exchangerate unificationand float,the eliminationof price contols and the drasticadjustment in pricesand publicutility rates, the trade reformsare to contributeto restoringrelative prices that are compatiblewith those prevailingon the internationalmarket, while at the same timehelping to brng inflationdown to worldlavel

30. The exchangeand tra systemsinherited by the admnstration that took office in 1990edhibited serious distortions owing to inconsistentdiscretional behavior by the State. Withina fixedexchange rate approach,multiple rates were establishedaccording to a systemof foreignexchange allocation and differentialpayment for variousexport categories. The outcome of such poicies wasthat Peru cameto have at least ten exchangerates, and one of the least tranpaet and mostarbitAy exchangesystems ever seen. This systemgenerated enormous implicittanms on variou exportsors and abnormalrevenues on certainimports, thereby promotingspeculation, leaving local production extremely vulnerable and givingrise to coruption withinthe public ista 31. Simlarly,the tarff systemshowed a bigh levelof nominalprotection and fragmentation,with overSO differet tarif The tariff systemwas appliedtogether with a broad rae of exemptions,bans, import monopolies,import permits,and a long list of non-tariff - 87 -

Page 9 of 18 administrativecontrols designed to grant additionaldiscretional protection to specificsectors. in spite of the highnominal protection, collections of import dutieswere lowbecause of the proUfration of exemptions. 32. In August1990, the exchangerate was unifiedand allowedto float withlimited CentralBank intervention.Free converdtilty of the inti wasestablished, and current and capital accounttransactions on the balanceof paymentswere hberalized. The obligationto surrenderto the CentralBank foreignexchange receipts from exports was eliminated,as wellas the innumerablerestictions on foreignexchange holdings and use insideand outsidethe county. 33. One undesirableconsequence of the stabilizationprogram adopted by the Governmentto attackrunaway inflation has been a revaluationof the currency,which has caused problemsin givingthe productiveapparatus a new export orientationand generatingimmediate impetusfor economicgrowth. The majoreconomic adjustment of August1990, in generating high corrective inflation, had the effect of bringing about an abrupt drop in the money supply and an increase in real interest rates when inflation subsequently fell substantially. The greater preferene for localcurrency liquidity, together withthe CentralBank's decision not to finance the non-financialpublic sector throughcurrency issue, have causedthe real exchangerate to appreate considerably.Ti situationbecame more acute withthe recent repatriationof capital held by Peruviansaboad, motivatedby high interestrates for localand foreigncurrency on the localcapital market and the need for businessto obtainworlkng capital given the prevailing recession.

34. The return of capitalhas occurreddespite a floatingexchange rate systemthat does not guaranteea particularnominal exchange rate. However,the revaluationprocess is now showingsdns of reversingitselL FSt, interestrates are alreadyfalling thanks to greater cnfiden tat inflationwill be beaten. Second,the CentralBank has proposedthat clear monetarypolicy goals be set in combinationwith efforts to effect a sustainablerehabilitation of the publicfinances. In addition,the CentralBank has taken steps to raise miimum required reservesand has created new financialinstruments to enhanceits monetarycontrol by allowing greatermterenuon on the exchangemarket. The Governmentremains determined to keep a free exchangesystem, and is convincedthat the current problemwith localcurrency revaluation wil be resolvedthrough a renewedattack against inflation by setting transparentmonetary goals and strengtheningthe fiscalsituation. 35. The trade reformhas evolvedin three stages. In the fist, beginningin August l990, a maximumtariff of 50 percentwas set while the exdstingsystem of tariff surcharges- which in effect madethe ceiling76 percent -was maintained.Also in the first stage, a minimumtariff of 10 percent wasset, whichaffected the systemof exemptions,and the list of banned imports wasdrasticaly reduced to 13 tariff positions,eliminating the prior import permit Duringthe second stage, begnng in late September 1990, tariffs were reduced to three, namely15, 25, and 50 percentwhile a 10 percetage point surchage wasretained on the 25 and 50 percent categories At this point, the Government announced its intentionto continue lornng tarffs to a singlerate of 15 percent by ijnuary 1995. In early 1991,however, it was clear that economic agentslackd confidencein the permanenceof the tariff measures,mainly because of the delayin liftg the temporary10 pcent surchargeand the establishmentof a specialreduced-rate import procedurefor iron and steel industryinputs. In this context,the Govemnmentaccelerated the - 88 - ANNEX6 Page 10 of 18 process,eliminating in a third stage (in March 1991)the 50 percent tariff and applyingthe 15 percent rate to the majority(81 percent) of tariff positions. 36. Also during this third stage of the trade reform,the Governmenteliminated importregisters and state monopolieson importsof food commoditiesand inputs,and streamlined health requirementsfor agriculturalimports, sanitary requirements and qualitycontrol in the health sector,and technicalquality standards for industrialproducts. It also eliminatednon-tariff barrierssuch as restrictionson he purchaseand sale of vesselsin the transportationand communicationsectors, and the eliminationof the state monopolyon the sale and importof fossil fuels and their byproductsin the energyand miningsectors. Also, to counteractthe effectsof subsidiesapplied by other countriesto agriculturalproduction and e;ports, compensatoty surcnargeswere introducedon importsof dairyinputs, wheat, corn, rice, sorghum,wheat flour, sugar,and pasta. These surchargesact as specificduties that varyaccording to intemational market prices. Also approvedwas a rule governingthe applicationof countervailingand antidumpingduties. 37. Under its new exportpolicy, the Govemmentlowered export subsidies (CERTEX)in August 1990and eliminatedboth them and the subsidizedinterest rate for financingof nontraditionalexports (FENT) in November1990. In March 1991,export restrictionswere eliminated,a simplifiedprocedure was adoptedfor the reimbursementof indirect taxes,and the temporaryadmission system was modified.For fiscalreasons, however, the tax on non-traditionalexports has been retained,at rates of 5 to 10 percent. 8. The trade reformthat beganin August1990, has includedthe reformof the institutionsthat administerforeign trade. In August 1990,it was decidedto dismantlethe Foreign Trade Institute,formerly responsible for settingpolicy and applyingcontrols on foreigntrade, a processthat was concludedin July 1991. Under the country'scnstitution, the executivebranch is responsiblefor Lettingtariff levelsand regulatingtrade in general,a task carriedout by the Ministryof the Economyand Finance. However,the Ministryof Industryshares certainfunctions havingto do with exportpromotion and trade negotiations,through an Interministerial Commissionchaired by the Presidentof the CabinetCouncil or his delegate. The National CustomsAuthority (SUNAD) is in the processof reorganization,having substantially modified proceduresfor clearingimports and exportsthrough customs. The new proceduresare intended to simplifyand modernizecustoms through a better allocationof resourcesand a significant investmentin training. 39. . he customsreorganization program also includesa staff reductionthrough incentives for early separationand mandatoryretirement. To date 500 of the 2,700customs employeeshave resignedvoluntarily, while competitions have been held to hire some 100 universitygraduates who mustfirst pass a trainingprogram. Also as part of the reorganization, legiation has been passedto expediteclearing goods in customswarehouses, giving private customsagents the authorityto calculateduties and makepayments, and leavingstaff to concentrateon reviewingdocuments and selectivevaluations. Fmally, there are new regulations on the administrtion of the temporaryadmission system to be used by the exportsector. Under the new system,payment of dutiesis suspendedupon presentationby the exporterof an applicationto customsand to the ministrygoverning the sector concerned. - 89 -

Page 11 of 18 40. In the area of ports and ocean transport,steps have been taken to reducethe cost of port activitysubstantially by elminatingthe monopolyon loadingand unloadingoperations and authorzng companiesand cooperathesto carryout such operationsfrom July 1991at all Peruvianports Also eliminatedby legislativedecree are all the administrativeand legal restrictionsand obstaclesthat impededfree accessto internationalocean routes and xraffic. Shipmentsof exportand importcargos have been freed and the cargo restrictionin favor of ships under the nationalflag has been lifted. 41. Ihe Govemmentintends to consolidateand advancethe trade reform in order to establisha permanentframework for dynamictrade developmentthat willbe consistentvinth the aim to promotegreater efficiencyand higherlevels of economicgrowth Maintainingthe curret foreignexchange-rate policy and strengtheningfiscal policy will serve in turn to shore up a stableeconomic policy over the long term,based on the principlesof free trade, free accessby economicagents to all kindsof trade activitywithout distinction as to the type of goodsor economicsector, thus ensuringfiuI privatesctor participationin all economicactivity. A vital part of the consolidationprocess was to pass into law,in September1991, all tarifE,non-tariff and admlnistratie reformmeasures, in the formof a legislativedecree with the force of law,under specal powersdelegated by the legislativebranch. 42. The legislationis intendedalso to ensure the permanenceof the foreigntrade reforms,in the spirit of the principlesmentioned. Specifically,the trade systemis prohibitedfrom diciminating amongproductive activties, whether exportsor imports. Export activitieswill permanently enjoy rights to the drawbacksthey currently have access to, and, as the fiscal situationpermits, these rightswil be etended to coverother indirecttaxes which exporters cannot currentlyget back Generalsurcharges and other taxes on importsare to be avoidedby the Governm t, as are other leviesother than customsduties and the generalsales tax It is obligatoryto complywith technicalstandards, sanitary requirements and all regulationsin such a waythat they do not functionas non-tariffprotective measures discriminating against imports. The State willensure that protectivemeasures against unfair competition (anti-dumping levies and countervailingduties) are not used to introduceundue protectionto localproduction. Fmally, furthe legislationwill be pased to makepermanent the ban on grantingcustoms exemptions and reductions. 43. In December,1990, the Governmentannounced its intentionto unifythe tariff structure at a singlerate of 15 percent by January1995. Sincethis time, substantialprogress in negotiationsbetwee the membercountries of the AndeanGroup has led to a decisionin principle(on December5 1991)of the AndeanPresidential Council to create a customsunion. Thiswould require Peru to applya commonexternal tariff (whichhas not yet been negotiated) from January1 1992. The tariff wouldhave no more than five rates, rangingfrom 0 to 20 pert, and the numberof rates wouldfall to no more than four (rangingfrom 0 to 15 percent) by Januaty 1 1994. , for any reason,the steps necessaryto implementthe commonexternal tariff,as it has been ageed in pdnciple,do not appear likelyto be taken withina reasonable perod, the Govenment intendsto maintainits current objectve of a singletarff rate. Also, if the fiscalsituation permits, the Governmentwill eliminate export taxes and attempt to provide equitable scal tatment to all exports,both traditionala id nontraditional - 90 - ANNEX 6 Page 12 of 18 44. Consistentwith the abovereform program, the Governmentis committedto carryout the scheduleof trade-policyand customs-reformactions in AppendixA.

V. Monitoringof the Macroeconomicand Trade-ReformPrograms and the FmancingPlan 45. In order for the Bank to be kept informedof the progressof the trade reform and of the conditionsthat wouldgovern the proposedloan and to formthe basisfor a continuing dialogueon trade and macroeconomicpolicy, the Governmentwill provide information to the Bankon the macroeconomic-stabilization,trade-reform, and customs-reformprograms according to the scheduleset forth in the attachedAppendix B. V. Conclusion 46. The Governmentwill continue to exchangeviews with the WorldBank in the areas coveredby this projectand to discussthe progressmade in implementingthe proposed reforms. 47. The trade policiesdescribed in paragraphs28 to 44 aboveare those that the Goernment is nowimplementing, or plans to implementin the near future. These policieswill also be the basis for Peru's positionin any internationalnegotiation related to trade issues. In the event that these negotiationsresult in an internationallegal instrument, the Pennian Governmentunderstands that the Bank could requestthe relevantinformation so as to decideif this instrumenthas, or could have,a significantnegative impact on the programagreed in ftis Letter. 48. Fmaliy,I wouldlike to reiterate that the Governmentis committedto carig forwardits trade-policyreform program and to continuingits policydialogue with the World Bank. In considerationof the trade reformsalready undertaken, within the contextof Peru's overallprogram of economicstabilization and reintegrationinto the internationalfinancial community,the Governmentrequests your favorableconsideration of this request for a Trade PolicyReform Loan.

Yours sincerely,

/S/ CarlosBolofia Behr Ministerof Economyand Fmance - 91 - ANNZ 6 Page 13 of 18

bppondixA

b%2=IJL1 OETRE POLIC AND AI)MINSITRAON ACIOLNSTC BE UNDERTAKEN

Polies to bt. Maintained.or ActionsUndertaken. by Time of Board Presentation

(a) EVcha=ie ra= pogy. Maintenance of the convertibilityof the local currency at a singlerate of exchangefor all externaltransactions. (b) Tarff Not to increasethe levelof protectionoffered by the tariff sucture beyondtJat effectiveon July 5, 1991,unless and until a new tarff is implementedin accordancewith the December5, 1991,statement ("Actade Barahona")of the VI AndeanPresidential Council Not to increasethe levelof protectionoffered by the tariff structure beyond that effectiveon July 5, 1991,will require the following:

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

(Ii) No tarff positioncurrently at 25% to be assigneda tariff any higher than 25% or ower than 15%;

(iii) No taiff positioncurrently at 15% to beamigned a tariffany higheror lowerthan 15%; (iv) The numberand coverageof tariff positionsnow subjectto the 5% rate not to be increased;

(v) No tarf positioncurrently at 5% to be assigneda tariff rate any lower than 5%;

(vi) Not to utilizea possiblereclassification of the tariff code fromthe curent NABANDINAMnomenclature to any other, if such a reclassificationwould have the effectof grantingadditional protection to any product.

Aleratively Peru may tmplement a common external tarff under the aegis of the Andean Gtoup, prvided that it is substantiallyin accordancewMth the Decmber 5, 1991,statement of the VI AndeanPresidential Council, which providesfor no more than fiverates, the highestat 20%.

Nommml/tumAnci de BUnssaspma el Gnpo Andio. - 92 - ANNEX 6 Page 14 of 18 (c) Tarif exemptio Not to reintroduceany exemption(frasauia or exonei) to the applicationof the tariffcode except:those that result from interational agreements;and those allowedin export-supportprograms establishedunder D.S. 034-91-EF(temporary admission), and DS 052-EF (rawback), internamientotemporaL and replenishmentof stocks. (d) AgQFral surhar. The Goernment willnot expandthe surchargescheme beyondthe 18 NA3ANDINApositions listed in D.S. 0016-91AG. In the calculationof the minimumEo.b. price for each of the 18 NABANDINAitems under the surchargescheme, several guidelines will be followed: (i) the floor price wBibe equal to the arithmeticaverage of the internationalprice registered in each of the 60 previousmonths; (ii) the relevantinteriational referencefo.b. price for tariff itemswill be taken fi-oma recognizedinternational publication agreed upon with the Bank. The methodologyfor calculating minimum prices willbe publishedand strictlyfolowed thereafter. In addition,the Goenment wM pubfish monthly. the minimum£o.b. price; the series of 60 previous monthlyrecordings of the relevantinternational price; and the source of the latter. Thi conditiondoes not applyto the importationof powderedmilk for winchthe surchargeshould be specificand wouldhave a ceilingof VS$496per ton for powderedmilk and US$614per ton for dehydratedmflk fat.

(e) Fet zones. Anynew, or expandedexisting, free trade zone willbe authorizedto sell finishedgoods or inputs onlywithin said zones or outsideof Peru. Anygood or input comingfrom these free trade zonesmay be sold in the domesticmarket if duties and other taxesare paid. (*f) No~n-tariffiEi§n (i) Refrain from usingreference prices and mirnmumvalue (aforou) pricesas a wayof protectingdomestic production. Mhiscondition wfll not applyto the customscategories includedin D.S.0016-91 ACt.

(ii) Not to reintroducenon-taiff barrierson importsor exports (includinghcensing, prohibitions, monopolies, quantitative resictions, controlsor prohibitionson second-hand imports,national-content coefficients, prior-registration requirements),nor domestictrade restrictionsfurther to those that prevaied on July 5, 1991. TIis conditiondoes not applyto the dipositionsof LegislativeDecree No. 653 and the subsequentamendment to LegislativeDecree No. 668 regardingpowdered milk within the contextof promotinginhestment in the agriculturalsector.

(iii) Agree withthe Bank on tersw of referencefor a studyto developconsistent criteria and correspondingregulations assuringthat health and fitosanitaryregulations and - 93 -

Page 15 of 18 technicalstandards (particularly those administerd by the Ministriesof Agriculture,Health and Industry)are applied impartially,without the aim of grantingnon-tadff protecton to localproducers.

() AAnti-dumpingcode. Agree wit;ithe Bank on terms of referencefor a studyto recommendamendments to the Code (D.S. 133-91-Er),and to proposea draft for the Code'simplementing regulations, in line with the Government's commitmentto amendseveral aticles of the Code so thzatit dons not become an instrument of unjustified protection for domestic produces

(h) Exoort taxes and subsidies.

(i) Not to raise or increasethe number of current exporttaxes or extend them to other products.

(ii) Not to introduceany fiscalor financialmeasures the effectof providingdirect exportsubsidies or providing exportersaccess to domesticcredit - credit fundedvia domesticsavings - at belowdomestic interest rates for loans of comparablerisk, maturityand co11ateraL (I) InstittoZn,alrfurmt Ensurethat the dismantlingof all of the trade-regulatoiy functionsof the Institutode ComercioExteric 'ICE) has been completedand that those functionsof ICE havingbeen transm.ed to other government agnies do not includeany relatedto the controlof importsor exportsin any rpect, includingthe grantingof .electiveor globalimport duty exemptionsfor Ny type of domesticactivity or the establishmentof exporttaxes, subsidies or selctive exportprobibitions Uj) Qutma' (i) agree on an ActionPlan to restructurethe CustomsSuperintendency (SUNAD)and to reformthe legalframework of customs;and (ii) complywith the first-phaseconditions listed in the ActionPlan for restructung Customs.

21 lhs Acin Planis conted in Plando Accidnam el Sisde de Aduanasde Pwn'Anexo IV of do&wU of tla hta-AmwicanDw.dlmnt Dank,PerS: Pr o de Ajqst dd Scam de Com g 10 S , 1991. - 94 - ANNEX Page 16 of 18 2. Ac&onsto be Undtaken by Mabc 19S9 A goneralcodition to be met by this tih'e is satisfactotyprogress in the executionof the trade policyreform program, including the non-reersa of the policyactions previously requiredfor Board presentation. Further conditionsin each of the areas of the programare listedbelow. (a) Tag PElininationof the S% tariff rate and establishmentof a two-tier tariff ucture. All tariff itemsthitt were previouslysubject to the 5% rate wM be subjectto the 15% rate. IE,on or aroundMarch 1992,it appeas likelythat a new tariffwill be implemented,during 1992,in accordancewith the December5, 1991,statement of the VI Andean PresidentialCouncil, the Govemmentand the Bank will consultwith a viewto postponingor cancellingthe eliminationof the 5% tarff rate. (b) AWcOturalsurcharges. Agree with the Bank on the terms of referencefor a study to evaluatethe surchargescheme (paragraph l(d) above). (c) Non-tfaia Agree with the Bank on the guidelinesand principlesto be appliedin implementingthe results of the studyof health md fitosanitary regulationsand technicalstandards agreed upon by Board presentation(para 1(f)(ii)above). (d) A W code, Enact the amendmentsto Decree D.S. 133-91-EF,based on the recommendationsof the studycommissioned and agreed up on wth the Bank, so that the Anti-dumpingCode does not becomean instrumentof unjustifiedprotection (para l(g) above). (e) oms. Implementsecond phase conditionsof the Acion Plan for restructung Customs.

3. Actionsto be Undertaen by June. 1992# A generd conditionto be met by this time is satisfactoryprogress in the eaecutionof the trade policyreorm program,including the non-reversalof the policyactions previously requied. Further conditionsin each of the areas of the programare listedbelow.

I/ Thisdate is inkdictve,rather tha binding,as fartas furthr conditionar concerned. 41IThs dae*is indicative,rather tha binding,as faras further conditions ar concerned. - 95 -

Page 17 of 18 (a) turil surthag Agreewith the Bank on the guidelinesfor the implementationof the recommendationsof the studyon the surchargescheme (paragraph2(b) above).

(b) No-ab . Appropnate implementationof reorms to health and phytosanitaiyregulations and technicalstandards in line with agreed guidelies (para 2(c) above).

(c) ms. Implement the third phase conitions of the Action Plan for restruuring Customs. 4. Actionsto be UndMert by September.1992k A geal conditionto be met by this time is satisfactoryprogress in the executionof the trade policyreform program, including the non-reversalof the policyactions previous required. A further conditionis as follows. (a) Agical surcharges.Appropriate implementation of reformsto the surchargescheme in line with the agreedguidelines (para. 3(a) above). 5. Acions to be Undetakn by December.1992 A genea conditionto be met by this time is satisfactotyprogress in the executionof the trade policyreform prognam, including the non-reversalof the policyactions previously required.

gI Thisddai b dcatve, rtr ta bindin,t,as foras fwre conditn a - 96 -

Page 18 of 18

&Mpen. B SCHEDULEOF REPORTW.Cv

1. dhe macroeconomicadjustment program: monthlypovision of monthlydata on:

(i) CentralGoernment current tax revenue; (i) PrimaryBalance of the non-financialpublic sector (on a v.guartcrybasis); (ii) Rate of creationof monetarybase;

(iv) Stock of other Central Bank monetary lhabflitiesin Soles.

2. Trade Reform: quarterlyprvision of

(i) all policydocuments and customscommunications relatng to: exchange-rateand trade and treuivalent measures (includinghealth & fitosanitaryregulations and technical standardswhich affect foreign trade, documentsrelatig to hearn of the Anti-dumpingcommission, documents related to regionalintegration). (il) monthlyexchange-rate- and trade-relatedstatistics: (il) importsand exportsby commodity(and advancecustoms statisticsrelating to trade throughCallao and JorBeChavez airport);

(iv) importtax colnection(tariffi and IGV tax separately)and exporttax collection(by export commodity); (v) for agricultural-surchargeproducts: referencepices and comparablecurrent world prices; value and volumeof imports(cif) and domestically-producedsales;

3. Cusoms : the Bankwil receivethe same report, on the sameschedule, as thoe to be sent to the Inter-AmercanDevelopment Bank (as specifiedin Paragraph3.25 of AnnexVM-A of Perd Pdstamo de Ajuste del Sector de 4 45QQ-9): Pouet de, 10 Septmber, 1991). - 97 -

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 Economfa Peruana October, 1991

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

Ing.Jorge A Cavallotti, Procedimientos Recomendadospara Aceterar los Desembolsos de los Pr&stamosde Ajuste Propuestos para Perd. September 16, 1991

Ing. Jorge A. Cavallotti,Perdl: Informe de Evaluaci6n del Sistema de Adquisicionesde Bienes y Serviciosv Obras Civiles.September 16, 1991

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

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

PNUD - Banco Mundial - ?rograma de ExpLnsi6ndel Comercio, Perd: Hacia una Economfa M-a Abierta draft, August, 1991

Rodrfguez, Carlos, Foreign Exchange Market, June, 1991 - 99 -

Page 1 of 2

STAlUSOF BANK GROUPOPERATIONS IN PERU

A. SUMtkAR UA M O]EgR1FLOA0N (As of November30, 1991)

Amountless lM YAK]mc E oseusI1on iluieakum1 (US$Millions) Fifty-eight(58) loans fidlydisbursed 1151.88

2091 1982 Republicof Peru Transpmt 93.0 50.39 2396 1984 Republicof Peru Rura Dev. 40.0 32.80

Total: 1284.88 Ofwhich has been repaid: 448.44 Total now outsanding: 836.44

Amountsold: 18.31 of which has been repaid: iL31

Total now held by Bank: 818.13

Total undisbursed: 1L12 - 100 -

Page 2 of 2

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

Amount in US$ million Date BoMrower Te of Busineys ln i in

1990 BUENAVENTURA Metal Ore Mining .00 1.01 1.01 1979 Non-Ferrous Ore Mining 2.00 .96 2.96 1983 4.00 .00 4.00 1986 .00 1.00 1.00 1986 CARISA Non-Ferrous Ore Mining 6.00 .50 6.50 1962 CEMENTO ANDINO Mfg of Cement Lime & Plaster 2.46 .20 2.66 1982 CONENHUA Mfg of Electric Light & Power 4.50 .00 4.50 1975 CUAJONE Non-Ferrous Ore Mining 15.00 .00 15.00 1960 DURISOL Mfg of Fabric Metal Products .30 .00 .30 1960 FERTILIZANTES Mfg of Fertilizers & Pesticides 3.19 .00 3.19 1962 .90 .00 .90 1960 LUREN Mfg of Non-Metallic Mineral PR .28 .00 .28 1985 MiNERA REGINA Non-Ferrous Ore Mining 6.08 .24 6.32 1986 ORCOPAMPA Non-Ferrous Ore Mining 9.00 .00 9.00 1964 PACASMAYO Mfg of Cement Lime & Plaster 1.60 .49 2.09 1967 .00 .01 .01 1983 PALMESA Mfg of Vegetable & Animal Oil 15.00 .00 15.00 1986 PODEROSA Non-Ferrous Ore Mining 3.30 .00 3.30 1960 REUNIDAS Mfg of Fabric Metal Products 25 .00 .25 1980 SIMSA Non-Ferrous Ore Mining 2.7 .50 3.20 1985 4.00 .00 4.00 1982 SOGEWIBSE Leasing CompaDies 3.00 .14 3.14

Total gross commitmen_: 83.56 5.04 8&60 Less cance1lations,terminations and sales: 762252Q

Total commitments now held by IFC: 7.31 2.27 9.58

Total undisbursed: - 101 - ANNEX9 Page 1 of 5

TECHNICALASSISTANCE

1. bThenew liberalizedtrade regimerequires procedures, skills, and institutionswhich differmarkedly from those applied under the previous dmitration. A technicalassistance program is proposedto financepolicy studies, seminars and training and institutionalreforms to advancethe Government'sefforts in foreigntrade liberalization. 2. lle cost of the technicalassistance program is estimatedat about $350,000,consisting of: (a) $150,000for policystudies ard seminarsand training;and (b) t*00,000 for support to MICITI's trade promotion and internationalnegotiations activities.l/ . ;ese activitieswill be financedfrom the JapaneseGrant Facilityfor structuralreforms. The Bankwould act as executing agencyfor the technicalassistance program. Both the MEF and the MICITIwill assign counterparts to coordinatethe technicalassistance program with the Band The programwill be made effective followingthe finalizationof the legal agreementfor the Japanese Grant Facilitybetween the PeruvianGovernment and the Bank.

A. Poliy Studiesand Seminars/Training:$150,000 Studyon Amendmentsto the Anti-DumpingCode

3. The studywould recommend amendments to the recentlyestablished anti-dumping and anti-subsidycode (D.S.133-91-EF issued on June 13,1991)and for its implementingregulations, in line with the Government'scommitment to amend the Code so that it does not become an instrumentof unjustifiedprojection. This involves, inter alia.establishing: (a) the need for an 'injury tests in all anti-dumpingclaims; (b) penaltiesfor claims that turn out to be unfounded;and (c) transparentprocedures in whichthe interestsof consumersand of other Peruvianfirms are weighed againstthose of the applicantfirm. The terms of referencefor the studyshould be agreed by the Bankand the Governmentby Boardpresentation of the TradePolicy Reform Loan, and amendments to the Code,based on studyrecommendations should be enactedby March, 1992. Evaluationof the Schemeof AgriculturalTariff Surcharges 4. The studywould review the objectivesand functioningof the surchargesystem as created under D.S.0016-91-AG (and subsequentmodifications). The studywould also includethe impactof pviions, relevantto productsfalling under the system,contained in D.L 653,Legislative Decree on AgriculturalInvestment. The studywould ascertain the economiceffects of the system on PeruvianpiJucts (includingregional impact - on Costa,Sierra, and Selva)and on consumes (especiallythe poor) and recommendmodifications to the system. Ihe terms of reference for the study should be agreed by the Bank and the Governmentby March, 1992,and guidelinesfor implementingthe study'srecommendations should be agreed by June, 1992.

IL In addition,the Bank plans to asist CaeMICMI in developinglocal industries ($70,000) and promong torism industry($30,000) dtough the sameJapaue GrantFacility. - 102 -

Page 2 of 5 Studyon Policyfor Non-Taiff Barriers

5. The studywould develop criteria and correspondingregulations assuring that health and phytosanitaryregulations and technical standards (particularlythose administeredby the Ministriesof Agriculture,Health, and Industty)are appliedimpartially, without the aim of granting non-taiff protectionto localproducersm The terms of referencefor the studyshould be agreed by the Bankand the Govemmentby Boardpresentation, and guidelinesand principlesto be appliedin imnlementingthe resultsof the studyshould be agreedby March, 1992. Studyon RegionalEconomic Integration Options for Pegu 6 The objectivesof the studyis to help Peruvianpolicy makers evaluate the economic ostsand benefitsof regional-traa;ngoptions currently under di£ ¢r"n (particularlyAndean Pact propostis) and help them identifycritical areas for negotiation. The study wouldbe particulary concemedabout the compatibilityof regirnalarrangements with the overallecononic reform process, includingtrade-policy refonn. It wouldbe organizedaround the followingtopics: historyof regional economicintegration arrangements in the Andean Group and within ALADI; current regionaleconomic-integrationoptions; current and plannedeconomic reforms; and the interactionsof regional integration,overal economicreform, and gainsfrom trade.

Trade PolicySminar andIrainint 7. Governmentofficials, private executives, the press and the wider communitywould benefit from a greeter understandingof the consequencesof the Government'snew trade policy measuresor of accessionto GAIT. To facilitatean informedpublic debate, it is importantto organizepublic seminars on the implicationsfor Peru of trends in internationaltrade, trade policy teform and experiencesof other nations,the GJATTsystem, and the Andean Pact The seminar wouldfeature speakers from relevant organizationsand draw upon several lines of research and technicalexpertise of the WorldBank. Fundswould be also made availableto providetraining on the abovetopics (both in Peru and abroad)for relevantGovernment officials

B. Institutnal Reforms:Support to the MICM for Export Promotionand International Tradc Negotiations:S2200.0 ackgound & During the past decade,Peru's experience in the promotionof exportshad mixed tesults. In the first attempt to liberalizePeru's foreigntrade regime,the governmentcreated the Fondo Promocionde Exportaciones(FOPEX) in 1979. FOPEX made importantcontributions to developingPeru's exportcapacity in closecollaboration with the privatesector. However,in late 1986,under the previousGovernment, it wasabsorbed into the Ilstituto de ComercioExterior (ICE). For variousreasons, ICE wasbureaucratized and becamethe focalpoint of discretionary import controlsand exportsubsidies. 9. In a renewedattempt to advanceforeign trade liberalization,the Fujimond Goverment decidedto de-activateICE in August,1990. In June, 1991,ICE's assetsand promotionalfunctions were transferredto the MICITI,and mostof its staff were released. With 103 -

Page 3 of S participationfrom the privatesector, the MICMTIplans to establisha small,but efficientgroup of professionalsin charge of export promotionand advisoryservices for internationaltrade negotiations. On September14, 1991,D.L 684 wasissued, authoring the constitutionof a new association.The membersof the new association(to be calledAsociacion para la Promociony Desarrollode las Exportacionesdel Peru - PROMOEX)would include both the Govenment (representedby the MICM) and leadingindustry associations: la Asociacionde Exportadores (ADEX),la SociedadNacional de Industriales(SNI), and la SociedadNacional de Exportadores (SNE). A SupremeDecree, which defines the organizationand operativeprocedures of PROMOEX,is being crafted, and its constitutionis to be ratifiedby the end of September,1991.

i "NOMOExFunctiomnsI 10. The majorobjectives of PROMOEXare to: (a) promoteand developPeruvian exportsin general;(b) enhance the qualityand imageof Peruvianproducts and services;and (c) promotedomestic and foreigninvestments for export-orientedactivities. To this end, PRO4OEX will: organizeinternational trade fairs,trade and commercialmissions, and other events;collect dataminfoans tion, undertakemarket research, and producevarious publications for the use of exporters;and providetechnical advice on internationalnegotiations. It willconsist of three functionaldepartments--information and studies,promotion and development,and intemationaltrade negotiations(see the appendixto this annexfor its organizationchart). PROMOEX'sbasic activitieswill be financedby the three privateagencies, ADEX, SNI and SNE.

TechnicalAgsistance for the MICIT 11. Technicalassistance for the MIClTI ($200,000)aims to foster the organizationc' PROMOEXand its capacityfor marketresearch, compilation of data and statistics,and intemationaltrade negotiations.It willfinance senior professionalstaff of PROMOEXand short- term consultants(both nationaland external)as follows: (a) Supportto PROMOEX'sprofessionals: @$2,500/mo. x 48 = $1?A.000 * GeneralManager: responsible for overalladministration, including developmentof its work program,financial management, and coordination with el ConsejoDirectivoL

* Managerfor informationand studies: responsiblefor marketresearch, compilationand disseminatiorof trade information/statistics, and librahy,

2J PROMOEXwill be govened by elConsjo Directivo, consting of two esetativ of dheGovemet ad _ vesof themember agences. El Cmose3oDirectivo will met at leastevey month.It will assumfinald ponsibilityfor development of its anal workprogrm., financial pusmnd andote keypolicies. - 104 -

Page 4 of S * Manager for promction and development: organization of trade fairs and events, development of design and fashion, promotion of sector activities, e.g., textile, foods, agro-fisheries, metal mining,chemicals, and art crafts; and

* Mianagerfor providing advisoryservices for international trade negotiations: responsible for Latin American regional integration, bilateral negotiations, and multilateral negotiations.

(bj Support to short-term national and external consultants: $8000_0 Consultants would assist in planning and implementingthe PROMOEX work program auAd provide technical training for its staff.

12 The Bankestechnical assistance would complement the support to be provided by other donors The IIDWsTrade Reform Loan (signed on September 18, 1991) includes a $400,000technical assistance program to PROMOEX in supoort of short-term national and internatioral consultants, purchase of computers, and other operational expenses. The European liconomic Communityand several bilateral donors (for instance, GTZ, the German Company for techncial Cooperation, and JEIRO, the Japan Externa! Trade Organization) have indicated their interests in assistingin the organization of trade fairs and commercial missions. - 105 - AMNX 9 Page 5 of 5

GEREENTE GENERAL

GERENCIADE GRRENCIADE GERENCIADE INFORMACIONY PROMOCIONY NEGOCIACIONES ESTUDIOS DESARROLLO COWERCIALES INTERNACIONALES

DEPARTANENTODE 1DEPARTAMENTO DEL IGERENCIA DE .4 INVESTIGACION ICENTRODE MODA _ INTEGRACION DEMERCADOS IYDESENO LATINOAMERICANA

DRPARTAMENTO DEPARTAMENTODE- GERENCIAD - DR INFORMACION LOWISTICAY - NEGOCIACIONES COMERCIALE ORGA19ZACION BILATERALES IlFORMATICA J,E-EVENTOS

DEPARTANENTODEL DEPARTAENTOS GERENCIADE CENTRODE SECTORLELS NEGOCIACIOUES DOCUMCION Y (TEXTILES, MULTlIATERALES ORIENTACIONBASICA COmECCIOnESY CUEROS,AGROPEC., PESCA, METALNEC. QUMICOS, ARTESA- NIAS, ETC.) - 107 - ANNEX 10 Page 1 of 3

PERU

TRADE POLICY REFORM LOAN

Supplementat Loan Data Sheet

Section I: Timetable of Key Events

(a) Tune Taken by the Government to prepare program: June 1991 - August 1991 (b) Program prepared by: Ministryof 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 Peru under the Bank's new policy of Additional Support for Workout Programs in Countries with Protracted Arrears. The Bank's workout is part of, and contingent on, an extemal financingplan for 1991and 1992agreed among the intemational financialinstitutions and a Support Group of bilateral donors. It is also contingent on Peru's performance under a Bank - and IMF - supported macroeconomicstabilization program. Under the Bank's new policy, the Board's approval would entitle Peru to the immediate disbursement of the whole loan amount after loan signing and effectiveness. These would take place at the erd of the performance period upon satisfactory implementation of the trade policy reform program, the economic stabilization program, and the external financing plan (includingclearance of all Bank arrears). The performance period, which started with the initial reforms of August 8, 1990,would terminate in December, 1992, concurrently with the termination of the IMFs rights accumulation program.

Section III: Special Conditions

1. The followingconditions for Board Presentation have been met:

(i) a macroeconomicstabilization program in place and agreed by the IMWand the Bank; this program provides the common framework for this loan and the two subsequent adjustment loans proposed for Pe-ru'sdebt workout.

(ii) an external financing plan. agreed among the intemational financial institutions and the Support Group, which provides for full clearance of arrears to the Bank and the normalizationof 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 coveredunder (h) above),on the termsaleady agreedwith the Govenment - 108 - ANNEX 10 Page 2 of 3

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

2. The followingsectoral conditions for Board Presentaiion have been met:

(a) Some sectoral measures designed to prevent reversal of trade reform policiesalready in place have been maintained. The following measures, if trAken,would have constituted a policy reversal:

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

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

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

(iv) extension of coverage of the agriculturalsurcharge scheme

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

(vi) reintroduction of banned non-tariff barriers, includingthe use of reference prices for protective purposes;

(vii) raising of export-dutv rates or extension to new products or reintroduction of fiscal or financial subsidiesto 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, and propose corresponding regulations,which minimizethe protective features (i.e. those that 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 against legitimate import competition and it operates in an transparent manner;

iIf Peru implementsa common extemal tariff which is in accordancewith the tariff crieria establishedm the recent decision-in-principleof the AndeanGroup of countries,dl s conditionwould no longerapply. - 109 - ANNEX 10 Page 3 of 3 (iii) agreement to an Action Plan to restructure the Customs Superintendeny. and compliance with the first phase of this plan.

3. Sectoral Conditions to be met between Board Presentation and Loan 'igning, in addition to continuing 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 the Government and the Bank agree that a new common external tariff is likely to be implemented in accordance with the recent decision-in-principleof the Andean Group;

(ii) agreement to a terms of reference for a study to evaluate the agriculturalsurcharge scheme. agreement on guiidines for implementingthe study's recommendations,and enactment of the reforms in line with the agreed guidelines;

(iii) agreement on the guidelinesand principlesto be applied in implementingthe findings of the study on health, phytosanitary,and technical regulations, and enactment of the reforms in line with the agreed guidelines;

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

(v) compliance with the required actions under the second and third phases of the Customs 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-supported program of macroeconomic stabilization, with particular reference to the Bank's quantitative indicators;

(iii) the continued viabilityof an external financing plan;

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

5. The followingconditions 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 satisfactory implementation of the trade reform and macroeconomicstabilization programs and the external financing plan, in accordance with the provisions of the Letter of Development Policy.