Document of The World Bank For Official Use Only Report No. 54858-PE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT FOR A PROPOSED FOURTH PROGRAMMATIC FISCAL MANAGEMENT AND COMPETITIVENESS DEVELOPMENT POLICY LOAN IN THE AMOUNT OF US$100 MILLION TO THE REPUBLIC OF PERU July 16, 2010 Poverty Reduction and Economic Management Bolivia- Chile- Ecuador-Peru-Venezuela Country Management Unit Latin America and Caribbean Region This document is being made publicly available prior to Board consideration. This does not imply a presumed outcome. This document may be updated following Board consideration and the updated document will be made publicly available in accordance with the Bank's Policy on Access to Information. REPUBLIC OF PERU FISCAL YEAR January 1­December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective July 15, 2010) Currency Unit = Nuevos Soles 2.82 Nuevos Soles = US$1 WEIGHTS AND MEASURES Metric System SELECTED ABBREVIATIONS AND ACRONYMS AAA Analytical and Advisory Activities BCRP Banco Central de Reserva del Perú (Central Reserve Bank of Peru) CAF Corporación Andina de Fomento (Andean Development Corporation) CAR Capital Adequacy Ratio CFAA Country Financial Accountability Assessment CGR Contraloría General de la República (Comptroller General) CNC Comisión Nacional de Competitividad (National Competitiveness Commission) COFIDE Corporación Financiera para el Desarrollo (Financial Corporation for Development) CONASEV Comisión Nacional Supervisora de Empresas y Valores (National Stock and Business Supervisory Commission) CONFIEP Confederación Nacional de Instituciones Empresariales Privadas (Business Association) CPAR Country Procurement Assessment Report CPS Country Partnership Strategy CY Calendar Year DDO Deferred Draw Down Option DGPM General Directorate of Multi-annual Public Sector Programming DIGESA Dirección General de Salud Ambiental (General Environmental Health Direction) DNEP Dirección Nacional del Endeudamiento Público (Debt Office) DNI Documento Nacional de Identidad (National Identity Card) DNPP Dirección Nacional de Presupuesto Público (National Office of Public Budgeting) DPL Development Policy Loan EFTA European Free Trade Association EMBI Emerging Markets Bond Index EU European Union FDI Foreign Direct Investment FIDECOM Fondo de Investigación y Desarrollo para la Competitividad FINCYT Science and Technology Fund FMCDPL Fiscal Management and Competitiveness Development Policy Loan FOGEM Fondo de Garantía Empresarial (Business Guaranty Fund) FONCAM Fondo Nacional de Camisea (National Camisea Fund) FONCOMUN Fondo de Compensación Municipal (Municipal Compensation Fund) FONCOR Fondo de Compensación Regional (Regional Compensation Fund) FONIPREL Fondo de Promoción a la Inversión Pública Regional y Local (Regional and Local Investment Fund). FRTL Fiscal Responsibility and Transparency Law FSAP Financial Sector Assessment Program FSL Fixed Spread Loan FTA Free Trade Agreement FY Fiscal Year GDP Gross Domestic Product GNI Gross National Income GoP Government of Peru GTZ German Agency for Technical Cooperation IADB Inter-American Development Bank IBRD International Bank for Reconstruction and Development ICT Information and Communications Technology IDF Institutional Development Fund IFC International Finance Corporation IMF International Monetary Fund INEI Instituto Nacional de Estadística e Informática (National Statistics Institute) JBIC Japan Bank of International Cooperation KfW German Development Bank LAC Latin America and Caribbean LPTF Ley de Prudencia y Transparencia Fiscal (Law of Fiscal Prudence and Transparency Law) LRTF Ley de Responsabilidad y Transparencia Fiscal (Law of Fiscal Responsibility and Transparency) M&E Monitoring and Evaluation MDO Ministries, Departments and Other government agencies MEF Ministerio de Economía y Finanzas (Ministry of Economy and Finance) MEL Mining Environmental Legacies MIC Middle Income Country MINCETUR Ministerio de Comercio Exterior y Turismo (Ministry of Trade and Tourism) MINEDU Ministerio de Educación (Ministry of Education) MMM Marco Marcroeconómico Multianual (Multiannual Macroeconomic Framework) MSME Micro, small and medium enterprises NFPS Non-financial public sector NPL Non-performing loan OECD Organization for Economic Cooperation and Development OEFA Environmental Evaluation and Enforcement Office ONGEI Oficina Nacional de Gobierno Electrónico e Informática (Information Technology and E-government National Office) OSCE Organismo Supervisor de las Contrataciones del Estado (Public Contracts Supervisor Organization) PBB Performance-Based Budgeting PCM Presidencia del Consejo de Ministros (Office of the Prime Minister) PER Public Expenditure Review PFM Public Financial Management PIT Programas Institucionales (Institutional Programs) PRODUCE Ministerio de la Producción (Ministry of Production) RER Régimen Especial del Impuesto a la Renta (Special Income Tax Regime) ROSC Report on Observance of Standards and Codes RUC Registro Único de Contribuyentes (Single Taxpayer Registry) RUS Régimen Único Simplificado (Unique Simplified Regime) R&D Research and Development SBA Stand-By Arrangement SBS Superintendencia de Banca y Seguros (Superintendence of Banks and Insurance Companies) SDC Swiss Agency for Development and Cooperation SENASA Servicio Nacional de Sanidad Agraria (National Agriculture Health System) SIAF Sistema Integrado de Administración Financiera (Integrated Financial Management System) SNIP Sistema Nacional de Inversión Pública (National System of Public Investment) SUNARP Sistema Nacional de Registros Públicos (National System for Public Registry) SUNAT Superintendencia Nacional de Administración Tributaria (Government Tax Agency) TAL Technical Assistance Loan TSA Treasury Single Account UCPS Unidad de Coordinación de Préstamos Sectoriales (Sectoral Loans Coordination Unit) UN United Nations US United States USAID United States Agency for International Development VAT Value Added Tax VUCE Ventanilla Única de Comercio Exterior (One Stop Shop for Foreign Trade) Vice President: Pamela Cox Country Director: Carlos Felipe Jaramillo Sector Director Marcelo Giugale Sector Manager: Rodrigo A. Chaves Sector Leader Carlos Silva-Jauregui Task Team Leaders: Paloma Anos-Casero Oscar Calvo-Gonzalez i ACKNOWLEDGEMENTS The World Bank Group greatly appreciates the close collaboration of the Government of Peru in the preparation of this development policy loan. This DPL was prepared by a team composed of Oscar Calvo-González, Paloma Anós-Casero, Enrique Fanta, Javier Illescas, Rogelio Marchetti, Diana Ortiz Sosa, José Valderrama, Lourdes Consuelo Linares, Florencia Liporaci, Francisco Rodriguez, Emmy Yokoyama, Milagro Mayuri and Guillermo Lagarda. Valuable inputs were received from Omar Arias, Fernando Rojas, Livia Benavides, Nelson Gutierrez, Ines Kudo, Ian Walker and Raul Tolmos. The DPL also benefited from the excellent support provided by the legal team (Teresa Genta-Fons, Solange Alliali and Viviana Maya). The team was lead by Paloma Anós-Casero (LCSPE, co-task manager) and Oscar Calvo-Gonzalez (LCSPE, co-task manager) and worked under the guidance of Carlos Felipe Jaramillo (Director, LCC6C), Marcelo Giugale (Director, LCSPR), Rodrigo A. Chaves (Sector Manager, LCSPE) and Carlos Silva-Jauregui (Lead Economist and Sector Leader, LCSPR). Paulo Guilherme Correa (ECSF1) and Juan Carlos Mendoza (LCRVP) are peer reviewers. ii PERU FOURTH PROGRAMMATIC FISCAL MANAGEMENT AND COMPETITIVENESS DEVELOPMENT POLICY LOAN TABLE OF CONTENTS LOAN AND PROGRAM SUMMARY ..........................................................................................v I. Introduction ..............................................................................................................................6 II. Country Context .......................................................................................................................7 A. Economic Developments ....................................................................................................... 7 B. Macroeconomic Outlook and Debt Sustainability ............................................................... 10 III. The Government Program and Participatory Processes .........................................................12 IV. Bank Support to the Government Program ............................................................................14 A. Link to the Partnership Strategy and Other Bank Operations.............................................. 14 B. Collaboration with the IMF and Other Donors .................................................................... 15 C. Lessons Learned................................................................................................................... 17 D. Analytic Underpinnings ....................................................................................................... 17 V. The Proposed Operation .........................................................................................................18 A. Operation Description .......................................................................................................... 18 B. Policy Areas ......................................................................................................................... 20 1. Efficiency and Quality of Fiscal Management .......................................................................23 2. Competitiveness .....................................................................................................................32 VI. Operation Implementation ......................................................................................................38 A. Poverty and Social Impact ................................................................................................... 38 B. Implementation, Monitoring and Evaluation ....................................................................... 41 C. Fiduciary Arrangements ....................................................................................................... 41 D. Disbursement and Audits ..................................................................................................... 43 E. Environmental Aspects ........................................................................................................ 44 F. Risks and Risk Mitigation .................................................................................................... 45 Annex 1. Fiscal and External Debt Sustainability Analysis ..........................................................48 Annex 2. Letter of Development Policy ........................................................................................53 Annex 3. Fourth Programmatic Fiscal Management and Competitiveness DPL Program Matrix .............................................................................................................66 Annex 4. Results Framework: Monitoring Progress on Outcome Indicators ................................71 Annex 5. Peru-IMF Relations ........................................................................................................75 Annex 6: Analytical and Advisory Work Underpinning the proposed operation .........................78 Annex 7. Peru At A Glance ...........................................................................................................81 Map of Peru....................................................................................................................................84 iii Tables Table 1: Key Economic Indicators (percent unless otherwise noted)............................................. 9 Table 2: Government Economic and Social Targets, 2006-11 ..................................................... 12 Table 3. Fourth Fiscal Management and Competitiveness DPL Program Matrix ........................ 21 Table 4: Poverty Rates, 2004-2009 (percent) .............................................................................. 40 Figures Figure 1: Real GDP growth ............................................................................................................ 8 Figure 2: EMBI Global spreads ...................................................................................................... 8 Figure 3: Total and food inflation ................................................................................................. 10 Figure 4: Exchange rate ................................................................................................................ 10 Figure 5: Peru's Competitiveness Ranking................................................................................... 32 Figure 6: Peru Export Composition .............................................................................................. 33 Figure 7: Human opportunity index, change from 1995 to 2006 ................................................. 41 Boxes Box 1: Good Practice Principles on Conditionality ...................................................................... 19 Box 2: Social Conflict in Peru ...................................................................................................... 47 iv REPUBLIC OF PERU FOURTH PROGRAMMATIC FISCAL MANAGEMENT AND COMPETITIVENESS DEVELOPMENT POLICY LOAN LOAN AND PROGRAM SUMMARY Borrower Republic of Peru Implementing Ministry of Economy and Finance Agency Financing Data IBRD Loan Amount: US$100 million Terms: Commitment linked variable interest rate loan, payable in 13.5 years, including 11 years of grace period, following a customized repayment schedule. Operation Type Single Tranche Development Policy Loan to be disbursed upon loan effectiveness. The loan agreement includes as a condition of effectiveness that the Bank be satisfied with the progress achieved by the Borrower in carrying out the Program and with the adequacy of the Borrower's macroeconomic policy framework. The loan closing date is 31, December, 2011. Main Policy Areas The proposed DPL is the fourth in a series of four loans aimed at supporting the Government of Peru's (GoP) reform program to improve the functioning of the country's public sector institutions and business environment. The loan supports two broad areas of policy reform: Efficiency and Quality of Fiscal Management Competitiveness Key Outcome The proposed loan will contribute to the achievement of the following outcomes: Indicators Strengthening the GoP's fiscal position and overall fiscal framework, with timely budget financing at reasonable terms; Improving the efficiency and quality of public spending with the objective of allowing for budgetary savings that could be directed towards priority poverty programs as well as more and higher quality public services for citizens; and Expanding international trade and improving the business environment with particular emphasis on small and medium enterprises that are critical to create jobs. For further details on key outcome indicators please see a complete Results Framework Matrix in Annex 4. Program The proposed loan supports progress towards medium-term program outcomes related to three Development CPS objectives: (i) maintaining macro stability (pillar I-cluster I), (ii) accelerating growth and Objectives and widening the base of growth (pillar I-cluster II), and (iii) modernizing institutions (pillar III-cluster Contribution to CPS VI). Risks and Risk There are two key sources of risks associated with the proposed loan: Mitigation Economic: Peru remains exposed to downside risks stemming from renewed uncertainty in international financial markets and doubts about the pace of the global economic recovery. The exposure to commodities remains high, as demand from fast growing emerging economies is shifting the destination of Peruvian exports. The program supported by the World Bank and this operation; in particular, contribute to the mitigation of these risks. The implementation of performance-based budgeting and technical assistance work on procurement to improve public investment capacity are examples of mitigating factors. Commitment to structural reforms and broad national consensus on the macroeconomic pillars remains strong. The decision by the authorities to curb the expansionary stance of fiscal policy demonstrates their commitment to regain fiscal space and is particularly noteworthy in light of the upcoming presidential elections to take place in April 2011. Political and social: Risks arising from social unrest tend to be correlated with high levels of poverty and inequality. These risks could be exacerbated if economic activity deteriorates substantially. Imperfect conflict resolution mechanisms with disaffected social groups remain a challenge to political stability. However, continued improvements in social safety nets and other social programs, a more equitable flow of resources to the country's regions, and an increase in spending on public investment assist in ameliorating social and political risks. Project ID Number P116214 v I. Introduction 1. This proposed Development Policy Loan for US$100 million is the fourth and last in a programmatic series of Fiscal Management and Competitiveness Development Policy Loans (FMCDPL). The FMCDPL series, along with parallel Development Policy Loans (DPLs) in the areas of social policy and environment, were designed in close partnership with Government of Peru (GoP) and in line with its policy program­ as outlined in the Country Partnership Strategy (CPS). The GoP stated a clear vision for: (i) building on recent economic successes to achieve higher growth and better social outcomes; (ii) constructing a better social contract between the government and citizens based on effective social development; and (iii) modernizing state institutions. This FMCDPL programmatic series has been prepared at the request of the GoP to support Peru's reform program. 2. The development objective of the loan is to contribute to growth and poverty alleviation by supporting two main policy areas: (i) efficiency and quality of fiscal management and (ii) competitiveness. Peru entered the global crisis in a solid position and has managed its challenges well. Good macroeconomic fundamentals and appropriate policy responses to the crisis moderated the negative impact of weaker external demand and external shocks. Aware of the downside risks to economic growth as well to poverty and employment, the GoP implemented counter-cyclical policies to mitigate the impact of the crisis. Nonetheless, the GoP has not lost sight of the medium-term objectives of its reform agenda, and has continued to make progress in improving the effectiveness of fiscal management and supporting the country's competitiveness and integration into the global economy. 3. The GoP has requested Bank financing for three main reasons. First, while Peru has achieved strong growth and poverty reduction in recent years, it still faces a high poverty rate as well as other important development challenges in areas such as infrastructure and human capital formation. This operation supports implementation of key policy reforms that can help increase the impact of public spending. Second, this is the fourth and last operation in a programmatic series agreed with the government under the current CPS and which has been included in the government's financing plan. Third, while global financial markets have improved, there remain uncertainties and risks that the authorities seek to mitigate with further Bank financing. 4. The GoP seeks to strike an appropriate balance between protecting the outstanding results in debt management and maintaining flexibility to respond to a volatile global environment. In this regard, the authorities made a strategic choice of maintaining DPL/DDOs as contingent lines of credit while drawing on traditional DPLs for immediate budget support. To date, the GoP has disbursed US$460 million of the US$1.56 billion DPL/DDOs approved since August 2008. The Peruvian authorities have informed the Bank that they intend to disburse an additional US$150 millio n by the end of CY2010 and US$560 million during CY2011. 6 II. Country Context A. Economic Developments 5. Peru faced the global economic crisis after a period of broad-based rapid economic growth. Before the global economic crisis, Peru displayed one of the strongest growth performances in the Latin America and the Caribbean region, with growth accelerating from 6.4 percent in 2005 to 9.8 percent in 2008. Rising commodity prices fueled export growth but the economic expansion from 2006 to 2008 was also based on buoyant domestic demand and was led by the private sector. Consumption and investment contributed roughly equally to economic growth. Private investment rose from 15 percent of Gross Domestic Product (GDP) in 2005 to around 22 percent of GDP in 2008, supported by a positive outlook and sound macroeconomic management. Strong capital inflows led to a reserve build up and put appreciation pressure on the Nuevo Sol. FDI inflows surged from US$2.5 billion in 2005, around 3.2 percent of GDP, to US$6.5 billion in 2008, around 5 percent of GDP. Bond spreads declined and in 2008 Peru's sovereign foreign currency rating was upgraded to investment grade first by Fitch and Standard and Poor's in 2008 and then by Moody's in 2009, reflecting the strong growth performance, prudent fiscal and liability management, and the resulting improvement in solvency indicators. 6. Sound macroeconomic management during the boom years created the fiscal space needed for countercyclical policies to soften the impact of the global economic crisis. The GoP maintained a prudent fiscal policy through the commodity boom period, running fiscal surpluses in the three years to 2008, with the overall budget surplus peaking at 2 percent of GDP in 2008. The authorities saved resources into a fiscal stabilization fund, which saw its balance increase from US$314 million in 2005 to US$1.8 billion in 2008 (around 1.4 percent of GDP). The authorities also brought public debt down from 38 percent of GDP in 2005 to 24 percent in 2008. Public external debt decreased from 28 percent of GDP in 2005 to 15 percent in 2008. In parallel, the Central Bank (BCRP) accumulated net international reserves which increased from US$14 billion in 2005 to US$31 billion in 2008--close to five times the stock of short-term external debt and 11 months of imports of goods and services. 7. Despite the magnitude of the challenges generated by the global economic crisis, financial and exchange rate stability were preserved. In the wake of the Lehman Brothers bankruptcy in mid-September 2008 the sharp increase in risk aversion in global financial markets was quickly felt in Peru. From mid-September to late October 2008 net international reserves fell by US$3.3 billion, or close to 10 percent of holdings. However, the central bank avoided sharp fluctuations of the exchange rate. The global economic crisis also had a relatively limited impact on the Peruvian financial sector, which did not rely heavily on short-term external borrowing or on exotic asset-based derivatives. In addition, there was no credit crunch as the growth of credit to the private sector remained positive, slowing down gradually to an annual rate of 9 percent at its trough in December 2009. 8. Economic growth decelerated sharply in 2009 but remained positive, as external demand and an anti-cyclical public spending program propped up growth. GDP growth stood at 0.9 percent in 2009, down from 9.8 percent in 2008, driven largely by a fall in 7 domestic demand prompted by the global economic crisis. Within the domestic demand, the drop in private investment was particularly sharp. Thus, private investment went from contributing around half of the growth in 2008 to a negative contribution in 2009. In contrast to the situation in previous years, the overall contribution to GDP growth of domestic demand was also negative in 2009. On the external side, the global crisis led to a decline in exports, which fell by 15 percent in 2009. However, imports decreased more, by 26 percent, as imports of capital and intermediate goods dropped sharply on account of the virtual standstill from private investment. The terms of trade recovered in the second half of 2009 and for the year as a whole the terms of trade index were broadly unchanged. These factors, together with the decrease in profit remittances (largely by foreign mining companies operating in Peru) explain why the current account balance turned from a deficit of 3.3 percent of GDP in 2008 to a slight surplus of 0.2 percent of GDP in 2009. Figure 1: Real GDP growth Figure 2: EMBI Global spreads Annual percentage change Basis points 16 14 12 10 8 6 4 2 0 -2 -4 Ap r-08 Aug -08 Dec-08 Ap r-09 Aug -09 Dec-09 Ap r-10 Source: INEI. Source: Bloomberg. 9. In response to the economic slowdown the authorities launched in 2009 a two- year economic stimulus plan amounting to US$4.8 billion, or about 3.5 percent of GDP. The plan focused primarily on increased public expenditures and attempts to balance the need for a stimulus in the short-term which reflected also medium-term priorities. Infrastructure projects accounted for around 51 percent of planned expenditures. In particular, about US$412 million were allocated for priority projects and US$567 million have been allocated to projects which were already in execution but had undisbursed budget balances in 2008--effectively funding the `carry over' of those projects into 2009. An additional US$912 million was earmarked to infrastructure projects to be chosen and implemented by regional governments. Other large items in the economic stimulus plan include US$313 million for a range of social protection policies as well as US$386 million to fund the fuel subsidies in place through a Fuel Stabilization Fund. Also, the so-called `duty drawback' paid to compensate exporters for the import duties paid on inputs was, was temporarily increased. As of end-April 2010 the disbursement ratio of the total economic stimulus plan was around 87 percent. 10. The fiscal stimulus plan combined with lower fiscal revenues caused a fiscal deficit of 1.9 percent of GDP in 2009. Peru's budget balance turned negative in 2009 due 8 to both lower revenues and increased public expenditure associated with the economic stimulus plan. The existing Fiscal Responsibility and Transparency Law sets two limits: (i) the fiscal deficit is not to exceed 1 percent of GDP, and (ii) the growth of current expenditures of the central government is not to exceed 3 percent p.a. in real terms. Article 5 of the Law states, however, that in cases of national emergency or international crisis the legislature can, at the request of the executive, grant exceptions to the fiscal rules for a period of up to three years. The administration proposed legislation--which the Congress approved-- to increase the limit on the fiscal deficit to 2 percent of GDP in both 2009 and 2010. In addition, the limit on the real growth of current expenditures by the central government--set at 3 percent by the Fiscal Responsibility and Transparency Law--was also temporarily lifted to 10 percent in 2009 and 8 percent in 2010. Finally, some fiscal rules for sub-national governments were also modified, the most important being that for non- financial expenditures the deficit limit was raised from 3 percent to 4 percent, excluding investment. In terms of deficit decomposition, it can be explained by both a 12 percent falling in Central Government tax revenue and a strong expansion of non-financial expenditures, particularly public investment. Table 1: Key Economic Indicators (percent unless otherwise noted) 2007 2008 2009 2010 2011 2012 2013 GDP growth rate 8.9 9.8 0.9 7.0 5.5 5.5 5.5 Growth of real domestic demand 11.9 12.1 -2.9 8.6 7.8 5.9 6.0 Inflation rate, CPI (period average) 1.8 5.8 2.9 1.4 2.1 2.0 1.9 Non-financial public sector balance/GDP 3.3 2.0 -1.9 -1.5 -0.9 -0.4 0.1 Public debt/GDP 29.7 24.0 26.7 24.3 22.9 21.8 20.4 Public external debt/GDP 18.7 15.1 16.3 14.7 13.9 13.0 12.0 Exports (FOB), change p.a. 17.5 13.1 -14.7 14.7 5.4 6.2 7.1 Imports (CIF), change p.a. 31.8 45.1 -26.1 17.0 15.0 8.4 8.8 Trade balance/GDP 7.7 2.4 4.6 4.3 2.6 2.2 2.0 External Current Account/GDP 1.4 -3.3 0.2 -0.7 -2.3 -2.5 -2.6 Terms of Trade (deterioration -); change 2.4 -2.9 -5.5 4.8 1.3 -0.5 0.3 Net international reserves (NIR), US$ billion 28.6 32.2 33.1 37.6 42.0 45.2 48.7 NIR, in months of G&S imports 13.9 11.4 15.4 15.0 14.8 14.6 14.5 NIR, as % of public external debt 143 167 161 176 187 201 218 NIR, as % of Money Stock 80 89 88 87 88 89 89 Source: Banco Central de Reserva del Perú (BCRP), Ministry of Economy and Finance (MEF) --Marco Macroeconómico Multianual 2010-2012, World Bank staff, IMF staff. 11. In parallel, the central bank eased monetary policy as inflation decreased and exchange rate appreciation pressures resumed. The central bank cut its policy rate every month from February to August 2009, bringing the rate to 1.25 percent for a cumulative easing since the beginning of 2009 of 525 basis points. Such a monetary policy easing took place in a context of declining inflation, down to 0.25 as of December 2009 and growth deceleration. In addition, the central bank adopted a number of measures aimed at supporting the flow of credit, such as reducing reserve requirements, accepting new instruments as 9 collateral for liquidity operations, and the extension of the term of liquidity management operations. Figure 3: Total and food inflation Figure 4: Exchange rate Percent Nuevos soles per US dollar, and index (downwards move represents appreciation) Source: INEI. Source: BCRP. 12. As the recovery seems to be takinges root, the authorities have started to cut back on the expansionary stance of fiscal and monetary policies. The authorities announced in May 2010 a series of measures aimed at controlling the pace of public spending. In particular, a new limit to ministries and agencies has been set on the growth of public spending on goods and services for 2010, which is not to exceed 3 percent in nominal terms. This new measure more than fully reverses the loosening of the constraint on growth of public expenditure that had been temporarily set for 2010 at 8 percent growth in real terms and is in fact tougher than the normal limit envisaged under the Fiscal Responsibility and Transparency Law. In addition new measures have been put in place to limit the increase in public investment which had grown by 26 percent in real terms in 2009. Thus, public investment projects that have been granted budgetary funds but which have yet to start disbursing will only be allowed to disburse 25 percent of their budget allocation. With regard to monetary policy, the central bank raised the reference rate, which had been held at 1.25 percent through April 2010, to 1.5 percent in May 2010 and to 1.75 percent in June 2010. The increase in interest rates is a preventive measure to preempt inflationary pressures in an environment of accelerating growth and despite the lack of substantial inflationary pressures thus far (see Figure 3). B. Macroeconomic Outlook and Debt Sustainability 13. While uncertainty about the near-term outlook remains elevated due to risks to the global economy, prospects for Peru continue to be positive provided that a sound policy framework is kept in place. While the slowdown in growth in 2009 was acute, Peru was one of the few economies in the region that avoided negative growth in 2009. Following a rapid pick-up in economic activity from the end of 2009 driven by both domestic demand and a recovery of commodity prices, the most likely scenario for 2010 is one of substantial recovery. Growth is expected to increase to around 6 percent in 2010 and to hover around 5.5 percent over the medium term. Downside risks to this baseline scenario include a weaker than expected recovery of the world economy which could soften both demand and prices for 10 key commodities of the Peruvian export sector such as copper, gold, and zinc. A weaker than anticipated global economy would not only translate into decreased external demand for Peruvian exports but, most importantly, could also affect domestic confidence and investment, as it did in 2009, slowing down the rebound in domestic demand which is once again expected to be the key driver for overall growth in Peru. 14. Peru's debt servicing indicators show a robust position, helped by an active liability management policy. Peru's total public debt in 2009 stood at US$34 billion, or 26.4 percent of GDP. Net international reserves closed 2009 at US$33 billion, about 15 months of imports of goods and services and near 200 percent of foreign currency deposits. The country's debt service profile and its currency and interest risks exposures continued to improve in 2009 as a result of active debt management policies and Peru's access to various funding sources, including multilateral banks, U.S. and European markets, and local markets. In particular, in the third quarter of 2009, the authorities pre-paid debt with the Paris Club for US$952 million while in May 2010 the authorities engaged in a pre-purchase and exchange of bonds totaling US$1.8 billion that resulted in a lengthening of maturities and a rebalancing towards domestic-currency denominated debt. The country's debt management strategy aims to mitigate refinancing risk, increase the share of domestic debt in nuevos soles (the share of debt in domestic currency has increased from 15 percent of total debt in 2004 to about 40 percent in 2009), lengthen the maturities of fixed-rate debt, and continue to develop the market for international sovereign bonds. 15. A debt sustainability analysis suggests that the public debt position is resilient to a range of simulated negative shocks. The recently completed Article IV consultation by the IMF in April 2010 included an updated debt sustainability analysis. The results of such debt sustainability analysis, which was conducted under similar assumptions as those reflected in the macroeconomic outlook provided in Table 1 above, confirm the results of earlier analyses provided in previous Program Appraisal Documents for this series of DPLs. In particular, public debt is expected to decline under the baseline scenario to below 20 percent of GDP by 2015. Public external debt is expected to decline to below 11 percent of GDP by 2015. A series of sensitivity analyses based on historical standard deviations of key variables suggest that the public debt profile is unlikely to differ significantly from the baseline and support the assessment that public debt sustainability is not a major concern in the medium term. 16. Notwithstanding the uncertainty about the near-term outlook, Peru's macroeconomic policies are deemed adequate for the proposed loan. Fiscal policy remains prudent as the expansion of Government expenditure in 2009 and 2010 does not threaten fiscal sustainability. In line with the temporary nature of the economic stimulus plan, the Government has already started to take actions to curb the expansionary stance of fiscal policy, which is particularly noteworthy in light of the upcoming presidential elections to take place in April 2011. Similarly, monetary and exchange rate policy is also supportive of macroeconomic and financial stability. 11 III. The Government Program and Participatory Processes 17. The broad objectives in the GoP's program for 2008-2011--a solid macroeconomic framework and reforms to generate sustainable and equitable growth--remain unchanged since the first loan in this series. The GoP's program aims to balance both human and economic development, and is divided into three main areas of action: accelerating and broadening economic growth; improving social development; and modernizing public sector institutions. The GoP has established a set of goals for the end of the administration and is monitoring and publicly reporting progress. The progress achieved at mid-term has been substantial, with relatively more success on the macroeconomic front (Table 2). Table 2: Government Economic and Social Targets, 2006-11 Progress to date Period Baseline Target (2009) GDP (millions of US$) 2011 79,446 140,000 126,738 Private investment (millions of US$) 2006-2011 12,285 100,000 54,829 Public investment (millions of US$) 2011 2,265 30,000 10,395 Poverty (%) 2011 48.7% 30.0% 34.8% Urban poverty (%) 2011 36.8% 20.0% 21.1% Rural poverty (%) 2011 70.9% 45.0% 60.3% Number of jobs created 2011 Na 1,500,000 1,388,111 Convergence to Inflation (average change %) 2011 1.8% 2.9% BCP's target Foreign debt (% of GDP) 2011 31.3% 13.0% 16.3% International reserves (millions of US$) 2011 14,683 30,000 33,135 Source: Marco Macroeconómico Multianual 2010-2012, Ministry of Economy and Finance. 18. The two policy areas supported by this proposed loan will assist in sustaining economic growth and spreading its fruits throughout Peruvian society. In terms of fiscal policy, the authorities are committed to continue strengthening control of overall fiscal balances through a more efficient tax system, managing wages and other current spending and public debt. Beyond quantity, the GoP is also focusing on the quality of public expenditure, implementing more rigorous monitoring and evaluation of spending programs using performance-based budgeting techniques, simplifying and rationalizing the tax system to reduce distortions, and making public sector processes more transparent and effective. In the area of competitiveness, the GoP has placed emphasis in improving producers' access to global markets and in reducing bottlenecks to trade and investment. Peru's involvement in the world economy has continued to increase, evidenced by the full implementation of the free trade agreement with the U.S. and Chile, the conclusion of negotiations with Singapore, Canada, Thailand, China, the European Union, and the European Free Trade Association. The Free Trade Agreement with Mexico was extended until 2011 and trade negotiations continue underway with Korea and Japan. In addition, Peru started negotiations for the Transpacific Partnership Agreement. 19. Since September 2008, the GoP dedicated resources to mitigate the effects of the global crisis. The GoP's priorities have been reflected in the reformulated 2009 budget, with 12 the inclusion of a two-year fiscal stimulus package of about 4 percent of GDP. For 2009, the Ministry of Economy and Finance (MEF) increased public investment by 60 percent over the year before (about US$2.5 billion in one year) with a particular focus on key obstacles to growth such as social infrastructure and a strong emphasis on poorer regions of the country. Increased public investment is occurring within a framework of overall fiscal discipline, with an official target for the overall deficit of the public sector of less than 2 percent of GDP for both 2009 and 2010, and returning gradually toward equilibrium in the following years. To ensure sustainability and impact of investment, the authorities are in the process of implementing medium-term budgeting for investment, which will ensure adequate funding for maintenance for these new investments. A legal initiative permitting greater private participation in public infrastructure has recently been approved, which could further spur increased investment in needed infrastructure. 20. Due to the expected reduction in transfers to sub-nationals, the central government created a new mechanism to compensate for these losses by providing funding (fideicomisos) for regional investments. Reforms to the national investment system (Sistema Nacional de Inversión Pública--SNIP) and efforts to build capacity for project planning and execution at the sub-national level are accelerating the ability of sub- national governments to undertake local investment projects. These initiatives are actively supported by the private sector and include, for example, efforts by business associations to train municipal officials. Mining companies also provide funding for numerous local development projects. The International Finance Corporation (IFC) Technical Assistance Facility has a project on efficiently investing mining canon resources at the municipal level which includes a component on public oversight to provide citizen feedback on municipal projects. 21. The authorities launched two results-based transfer programs to improve efficiency of public spending at sub-national level. In January 2010, the Government launched the Municipal Modernization Program (PMM for its Spanish acronym1) and the Incentive Plan for the Improvement of Municipal Management (PI for its Spanish acronym2). Despite its relatively small size (0.3 percent of GDP), the two programs are likely to influence spending priorities of all municipal expenditures which in 2009 were worth 4.1 percent of GDP. The main goals of the PMM and the PI are: (i) to improve the financial sustainability of municipalities by raising the collection of the property tax as well as strengthening municipal tax administration; and (ii) to improve service delivery outcomes, related to social services (e.g. child nutrition), infrastructure development, and business climate (e.g. simplification of procedures for business and construction licenses). The Budget Office at MEF is responsible for the management of these transfers, which includes information processing and assignment of resources. Targets to trigger disbursements for February and August 2010 have been established and for 2011 and beyond are under revision. 22. The authorities have a strong commitment to transparency and accountability. Clear policy targets for the end of the administration (2011) and annual progress on these 1 Decreto Supremo No 002-2010-EF, January 11, 2010. 2 Decreto Supremo No 003-2010-EF, January 11, 2010. 13 targets are published in the annual Multi-year Macroeconomic Framework. The GoP has made substantial effort to establish a broad national consensus on its policy program with the legislative branch and society at large as reflected in consultation mechanisms like the `mesas de concertación'. In addition, a committee consisting of the MEF, the Superintendence of Banking and Insurance, and the central bank has been created to monitor the impact of the global crisis and to propose prompt remedial actions. 23. Government consultations for the policy reforms supported by this operation take place regularly in the context of an open political process. Policies supported by this operation were also discussed in consultations held by the government for the preparation of the CPS with civil society. Participants included representatives of small-scale farmers and businesspeople from the mountain region in Ayacucho, private sector representatives in Lima, regional and local government representatives, urban and rural businesspeople, and a diverse group of community organizations, indigenous groups, academia, religious groups and NGOs. The CPS progress report also followed up on these issues and confirmed the need to support the policies supported by the operation. Relevant line ministries were involved in the preparation and dissemination of performance evaluations of priority social programs (education, nutrition, health). These activities are supported by this loan series and also by the Bank's Results and Accountability (REACT) DPL series in the area of social policy. The Defensoría del Pueblo (Human Rights Ombudsman, appointed by Congress) has participated in many of these events. IV. Bank Support to the Government Program A. Link to the Partnership Strategy and Other Bank Operations 24. The fourth phase of this programmatic DPL series is at the heart of the CPS. The latest CPS for Peru was discussed by the Board on December 19, 2006; along with the first DPL in the series, for a total amount of US$200 million. The second DPL/DDO of the series amounted to US$370 million and was approved in August 2008. It was complemented shortly thereafter with additional financing for US$330 million approved in December 2008 to mitigate the impact of a deteriorating economic context. The Progress Report for the CPS, presented to the Board in February 2009, endorsed the relevance of the reform agenda supported by this programmatic series to implement the CPS pillars aimed at maintaining macro stability (pillar I-cluster I), accelerating growth and widening the base of growth (pillar I-cluster II), and modernizing institutions (pillar III-cluster VI). The third DPL of the series, amounting to US$150 million, was approved in November 2009. The fourth and final DPL of this series, proposed under the current CPS, amounts to US$100 million and builds on the reform progress supported by the previous operations. 25. In the context of global uncertainty, the authorities seek Bank funding to buttress market confidence. The GoP seeks to strike an appropriate balance between protecting the outstanding results in debt management and maintaining flexibility to respond to a volatile global environment. To date, the GoP has disbursed US$410 million of the US$1.56 billion DPL/DDOs approved since August 2008. The Peruvian authorities have 14 informed the Bank that they intend to disburse US$200 million by the end of CY2010 and US$560 million during CY2011. 26. This operation is complemented by other series of DPLs suppporting the government's efforts to sustain the economic recovery from the global crisis. The authorities have sought financing from the World Bank through three complementary series of DPL-DDOs in the fiscal, social (REACT) and environmental sectors. Since August 2008, four DPL-DDOs (including the supplemental financing for the second Fiscal Management and Competitiveness DPL-DDO) have been approved by the Board, totaling US$1.56 billion. At the request of the GoP, the approval of this series of loans supported the achievement of fiscal goals set forth by the MEF and sectoral reforms implemented by line ministries. 27. The REACT DPL series focuses on the social sectors and is complementary to the FMCDPL series. To date, two of the three operations in the REACT series have been approved. They support improving the performance of social programs--especially health and education--through transparent performance standards, mechanisms to empower citizens to demand improvements from public service providers, and stronger links between budget decisions and final outcomes. REACT is playing an important part in the adoption of performance-based budget management through the definition of strategic outcomes in education, health and nutrition, linked to transparent standards. It also supports the establishment of effective monitoring systems, based on institutional data, which allow each service production unit to be held accountable for its performance. Both the FMCDPL and REACT series support improved budgetary performance. 28. In addition, a number of investment projects, non-lending technical assistance (NLTA), and trust funds under implementation are consistent with the reform agenda supported by this DPL. Specifically, the Institutional Capacity for Decentralization TAL supports performance-based budgeting efforts. Bank non-lending technical assistance (NLTA) efforts are assisting in strengthening the quality of public expenditure and the capacity of the central and sub-national government capacity to execute public expenditures­ in the context of the stimulus package. These NLTA activities include the Programmatic Governance and Governability NLTA, the Sub-national Pilots NLTA, and several IFC- funded technical assistance efforts to improve the capacity of the regional and municipal governments to manage natural resource revenues. Two Institutional Development Trust Funds (IDFs) are also contributing to the implementation of the reform program supported by this DPL. The Peru Public Expenditure Management IDF is focused on performance budgeting and investment management through the Regional and Local Investment Promotion Fund (FONIPREL) and the Strengthening Congress Budget Oversight IDF focuses on strengthening the capacity to monitor and evaluate the quality of the budget formulation and execution of the Peruvian Congress' Budget Commission. B. Collaboration with the IMF and Other Donors 29. The Bank collaborated closely with the International Monetary Fund (IMF) in the development and implementation of the last Stand-By Agreement (SBA) which expired in January 2009. The SBA was approved by the IMF Board on January 26, 2007 and entailed SDR172.4 million to support Peru's economic program. Peru treated the 15 agreement as precautionary in a context of strong fiscal discipline. The fourth and last program review was successfully completed in January 2009. As in the previous two SBAs, no withdrawals were requested and Peru did not pursue a new agreement. Upon completion of the SBA, the IMF and the World Bank have maintained a close dialogue on Peru, particularly in the areas of monitoring the macro situation, discussing the GoP program, and evaluating Bank operations. The latest IMF Article IV Consultations were satisfactorily concluded in April 2010. 30. The Bank's close coordination with the donor community in Peru, including bilateral and multilateral organizations, continues. The design of policy-based operations has been coordinated with the Inter-American Development Bank (IADB), the IMF and the Corporación Andina de Fomento (CAF), as well as several bilateral agencies which also support policy reform, including the German Development Bank (KfW), GTZ, United States Agency for International Development (USAID), JBIC, DFID, SDC and the European Commission, among others. This coordination extends to investment lending operations in the areas of transport, education, health, social protection, fiscal management, competitiveness, competitiveness, rural electrification, water and sanitation, water resources management, rural development, justice and governance initiatives, and nutrition. The World Bank Group (WBG) is also strengthening its partnership with the Global Water and Sanitation Program around the "Agua para Todos" program. The Bank has been a leading actor in donor thematic groups and has hosted several workshops in the areas of decentralization, justice modernization, education, and rural development. 31. Strong donor cooperation around budgetary management at the national and local levels is particularly relevant for this proposed DPL operation. The Bank and the IADB maintain close coordination in the design and implementation of their policy loans. In a recent programmatic series now completed, IADB supported performance-based budgeting specifically linked to investment spending, which complemented well the Bank's work on budgeting reform in other areas. The GoP has ensured that the areas of support are complementary and not redundant. Several bilateral programs are also supporting related reforms, including those of KfW (which co-financed earlier loans in this and previous programmatic series), USAID and the Swiss aid agency SDC. 32. Peru's competitiveness agenda has also benefited from coordinated support between the World Bank and other multilateral and bilateral partners. The Peru teams of the IFC and the Bank are in close collaboration regarding the competiveness agenda supported by this operation. The IFC in conjunction with the World Bank's Doing Business team is providing technical assistance to the National Competitiveness Agency (CNC) in activities linked to a set of reforms specifically targeted to improve Peru's business environment. The IADB is also working on helping smaller-scale agricultural producers improve competitiveness to take better advantage of free trade agreements and reducing productivity constraints to micro, small and medium enterprises (MSMEs). USAID, SDC and the European Commission are also all involved in projects to increase the flow of credit to MSMEs to improve their ability to invest and grow. 16 C. Lessons Learned 33. An important lesson learned is that a strong focus on a limited number of key outcomes based on a well-defined program that is a priority for the GoP is essential for the sustainability of reforms. The GoP's strong desire to consolidate the progress achieved under the previous operations has resulted in strong ownership of the next phases of the series-- with a focus on a limited number of outcomes to increase their development impact and sustainability. In addition, throughout the implementation of the reforms under the DPL series, it has been clear that complex reforms take time and require building consensus and awareness of the benefits of reforms among the main stakeholders. In particular, resistance to modernizing public finance is often strong, so sequencing together with training and capacity building are critical for success. The program of policies and reforms under this series has taken this lesson into consideration, as well as with the reality that there is no perfect "end state" since further improvement is always possible. 34. In addition to the need for selectivity and adequate phasing, it is important to maintain flexibility to react to potential changes in policy priorities in the context of local and global uncertainty. The strong focus on fiscal discipline that characterized the previous operation had to be adjusted to address the increasing impact of the global financial crisis. Counter-cyclical policies called for significant increases in public expenditures that justified a shift in previous fiscal targets and policies. The programmatic approach calls for built-in flexibility both at the policy level and allocation of resources to address unforeseen changes in the country's development needs. The evolving impact of the global crisis is clear evidence of the need for a flexible approach. D. Analytic Underpinnings 35. The DPL supports a sub-set of policies within the GoP's broad reform program. These policies were selected on the basis of analytical work aimed at determining key policies with large development impact. Substantial diagnostic work has informed the design of the proposed loan. Some studies have been completed, and others are underway. For example, the recent Public Expenditure and Financial Management Assessment completed and the ongoing Public Expenditure Review have contributed to inform policy dialogue in the areas of public financial management and fiscal transparency. Similarly, the Governance and Governability NLTA supported policy analysis related to results-based transfers to sub- national governments, which underpinned the reforms supported by this operation. On the competitiveness agenda, the Informality ESW addressed the question of how informality affects the productivity and competitiveness of small and medium-sized businesses (see Annex 6 for a detailed summary of analytical and advisory work underpinning the proposed operation). 17 V. The Proposed Operation A. Operation Description 36. The proposed operation responds to the GoP's request for continued Bank support of its broad reform agenda and its reaction to the crisis. This operation is the Fourth in a series of four loans each supporting implementation progress in a well defined economic program. The two policy areas supported by this DPL are: Efficiency and Quality of Fiscal Management Competitiveness 37. Fiscal management and competitiveness are mutually reinforcing areas which offer a potentially significant payoff in terms of economic growth, social development and poverty reduction. Strong fiscal management improves the effectiveness of limited public resources and supports country competitiveness by generating private sector confidence in overall macroeconomic stability and the ability to undertake long-term investments and planning. In turn, increased competitiveness improves the fiscal situation by generating tax revenues and decreasing the need for government intervention to stimulate economic growth. Together, reforms in these two areas may strengthen the ability to achieve GoP's goal of accelerating and broadening economic growth to improve the standard of living of all Peruvians, especially the poor. The mix of macroeconomic policy stability with gradual structural reforms thus far has already shown positive results in terms of greater business creation and growth, generating confidence that these trends will continue going forward. Moreover, the combination of high growth with prudent fiscal/financial management will provide additional fiscal space to address social needs. 38. The programmatic approach taken by this loan series reflects the flexibility requested by the GoP to best address evolving challenges. By incorporating flexibility into the FMCDPL series within a defined policy framework, the Bank is serving the needs of Peru, a middle-income country with strong macro-economic fundamentals now facing second and third generation reform challenges. While broad policy areas were established from the start of the series, specific policy actions have evolved along with Peru's changing political and economic circumstances. The policy actions supported by this DPL were chosen by the GoP as critical to achieve fiscal management and competitiveness outcomes (Box 1). 18 Box 1: Good Practice Principles on Conditionality Principle 1: Reinforce ownership There is broad consensus in the administration and the legislature on the importance of the fiscal management and competitiveness reforms supported by this loan series. Evidence of this is steady parliamentary support for fiscal discipline by all parties, passage of two successive budgets including the new performance-based budgeting initiative, and the broad participation of sub-national governments in administrative reforms and e-government procedures. The García administration has demonstrated an excellent track record in maintaining a stable macroeconomic framework and clear, sustained policy directions regarding improving the impact of public spending and improving country competitiveness to sustain high growth and poverty reduction. By designing the loan in close alignment with the GoP's own policy reform priorities, the Bank has maintained harmony between the loan program and the policy realities faced by the administration. The GoP has committed its political capital to reforms which will be positive for the country's development and which are supported by this loan series. Principle 2: Agree up front with the government and other financial partners on a coordinated accountability framework The policy matrix was negotiated with the aim of choosing measurable, relevant program progress indicators while leaving sufficient flexibility to address the changing needs and priorities of a fast- developing middle-income country with strong fundamentals. The policies addressed in the loan series are well-coordinated with the IADB, which ensures that that the programs provide mutual support without overlap and with several bilateral donor and technical assistance projects currently working on related projects in Peru. Principle 3: Customize the accountability framework and modalities of Bank support to country circumstances The modalities and timing of the lending program are based on specific requests by the GoP so that the Bank can provide optimum support for Peru's specific needs. The Bank program is designed to evolve as the country's needs evolve, within a defined group of policy areas and outcome goals. The policies involved in the FMCDPL series derive directly from the priorities of both the previous and current administrations in the area of fiscal management and competitiveness. For example, to address the current difficulties arising from the international economic crisis, the Bank worked with the GoP to replace policy conditions related to fiscal decentralization with those supporting a well-targeted economic stimulus plan, putting off the original policy reforms until conditions improve. Principle 4: Choose only actions critical for achieving results as conditions for disbursement Despite the policy complexity of fiscal management and competitiveness, this loan series has chosen a reduced number of benchmarks, and even fewer program triggers, that were considered by both the Bank team and the GoP to embody the reforms most critical for maintaining a steady policy reform direction. Principle 5: Conduct transparent progress reviews conducive to predictable and performance-based financial support The progress reviews for FMCDPL III took place in parallel with the discussions for this Fourth proposed loan in the series. Bank staff specializing in all loan policy areas as well as fiduciary and oversight areas held detailed discussions with relevant representatives of the GoP regarding measurable progress in achieving program triggers and benchmarks. Further discussions are planned to assess developments during the course of 2009, and the Bank stands ready to provide technical assistance as needed to achieve the triggers called for under this proposed loan. Source: World Bank (2005), `Review of World Bank Conditionality.' 19 B. Policy Areas 39. This is the last in a series of four programmatic DPLs supporting policy reforms in the areas fiscal management and competitiveness. Overall, reform progress in both policy fronts has been positive. Fiscal policy has remained prudent. Tax administration has improved thanks to government efforst to simplify tax regulations and tax payment procedures. Financial management and fiscal transparency have been strengthened. Achievements worth mentioning include the approval of the Treasury and Accounting System Laws, which brought the budget classification syste in line with international standars. The implementation of the Treasury Single Account (TSA) consolidated over 80 percent of all public resources and strengthened the government's cash management system. The introduction of public expenditure performance information in the budgeting process (measuring outcomes and performing independent evaluations of service delivery) is also a remarkable achievement. On the competitiveness front, the authorities have expanded international trade through the signing of FTAs with the USA, China and more recently, with the EU, inter alia. These trade agreements have acted as catalysts to improve the country's competitiveness, opening new market opportunities and facilitating trade across borders. See Annexes 3 and 4 for a summary of the prior actions and outcomes achieved over the loan series. 40. The GoP has continued to make substantial progress as evidenced by the prior actions taken under this fourth operation. These prior actions are discussed in detail in the next sections. There has been significant progress in the six policy areas seeking to strengthen the quality and transparency fiscal management, with the exception of the e- government agenda, that experienced delays owing to institutional changes. The program has supported an improved debt and cash management. It contributed to set up the Treasury Single Account, which now channels 80 percent of all public resources whereas no such Treasurey Single Account existed at the outset of the program. The DPL series has also supported the gradual introduction of performance-based budgeting, both in terms of introducing strategic programs that reflect the policy priorities of the GoP and also making available new performance information from evaluations of public expenditure interventions. Ten such evaluations of public expenditure have now been conducted and three of them have already led to agreements on how to improve public service delivery. Substantial progress has also been achieved on the policy areas related to competitiveness, as reflected in the signing of free trade agreements with the EU and EFTA, the reduction of tariffs, and regulations to promote asset securitization. See Table 3 for a summary of the prior actions under this fourth DPL and the corresponding indicative triggers that were agreed with the GoP in the previous operation. 20 Table 3. Fourth Fiscal Management and Competitiveness DPL Program Matrix Indicative Triggers for DPL IV (as described Prior Actions taken under the Program (DPL IV) in the DPL III operation) Increase the Sustainability and Transparency of Fiscal Policy Continue with prudent fiscal policy and (1) Issuance of various legal instruments pertaining to continue implementation of the Economic performance-based transfer of resources from the Stimulus Plan within the framework provided Executive to Municipalities, including, inter alia, the by the Fiscal Responsibility and Transparency following: (a) Decree (Decreto de Urgencia No. Law. Continue with measures that strengthen 119-2009 Modifican Artículos de las Leyes Nos. decentralization, including incentives to 29332 y 29465 y Dictan Medidas Extraordinarias strengthen municipal administration. Para el Financiamiento de la Continuidad de las Inversiones durante el Año Fiscal 2010) dated December 23, 2009 and published in the Borrower's Official Gazette (El Peruano) on December 24, 2009; (b) Supreme Decrees no. 002-2010-EF and 003-2010-EF, both dated January 11, 2010 and published in the Borrower's Gazette (El Peruano) on January 12, 2010 estalishing the procedures regulating performance measurement criteria and targets and the allocation of resources to Municipalities; and (c) Resolution no. 008-2010- EF/76.01 issued by the Directorate of Public Budget on March 30, 2010 and published in the the Borrower's Gazette (El Peruano) on April 1, 2010, approving the results of compliance by Municipalities of performance targets as reported by said Municipalities by February 2010. Make the Tax System More Neutral and Stable Implement measures to facilitate tax (2) Issuance of Resolution No. 036-2010/SUNAT dated compliance including increasing availability of January 29, 2010 and publihed in the Borrower's on-line tax administration services. Official Gazette (El Peruano) on January 31, 2010, providing for procedures aimed at improving tax compliance, through, inter alia, the establishment of online tax filing procedures (Formulario Virtual para la Declaración y Pago de Renta de Segunda Categoría) in regard to income taxes (impuesto a la renta). Strengthen Budget Reporting and Planning Continue implementing the TSA, including (3) Enactment by the Legislature of the Borrower's Law further improving the information management No. 29537 dated June 7, 2010 and published in the systems; and expanding training for TSA users. Borrower's Official Gazette (El Peruano) on June 8, 2010, mandating the timely preparation and disclosure of consolidated government financial statements (Cuenta General de la República) and audit reports aimed at strengthening further the Borrower's budget reporting capacity. 21 Indicative Triggers for DPL IV (as described Prior Actions taken under the Program (DPL IV) in the DPL III operation) Increase Equity in Intergovernmental Transfers Continue policies oriented toward reducing (4) Issuance of Supreme Decree No. 060-2010-EF dated inequities in inter-governmental transfers, in February 17, 2010 and published in the Borrower's particular, through continuing use of sub- Official Gazette (El Peruano) on February 18, 2010, national compensatory funds to sub-national setting forth a new methodology for the allocation of governments such as the FONCOR and FONCOMUN resources to Municipalities, thereby FONCOMUN. promoting equity in transfers of resources from the Executive to the Municipalities. Improve the Efficiency and Impact of Public Spending Continue the gradual implementation of The Borrower has included six additional budgetary performance-informed budgeting, including programs with a results-orientation framework in the through: (i) signing agreements (matrices de 2010 Budget Law.* compromisos) between MEF and line ministries to address the recommendations from at least 3 executive evaluations; and (ii) broadening the number and coverage of results-orientation programs--Strategic and Institutional programs--in the 2010 budget. Make Public Sector Processes More Transparent, Accessible and Agile Continue strengthening the use of e- The Borrower has approved (a) twenty mandatory government and the improvement of public Standard Bidding Documents for goods, consultant's procurement processes. In particular: services and civil works (Resolution No. 195-2010- OSCE/PRE published in the Official Gazette on April E-government: (i) implement the 21, 2010); and (b) a procurement accreditation interoperability platform to enable data framework, covering all public agencies.* integration across government agencies that feed the online applications for Government services Procurement: (i) develop standard bidding documents and mandate their use; (ii) design the accreditation framework covering all public agencies, including the preparation of a roll-out plan. Expand and Deepen International Trade Continue implementing policy actions related (5) The Borrower has expanded and facilitated to the expansion of international trade through international trade through: (i) the closure of the signing of additional FTAs; and policy actions negotiation process of a proposed trade agreement aimed at improving trade facilitation, including between the Borrower and the EU, as evidenced by further simplification of customs procedures. the signing of the Joint Declaration on May 19, 2010; and (ii) the issuance of Supreme Decree no. 096-2010-EF dated March 26, 2010 and published in the Borrower's Official Gazette (El Peruano) on March 27, 2010 establishing October 1, 2010 as the completion date for the progressive implementation of simplified customs procedures. 22 Indicative Triggers for DPL IV (as described Prior Actions taken under the Program (DPL IV) in the DPL III operation) Promote Sustainable Financial Deepening Expand financial services, including, (6) The adoption of Resolution CONASEV No. 068- strengthening regulations to improve 2009/94.01.1 dated September 24, 2009 and securitization, credit registration and published in the Borrower's Official Gazette (El processing in the mortgage area; and expand Peruano) on September 29, 2010, aimed at access of credit to MSMEs. strengthening the Borrower's regulatory framework for asset securitization and therefore promoting the development of the Borrower's capital markets. NB: * Refers to policy measures that are a continuation of a reform already initiated under previous operations in this series and are therefore considered a benchmark. 1. Efficiency and Quality of Fiscal Management 41. A central element of the administration's policy agenda is to continue strengthening macroeconomic stability and fiscal prudence, while improving the quality of public expenditure. Policy areas to achieve the program objectives include strengthening fiscal rules as well as public debt management and tax policy; improving the efficiency of budgetary accounting; implementing efficient, performance-based budgeting; and increasing transparency and agility in public processes, including procurement. Going forward, the key challenge will be to continue improving the quality of public expenditure at all levels of government while preserving the fiscal prudence that has characterized the conduct of macroeconomic policy in Peru in recent years. Increase the Sustainability and Transparency of Fiscal Policy 42. The fiscal framework has proven to be sufficiently flexible to support a counter- cyclical stance while preserving long-term fiscal stability. In 2009 the authorities acted decisively to soften the impact of the global economic crisis by launching a stimulus package that quickly turned Peru's budget balance from a surplus of 2 percent of GDP to a deficit of 1.9 percent of GDP. Such a counter-cyclical stance was consistent with existing fiscal rules. The Fiscal Responsibility and Transparency Law (Law 27958 of May 10, 2003) limits the annual non-financial public sector deficit to 1 percent of GDP. However, Article 5 states that in the case of a an international crisis that can seriously affect the domestic economy, Congress can, at the request of the executive, grant exceptions to the fiscal rules for a period of up to three years. The global economic crisis was an exceptional situation that justified the use of the room for maneuver built into the law. In this context, the administration proposed legislation to increase the limit on the fiscal deficit to 2 percent of GDP in 2009 and 2010. In addition, the limits on the growth of current public expenditures, set at 3 percent annually in real terms, were temporarily increased to 10 percent in 2009 and to 8 percent in 2010. The legislation was approved by Congress as Law 29368 on May 29, 2009. 43. Fiscal policy continues to support macroeconomic stability. The authorities have responded quickly to the economic recovery in early 2010. As the economy started to pick up in 2010 the Government has tightened its fiscal policy stance and the fiscal deficit is 23 projected to be 1.6 percent of GDP in 2010 (instead of the 2 percent of GDP which would be within the legal framework). The authorities have demonstrated that they remain committed to a prudent fiscal policy, as shown by the measures adopted in May 2010 to limit the growth of public spending on goods and services for 2010 at 3 percent in nominal terms. The fiscal deficit is expected to decrease to below 1 percent of GDP in 2011 and to return to surplus by 2013. Thus, the size of the fiscal deficits planned for the next three years are relatively limited and are not expected to pose a risk to public debt sustainability (Annex 1). In addition, the authorities have revised the set up of the Fuel Stabilization Fund, which since its inception in September 2004 has used up around $1.6 billion in public resources (or 7.5 times the amount spent on the conditional cash transfer program Juntos). The changes introduced will allow for a faster adjustment to the consumer price ceilings (which lead to a drawdown of resources from the stabilization fund) and, as a result, aim to achieve the self-sufficiency of the fund over the medium term. Overall, the authorities are aware of the importance to create fiscal space during years of high economic growth that could allow, as it did in 2009, for a countercyclical fiscal policy during times of crisis. 44. To incentivize local governments to improve their performance two new conditional transfer schemes have been launched. The GoP has launched two mechanisms to provide incentives for municipalities to increase their efforts on priorities such as reducing malnutrition and improving the business environment and to broaden the still very narrow tax base at the local government level. The goal is to provide an incentive scheme by which municipalities that meet certain targets would benefit from higher transfers of Municipal Compensatory Fund (FONCOMUN) resources--a fund on which many municipalities draw largely for their recurrent expenditures. The schemes have been designed so that the heterogeneity of municipalities is taken into account, so that targets on local tax collection are only set for larger urban municipalities. Importantly, the targets set pertain to areas where the municipalities play a significant role. For example, targets pertaining to the business environment refer to the licenses for opening and operating a business, which are a municipal responsibility. 45. Targets for municipalities are set so as to require a gradual improvement in performance. The targets have also been set in a progressive manner, with the first set of targets being relatively simple ones, such as whether municipalities display information about their processes to the public. While the transfers are relatively small (around 0.3 percent of GDP), they have the potential to help improve the performance of the local level of government and also help shape the priorities of the overall local spending, which stood at 4.1 percent of GDP in 2009. So far municipalities have complied with most of the targets set for them for the first assessment that took place in March 2010 and, on aggregate, will receive 88 percent of the potential resources available to them (the undisbursed resources will be distributed at the end of the year among the municipalities that meet all targets in both the March and September evaluations). 46. Going forward, a key challenge is to maintain the sound fiscal management that has served Peru well in recent years. Peru has taken the opportunity of high economic growth to bring down debt and build a fiscal space. The budget balance was in surplus for the three years to 2008, when it reached a surplus of 2.1 percent of GDP. This has served Peru 24 well, allowing the authorities to implement a countercyclical fiscal policy in 2009 without compromising long-term macroeconomic sustainability. As the economy recovers, the authorities are focused on rebuilding the fiscal room for maneuver. Actions completed under the Program (DPL IV) 47. Prior actions completed by the Borrower under the Program include the following (Annex 3): (1) Issuance of various legal instruments pertaining to performance-based transfer of resources from the Executive to Municipalities, including, inter alia, the following: (a) Decree (Decreto de Urgencia No. 119-2009 Modifican Artículos de las Leyes Nos. 29332 y 29465 y Dictan Medidas Extraordinarias Para el Financiamiento de la Continuidad de las Inversiones durante el Año Fiscal 2010) dated December 23, 2009 and published in the Borrower's Official Gazette (El Peruano) on December 24, 2009; (b) Supreme Decrees no. 002- 2010-EF and 003-2010-EF, both dated January 11, 2010 and published in the Borrower's Gazette (El Peruano) on January 12, 2010 estalishing the procedures regulating performance measurement criteria and targets and the allocation of resources to Municipalities; and (c) Resolution no. 008-2010-EF/76.01 issued by the Directorate of Public Budget on March 30, 2010 and published in the the Borrower's Gazette (El Peruano) on April 1, 2010, approving the results of compliance by Municipalities of performance targets as reported by said Municipalities by February 2010. Make the Tax System More Neutral and Stable 48. The goal of increasing the tax base became increasingly difficult in 2009 as the authorities coped with the impact of the global economic crisis. In 2009 tax revenues dropped sharply to 13.8 percent of GDP, down from 15.6 percent of GDP in 2008. By comparison the average for lower middle income countries stands around 19 percent of GDP. The difficult economic environment also made it difficult to redress other features of the tax system that still hamper its neutrality. For example, the severe drop in exports, which fell by 15 percent in 2009, prompted authorities to temporarily increase the so-called `duty drawback' for exporters (aimed at compensating exporters for tariffs paid on imported inputs) from 5 to 8 percent of the value of exports. Similarly, a new tax exemption was introduced by which producers operating in high altitudes of more than 2,500 meters above sea level (but excluding regional capitals) are exempt from income tax, tariffs, and sales tax for a period of 10 years (Law 29482). 49. The authorities introduced a tax on capital gains. In line with the intention to reduce the gap between the tax rates on labor and capital income, the authorities passed a law in December 2009 (No. 29492) and its regulations in February 2010 for taxing capital gains from stocks. The applicable tax rate differs on whether the capital gains accrue to a legal entity (30 percent) or a person (5 percent). Besides the introduction of the capital gains tax, other tax measures implemented during 2009 that have helped to make the tax system more 25 neutral include the reduction of the financial transfers tax from 0.07 to 0.06 percent, the reduction of the temporary tax on net assets from 0.5 to 0.4 percent. 50. On-line access to tax administration services has continued to improve. The progress in this regard noted in the previous operation has continued. In the most recent income tax annual declaration 95 percent of all taxpayers filed online. The administration remains committed to reducing tax compliance costs, in particular by facilitating on-line services. Following SUNAT Resolution 036/2010, published on January 31, 2010, the authorities launched in February 2010 a new simplified virtual tax return for the monthly returns to be filed by third-category income (income from professional or business activities) regarding income tax and VAT. In addition, the authorities have launched a new report which will allow taxpayers to obtain on-line certificates showing that they are current with the tax authorities, facilitating for example access to credit for the taxpayer. These and other on-line services are expected to help lower the cost of tax compliance and contribute to broadening the tax base. 51. Going forward, continuing to make tax system more neutral by reducing compliance costs and tax exemptions will help to increase the tax base. The authorities remain committed to increasing the tax base, which is eroded by tax exemptions as well as evasion. Addressing tax exemptions has proven to be particularly challenging and remains an area where further progress can be made. Similarly, while tax evasion has many determinants, reducing tax compliance costs may help reduce informality and would also help reduce the burden on micro and small businesses. The authorities have set out a clear path for simplifying tax administration through a variety of on-line services. Actions completed under the Program (DPL IV) 52. Prior actions completed by the Borrower under the Program include the following (Annex 3): (2) Issuance of Resolution No. 036-2010/SUNAT dated January 29, 2010 and publihed in the Borrower's Official Gazette (El Peruano) on January 31, 2010, providing for procedures aimed at improving tax compliance, through, inter alia, the establishment of online tax filing procedures (Formulario Virtual para la Declaración y Pago de Renta de Segunda Categoría) in regard to income taxes (impuesto a la renta). Strengthen Budget Reporting and Planning 53. In terms of security and liquidity, the current coverage of the Peruvian Treasury Single Account (TSA) is sufficient, at this time, to meet international standards. There has been, however, a delay with respect to transitioning into the TSA the revenues of FONCOMUN. The inclusion of FONCOMUN into the TSA is now expected to take place in July 2010. To that end, the MEF has internally agreed on the actions required, including the implementation and operation of some functions in the existing Financial Integrated Administration System (SIAF for its initials in Spanish). Additionally, the National 26 Directorate of the Public Treasury (Dirección Nacional de Tesoro Público, DNTP) is also working on a strategy that allows them to deal with certain legal and administrative issues that may arise in the operation of the TSA once FONCOMUN proceeds are included. The directly collected revenues (RdR) will be gradually incorporated into the TSA following a medium term framework. 54. Progress has also been made in eliminating redundant bank accounts within the public sector. Although the actual number of bank accounts is less important than whether the funds in all accounts are managed virtually as a virtual single account (TSA), the DNTP has also made progress in eliminating redundant accounts. Since the implementation of the TSA, about 5,000 bank accounts (opened in the Banco de la Nación) have been closed and an additional 2,500 bank accounts are expected to be closed by the end of 2010. 55. Financial reports from the TSA continue to be generated and evaluated on a daily, weekly and monthly basis by MEF. These reports are provided to the Cash Committee that reviews the monthly cash reports, which provide an up-to-date data regarding projections of the cash position, allowing the committee to make more informed decisions in adjusting the original cash plan. Additionally, the DNTP will work with the support of an international consultant in the design of an improved cash flow. 56. The design of the new integrated financial management system (SIAF II) has continued to make progress. The conceptual framework for the SIAF II was approved in March, 2010. On that basis, the budget programming module is expected to be launched in March 2011 on a pilot basis for the preparation of the 2012 budget. 57. The 2009 Consolidated Government Financial Statements reflects the implementation of the new budget classification system and the new chart of accounts. This change in the presentation of the Consolidated Government Financial Statements (Cuenta General de la República) will bring Peru in line with international standards. Despite the challenges associated to the change in such a complex information system, the transition has been relatively smooth since only 10 percent of the implementing agencies ­ largely small municipalities ­ were unable to comply with the submission of financial reports under the new system by end-March 2010 (compared to 5 percent of non-complying entities under the previous system in 2009). The Consolidated Government Financial Statements for 2009 and the corresponding audit report will be presented to the National Congress by August 15, 2010, thus providing additional elements on the results of the use of public funds to for the discussion and approval of the budget bill for the following year. This improvement in the timeliness for the submission of audited Consolidated Financial statements represents a key step towards increasing transparency in public resource management. 58. Going forward the authorities aim at strengthening further the transparency of public accounts, helped by the launch of a new integrated financial system (SIAF II). While Peru has made great progress to improve the efficiency and transparency of public accounts, the authorities remain committed to making further progress in this area. [In the short-term the new Consolidated Government Financial Statements and the corresponding audit report require an amendment to the General National Accounting System Law (Law 27 28708)]. In the medium-term, the shift to a new integrated financial system (SIAF II) will pose logistical challenges to ensure a smooth transition. Actions completed under the Program (DPL IV) 59. Prior actions completed by the Borrower under the Program include the following (Annex 3): (3) Enactment by the Legislature of the Borrower's Law No. 29537 dated June 7, 2010 and published in the Borrower's Official Gazette (El Peruano) on June 8, 2010, mandating the timely preparation and disclosure of consolidated government financial statements (Cuenta General de la República) and audit reports aimed at strengthening further the Borrower's budget reporting capacity. Increase Equity in Intergovernmental Transfers 60. The launch of FONIPREL and the changes to the allocation of the FONCOR were early efforts to address the inequity in the transfer mechanisms. The first two years of operation of FONIPREL proved a success in competitively allocating funds for projects in poor regions. Under this fund, municipal and regional governments submit proposals for investment projects that are assessed on the basis of project feasibility and their expected impact on poverty reduction. Moreover, 88 percent of resources went to areas which are classified as having less access to other resources. Besides FONIPREL, the GoP also introduced changes in 2007 and 2008 to the formula for calculating the coefficients used for distributing transfers under the Regional Compensation Fund (FONCOR). The new formulas take into consideration the gap between regional needs (a function of population, poverty, geographical location, and a performance indicator related to the execution of investment projects) and other transfers that the region receives, including canon and regalías. 61. The fiscal stimulus plan also included measures to help make transfers to the regions more equitable in 2009 and 2010. As part of the economic stimulus plan the authorities earmarked 2.6 billion nuevos soles for regional governments (Decree 028-2009). The specific allocations take into account the extent to which individual regional governments receive other transfers. While all regional governments are to receive transfers under this policy, the final allocation was tilted towards poorer regions and those without access to canon and regalías. 62. Most recently, the authorities have modified the methodology to distribute the FONCOMUN among municipalities, resulting in more equitable transfers. In 2010 the authorities changed the methodology for distributing the municipal compensation fund, so that a broader set of unmet needs was taken into account (under the previous methodology the only criterion for the allocation of funds among provinces was the infant mortality rate). The new methodology also considers variables such as the fiscal effort of municipalities and the extent to which they are prioritizing on public investment to allocate funds among different municipalities within a given province. All in all, the change in methodology for the 28 allocation of FONCOMUN will decrease the Gini coefficient of FONCOMUN transfers from 0.39 in 2009 to 0.35 in 2010. 63. Going forward a key challenge to increase the equity of inter-governmental transfers is to take account of existing mechanisms to share revenues from natural resources. The canon and other mechanisms by which revenues from natural resources are divided between the central, regional and local governments can exacerbate regional disparities as well as generating vertical asymmetries between levels of government. The authorities have continued to allocate funds to regional governments using the new methodology for determining transfers under FONCOR that was first used in 2007 and that helps to reduce inequities in intergovernmental transfers. The authorities have increasingly taken such factors into account. This is evidenced by the changes to the FONCOR and FONCOMUN transfer schemes, and the setting up of the FONIPREL. Actions completed under the Program (DPL IV) 64. Prior actions completed by the Borrower under the Program include the following (Annex 3): (4) Issuance of Supreme Decree No. 060-2010-EF dated February 17, 2010 and published in the Borrower's Official Gazette (El Peruano) on February 18, 2010, setting forth a new methodology for the allocation of FONCOMUN resources to Municipalities, thereby promoting equity in transfers of resources from the Executive to the Municipalities. Improve the Efficiency and Impact of Public Spending 65. The GoP has maintained a strong emphasis on improving the quality and impact of public spending, giving a results-orientation to the budget. The GoP decided to introduce performance-based budgeting, and launched its formal efforts in the 2007 and 2008 Budget Laws to aid budget decision-making, with the focus on improving the performance and accountability of public spending. The results-orientation is based on the gradual implementation of three complementary pillars: (i) budget programming; (ii) monitoring and evaluation; and (iii) developing tools to collect the information required. 66. Progress was made in 2009 in all three pillars of the results-oriented budget. First, budgetary programming with a results orientation was extended to 15 strategic programs for the 2010 budget, up from 9 strategic programs in 2009 and 5 programs in 2008. As a result, the share of budget under strategic programs increased from 4 percent in 2008 to 9 percent in 2009 to 13 percent in 2010. In addition, the authorities have introduced 60 institutional programs in the 2010 budget. Such institutional programs also display a results- orientation as they relate inputs to outputs of a given agency. Second, results-oriented executive evaluations continue to be developed. Following the initial independent evaluations of four budgetary programs in 2008, the authorities commissioned an additional ten independent evaluations in 2009, all of which have been made public on the MEF website. Agreements with the implementing agencies on the recommendations from three of 29 the first four evaluations have been reached and were made public. Third, the data gathering efforts have been noteworthy. The number of executing agencies that report detailed information on inputs, outputs, and intermediate outcomes to the results secretariat in MEF through software (SIGA-PpR) has increased from one thousand in 2008 to more than six thousand in 2010. 67. More broadly, Peru continues to make progress in putting in place the foundations for performance-based budgeting. These include the multi-year budget perspective, a programmatic budget classification, robust financial management and evaluation information management systems, and the development of well-defined measures of performance that link priority policies, objectives and programs. The Budget Office (DGPP) has also strengthened its role in the process, as reflected by the internal reorganization within MEF in March 2010. 68. Going forward the challenge remains to continue strengthening the linkages between budget allocations and program outputs. The authorities intend to continue to extend and deepen their reforms as described above over the medium term. This is an ambitious undertaking and international experience suggests that it will be important to continually monitor and evaluate the experiences and to adapt the performance-informed budget framework where desired. Over the longer term, it will be important to link the performance-based budget framework to the process for the drawing up of a Multiple-year Budget Framework. Benchmarks completed under the Program (DPL IV) 69. Benchmarks completed by the Borrower under the Program include the following (Annex 3):3 The Borrower has included six additional budgetary programs with a results- orientation framework in the 2010 Budget Law. Make Public Sector Processes More Transparent, Accessible and Agile 70. The e-procurement agenda has shown significant progress since the last operation in this series. The Bank continued providing technical assistance to the Government supporting the National Procurement Strategy and its implementation plan. The strategy along with the use of OECD benchmarking indicators helped in establishing a baseline of the performance of the national procurement system with the appropriate strategies to strengthen the system. The authorities have also reorganized the Supervisory Unit for State Procurement (Organismo Supervisor de las Contrataciones del Estado-- OSCE). 3 The policy measures completed by the Borrower are a continuation of a reform already initiated under previous operations in this series and are therefore considered a benchmark. 30 71. The development of the National Procurement Strategy sets Peru on a path toward consolidating a modern national procurement system. The Plan to implement the Procurement Strategy identifies eight key areas that will be addressed within a coordinated framework to strengthen the performance of the national procurement system. When implemented, these strategic areas will provide the GoP with a dynamic, transparent and efficient system--an increasingly critical tool to implement the GoP's policy agenda. According to OSCE information database, Peru's national procurement system only achieves about 40 percent of its planned activities. Further pressure is placed on this system by the government stimulus program. Currently, at the request of the GoP, the Bank is providing procurement assistance in the context of the economic stimulus package, with a particular focus on infrastructure spending. 72. The legal framework for procurement has been improved. A new procurement law was approved (Decree 1017), together with its regulation. This law establishes the division of the regulatory and procurement functions. OSCE will continue its regulatory role, while the newly-established PeruCompras agency will be in charge of aggregate/strategic procurement and framework contracts. However, the appointment of a director and team for PeruCompras is still pending. 73. In contrast, progress in other areas of e-Government, including regarding the digital signature, has experienced delays. The authorities remain committed to the objective of bringing the e-government and digital agendas in line with changes in evolving international information and communications technology (ICT) standards. However, progress has been limited, in part as a result of institutional changes at the National E- Government Office (Oficina Nacional de Gobierno Electrónico e Informática--ONGEI). 74. Going forward, further progress in public procurement will help to make public processes more agile. While progress has been made in the procurement agenda, there remain a number of key areas to be strengthened. In the short- and medium-term these include: (i) implement the procurement accreditation framework; (ii) carry out in-depth studies and diagnoses of Procurement Planning Manuals, planning and payroll systems, mechanisms for assessing the quality of planning and, ranking of entities in the quality and efficiency of its procurement; (iii) develop three standard bidding documents for specific sectors; (iv) review the Regulation of the Procurement Law and; (v) continue with the development of the new version of the e-GP System SEACE II. Benchmarks completed under the Program (DPL IV) 75. Benchmarks completed by the Borrower under the Program include the following (Annex 3): 4 The Borrower has approved (a) twenty mandatory Standard Bidding Documents for goods, consultant's services and civil works (Resolution No. 195-2010- 4 The policy measures completed by the Borrower are a continuation of a reform already initiated under previous operations in this series and are therefore considered a benchmark. 31 OSCE/PRE published in the Official Gazette on April 21, 2010); and (b) a procurement accreditation framework, covering all public agencies. 2. Competitiveness 76. Peru's resilience to the global crisis owes to its prudent macroeconomic policy management. However, sustaining economic growth requires improvements in the country's competitiveness. The World Economic Forum ranks Peru 78rd in its Competitiveness Index, an improvement compared to the 83rd ranking in the previous year. However, Peru lags behind regional competitors, such as Chile (30), Brazil (56) or Mexico (60) (See Figure 5). Competitiveness is affected by cumbersome business regulations, high trade and logistics costs and low innovation. Figure 5: Peru's Competitiveness Ranking5 Source: World Economic Forum, 2009 77. Competiveness and policies to foster deeper trade integration continue to be key pillars of the Government's policy agenda to support growth. Competitiveness and the investment climate have and will continue to benefit from several of the reforms noted in the previous section, in particular fiscal and public debt consolidation, improved transparency in economic policy and a modern public sector. A number of bottlenecks to private sector activity are being addressed by specific policies, particularly regarding procedure simplification, sustainable expansion of private credit, and fostering innovation practices especially to MSMEs. The government has also launched measures to reduce transaction costs to start, operate and close a business. According to Doing Business (2010), in 2009 starting a business took 9 procedures and 41 days, compared to 10 procedures, 65 days and 25 percent of per capita income in 2008. Expand and Deepen International Trade 78. Peru's export performance was affected by the global crisis but recovered by December 2009. Peru's export performance has been impressive over the last years, with 5 The index receives a better rating when closer to the origin. 32 compound annual growth rates averaging above 21 percent between 2003 and 2009. However, as the global crisis unfolded, export growth slowed down to 12 percent in 2008 and -14 percent in 2009. The global slump hurt the performance of Peru's large exporting companies producing traditional commodity products (especially minerals and hydrocarbons). However, by December 2009, they were back to the levels prior to the crisis, with traditional exports amounting to US$2.8 billion, a 43 percent increase compared to the same month in 2008. Non-traditional exports (textiles and agro-business) held up relatively well, although they represent a small share of total exports, about 23 percent (about US$6.3 billion). In spite of their strong performance, total exports in Peru still represent a low percentage of GDP, about 21 percent in 2009. Figure 6: Peru Export Composition Exports (US$ bn) Exports (US$ bn at 2002 Prices) 35 35 40 Non Traditional Non Traditional 30 30 35 Traditional Traditional 30 25 25 25 20 20 20 15 15 15 10 10 Non Traditional Exports (as % total) 10 Non Traditional Exports in 2002 5 5 5 constant prices (as % total) 0 2002 2003 2004 2005 2006 2007 2008 2009 2002 2003 2004 2005 2006 2007 2008 2009 2002 2003 2004 2005 2006 2007 2008 2009 Note: Traditional exports refer to minerals and metals, hydrocarbons, and selected agricultural and fishing products (sugar, cotton, coffee, and fishmeal). Source: Bank staff calculations based on UN COMTRADE. 79. The administration has moved ahead in deepening connections to international markets and promoting trade diversification. The Peru-U.S. Trade Promotion Agreement (TPA), a comprehensive free trade agreement, entered into force on February 1, 2009. Since this date, Peru has passed more than 100 regulatory measures related to the treaty's implementation, including those related to intellectual property and copyright protection. Peru's FTA with Chile came into effect in March 2009. The FTA with China (Peru's second- largest trading partner) became effective on March 1, 2010. In August 2009, two additional FTAs--one with Canada and one with Singapore--went into effect, and similar arrangements with Republic of Korea, Japan and other countries are underway. Trade expansion is expected to continue to help Peru create a more diversified portfolio of export markets. In 2009 the United States (U.S.) and the European Union (EU) accounted for about one-third of traditional exports products and 40 percent of non-traditional products, with the remainder purchased by other countries around the world. China, in particular, has become a major consumer of Peruvian traditional exports, roughly equal to the U.S. and EU in 2009. 80. The GoP continued reducing average tariffs and tariff dispersion as well as simplifying the tariff structure, benefiting consumers as well as exporters who rely on imported inputs. Following the major tariff reduction in October 2007 involving over 4000 products, the administration undertook two further reductions in 2009, simplifying the tariff 33 structure to just three levels--0 percent, 9 percent and 17 percent--with an average tariff of 5 percent and tariff dispersion of 5.9 percent. 81. The administration took several temporary measures to ease the impact of the crisis on export industries, and is gradually reversing them. In January 2009, the drawback program to support non-traditional exports was increased from 5 to 8 percent for the duration of the calendar year. In December 2009, the government issued a decree seeking to reduce the drawback program from 8 to 6.5 percent by July of 2010, and back to 5 percent by December 2010. 82. The promotion of micro, small and medium exporting enterprises remains a key policy priority. In early 2009, the administration set aside US$100 million to expand access to credit for small and medium exporting firms. These resources will be available until March 2011. In addition, the administration supported the creation of a new insurance program called Sepymex, backed by US$83 million and managed by the second-tier development bank COFIDE. The program offers insurance coverage to pre-shipment credits given by a financial institution to a small or medium exporting firm (less than US$8 million of exports per year). The coverage is 50 percent of the total loan insured, up to a maximum US$3 million. In addition, to promote exports by micro and small firms, the GoP increased the exportable sale value of products of the Exporta Fácil program from US$2,000 to US$5,000. 83. In 2009, the GoP created two funds geared toward the support of small and medium-sized enterprises and their integration into global markets through the provision of training, technological innovation and access to finance. The Research and Development for Competitiveness Fund (Fondo de Investigación y Desarrollo para la Competitividad--FIDECOM) aims to (i) promote research and development for productive innovation in firms and (ii) develop and strengthen capacities for generating and applying technological knowledge towards upgrading productive and management capabilities in micro-firms. Project proposals will compete for FIDECOM resources on the basis of impact, feasibility, and cost-benefit considerations. Calls for projects will be conducted periodically and a process of evaluation is contemplated to select the beneficiaries. Currently FIDECOM has allocated 200 million nuevos soles to develop its activities. FIDECOM's regulations were approved in February 2009, an executive committee has been convened, and the science and technology fund FINCYT--which has proven experience in administering technology funds--has been named as FIDECOM's technical secretariat. Putting FIDECOM in operation, however, implies a significant challenge, as there is no experience of managing a competitive fund in Peru's public sector. A proper legal framework needs to be developed to operate FIDECOM, which is under design by the fund's executive committee. The second fund to access financial factoring services is still in the design stage. 84. Going forward, the GoP is committed to continue trade expansion through the signing of Free Trade Agreements. The GoP successfully concluded negotiations of the FTA with the EU in May 2010. Four negotiation rounds of the FTA with Korea have already taken place and negotiations are expected to be very close to conclusion. Four negotiation rounds have been completed with Japan, achieving progress on rules of origin, procurement, 34 competition policy and cooperation, among others. In 2010, Peru started negotiations with the Trans Pacific Partnership Agreement (Chile, New Zealand, Brunei, Singapore, Vietnam, Australia, Peru, and U.S.) and Central America. In addition, the FTA with Mexico has been extended until December of 2011. 85. Another challenge is to deepen efforts to simplify customs procedures. The One- Stop-Shop for Trade (Ventanilla Única de Comercio Exterior, or VUCE) is underway but the implementation of phase one is expected to be completed by the end of 2010. The GoP is committed to undertake actions for trade facilitation. The introduction of an electronic processing of the cargo manifest and the customs declaration is expected to be fully operational by October 2010. Customs clearance procedures will be further simplified through the following measures: (i) data harmonization with other agencies based on the WCO Customs Data Model; (ii) integration with other customs and One-Stop-Shop of the world; and (iii) the implementation of the phase two of the VUCE. In the medium-term, the GoP plans to complement these efforts with additional measures to improve customs services and customs duty regulation. Actions completed under the Program (DPL IV) 86. Prior actions completed by the Borrower under the Program include the following (Annex 3): (5) The Borrower has expanded and facilitated international trade through: (i) the closure of the negotiation process of a proposed trade agreement between the Borrower and the EU, as evidenced by the signing of the Joint Declaration on May 19, 2010; and (ii) the issuance of Supreme Decree no. 096-2010-EF dated March 26, 2010 and published in the Borrower's Official Gazette (El Peruano) on March 27, 2010 establishing October 1, 2010 as the completion date for the progressive implementation of simplified customs procedures. Promote Sustainable Financial Deepening 87. The Peruvian financial sector proved resilient to the global crisis with solid indicators. Credit growth decelerated significantly but remained positive in 2009. Despite the global financial crisis, access to credit has expanded during the last years accompanied by stronger supervision. Credit portfolio growth in all client segments has been strong among supervised financial entities during the last three years.6 Credit growth to the private sector by the banking sector has been led by the retail market. It maintained a robust expansion during 2008 and first semester of 2009, with annual growth rates above 30 percent, though this pace decelerated on a monthly basis from the second part of 2009, reaching 4.32 percent in December 2009. Total credit to the private sector stood at 35.5 percent of GDP in 2009, from which 24.1 of GDP was credit provided by the banking sector. 6 Supervised financial entities include banks, financial companies (empresas financieras), municipal and rural savings and loans institutions (cajas municipales and cajas rurales) and microfinance institutions (EDPYMES). 35 88. Peru's strong policy framework and timely response to the global crisis were key to contain the financial impact on the Peruvian economy. The financial sector was well- positioned to face the global financial crisis, with a regulatory and supervisory framework that had been strengthened significantly in recent years. These regulatory measures contributed to improve the performance of asset quality indicators, with non-performing loans (NPLs) decreasing from levels of 4 percent in 2005 to 1.5 in 2008. The impact of the economic slowdown on portfolio quality was limited, as NPLs loans increased modestly from 1.91 in 2009 to 2.08 percent in February 2010. The coverage of provisions over NPLs has been above 200 percent during the last two years. In February 2010 coverage was 206 percent decreasing from 219.1 in February 2009. Banks remained well-capitalized, liquid, and profitable during 2009. Moreover, as of February 2010, the SBS reported a capital adequacy ratio (CAR) for the banking sector of 13.4 percent, well above the minimum 8 percent recommended by the Bank of International Settlements. 89. In reaction to a deteriorating economic environment, the central bank took several preventive measures at the beginning of the crisis. During the period of heightened global risk aversion and deleveraging, the central bank injected substantial liquidity in the system, both in Soles and U.S. dollars in order to prevent liquidity squeeze and credit crunch. Starting September 2008 and along 2009, the central bank offered repos in dollars to boost dollar liquidity, with total interventions reaching more than US$8.1 billion. It also extended the terms of repo operations up to one year and allowed pension funds and mutual funds to participate in these operations. Also in October, the central bank cut the marginal reserve requirements for foreign currency from 49 percent to 35 percent and eliminated marginal reserve requirements for local currency. The marginal deposit requirement was cut to 30 percent from 35 percent for foreign currency accounts. The minimum legal reserve requirement has been cut three times since December 2008, from 9 percent to the current 6 percent, increasing liquidity by a total of 1.2 billion nuevos soles. 90. Peruvian authorities remain strongly committed to further enhancing the regulatory framework by applying the lessons from the financial crisis. The Peruvian authorities have taken additional measures to mitigate risks and promote sustainable credit expansion. Regulatory norms on capital, liquidity and dynamic provisioning are ahead international standards. SBS issued a regulation (Resolution 1237/2006) to ensure that supervised institutions are adequately managing over-indebtness risk and that their corporate governance arrangements and underwriting standards adequately reflect these risk management practices. Further regulations changing the ways to calculate net worth of financial institutions, specifying criteria for classifying different types of debtors, and mandating systems to prevent money laundering and terrorism finance have also put into place since 2008, improving the management and resilience of the financial sector. More recently, regulatory authorities have established additional capital requirements linked to the assessment and risk of borrowers' FX credit risk, which will become effective in July 2010, to further promote that banks internalize such risk. In addition, authorities are considering several initiatives, including capital requirements for systemic risk; strengthening the crisis resolution framework; and improving liquidity provisioning under systemic stress. 36 91. The GoP has also taken measures to further develop domestic capital markets. Although a regulatory framework for securitization has existed in Peru since 1997, a relatively limited number of transactions have been conducted. This was in part due to an outdated framework which did not keep pace with market developments. However, in recent years the Peruvian Securities and Exchange Commission (Comisión Nacional Supervisora de Empresas y Valores--CONASEV) has approved new securitization regulations (Resolution 087/2007 and Resolution No. 068-2009/94.01.) to facilitate the development of new instruments, to allow the issuance of asset-backed securities and reduce transaction costs. In addition, steps are being taken to develop the mortgage market in Soles of a covered bond instrument, and to foster the development of key financial instruments such as the repo and interest rate swap markets that would facilitate lending in Soles. Moreover, the authorities intend to strengthen the function of CONASEV which would help ease access to the domestic capital markets. A current agreement to integrate the Chilean, Colombian and Peruvian stock markets by 2011 is also expected to increase investible assets for pension funds and increase market liquidity. The rationale behind these regulatory efforts is to create an enabling environment for structured financing solutions to flourish, to tap the potential demand of institutional investors, while channeling much-needed financing to under-served sectors. 92. The MSME sector continues to be a particular focus of attention for credit expansion by the Peruvian authorities. The GoP is seeking to diversify the product offering of financial institutions by lowering the regulatory costs involved. The 2008 law on MSMEs gave the state development bank COFIDE the power and means to promote access to financing for MSMEs, including 900 million nuevos soles (about US$300 million) to finance working capital, pre and post shipments, investment and exports of capital goods for MSMEs exporting non-traditional products. On February 19, 2009 the decree 024-2009 created Fondo de Garantía Empresarial (FOGEM) to provide partial guarantees on new loans granted by Peruvian banks to MSMEs. In addition, COFIDE developed a reverse factoring scheme for MSMEs to provide an alternative way for smaller firms to access financing. This fund was settled on May 2009 and will operate through private banks by May 2010. 93. Going forward, facilitating sustainable financial deepening remains a key challenge. This will require the design and implementation of more flexible financial instruments. The GoP is currently considering two areas of policy reforms: (i) securitization and mortgage product development; and (ii) improve banking services and access to finance by MSMEs. As of February 2010, there were approximately 124 thousand mortgages in the banking sector, which is relatively low if compared with 837 thousand mortgages in Chile (a country with roughly half of the population of Peru). Additionally, the penetration of mortgage products in low income groups (groups C and D) could be significantly increased. Improvements in SBS regulations on bank's mortgage registration and liquidation processes as well as standardized documentation and improved clarity on the scope of mortgage collateral would significantly improve the development of the capital market. 37 (i) Securitization and mortgage product development. In September 2009, the GoP approved a regulation to promote asset securitization. The primary objective of this regulation aimed at reducing transaction costs for securitization. The first issuance of mortgage securities took place in 2009 for a total of US$35 million with the participation of BCP, Interbank and IFC. An additional issuance in the amount of US$100 million is currently being prepared by Titulizadora Peruana. In addition, covered bonds (synthetic securitization) for mortgages and principal home are being developed and the draft regulation for the implementation has already been prepared. The Bill was sent to Congress on February 17, 2010. Finally, a new segment of mortgage administration companies is currently being developed. These are securitization companies issuing tradable securities targeted to mortgages between US$25 thousand and US$60 thousand. A company - INCASA- has already been created and it has issued already S/ 7 million. (ii) Improve banking services and access to finance by MSMEs. The GoP has undertaken measures to provide access and guarantees on loans to support MSMEs. However, considering the importance of MSMEs for the economy (accounts for nearly 97 percent of total firms), it is essential to expand credit and improve access to finance. The government expects to issue new regulations on bank correspondents by end June 2010. As a medium run objective, the GoP expects to issue a new regulation for the use of electronic payment instruments (pre-paid cards). Prior Actions completed under the Program (DPL IV) 94. The prior actions completed under the Program include the following (see Annex 3): (6) The adoption of Resolution CONASEV No. 068-2009/94.01.1 dated September 24, 2009 and published in the Borrower's Official Gazette (El Peruano) on September 29, 2010, aimed at strengthening the Borrower's regulatory framework for asset securitization and therefore promoting the development of the Borrower's capital markets. VI. Operation Implementation A. Poverty and Social Impact 95. The actions supported by this operation are not expected to have significant negative poverty and social impact. In fact, the poverty and social impacts of the policies supported by this loan series have been positive. On the fiscal side, the sound fiscal policy framework supported by the FMCDPL series has allowed the GoP to increase its attention to social spending, particularly through the Juntos conditional cash transfer program for the poor, and to undertake a sizeable emergency fiscal stimulus program to mitigate the effects of the global economic downturn on Peru and sustain the social and economic gains of recent 38 years. Actions to improve the performance orientation of budgeting processes began with pilot projects in specific areas related to improving the impact of social spending on the poorest sectors of the population. These activities are also receiving intensive support from the parallel REACT DPL series working to improve results and accountability in public social programs. Initiatives to improve the equity of how fiscal resources are distributed throughout the country, in particular through the new FONIPREL investment fund, have also benefited poorer parts of the country. The fund accepts project proposals not just on project viability, but also on poverty rates and the level of a locality's resources, thus disproportionately benefiting regions with high poverty levels and limited natural resources. More than half of the fund's investments thus far have been in the country's six poorest regions. 96. Competitiveness policies have helped with the impressive economic activity experienced in Peru in the past several years, which in turn has boosted employment creation and poverty reduction. This has been particularly notable in the growth of micro, small and medium enterprises and the non-traditional export sector, which contribute more significantly to employment creation than the traditional commodity export sectors. The long-term strategy for reducing barriers to international trade through reductions in tariffs and export subsidies and pursuing free trade agreements with Peru's major trading partners has unquestionably benefited Peru overall, as evidenced by recent high rates of export growth and overall economic activity. By opening new markets and helping to diversify the export mix of Peru, the measures adopted by Peru to expand and facilitate international trade are likely to have positive poverty and social impacts. As well, consumers have benefited with lower prices for many goods. 97. To assist the poor and those living in rural areas to take advantage of the opportunities from Peru's greater integration into the world economy, the GoP is combining short-term social assistance programs with medium- and longer-term efforts in human capital and infrastructure investments. While Peru's greater integration in the world economy will bring opportunities for the country as a whole, it must also be acknowledged that not all social groups are in the same position to take advantage of these opportunities. One of the flagship programs of the 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 region. The project is directing significant technical assistance, infrastructure investment, and credit to boost export-oriented agriculture, forestry and artisan production based on local knowledge and specialties. The Bank's Sierra Development Project, included in the CPS, is supporting aspects of Sierra Exportadora. In the medium and long term, the GoP is undertaking significant efforts to increase logistical links to more remote areas of the country to help these poorer areas access broader domestic and international markets. Additionally, the GoP is cognizant that human capital deficits are critical in holding back many poorer Peruvians, and improving the quality of education is a top administration priority. This is fully supported by the Bank, through the RECURSO analytical project on social sector results, the ongoing social sector DPL (which has a strong focus on education), and through the results- budgeting orientation included in this operation. 39 98. Fast economic growth in recent years has been accompanied by poverty reduction and job creation. Between 2005 and 2009 poverty fell from 48.7 percent to 34.8 percent, while extreme poverty was reduced from 17.4 percent to 11.5 percent (Table 4). The continued reduction in poverty is remarkable given that 2008 saw high food price inflation and that economic growth slowed down in 2009 as a result of the global economic crisis. The reduction of poverty in 2009 was concentrated mainly in urban areas, especially in Lima, and took place at a lower rate than in previous years. Poverty incidence remains highly unequal in geographic terms, with some regions posting poverty rates above 60 percent. Table 4: Poverty Rates, 2004-2009 (percent) Total poverty Extreme poverty 09-04 09-04 2004 2005 2006 2007 2008 2009 (ppts) 2004 2005 2006 2007 2008 2009 (ppts) National 48.6 48.7 44.5 39.3 36.2 34.8 -13.8 17.1 17.4 16.1 13.7 12.6 11.5 -5.6 Coast urban 37.1 32.3 29.9 25.1 23.4 21.4 -15.7 5.6 4.0 3.0 2.1 2.4 2.3 -3.3 Coast rural 51.2 50.0 49.0 38.1 34.8 40.6 -10.6 13.8 13.4 14.4 10.5 7.9 9.2 -4.6 Sierra urban 44.8 44.4 40.2 36.3 33.5 31.3 -13.5 13.6 11.6 10.3 8.5 9.2 6.8 -6.8 Sierra rural 75.8 77.3 76.5 73.2 68.8 65.6 -10.2 44.0 46.6 46.5 40.8 37.4 33.2 -10.8 Selva urban 50.4 53.9 49.9 40.3 31.3 32.5 -17.9 18.7 22.5 18.1 11.0 7.2 8.8 -9.9 Selva rural 63.8 65.6 62.3 55.3 49.1 57.4 -6.4 30.4 28.0 24.6 23.4 20.7 23.8 -6.6 Metropolitan Lima 30.9 32.6 24.2 18.5 17.7 14.1 -16.8 1.3 2.0 0.9 0.5 0.7 0.2 -1.1 Source: Instituto Nacional de Estadística e Informática (INEI). 99. While inequality of opportunity remains high, Peru has made substantial progress in addressing it. The Human Opportunity Index, which measures equality of opportunity in access to social services, shows substantial improvement between 1995 and 2006 when compared to other countries in the region (Figure 7). Increased public investments in water, sanitation and electricity during the last years support a trend of reduction in inequality of opportunity. Despite this progress, large opportunity gaps remain a challenge for policy-makers. 40 Figure 7: Human opportunity index, change from 1995 to 2006 Average annual change in index Source: World Bank B. Implementation, Monitoring and Evaluation 100. The Bank will monitor actions and review progress of the implementation of the proposed operation using different sources including: Fiscal transparency 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 Estadística (INEI), www.inei.gob.pe Investment Climate Survey Credit rating agencies reports ­ several sources World Bank Doing Business indicators World Economic Forum competitiveness indicators Government Tax Agency SUNAT ­ www.sunat.gob.pe IMF and IADB reports 101. The GoP and the Bank have agreed from time to time, at the request of either party, exchange views on the Borrower's macroeconomic policy framework and the progress achieved in carrying out the Program. The Sectoral Loans Coordination Unit (Unidad de Coordinación de Préstamos Sectorales--UCPS) in the MEF 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 track indicators. Other important agencies are the central bank, SUNAT, PCM and Ministerio de Comercio Exterior y Turismo (MINCETUR). C. Fiduciary Arrangements 102. During 2009, in the context of the preparation of a series of DPLs, including the Programmatic Fiscal Management and Competitiveness DPL series, the Environmental 41 DPL series, and the REACT DPL series, the Bank undertook a review of Peru's public financial management (PFM). The review of the status of PFM in Peru was further complemented by a joint assessment with other development partners following the Performance Measurement Framework (Public Expenditure and Financial Accountability, PEFA) assessment. The final report was published and disseminated in June 2009. 103. The results of the PEFA assessment, from the perspective of the six budget dimensions measured by the framework, concluded that, overall, PFM in Peru is functioning well and is in line with international best practices. The main findings of the PEFA assessment are summarized below: (i) The central government's budget in Peru is a reliable and credible financial tool, despite the discrepancies between the executed and the initial budget. Overall, the budget formulation follows international best practice. It is an orderly and institutionalized process; is transparent; and the documentation attached to the Budget Bill submitted to Congress for scrutiny is fairly comprehensive, with the public having access to key information in a timely manner. (ii) The predictability of budget resources and internal controls of budget execution are also working relatively well. Budget execution is well documented and Consolidated Government Financial Statements (Cuenta General de la República) are prepared annually and submitted in a comprehensive document that contains information regarding revenues, expenditures, and financial assets and liabilities, and is audited within the legally established time periods by the Supreme Audit Institution (Contraloría General de la República, CGR). The annual audit of public institutions covered approximately 73 percent (for 2008), and it is conducted pursuant to the respective regulations and within the time frames established by law7. (iii) Legislative scrutiny of the annual budget bill is conducted in accordance with well-established procedures and the scrutiny of the Cuenta General is performed in a similar way. However, there is limited capacity in the Congress for following up on the audit recommendations proposed to Congress, which are not always implemented due to lack of follow-up capacity. 104. The most critical reforms to improve the management of public finances and efficiency of public spending initiated during the last two years are well advanced, and key reforms were completed in 2009. A new budget classification system and a new accounting chart of accounts was adopted in line with international standards and are operating in all government ministries and agencies. The implementation of the Treasury Single Account (TSA) at the central government level is progressing well, with its coverage sufficient enough at this time to meet international standards. The foundations for performance-based budgeting have made steady progress with the development of well- defined measures of performance that link priority policies and programs. The reforms in the area of performance based budgeting included several policies and procedural changes and 7 The time frame for the submission of the Cuenta General de la República and the corresponding audit report issued by the CGR, from the President to the Congress has been modified to August 15. 42 expansion of the strategic programs in the budget. Continued efforts are currently underway to fully implement the TSA and ensure common standards and timely budget and financial reporting by all levels of government (central and subnational). 105. Efforts to continue modernizing the budget and improving PFM could be scaled- up by prioritizing activities within the PFM reform agenda using the results of the country PFM performance (complemented by other sources of information and GOP strategies The dissemination of the results of the PEFA assessment among GOP stakeholders and the donor community has facilitated the dialogue between the GOP and the donors around a common framework. Thus, following the PEFA dissemination, the formation of a working group led by MEF -including high level government officials and representatives of donor agencies is in place and as a result the GOP, with the support of donors resources has been able to establish a PFM study group within MEF, to monitor and follow up on concrete reforms within the PFM agenda. The study group will initially provide strategic support in three areas: (i) implementation of the new SIAF; (ii) design and gradual implementation of a multi-annual budget framework; and (iii) support to the recently re-structured Budget Directorate in certain new units such as quality of expenditure. 106. The Integrated Financial Management System (SIAF) is a cornerstone of the country's reform process and as such constant adjustments are needed to it to support changes in policies, processes, and institutions. Thus, the design and implementation of the new system are critical for Peru to support the PFM reform agenda. The design of the new system and its platform began at the end of 2008, and the conceptual framework has been approved in March, 2010. On such basis, it is expected that on a first stage the Budget Programming module be launched in March, 2011 on a pilot basis for the preparation of the 2012 budget. D. Disbursement and Audits 107. Disbursement arrangements will follow the standard procedures for DPLs. The Bank would make the single tranche disbursement of US$100,000,000 following the provisions set out in OP. 8.60, namely (i) the Bank will deposit the funds into an account designated by the GoP which forms part of the country's foreign exchange reserves at the Central Bank of Peru; and (ii) the GoP shall ensure that upon deposit of the funds into said account, such amount or an equivalent amount is credited in the GoP's accounting system to an account that finances budgeted expenditures. The GoP may be required to provide confirmation of steps (i) and (ii) as soon as funds are received. The proceeds of the loan may not be used to finance expenditures typically excluded under the Loan Agreement. 108. The last IMF Safeguards Assessment was completed in 2007, and the assessment concluded that there were no significant weaknesses in the Central Bank's safeguards framework (IMF Country Report No. 07/241). The external audit report on the 2009 financial statements of Central Bank does not reveal any significant issue related to the internal control environment. 43 109. No dedicated account at the central bank will be required for this operation. Given that the Bank's review of the borrower's current PFM system is satisfactory and fiduciary arrangements for this operation are adequate, the Bank will not require a dedicated account at the Central Bank for loan proceeds. As such, no audit will be required for the deposit account. E. Environmental Aspects 110. This DPL operation is not likely to have any significant effects on the environment, forests, and other natural resources. The reforms supported by the program are related to the adoption of policies and only a few could have a future environmental impact. In fact some of the proposed policy reforms under the proposed DPL are likely to be positive for environmental management, particularly related to improved monitoring and evaluation for government expenditure, including environmental expenditure. These reforms could contribute in strengthening GoP's ability to set clear environmental priorities, coordinate with environmental authorities on developing indicators to evaluate the impact of spending on achieving these priorities, and ensure that all sectors follow legal norms related to the environment. The Bank is supporting the authorities' efforts to reform environmental management through the parallel programmatic Environmental DPL series. The fiscal space created through making the budget and expenditure process more efficient could also serve to strengthen under-funded environmental spending. 111. In the medium and long term, further trade liberalization and economic activity in Peru--by means of desirable growth and poverty reduction--would lead to greater infrastructure development. While SNIP does evaluate environmental considerations for each infrastructure project approved, this is done in an ex-ante manner. The challenge regarding potential environmental impacts is during execution. The Bank's Country Environmental Assessment highlighted shortcomings in Peru's institutional framework for environmental protection and sustainability. It also pointed to the need to continue protection efforts in natural areas such as tropical forests while mitigating the serious health impacts and high costs of environmental degradation, particularly in terms of air and water contamination. As a result of this study and the ensuing dialogue with GoP, the Bank prepared a planned three-phase DPL operation on environmental policy, the first phase of which (for US$330 million) was approved by the Board in February 2009. 112. The environmental DPLs supported by the Bank (the third and last in the series is currently under preparation) focus on reordering the institutional and legal framework for environmental management.8 The creation of an adequate national-level authority to enforce environmental issues (Environmental Evaluation and Enforcement Office--OEFA) is a major step, given that the system in place is fragmented and adversely affects the country's ability to tackle numerous environmental challenges. An important trigger under the second environmental DPL is the approval of the regulation of the Law on the National System of Environmental Impact Assessment, which allows the Ministry of the Environment to review environmental impact assessments for large infrastructure/investment projects with potentially significant impacts. An IDF grant was awarded to promote capacity 8 A new Ministry for Environment was created on May 20, 2008. 44 building within the key environmental authority. The areas covered under the environmental DPL include implementing an updated mining environmental legacies (MELs) inventory and a national strategy for remediation of priority MELs, reducing air pollution through reduction of sulfur content in diesel to 50 ppm and promoting and implementing vehicle conversions to natural gas. In addition, the Bank has recommended that the authorities include environment and resource management in the desk evaluation pilots programmed for the next years. F. Risks and Risk Mitigation Macroeconomic Risks 113. Peru remains exposed to downside risks stemming from renewed uncertainty in international financial markets and doubts about the pace of the global economic recovery. Following developments in Europe in May 2010, volatility in global financial markets increased to levels last seen in March 2009 while asset markets worldwide posted substantial losses. So far, the spread of the sovereign stress in European countries to Peru and other emerging countries has been limited, due to stronger economic fundamentals in emerging countries and the EU/IMF intervention. However, global growth prospects may be affected by concerns about the recovery in Europe and how it may spill over other regions of the world. Stock markets in emerging markets, as measured by the MSCI emerging market index, dropped 9 percent in May while the price of commodities such as copper decreased by 7 percent. 114. The exposure to commodities remains high, as demand from fast growing emerging economies is shifting the destination of Peruvian exports. Traditional exports still account for over three-quarters of Peru's exports. In fact, the share of traditional exports rose slightly in 2009 on account of the increase terms of trade for Peru recorded for 2009 as a whole. The importance of emerging markets as a destination for Peruvian exports has grown sharply during the global economic crisis. Thus, while Peru's total exports dropped by 13 percent in 2009, its exports to China grew by 14 percent. In 2009 China was the second largest destination of Peruvian exports, accounting for 15.3 percent of all exports (up from 11.6 percent in 2008). In contrast the share of exports to the US dropped from 19.1 percent in 2008 to 17.0 percent in 2009. Similarly, there were large declines in excess of 30 percent in exports to large European trading partners, like Spain, Italy, the UK, and the Netherlands. These developments suggest that while exposure to weaker EU growth may be more muted than in the past, exposure to commodities may have increased. In addition, the fast recovery of economic growth observed in Peru has also contributed to making the country a more attractive investment destination, adding to exchange rate appreciation pressures from already high portfolio capital inflows and affecting the prospects of the non-traditional sector to gain competitiveness and export shares. 115. Commitment to structural reforms and consensus over the macroeconomic pillars has been and remains strong. The decision by the authorities to curb the expansionary stance of fiscal policy demonstrates their commitment to regain fiscal space and is particularly noteworthy in light of the upcoming presidential elections to take place in April 2011. In early June 2010 Fitch Ratings confirmed the investment grade rating for 45 Peruvian foreign currency sovereign debt and upgraded the outlook from stable to positive on account of the resumption of fast growth in the country. The country's solid fundamentals suggest that, in the absence of unexpected policy shifts, it is unlikely that the macroeconomic situation would become incompatible with continued budgetary support lending during the course of this proposed operation. Political and Social Risks 116. The policy reforms supported by this loan enjoy broad support across the main political groups and the population at large, however social tension remains a risk. Improved fiscal management has the potential to threaten some vested interests, but the consensus on the need to improve the efficiency and effectiveness of public spending is strongly supported by the President, the Prime Minister, the Finance Minister, and all the main parties in the National Congress. Some measures to simplify the tax code by eliminating regional exemptions, particularly in the Amazon region, have proved politically difficult, but the administration has moved this agenda forward in a consensual way. As well, reforms to ease the ability of companies--especially small and medium companies--to access credit, receive licenses, and access export opportunities are widely supported by all relevant stakeholders. Local governments that may have resisted simplifying procedures have been brought along with technical assistance support to undertake reforms. The free trade agenda is also generally supported by the political class and the population at large, but some issues have caused social conflict. In particular, recent conflicts in a region of the Amazon basin have centered on amendments to the code governing the exploitation of forest resources, which were done to comply with the free trade agreement with the U.S. The administration is moving to build a consensus on the issue with the main political groups and the human rights ombudsman, and has continued its dialogue with representatives of the local population. 117. The upcoming change in administration in Peru in 2011 could present risks related to the sustainability of the policy reforms supported by the operation. As with any change in administration, the upcoming electoral process and change in administration in Peru implies a certain risk about the continuity of policy reforms. Mitigating this risk is the broad political consensus for the policy reforms supported by this programmatic series. The drive for many of the reforms supported by this programmatic series and the maintenance of a sound macroeconomic management framework precede the current administration and are relatively well-entrenched. To continue the policy dialogue on these areas of reform, the Bank is preparing a series of Policy Notes that will be presented to the Peruvian authorities in 2011. 118. While the government has made efforts to set up consultation mechanisms with the society at large, the lack of appropriate conflict resolution channels with disaffected social groups is still a significant challenge. More decisive efforts for conflict resolution would be welcome (see Box 2). However continued improvements in social safety nets and other social programs, more equitable flow of resources to the country's regions, and an increase in spending on investments as part of the economic stimulus package should ameliorate social and political risks. 46 Box 2: Social Conflict in Peru A society like Peru's always had and (most likely) will continue to have some degree of social unrest and polarization. Social conflicts are partly explained by a historically high degree of inequality, in spite of government's efforts to reduce it. They are also partly driven by the country's development process itself, as sustained growth episodes may raise societal aspirations and demands for improved opportunities. Against this backdrop, Peruvian governments have to live with latent social conflicts, some of which eventually emerge from time to time. But these conflicts tend to remain focalized; both in terms of the issues and the geographical area. The vast majority are resolved peacefully. However, sometimes social conflicts eventually drag on for some time, and risk becoming nationally politicized, making conflict resolution harder. The most recent example was the conflict that emerged in June 2009 in Bagua, in Peru's Amazon region, which caused 34 deaths and led to the resignation of the president of the council of ministers and other members of the cabinet. Indigenous communities in the area feared that a new forestry law and other legal changes would lead to over- exploitation of natural resources by foreign companies, while they would lose traditional rights. A key contentious point was that it was unclear whether these laws needed to be consulted with indigenous communities prior to their approval (as per ILO agreements on indigenous populations). Legal opinions on whether these laws required prior consultation were divided on this, but indigenous communities felt that they had been excluded from decision-making processes. The main lesson emerging from the Bagua conflict is the need to listen and have a sustained dialogue with all stakeholders whose livelihoods could be affected by government decisions. The Government of Peru has made efforts to set up consultation mechanisms with the broader society. In 2001, the government set up the National Accord (Acuerdo Nacional), a national discussion forum designed to provide a space to build national consensus around policy priorities. It included broad representation from across Peruvian society, including government officials, politicians, academics, church officials, labor and business representatives and indigenous groups. More recently, discussions had been underway since early 2008 between indigenous groups, the Human Rights Ombudsman (Defensoría del Pueblo), members of Congress and representatives of the executive branch. When talks broke down in the spring of 2009, road blockades were erected, eventually leading to the events of June. In the weeks after the violence, the laws in question were repealed and the blockades removed, agreements were signed between the government and local protestors and a formal dialogue mechanism was instituted (Mesas de Concertación) to ensure sustained dialogue with indigenous communities. 47 Annex 1. Fiscal and External Debt Sustainability Analysis9 Peru's public debt-to-GDP ratio is projected to decline under the baseline debt scenario to below 20 percent of GDP. Economic growth will recover after the dip in 2009, and will reach potential this year. Growth will average 6 percent a year in 2010­15 underpinned by domestic demand dynamics and the global recovery. The public sector revenue-to-GDP ratio is expected to increase by a cumulative 0.9 percentage points, reflecting the recovery in growth and mining revenues. Under these assumptions, Peru's public sector debt stock (including CRPAOs) would decline from 27.4 percent of GDP at end-2009, to 19.7 percent of GDP by 2015. External debt is projected to remain below 30 percent of GDP. The decline in external public sector debt over the medium term (of about 5 percentage points of GDP) would be compensated by a marginal increase in private sector external debt as financing conditions improve globally. Given the recent declines in public external debt, total external debt is projected to diminish from 32 percent of GDP at end-2007 to 26 percent by 2015 (public external debt would decline from 18 percent to 11 percent over the same period). Peru's external and public sector debt ratios are robust to alternative assumptions about underlying macroeconomic variables. Sensitivity tests based on 10-year historical standard deviations for GDP growth and interest rates show that Peru's debt dynamics are only moderately vulnerable to such changes. Despite the increasing share of public sector debt in domestic currency, external and public debt ratios remain sensitive to large and permanent exchange rate shocks. Under a one-off 30 percent real depreciation of the exchange rate, the external and public debt ratios would increase by about 10 percentage points above the baseline projections over the medium term. This test assumes that the exchange rate would remain at a depreciated level permanently, which would occur if the current level of the exchange rate was significantly overvalued. CGER estimates, however, indicate that the Sol is broadly in line with fundamentals. Noninterest current account shocks (such as in the terms of trade) would have a moderate adverse impact on external indebtedness. A contingent liabilities shock to the public sector of 10 percent of GDP would increase public debt by a similar amount over the medium term. The public debt ratio would rise sharply in the short run and decline over the medium term. By 2015 the debt ratio would remain 9.6 percentage points above the baseline scenario. The authorities are strongly committed to continue improving the debt profile through the implementation of a proactive debt management strategy. Currency risks have declined significantly in recent years, with the foreign currency share in total public debt declining from 94 percent in 2000 to less than 60 percent in 2009. In 2010, the authorities are targeting a decline in the share of debt at fixed interest rate to 70-80 percent, as well as extending the average maturity of debt to 11-12 years. 9 Source: Staff Report, Article IV Consultation, IMF, 2010. 48 Figure A1.1. Peru: External Debt Sustainability: Bound Tests 1/ (External debt in percent of GDP) Sources: International Monetary Fund, Country desk data, and staff estimates. 1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown. 2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance. 3/ One-time real depreciation of 30 percent occurs in 2011. 49 Figure A1.2. Peru: Public Debt Sustainability: Bound Tests 1/ (Public debt in percent of GDP) Sources: International Monetary Fund, country desk data, and staff estimates. 1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten- year historical average for the variable is also shown. 2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance. 3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2010, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator). 50 Table A1.1. Peru: External Debt Sustainability Framework, 2005-2015 (In percent of GDP, unless otherwise indicated) Actual Projections 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Debt-stabilizing non-interest current account 6/ Baseline: External debt 36.1 30.8 32.1 28.7 32.0 28.4 29.4 28.8 28.2 27.0 26.1 -1.6 Change in external debt -8.8 -5.2 1.3 -3.4 3.4 -3.6 1.0 -0.6 -0.6 -1.3 -0.9 Identified external debt-creating flows (4+8+9) -11.4 -10.1 -10.8 -6.8 -0.1 -2.2 -1.2 -0.1 -0.2 -0.6 -0.9 Current account deficit, excluding interest payments -3.5 -5.1 -3.1 1.9 -1.7 -0.8 -0.1 1.0 1.0 0.7 0.7 Deficit in balance of goods and services -5.6 -8.9 -6.6 -0.9 -3.8 -3.4 -3.1 -1.9 -1.2 -0.4 0.5 Exports 24.7 28.6 29.0 27.6 24.1 24.7 25.6 25.4 24.8 24.0 23.4 Imports 19.1 19.7 22.3 26.7 20.3 21.3 22.5 23.5 23.5 23.6 23.9 Net non-debt creating capital inflows (negative) -4.4 -2.0 -5.5 -5.4 0.0 -1.2 -1.4 -1.3 -1.2 -1.3 -1.4 Automatic debt dynamics 1/ -3.4 -3.0 -2.2 -3.3 1.6 -0.3 0.2 0.2 0.1 0.0 -0.1 Contribution from nominal interest rate 2.1 2.0 2.0 1.8 1.5 1.5 1.8 1.8 1.6 1.5 1.4 Contribution from real GDP growth -2.7 -2.4 -2.4 -2.6 -0.2 -1.8 -1.6 -1.6 -1.5 -1.5 -1.5 Contribution from price and exchange rate changes 2/ -2.8 -2.7 -1.8 -2.5 0.4 ... ... ... ... ... ... Residual, incl. change in gross foreign assets (2-3) 3/ 2.6 4.9 12.1 3.3 3.5 -1.4 2.2 -0.5 -0.4 -0.6 0.0 External debt-to-exports ratio (in percent) 145.8 107.6 110.9 103.8 133.0 115.2 115.1 113.2 114.0 112.2 111.4 Gross external financing need (in billions of US dollars) 4/ 6.7 1.7 8.7 11.6 7.8 9.8 10.1 12.0 11.4 11.3 10.5 in percent of GDP 8.4 1.8 8.1 9.1 6.2 6.7 6.5 7.4 6.6 6.1 5.4 Scenario with key variables at their historical averages 5/ Key Macroeconomic Assumptions Underlying Baseline 28.4 25.3 19.5 14.6 9.6 5.2 -2.7 Real GDP growth (in percent) 6.7 7.7 8.9 9.8 0.9 6.3 6.0 5.7 5.7 5.7 5.8 GDP deflator in US dollars (change in percent) 6.8 8.0 6.4 8.3 -1.4 8.5 -0.4 -1.0 1.0 0.9 0.5 Nominal external interest rate (in percent) 5.3 6.6 7.6 6.6 5.2 5.4 6.8 6.3 6.1 5.7 5.4 Growth of exports (US dollar terms, in percent) 32.8 34.8 17.2 13.3 -13.2 18.2 9.4 4.2 4.0 3.5 3.6 Growth of imports (US dollar terms, in percent) 21.4 20.0 31.2 42.2 -24.3 20.9 11.3 9.6 6.9 7.1 7.4 Current account balance, excluding interest payments 3.5 5.1 3.1 -1.9 1.7 0.8 0.1 -1.0 -1.0 -0.7 -0.7 Net non-debt creating capital inflows 4.4 2.0 5.5 5.4 0.0 1.2 1.4 1.3 1.2 1.3 1.4 1/ Derived as [r - g - (1+g) + (1+r)/(1+g++g) times previous period debt stock, with r = nominal effective interest rate on external debt45change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt. 2/ The contribution from price and exchange rate changes is defined as [-(1+g) + (1+r)]/(1+g++g) times previous period debt stock. increases with an appreciating domestic currency ( >0) and rising inflation (based on GDP deflator). 3/ For projection, line includes the impact of price and exchange rate changes. 4/ Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period. 5/ The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP. 6/ Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year. 51 Table A1.2. Peru: Public Sector Debt Sustainability Framework, 2005-2015 (In percent of GDP, unless otherwise indicated) Actual Projections 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Debt-stabilizing primary balance 9/ Baseline: Public sector debt 1/ 37.7 33.2 30.9 25.7 27.4 26.7 25.6 24.3 22.7 21.1 19.7 -0.3 o/w foreign-currency denominated 29.6 25.2 21.3 16.2 16.8 15.1 14.5 13.3 9.1 8.5 7.9 Change in public sector debt -6.6 -4.6 -2.3 -5.2 1.7 -0.6 Identified debt-creating flows (4+7+12) -5.0 -7.4 -7.7 -3.8 0.7 -0.6 Primary deficit -1.6 -4.0 -4.0 -2.9 1.1 0.3 Revenue and grants 18.9 20.6 20.8 21.0 18.6 19.3 Primary (noninterest) expenditure 17.3 16.7 16.8 18.1 19.7 19.5 Automatic debt dynamics 2/ -3.3 -3.4 -3.5 -0.9 -0.4 -0.9 Contribution from interest rate/growth differential 3/ -2.1 -3.2 -1.5 -1.5 0.7 -0.9 Of which contribution from real interest rate 0.6 -0.7 1.1 1.2 0.9 0.7 Of which contribution from real GDP growth -2.7 -2.5 -2.6 -2.7 -0.2 -1.6 Contribution from exchange rate depreciation 4/ -1.2 -0.2 -2.0 0.6 -1.2 ... ... ... ... ... ... Other identified debt-creating flows -0.1 -0.1 -0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Privatization receipts (negative) -0.1 -0.1 -0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) 5/ -1.6 2.9 5.4 -1.4 1.0 0.0 -0.1 -0.1 -0.1 -0.1 -0.1 Public sector debt-to-revenue ratio 1/ 199.2 160.7 148.5 122.3 147.2 138.8 134.0 124.4 114.5 107.7 101.4 Gross financing need 6/ 6.8 1.6 4.8 0.8 4.6 3.9 2.9 2.3 1.8 1.6 1.5 in billions of U.S. dollars 5.4 1.4 5.1 1.0 5.9 5.7 4.5 3.8 3.2 3.0 2.9 Scenario with key variables at their historical averages 7/ 26.7 24.7 22.7 20.8 18.9 17.1 -0.4 Scenario with no policy change (constant primary balance) in 2010-2015 26.7 25.5 25.2 24.9 24.7 24.6 -0.3 Key Macroeconomic and Fiscal Assumptions Underlying Baseline Real GDP growth (in percent) 6.7 7.7 8.9 9.8 0.9 6.3 6.0 5.7 5.7 5.7 5.8 Average nominal interest rate on public debt (in percent) 8/ 4.8 5.8 6.0 5.6 5.2 5.3 5.4 5.2 5.1 5.1 5.1 Average real interest rate (nominal rate minus change in GDP deflator, in percent) 1.8 -1.5 4.0 4.5 3.7 2.9 3.3 3.7 3.9 4.1 4.3 Nominal appreciation (increase in US dollar value of local currency, in percent) 3.6 0.6 9.2 -3.1 7.5 ... ... ... ... ... ... Inflation rate (GDP deflator, in percent) 3.0 7.2 2.0 1.1 1.5 2.4 2.1 1.5 1.1 0.9 0.9 Growth of real primary spending (deflated by GDP deflator, in percent) 8.9 3.7 9.6 18.3 10.1 5.4 1.9 5.8 4.8 5.1 5.3 Primary deficit -1.6 -4.0 -4.0 -2.9 1.1 0.3 -0.3 -0.7 -1.1 -1.1 -1.0 1/ Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used. 2/ Derived as [(r - (1+g) - g + (1+r)]/(1+g++g)) times previous period debt ratio, with r = interest rate; = growth rate of GDP deflator; g = real GDP growth rate; = share of foreign-currency denominated debt; and = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar). 3/ The real interest rate contribution is derived from the denominator in footnote 2/ as r - (1+g) and the real growth contribution as -g. 4/ The exchange rate contribution is derived from the numerator in footnote 2/ as (1+r). 5/ For projections, this line includes exchange rate changes. 6/ Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period. 7/ The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP. 8/ Derived as nominal interest expenditure divided by previous period debt stock. 9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year. 52 Annex 2. Letter of Development Policy (English Translation Follows) 53 54 55 56 57 58 59 PERÚ Ministerio Despacho de Economía y Finanzas Ministerial "DECENIO DE LAS PERSONAS CON DISCAPACIDAD EN EL PERÚ" "AÑO DE LA CONSOLIDACIÓN ECONÓMICA Y SOCIAL DEL PERÚ" MERCEDES ARÁOZ FERNÁNDEZ OFICIO N° -2010-EF/10 MINISTRA Letter of Development Policy English Translation Lima, COMMUNIQUE N° -2010-EF/10 LETTER OF DEVELOPMENT POLICY Mr. ROBERT B. ZOELLICK President World Bank Reference: Programmatic Loan for Fiscal Management and Economic Growth IV Dear Mr. Zoellick, This document confirms the commitment of the Government of President Alan Garcia to continue efforts to implement a series of policies aimed at ensuring sustained economic growth based on efforts to increase public and private investment, improve the country's infrastructure and promote inclusion of the most vulnerable sectors of society. In this framework, we have developed the fourth operation of the "Programmatic Loan for Fiscal Management and Economic Growth" with the World Bank (WB) and have requested US$ 100 million. This loan will cover specific actions with regard to: i) enhancing the efficiency and quality of fiscal management and public spending and ii) developing policies aimed at strengthening competitiveness. It is important to emphasize that this loan will be used to continue the reforms undertaken in the third operation, which was signed in December 2009. Next, we will describe Peru's economic context, the objectives and reforms achieved and the proposals linked with the loan requested. A. Economic Context The global economy is in the process of emerging from the most significant contraction since the Second World War. Global GDP dropped 0.6% in 2009 and is expected to rebound to 4.2% [1] due to the fiscal and monetary stimulus plans in place. In terms of the growth forecasts for our main trading partners, the United States has been experiencing rapid recovery. Progress, however, is rooted primarily in transitory factors (inventory effects and stimulus plans). Fiscal problems in Europe and plans to implement austerity measures limit perspectives for growth in the region in the mid-term. In the Asian block, China continues to lead economic growth and Jirón Junín N° 319, Lima 1 - Teléfonos 311-9900 311-5930 60 PERÚ Ministerio Despacho de Economía y Finanzas Ministerial "DECENIO DE LAS PERSONAS CON DISCAPACIDAD EN EL PERÚ" "AÑO DE LA CONSOLIDACIÓN ECONÓMICA Y SOCIAL DEL PERÚ" MERCEDES ARÁOZ FERNÁNDEZ OFICIO N° -2010-EF/10 MINISTRA has reported quarterly rates that top 10% a year, which is primarily attributable to dynamism in industrial production and bank loans. In Peru, the trade channel was the primary venue for international crisis transmission. The terms of exchange suffered significantly, contracting 15.5% in the 2008-2009 period. In this context, GDP grew only 0.9% in 2009. This low growth is primarily due to an over-adjustment in private investment and a contraction in inventory levels. Nevertheless, the move to implement adequate expansive monetary and fiscal policies helped the Peruvian economy avoid further deterioration. In the fiscal ambit, a strong Economic Stimulus Plan (PEE) was implemented for the 2009-2010 biennium for 3.5% of GDP. Emphasis has been placed on infrastructure projects, which has allowed public spending to contribute 2.5 percentage points to product growth. The Central Reserve Bank of Peru has also reduced the interest rate to historic lows (1.25%) and is focused on ensuring the liquidity levels needed to maintain the continuity of the chain of payments. In the current context, the signs of recovery are clear. Since 3Q09, the economy has grown in deseasonalized terms due to monetary and fiscal stimuli and inventory restructuring over the last few months. Proof of the PEE's success is evident in the construction sector, which has grown more than 10% since last October. Non-primary manufacturing sector was hardest hit by the crisis. In December 2009, this sector achieved its first positive growth figure (in yearly terms) and over the last few months, it has shown high growth rates. The pace of exports began to fall in 2Q09 but has reported positive rates since 4Q09 in nominal terms. In 1Q10, the economy grew 6.0%, which is the highest growth rate since 4Q08. Private investment grew 11.3% while private consumption rose 3.6%, indicating that private demand is undergoing rapid recovery. In the same way, internal indicators of activity forecasts indicate that good economic performance will continue to consolidate over the next few months. In April, GDP grew 9.3%, which is primarily attributable to a rebound in manufacturing (16.4%), commercial activity (11.1%), services (7.1%) and construction (21.1%). During this same month imports of consumer goods rose 36.2% and new vehicle sales surged 63.8% in annual terms. In the month of May, local cement deliveries, electricity production and total imports grew 20.4%, 7.8% and 33.9% a year respectively. Based on international and local economic recovery, 5.5% growth is expected in 2010. The main factors behind this growth are: i) improved perspectives for global growth and terms of exchange; ii) an increase in exports, which will return to pre-crisis levels and, iii) an increase in private investment due to the business community's renewed confidence. B. Reforms associated with the Program 1. Strengthening Fiscal Policy Management Sustainability and Transparency of Fiscal Policy The Peruvian Government set an Economic Stimulus Program (PEE) in motion to offset the international financial crisis's impact on economic activity, public investment in infrastructure and social protection. The PEE is expected to culminate in 2010 when the infrastructure projects scheduled by the national and Jirón Junín N° 319, Lima 1 - Teléfonos 311-9900 311-5930 61 PERÚ Ministerio Despacho de Economía y Finanzas Ministerial "DECENIO DE LAS PERSONAS CON DISCAPACIDAD EN EL PERÚ" "AÑO DE LA CONSOLIDACIÓN ECONÓMICA Y SOCIAL DEL PERÚ" MERCEDES ARÁOZ FERNÁNDEZ OFICIO N° -2010-EF/10 MINISTRA regional governments are executed. At the end of April 2010, the PEE had executed 93% of the budget allotted and 87% of the total estimated cost. In order to generate conditions that ensure sustained growth in the local economy, the Law Nº 29465- The Public Sector Budget Law- was passed for the 2010 fiscal year and the Municipal Modernization Program (PMM) was approved for the 2010-2013 period. The PMM's purpose is to incentivize the municipalities to increase municipal tax collections by bolstering financial management and generating favorable conditions in the business climate by improving public service provision, basic infrastructure and procedure/process simplification. Along these lines, Supreme Decree N° 002-2010-EF approved the procedures to meet goals and allot PMM resources. The latter are disbursed according to the municipalities' classification criteria, which are based on each municipality's specific characteristics and potential and compliance with requirements for municipal tax collection results and efforts to generate a favorable business climate. The Government created the Incentive Plan to Improve Municipal Management (PI) through Law N 29332. This effort seeks to incentivize Local Governments to improve municipal tax collection levels as well spending on investment and reduce chronic childhood malnutrition throughout the country. This plan is implemented with resources from the Municipal Compensation Fund (FONCOMUN) for the 2010 fiscal year. Supreme Decree N° 003-2010-EF approved the procedures to ensure that goals are met and allot PI resources. Finally, Supreme Decree N°100-2010-EF was passed. This decree stipulates that beginning this year, additional FONCOMUN resources will be transferred to the municipalities to implement the PI and PMM to promote investment at the local level. More stable and neutral tax system The National Superintendence of Tax Administration (SUNAT) has created an internet-based Consultation and Payment Declaration to help taxpayers search for the declarations and payments they have made. A new system for differentiating search criteria has been implemented (by format, period or date range of declarations filed) and will generate more precise search results while consuming less of the system's resources. SUNAT's virtual search option for declarations and payment consultation has been improved, which will allow taxpayers to visualize the declarations and/or payments they have made by entering a single module to ask questions and store all information that has been sought. SUNAT has also created a new tax payment portal offering the possibility to pay taxes online for taxpayers who use simplified tax payment forms from SUNAT On-line. This will increase the number of transactions that are conducted on-line, generating a subsequent decrease in payment transactions through banks. Transparency in Budget Planning and Reporting In terms of the process to implement the Treasury Single Account (CUT), the Government has continued to make efforts to liquidate and close the bank accounts held by the Executing Units of the National Government and Regional Government and the budget allotments to Local Governments, that are Jirón Junín N° 319, Lima 1 - Teléfonos 311-9900 311-5930 62 PERÚ Ministerio Despacho de Economía y Finanzas Ministerial "DECENIO DE LAS PERSONAS CON DISCAPACIDAD EN EL PERÚ" "AÑO DE LA CONSOLIDACIÓN ECONÓMICA Y SOCIAL DEL PERÚ" MERCEDES ARÁOZ FERNÁNDEZ OFICIO N° -2010-EF/10 MINISTRA currently inactive in the National Bank. Efforts are also being made to include the FONCOMUN item (Municipal Compensation Fund) in the CUT as well as Resources from Direct Collections (RdR). Equity in inter-governmental transfers Supreme Decree 060-2010 has been passed to ensure the continuity of efforts to implement the equity policy for inter-governmental transfers. The decree in question approves the criteria, procedures and methodology to distribute FONCOMUN. This entails calculating geographic allotments by province in order to distribute funds among all the district municipalities, including the provincial municipality. The new methodology consists primarily in replacing variables such as the infant mortality rate with other variables that better reflect the basic unsatisfied needs of the target population. Public Spending Efficiency and Impact The process to implement a Results-Based Budget (PPR) to ensure efficient public finance management has made significant progress in terms of strategic budget planning, follow-up and independent assessment as well as systems for managing inputs and products. Strategic budget planning generates Strategic Programs by requiring that the design and execution of efficient strategies and interventions be geared to achieve results that reduce chronic childhood malnutrition; reduce maternal and neonatal deaths; increase children's learning levels up to second grade of primary; increase access to energy, water and human waste disposal in rural areas; increase the productivity of small and medium businesses; improve citizen safety; increase productivity of small farmers in rural areas, etc. In this context, the Public Sector Budget Law for the 2010 Fiscal Year includes designing six new strategic programs related to: i) Non-communicable diseases, tuberculosis, HIV and metaxenic diseases and zoonosis, ii) Learning achievements in primary education and alternative basic education, iii) Child labor, iv) Domestic and sexual violence and food safety, v) Environmental Sustainability and vi) Expanding the tax base. Transparency, accessibility, agility of public sector processes The Supervisory Body for State Contracts approved, through Resolution N°195-2010-OSCE/PRE, the Directive that stipulates the content of the Standardized Bases that the State Entities must use in selection processes. This directive aims to inform State entities about the content of an obligation to use the Standardized Bases that will be applicable to twenty (20) types of selection processes. 2. Strengthening competitiveness in the country Expand and deepen Foreign Trade In order to maintain a policy to promote foreign trade development of all kinds as well as expand the universe of exporters, which should include micro and small businesses, the Government has implemented projects to facilitate the export process for micro and small businesses by means of the postal service. As such, it was necessary to increase the FOB value of the merchandise exported through this system. It was also necessary to enact a set of complementary norms relative to this export method. Jirón Junín N° 319, Lima 1 - Teléfonos 311-9900 311-5930 63 PERÚ Ministerio Despacho de Economía y Finanzas Ministerial "DECENIO DE LAS PERSONAS CON DISCAPACIDAD EN EL PERÚ" "AÑO DE LA CONSOLIDACIÓN ECONÓMICA Y SOCIAL DEL PERÚ" MERCEDES ARÁOZ FERNÁNDEZ OFICIO N° -2010-EF/10 MINISTRA According to the General Customs Law approved by Legislative Decree Nº 1053 and its Rules, the advanced delivery process under the import regimen for consumption will be in effect as of April 12, 2010 at the Superintendence of Maritime Customs of Calla and as of April 12, 2010 at the Superintendence of Air Customs of Callao. In this sense, a plan and schedule was approved to progressively implement the new customs delivery process at the aforementioned customs superintendence units and later at the customs superintendence facilities in Arequipa, Chiclayo, Cusco, Iquitos, Post Office of Callao, Pucallpa, Puerto Maldonado, Puno, Tacna, Tarapoto, Tumbes and the La Tina Customs Agency. Implementation will be complete by October 01, 2010. Additionally, the Trade Agreement signed by Colombia, Peru and the European Union will facilitate the progressive and reciprocal liberalization of goods and services through a free trade area that complies with the regularizations and obligations put forth by the World Trade Organization and establishes common rules in all of the trade areas included in the agreement. Finally, negotiations are underway to sign a Trans-Pacific Association Agreement (TPP) with Australia, Brunei, Chile, the USA, New Zealand, Peru, Singapore and Vietnam to build an inclusive and high- quality agreement for economic growth, development and employment generation in member countries. This will be used as the basis for the Free Trade Agreement for the Asia-Pacific (FTAAP). Deepening the financial sector To clarify the regulatory framework regarding securitization and reduce transaction costs, the National Supervisory Commission of Companies and Securities (CONASEV) authorized the registration of asset- backed securities known as the "First Issuance of Mortgage Securities TP USD E-1" for a maximum of US$ 35 000 000 (thirty-five million US Dollars) and the registry of the respective informative prospectus in the Public Registry of the Securities Market. In order to ensure that mortgage market development benefits sectors of the population that still do not own their own their own homes, a Bill was sent to the Congress of The Republic to regulate the treatment applicable to the issuance of covered mortgage bonds (CMB) as negotiable securities that give holders credit rights that are backed by Asset Backed Securities. These assets can be mortgage loans for housing, cash, instruments issued by the Central Reserve Bank of Peru (BCRP), securities issued by the Peruvian State, CMB and other entities authorized by the Superintendence of Banking, Insurance or AFP (SBS). The quality of the asset backed securities makes the CMB attractive for investors, which allows the issuers to exercise a degree of flexibility in terms of maturity of loan installments. Finally the Financial Cooperation Development Entity (COFIDE) has created the Peru Factoring Program to facilitate financing for micro, small and medium (SMEs) suppliers of goods and services. This effort allows national financial institutions that are supervised by SBS and have signed an inclusion agreement with COFIDE to make advance payments on invoices. In this regard, COFIDE has signed inclusion agreements with the National Health Service - ESSALUD, Gloria S.A. and the Banco de la Microempresa S.A.- MIBANCO. Jirón Junín N° 319, Lima 1 - Teléfonos 311-9900 311-5930 64 PERÚ Ministerio Despacho de Economía y Finanzas Ministerial "DECENIO DE LAS PERSONAS CON DISCAPACIDAD EN EL PERÚ" "AÑO DE LA CONSOLIDACIÓN ECONÓMICA Y SOCIAL DEL PERÚ" MERCEDES ARÁOZ FERNÁNDEZ OFICIO N° -2010-EF/10 MINISTRA Conclusion The aforementioned attests to the Peruvian Government's commitment to continue undertaking significant efforts to ensure sustained economic growth that goes hand-in-hand with more efficient and equitable processes to allot public resources in a framework for fiscal management based on responsibility and transparency. The Government is committed to continuous progress in these areas and as such will require the World Bank's support in the areas outlined above. Accordingly, the Peruvian Government would like to request the approval of the "Programmatic Loan for Fiscal Management and Economic Growth IV" for a total of US$100 million. Sincerely, Jirón Junín N° 319, Lima 1 - Teléfonos 311-9900 311-5930 65 Annex 3. Fourth Programmatic Fiscal Management and Competitiveness DPL Program Matrix Prior Actions taken under the Prior Actions taken under the Prior Actions taken under the Program Prior Actions taken under the Program Program DPL I Program DPL II DPL III DPL IV Increase the Sustainability and Transparency of Fiscal Policy (1) Presented legislation to (1) Strengthening sustainability and (1) The Borrower has: (a) issued an economic stimulus (1) Issuance of various legal instruments Congress to strengthen transparency of fiscal policy through plan to respond to the global economic crisis which pertaining to performance-based monitoring and enforcement the full compliance with fiscal rules is included in the Borrower's 2010-2012 Multi- transfer of resources from the of fiscal rules, including the as evidenced by the Marco Annual Macroeconomic Framework (approved by Executive to Municipalities, including, Sanctions Law and the Macroeconómico Multianual and the the Borrower's Council of Ministers on May 30, inter alia, the following: (a) Decree creation of a Fiscal Policy enactment of a regulatory framework 2009 and published in the Borrower's Official (Decreto de Urgencia No. 119-2009 Committee. for the treatment, limits, and Gazette on June 1, 2009, and updated on August Modifican Artículos de las Leyes Nos. registering of firm and contingent 28 2009 and published in the Official Gazette on 29332 y 29465 y Dictan Medidas Published a public debt operations associated with Private August 30, 2009, pursuant to the provisions of the Extraordinarias Para el management strategy for and Public Partnerships (PPPs). Borrower's Supreme Decree No. 066-2009-EF), Financiamiento de la Continuidad de 2006-2008 that provides and includes, inter alia, fiscal stimulus measures las Inversiones durante el Año Fiscal aimed at expediting budget execution, as 2010) dated December 23, 2009 and guidance to the debt evidenced by the provisions of Section 4.2 of said published in the Borrower's Official manager's actions in funding framework; and (b) committed to maintain prudent Gazette (El Peruano) on December and portfolio management, fiscal policy during the implementation of such 24, 2009; (b) Supreme Decrees no. based on cost and risk plan, pursuant to the terms of the "Declaration of 002-2010-EF and 003-2010-EF, both analysis. Principles for Fiscal Policy", approved by the dated January 11, 2010 and published Borrower's Ministerial Resolution 254-2009- in the Borrower's Gazette (El EF/15 dated June 1, 2009, published in the Peruano) on January 12, 2010 Borrower's Official Gazette on June 2, 2009. estalishing the procedures regulating performance measurement criteria and targets and the allocation of resources to Municipalities; and (c) Resolution no. 008-2010-EF/76.01 issued by the Directorate of Public Budget on March 30, 2010 and published in the the Borrower's Gazette (El Peruano) on April 1, 2010, approving the results of compliance by Municipalities of performance targets as reported by said Municipalities by February 2010. 66 Prior Actions taken under the Prior Actions taken under the Prior Actions taken under the Program Prior Actions taken under the Program Program DPL I Program DPL II DPL III DPL IV Make the Tax System more Neutral and Stable (2) Implemented first phase of (2) Measures for improving the (2) The Borrower: (a) has incorporated into its Law for (2) Issuance of Resolution No. 036- tax reforms: Prepared a cost- efficiency and neutrality of the tax the Promotion of Competitiveness, Formalization 2010/SUNAT dated January 29, 2010 benefit analysis of system were implemented, through and Development of Micro and Small Enterprises and publihed in the Borrower's eliminating existing sectoral the issuance of legislatives decrees and of Access to Decent Employment, tax Official Gazette (El Peruano) on and regional tax exemptions, 972, 978 and 975 which provide the simplification measures for micro and small January 31, 2010, providing for enabled Internet registration legal framework for (i) strategy for enterprises, through the issuance of the Borrower's procedures aimed at improving tax for the single taxpayer eliminating regional and sectoral Supreme Decree No. 007-2008-TR, published in compliance, through, inter alia, the identification number (RUC) exemptions, (b) cost ­ benefit the Borrower's Official Gazette on September 30, establishment of online tax filing and made updated RUC analysis requirement for maintaining 2008; and (b) is implementing such law as procedures (Formulario Virtual para database available by current exemptions and granting new evidenced by Resolution No. 120-2009/SUNAT la Declaración y Pago de Renta de Internet. ones, and (c) reduction of ITF's issued by SUNAT on June 3, 2009, which, inter Segunda Categoría) in regard to effective rate to 0.07 % starting 2008 alia, approves the use of online tax declarations for income taxes (impuesto a la renta). and to 0.05% starting 2010. micro and small enterprises. Strengthen Budget Reporting and Planning (3) Defined action plan and (3) Strengthen budgetary management (3) The Borrower has strengthened its budget (3) Enactment by the Legislature of the implemented first steps for through: the issuance of the Decree reporting and planning system as evidenced by: Borrower's Law No. 29537 dated June adopting a TSA, aligning No. 082 which rules the (a) the generation of monthly TSA reports (from 7, 2010 and published in the budget classification to incorporation in the TSA, at Banco January 2009 until July 2009) covering 76 percent Borrower's Official Gazette (El international standards and de la Nación, of all "ear marked of the Borrower's public resources set forth in its Peruano) on June 8, 2010, mandating with the chart of accounts, resources" (covering 16.3 percent of budget law for 2009 (Law No. 29289 published in the timely preparation and disclosure and automatic accounting by public resources), and the 2008 the Borrower's Official Gazette on December 11, of consolidated government financial SIAF, and approved Treasury Budget Law 29142 which calls for 2008); and (b) the incorporation into SIAF of the statements (Cuenta General de la System Law and Accounting the elaboration of a new budgetary new functional budgetary classification (as República) and audit reports aimed at Law. classification, unifying budgetary and reflected in its budget law for 2009). strengthening further the Borrower's chart of account classification budget reporting capacity. systems. 67 Prior Actions taken under the Prior Actions taken under the Prior Actions taken under the Program Prior Actions taken under the Program Program DPL I Program DPL II DPL III DPL IV Increase Equity in the Intergovernmental Transfers (4) A compensatory fund for regions and (4) The Borrower has: (a) completed a progress report (4) Issuance of Supreme Decree No. 060- departments without access to on the implementation of FONIPREL as of May, 2010-EF dated February 17, 2010 and revenues from mining activities was 2009; and (b) updated the criteria for assigning published in the Borrower's Official designed. FONIPREL resources, as evidenced by: (i) the Gazette (El Peruano) on February 18, issuance of MEF's Ministerial Resolution No. 168- 2010, setting forth a new methodology 2009-EF/15 dated April 3, 2009, and published in for the allocation of FONCOMUN the Borrower's Official Gazette on April 5, 2009; resources to Municipalities, thereby and (ii) the publication on June 1, 2009 of the promoting equity in transfers of competitive procedures (dated May 2009) for a resources from the Executive to the third tender inviting the Borrower's sub-national Municipalities. governments to submit proposals for investment projects. Improve the efficiency and Impact of Public Spending (4) Enacted regulatory (5) The implementation of Result Based (5) The Borrower has: (a) completed a separate The Borrower has included six additional framework for performance Budgeting has proceeded as reflected evaluation report for each of the following four budgetary programs with a results- measurement and reporting, in the 2007 Budget Law (Law programs: (i) road maintenance; (ii) conditional orientation framework in the 2010 Budget linking the budget 29142) and 2008 Budget law (Law cash transfers; (iii) strategic nutrition; and (iv) life- Law.* presentation cycle with 29142), which stipulates the gradual long education and training, dated June 9, 2008, performance indicators, by implementation of Result Based February 2009, June, 2008 and July 11, 2008, which all sectors and regional Budgeting and the introduction of respectively; and (b) published in the MEF's web governments are required to programmatic formulation for the page the results of the evolution of the first three generate output and budget, and five priority programs programs mentioned in (a) herein. performance indicators as with a results framework. part of their budget submission. The 2007 sector budget submission included sector performance indicators (programs, activities and projects), including for the environment. 68 Prior Actions taken under the Prior Actions taken under the Prior Actions taken under the Program Prior Actions taken under the Program Program DPL I Program DPL II DPL III DPL IV Make Public Sector Processes more Transparent, Accessible and Agile (5) Launched a strategy of e- (6) Policies to make public sector (6) The Borrower has: (a) enacted a new procurement The Borrower has approved (a) twenty government, including a web processes more transparent, law (Legislative Decree No. 1017 published in the mandatory Standard Bidding Documents portal of public services such accessible and agile were introduced, Borrower's Official Gazette on June 4, 2008); (b) for goods, consultant's services and civil as tax administration+ and including: (i) the integration of the approved regulations to such new procurement law works (Resolution No. 195-2010- civil registry, and issued State Procurement Electronic System (Supreme Decree 184-2008-EF published in the OSCE/PRE published in the Official National Digital Agenda. (SEACE) with the SIAF at the Borrower's Official Gazette on January 1, 2009); Gazette on April 21, 2010); and (b) a process level, (ii) the new regulation and (c) published in OSCE's website a national procurement accreditation framework, for Electronic Signature was issued, procurement strategy dated April 2009. covering all public agencies.* and (iii) the Draft Law on National Information System was discussed at the vice-ministry commission. Expand and Deepen International Trade (6) Signed Peru-US FTA and (7) Measures for the strengthening of (7) The Borrower has: (a) signed a Free Trade (5) The Borrower has expanded and ratified by Peruvian external trade were implemented, Agreement with the Popular Republic of China on facilitated international trade through: Congress. including: the completion of the April 28, 2009; and (b) enacted/issued (as the case (i) the conclusionclosure of the negotiations for a free trade may be) the following laws and regulations negotiation process of a proposed Reduced from 7 to 4 percent agreement with Canada reduction of oriented toward facilitating trade, all of which are trade agreement between the Borrower tariffs to capital goods in 196 the average tariff rate to 5 % and the consistent with the provisions of the Borrower's and the EU, as evidenced by the lines and published national tariff dispersion to 5.9 % (Decrees Trade Promotion Agreement (Acuerdo de signing of the Joint Declarationfor a 091-2007, 105-2007, 158-2007, 038- Promoción Comercial) with the United States of Free Trade Agreement with the EU on guidelines to tariff policy. 2008), and implementation of the America, dated April 12, 2006 (ratified by the May 19, 2010; and (ii) the introduction Created a Ventanilla Única, External Trade One Stop Shop to the Borrower's Legislative Resolution No. 28766, of expedited custom procedures one-stop shop, with the 90 percent of controlled merchandise. dated June 29,2006): (i) Legislative Decree No. through the issuance of Supreme objective of establishing 1036, published in the Borrower's Official Gazette Decree no. 096-2010-EF datedon uniform authorization and The Tramifácil program was on June 25, 2008, which expands the application of March 26, 2010 and published in the control of imports and expanded to municipalities in three the Borrower's one-stop shop for international Borrower's Official Gazette (El exports subject to non-tariff regions (Puno, Cajamarca, and trade; (ii) Supreme Decree No. 009-2008- Peruano) on March 27, 2010 Lima). ** MINCETUR, published in the Borrower's Official establishing October 1, 2010 as the measures. Gazette on December 5, 2008, which regulates the completion date for the progressive provisions of the Legislative Decree mentioned in implementation of simplified customs (i) herein; (iii) Legislative Decree No. 1053 procedures. published in the Borrower's Official Gazette on June 27, 2008, which approves the Borrower's General Customs Law; and (iv) Supreme Decree No. 010-2009-EF published in the Borrower's 69 Prior Actions taken under the Prior Actions taken under the Prior Actions taken under the Program Prior Actions taken under the Program Program DPL I Program DPL II DPL III DPL IV Official Gazette on January 16, 2009, which regulates the provisions of the Legislative Decree mentioned in (iii) herein. Promote Sustainable Financial Deepening (8) Promote sustainable financial (8) The Borrower has approved banking norms which (6) The adoption of Resolution deepening of micro and consumer conform to the regulatory, capital, evaluation and CONASEV No. 068-2009/94.01.1 credit: the Super Intendance of risk management standards of Basel II, including dated September 24, 2009 and Banks and Insurances issued the strengthening of the regulatory framework published in the Borrower's Official Resolution 1237 / 2006, which governing over-indebtedness risk management, as Gazette (El Peruano) on September approves the Rule for the Retail evidenced by the issuance of: (a) Legislative 29, 2010, aimed at strengthening the Debtor's Over Indebtedness Risk Decree No. 1028 published in the Borrower's Borrower's regulatory framework for Management; Resolution 1122 / Official Gazette on June 22, 2008, which amends asset securitization and therefore 2006, which approves the Rule for the Borrower's General Law of the Financial and promoting the development of the the Expanding the Operations of Insurance System and the Organic Law of the Borrower's capital markets.. Non Banking Financial Institutions: Superintendency of Banking and Insurance; and and Resolution 215 / 2007, which (b) Resolution S.B.S. No. 6941-2008 published in approves the Micro Insurance Rule. the Borrower's Official Gazette on August 26, Measures were taken to deepen 2008, which approves the regulations for the financial instruments and services: administration of over-indebtedness risk of small The National Stock and Business debtors. Supervisory Commission (CONASEV) approved the Rule of Securitization, Resolution 087 / 2007, which allows the use of assets in the securitization process. NB: * Refers to policy measures that are a continuation of a reform already initiated under previous operations in this series and are therefore considered a benchmark. ** This prior action under FMCDPL 2 was part of a policy area whose objective was to reduce transaction costs for the private sector to enter, operate in, and exit markets. As this action was fully met under FMCDPL 2 no further mention of this policy area is made in subsequent operations. 70 Annex 4. Results Framework: Monitoring Progress on Outcome Indicators Expected Outcomes by the end Baseline Actual of the program by 2011 2005 2006 2007 2008 2009 2010 (est.) Increase sustainability and transparency of fiscal policy Fiscal balance of the -0.3 % of GDP 2.1% of GDP 3.1 % of GDP 2.1 % of GDP -1.9 % of GDP -1.6 of GDP consolidated public sector remains > -1 % of GDP. Current expenditure growth10 8.9 % 2.5% 0.8% 3% 12% 3% is prudent and within the Fiscal rules limits. Stock of public debt/GDP 37.7% of GDP 32.7% of GDP 29.1 % of 23.8 % of 26.7 % of 24.5 % of decrease to 18% by 2011 if GDP GDP GDP GDP no adverse external shocks or 32 percent if some external shocks. Reduce the foreign currency 78.1% of Public Debt 75.5 % of 63.7 % of 63.4% of 61.0% of 59.2% of public debt to at least 60 % of Public Debt Public Debt Public Debt Public Debt Public Debt the total outstanding debt. Make the tax system more neutral and stable Increase medium term tax 13.9% of GDP 15.1 % of GDP 15.6% of 16% of GDP 14.1 % of GDP 15.2 % of GDP revenue of the central GDP government to at least 16 % of GDP. Strengthening budget reporting and planning Number of banking accounts 25,000 25,000 25,000 25,000 20,000 n.a. of public sector entities is (estimate by the MEF (5,000 banking reduced to a minimum level staff- lack of accurate accounts of (estimate of 500). baseline- not adequate public sector monitoring indicator) entities were closed) 100 % of the public national n.a. n.a. 65% of public 70% of public 80% of public n.a. budget resources are in the national national national TSA. budget budget budget 10 Wages and goods and services expenditures. 71 Expected Outcomes by the end Baseline Actual of the program by 2011 2005 2006 2007 2008 2009 2010 (est.) Increase equity in intergovernmental transfers An increasing number of n.a. n.a. n.a. 8 projects n.a. n.a. investment projects are financed by financed through FONIPREL FONIPREL fund for sub- national for sub- governments with poverty national levels above 60% and without governments access to canon and royalties. with poverty levels above 60% and without access to canon and royalties Improving the efficiency and impact of public spending on a national, sub-national and sectoral level 7 % of national and regional 0 0 0 4.1% 8.8% 13.2% governments' budget is linked to performance indicators. Use of M&E instruments for 0 0 0 4 program 10 program 10 program budgetary discussions. (executive) (executive) (executive) evaluations evaluations evaluations completed and completed and and 2 impact published published evaluations The 2010 completed and Budget published discussions will be informed by the results of the program evaluations. Make public sector processes more transparent, accessible and agile 90% of central government 68% publishing 74% 81% 82% 90% 90% agencies are publishing and through SEACE publishing publishing publishing publishing publishing purchasing through SEACE. through through through through through SEACE SEACE SEACE SEACE SEACE 72 Expected Outcomes by the end Baseline Actual of the program by 2011 2005 2006 2007 2008 2009 2010 (est.) 90% of local governments are 45% publishing 65% 82% 86% 90% 90% publishing and purchasing through SEACE publishing publishing publishing publishing publishing through SEACE. through through through through through SEACE SEACE SEACE SEACE SEACE Improvement in E ­ 56/182 e-government n.a. 55/182 e- n.a n.a n.a. Government Readiness rank n.a. government Ranking. 0.2698 n.a. rank Improvement in E- 0.1091 0.136 participation index. 0.137 Infrastructure Index Expand and deepen international trade Non ­ traditional exports 24.6 22.1 22.5 23.9 26 (based on n.a. share in total exports first four increases to 35 %. months of 2009) Gradual decrease in average 10.05% average tariff 8.29% average 5.68% 5% average 5% average n.a. tariff and tariff dispersion rate tariff rate average tariff tariff tariff reduction. 6.28% tariff dispersion 7.96% tariff rate 5.9% tariff 5.9% tariff dispersion 6.22% tariff dispersion dispersion dispersion Trade costs (measured by 8 documents to export 7 documents to 7 documents 7 documents n.a. n.a. delays, document, and 24 days to export export to export to export administrative fees) are 13 documents to 24 days to 24 days to 24 days to reduced to an acceptable import export export export minimum levels.11 31 days to import 13 documents 8 documents 8 documents to import to import to import 31 days to 31 days to 25 days to import import import 8 trade government agencies 0 0 4 agencies 4 agencies 5 agencies n.a. are connected to the one- 0 40% 60% of total 70% of total 80% of total stop-shop for foreign trade. trade trade trade 90% of trade authorizations authorizations authorizations authorizations from other agencies for customs clearance done electronically. 11 Source: Doing Business Indicators, several issues. 73 Expected Outcomes by the end Baseline Actual of the program by 2011 2005 2006 2007 2008 2009 2010 (est.) Increase the number of new 39 new exporting 49 new 40 exporting n.a. n.a. n.a. exporting firms located in firms. exporting firms. developing regions12 firms. Reduce transaction costs for the private sector to enter, operate in, and exit markets Double the number of new n.a. July*: 55 July*: 65 n.a. n.a. n.a. businesses with operating August*: 64 August*: 125 licenses in municipalities that September*: 42 September*: have implemented TramiFácil October*: 40 130 October*: 132 *Puno *Puno Promote sustainable financial deepening Increase MSME credit (as a 8.5% of total credit. 9.2% of total 9.3% of total 10.1% of total 11.6% of total 11.8% of total share of total loans) credit credit. credit credit credit Declining ratio of non- 2.14% of total gross 1.63% of total 1.35% of total 1.27% of total 1.56% of total 1.67% of total performing loans is loans gross loans gross loans. gross loans gross loans gross loans maintained at a minimum acceptable level. 12 Source: PROMPERU, developing regions correspond to Puno, San Martín, Madre de Dios, Huancavelica, Amazonas, Ayacucho and Apurímac. 74 Annex 5. Peru-IMF Relations Peru--Assessment Letter to the World Bank (Board discussion--Fiscal Management and Competitiveness Development Policy Loan IV and Environmental Development Policy Loan III) June 23, 2010 1. Peru's commitment to prudent macroeconomic policies and economic resilience during the global financial crisis has been commended by the Executive board of the IMF. In April, the Executive Board concluded the 2010 Article IV consultation (see the Public Information Notice at http://www.imf.org/external/np/sec/pn/2010/pn1050.htm). The next Article IV consultation is expected to take place on the standard 12-month cycle. 2. Peru successfully managed the global financial crisis. Following a decade of strong growth that peaked at 9.8 percent in 2008, activity decelerated sharply in 2009, expanding 0.9 percent for the year. Thanks to sound fundamentals and the strong buffers built in recent years, Peru was able to launch a significant countercyclical fiscal and monetary policy response, which helped avoid a credit crunch, supported economic activity and sustained employment. Poverty alleviation gains continued at a slower pace. 3. Peru's banking sector also proved resilient to the global crisis. The banking system was well-positioned to weather the global financial crisis as the regulatory and supervisory framework had been strengthened substantially in past years, including through the introduction of dynamic provisioning in 2008. The proactive response of the central bank helped maintain orderly financial conditions and avoid a liquidity squeeze. Banks remain well-capitalized, liquid, and profitable. 4. Economic activity is expected to grow strongly in 2010. Activity began to rebound in the second half of 2009 supported by faster execution of the fiscal stimulus, the lagged impact of the monetary easing, dynamics from the inventory destocking cycle, and better terms of trade and global recovery prospects. Growth for 2010 is projected at around 6¼ percent of GDP and 6 percent in 2011. Peru's recovery appears less dependent on policy support than in other economies, as it did not open a significant output gap and the balance sheets of the corporate, household, and financial sectors remain unimpaired. 5. Risks to Peru's outlook are tilted to the upside. Prospects of renewed capital inflows to strong emerging markets, the cyclical rebuilding of inventories, and acceleration of private investment projects put on hold last year, could intensify growth this year and next. With limited slack in resource utilization, the announced fiscal consolidation and policy rate hike are judicious to avoid inflationary pressures later on as inflation is already at 1.04 percent (yoy) by May, above the lower limit of the 1-3 percent inflation target range. A relapse in global growth and a return of global risk aversion are the principal downside risks, but Peru retains policy room to limit the fallout. Peru's 75 fiscal deficit remains moderate (about 2 percent of GDP in 2009) and is expected to be reduced in 2010, while public debt stands at about 25 percent of GDP. 6. Peru's medium-term outlook remains bright, linked to sustained efforts in the implementation of an ambitious structural reform agenda. The authorities' reform agenda is focused on sustaining high growth and the trend of poverty reduction, including through enhancing productivity and competitiveness, developing the local capital market, and solidifying further the policy framework. 76 Table 1. Peru: Selected Economic Indicators Projections 2005 2006 2007 2008 2009 2010 2011 Social Indicators Life expectancy at birth (years) 70.7 72.8 73.1 73.3 ... ... ... Infant mortality (per thousand live births) 22.8 18.9 17.2 17.0 ... ... ... Adult literacy rate 87.9 88.7 89.6 ... ... ... ... Poverty rate (Total) 1/ 48.7 44.5 39.3 36.2 ... ... ... Unemployment rate 9.6 8.5 8.4 8.4 8.6 ... ... (Annual percentage change; unless otherwise indicated) Production and prices Real GDP 6.8 7.7 8.9 9.8 0.9 6.3 6.0 Real domestic demand 5.8 10.3 11.9 12.1 -2.9 7.4 7.0 Of which: Private sector 5.9 9.0 11.4 12.6 -2.1 4.9 6.2 Consumer Prices (end of period) 1.2 1.1 3.9 6.7 0.2 2.0 2.0 Consumer Prices (period average) 1.6 2.0 1.8 5.8 2.9 1.5 1.8 External sector Exports 35.6 37.2 17.0 13.1 -14.7 19.7 10.0 Imports 23.2 22.9 32.0 45.1 -26.1 21.4 13.4 Terms of trade (deterioration -) 5.9 28.3 3.4 -13.7 -0.8 3.7 1.1 Real effective exchange rate (depreciation -) 2/ -0.5 -1.3 -0.6 4.9 2.4 ... ... Money and credit 3/ 4/ Liabilities to the private sector 18.4 8.8 22.7 24.2 6.2 14.7 14.0 Net credit to the private sector 16.3 6.2 30.8 31.5 1.7 14.4 14.1 (In percent of GDP; unless otherwise indicated) Public sector General government current revenue 18.0 19.9 20.7 20.9 18.5 19.2 19.0 General government noninterest expenditure 16.8 16.3 16.0 17.3 19.5 19.6 18.9 Combined public sector primary balance 1.6 4.1 5.1 3.7 -0.7 -0.2 0.3 Interest due 1.9 1.9 1.8 1.6 1.3 1.3 1.3 Combined public sector overall balance -0.3 2.2 3.3 2.2 -2.0 -1.5 -1.0 Combined public sector overall balance (including CRPAOs) -0.3 2.1 2.2 1.5 -2.4 -1.6 -1.0 External Sector External current account balance 1.4 3.1 1.3 -3.7 0.2 -0.7 -1.8 Gross reserves In millions of U.S. dollars 14,120 17,329 27,743 31,250 33,190 35,690 37,190 Percent of short-term external debt 5/ 314.2 174.9 405.3 421.1 397.5 473.7 481.4 Percent of foreign currency deposits at banks 131.0 148.2 208.7 175.0 190.3 180.6 182.3 Debt Total external debt 36.1 30.8 32.4 28.9 32.3 28.6 29.6 Combined public sector debt (including CRPAOs) 37.7 33.2 30.9 25.7 27.4 26.7 25.6 External 6/ 28.1 23.9 19.9 16.7 17.4 15.8 15.1 Domestic 9.7 9.2 11.0 9.0 10.0 10.9 10.6 Savings and investment Gross domestic investment 17.9 20.0 23.0 26.7 20.6 23.3 24.9 Public sector 7/ 2.9 2.8 3.1 4.2 5.3 6.0 6.0 Private sector 15.0 17.2 19.9 22.5 15.3 17.3 18.8 National savings 19.3 23.1 24.2 23.0 20.8 22.6 23.1 Public sector 8/ 2.6 5.1 6.0 6.1 3.4 4.2 4.7 Private sector 16.8 18.0 18.3 16.9 17.4 18.4 18.4 External savings -1.4 -3.1 -1.3 3.7 -0.2 0.7 1.8 Memorandum items Nominal GDP (S/. billions) 261.7 302.3 335.2 372.6 381.7 415.5 449.3 GDP per capita (in US$) 2,917 3,340 3,797 4,446 4,356 4,950 5,147 Sources: Central Reserve Bank of Peru; Ministry of Economy and Finance; ECLAC 2002-03; National Statistical Institute (INEI); and Fund staff estimates/projections. 1/ Defined as the percentage of households with total spending below the cost of a basic consumption basket. 2/ Based on Information Notice System. 3/ Corresponds to the banking system. 4/ Foreign currency stocks are valued at end-of-period exchange rates. 5/ Short-term debt is defined on a residual maturity basis, and includes amortization of medium- and long-term debt. 6/ Includes debt by the Central Reserve Bank of Peru. 7/ Includes CRPAOs. 8/ Excludes privatization receipts. 77 Annex 6: Analytical and Advisory Work Underpinning the proposed operation Completion Activity Brief description Date Public Expenditure PEFA is a partnership between the World Bank, the European Commission, the UK's FY09 and Financial Department for International Development, the Swiss State Secretariat for Economic Assessment Affairs, the French Ministry of Foreign Affairs, the Royal Norwegian Ministry of Foreign Affairs, and the International Monetary Fund. PEFA aims to support integrated and harmonized approaches to assessment and reform in the field of public expenditure, procurement, and financial accountability. The PEFA exercise for Peru was completed in FY2009 and the findings were used to inform the reform progress, triggers, and indicative actions that aim at strengthening budget reporting and planning that are part of this operation. OECD-DAC This activity financed the application of the OECD-DAC methodology for assessment FY09 Procurement of the quality and effectiveness of the national procurement systems in Peru. The assessment provided the basis to formulate Peru's national procurement strategy. The strategy is made up of eight key areas, one of which focuses on capacity development to improve Peru's procurement systems. The assessment was also useful to design a capacity develop plan to mitigate risks in the individual operations financed by the Bank. The Bank's technical assistance in this area helped accelerate reforms that had been considered as part of the FMCDPL II to support the objective to make the public sector processes more transparent, accessible and agile. REDI The Infrastructure Public Expenditure Review (REDI) aims at providing the GoP with FY10 a strategic assessment of three infrastructure sectors--transport, water/sanitation, electricity. Building on a large number of background studies, this assessment is structured around cross-cutting thematic issues (e.g. decentralization of infrastructure services, the PPP agenda, infrastructure and logistics planning) and around sector- specific analysis. Strategic recommendations are provided in the broader context of the infrastructure focus of Peru's stimulus package. The REDI is expected to be completed before the end of the FY10. PER The PER's main objective is to analyze the efficiency and effectiveness of public FY11 expenditure in a context of decentralization and performance-informed budgeting and provide policy recommendations to support the use of fiscal policy as an effective development tool. In addition, the PER will review policy challenges on the revenue side, in particular those related to narrow tax base and heavy reliance on natural resources activities. Evaluation of SIAF's This evaluation was supported by the Bank's Social TAL and conducted by FY10 Consulta Amigable Ciudadanos al Día, an independent Peruvian NGO. It identified the main obstacles preventing citizens and civil society organizations from accessing and using Consulta Amigable to track public expenditures in the social sectors. The study recommended the publication of the modified budget as a key action to improving budget transparency and civil society monitoring. This is an essential element in the reforms supporting the objective to make the public sector processes more transparent, accessible and agile. Informality ESW This programmatic ESW aimed to better understand the trajectories of businesses FY09 towards formalization and to identify the key factors that maintain most businesses in the informal sector. The topic has implications for both pillars of this operation. On the fiscal side, the limited tax base is in part the consequence of a large informal sector. In this regard, the ESW investigated the extent to which tax regimes, particularly due to compliance costs, may be contributing to informality. On the competitive agenda the ESW addressed the question of how (in) formality affects the productivity and competitiveness of businesses. 78 Completion Activity Brief description Date Education ESW This AAA responds to a request from the National Assembly of Regional FY10 Governments (ANGR), which is concerned with improving the efficiency and efficacy of performance-based budgeting (PBB) at the regional level. The objective is to improve education quality through enhanced PBB planning and intervention strategies in the education sector in the context of decentralization. The ESW will focus on the analysis of the relationship between resources, physical outputs and the high-level development outcomes of the PBB program in education so as to increase the potential of the system to align priorities and actors; improve efficiency and effectiveness of financial allocation and product costs identification; help identify critical bottlenecks; and recommend the reassignment of resources, the definition of responsibilities, and improvements in the institutional arrangements to tackle the main weaknesses of the program. This ESW was delivered to the client in March 2010. Nutrition NLTA This NLTA supports the restructuring and re-launching of the conditional cash transfer FY10 program Juntos, which is to become the country's emblematic program for reducing chronic malnutrition and extreme poverty as part of the National Strategy CRECER. The NLTA is helping an inter-institutional effort to effectively articulate the demand and supply side of the program with emphasis on ensuring health/nutrition services. The activities are closely linked with the PBB agenda, as nutrition is one of the first strategic programs launched in the context of PBB. This NLTA is expected to be completed by the end of the FY10. Policy Effectiveness This NLTA is helping to develop processes and mechanisms for continuous and FY10 NLTA systematic evaluation and improvement of anti-poverty interventions. In particular, the activity provided technical assistance for the design and evaluation of specific programs, including Juntos, and is also supporting an institutional framework to facilitate the systematic use of existing information systems and analyses of the effectiveness of anti-poverty interventions in Peru. These activities complement and are closely coordinated with the monitoring and evaluation efforts being undertaken in the context of PBB. This NLTA is expected to be completed by the end of the FY10. Education Sector This NLTA complemented the Education ESW by working with different FY09 NLTA counterparts, with an emphasis on regional governments, to improve the design and implementation of priority strategies within the PBB program. The activities were organized in three components. First, clarifying the PBB framework in education by promoting dialogue with counterparts (MEF, MED, ANGR) to agree upon the elements of an effective PBB system and highlight areas that merit more attention and support. Second, improving intergovernmental fiscal relations and institutional arrangements for the implementation of the PBB program. Third, fostering the evaluation of learning and teaching to improve results. The NLTA also responded with some small just-in-time technical assistance within the framework of improving education results and strengthening accountability. Governance and The Programmatic Governance AAA provided technical advice and training-by-doing First phase Governability NLTA to the Ministry of Finance. The assistance included the assessment of basic finance completed management systems, with a focus on performance budgeting, multi-year investment in FY09, budgeting (MIB) and SNIP. The latter included assessment of FONIPREL, a fund for Second sub-national investment with an emphasis on infrastructure projects. The second phase phase will expand the analysis of key elements in performance oriented management and underway service improvements in the following areas: (i) civil service reform; (ii) results-based transfers to subnational governments; (iii) treasury systems; and (iv) public investment. 79 Completion Activity Brief description Date Sub-national Pilots This NLTA addresses the need to build capacity in subnational governments by First phase NLTA providing on-site support to help them design and implement public investment completed projects. In particular, this NLTA has helped subnational governments build capacity in FY09 to develop technically sound proposals for investment projects eligible for FONIPREL Second funding. A second phase currently under implementation is intended to (i) support the phase implementation of projects awarded resources by FONIPREL, and (ii) tackle delays in underway public investment projects. This NLTA also supported the adoption of performance- based budgeting by a regional government and the preparation of project proposals for submission to FONIPREL. Decentralization A multi-sectoral ESW on decentralization is currently underway. It includes an overall FY10 Policy Notes assessment of the evolution of the political and fiscal decentralization in Peru. A second component will assess the use of participatory budgeting as an instrument to increase voice of local actors and its potential impact on improving results, particularly those prioritized in performance-based budgeting (PBB). A third component will focus on analyzing the actual and potential contributions of PBB approaches to improving the efficiency and effectiveness of expenditures in the education sector (Education ESW mentioned above). 80 Annex 7. Peru At A Glance13 Peru at a glance 2/25/10 Latin Upper Ke y D e v e lo pm e nt Indic a t o rs A merica middle P eru & Carib. inco me Age distribution, 2008 (2008) Male Female P o pulatio n, mid-year (millio ns) 28.8 565 948 75-79 Surface area (tho usand sq. km) 1,285 20,421 47,176 60-64 P o pulatio n gro wth (%) 1.2 1.1 0.8 Urban po pulatio n (% o f to tal po pulatio n) 71 79 75 45-49 30-34 GNI (A tlas metho d, US$ billio ns) 1 1 5.1 3,833 7,472 15-19 GNI per capita (A tlas metho d, US$ ) 3,990 6,780 7,878 GNI per capita (P P P , internatio nal $ ) 7,980 10,309 12,297 0-4 6 4 2 0 2 4 6 GDP gro wth (%) 9.8 4.4 4.7 percent of total population GDP per capita gro wth (%) 8.5 3.2 3.8 ( m o s t re c e nt e s t im a t e , 2 0 0 3 ­ 2 0 0 8 ) .25 P o verty headco unt ratio at $ 1 a day (P P P , %) 8 8 .. Under-5 mortality rate (per 1,000) P o verty headco unt ratio at $ 2.00 a day (P P P , %) 18 17 .. Life expectancy at birth (years) 73 73 71 90 Infant mo rtality (per 1,000 live births) 17 22 21 Child malnutritio n (% o f children under 5) .. 5 .. 60 5 A dult literacy, male (% o f ages 1 and o lder) 95 92 95 5 A dult literacy, female (% o f ages 1 and o lder) 85 90 93 Gro ss primary enro llment, male (% o f age gro up) 1 17 1 19 121 30 Gro ss primary enro llment, female (% o f age gro up) 1 18 1 15 108 0 A ccess to an impro ved water so urce (% o f po pulatio n) 84 91 94 A ccess to impro ved sanitatio n facilities (% o f po pulatio n) 72 78 82 1990 1995 2000 2007 Peru Latin America & the Caribbean N e t A id F lo ws 19 8 0 19 9 0 2000 2008 a (US$ millio ns) Net ODA and o fficial aid 201 397 398 263 Growth of GDP and GDP per capita (%) To p 3 do no rs (in 2007): Spain .. 6 19 109 15 No rway 1 1 1 94 10 United States 53 79 92 94 5 A id (% o f GNI) 1.0 1.6 0.8 0.3 0 A id per capita (US$ ) 1 2 1 8 15 9 -5 Lo ng- T e rm E c o no m ic T re nds -10 95 05 Co nsumer prices (annual % change) .. .. .. 5.3 GDP implicit deflato r (annual % change) 65.9 6,836.9 3.7 2.3 GDP GDP per capita Exchange rate (annual average, lo cal per US$ ) 0.0 0.2 3.5 2.9 Terms o f trade index (2000 = 100) .. 126 100 142 19 8 0 ­ 9 0 19 9 0 ­ 2 0 0 0 2 0 0 0 ­ 0 8 (average annual gro wth %) P o pulatio n, mid-year (millio ns) 17.3 21.8 26.0 28.8 2.3 1.8 1.3 GDP (US$ millio ns) 20,661 26,294 53,290 1 09 29,1 -0.1 4.7 6.0 (% o f GDP ) A griculture 1 1 .7 8.5 8.5 7.2 3.0 5.5 4.0 Industry 42.8 27.4 29.9 36.2 0.1 5.4 6.8 M anufacturing 23.5 17.8 15.8 15.9 -0.2 3.8 6.7 Services 45.5 64.1 61.6 56.6 -0.5 4.0 5.9 Ho useho ld final co nsumptio n expenditure 57.5 73.7 71.4 64.2 0.7 4.0 5.1 General go v't final co nsumptio n expenditure 10.5 7.9 10.6 8.9 -0.9 5.2 4.6 Gro ss capital fo rmatio n 29.0 16.5 20.2 26.3 -3.8 7.4 10.9 Expo rts o f go o ds and services 22.4 15.8 16.0 27.1 -0.9 8.5 8.6 Impo rts o f go o ds and services 19.4 13.8 18.2 26.5 -3.2 9.0 10.1 Gro ss savings 27.7 16.5 17.2 22.6 No te: Figures in italics are fo r years o ther than tho se specified. 2008 data are preliminary. .. indicates data are no t available. a. A id data are fo r 2007. Develo pment Eco no mics, Develo pment Data Gro up (DECDG). 13 The data presented on this table may not necessarily coincide with the projections presented in the macroeconomic section due to differences in the date that the data were collected and definitions of some variables. 81 Peru B a la nc e o f P a ym e nt s a nd T ra de 2000 2008 Governance indicators, 2000 and 2008 (US$ millio ns) To tal merchandise expo rts (fo b) 6,955 33,771 To tal merchandise impo rts (cif) 7,358 29,542 Voice and accountability Net trade in go o ds and services ,1 -1 38 ,1 1 61 Political stability Current acco unt balance -1,546 -4,180 as a % o f GDP -2.9 -3.2 Regulatory quality Rule of law Wo rkers' remittances and co mpensatio n o f emplo yees (receipts) 718 2,200 Control of corruption Reserves, including go ld 8,563 37,297 0 25 50 75 100 2008 Country's percentile rank (0-100) C e nt ra l G o v e rnm e nt F ina nc e higher values imply better ratings 2000 (% o f GDP ) Current revenue (including grants) 14.9 18.0 Source: Kaufmann-Kraay-Mastruzzi, World Bank Tax revenue 12.2 15.4 Current expenditure 1 5.1 13.6 T e c hno lo gy a nd Inf ra s t ruc t ure 2000 2008 Overall surplus/deficit -2.8 2.2 P aved ro ads (% o f to tal) 13.4 13.9 Highest marginal tax rate (%) Fixed line and mo bile pho ne Individual 20 30 00 subscribers (per 1 peo ple) 12 83 Co rpo rate 30 30 High techno lo gy expo rts (% o f manufactured expo rts) 3.6 2.1 E xt e rna l D e bt a nd R e s o urc e F lo ws E nv iro nm e nt (US$ millio ns) To tal debt o utstanding and disbursed 28,644 28,555 A gricultural land (% o f land area) 17 17 To tal debt service 2,572 4,924 Fo rest area (% o f land area) 54.1 53.7 Debt relief (HIP C, M DRI) ­ ­ Natio nally pro tected areas (% o f land area) .. 13.7 To tal debt (% o f GDP ) 53.7 22.1 Freshwater reso urces per capita (cu. meters) 60,377 56,685 To tal debt service (% o f expo rts) 27.8 1 1 .7 Freshwater withdrawal (billio n cubic meters) 20.1 .. Fo reign direct investment (net inflo ws) 810 4,079 CO2 emissio ns per capita (mt) 1.1 1.3 P o rtfo lio equity (net inflo ws) 123 180 GDP per unit o f energy use (2005 P P P $ per kg o f o il equivalent) 1 1 .4 14.0 Composition of total external debt, 2008 IBRD, 2,712 Energy use per capita (kg o f o il equivalent) 482 481 Short-term, IDA, 0 6,147 IMF, 0 Wo rld B a nk G ro up po rt f o lio 2000 2008 Other multi- (US$ millio ns) lateral, 5,227 IB RD To tal debt o utstanding and disbursed 2,590 2,712 Private, 10,133 Bilateral, 4,336 Disbursements 266 294 P rincipal repayments 93 230 Interest payments 189 136 US$ millions IDA To tal debt o utstanding and disbursed 0 0 Disbursements 0 0 P riv a t e S e c t o r D e v e lo pm e nt 2000 2008 To tal debt service 0 0 Time required to start a business (days) ­ 65 IFC (fiscal year) Co st to start a business (% o f GNI per capita) ­ 25.7 To tal disbursed and o utstanding po rtfo lio 292 648 Time required to register pro perty (days) ­ 33 o f which IFC o wn acco unt 157 41 8 Disbursements fo r IFC o wn acco unt 70 1 16 Ranked as a majo r co nstraint to business 2000 2008 P o rtfo lio sales, prepayments and (% o f managers surveyed who agreed) repayments fo r IFC o wn acco unt 10 29 A ntico mpetitive o r info rmal practices .. 22.1 Tax administratio n .. 17.9 M IGA Gro ss expo sure 329 8 Sto ck market capitalizatio n (% o f GDP ) 19.8 43.1 New guarantees 40 0 B ank capital to asset ratio (%) 9.1 8.8 No te: Figures in italics are fo r years o ther than tho se specified. 2008 data are preliminary. 2/25/10 .. indicates data are no t available. ­ indicates o bservatio n is no t applicable. Develo pment Eco no mics, Develo pment Data Gro up (DECDG). 82 Millennium Development Goals Peru With selected targets to achieve b etween 1990 and 2015 (estimate clo sest to date sho wn, +/- 2 years) P e ru G o a l 1: ha lv e t he ra t e s f o r e xt re m e po v e rt y a nd m a lnut rit io n 19 9 0 19 9 5 2000 2008 .25 P o verty headco unt ratio at $ 1 a day (P P P , % o f po pulatio n) <2 8.6 12.6 7.9 P o verty headco unt ratio at natio nal po verty line (% o f po pulatio n) .. .. 54.3 53.1 Share o f inco me o r co nsumptio n to the po o rest qunitile (%) 5.6 4.4 3.1 3.9 P revalence o f malnutritio n (% o f children under 5) 8.8 5.7 5.2 .. G o a l 2 : e ns ure t ha t c hildre n a re a ble t o c o m ple t e prim a ry s c ho o ling P rimary scho o l enro llment (net, %) 88 .. 98 96 P rimary co mpletio n rate (% o f relevant age gro up) .. 90 103 104 Seco ndary scho o l enro llment (gro ss, %) 67 71 87 98 Yo uth literacy rate (% o f peo ple ages 15-24) .. 95 .. 97 G o a l 3 : e lim ina t e ge nde r dis pa rit y in e duc a t io n a nd e m po we r wo m e n Ratio o f girls to bo ys in primary and seco ndary educatio n (%) 96 .. 97 102 Wo men emplo yed in the no nagricultural secto r (% o f no nagricultural emplo yment) 29 30 33 36 P ro po rtio n o f seats held by wo men in natio nal parliament (%) 6 11 11 29 G o a l 4 : re duc e unde r- 5 m o rt a lit y by t wo - t hirds Under-5 mo rtality rate (per 1 ,000) 78 65 40 20 Infant mo rtality rate (per 1,000 live births) 58 50 33 17 M easles immunizatio n (pro po rtio n o f o ne-year o lds immunized, %) 64 98 97 99 G o a l 5 : re duc e m a t e rna l m o rt a lit y by t hre e - f o urt hs M aternal mo rtality ratio (mo deled estimate, per 1 00,000 live births) .. .. .. 240 B irths attended by skilled health staff (% o f to tal) 80 56 59 71 Co ntraceptive prevalence (% o f wo men ages 1 5-49) 59 64 69 71 G o a l 6 : ha lt a nd be gin t o re v e rs e t he s pre a d o f H IV / A ID S a nd o t he r m a jo r dis e a s e s P revalence o f HIV (% o f po pulatio n ages 1 5-49) 0.1 0.2 0.4 0.5 Incidence o f tuberculo sis (per 100,000 peo ple) 31 7 242 184 126 Tuberculo sis cases detected under DOTS (%) .. 102 88 93 G o a l 7 : ha lv e t he pro po rt io n o f pe o ple wit ho ut s us t a ina ble a c c e s s t o ba s ic ne e ds A ccess to an impro ved water so urce (% o f po pulatio n) 75 79 81 84 A ccess to impro ved sanitatio n facilities (% o f po pulatio n) 55 60 65 72 Fo rest area (% o f to tal land area) 54.8 54.4 54.1 53.7 Natio nally pro tected areas (% o f to tal land area) .. .. .. 13.7 CO2 emissio ns (metric to ns per capita) 1.0 1.0 1 .1 1.3 GDP per unit o f energy use (co nstant 2005 P P P $ per kg o f o il equivalent) 9.8 1 1 .2 1 1 .4 14.0 G o a l 8 : de v e lo p a glo ba l pa rt ne rs hip f o r de v e lo pm e nt 00 Telepho ne mainlines (per 1 peo ple) 2.6 4.6 6.6 10.0 00 M o bile pho ne subscribers (per 1 peo ple) 0.0 0.3 4.9 72.7 00 Internet users (per 1 peo ple) 0.0 0.0 3.1 24.7 00 P erso nal co mputers (per 1 peo ple) .. 1.5 4.0 10.1 Education indicators (%) Measles immunization (% of 1-year ICT indicators (per 100 people) olds) 125 100 90 100 75 75 60 50 50 25 30 25 0 2000 2002 2004 2006 2008 0 0 1990 1995 2000 2007 2000 2002 2004 2006 2008 Primary net enrollment ratio Fixed + mobile subscribers Ratio of girls to boys in primary & secondary Peru Latin America & the Caribbean education Internet users No te: Figures in italics are fo r years o ther than tho se specified. .. indicates data are no t available. 2/25/10 Develo pment Eco no mics, Develo pment Data Gro up (DECDG). 83 IBRD 33465R 80°W 75°W 75 70°W 70 0° 0° ADO R EC U AD OR Arcadia LOMBIA CO LO MBIA ap N o Putumayo Puerto Curaray Co rr i Tig en r tes e To Machala Tumbes ma A zona Santiago s TUMBES Iquitos taza Caballococha AMAZON A To A ZI BR AZI L Pas Loja Talara Ayar Manco LORETO Ya var i Sullana ZON 5°S PIURA San Maraño 5°S li n ya Ignacio a Uc Piura CAJ C J A A AS Yurimaguas Tamánco n n AM Chachapoyas Moyobamba M d Tarapoto AR AR LAMBA- SAN PERU e YEQUE A C C Chiclayo MARTIN A s s Cajamarca To Cruzeiro do Sul Trujillo Santa Lucia LIBERTA LIBERTAD LA LIBERTAD Pucallpa Hu Nevada Sihuas alla Hueascarán ga Chimbote (6768 m) ANCASH Tingo María Uc ay HUANUCO ali Huaraz Nevada Huánuco 10°S Yerupaja 10°S 10 (6634 m) UCAYALÍ Goyllarisquizga PASCO Purús Cerro de Pasco PA C IF I C M M Huacho Sayán Atalaya Satipo LIMA La OCEAN C A L L A O Ap MADRE t t Oroya JUNIN uri Uru m DE DIOS n n ac ba Huancayo M ad mba Callao r LIMA ed s eD ios Puerto Ayna CUSCO Sintuya Maldonado . Huancavelica Quillabamba 0 100 200 300 Kilometers Nevada HUANCA- Ayacucho Salcantay (6271 m) Lanlacuni Astillero 0 100 200 Miles VELICA A Cusco Bajo PU In a Pisco mb Abancay Nudo a ri RI AY Ausandate Ica M PUNO AC (6384 m) AC ICA To San Buenaventura UC Puquio PER U Caballas Nazca O 15°S 15 H H Alca Cailloma Nevada To San Juan Juliaca Carabuco An Coropuna SELECTED CITIES AND TOWNS (6271 m) de Lago e s Antiquipa Puno Titicaca REGION CAPITALS AREQUIPA To M M Atico Arequipa La Paz NATIONAL CAPITAL tn Desaguadero s. . RIVERS MAIN ROADS Mollendo Moquega RAILROADS TACNA MOQUEGUA REGION BOUNDARIES To Visviri IV I A B OL I V IA Tacna INTERNATIONAL BOUNDARIES To Belén 75°W To Iquique CHILE NOVEMBER 2006