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PROGRAM INFORMATION DOCUMENT (PID)
APPRAISAL STAGE
Report No.: AB2660
Fiscal Management and Competitiveness Development Policy
Operation Name
Loan
LATIN AMERICA AND CARIBBEAN
Region
Sub-national government administration (45%);Central
Sector
government administration (35%);General industry and trade
sector (20%)
P101335
Project ID
MINISTRY OF ECONOMY AND FINANCE
Borrower(s)
INISTRY OF ECONOMY AND FINANCE
Implementing Agency
November 8, 2006
Date PID Prepared
November 10, 2006
Date of Appraisal
Authorization
December 19, 2006
Date of Board Approval
1. Country and Sector Background
Political Developments
Peru is strengthening and consolidating its democratic political system. Following the
Fujimori regime and a brief transitional government, the administration of former President
Toledo governed a country at peace and with economic growth during 2001-2006. Despite many
political difficulties and a generally low public approval rating, Toledo faced no major threats to
his democratic authority, and was able to not only complete his mandate in office but also to
muster enough support in Congress to undertake several reforms and to maintain disciplined
control over economic policy. By the end of Toledo’s term, it appeared that a majority of
Peruvians had come to see the benefits of a stable, democratic political system.
President Alan García won the second round of presidential elections in June 2006 by 53
percent against 47 percent for Ollanta Humala, a former military officer. Humala failed to
convince a majority of voters, who preferred the platform of García, despite the memories of his
difficult first presidential term in the late 1980s. At the same time, the narrowness of García’s
victory and the success of Humala in Peru’s poorer regions—especially the southern Andes—
points to dissatisfaction of many Peruvians with the thus-far limited improvements for the poor
after recent years of economic growth.
President García faces a fragmented Congress, which will require building coalitions to
pass legislation. His Alianza Popular Revolucionaria Americana (APRA) party has 37 seats,
compared to 44 for Humala’s Unión por el Perú (UPP) and 39 divided among five other parties.
UPP has said it will strongly defend their candidate’s platform, meaning it will likely form the
core of opposition to García’s agenda, requiring APRA to seek coalitions with the other parties.
García’s first cabinet, led by Prime Minister Jorge del Castillo and Finance Minister Luis
Carranza, is a mix of APRA members and well-respected technocrats, with a record six women
in ministerial posts. The latest poll numbers show García’s public support between 60 and 70
percent. The first major test for the new government will be the November 19 elections for 26
regional presidents and all 1,832 municipal governments.
Economic Developments
In the past four years, Peru has had one of the best-performing economies in Latin
America, surpassed only by Venezuela—an oil exporting country—and Argentina—which is
coming out of a deep recession. Based on sound macroeconomic policies and strong demand for
Peruvian commodity exports, GDP grew 5 percent on average in the four years since 2002, and
reaching a remarkable 6.4 percent in 2005. This growth has been all the more impressive
considering the external shock of the region in the early 2000s as well as the political instability
that prevailed during the Toledo administration.
Table 1: Key Economic Indicators (% change)
2000
2001
Annual GDP growth rate
3.0
0.2
Inflation rate (CPI, end of period)
3.7
-0.1
Overall Public Sector Balance/GDP
-3.3
-2.5
Public Sector Debt/GDP
45.7
46.1
Exports (FOB); change p.a.
14
1
Imports (CIF); change p.a.
9
-2
External Current Account/GDP
-2.9
-2.3
Source: BCRP, Revised Marco Macroeconómico Multianual 2006-2008.
2002
5.2
1.5
-2.2
46.9
10
3
-2.0
2003
3.9
2.5
-1.7
47.5
18
11
-1.6
2004
5.2
3.5
-1.0
45.1
41
19
0.0
2005
6.4
1.5
-0.3
37.8
35
23
1.4
2006e
6.6
1.5
0.6
32
31
26
1.1
Growth has been led by an upswing in exports, which rose 26 percent annually on average
in 2002-2005, and the external current account posted a surplus of 1.7 percent of GDP in
2005. This increase was driven in good measure by the boom in commodity prices, particularly
for mineral exports, as well as the coming on line of new mining and hydrocarbon projects.
Although mining production account for over half of all Peruvian exports, non-traditional
exports have grown rapidly, 20 percent on average annually since 2000, particularly in
specialized agricultural products such as asparagus, grapes and avocados. Other export sectors
such as fisheries and textiles have also posted significant gains in recent years. Private
investment, encouraged by the growing economy and sound policies, has also helped fuel
growth, rising nearly 14 percent in real terms during 2005.
Fiscal and monetary policy has been well-managed during recent years, with steady
declines in public sector deficits and low, stable inflation rates. The combined public sector
deficit has come down every year since 2001, falling from 2.5 percent of GDP in 2001 to 0.3
percent of GDP in 2005, lowering public debt from 46 percent of GDP in 2001 to 38 percent of
GDP in 2005 (of which 28 percent is foreign and 10 percent domestic), and down to 32 percent
of GDP by October 2006. These gains came from increases in revenue from mining taxes, as
well as from cuts in public investment spending. Tax collection for the combined public sector
will reach 15 percent of GDP in 2006, low by international standards and below the 18 percent of
GDP collected in the mid-1990s. This indicates that improvements in broadening the tax base
and increasing collections remain needed. Year-end inflation for 2005 was 1.5 percent, at the
low end of the target range of 1.5-3.5 percent. Fiscal consolidation has continued in 2006, with
the non-financial public sector expected to report a surplus of 0.6-0.8 percent of GDP, only the
second budget surplus in 40 years. Tax revenue is estimated to reach 15 percent of GDP in 2006
(Figure 1), pushed particularly by increases in income tax.
Figure 1. Central Government Tax Revenue (% of GDP)
16
14.9
15
% GDP
14
13.6
12.8
13
12.2
13.1
12.4
12.0
12
11
10
2000
2001
2002
2003
2004
2005
2006
Source: Central Bank and projections from MMM 2007-2009 MEF.
While Peru’s macroeconomic performance has been very good in the past few years,
poverty remain high. The national poverty rate dropped two percentage points between 2002
and 2004, and half the population (51.6 percent) lives in conditions of poverty. However, since
2003 per capita incomes of the poor and the rates of poverty and extreme poverty have started
showing improvements, especially in rural areas, driven by broadening economic growth.
Average incomes of the poorest tenth of the population rose 33 percent between 2001 and 2004,
while the incomes of the wealthiest tenth of the population remained level over the same period.
Growth has had the most impact on extreme poverty rates, especially in rural areas. Extreme
poverty declined from 24 percent to 19 percent between 2001 and 2004 nationally, but rural
extreme poverty fell from 50 percent to 40 percent over the period, while urban extreme poverty
declined from 10 percent to 8 percent. Although no poverty numbers are available after 2004,
recent improvements in employment in urban areas indicate that the growth of 2005 and this year
(Figure 2) are having further impacts on poverty. Income inequality also remains relatively high,
with the Gini coefficient improving slightly from 0.52 to 0.50 during the same period.
2. Operation Objectives
The proposed DPL is intended to be the first in a series of four loans supporting the GoP’s reform plan to
improve the functioning of Peru’s public sector institutions and business environment. The loan focuses
on two broad areas of policy reform:
 Efficiency and Quality of Fiscal Management
 Competitiveness
In each of these areas, the GoP has committed to a detailed series of important policy changes as part of
an integrated strategy to progressively reform fiscal administration, public spending and the business
climate in ways that will lead to specific results that have a broad impact on growth and will be difficult
to reverse.
3. Rationale for Bank Involvement
Link to Country Partnership Strategy and Other Bank Operations
This programmatic series on improving fiscal management and competitiveness is at the
core of the CPS’s proposed assistance program, and is envisioned as part of the country’s
base-case lending scenario. The CPS foresees several thematic “clusters” forming the basis of
the Bank’s partnership with Peru, and this proposed loan series directly addresses aspects of:
maintaining macro stability; accelerating growth; widening the base of growth; justice;
governance; and decentralization. Policies which form part of the FMCDPL series include,
among other reforms, simplifying and improving tax collection, controlling sub-national debt,
implementing incentives for greater sub-national revenue creation and judicious use of natural
resource revenues, promoting results-based budgeting, expanding e-governance procedures and
specialized commercial courts, and moving forward with budget-neutral, capacity-based
decentralization of government services. All of these directly promote the goals stated in the
CPS.
The proposed operation also fits into a series of Bank operations that support the
Government’s reform agenda. It was developed jointly with another multi-year DPL series for
the social sectors and a Health APL, which address issues of improved service quality and
results-based management, as well as the on-going Accountability for Decentralization TAL,
which also focuses on the social sectors. Because of the importance of monitoring indicators in
the social sectors, the Bank team working on the social DPL series will work closely with the
team on this loan to ensure that the monitoring and evaluation component supported by this loan
bring together both the overall budgetary and fiscal goals of the MEF as well as the sectoral
improvement goals in the line ministries. Actions under this loan will be supported by the ongoing Institutional Capacity for Sustainable Fiscal Decentralization TAL, designed to improve
fiscal planning, expenditure efficiency, and decentralized public investment. The on-going
Justice Reform Project will help support implementation of improvements in the conciliation
system, which form part of the competitiveness component of this loan. In addition, the
FMCDPL is complemented by three technical assistance projects, one by the IFC in Cajamarca
and the second under the EITI in Cuzco that aim to build capacity at the municipal level for
management of natural resource-based revenues and investments, and a third by the IFC on
administrative simplification in provincial municipalities.
Lessons Learned
The experience of designing and implementing previous loan projects in Peru on policy
reforms, in particular the three-stage Decentralization and Competitiveness DPL
(DECDPL) series, provided important input in the design of this programmatic series. The
aim of this programmatic series regarding decentralization was to establish a conceptually
coherent and fiscally sound foundation on which to build a decentralized system of governance
in Peru, a process that will take a number of years. The DCDPL series helped ensure that Peru
began the process of decentralization in a deliberate, well-conceived manner, strengthening fiscal
responsibility and administrative efficiency at all levels of government and avoiding the pitfalls
seen in other countries of deteriorating public services and confusion of responsibilities. In
parallel, significant legal, institutional and administrative initiatives were undertaken to enhance
competitiveness, many with a strong focus on promoting growth in non-traditional exports and in
economic activity outside the capital region. The results and pending agenda from the DECDPL
series informed the design of aspects of this proposed loan series.
One key lesson from the DECDPL series is the importance of choosing reform areas
carefully and not pressing for the government to make too many changes too fast. Complex
and technical processes like e-government and the devolution of service delivery to the subnational level need critical time for development and implementation, or capacity constraints will
impede progress. Moreover, time is also needed to overcome the resistance of groups that may
feel threatened by the uncertainty brought about by changes and the accountability brought about
by result-oriented reforms. Because the GoP is moving ahead with the devolution of resources
and service delivery to sub-national governments, this operation will focus only on fiscal
management aspects of decentralization, and specific sectoral issues regarding oversight and
service delivery will be addressed in other operations.
Design of the DPL and Analytic Underpinnings
The proposed FMCDPL series responds to the GoP’s request for Bank support to their
public sector institutions and competitiveness reform program. This operation is intended as
the first in a series of four loans, one per year, each marking progressively advanced stages in the
reform program. The two broad areas addressed by the operation are:


Efficiency and Quality of Fiscal Management
Competitiveness
In the view of both the GoP and the Bank, these two areas are mutually reinforcing and, if
reforms advance as planned, will offer a significant payoff in terms of economic growth,
social development and poverty reduction. Strengthened fiscal management is a desirable end
in itself, to maximize limited public resources, but also supports country competitiveness by
generating confidence in the private sector on overall macroeconomic stability and the ability to
undertake long term investments and planning. As well, greater country competitiveness will
only improve the fiscal situation, by generating increased tax revenues and decreasing the need
for government intervention to stimulate economic growth. In view of governmental priorities,
the first proposed loan will focus more on fiscal management, while later loans in the series will
be more weighted toward competitiveness.
This proposed DPL series takes into account lessons learned during past programmatic
operations in Peru, as well as current best practices in policy-based lending to wellperforming middle income countries.1 As such, the FMCDPL emphasizes up-front actions
based on a well-defined reform program. This loan is motivated by Peru’s laudable performance
in recent years in consolidating its economy, and the clear desire of the new administration to
move into the next stage of reform by improving the efficiency and impact of governance
institutions and public resources. The programmatic approach is intended to support the
government with a reliable source of low-cost financing linked to its budgetary cycle.
1
Including Peru’s DECSAL and PSRL series, and the Development Policy Lending Retrospective, July 7, 2006.
The Bank team selected a sub-set of specific policies within the GoP’s program to support
with the FMCDPL series which it considers will have the most impact, based on the Bank’s
diagnostic work. Among the principal pieces of research and analysis used in the preparation of
this loan are: the policy notes collection for the new administration collected in the volume Perú:
La Oportunidad de Un País Diferente—Próspero, Equitativo y Gobernable, Public Expenditure
Review, Country Financial Accountability Assessment, Country Procurement Assessment
Report, Investment Climate Assessment, Poverty Assessment, Country Economic Memorandum,
and sector specific studies such as Municipal Debt, Microconstraints to Growth, and
Environmental and Social Impact of the Mining Sector.
4. Financing
The loan is expected to be disbursed in a single tranche of US$[100-150] million.
Source:
BORROWER
INTERNATIONAL BANK FOR RECONSTRUCTION AND
DEVELOPMENT
Total
($m.)
0
[100-150]
[100-150]
5. Institutional and Implementation Arrangements
The Government of Peru and the Bank have agreed to monitor progress in the DPL
program regularly, including the annual reviews of the CPS progress. The Sectoral Loans
Coordination Unit (UCPS) in the Ministry of Economy and Finance is the main counterpart
agency for the proposed loan, which will be in charge of M&E for the loan and for collecting the
appropriate data to follow the proposed indicators. The UCPS will also coordinate with the Bank
to collect baseline numbers for numerical indicators. Other important agencies are the Central
Bank of Peru, the Government Tax Agency (SUNAT), Office of the Prime Minister (PCM) and
Ministry of Trade (MINCETUR).
The Bank will monitor actions and review progress of the implementation of the proposed
operation using the different sources, among them:











Fiscal Transparency Reports – MEF, www.mef.gob.pe
Leading Indicators Reports – MEF, www.mef.gob.pe
Central Bank of 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
Indice de Gestión Gubernamental – Universidad del Pacifico
Ciudadanos al Dia – Reports and Technical Notes, www.ciudadanosaldia.org


Government Tax Agency SUNAT – www.sunat.gob.pe
IMF and IADB reports
6. Benefits and Risks
In the short term, the DPL will have the twin benefits of:
 Strengthening the GoP’s fiscal position with timely budget financing at reasonable terms; and
 Supporting the GoP’s public sector and competitiveness reform agenda.
In the medium and long term, reforms supported by the proposed loan series will solidify Peru’s overall
fiscal framework, greatly improve the efficiency and quality of public sector spending, and reduce
bottlenecks to faster economic growth. This will in turn result in budgetary savings that can be directed
toward priority poverty programs; more and higher quality public services for the citizenry; and more
sustainable and broad-based growth.
Political Risks include a slowing of reform momentum, especially if the November local elections are
unfavorable to the administration and the divided Congress becomes less cooperative. Reforms to
promote results-based management could generate opposition from politically active interest groups, such
as public employee unions. President García has launched a high-profile series of actions for his first 180
days in government as a way to quickly demonstrate his determination to move forward on reform.
Government officials are re-engaging with the Acuerdo Nacional, a group of political parties, civil society
and community groups, academics and NGOs who came together in 2002 to help generate a consensus on
a broad national agenda.
Social risks relate principally to resource extractive industries, which have been accused by community
residents near some mines and oil wells of polluting, leading to protests, particularly in remote areas with
limited state presence. Government policies supported by this operation to improve the flow of resources
from mining and hydrocarbon royalties to local governments are intended to help with this problem.
Economic risks include Peru’s vulnerability to a drop in the international commodity prices, in particular
minerals, which form a large share of exports. A slow-down in the U.S. economy or the failure for the
U.S. Congress to ratify the Peru FTA could also impact exports. Political pressures could lead to a
deterioration of fiscal accounts should the GoP attempt to placate opposition with increased public
spending. The high level of dollarization of the banking system could become a problem in the event of a
currency devaluation. These risks are mitigated by growing non-traditional exports as well as a
broadening of export markets through trade agreements. The Government’s disciplined fiscal
performance in the past several years has greatly reduced country risk and lowered interest rate spreads,
meaning the cost of rising international interest rates will be lower than previously. Dollarization is also
being reduced by an increase in local-currency debt.
7. Poverty and Social Impacts and Environment Aspects
Poverty and Social Impact
The proposed loan would help reduce poverty by supporting the implementation of
reforms to improve the transparency and quality of public spending and the provision of
public services, and promoting broad-based economic growth through strengthened
competitiveness. Numerous studies by the Bank and other institutions have pinpointed
inefficiencies in public sector management, the lack of accountability and results-focus on public
spending, and an inadequate government focus on obstacles to competitiveness are the most
significant bottlenecks to economic growth having a greater impact on poverty and inequality.
As well, further steps to promote strengthened fiscal management at the decentralized level and
to improve the redistributive impacts of fiscal transfers will increase the effectiveness of fiscal
resources, devolving spending authority to lower levels of government that are more aware of
local needs. This will allow resource expenditure to be more tightly focused on addressing the
varied needs different regions to improve the provision of public services. Improving the
distributional impacts of fiscal transfers, including natural resource income, will also help redress
the large disparities between the coastal, mountain, and jungle regions. The policies supported
by this loan series will likely face isolated resistance among specific sectors (such as regions
who don’t want to reduce their transfer income, or public sector employees resistant to resultsoriented budgeting), but these policies are broadly supported on a national level and are not
expected to generate widespread social opposition.
Social tensions have been an issue in isolated areas related to natural resource extraction,
which is indirectly addressed in this loan series, and the GoP is taking actions to address
these problems. The new administration has for the first time created a Conflicts Unit in the
Presidential Council of Ministers, a high-level office for negotiating conflicts as they arise. The
unit works hand-in-hand with the Defensoría del Pueblo (Human Rights Ombudsman) to create
a space for dialogue with disaffected groups. A first result has been the peaceful negotiations
with the Achuar indigenous group in Loreto, which has protested pollution and lack of social
benefit from oil production in their region. The negotiations led to a decree mandating that a
portion of the oil canon for Loreto be specifically dedicated to ethnic groups in the region, as a
way to finance projects to improve their living conditions, and also commitments by the oil
company to undertake environmental rehabilitation. The work of IFC’s Technical Assistance
Facility on improving the use of mining canon use around the Yanacocha gold mine has also
been successful in illustrating how the industry can benefit local communities. As part of the
CPS, the Bank is planning a series of environmental DPLs to help strengthen the GoP’s ability to
address the environmental impact of resource extraction industries.
Peru’s greater integration into the world economy will provide greater opportunities for
economic growth, but may also lead to economic dislocation in some sectors, and the GoP is
working to ameliorate that impact. One of the flagship programs of the new administration is
Sierra Exportadora, a package of measures designed to promote greater economic opportunities
through trade and market integration to poorer, heavily indigenous Andean mountain. Proposals
include directing significant technical assistance, infrastructure investment, and credit to boost
export-oriented agriculture, forestry and artisan produce based on local knowledge and
specialties. The Bank’s Sierra Development Project, proposed as part of the CPS, would support
aspects of Sierra Exportadora. As well, increasing the efficiency in government spending as a
whole will free greater resources to be dedicated to redistributive social programs such as those
to re-train those affected by lower tariff barriers and for poor, underprivileged people, including
ethnic groups which have historically faced discrimination and scant opportunities for
advancement. The Juntos conditional cash transfer program, which is expected to be scaled up
during this administration, will be important to achieving these goals.
Environmental, Forest and Natural Resource Aspects
The policies supported by this DPL operation, which focus on reforming economic and
social policies and institutions on the macro level, are not expected to entail any significant
direct impact on the environment. Some policies will likely prove positive for environmental
management, particularly aspects related to improved monitoring and evaluation for government
expenditure, including environmental expenditure (see para. 32). This will allow the GoP to set
clear environmental priorities, to coordinate with environmental authorities on developing
indicators to evaluate the impact of spending on achieving these priorities, and to 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-funded
environmental spending. As well, the decentralization of SNIP could lead to improved
environmental assessment of investment projects, taking into account local conditions instead of
employing uniform criteria for the entire country.
However, it will likely be the case that in the medium and long term, further trade
liberalization and economic activity in Peru—though desirable for growth and poverty
reduction—will lead to greater infrastructure development and resource extraction, that
will affect the environment. The Bank recently completed a Country Environmental
Assessment, highlighting shortcomings in Peru’s institutional framework for environmental
protection and sustainability. It also pointed to the need to not only continue focusing on
protection natural areas such as tropical forests, but also mitigating the serious health impacts
and high costs of environmental degradation, particularly related to air and water contamination.
As a result of this study and the ensuing dialogue with GoP, the Bank is preparing two
environmental DPLs in coming years. Principal topics to be addressed in the loans will be
reordering the institutional and legal oversight for the environment, both at the national level—
possibly through the creation of a new, single authority—and at regional and municipal levels.
Decentralized environmental oversight of the mining sector will be a priority, as well as
adjusting spending priorities to achieve concrete results in reducing air and water contamination.
8. Contact point
Contact: Rossana Polastri
Title: Sr Country Economist
Tel: 5357+259
Fax:
Email: [email protected]
Location: Lima, Peru (IBRD)
9. For more information contact:
The InfoShop
The World Bank
1818 H Street, NW
Washington, D.C. 20433
Telephone: (202) 458-4500
Fax: (202) 522-1500
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