Peru and the IMF
Country's Policy Intentions Documents
Free Email Notification
of Intent and Technical Memorandum of Understanding
Mr. Horst Köhler
1. In our letter of January 18, 2002, the Government of Peru described its economic program supported under the current two-year Stand-By Arrangement. This letter describes performance under the program in 2002, discusses additional policies and prospects for 2003 in order to achieve the objectives of our economic program, and describes our revised structural reform strategy. Macroeconomic performance in 2002 has been in line with the program, and significant progress has been made in implementing the program's structural reform agenda. In this letter we request the modification of the fiscal performance criterion and all privatization-related adjustors for end-2002, and the replacement of the performance criterion on net domestic assets of the central bank by a consultation mechanism based on inflation.
2. The Peruvian economy has weathered the turmoil in the world economy in 2002, and our program has been successful in minimizing contagion. Economic growth has resumed and is projected to be in line with the program projection for the year of 3.7 percent. Inflation has remained in check and should end the year at around 2 percent. The balance of payments position has stayed strong all year, and the net international reserves of the central bank are expected to increase by some US$1.25 billion in 2002. Deposits in the banking system have been growing throughout the year, interest rates (particularly in local currency) have fallen, and the exchange rate has been in line with program projections. Vulnerability indicators have remained strong as well, and by year-end gross international reserves of the central bank are expected to continue to exceed the stock of dollar deposits in the banking system and cover close to 190 percent of short-term debt on a residual-maturity basis.
3. Notwithstanding these positive developments, external and domestic factors have been challenging the recovery in economic activity. Continued difficulties in the external environment, in particular in the region, and, to some extent, certain domestic political developments, have adversely affected private investment, including the transfer to the private sector of state enterprises under the Government's Private Investment Promotion Program (PIPP). For 2003, real GDP is projected to grow around 3.5-4 percent, slower than originally forecasted.
4. In this context, the Peruvian authorities, in consultation with Fund staff, have revised slightly the fiscal deficit targets for this year and the next. We are requesting that the performance criterion on the fiscal deficit for end-December 2002 be modified from S/.3,915 million to S/.4,520 million. The latter, equivalent to 2.3 percent of GDP, is equal to the maximum fiscal deficit target that would have been allowed under the program adjustor in the event of higher-than-programmed receipts from the PIPP (and equivalent to an upward adjustment of 0.3 percent of GDP). For next year, we are now targeting a fiscal deficit of 1.9 percent of GDP (which reflects a planned primary balance adjustment from a deficit of 0.2 percent of GDP to a surplus of 0.4 percent of GDP).
5. The primary balance adjustment in 2003 would mainly reflect an anticipated increase in tax revenue, which is projected to rise from 12.2 percent in 2002 to 12.7 percent of GDP in 2003. Tax reform measures and tax rate increases introduced in 2002 are projected to more than compensate for expected lower revenue collections from taxes on public enterprise assets and exceptional fines. Current expenditure will remain under strict control, while general government non-interest expenditure is projected to grow by only 2 percent in real terms in 2003.
6. The government will continue to carry out social programs and important structural reforms with the support of the World Bank, the Inter-American Development Bank, and the Andean Development Corporation, which together are expected to make disbursements in 2003 in a similar amount to that in 2002. Moreover, we intend to build upon the successful reentrance into the international private capital market in 2002 and place additional sovereign bonds in 2003. The financing of the deficit in 2003 would be closed by placing local currency bonds, prefinancing arranged in 2002, and proceeds from the PIPP. The government will not seek to cover its financing needs with resources of the pension reserve fund (FCR) that are held at the central bank and that form part of its international reserves.
7. As indicated in our letter of January 18, 2002, the program envisaged a modification of performance criteria in the event that the BCRP adopted a full-fledged inflation-targeting framework for monetary policy. Such a framework has been implemented, with the operational target of monetary policy being the monthly average stock of banks' local currency deposits at the BCRP. In July, the first inflation report was issued, and the BCRP Board announced a medium-term inflation target range of plus or minus 1 percentage point around the midpoint of 2.5 percent. Accordingly, we request that the end-December 2002 performance criterion on the net domestic assets of the central bank be replaced with the consultation mechanism described in Table 1. The BCRP will continue to maintain the floating exchange rate system, intervening in the spot foreign exchange market to limit volatility in the exchange rate, while continuing the practice of not intervening in the forward foreign exchange market. Reserve requirements on U.S. dollar deposits will continue to be managed prudently to ensure that the high level of coverage of dollar deposits in the banking system by the international reserves of the BCRP is maintained.
8. Our structural reform agenda is being implemented mainly as planned. In the fiscal area, the tax audit program of corporations and independent professionals is ahead of schedule, and as of end-September, 15,318 audits have been carried out; tax expenditures have been incorporated in the 2003 budget submission to congress; and draft legislation has been submitted to congress to revise the Law on Fiscal Transparency and Responsibility. Progress has been made in strengthening bank supervision, including the submission to congress of draft legislation to provide the necessary statutory protection to the staff of the Superintendency of Banks in the discharge of their responsibilities. All performance criteria pertaining to special public lending programs have been observed; and measures have been put in place to begin reforming the public pension system.
9. In 2003, the government will continue to implement its structural reform agenda. Bank supervision will continued to be strengthened, including through the tightening of regulations on credit risk derived from foreign-currency lending by banks (and the associated exposure to exchange rate changes). Cofide will maintain its operations as a second-tier development bank. We will continue to: (i) strengthen the public and private pension systems; (ii) maintain our trade policy strategy; and (iii) not use public resources to establish new financial institutions for direct lending to the public.
10. As part of the government's decentralization program, elections are to be held on November 17 for new regional administrations (at the same time as municipal elections). Congress approved in July the legal framework for decentralization. The law sets specific principles on fiscal decentralization that call for an orderly process of decentralizing government services to ensure that the impact on the consolidated public finances is neutral and that any external borrowing carried out by the new regional administrations require approval of the MEF. Also, the law earmarks 60 percent of the proceeds from the PIPP to the regional development fund (FONCOR) and the decentralization fund (FIDE).
11. The design of the PIPP is being refined to address domestic considerations and reduced interest by foreign investors in the region. The less favorable environment adversely affected the process of transferring the operations of two public enterprises to the private sector (which constituted structural benchmarks under the program for end-June and end-September). Receipts from the PIPP are expected to reach US$400 million in 2002. In light of this outlook, the government is requesting a modification to the adjustor on the end-December 2002 performance criterion on the net international reserves of the central bank for shortfalls in PIPP receipts. For 2003, proceeds from the PIPP are expected to yield US$400 million.
12. As part of our economic program, a comprehensive reform of the tax system is being implemented, albeit over a longer time horizon than originally envisaged in the program. Measures have been adopted to lower evasion, enhance equity, and reduce distortions, that are expected to yield 0.2 percent of GDP this year and 0.8 percent of GDP in 2003. Other measures will be introduced in 2003 that will aim at strengthening tax administration, rationalizing tax rates, and increasing income tax rates and widening the income tax base. In addition, we will begin to phase out certain regional and sectoral tax exemptions by end-June 2003. Full implementation of this process is expected to occur by end-2004, as it involves reaching agreements with the incoming regional administrations on the phasing out of these exemptions (to be ratified by congress) in exchange for investment in infrastructure in the affected regions. The current estimated cost on an annual basis of the exemptions to be phased out by end-2004 is 0.9 percent of GDP, with exemptions costing 0.4 percent of GDP to be phased out by end-2003. In total, the comprehensive tax reform introduced from 2002-2004 is expected to yield around 2 percent of GDP on an annual basis over the medium term.
13. An important element of the Government of Peru's structural program for 2003 is to improve the functioning of the domestic market for government securities, and in particular, the auction system. We aim to introduce in January/February 2003 a system of primary dealers for auctioning government paper. To best ensure a well-functioning domestic bond market auctions will follow an established calendar to allow market participants to better account for government issues in their cash-flow plans. At the same time, to ensure transparency in the auction process, government entities could voluntarily buy government bonds only through direct placements at the prices determined in the auctions or in the secondary market.
14. In addition to the policies outlined in this letter, the Government of Peru stands ready to take additional measures as appropriate to ensure the achievement of its program's objectives. During the period of the Stand-By Arrangement, the authorities of Peru will maintain the usual close policy dialogue with the Fund. The second review with the Fund, to be completed by March 15, 2003, will establish the quarterly performance criteria and structural benchmarks for the program in 2003, set the timing of the third review, and cover the implementation of the economic program described in this letter and our letter of January 18, 2002. The review will focus, in particular, on: (i) progress in implementing the tax reform and fiscal responsibility law; (ii) developments in the decentralization process; (iii) the functioning of the domestic bond market; (iv) steps being undertaken to strengthen banking supervision; and (v) the operations and impact of government initiatives to aid specific sectors.
This Memorandum includes definitions of concepts and the format for periodic reporting to the Fund on performance under the program for 2002 described in the letter of the Government of Peru dated November 26, 2002.
I. Definitions of Concepts1
1. The borrowing requirement of the combined public sector (PSBR) will be measured as: (a) net domestic financing of the nonfinancial public sector, plus (b) net external financing of the nonfinancial public sector, plus (c) proceeds from the Private Investment Promotion Program (PIPP), less (d) the operating balance of the BCRP. The PSBR will be adjusted to exclude the impact of data revisions that do not represent a change of its flows during 2002. The nonfinancial public sector (NFPS) comprises the central government, the autonomous agencies, the local and regional governments and the nonfinancial public enterprises. The components of the PSBR (Table 1), will be defined and measured as follows:
(a) The net domestic financing of the NFPS is defined as the sum of: (i) the increase in net claims of the domestic financial system2 on the nonfinancial public sector (excluding Peruvian Brady bonds and other government bonds initially sold abroad); (ii) the net increase in the amount of public sector bonds held outside the domestic financial system and the nonfinancial public sector, excluding Peruvian Brady bonds and other bonds initially sold abroad; and (iii) the increase in the floating debt of the nonfinancial public sector due to expenditure operations and tax refund arrears; less (iv) the accumulation of stocks, bonds, or other domestic financial assets by the nonfinancial public sector. In the case of enterprises that are divested after December 31, 2001, the net credit of the financial system to these enterprises will be recorded, for the remainder of the program period, as unchanged from their level at the time of the PIPP.
(b) The net external financing of the NFPS comprises (i) disbursements of loans; plus (ii) receipts from the issuance of government bonds abroad; minus (iii) cash payments of principal (current maturities of both loans and bonds); minus (iv) cash payments of arrears (principal and interest); plus (v) the net increase (or, minus the decrease) in short-term external debt; minus (vi) debt buy-backs or other prepayments of debt (at market value) not included in the following item (including repayments of short-term external debt assumed by the government at the time of the divestiture of public enterprises, net of the proceeds from the sale of inventories of such enterprises); minus (vii) debt-equity swaps used in the PIPP accounted at the market value of these papers as defined by ProInversion; minus (viii) the net increase (or, plus the decrease) in foreign assets of the nonfinancial public sector (including those held abroad by the Fondo Consolidado de Reservas (FCR), and any other fund managed by the Oficina de Normalización Previsional (ONP)) (Table 2).
(c) PIPP proceeds are defined as (i) the cash payments received by the Treasury from the sale of state-owned assets (including proceeds transferred to the FCR, and any other specialized funds) valued at the program exchange rate, plus (ii) debt equity swaps used in the PIPP, accounted at market values as defined by ProInversion. PIPP proceeds also include up-front payments received by the Treasury for the granting of concessions for public services but exclude the annual payments under the concession program, which are part of central government nontax revenue.
(d) The operating balance of the BCRP includes: (i) cash interest earnings of the BCRP minus cash interest payments by the BCRP, in both domestic and foreign currency; (ii) the administrative expenses of the BCRP; and (iii) any realized cash losses or gains from activities in currencies, financial instruments, and derivatives.
2. The consultation bands for inflation are based on the 12-month rate of change in consumer prices as measured by the Indice de Precios al Consumidor (IPC) at the level of Metropolitan Lima by the Instituto Nacional de Estadística e Informática (INEI). Should inflation fall outside an inner band of 2 percentage points around the central point of 2.5 percent, the authorities will discuss with the Fund staff on an appropriate policy response. Should inflation fall outside an outer band of 3 percentage points around the central point, the authorities will also complete a consultation with the Executive Board of the Fund on the proposed policy response before requesting further purchases under the program.
3. The net consumer lending of the BN will be defined as disbursements of loans under the "Multired Program", established in November 2001, less cash amortizations under the loan program. Interest payments on these loans are excluded from the definition of net lending.
4. The net international reserves of the BCRP, excluding foreign-currency deposits of financial institutions, are defined for the purpose of the program as: (a) the foreign assets of the BCRP (excluding subscriptions to the IMF and the Latin American Reserve Fund (FLAR), Pesos Andinos, credit lines to other central banks, Corporación Andina de Fomento (CAF) bonds, and foreign assets temporarily held by the BCRP as part of swap operations); less (b) reserve liabilities, defined as the sum of: (i) the BCRP's external liabilities with an original maturity of less than one year, and (ii) its liabilities to the IMF, to the Inter-American Development Bank (IADB) and to the FLAR; and less (c) deposits in foreign currency by the banking system, other financial intermediaries and the private sector, net of repos of Treasury bonds with the financial system.
BCRP's silver holdings will be included in the net domestic assets and excluded from the net international reserves. The gold holdings of the BCRP will be accounted at US$234.685 per troy ounce (the average book value as of December 31, 2001), SDRs at US$1.257 per SDR, and foreign currency assets and liabilities of the BCRP in other currencies at the exchange rate of December 31, 2001. Net international reserves will be adjusted to exclude any valuation gains or losses resulting from net sales or deliveries of gold by the BCRP. The end-December 2001 level of net international reserves is shown in Table 3.
5. The stock of government guarantees for housing support programs will be defined as the portion of the face value of mortgages backed by government guarantees, issued starting January 1, 2002.
6. The flows of the short-term external debt of the NFPS are defined as the net change in the NFPS's outstanding external indebtedness with a maturity of less than one year (including instruments with put options that would be triggered within one year of the contracting date), measured, in part, on the basis of the operations of a selected sample of public enterprises comprising Petroperú, Centromín Perú, and Electroperú. These limits exclude normal import financing but include forward commodity sales. In the case of companies sold to the private sector under the PIPP, the short-term debt of these entities will be recorded, for the remainder of the program period, as unchanged from their level at the time of the PIPP. The end-December 2001 stock of short-term external debt of the NFPS is shown in Table 4.
7. The contracting or guaranteeing of nonconcessional external public debt with a maturity of at least one year refers to all external obligations of the NFPS, COFIDE, the BCRP, the BN, and any other state development bank, except for loans classified as reserve liabilities of the BCRP. The program limits on nonconcessional debt will exclude: (i) any new loans extended in the context of a debt rescheduling or debt reduction operation; and (ii) any lending at concessional terms.
The performance criterion on the contracting or guaranteeing of external public debt applies also to commitments contracted or guaranteed for which value has not been received. For the purpose of this performance criterion, the term "debt" has the meaning set forth in point No.18 of the Guidelines on Performance Criteria with respect to Foreign Debt adopted on August 24, 2000 (Board Decision No. 12274-(00/85)). Thus, the term "debt" will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time: these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows: (i) loans, i.e., advances of money to the obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans, and buyers' credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements); (ii) suppliers' credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the performance criterion, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property. Under the definition of debt set out above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.
For program purposes, a debt is concessional if it includes a grant element of at least 35 percent, calculated as follows: the grant element of a debt is the difference between the net present value (NPV) of debt and its nominal value, expressed as a percentage of the nominal value of the debt (i.e., grant element is equal to (nominal value minus NPV) divided by nominal value). The NPV of debt at the time of its disbursement is calculated by discounting the future stream of payments of debt service due on this debt. The discount rates used for this purpose are the currency specific commercial interest reference rates (CIRRs), published by the OECD. For debt with a maturity of at least 15 years, the ten-year average CIRR will be used to calculate the NPV of debt and, hence, its grant element. For debt with a maturity of less than 15 years, the six-month average CIRR will be used. For the purposes of the program through December 2002, the CIRRs published by the OECD in December 2001 will be used (Table 5).
The concessionality of loans in currency baskets will be assessed on the basis of U.S. dollar interest rate tables. For loans with interest rates based on the internal policy of the creditors, the relevant interest rate to define concessionality will be the interest rate for each creditor at the time of the commitment. Loans or portions of loans extended in the context of a debt rescheduling or a debt reduction operation will be excluded from the ceiling.
8. The external payments arrears of the public sector include arrears to multilateral financial institutions, to Paris Club creditors, and to other foreign creditors with whom debt restructuring agreements have been concluded. They exclude arrears outstanding at end-2001 that were not covered under restructuring agreements. The public sector will be defined to include the NFPS, COFIDE, the BCRP, the BN, and any other state development bank.
9. Definitions used in Table 1 of the letter of intent dated November 26, 2002 for the calculation of adjustments to limits and targets for net international reserves:
a. PIPP proceeds in foreign currency are calculated as (a) PIPP proceeds as defined above in Section I.1.c, less (b) domestic currency PIPP proceeds from citizens (Participación Ciudadana) and from Administradoras Privadas de Fondos de Pensiones (AFPs).
b. Net foreign borrowing (Table 2) is defined as the sum of disbursements of loans (I.1.b.i), plus receipts from the issuance of government bonds abroad (I.1.b.ii); minus cash payments of principal (I.1.b.iii); minus cash payments of arrears (principal and interest) (I.1.b.iv); plus the net increase (or minus the decrease) in short-term external debt (I.1.b.v).
c. The withdrawals for portfolio management purposes of deposits held at the BCRP by the FCR and any other fund managed by the ONP, mentioned in footnote 7 of Table 1 attached to the letter of intent refer to placements of funds that are in accord with an investment plan approved by the Board of the FCR, excluding deposits in public financial institutions and government securities.
II. Periodic Reporting
10. The regular reporting will include the following:
(b) Monthly Report
1For purposes of the program for 2002, operations in foreign currency will be valued at S/ 3.54 per U.S. dollar.
2The financial system comprises the banking system, the Corporación Financiera de Desarrollo (COFIDE) and all other nonbank financial intermediaries. The banking system comprises the Central Reserve Bank of Peru (BCRP), the commercial banks, the Banco de la Nación (BN); Banco Agropecuario, and any development bank in liquidation.