Document o f The World Bank F o r Official Use Only Report No. 50620-PE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT FOR A PROPOSED THIRD PROGRAMMATIC FISCAL MANAGEMENT AND COMPETITIVENESS DEVELOPMENT POLICY LOAN IN THE AMOUNT OF US$150 MILLION TO THE REPUBLIC OF PERU September 24,2009 Poverty Reduction and Economic Management Bolivia-Ecuador-Peru-Venezuela Country Management Unit Latin America and Caribbean Region This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not otherwise be disclosed without World Bank authorization. REPUBLIC OF PERU FISCAL YEAR January 1-December 3 1 CURRENCY EQUIVALENTS (Exchange Rate Effective September 23,2009) Currency Unit = Nuevos Soles 2.89 Nuevos Soles =US$] WEIGHTS AND MEASURES Metric System SELECTED ABBREVIATIONS AND ACRONYMS AAA Analytical and Advisory Activities BCRF' Banco Central de Reserva del Perli (Central Reserve Bank o f Peru) CAF Corporacidn Andina de Fomento (Andean Development Corporation) CAR Capital Adequacy Ratio CFAA Country Financial Accountability Assessment CGR Contraloria General de la Repliblica (Comptroller General) CNC Comisidn Nacional de Competitividad COFIDE Corporaci6n Financierapara el Desarrollo (Financial Corporation for Development) CONASEV Comisidn Nacional Supervisora de Empresas y Valores (National Stock and Business Supervisory Commission) CONFIEP Confederacidn Nacional de Instituciones Empresariales Privadas (Business Association) CPAR Country Procurement Assessment Report CPS Country Partnership Strategy CY Calendar Year DDO Deferred Draw Down Option DGPM General Directorate o f Multi-annual Public Sector Programming DIGESA Direccidn General de Salud Ambiental (General EnvironmentalHealth Direction) DNEP Direccidn Nacional del Endeudamiento Pliblico (Debt Office) DNI Documento Nacional de Identidad (National Identity Card) DNPP Direccidn Nacional de Presupuesto Pliblico (National Office of Public Budgeting) DPL Development Policy Loan EFTA European Free Trade Association EMBI EmergingMarkets Bond Index EU European Union ~ FDI Foreign Direct Investment FIDECOM Fondo de Investigacibn y Desarrollopara l a Competitividad FINCYT Science and Technology Fund FMCDPL Fiscal Management and Competitiveness Development Policy Loan FOGEM Fondo de Garantia Empresarial FONCAM Fondo Nacional de Camisea (National Camisea Fund) FONCOMUN Fondo de Compensacidn Municipal (Municipal Compensation Fund) FONCOR Fondo de Compensacidn Regional (Regional Compensation Fund) FONIPREL Fondo de Promocidn a la Inversidn Pliblica Regional y Local (Regional and Local Investment Fund). FRTL Fiscal Responsibility and Transparency Law FSAP Financial Sector Assessment Program FSL Fixed Spread Loan FTA Free Trade Agreement FY Fiscal Year GDP Gross Domestic Product GNI Gross National Income GoP Government o f Peru GTZ German Agency for Technical Cooperation IADB Inter-AmericanDevelopment Bank IBRD InternationalBank for Reconstructionand Development ICT Information and Communications Technology IDF Institutional Development Fund IFC InternationalFinance Corporation FOR OFFICIAL USE ONLY IMF International Monetary Fund ME1 lnstituto Nacional de Estadistica e Informdica (National Statistics Institute) JBIC Japan Bank o f InternationalCooperation KfW German Development Bank LAC Latin America and Caribbean LPTF Ley de Prudenciay Transparencia Fiscal (Law of Fiscal Prudence and Transparency Law) LRTF Ley de Responsabilidady TransparenciaFiscal (Law of Fiscal Responsibility and Transparency) M&E Monitoring and Evaluation MDO Ministries, Departments and Other government agencies MEF Ministerio de Economia y Finanzas (Ministry of Economy and Finance) MEL Mining EnvironmentalLegacies MIC Middle Income Country MMCETUR Ministerio de Comercio Exterior y Turismo (Ministry o f Trade and Tourism) MINEDU Ministerio de Educacidn (Ministry of Education) MMM Marco Marcroecondmico Multianual (Multiannual MacroeconomicFramework) MSME Micro, small and medium enterprises NFPS Non-financial public sector NPL Non-performing loan OECD Organization for Economic Cooperation and Development OEFA Environmental Evaluation and Enforcement Office Oficina Nacional de Gobierno Electrdnico e Informdtica (Information Technology and E-government National ONGEI Office) OSCE Organism0 Supervisor de Ius Contrataciones del Estado PBB Performance-Based Budgeting PCM Presidencia del Consejo de Ministros (Office of the Prime Minister) PER Public Expenditure Review PFM Public Financial Management PIT Programas Institucionales PRODUCE Ministerio de la Produccidn (Ministry of Production) RER RPgimen Especial del Impuesto a la Renta (Special Income Tax Regime) ROSC Report on ,Observance of Standards and Codes RUC Registro Unico de Contribuyentes (Single Taxpayer Registry) RUS RCgimen Unico Simplificado (Unique Simplified Regime) R&D Research and Development SBA Stand-By Arrangement SB S Superintendencia de Banca y Seguros (Superintendence o f Banks and Insurance Companies) SDC Swiss Agency for Development and Cooperation SENASA Servicio Nacional de Sanidad Agraria (National Agriculture Health System) SIAF Sistema Integrado de Administracidn Financiera (Integrated Financial Management System) SNIP Sistema Nacional de Inversidn Publica (National System o Public Investment) f SUNARP Sistema Nacional de Registros Publicos (National System for Public Registry) SUNAT Superintendencia Nacional de Administracidn Tributaria (Government Tax Agency) TAL Technical Assistance Loan TSA Treasury Single Account UCPS Unidad de Coordinacidn de Prkstamos Sectoriales (Sectoral Loans Coordination Unit) UN United Nations us United States USAID United States Agency for International Development VAT Value Added Tax VUCE Ventanilla Unica de Comercio Exterior (One Stop Shop for Foreign Trade) Vice President: Pamela Cox Country Director: Carlos Felipe Jaramillo Sector Director Marcel0 Giugale Sector Manager: Rodrigo A. Chaves Sector Leader Carlos Silva-Jauregui Task Team Leaders: Paloma Anos-Casero Rossana Polastri T h i s d o c u m e n t h a s a restricted d i s t r i b u t i o n and may b e u s e d by recipients only in t h e p e r f o r m a n c e o f t h e i r official duties. I t s contents may not b e o t h e r w i s e disclosed without World Bank authorization. ACKNOWLEDGEMENTS The World Bank Group greatly appreciates the close collaboration o f the Government o f Peru in the preparation o f this development policy loan. This DPL was prepared by a team composed o f Oscar Calvo-Gonzalez, Paloma An6s-Casero, Rossana Polastri, Enrique Fanta, Maria Dolores Arribas-Baiios, The0 David Thomas, Javier Illescas, Rogelio Marchetti, Christopher Humphrey, Diana Ortiz Sosa, Jose Valderrama, Xiomara Morel, Fabiola Altimari, Florencia Liporaci, Eileen Brown, Miguel Jaramillo, Jog0 Veiga Malta, Jose Luis Guasch, Ole Jorgensen, Maria Ivanova Reyes, Riccardo Trezzi, Pilar Gonzalez, Banu Demir and Pilar Larreamendy. The team also received valuable inputs from Emmy Yokoyama, Fernando Rojas, Livia Benavides, Nelson Rodriguez, Ines Kudo, Ian Walker, Mark Austin and Raul Tolmos; and the IFC Technical Assistance Facility staff. Milagro Mayuri provided useful administrative assistance. The team was lead by Paloma An6s-Casero (LCSPE, co-task manager) and Rossana Polastri (LCCPY, co-task manager) and worked under the guidance o f Carlos Felipe Jaramillo (Director, LCC6C), Marcel0 Giugale (Director, LCSPR), Rodrigo A. Chaves (Sector Manager, LCSPE) and Carlos Silva-Jauregui (Sector Leader, LCC6). Graham Scott (PRMPS, consultant) and Jean Francois Arvis (PRMTR) were peer reviewers. .. 11 PERU THIRD PROGRAMMATIC FISCAL MANAGEMENT AND COMPETITIVENESS DEVELOPMENT POLICY LOAN TABLE OF CONTENTS L O A N AND PROGRAM SUMMARY .......................................................................................... v I Introduction .............................................................................................................................. . 1 I1 Country Context ....................................................................................................................... . 2 A . Economic Developments ....................................................................................................... 2 B. Macroeconomic Outlook and Debt Sustainability ................................................................. 8 . I11 The Government Program and Participatory Processes ......................................................... 10 I V. Bank Support to the Government Program ............................................................................ 12 A . Link to the Partnership Strategy and Other Bank Operations.............................................. 12 B. Collaboration with the IMF and Other Donors .................................................................... 14 C . Lessons Learned................................................................................................................... 15 D. Analytic Underpinnings ....................................................................................................... 15 . V . The Proposed Operation ......................................................................................................... 18 A . Operation Description .......................................................................................................... 18 B. Policy Areas ......................................................................................................................... 21 1.Efficiency and Quality o f Fiscal Management .................................................................. 21 2.Competitiveness ................................................................................................................. 35 V I. Operation Implementation ...................................................................................................... 46 A . Poverty and Social Impact ................................................................................................... 46 B. Implementation, Monitoring and Evaluation ....................................................................... 48 C . Fiduciary Arrangements ....................................................................................................... 49 D. Disbursement and Audits ..................................................................................................... 50 E. Environmental Aspects ........................................................................................................ 51 F . Risks and Risk Mitigation .................................................................................................... 52 Annex 1. Debt Sustainability Analysis .......................................................................................... 55 Annex 2. Letter o f Development Policy ........................................................................................ 61 Annex 3 . Third Fiscal Management and Competitiveness DPL Program Matrix ......................... 77 Annex 4. Results Framework: Monitoring Progress on Outcome Indicators ................................ 81 Annex 5 . Peru-IMF Relations ........................................................................................................ 85 Annex 6. Peru At A Glance ........................................................................................................... 86 Map o f Peru.................................................................................................................................... 89 ... 111 Table 1: Key Economic Indicators ................................................................................................. 3 Table 2: Poverty Rates .................................................................................................................... 4 Table 3: Selected Quarterly Economic Indicators .......................................................................... 6 Table 4: Public financing requirements ........................................................................................ 10 Table 5: Government Economic and Social Targets .................................................................... 10 Table 6: Analytical and Advisory Work Underpinningthe FMCDPL Series .............................. 16 Table 7: Redistributive Government Programs ............................................................................ 47 Table 8: Poverty Rates by Geographic Area ................................................................................. 48 Figures Figure 1: Inflation ........................................................................................................................... 4 Figure 2 : Exchange Rate ................................................................................................................. 4 Figure 3: Current Account and FDI ................................................................................................ 5 Figure 4: EMBI Global Spreads ..................................................................................................... 5 Figure 5: Components o f Peru's Competitiveness Ranking......................................................... 35 Figure 6: Peru Export composition ............................................................................................... 37 . Boxes Box 1: Good Practice Principles on Conditionality ...................................................................... 20 Box 2: Social Conflict in Peru ...................................................................................................... 54 iv REPUBLIC OF PERU THIRD PROGRAMMATIC FISCAL MANAGEMENT AND COMPETITIVENESS DEVELOPMENT POLICY LOAN LOAN AND PROGRAM SUMMARY Borrower Republic of Peru Implementing Ministry of Economy and Finance Agency Financing Data IBRD Loan Amount: US$l50 million Terms: Commitment linked variable interest rate loan, payable in 21 years, including 8 years of grace, following a customized repayment schedule. Operation Type Single Tranche Development Policy Loan to be disbursed upon loan effectiveness Main Policy Areas The proposed DPL i s the third in a series of four loans aimed at supporting the Government of Peru's (GoP) reform program to improve the functioning of the country's public sector institutions and business environment. The loan supports two broad areas of policy reform: Efficiency and Quality of Fiscal Management Competitiveness Key Outcome The proposed loan will contribute to the achievement o f the following outcomes: Indicators Strengthening the GoP's fiscal position and overall fiscal framework, with timely budget financing at reasonable terms; Improving the efficiency and quality of public spending with the objective of allowing for budgetary savings that could be directed towards priority poverty programs as well as more and higher quality public services for citizens; and Expanding international trade and improving the business environment with particular emphasis on small and medium enterprises that are critical to createjobs. For further details on key outcome indicators please see a complete Results Framework Matrix in Annex 4. Program The proposed loan supports progress towards medium-term program outcomes related to three Development CPS objectives: (i) maintaining macro stability (pillar I-cluster I), accelerating growth and (ii) Objectives and widening the base of growth (pillar I-cluster I ) (iii) , I and modernizing institutions (pillar 111-cluster Contribution to CPS VI). Risks and Risk There are two key sources of risks associated with the proposed loan: Mitigation Economic: The main economic risk comes from the effect that the global crisis may have on the Peruvian economy. On the domestic side, there i s a risk that the countercyclical spending (mainly on public investment) may not materialize at the rate planned and may not have the desired impact on growth-due to limited spending capacity in certain government agencies. If the global economic situation were to worsen and the current stimulus package i s not sufficient, there i s the risk that (i)potential additional public expenditure could jeopardize fiscal stability in the medium term, and/or (ii) GoP may lose momentum in implementing the reforms supported under the the series o f DPLs. The program supported by the World Bank and this operation, in particular, contribute to the mitigation o f these risks. The implementation o f performance-based budgeting and technical assistance work on procurement to improve public investment capacity are examples of mitigating factors. Commitment to structural reforms and broad national consensus on the macroeconomic pillars remains strong. In addition, Peru faces the external risk o f a slow recovery o f the global economy, which could imply weak aggregate demand and low prices for Peruvian exports. Political and social: Risks arising from social unrest tend to be correlated with high levels of poverty and inequality. These risks could be exacerbated if economic activity deteriorates substantially. Imperfect conflict resolution mechanisms with disaffected social groups remain a challenge to political stability. However, continued improvements in social safety nets and other social programs, a more equitable flow o f resources to the country's regions, and an increase in spending on public investment as part of the economic stimulus package assist in ameliorating social and political risks. Project ID Number PI 06720 V I. Introduction 1. This proposed Development Policy Loan for US$150 million i s the third in a programmatic series of four Fiscal Management and Competitiveness Development Policy Loans (FMCDPL). The FMCDPL series, along with parallel Development Policy Loans (DPLs) in the areas o f social policy and environment, were designed in close partnership with Government o f Peru (GoP) and in line with its policy program--as outlined in the Country Partnership Strategy (CPS). The GoP stated a clear vision for (i) building o n recent economic successes to achieve higher growth and better social outcomes; (ii) constructing a better social contract between the government and citizens based on effective social development; and (iii) modernizing state institutions. This F M C D P L programmatic series has been prepared at the request o f President Garcia's administration. I t has been designed to support Peru's own program. Unlike the previous two loans in the series, this proposed third operation includes policies to deal with short-term issues such the effects o f the global crisis, while maintaining momentum in the implementation o f reforms that address structural issues and which will have medium-term effects. 2. The operation supports the GoP's efforts in the context o f a global economic slowdown. The development objective o f the loan i s to contribute to growth and poverty alleviation by supporting two main policy areas: (i)quality of fiscal management and (ii)competitiveness. Peru entered the global crisis in a solid position and has managed its challenges well. Good macroeconomic fundamentals and appropriate policy responses to the crisis moderate the negative impact o f weaker external demand and external shocks. Aware of the downside risks to economic growth as well to poverty and employment, the GoP has implemented counter-cyclical policies to mitigate the impact o f the crisis. Nonetheless, the GoP has not lost sight o f the medium-term objectives o f i t s reform agenda, and has continued to make progress in improving the effectiveness o f fiscal management and supporting the country's competitiveness and integration into the global economy. 3. Due to the severity o f the global crisis, the GoP has directed resources and designed policies to mitigate its negative impact. Consequently, a few areas o f the reform agenda expected to be supported by the loan experienced delay. In particular, triggers related to the e-government and to the revision o f fiscal rules for sub-national governments are yet to be implemented. Instead, the GoP has made progress in urgent areas such as implementing i t s Economic Crisis Plan and improving public procurement legislation that contribute to the achievement o f equivalent objectives. 4. I n response to the challenging economic situation, the Government has indicated i t s intention to request the disbursement o f available Bank DPL/DDOs at a faster pace than initially anticipated. To date, the GoP has disbursed US$70 million o f the US$1.36 billion approved since August 2008. However, in view o f evolving conditions, the Peruvian authorities have informed the Bank that they intend to disburse US$340 million by the end o f CY2009 and US$200 million by the end o f CY201 0. 1 11. Country Context A. Economic Developments 5. Peru i s facing the global economic crisis after a period o f broad-based rapid growth. I t has displayed one o f the strongest growth performances in the Latin America and the Caribbean region in recent years, with growth accelerating from 6.4 percent in 2005 to 9.8 percent in 2008. Rising commodity prices fueled export growth but the economic expansion from 2006 to 2008 was also based on buoyant domestic demand and was led by the private sector. The rapid increase in imports contributed to turning the current account into deficit in 2008. Consumption and investment contributed roughly equally to economic growth. Private investment rose from 15 percent o f Gross Domestic Product (GDP) in 2005 to around 22 percent o f GDP in 2008, supported by a positive outlook and sound macroeconomic management. While the expansion was particularly rapid in construction, trade and services, all other sectors o f the economy grew by at least 6 percent in 2008. 6. Fast economic growth in recent years has been accompanied by poverty reduction and job creation. Between 2005 and 2008 poverty fell from 48.7 percent to 36.2 percent, while extreme poverty was reduced from 17.4 percent to 12.6 percent (Table 2). This reduction in poverty i s remarkable given that 2008 saw high food price inflation, which made poverty reduction even more challenging. The rise in food prices explains why decreases in poverty in 2008 were highest in rural areas. The growth o f labor-intensive sectors o f the economy such as services, trade and construction also led to notable increases in employment, which rose by 11 percent in 2008. Poverty incidence remains highly unequal in geographic terms, with some regions posting poverty rates above 60 percent. 7. While inequality remains high, the GoP has made progress in addressing it. The Gini coefficient has been improving (albeit slowly). Moreover, the Human Opportunity Index, which measures equality o f opportunity in access to social services, shows substantial improvement between 1995 and 2006. Increased public investments in water, sanitation and electricity during the last three years support a trend o f reduction in inequality o f opportunity. Despite this progress, still large opportunity gaps remain a challenge for policy-makers. Table 1: Key Economic Indicators (YOunless otherwise noted) 2006 2007 2008 2009p 2010p 2011p 2012p Base Low Base Low Base Low Base Low GDP growth rate 7.7 8.9 9.8 1.5 0.5 4.0 3.0 5.0 5.0 5.5 5.5 Growth o f real domestic demand 10.3 11.8 12.3 1.2 -1.5 3.3 3.2 4.2 4.1 4.6 4.6 Inflation rate, CPI (period average) 2.0 1.8 5.8 3.0 2.7 2.9 2.9 2.9 2.8 2.8 2.8 General government balance/GDP 2.2 3.3 2.0 -2.0 -2.3 -1.5 -1.9 -1.0 -1.0 -1.0 -1.0 Total external debt (public & priv.)/GDP 31 30 24 27 27 26 27 25 26 24 24 Public external long- term debt/GDP 24 18 15 17 17 16 17 16 16 15 16 Export growth 37 18 13 -21 -20 7 7 8 8 9 9 Import growth 23 32 45 -16 -24 7 13 6 6 7 7 Trade balance/GDP 9.6 7.7 2.4 1.0 2.8 1.2 2.0 1.6 2.4 2.0 2.9 External current account/GDP 3.0 1.4 -3.3 -2.3 -0.5 -2.0 -1.1 -1.4 -0.4 -1.0 0.1 Terms o f trade (deterioration -); percentage change 23.1 2.4 -5.0 -1.4 -2.3 -1.1 -1.1 -1.6 -1.6 -0.9 -0.9 Net international reserves (NIR), US$ billion 17 28 31 30 31 30 30 30 29 31 29 NIR in months o f G&S imports 11 14 11 12 14 12 12 11 11 11 10 NIR as 'YOo f public external debt 78 141 163 148 150 142 143 140 137 141 134 NIR as % o f money stock 64 83 71 74 76 70 72 68 69 66 64 Note: For 2009-2012 the base case reflects an economic recovery starting in the second half o f 2009. The low case reflects a scenario with no economic recovery in 2009, in line with a global scenario o f sluggish economic recovery. Tax revenues are expected to fall in 2009 by 14 percent, broadly in line with the evolution o f tax revenues in the first seven months o f 2009 which have seen a decline of 13 percent under the low case. Capital expenditures are expected to increase by 34 percent in 2009, reflecting the challenge o f fully disbursing the public investment program envisaged in the economic stimulus plan (the base case reflects approximately a 60 percent disbursement o f the planned capital expenditures).The low case also reflects a growth rate of 0.5 percent close to the 0.6 percent growth recorded in the first semester o f 2009. Source: Banco Central de Reserva del Peni (BCRP), Ministry o f Economy and Finance ( M E F F M a r c o Macroecon6mico Multianual2010-2012, World Bank staff, I M F staff. 3 Table 2: Poverty Rates, 2004-2008 (YO) Total poverty Extreme poverty 2004 2005 2006 2007 2008 2004 2005 2006 2007 2008 National 48.6 48.7 44.5 39.3 36.2 17.1 17.4 16.1 13.7 12.6 Coast urban 37.1 32.3 29.9 25.1 23.4 5.6 4.0 3.0 2.1 2.4 Coast rural 51.2 50.0 49.0 38.1 34.8 13.8 13.4 14.4 10.5 7.9 Sierra urban 44.8 44.4 40.2 36.3 33.5 13.6 11.6 10.3 8.5 9.2 Sierra rural 75.8 77.3 76.5 73.2 68.8 44.0 46.6 46.5 40.8 37.4 Seha urban 50.4 53.9 49.9 40.3 31.3 18.7 22.5 18.1 11.0 7.2 Selva rural 63.8 65.6 62.3 55.3 49.1 30.4 28.0 24.6 23.4 20.7 MetroDolitan Lima 30.9 32.6 24.2 18.5 17.7 1.3 2.0 0.9 0.5 0.7 Source: Instituto Nacional de Estadistica e Informatica (INEI). 8. Sound macroeconomic management underpinned the fast growth recorded until late 2008. The GoP maintained a prudent fiscal policy through the commodity boom period, running fiscal surpluses in the three years to 2008, when the overall budget surplus reached 2 percent o f GDP in 2008. The authorities saved resources into a fiscal stabilization fund, which saw i t s balance increase from US$314 million in 2005 to US$1.8 billion in 2008 (around 1.4 percent o f GDP). The authorities also took the opportunity to bring public debt down from 38 percent o f GDP in 2005 to 24 percent in 2008. Public external debt has decreased from 28 percent o f GDP in 2005 to 15 percent in 2008. In parallel, the Central Bank (BCRP) accumulated net international reserves which increased from US$14 billion in 2005 to US$31 billion in 2008-close to five times the stock o f short-term external debt. Despite the worldwide rise in food prices during 2008, inflation remained among the lowest in the region at 5.8 percent in 2008 and had come down to 3.1 percent by June 2009 (Figure Jan-05 Jan-06 Jan-07 Jan-08J an-09 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Source: BCRP. Source: BCRP. 4 9. T h e sound macroeconomic situation brought the country's sovereign ratings to investment grade and new foreign direct investment (FDI) inflows. In 2008 Peru's sovereign foreign currency rating was upgraded to investment grade, as a result o f the strong economic growth performance o f the previous years, prudent fiscal and liability management, and the resulting improvement in solvency indicators. Strong capital inflows led to reserves build up and put appreciation pressure on the Nuevo Sol through mid-2008 (Figure 2). FDI inflows surged from US$2.5 billion in 2005, around 3.2 percent o f GDP, to US6.5 billion in 2008, around 5 percent o f GDP (Figure 3). As in other countries in the region, the overall positive sentiment in international capital markets led to declining spreads through mid-2007, and to limited increases during the first eight months o f 2009 (Figure 4). Figure 3: Current Account and FDI Figure 4: EMBI Global Spreads Percent o G D P f Basis points 1:000 6 5 CAB -FDI 1 900 Peru 4 800 LAC 3 700 2 600 1 0 400 . -1 300 -2 200 -3 IOU -4 2004 2005 2006 2007 2008 0 Ja n-05 Ja n-06 Ja n-07 Ja 11-08 Ja n-09 Source: BCRP, IMF. Source: Bloomberg. 10. Since September 2008, economic activity has slowed sharply and uncertainty has increased. Economic growth dropped from double-digit growth in the first three quarters o f 2008 to 6.5 percent in 442008, to 1.8 percent in 1Q2009, and to -1.1 percent in 242009. The slowdown reflects weakness in both external and domestic demand and has been particularly intense in the manufacturing sector, which saw declines o f 5.3 percent in 1Q2009 and 11.1 percent in 2Q2009. The best performing sector o f the economy i s other services, which posted growth around 5 percent growth in 1Q2009 and 3.6 percent in 2Q2009. Uncertainty about the short-term outlook has increased and i s reflected in a wide dispersion o f growth forecasts. 5 Table 3: Selected Quarterly Economic Indicators, lQ2008-2Q2009 142008 242008 342008 442008 1Q2009 2Q2009 Real percentage change over same quarter in previous year GDP 10.3 11.8 10.9 6.5 1.8 -1.1 Domestic demand 11.9 14.6 13.7 9.1 -0.9 -5.5 Private consumption 8.4 9.3 9.2 8.0 3.8 1.9 Public consumption 3 .O 3.5 2.4 -1.0 8.2 8.9 Gross domestic investment 25.3 34.2 30.1 15.4 -15.1 -27.2 Fixed private investment 19.7 34.0 28.0 21.0 1.7 -20.8 Fixed public investment 68.8 60.2 56.8 21.7 22.2 12.9 Percentage change in US$ value over same quarter in.previous year Exports 35.4 27.1 16.9 -18.4 -3 1.6 -29.6 Traditional exports 36.5 26.9 14.7 -25 .O -35.0 -3 1.7 Non-traditionalexports 31.6 27.0 22.6 2.3 -2 1.o -22.9 Imports 48.9 68.0 50.8 18.7 -22.3 -29.7 Terms o f trade (1 994=100) 130.8 127.9 118.7 100.2 100.8 108.2 Source: BCRP. 11. Exports have decreased by about 30 percent in the first semester o f 2009 but appear to have bottomed out. Weak international demand since September 2008 has negatively affected the export sector. The initial impact was felt on the terms o f trade, as international prices o f both traditional and non-traditional exports declined. The terms o f trade f e l l from the peak o f 138 in 2007 (1994=100) to 95 as o f December 2008, though it has since recovered to 108 in the second quarter o f 2009 and stand at 112 as o f August 2009. The decline in exports has been accompanied by a large contraction in imports, especially o f foodstuffs and inputs. However, the most important factor in explaining the shift in the current account from surplus to deficit was the repatriation o f corporate profits by mining and other international companies as in 2008 the repatriation o f profits amounted to US$7.7 billion (about 6.0 percent o f GDP). Thus, the trade balance has remained in surplus. The evolution o f the current account balance will depend greatly on the evolution o f the profit remittances o f mining and other companies which, as noted above, are particularly large. So far in the first semester o f 2009 net factor income outflows have halved compared to the first semester o f 2008 (from $5.4 billion to $2.8 billion net outflows). The expected decline o f profit remittances helps to explain why the current account deficit i s projected to narrow in 2009 compared to 2008 (Table 1). 12. Domestic demand has decreased as businesses deplete inventories. The growth o f private consumption has halved in early 2009. Private investment in fixed capital has also slowed down substantially, growing at only 1.7 percent during the first quarter o f 2009 and plummeting to -21 percent in 2Q2009 after posting double-digit growth rates for 15 consecutive quarters. Public consumption and investment have started to pick up in the first half o f 2009 but have not offset the slowdown o f private sector activity. Overall, the negative growth rate o f domestic demand can be explained by the uncertain economic environment, which has prompted businesses-particularly in manufacturing-to run down existing inventories rather than producing to meet new orders. 6 13. T h e crisis i s expected to turn the fiscal balance into a deficit as revenues contract and expenditures -especially capital spending- increase. The overall non-financial expenditures o f the general government are expected to increase in 2009 b y 15 percent, to around US$ 25 billion or 17.3 percent o f GDP. The increase is expected to be particularly steep in capital expenditures, envisaged to rise by 46 percent, to around US$ 7.3 billion or 5.7 percent o f GDP. In contrast, current expenditures are projected to increase b y 6 percent, to around US$ 17.4 billion or 13.5 percent o f GDP (compared to 13.2 percent o f GDP registered in 2008). As a result, the share o f capital expenditure in the overall non-financial expenditures o f the general government i s projected to rise from 23 percent in 2008 to 30 percent in 2009. The economic slowdown has negatively affected tax collections, which decreased by 11 percent in the first seven months o f 2009 compared to the same period in 2008; the largest drops have been observed in corporate income tax collections (-31 percent) and the VAT collections on imported goods (-21 percent) which are two important revenue generating taxes accounting for, respectively, 25 and 24 percent o f all tax collections in 2008. In contrast, personal income tax collections have continued to grow (at 4 percent over the first seven months o f 2009) and VAT collections on domestically produced goods have also held up well, increasing by 9 percent over the first seven months o f 2009 - a phenomenon that can be explained in part by the impact o f the draw-down o f inventories by private businesses during the first half o f 2009. 14. Despite these magnitude of the challenges, financial and exchange rate stability have been preserved. In the wake o f the Lehman Brothers bankruptcy in mid-September 2008 the sharp increase in risk aversion in global financial markets was quickly felt in Peru. From mid-September to end-October 2008 net international reserves fell by US$3.3 billion, or close to 10 percent o f holdings. There was also an increase in the dollarization o f deposits, which rose from 43 percent in March 2008 to 52 percent in March 2009. However, the central bank avoided sharp fluctuations o f the exchange rate, which, as o f early September 2009, is back to its level o f early September 2008. The global financial crisis has had a relatively limited impact on the Peruvian financial sector, which did not rely heavily on short-term external borrowing. The international financial crisis has also failed to cause a credit crunch in Peru. The growth o f credit to the private sector has slowed down but continued to grow at an annual rate o f 18 percent as o f July 2009. 15. I n response to the economic slowdown the authorities launched a two-year fiscal stimulus package amounting to $4.2 billion, o r about 3 percentage points of GDP. The plan focuses primarily on increased public expenditures and attempts to balance the need for a stimulus in the short-term with a focus on medium-term priorities. Infrastructure projects account for around 69 percent o f planned expenditures. In particular, about US$667 million have been allocated for priority projects and US$567 million have been allocated to projects which are already in execution but which had undisbursed budget balances in 2008- effectively funding the `carry over' o f those projects into 2009. An additional US$867 million was earmarked to infrastructure projects to be chosen and implemented by regional governments. Other large items in the economic stimulus plan include US$400 million for a range o f social protection policies, including some maintenance o f education infrastructure, as well as US$333 million to fund the fuel subsidies in place through a Fuel Stabilization Fund. Another subsidy fimded by the economic stimulus plan is the so-called `duty drawback' paid to exporters to compensate them for the import duties paid on inputs and which has been temporarily increased. The challenge i s to implement this economic stimulus 7 package rapidly enough to meet the goal set by the authorities o f increasing public investment by 52 percent in 2009, compared to a growth o f around 40 percent in 2008. In contrast with the expected fast growth o f public investment, current expenditures o f the central government are expected to increase only by around 1 percent in 2009. 16. T h e fiscal stimulus plan combined with lower than expected fiscal revenues i s expected to cause a fiscal deficit o f 2 percent o f GDP in 2009. Peru's budget balance is expected to turn negative in 2009 due to both lower revenues and increased public expenditure associated with the economic stimulus plan. The existing Fiscal Responsibility and Transparency L a w sets two limits: (i) fiscal deficit i s not to exceed 1 percent o f GDP, the and (ii) growth o f current expenditures o f the central government i s not to exceed 3 the percent p.a. in real terms. Article 5 o f the L a w states, however, that in cases o f national emergency or international crisis the legislative can, at the request o f the executive, grant exceptions to the fiscal rules for a period o f up to three years. The administration proposed legislation-which the Congress approved- to increase the fiscal deficit to 2 percent o f GDP in both 2009 and 2010. In addition, and while more than 70 percent o f the stimulus plan i s envisaged to be used for capital expenditures, the limit on the real growth o f current expenditures by the central government-set at 3 percent by the Fiscal Responsibility and Transparency Law-was also temporarily lifted to 10 percent in 2009 and 8 percent in 2010. While tax revenues have deteriorated more than initially expected, the fiscal deficit i s unlikely to increase substantially more than what i s currently envisaged by the authorities. In part this i s because fully disbursing the economic stimulus will be challenging. In fact, in previous years the execution o f public investment was below 60 percent o f planned expenditures due to a variety o f factors ranging from lack o f shovel-ready projects, burdensome administrative and procurement processes, and limited implementation capacity at different levels o f government. 17. I n parallel, the central b a n k has eased monetary policy as inflation decreased and exchange rate appreciation pressures resumed. The central bank has cut its policy rate every month from February to August 2009, bringing the rate to 1.25 percent for a cumulative easing since the beginning o f 2009 o f 525 basis points. Such a monetary policy easing takes place in a context o f declining inflation, down to 1.9 percent as o f August 2009 and growth deceleration. In addition, the central bank adopted a number o f measures aimed at supporting the flow o f credit, such as reducing reserve requirements, accepting new instruments as collateral for liquidity operations, and the extension o f the t e r m o f liquidity management operations. B. Macroeconomic Outlook and D e b t Sustainability 18. W h i l e uncertainty about the near-term outlook has increased, prospects for P e r u remain positive--provided that a sound policy framework remains in place. The slowdown in growth in 2009 w i l l be undoubtedly substantial. However, the baseline scenario i s that activity will pick up in the second half o f 2009, in line with the global economy. Moreover, the sharp reduction in inventories which occurred during the first semester o f 2009 i s expected to be partially reversed, which would support an expansion o f domestic demand b y year-end. The current fiscal and monetary policy stance will also contribute to the recovery. Accordingly, Peru will be one o f the few economies in the region that is likely to avoid a recession in 2009. Given the extent o f the slowdown and the dynamics o f 8 international food prices, inflation i s expected to remain l o w in the remainder o f 2009 and to be within the central bank's target range from 2010 onwards. The trade balance is expected to shrink in 2009 but profit repatriation from foreign firms in Peru can also be expected to be reduced in line with the decrease in exports, resulting in a roughly unchanged current account deficit. Over the next few years, economic growth i s expected to converge towards 5.5 percent. As the global economy recovers, exports are expected to grow faster than imports in the medium-term and help drive growth up. The economic stimulus plan i s likely to be felt strongly in both 2009 and 2010 when a return to a more normal fiscal policy stance is expected. 19. A debt sustainability analysis suggests that the public debt position i s resilient to a range o f simulated negative shocks. The baseline scenario in the debt sustainability analysis envisages a temporary increase o f public debt in 2009 to 25.1 percent o f GDP, up from 24.4 percent in 2008, and which i s expected to decline to 21.8 percent by 2012. A series o f stochastic simulations suggest that the public debt profile i s unlikely to differ significantly from the baseline and support the assessment that public debt sustainability is not a major concern in the medium term (see Annex 1 for details). Sound macroeconomic management has given Peru the room to implement counter-cyclical fiscal policies. However, fiscal risks remain, both in the short and medium term. In the short-term the decline in revenues i s likely to be exacerbated before tax collections improve, because o f collections o f the value-added tax would be reduced by the normalization o f inventories held by businesses. In the medium term Peru faces the challenge o f broadening the tax base and increasing revenue collection at all levels o f government. 20. Peru's medium-term fiscal framework still relies on external financing. The authorities envisage in their Multiannual Macroeconomic Framework that external financing requirements for the period 2009-2012 would total US$8.8 billion (US$2.2 billion per year o n average). O f this amount, US$5.2 billion are expected to come from budget support from multilaterals and global credit markets (US$l.3 billion per year on average). Peru has been able to raise US$2 billion so far this year in international markets first by issuing a US$1 billion 1O-year international bond in March and recently by reopening the existing 2025 Peru international bond for another U S $ l billion. Around US$1.4 billion o f the financing raised in international markets has been devoted for pre-paying higher-interest rate debt to Paris Club creditors. On balance, the public financing requirements are manageable. But in a context o f deteriorating fiscal accounts, the proposed operation provides timely budget support, contributing to the GoP's efforts to manage the current economic downturn. 2 1. Notwithstandingthe economic downturn and the risks to the near-term outlook, Peru's macroeconomic policies are deemed adequate for this proposed loan. Fiscal policy remains prudent as the envisaged expansion o f government expenditure does not threaten fiscal sustainability. Moreover, the economic stimulus package is designed and expected to be temporary. The economic stimulus plan is focused on capital investments that are likely to be easily reversed once the economy regains i t s momentum and which will support future economic growth. In addition, monetary and exchange rate policy i s also supportive o f macroeconomic and financial stability. 9 Table 4: Public financing requirements, 2009-2012 Datafor the non-financial public sector (NFPS) in US$ million, as reported by the authorities 2009p 2010p 2011p 2012p (a) NFPS Primary balance -856 -400 56 1 1,822 (b) Interest payments 1,737 1,92 1 2,068 2,192 o/w interest on external debt 1,02 1 1,107 1,174 1,305 interest on domestic debt 716 814 894 887 NFPS balance -2,593 -2,321 -1,507 -370 (c) Amortizations 2,064 1,244 1,765 1,724 o/w amortization o f external debt 1,776 935 94 8 1,407 amortization o f domestic debt 288 309 817 317 (d) Public financing requirements = (b)+(c)-(a) 4,657 3,566 3,272 2,094 Memo items NFPS financing requirements, percent o f GDP 3.7 2.5 2.1 1.2 Sources: Ministry o f Economy and Finance (Marco Macroecondmico Multianual, August 2009). 1. 11 The Government Program and Participatory Processes 22. The priorities o f the GoP's program for 2008-2011-a solid macroeconomic framework and reforms to generate sustainable and equitable growth-remain unchanged since the first loan in this series. The GoP's program aims to balance both human and economic development, and i s divided into three main areas o f action: accelerating and broadening economic growth; improving social development; and modernizing public sector institutions. The GoP has established a set o f goals for the end o f the administration and is monitoring and publicly reporting progress. The progress achieved at mid-term has been positive, with relatively more success o n the macroeconomic front (Table 5). Table 5: Government Economic and Social Targets, 2006-11 I Period Baseline Target Progress to date GDP (millions o f US$) 201 1 79,446 140,000 127,738 Private investment (millions o f US$) 2006-201 1 12,285 100,000 54,829 Public investment (millions o f US$) 201 1 2,265 30,000 10,395 Poverty (%) 201 1 48.7% 30.0% 36.2% Urban poverty (%) 201 1 36.8% 20.0% 23.5% Rural poverty (YO) 201 1 70.9% 45.0% 59.8% 1 Number ofjobs created 201 1 Na 1,500,000 1,388,111 Convergence to Inflation (average change YO) 2011 1.8% 6.7% BCP`s target Foreign debt (YO f GDP) o 201 1 3 1.3% 13.0% 15.1% Internationalreserves (millions o f US$) 201 1 14,683 30,000 3 1,030 10 23. The two policy areas supported by this proposed loan will assist in sustaining economic growth and spreading its fruits throughout Peruvian society. In terms o f fiscal policy, the authorities are committed to continue strengthening control o f overall fiscal balances through a more efficient tax system, managing wages and other current spending and public debt. Beyond quantity, the GoP is also focusing on the quality o f public expenditure, implementing more rigorous monitoring and evaluation o f spending programs using performance-based budgeting techniques, simplifying and rationalizing the tax system to reduce distortions, and making public sector processes more transparent and effective. In the area o f competitiveness, the GoP has placed emphasis in improving producers' access to global markets and in reducing bottlenecks to trade and investment. Peru's involvement in the world economy has continued to increase, evidenced by the full implementation o f the free trade agreement with the U.S. and Chile, the conclusion o f negotiations with Singapore, Canada, Thailand and China. Trade negotiations are underway with Mexico, the European Union, Korea, Japan, and the European Free Trade Association. 24. Since September 2008, the GoP dedicated resources to mitigate the effects o f the global crisis. The GoP's priorities have been reflected in the reformulated 2009 budget, with the inclusion o f a two-year fiscal stimulus package o f about 3 percent o f GDP. For 2009, the Ministry o f Economy and Finance (MEF) envisages increasing public investment by 52 percent over the year before (about US$2.5 billion in one year) with a particular focus on key obstacles to growth such as social infrastructure and a strong emphasis o n poorer regions o f the country. Increased public investment is occurring within a framework o f overall fiscal discipline, with an official target for the overall deficit o f the public sector o f less than 2 percent o f GDP for both 2009 and 2010, and returning gradually toward equilibrium in the following years. To ensure sustainability and impact o f investment, the authorities are in the process o f implementing medium-term budgeting for investment, which will ensure adequate funding for maintenance for these new investments. A legal initiative permitting greater private participation in public infrastructure has recently been approved, which could further spur increased investment in needed infrastructure. 25. Due to the expected reduction in transfers to sub-nationals, the central government i s creating a new mechanism to compensate for these losses by providing funding Wdeicomisos) for regional investments. Sub-national government investment spending rose from 25 percent o f total public investment in 2004 to 67 percent in 2008. Reforms to the national investment system (Sistema NacionaZ de Inversidn Pziblica-SNIP) and efforts to build capacity for project planning and execution at the sub-national level are accelerating the ability o f sub-national governments to undertake local investment projects. These initiatives are actively supported by the private sector and include, for example, efforts by business associations to train municipal officials. Mining companies also provide funding for numerous local development projects. The International Finance Corporation (IFC) Technical Assistance Facility has a project o n efficiently investing mining canon resources at the municipal level which includes a component on public oversight to provide citizen feedback o n municipal projects. 26. The authorities have a strong commitment to transparency and accountability. Clear policy targets for the end o f the administration (2011) and annual progress on these targets are published in the annual Multi-year Macroeconomic Framework. The GoP has made substantial effort to establish a broad national consensus o n its policy program with the 11 legislative branch and society at large as reflected in consultation mechanisms like the `mesas de concertacion'. In addition, a committee consisting o f the MEF, the Superintendence o f Banking and Insurance, and the central bank has been created to monitor the impact o f the global crisis and to propose prompt remedial actions. 27. I n the context o f this loan, the G o P has led a consultation process that involved relevant agencies and representatives o f civil society. The GoP has involved all relevant sector ministries and government agencies in the design o f the policy program supported by this loan. Policies supported by this operation were discussed in consultations held by the government for the preparation o f the CPS. Participants included representatives o f small- scale farmers and businesspeople from the mountain region in Ayacucho, private sector representatives in Lima, regional and local government representatives, urban and rural businesspeople, and a diverse group o f community organizations, indigenous groups, academia, religious groups and NGOs. The CPS progress report also followed up o n these issues and confirmed the need to continue supporting the strengthening o f regional and local government institutional capacities, as well as facilitating access o f micro and small enterprises to credit and markets. Relevant line ministries were involved in the preparation and dissemination o f performance evaluations o f priority social programs (education, nutrition, health). These activities are supported by this loan series and also by the Bank's Results and Accountability (REACT) D P L series in the area o f social policy. The importance o f improved service delivery, consultation with civil society, and strengthening the capacity o f sub-national governments was highlighted at several o f these meetings. The Defensoriu del Pueblo (Human Rights Ombudsman, appointed by Congress) has participated in many o f these events. IV. B a n k Support to the Government Program A. Link to the Partnership Strategy and O t h e r B a n k Operations 28. T h e third phase o f this programmatic DPL series i s at the heart o f the C P S and i s an important instrument for the G o P to address the effects o f the global crisis. The latest CPS for Peru was approved by the Board in December 19,2006; together with US$200 million for the first D P L in the series. The second DPL/DDO o f these series for US$370 million was approved in August 2008. It was complemented shortly thereafter with ~ additional financing for US$330 million approved in December 2008 to mitigate the impact o f a deteriorating economic context. The Progress Report for the CPS, discussed by the Board in February 2009, endorsed the relevance o f the reform agenda supported by this programmatic series to implement the CPS pillars aimed at maintaining macro stability (pillar I-cluster I), I , accelerating growth and widening the base o f growth (pillar I-cluster I ) and modernizing institutions (pillar III-cluster VI). This proposed D P L builds o n the progress made in reforms supported by the previous operations and remains an important element o f the GoP's anti-crisis package. 29. I n the context o f the crisis, the authorities have implemented counter-cyclical policies, making this loan even more relevant. The increasing public expenditures pressures at all levels o f government make the reforms supported by this loan, particularly 12 those geared to improve the effectiveness and efficiency o f the public expenditures, critical at this juncture. The importance o f an appropriate balance between protecting the outstanding results in debt management-due in part to Peru's strong growth and rising fiscal revenues- and responding to the deteriorating external environment is now the key challenge. 30. This operation i s complemented by several World Bank initiatives to support the anti-crisis package and the overall reform agenda. To support the anti-crisis plan, the authorities have sought financing from the World Bank through three complementary series o f DPL-DDOs in the fiscal, social (REACT), and environmental sectors. Since August 2008, four DPL-DDOs (including the supplemental financing for the second Fiscal Management and Competitiveness DPL-DDO) have been approved by the Board, totaling US$1.36 billion. At the request o f the GoP, approval o f these three programmatic series o f DPLs has been staggered to meet the fiscal goals o f the MEF and the sectoral improvements in the line ministries. Bank funding buttresses confidence while the strong focus o f all three series on monitoring results and performance indicators is expected to increase the quality o f public expenditures and to inform budget formulation in the future. 3 1. I n response to the deteriorating economic environment, the Government intends to disburse the approved DDOs at a faster pace than initially anticipated. To date, the GoP has disbursed US$70 million o f the US$1.36 billion approved since August 2008. However, in view o f evolving conditions, the Peruvian authorities have informed the Bank that they intend to disburse US$340 million by the end o f CY2009 and US$200 million by the end o f CY2010. 32. The REACT DPL series focuses on the social sectors and i s complementary to the FMCDPL series. To date, two o f the three operations in the REACT series have been approved. They support improving the performance o f social programs-especially health and education-through transparent performance standards, mechanisms to empower citizens to demand improvements from public service providers, and stronger links between budget decisions and final outcomes. REACT i s playing an important part in the adoption o f performance-based budget management through the definition o f strategic outcomes in education, health and nutrition, linked to transparent standards. I t also supports the establishment o f effective monitoring systems, based on institutional data, which allow each service production unit to be held accountable for i t s performance. Both the FMCDPL and REACT series support improved budgetary performance. 33. I n addition, a number of investment projects, non-lending technical assistance (NLTA), and trust funds under implementation are consistent with the reform agenda supported by this DPL. Specifically, the Accountability for Decentralization o f the Social Sectors TAL and the Institutional Capacity for Decentralization TAL support performance- based budgeting efforts. Bank non-lending technical assistance (NLTA) efforts are assisting in strengthening the quality o f public expenditure and the capacity o f the central and sub- national government capacity to execute public expenditures- in the context o f the stimulus package. These NLTA activities include the Governance and Governability NLTA, the Sub- national Pilots NLTA, and several IFC-funded technical assistance efforts to improve the capacity o f the regional and municipal governments to manage natural resource revenues. Two Institutional Development Trust Funds (IDFs) are also contributing to the implementation o f the reform program supported by this DPL. The Peru Public Expenditure Management IDF i s focused on performance budgeting and investment management through 13 the Regional and Local Investment Promotion Fund (FONIPREL) and the Strengthening Congress Budget Oversight IDF focuses on strengthening the capacity to monitor and evaluate the quality o f the budget formulation and execution o f the Peruvian Congress' Budget Commission. B. Collaboration with the IMF and O t h e r Donors 34. T h e B a n k collaborated closely w i t h the International Monetary Fund (IMF) in the development and implementation o f the last Stand-By Agreement (SBA) which expired in January 2009. The SBA was approved by the IMF Board on January 26,2007 and entailed SDR172.4 million to support Peru's economic program. Peru treated the agreement as precautionary in a context o f strong fiscal discipline. The fourth and last program review was successfully completed in January 2009. As in the previous two SBAs, no withdrawals were requested and Peru did not pursue a new agreement. Upon completion o f the SBA, the IMF and the World Bank have maintained a close dialogue on Peru, particularly in the areas o f monitoring the macro situation, discussing the GoP program, and evaluating Bank operations. 35. T h e Bank's close coordination with the donor community in Peru, including bilateral and multilateral organizations, continues. The design o f policy-based operations has been coordinated with the Inter-American Development Bank (IADB), the IMF and the Corporacidn Andina de Fornento (CAF), as well as several bilateral agencies which also support policy reform, including the German Development Bank (KfW), GTZ, United States Agency for International Development (USAID), JBIC, DFID, SDC and the European Commission, among others. This coordination extends to investment lending operations in the areas o f transport, education, health, fiscal management, competitiveness, infrastructure, competitiveness, water and rural development, infrastructure, justice and governance initiatives and nutrition. The World Bank Group (WBG) i s also strengthening its partnership with the Global Water and Sanitation Program around the "Agua para to do^^^ program. The Bank has been a leading actor in donor thematic groups and has hosted several workshops in the areas o f decentralization, justice modernization, education, and rural development. 36. Strong donor cooperation around budgetary management at the national and local levels i s particularly relevant f o r this proposed DPL operation. The Bank and the IADB maintain close coordination in the design and implementation o f their policy loans. In a recent programmatic series now completed, IADB supported performance-based budgeting specifically linked to investment spending, which complemented well the Bank's work on budgeting reform in other areas. The GoP has ensured that the areas o f support are complementary and not redundant. Several bilateral programs are also supporting related reforms, including those o f KfW (which co-financed earlier loans in this and previous programmatic series), U S A I D and the Swiss aid agency SDC. 37. Peru's competitiveness agenda has also benefited f r o m coordinated support between the W o r l d Bank, IFC, and other multilateral and bilateral partners. The Peru teams o f the I F C and the Bank are in close collaboration regarding the competiveness agenda supported by this operation. In particular, the I F C has been involved in providing guidance and municipal-level technical assistance in the "TrarniJdcil" administrative simplification program, which is supported by this loan. The I F C in conjunction with the World Bank's Doing Business team i s involved in designing a set o f reforms specifically targeted to 14 improving Peru's ranking on the competitiveness index. The IADB is also working on helping smaller-scale agricultural producers improve competitiveness to take better advantage o f free trade agreements and reducing productivity constraints to micro, small and medium enterprises (MSMEs). USAID, SDC and the European Commission are also all involved in projects to increase the flow o f credit t o MSMEs to improve their ability to invest and grow. C. Lessons L e a r n e d 38. An i m p o r t a n t lesson learned i s that a s t r o n g focus o n a l i m i t e d n u m b e r o f k e y outcomes based o n a well-defined p r o g r a m that i s a p r i o r i t y f o r t h e G o P i s essential f o r the sustainability o f reforms. The GoP's strong desire to consolidate the progress achieved under the previous operations has resulted in strong ownership o f the next phases o f the series-- with a focus on a limited number o f outcomes to increase their development impact and sustainability. In addition, throughout the implementation o f the reforms under the DPL series, it has been clear that complex reforms take time and require building consensus and awareness o f the benefits o f reforms among the main stakeholders. In particular, resistance to modernizing public finance i s often strong, so sequencing together with training and capacity building are critical for success. The program o f policies and reforms under this series has taken this lesson into consideration, as well as with the reality that there i s no perfect "end state" since further improvement i s always possible. 39. I n addition t o the need f o r selectivity and adequate phasing, it i s i m p o r t a n t t o m a i n t a i n flexibility t o react t o potential changes in policy priorities in t h e context o f local a n d global uncertainty. The strong focus on fiscal discipline that characterized the previous operation had to be adjusted to address the increasing impact o f the global financial crisis. Counter-cyclical policies called for significant increases in public expenditures that justified a shift in previous fiscal targets and policies. The programmatic approach calls for built-in flexibility both at the policy level and allocation o f resources t o address unforeseen changes in the country's development needs. The evolving impact o f the global crisis is clear evidence o f the need for a flexible approach. D. A n a l y t i c Underpinnings 40. T h e DPL supports a sub-set o f policies within the GoP's b r o a d p o l i c y program. These policies were selected o n t h e basis o f analytical w o r k aimed at d e t e r m i n i n g k e y policies with large development impact. Substantial diagnostic work has informed the 1. design o f FMCDPL 1 1 Some studies have been completed, and others are underway (Table 6). 15 Table 6: Analytical and Advisory W o r k Underpinning the proposed operation Completion Activity Brief description Date Public Expenditure PEFA i s a partnership between the World Bank, the European Commission, the UK's FY09 and Financial Assessment planning that are part o f this operation. OECD-DAC This activity financed the application o f the OECD-DAC methodology for FY09 Procurement assessment o f the quality and effectiveness o f the national procurement systems in Peru. The assessment provided the basis to formulate Peru's national procurement strategy. The strategy i s made up o f eight key areas, one o f which focuses on capacity development to improve Peru's procurement systems. The assessment was also useful to design a capacity develop plan to mitigate risks in the individual operations financed by the Bank. The Bank's technical assistance in this area helped accelerate reforms that had been considered as part o f the FMCDPL I1 to support the objective to make the public sector processes more transparent, accessible and-agile. REDI The Infrastructure Public Expenditure Review (REDI) aims at providing the GoP underway PER underway Evaluation of SIAF's Consulta Amigable 2007 accessible and agile. Informality ESW This programmatic ESW aimed to better understand the trajectories o f businesses FY09 towards formalization and to identify the key factors that maintain most businesses in the informal sector. The topic has implications for both pillars o f this operation. On the fiscal side, the limited tax base i s in part the consequence o f a large informal sector. In this regard, the ESW investigated the extent to which tax regimes, particularly due to compliance costs, may be contributing to informality. On the competitive agenda the ESW addressed the question o f how (in)formality affects the productivity and competitiveness o f businesses. 16 Completion Brief description Date Education ESW This AAA responds to a request from the National Assembly o f Regional underway Governments (ANGR), which i s concerned with improving the efficiency and efficacy o f performance-based budgeting (PBB) at the regional level. The objective i s to improve education quality through enhanced PBB planning and intervention strategies in the education sector in the context of decentralization. The ESW will focus on the analysis o f the relationship between resources, physical outputs and the high-level development outcomes of the PBB program in education so as to increase the potential o f the system to align priorities and actors; improve efficiency and effectiveness of financial allocation and product costs identification; help identify critical bottlenecks; and recommend the reassignment of resources, the definition of responsibilities, and improvements in the institutional arrangements to tackle the main weaknesses of the program. ~ Nutrition NLTA This NLTA supports the restructuringand relaunching of the conditional cash transfer underway program Juntos, which i s to become the country's emblematic program for reducing chronic malnutrition and extreme poverty as part of the National Strategy CRECER. The NLTA i s helping an inter-institutional effort to effectively articulate the demand and supply side o f the program with emphasis on ensuring healtldnutrition services. The activities are closely linked with the PBB agenda, as nutrition i s one o f the first strategic programs launched in the context of PBB. This NLTA i s helping to develop processes and mechanisms for continuous and underway systematic evaluation and improvement of anti-poverty interventions. In particular, the activity provided technical assistance for the design and evaluation of specific programs, including Juntos, and i s also supporting an institutional framework to facilitate the systematic use o f existing information systems and analyses of the effectiveness o f anti-poverty interventions in Peru. These activities complement and are closely coordinated with the monitoring and evaluation efforts being undertaken in the context o f PBB. Education Sector This NLTA complemented the Education ESW by working with different FY09 NLTA counterparts, with an emphasis on regional governments, to improve the design and implementation of priority strategies within the PBB program. The activities were organized in three components. First, clarifying the PBB framework in education by promoting dialogue with counterparts (MEF, MED, ANGR) to agree upon the elements o f an effective PBB system and highlight areas that merit more attention and support. Second, improving intergovernmental fiscal relations and institutional arrangements for the implementation o f the PBB program. Third, fostering the evaluation of learning and teaching to improve results. The NLTA also responded with some small just-in-time technical assistance within the framework o f improving education results and strengthening accountability. Governance and The Programmatic Governance AAA provided technical advice and training-by- First phase Governability NLTA doing to the Ministry of Finance. The assistance included the assessment o f basic completed in finance management systems, with a focus on performance budgeting, multi-year FY09 investment budgeting (MIB) and SNIP. The latter included assessment of Second phase FONIPREL, a fbnd for sub-national investment with an emphasis on infrastructure underway projects. Sub-national Pilots This NLTA addresses the need to build capacity in subnational governments by First phase providing on-site support to help them design and implement public investment completed in projects. In particular, this NLTA has helped subnational governments build capacity FY09 to develop technically sound proposals for investment projects eligible for Second phase FONIPREL fbnding. A second phase currently under implementation i s intended to underway (i) support the implementation of projects awarded resources by FONIPREL, and (ii) tackle delays in public investment projects. T h i s NLTA also supported the adoption I of performance-based budgeting by a regional government and the preparation of project proposals for submission to FONIPREL. 17 Completion Brief description Date Decentralization A multi-sectoral ESW on decentralization i s currently underway. I t includes an Underway Policy Notes overall assessment o f the evolution o f the political and fiscal decentralization in Peru. A second component w i l l assess the use o f participatory budgeting as an instrument to increase voice o f local actors and i t s potential impact on improving results, particularly those prioritized in performance-based budgeting (PBB). A third component w i l l focus on analyzing the actual and potential contributions o f PBB approaches to improving the efficiency and effectiveness o f expenditures in the education sector. V. T h e Proposed Operation A. Operation Description 41. T h e proposed operation responds to the GoP's request for continued B a n k support o f i t s broad reform agenda and i t s reaction to the crisis. This operation i s the third in a series o f four loans each supporting implementation progress in a well defined economic program. The t w o policy areas supported by this D P L are: Efficiency and Quality o f Fiscal Management Competitiveness 42. Fiscal management and competitiveness a r e mutually reinforcing areas which offer a potentially significant payoff in terms o f economic growth, social development and poverty reduction. Strong fiscal management improves the effectiveness o f limited public resources and supports country competitiveness by generating private sector confidence in overall macroeconomic stability and the ability to undertake long-term investments and planning. In turn, increased competitiveness improves the fiscal situation by generating tax revenues and decreasing the need for government intervention t o stimulate economic growth. Together, reforms in these t w o areas may strengthen the ability t o achieve GoP's goal o f accelerating and broadening economic growth to improve the standard o f living o f all Peruvians, especially the poor. The mix o f overall macroeconomic policy stability with gradual reforms in a few key areas that the Garcia administration has followed thus far has already shown positive results in terms of greater business creation and growth, generating confidence that these trends will continue going forward. Moreover, the combination o f high growth with prudent fiscal/financial management will provide additional fiscal space to address social needs. 43. T h e programmatic approach taken by this loan series reflects the flexibility requested by the G o P to best address evolving challenges. By incorporating flexibility into the FMCDPL series within a defined policy framework, the Bank i s serving the needs o f Peru, a middle-income country with strong macro-economic fundamentals n o w facing second and third generation reform challenges. W h i l e broad policy areas were established from the start o f the series, specific policy actions have evolved along with Peru's changing political and economic circumstances. The policy actions supported by this DPL were chosen by the GoP as critical to achieve fiscal management and competitiveness outcomes (Box 1). 44. Implementation o f the reform program supported by this operation i s well advanced. The global crisis required shifting immediate priorities. Accordingly, seven o f 18 the nine policy areas have advanced well. Fifteen triggers have been met. Policy actions that were deemed to be less urgent in dealing with the crisis have been delayed, in particular (i) the simplification o f fiscal rules for regional governments and (ii) e-government (see below). The trigger related to the modification o f fiscal rules f o r regional governments was not completed and for the purposes of this DPL has been replaced with the key fiscal measures included in the Economic Stimulus Plan (PEE). The PEE was approved in 2009 to shield the Peruvian economy from the global recession and protect the most vulnerable from the downturn o f the economy. In addition to fiscal stimulus package, i t includes a series o f policy measures aimed at expediting budget execution and improving monitoring and evaluation o f expenditures. The government has postponed any modification o f the fiscal rules for regional governments until a full assessment o f the decentralization process i s available. Nonetheless, there has been progress as authorities are approaching the decentralization agenda in a gradual manner. For instance, a new law enacted on March 20, 2009, introduces incentives for improved fiscal management at the municipal level. It stipulates that transfers to municipalities from the Fondo de Compensacidn Municipal (FONCOMUN) will be subject to performance criteria, including: (i) improved real estate tax collection (particularly in larger municipalities) and (ii)performance-based budgeting principles in municipal fiscal management (execution o f planned budget expenditures linked to strategic social programs and better integration o f poorer municipalities to national household targeting databases). The trigger related to the e-government and digital agenda has been partially completed. By contrast, reforms in public procurement have made significant progress, and are included as prior actions, instead. There has been significant progress in the area o f public procurement that reinforces the objective o f the triggers envisaged previously in e-government, namely to (make public sector processes more transparent and agile. Progress in public procurement has been partly driven by the need t o comply with the Free Trade Agreement (FTA) signed with the US, and partly by the need to expedite the execution o f public investments envisaged in the fiscal stimulus package. Much o f the package is directed towards investments in infrastructure, where the need for effective procurement processes is critical. In particular, a new Procurement L a w was passed and the National Procurement Strategy was completed and published. The key reform introduced in the law i s the separation o f regulatory and operating procurement functions. I t also includes an action plan that sets the next steps for a more effective public procurement system. 45. The GoP has achieved substantial progress in implementing the reform program envisaged to be supported by the series o f programmatic DPLs. These reforms are discussed in detail in the next section. Examples include policy actions aimed at improving economic integration and competitiveness. The implementation o f the One-Stop-Shop for Trade (VUCE) has been accompanied by a series o f free trade agreements with several countries that promote Peru's integration into global markets. Another example relates to measures aimed at promoting the inclusion o f small and medium enterprises into the globalization agenda. 19 Box 1: Good Practice Principles on Conditionality 'rinciple 1: Reinforce ownership There i s broad consensus in the administration and the legislature on the importance o f the fiscal management and competitiveness reforms supported by this loan series. Evidence o f this i s steady parliamentary support for fiscal discipline by all parties, passage o f two successive budgets including the new performance-based budgeting initiative, and the broad participation o f sub-national governments in administrative reforms and e-government procedures. The Garcia administration has demonstrated an excellent track record in maintaining a stable macroeconomic fi-amework and clear, sustained policy directions regarding improving the impact o f public spending and improving country competitiveness to sustain high growth and poverty reduction. By designing the loan in close alignment with the GoP's own policy reform priorities, the Bank has maintained harmony between the loan program and the policy realities faced by the administration. The GoP has committed i t s political capital to reforms which w i l l be positive for the country's development and which are supported by this loan series. 'rinciple 2: Agree up front w i t h the government and other financial partners on a coordinated lccountability framework The policy matrix was negotiated with the aim o f choosing measurable, relevant program progress indicators while leaving sufficient flexibility to address the changing needs and priorities o f a fast- developing middle-income country with strong fundamentals. The policies addressed in the loan series are well-coordinated with the IADB, which ensures that that the programs provide mutual support without overlap and with several bilateral donor and technical assistance projects currently working on relat 'rinciple 3: Customize the accou s o f B a n k support to country ircumstances 1 The modalities and timing o f the lending program are based on specific requests by the GoP so that the Bank can provide optimum support for Peru's specific needs. T h e Bank program i s designed to evolve as the country's needs evolve, within a defined group o f policy areas and outcome goals. 1 The policies involved in the FMCDPL series derive directly from the priorities o f both the previous and current administrations in the area o f fiscal management and competitiveness. For example, to address the current difficulties arising fi-om the international economic crisis, the Bank worked with the GoP to replace policy conditions related to fiscal decentralization with those supporting a well-targeted economic stimulus plan, putting o f f the original policy reforms until conditions improve. 'rinciple 4: Choose only actions critical for achieving results as conditions for disbursement 1 Despite the policy complexity o f fiscal management and competitiveness, this loan series has chosen a reduced number o f benchmarks, and even fewer program triggers, that were considered by both the Bank team and the GoP to embody forms most critical ady policy reform direction. 'rinciple 5: Conduct transpar rogress reviews c table and performance-based inancial support The progress reviews for FMCDPL 1 1 took place in parallel with the discussions for this third proposed 1 loan in the series. Bank staff specializing in all loan policy areas as well as fiduciary and oversight areas held detailed discussions with relevant representatives o f the GoP regarding measurable progress in achieving program triggers and benchmarks. Further discussions are planned to assess developments during the course o f 2009, and the Bank stands ready to provide technical assistance as needed to achieve the triggers called for under this proposed loan. 20 B. Policy Areas 46. This section reviews the progress achieved on the two key policy areas supported by the proposed DPL. 1. Efficiency and Quality o f Fiscal Management 47. A central element o f the administration's policy agenda i s to continue strengthening macroeconomic stability and fiscal prudence, while improving the quality o f public expenditure. Policy areas to achieve the program objectives include strengthening fiscal rules as well as public debt management and tax policy; improving the efficiency o f budgetary accounting; implementing efficient, performance-based budgeting; and increasing transparency and agility in public processes, including procurement and e-government. Strengthening Fiscal Policy 48. The economic slowdown required a counter-cyclical fiscal policy stance, which has been supported by existing fiscal rules. Peru's budget balance is expected to turn negative in 2009 due to both lower revenues and the increased public expenditure associated with the economic stimulus plan. The economic stimulus package accounts for around 3 percent o f GDP, to be implemented over 2009 and 2010. The counter-cyclical stance i s foreseen by existing fiscal rules. The Fiscal Responsibility and Transparency L a w (Law 27958 o f May 10, 2003) limits the annual non-financial public sector deficit to 1 percent o f GDP. However, Article 5 states that in the case o f a an international crisis that can seriously affect the domestic economy, the Congress can, at the request o f the executive, grant exceptions to the fiscal rules for a period o f up to three years. The current global economic crisis i s clearly an exceptional situation that justifies the use o f the room for maneuver built into the law. In this context, the administration proposed legislation to increase the limit on the fiscal deficit to 2 percent o f GDP in 2009 and 20 10. In addition, the limits on the growth o f current public expenditures, set at 3 percent annually in real terms, were temporarily increased to 10 percent in 2009 and to 8 percent in 2010. The legislation was approved by Congress as Law 29368 on May 29,2009. 49. Fiscal policy remains supportive o f macroeconomic stability. The authorities remain committed to a prudent fiscal policy. The size o f the fiscal deficits planned for the next three years are relatively limited and are not expected to pose a risk to public debt sustainability (Annex 1). The composition o f the fiscal easing is tilted towards investment, making it less likely that new spending would be entrenched. In fact, current expenditures are expected to decline as a share o f non-financial public expenditures f i o m 46 percent in 2008 to 44 percent in 2009 and 43 percent by 2012-when the overall fiscal deficit is expected to be below 1 percent o f GDP. The authorities are aware o f the existing fiscal risks, particularly on the revenue side as tax collections are expected to decrease from 15.6 percent o f GDP in 2008 to 14.1 percent o f GDP in 2009. In this context, the GoP has launched a mechanism that can potentially broaden the still very narrow tax base at the local government level. The goal i s to provide an incentive scheme by which municipalities that meet certain tax collection targets would benefit from higher transfers o f Municipal Compensatory Fund (FONCOMUN) resources-a fund on which many municipalities draw largely for their recurrent expenditures. The law setting up, this mechanism (Law 29332) is currently awaiting 21 regulation and i s expected to focus the incentive scheme o n the largest municipalities, which are those that have the greatest potential for increasing collection o f real estate taxes. 50. T h e transparency o f fiscal policy has continued to improve. The coverage o f the financial management information system (Sistema Integrado de Administracidn Financiera-SIAF) was expanded at the local level from 739 municipalities in 2007 to all 1,834 municipalities in 2008. T h i s i s a key step which permits c i v i l society t o monitor through a user-friendly website the budget allocation and execution by every single municipality in the country. The authorities also issued the regulations implementing the framework law that regulates public-private partnerships (PPPs), which i s expected to help increase transparency about the expected fiscal impact o f such PPPs. 51. Given the difficult economic environment, the priority has shifted to economic stimulus policies; the redesign o f fiscal rules for regional a n d local governments envisaged as a trigger for this operation has been postponed. Understandably, the first fiscal policy priority o f the authorities has been the design and implementation o f the economic stimulus package. In itself, this i s already a significant task, as the stimulus plan i s a collection o f 17 emergency decrees, seven supreme decrees, and two laws. Given the current exceptional situation it would not be appropriate to divert scarce staff away from the challenges o f implementing the stimulus plan to the redesign o f fiscal rules for regional and local governments. Moreover, the MEF i s currently receiving technical assistance from the C A F to thoroughly assess the decentralization process, which will be a valuable input when reconsidering the fiscal rules for regional and local governments in due time. 52. T h e authorities have strengthened policy coordination through the creation o f a monitoring committee. As a response to the international economic crisis, the authorities have set up an inter-institutional committee that meets every fortnight to follow up on financial issues which may have economy-wide implications. Such policy coordination forum can be particularly valuable should a crisis situation arise, as it facilitates the decision- making process. The committee i s composed o f representatives o f the Ministry o f Economy and Finance, the central bank, the supervisory authority (Superintendencia de Banca y Seguros-SBS) and the state banks Banco de la Nacidnand the Development Finance Corporation (Corporacidn Financiera de Desarrolllo-COFIDE). An output o f this committee has been the creation o f the Business Guarantee Fund (Fondo de Garantia Empresarial) which was included in the anti-crisis plan, a mortgage credit line by the Banco de la Nacidn, and the agreement on new regulations that would allow the central bank to provide liquidity to financial sector entities against asset-backed securities as collateral. These and other measures are expected to increase the resilience o f the economic policy framework against possible shocks. 53. Going forward, the main task at the national level will b e to steadily return to fiscal surpluses as economic recovery takes hold. T o continue strengthening Peru's tax base, particularly at sub-national levels, the GoP i s also seeking t o implement the newly- designed mechanism to incentivize municipalities t o increase the collection o f real estate taxes. In particular, municipalities that meet the performance criteria would be guaranteed that their transfers under F O N C O M U N would not fall, even if the sales tax collections from which the F O N C O M U N i s funded have decreased noticeably. The performance criteria are expected to include targets for real estate tax collection for urban municipalities as well as 22 meeting some disbursement targets on budgeted expenditures related to key social issues such as nutrition. Prior Actions completed under the Program (DPL 111) I Indicative Trigger (as described in the previous operation): 1 "Redesign fiscal rules schemes for regional and local governments, reflecting consistency with national-level rules requirements; and develop a mechanism to monitor fiscal rules at the sub-national level with public disclosure '' 54. I n light o f the severity o f the global crisis, the indicative trigger envisaged for this operation prior to the crisis was replaced by the following policy action that contributes to meet the objective of the original trigger. This policy action has been completed (see Annex 3). (1) Peru has: (a) issued an economic stimulus plan to respond to the global economic crisis which i s included in the Borrower's 2010-2012 Multi-Annual Macroeconomic Framework; and (b) committed to maintain prudent fiscal policy during the implementation o f such plan, pursuant to the terms o f the "Declaration o f Principles for Fiscal Policy". Indicative Triggers for DPL I V 55. Continue with prudent fiscal policy, in particular: (i) Continue implementation o f the Economic Stimulus Plan within the fiscal framework provided by the Fiscal Responsibility and Transparency Law; and (ii) Strengthen the decentralization process, including measures t o improve municipal administration. Making the Tax System More Neutral and Stable 56. The administration remains committed to the elimination of tax exemptions, though opposition to this policy has mounted. The GoP used legislative powers delegated by Congress to introduce a number o f modifications in the tax system to gradually reduce existing exemptions on indirect taxes in six departments (which amount to around 2 percent o f GDP) and control the granting o f new ones. As envisaged in the previous operation, the authorities developed a cost-benefit methodology to assess any such new proposed exemptions. However, the process for dismantling exemptions has been put on hold. First, the timetable for phasing out exemptions was pushed back until after 2012. Second, a legal challenge to the use o f the delegated legislative powers for this purpose was successful and the Constitutional Tribunal dictated a judgment requiring that the planned elimination o f tax exemptions be the subject o f a new law t o be considered by the Congress. 57. Progress has continued on tax simplification measures for micro and small enterprises. Regulations for the new l a w for micro and small enterprises simplified the requirements for businesses filing corporate income tax under the special income tax regime (rigimen especial de l a renta-RER). Under FER, micro and small businesses pay a turnover 23 tax in lieu o f income tax. The new regulations lowered the requirements in terms o f accounting books that businesses filing under RER must keep. As well, the rate at which the turnover tax is collected was unified to 1.5 percent (previously the rate was either 1.5 or 2.5 percent depending on the type o f activity o f the business). Simplifying and making the RER more attractive i s an important policy goal. An analysis conducted by the Bank in the context o f analytical work on informality suggests that this tax regime has the most advantageous treatment o f capital investment (as measured through a marginal effective tax rate analysis), but only 14 percent o f sampled f i r m s opted for it. 58. On-line access to tax administration services has been expanded. The progress in this regard noted in the previous operation has continued. In the recent income tax annual declaration virtually all taxpayers filed online, up from around 80 percent in 2007. With regard to tax administration services specifically geared to micro and small enterprises, the tax authority (SUNAT) has made it possible for micro and small f i r m s to make simplified tax declarations. SUNAT i s also increasingly communicating with taxpayers electronically and has launched a virtual service center where taxpayers can make observations and upload complementary information following a tax audit. Similarly, the system for requesting the payment in installments i s already on-line and SUNAT i s communicating with taxpayers on these issues electronically. Besides the increased access to on-line services, SUNAT has also stepped up its efforts to physically bring their services to taxpayers through `mobile service centers.' Such mobile service centers can reach informal businesses that are otherwise difficult to bring into the tax system. For example, during the three months to May 2009 the mobile service center assisted a total o f 11,000 taxpayers in different districts o f Lima. 59. The challenge remains to increase the tax base, which has become increasingly difficult in a context of economic slowdown. Following a steady increase in tax revenues over the last years, the economic slowdown is expected to decrease tax revenues from 15.6 percent o f GDP in 2008 to 14.1 percent o f GDP in 2009. B y comparison the average for lower middle income countries stands around 19 percent o f GDP. The current economic environment has also made i t difficult to redress other features o f the tax system that still hamper i t s neutrality. A case in point i s that o f the so-called `duty drawback' for exporters, aimed at compensating exporters for tariffs paid on imported inputs. The severe drop in exports, which have fallen b y more than 30 percent in 1Q2009, prompted authorities to temporarily increase the drawback from 5 to 8 percent o f the value o f exports until the end o f 2009. 60. The launch of a mechanism to incentivize municipalities to increase tax collections may help to broaden the tax base at the local level. The property tax accounts for less than 0.2 percent o f GDP-low compared to other countries in the region, as neighboring countries such as Brazil, Colombia, and Ecuador all have ratios that are at least three times higher. As a share o f the budget o f local governments, the property tax accounted in 2006 for only around 6 percent o f resources. Increasing property tax collection, especially in urban municipalities, i s an important policy goal. Therefore the recently approved law to incentivize municipalities in their collection o f property taxes (Law no. 29332) by linking some transfers to collection goals i s an important step which, when fully implemented, may help to broaden the tax base. 61. Going forward the authorities aim at strengthening tax policy and tax administration to support macroeconomic stability. The GoP intends to continue to 24 implement tax simplification measures, including expanding on-line access to tax administration services. These activities are expected to help lower the cost o f tax compliance and contribute to broadening the tax base. Prior Actions completed under the Program (DPL 111) Indicative Triggers (as described i n the previous operation): f "Develop methodology o cost-beneJit assessments o tax exemptions i n accordance with the f legal framework for tax exemptions. Continue with tax simplijkation measures aimed at micro and small enterprises sectors. '' 62. The prior actions completed under the Program include the following (see Annex 3): (2) The Borrower: (a) has incorporated into i t s Law for the Promotion o f Competitiveness, Formalization and Development o f Micro and Small Enterprises and o f Access to Decent Employment, tax simplification measures for micro and small enterprises, through the issuance o f the Borrower's Supreme Decree No. 007- 2008-TR, published in the Borrower's Official Gazette on September 30, 2008; and (b) i s implementing such law as evidenced by Resolution No. 120-2009/SUNAT issued by SUNAT on June 3, 2009, which, inter alia, approves the use o f online tax declarations for micro and small enterprises. Indicative Triggers for DPL I V 63. Implement measures to facilitate tax compliance, in particular: (i) ncreasing availability o f on-line tax administration services I Improving the Efficiency and Transparency o Public Accounts f 64. I n terms o f security and liquidity, the current coverage o f the Peruvian Treasury Single Account (TSA) i s sufficient, at this time, to meet international standards. The TSA now receives daily fund flows o f all ordinary and most dedicated revenues, with the exception o f the municipal compensation fund FONCOMUN.' The TSA does not receive flows o f revenues collected directly by ministries, departments and other government agencies (MDOs). The MEF issued a decree in 2007 mandating that all earmarked resources (recursos determinados) would be phased into the TSA by April 2009, FONCOMUN being last. There has been some delay with respect to transition FONCOMUN into the TSA, mainly due to institutional arrangements in place between Banco de la Nacidn and many municipalities. 65. The major benefits o f a TSA are security o f public funds, concentration o f cash for more efficient use during budget execution and constantly updated comprehensive I The FONCOMUN i s a compensatory h n d for municipalities, which i s distributed according to certain criteria. It comes from the Municipal Tax Promotion (IPM) and represents 2 percentage points of the VAT. 25 cash position financial reporting. The creation and use o f a TSA allows the Treasurer to manage deposited funds as fungible cash, using the accounting system rather than bank accounts to track fund availability and use. The actual number o f bank accounts i s less important than whether the funds in all accounts are managed virtually as a virtual single account (TSA). W h i l e there are advantages to eliminating redundant accounts in terms o f information technology and bank charge overheads, many international budget experts agree that the elimination o f redundant bank accounts must prudently await a robust information system, preferably one that has been audited to gain user and investor credibility. In the case o f Peru, the concentration o f cash exists to a large degree and the elimination o f redundant accounts can safely be postponed until the new SIAF now being designed i s in place and controls are reliable enough to inspire confidence in the TSA by all budget users. 66. T h e T S A i s functioning for about 81 percent o f flows, with only two types o f resources (FONCOMUN and directly collected revenues) not yet incorporated. In addition, more than 20 seminars and training sessions for users have been held, with the support o f the Bank and the IMF. Financial reports from the TSA are being generated and evaluated on a daily, weekly and monthly basis by MEF. These reports are and provided to the Cash Committee, an executive oversight board whose members include MEF, the central bank, and Banco de la Nacidn. The Cash Committee reviews the monthly cash reports, which provide an up-to-date data regarding projections o f the cash position, allowing the committee to make more informed decisions in adjusting the original cash plan. 67. T h e GoP has also completed the implementation o f the new budget classification system in line with international standards for the 2009 budget, and a new Chart o f Accounts has also been completed in line with the new budget classification system. The reforms o f the budget classification system, and i t s integration with the new accounting chart o f accounts in SIAF, will allow the automatic accounting o f government accounts (except for a few manual accounting adjustments), ensuring alignment between the generation o f budget and accounting financial reports. This i s a key step towards increasing transparency in public resource management. 68. T h e MEF i s considering a medium-term framework for continued implementation o f the T S A that suggests several simultaneous courses o f action, including: 0 Review data flow from SUNAT, BCRP and Banco de la Nacidn, leading to even more useful daily cash position reporting. Until the new SIAF is implemented, the Treasury General Ledger (TGL) will not be available except as a surrogate set o f reports approved by the Vice-Minister o f Finance in May 2009; 0 On-going comprehensive training for all stakeholders (TSA users). During 2008- 2009, a series o f 24 seminars were presented at MEF, the MDOs and the subnational governments as well as banking partners and SUNAT. The MEF has created a full- time position to formalize an on-going professional training program; 0 The integration o f the FONCOMUN into the T S A and the pursuit o f whatever account balances l i e outside the TSA, including closing o f redundant accounts. 26 Prior Actions completed under the Program (DPL 111) Indicative Triggers (as described in the previous operation): f "Phasing o the TSA implementation continues. The TSA balances in SIAF reflect new budget classi$ers and the chart o accounts is incorporated in SIAF. f I' 69. The prior actions taken under the Program include the following (see Annex 3): (3) The Borrower has strengthened i t s budget reporting and planning as evidenced by: (a) the generation o f monthly TSA reports (from January 2009 until July 2009) covering 76 percent o f the Borrower's public resources set forth in i t s budget law for 2009; and (b) the incorporation into SIAF o f the new functional budgetary classification (as reflected in i t s budget law for 2009). Indicative Triggers for DPL I V 70. Continue implementing the TSA, including: (i)mproving the information management systems in the daily accounts reports; and I (ii) Expanding training for TSA users. Making the Transfer System Sustainable and Equitable 71. Making the transfer system more equitable has become even more challenging by the sharp fluctuations in commodity prices. In 2008 total transfers to regional and local governments amounted to 11.6 billion nuevos soles, or around 3 percent o f GDP, o f which 56 percent were accounted for solely by transfers that are linked to mining and hydrocarbon (the so-called canon and regalias). The canon is half o f the income tax paid by the producing companies, while regalias are a function o f the volume o f sales. Thus, the rise in commodity prices had a significant impact on the amounts o f canon and regalias. For example, the canon and regalias increased from 0.2 percent o f GDP in 2001 to close to 2 percent o f GDP in 2008. These transfers go largely to the producing areas and are concentrated in a few departments, with 71 percent o f natural resource transfers accrued in 2008 to only seven departments. 72. The GoP has continued to address the inequity in these transfer mechanisms through a variety o f policies. In addition to the launch o f the FONIPREL discussed below, the GoP introduced changes in 2007 and 2008 to the formula for calculating the coefficients used for distributing transfers under the Regional Compensation Fund (FONCOR). The new formulas take into consideration the gap between regional needs (a function o f population, poverty, geographical location, and a performance indicator related to the execution o f investment projects) and other transfers that the region receives, including canon and regalias. However, the impact on increasing the equity o f transfers to regional governments is limited by the relatively small amounts involved compared to the mining and hydrocarbon- linked transfers. Regional governments are more dependent on mining and hydrocarbon resources, which accounted for 81 percent o the 1.9 billion nuevos soles they received in f 27 transfers in 2008. Attempts to propose even slight modifications to the formulas for the allocation o f the canon between municipalities and regions have been met with stiff opposition and social unrest. In this difficult context, the GoP has continued to introduce other mechanisms to ensure that overall transfers are better targeted. 73. The fiscal stimulus plan includes measures to help make transfers to the regions more equitable in 2009 and 2010. As part o f the economic stimulus plan the authorities have earmarked 2.6 billion nuevos soles for regional governments (Decree 028-2009). The specific allocations take into account the extent to which individual regional governments receive other transfers. While all regional `governments are to receive transfers under this policy, the final allocation has been tilted towards poorer regions and those without access to canon and regalias. 74. The first year of operation o f FONIPREL proved a success in competitively allocating funds for projects in poor regions. Under t h i s fund, municipal and regional governments submit proposals for investment projects that are assessed on the basis o f project feasibility and their expected impact on poverty reduction. The f i r s t competition was launched in June 2008 with a second tender launched in December 2008. For 2008 as a whole a total o f 670 million nuevos soles were allocated, o f which 85 percent o f the resources went to areas classified as areas o f high or very high needs. Moreover, 88 percent o f resources went to areas which are classified as having less access to other resources. It i s important to stress that these outcomes were the result o f a transparent grading system, rather than ad hoc allocations. Overall, this suggests that the mechanism was successful in competitively allocating funds to deserving projects in deserving areas. The challenge now i s to ensure a quick execution o f FONIPREL-funded projects. Execution got to a late start, as funds were only transferred in October 2008, just before the rain season that affects many areas o f the country and typically delays physical execution o f investment projects. Still, as o f early June 2009 it i s estimated that around 70 percent o f projects that were awarded funds in the firit tender o f June 2008 have now entered the execution phase, and financial execution i s estimated to have reached 45 percent. 75. A number o f improvements have been introduced in the latest tender of FONIPREL, launched in May 2009. As envisaged in the previous operation, the authorities have completed an evaluation o f the early experience with FONIPREL. As a result o f this evaluation, a number o f improvements were introduced in the third tender launched in June 2009, which is expected to allocate a total o f 260 million nuevos soles. First, the budget execution rate o f the regional or local government that seeks funding will now be considered within the l i s t o f criteria that will determine the total score assigned to a given project proposal. Second, the required co-financing by the authority that submits the proposed project was decreased from 10 percent to 2 percent for the municipalities in the poorest areas. Third, a new thematic priority has been added to the l i s t o f eligible projects (management o f irrigation basins). Fourth, a new type o f eligible project was added within the water and sanitation thematic priority (management o f solid waste). These measures, especially the first two, will help to increase the equity o f the allocations o f funds. 76. The continuation o f FONIPREL will help to make the transfer system more equitable, but in the medium term a broader debate on more concerted reforms i s needed. FONIPREL has a number o f highly positive characteristics, but making the transfer system more equitable will require a broader discussion that includes other transfers. Local 28 and regional governments received in 2008 a total o f 6.5 billion nuevos soles just from mining and hydrocarbon canon and regalia, compared to total allocations under FONIPREL o f 670 million nuevos soles in 2008 and 260 million nuevos soles in 2009. N o consensus currently exists on fundamental issues such as the role o f inter-regional equity in the transfer system, but efforts to build more concerted reforms with the departments will be increasingly relevant. The National Assembly o f Regional Governments is emerging as an increasingly important player in this debate. The GoP has announced the Intergovernmental Council as a mechanism o f dialogue between central, regional, and municipal governments, though i t has yet to become operational. 77. Going forward, the Government intends to increase the equity o f inter- governmental transfers by devoting a greater share of FONCOR resources to poorer regions. As noted above, the Government has introduced a formula for allocating resources under FONCOR in order to take into consideration regional unmet needs. However, only half o f the total resources o f FONCOR, which amounted to 678 million nuevos soles in 2008, are allocated based on this formula. The Government has developed a methodology, with technical assistance from the C A F (executed by Georgia State University) that will help to increase the transparency o f allocations to regions. In addition to the methodology, the Government i s currently preparing a regulation by MEF to increase over time the share o f FONCOR resources that are to be allocated on the basis o f this formula. Prior Actions completed under the Program (DPL 111) Indicative trigger (as described in the previous operation): "Evaluate implementation o FONIPREL and propose recommendations for expanding and f improving it. 'I 78. The prior actions completed under the Program include the following (see Annex 3 ) : (4) The Borrower has: (a) completed a progress report o f the implementation o f FONIPREL as o f May, 2009; and (b) updated the criteria for assigning FONIPREL resources, as evidenced by: (i) issuance o f MEF's Ministerial Resolution No. 168- the 2009-EF/15 dated April 3, 2009; and (ii) publication o f the bidding documents the (dated M a y 2009) for the third tender inviting the Borrower's sub-national governments to submit proposals for investment projects. Indicative Triggers for DPL I V 79. Continue policies oriented towards reducing inequities in inter-governmental transfers, in particular: (i) Continue allocating funds to subnational governments through compensatory funds such as the FONCOR and F O N C O M U N 29 Implementing Performance-Based Budgeting 80. The GoP has placed strong emphasis on improving the quality and impact o f public spending, and performance-based budgeting can be a powerful tool for this objective. The GoP decided to introduce performance-based budgeting, and launched i t s formal efforts in the 2007 and 2008 Budget Laws to aid budget decision-making, with the focus on improving the performance and accountability o f public spending. As economic growth slows during the current global downturn, performance information can also be used to better prioritize expenditures toward national and local priorities, particularly if the accountability for results i s combined with additional delegation o f managerial authority to program managers and service providers. 81. Peru continues to make steady progress in putting in place the foundations for performance-based budgeting. These include the multi-year budget perspective, a programmatic budget classification, robust financial management and evaluation information management systems, and the development o f well-defined measures o f performance that link priority policies, objectives and programs. Recent reforms aimed at institutionalizing performance-based budgeting include the following: A new directive2 was issued clarifying the overall framework for performance- based budgeting that will be used to prepare the 2010 budget, including the new "institutional programs" (programas institucionales-PIT) located within ministries and are being linked, in most cases, to basic output indicators. These differ from the inter-sector programs th at seek to encapsulate higher-level policies (programas estratigicos). However, there are inevitably overlaps and linkages between the programs. The purpose o f the exercise is to identify the relationships between inputs and outputs in key lines o f action identified by the ministries themselves and around 60 PITS and the six new strategic programs3 expected to be included in the 2010 budget. O n top o f the strategic programs already using the new performance orientation, this significantly increases the coverage o f the budget linked t o results information. The directive also sets out the procedures for producing the multi-annual investment budget for 2010 and piloting the medium-term budgeting for the strategic programs. The pilot for the 2010 budget is the nutrition program. The Budget Office (DNPP) has also strengthened i t s role in the process, firstly by incorporating the program evaluation function, which was previously a separate body, and also through the w o r k with the Multi-annual Programming Office (DGPM) to develop the multi-annual investment budget. Results-focused executive evaluations continue to be developed. Four evaluations were completed in 2008, with three already published on the MEF website, and agreements with the implementing agencies on the recommendation are being * Directiva General para la Programacion y Formulaci6n del Presupuesto del Sector Pliblico-Enfoque por Resultados httu://www.mef.gob.pe/DNPP/directivas/201O/directivas201O.php. 3 The new priority strategic programs, outlined in the 2009 budget, relate to: public safety, SME competitiveness, rural agriculture, crime prevention, access to justice, and the prevention o f traffic accidents. 30 discussed and should be published s00n.~ Ten evaluations are planned for FY2009, covering both strategic programs and specific budget lines (see website for list). 82. Recent developments constitute an ambitious program o f interlinked budget management reforms. While the authorities clearly recognize the progressive nature o f the development o f a performance-based budget framework, there are nonetheless significant changes proposed for the 2010 budget, including the new program classifications, the introduction o f new strategic and institutional programs and the creation o f the medium-term investment budget. These entail the development o f technical capacity, management information systems and human capacity in both the MEF and the executing agencies (the line ministries and the sub-national governments for some o f the strategic programs). Sufficient support i s therefore needed for these initiatives, both from a policy and a resource perspective, and duplication and overlaps need to be minimized through careful planning and management o f the process with the key stakeholders. 83. The challenge going forward i s to continue to strengthen the linkages between budget allocations and program outputs and broaden the general focus on results. The authorities intend to continue to extend and deepen their reforms as described above over the medium term, which will rapidly expand the coverage o f national and regional budgets that link programs to performance indicators-particularly with the addition o f six new strategic programs and 60 institutional programs in the 2010 budget. In doing so it will be important to continue to ensure that the overall strategy for implementation remains internally consistent, and to bolster the linkages, support and capacity o f a wide range o f stakeholders to fully participate in the process. In the short-term this includes the line ministries, regional governments and senior policy makers, and in the medium-term service users. In this regard, it may be helpful to explicitly agree on the rationale and develop a flexible, strategic program for the medium-term amongst key Stakeholders. 84. I t will also be important to continue to build on the experience and lessons learned during the first phase o f the initiative. Peru is undergoing an ambitious reform program and international experience suggests that it will be important to continually monitor and evaluate the experiences and to adapt the performance-informed budget framework where desired. I t is therefore important to continually evaluate the quality and relevance o f the institutional and strategic programs and strengthen the monitoring and evaluation systems by expanding the program o f executive evaluations, 10 o f which are planned for 2009. Over the longer term, i t will be important to link the performance-based budget framework to the process for the drawing up o f a Multiple-year Budget Framework, which has begun with investment spending for FY2010, as many results will inevitably, due t o their nature, take a number o f years to be achieved. The process i s set out on the MEF website: h~://www.mef.~ob.ue/DNPP/directivas/2010/directivas2010.uhu. This includes the recommendations and will include the agreements on how ministries will address the recommendations. The evaluation o f the capacity building program, completed in 2008, i s still under discussion with the Education Ministry. 31 Prior Actions completed under the Program (DPL 111) Indicative trigger (as described in the previous operation): "Formalize the use o evaluations i n budget discussions and follow up on these evaluations' f recommendations. Undertake four 2008's budgetary program evaluations based on the f improved methodology (including recommendations o the first group o evaluations). " f 85. The prior actions completed by the Borrower under the Program include the following (see Annex 3): (5) The Borrower has: (a) completed a separate evaluation for each o f the following four programs: (i) road maintenance; (ii) conditional cash transfers; (iii) strategic nutrition; and (iv) life-long education and training; and (b) published in the MEF's web page the results o f the evolution o f the first three programs mentioned in (a) herein. Indicative Triggers for DPL I V 86. Continue the gradual implementation o f performance-informed budgeting, through: (i) Signing agreements (matrices de compromisos) t o address the recommendations from at least 3 executive evaluations; and (ii) Broadening the number and coverage o f results-orientation programs--Strategic and Institutional programs--in the 20 10 budget. Make Public Sector Processes More Transparent, Accessible and Agile 87. The management transition at the National E-Government Office (Oficina Nacional de Gobierno Electrdnico e Informdtica-ONGEI) has resulted in delays in the implementation o f the e-government and digital agendas. The transition is n o w completed and there i s a renewed commitment to update the previous strategies and to develop and action plan that builds o n the advances o f the previous years. The main objective is to bring the e-government and digital agendas in line with changes in evolving international information and communications technology (ICT) standards. ONGEI has already started the implementation o f I S 0 17799 for information security and I S 0 12207 to establish the life- cycle o f software and harmonize applications in all central govemment agencies. 88. There has been some progress in the monitoring o f telecom infrastructure indicators, which are showing a gradual improvement in this area over the years. The results from the e-readiness evaluation carried out by the United Nations (UN) every two years, show that Peru i s lagging behind in the telecommunications infrastructure sub-index compared with other countries in the region and the world. Preliminary discussions with the new management at ONGEI indicate that the new e-government and digital agendas will continue to place strong emphasis on reducing geographic differences by improving access in rural areas. Improvements in telecommunications infrastructure are essential to reach this objective. Updated objectives and targets and their inclusion in the e-government and digital 32 agendas i s also key to ensure the required resources and political endorsement. To monitor progress in this area, ONGEI has started to include infrastructure indicators in the digital agenda action plan which i s available online for public access. In March 2009, ONGEI published the "Peru E-government Master Plan"s. The document includes a historic comparison o f the telecommunication indicators, which have been improving over the last few years. 89. Additional reforms that w i l l contribute to reduce geographic differences in access have been implemented. A regulation to implement on-line accessibility standards was approved in 2009. In the area o f domain management, ONGEI has established a service to develop web portals and provide capacity building to municipalities on information management and website maintenance. ONGEI currently hosts web applications for 187 municipalities. An agreement with Red Cientijka Peruana was formalized to provide free domains to municipalities for one year. 90. But the transition to on-line transactions o f government services for citizens i s progressing slower than originally anticipated. The GoP continues with its efforts to automate the most used transactions by citizens through an on-line one-stop-shop (Ventanilla Unica). The terms o f reference to launch the first phase with the seven most popular government services online (including ID, passport, criminal records, etc.) were recently completed. However, the implementation o f the Ventanilla Unica requires a payment application to enable online transactions, as well as the implementation o f the electronic signature, which has experienced significant delays. The first request for proposals to automate the process supported by the certification unit (INDECOPI) did not receive interest from vendors and a draft for an adjusted request for proposals was recently completed. It i s unlikely that the implementation o f electronic signature will be completed prior to the design o f DPL-IV; therefore the trigger for D P L - I V in the area o f e-government will focus on monitoring the implementation o f an interoperability platform to standardize and share information by Government agencies at the national level, a key step in the integration o f Government services and information online. 91. By contrast, the e-procurement agenda has shown significant progress. The delays observed in the area o f e-procurement during the preparation o f the earlier loan resulted in a reformulation o f the reforms supported by this series. However, the Bank continued providing technical assistance to the Government. As a result, and despite the reorganization o f the Supervisory Unit for State Procurement (Organism Supervisor de las Contrataciones del Estado-OSCE), a National Procurement Strategy was completed, including a multi-year implementation plan to 201 1. In addition, the Bank and the IADB assisted the GoP in developing the national procurement strategy. The strategy along with the use o f OECD benchmarking indicators helped in establishing a baseline o f the performance o f the national procurement system with the appropriate strategies to strengthenthe system. 92. T h e development o f the National Procurement Strategy sets P e r u on a path toward consolidating a modern national procurement system. The Plan to implement the Procurement Strategy identifies eight key areas that will be addressed within a coordinated framework to strengthen the performance o f the national procurement system. When implemented, these strategic areas will provide the GoP with a dynamic, transparent and 5 Httrx//www.ongei.gob.De/pdf/egovernment.pdf. 33 efficient system-an increasingly critical tool to implement the GoP's policy agenda. According to OSCE information database, Peru's national procurement system only achieves about 40 percent o f i t s planned activities. Further pressure is placed o n this system by the government stimulus program. Currently, at the request o f the GoP, the Bank is providing procurement assistance to implement the economic stimulus package, with a particular focus on infrastructure spending. 93. Overall, there have been improvements in the legal framework in these areas, consolidating the progress made in previous operations. A new procurement law was approved (Decree 1017), together with i t s regulation. This law establishes the division o f the regulatory and procurement functions. OSCE will continue i t s regulatory role, while the newly-established PeruCompras agency will be in charge of aggregatehtrategic procurement and framework contracts. However, the appointment o f a director and team for PeruCompras i s s t i l l pending. In the area o f e-government, the regulation about accessibility was approved (Resolution 126-2009- Presidencia del Consejo de Ministros - PCM), and includes the mandatory implementation for state agencies o f web accessibility standards for the visually impaired. I t also includes the mandate to provide mobile access for public services available online. 1) Prior Actions completed under the Program (DPL 1 1 Indicative triggers (as described in the previous operation): "Continue strengthening the use o e-government, particularly in the area o digital f f signatures". Include telecommunications infiastructure indicators in the "digital agenda progress matrix" to monitor Peru 5 progress versus the regional average. '' 94. T h e trigger has been replaced with policy actions in the area o f public procurement that contribute to meet the objective o f the original trigger. As mentioned earlier, there has been substantial progress in the digital agenda (in particular, the monitoring o f telecommunications infrastructure indicators). However e-government reforms have advanced on a slower pace due to institutional changes. In particular, the implementation o f the digital signature has suffered significant delays and was not completed on time for this operation. At the same time, there has been significant progress made in the area o f public procurement, contributing to the objective of the original trigger. 95. P r i o r actions completed by the Borrower under the Program include the following (see Annex 3): (6) The Borrower has: (a) enacted a new procurement law (Legislative Decree No. 1017 published in the Borrower's Official Gazette on June 4, 2008); (b) approved regulations to such new procurement law (Supreme Decree 184-2008-EF published in the Borrower's Official Gazette o n January 1, 2009); and (c) published in OSCE's website a national procurement strategy dated April 2009. Indicative Triggers f o r DPL I V E-Government: implement the interoperability platform to enable data integration across government agencies that feed the online applications for Government services; 34 0 Procurement: (i) develop standard bidding documents and mandate their use; and (ii) design the procurement accreditation framework, covering all public agencies, and develop a roll-out plan to implement it. 2. Competitiveness 96. Prudent macroeconomic and fiscal policy and an open trade regime are necessary but not sufficient conditions to sustain growth without decisive reforms to boost the investment climate and competitiveness, particularly in the current difficult global economic conditions. Peru's solid macroeconomic performance o f the last years has not been accompanied with a similar success o n the competitiveness front. The pending agenda in the area o f competitiveness i s substantial. The World Economic Forum ranks Peru 83rd in its Competitiveness Index, an improvement from 86 in the previous year but s t i l l well behind Chile (28), Mexico (60) or Brazil (64). Competitiveness is affected by l o w human capital, high logistical and transportation costs, weak quality standards, cumbersome business regulations, l o w research and development (R&D) investment, and fragmented supply chains. Figure 5: Components o f Peru's Competitiveness Ranking6 C GA Innovatiiqij5aT---7 Institutions Business sophetcabon ,,,Infrastructure Market s z e -- Mcrceconomc stability Health and primry Technologcal readiness educatm Financial m r + I-kgher education and sophistcaton - ,. ,/' training Labor mrket e f f c l e n + - - - k & d d s mrket effclency Source: World Economic Forum, 2009. 97. Competitiveness enhancement and policies to foster deeper trade integration continue as priority areas o f the Government's policy agenda to support broad-based growth. Competitiveness and the investment climate have and will continue to benefit from several o f the reforms noted in the previous section, in particular fiscal and public debt consolidation, improved transparency in economic policy and a modern public sector. A number o f bottlenecks to private sector activity are being addressed by specific policies, particularly regarding trade policy, procedure simplification, e-government, sustainable expansion o f private credit, and fostering innovation practices especially to MSMEs. 6 The index receives a better rating when closer to the origin. 35 Expand and Deepen International Trade 98. Peru's export performance has been affected by global crisis, although the small exporting firms have suffered less than the larger ones operating in traditional commodity sectors. Peru's export performance has been impressive over the last years, with compound annual growth rates averaging above 20 percent between 2001 and 2008. However, the rhythm o f export growth slowed in the past two years, down from 37 percent in 2006 to 18 percent in 2007 and 13 percent in 2008. The global economic slump starting in September 2008 has had a sharply negative impact on exports, which dropped from US$8.8 billion (342008) to US$5.3 billion (1Q2009). The downturn has particularly hurt the performance o f the around 100 large exporting companies in Peru producing traditional commodity products, especially minerals and hydrocarbons, with declining export revenues each month between September 2008 and February 2009. One positive sign i s that the exports o f micro-firms have held up relatively well, with strong monthly gains in revenues since the crisis began, apart from one negative month in December 2008. `Nevertheless micro-firms s t i l l represent only a small fraction o f the export sector. 99. Peru i s yet to fully exploit all the opportunities created by recent trade agreements. Total exports in Peru have grown at a fast pace since 2003 but they s t i l l represent a low percentage o f GDP, about 19 percent in 2008. Mining and petroleum (which are capital-intensive activities and hence generate relatively few jobs) account for about two- thirds o f exports by value, while manufactured exports remain a small component o f Peru's trade. Non-traditional exports s t i l l account for only 24 percent o f total exports. Increasing and diversifying exports are key opportunities for the country. 100. While traditional exports such as mining have the largest share in total exports, non-traditional exports have been very dynamic in recent years, exhibiting a steady pace of growth. Non-traditional exports have grown rapidly in recent years, reaching US$7.5 billion in 2008, nearly tripling in value since 2003. Yet, as a result o f the increase in the global price o f minerals, the share o f traditional exports (expressed in value) in total exports rose to 77 percent on average during 2006-2008. This explains why, as shown in Figure 7, the share o f non-traditional exports in total exports has declined when measured in current prices, while it has actually increased if we consider volumes (i.e., assuming that prices would have remained constant). 36 ExpoRs E x p m s (using mnstant 2002 prices) Share of n m - m d i t b n a l expons InUSSbllton In US$ bllton Percent 40 ~ .... .... .............. . .. ..... ..... . . . 15 + ..... ..... - 10 1 -Share -s.. -I -- ofnon-~adkmnalexpo~s 5 9-----Shmd-~*lo^-.m,ntotd-.-- intotal l--l..--._--l..---.l.-. . I--- . exports (usng 2002 pnces) * , -, , 2002 2003 2004 2005 2006 2007 2008 2002 2003 2004 2005 2006 2007 2008 2002 2W3 2W4 2005 2006 2007 2W8 - cotton, coffee, and fishmeal). Source: Bank staff calculations based on UN COMTRADE. 101. The administration has moved ahead strongly in deepening connections to international markets and promoting trade diversification. The FTA with the U.S. took effect in late 2007, and Peru has since passed nearly 100 regulatory changes related to the treaty's implementation, including those related to intellectual property and copyright protection. Peru's FTA with Chile came into effect in April 2009, and in that same month the country signed an FTA with China (Peru's second-largest trading partner). This trade policy i s expected to continue to help Peru create a more diversified portfolio o f export markets. For example, in 2008 the United States (U.S.) and the European Union (EU) accounted for about one-third o f traditional exports products and 40 percent o f non-traditional products, with the remainder purchased by other countries around the world. China, in particular, has become a major consumer o f Peruvian traditional exports, roughly equal to the U S and EU in 2008. 102. The GoP has continued reducing average tariffs and tariff dispersion as well a s simplifying the tariff structure, benefiting consumers as well as exporters who rely on imported inputs. Following the major tariff reduction in October 2007 involving over 4000 products, the administration has undertaken two further reductions, simplifying the tariff structure to just three levels-0 percent, 9 percent and 17 percent-with an average tariff o f 5 percent and tariff dispersion o f 5.9 percent. These actions clearly demonstrate that the GoP sees international trade opportunities as the best motor for growth and poverty reduction in Peru. 103. The administration has taken several temporary measures to ease the impact o f the crisis on export industries. In January 2009, the drawback program to support non- traditional exports was increased from 5 to 8 percent for the duration o f the calendar year, representing a fiscal cost o f about US$lOO million. The measure aims to ease the credit restrictions faced b y companies during the downturn. A further U S $ l 00 million was set aside to expand access to credit for small and medium exporting firms, to continue until March 20 11. In addition, the administration has supported the creation o f a new insurance program called Sepymex, backed by US$50 million and managed by the second-tier development bank COFIDE. The program offers insurance coverage to pre-shipment credits given by a financial institution to a small or medium exporting firm (less than US$8 million o f exports 37 per year). The coverage is 50 percent o f the total loan insured, up to a maximum U S $ l million. 104. A crucial element in a pro-export strategy i s facilitating trade-related processes. VUCE, a one-stop shop for import and export procedures, is advancing towards its implementation. The V U C E has n o w integrated the required procedures o f the eight main government agencies. Five o f the eight agencies7 -representing well over 90 percent o f import transactions-have now linked their systems as a necessary step before the V U C E becomes fully operational, which i s expected for 2010. Another important component, the complete official list o f restricted merchandise approved by Customs, is expected t o be completed by end 2009. 105. T h e GoP i s gradually incorporating more stages o f the international trade chain into the VUCE framework. A port module for the V U C E was authorized through the modification o f the L a w o f Port Systems approved under the extraordinary faculties granted for the US-Peru free trade agreement implementation. This is an important step towards facilitating trade processes, reduce transaction costs and streamline procedures. M o r e than 80 percent o f import and export operations are made by sea, so the impact o n having the ports-especially Callao-connected to the V U C E should be high. Moreover, including ports in the V U C E connection could allow a better coordination the enforcement agencies, improving the security side, key to reduce costs o f inspection for exporting goods. A preliminary version o f the port V U C E - c o v e r i n g arrivals and departures, but not time in port-is expected t o be put into operation in early 2010. In the medium term, the authorities are planning to incorporate "transit" into the V U C E framework. Compared to other L A C countries, Peru is at the forefront in facilitating and modernizing foreign trade transactions through the implementation o f a one-stop shop portal. 106. T h e promotion o f micro, small and medium enterprises and their integration into export markets also remains a priority for the GoP, and a number o f policy actions have been taken in that direction in the past year. An important step to promote the M S M E sector was the approval o f a new law (Decree 1086) in 2008 o n MSMEs, which makes a number o f important improvements to the prior law (passed in 2003) regulating the sector. T o increase formalization and provide improved labor conditions, the law expands the definition o f small firms to 100 employees (up from 50 previously), as well as doubling the volume o f sales permitted and giving more flexibility o f f i r m s temporarily exceed sales limits. The idea i s to incorporate a larger portion o f the labor force to a more flexible and less onerous labor regime. As well, the temporary nature o f the labor regime in the previous norm was replaced with a permanent status. This i s important to attract MSMEs into formalization because it eliminates a source o f uncertainty about what will be the labor regime in the future. An added incentive to formalization i s that the state will n o w partly subsidize the contributions o f workers in micro-firms (10 employees or less) for health care. In the case o f pensions a Social Pension System i s created, in which participation is voluntary. The minimum contribution, not to exceed 4 percent o f the minimum wage, is set by MEF. Other changes included reducing the tax rate o n net sales o f micro-firms from 2.5 percent to 1.5 ' The five agencies are as follows: SENASA (MINAG), DIGEMID, MTC, DIGESA y DICSCAMEC (MINCETUR). 38 percent. For small f i r m s accelerated depreciation i s allowed for income tax purposes. Implementation o f the new norm has thus far been modest, due to the considerable challenges involved. 107. The GoP has recently created two funds geared toward MSMEs, to facilitate their integration into global markets through the provision of training, technological innovation and access to finance. The Research and Development for Competitiveness Fund (Fondo de Investigacidn y Desarrollo pura l a Competitividad-FIDECOM) aims to (i) promote research and development for productive innovation in f i r m s and (ii) develop and strengthen capacities for generating and applying technological knowledge towards upgrading productive and management capabilities in micro-firms. Project proposals will compete for FIDECOM resources on the basis o f impact, feasibility, cost-benefit ratio, and complementary factors. Calls for projects will be conducted periodically and a process o f evaluation i s contemplated to select the beneficiaries. Currently FIDECOM has appropriated 220 million nuevos soles to develop its activities. FIDECOM's regulations were approved in February this year, an executive committee has been convened, and the science and technology fund FINCYT-which has proven experience in administering technology funds-has been named as FIDECOM's technical secretariat. Putting FIDECOM in operation, however, implies a significant challenge, as there i s no experience o f managing a competitive fund in Peru's public sector. A proper legal framework needs to be developed to operate FIDECOM, which i s under design by the fund's executive committee. The second fund to access financial factoring services i s s t i l l in the design stage. The necessary supreme decree and final institutional arrangements are expected to be completed before the end o f 2009. 108. Going forward, the GoP i s committed to continue trade expansion through the signing of Free Trade Agreements and the implementation of additional measures to simplify custom procedures. As o f July 2009, the GoP i s in the fifth round o f negotiations o f the FTA with the European Union and EFTA countries (Switzerland, Liechtenstein, Norway and Iceland); in the third round with Korea; and in the second round with Japan. The authorities expect to conclude these negotiations by June 2010. The GoP has also started discussions with Australia regarding the negotiation o f a FTA and with Mexico to replace the existing FTA. To comply with the FTA with the US, SUNAT has developed a new business model to simplify customs procedures and an implementation plan that i s expected to be completed by January 1, 2010. Among other aspects, the plan includes measures to expedite imports and postal services, use o f electronic documentation to move progressively towards paperless custom procedures. Prior Actions completed under the Program (DPL 111) Indicative Triggers (as described in the previous operation): "Continue implementing actions related to competitiveness enhancement including progressively incorporating more agencies in the use o the one-stop-shop VUCE and f measures to facilitate innovation, quality and service marketsfor exporters. " 109. The gradual implementation of the One-Stop-Shop for Trade (VUCE) has been complemented by trade policy measures aimed at promoting international trade and 39 . . competitiveness. In particular, the regulatory measures to comply with the FTA signed with the U.S help to facilitate trade, innovation and expand service markets for exporters. The FTA signed with China also contributes to create a more diversified portfolio o f export markets. 110. Prior actions completed by the Borrower under the Program include the following (see Annex 3): (7) The Borrower has: (a) signed a Free Trade Agreement with the Popular Republic o f China in April 28, 2009 and (b) enacted the following laws and regulations oriented toward facilitating trade, all o f which are consistent with the provisions o f the Borrower's Trade Promotion Agreement with the United States o f America: (i) Legislative Decree No. 1036, published in the Borrower's Official Gazette on June 25, 2008 which expands the application o f the Borrower's one-stop shop for international trade; (ii) Supreme Decree No. 009-2008-MINCETUR7 published in the Borrower's Official Gazette on December 5, 2008 which regulates the provisions o f the Legislative Decree mentioned in (i) herein; (iii) Legislative Decree No. 1053 published in the Borrower's Official Gazette on June 27, 2008 which approves the General Customs Law; (iv) Supreme Decree No. 010-2009-EF published in the Borrower's Official Gazette on January 16, 2009 which regulates the provisions o f the Legislative Decree mentioned in (iii) herein. Indicative Triggers for DPL I V 111. Continue implementing policy actions related to the expansion o f international trade through: (i)Signing o f additional FTAs; and (ii) Improving trade facilitation through the simplification o f customs procedures; Public Procedure Simplijication 112. Reducing the transactions costs and times for the private sector to start, operate and close a business i s an important component of the GoP's strategy to improve competitiveness. These costs reduce the attractiveness o f the investment climate and act as a strong disincentive to economic activity. According to Doing Business (2009), in 2008 starting a business took 10 procedures and 65 days and cost 25 percent o f per capita income, compared to 10 procedures, 72 days and 3 1 percent of per capita income in 2007. Receiving a business license can take up to 65 days, while clearance for export and import takes 24 and 25 days respectively. The GoP recognizes that procedural simplification is an essential component o f any strategy to improve competitiveness. Several Bank studies such as the Country Economic Memorandum, and the Peru Policy Notes also noted that procedure related transactions costs are a significant obstacle to economic activity. 113. Expanding Tramifhcil was dropped as a trigger in the previous operation. I t was left in the policy reform matrix as a benchmark to measure progress in the area o f `doing business' reforms. The Ministry o f Economy and Finance requested to drop the Tramifacil as a trigger because it did not have direct control over i t s execution, due to 40 municipalities' autonomy in implementing streamlined public procedures. Nevertheless, i t i s important to note that the GoP strongly supports this initiative. The aim o f this section i s to report progress in this area. 114. The GoP has made notable efforts to reduce public procedure times and costs on both the national and local level in recent years. The Tramifacil program-a joint initiative between the IFC, USAID, GTZ, other donors and both national and local government agencies-began work in 2005 with the aim o f cutting the red tape faced b y entrepreneurs seeking licenses for opening a business or construction permits. Laws governing these procedures were reformed at the national level, and technical assistance teams began working with municipalities to implement new streamlined procedures. The work began in L i m a and soon initiated in Arequipa, Ica and Piura. As o f M a y 2009, 42 municipalities in 12 regions-administrative areas accounting for 70 percent o f Peru's GDP-now incorporated into the program. The results o f Tramifacil include substantial declines in the amount o f days, number o f visits and costs required for business and construction licenses. While most attention has been understandably focused on improvements in the country's main economic centers, significant progress has also been achieved in more remote areas, improving their potential to j o i n in Peru's development. For example, in the municipality o f Maynas in the Amazon region the cost o f an operating license fell from 640 nuevos soles to 145 nuevus soles, the time required from 145 days to five days, and the number o f requirements from 21 to seven. As a result, the number o f new companies registered in the municipality jumped from 102 the year before the reform to 843 the year after. Other municipalities have shown even larger improvements. Considering that 60 percent o f the time required to start a business in Peru i s absorbed by municipal-level procedures, these improvements represent important reductions in the time and money spent by businesspeople in their dealings with the public sector. 115. Tramificil continues expanding to new municipalities. At the same time, the GoP i s taking action both to broaden administrative reforms to new areas as well as to guard against backsliding in municipalities where Tramifacil has been implemented. The next new administrative procedures undergoing simplification are "sectoral authorizations" required from various government agencies depending on the type o f business seeking an operating license. The prime minister's simplification office has compiled a l i s t o f 130 sectoral authorizations currently in use, and i s finalizing arrangements to begin simplification o f these procedures. A decree launching the reform is expected before the end o f 2009, and the most frequently required authorizations will be addressed first. The simplification office has also implemented its first independent evaluation o f municipal procedures, in local government offices in Lima and Callao. The results were generally positive, although the study-which entailed interviews with users as well as researchers posing as businesspeople seeking a license-did uncover some cases o f non-compliance. Further evaluations are expected in the near future. While the central government cannot impose sanctions on the municipalities, it w i l l deliver a detailed evaluation to local authorities as well as publish results to encourage compliance. 116. Broader reforms are also underway in several areas targeted toward improving Peru's ranking in the Doing Business indicators. The P C M and the National Competition 41 Commission (Comisidn Nacional de Competitividad-CNC) i s working with a team from the IFC, Doing Business and the World Bank t o target specific reforms in several areas t o improve the country's climate for business activities. The project has drawn up a medium- term plan in areas such as investor protection, streamlined resolution o f business disputes, and property registration, as well as policies supported by this loan including the VUCE, procedure simplification and electronic tax payments. The first round o f reforms i s to be completed by early 20 10, before the next round o f Doing Business rankings are assembled. 117. The recent Doing Business 2010 report mentions the following reforms undertaken by the GoP over the past year aimed at simplifying procedures for contract enforcement and tax payments: E nforcing Contracts: (i) Legislative Decree NO1069 was passed in order to improve the justice administration in commercial matters. It contains provisions regarding clearing backlog o f cases evidence filing deadlines and deadlines to contest enforcement procedures; (ii) Legislative Decree N"1070, which aims to reform the scope and use o f conciliation; (iii)The new legislative decrees N"1067, NO1069 & NO1029 allow for the use o f electronic notifications. The judiciary n o w offers the possibility o f creating email accounts at their web portal to receive electronic notifications. Further, the Judiciary by Ruling No 336-2008, published in the Official Gazette o n January 28 2009, has established putting in practice the Electronic judicial notices, in l i e u o f traditional means o f publication; (iv) Art 51 o f the civil procedural code as well as the Ley Orghnica del Poder Judicial n o w provide for oral proceedings as an alternative to written proceedings. Paying Taxes: (9 The use o f the Peruvian Tax Authority's VAT software, which i s n o w widespread across all businesses, has made filing simpler and faster; (ii) Effective 1 Jan 2009, the cost o f doing business was lowered by reducing the rate o f tax o n check transactions from 0.8 percent t o 0.7 percent; (iii)Effective 1 Jan 2009 the GoP undertook reforms t o encourage capital investment, with a new regime o f accelerated building depreciation at 20 percent for buildings started by 1 Jan 2009 and finished by 1 Jan 2010. In addition, the ordinary rate o f depreciation for buildings was raised from 3 percent t o 5 percent. 42 Promote Sustainable Financial Deepening and Improve Credit Access for MSMEs 118. Access to credit has expanded during the last years in Peru accompanied by stronger supervision. Credit portfolio growth in all client segments has been strong among supervised financial entities during the last three years8 Credit growth to the private sector has been led by the retail market. It maintained a robust expansion last year, reaching 33.8 percent, though this pace has decelerated on a monthly basis in 2009. B y 2008, credit to the private sector stood at 24.3 percentg o f GDP. 119. An upgraded supervision framework and a positive macroeconomic environment have contributed to Peru's solidly capitalized financial sector. The financial system has been strengthened significantly, as reflected in improvements in asset quality. SBS reported non-performing loans (NPLs) o f the gross portfolio o f supervised financial entities o f 1.4 percent in March 2009. The coverage o f provisions over NPLs has been above 200 percent during the last two years. In March 2009 coverage was 243.5 percent, decreasing from 257.7 in March 2008. Moreover, as o f March 2009, the SBS reported a risk-weighted capital adequacy ratio (CAR) o f 12.6 percent, well above the minimum 8 percent recommended by the Bank o f International Settlements. 120. I n reaction to a deteriorating economic environment, the central bank has taken several preventive measures. In October 2008, the central bank started to offer repos in dollars to boost dollar liquidity. I t also extended the terms o f rep0 operations up to one year and allowed pension funds and mutual funds to participate in these operations. Also in October, the central bank cut the marginal reserve requirements for foreign currency from 49 percent to 35 percent and eliminated marginal reserve requirements for local currency. The marginal deposit requirement was cut to 30 percent from 35 percent for foreign currency accounts. The minimum legal reserve requirement has been cut three times since December 2008, from 9 percent to the current 6 percent, increasing liquidity by a total o f 1.2 billion nuevos soles. 121. T h e Peruvian authorities have taken additional measures to mitigate risks and promote sustainable credit expansion. SBS issued a regulation (Resolution 1237/2006) to ensure that supervised institutions are adequately managing over-indebtness risk and that their corporate governance arrangements and underwriting standards adequately reflect these risk management practices. Additionally, the National Stock and Business Supervisory Commission (Comisidn Nacional Supervisora de Empresas y Valores-CONASEV) has approved a new securitization regulation (Resolution 087/2007) that should facilitate the development o f new instruments to allow the issuance o f asset-backed securities. Further regulations changing the ways to calculate net worth o f financial institutions, specifying criteria for classifying different types o f debtors, and mandating systems to prevent money laundering and terrorism finance have also put into place since 2008, improving the management and resilience o f the financial sector. 8 Supervised financial entities include banks, financial companies (empresusfinancierus), municipal and rural savings and loans institutions (cujus rnunicipules and cujus rurules) and microfinance institutions (EDPYMES). The average credit to the private sector for Latin America and the Caribbean was 33 percent o f GDP at the end o f 2008 (country bank superintendencies and central banks). 43 122. T h e G o P i s seeking to diversify the product offering o f financial institutions by lowering the regulatory costs involved. The SBS has issued regulations to allow the expansion o f services that financial institutions may provide (Resolution 1122/2006) by not requiring full application for the entire set o f products but by defining capital and operational requirements for individual products. This reform will help further liberalize the supply o f financial services in Peru while ensuring adequate prudential requirements are in place. Additionally, the regulation establishing the basic regulations and characteristics o f micro- insurance (Resolution 215/2007) i s an important step toward helping the poor adequately manage their risks. Financial insurance, a key instrument to mitigate this risk, was until recently not available to the poor. 123. T h e G o P has also taken measures to further develop domestic capital markets. Although a regulatory framework for securitization has existed in Peru since 1997, a relatively limited number o f transactions have been conducted. This i s in part because the framework was not updated to keep pace with market developments. CONASEV, in consultation with the industry, updated the rules to include new assets that can be securitized. This update o f the regulatory framework included streamlined procedures to register new transactions and facilitated processes to review assets before they are offered to investors. This regulatory update i s already having a positive impact. Domestic capital markets have been growing. The mutual fund industry has 207,000 participants who have accumulated 10.4 billion soles as o f June 2009. Another example o f progress in capital market development is the new mortgage securitization firm that has been established with IFC support. This could not be done under the previous regulatory framework given the existence o f limitations on the type o f assets that could be securitized. 124. T h e MSME sector i s a particular focus o f attention f o r credit expansion by the Peruvian authorities. The 2008 l a w on MSMEs gave the state development bank COFIDE the power and means to promote access to financing for MSMEs, including 900 million nuevos soles (about US$300 million) to finance working capital, pre and post shipments, investment and exports o f capital goods for MSMEs exporting non-traditional products. Additionally COFIDE i s entrusted with 300 million nuevos soles to partially guarantee financial sector loans for MSMEs. In 2007 this financing guaranteed US$285 million and close to US$300 million in 2008. 125. Going forward, the main challenge i s facilitating sustainable financial deepening. This will require the design and implementation o f more flexible financial instruments. The GoP i s currently considering two areas o f policy reforms: (i) securitization and mortgage product development; and (ii) improved access to finance by MSMEs: (i) Securitization and mortgage product development. The GoP has done significant efforts to strengthen securitization regulations and develop the mortgage markets. However, the number o f mortgages loans i s s t i l l very low. A s o f May 2009, there are approximately o f 116 thousand mortgages in the banking sector, compared with 837 thousand mortgages in Chile (a country with roughly h a l f o f the population o f Peru). Additionally, the penetration o f mortgage products in l o w income groups (groups C and D) could be significantly increased. Improvements in SBS regulations on bank's mortgage registration and liquidation processes as well as standardized 44 documentation and improved clarity on the scope o f mortgage collateral would significantly improve the development o f the capital market; (ii) Improved access to finance by MSMEs. On February 19,2009 the decree 024-2009 created Fondo de Garantia Empresarial (FOGEM) to provide partial guarantees on new loans granted by Peruvian banks to MSMEs. COFYDE has been developing a reverse factoring scheme for MSMEs. Factoring financial services provides an alternative way for smaller f i r m s to access financing. Prior Actions completed under the Program (DPL 111) Indicative trigger (as described in the previous operation): "Strengthen the credit risk management rules to promote sustainable credit expansion. These measures include reinforcing the rules regarding over-indebtedness risk management, the f adjustment o credit, operational, and market risk management rules to contemplate integral risk management so that upper management can effectively control risk, and the elaboration 1 o rule projects consistent with the Basel 1 risk-based capital accord. " f 126. The prior actions completed under the Program include the following (see Annex 3): (8) The Borrower has approved banking norms which conform to the regulatory, capital, evaluation and risk management standards o f the Basel 1 , including the strengthening 1 o f the regulatory framework governing over-indebtedness risk management , as evidenced by the issuance o f (a) Legislative Decree 1028-2008 published in the Borrower's Official Gazette on June 22, 2008 which amends the Borrower's General L a w o f the Financial and Insurance System and the Organic Law o f the Superintendency o f Banking and Insurance; and (b) Resolution S.B.S. 6941-2008 published in the Borrower's Official Gazette on August 26,2008 which approves the regulations for the administration o f over-indebtedness risk o f small debtors. Indicative Triggers for DPL I V 127. Expand financial services, including: (i) Strengthenin g regulations to improve securitization, and credit registration and processing in the mortgage area; and (ii) Expand access o f credit to MSMEs. 45 VI. Operation Implementation A. Poverty and Social Impact 128. T h e actions supported by this operation are not expected to have significant negative poverty and social impact. In fact, the poverty and social impacts o f the policies supported by this loan series have been positive. O n the fiscal side, the sound fiscal policy framework supported by the F M C D P L series has allowed the GoP to increase i t s attention to social spending, particularly through the Juntos conditional cash transfer program for the poor, and to undertake a sizeable emergency fiscal stimulus program to mitigate the effects o f the global economic downturn on Peru and sustain the social and economic gains o f recent years. Actions to improve the performance orientation o f budgeting processes began with pilot projects in specific areas related to improving the impact o f social spending o n the poorest sectors o f the population. These activities are also receiving intensive support from the parallel R E A C T D P L series working t o improve results and accountability in public social programs. Initiatives to improve the equity o f how fiscal resources are distributed throughout the country, in particular through the new FONIPREL investment fund, have also benefited poorer parts o f the country. The fund accepts project proposals not just o n project viability, but also o n poverty rates and the level o f a locality's resources, thus disproportionately benefiting regions with high poverty levels and limited natural resources. More than half o f the fund's investments thus far have been in the country's six poorest regions. 129. Competitiveness policies have helped with the impressive economic activity experienced in P e r u in the past several years, which in turn has boosted employment creation and poverty reduction. This has been particularly notable in the growth o f micro, small and medium enterprises and the non-traditional export sector, which contribute more significantly to employment creation than the traditional commodity export sectors. The long-term strategy for reducing barriers to international trade through reductions in tariffs and export subsidies and pursuing free trade agreements with Peru's major trading partners has unquestionably benefited Peru overall, as evidenced by recent high rates o f export growth and overall economic activity. A s well, consumers have benefited with lower prices for many goods. 130. T o assist the poor and those living in rural areas to take advantage o f the opportunities from Peru's greater integration into the world economy, the G o P i s combining short-term social assistance programs w i t h medium- and longer-term efforts in human capital and infrastructure investments. While Peru's greater integration in the world economy will bring opportunities for the country as a whole, it must also be acknowledged that not all social groups are in the same position to take advantage o f these opportunities. One o f the flagship programs o f the administration i s Sierra Exportadora, a package o f measures designed to promote greater economic opportunities through trade and market integration to poorer, heavily indigenous Andean mountain region. The project is directing significant technical assistance, infrastructure investment, and credit to boost export-oriented agriculture, forestry and artisan production based on local knowledge and specialties. The Bank's Sierra Development Project, included in the CPS, is supporting aspects o f Sierra Exportadora. In the medium and long term, the GoP is undertaking 46 significant efforts to increase logistical l i n k s to more remote areas o f the country to help these poorer areas access broader domestic and international markets. Additionally, the GoP i s cognizant that human capital deficits are critical in holding back many poorer Peruvians, and improving the quality o f education i s a top administration priority. This i s fully supported by the Bank, through the RECURS0 analytical project o n social sector results, the ongoing social sector DPL (which has a strong focus on education), and through the results- budgeting orientation included in this operation. 131. The administration i s also aware o f the need for redistributive programs, and has increased spending in these areas, with a .particular emphasis o n the Juntos cash transfer program to the poorest communities in the country, and basic infrastructure projects in rural areas (Table 7). Table 7: Redistributive Government Programs (in millions o f soles) Program 2005 2006 2007 2008 I Property Formalization 19 19 30 102 132. The most recent statistics on income and poverty support the fact that Peru's recent growth pattern i s pro-poor although the challenge o f reducing regional income disparities remains. Peru's policy mix appears to be successfully overcoming one o f Latin America's most difficult challenges: ensuring that growth benefits all segments o f the population. The national poverty numbers are positive-with poverty falling f i o m 44.5 percent o f the population in 2006 to 36 percent in 2008, and extreme poverty dropping from 16 percent to 12.6 percent-but even more promising is h o w the distribution o f these gains. The fifth o f the population with the lowest income level saw their income increase by about 12 percent in 2008, while the top fifth o f the population saw n o income growth. As a result, the income Gini coefficient f e l l f i o m 0.51 to 0.48 in 2008. What is more, declines in poverty were most notable not in the country's economic center, Lima, but in the jungle and mountain regions (Table 8). A s these numbers indicate, Peru s t i l l has a great deal o f work ahead o f it to reduce major disparities in the distribution o f income and in the geographic incidence o f poverty around the country-particularly in the rural mountain region-but it is clearly moving in the right direction. 47 Table 8: Poverty Rates by Geographic Area (YO population) of Total poverty Extreme poverty 2004 2008 YO change 2004 2008 YOchange National 48.6 36.2 -25.5 17.1 12.6 -26.3 Coast urban 37.1 23.4 -36.9 5.6 2.4 -57.1 Coast rural 51.2 34.8 -32.0 13.8 7.9 -42.8 Sierra urban 44.8 33.5 -25.2 13.6 9.2 -32.4 Sierra rural 75.8 68.8 -9.2 44.0 37.4 -15.0 Selva urban 50.4 31.3 -37.9 18.7 7.2 -61.5 Selva rural 63.8 49.1 -23.0 30.4 20.7 -3 1.9 Metropolitan Lima 30.9 17.7 -42.7 1.3 0.7 -46.2 Source: INEI ENAHO 2004-2008. B. Implementation, Monitoring and Evaluation 133. The Bank will monitor actions and review progress o f the implementation o f the proposed operation using different sources including: Fiscal transparency reports - MEF, www.mef.gob.pe Leading indicators reports - MEF, www.mef.Rob.De Central Bank o f Peru, reports and research publications, www.bcrp.gob.pe SIAF - MEF, www.mef.gob.pe Instituto Nacional de Estadistica (INEI), www.inei.gob.pe Investment Climate Survey Credit rating agencies reports - several sources World Bank governance indicators Doing Business indicators World-Economic Forum competitiveness indicators Indice de Gestidn Gubernamental - Universidad del Pacific0 Ciudadanos a1 D i a - reports and technical notes, www.ciudadanosaldia.org Government Tax Agency SUNAT - www.sunat.aob.pe IMF and IADB reports 134. The GoP and the Bank have agreed to monitor progress in the DPL program regularly. The Sectoral Loans Coordination Unit (Unidad de Coordinacidn de Pristamos Sectorales-UCPS) in the MEF is the main counterpart agency for the proposed loan, which will be in charge o f M&E for the loan and for collecting the appropriate data to track indicators. Other important agencies are the central bank, SUNAT, P C M and Ministerio de Comercio Exterior y Turismo (MINCETUR). 48 C. Fiduciary Arrangements 135. During 2008, in the context o f the preparation o f a series o f Bank DPLs, including the FMCDPL 11, the Environmental DPL and the REACT DPL 11, the Bank undertook a review o f Peru's public financial management (PFM) and the reforms undertaken to strengthen it. These P F M reforms, which are supported by this proposed loan, are based on the recommendations o f the 2001 Country Financial Accountability Assessment (CFAA), the 2004 IMF Fiscal Report on Observance o f Standards and Codes (ROSC), the 2005 Country Procurement Assessment Report (CPAR), and other GoP initiatives to modernize i t s public institutions, including a Performance Financial Assessment (PEFA) conducted jointly with other development partners. The findings o f the PEFA have been shared with the GoP and the final report, agreed with the authorities, was published in June 2009. 136. The PEFA concluded that PFM in Peru i s functioning well and in line with international best practices.The main findings o f the PEFA are summarized below: (i) The PEFA showed that the central government's budget in Peru i s a reliable and credible financial tool, despite the discrepancies between the executed and the initial budget. Overall, the budget formulation follows international best practice. It i s an orderly and institutionalized process; i s transparent, and the documentation attached to the Budget Bill submitted to Congress for scrutiny i s fairly comprehensive, with the public having access to key information on the subject in a timely manner; (ii) The predictability o f budget resources and internal controls o f budget execution are also working relatively well. Budget execution i s well documented and Consolidated Government Financial Statements (Cuenta General de l a Republica) are prepared annually and submitted in a comprehensive document which contains information regarding revenues, expenditures, and financial assets and liabilities, and i s audited within the legally-established time periods by the Supreme Audit Institution (Contraloria General de la Republica -CGR). The annual audit o f public institutions covers approximately 75 percent o f the total expenditures set forth in the budget, and is conducted pursuant to the respective regulations and within the time frames established by law; (iii)Legislative scrutiqy o f the annual budget bill i s conducted in accordance with well established procedures and the scrutiny o f the Cuenta General is performed in a similar way. However, there i s limited capacity in the Congress for following up on the audit recommendations proposed to Congress which are not always implementeddue to lack o f follow-up. 137. The most critical reforms to improve the management o f public finances and efficiency of public spending initiated during the last couple o f years are well advanced and some o f them were completed in early 2009. A new budget classification system and a new accounting chart o f accounts have been adopted in line with international standards and are operating in all government ministries and agencies. The implementation o f the TSA at the central government level i s progressing well with its coverage sufficient enough at this time to meet international standards. The foundations for performance-based budgeting have 49 made steady progress with the development o f well-defined measures o f performance that link priority policies and programs. The reforms in the area o f performance-basedbudgeting included several policies and procedural changes and expansion o f the strategic programs in the 2009 budget. Continued efforts are currently underway to fully implevent the TSA and ensure common standards and timely/adequate budget and financial reporting by all levels o f government (central and sub-national). 138. Efforts to continue modernizing the budget and improving P F M could be scaled up. Activities within the PFM reform agenda can be prioritized using the results o f the PEFA (and other information sources and GoP strategies) as a basis for discussing future reforms needs among different stakeholders. As well, a system for monitoring progress over time in the medium and long term could be implemented. The dissemination o f the PEFA i s expected to serve as a basis for facilitating dialogue between the GoP and the donors around a common framework contributing to harmonization and reduction o f transaction costs for the GoP. 139. SIAF i s a cornerstone o f the country's reform process, and as such the tool requires constant adjustments to support changes in policies, processes and institutions. The design and implementation o f the new system (which the GoP decided to undertake last year after an evaluation o f the current system platform) i s critical to support the PFM reform agenda. The design o f the new system and i t s platform started at end o f 2008 with the development o f terms o f reference for a consultancy to develop the conceptual framework. 140. On fiscal transparency, Peru ranks about average among Latin American countries, comparing favorably to Brazil and Mexico, but lagging behind regional leaders Chile and Uruguay. In the last few years, Congress approved a Law o f Transparency and Access to Public Information (2003) and i t s regulations; also, SIAF became available through an on-line portal "Consulta ArnigubZe", and a pilot system for users' assessment o f government services was launched. With the further development o f the new S I A F and continued dissemination o f budgetary information through the web, Peru's ranking should improve considerably. D. Disbursement and Audits 141. Disbursement arrangements will follow the standard procedures for DPLs. The Bank would make the single tranche disbursement o f US$150,000,000 following the provisions set out in OP. 8.60, namely (i) Bank w i l l deposit the funds into an account the designated by the GoP which forms part o f the country's foreign exchange reserves at the Central Bank o f Peru; and (ii) GoP shall ensure that upon deposit o f the funds into said the account, such amount or an equivalent amount i s credited in the GoP's accounting system to an account that finances budgeted expenditures. The GoP will be required to provide confirmation o f steps (i) (ii) soon as funds are received. The proceeds o f the loan may and as not be used to finance expenditures typically excluded under the Loan Agreement. 142. Disbursement arrangements were reviewed during the preparation o f this proposed loan. The Bank review included meetings with GoP officials within MEF, and the Office o f the Comptroller General (CGR), as well as desk review o f available information, such as the annual external 2008 Audit Report o f the Central Bank which contained an unqualified opinion; a review o f the results o f IMF Article I V Consultation (Staff Report, 50 January 14, 2009) and the IMF Second Review Under the Stand-By Arrangement (Staff Report, July 2008). 143. The last IMF Safeguards Assessment was completed in 2007, and the assessment concluded that there were n o significant weaknesses in the central bank's safeguards framework (IMF Country Report 07/241). The safeguards assessment identified a few measures to address minor weaknesses related to the term o f the appointment o f the external auditor and the terms o f the law o n recording unrealized revaluation gains. These minor weaknesses do not compromise the control environment surrounding foreign reserves at the central bank. 144. N o dedicated account at the central b a n k will be required f o r this operation. Given that the Bank's review o f the borrower's current P F M i s satisfactory and the conclusion that fiduciary arrangements for this operation are adequate, the Bank will not require a dedicated account at the central bank for loan proceeds. As such, no audit will be required for the deposit account. E. Environmental Aspects 145. This DPL operation i s n o t likely t o have any significant effects o n the environment, forests, and other natural resources. The reforms supported by the program are related to the adoption o f policies and only a few could have a future environmental impact. In fact some o f the proposed policy reforms under the proposed D P L are likely to be positive for environmental management, particularly related to improved monitoring and evaluation for government expenditure, including environmental expenditure. These reforms could contribute in strengthening GoP's ability to set clear environmental priorities, coordinate with environmental authorities on developing indicators to evaluate the impact o f spending on achieving these priorities, and ensure that all sectors follow legal norms related to the environment. The fiscal space created through making the budget and expenditure process more efficient could also serve to strengthen under-fundedenvironmental spending. 146. I n the medium and long term, f u r t h e r trade liberalization a n d economic activity in Peru-by means o f desirable growth a n d poverty reduction-would lead t o greater infrastructure development. While SNIP does evaluate environmental considerations for each infrastructure project approved, this is done in an ex-ante manner. The challenge regarding potential environmental impacts i s during execution. The Bank's Country Environmental Assessment highlighted shortcomings in Peru's institutional framework for environmental protection and sustainability. I t also pointed to the need to continue protection efforts in natural areas such as tropical forests while mitigating the serious health impacts and high costs o f environmental degradation, particularly in terms o f air and water contamination. As a result o f this study and the ensuing dialogue with GoP, the Bank prepared a planned three-phase D P L operation on environmental policy, the first phase o f which (for US$330 million) was approved by the Board in February 2009. 147. The B a n k and GoP are currently negotiating t h e second environmental DPL a n d expect t o complete it by the end o f 2009, and a third i s planned f o r the next year. T h e environmental D P L s focus o n reordering the institutional a n d legal framework f o r environmental management through the new Ministry o f Environment." The creation o f loA new Ministry for Environment was created on May 20,2008. 51 an adequate national-level authority to enforce environmental issues (Environmental Evaluation and Enforcement Office-OEFA) is a major step, given that the system in place i s fragmented and adversely affects the country's ability to tackle numerous environmental challenges. An important trigger under the second environmental D P L i s the approval o f the regulation o f the Law on the National System o f Environmental Impact Assessment, which allows the Ministry o f the Environment to review environmental impact assessments for large infrastructurehnvestment projects with potentially significant impacts. An IDF grant was awarded to promote capacity building within the key environmental authority. The areas covered under the environmental D P L include implementing an updated mining environmental legacies (MELs) inventory and a national strategy for remediation o f priority MELs, reducing air pollution through reduction o f sulfur content in diesel to 50 ppm and promoting and implementing vehicle conversions to natural gas. Fiscal reforms are currently being designed (and will likely be implemented in 2009) to promote the use o f newer cars, cleaner fuels, and vehicular conversion to natural gas. A conversion program is already underway, with nearly 70,000 vehicles converted to compressed natural gas use since 2008. In addition, the Bank has recommended that the authorities include environment and resource management in the desk evaluation pilots programmed for the next years. F. R i s k s and Risk Mitigation Macroeconomic Rkks 148. Peru i s exposed to the negative effects o f the global economic downturn, particularly through a slowing demand and declining prices o f its main export products. Peru i s exposed to the negative effects o f the global economic downturn, particularly through slowing demand for and declining prices o f i t s main export products. Exports have slowed sharply since the financial crisis broke, down by 32 percent in the second quarter o f 2009 compared to the second quarter o f 2008. This, combined with a weaker domestic demand, has negatively affected the growth rate o f the economy, which slowed to 1.8 percent in the first quarter o f 2009 and to -1.1 percent in the second quarter o f 2009 (sharply down from growth o f 10.4 percent in the first quarter o f 2009 and 6.6 percent in the fourth quarter o f 2008). However, Peru's solid macroeconomic and fiscal policies in recent years have l e f t it well placed to take measures to limit the impact o f the global crisis. Peru ran fiscal surpluses for three consecutive years (of 2.1 percent o f GDP in 2008), built up i t s fiscal stabilization fund (reaching US$l.8 billion in 2008), and reduced public debt (to 23 percent o f GDP in 2008, down from 38 percent in 2005). As a result, the GOP has been able to launch an emergency fiscal stimulus package totaling around 3 percent o f GDP and is securing lines o f credit from International Financial Institutions (IFIs) and tapping private credit markets, without threatening overall fiscal stability. L o w and declining inflation rates have allowed the Central Bank to loosen monetary policy, further easing the economic impact o f the global crisis. The country's strong fundamentals suggest that, in the absence o f unexpected policy shifts, it is unlikely that the macroeconomic situation would become incompatible with continued budgetary support lending during the course of this proposed operation or a possible following loan in the series. 149. There i s a risk that the counter-cyclical spending (mainly on public investment) may not be materialized at the rate planned and will not have the desired impact on growth, due to limitations in spending capacity o f government agencies. In fact, in 52 previous years the execution o f public investment was below 60 percent o f planned expenditures due to a variety o f factors ranging from lack o f shovel-ready projects, burdensome administrative and procurement processes, and limited implementation capacity at different levels o f government. If the economic situation worsens and the stimulus package i s not sufficient, there i s the risk that (i) additional measures could jeopardize fiscal stability in the medium term, and/or (ii) GoP will lose momentum in the reforms under this D P L the to attend a short run problem. The overall Bank program and this operation in particular are contributing to mitigate the above-mentioned risks. The implementation o f performance- based budgeting and the technical assistance work on procurement to improve public investment capacity are examples o f these mitigating factors. 150. Commitment to structural reforms and consensus over the macroeconomic pillars has been and remains strong. The country's solid fundamentals suggest that, in the absence o f unexpected policy shifts, i t i s unlikely that the macroeconomic situation would become incompatible with continued budgetary support lending during the course o f this proposed operation or a possible following loan in the series. Political and Social Risks 151. T h e policy reforms supported by this loan enjoy broad support across the main political groups and the population at large, social tension remains a risk. Improved fiscal management has the potential to threaten some vested interests, but the consensus on the need to improve the efficiency and effectiveness o f public spending i s strongly supported by the President, the Prime Minister, the Finance Minister, and all the main parties in the National Congress, meaning the reform agenda in this area faces no significant opposition. Some measures to simplify the tax code by eliminating regional exemptions, particularly in the Amazon region, have proved politically difficult, but the administration has moved this agenda forward in a consensual way. As well, reforms to ease the ability o f companies- especially small and medium companies-to access credit, receive licenses, and access export opportunities are widely supported by all relevant stakeholders. Local governments that may have resisted simplifying procedures have been brought along with technical assistance support to undertake reforms. The free trade agenda is also generally supported by the political class and the population at large, but some issues have caused social conflict. In particular, recent conflicts in a region o f the Amazon basin have centered o n amendments to the code governing the exploitation o f forest resources, which were done t o comply with the free trade agreement with the U.S. The administration i s moving to build a consensus on the issue with the main political groups and the human rights ombudsman, and has continued i t s dialogue with representatives o f the local population. 152. While the government has made efforts to set up consultation mechanisms with the society at large, the lack o f appropriate conflict resolution channels with disaffected social groups i s s t i l l a significant challenge. More decisive efforts for conflict resolution would be welcome (see Box 2). However continued improvements in social safety nets and other social programs, more equitable f l o w o f resources to the country's regions, and an increase in spending on investments as part o f the economic stimulus package should ameliorate social and political risks. 53 Box 2: Social Conflict in Peru A society like Peru's always had and (most likely) will continue to have some degree of social unrest and polarization. Social conflicts are partly explained by a historically high degree o f inequality, in spite o f government's efforts to reduce it. They are also partly driven by the country's development process itself, as sustained growth episodes may raise societal aspirations and demands for improved opportunities. Against this backdrop, Peruvian governments have to live with latent social conflicts, some o f which eventually emerge from time to time. But these conflicts tend to remain focalized; both in terms o f the issues and the geographical area. The vast majority are resolved peacefdly. However, sometimes social conflicts eventually drag on for some time, and risk becoming nationally politicized, making conflict resolution harder. The most recent example was the conflict that emerged in June 2009 in Bagua, in Peru's Amazon region, which caused 34 deaths and led to the resignation o f the president o f the council o f ministers and other members o f the cabinet. Indigenous communities in the area feared that a new forestry law and other legal changes would lead to over- exploitation o f natural resources by foreign companies, while they would lose traditional rights. A key contentious point was that i t was unclear whether these laws needed to be consulted with indigenous communities prior to their approval (as per ILO agreements on indigenous populations). Legal opinions on whether these laws required prior consultation were divided on this, but indigenous communities felt that they had been excluded from decision-making processes. The main lesson emerging from the Bagua conflict i s the need to listen and have a sustained dialogue with all stakeholders whose livelihoods could be affected by government decisions. The Government o f Peru has made efforts to set up consultation mechanisms with the broader society. In 200 1, the government set up the National Accord (Acuerdo Nucional), a national discussion forum designed to provide a space to build national consensus around policy priorities. It included broad representation 6om across Peruvian society, including government officials, politicians, academics, church officials, labor and business representatives and indigenous groups. More recently, discussions had been underway since early 2008 between indigenous groups, the Human Rights Ombudsman (Defensoriu del Pueblo), members o f Congress and representatives o f the executive branch. When talks broke down in the spring o f 2009, road blockades were erected, eventually leading to the events o f June. In the weeks after the violence, the laws in question were repealed and the blockades removed, agreements were signed between the government and local protestors and a formal diaiogue mechanism was instituted (Mesas de Concertacihn) to ensure sustained dialogue with indigenous communities. 54 Annex 1. Debt Sustainability Analysis" Debt Trends and Structure Due to the strong downward trend in Peru's public debt as a share o f GDP, as well as its sound composition and structure, public debt i s likely to be sustainable over the medium term. The expected positive (or at least non-negative) growth for 2009 reinforces this finding, while the fiscal stimulus plan may potentially have ambiguous implications for the primary surplus and thus debt sustainability. The GoP intends to finance the stimulus plan first by fiscal savings and second through multilateral borrowing. As a result, the plan i s expected to have no (or very little) impact on debt sustainability. As indicated in the present debt sustainability analysis, public debt i s on a credibly declining path, and GoP's deposits amounted to 7 percent o f GDP in the end o f 2008. Since the plan i s expected to account for approximately 2.5 percent o f GDP there i s fiscal space to manage different levels o f fiscal stimulus without the need to resort to financing i t through debt. The implications for debt sustainability i s expected to be minor-unless the crisis i s prolonged through 2010, in which case the GoP may have to resort to incurring debt. An additional feature o f the plan i s that employment and growth i s likely to be created-r at least sustained at current levels- which implies that government revenues will increase, or at least will drop less. As a result, the debt sustainability implications o f the plan will be minor, because the primary balance will not be directly reduced by the plan, while sustained employment is likely to slightly boost the primary balance. ; Figure A l . Quarterly public debt (nuevos soles) Figure A2. Annual public debt as a share of GDP 35000 30000 I - 40 0 ii: --------------_------ 25000 --- 20 25 0 ------ 20000 15000 15 0 100 50 --..--- ------- 9- . 9-0 0 - ___ - __ __ 2007Ql 200793 2008Ql 2008Q3 200941 Source: Peru Ministry o f Economy and Finance Source: IMF Aggregate public debt i s slightly increasing, but as a share o f GDP has sharply fallen in recent years. The GoP prepaid U S $ I .55 billion principal maturities o f i t s debt to Paris Club falling due between 2005 and 2009 in 2005, and US$2.535 billion o f i t s non-concessional debt maturing in 2007-15 in 2007. These operations were mostly financed by issuance o f domestic currency-denominated bonds. As a result o f these prepayments, the share o f external debt in Peruvian public debt has declined considerably. Aggregate public debt is projected to fall from approximately 30 percent in 2008 to 13.6 percent o f GDP by 2013 'I Debt Sustainability Analysis conducted by World Bank staff and reviewed by the IMF. 55 (Figure A2). Such an estimate should be interpreted with caution due to the uncertain financial and economic environment that Peru (and the rest o f the world) is facing. Since the debt-GDP ratio has been falling because GDP rose and not because debt levels had fallen (Figure Al), the debt-GDP ratio i s expected to be relatively unchanged over the near future due to the close-to-zero rate o f GDP growth projected for 2009 and slightly increasing levels o f debt. The external component o f public debt has fallen at a higher rate than the domestic component, so aggregate debt is increasingly domestic. However, two-thirds o f public debt remains to be externally financed (as o f 31 March 2009), which is unfortunate due t o i t s exposure to interest rate and currency volatility risks. As a result, external debt largely determines the path o f future debt sustainability. In fact, 62 percent o f external debt i s associated with a fixed interest rate, compared to essentially all internal debt. This is evidence o f very prudent debt management policy by the GoP. T h e composition and structure o f public debt in P e r u are important indicators for debt sustainability and these are, overall, considered to b e sound. In terms o f currency composition, about 71 percent o f total external debt as o f 3 1 March 2009 i s denominated in U dollars, which indicates a certain degree o f dollarization (Figure A3). This makes the S external debt very sensitive t o changes in this exchange rate. While the U S economy is often S the engine o f growth in the region, it i s likely that the U rebounds earlier than Peru, so while increased export demand from the U S will lead t o higher employment and growth in Peru, i t may also increase the value o f Peru's dollar-denominated external debt. In light o f the recent appreciation o f the nuevo sol vis-&vis the U S dollar, this risk becomes smaller. For example, a one-time 30 percent real depreciation o f the nuevu sol in 2009 would raise the public debt ratio to 21 percent in 2010, compared to 18.7 percent under the baseline scenario. Hence, exchange rate stability plays a crucial role in lowering the Peruvian public debt. As a result o f this allocation o f debt across currencies, 38 percent o f total external debt i s associated with a variable interest rate, while the remaining 62 percent is at a fixed rate (Figure A4). This high degree o f certainty about the impact o f interest rate changes leaves Peru in a very favorable position. In addition, 59 percent o f external public debt i s owed to either multinational organizations (40 percent) or the Paris Club (19 percent), both o f which are generally associated with less risk than private corporations. Figure A3. External Public Debt by Currency Figure A4. External Public Debt by Interest Rate .$US RYen Euro @Other m Fixed Interest Rate I Variable Interest Rate Source. Peru Ministry of Economy and Finance. 56 Debt Sustainability Analysis I n the context o f the currently favorable debt situation in Peru, but also given the impact o f the financial crisis and the GoP's fiscal stimulus plan, a detailed fiscal and debt sustainability simulation i s warranted. The implementation o f the analyses will be within two frameworks: first, a deterministic scenario for the key determinants o f the evolvement o f aggregate debt over time; and second, a stochastic scenario where the key determinants are subject to stochastic shocks-either as singular shocks or as one composite shock. The baseline public debt dynamics are based on the macroeconomic projections produced by the Bank country team. Peru's favorable medium-term macroeconomic framework would help preserve a stable path for its public debt in 2009-2014, albeit with a small upward trend in 2009-10 (Figure A5). The public debt/GDP ratio declined from 47 percent in 2003 to 24.8 percent in 2008, mainly due to a marked improvement in public finances reflected in an average public sector primary surplus o f 2.3 percentage points o f GDP over this period. Projections o f Peruvian public debt/GDP ratio under plausible assumptions about real growth rate, interest rates, and the exchange rate suggest that sustained primary surpluses averaging 1 percent o f GDP during the period 2009-13 would be sufficient to keep public debt ratio on a stable path in the medium term. Figure A5. Peru's Public Debt/GDP Ratio (2003-2014) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: World Bank staff projections. Public debt sustainability hinges on continued fiscal discipline. The baseline scenario assumes an average primary surplus o f 1 percent o f GDP, stable exchange and interest rates, and an average annual economic growth o f 4.7 percent over the period 2009-2013. A loosening o f fiscal discipline could itself trigger a shock to these key macroeconomic variables. An alternative scenario was constructed assuming two-standard deviations shocks to primary surplus-to-GDP ratio, real growth rate and real interest rates in 2009-2010. Under this scenario, public debt-to-GDP ratio would reverse its trend in 2009-201 1, increasing to 28.5 percent by 2010 and declining gradually thereafter. 57 The public debt dynamics o f Peru are also highly sensitive to the growth rate o f GDP. The recent reduction in public debt owes much to robust economic growth. The economy grew by an annual rate o f 7 percent on average in the period 2003-2008-posting one o f the highest economic growth rates in the world in this period. Sensitivity analyses o f the public debt suggest that a two-standard deviations shock to the real GDP growth rate in 2009 and 2010 would raise the public debt ratio to 27 percent by 2010, compared to 24.5 percent under the baseline scenario (Table Al-baseline scenario vs. scenario B2). Table A l : Debt Ratios under Sensitivity Tests (in percent o f GDP) 2008 2009 2010 2011 2012 2013 Baseline 24.4 25.1 24.5 23.2 21.8 20.1 A l . Key variables are at their historical averages in 2009-14 24.4 22.8 21.0 18.9 16.9 14.9 A2. N o policy change (constant primary balance) in 2009-14 24.4 25.1 24.5 23.1 21.8 20.1 B 1. Real interest rate i s at historical average plus two standard deviations in 2009 and 2010 24.4 25.6 25.5 24.1 22.7 21.0 B2. Real GDP growth i s at historical average minus two standard deviations in 2009 and 2010 24.4 26.1 27.0 25.7 24.3 22.4 B3. Primary balance i s at historical average minus two standard deviations in 2009 and 2010 24.4 25.1 24.5 23.1 21.8 20.1 B4. 'Combination o f 1-3 using one standard deviation shocks 24.4 26.8 28.5 27.1 25.6 23.8 B5. One time 30 percent real depreciation in 2009 24.4 29.8 36.0 34.7 33.4 31.6 B6. 10 percent o f GDP increase in other debt-creating flows in 2009 24.4 25.1 24.5 23.1 21.8 20.1 Summary 2008 2009 2010 2011 2012 2013 Baseline 24.4 25.1 24.5 23.2 21.8 20.1 Second most extreme stress test (B2) 24.4 26.8 28.5 27.1 25.6 23.8 Most extreme stress test (B5) 24.4 29.8 36.0 34.7 33.4 31.6 Source: World Bank staff projections. Stochastic simulations assign a low probability to a sharp increase in the debt ratio. Stochastic simulations produce confidence intervals for the public debt ratios corresponding to varying degrees o f uncertainty for four key macroeconomic variables: (a) domestic interest rates, (b) the growth rate, (c) the exchange rate, and (d) the foreign interest rate. Assuming an average fiscal surplus o f 1 percentage points o f GDP in the period 2009-2013, there is a 97.5 percent probability that the public debt-to-GDP ratio will remain between 16.5 and 24 percent by end-2013 and a 75 percent probability that the ratio will remain within 14 to 21 percent (Figure A6). 58 Figure A6. Public Debt to GDP Ratio (YO) Figure A7. Public Debt to GDP Ratio (%)-Anti- crisis Plan Scenario __ . . , m)8 zw9 2010 MI1 2012 MI3 I 2 m 2 m 2010 2011 MI2 I 2011 I Source: World Bank Staff projections. The GoP's anti-crisis plan could potentially place public debt on an upward path in 2009. The plan includes some unbudgeted fiscal measures totaling about 2.5 percent o f GDP, which might have an adverse impact on public debt dynamics. Nevertheless, the impact, if i t materializes, would be approximately 3 percentage points o f GDP (Figure A6) and limited to 2009. Nevertheless, these results do not factor in the possible secondary effects o f this policy on the real growth and interest rates, which should be taken into consideration in a long-run debt sustainability analysis. These simulations imply a worst case scenario with and without the fiscal stimulus plan (Table A 2 and the upper debt paths on Figures A 6 and A7). The worst case scenario including the fiscal stimulus plan clearly implies a larger debt to GDP ratio, but already in 2010 the debt path i s declining again. Note, however, that the figures represent gross public debt, while net public debt includes public deposits and public debt to the Central Bank. As a result, the financing o f the fiscal plan by public deposits will not alter the gross measure o f public debt but it will be captured by the measure o f net public debt. 2008 2009 2010 2011 2012 2013 2014 Fiscal plan i s fully financed by public deposits 24.4 25.5 25.6 24.9 23.8 22.4 24.4 Fiscal plan i s fully financed by additionalpublic borrowing 24.4 28.4 28.3 27.4 26.5 24.9 24.4 59 Table A3. Public Sector Debt Sustainability Framework, 1997-2013 Public Sector Debt Sustainability Framework, 1997-2013 (In percent of GDP, unless otherwise indicated) 2003 2004 2005 2006 2007 2008 12009 2010 2011 2012 2013 I . I Baseline Projections Public sector debt 47.1 44.3 37.7 33.1 29.6 24.4 27.6 21.0 25.6 24.2 22.4 Change in public sector debt 0.4 -2.8 -6.6 -4.7 -3.5 -5.2 3.2 -0.7 -1.4 -1.4 -1.8 Identified debt-creating flows -2.5 -6.9 -4.3 -9.2 -11.0 -6.156 3.2 -0.7 -1.4 -1.4 -1.8 Primary deficit -0.5 -1.0 -1.6 -4.0 -4.0 -2.9 2.8 -0.1 -0.5 -0.5 -0.8 -Seignorage -1.0 -2.4 -3.0 -2.5 -3.6 - l . C -0.4 -0.6 -0.7 -0.7 -0.8 +Automatic debt dynamics: -1.2 -3.7 0.2 -2.9 -3.5 -2.3 0.9 0.0 -0.1 -0.1 -0.3 Contribution from interest ratdgrowth differential -0.6 -1.5 -1.9 -1.6 -1.9 -2.1 0.4 0.0 -0.2 -0.3 -0.4 Contribution from real exchange rate depreciation -0.6 -2.2 2.1 -1.3 -1.6 -0.2 0.5 0.0 0.1 0.1 0.1 Other identified debt-creating flows 0.1 0.2 0.1 0.1 0.1 0.0 0.0 0.0 0.0 0.0 0.0 -Privatizationreceipts 0.1 0.2 0.1 0.1 0.1 0.01 0.0 0.0 0.0 0.0 0.0 Recognition o f implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes 3.0 4.1 -2.3 4.6 7.5 0.9 0.0 0.0 0.0 0.0 0.0 Key Macroeconomic and Fiscal Assumptions Real GDP growth (in percent) 4.0 5.1 6.4 7.6 9.0 9.1 2.5 4.0 5.0 5.5 6.5 Average nominal interest rate on public debt (in percent) 5.0 4.8 4.8 5.8 6.0 5.6 6.3 6.5 6.9 7.2 1.6 Change in the real exchange rate (Local currency per US dollar) -1.6 -6.0 6.3 -4.8 -7.3 -1.0 3.5 -0.1 0.5 0.9 0.8 Inflation rate (in percent) 2.5 3.5 1.5 1.1 3.9 6.4 3.1 2.9 2.9 2.8 2.4 Primary deficit -0.5 -1.0 -1.6 -4.0 -4.0 -2.9 2.8 -0.1 -0.5 -0.5 -0.8 60 Annex 2. Letter o f Development Policy (English Translation Follows) Lime, a I SET. 2009 CARTA DE FOUTICA SECPOfiIAf Estirnado seAor zoellrck, Medimte la presenie le rnanbkxfo el cumpromiso de4 Gohiem del Pmicbnte Alan GmJa PBrez de wnSlnuar Implemsntando una sede de pomicsS orientadas a/ W m l e n t o econ&nico SOstenidD con base en el eumento de lo hversidn p4birCa y p h d a , la mefors en /a infraestrucfura del pels y la pnxnoci6n de I6 Indusi6n de /os secfcres sucmles m8s winerabies. En este mam, se ha de.%m/lado le femm opsracibn dei qPrcastamo Pmgtam6tico de Gestidn Fiscal y Crecimlento fcon6mfa' con el 68na1 Mundiel (EM), solicnado p ~ el r morito de US$ j50 millones, que compmndar4 ecclones especlficas en: 4 m'ici6ncia y candad de le ge&n fiscal y gSsr0 p&!blko, y g desarrollo de pllticas Odmt8dt3S ai fortdm'mento de /B competffivkjad. Cab6 hdlcar que, este pr6starno continu& 18s reformas comprendidas en la segunda cy~ered6n suscljfd en novimbre de 2008. A continuechjn sa de3cW el contexto eoonbmiso de/ Ped y psferiOrmente 10s ob.$dhs y tes refonas laalhadss y 13s pmpuestas para elpM6mo solidh&. A. Confexto econt5mim 61 - Jr. Junln 318 Uma I Tal6kno: 3116890 2 62 Luis CARRANZAUGARTE lRlMS7RO economia peruana de! impact0 negativo del enforno inkvnacional, y mey'omr4 la expectstiva de/ sectorpnifado respecto a las invemiones El PEE adende a #ma de US$4,500 mRlones b 3,4% &t PBI y b u m aiendw priodtahmente a aqudlos sectores que SOR Ios m5s afeectedas par la Msis, es d&, este enfocado a moderar /os impactcxs: de wrfo @azo. No obstanfe, no p i e d la visidn y de t'n6di~flO kirgo plazo. Por efio, dos temios de /os recursos del PEE esUn &ntedcs a un progmrna de aumenfo de la inversi6n piblica que cQsrninuir$ la breche de inf&estntctora con el efecto de aumentar la productivdad y plmmover el Crecimiento de lam0 plazo. En &e mntexi'q se ha m a d o un Cornit# interinStruciona! confwmado por representantes del Minkteria de Econmla y Finenzss (ME@, BWRW CsntrsJ de Resenfa de/ Peril (BCRP), SUpet7hbndenCia de Barn y Seguros (SBS), Banco de la Nedt3n y la cOrp0mci6n Financiem de D%&o (COFIDE) para ei monitoreo de los temas finmiems que pudieran efectar I8 implementad& d61 PEE Asimlsmo, se publicd el Reglamento del Dewto Legisletiva No 7012 que apmeba la Ley Marcr, de Asociadmes P & b h d a s {APP) para la generaci6n del emP(e0 produdivo y dicle mm8s para la agnizecWn de los pmeasos de pmmcddn de le inversicin privada. Entre dhhas nomas se d i d e m disposiciones sobre la cUantificeci6n y mgktm de /os pesivos Iirmes y contit?gentes,esumidos por /as entidedes del sector p&hko no finam'em en /os cpntratos suscritos, as! como de 10s fiuy3.s de ingmsos dedvados de la explotaaci6n del respsctivo pmpdo, con la flna1;dad de contribuir a un manojo prudente, adenado y transparsnte de las finamas pOblicas, en cumplimimto de -lakey de Responsabflldedy TranspamnciaFiscal. Otra iniCatEJa del Gobierno por forfalecer b e f m e del gasto prSbliC0 na sd'o a naciond sin0 fambi4n sub-nechnal fue la emisi6n de la Ley NO28332 que c ~ 8 8 Plan el de /ircentivos e 18 m e j m de la Gesti&nMunicipal, la m&ma que busca incdhr a los gobiernos locales a meforar b nivefes de rewuWi6n de 10s fribufos rnunicipaies y la s ejewdh del gasto en inversibn. Sistema T r b h t i omds estabie y neutro LR apmba&n del Reglamento de la Ley de Fmmod6n de la Comptkivld& Fmdkacldn y Desamlio de la Mhm y PequaAa Gnpresa ( W P @ y del Aoceso ai ' Empie0 Decente, dsmuestm que $8 contfnnlle wanrando con las mdhjas de SirnpMcadk3n Mbdaria con Bnfess en las MYPE incentivando scl creclmmnto en el nemdo Interno y exfemo. En esfe mnfexTo, se han dictado medfdas p m faMar la declaracidn y p e p de ltnpimstos implementendo la dedaraokin Simplificaapara M P E s mediente R W u & de Supen'ntendendaND 120-200USUNAT. La declsraci6n sirnp,Wcads busca faciitar ei curnplimienio fributado SirnpMmdo la pmsentacriin de les declmtdoms y pago de impuesfos y elhina los ~imuimas fisicos p m i m p w . - Jr. Junln 319 Ulna I Tdbfono: 311-5@30 3 63 'MCENIO DE UIS PERSONAS CON DISCAPACIDAD EN EL ERW 'Atlo DE UUNlbNNACIONAL F R a m A LA CFSU MTERNA" - Jr. Junln 318 Uma 1 TertBfOno: 3116830 4 64 "DECENIO DE LAS P W O W CON DISCAPACIDAJ EN EL PERfi" " M O DE L UNlbW NACIONAJ. RENTEA IA CRISIS MTERKA' A en la pmvid6n de ios servkios e infraesstructora bbsica, con mayor impacto posjbfe en IG redurnin de la pchreza y ia pbbreza extrema en el pals. Asirnismo, les evaluaciones perrnifieron incarporar una serie de rnejora8 en la Tercera Convmfoda publhda el 01 delunio, entre e h s le h w n del mane,b jn@d de c dcomo una nueva tlpoagla en la prionbbd de Samamienfo, el D e s a d h residcos s% s de Capaddades para le GestiBn lntegm/ de Cuenoas como una nueva priwidad, y el incremedo del cofinmciamiento m&/m permitido del FONPREL en los grupos de moy alta newskiad y &e m s i d e d que cuenian con menos mcursos y ncursas medlos, pem&endo de esta h a que los GG.RR. y GG.K bajo esta condiQijn eporfsn one menor contrepertida. Efk iWtCf8 e Impat& del Pllbiim Preswuesto wor Resithados (PPR) Se han logrado avanms importantes en IB utfliracidn del PPR m o henamienta de gesti6n pOhke para mejam le eficiencia e impact0 del gasto, genetando indicedores de desempetio y evaluacbnes de pmgi-ames estrat6gims. De e& manera SB han wmpleiado cuatro evaluacbnes de p m g m a s 13 - Conse~~ecibnMarifenhiento de C8mbms; (74 Juntos pmgratnk de fransferencias o condiclwradas; (@ P m g m a Integral de' N W 6 n ; y @] Pmgrama Naciond Pennaoente para Educacibn y i3tmnmienio. TmbiBn, se han incoporedo ios progmmas instituciondes vinculados a resuffados presupuestales de pducio, aderntss de 10s pr~gremas estrat&icos inter-sectotiaies con 10s que se empezo la irnplementecian de PPR. Tanspanencia,accesikriiidad,y agilfdad de ias procesos del ssctorpiblico Con el obbtlvo de contintlar con el desanolk, y la implementaci6n de le infraestnrcture de Gubbierno Electnlnboen el m a m de la Agenda Dlg8al Peruana, la Oflcine Naclonal de Gobierno EIei&t5nlniCo e lnformatica (ONGEI) ha propuesto lmetunientos pera el dim70 ScCesibEe de pdghas webs p m (as entidades del Sisfeme Nacional de lnfonn8tica, el mismo que Comieme can la identikaci6n y evaluaddn de 10s mrnponentes funcbnales requetidos, e d o m n de estandares abiertos y aceptados Iniemaclonalrnente, la phnificed6n y us0 de las tecnokigtas de la hfonnacion y w m u n W n e s en la A#rnii?isfmd#nPr'hha. - Jr, Junln 319 U n 1 ra TelBfono:3 f5830 7 5 65 `AN0 DE LA UHldN NAUONAL R N E A L4 CRISIS MTERNA* ET - Jr. Junln 319 Uma 1 T e l B h : 311-5930 6 66 Letter o f Development Policy English Translation "DECENIO DE LAS PERSONAS CON DISCAPACIDAD EN EL PER&' "AAO DE LA U N I ~ N NACIONAL FRENTEA LA CRISIS EXTERNA" LUIS CARRANZA UGARTE MINISTRO COMMUNICATION No -2009-EFB0 Lima, COMMUNICATION No -2009-EF/lO SECTOR POLICY LETTER Mr. ROBERT B. ZOELLICK President World Bank Reference: Programmatic Loan for Fiscal Management and Competitiveness III Dear Mr. Zoellick, This letter is to express the Government o President Alan Garcia Perez's f f commitment to continuing efforts to implement a series o policies to ensure sustained economic growth based on an increase in public and private investment, improvements in the country 's infrastructure and promoting the inclusion o the most f vulnerable social sectors. f The third operation o the "Fiscal Management and Competitiveness Loan" with the World Bank (WB), for a total amount o US$150 million, w i l l take place i n this f JFamework and w i l l focus on: i) the eficiency and quality offiscal management and public debt and ii) developing policies to strengthen competitiveness. It is important to emphasize that this loan w i l l be used to continue reforms that were begun during the second operation, which was signed i n November o f 2008. 67 "DECENIO DE LAS PERSONASCON DISCAPACIDADEN EL PER&' "ARO DE LA UNldN NACIONAL FRENTE A LA CRISIS EXTERNA" LUIS CARRANZA UGARTE MINISTRO COMMUNICATION No -2009-EF/I 0 Next, we will describe Peru's economic context and the objectives and reforms that have been achieved as well as the proposals associated with the loan requested. A. Economic context The Peruvian economy faces a complicated international context. This year, the world economy will experience the most significant decline since World War Two. The American economic crisis, which began with the mortgage market, translated to f the financial markets and later to the real sector o the economy, leading the American Government to intervene with two bailout packages for US$ 1.5 trillion. The Jirst concentrated primarily on reducing taxes and providing resources to Jinancial institutions through preferred share issuances while the second focused mainly on expense measures (approximately two-thirds o the US$ 787 billion was f for this purpose), purchasing toxic assets and, unlike the first package, on providing resources to banks by means o debt structure. The Euro zone and Asian countries f have also been afected; in the first case, problems are primarily concentrated in the financial sector while the second case, diflculties are visible primarily in the export sector. After 8 years, Japan recorded negative growth in 2008. I n our country, despite the adverse environment during 2008, economic growth has reached a solid 9.8% due primarily to the dynamism o private consumption (8.7%) f and private investment (25.6%), which led to a 12.3% increase in internal demand. The expansion in private consumption is attributable to an increase in buying power due to higher levels o employment creation and more access to consumer credit. I n f terms ofprivate investment, investment projects in hydrocarbons, manufacturing and construction (housing and shopping centers) stand out. Public investment also recorded a signiJcant increase (42.8%), attributable primarily to an increase in spending at the Regional Government level. I n the first fav months o 2009, economic deceleration has been greater than f f originally predicted due to the severity o the international crisis and a strong decline in inventories. I n the first quarter, internal demand fell 0.8% in comparison to the Jirst period last year after having grown 9.1% in the fourth quarter o 2008. I t is f f important to stress that ifwe isolate the efect o a decline in inventories, domestic demandgrew 4.1% in thefirst quarter. I n April, the Gross Domestic Product (GDP) 68 "DECENIO DE LAS PERSONAS CON DISCAPACIDAD EN EL PERU" "ARO DE LA UNldN NACIONAL FRENTE A LA CRISIS EXTERNA" LUIS CARRANZA UGARTE MINISTRO COMMUNICATION No -2009-EF/lO fell 2.01 % in comparison with figures for the same month last year, constituting the first signij2avlt drop since June 2001. Between January and April, the economy accumulated 0.93% growth. I n May, GDP grew 0.46% accumulating 0.83 % growth thusfar this year. Currently, authorities at the Ministry o Economy are intent on implementing f counter-cyclical policies in order to mitigate the international financial crisis 's impact on the local economy and safeguard gains made in reducing poverv, which fellji-om 48.7% in 2005 to 36.2% in 2008. The Central Reserve Bank has reduced its reference rate to historical lows and is focusing on providing enough liquidiv to meet market needs to ensure continuity in the chain ofpayments The Ministry o f Economy and Finance has begun executing the Fiscal Stimulus plan (PEE) for 2009 and 2010. I t is important to mention that an expansive counter-cyclical policy would not have been possible, particularly in light o reduced tax collections, ffiscal and f savings surpluses had not accumulated over the past three years. As such, the macroeconomic prudence exercised in previous years will finance the Fiscal Stimulus Plan without putting the stability ofpublic finance at risk. I n the second half o the year, we expect that the countercyclical policies f implemented thus far will drive economic growth. As such, economic growth in 2009 w i l l be around 3.0% and will experience an upturn in 201 0, hitting 5.0%. B. Reforms associated with the Program I.Strengthening Fiscal Policy Management Fiscal Policy Sustainability and Transparency The Peruvian Government put forth an Economic Stimulus Plan (PEE) to ofset the efect o the international Jinancial crisis on economic growth, employment and f social inclusion. n e economic policy package implemented by the government seeks to allocate resources to protect the social and productive sectors that are most vulnerable to the crisis, focuses on protecting the Peruvian economy ji-om the negative impact o the international crisis, and strives to improve the private sector's f I expectations regarding investment. 69 "DECENIO DE LAS PERSONAS CON DISCAPACIDAD EN EL PERU" "Am0 DE LA UNldN NACIONAL FRENTE A LA CRISIS EXTERNA" LUIS CARRANZA UGARTE MINISTRO COMMUNICA TION No -2009-EF/I 0 The PEE w i l l amount to US$4.500 million, or 3.4% o GDP, and w i l l be primarily f f channeled to meet the needs o those sectors that have been most afected by the crisis. As such, the Plan is focused on mitigating short-term impacts. This does not mean, however, that it lacks a mid and long-term vision. For this purpose, the PEE consists o a program to increase public investment to reduce the infrastructure gap f in order to increase productivity and promote long-term growth. I n this context, , an inter-institutional Committee has been set up with representatives JFom the Ministry o Economy and Finances (hrlEF), the Central Reserve Bank o f f Peru (BCRP), the Superintendence o Banking and Insurance (SBS), the Bank o the f f Nation and the International Financial Development Corporation (COFIDE) to monitor financial matters that may afect PEE implementation. Additionally, Legislative Decree No1012 was published. This decree approves the Framework Law for Public-Private Partnerships (APP) to generate productive employment and provide norms that make processes to promote private investment more agile. These norms include dispositions regarding the quantijkation and registry o f i r m and contingent liabilities assumed under contract by the non- f financial public sector as well as income flows derived JFom the exploitation o the f project itselJ: The purpose is to enhance the prudent, ordered and transparent management o public Jinances in compliance with the Fiscal Responsibility and f Transparency Law. f Another Government initiative to strengthen the eficiency o public spending at a national and sub-national level was the issuance o Law N"29332, which creates the f Incentive Plan to Improve Municipal Investment. This plan also seeks to encourage local governments to improve municipal tax collection and spending in investment. More stable and neutral tax system Thefact that the Rules for the Law to Promote Competitiveness, Formalization and Development o Micro and Small Businesses ( M P E ) and Access to Decent f Employment was passed shows that progress is being made in terms o developing f tax simpli3cation measures that focus on MPEs, encouraging their growth in both internal and external markets. 70 "DECENIODE LAS PERSONAS CON DISCAPACIDAD EN EL PERP " A n 0 DE LA UNldN NACIONAL FRENTE A LA CRISIS EXTERNA" LUIS CARRANZA UGARTE MINISTRO COMMUNICATION No -2009-EF/lO I n this context, we have developed measures to facilitate tax declaration and payment by implementing a simplified tax declaration format for M P E s (medium and small sized businesses) through Superintendence Resolution N" 120-2009/SuNAT The simplified tax declaration form is meant to increase compliance with tax obligations by simplibing the process to declare and pay taxes. This process no longer requires contributors to f i l e physical tax forms. Planning and Budget and Financial Transparency I n terms o the implementation process for the Sole Public Treasury Account (CUT), f we have begun the process to rationalize Public Sector Entities' bank accounts and design a procedure to operatize loan payments and other bank operations based on the CUT'S working system. These actions are geared towards incorporating F0NCOMC;IV (Municipal Compensation Fund), which is categorized under the concept o "Targeted Resources, " into the CUT This will allow us to consolidate f the centralization process that began with other F O N C O W items in the C m . Another objective is to determine the conditions necessary to progressively incorpopate other Sources o Financing and Items. f The government, with an eye on strengthening fiscal management, has incorporated new budget classiJcations in the Integrated Financial Administration System (SIAF). The Budget Law for 2009 specifies how these classiJcations must be applied. The new categories have been modernized according to international standards to ensure that the information base developed is wide enough and suficiently up-dated to allow both internal and external users to generate meaning@ reports. Specifically, the new budget classi3er-sfor income and other expenses w i l l be aligned f with the Public Finance Statistics Manual 2001 o the International Monetary Fund (MEFP 2001) to guarantee that they be widely used in public finance management, lending as such greater transparency to public resource management. Along the same lines, we have incorporated a new government accounting plan that is in line with international accounting norms and new budget classifiers. This w i l l ensure that the new table o SIAF-SP operations is capable o improving its f f automaticity and expand its ability to disaggregate information. According to the Manual o Statistics o Public Finance 2001, this w i l l allow information to be f f 71 "DECENIO DE LAS PERSONAS CON DISCAPACIDAD EN EL PER&' "Am0 DE LA UNldN NACIONAL FRENTE A LA CRISIS EXTERNA" LUIS CARRANZA UGARTE MINISTRO COMMUNICATION No -2009-EF/I 0 analyzed according to economic flows and equity variation. This w i l l subsequently improve economic analysis by tying it to fiscal and national account formulation and respond to I W ' s information requirements under the MEFP 2001 JFamework Equity in inter-government transfers Fund to Promote Regional and Local Public Investment (FONIPREL) Evaluations o f tenders for 2008 show that the funds are concentrated in District Governments with many needs andfew resources and that the areas that beneJit mostfiom the Fund are those related to agricultural infiastructure, basic education, road infiastructure and sanitation. As such, it has been possible to veri& that the fund's objectives to increase equity in inter-governmental transfers and reduce the gaps in service provision and basic infrastructure have been achieved with the greatest possible impact on reducing poverty and extreme poverty in the country. Additionally, the evaluations facilitated the process to incorporate a series o f improvements in the Third Tender published on June 01, which included integral management o solid wastes as a new typology that emphasizes Sanitation and f Capacity Development in the Integral Management o Basins apriority. We are also f focusing on increasing the maximum co-financing permitted under FONIPREL for very high or high necessity group in low or medium income brackets. This w i l l ensure that the GG.RR. and the GG.LL contribute less under the counterparty agreement. Efficiency and Impact in Public Spending Results-based budget (P) SigniJicant progress has been made in the utilization of PPR as a public management tool to improve spending eficiency and impact. Performance indicators and strategic program evaluations have been generated for this purpose. Up to this point, we have completed four program evaluations i) Highway Conservation or Maintenance; (ii) Juntos - Conditional Transfer Programs; (iii) Integral Nutrition Program; and (iv) Permanent National Program for Education and Training. Institutional programs have also been included in 72 "DECENIO DE LA5 PERSONAS CON DISCAPACIDAD EN EL PER&' "ARO DE LA UNldN NACIONAL FRENTE A LA CRISIS EXTERNA" LUIS CARRANZA UGARTE MINISTRO COMMUNICATIONNo -2009-EF/I 0 product based budgeting along with the inter-sector strategic programs that were the initial focus o RBB implementation. f f Transparency, accessibility and agility o public sector processes I n order to continue eflorts to develop and implement the inpastructure for Electronic Government in the Peruvian Digital Agenda pamework, the National Ofice o Electronic Government and Informatics (ONGEI) has proposed guidelines f f for the accessible design o web pages for entities in the National System o f Informatics. These guidelines initially concentrate on identihing and evaluating necessary functional components, adopting standards that are open and internationally accepted, planning and use o information technology and f communications in Public A dministration. f The creation o the Supervisory Entity for State Contracts (OSCE) and the publication o the Rules o Organization and Functions are geared at improving the f f public contracting system to optimize and integrate technical procurement processes at the State level that contemplate economic sanctions for Entities that fail to comply with public contracting norms. The L w on State Contracts, approved through Legislative Decree No 1017, a stipulates the dispositions and guidelines that Public Sector Entities must follow in processes to enter into contracts for goods, services or works and regulates the obligations and rights associated with the same. n e objective is to maximize the use f o taxpayers' contributions relative to Public Sector contracts, ensuring that the latter are executed in a timely manner that reflects the best possible conditions for price and quality. I n this context, the Strategic Plan for Public Contracts with the Peruvian State was approved to ensure that the public budget is transformed in the shortest possible time and at the lowest possible cost into goods and services for the community. This process should be agile, reliable, and fair and its results should be available to all citizens. 73 "DECENIO DE LAS PERSONASCON DISCAPACIDAD EN EL PERU" "Am0 DE LA UNldN NACIONAL FRENTE A LA CRISIS EXTERNA" LUIS CARRAN24 UGARTE MINISTRO COMMUNICATION No -2009-EF/10 2. Strengthening productivity and competitiveness in the country Expand and Deepen Foreign Trade I n application o the powers granted by Executive Branch through Law No 29157, f established to legislate the implementation o the Agreement to Promote Trade f between Peru and the United States o America, a total o 99 Legislative Decrees f f were published in the Government Daily "El Peruano. " These norms authorize actions meant to strengthen Public Administration by generating public and private policies to stimulate the c o u n t y 's competitiveness, promote investment and employment, enhance institutionality and administrative simplijkation and improve other important aspects. Additionally, the Free Trade Agreement with China is evidence o signiJicant f progress in the Peruvian Government's policy to expand Foreign Trade. China is currently one o the three largest importers worldwide. As the world's largest f market, China w i l l generate an increase i n national imports for raw materials, intermediate goods and capital goods. The FTA with China represents an opportunity to establish clear playing rules with a transparent and predictable JFamework that facilitates ordered bilateral trade. This will justifiably safeguard Peru 's national interests. Negotiations are underway to enter into Free Trade Agreements with Thailand, Korea and the countries comprising the European Free Trade Association (EFTA) and sign a Trade Agreement with Mexico and an Economic Partnership Agreement with Japan. The Government continues its eforts to implement measures that support the f competitiveness o Micro and Small Businesses to promote their access and integration to external markets through the Fund for Research and Development of Competitiveness (FIDECOW. These measures allow M P E S to access credit to invest in innovation and technology and the Easy Export Program is the export mechanism through which the M P E can access international markets. 74 "DECENIODE LAS PERSONAS CON DISCAPACIDAD EN EL P E R U "ARO DE LA U N I ~ N NACIONAL FRENTEA LA CRISIS EXTERNA" LUIS CARRANZ4 UGARTE MINISTRO COMMUNICATION No -2009-EFAO Finally, through the implementation o the One Stop W c e for Foreign Trade, f (VUCE), we are making progress in eforts to reduce operating costs for businesses, increasing Peru js competitiveness on the world scene and improving the quality, transparency and speed ofprocesses relative toforeign trade procedures. Deepening the Financial Sector I n this area, the priority continues to be strengthening the rules for credit risk management to promote sustainable credit growth and reduce risk o over- f indebtedness. As such, we are making changes to the Banking Law, requiring more risk control according to the norms established in Basilea II.A general pro-cyclical provisions regime has been set up that includes rules for activation or deactivation. The Rules to Manage Risk o Over-Indebtedness have also been approved topreserve f the quality o the credit approval process and ensure that the Jinancial system f remains solid. Under this scheme, companies must adopt a system to manage risk o over- f indebtedness that reduces risk prior to and after credit issuance by engaging in a f permanent monitoring o the portfolio to identi& over-indebted credit applicants. This includes a periodic evaluation o the control mechanisms utilized as well as the f corrective actions or improvements required. Conclusion As is evident in the preceding paragraphs, the Peruvian Government continues to make signijkant eforts to consolidate economic growth and improved eJtficiency and equity in the allocation o public resources in a fiscal administration ji-amework f based on responsibility and transparency. The Government is committed to pushing forward in these ambits and as such requires the continuing support o the World Bank in the areas outlined above. f 75 "DECENIO DE LAS PERSONAS CON DISCAPACIDAD EN EL PERU" " A n 0 DE LA UNION NACIONAL FRENTE A LA CRISIS EXTERNA" LUIS CARRANU UGARTE MINISTRO COMMUNICATION No -2009-EF/lO As such, the Peruvian Government would like to request approval for the "Programmatic Loan for Fiscal Management and Competitiveness 11" for US$150 1 million. Sincerely, 76 3 4 tt tt P Y E p: ul w s s - a ; - a E b C - E a a E 5 ;r 7 E - W a E C : e a E C a E C E 4 f n h h E 3 9 2 i E E C a t e s 4 z w E w E E - 0 00 a n r3 cr 0 E 2 0 3 00 3 0 4 C 0 0 e e 0 4 C 0 0 e 0 e - PI 6 C C a - L f k c a i t a C 0 0 L 0 0 c L E V 4 k i C c 4 L f E a a e E - . . 4 C I- 0 Y Y 0 . . 9 m (u .... I. .... .... 0 0 0 . . . . . I_ E i E 0 'ct 9 m 0 Y i c, Annex 5. Peru-IMF Relations IMF Assessment Letter August 27,2009 I'EKL'--AssEssI\.I~:s~' J.,~:I-~I;I< 'io -I1 1 1 Woiu,i) 1 3 ~ s ~ (Board discussion o f rhe l'hircl l'rogramm:itic Fiscal Management and Con!petitiveness r>c\;i.Iopiricnt Policy l h a n ) August 19% 2009 1. Pcrii 'r stmrrg ecorioirric pei:forrririiicc i i r i i i wirirriitriieiii 10 ri soiiirdpolic.;~~ frriiiteri~orlt Itcis hemi rec:ogriireil by the Eseciirive R o i i r d of tire IjtlF. In .juiiiiaiy. the Iisecutiue 13oartl concliiclcd the 2000 Ai-ticle 1V coiisuliation and tlic t i n a l rcvic\v of' I'eru's 25-month StaiiLl-By Arrangement. in an aiiiount eyuivalciit to SDI< 172.4 m i l l i o n (about USS257.2 niillion)(scc the Public Iiiformatiori Notice at ~ : ~ : \ \ ' ~ v \ ~ . i m f . o r ~ ! / c s t c r i i a I ~ i i ~ ~ s e ~ ~ n : ' 2 0 0 ' ) ; l , l l C J 9 12.litin). T h e authorities trcatcd the arrangement a s prccautioiiary. The next A r t i c l e I\'coiisult:irion is expcctcd to take pilice 011 the standard 12-lnontll 2. g I r i tli e rii iilst c th LJ g lohril f ir r iir iciri I crisis (iii il ecori o iir ic s l o ~ i ~ dw i , Perii 's ,qiw ivth , n rlrcelerntcd s l r u r p ~ ~ recerrt irroiiths. Fol lo\ving a 1 0-year long cspaiision period which /iris iir peaked ut 9 . 8 pcrcent in 2008. ecoiioiiiic g r o l~ st:idccl to dccclcratc i n the l i i i t qtiiii-rcr o f h 2008. Growth was nearly tlat iii rhc first balf'ot'2009, ;it aboui 0.3 percent year-on-ycilr. Inflation fcll to 2.7 percent i t 1 July ( w i t l i i i i the 1-3 percent target range o f t h c Cenrlal Hnrik) from a peak ofh.7 percent in 1)ecemher 2008. 3. The strong buffers built t i receiit yeurs Irnw allottwl Peru r o Iririircli a si gi i ~ i cui i t corintercyclicul po1ic.y respori,se, which is evpected to siipporr C C O I I I I ~ I ic iictiviiy. 'I'hc I authorities announced an economic stiniulus plun Inst December. w i t h a discretionary fiscal stimulus o f about 3 pcrcent o f CiDP over 2009- I O . 'I'he fiscal b;il:incc is projcctcd to register a deficit i n 1009. consistent \vitli thc :uiicnded k'iscal Ibsponsibility aiicl Transparency Law. i This delicit, retlecting both discretionary iiicosures a d the full o p e ~ i i i o io f the ailtomatic stabilizers, would be financed w i t h liscal savings nccuiiitilatctl iii recent years. 4. The ceritrul baiik lras acted piwcictive!p io cusc iiioiictiiry c o t z d i t i ~ i itlirorrgli crtrs iir .~ the re$?reiice polic-v ruie rirrrl a rcdricrioir iir reserve reqiiireiiieiits. Thc p o l i c y interest I'iirc has been redirced by 525 bps since the bcgiiining o f this year. to 1 % percent. Fin;incial sector indicators remain sound, w i t h existing buffers expected to be able to absorb the cyclical increase in nonprrforrning Ioaiis anticipated over thc coining inonths. Pcru's externul position remains coniiiirtablc. utirh forcign r c s c r w s at C!S$32 billion, equivalent to I 10 percent o f the s i i i ~ i f s l i m - t e r m extcrual debt, h r e i g n currency deposits with t l i c banking systeiii, and rhc o external current iiccount deficit. 5. Tire ~1)iiihinUlilJiif iiii)iietury stiiiiriliis crriiljiscul irripriist! is expected lo s1ipi)or.r o ecor~oniicuc1ivit.v i n the second hulf i f this yerir arid iiiro 2010. G r o w t h for 3009 i s projcctcd at around 2 pcrcent, w i t h downside risks arising froin private iii\,estiiiciit dynainics and the timing o f execution o f public investment projects. Gro\vth is cxpcctcd to pick u p nest year to\vard potential rate, i n the context of the cnvisagcd irnprovement in global condirioiis. 6. Siist~iiiieiladvnirceiirerit wirli I'erir 's srriictiiriil refiiriii uggciidu reiriuiri.s Iity to iiiuititniiring progress ivitli respect I O ~ I Y J I V I u rI i d i)overty rediictioir . Strengthening thc tax ~ base m d enhancing the current fiscal framework, including possibly with ii structural balance measure, would allow entrenching the prudent lisctil policies o f rcccnt years. To s1rengtlien poverty reduction, the authorities' ongoing efforts to assess existing programs, improve targeting, and link public cxpenditurcs ro efficiency are welcomed steps to dccpeii progress made in recent years. 85 Annex 6. Peru At A Glance16 Peru a t a glance 9/24/06 Latin Lowr K e y D e v e l o p m e n t Indicators Amenca middle Peru a Canb income Age distribution, 2007 '(2007) Population. mid-year (millions) 27 9 563 3,437 7579 Surface area (thousand sq. km) 1285 20.421 35.50 5064 Population gmwth (%) 11 12 10 Urban population (%of total population) 71 78 42 4-9 GNI (Atlas method, US$ billions) 96.2 3,m 6.485 3-4 GNIpercapita(At1as method, US$) 3,450 5.540 1887 1519 GNI per capita (P P P , international$) 7.240 9,320 4,544 GDP growth (%) 90 57 97 15 10 5 0 5 10 15 GDP percapitagrowth(%) 78 45 88 F - C ~ (most r e c e n t a s t i m a t e , 2000-2007) Poverty headcount ratio at $125 a day (P P P , %) 8 Poverty headcount ratio at 92.00 a day (PPP. %) U n d e r 4 mortality rate (per 1,000) B Lifeekpectancyat birth (years) 71 73 69 infant mortality (per 1000 live births) Child malnutrition(%of children under5) 21 5 22 5 41 25 '0° 1 Adult literacy,male (%of ages 6 and older) 94 91 93 Adultliteracy,female(%ofages Sandolder) 82 89 85 Gross primaryenrollment.male (%of age group) 1 % 120 1 12 Gross primaryenmIlment,female (%of age group) ll7 m 09 Access to animprovedwatersource(%of population) 84 91 88 Access to improved sanitation facilities (%of population) 72 78 54 Net Aid F l o w 1980 1990 2000 2007 * (US$ millions) Net ODA and official aid 201 397 398 468 Growth of GDP and GDP per capita ( O h ) Top3donom (in2006): UnitedStates Spain 53 79 6 92 a 87 69 15 . Eumpean Commission 1 22 24 54 Aid(%ofGNl) 10 16 0.8 0.6 Aid percapita (US$) 12 B 6 ff Long-Term E c o n o m i c Trends .10 1 95 05 Consumer prices (annual %change) 04 GDP implicit deflator (annual %change) 659 6,836 9 37 26 ExEhange rate (annual average, local per US$) 00 02 35 31 T e n s of trade index(2000= 0 0 ) 96 w 68 1980-90 1940-2000 2000-07 (average annualgmwth sy Population. mid-year (millions) ff.3 218 25 7 27 9 23 16 12 GDP (LIS$ millions) 20.661 26,294 53,290 09,088 -01 47 54 (96ofGDP) Agriculture n7 85 85 63 30 55 37 Industry 42.8 27 4 29 9 35 2 01 54 58 Manufacturing 23.5 ff8 6 8 151 -0 2 38 54 Services 45.5 641 616 58 5 -0 5 40 54 Household final consumption eqenditure 57.5 73 7 714 63 3 07 40 46 General gov't final Consumptionexpenditure 0.5 79 a6 86 -0 9 52 51 Gross capital formation 29.0 6 5 20 2 20 2 -3 8 74 77 Eqorts of goods and services 224 6 8 6 0 274 -0 9 85 88 imports of goods and services a 4 D 8 132 a 5 -3 2 90 79 Gross savings 83 202 224 Note Figures in italics are for years otherthanthosespeclfied 2007 dataare preliminary indicates dataare not available a Aiddataarefor2006 Development Economics Development Data Group (DECDG) " The data presented on this table may not necessarily coincide with the projections presented in the macroeconomic section due to differences m the date that the data were collected and definitions of some variables. 86 Peru B a l a n c e o f P a y m e n t s and Trade 2000 2007 (US$ millions) I Governance indicators, 2000 and 2007 Total merchandiseexports (fob) 6.955 32.775 Total merchandise imports (cif) 7.358 21854 V U W d accoumabllty Net trade in goods and services -11465, 684 P d i b d sbblity Workers' remittances and compensation of employees (receipts) 78 2.QO RWJatW q a i v Current account balance Rule of law -1557 3,299 as a %of GDP -29 30 Control d corruphcm Reserves. including gold 8,563 24,971 0 25 50 75 100 C e n t r a l G o v e r n m e n t Flnance (%of GDP) Current revenue (including grants) 149 15.6 Tax revenue Q.6 14.4 Current expenditure 5 1 151 Technology and Infrastructure 2000 2007 Overall surplus/deficit -2.8 0.8 Paved roads (%of total) 13.4 w.4 Highest marginaltax rate (%) Fixedlineandmobile phone Individual 20 30 subscribers (per 1000 people) P 65 Corporate 30 30 High technologye~orts (%of manufactured exports) 3.6 2.0 External D e b t and R e s o u r c e F l o w s Environment ( U S millions) Total debt outstanding anddisbursed 28,661 28.R4 Agricultural land (%of land area) R R Total debt service 2,573 3,746 Forest area (%of land area) 54.1 53.7 Debt relief (HIPC. M DRI) - - Nationally protected areas (%of land area) .. 16.9 Total debt (%of GDP) 53.8 30.2 Freshwater resources per capita (cu. meters) .. 59,250 Total debt service (%of exports) 25.8 P.9 Freshwater withdrawal (%of internal resources) 12 Foreign direct investment (net inflows) 8Q 3,467 C 0 2 emissions per capita (mt) 11 12 Portfolio equity(net inflows) 723 82 GDP per unit of energy use (2005 PPP $ per kg of oil equivalent) n4 ns Composltlon of total external debt, 2006 Energy use per capita (kg of oil equivalent) 488 506 W o r l d B a n k Group portfollo 2000 2007 (US$ millions) IBRD Total debt outstanding and disbursed 2.590 2.649 Disbursements 266 256 Pnncipal repayments 93 241 Interest payments 89 150 U S miliiw IDA Total debt Outstanding and disbursed 0 0 Disbursements 0 0 Private Sector Development 2000 2008 Total debt service . o 0 Time required to start a business (days) - 65 IFC (fiscalyar) Cost to start a business (%of GNI per capita) - 25.7 Total disbursed and outstanding portfolio 292 324 Time required to registerproperty(days) - 33 of which IFC own account 157 3n Disbursements forlFC own account 70 148 Ranked as a major constraint to business 2000 2007 Portfolio sales, prepayments and (%of managers surveyed who agreed) repayments forlFC own account 0 24 Anticompetitive or informal practices 22.1 Tax administration l7.9 M IGA Gross exposure 329 8 Stock market capitalization (%of GDP) 8.8 97.1 New guarantees 40 0 Bank capital to asset ratio (%) 9.1 8.6 Note Figures in italics are for years otherthan those specified 2007data are preliminary 9/24/08 indicates data are not available -indicates Observation is not applicable Development Economics Development Data Group (DECDG) 87 Millennium Development Goals Peru With selected targets to achieve between 1990 and 2015 (estimateclosest to dateshow. +/-2jears) Peru G o a l 1: h a l v e t h e r a t e s f o r e x t r e m e p o v e r t y a n d m a l n u t r i t i o n 1990 1995 2000 2007 Povertyheadcount ratio at$125aday(PPP.%of population) Poverty headcount ratio at national poverty line ( % o f population) 54.3 53.1 Share of income or consumption l o the poorest qunitiie (Oh) 5.6 4.4 3.0 3.7 Prevalenceof malnutrition(%of children under 5) 8.8 5.7 52 G o a l 2: ensure t h a t children a r e a b l e t o c o m p l e t e p r i m a r y s c h o o l i n g Primaryschooienrollment (net.%) 88 98 96 Primarycompletion rate(%of relevant agegroup) 103 Wl Secondaryschool enrollment (gross, %) 67 87 94 Youth literacyrale (%of peopleages 15-24) 95 97 G o a l 3: e l i m i n a t e gender disparity i n e d u c a t i o n a n d e m p o w e r w o m e n Ratio of girls lo boys in pnmaryand secondaryeducation ( O h ) 96 97 01 Women employed in the nonagricultural sector (%of nonagricuituratemployment) 31 33 38 Proportion of seats held bywomen in national parliament ( O h ) 6 n 11 29 G o a l 4: r e d u c e under-5 m o r t a l i t y b y two-thirds Under-5 mortality rate (per 1,000) 78 63 41 25 Infant mortality rate (per to00 live births) 58 48 33 21 Measles immunization(proportionof oneyearoids immunized.%) 64 98 97 99 G o a l 5: reduce maternal mortality by three-fourths M atemal mortalityratio (modeled estimate. per 00,000 live births) 240 Births attended byskilled health staff (%of total) 80 56 59 87 Contraceptive prevalence (Ohof women ages -9) 59 64 69 46 G o a l 6: h a l t a n d begin to r e v e r s e t h e s p r e a d o f H I V / A I D S a n d o t h e r m a j o r d i s e a s e s Prevalence of H N (%of populationages 5-49) 0.4 0.5 Incidenceof tuberculosis (per W.000 people) 388 295 225 52 Tuberculosis cases detected under DOTS (%) 01 87 96 G o a l 7: h a l v e t h e p r o p o r t i o n o f p e o p l e without s u s t a i n a b l e a c c e s s t o basic n e e d s Access to an improvedwatersource(%of population) 75 79 81 e4 Access to improved sanitation facilities (%of population) 55 60 65 72 Forest area (%of total land area) 54.8 54.1 53.7 Nationally protected areas (%of total land area) 5.9 CO2 emissions (metric tons per capita) 10 10 11 12 GDP per unit of energy use (constant 2005 P P P $ per kg of oil equivalent) 9.6 n2 n4 Q.8 G o a l 8 : d e v e l o p a g l o b a l partnership for d e v e l o p m e n t Telephone mainlines (per 0 0 people) 2.6 4.6 6.7 9.6 Mobile phone subscribers(per 100 people) 0.0 0.3 5.0 55.3 Internet users (per W people) 0.0 0.0 3.1 27.4 Personal computers (per 0 0 people) 1.5 4.1 w.3 Measles immunization (X of 1-year ICT Indicators (per 1,000 people) olds) 125 - 100 1 100 75 75 ' 50 * 50 25 a 25 . . . . . . . . . 2000 2002 2004 2w6 0 1990 1995 2000 2006 2000 2W2 2004 2006 -Primary net enrollmentratio =Fixed +mobile subscriben &Ratio of gills l o boys inprimary 6 secondary OPcru OLslin America b h e Caribbean education Olntemet usem Note: Figures in italics are for years other than those specified. ..indicates data are not available. 9/24/08 Development Economics, Development Data Group (DECDG) 88 IBRD 33465R 80°W 75°W 70°W 0° 0° EC U AD OR Arcadia CO LO MBIA ap N o Putumayo Puerto Curaray Co rr i Tig en r tes e To Machala Tumbes ma A zona Santiago s TUMBES Iquitos taza Caballococha AMAZON A To BR BR AZI L Pas Loja Talara Ayar Manco LORETO Ya var i Sullana ZON 5°S PIURA San Maraño 5°S li n ya Ignacio a Uc Piura CAJ C J A A AS Yurimaguas Tamánco n n AM Chachapoyas Moyobamba M d Tarapoto AR AR LAMBA- SAN PERU e YEQUE A C C Chiclayo MARTIN A s s Cajamarca To Cruzeiro do Sul Trujillo Santa Lucia LA LIBERTAD Pucallpa Hu Nevada Sihuas alla Hueascarán ga Chimbote (6768 m) ANCASH Tingo María Uc ay HUANUCO ali Huaraz Nevada Huánuco 10°S Yerupaja 10°S (6634 m) UCAYALÍ Goyllarisquizga PASCO Purús Cerro de Pasco PA C IF I C M M Huacho Sayán Atalaya Satipo LIMA La OC E AN C A L L A O Ap MADRE t t Oroya JUNIN uri Uru m DE DIOS n n ac ba Huancayo M ad mba Callao r LIMA ed s eD ios Puerto Ayna CUSCO Sintuya Maldonado . Huancavelica Quillabamba 0 100 200 300 Kilometers Nevada HUANCA- Ayacucho Salcantay (6271 m) Lanlacuni Astillero 0 100 200 Miles VELICA A Cusco Bajo PU In a Pisco mb Abancay Nudo a ri RI AY Ausandate Ica M PUNO AC (6384 m) AC ICA To San Buenaventura UC Puquio PER U Caballas Nazca O 15°S H H Alca Cailloma Nevada To San Juan Juliaca Carabuco An Coropuna SELECTED CITIES AND TOWNS (6271 m) de Lago e s Antiquipa Puno Titicaca REGION CAPITALS AREQUIPA To M M Atico Arequipa La Paz NATIONAL CAPITAL tn Desaguadero s. . RIVERS MAIN ROADS Mollendo Moquega RAILROADS TACNA MOQUEGUA REGION BOUNDARIES To Visviri B OL I V I A Tacna INTERNATIONAL BOUNDARIES To Belén 75°W To Iquique CHILE NOVEMBER 2006