Press Release No. 07/15

Press Release: IMF Executive Board Approves US$258 Million Stand-By Arrangement for Peru

January 26, 2007

The Executive Board of the International Monetary Fund (IMF) today approved a 25-month SDR 172.4 million (about US$257.7 million) Stand-By Arrangement for Peru to support the country's economic program. The Peruvian authorities have indicated their intention to treat the arrangement as precautionary.

The main objectives of the Fund-supported program are to consolidate macroeconomic stability, tackle high poverty levels, strengthen the resilience and depth of the financial system, and press ahead with growth-enhancing reforms.

Following the Executive Board discussion, Murilo Portugal, Deputy Managing Director and Acting Chair, said:

"Over the past several years, Peru has implemented sound economic policies which, in the context of a favorable external environment, have resulted in the longest economic expansion on record, low inflation, a robust external position, and declining vulnerabilities. The new authorities are taking measures to further improve this excellent performance during 2007-08.

"At the same time, Peru still faces important challenges. Half of the population lives in poverty, and structural weaknesses continue to constrain growth. To address these challenges, the authorities' program for 2007-08 aims at consolidating macroeconomic stability and implementing reforms to boost growth prospects, while tackling high poverty. To support the program, the authorities have requested a successor 25-month Stand-By Arrangement.

"Fiscal prudence remains the backbone of the authorities' program. Following a strong surplus in 2006, the public sector result in 2007-08 is expected to remain below the deficit ceiling set out in the Fiscal Responsibility and Transparency Law. This will help ensure that pressing social and infrastructure needs are addressed while the public-debt-to-GDP ratio remains on a downward path.

"Monetary policy continues to be guided by the inflation targeting framework, aimed at keeping inflation within the 1½-3½ percent official range. The authorities intend to gradually introduce more flexibility in exchange rate management in order to further enhance the credibility of the inflation targeting framework, help economic agents better internalize currency risks, and provide more incentives for hedging. This will reduce dollarization and help develop the domestic capital market.

"Structural reforms remain an important building block of the authorities' program. Reforms will aim, inter alia, at strengthening the effectiveness of the tax system, improving the quality of public spending, and providing a legal framework for public-private partnerships. The effectiveness of social assistance programs is to be enhanced in the context of a comprehensive anti-poverty strategy. Decentralization would proceed in a manner consistent with the implementation of high-quality investment projects under the auspices of the National System of Public Investment and with sound public finances. Other reforms will aim at reducing risks associated with financial dollarization, strengthening the financial regulatory framework, improving the business environment, reducing the size of the informal labor market, and sustaining trade liberalization," Mr. Portugal said.

ANNEX

Recent Developments

Supported by a favorable external environment, the Peruvian economy has continued to expand at a rapid pace during 2006, with inflation well contained and an improved external position. During January-November 2006, real GDP grew by 7½ percent year-on-year, propelled by a sharp increase in the terms of trade and strong domestic demand, which has been underpinned by growing investment as well as higher incomes and rising employment. After peaking at 2.9 percent in April, 12-month inflation abated to around 1.1 percent in December 2006. Strong export performance, including for nontraditional exports, has boosted the current account surplus, while net international reserves have reached US$17.3 billion at end-2006, about 150 percent of foreign currency deposits at commercial banks.

Fiscal policy has continued to strengthen, and the combined public sector is estimated to have recorded a surplus of about 1½ percent of GDP in 2006. On the back of buoyant revenues, expenditure growth has been strong, estimated to have risen by 9 percent in real terms. Public sector debt is estimated to have declined to 31½ percent of GDP by end-2006, about 15 percentage points below its 2002 levels.

Notwithstanding this strong economic performance, the challenges faced by Peru are significant and pressing. Half the population lives in poverty and structural weaknesses need to be addressed to lower underemployment and continue to boost employment creation in the formal sector, as well as economic growth, while reducing poverty decisively. To achieve these objectives, maintaining an environment favorable to foreign direct investment and trade openness will be critical to growth prospects in the mining sector and to help diversify the productive structure toward nontraditional labor-intensive sectors. Enhancing the provision and quality of services to the poorest areas of the country would be fundamental to tackle poverty decisively, while more flexible labor regulations would help absorb a growing labor force into the formal sector and strengthen anti-poverty efforts.

Program Summary

The 2007-08 program is based on the policies needed to address Peru's key challenges and aims at consolidating macroeconomic stability, reducing poverty swiftly, strengthening the resilience and depth of the financial system, and advancing other reforms to enhance the business environment.

The most important objectives of the authorities' new program are:

Consolidation of macroeconomic stability. Fiscal targets for 2007-08 are well within the 1 percent of GDP deficit ceiling in the Fiscal Responsibility and Transparency Law, helping entrench macroeconomic stability and keep the public debt-to-GDP ratio on a downward path. The government intends to adopt measures to lower distortionary taxes and exemptions and to improve the quality of public spending. Greater exchange rate flexibility will solidify the credibility of the inflation targeting framework.

Tackling high poverty. An action plan to strengthen current efforts at poverty alleviation will be elaborated, mainly to enhance the effectiveness and scope of social assistance programs, as these programs are numerous and to ensure that the resources reach the targeted population.

Strengthening and deepening the financial system. Reducing dollarization, particularly of mortgage loans is a critical objective, as this will help to fortify the resilience of the banking system. These efforts will be assisted by measures to allow for a better internalization of risks and to further develop domestic capital markets.

Growth-enhancing reforms. Reforms will focus on continuing to improve the business environment, including by simplifying regulatory requirements and extending commercial courts nationwide. Efforts will also be made to enhance labor market flexibility and to further liberalize external trade, critical for boosting competitiveness. In late December, the authorities lowered average import tariff rates from 10.1 percent to 8.3 percent, effective January 1, 2007.