Country Report Peru at a Glance: 2004-05

Country Report April 2004

Peru

Peru at a glance: 2004-05

OVERVIEW The government, led by Alejandro Toledo, is weak, and his personal popularity remains low. Although continued criticism of Mr Toledo’s leadership has prompted speculation over the past year that he might not last until the end of his constitutional term, in July 2006, there is little political desire to remove him, meaning that unless a serious scandal involving him or his inner circle of advisers emerges, he will remain president until July 2006. In mid-February Mr Toledo inaugurated his fifth cabinet in three years to prevent a collapse of his administration. The largely non-party-political nature of the new cabinet is expected to benefit the government. Opposition parties will take advantage of Mr Toledo's weakness, but they have little interest in forcing him from office. The government will be supported by continued economic stability and growth. Economic policy will be kept broadly pro-market, with particular emphasis given to tight fiscal policy and low inflation, but some policy dilution can be expected. Solid economic growth will help the government to increase revenue collection in 2004-05. A global economic recovery is under way, but there are medium-term risks to the Economist Intelligence Unit’s forecast. Economic growth in Peru will reach an annual average of 4% in 2004- 05, driven by mining and exports. Inflation will stay low, the exchange rate will be stable and the current-account deficit will stay within manageable levels.

Key changes from last month Political outlook • The president's position remains weak, but we consider that he will remain in the post until his constitutional mandate ends, in 2006. Economic policy outlook • A substantial increase in tax revenue in 2004 will allow the government some room for manoeuvre in increasing social expenditure. Economic forecast • There are no major changes to our economic forecast.

April 2004

The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group.

London New York Hong Kong The Economist Intelligence Unit The Economist Intelligence Unit The Economist Intelligence Unit 15 Regent St The Economist Building 60/F, Central Plaza London 111 West 57th Street 18 Harbour Road SW1Y 4LR New York Wanchai United Kingdom NY 10019, US Hong Kong Tel: (44.20) 7830 1007 Tel: (1.212) 554 0600 Tel: (852) 2585 3888 Fax: (44.20) 7830 1023 Fax: (1.212) 586 0248 Fax: (852) 2802 7638 E-mail: [email protected] E-mail: [email protected] E-mail: [email protected]

Website: www.eiu.com

Electronic delivery This publication can be viewed by subscribing online at www.store.eiu.com Reports are also available in various other electronic formats, such as CD-ROM, Lotus Notes, online databases and as direct feeds to corporate intranets. For further information, please contact your nearest Economist Intelligence Unit office

Copyright © 2004 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author's and the publisher's ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it. ISSN 1356-4064

Symbols for tables “n/a” means not available; “–” means not applicable

Printed and distributed by Patersons Dartford, Questor Trade Park, 151 Avery Way, Dartford, Kent DA1 1JS, UK. Peru 1

Contents

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2004-05 7 Political outlook 8 Economic policy outlook 9 Economic forecast

12 The political scene

16 Economic policy

18 The domestic economy 18 Economic trends 21 Agriculture 22 Mining 23 Manufacturing 23 Infrastructure

24 Foreign trade and payments

List of tables 9 International assumptions summary 11 Forecast summary 16 Non financial public-sector (NFPS) operations 18 Gross domestic product by expenditure, 2003 19 Gross domestic product growth by sector 20 Consumer price inflation 21 Average interbank exchange rate 24 Merchandise exports 25 Merchandise imports 25 Current account

List of figures 11 Gross domestic product 11 Consumer price inflation

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 . Peru 3

Summary April 2004

Outlook for 2004-05 The government, led by Alejandro Toledo, is weak, and his personal popularity remains low. Although continued criticism of his leadership has prompted speculation that he might not last until the end of his constitutional term, in July 2006, the Economist Intelligence Unit considers it likely that he will see out his term of office. Economic policy will be kept broadly pro-market, with particular emphasis given to tight fiscal policy and low inflation, but some policy dilution can be expected. Solid economic growth will help the government to increase revenue collection in 2004-05. A global economic recovery is under way, but there are medium-term risks to our forecast. Economic growth will reach an annual average of 4% in 2004-05, driven by mining and exports. Inflation will remain low, the exchange rate will be stable and the current-account deficit will stay within manageable levels.

The political scene A number of new scandals have further damaged Mr Toledo's credibility. In mid-February Mr Toledo inaugurated his fifth cabinet in three years, with Pedro Pablo Kuczynski returning to the Ministry of Finance. The prime minister, Carlos Ferrero, only just won the congressional vote to support his new cabinet's programme. Mr Toledo's Perú Posible party remains divided and its alliance with the FIM strained. The new head of the intelligence service has been forced to resign. The opposition has started to take a stronger stance against Mr Toledo. Congressmen have been criticised over their salaries.

Economic policy The fiscal deficit target of 1.9% of GDP was reached in 2003. Current revenue continues to rise strongly following the implementation in 2003 and early 2004 of a number of tax reforms, including, from March 2004, the introduction of a controversial new tax on banking transactions. The Central Bank has imposed a 20% reserve requirement on foreign bank credits. The government is starting to prepare for negotiations towards an FTA with the US.

The domestic economy Economic growth reached 4% in 2003, driven by mining and exports. Non- primary manufacturing expanded by 3.4% in 2003, owing mainly to increased demand from the US for Peruvian textile products. Construction continues to be buoyed by Mivivienda and the Camisea natural-gas project. Consumer price inflation has edged upwards but remains within target. Exchange-rate stability continues. Agricultural output has increased only slowly. Metallic mining remains the economy's most dynamic sector. Manufacturing output has been sluggish. Competition in the mobile-phone market has been threatened by Telefónica's purchase of BellSouth's South American operations.

Foreign trade and payments The merchandise trade surplus expanded to US$710m in 2003, helping to bring the current-account deficit down to 1.8% of GDP. The incomes deficit continues to rise sharply, owing to rapidly increasing profit remittances abroad. Editors: Martin Pickering (editor); Justine Thody (consulting editor) Editorial closing date: April 8th 2004 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 4 Peru

Political structure

Official name Republic of Peru

Form of state Presidential democracy

The executive The president, who is directly elected for a five-year term, may not be re-elected to a second consecutive term; he appoints a Council of Ministers

Head of state Elected president, currently Alejandro Toledo, who was inaugurated as president in July 2001, having won a second-round election in June; he is scheduled to govern until July 28th 2006

National legislature Congress consists of a 120-member single chamber, which can be dissolved once during a presidential term

Legal system Courts of first instance in the provincial capitals; the Supreme Court sits in Lima

National elections November 2002 (regional and municipal); next elections due 2006 (presidential and congressional)

National government Mr Toledo leads the government; his party, Perú Posible, with 47 of 120 seats in Congress, formed an alliance with the FIM and has also co-opted the congressman elected under the banner of Todos por la Victoria

Main political organisations Government: Perú Posible, in alliance with the Frente Independiente Moralizador (FIM) Opposition: Partido Aprista Peruano (Apra); Unidad Nacional; Unión Parlamentaria Descentralista, an alliance of three parties—Unión por el Perú, Somos Perú and Acción Popular; four independents

President Alejandro Toledo President of the Council of Ministers & prime minister Carlos Ferrero Key ministers Agriculture José León Defence Roberto Chiabra Economy & finance Pedro Pablo Kuczynski Education Javier Soto Energy & mining Jaime Quijandría Foreign relations Manuel Rodríguez Health Pilar Mazetti Housing, construction & sanitation Carlos Bruce Interior Fernando Rospigliosi International trade & tourism Alfredo Ferrero Justice Baldo Kreslja Production Alfonso Velásquez Transport & communication José Ortiz Women & social development Ana María Romero Work & employment promotion Javier Neves

Central bank president Javier Silva Ruete

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 Peru 5

Economic structure

Annual indicators 1999a 2000a 2001a 2002a 2003a GDP at market prices (Ns bn) 174.7 186.8 188.2 198.4 212.2 GDP (US$ bn) 51.6 53.5 53.7 56.4 61.0 Real GDP growth (%) 0.9 3.1 -0.1 4.9 4.0 Consumer price inflation (av; %) 3.5 3.8 2.0 0.2 2.3 Population (m) 25.5 25.9 26.3 26.7 27.2b Exports of goods fob (US$ m) 6,087.3 6,950.8 7,006.8 7,647.0 8,954.2 Imports of goods fob (US$ m) 6,793.3 7,406.6 7,273.4 7,439.9 8,244.4 Current-account balance (US$ m) -1,518.7 -1,557.2 -1,183.8 -1,206.1 -1,115.9 Foreign-exchange reserves excl gold (US$ m) 8,730.5 8,374.0 8,671.9 9,339.1 9,776.8 Total external debt (US$ bn) 29.2 28.7 27.5 27.9b 30.0b Debt-service ratio, paid (%) 28.2 25.6 22.2 48.8b 33.7b Exchange rate (av) Ns:US$ 3.38 3.49 3.51 3.52 3.48 a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2003 % of total Components of gross domestic product 2003 % of total Agriculture, livestock and forestry 9.0 Private consumption 71.1 Fisheries 0.4 Government consumption 10.8 Mining and hydrocarbons 6.6 Gross fixed investment 17.7 Construction 5.2 Stockbuilding 0.8 Manufacturing 14.7 Exports of goods & services 17.4 Services 62.0 Imports of goods & services -17.5

Principal exports 2003 US$ m Principal imports 2003 US$ m Gold 2,044.7 Intermediate goods 4,337.4 Copper 1,260.5 Capital goods 1,982.0 Fishmeal 821.0 Consumer goods 1,849.7 Zinc 528.7 Other goods 75.3 Total exports fob 8,954.2 Total imports fob 8,244.4

Main destinations of exports 2002 % of total Main origins of imports 2002 % of total US 26.0 US 25.3 China 9.1 Chile 7.7 UK 6.4 Spain 5.0 Switzerland 5.6 Colombia 4.9

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 6 Peru

Quarterly indicators 2002 2003 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Non-financial public sector finance (Ns m) Central government revenue 6,160 7,200 7,429 7,530 7,403 7,858 7,840 8,222 Central government expenditure 6,333 7,078 7,658 7,968 6,996 7,620 8,100 8,585 Other entities 698 371 440 354 405 558 487 486 Capital revenue 49 34 32 82 14 15 125 65 Capital expenditure 1,076 1,516 1,554 1,858 1,222 1,468 1,426 2,161 Overall balance -502 -988 -1,312 -1,860 -395 -656 -1,074 -1,974 Overall balance (% of GDP) -1.1 -1.9 -2.7 -3.7 -0.8 -1.2 -2.1 -3.7 Output Manufacturing production index (1995=100) 105.6 118.4 112.8 117.1 112.9 119.7 113.9 116.3 Manufacturing production index (% change, year on year) -0.8 4.4 5.7 7.6 6.8 1.1 1.0 -0.7 GDP at constant 1994 prices (Ns m) 29,392 34,035 31,354 32,225 31,217 35,283 32,418 33,134 GDP at constant 1994 prices (% change, year on year) 3.2 6.3 5.1 4.7 6.2 3.7 3.4 2.8 Employment, wages and prices Unemployment rate (end-period; % of the labour force) 10.6 9.9 8.5 8.6 10.0 9.3 9.0 9.4 Average nominal wages (Ns per month) 885 901 899 899 n/a n/a n/a n/a Average nominal wages (% change, year on year) 4.7 6.0 3.7 4.9 n/a n/a n/a n/a Consumer prices (Dec 2001=100) 99.6 100.7 100.9 101.7 102.5 103.1 102.8 103.6 Consumer prices (% change, year on year) -1.0 0.1 0.3 1.4 2.8 2.4 1.9 1.9 Wholesale prices (1994=100) 151.2 152.1 153.7 155.0 155.0 155.5 155.2 156.7 Wholesale prices (% change, year on year) -2.9 -2.3 -0.5 1.5 2.5 2.2 1.0 1.1 Financial indicators Exchange rate Ns:US$ (av) 3.46 3.46 3.57 3.57 3.49 3.48 3.48 3.48 Exchange rate Ns:US$ (end-period) 3.45 3.51 3.64 3.51 3.47 3.47 3.48 3.46 Deposit rate (av; %) 4.5 3.3 3.7 5.2 4.4 4.0 3.8 3.2 Lending rate (av; %) 16.0 14.5 13.7 14.7 14.7 13.8 14.3 14.0 M1 (end-period; Ns m) 21,134 21,589 21,999 22,049 21,790 21,004 20,812 21,524 M1 (% change, year on year) 1.9 4.4 8.5 2.8 3.1 -2.7 -5.4 -2.4 M2 (end-period; Ns m) 60,482 61,724 65,351 64,262 63,362 62,429 61,939 62,540 M2 (% change, year on year) 1.7 3.0 8.2 5.1 4.8 1.1 -5.2 -2.7 IGBVL stockmarket index (end-period, 1991=100) 1,299.8 1,135.0 1,150.0 1,391.9 1,558.9 1,824.9 1,980.8 2,435.0 IGBVL stockmarket index (% change, year on year) 2.2 -15.7 -5.6 18.3 19.9 60.8 72.2 74.9 Foreign trade & payments (US$ m)a Exports fob 1,579 1,966 2,125 1,982 2,023 2,184 2,316 2,431 Gold 313 334 390 442 438 512 564 530 Copper 266 313 314 294 280 289 317 375 Fishmeal 107 335 353 99 214 248 222 137 Imports fob -1,643 -1,862 -1,968 -1,967 -2,045 -1,982 -2,086 -2,130 Merchandise trade balance fob-fob -64 104 157 15 -23 202 230 300 Services balance -253 -231 -238 -226 -269 -246 -259 -221 Income balance -310 -383 -424 -392 -513 -461 -551 -549 Net transfer payments 244 253 252 294 271 281 372 319 Current-account balance -388 -257 -253 -308 -534 -224 -208 -151 Reserves excl gold (end-period) 8,628 8,946 9,598 9,339 10,098 9,651 9,348 9,777 a Banco Central de Reserva del Peru. Sources: IMF, International Financial Statistics; Banco Central de Reserva del Perú, Nota Semanal; Bolsa de Valores de Lima.

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 Peru 7

Outlook for 2004-05

Political outlook

Domestic politics The government of the president, Alejandro Toledo, remains fragile. Although continued criticism of Mr Toledo’s leadership has prompted speculation over the past year that he might not last until the end of his constitutional term, in July 2006, there is little political desire to remove him, meaning that unless a serious scandal involving him or his inner circle of advisers emerges, he will remain president until July 2006. His personal approval ratings will remain very low, however, and he is unlikely to recover his credibility with the public. As a result, his priority will be to maintain enough political support to allow his government to survive until 2006. Continued economic growth is likely to be the government’s main asset over the forecast period. That growth, however, will continue to be led by mining and a large natural-gas project, neither of which provide many links to the real economy, and unemployment will remain high. The failure of economic growth to stimulate employment growth and alleviate poverty means that latent unrest will remain a risk. Mr Toledo reshuffled his cabinet in February in a bid to regain credibility and garner the support of the opposition after a scandal involving a close adviser. The main opposition parties, however, have clearly distanced themselves from Mr Toledo and criticism of his government will increase as the 2006 elections draw closer. Mr Toledo has been criticised throughout his presidency for his leadership, and many had suggested that he should allow his cabinet a greater executive role and take a less active role himself. His cabinet change in February went some way towards this—he has given his ministers room to manage their portfolios, as has the prime minister, Carlos Ferrero, which should work in the government’s favour. It is not clear if Mr Toledo will reshuffle his cabinet again in July, when ministers traditionally tender their resignations ahead of the president’s annual address. Mr Ferrero has been able to manage relations with Mr Toledo's party, Perú Posible, and the airing of intra-party disputes in public has declined in recent months. Nevertheless, Perú Posible legislators are likely to continue to display a lack of cohesion and discipline. Perú Posible has a minority position in Congress and its alliance with the Frente Independiente Moralizador (FIM) remains tenuous. The FIM will continue to back the government, but its leadership wants to distance itself from the president's party, which it sees as divisive. The alliance with the FIM is important to guarantee that vital legislation will be approved. For this reason, it is not likely that the alliance will be ended in the near term. The opposition parties have begun to take the offensive against Mr Toledo’s government, as well as to gear up in advance of the 2006 presidential and congressional elections. The main opposition party, Partido Aprista Peruano (Apra), under its leader, a former president (1985-90), Alan García, is seeking to form a broad front with political, union and some business groups ahead of 2006, although it is not clear if it will be successful. Mr García's presidency was marked by hyperinflation, economic collapse and social unrest, and his desire

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 8 Peru

to attract a broad team for 2006 is an effort to dispel the mistrust he still inspires among a majority of Peruvians after his disastrous presidency in 1985- 90. He will seek to project himself as a statesman and as a force for political stability. The centre-right parties do not appear likely to unite to provide a coherent opposition to Mr García. A political outsider could also emerge ahead of the elections. In the short term, Mr García and the leader of the centre-right Unidad Nacional, Lourdes Flores, have discussed the possibility of their parties joining forces in a bid to gain the Congress presidency in July. Pressures on the government will also continue on the social front and there could be sporadic social and industrial unrest. However, revenue from the dis- tortionary financial transactions tax (Impuesto a las Transacciones Financieras, ITF) should help the government ease fiscal constraints and finance a salary increase for teachers and badly needed infrastructure projects. Although there has been strong criticism of the tax from business groups and the public at large, the main union grouping, the Confederación General de Trabajadores del Perú, has supported the tax.

International relations Peru’s foreign relations will concentrate on advancing talks on bilateral free- trade agreements (FTAs), particularly with the US. The minister for international trade and tourism, Alfredo Ferrero, has said that he expects negotiations on an FTA with the US to begin in May and is confident that a schedule for resolving conflicts involving several US companies can be drawn up.

Economic policy outlook

Policy trends The government will endeavour to keep economic policy broadly pro-market and focused on prudent fiscal management, but some policy dilution can be expected given the government’s weak congressional position. However, there is consensus on many important policy issues, such as the desire to agree an FTA with the US. The government will also continue to carry out an overhaul of the tax system. The president has stated his desire to translate economic growth into improved social programmes and poverty alleviation, which has so far failed to happen. This is likely to be a focus of his last two and a half years in power. Recent tax increases will enable the government to expand expenditure in 2004-05, while maintaining a falling trend in the fiscal deficit. The government will also move forward with the sale of concessions to manage transport infrastructure.

Fiscal policy Sustained economic growth and continued improvements in the efficiency of the tax authority, Superintendencia Nacional de Administración Tributaria (Sunat), are helping the government to increase revenue collection. However, in mid-2003 the government committed to a pay settlement for teachers and an increase in security spending, and in order to reach its target for the non- financial public-sector (NFPS) deficit of 1.9% of GDP in 2003, the government pushed through some tax rate increases. In March 2004 it introduced a new 0.1% tax on banking transactions, and is targeting an overall NFPS deficit of 1.5% of GDP in 2004, which the Economist Intelligence Unit expects it to achieve. We

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 Peru 9

expect policy continuity in 2005, leading to a further drop in the deficit, to 1.3% of GDP.

Monetary policy The Banco Central de Reserva del Perú (the Central Bank) will continue to target an inflation rate of 1.5-3.5%. The dollarisation of the economy in the late 1980s, when confidence in the currency was shattered by hyperinflation, is slowly being reversed, as reflected by bank deposits. The Central Bank will work to accelerate de-dollarisation and deepen local credit and capital markets. Local interest rates are likely to rise again over the forecast period as international rates rise.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2002 2003 2004 2005 Real GDP growth World 2.9 3.8 4.6 4.1 US 2.2 3.1 4.4 3.2 EU 1.0 0.7 1.9 2.1 Exchange rates ¥:US$ 125.3 115.9 105.5 106.5 US$:€ 0.94 1.13 1.30 1.38 SDR:US$ 0.77 0.71 0.66 0.64 Financial indicators US$ 3-month commercial paper rate 1.70 1.10 1.15 3.13 US$ 3-month Libor 1.80 1.21 1.26 3.24 Commodity prices Gold (US$/troy oz) 310.3 362.8 421.3 375.0 Copper (US cents/lb) 70.4 80.3 114.3 98.5 Oil (Brent; US$/b) 25.0 28.8 27.0 22.1 Food, feedstuffs & beverages (% change in US$ terms) 12.7 6.6 6.4 2.5 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. Economic activity in the major OECD countries, particularly the US and Japan, has picked up, improving prospects for 2004-05, with positive effects for Peru. The regional context is also set to become more favourable, as Brazil will return to growth in 2004 and the recovery in Argentina remains on track. International prices for gold and copper, Peru’s main exports, are forecast to rise strongly in 2004, helping to improve Peru's terms of trade. This growth will be supported by firmer industrial demand in Peru's main markets of the US and China. Despite the brighter outlook for global economic activity, there remain considerable risks as the substantial external (in the US) and internal (in the US, the EU and Japan) imbalances have not been corrected and will remain sources of vulnerability over the forecast period. Economic growth Domestic economic growth over the forecast period will be driven by the development of the giant Camisea natural-gas project, as well as by mining and exports (principally mining, textiles and agriculture). We expect the recent dynamism in the mining sector to be sustained on the back of continued investment in new operations and rising prices for gold and copper.

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 10 Peru

Agricultural and textiles exports will also benefit from the Andean Trade Promotion and Drug Eradication Act (ATPDEA, which grants tariff-free access to the US market to around 6,000 Andean export items). Domestic public investment and private investment in both Camisea and a new mining project, Las Bambas, will also contribute to growth. Although we assume that Mr Toledo’s government will retain power throughout the forecast period, there is a risk that it could collapse, with the potential seriously to undermine Peru’s economic recovery. Our current forecast is for growth of 4.1% in 2004, and of 3.9% in 2005, driven by export growth and, to a lesser extent, private demand. The Camisea natural-gas project is going ahead on schedule, and a contract has been signed that will enable a second stage of the project to proceed, to export natural gas to Mexico by 2007. The project remains on schedule to start delivering cheaper fuel to the capital, Lima, by August 2004. Both parts of the project will provide a strong boost to economic growth and help to reduce energy costs, and will also reverse Peru’s hydrocarbons deficit.

Inflation Inflation has been at OECD levels since 1999 and is likely to remain so in the forecast period. Consumer price inflation averaged 2.3% in 2003, and the wholesale price index rose by 1.7% in the same period, confirming an absence of inflationary pressures. The Central Bank’s monetary policy is focused on keep- ing year-end inflation within a target range of 1.5-3.5%, which it should manage.

Exchange rates The free-floating nuevo sol will remain broadly stable in the forecast period, owing to solid economic growth prospects, driven by export growth and prudent macroeconomic management. The nominal exchange rate has varied little since 1999, hovering between Ns3.34:US$1 and Ns3.62:US$1 despite a high level of political uncertainty. The local currency appreciated by 1.1% in real terms against the US dollar in 2003. The Central Bank will maintain a hands-off policy in order to allow the market to determine the exchange rate, limiting its brief interventions to the provision of liquidity in the event of external or domestic shocks. We forecast year-end rates of Ns3.46:US$1 in 2004, and of Ns3.43:US$1 in 2005.

External sector After widening to US$710m in 2003 on the back of strong growth in merchandise export earnings, the trade surplus will widen further in 2004, to US$1.5bn, before moderating again in 2005 as import demand strengthens. Growth in merchandise exports will remain robust owing to strengthening mining export earnings resulting from both higher export volumes, particularly gold, and higher forecast prices. Non-traditional exports will continue to rise at a steady pace, with a strong performance from the export of cotton and wool garments. This will be helped by the ATPDEA, although increased competition from China will mean that growth is not as sharp as had originally been envisaged. Import growth will be firm in the first half of 2004 owing to domestic demand, including capital import growth, before moderating once the Camisea natural gas arrives in Lima, which will lead to steadily falling fuel imports. We expect the current-account deficit to remain moderate in 2004-05, although a continued widening of the income deficit as corporate profit remittances increase will partly offset the strengthening merchandise trade surplus. The

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 Peru 11

deficit will remain manageable, assuming that capital inflows hold up. With strong investment commitments in large mining and natural-gas projects, we consider this to be likely.

Forecast summary (% unless otherwise indicated) 2002a 2003a 2004b 2005b Real GDP growth 4.9 4.0 4.1 3.9 Industrial production growth 4.2 2.0c 5.2 5.2 Gross fixed investment growth -0.7 4.9 4.2 0.4 Unemployment rate (av) 8.9 9.7 10.8 10.6 Consumer price inflation (av) 0.2 2.3 3.4 3.0 Consumer price inflation (year-end) 1.5 2.5 3.5 3.1 Short-term interbank rate 14.7 14.2 15.8 16.9 NFPS balance (% of GDP)d -2.3 -2.0 c -1.5 -1.3 Exports of goods fob (US$ bn) 7.6 9.0 11.1 11.4 Imports of goods fob (US$ bn) 7.4 8.2 9.6 10.5 Current-account balance (US$ bn) -1.2 -1.1 -0.9 -1.4 Current-account balance (% of GDP) -2.1 -1.8 -1.3 -2.0 External debt (year-end; US$ bn) 27.9c 30.0c 31.3 32.0 Exchange rate Ns:US$ (av) 3.52 3.48 3.47 3.45 Exchange rate Ns:US$ (year-end) 3.51 3.46 3.46 3.43 Exchange rate Ns:¥100 (av) 2.81 3.00 3.29 3.24 Exchange rate Ns:R (av) 4.56 4.87 5.25 5.35 a Actual. b Economist Intelligence Unit forecasts. c Economist Intelligence Unit estimates. d Non- financial public sector, excluding privatisation receipts.

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 12 Peru

The political scene

Scandals continue to damage The president, Alejandro Toledo, remains deeply unpopular with the public, Mr Toledo’s credibility and his credibility suffered further setbacks in the first quarter of the year following more scandals within his administration and another mishandled public appointment. In January a scandal involving his adviser and former intelligence chief, César Almeyda, caused Mr Toledo’s popularity to fall to 7% according to local polls, its lowest level ever. His standing did recover in early February, to 10%, following a cabinet reshuffle. However, since February, reports of influence-peddling by his siblings, the start of a new tax on banking transactions and price increases caused by a truckers' strike have again reflected badly on the president. In mid-March another scandal, this time involving the intelligence service, further eroded public confidence in the government. Mr Toledo continues to be seen as a weak and ineffective leader who has failed to fulfil promises made during his campaign for the presidency in 2001. In addition, his party, Perú Posible, is plagued by infighting and opportunism and is seen as more of a hindrance to the government than an asset.

Another cabinet reshuffle Mr Toledo reshuffled his cabinet in mid-February in a bid to shore up his battered credibility and stave off calls for early elections. He had already been forced to change two ministers appointed in December, both of Perú Posible, after accusations of corruption and nepotism. In late January the prime minister, Carlos Ferrero, announced that cabinet changes would be made, and invited opposition parties to participate in the process of naming a new cabinet. Mr Toledo, aware of the weakness of both his congressional position and party, has sought to shore up governability through continued dialogue with the opposition. However, most want to maintain a distance from the president. As a result, the two main opposition parties, Partido Aprista Pruano (Apra) and Unidad Nacional, declined to participate in the talks. However, the new cabinet is less party-political, and Perú Posible's role is greatly reduced. Seven new ministers entered the cabinet; eight, including Mr Ferrero, stayed on and one moved to another post. The most notable new entrant to the cabinet was Pedro Pablo Kuczynski, a fund manager who has good relations with the investment community and who returns to the Ministry of Finance after an absence of almost two years. Mr Kuczynski left the ministry after a year, in June 2002, following violent protests in the southern city of Arequipa over the privatisation of two regional electricity firms. These sales were later shelved in response to the protests. Mr Kuczynski had been criticised for trying to force the sales through without listening to local demands. This time, he has pledged to be more flexible. In his first days in the post he held talks with the leader of the Apra and former president, Alan García, and the leader of Unidad Nacional, Lourdes Flores, to try to reach consensus on some policy issues. Mr Kuczynski replaced Jaime Quijandría, who returned to the Ministry of Energy and Mining, a post that he occupied before being appointed finance minister. Alfredo Ferrero, seen as key in talks with the US for a free-trade agreement, remains in the Ministry of International Trade and Tourism. Other

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 Peru 13

ministers who remained in the cabinet are Manuel Rodríguez Cuadros (foreign relations), Fernando Rospigliosi (interior), Roberto Chiabra (defence), José León (agriculture), and Ana María Romero (women and social development). Besides Mr Kuczynski, the new ministers include Baldo Kreslja, as minister of justice, Pilar Mazetti (health), Javier Soto Nadal (education), Javier Neves (labour), José Ortiz (transport and communication), and Alfonso Velásquez (production). The new ministers are considered political independents and are seen as bringing more technical substance to the cabinet. Some politicians had also called for an independent prime minister but Mr Toledo ratified Mr Ferrero, a veteran politician who has been a close ally since 1999. The representation of Perú Posible in the cabinet now stands at just two posts. The Frente Independiente Moralizador (FIM), which has supported Mr Toledo and Perú Posible in a loose coalition, has lost its two cabinet posts. The FIM's leader, Fernando Olivera, had been implicated in the Almeyda scandal but the party leadership has stated it will remain supportive of the government in Congress. Without the support of the FIM in Congress, the president’s position would become even more tenuous.

Mr Almeyda linked to corrupt The latest cabinet change followed revelations that Mr Almeyda tried to nego- general tiate in 2001 with Oscar Villanueva, a retired army general facing criminal charges for his links to the corruption network run by Vladimiro Montesinos, the imprisoned former spy chief of ex-president, Alberto Fujimori (1990-2000). Following the publication of excerpts of an audio tape of a conversation between Mr Almeyda and Mr Villanueva—considered to be Mr Montesinos’s “cashier”—Mr Toledo told the nation that the December 2001 meetings were carried out behind his back. He also said that Mr Almeyda had been discharged from his duties as an adviser. Before the broadcast of the tapes, Mr Almeyda had stated that Mr Olivera, then justice minister, was aware of his negotiations with Mr Villanueva, who was interested in a plea-bargaining agreement. Mr Olivera vehemently denied any knowledge of the conversations and said that the accusations were part of a plan to destabilise the government. Mr Alymeda was detained in late February on charges of usurpation of powers, influence-trafficking and failing to report a crime. In the midst of the scandal, the vice-president, Raúl Diez Canseco, handed in his resignation, to answer influence-peddling allegations that had been made against him as an ordinary citizen. Mr Diez Canseco is facing a congressional allegation that he used his post as minister of foreign trade and tourism, from which he had resigned in November, to favour the business of his girlfriend's father and to hire her relatives. In newspaper advertisements, he acknowledged that his decision to resign could be confused with “the difficult moments” the country was experiencing, a reference to the scandal and the heightened sense of crisis caused by the timing of his resignation.

Prime minister scrapes In mid-January Mr Ferrero presented his cabinet programme to Congress as through confidence vote required by the constitution. Although Mr Ferrero, who had served twice as the president of Congress, held out an olive branch to the legislature, his present- ation was criticised by opposition legislators as lacking concrete initiatives. A confidence vote, which is usually obtained easily, became a major issue when

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 14 Peru

most opposition congressmen decided to abstain. The result—49 votes in favour, 44 abstentions and six against—meant that Mr Ferrero won the confidence vote, but only after he had made a deal with some legislators linked to the government of Mr Fujimori.

Perú Posible's problems The alliance between Perú Posible and the FIM remains strained, and the FIM continue is now claiming that it has an alliance with Mr Toledo, but not with his party. The alliance, which has weakened over the past year, became further strained over the Almeyda scandal when some Perú Posible congressmen called for the resignation of Mr Olivera as ambassador to Spain. In addition, some FIM congressmen were opposed to the party giving up cabinet posts. Margarita Toledo, Mr Toledo's sister and the leader of Perú Posible, was also reported to have been involved in influence-peddling in the national ports company, Empresa Nacional de Puertos del Perú (Enapu), helping to secure a contract for a businessman friend as well as placing Perú Posible activists in posts in the company. She denied the charges but was called before a prosecutor to answer questions in the case. Further tension in the government has been apparent in a dispute between a prominent Perú Posible congressman, Jorge Mufarech, and the minister of the interior, Fernando Rospigliosi. The dispute arose over a ministry bidding process for police uniforms. Mr Mufarech claimed that there had been irregularities in the process, which took place when Mr Rospigliosi had first served as a minister, from July 2001 to July 2002. Mr Mufarech called the minister before the congressional fiscalisation commission to testify on the bidding process. Mr Rospigliosi said the accusations were linked to the fact that a textiles business owned by Mr Mufarech’s sons was not chosen in the bidding. Mr Rospigliosi accused Mr Mufarech of using his power and money to wield influence, and Mr Mufarech accused Mr Rospigliosi of heading a network of corruption. Mr Rospigliosi also made reference to the fact that Mr Mufarech had previously served as a minister in Mr Fujimori’s discredited government. It seems that Mr Rospigliosi, who is one of the most popular ministers in the government, was attempting to convince Mr Toledo that he should dismiss Mr Mufarech from the party's bench in Congress, which the president did not do. Prior to the commission hearings, Mr Rospigliosi had received public backing from the entire cabinet.

Intelligence service heads Mr Rospigliosi faced another campaign to discredit him, this time by the forced to resign National Intelligence Council (CNI), the intelligence service that reports directly to the president. In mid-March a newspaper, Correo, reported that a police colonel in charge of strategic intelligence had contacted the newspaper with information intended to lead to the publication of a negative story about Mr Rospigliosi. The reporter taped the conversations, in which the colonel, José Valdivia, said that Mr Rospigliosi should be removed from his post, and Correo ran a story about his attempts to discredit Mr Rospilgiosi. The head of the CNI, a retired general, Daniel Mora, initially denied any knowledge of Mr Valdivia’s contacts with the newspaper but later that day resigned from his post. Mr Rospigliosi had reportedly given Mr Toledo an ultimatum to show his

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 Peru 15

support for him by asking for the resignation of Mr Mora, who is also a member of Perú Posible. A few days later, Mr Toledo appointed a retired navy admiral, Ricardo Arboccó, to replace Mr Mora, making him the seventh intelligence chief in Mr Toledo’s government. However, Mr Arboccó lasted just two days in the post after Correo reported that he was being investigated by anti-corruption prosecutors for a case in which a piece of property was overvalued when he served on the board of military and police pension fund, which has considerable investments in real estate. Later that day, Mr Arboccó resigned, claiming he was innocent of the charges but was quitting to protect the government from further discredit. The continued problems within the security services, which had been discredited under Mr Fujimori's administration (1990-2000) led Mr Ferrero to an- nounce that the CNI would be deactivated and that a four-member committee would decide within 90 days what should be done with the service.

Opposition goes on offensive The problems that continue to beset the government—barely a month has passed in the last year without a new scandal or controversy—have encouraged the opposition to start to take a stronger stance against Mr Toledo and his government. While there is no political will for an immediate change in regime, the elections of 2006 are approaching and the opposition is keen to distance itself from the government. Mr García has called the new cabinet the government’s last chance to govern effectively and said that if Mr Toledo does not make changes in his programme, the people will ask for a change of government. He also criticised Mr Toledo’s decision to retain Mr Ferrero as prime minister. Mr Flores, the UM's leader, has urged Mr Toledo to take a lower profile and give the prime minister full powers to run the government.

Congressmen criticised on The public is not only disenchanted with Mr Toledo and his government, but salaries with all Peru's democratic institutions. Congress is viewed with particular disdain, and its stock fell further in the opening months of the year. Press reports that various legislators who have no children of school-age received a Ns16,000 (US$4,600) payment to cover school expenses further damaged the public's perception of Congress. A March Apoyo poll showed that only 8% of Lima's residents approved of Congress, its lowest-ever approval rating, whereas 84% disapproved. Several Perú Posible congressmen exacerbated the problem when they refused to return the stipend. Apra’s parliamentary bench announced its members would return the payment but a few weeks later a report by the Congress Treasury manager showed that only two of 28 had actually done so. The issue also sparked a high-profile debate about public-sector salaries. In early April, Congress approved a bill by a slim margin, proposed by the president of Congress, Henry Pease (Perú Posible), to create a Unidad Remunerativa de Sueldos en el Sector Público (URSP), a sum of money that would fix public- sector salaries under a hierarchy, with the president at the top earning ten URSP. Congressmen, ministers, Supreme Court judges and prosecutors of the same level would all earn the same. Congress left it to the executive branch to determine the actual amount of the URSP, but Mr Toledo appears likely to veto the bill.

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 16 Peru

Economic policy

Fiscal accounts reach target The overall non-financial public-sector (NFPS) deficit reached 3.7% of GDP in the fourth quarter of 2003, the same level as in the fourth quarter of 2002. Over the whole year, the deficit narrowed to Ns4.1bn (US$1.2bn), equivalent to 1.9% of GDP, from Ns4.7bn (2.3% of GDP) in 2002. This result was in line with the target agreed with the IMF. Tax revenue increased sharply in 2003, owing in part to continued economic growth, and in part to several administrative measures to reduce tax evasion, particularly on the Impuesto General a las Ventas (IGV, value-added tax). In addition, in August the government increased the rate of IGV by 1 percentage point to 19%, and the rate of corporate tax from 27% to 30%.

Non financial public-sector (NFPS) operations (Ns m unless otherwise indicated) 4 Qtr Year 2002 2003 % change 2002 2003 % change Central government current revenue 7,530.0 8,221.7 9.2 28,318.9 31,322.7 10.6 Central government current expenditure 7,968.4 8,585.4 7.7 29,038.0 31,301.2 7.8 Non-financial 6,901.8 7,591.0 10.0 25,073.7 27,114.6 8.1 Financial 1,066.7 994.4 -6.8 3,964.3 4,186.6 5.6 Central government current balance -438.5 -363.7 -17.1 -719.1 21.6 n/a Other entities 354.4 485.5 37.0 1,863.6 1,935.9 3.9 NFPS current balance -84.1 121.8 n/a 1,144.5 1,957.5 71.0 Capital revenue 82.1 65.1 -20.7 196.9 218.9 11.2 Capital expenditure 1,858.4 2,160.8 16.3 6,004.1 6,276.2 4.5 Public investment 1,787.9 2,035.7 13.9 5,583.5 5,901.8 5.7 Other capital costs 70.5 125.1 77.4 420.6 374.4 -11.0 Overall balance -1,860.4 -1,973.8 6.1 -4,662.8 -4,099.7 -12.1 % of GDP -3.7 -3.7 n/a -2.3 -1.9 n/a Net financing 1,860.4 1,973.8 6.1 4,662.8 4,099.7 -12.1 External 1,547.7 2,245.2 45.1 4,113.4 2,914.5 -29.1 Domestic 160.9 -387.0 n/a -953.8 1,004.5 n/a Privatisation 151.8 115.6 -23.8 1,503.1 180.7 -88.0

Source: Banco Central de Reserva del Perú.

The government has reported that tax revenue increased by 12% year on year in the first two months of 2004, with IGV collection up by 10.8% and corporate income tax by 36%. Central government non-financial current expenditure fell by 10.5% year on year, with capital expenditure down by 46.5% and current expenditure down by 6.7% year on year in real terms. In late March, at a speech during the annual Inter-American Development Bank conference, in the capital, Lima, the president, Alejandro Toledo, expressed his concern that Peru's steady growth in recent years has yet to translate into improvements in living standards for most Peruvians. Mr Toledo estimates that an annual US$8bn in inward investment is needed to raise economic growth to an annual average rate of 7%, the government's desired growth rate in the medium term. For 2004 there is an estimated US$4.8bn of programmed foreign private investment, mostly related to the Camisea natural-gas project (US$2bn

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 Peru 17

this year) and the development of Las Bambas, a copper development project (see The domestic economy).

A new tax on banking The government's eagerness to increase social expenditure while maintaining a transactions proves unpopular manageable fiscal deficit led to the increases in the rates of IGV and corporate tax in 2003, and in March this year a new tax, the Impuesto a las Transacciones Financieras (ITF, a 0.1% tax on all banking transactions) was introduced, until 2006. Opposition parties, economic analysts, the business community, commercial banks and the Banco Central de Reserva del Perú (Central Bank) have all criticised the tax, calling it regressive and counterproductive to economic growth. However, for the government it is, for the short term at least, a very useful tax; it is an easy tax for the government to collect, and it hopes that it will raise revenue of around Ns1bn. In order to lessen the criticism, the government lowered the original rate from 0.15% to 0.1% in March, and has announced that in 2005 it will be reduced to 0.8%, and to 0.6% in 2006, after which it is scheduled to expire.

Reserve requirement on In March the Central Bank imposed a 20% reserve requirement on foreign foreign bank credits credit lines of the banking system. According to the Central Bank, the measure is intended to protect the financial system from unforeseen events related to capital flows. In the past year, the Peruvian banking system has significantly reduced the use of foreign credit lines, given ample domestic liquidity, so the measure is not expected to have much effect in the short term.

Negotiations towards an FTA The government is continuing to prioritise negotiations towards an eventual with the US free-trade agreement (FTA) with the US. Existing unresolved judicial cases for a group of US firms remain the main stumbling-blocks in efforts to organise a negotiation schedule. The minister of international trade and tourism, Alfredo Ferrero, has established working groups to prepare for the negotiations. These groups will discuss the different aspects of the negotiations, such as market access, investment, government procurement, defence measures, intellectual property, labour and the environment. The private sector has appointed Roque Benavides, a former head of Peru's private business lobby, Confiep, as its representative in the negotiations. Mr Ferrero has emphasised that the benefits of the FTA will depend on the success of efforts on the part of the Peruvian government to increase competitiveness, particularly in relation to its labour market, which because of high non-wage employment costs has lost competitiveness in recent years. Peru's infrastructure is the other major area in which the government hopes to make improvements. In February, after years of delays, Congress approved the regulatory provisions for the application of the ports law, which will allow the government to go ahead with selling concessions to maintain and operate Peru's five largest ports. There is also an ongoing concessions programme for Peru's major highways.

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 18 Peru

The domestic economy

Economic trends

Economic growth remains Economic activity increased by 2.8% year on year in the fourth quarter of 2003, solid lower than the 3.4% rate of the third quarter, bringing growth for the year to 4%. Growth in the fourth quarter was led by public investment, which increased by 11.8% year on year; public-sector consumption also increased sharply, by 7.3% year on year. Public investment growth accelerated in the fourth quarter owing to increased central government investments (13% in real terms) on transport, energy and mining, and housing projects. Private investment growth, at 2.8% year on year, lagged overall growth but the fourth quarter marked the sixth consecutive quarter of year-on-year growth in private investment. Private investment was led by investment in the Camisea natural-gas project, which is scheduled to come on stream in August 2004. Camisea has been the largest single investment project in the country since the Antamina copper and zinc mine opened in July 2001; by the end of January, investment in Camisea had reached US$650m. Investment in the project will continue beyond August 2004, as the so-called phase two—a project to export the gas to the west coast of the US—gears up. In addition to Camisea, private investment was focused on capacity improvements and machinery renewal in non-primary industries such as textiles, food and beverages, and chemicals. Investment in mining was also robust, particularly by Yanacocha (Cerro Negro y Minas Conga) and Barrick (Alto Chicama). Private investment in construction and telecommunications has also held up. With private investment typically accounting for over 80% of total investment, gross fixed investment (which discounts changes in stocks) increased by 4.5% year on year in the fourth quarter.

Gross domestic product by expenditure, 2003 (% change, year on year) 1 Qtr 2 Qtr 3 Qtr 4 Qtr Full year Private consumption 4.5 3.0 2.9 2.6 3.2 Government consumption 6.0 2.0 2.7 7.3 4.5 Gross domestic investmenta 14.0 1.5 8.0 -0.6 5.2 Private 6.9 4.8 6.5 2.8 5.2 Public 9.5 -3.8 -4.5 11.8 3.4 Exports of goods & services 7.0 7.9 1.8 3.9 5.0 Imports of goods & services 7.2 1.5 3.5 2.0 3.5 Domestic demand 6.2 2.6 3.7 2.5 3.7 GDP 6.2 3.7 3.4 2.8 4.0 a Includes change in stocks. Source: Banco Central de Reserva del Perú.

Public-sector consumption increased by 7.3% year on year, owing to higher wages and salaries in education and health services, as well as in the military and police budgets. Private consumption growth lagged overall economic growth throughout 2003, but lower interest rates and improved access to credit,

after five years of conservative lending policies, is starting to help growth in private consumption. On the supply side, non-primary sectors led growth of 4% over 2003, whereas primary-sector growth reached just 2.5% year on year. Non-primary manufacturing expanded by 3.4% in 2003, owing mainly to increased demand from the US for Peruvian textile products, exports of which have been boosted since October 2002 by the Andean Trade Promotion and Drug Eradication Act (ATPDEA), which grants tariff-free access to the US market to around 6,000 Andean export items. However, greater competition from low-priced products from China started to slow the growth of the textile industry in the fourth quarter, to 16.9% year on year, bringing overall growth in textile production in 2003 to 20.8%. Construction activity grew by 4% year on year, following growth of 7.9% in 2002, and continues to be supported by the government’s low-cost housing programme, Mivivienda, as well as by work on the Camisea project. In 2003, 6,842 construction credits were granted by Mivivienda, 3,232 more than in 2002. Between 1999, when the scheme started, and December 2003, a total of 12,422 credits were granted. Mining led growth in the primary sector, for the third successive year, with output up by 7.8% year on year. Over the year, gold output increased by 13.6%, zinc by 12% and iron by 12.2%. The country's largest zinc mine, Antamina, increased output by 54% year on year.

Gross domestic product growth by sector (% change, year on year) 2003 2004 Sep Oct Nov Dec Full year Jan Agriculture & livestock 0.8 1.8 -1.3 -1.2 2.3 3.5 Fishing -1.4 27.2 0.0 -43.6 -13.4 12.0 Mining & fuel 10.0 4.8 5.0 2.6 6.7 11.4 Metals 11.7 5.6 5.8 2.9 7.8 12.7 Fuel -7.5 -3.7 -4.1 -1.5 -4.5 -3.4 Manufacturing 2.5 1.1 0.3 -1.9 2.1 2.8 Primary resource processing 2.7 4.9 -2.4 -16.0 -2.8 5.7 Non-primary industry 2.4 0.2 1.1 2.4 3.4 2.2 Electricity & water 2.5 3.6 4.2 2.8 4.2 3.1 Construction 2.8 6.4 -1.0 4.2 4.0 7.5 Commerce 2.7 3.3 -1.2 0.1 3.6 1.1 Other services 2.8 6.4 0.9 6.8 4.4 2.2 GDP 3.5 4.6 0.8 3.1 4.0 3.0 Primary sectors 4.6 4.1 0.8 -4.2 2.5 7.1 Non-primary sectors 2.7 4.7 0.5 4.6 4.0 2.4 Seasonally adjusted GDP (month on month) 0.6 0.3 -0.7 1.1 - 1.9

Source: Banco Central de Reserva del Perú.

In January 2004 growth reached 3%, just below the 3.1% achieved in December. Mining continues to be the most dynamic economic sector; although growth from fisheries outstripped that of mining in January, the sector's growth pattern is often skewed by temporary fishing bans. Apart from construction, which continues to be buoyed by Mivivienda and the Camisea natural-gas project, growth of non-primary sectors dipped in early

2004. In seasonally adjusted terms, monthly growth reached 1.9% in January, its highest rate since November 2002. This was a result of exceptionally strong growth from the mining sector, which has responded to continued high prices for gold and copper by expanding output.

Consumer price inflation The consumer price index increased by 1.08% in February, bringing the 12- edges upwards month rate up to 3.42%, only marginally below the upper limit of the target range of 1.5-3.5% set by the Banco Central de Reserva del Perú (Central Bank). This upward trend reflected high food prices caused by scarce food supply, owing to a harsh dry season in the Peruvian highlands. An increase of 3.21% in fuel prices between December 2003 to February 2004, owing to high international oil prices, also increased upward pressure on prices. Core inflation, which excludes non-tradeable goods, fuel and urban transport, registered an increase of 1.93% in the 12 months to February, averaging 1.65% over the year. The monthly and 12-month rates dipped in March, and the Central Bank is confident that inflation will remain within target throughout the year. It has no plans to change its monetary policy because it believes that February's blip—as with that in March 2003 when oil prices surged on the eve of the US-led war in Iraq—came from a temporary supply shock.

Consumer price inflation (% change) 2002 2003 2004 Monthly Annual Monthly Annual Monthly Annual Jan -0.52 -0.83 0.23 2.28 0.54 2.80 Feb -0.04 -1.11 0.47 2.80 1.08 3.42 Mar 0.54 -1.08 1.12 3.39 0.46 2.76 Apr 0.73 0.05 -0.05 2.60 May 0.14 0.17 -0.04 2.41 Jun -0.23 0.00 -0.46 2.17 Jul 0.03 -0.14 -0.16 1.98 Aug 0.10 0.26 0.02 1.89 Sep 0.47 0.68 0.56 1.98 Oct 0.72 1.36 0.05 1.30 Nov -0.40 1.46 0.16 1.87 Dec -0.03 1.52 0.57 2.48 Annual average – 0.19 – 2.26

Source: Banco Central de Reserva del Perú.

Exchange-rate stability The average interbank exchange rate reached Ns3.460:US$1 at the end of March, continues a nominal appreciation of 0.1% since the end of 2003. The average nominal exchange rate has remained between Ns3.435:US$1 and Ns3.619:US$1 since 2000, with occasional volatility caused by political instability swiftly smoothed, sometimes following intervention by the Central Bank. A rapid increase in export earnings in recent years and increasing levels of international reserves have helped to underpin this stability. So far in 2004, low demand for foreign currency and relatively high commodities prices have also contributed to the stability.

Average interbank exchange rate (Ns:US$) 2003 2004 2003 2004 End-period End-period Average Average Jan 3.481 3.501 3.493 3.467 Feb 3.480 3.473 3.484 3.483 Mar 3.474 3.460 3.479 3.465 Apr 3.461 – 3.464 – May 3.495 – 3.482 – Jun 3.470 – 3.479 – Jul 3.473 – 3.471 – Aug 3.480 – 3.480 – Sep 3.483 – 3.481 – Oct 3.472 – 3.478 – Nov 3.480 – 3.478 – Dec 3.463 – 3.471 – Annual average 3.463 – 3.517 –

Source: Banco Central de Reserva del Perú.

Agriculture

Agricultural output increases, Agricultural and livestock output increased by 2.3% in 2003, with growth led by but only slowly poultry and yellow corn. Agricultural production grew by 1.8% despite a slightly smaller harvested area for many of the main products. Livestock output grew by 3%, led by poultry (4.4%) and milk (2.7%). Yellow corn production increased by 5.8%, stimulated by the higher demand from the poultry sector. In December, total agricultural output dropped for the second consecutive month owing to a 27.5% year-on-year fall in potato production. Potato output fell because of a long dry season in Cajamarca and Huánuco, where the area under cultivation fell by 61% and 38% between June and July respectively, owing to the drought. Bad weather conditions affected several valleys and caused an overall fall of 7% in the total land area under cultivation in 2003. In January 2004 output picked up again, with overall growth of 3.5% year on year. A recovery in potato production and large gains in the mango sector led agricultural growth, with poultry and beef production leading the growth in livestock output. The government is endeavouring to support growth in the agricultural sector through the so-called Carta Verde (green letter, also known as the Agrarian Pact), a document signed by the Ministry of Agriculture, the Agrarian Commission of Congress and different agrarian guilds. The Carta Verde outlines 12 broad policy areas for the sector, although it contains only a few concrete proposals. Among the specific proposals are government promises to send to Congress in the first half of 2004 a law to reorganise the Ministry of Agriculture; to increase by Ns357m (US$100m) public investment in the AgroBanco (the Agrarian Bank); and to invest US$72m in irrigation and water projects. The government has also set a target to have 80% of rural property titled and registered by 2006. Furthermore, the government is working on reducing import tariffs for inputs and capital goods for the agricultural sector to zero, and reducing the Impuesto General a las Ventas (IGV, value-added tax) for

rice to 4%, and the IGV on fertiliser and breeding cattle to zero. These measures will be phased in gradually. However, the lack of specific deadline targets has caused some concern, and any reduction in IGV for specific products will lead to calls from other sectors for similar reductions. Peru is the largest rice consumer per head in Latin America, with average annual consumption per head of 50 kg. The recent drought in the north coastal growing regions will affect production in 2004. The authorities at the Tinajones Reservoir in Lambayeque, which serves some of the largest rice fields in Peru, have warned that the reservoir will only be able to supply sufficient irrigation to produce 5,000 tonnes (where production in some years has been up to 55,000 tonnes) as it currently has only 36m cu metres of water of a total capacity of 320m cu metres. Lambayeque is the country's most important rice- producing region, accounting for more than 20% of annual production. The government has pledged to grant loans of up to Ns6m through the Agrarian Bank, to help farmers produce alternative crops like corn and beans, which need less water. The minister of agriculture, José León, has announced a contingency plan to sow 50,000 ha of rice in San Martín, Tarapoto and Amazonas, in the east of Peru. Nevertheless, Peru will depend to a greater degree than usual on imports in 2004, and a reduction in IGV for rice would be welcomed by consumers and producers. Fisheries production fell by 13.4% in 2003, with maritime production down by 14.8%, as a result of long bans on anchovy fishing over the year to help replenish stocks; output from continental fishing increased by 14%. In January 2004 output from the fishing sector grew by 12% year on year, with an increase of 14.2% in maritime output owing to the larger anchovy and mackerel catches. This was in part the result of a rebound from a low base in January 2002, when a ban on anchovy fishing was in place. However, another anchovy ban started in mid-January, and lasted until the end of March.

Mining

Metallic mining continues to Metallic mining has been the most dynamic sector of the economy in recent drive growth years, particularly following the opening of the massive Antamina copper and zinc mine in 2001. In 2003 output increased by 7.8%, with gold (13.4%), zinc (12%) and iron (14%) leading growth. Gold production at the large Yanacocha mine increased by 22.2%, whereas zinc output at Antamina increased by 53.8%. Demand from China drove much of the growth, particularly in iron; Shougang Peru, which is owned by Chinese interests, is the only iron producer in Peru. Copper was the only major mineral that experienced a fall in output, of 2.7% year on year, although an increase in the average price of copper over the year meant that export earnings from the mineral increased, by 6.2% to US$1.3bn. A new mega-project is due to go to tender this year. Las Bambas, a high-grade 80,000-ha copper deposit, has proven reserves of around 40m tonnes with grades averaging 2% copper. The government estimates that there is potential for up to 500m tonnes of high-grade copper at Las Bambas, making it an equivalent project to Antamina; since the Antamina mine was opened in 2001, copper output has increased from 529,100 tonnes in 2000, to a peak of 858,800

tonnes in 2002. The government appears likely to offer an initial four-year tender to continue exploration, with the winning bidder then allowed to decide whether to continue with the project. Bidders include Anglo American (South Africa), Vale do Rio Doce (Brazil), BHP Billiton (Australia), Southern Peru (Mexico), Antofagasta (UK), Aur Resources (Canada), Phelps Dodge (US), Noranda (Canada), Xtrata (Canada), Peñoles (Mexico), Barrick (Canada), Cambior Inc (Canada), RTZ (UK) and Teck Cominco (Canada). The government's investment promotion agency, ProInversión, estimates that the project would attract at least US$500m in investment. If the project goes ahead, Peru would become the fourth-largest copper producer in the world, after Chile, Indonesia and the US.

Manufacturing

Manufacturing output is Manufacturing output contracted in year-on-year terms in the fourth quarter of inconsistent 2003, the first contraction since the first quarter of 2001, but output started to increase again in early 2004. Lengthy fishing bans in 2003 meant that processing of fishmeal, canned and frozen fish all dropped sharply. Non- primary processing increased by just 1.2% in the fourth quarter as the rapid output growth of textiles dropped sharply. Over the year as a whole, fisheries- related manufacturing contracted by 13.3%, bringing the overall contraction in primary resource processing to 2.8%. The end of a fishing ban contributed to growth of 5.7% year on year in primary resource processing in January 2004, but more fishing bans over the course of the year will mean that growth in primary processing will be patchy at best.

Infrastructure

Competition in telecoms is Telefónica del Perú (a subsidiary of Spain's Telefónica, which has a virtual threatened monopoly of fixed-line telephony in Peru) announced in early 2004 that it was buying US-based BellSouth's mobile-phone operations in Latin America for US$5.85m. Telefónica already has a share of 51.4% in mobile telephony in the Peruvian market; once it purchases BellSouth this will rise to 73.6%, with TIM (the Peruvian operation of Telefonia ItaliaMobile, Italy) its main competitor, with a 21.4% market share in 2003. TIM entered the market in 2001 and Brazil's Nextel, with a 5% share of the market in 2003, is the other mobile-phone operator in Peru. Since TIM entered the market, it has driven growth in Peru's customer base, the range of services, and has competed strongly on price, driving down average tariffs. According to data from the Organismo Supervisor de la Inversión Privada en Telecomunicaciones (Osiptel, the telecoms regulator), by end-2003 there were 2.9m mobile lines, compared with 1.8m fixed lines. There are fears that the acquisition of BellSouth Latin America by Telefónica will further stifle competition in the Peruvian telecoms sector and slow growth in the mobile market. Osiptel has pledged to continue to assess competition and tariff evolution in the sector, and is determined to enforce a commitment to reduce call rates from fixed to mobile lines by 30% within 18 months.

In response to the takeover, the Ministry of Transport and Communications (MTC) announced plans to sell another mobile licence and the authorities are also considering introducing number portability, a proposal that Telefónica has strongly resisted in the past. For the new licence, in order to promote competition further, the government is considering asking firms to compete on the lowest proposed prices of the service, as opposed to investment or coverage commitments as has been the case with previous mobile licence auctions.

Foreign trade and payments

The trade surplus increases The merchandise trade surplus increased in 2003, to US$710m, owing to 17.1% growth in export earnings, with hydrocarbons, mining and textiles exports driving growth. Mining and hydrocarbons exports benefited from continuing strong demand from China and, to a lesser extent, the US, as well as higher prices for most minerals over the year. Textiles production and exports have been boosted since 2002 by the Andean Trade Promotion and Drug Eradication Act (ATPDEA), which allows tariff-free entry of around 6,000 products (including textiles) to the US. The strong growth in exports has continued into 2004; in the first two months of the year export earnings increased by 23.7% year on year, with all major categories of export showing robust growth apart from agriculture (owing to drought) and oil. Improving terms of trade and continued strong demand from both Asia and the US are forecast to continue throughout the year. Once again, minerals (particularly gold and copper) and textiles are leading the growth in earnings.

Merchandise exports (US$ m) 2002 2003 2003 2004 Year Year % change Jan-Feb Jan-Feb % change Traditional exports 5,312.4 6,280.9 18.2 986.2 1,196.9 21.4 Fisheries 892.3 821.0 -8.0 116.1 116.1 0.0 Agriculture & livestock 216.2 221.9 2.6 25.5 17.8 -30.5 Minerals 3,734.4 4,573.3 22.5 670.2 937.5 39.9 Petroleum & derivatives 469.4 664.7 41.6 139.6 125.5 -10.1 Non-traditional exports 2,334.6 2,673.3 14.5 393.3 509.6 29.6 Agriculture & livestock 554.3 618.9 11.6 93.4 122.5 31.1 Textiles 676.6 817.6 20.8 119.5 157.6 31.8 Fisheries 163.8 203.8 24.4 32.3 41.4 28.1 Total 7,647.0 8,954.2 17.1 1,379.5 1,706.4 23.7

Source: Banco Central de Reserva del Perú.

The merchandise import bill increased by 10.8% in 2003, to US$8.2bn. Intermediate goods imports led the growth, with the construction and textiles industries increasing capacity. However, this growth in domestic demand has not continued into 2004—in the first two months of the year imports increased by just 1.7% year on year.

Merchandise imports (US$ m) 2002 2003 2003 2004 Year Year % change Jan-Feb Jan-Feb % change Consumer goods 1,769.7 1,849.7 4.5 276.2 259.5 -6.1 Intermediate goods 3,747.3 4,337.4 15.7 697.6 732.9 5.1 Capital goods 1,842.6 1,982.0 7.6 346.7 346.9 0.1 Other 80.2 75.3 -6.0 11.5 15.4 34.0 Total 7,439.9 8,244.4 10.8 1,332.0 1,354.7 1.7

Source: Banco Central de Reserva del Perú.

The rising trade surplus enabled the current-account deficit to narrow in 2003, to US$1.1bn, equivalent to 1.8% of GDP. The deficit on the services account increased slightly, to US$995m, but is forecast to narrow over the coming years as tourism starts to realise some of its potential. The widening of the trade surplus was offset in 2003 by a US$564m increase in the incomes deficit, owing largely to rapidly rising profit remittances overseas from companies operating in Peru. In mid-March net international reserves held by the Banco Central de Reserva del Perú (the Central Bank) totalled US$10.5bn, US$50m lower than at the end of February, but US$265m higher than at the end of 2003.

Current account (US$ m unless otherwise indicated) 1999 2000 2001 2002 2003 Exports of goods fob 6,087 6,951 7,007 7,647 8,954 Imports of goods fob -6,793 -7,407 -7,273 -7,440 -8,244 Trade balance -706 -456 -267 207 710 Exports of services 1,594 1,604 1,510 1,545 1,585 Imports of services -2,256 -2,295 -2,345 -2,493 -2,581 Service balance -663 -691 -835 -948 -995 Factor services -1,115 -1,409 -1,123 -1,509 -2,073 Public -567 -513 -573 -748 -864 Private -549 -896 -550 -761 -1,210 Current transfers 966 999 1,042 1,043 1,243 Current-account balance -1,519 -1,557 -1,184 -1,206 -1,116 % of GDP -2.9 -2.9 -2.2 -2.1 -1.8

Source: Banco Central de Reserva del Perú.