## _wp06120 - 1. By Area: Poverty Rate “Extreme Poverty, 2002 ## Source details **Canonical URL:** [_wp06120 - 1. By Area: Poverty Rate “Extreme Poverty, 2002](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp06120.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp06120.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp06120.pdf.json) --- ### Introduction and purpose - Reviews experience and prospects for fiscal decentralization in Peru within a policy context of macroeconomic stability and fiscal prudence. - Focus areas: - Legal framework. - Sequencing of devolution of responsibilities and financing. - Limitations arising from subnational public financial management capabilities. - Decentralization process started in 2002; intended to be gradual, address geographical disparities, and ensure fiscal sustainability. ### Key factual summary and metrics - In 2004, local governments carried out 13 percent of total primary expenditures of general government. - Peru’s decentralization experience is relatively limited and data availability is sparse in many crucial respects. - Local financing composition (2003): - Local revenues accounted for 43 percent of total local government current resources in 2003. - Shared-revenues (canon) and specific program transfers comprised the rest. - Local governments executed 10 percent of general government nonfinancial expenditures in 1999 and about 13 percent in 2004. ### II. Background — Current decentralization process and regional disparities - Decentralization attempt started in 2002 amid sizable geographical income disparities. - Negative correlation between poverty and income levels across departments. - Within departments, poverty rates (INEI, Table 1): - Rural: 50.3 - Urban: 9.7 - Costa: 7.2 - Lima Metropolitana: 2.8 - Selva: 37.8 - Sierra: 43.0 - Risk: Regional disparities may grow if decentralization lacks mechanisms to ensure minimum/reasonably similar provision of public services. ### III. Decentralization and overall fiscal constraints — Subnational share and financing - Medium-term fiscal concern: as subnational governments improve capacity to execute investment projects, their overall primary balance contribution is expected to deteriorate, challenging the NFPS 1 percent of GDP deficit ceiling under the Fiscal Responsibility Transparency Law (FRTL). - Fiscal rules limiting subnational fiscal deterioration include: - 3-year average primary balance must be positive. - Annual real primary expenditure cannot grow more than 3 percent. Key fiscal figures (2003, Table 2; millions of soles): - General government current revenue: 37,259 - Local governments current revenue: 4,590 (includes S./ 2,609 million of current transfers from central to local governments) - General government capital revenue: 382 - Local governments capital revenue: 167 (includes S./ 249 million of capital transfers from central to local governments) - General government current non-interest expenditures: 30,805 - Local governments current expenditures: 2,655 - General government capital expenditures: 5,830 - Local governments capital expenditures: 1,765 - General government interest payments: 4,538 - Local governments interest payments: 111 - Overall balance: General government -3,532; Local governments 227 (Source: MEF) NFPS fiscal operations (percent of GDP, Table 4): - NFPS primary balance: 1995: 0.30; 1996: 1.60; 1997: 2.10; 1998: 1.20; 1999: -0.90; 2000: -0.80; 2001: -0.20; 2002: -0.10; 2003: 0.40; 2004: 1.00. - Interest payments: 1995: 3.50; 1996: 2.70; 1997: 2.00; 1998: 2.20; 1999: 2.40; 2000: 2.50; 2001: 2.30; 2002: 2.20; 2003: 2.20; 2004: 2.10. - Overall balance: 1995: -3.20; 1996: -1.10; 1997: 0.10; 1998: -1.00; 1999: -3.20; 2000: -3.30; 2001: -2.50; 2002: -2.30; 2003: -1.70; 2004: -1.10. (Source: BCRP) ### IV. Legal framework — Constitutional and statutory structure, debt and fiscal rules - 2002 constitution amendment mandated political and fiscal decentralization; established three levels of government (national, regional, local). There are 1,829 municipalities and 26 regional governments in Peru. - Three organic laws enacted: 1. Organic Law of Regional Governments of 2002 (Law No. 27867) 2. Organic Law of Municipalities of 2003 (Law No. 27972) 3. Framework Decentralization Law of 2002 (Law No. 27783) — mandates gradual, fiscally neutral devolution; devolution sequence: social and infrastructure programs first, education and health last. - FRTL (amended 2003) restrictions on subnational operations: - Central government guarantee required for external debt by subnationals. - External debt only to finance public investment. - Debt-to-current revenue ratio and annual debt service-to-current revenue ratio must be below 100 and 25 percent respectively for each subnational government. - 3-year average primary balance of subnational governments must be positive. - FDL (Decree No. 955, early 2004) features: - Two-stage revenue transfer to regions: Stage 1—transfers earmarked for social programs/infrastructure; Stage 2—for merged regions, regions receive 50 percent of certain taxes collected in their jurisdictions (indirect taxes VAT and excises and the personal income tax). - Additional transfers if expenditures (excluding wage bill increases) exceed shared-transfers due to external factors. - Bonus equal to the increase in tax collections above potential level from improved tax administration; bonus earmarked for investment and maintenance of infrastructure. - Regulations (Sept 2005) clarified shared-transfers will not exceed estimated cost associated to devolved functions. - FDL fiscal ceilings and reporting: - Non-guaranteed debt-to-current-revenue ratio < 40 percent; annual non-guaranteed debt service-to-current-revenue ratio < 10 percent. - Domestic/external indebtedness to be used exclusively for investment projects. - 3 percent annual limit on real primary expenditure growth. - Short-term debt (including floating debt) end-year cannot exceed one-twelfth of annual current revenues. - Subnationals must provide medium-term fiscal projections consistent with the three-year Multi-annual Macroeconomic Framework and quarterly fiscal performance reports. - Accreditation System Law (approved July 2004; regulations Nov 2004): - Sets capacity standards and annual devolution procedure. - NDC prepares annual transfer plan; certification timeline: by end-March plan approved, capacity assessment Aug–Sept, certification by end-October for next budget cycle. - Law on Incentives for Integration and Creation of Regions (June 2004): - Referenda held Oct 30, 2005 resulted in 15 of 16 departments rejecting proposed mergers. - A fixed annual transfer for each region created in 2005 referendum would have been S./210 million (equivalent to 0.08 percent of GDP) during four years (per FDL regulations). ### V. Assignments and accountability — Expenditure assignments, own-source revenues, natural resource sharing A. Expenditure assignments - Framework Decentralization Law specifies exclusive vs shared functions and calls for clarification via sectoral transfer plans; responsibilities remain incompletely clarified in practice. - Education and basic health care currently not assigned to local governments; education and health are last functions to be devolved. - Devolution proceeds via NDC annual transfer plans and accreditation; limited devolution since 2003 due to accreditation regulation delays. Devolution of functions (Table 5, number of governments certified in 2003): - Regional governments: Special programs of INADE: Recipient 9, Certified 8. - Regional: Maintenance of rural roads of PROVIAS RURAL: 12 recipients, 4 certified. - Regional: Projects of rural electrification: 17 recipients, 17 certified. - Local: Food programs of PRONAA: 194 recipients, 67 certified. - Local: Maintenance of rural roads of PROVIAS RURAL: 22 recipients, 12 certified. - Local: Reconstruction projects of ORDESUR: 29 recipients, 29 certified. - Local: Social infrastructure projects of FONCODES: 498 recipients, 241 certified. (Source: PRODES) B. Own-source revenues - Local governments lack discretion over tax rates/bases; tax policy determined by Congress; property tax rates centrally determined. - Design notes and recommendations: - Subnational discretion over own-sources is necessary for accountability — e.g., rate bands for real estate tax (predial) with upper and lower bounds. - Local tax administration could be centralized (SUNAT) with "piggy-backing" arrangements where appropriate. - Ensure discretion does not conflict with administrative feasibility and central oversight. C. Sharing of natural resources (canons) - Canon evolution (2000–04, millions nuevos soles; Table 6): - Mining canon: 2000: 55; 2001: 81; 2002: 136; 2003: 286; 2004: 451. - Petroleum canon: 2000: 407; 2001: 333; 2002: 351; 2003: 401; 2004: 440. - Hydro-energy canon: 2000: 0; 2001: 0; 2002: 51; 2003: 92; 2004: 109. - Fishing canon: 2000: 0; 2001: 0; 2002: 0; 2003: 26; 2004: 40. - Forestry canon: 2000: 0; 2001: 0; 2002: 0; 2003: 1; 2004: 1. - Gas canon: 2000: 0; 2001: 0; 2002: 0; 2003: 0; 2004: 73. - Total canon: 2000: 463; 2001: 414; 2002: 539; 2003: 806; 2004: 1114. - Canon as percent of GDP: 2000: 0.25; 2001: 0.22; 2002: 0.27; 2003: 0.38; 2004: 0.48. (Source: MEF) - Canons accrue exclusively to producing local and regional governments, often those with lower poverty rates; distribution risks increasing disparities between producing and non-producing areas. Canon distribution by department (selected entries, Table 7, 2004, millions of soles; includes GDP Per Capita (2003) and Poverty Rate “Extreme Poor”): - Amazonas: Canon 0.5; GDP per capita 2.4; Poverty rate 53.4 - Áncash: Canon 83.3; GDP per capita 4.1; Poverty rate 24.1 - Cajamarca: Canon 186.6; GDP per capita 2.4; Poverty rate 51.5 - Lima y Callao: Canon 47.8; GDP per capita 6.8; Poverty rate 3.8 - Loreto: Canon 193.1; GDP per capita 4.3; Poverty rate 40.8 - Total canon transfers (aggregate): 1112.8 (Source: INEI) D. Earmarking — Impacts and evidence - Earmarking at subnational level is extensive and mostly for investment (e.g., canon fully allocated on origin basis and must be used for capital expenditures). - Other earmarked transfers: FONCOR (regional government compensation fund) allocated to investment projects; Foncomún (municipality compensation fund) can be used partly for current expenditures. - Earmarking consequences: - Limits local government operations and autonomy when combined with absence of own-source revenues and lack of general-purpose transfers. - Earmarking + SNIP investment standards can prevent dissipating nonrenewable-resource receipts but may create capital underspending if administrative capacity is weak. Examples (Table 8 — Cuzco and Cajamarca, 2005, thousand soles): - Municipality of Cuzco total revenues: 35,278; canon 2,498; Foncomun 9,214; other municipal fees 3,307; local-resources 11,674; other transfers 7,960. - Municipality of Cajamarca total revenues: 26,103; canon 15,195; Foncomun 6,094; other municipal fees 1,560; local-resources 2,213; grants and transfers 553; other transfers 488. (Source: Municipality of Cuzco; Municipality of Cajamarca) Capital under-execution examples (Table 9, 2004; thousand soles): - Regional Government of Cajamarca: - Amended budget current 453,621; actual spending current 441,580 (97.3 percent). - Capital amended budget 68,619; actual spending 44,965 (65.5 percent). - Municipality of Lima: - Amended budget current 343,132; actual spending current 334,037 (97.3 percent). - Capital amended budget 303,104; actual spending 131,497 (43.4 percent). (Sources: Regional Government of Cajamarca; Lima municipality) - Earmarking can lead to capital under-spending while floating debt and arrears build up if current commitments exceed non-earmarked resources. E. Managing subnational spending — PFM shortcomings and reforms - Common PFM shortcomings at subnational level: - Fragmented PFM process; SIAF expected to help but requires institutional and procedural preconditions. - Lack of an adequately designed Treasury Single Account at any level; proliferation of government cash balances leading to increased Treasury borrowing, fragmented information, weaker controls. - Weaknesses in timeliness, clarity, transparency, and information flows due to nonstandard and changing budget classifications; chart of accounts not fully aligned with SIAF; accounting often manual and outside SIAF. - Disjointed and weak spending control mechanisms. - Recommended measures: - Revise budget classification to align with international standards and ensure chart of accounts and SIAF reflect it with automatic accounting. - Establish Treasury Single Accounts for each level of government to minimize idle cash balances and reduce arrears/borrowing. - Standardize reporting and accounting across jurisdictions; simplified formats for smallest municipalities. - Participatory budgets (PB) observations: - PB allows citizen participation in identifying/prioritizing investment projects but does not enforce a hard budget constraint. - PB design issues include timetable mismatch with annual budget, lack of clear responsibilities or own-source revenues, constrained monitoring, and absence of sanctions and adequate audit channels. - Debt management and reporting: - Subnationals may contract external or domestic debt under FRTL/FDL limits; central government guarantee required for external debt and counted against central government annual indebtedness limit. - Difficulty estimating municipal debt exposure due to disjointed treatment of debt and absence of centralized risk register covering floating debt, guarantees, contingent liabilities. - World Bank preliminary study: unregistered debt significant (ratio of unregistered to registered debt about 4); debt highly concentrated (40 percent of total debt explained by 20 municipalities); many municipalities not complying with FRTL rules. - General Public Debt Law (July 2005) mandates registration of indebtedness by all levels using SIAF-GL debt module (not yet operational). - Floating debt definition/recording not yet fully addressed; need full information on subnational operations including floating debt and commitments. F. Transfer design — Neutrality and equalization considerations - Transfers should be linked to devolved responsibilities; magnitude calculated when expenditure assignments are determined. - Peru’s range of transfers and automatic transfers (canons) pose risk of exacerbating geographical disparities. - Some transfers (FONCOMUN, FONCOR) distributed based on poverty indicators, demography, unmet basic needs, and capacity to execute investment projects; however, an integrated assessment of transfer effects is lacking. - International best practice suggests equalization mechanisms accounting for differential costs of service provision and capacity to raise own-source revenues; Peru needs to consider such mechanisms given topography and linguistic differences. ### VI. Conclusions — Sequencing, transparency, and capacity - Decentralization effort in Peru is grounded in prudent fiscal sustainability but requires additional work to deepen decentralization and strengthen incentives for effective subnational governance. - Critical sequencing priorities: - Clarify spending responsibilities across tiers of government. - Increase reliance on own-source revenues for subnational administrations. - Establish more transparent and equitable transfer mechanisms to avoid exacerbating regional disparities. - Significantly strengthen subnational administrative capacity and public financial management. - Require standardized information on all government operations, including floating debt and buildup of commitments. *Source: IMF staff analysis of Peru decentralization (sections II–VI) as contained in the provided content unit.* ### 1. By Area: Poverty Rate “Extreme Poverty, 2002 ...........................................................4 ### _wp06120 - 1. By Area: Poverty Rate “Extreme Poverty, 2002 ### Introduction and purpose - The paper reviews the experience and prospects for fiscal decentralization in Peru within a policy context of macroeconomic stability and fiscal prudence. - Focus is on: legal framework, sequencing of devolution of responsibilities and financing, and limitations from subnational public financial management capabilities. - The decentralization process in Peru started in 2002 and is intended to be gradual, address geographical disparities, and ensure fiscal sustainability. ### Key factual summary and metrics - In 2004, local governments carried out 13 percent of total primary expenditures of general government. - The paper emphasizes Peru’s relatively limited experience with decentralization as of the time of writing and notes a paucity of available information in many crucial respects. ### Structure of the paper (topics covered) - Historical background to the current decentralization debate (Section II). - Decentralization placed in the context of the overall fiscal framework (Section III). - Summary of the legal framework underlying current decentralization efforts (Section IV). - Review of the components of the decentralization process (Section V), specifically: - Evolving spending responsibilities. - Design of own-source revenues. - Current focus on revenue-sharing, including natural resource revenues. ### Analytical emphasis and approach - The paper concentrates on an overview of the legal framework and its implementation to date, given limited decentralization experience and data availability. - Attention is given to the sequencing of spending and the devolution of responsibilities and revenue assignments. - The analysis raises issues for future work, notably concerning capability constraints at subnational levels and the fiscal sustainability of the devolution path. *Source: _wp06120 - 1. By Area: Poverty Rate “Extreme Poverty, 2002 (PDF chapter/section).* ### Section V also examines the fiscal transfer system. The role of the public financial ### Section V also examines the fiscal transfer system. The role of the public financial management system on the sequencing of decentralization is discussed. ### II. BACKGROUND — Current decentralization process and regional disparities - Decentralization attempt started in 2002 amid sizable geographical income disparities. - Income (GDP per capita) is distributed unevenly across departments; clear negative correlation between poverty and income levels across departments. - Within departments, poverty rates: - Rural: 50.3 - Urban: 9.7 - Costa: 7.2 - Lima Metropolitana: 2.8 - Selva: 37.8 - Sierra: 43.0 (Source: INEI, Table 1) - Regional disparities risk growing imbalances in incomes and public services if decentralization lacks mechanisms to ensure minimum/ reasonably similar provision of public services. ### III. DECENTRALIZATION AND OVERALL FISCAL CONSTRAINTS — Subnational share and financing - Local governments executed 10 percent of general government nonfinancial expenditures in 1999 and about 13 percent in 2004. - Local financing composition (2003): - Local revenues accounted for 43 percent of total local government current resources in 2003. - Shared-revenues (canon) and specific program transfers comprised the rest. - Medium-term fiscal concern: as subnational governments improve capacity to execute investment projects, their overall primary balance contribution is expected to deteriorate, challenging the NFPS 1 percent of GDP deficit ceiling under the Fiscal Responsibility Transparency Law (FRTL). - Fiscal rules limiting subnational fiscal deterioration include: - 3-year average primary balance must be positive. - Annual real primary expenditure cannot grow more than 3 percent. Key fiscal figures (2003, Table 2; millions of soles): - General government current revenue: 37,259 - Local governments current revenue: 4,590 (includes S./ 2,609 million of current transfers from central to local governments) - General government capital revenue: 382 - Local governments capital revenue: 167 (includes S./ 249 million of capital transfers from central to local governments) - General government current non-interest expenditures: 30,805 - Local governments current expenditures: 2,655 - General government capital expenditures: 5,830 - Local governments capital expenditures: 1,765 - General government interest payments: 4,538 - Local governments interest payments: 111 - Overall balance: General government -3,532; Local governments 227 (Source: MEF) NFPS fiscal operations (percent of GDP, Table 4): - NFPS primary balance: 1995: 0.30; 1996: 1.60; 1997: 2.10; 1998: 1.20; 1999: -0.90; 2000: -0.80; 2001: -0.20; 2002: -0.10; 2003: 0.40; 2004: 1.00. - Interest payments: 1995: 3.50; 1996: 2.70; 1997: 2.00; 1998: 2.20; 1999: 2.40; 2000: 2.50; 2001: 2.30; 2002: 2.20; 2003: 2.20; 2004: 2.10. - Overall balance: 1995: -3.20; 1996: -1.10; 1997: 0.10; 1998: -1.00; 1999: -3.20; 2000: -3.30; 2001: -2.50; 2002: -2.30; 2003: -1.70; 2004: -1.10. (Source: BCRP) ### IV. LEGAL FRAMEWORK — Constitutional and statutory structure, debt and fiscal rules - 2002 constitution amendment mandated political and fiscal decentralization; established three levels of government (national, regional, local). There are 1,829 municipalities and 26 regional governments in Peru. - Three organic laws enacted: 1. Organic Law of Regional Governments of 2002 (Law No. 27867) 2. Organic Law of Municipalities of 2003 (Law No. 27972) 3. Framework Decentralization Law of 2002 (Law No. 27783) — mandates gradual, fiscally neutral devolution; devolution sequence: social and infrastructure programs first, education and health last. - FRTL (amended 2003) restrictions on subnational operations: - Central government guarantee required for external debt by subnationals. - External debt only to finance public investment. - Debt-to-current revenue ratio and annual debt service-to-current revenue ratio must be below 100 and 25 percent respectively for each subnational government. - 3-year average primary balance of subnational governments must be positive. - FDL (Decree No. 955, early 2004): - Two-stage revenue transfer to regions: Stage 1—transfers earmarked for social programs/infrastructure; Stage 2—for merged regions, regions receive 50 percent of certain taxes collected in their jurisdictions (indirect taxes VAT and excises and the personal income tax). - Additional transfers if expenditures (excluding wage bill increases) exceed shared-transfers due to external factors. - Bonus equal to the increase in tax collections above potential level from improved tax administration; bonus earmarked for investment and maintenance of infrastructure. - Regulations (Sept 2005) clarified shared-transfers will not exceed estimated cost associated to devolved functions. - Additional FDL fiscal ceilings and reporting: - Non-guaranteed debt-to-current-revenue ratio < 40 percent; annual non-guaranteed debt service-to-current-revenue ratio < 10 percent. - Domestic/external indebtedness to be used exclusively for investment projects. - 3 percent annual limit on real primary expenditure growth. - Short-term debt (including floating debt) end-year cannot exceed one-twelfth of annual current revenues. - Subnationals must provide medium-term fiscal projections consistent with the three-year Multi-annual Macroeconomic Framework and quarterly fiscal performance reports. - Accreditation System Law (approved July 2004; regulations Nov 2004) sets capacity standards and annual devolution procedure; NDC prepares annual transfer plan; certification timeline: by end-March plan approved, capacity assessment Aug–Sept, certification by end-October for next budget cycle. - Law on Incentives for Integration and Creation of Regions (June 2004) provided incentives for voluntary mergers; referenda held Oct 30, 2005 resulted in 15 of 16 departments rejecting proposed mergers; a fixed annual transfer for each region created in 2005 referendum would have been S./210 million (equivalent to 0.08 percent of GDP) during four years (per FDL regulations). ### V. ASSIGNMENTS AND ACCOUNTABILITY — Expenditure assignments, own-source revenues, natural resource sharing A. Expenditure assignments - Framework Decentralization Law specifies exclusive vs shared functions and calls for clarification via sectoral transfer plans; in practice responsibilities remain incompletely clarified. - Education and basic health care currently not assigned to local governments; education and health are last functions to be devolved. - Devolution proceeds gradually via NDC annual transfer plans and accreditation; 2003/2004 transfer plan included social and infrastructure programs; limited devolution since 2003 due to accreditation regulation delays. - Devolution of functions (Table 5, number of governments certified in 2003): - Regional governments: Special programs of INADE: Recipient 9, Certified 8. - Regional: Maintenance of rural roads of PROVIAS RURAL: 12 recipients, 4 certified. - Regional: Projects of rural electrification: 17 recipients, 17 certified. - Local: Food programs of PRONAA: 194 recipients, 67 certified. - Local: Maintenance of rural roads of PROVIAS RURAL: 22 recipients, 12 certified. - Local: Reconstruction projects of ORDESUR: 29 recipients, 29 certified. - Local: Social infrastructure projects of FONCODES: 498 recipients, 241 certified. (Source: PRODES) B. Own-source revenues - Local governments lack discretion over tax rates/bases; tax policy determined by Congress; even property tax rates are centrally determined. - Recommendations / design notes: - Subnational discretion over own-sources is necessary for accountability — e.g., rate bands for real estate tax (predial) with upper and lower bounds. - Local tax administration could be centralized (SUNAT) with "piggy-backing" arrangements where appropriate. - Ensure discretion does not conflict with administrative feasibility and central oversight. C. Sharing of natural resources (canons) - Canon evolution (2000–04, millions nuevos soles; Table 6): - Mining canon: 2000: 55; 2001: 81; 2002: 136; 2003: 286; 2004: 451. - Petroleum canon: 2000: 407; 2001: 333; 2002: 351; 2003: 401; 2004: 440. - Hydro-energy canon: 2000: 0; 2001: 0; 2002: 51; 2003: 92; 2004: 109. - Fishing canon: 2000: 0; 2001: 0; 2002: 0; 2003: 26; 2004: 40. - Forestry canon: 2000: 0; 2001: 0; 2002: 0; 2003: 1; 2004: 1. - Gas canon: 2000: 0; 2001: 0; 2002: 0; 2003: 0; 2004: 73. - Total canon: 2000: 463; 2001: 414; 2002: 539; 2003: 806; 2004: 1114. - Canon as percent of GDP: 2000: 0.25; 2001: 0.22; 2002: 0.27; 2003: 0.38; 2004: 0.48. (Source: MEF) - Canons accrue exclusively to producing local and regional governments, often those with lower poverty rates; distribution risks increasing disparities between producing and non-producing areas. - Canon distribution by department (selected entries, Table 7, 2004, millions of soles; includes Gross Domestic Product Per Capita (2003) and Poverty Rate “Extreme Poor”): - Amazonas: Canon 0.5; GDP per capita 2.4; Poverty rate 53.4 - Áncash: 83.3; 4.1; 24.1 - Cajamarca: 186.6; 2.4; 51.5 - Lima y Callao: 47.8; 6.8; 3.8 - Loreto: 193.1; 4.3; 40.8 - Total canon transfers (aggregate): 1112.8 (Table 7 total) (Source: INEI) ### D. Earmarking — Impacts and evidence - Earmarking extensive at subnational level, mostly for investment (e.g., canon fully allocated on origin basis and must be used for capital expenditures). - Other earmarked transfers: FONCOR (regional government compensation fund) allocated to investment projects; Foncomún (municipality compensation fund) can be used partly for current expenditures. - Earmarking consequences: - Limits local government operations and autonomy when combined with absence of own-source revenues and lack of general-purpose transfers. - Earmarking + SNIP investment standards can prevent dissipating nonrenewable-resource receipts but may create capital underspending if administrative capacity is weak. - Examples (Table 8 — Cuzco and Cajamarca, 2005, thousand soles): - Municipality of Cuzco total revenues: 35,278; breakdown by revenue sources and expenditures shown in Table 8 (canon 2,498; Foncomun 9,214; other municipal fees 3,307; local-resources 11,674; other transfers 7,960). - Municipality of Cajamarca total revenues: 26,103; canon 15,195; Foncomun 6,094; other municipal fees 1,560; local-resources 2,213; grants and transfers 553; other transfers 488. (Source: Municipality of Cuzco; Municipality of Cajamarca) - Capital under-execution examples (Table 9, 2004; thousand soles): - Regional Government of Cajamarca: Amended budget current 453,621; actual spending current 441,580 (97.3 percent). Capital amended budget 68,619; actual spending 44,965 (65.5 percent). - Municipality of Lima: Amended budget current 343,132; actual spending current 334,037 (97.3 percent). Capital amended budget 303,104; actual spending 131,497 (43.4 percent). (Sources: Regional Government of Cajamarca; Lima municipality) - Earmarking can lead to capital under-spending while floating debt and arrears build up if current commitments exceed non-earmarked resources. ### E. Managing subnational spending — PFM shortcomings and reforms - Common PFM shortcomings at subnational level: - Fragmented PFM process; SIAF expected to help but requires institutional and procedural preconditions. - Lack of an adequately designed Treasury Single Account at any level; proliferation of government cash balances leading to increased Treasury borrowing, fragmented information, weaker controls. - Weaknesses in timeliness, clarity, transparency, and information flows due to nonstandard and changing budget classifications; chart of accounts not fully aligned with SIAF; accounting often manual and outside SIAF. - Disjointed and weak spending control mechanisms. - Recommendations / needs: - Revise budget classification to align with international standards and ensure chart of accounts and SIAF reflect it with automatic accounting. - Establish Treasury Single Accounts for each level of government to minimize idle cash balances and reduce arrears/borrowing. - Standardize reporting and accounting across jurisdictions; simplified formats for smallest municipalities. - Participatory budgets (PB): - PB allows citizen participation in identifying/prioritizing investment projects but does not enforce a hard budget constraint. - PB design issues: - Timetable mismatch between PB and entity annual budget; creates false expectations. - Lack of clear responsibilities or own-source revenues weakens prioritization incentives. - Monitoring constrained by reporting/information limitations. - No sanctions for non-delivery and inadequate audit channels. - Debt management and reporting: - Subnationals may contract external or domestic debt under FRTL/FDL limits; central government guarantee required for external debt and counted against central government annual indebtedness limit. - Difficulty estimating municipal debt exposure due to disjointed treatment of debt and absence of centralized risk register covering floating debt, guarantees, contingent liabilities. - World Bank preliminary study: unregistered debt significant (ratio of unregistered to registered debt about 4); debt highly concentrated (40 percent of total debt explained by 20 municipalities); many municipalities not complying with FRTL rules. - General Public Debt Law (July 2005) mandates registration of indebtedness by all levels using SIAF-GL debt module (not yet operational). - Floating debt definition/recording not yet fully addressed; need full information on subnational operations including floating debt and commitments. ### F. Transfer design — Neutrality and equalization considerations - Transfers should be linked to devolved responsibilities; magnitude calculated when expenditure assignments are determined. - Peru’s range of transfers and automatic transfers (canons) pose risk of exacerbating geographical disparities. - Some transfers (FONCOMUN, FONCOR) distributed based on poverty indicators, demography, unmet basic needs, and capacity to execute investment projects; however, overall integrated assessment of transfer effects is lacking. - International best practice suggests equalization mechanisms accounting for differential costs of service provision and capacity to raise own-source revenues; Peru needs to consider such mechanisms given topography and linguistic differences. ### VI. CONCLUSIONS — Sequencing, transparency, and capacity - Decentralization effort in Peru based on prudent fiscal sustainability but requires additional work to deepen decentralization and strengthen incentives for effective subnational governance. - Critical sequencing priorities: - Clarify spending responsibilities across tiers of government. - Increase reliance on own-source revenues for subnational administrations. - Establish more transparent and equitable transfer mechanisms to avoid exacerbating regional disparities. - Significantly strengthen subnational administrative capacity and public financial management. - Require standardized information on all government operations, including floating debt and buildup of commitments. _Italic: Source: IMF staff analysis of Peru decentralization (sections II–VI) as contained in the provided content unit._ ### References ### _wp06120 - References ### Bibliographic entries - Ahmad, Ehtisham, ed., 1997, Financing Subnational Expenditures, an International Comparison of Grants (Cheltenham, UK: Edward Elgar). - Ahmad, Ehtisham, María Albino-War, and Raju Singh, 2006, “Subnational Public Financial Management: Institutions and Macroeconomic Considerations,” in Handbook of Fiscal Federalism, ed. by Ehtisham Ahmad and Giorgio Brosio (Northampton, Massachusetts: Edward Elgar). - Ahmad, Ehtisham and Maria Albino-War, eds., 2006, Managing Subnational Finances (Washington: International Monetary Fund). - Ahmad, Ehtisham, and Robert J. Searle, 2006, “On the Implementation of Transfers to Subnational Governments,” in Handbook of Fiscal Federalism, ed. by Ehtisham Ahmad and Giorgio Brosio (Northampton, Massachusetts: Edward Elgar). - Casas, C., and G. Yamada, 2005, “Medición de impacto en el nivel de vida de la población del desempeño macroeconómico para el período 2001–04,” Universidad del Pacífico. Documento de trabajo. - Dabán, Teresa, 2004, Peru—“Fiscal Decentralization in Latin America: Lessons for Peru,” in Peru: Selected Issues, IMF Staff Country Report No 04/156 (Washington: International Monetary Fund). *Source: _wp06120 - References* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp06120.pdf_