Document of

The World Bank

FOR OFFICIAL USE ONLY

i-K! 3~ _- p,g Report No. P-5929-PE

REPORT AND RECOMMENDATION

OF THE

PtBESIDENT OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND PE"ELOPMENT

TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED PRIVATIZATION ADJUSTHMENT LOAN

IN AN AMOUNT EQUIVALENT TO US$250 MIrLLION

TO THE

REPUBLIC OF PERU

MARCH 30, 1993

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This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS(as of March 1, 1993)

Currency Unit = SolUS$1.00 = 1.77 Soles

1 Sol = US$0.56

FISCAL YEAR

January 1 to December 31

ABBREVIATIONS AND AZCRGOMS

AEROPERU - Empresa de Transportes Adreo del Perd (Peru National Airline)CENTROMIN - Empresa Minera del Centro del Perd (Central Peru Minmng Company)COPRI - Comision de Promoci6n de la Inversi6n Privada (Commission for the Promotion of

Private Investment)CPT - Compaifa Peruana de Telefonos (Peru Telephone Company)CPV - Compaiia Peruana de Vapores (National Shipping Company)EFF - Extended Fund FacilityELECTROPERU - Empresa de Electicidad del Perd (Peru Electricity Company)ENATRU - Empresa Nacional Transporte Urbano del Perd (National Urban Trnsport

Company)ENTEL - Empresa Nacional de Telefonos (National Telephone Company)FONCODES - Fondo Nacional de Compensacidn y Desarrrollo (National Social Compensation

and Development Fund)FOPRI - Fondo de Promoci6n de la Inversidn Privada (Fund for the Promotion of Private

Investment)FSAL - Financial Sector Adjustment LoanIDB - Inter-American Development BankIF! - international financial institutionIMF - Intenational Monetary FundHIERRO PERU - Empresa Minera del Hierro del Perl (Peru Iron Ore Company)MINERO PERU - Empresa Minera del Peri (Peru Mining Company)PESCAPERU - Empresa Nacional Pesquera (National Fish Company)PETROPERU - Petr6leos del Peri (National Petroleum Company)QUIMPAC - Qufriuca del Pacffico (Pacific Chemicals Company)RAP - Rights Accumulation ProgramSAL - Structural Adjustment LoanSEDAPAL - Servicio Agua Potable do Lima (Lima Water Company)SIDERPERU - Empresa Siderdrgica del Peri (National Steel Company)SOEs - State-owned enterprisesSOLGAS - Coqpahfa Peruana de Gas (Peru Gas Company)SUNAT - Superintendencia Nacional do Administracidn Tributaria (National Tax

Administration Office)TA - Technical AssistanceUNDP - United Nations Development ProgramVAT - Value added tax

FR0M FFCIA6L USE ONLY

PERLUPRIVATIZATION ADUENT LOAN

Table of Cone=t

Loan and Program Summary ................................... i

L Country Policies and Bank Group's Assistance Stra ............ ..... 1

A. Historical Perspective 1................................ B. Recent Developments ................................ 2C. Macroeconomic Assessment ............................ 4D. Peru's Extern Environment .......................... 7E. Peru's Development Objectives and Policies ................ 8F. Bank's Assistance Saegy: Objectives and Activities .... ........ 13G. FCfMIGA Operations ............................... 18H. Relations widh Other Multilateral Institutions and

Bfateral Donors ................................ 19

HI. 1he Privatization Pogram ....... ............................. 20

m. The Reform Program to beSupported by the Loan ................... 21A. Macroeconomic Progam and Fnaning Plan ................. 21B. Sectoral Policy, Legal and Reguatory Reforms ................ 21C. Implementing the Privatiation Agenda ..................... 25D. Fiscal Impact ..................................... 27E. SocialImpact ..................................... 27F. Environment Aspects .... ; .......................... 28

IV. The Proposed Loan ....................................... 28A. Description ................... ................... 28B. Policy Letter .................. ................... 29C. Loan Conditions ....... ........ .. .................. 29D. Monitoring and Reporting ............................. 30E. Technical Assistance ................. ................ 30F. Procuroment, Disbursement, Audit and Admiistration........ . 30G. Benefits and Risks .................................. 31

V. Recommendation .......... 32

This document has a restcted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

T bW§ of Cm= (Cont.)

ANhZ

Annex I PrivatzatlonAdjustm.ntLoan:Pofly Mcy .................. 33Annex E Maroeconomic Perfomancead Projctou . ................. 39Annex m PrivatizationA4dustamenLoa:PolicyLtter ................. . 48Annex IV SecorelReoayReformsa ndv.nzi.o ....... ........... 53Annex V Supplemen y Loan Daa Sheet ............................. 61Annex VI The Stas of Bank Gr=pOPerions hinPeru .................. 63

PERUPRIVATIUATION ADJUT1TN T LOADN

LO0AN ANQD PROGA YUfMR

Bonrwer: Republic of Peru

lEeuindog Agency: Commission for Promotion of Private Investment (COPRI)

Amount: US$250 million equivalent

Terms: Repayment in 20 years, including five years of grace, with interest at theBank's standard variable rate

Loan Objectves: The proposed loan would support the privatization program and relatedsectoral policy, legal and regulatory reforms being implemented by theGovernment of Peru. lhe program is designed to promote competition andprivate investment and improve economic efficiency and fiscal performance.

Loan Description: The reform program to be supported by the proposed loan would include threecomponents: (a) maintaining a satsfactory macroeconomic program andfinancing plan; (b) implementng policy, legal and regulatory reforms in keysectors to promote competition and private investment and to facilitateprivatization; and (c) implementing the Government's privatzation progm,focussing on mining, hydrocarbons and telecommunications, and selectedholdings in fisheries, industry, air/urban transport and the water sector.

Benefits: Privatization and related sectoral reforms are expected to have major benefits:(a) improved fiscal performance through elimination of the recurring fiscalburden of state enterprises; (b) restored prvate sector confidence in theeonomy and in the Government's commitment and ability to reduce thepublic sector and implement the refrm program; (c) increased privateinvestment, thereby speeding up economic recovery and alleviating Peru'sunemployment/underemployment problem; and (d) increased economicefficiency due to the implementation of sectoral policy/regulatory reformstogether with privadzation.

Rs": There are two main risks. One risk is that domestic pressures will result insome backsliding or deviations in the Governes macroeconomic andstructral reform program, thereby undermining economic recovery. In thisregard, the Government has maintained sound macroeconomic policies andperformance since taking office in August 1990, and has adopted a satisfactorymacroeconomic program and externa financing plan for 1993-95, to besupported by this operation and an IMB Extended Fund Facility. Maintenneof a sadsfactory macroeconomic program and external financing plan is acondition of effectiveness, second and thid tranche release for this operation.A second risk is that privatization will get delayed as a result of domesticpolitical opposition or foreign investor reluctamce to invest in Peru at thistime, given the fragility of the political and economic situation. Ihis risk hasdiminished markedly over the last year with the init success of the

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privatizatlon program and tie opening of the eoonomy. Ihe recentcongressional and municipal elecdions are also expected to increase investorconfidence in Peru. The Govenment has also launched a public lnformationprogram within Peru to stregh public support and understanding of theprivatzaton program. It i also fincing a number of community projefhom the proceeds of privatiaon. MIis will help alleviate poverty, whilebuflding support for privatzato Finally, the Government is also developingpromotDonal campags for Investors abroad to explain the Govement'sprogram and privaiaton/investmen opporuities In Peru. Theinformaional and promotional progrms are being finaced, in part, by thePrivadtzaion Technical Assistance Loan

F_mtedDisbus t: The loan wil be disbursed in three tranches of $75 million, $75 milion, and

$100 million, upon fulfillment of conditions of effectivens, second and thirdrnche respetvely.

Clasifcaton: B

REPORT AND RJIEATION OF TOF TEE DMD TO THE EXCtTI lllnln

ON A PROPOSID PRIATMZATION ADUW LOANO TE RlUIBL!UOF PERU

1. I submit the following report and recommendaton on a proposed loan to the Republicof Peru for the eqvalent of US$250 million. The proposed loan would support the pri donprogram ad related sectoral policy, legal and regulatory reforms being implemented by theGovernment of Peru. The loan would be repayable over 20 years on a Sxed amortizaon schedule,including five years grace, at the Bank's standard variable interest rat.

L l:ontrv Poldes and Bank Grop' Ance balm

A. lHrleal P

2. Peru is the world's second largest silver producer, ffth largest copper producer, andhas abundant fishing and hydrocarbon resources. Despite these considerable endowmen, Peru Is oneof Latin America's poorest countries 'with per capita income of $1020) and deeply tor by socialconflict. Income distribution traditionally has been one of the most unequal, infnt mortality amongthe highest, and life expectancy among the lowest in the reion.

3. Peru's recent history has been marked by political and economic Instability. A 12-year period of military rule ended in 1980, when Fernando Belaunde Terry reuned to thePresidency. His Government engaged in expansiona fisca and monetary policies, which causedinflation to double to over 100 percent in 1983. Duing 1984 and early 1985, efforts to stablize theeconomy brought about a significant reduction in the fiscal deficit and reversed the dteroation InPeru's competitiveness that had occurred over the preceding five years. However, economic activityremained depressed and inflation accelerated.

4. In 1985, Alan Garcia, of the nationalist APRA party, was elected Preident on apopulist economic platform. His Government followed expansionary fiscl policies and IsdUtedwidespread foreign-exchange controls with multiple exchange rates which we subject to firequentchange. It increased minimum wages, expanded directed credit and subsidies, reduced the rate ofvalue-added tax, and decreased public sector prices. The program ally appeared to work, and theeconomy grew rapidly for a couple of years. But these policies increaed the fisc defict, fueledinflation and misatlocated resources.

S. The consequences of eaonomic mismanement reached a climax In 1989-90. inJuly 1990, inflaion reached an annualized rat close to 36,000 percent Tax revenues dropped to lessthan 6 percent of GDP from 14 percent in 1985. Per capita income ha ddlined to the levels of 30years earlier. In Lima, seventy-five percent of the labor force was either unemployed orunderemployed, and real wages declined by 60 percent between 1985 and 1990.

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6. Peru's relations with the international financial community contned to deterioratethrough the 1980s. In 1983, Peru adopted a best-effort-to-pay practice on Its foreign debt (then $12.4billion) and its foreign arrears grew rapidly. Then, in July 1985, the Garcia Government announcedthat total foreign debt paymets would be capped at 10 percent of exports. Not until 1988, however,did actual debt service fall to the 10 percent level. Initially only payments from public creditors toprivate foreign banks were suspended, but in 1987 Peru extended the moratorium to the intenationalfinancial institutions IFIs) and also banned external debt-service payments by private debtors. InAugust 1986, Peru was declared ineligible for IMF lending and was placed on "non-accrual status bythe Bank one year later. In early 1989, the EDB also took this last step. Peru was finacialy cut offfrom the rest of the world. By end-1990, Peru's external debt was almost $22 billion, with about 40percent owed to Paris Club members, 37 percent to private creditors, 12 percent to IFk;, and 10percent to other official bilateral creditors. Almost two-thirds of this was in arrears; arrears to thethree IFIs alone totalled $2.2 billion.

B. Recent Developments

7. Stabilization and Structural Reform. Following presidential elections in July 1990,the new Government inder Alberto Fujimori introduced fimdamental changes in the economy. Tbeextent of the crisis led the Govermnent to adopt a comprehensive macroeconomic stabilization andstrucural reform program. The ptincipal short-term objective of the program was to halthyperinflation and lower the rate of inflation to acceptable levels. she longer-tem objective was towansform a statist interventionist economy into a market-oriented economy. Th'. reform progmradically departs from the ad hoc nature of past policy responses to macroeconomic imbaanc andstctura wealnesses of the economy.

8. The stabilization component Iacluded not only stringent short-term fiscal andmonetary measures, but also reforms in the areas of taxation, public expenditu.es, interest rates, andexchange rate policy. To cope with hyperinfltion and the fiscal crisis that lay at its root, theGovernment adopted a tight monetary policy, full convertibility for the domestic currency, and a cashmanagement system for the budget. Tight controls were instituted on public sector wages, sometemporary taxes were uoduced, most tax concessions and price- and interest-rate controls wereremoved, and public-utiity prices were increased substantially. Tax aminon was reorganizedand strengthened.

9. The structual reform package included liberalization measures on boti an economy-wide and sectoral basis. Reform has gone furthest in trade policy, and Peru's regime is now amongthe freest in Latin America. Non-tariff barriers and exemptions from import tariffs were elimnted,and Peru's complex tariff rate structure was simplified to a two-rate system of 15% and 25% of c.i.f.prices. The Customs administration has also been reformed. Monopoly rights of public firms havebeen abolished. Reforms have also been introduced to remove distortions in capital and labormarkets. Considerable flexibility has been introduced into Peru's labor laws. A new banking law hasstreugthened prudential regulations, promoted universal type banking, and opened commercialbankig to foreign investment. The four development banks are In the process of liquidation and theGovernment Is withdrawing completely from commercW banlkng. Private pension funds have beenmade legal. Insurace has been partily deregulad by freeing premiums and abolishing somegovernment monopolies. Foreign investment policies have been liberalized. And, after a slow start,the Government is now implemendng a sweeping program of privatization.

3

10. Policy, lg nd rgutoy Sd hav lo bee arodced In virtuay all sectorto promote comp pDvae v and eownomic efficiy. In agImue% reorm haveliberized land, product and fnl maes. Prc controls have bee removed and a number ofsgdcuSv parastatds ban bew i 1 or restructurd. With few excton, land cn now befeely ted or leased to any or legalt, foen or domestic, ad landowns camorte lands in excess of five hoctes. In addition, maxium land holding limib have bee raiedand land registration procedures have been simplified. in iua fine, preferti hres re toagrdcut have been dimid and the unprofitable Agdcutral Banka has been Uquidated. And, Inirrigation, reponsibility for magemen and opation of public brigatioa schem has beentransferred to user grups and water fbav been adjuwd to e cost revy for operaonand maintenance.

11. In trsport li ization s bean omprehensive. The Govemehas deregulated prices, ey and routs in shipping, urban, ineru and ai transport Inhighways, almost fAll cost recovery ha been achieved using a variety of user charges, icludig tolls.In ports, cargo handling has been tr o the rivte sector. Mm naiona aine (Aoperu)and the Lima bus company (ntu) hv beo privatized. n the Ihosec, the Goverme hasappoitd a commiee to prepar the prvaizaton of the Lima wat company (Sedaa) and isdeveloping a new lea and regulatory amework for the sec to sr wewr quty and fosterprivate sector participation. In ho the Governent Is widrawing fm direc prvion ofhousing, in favor of the privae setor.

12. In enev and Idutry, the refoms have been aimd at liberalizing the policy andrewaory environamet to promote com iion ad pat Iv nt, while substantally reducingand redefining dte role of the state. In mIin, the Govment enacted a new law faciitating priaeinvestmen,nitat a pdvatizadon program for the sale of all mining stae-owne enterpises (SOBs),and removed the 10 percet expor t In , the Governmt deinated Petroperu!s(the statowned enterpr) rnowoly in dow acvities, modified th tax regims forperleum products to bring it mor into line with ot brae tax system, and nitid thepdvaization of Petperu with the salo of mof itss bsiarles. A daft hydowbons law wasrecly prepared and submitted to the Eneg Commisin of the new Congr. In power, a lawenacted in 1992 opens the secto to privat investmet, promotes competition dwough the separationof generation, tasmission, and distruon actviies, ad allows for market prices at the generationstage, *While regating pries at the asn ad disbuin stae. And in fiheies, a keyexport setor, the Govemet elmtod the monopoly of the sta-ow:ned fish markeig anddistribution agencies, ope te sector to foreig nvesment, and enated a new fisheries law.Technical studies are underway for eth pivazaton of Pecaperu, the fish-prceing SOE.

13. In the soi 1al , th Goverment, with Bank asitace, has formulated a poveryalleviation segy imed at Wmrving the siao of the pooe so of the poulatin andincreasing efficiency ihe l impl n of social proams. Th strate set policie, priorieand target groups. lhe Govenmet ha alo prepard a national nutrition plan, wbhh ss outreforms in food assis e to imp dle and nuitona macL In late 1992, the Govermeissued three dece to lay the basi for an educational r enrm aimed at dsiftg responsibility andresources for man _ag eational seic to communes, fimnacing schl on the ba of dailyatendac res and Woduc a natna educational systm for tgeting educaona

terventions. FinAlly, tugh the creaton of FONCODES (the Soc ilwdeopmnt Fund) as amWsti level autonomo istion, th vernn hs b deelped a mehnim to rspond to

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the dispersed demand from poor communities for improvem in social and physical Infrastructureand for tompt.a employment oppornities.

14. IntemnatIonal Support for the Program. Ihe Bank, in close collaboration with theIMF, the IDB and bilatera donors, has supported these reforms. In May 1991, the Bank adopted anew debt werkout approach for counries with protracted arrears; in July 1991, the Bank approved theapplication of the new approach to Peru. Under this policy, the Governmenit maintained current debtservicing to the Bank and undertook a Bank-supported macroeconomic adjustmert program for aperfonnance period ending in December, 1992. During this period, the Bank approved threeadJustment loans: a $300 million Trade Policy Reform Loan C(PRL); a $300 million StructuralAdjustment Loan (SAL); and a $400 million Financial Sector Adjustment Loan (FSAL). The IDBsupported the program with a trade policy reform loan and financial sector adjustment loan.

15. In parallel, the IMP approved a Rights Accumulation Program (RAP) for Peru inSeptember 1991, under which Peru accrued rights to future disbursements of 188 percent of its quotaor SDR625 million, equivalent to its arrears to the IMF. The adoption of the RAP paved the way fora successful Paris Club rescheduling in September 1991 (involving debt relief from October 1991through December 1992) and enabled Peru to re-establish relations with bilateral creditors. ASupport Group of bilateral donors provided approximately $500 million in quick-disbursing balance ofpayments support in 1991/92.

C. Maroeonomic Assessment

16. Progam Implemetation and Economic Performance. The economy respondedstrongly to the emergency stabilization and structual reform measures. The rate of inflation fell fromover 7,000 percent in 1990 to 139 percent in 1991 and 57 percent in 1992. After contracting forthree years, real £DP grew by 2.6 percent in 1991. For 1992 as a whole, real GDP is esdmated tohave declined by 3 percent. The sharp slowdown in economic activity occurred during the fist halfof 1992, when a severe drought and related fall in electricity generation, and an escalation interrorism adversely affected agricultural, fishery, and m output. But, since August 1992there has been a fast recovery.

17. Recent developments in the balance-of-payments have also shown the impact of thereform program. The liberalization of the trade regime and private capital inflows allowed increasesin Imports, thus relieving the pressure caused by the pent-up demand for imports of raw materials,capital and consumer goods. Consequentiy, the external current account deficit to GDP ratioincreased from about 4 percent in 1990 to 5 percent in 1992. Significant private capital inflows,induced by high real domestic interest rates, also led to an increase of more than $1 billion in grossinteational reserves during 1990-92.

18. Tight fiscal and monetary policies since mid-1990 have played a major role inachieving a sharp deceleration in inflation. The consolidated public sector fiscal deficit declined from6.5 percent of GDP in 199 to 3 percent in 1991, and futher to 2.S percent during 1992. Thenonfinancial public sector had an estimated operational surplus of 0.5 percent of GDP during 1992.Ihe ratio of tax revenue to GDP increased by almost two percentage points since 1990, reaching 9.3percent in 1992, despite a large decline in 1992 revenues from the excise tax on energy and oilproducts (this tax represented 26 percent of total tax collections in 1991) and the fall in GDP.

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19. The operational surplus of the public sector in 1992 enabled t'ie Central Bank topurchase foreign currency in the market without inflationary pressure. This led to an 11 percent realdepreciation of the sol, which should help Peru's export performance, which had been adverselyaffected by the appreciation of the real exchange rate in 1990-91, caused by the large inflows ofprivate capital.

20. The financial system entered a reriod of stepped-up adjustment in 1992, responding toboth changes brought about by the new banking law and prudential regulations as well as tosignificant changes in the relative prices and profitabilities in the economy. Since March 1992,several small financial institutions have been liquidated, and the remaining ones are undertakingportfolio restructuring and changing their lending practices in accordance with the new economicenvironment and shifts in business risks. Structural reforms since August 1990 have drasticallyaltered domestic relative prices, and some previously lucrative activities have become unprofitable.And, the financial situation of some SOEs has worsened even furher. These developments haveinfluenced portfolios of Peru's banking sector in several ways. The percentage of non-performingioans in the banks' portfolios has increased, some loans have had to be written off, and others havebeen rescheduled as firms have facad difficulty in repaying them on the originally agreed terms. Insummary, the reforms and associated adjustments have resulted in a reduction in the collectibiity ofbanks' portfolios which, in tura, has induced banks to tighten loan terms and to attempt to recoverpart of the outstanding credit.

21. Nominal Interest rates in the banking system for deposits and loans in both soles anddollars declined in 1992. The dispersion in interest rates between sol and dollar deposits alsodeclined, suggesting that the market expects a decrease in the rate of devaluation and a higher degreeof credibility in the stabilization program. Real interest rates for deposits in soles also declined butremained positive (the real yield of time deposits in soles during 1992 was 1.7 percent). The declinein interest rates for loans has been less than that for deposits. The high spread between loan anddeposit rates in dollars reflects adjustment costs of the banking system and higher business risksassociated with the changing economic environment. The high real cost of credit has adverselyaffected the pace of economic recovery. The growing cunfidence in the Government'smacroeconomic program, as reflected in falling interest rates and inflation, and further improvementsin the banks' financial health should progressively lower the real cost of credit, thus increasing thefinancial sector's involvement in meeting the ewnomy's new investment and restructring needs.

22. In short, the process of stabilization, which started in August 1990, has beenaccompanied by remarkable achievements but has yet to be consolidated. The stabilization has beenbased on a reduction of the fiscal deficit and the elimination of credit from the Central Bank to theTreasury. Monetary and exchange rate policies, while imDortant, have accompanied fiscal disciplinerather than taking a leading role in reducing inflon. Tax revenues at 9.3 percent of GDP are lov7in comparison to that of other countries (the average for a sample of 15 countries in Latin America isabout 14.8 percent of GDP), and have fcrced the Government to maintain comparable levels ofspending.

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Table I - Selected Economi Idicatons

Pel. P-ojectd

1991 1992 1993 1994 1995 2000

Real growth rates:GDP 2.6 -3.0 3.5 S.0 5.0 6.0GDP per capita 0.1 -5.4 1.1 2.6 2.7 3.8Private consumptionper capit 4.3 2.9 -2.7 0.2 0.8 2.5

Ilvestment (as % of rent GDP) 16.3 15.5 16.8 17.2 i7.6 19.4

Private Investment 12.0 11.2 13.1 13.3 13.6 14.8Public Investment 2.2 3.5 3.6 3.8 3.9 4.5Change in Stocw 2.1 0.8 0.1 0.1 0.1 0.1

ICOR 8.4 -7.9 6.4 4.9 5.0 4.6

Domestic Saing (as % of cret GDP) 13.3 12.7 13.6 13.9 14.3 17.3

Inflation year-end 139.2 56.7 27.0 15.0 10.0 10.0

Creditwortiness Indicators n %)

Debt/GDP 130.3 121.1 156.9 174.6 180.9 147.8Debtxpots S60.6 560.6 573.0 540.2 503.2 330.4Total Debt Service/Exports 212.7 55.6 280.7 48.4 45.7 29.0Total Interest/GDP 9.3 7.8 10.1 9.8 10.6 8.5CoutrSy ExposueBRD ttal

outstang portllio 1.5 1.4 1.4 1.5 1.5 1.4IBRD/Couui-ry Alic Debt 7.1 6.4 6.4 7.0 7.3 6.9IBRD/Country PuWblic Debt Savice 2.3 10.4 9.0 6.8 7.3 9.8IBID Debt Servi/xports Of 4.7 5.4 24.1 3.0 3.0 2.6Preferred Creitrs/Public DebtService' 14.5 23.8 18.8 21.3 22.3 31.8

W 1991 gues include epment of ears to th IDB;1993 figures incde repayment of arrarm fa the Bank ad the IM.

Source: Cental Reserve Ba,k of Pera; and Dank IM staff estmat.

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D. Pw lEnuIrsimRa in

23. Improvements in Peru's external viroment are expected to contribute to astrengthening of its balance of payment in the 1990s. lTis section assesses export performance andgrowth prospects, and the exerna debt and financing situation.

24. Export Performance. Peru's exports of goods and non-facto. services at constantp,ices declined at a yearly average of 1.4 percent during 1980-91. This decline reflects both domesticeconomic policies pursued during the 1980s, as well as declining world prices for some of Peru'smajor exports. In petroleum, Peru earned about $800 million from exports in 1980. However,production dropped sharply during the 1980s due to the distorted policy frmework, with the resultthat the country became a net importer of petroleum by the end of the decade. Severemacroeconomic instability and appreciation of the sol in recent years also adversely affected exportperformance. Externlly, declining intnational prices for some of Peru's traditional exports led tobelow-potential export peromance. For example, silver prices fell from about $20/oz. troy in 1980to almost $4/oz.troy in 1991. Similarly, world lead prices decreased by 59 percent and fishmeal by16 percent in current dollars greater in constant dollars) over the same period.

25. In the 1990s, significant improvements are expected in Peru's export performance,with exports forecast to grow by 9-10 percent annually from 1994-2000. In part, this reflectsexpected trends in the exenal envirorment. First, following vual stagnation in 1991-92, globaleoomic growth is projected to reach at least 3 percent in the remainder of the decade, with thevolume of world trade growing 5-6 percent. Second, Peru's terms of trade are epected to movefavorably in the second half of the 1990s, due mainly to a recovery of mineral prices. Finally, as arsult of Peru's small share of world trade and the product mix of its principal exports, it is unlikelyto be targeted for protectionist or retaliatory measures.

26. While world trends are favorable (or neutra) for Peru's export growth, the forecastexpansion in exports is expected to come primarily from a 'supply.side" response, rather thaninternational developments. This reflects two factors: ch g rehitive prices as a result of theradical trade liberalization and rdated strucral reforms; and major efficiency improvements in keysectors as a result of prvaization and increased competiin The recent depreciation of thecurrency, together with maitenan of the Governe's prudent pnetay and fiscal policies, shouldalso facilitate export growth. Based on Peru's past experience, the forecast level of export growth isattanble. In the 1950s and early 1960s, whfle Peru's economy was still relatively open and healthy,the ratio of exports to GDP was in the range of 17-21 percent. Following a prolonged period ofeoomic colLapse, this ratio had slumped to 8-11 percent by the end of the 1980s. Even with exportgrowth of 9-10 percent anally though the 1990s, exports will sM not have recovered to therelative level they enjoyed in the 1950s, although the world econor, is considerably more open.

27. Extenl Debt. The Government has made signific progress at setting arreas onits exteral debt and secutig new financing for its progam from commercidal banks, the Us, andbilater donors. On November 20, 1992, the Government oncluded a tolling agrement with theBank Advisory Committee for commercia bank debt, which, If approved by the member banks,would suspend potendal lawsuits over the non-payment of debt during the next six years.Negotidons with commercial banks are expected after substaaly al lawsuits are widrawn. Inadditon, the Government plans to reschedule its official bilatera debts with the Paris Club creditors

8

in May 1993. Finally, Peru cleared its arreas with the IM: with the IDB In September 1991 andwith the Bank and the IMF in March 1993.

28. In the short and medium-term, new external financing is necessary for the success ofthe program. In March 1993, the Government agreed with the IMF on a three-year stabilizationprogram and financing plan for 1993-95, to be supported by an Extended Fund Facility (EFF). TheEFF follows the Rights Accumulation Program which was completed in December 1992. The Bankwill also support the program through this adjustment loan and follow-up operations. The programaims to consolidate the gains made since August 1990. The financing plan for the medium-termprogram is discussed in the following section.

E. Peru's Develonment OWecves and EPlicies

29. Although the Government has achieved remarkable economic progress over the pasttwo and one-half years, Peru remains in a very fragile economic, social and political situation. Itschallenges in the next few years are daunting. The economy, though beginning to recover, mustcontinue adjustment to a full market economy with a growing private sector. Government fiscal andinstitutional capacity remain weak. Basic infrastructure is badly deteriorated from a decade ofneglect. Poverty and ethnic rifts continue to divide the country. Terrorism and drug traffickingheavily drain Government resources, discourage foreign investment, and weaken efforts to reintegratethe country. And political instability poses the constant risk that fundamental economic reforms couldbe reversed.

30. Against these challenges, the Government has an ambitious medium-term agenda fordevelopment. The agenda is centered on the following objectives: sustaining the macroeconomicstabilization program; stimulating private sector growth/invesument and reintegrating the largeinformal sector into the formal economy; radically reducing the role of the state through privatizationand reshaping the public sector to carry out new responsibilities in a liberalized economy; attackingpoverty and expanding basic social services to improve the living conditions and opportunities of thepoor; rehabilitating essential infrastructure; and strengthening institutions at all levels of society. Thekey policies supporting this agenda, and the major reforms to be undertaken, are described below.

31. Macroeconondc stabiltion. The Government's macroeconomic objective is toachieve sustained growth with price stability. Its 1993-95 economic program and financing plan, tobe supported by the Bank and the IMP, are designed to achieve this objective. In the short-term,GDP is expected to grow at a rate of 3.5 percent in 1993. The extera current account deficit isprojected to increase from 5.1 percent of GDP in 1992 to 6.2 percent in 1993. This expansionreflects primarily an increase in investment from 15.5 to 16.8 percent of GDP. Tax collection isprojected to increase from 9.3 to 10 percent of GDP. The consolidated public sector fiscal deficit isforecast at 2.9 percent of GDP, slightly above that of 1992, primarily as a result of the projectedincrease in interest payments and public sector investment. It will be financed with externalresources, without recourse to credit from the Central Bank to the Treasury. Inflation is forecast todecline from 57 percent in 1992 to 27 percent in 1993.

32. The program objectives for 1993 are achievable. There are several indications thatthe credibility of the stabilization and suctural reform program has greatly increased during 1992.The response of foreign investors to the privadzation program, the high surplus in the capital accountof the balance of payments and gain in international reserves, and the steady decline in the spread

9

between sol- and dollar-deposit interest rates are positive signs. The fiscal situation has greadyimproved and a significant real exchange rate depreciation occurred between March and December1992. There has been a strong economic recovery since August 1992, with GDP growing 10 percentIn the second half of the year. The strength of the recovery indicates that GDP is likely to increase In1993 at a rate higher than projected in the program.

33. The medium term projections (table 1 and Annex II) assume the following keytargets: an increase in aMmal GDP growth to at least 5% and a reduction in inflation to 10% by1995; a gradual reduction in the external current account deficit in the second half of the decade tobelow 5% of GDP; an increase in investment (both public and private) from 15.5% of GDP in 1992to 17.6% by 1995; and an increase in gross international reserves from $2.3 billion to $3.3 billion.

34. To achieve these objectives, the Government must continue tight fiscal and monetarypolicies, while mainaning its structural reforms, particularly trade, price, exchange rate and interestrate liberalization. T'he economic projections reflect several positive factors. The process ofderegulation and privatization is likely to result in rapid increases in efficiency in key sectors of theeconomy, such as mining and agriculture which had stagnated in the previous decade. Throughoutthe economy, domestic relative prices now reflect more closely the relative scarcity of resources. ITeGovernment's adoption over the last two years of a more neutral and less protectionist trade policy isexpected to stimulate export growth. Productivity is also expected to increase as the restructuring ofthe economy is underway. Growth in private investment is expected to contne due to increasedinvestor confidence, the Government's broad privatlzation program, and policy refoims andderegulation measures to encourage business activity. The increase In public investment, particularlythe urgent rehabilitation of transport, is expected to be financed by improved tax collections,increased multilateral and bilateral assistance, proceeds from privadzation, and the elimination ofprior subsidies to state enterprises.

35. Flnancing Plan. The financing plan for the 1993-95 program reflects recentdevelopments in Peru's efforts to settle its arrears and secure new finaning. Under the plan, it isassumed that Peru would obtain: (1) rescheduling from Paris Club creditors on all pre-cutoffmaturities failing due during the three-year period; and (Hi) full debt relief from foreign commercialcreditors on most medium-and long-term debt and the stock of short-term debt that has been in arrearssince 1984. Peru would continue servicing debts to Latin American creditors and seek debt relieffrom them on terms comparable to those obtained from Paris Club creditors. Peru has resumedpayments to certain suppliers without official guaantee and is taking steps to solve specific claimsthat have arisen from the nationalizations of the previous administion. It is assumed that theGovernment will continue to service short-term trade credits.

36. The financing plan for the 1993-95 program shows a gap for 1993 of $410 million,which is expected to be secured. The Support Group of bilateral donors met in December 1992 andearly March 1993 and pledged $265 million for 1993. The remainder ($145 million) is expected tobe provided through concessional terms on Paris Club financing and/or additional commitments frombilateral donors.

37. Beyond 1993, the projections indicate a financing gap averaging$205 mullion annually in 1994-95. The gap could be lower if any variables proved to be morefavorable than assumed, for example, if Peru were able to secure new flows on more concessionalterms than in the past, or other exceptional treatment (e.g. debt reduction, and rescheduling or

10

deferral of moratorium interest under future Paris Club rescheduling), or if fister GDP growth wereto lead te higher government revenues.

38. Peru's public ecternal debt i expected to incse by 35 percent between 1994 and2000. The Government's ability to service its debt, however, is projected to incrase subst ly aseconomic reforms take hold and the economy improves, thereby loweing the projected ratio of debtservice to exports to 29 percent by 2000 from 48 percent in 1994 (see Table 1 on page 6).Debt/GDP and other debt indicators are also projected to improve in the second half of the decade.

39. Private sector development. Increasing the scope and size of private sector activity iscrucial for economic growth over the medium-term. The Government's agenda in this area includesseveral major elements: the privadzation of all its holdings by mid-1995, when the currentGovernment's term expires (an enormous task given the breadth of the public sector in the economyand its deteriorated situation); fiuther structural reforms to eliminate any remaining impediments toprivate business, competition and investment; and further reform of the financl sector anddevelopment of domestic capital markets.

40. The privaizaton program, backed by a strong poldii commitment and widespreadpublic support, is expected to have profound Implications for the consolidation of the economicreform program. A successful program wiUl give a major signal of the Govemment's priorities andthe fiture role of the private sector in the economy. It will lead to major efficiency gains,particularly in key sectors which have stagnated over the past decade, such as mining andhydrocarbons. Privatization could also provide additional resources to ameliorate the tension betweenthe short-term inflexibility of tax revenue and the demans for increased government expndie.

41. Pove alleviation. Alleviating poverty i a funid ntal objective In theGovernment's agenda. One fifth of Peru's households are extremely poor-their entire per capitaexpenditures are inadequate to purchase a basic food bakt. Ihey are fourd disproportionately In therural sierra, where half of all households are aetremely poor, especially among the Quechua andAymara, who account for 40 percent of the extremely poor although they make up only 16 percen ofall households. Ten percent of Lima!s households and 20 pect of those in the urban coast andsierra are also extremely poor. Incldling households who can purchase adequate food but not othercomplementary goods, over half of all Peruvians are poor.

42. The Government's stategy recognizes that poverty alleviation calls for revitalizationof the economy through stabilization'and liberalizaon, increased and more efficient social spending,and close coordination with community representatives. Under the strategy, targeted interventionswill concenate on the extremely poor, with the objective of reducing the incidence of extremepoverty from 21 percent to 15 perceni of houeholds by 1995. In health, the ste seeks toimprove the quality of primary health services in rural and margina urban as and to improvematera and child health. In education, it seek to inrease the efficiency and quality of primaryschooling in rural and marginal urban areas through the provisinw of school feeding, textbooks andteaching maeris, and to improve literacy and job skills among non-literate adults. In employment,the strategy emphasizes the generation of employment and inoome in rral and margnal urban areasthrough social infrstructure and production support projects. In food a nce, it aims at providingfood to vulerable rural and marginal urban groups to meet their mntritonal requirements. Thestrategy incorporates geographic targetng through the use of the exWn poverty map to identify

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areas with high concen ons of exureme poverty. It Inteseor coordination and relies oncontinued strong NGO pardcipation.

43. Infrstture RabIltdon. The abitation of Inastucture is a further itemon the Government's agenda. Infrasucue has suffered from a lack of mainten and failures Ineconomic policy. In the first phase of the reform progm, the Govermnont has focwed its eforts onliberalizing prices and entry as a sdmulus to expd and improve sevices. Competion has beenpromoted wherever feasible and restrictions on private invevent h bee diminated. 1u somesectors, notably urban transport, there has been a rapid supply response. In other sectors, particuarlywater, electricity and telecom unications, the Govenment has launched major eforts to privadze itsholdings as rapidly as possble to incree efficiecy and bring new management and investment intothe sectors. But, increased public invesent will also be crucial. Urgent rehabiitation ofdeteiorating transport Infrastructure is essentl. And dwsoges of deecicity and water in Limarequire new invesmens power generation and wate supply.

44. Rehabilitation of irrigatin works I also h r mgTed T agrculumre accounts forover half of the value-added in agrilture, and Irgatio projec hve absorbed 90 percent of publicinvestments in the sector. But, public projects have suffered frm poor management, inadequatemantenance and low cost recovery. hinit reforms have fod on tsfering the management ofirrigation works to local water user groups and esing adeqo water tarif. The next phase willstrengtn the insitutional and legal frmework and involve beficaries in the planning andoperaton and maintenace of existing and new Irigation work.

45. Ishtiutonal str. Pehap most crtcal development task over thelonger term is the rebuilding of Instutions throughout sociy. I agenda for institutionalstrengthenig has many dimensions. First, the recont congressiona and municipal elections areImportat sstep in broadening participation in the polhiW prce and ngpoliticalinstitutions. Ite Congress will draft a new Contitton, expectd to be completed by July 1993.Second, the Governent is strongly committd to defeatg teorism and eliminating the high sociaand economic cost that it has wrought on the country over t last decade. Third, throughlralization of rural property right and land tidig for small fames, the Govenment is seeking toimprove the economic prowspects for the nru population nd sregthen ther commitment to localInstidtions. Fourth, the Government intends to strengthen h role of local governents in theprovision of services. The reform of the oducational system is part of an effort to give localgovenments the capacity to manage the povision of primary d secondary oducato Fifth, theGovernment Intends to make the civil sarvice smaller ad more efficient.

46. A furither objective is the ntegn of the larw inform sector into the formaleconomy. It is expected tha recent legiative chages to eance fexibRiiq in labor markets andbusiness entry will help the absorpdon of the informal sector. Ths is expected to have severalbenefits, including improved tax collection, more effient producdon ad incteased competitivenessof domestic firms.

47. Possible Risks. It is expected tha the Govenmet will achieve the program targets,given the impressive results to date and its strong commitment to susin the stabilization andstructura reform program. However, the risks ae significat and other scenarios are possible, wherethe economy moves into a path of high ina and low gw Th insdutional weaknessesIncreae uncertaty and could delay the proes of adjustment one the reforms are enacted.

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48. Social, political and institutional risks pose the greatest threat to the program. First,long-standing social tensions could jeopardize the consensus necessary to sustain economic reform.Second, the current reforms are being implemented by a small group of persons who occupy keypositions in the government. Political instability increases the risk that they may not remain tocomplete the reforms. Third, the civil service, which had detariorated sharply in the 1980s as a resultof falling real wages and increasing budgetary constraints, may not have the capacity to carry out thenew functions of government under a privatized and liberalized economy. Weaknesses in localgovernment could also delay program implementation, given that the program depends in part upontheir strengthening.

49. The Government is continuing to take steps to reduce these risks. Its povertyalleviation strategy Is aimed at improving living conditions and opportunities for the poorest segmentof the population, thereby building social cohesion. Recent successes against terrorism, and theGovernment's strong commitment to eliminate it by 1995, have buoyed public morale and confidencein Peru's future. And the recent congressional and municipal elections, together with the expectedadoption of a new Constitution, should strengthen political stability and institutions. Over themedium-tem, these measures will be supplemented by a broader reform of the public service andstrengthening of local government institutions.

50. The macroeconomic program faces risks in both fiscal and monetary policy. On thefiscal side, pressures for increased government expenditures are widespread - for improvement andexpansion of public and social services, and for fighting terrorism and drug trafficking. Pressure mayalso build to bail out businesses and banks which are not successfully adjusting. At the same time,tax revenue remains low. Despite these pressures, the Government has maintained, and is committedto continuing a tight fiscal policy. Ihe introduction of cash-based budgeting, the elimination ofCentral Bank credit to the Treasury, and improvements in the tax base and tax administration have allcontributed to an improved fiscal position.

51. Ihe Government's flexibility is also limited in monetary policy, as a result ofdollarization. Pressures from exporters for accelerated depreciation could lead the Government toexpand the money supply beyond program targets in order to purchase foreign exchange, therebyfueling renewed inflation. However, the Government has followed a tight monetary policy and itspurchases of foreign exchange have been within program targets. The Government is committed tocontiuing this policy.

52. Given the importanct. of privatization in the reform program, delays in privatizationand the influx of foreign investment could also impede recovery and growth. However, this risk isdiminishing, particularly as the Government's track record on privadzation continues to strengthen.A dozen transactions have been completed in the last eight months and the Government has madeclear its commitment to accelerate the program and privatize all its holdings. Public support forprivatization remains strong. And the Government has also launched a promotional and informationcampaign both domestically and abroad. Ihe public will have to recognize, however, that even witha successful and rapid transfer of ownership of key public service SOEs (e.g. telecommunications,water), service improvements and expansion will require new investments and may only be felt overthe medium term.

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F. Bank' Assistance Stra: Obectives and Activities

53. Background. The Bank provided extensive assistance to Peru in the past, financingprojects in most major sectors. Outstanding Bank loans (net of cancellations) reached about $1.6billion by the mid-1980s. Approximately 90% of Bank lending was allocated in roughly equalproportions to three sectors: industry/energy, infrastructure, and agriculture; of the remainder, 7%was allocated to education and health. Following the moratorium in its debt service to the Bank,Peru's loans were placed on non-accrual status in August 1987. The number of active Bank projectsdecreased from ninetean in mid-1987 to five in 1990. The difficulty in maiaining these projectswithout Bank disbursements or supervision for more than four years, together with changes inGovernment priorities and the deteriorating security situation, led the Bank, in consultation with theGovernment, to cancel the undisbursed balances of the remaining five projects.

54. Since August 1990, when the Fujimori Government took office, the Bank has made anintensive effort to assist the Government in preparing and implementing its stabilization and structrareform program. The Bank has supported the Government's reform program through economic andsector work, technical assistance, and the three adjustment loans approved in FY92 (TPRL, SAL andFSAL). These loans were signed in December 1992 upon fulfillment of the required conditions. TheSAL and TPRL and the first tranche of the FSAL, were disbursed in March 1993, following arrearsclearance.

55. In all sectors, the Peruvian policy- and decision-makers have sought to benefit frominternational experience and adopt best practices. To assist them, the Bank has organized severalseminars attended by international experts to share their experience. To date, conferences have beenheld on privatization, dollarization of the economy, fisheries resource management, power sectorprivatization and regulation, and water sector privadzation. As well, the Bank organized a seminarfor the incoming Congress, attended by experts from several countries in the region, to exchangeviews and experience on macroeconomic adjustment and poverty alleviation.

56. To strengthen Government institutional capacity, the Bank has played a major role inmobilizing technical assistance. During FY91-93, the Bank mobilized approximately $10.5 millionequivalent through the Japanese Grant Facility and $1 million equivalent from Germany through theDeutsche Gesellschaft fuer Technische Zusammenarbeit (GIZ). These grants support economic andsector analysis, as well as preparation and implementation of reforms and projects in a number ofareas, including macroeconomic stabilization, the financial sector, privatization, the social sectors,transport, water and sanitation, irrigation, energy, urban development, and debt statitics andmanagement.

57. Key Bank Objectives. The Bank's country assistance strategy over the medium termhas been carefully tailored to support the Government's development agenda and strengthen thereform measures initiated over the last two and one-half years. The assistance strategy for Peru hasfour main objectives: (a) to sustain stabilization and consolidate structural reforms; (b) to fosterprivate sector development and public sector reform; (c) to alleviate poverty and promote humanresource development; and (d) to rehabilitate key infrastructure and reform related policies.Strengthening institutional capacity is fundamental to all four strategic objectives. These objectives,and the Bank's support through lending and economic and sector work, are discussed below.

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(a) Sutaanng Stabion and Consoladang Strcual ) orms

58. While the Govenment has made impressive progress since mid-1990 in stabilizadonand strucwtul reform, k must sustain its macroeconomic policies and deepen the policy and reguloryreforms to achieve economic recovery and sustained growth. The Bank wil support the Govesnmentin this process through tree mecnsm. First, the Bank's new adjustmen loans will contiue toinclude conditions linked to maintenance of a sadtaory macroeconomic program and financing pla.Under these operatons, the Bank will monitor key macroeconomic indicators, consistent with theIW program. The adjustment loans will also srpport firlher structra reforms, particulaly relatedto privatzation and dereguation. Second, the Bank's investment loans will include policycomponents to ensure that sectoral liberaization measures are maninWned and expanded, and that newlegal/regulatory regimes are enacted where necessary. Third, the Bans economic and sector work(ESW) will, inter alia, support consolidation of the macroeconomic reforms and identify and analyzepriorities for fiuther structural reforms. During FY92-93, the Bank has prepared formal and informalreports on various policy issues including economic stabliaon, labor markes, poverty, andagriculural policies. A Country Economic M ndum is also under preparation. The majorupcoming ESW tasks include: macroeconomic policy (fcusing on inflation, exal debt, and capitalmarkets), public administation, mining enviromnent, oil and gas development, basic health andnutiion, education, policy reforms in infrstrucure, and basic inhastructure services to the poor.

(1) Fotering Pdriate Sector Dewlopment and Public Sector Reform

59. Privatizaon forms a key element of the Government's program for private sectordevelopment and public sector refonr. The Governmenets privaizaton program is aimed atprivatzing all SOEs by mid-1995. Bank support has been provided primarily through technicaassistance (TA), finaced by a Japnese grant ($3 million equivalent, approved in August 1991). A$30 million Privatzatlon Technical Assistance Loan was approved on December 10, 1992 to financecontned TA for privaion and related regulatory reforms. As well, under the SAL the Bank hasagreed with the Govement on sectoral privatizaon strategies for banking, mining, hydrocarbons,telecommunications, sheries, war, industria, transport and electricity sectors. Imlementation ofthese stratei-es is being supported by several operations, including: (a) the Privatzatlon AdjustmentLoan (this operation), which will support privatization and regulatory reform in mining,hydrocarbons, telecommunicaions, water, fisheries and industry; (b) the Financial Sector AdjutmentLoan, which is supporting the prvatzaton of state-owned banks; (c) the proposed Power SectorPrivatzation Loan, which will support prvatizaon of the electric udlities and implementation of anew policy/regulatory framework for the sector; and (d) sector loans being prepared forwater/sewerage and tasport, which will include privatizaon cmponents. Rlated economic andsector work will focus on regulatory policies that govern natura monopolies, financi restrucurigrquiements and labor redundancy.

60. At the same time, the Bank will support the Government's efforts to reform publicsector policies that have restrcted private sector participation. Despite widespread recentdeguaion, there are sdtl a few lega and regulatory restrictions which maintain barriers to entry,undermine property rights, raise the cost of doing busins, and help account for a huge infrmalsector. To evaluate the impact of recent reforms and assess the exten of regulatory and legal reformstfll required, the Bank is undertaking a private sector assessment of Peru. Also, an ESW report hasjust been completed which assesses the legal aspects of compettion policies and makesrecommendations on fiuter reforms. This report wfll be discussed with the Govenment shordy. A

15

proposed second Structr Adjustment Loan is expected to support additional economy-widemeasures to enhance the enabling environment for business, competition, and private investment.

61. In parallel, the Bank will continue to support futher public sector reforms in energyand agriculture. In the energy sector, the Bank will focus on assisting the Government in establishinga well functoning regulatory framework and economically sound pricng policies, with maximumreliance on markets where competition is feasible. The Bank has been providing techp;al assistancefor development of a new Hydrocarbons Law and a new Electricity Law. Lending operations andeconomic and sector work will support the implementation of the new legal/reguatory regimes forthese key sectrs.

62. In agriculture, the Bank has supported the liberalization of agricultural land, productand rural financial markets tirough the adjustment loans approved in FY92. These reforms, whichhave redefined the role of Government and changed the legal framework, are expected to improveeconomic efficiency. Ihe Bank has also prepared a report on agricultural policies and discussed withthe Government an agenda for further policy reforms. Ihe Bank, through contined economic andsector work and new lending, wiUl assist the Govermment to prepare and implemeat these reforms.Priority areas include: (a) landlproperty reform: the elimination of remaining minimum limits on landsize and restrictions on property rights, and the creation of a rural property register; (b) rural finance:the selling or leasing of rural branches of the Agriculture Bank to private itnsttions, thestrngthening of supervision and regulation of rural financial instutions, and the provision ofassistance to margina farmers through targeted poverty alleviation programs rather than throughcredit; (c) water resource management/irrigation: strengthening the technical and financial capabilitiesof the new water users associations and river basin authorities; evaluating the feasibility ofetablishing a market for water rights or of proviling concessions for water use; and transferring theconstruction, management and agricultural development of the large public irrigation projects to theprvate sector; and (d) tecbnology and extension: defining an appropriate role for the state, andImplemening a strategy based on a mix of private and public involvement.

(c) Allevitng Povert d Promoting Hwnan Rsource Deveopme

63. The Bank has assisted the Government in formulating a two-part poverty alleviationstraegy. Under the first part, the Government is putting in place policies that encourage broad-basedeconomic growth. Ihe Bank has been supporting this part of the strategy through its adjustmentloans. The Government is also taking steps to mitigate any short-term impact that adjustmentmeasures might have on the poor. For example, with respect to the privatization of swie enterprisesthat are the major employer and provider of social services in certain communites, measures arebeing taken to secure the continued provision of essental services and to provide job remientation fordisplaced workers.

64. Under the second part, the Government wil seek to improve basic social services,especially primary education, basic health care, family planning and nutrition. The emphasis will beon improving living conditions and protecting the consumption and welfare levels of the poor untilgrowth occurs, and on ensuring that the poor are able to respond to employment oppornites arisingfrom economic growth. 'Te Bank has prepared a poverty assessment report which analyzes thechaacteristics of poverty and recommends priority programs for possible Bank and donor support.lbe report highighted three issues that must be considered in designing the programs. First, thepredominantiy rural nature of severe poverty, particularly among the Quechua and Aymara, calls for

16

appropriat strewgies to ensure basic social services in rural aes, including those related to cholerapreventio and care. Second, the lack of emphasis on programs to reach vulnerable groups least ableto captr new economic opportunities, such as lactating and pregnant women, young children, thehronkally M and the elderly, suggests the need to develop and adequaty fince well-targeted

interventions. TMird, the high level of resources now channlled into food assistnce programs callsfor imprvement In tageiDg and cot-effectiveness.

65. The Bank wil support the implementaion of the Government's poverty alleviationstrategy through project lending and firther ESW. Emphasis m Bank assistance will be placed on:reforming the provision of food assistance; developing a policy for decentralizing health andeducation; improving living standards information in order to improve targetag and the quality ofsocial spending; and invesdtg in the priority projects idendfied in health and education. The Bank'slending program for the social sectors includes projects for basic health and nutrkion, primary healthcare, basic education, and institutional development in the social sectors. As well, the Bank willassist FONCODES (the Social Development Fund) in local initiatives to improve social and physicalinfastructure and to provide direct assistance in health, food production and distibution, educationand sanitation. FONCODES fiances small projects with rapid implementation on a demand drivenbasis. Bank assistance will aim to Increase the impact in terms of employment generation and povertyallevation by improving project selection criteria and stengthening systems for management andspvision

(d) Rehabiitating Key Ihastruture and Refrming Related Pofides

66. The Bank's strategy for assisting the Goverment in has tbree elements:(a) preparing lending operations to help address immediate rehabilitaton needs in transport, water,municipal services and irrigation; (b) introducing immediate legal, policy and regulatory reforms toliberali prices and service and promote competition; and (c) developing longer-term strategies foreach sub-sector. I transpt, lending will intially focus on immediate measures to rehabilitate thedeteriorating transport infraucture, primarily highways, bridges, rail and airports. Particularemphasis wil be placed on providing low-cost replacement bridges damaged by terrorist acdvities. Inwater, the Bank is assisfing the Government, through technical assistance and adjustment operations,in establishing a new legal/regulatoy framework for the sector which will ensure improved resourceuse and access to safe water, while promoting private investment. In parallel, the Bank is assistdie Govement in preparing and implementhig the privataon and rehabilitation of the Limawaterlsewerage newo l municipal servlce, the Bank will help the Govermment assess and solvebodh pricing and institltional bottlenecks, and encourage sustainble municipal development projectsthat are self-financing and have cost-recovery mechanisms. These projects wil use labor-intensiveconstuction to support the Govment's employment generation program and allevia poverty. Inirriton, the Bank wil assist the Government in rebabilitation, strengthening the legal andinstutional famework establishing a water market, and improving the efficiency of water resourcemanagement through greater participation of user organzations.

67. Areas of Spial Operational Emphasis. Two of the Bank's areas of specialoperatilemphs are explicitly highligted in the country assistance sLategy for Peru, namelypo i alleion and private sector development. The Bank has assisted the Govemnent In thedevelpnt of its poverty alleviaton strategy and is now helping to implement it through anartiuaed program of lending and ESW, primaily in health, nutrton, education and commmutyprojects. Povety alleviation measures are also incoporated in all operations to Improve livingcondtons and help the poor respond to employment opportunities. Similarly, the Bank has placedspecl emphasis in its assistance strategy in promoting private sector development and privatization inPem Given the virta collpse of the public sector in the late 1980s and the imporane of targetingscarce budget resources to poverty alleviation and the provision of basic social services, privatizatkand the growth of private investment are crucial to economic recovery and growth.

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68. In environment, lending and ESW will address two growing environmental concerns:(a) natural resource management; and (b) mining pollution. First, the Bank wiUl undertake a series ofstudies over the next three years to provide an analytical, legislative and institutional basis foraddressing the problems of water and soils management, degradation and deforestation. These studieswill help the Government create a policy framework for proper resource use and develop action plansto address priority problems. The Bank will also continue to support the implementation of aNadonal Parks project, which will be financed under the Global Environmental Facility (GEF).Second, the Bank will evaluate the magnitude of mining pollution in economic and technical terms (inboth private firms and state-owned enterprises to be privatized) and recommend ways of establishingand enforcing appropriate technical standards. A lending operation is also being prepared to helpfinance the cleanup of environmental damage from public sector mining operations.

69. The emphasis in the country assistance strategy on human resource development andpoverty alleviation is also expected to have a major impact on women in development. Indeed, theInitial focus of lending in the social sectors will be on the provision of basic health and nutritionservices to vulnerable mothers and children in rural or marginal urban areas. It will seek tostrengthen four services: (a) pre-natal care and delivery; (b) child nutrition promotion andsupplementation; (c) treatment of diarrhea, acute respiratory illnesses and tuberculosis; and (d) familyplanning. Follow-up projects in primary health care, basic education, nutrtion, and the SocialDevelopment Fund wiil also help improve living conditions and opportunities for women.

70. Lending Levels and Composition. Bank lending to Peru is forecast at $400 millionin FY93 and $500 million annually for FY94-96. These levels assume maintenance of a satisfactorymacroeconomic program and financing plan. The lending program will have a major focus onprivatzation, basic infrastructure and the social sectors. This pro" Am includes three adjustmentoperations (the Privatization Adjustment Loan, the Power Sector Frivatization Loan, and the SAL 11),two technical assistance loans (the Privatization Technical Assistance Loan and the Energy andMining Technical Assistance Loan), and investment loans for inlfastructure rehabilitation (transport,water, irrigation), health and nutrition, social development fund, primary education, municipaldevelopment, and mining environment.

71. During FY93-94, about half of the lending volume would be devoted to adjustmentlending. By FY95, lending would comprise only investment operations. About two-thirds of theFY93-96 lending would aim to increase the access of the poor to basic social services and improvethe institutional capacity to provide social and economic infistructure (of which one-Wthird woulddirectly alleviate poverty), with the remainder to foster private sector development. In general, as thefocus of the lending program moves from adjustment to investment operations, continuedimnprovements in the Government's implementation capacity, as well as the security situation, will bevital to expand lending.

72. The lending program will be adjusted, if necessary, dependhig upon the Government'gprogress in implementing the reform program. To ensure that the lending program reflects overallprogress, we will monitor closely the implementation of the program vis-a-vis the program objectivesand targets. In assessing the success of the GovernmeWt's program, we wiUl focus on the following:(a) achievement of the macroeconomic program targets (GDP, inflation, fiscal deficit, etc); (b)maintenance and deepening of key structural reforms (e.g. trade, price, exchange rate and interest rateliberalization; labor and financial market reforms; land reform); (c) progress in achieving otherprogram targets, particularly those related to poverty alleviation, privatization and improvement ofbasic services; (d) increased political and social stability; and (e) strengthening of governmentinsttional capacity to carry out the reforms.

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73. Actual leng lovels will dpend on the above factors. hnadequa progress onmaroeconomic policy and/or a revesal of structr reforms w tiger a subs rdction inthe lending program, pedrps a halt f conditons deteriorate signifcanfly. As well, to re thatBank diabursements on ngoin operadons can be modied to rect changes In the progress of theoveral reform program, al adjustment operadons will condue to incude conditions linked tomaintenance of a satisctory mc program and financig pla In assnssingmacoeconomic performae, the Bank will monitor indicators consistent wih the IDF ptogrmFurther stuctr reforms will be Incorpoted in adjusme and investment operation, asappropriate

74. Isues for Bank Asistane Strategy. Rebuilding instuona capacty wiin theGoveranment is crucial to successful Implementaion of the proposed assistance sura. In the short-term, the Bank is helping to strghen government capacity through technical assistance andorganizing seminars and confaences to excage best practices. At the same tme, insitionalstrengthening is a key component of al Bank operadons to ensure sustainability.

75. Given the five-year hiatus in Bank lending for Peru, there is a need to familiarizecounerpart staff with Bank operatg procedures. We are planning project launch workswps andsemmars to train project officials in Bank procurement, disburement and auditing requrements.

76. The Bank is consdeng setting up a locally-staffed representa office in Lima, andeventually expanig this into a full Residen Mlission, provided there are continued impovements inthe securty suation. In view of the expanding assistance progm, a Residen Mission is importantfor the Bank to support effectively Per's economic development in the medium and the long term.

77. Bank Exposu. Under the proposed lending program, which assumes sustainedstabilizado and stuctural reform, Bank eposure is expected to increase from $1.6 billionto $2.2bfflion between 1994 and 2000. However, aUl exposur ratios are epWeced to remin witin Banknorms during this period (see Table l). In 1999, debt service to prerraed creditors is exected toreach 34.7 percent of toa public debt service, after gradually rising thoghu the decade. Theincrease Is due largely to the substa disbu from prefrred creditors expected in 1992 and1993. The other debt indic also remain within Bank norms trough 2000. Debt service to theBRD, as a percentage of total public debt service, is expected to increase fiom 6.8 percent in 1994 to9.8 percet by 2000. At the same time, debt seri to the MRD, as a percentage of exports, isexpected to decrease from 3.0 percen in 1994 to 2.6 percent in 2000.

78. Ihe program is highly conditioned on sustned progress by the Government inimplemeing its refom program. Iadequate macroeconomic progress or mjor policy reversalscould lead to a substan y reduced leading program, with correspondingy less exposure, but higherrisk for the Bank.

G. IFC/1GA Oasadm

79. Since beginning operations in Peru in the 1960s, IFC has approved 24 invesmen.Mining has been the most important sector. Although the IFC processed an aveage of two projectsannally prior oD FY86, only two new projects were processed between FY86 and FY92 due to thepoor investment cimate and macroeconomic policies, as wel as the arrears siuation wih the BaiLIn 1990, the IFC partcipated in the capital increase of Compafia de Minas Buaenura S.A. In1992, it approved an equity inesme and credit line for Sogewlese Leasing. At end-Febrary1993, IFC held an aggrega of $9.36 mlioninoutstanding loans. It held an addtional S3.7 mllionin equity invem ts in seven compaies. Total exposure (outtandig investments plus undisbrsedCO _mmt ) rerents about 0.2 percent of IFC total portoli. Currently, IFC is rtiewingprvadzaon prposas. During FY93, it expects to approve three projects in and

19

minig, Increasing its exposure by toughly $40 million. Over the next few years, the IFC willcontnue Its involvement in mining in view of Peru's comparative advantage, but will also explorepossible lending and investments in infrastructur, general manufcturing, capital market, andagribusiness.

80. Peru completed its MIGA membership requirments on Dcmber 2, 1991. MIGAhas not yet issued any guarantees there, but has received 5 applications.

H. Relations with Qle lulta InZi_sndillDn

81. OMf Coordinadon. During the debt workout, the Bank and the I1 worked closelytogether to assist Peru in preparing and implementing the Government's stabilization and structulreform program. Arrears have now been cleared with both IFI, and a macroeconomic program andfinancing plan for 1993-95 Is now in place, to be supported by this operation and the IM's EFF.Ihe Bank and the JM will continue to cooperate closely in supporting Peru's reform program andsecuring 0Xex al financing.

82. 1 DB Coordinaton. The Bank will continue close coordinton with the IDB on policyreforms and project design. During PY91-93, the Bank and the IIB worked together to prepare theirrespective adjustment operations for trade reform .nd financl sector reform. Ihe two insttionshave also agreed on a program of collaboration in the transportion and power sectors. Ihe Bankwill continue to stay abreast of the IDB's work program, and cafry out joint preparations asnecessary.

83. Ihe IDB's assistance strategy in Peru focuses on supporting the consolidation ofstablization and structural reforms and promoting edium- and long-term development. It

e sizes: (a) instutional strengthening and preinvestment support; (b) privatizaon and privatesector development; (c) poverty alleviation and social development; and (d) basic infrastructurerehabilition. Tne IIDB plans to implement the strategy through a combination of tehnicalasistance, quick-disbursing sector loans, and invetm loans. Given Peru's critical social sitatioDn,high priority will be placed on projects in health and nutrition, education, water aad sanitation andother povety-reduction efforts. The MDB is currently preparing a lending program for 1993-94encompassing projects in health, water and sanitation, electricity, agriculture, and small-scaleentprises. The other possible projects include: education, housing and urban development, andrigadon.

84. Aid Coordhnton. Ihe Bank will assume a leading role in aid coordination. Giventhe magnitude of Peru's resource needs, cofinancing with concesslonal loans and grants is beingsought from bilateral donors. Ihe Bank plans to organize a Consultaive Group meeting for Peru inmid-1993. The meeting would discuss the Govemens economic program, poverty alleviationstrategy, and the profiles of priority social projects.

85. The Bank will continue working closely with bilateral donors to ensure the successfulimplementation of the Governmene's medium-term economic and structural reform program.

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86. SOEs In the Economy. Given the virtual collapse of the public sector, includingstatowned enteprises, In the late 1980s, the Govrment's prvadztizon program is essental foreconomic recovry and private investment. During the 1980s, SOEs accounted for roughly 15percen of GDP, 30 prcen of merchandise exports and 7 percent of employm In the non-agricultural formal sector. The number of -OBs increased from 29 in 1968 to 177 by 1990, as theresult of nationalistic policies aimed at increasing the sae's operations, precluding foreip invstMIn stegic sectors, and generating suplus funds to finance developmenL Seventy-six firms wereacquired through nationalization; many operat in key sectors and were profitable beforenadonalizadon. Consequently, SOEs became dominant In many sectorS, including: oil/gas (Petoperuand its subsidiarmi); mining (Centromin, Hierro Peru and Minero Peru); electricity (Electrolima,Eletoperu and the regional utlities); telecimmunications (the Government holds 21 percent of Lima-based CPT and 100 percent of Entel, whicd operates outside Lima); and water. The Governen alsohas major holdings in banking and manuactuing (steel, pulp/paper, chemicals). Aggregae SOEassets total roughly $8.5 billion (year-end 1991 book value).

87. SOE Performance. The fmanci peromce of the SOE sector has genrally beenpoor, and worsened during the lat haf of the 1980s due to Peru's economic turmoil and theconsequent difficulty of most SOEs in meetg their fnacing needs. Continued use of public sectorprices by the previous govermment to contain inflationary pressure led to a sharp fall in the sector'srevenues from an average of over 25 percent of GDP in 1980-85 to less than 11 percent in 1989-90.Until 1990, the wage bill continued to increase as a proporon of expenditures due to faster wageadjusments and increased employment; employment in the sector doubled to roughly 150,000 duringthe 1980s. These developments reduced the sector's cureat account savings from 2.3 percent ofGDP in 1985 to 0.2 percent of GDP in 1990. Lack of inter funds and ernmal financng in tumrncaused a sharp reduction in maintenance and investment expenditures - SOE investmt as aproportion of GDP fell from 4.3 percein L 1981-85 to 1.8 percent in 1986-89 and tO less than1 percent in 1990. Most SOEs were operating at a loss by 1989, when aggregate net losses totalled$531 million equivalent Net losses were $174 million in 1990, reflect sharp price increasesImplemented by the new Govenment in August 1990 in key public services. Total SOE debt is $5.2billion, including $3.1 billion in domestic liabilities and $2.1 billion in extral debt.

88. Privatzaton Framework. In mid-1991, the Government expanded its structuralreform program to include privatzaion, with the objective of privadzing all SOEs by mid-1995 whenits term expires. A legislative decree (#674) was passed in Sepmber 1991, establig the broadlegal and insiuonal famework for privatiation. Ihe decree set up an inter-ministerial commson(COPRI), under the direct supervision of the President, to oversee the pdvatzton program. Thetechnical preparatory work is to be canried out in a decentaized manner by special comm_ts whichare designated by COPRI for either one or a group of SOEs. Decree 674 authorizes a wide range ofprvatzation methods (e.g. sae of shares, increase in share capital, sale of assets) and also establisheda revolving Privatiaton Fund (FOPRI) which would be allocated two percent of the privatizonproceeds to finance privatization-related expenses. COPRI would determine the Fund's utlzation.

89. Progam Status. A small technical secetriat to support COPRI was established inFebruary 1992. As well, more than 30 speci committees were appointed during 1992 to prepareand implement idividual privatizations. The speci committs report reguary to COPRI.Ptivatation plans prepared by the speial commitees have been approved by COPRI for rou.bly 20SOEs. From May 1992 to end-February 1993, twelve pdvatizions were completed, yielding $260million in cash proceeds, including the iron ore company (Hierro Peru) which was sold on November8,1992 for $120 million In cash (plus $150 million in investmt commiments), and the ntonalaidin (Aeropern), which was sold on Jamny 16, 1993 for $54 mfllionl Other privatzations haveincluded holdings in mining (inera Condestae, Minpoo, Quelaveco), banking (Banco de

21

Comer:io), chemicals (Quimpac, Reynasa), ship repair (Inasa), urban transport (452 buses of theLima bus company), and hydrocarbons (Solgas and 78 of Petroperu's 82 gas stadons).

DEL Th2 Rd= Pgm to be SoRted hi the Pr_vtaon Adjustmt oan

90. The reform program to be supported by the proposed three-tranche loan includes threemajor components: (a) maitenance of a satsfactory macroeconomic program and fnancing plan; (b)implementation of policy, legai and regulatory reforms in key sectors to promote economic efficiency,competition and private investment and to faciitate privatization; and (c) implementation of theGovnent's privatizaon progrm, focussing on mining, hydrocarbons, and telecommunications,and selected holdings in fisheries, industry, air/urban transport and the water sector. Outlined belowis a description of the reforms to be supported by the Loan in these areas, as well as a description ofthe fiscal impact, social impact and environment aspects of the program.

A. Maaoeeonomic Proarm and Fmnaning lPlan

91. Economic recovery, growth in private investment, as well as the success of theprivatization program wil depend upon the Government sustaining its macroeconomic policies andstrural reform program. As noted earlier, the Government has reached agreement with the Bankand the IMP on the macroeconomic program and extal financing plan for 1993-95, to be supportedby this operation and a three-year Fund EFF. Under this operaton, maintenance of amawen nomle poicy framework and a frandng pla consstent with the objecves of thereform program is a condition of effectiveness, second and third tranche release. In aseingmacroeconomic peformance during the period of this operation, the Bank wvll monitor key indicatorsconsistent with the IMF program.

92. In addition to sustaing sound macroeconomic management, the Government iscommited to maintning and deepening complemenry structral reforms implemented over the last24 months, aimed at deagulating/lerizing the economy and promoting competition. Thesemeasures pertain to, inter alia: price, trade and exchange rate libealization; eimination of entry/exitrestrictions and monopoly rights of state-owned companies; financial sector reform/liberalization; andthe broadening of provisions in the labor laws for layoffs. Ibe Govermen's commitment tomaiting and deepening its struct reforms is included in the Policy Letter for this operation(Annex I[l). Adherence to these commitments will be monitored as part of the Bank's generalreview, prior to second and third tranche release, of overall progress in implementing the refotmprogram set out in the Policy Letter (see para 127).

B. Seoral Pogk. Jal and RggWaIgtor!rormi

93. In addmion to ecnomy-wide measures, the Govenmet is implementng new enabliwlegislation in virtly all sectors to foster compeion, privawe ivestme and relianc on marketforces. Even in traditionally monopolistc sectors (e.g. electricity, telecommuicatins), thelega/regulatory fameworks are being designed to promote competition, or at a minimumoestability, and to put in place streamlined regulatory amangements in order to avoid regulatory

burden and to ensure greater reliance on marketbased ientives.

94. This operation will focus on sectoral policy, legal and regulatory reforms inhydrocabons, mining, elecommunications, fisheries and water. These sectors have been targeted forpriority aention for two reasons: 'a) regulatory reforms in these sectors are needed prior to, or inparallel with, priafzaton, not only to filcitae prinvazion, but also to maxmize economicefficiency; and 0) SOEs in these sectors dominae the Goverments privatization agenda and accountfor rougly 60 per cent of total SOE assets (excluding electricity SOEs, which will be covered by a

22

separate Power Sector Privatization Loan). In Peru's program, all privatizations will be preceded bya thorough analysis of the structural options (where relevant) to ensure that alternatives for Increasingcompetition and contestabiity have been fully examined. Key sectoral measures taken to date, andthe additional reforms to be supported by the Loan, are summarized below (see annex IV foradditional details).

95. Hydrocarbons. Despite its potential, Peru's hydrocarbons sector - which accounts forabout five per cent of GDP - declined sharply during the 1980s. Domestic productiop dropped from195,000 barrels per day (bpd) in 1982 to 1 10,000 bpd in 1992, and the country shifted from being apetroleum exporter to a net importer ($186 million in 1991). Known reserves dropped by 50 per centfrom 1982 (their peak level) to 1989 (300 million barrels - enough for less than nine years ofconsumption at current levels), as investments in exploration and development also declined sharply.Many of the problems stemmed from the heavily controlled policy environment and the monopolyposition held by Petroperu on virtualy all upstream and downstream activities.

96. The Government's objectives are to deregulate the sector, encourage competition andprivate investment, and privatize Petroperu and its subsidiaries. This will require a series of legal,policy, regulatory and tax reforms, given that the prior regime reflected Petroperu's monopolyposition in upstream/downstream markets and its role as fiscal agent for the Government in collectingpetroleum product taxes. Several transitional measures have been implemented, though fillderegulation and competition can only be achieved through the enactment of a new hydrocarbons law(under preparation), implementation of a new contractual framework for private firms to carry outexploration and production, and the privatization of Petroperu.

97. The transitional measures taken to date include: (a) issuance of a decree in 1991eliminating Petroperu's monopoly on downstream activities (importing, refining, storage,transportation, distribution) and modifying procedures to facilitate contracting out, to the privatesector, of upstream activities (exploration and production); (b) increase in domestic petroleum productprices by 3000 per cent in August 1990; retail prices for 84 octane gasoline are roughly $2/gallon,though the bulk of this reflects special taxes; ex-refinery prices net of taxes are actually slightly belowinternational levels (roughly 17 per cent on average at end-1992) for most products; and (c) issuanceof a decree in June 1992 formaly deregulating petroleum product prices; however, the Governmenthas mainained de facto control over Petroperu's prices, pending the implementation of the new legalfamework for the sector which will redefine Petroperu's relationship with the Government.

98. While the measures taken to date are aimed at deregulation/liberalization, a new legalframework for the sector is required to complete and implement the sectoral reforms. A draft of anew hydrocarbons law has been prepared, which would fiully liberalize the sector, transfer thepolicy/regulatory functions from Petroperu to the Government (e.g. the granting of concessions toprivate companies for oil exploration and production), and establish new legal/contrctalarangements between the Government and petroleum companies. Within the new legal framework,Petroperu's relations with the Government would be on a filly commercial basis (identical to privatefirms), while it is being privatized. Prices would be filly liberalized. Royalties and concession feesfor exploration and production would be established on an identical basis for private petroleumcompanies and Petroperm. Simiarly, the existing special consumption taxes on petroleum products(curnty collected from Petroperu) would be progressively replaced by excise taxes and a value-added tax applied to aUl downsam products (consistent with the economy-wide VAT). These taxreforms are necessary in a deregulated/competitive market and would bring petroleum producttaxation in line with the overaU tax system, while maintaining fiscal revenues from petroleumproducts during the maonomic adjustment period.

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99. Given the importance of this new legal framework and tax regime for deregulaon,competition and private investment in the hydrocarbons sector, submission to Congress of a draftlaw on hydrocarbons and a draft law establishing the tax regme for petroleum products, andpreparation of draft regulation for these laws 18 a condition of second tranche release.Enactment of the hydrocarbons law and legislation establishing the tax regime for petroleumproducts, and Issuance of the regulations for these laws b a condition of third tanche release.(Note: this condition has been partially fulfilled, with the enactment in December 1992 of legislationestablishing the new tax regime for petroleum products.)

100. The Policy Letter for this operation (Annex HI) sets out the Government's proposedseries of legal, policy, regulatory and tax reforms for the hydrocarbons sector. In addition to thespecific tranche release conditions pertaining to enactment of the laws and regulations, the Bank willmonitor the implementation of other reforms in this sector as part of its general review, prior tosecond and third tranche release, of overall progress in implemening the reform program set out inthe Policy Letter.

101. Mining. The new Government has enacted a series of measures to deregulate mining(which accounts for 5 per cent of GDP and 45 per cent of merchandise exports) and open the sectorto private investment. These measures include: (a) issuance of a decree in July 1991 authorizingmajority private sector ownership of the major government holdings (Centromin, Hierro Peru andMinero Peru); (b) enactment in November 1991 of a new Mining Law (Decree Law 708) which:establishes transparent mles for granting concessions for exploration and exploitation of minerals andmetals; ensures minig companies the right to remit profits, free access to foreign exchange and theright to freely market their production, both abroad and locally; (c) release, for private sectorexploration, of more than two million hectares of land previously reserved for the state companies;and (d) initiation of the reorganization and streamlining of the sector agencies to facilitate grantingconcessions for private exploration/development Regulations for the law have been drafted and willbe issued in 1993. Issuance of regulations for the Mining Law is a condition of second trancherelease.

102. The private sector's response to these refms has been encuraging. Four state-owned holdings have already been privatized, all to foreign investors. Two of these privatizaons(Hierro Peru, the iron ore company, and Quellaveco, an undeveloped ming property) includecommitments by the new owners to invest more than $700 million for fit=re development/expansion.The largest international mining company currently operating in Peru has also commenced a majorexpansion program.

103. Telecommunications: Telecomnmnications service in Peru is very undeveloped. Peruhas only 2.6 lines per hundred population (compared to 10.2 in Argentina and 8.2 in Venezuela).The lack of service reflects several factors: prior legal restrictions on private and foreign investment;erosion of real tariffs from 1980-90; and the sector organization and revenue-sharing arrangementsbetween Entel and CPT (the Lima-based company) which inhibited competition and efficiency. Toaddress these problems, the new Govenment hntroduced a number of reforms. Telephone rates wereincreased by 1000 percent in August 1990 and have been periodically adjusted since then. Revenueper subscriber line is currently estited at $600 annually, which compares favorably with othercountries in the region. In November 1991, a new Telecommunications Law was enacted whicheliminated prior restrictions on private sector participation and Entel's monopoly on long distanceservice. The Law sets out a broad policy and legal framework to liberalize the sector and promotecompetition and private (including foreign) investment The Law also streamlines the exisingregulatory agency, consistent with liberalization of the sector. Draft regulions are currently beingprepared for the Telecommunications Law.

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104. Fuher reform are necessary to Improve and implement the new regime. Revisiosto the curren service and reenue aing arragements between Ene and CPT are required toensure consistcy with th sector's liberalization, and to flitate privaization of the Govenmensholdings. Rebalancing of the tariff structure is also required to reduce intaonal ras to economiclevels, while Increasing local residential rates. The special committee for privatization of theGovmen tecommunicaons holdings was appoiied in mid-1992. International consultingfims were hired in late 1992 and are cumently preparing the technical analyses and biddingdocumens. MTe iial phase of the thnical work involves assessing structural options forcompetition and privazaion and modifying the tariff structure. As a condition for second randerelease, the Government will prepare a new competition regime, tariff stsucture andprivatiz on Plan for th eilecommuication sector. As a condidon of third tranche release,the Government will Implement the competition regime, tariff structre and privatization plan,and issue regulations for the Telecommunications Law with respect to: (a) the operation of thenew regulatory agency; (b) the major classes of service; (c) the process and methodology forsettg tarffs; and (d) the process for granting of concessions.

105. Fisheries. Fisheries is a key sector, contributing roughy $500 million aually inexport eaning (15 per cent of total Peruvin exports), virtualy all in fishmeal and fish-oil. Anchvand sardines account for 90 per cent of fishmeal and fish-oil production. Apart from the problem ofinefficiency in Pescaperu (the state-owned fish processing company), there is also a serious over-fishing problem in anchovy and sadines. To ensure biological sustainability as weil as to helpopmize economic benefts for the country, the Govenment is takling steps to put in place a newfisheries resource management regime. An inational conference was held in mid-1992 toexchange views on other countries' experience and to provide a basis for developing a new legal andregulatoy frawork for the sector in Peru. Following this conference, a govemenl task forceprepared a new fisheries law. The operational details of a new fisheries management resoarce regimeire also being worked out, with the advice of internatonal fisheries experts. The regime will be setout in regulations to the new fisheries law. Submission to Congress of a draft fisheries law andpreparation of draft regulations establshing the fisheries resource management regime Is acondition of second trnche relase. Enactment of the risheries law and issuance of thereglatons establishing the fisheries resource management reglme Is a condition of Utird trancuerela. (Note: this condition has been partally fulfilled with the enactment in December 1992 of thenew fisheries law).

106. Water. The water sector, partcularly in Lima, has serious problems, includingshortages (here is currendy rationing), indequate access to clean water (over 30 per cent of Umaresidents are not connected to the disbuon system), poor water quality, with reated healthproblems (e.g. cholera), and inadequate access to safe saitation (only 50 per cent of Lima residenhave access to safe saniadon). The Government Is implementing a number of reforms: (a) rates wereincreased 100 per cent in August 1990 and were periodicaly adjusted until mid-l99, tough havedeclined in re tems since; (b) a special privatization committee was appointed in May 1992 forprvatzing the Lima company (Sedapal). This committe is currently contracting internationalconsultants to assist with the priv on and (c) a new water sector law and water resourcesmanagement regime are being developed to ensure adeque water quality and access to service, andto fbster private sector participation. his wil also entail the establishment of an autonomousrgulatory agy for te sector. Submission to Congress of a draft water sector law andprpaton of draft reqgltons for this law is a condition of second trche reles Enactmentof the wat sector law, iuance of the regulations, and establishment of the reuoy genyfor the sector is a dilion of third tranche rels

107. The Bank has been prvidig technical assistance for water sector reform andprivatizato of Sedapal trough a Japanese grnt for the water sector ($600,000 equivalent) and ispreparg a separate Lima Watetization Project to asist with the needed inv_emes in the

25

Lima water/sewerage networlc The legal and reglatory rdfoms being Implemented under thePdvazation Adjustme Loan will lay the basis for successful implem of the proposed LUmawster projecL

C. JmpDedgltihgJ lmjizatm gdn

108. The Govenmen Is committed to privazing al lts holdings by mid-l995 when Itsterm expires. Special commtees were appointed in 1992 to prepare and implement more than 30priatizatlons, Inuluding all the major state entprises. Twelve privazations have been completedsince May 1992, yielding $260 million in cash proceeds, and several additional holdings are slated forsale in the next few months, including: the petroleum shipping company (Petrolera Transoceanica),the remaninig Petroperu gas stations, two industrial companies (Cementos iAma, Bayer IndustrW), arice tading company (Ecasa), and the remaining ships of the shipping company (CPV).

109. Over the next two years, the Government expects to privatize its larger, morecomplex holdings, including the remaimng mining SOEs (Centromin and Minero Peru, which wiL beprivatized in several units), the telecom holdings (Entel and CPT), the oil company (Petroperu), themajor fish processing company (Pescaperu), the major electricity SOEs (Electrolima, Electrpero), theLima water company (EDAPAL), the steel company (Siderperu), the pulp and paper company(Paramonga), and the remaining state-owned banks (Continental, lnterbanc, lipotecario, Banco SurMedio y Callao, Banco Nor-Peru, Banco Amazonico, and Banco de los Andes). Special privatizationcommie have been appointed for all these holdings and technical preparatory work is wellunderway. These privatizations ae expected to require a longer preparatory period to address policyand regulatory issues and/or sensitive labor and political issues.

110. This operation wEil support the implemention of prvtizaion in mining,hydrocarbo, and telecommunications, as well as selected holdings in alr/urban transport, industry,fisheries and water (where privatization initiatives are already undeway). Ihi agenda includes 25SOEs with total assets of $ 4.135 billon (1991 book value). Two-thirds of this total ($2.779billion) are in minng (28% - $1,182 million), hydrocarbons (22% - $908 milion) andtelecmmunications (17% - $689 million), and six companies in these three sectors (Cenromin,Hierro Peru, Minero Peru, Petroperu, Entel, CPT) account for vitualy al of this amount ($2.622billion or 63% of the total agenda under this operation). Other major companies on the agendainclude Siderper (steel), Paramonga (pulp/paper), Pescaperm (fish processing), Aeroper (nationalairline), and Sedapat (Lima water). The privation agenda of SOE companies (and their 1991 assetvalues) to be covered under this operation were agreed during loan negotations. Excluding theelectricity SOEs (which together account for an additional $4 billion in assets and are being coveredunder a separate power sector operation), these holdings account for more than 90 per cent of all SOEassets.

111. In the case of hydrocarbons, the privadzation of Petopeu has commenced withselected downstream actdvities (gas stations, liquified gas distrtion petroleum shipping). TheGovermet is committed to privazing all of Petroperu by end-1994. Given the size and complexityof Peoper's remaning upstream and downstream operations, COPM2 has recently hired externalcOnultan to assess in greater detail the structr opdons (i.e. how to break it up) and sequencingfor the privatization of Petrperu, consistent with the overall timetable to have the company fullyprivatized by end-1994. Ihis study will be finalized by mid-1993 and prvide the basis for preparinga detaed implementaton plan for privatization of Petroperu.

112. The proposed tranche release condtions are structured to reflect the privatizaonagenda and expected phasing of the program, while ensuring sustined commiment and progress inprivaFzaion of companies in the economically important sectors of minig, hydrcarons, andtelecommunications. Given that the Government has started with smaller holdings and will move to

26

larger, More complex prvaizios, the tanches have progreivdy hlgher (cumulative) target.Rather than specifying ndividual companies, the tanche condios ae based n the toal amount ofassets being offred for sale and pivaized from the agreed agenda. Ibis reflects two bct: (a) inmany cases (e.g. mining, petroleum), the companies wl be broken up into several units and sold byunlt and (b) it is difficulit to frecast te precise tming e oprivaon of specficcompanies, as etnal ftors beyond govemens control may hamper act sales.

113. Based on these principles, the conditdons of send trane readse are (a) offer forsale of at leas $450 mlon In assets from heb prlvat on ageda, with a minimum of $275miDlion In assets from two of the th" sectors of mni oga byd, andteleconmuniationsIV; and (b) preparaton of an Implemeti plan and timetable for theprivatizton o Petroperu. On the basis of the implenton plan fo Petoperu, the Bank and theGovenment will agree on the assets of Petpero to be offered fo sale by third tranche. Mmecondidon of third tranche relase Is: offer for sale of at least $1,2 milion (cumulative) Inassets from the privatization sgda, with: (a) a minmm of $300 mlon in assets of companiesfrom mgh of the minig and tlecemmuniatons sectos; and (b) assets fhrm Petroper. Inaccordance with the agreed Implemenion plan and timetabli

114. Acmievement of the tache condition (i.e. *offered for salea) will require completionof the techical studies, Isanc of the bidding docmens, and carying out the public bWdingprocess for sale of the assets or shares. The third tranhe target represens rouhy 30 per cent oftotal assets on the agenda. Based on inrnationa pdvatzation exeience, this is an ambitious target

115. As the primary objective of the Loa is to complete the privaizatin of SOEs (not justoffering for sale), the Loan wil also include, as a condition of the thd tranche release, the transferto the private sector of at least $600 millon in assets included In the privatzation agenda. hecondition, as proposed, does not require the sale of any speific company, and t oe wil notinfluence the biddng process nor force the Govenment to rush or accept hipproprate trnactions.It does recognize, however, tha unless a signficant proporton of the companies offered for sale aresubsequendy sold, the program wfll lose credibility and hence susainabity.

116. For putposes of assessing the Government's progress vis-a-vu th tranche rleasetargets, asset value will be measured in terms of the 191 book value of total assets (on a revauedbasis) for companies on the agreed agenda that are privaized or liqiated Where a cmpany isprivized in segments, only those segments of the compas tal assets will be counted towards the

etandie release targets. Ihese figures do not necearily reflect the maet vae, nor expected salesprice. However, as neither the valuations, nor sales (or base) prices are nown at this time, theyprovide the only available benhmak for purposes of establishing tache release tagets. Moreover,the figures reflect, to some degree, the historical impoance of the paricular SOEs. Onlyprlvatzations of companies on the aged agenda will be counted towads the tranche release targets.

117. To ensure trsparency and conistancy in the impleme process, COPRI hasissued ope al guidles to all specia pdvazaon s, settDg out the process to befollowed by the com_m concernig: public anno of compaies or assets to beprivatzed; suane of preiminary and final bidding documents; communicaton with interestedbidders; valuation and prcin,g (including the proes for setting ad announcing the base price);public bidding; employee paricipation; and the use of consultants. In the Policy Letter for thisoperation (amex o), the Government has noted that COPRI and the spe committee Wi llow

IV By March 1, 1993, $300 milion had been offered for sa frm the Privatation Agenda,including $210 fiom mini and hydrocarbons. Of these s, $2 nmilion in asset (ook value)fom the Agenda had been aserred to the private sector.

27

ihese guidelines, under the framework of Privatization Law 674, In implmmntg the pratzatoprogram For a company to be eligible for conideraton toward the triche releas tages forprivatizadon, the Bank will review the privatization process for the company to esr that Iis Inaccordance with the Privatiaon Law (DL 674) and consistent with the opeaonal guidelines issuedby COPM to the Specal Commiees and with the principles set out in the Poc Letter.

D. Imn

118. The prvatizaon program is expected to have a posiive net fiscal Impact over boththe short and medium term The positive impact wil be due to: (a) diminaton of tansfers andgovrnnme-guaranteed loans to SOBs to cover operating losses and capitalpexpel (SOB lossespeaked at $530 million in 1989); (b) higher tax revenue as a result of hnrased profits of prvaizedcompanies; and (c) proceeds from the sale of SOEs. At this stage, it is difficut to forecast salesprices and the dming of the sales. Government officials are tentatvely foasig gross pdvazationproceeds of roughly $1.2 - 1.5 bilion annually in 1993 and 1994.

119. There will be short-term costs in the pnvatizaon progm associated with severancepayments for SOB workforce reductions, but these costs are expected to be substantally bdow theproceeds of privazation. There have been rougbly 10,000 SOB layoffs over the past two years aspart of a cost reducdon program. The costs of these layoffs ($66 million, or $6600/worker) havebeen financed by SOE intnal funds, loans from Banco de la Nacion, and cental budget transfers. ItIs apected that frher reductions of approximately 15,000 employees wi be implmented by SOEsprior lo their privatzaton. Payments to displaced workers will be limited primarily to cnactalobligadons for social benefit. While the legal obligation for payment of these social benefit lieswith the SOEs (not the Govermment), the Government will monitor this process closely to ensure thatall efforts are being made to meet these obligations. Under this operation, the Bank will review theimplementation and fiancing of workforce reductions, as part of the k's general rmiew, prior toscond and third tranche release, of overaU progress in implementig the refiom program set out inthe Policy Letter.

120. While some goveanment-guaranteed SOE debts may have to be assumed in theprivazation process, this is not expected to have a cashflow impact on the Government, sine theGovemet is already responsible for servicing this debt under its sovereign debt reschedulingagreements. In some cases, formal creditor waivers are required to enable the companies to beprivadzed. Discussions wi creditors are being handled as part of the Government's ongoingdiscussions with the commercial banks on Peru's overall external debt.

121. To date, all prvatizaions have been cash transactions. he Governmeat isconsidering the possible use of debt/equity swaps for privatization in order to attract additionalpotential bidders. This would enable strong tecbhical fitms, which might lak adequat financing toparticipate in the bidding, to combine with financial institutions seeking to reduce their debt exposurein Peru. If the Goverment does decide to use some form of debt/equity swaps, they wi be: (a)used selectively on a case-by-case basis; (b) combined with a minimum cash payment; and (c) limitedto identical debt Istumen in order to facilitate comparison of bids.

E. ftW 1

122. Apart from the genera SOE labor reductions, some communities, which arededet on one or two major SOB employers, may be particlady adversely affected by workorereducdons. Examples include: Parmonga, Chimbote (Siderperu and Pescpeu), and the miningcommunides (e.g. Marcona, La Oroya). Hierro Peru (iro ore compay) has implemented a progamin Marcona whereby displaced employees, in addition to reein severance pay, bhav been providedwith counselling on investment and employment oppornites, n-house vocaona trning, and

28

advice on setting up micro-entrises. The program also included the subcontauing of some SOEon-core acttie to dismissed workers. As well, social sevices, previously provided by Hierro

Peru, have bee transfered to other public agencies. Othe SOEs which are most likely to beaffcted aamonga, Cenrmin, and Siderperu) are in the process of developing similar programs.The UNDP and the Bank, through the Pvaizatio Technical Assistance Loan, are providingfinancia assista in developing these programs. The Bank wil assess the Government's progress inImplementing these measures as part of the general review by the Bank, prior to second and thirdtrche release, of overall progress in implementing the reform program set out in the Policy Letter.

123. In addion to these measures, a portion of the privatzation proceeds are beingallocated to small community projects throughout Peru. COPRI recendy approved 80 communityprojects, ranging from $50,000-150,000 to be finaced from privaization proceeds. PromotionalInformaton will specifically tie the fimding of each project to privaization. his will help alleviatepoverty and build support for privatization.

F. nrIal Aspgo

124. Some of the enterprises being privadzed, particularly in the minigg sector, haveenvironmental problems. Potential Investors are seeking clarification from the Govermentconcering the scope of the problems and the environmena standards and enforcement measures tobe applied. To address these concerns, the Goverment is carying out environmental sudits, wherenecessary, as part of the technical preparation for privatiztion. These audis will specidy: the extentof environmental problems; the estmated cost of cleaning up past problems and of improvingoperations to comply with environment standards. On the basis of the environmental audits, theGovernm will clarif for potential invests their envirmenl responsibilities (if any) withrespect to cleanup of existing pollution. In all cases, privadzed firms will be subject to the sameeronmental lawS and standards as other companies. Adherence to these policies/procedures will bemonitored by the Bank, as part of its review of the privaizaton process and bidding/sales documentsfor individua privatzations, prior to counting the company towards the tranche release targets forprivatzation.

125. The environmental audts for the mining companies will be fimanced by the BaksPrvadzaton Technical Assistance Loan, as well as a recently approved Japanese grant ($2.2. millionequivalent) for the preparation of a Mining Sector Environmental Project. The Japanese grant willalso finance technical assistance to develop guides/procedures for environmental aPessments. Aproposed mining sector environmental project is being prepared to help fince cleanup of pastenvironmenta damage at Centromin and Mo Peru. In additon to these projects, a proposedEnergy and Mining TA Loan will finance tecical assistance to strengthen the environmental policyand reguory fmework and the Environmental Directorate wihin the Ministry of Energy andMines. The Energy and Mining TA project will also support, on a pilot basis, a system formonitoring air, water and soil quality, focusing on specific problem locations such as Centromin's LaOya refinery.

IV. THEPROPOSD LA

A. Dmlb

126. Ihe $250 million loan would be diused in three tranches of $75 million, $75million, and $100 milion. The fis tranche would be disbursed on effectiveness and the othertranches upon fulfillment of specific conditions for tranche release. Ihe Policy Matix (annex 1)summarzes the reform program to be supported by the Loan, including the actons taken to date, thepecific tranche conditions (marked with an asteris), as well as other reforms which are ipoaed

In dte Policy Letter signed by the Government.

29

B. olicy Letr

127. The Policy Letter signed by the Government (annex El) sets out the reform programbeing implemented under the proposed loan, including the program objectives and rationale, andmajor actions to be carried out. Prior to second and third tranche release, the Government willsubmit to the Bank a report on the overall progress in implementing the reform program set out in thePolicy Letter. The Bank will review the overall progress to ensure that it is satisfactory, prior tosecond and third tranche release.

C. Loan Conditions

128. The loan conditions are summarized below:

Condition of Effectiveness

Maintenance of a macroeconomic policy framework and a financing plan consistent with theobjectives of the reform program.

Conditions of Second Tranche

(1) Maintenance of a macroeconomic policy framework and a financing plan consiste-$ with theobjectives of the reform program.

(2) Submission to Congress of a draft law on hydrocarbons and a draft law establishing the taxregime for petroleum products, and preparation of draft regulations for these laws.

(3) Issuance of the regulations for the Mining Law.

(4) Preparation of a new competition regime, tariff structure, and privatization plan for thetelecommunications sector.

(5) Submission to Congress of a draft water sector law and preparation of draft regulations for thelaw.

(6) Submission to Congress of a draft fisheries law and preparation of draft regulationsestablishing the new fisheries resource management regime.

(7) Offer for sale of at least $450 million in assets from the privatization agenda, with a minimumof $275 million in assets from two of the three sectors of mining, hydrocarbons, andtelecommunications.

(8) Preparation of an implementation plan and timetable for the privatization of Petroperu.

Conditions of Third Tranche

(1) Maintenance of a macroeconomic policy framework and a financing plan consistent with theobjectives of the reform program.

(2) Enactment of the hydrocarbons law and legislation establishing the tax regime for petroleumproducts, and issuance of the regulations for these laws.

30

(3) Implementation of the competition regime, tariff structure and privatization plan for thetelecommunications sector, and issuance of regulations for the Telecommunications Law withrespect to: (a) the operation of the new regulatory agency; (b) the major classes of service; (c)the process and methodology for setting tariffs; and (d) the process for granting ofconcessions.

(4) Enactment of the water sector law, issuance of the regulations for this law, and establishmentof the regulatory agency for the sector.

(5) Enactment of the fisheries law and issuance of the regulations establishing the fisheriesresource management regime.

(6) Offer for sale of at least $1200 million in assets from the privatization agenda, with: (a) aminimum of $300 million in assets of companies from each of the mining andtelecommunications sectors; and (b) assets from Petroperu in accordance with the agreedimplementation plan and timetable.

(7) Actual sale to the private sector of at least $600 million in assets from the privatizationagenda.

D. Monitoring and Reporting

129. As noted above, prior to second and third tranche release, the Government will submitto the Bank a report on the overall progress in implementing the reform program set out in the PolicyLetter. In addition, the COPRI secretariat will submit to the Bank a semi-annual report on the resultsof the privatization/regulatory reform program and an updated implementation timetable.

E. Technical Assistance

130. Given the scope of the privatization program and the technical work required todevelop sectoral regulatory frameworks, substantial technical assistance is necessary to ensureadequate preparation and implementation of the program. Considerable consulting assistance hasalready been contracted and is being financed through SOEs' internal funds and bilateral/multilateralgrants. The $30 million Privatization Technical Assistance Loan, approved in December 1992, willprovide continued financing for consulting services for the preparation and implementation of theprivatization program and for the drafting of new sectoral laws and regulations.

F. Procurement, Disbursement, Audit. and Administration

131. The proposed loan would finance 100 per cent of the c.i.f. costs of general importsnot contained in a negative list. Ineligible imports include: goods financed by other Bank loans orloans from official multi- or bilateral sources; alcohol, tobacco, luxury and environmentally hazardousgoods; and goods intended for military use. Retroactive financing in the amount of $50 million (20per cent of the loan amount) would be available to fimance eligible expenditures incurred afterSeptember 30, 1992.

132. A Country Procurement Assessment Report prepared by the Bank in September 1991noted that the laws and decrees governing the procurement procedures followed by both public andprivate sector importers were in broad conformity with the World Bank's Procurement Guidelines. Inaddition, the annual budget law provides that goods and works financed by international financialinstitutions will be procured in accordance with the requirements of these institutions.

31

133. Trade policy reform since August 1990 - the wholesale reduction of tariff and non-tariff barriers, the elimination of fiscal privileges, the removal of controls on foreign-exchangetransactions, and the beginning of customs reforms - has immeasurably strengthened the competitiveenvironment in which private purchasing decisions are made.

134. In view of these reforms, the following procurement procedures would apply:

i. Contracts for the procurement of imports made by public and private importers valued ator exceeding $5.0 million would be procured under simplified ICB procedures inaccordance with Bank Procurement Guidelines. Imports of petroleum products andcommodities such as -)ieat, corn, sugar, etc., would be purchased under competitiveprocedures acceptable to the Bank. In addition, direct contracting would be acceptable ifit is in accordance with the requirements of paragraph 3.5 of the Procurement Guidelines.Contracts below $5,000 would not be eligible for Bank financing.

Hi. Public sector imports valued at below $5.0 million and above $5,000 would be procuredin accordance with local norms which have been assessed as acceptable to the Bank in theCountry Procurement Assessment Report of September 1991.

iii. Import contracts by private importers below $5.0 million and above $5,000 would beawarded in accordance with established commercial practices, which are acceptable to theBank. These practices generally consist of inviting more than one quotation, except forimporters of small amounts of consumer goods, who generally buy from traditionalsources using direct negotiation.

135. Disbursements for contracts under $5.0 million would be made against Statementsof Expenditure, for which the customs certificate documentation would be kept locally for supervisionby the Bank staff in the field and for auditors whose terms of reference for auditing would beacceptable to the Bank.

136. The Ministry of Economy and Finance would administer the loan and beresponsible for submitting the relevant documentation for disbursement. A Coordinating Unit hasbeen established within the Ministry to ensure compliance with loan conditions, prepare disbursementrequests and fulfill reporting requirements to the Bank, for the three prior adjustment loans. ThisCoordnating Unit will have similar responsibilities for this operation.

137. To assist in the preparation of disbursement requests for the three prior adjustmentoperations, the Ministry and the Central Bank created, in conjunction with the CustomsAdministration, a Special Procurement Unit responsible for the collection of relevant procurementdocumentation, ensuring that only eligible and correctly procured imports are included in withdrawalapplications. This unit will carry out the same tasks for this operation. Documentation would beretained for review, as required, by the Bank and the project auditors.

G. Benerits and Risks

138. The program to be supported by the Loan is expected to have major benefits: (a)improved fiscal performance through elimination of the recurring SOE fiscal burden; (b) restoredprivate sector confidence in the economy and in the Government's commitment and ability to reducethe public sector and implement the reform program; (c) increased private investment, therebyspeeding up economic recovery and alleviating Peru's unemployment/underemployment problem; and(d) increased economic efficiency due to the implementation of sectoral policy/regulatory reformstogether with privatization.

32

139. Ihere are two main risks. One risk is that domestic pressures will result in somebacksliding or deviations in the Government's macroeconomic and structural reform program, therebyundermining economic recovery. In this regard, the Government has maintained soundmacroeconomic policies/performance since taking office in August 1990, and has agreed with theBank and the IMF on a macroeconomic program and external financing plan for 1993-95, to besupported by, inter alia, this operation and an EFF. Maintenance of a satisfactory macroeconomicprogram and external financing plan is a condition of effectiveness, second and third tranche releasefor this operation.

140. A second risk is that privatization will get delayed as a result of domestic politicalopposition or foreign investor reluctance to invest in Peru at this time, given the fragility of thepolitical and economic situation. Ihis risk has diminished markedly over the last year with the initialsuccess of the privatization program and the opening of the economy. The Government has alsolaunched a public information program within Peru to strengthen public support and understanding ofthe privatization program. It is also financing a number of community projects from the proceeds ofprivatization. This winl help alleviate poverty, while building support for privatization. TheGovernment is also developing promotional campaigns for investors abroad to explain theGovernment's program and privatization/investment opportunities in Peru. The informational andpromotional programs are being financed, in part, by the Privatization TA Loan. The recentcongressional and municipal elections are also expected to increase investor confidence in Peru.

V.

141. I am satisfied that the loan would comply with the Articles of Agreement, andrecommend that the Executive Directors approve it.

Lewis T. PrestonPtesident

AttachmentsWashington, D.C.March 30, 1993

mUOATMATON ADUTEaDA

(Legal condition murked with #.)(eal coaiton nmzked Wit

A. MACROBCONOMIC The Gove1m1t has been lplemenmg, ince Augst 1990, a * Maintenance of a _ of a _POUCIES AND _abIzation and I AtumrefOm progrm. policy fmame k nd fincing pl pohy fsiewoik and Apan

FORMACE Key measurs l deo (i) l ben of oade, primes, and consdent with th objetie of the consistent with the objectives of thforlp exchae mark; (i) fisa and tax reoms to refom pgmm (dao a condibon of refm prgm.isaeue inx nwm and rdowe sube ie; (lii) chnation of efctiven).monopolies anid restuictions on privateo ureign inehweswwand v) libe of hbor and finanal makt. Thpogmn he bow sppored by dth Wodd Bank (SAL, Trad

fUgSs Ac m nporn) and die IDI). Aee_W hasboee oedd on ds wAnooom pWm gnd ftfpan for 1999-95. to be suppodo by thi opertion and an IMPExeAed PF, 'FPaclty.

8. POIJCY LETTER Th Pol - -nr, siged by the Minis of conomy and * Sa_qfsy in Sats oy progvs inFm.. eats out te ovel reform prgm being impementing the oveal refhrm the ovasa rfunlnpemaedo under th prposed loa, Inluing the prora prgrm as get out in Pals lAter. program an n GtM int PNOY 141cr.objectives and mtioaale momc reforms to be carred out, andndative tmab (see Annex 1.

C. SBCTORAL POUCY,BGAL AND

REGULATORYYRFORMS

(a) MININ T Goveami kssued a nm Mining Law, Daere 708 in * ue of for teNovendb 1991 prmoti prvae dse investomeA in dhe Mining Law.

pit s eop calo e. TheGoernmen io ulowSm- DS 60"o sd o eb atn

omm&_ hA -- n, M * F-mp- Eu3Ld~~~~A_dihI

nb=bnbwptqky h_ do nowrVk le oaw.

PERUP'RIVATNATION ADJUSTBMEN WAN

(Lad coonn mathd w_h 0) (ALgl co o marke wih S)O) HYD AROCA S Ii Govegannt has tae sveal dep to *Submssion to Congss of a drft *BnaePRn of the bydrabons kw

sector. A 1991 demo iminated Peipewn's monopoly on la on bydrocabons and a dria law and klision esabbisig the Iaall do _utra actvi, and moded procdu re ho ft edsabllhing the tax egqim fr regime or pro product, andeontg out to tde pivat sectr, of up m advhi ptolem produc, and pepation isanceof toe 1 nfor tIhe

(-s-W-4-od"dion). Donesic gvoliees were of daft nrgao for thesel. las. (Notr this onito h beaIn s30% lacaed in Aut 1990 (64 oce gsolino ll fille_is curargly Wslon). In May M992, a decre was ise o n in

G5_bmot h mai was ed e ndo fu b o ovsmpeWr 19 s p1.olpmthn d).

primpoeft di so . Draaw ftto rultof s a thec maw lAw

fin_ok A am bymm oal, ,w v lhs bom dmab&

UM&egrqc&L direOspec to (a the operatio anot

noliccotmpettio endme 6otariff dstrctu w a dopialrtc s h e rgltoyaecyw.heui

(el lbov _lue inreased Wq6o Mm by I=% in1 PJ lioZ Olaf a am _ot81Fk limplasses of er do atm sTELBcONSU MM A_pa t19ShROw,d by I psm _ir L A new ski I. bal _ot1_---1 I Moed i Nevaw E"_ 9, pivtao VW hr l" ad pd sb# Xrh dwn,An o _"nm*ma d p pia,-1 0m i _. _ ,a demO lf-

ww co_* o nsbn_ kw anwt d nieed P. mw wk om. (b) ft 2orc_m of :o;i (0) ft pres md

Ug * AM do _oaumot _VdwS&,% m Rar in of Mm- sdgl;Po" _iama a tfmdt1he8eeft t I (d) 1l i mef

PERUPIWAIMIZAON ADJU MLOAN

I<IUCY AcD TCllONS D)ATE BYXSEMND BY 1I llRo

(La coon wA*ed with ( codI"Ku mtd "ath *)(4d) Fbo lho d 5 a conceh inl 1992 lo mvlw * SobCong of a Dnessota. of the othso kiw sod

_Smnafind exp_ima iik fidheries nwwm ooname a a hurisb w and uat1on ofdnr u of the ;tofbas fr sd_qt aamk ande w d_ nw ym _e_A* oolihn oa alb8oiXtefseds,

ofthmew Alokosueg* pepa sow r oom loswh beci pW* lbfi03 bwM . The spandond damile ofdo am r W 9wit to _ntaim of dbUra

W Qla__thI'lpllatheabal

(o) WATINtM AllUlft homid w_ft b_r by 1 ISS IAUgUi 0A_ 'i_ to C of adsif *of* do ws tio me w,I.vt ,-_s b_sil1I t 2jdoMng dt. &1 w p of otso dot lpbb r doA dmB wan esw kw is bein, p_,e sad aa daf tnIlos at Sbd kw. kw, and atabbAmmt of do2_~~~~~~~~~X sozr. ~ ~ ~ ~ ~ ~ ~~~~~~gut~ agenc farli *DShe esiertiammeGooott diend with The anm 1m da

brAOod _S_ A 4-Womb

Ul f SLls do mmt aosl wilb do liran a1oft ficameandt and _ * wa do bXsodw.

1N

rIAVATIZAlON ADJUSfMEN LOAN

(IAsl condition marisd with 0) (LeAl condton Masked wMt 0)D. ILl NTATION FrIamwor. Te Govenment aenouned Sofr for ads of at last $450 * Oflfr inr sl of at lIA $1,20

OF PRIVATIZATION in Septmber 1991. itB intention to Impkent a boad Mo in sss km th million (cwulav) in asee fomAGE0DA pro* pr m Incuding vitalty a dlat owned } riatlation Agenda, with a o Pt d Aga, wild (a) a

eneise and bisued Dee Law 674 atoribing the minimu of US$275 million frio mnmum Of $0 minlofnfi_mwork for the oavr prgm. Under DL 674, th two of the hm seto of minig, (cumuotv) fom each of th mingGovernm estWblished a Int-Miniserial Connssln hydr b, and and a_ -- seac ; and(COPR4 to ovme te progmam. A tehial secretara Ir " -m0) assus from PEperu inCOPM! was estbished in Februy 1992. As well, COP! has c wih the s-edappoinod 30 Specia Prvaion Com _itles to prepae an s Ppation of an imp _me n im e pmn and timetable.Imple nt individual rivtitios. plan o andtble for the

prializaton of Petropern. * Acu ale to th prvat secr ofReals to d0aL S May 1992, the Govenme has at lkast S60 millionina ina fiompiaizod 12 holdhn yieldin US$260 million cah Privatidtion Agenda.proceeds. Msjor priv _ons completed to daft incbe thenatonal ain (Ae- ) and oie hon ore company (HWoPau). Ote compkded piatalon Include holdings inmining (Mipo, hna Condestble, Quellaveco),hydrocrons (Solgs, 78 gs stations of Pestopen), usbantanpop (452 bues of Enatru), a ship rair company ([lna).two chemica firms (Quimpac, Reyns), and a commeronbank (ac do Cameoi).

Agena. The Goernmet plans to prvatize Its lre holdingsin 1993-94. Agreeme has boen reached on a P*vatizationAgeda of comnien to be covered undert operio and

ir 199 asnt values (Ir purposes of tanche reasetarps). Te Aenda includes 25 enmprises, totling $4.135billion in sstse (191 book vabu), in hydrocarbon, mining,Vi , and sdeced holdings hwat ald ,Jidhie ,amo j and blmft w_oiL lbc AMpoindudes 90% of SOB assts, xcludig electriciy SO0s (to becovered under a seate opeaion).

muVIATIMITAlaN ADUSAWII LOAbN

M=MM RB AS 6MT DIAIS B IT;ICMR TRANCOR SYnm111R

gad condition h moed wIh Lcodition matkd with 0)L SOCIAL IMACT Statewned etprs hav rduced empioymect by rogl Ih Bank wl rview the Ib Bark wl ieviw the

10,000 ovor t lst two yr as pat of a cos nd on and fn of and Bn Ofprga.An addItiona 15,000 lay-offit are excpetd in SOBs wouitorc reductions. and the specal workitfrc reduction, and tdo special

* to pivalzation. Severn pay is basd on con _ttal measurc beng implented in masmes being impleented inobgions, and I tho legal rposbt of the _es commti p ar dvrsel oo py advew*SOL. Mm Polcq e enhcde. a co_mmmnt by the affed by SOB woaskorc affected by SOB workteGvnmen to onitor SOB worobreducons to anure redutions, pat of its reiw, prior educions, as pat of its eview,hat all dft ae beig made by SOBs to met thi to eo trnche Masse, of ovea prior to third anhei relse, ofcorac obugao. pgrss in imple_mting the reom ovel progess in implemeng the

progrm sot out in die Poliy Lter remfom prgm set out in tIe FoleyThe Governmet plementing spcia measur in selected (see em B). Litet (Se item B).communit tht b particulay adversely affected bySOB workfor redons. In addion to seveance pay, hesemeasures _nludoe of non-core SOB actvtie todimised woks; counsming on employmnat and invementoppostunities; hous vocational aining; and advioe on

A portion of p nvatio proceeds ar being used to finanecommunity prjet. To dae, COPMI has apoved 80- _ c thougou , ranging fkom $50o.-ISO000 per pr*ject.

30

MuVAT1EA11IOUN ADJUIST I LOAN

ajod mwnM"m )sM mho 2w06

P. WAL hes GOammust boaasbllhd an unblmm.alnl Mar to cOuting 2 comp WOwUla PAle t counlig aPSPACf and uMnIt X bas MkIn o aeqt ' and M. dXn unoe_ Xm t s 1w o t ndso mIsse ftae 1w

lbi OmW Mining Law et Out air quaity *landI (de10i1ed p_itwt _ (m bs D), lb Bank I(so. bsk D), As Bankwaler qumilly standanaideA ao. being - rP.dbiditfad dmmtb

_whoomWd aian bm to Ideat p lbso. of IPoley L Dsgi tlo l un 1ee tak.

iopmvw_ of oen fCompyW ebo m 0' e gqobM (f an)in do s0 Fwe a'odOmbs On Oadis basi of dIme_s a dt, sovomumt _will saledo ,ad apply do emm (if ay) is dotade menanddu or_gw OAN o _ o _ _t_tEt awhomna wddhf PI 0somSW -lM

nopoombWo (itf any). In all cau1 pvand fi, wil be jv AotWieOmp . bwd tfis assubject to _do wA em6ommead k9hdudu* as *&w o6artionvooks.

CD

tebloe - PM s Projection of Ke Ecyeonmc Indleators..,,, ,.......................................................................................................................................................................

A aW'o -- Pro(.0 -- . - Projcted ..............................................................1 e io 1,01 t1992 19 1996 t95 196 1998 1W9 2000

......................................................................................................................................................................UB t totesz (pecnt):,.......................

GOP 0.t1 -4.4 2.6 -3.0 3.5 5.0 S.0 6.0 6.0 6.0 6.0GOP per pita -2.6 6.9 0.1 -5.4 1.1 2.6 2.7 3.7 3.8 3.8 3.8cemaption -0.1 -0.1 3.7 0.6 0.0 2.6 3.3 6.4 4.8 4.8 4.BPrivate 0.1 -2.1 6.8 S.3 -0.3 2.6 3.1 4.3 4.7 4.7 4.Sbife -1.6 14.1 -14.0 *33.S 3.5 5.0 S.0 6.0 6.0 6.0 6.0Cow ptton par Capita *2.? -2.6 1.2 -1.8 -2.4 0.4 1.0 2.1 2.6 2.6 2.6Grosw Capital Uretion 0.0 t.2 -2.5 1.8 18.7 7.4 r.3 B.3 8.2 8.1 8.1Private S.4 14.8 -2.0 -8.1 22.4 7.0 7.0 7.9 7.9 7.8 7.8PItife .11.1 -19.3 -S.1 53.1 7.2 8.6 B.S 9.4 9.2 9.1 9.0

stic D_mid O.S 0.2 S.S -1.4 2.7 3.9 4.3 S.4 S.8 S.7 S.7fEporto W19s *0.2 -9.9 2.0 -0.7 2.0 10.9 10.1 9.5 9.5 9.6 t9.qowts =6FS -0.2 14.4 7.S 7.3 .1.4 6.3 1.4 7.5 9.0 9.1 9.3

Shws. in COrrent UP (pertt):e, ................................. . ....

Coeltriof 78.1 86.8 66.7 87.3 66.4 06.1 as.? 8S.0 83.8 8.2 82.7Privew 69. S 78.9 1.6 83.8 62.9 82.6 82.2 81.5 60.3 79.? 79.2PtAA I 8.6 5.9 S.1 3 3.S 3.5 3.5 3.5 3.S 3S 3.5Touta Itstant 21.3 15.7 16.3 1S.S 16.8 17.2 17.6 17.9 t8.7 19.0 1T.4Gross Capital fototlon 19.7 15.3 14.2 14.7 16.7 1M.1 17.5 17.8 18.6 19.0 19.3om/ Private 15.0 12.9 12.0 11.2 13.1 13.3 13.6 13.8 14.3 14.6 14.8P"tic *.7 2.3 2.2 3.5 3.6 3.8 3.9 4.0 6.3 4.4 4.5taJ In Stocks 1.6 0.4 2.1 0.8 0.1 0.1 0.1 0.1 0.1 0.1 0.1Remuree Setaee 0.6 -0.5 -3.0 -2.8 -3.2 -3.3 -3.3 -2.9 -2.S -2.3 -2.1Expets UFS 1S.0 12.0 8.S 8.5 10.8 12.7 14.2 14.8 16.1 16.8 17.6t_iots ClS 14.4 12.S 11.6 11.3 14.0 16.0 17.4 17.7 18.6 19.1 19.7National Savin 16.9 11.8 11.6 10.4 10.6 11.1 11.3 12.1 13.8 14.S 1S.2DsatIc Saving 21.9 15.7 13.3 12.7 13.6 13.9 14.3 1S.0 16.2 16.8 1.3current Account 4.4 *3.9 -4.S -S.1 -6.2 -6.0 -6.3 -5.8 -4.9 -4.6 -4.3Tem of Trada (1966 100) 108.S 108.6 96.6 95.4 93.7 92.6 92.2 3.5 96.1 97.S 96.9X PRICE 114.5 136.0 123.4 12S.3 127.7 128.6 131.6 136.0 151.6 158.7 166.1NJRICE 106.0 125.3 127.8 131.3 136.3 138.9 142.7 147.5 157.7 162.8 168.0LIMt 7.93 6.4" 6.3X 7.0 4.5S 5.63 6.5% 7.0X 7.03 7.03 7.0o

PM Item a > ICON 1.7 -4.7 8.4 -7.9 6.4 4.9 5.0 4.2 4.4 4.S 4.6GDP Deflator (can in percentage) 728.6 6392.1 430.4 3.s 37.4 22.3 10.0 10.0 10.0 10.0 10.0 1

(continued)

tabte 2- PM 1: Swy Balae of Payments : Current AceIknteludiny tnteret paymets an Pubilc NLT Debt.

(US, Pitlion)................................................ .............................................................................................. ............ ..................... . .................................... ...........................

Projected*Prel. ...................-..................................................

1990 199 192 1993 1994 199S 1996 19"? 19 t1 2000.......... ................ .................................................... ................................................................................................... ... ...................................................

Netbudase trade Accoet 340 (165) (639) (609) (535) (496) (404) (349) (292) (209) (113)Exlaerts of Goods 3,231 3,329 3,333 3,466 3.8 4,372 , 00* 5,714 6,S29 7.472 3.5Stcopr 70 78- 677 704 S 'r8 1,01? 1,140 1,326 1,517 1,737Other aroditionat 1565 1,640 1,639 1 704 1,907 2.149 2,462 2,809 3.20f 3,673 4.203hnot Troditlonei 966 951 1,0la 1,058 1,'8M 1,335 1,529 I t 1 994 2,212 2,611lwoprts of Goods (2.891) (3,494) (3,972) (4,075) (4,414) (4,868) (5,413) (603) (6.821) (7,680) (8,664)NFS alace (665) (724) (726) (7004) (729) (779) (828) (89) (984) 1,076) (1,181)Exports of IFS 831 836 878 926 1,037 1,169 1 338 1,527 1,745 1,997 2,285xponts of OfS (1,496) (1,560) (1,604) (1,631) (1,766) (1,948) (2, 66) (2.426) (,729) (3,073) (,467)Resource Balance (325) (869) (1,365) (1,313) (1.264) (1,275) (1,234) (1,249) (1,276) (1.285) (t,294)........ ,.,,,,, ..... ..... ..... ..... ..... , ..... ..... ..... ..... .....

Factor Inca" (132) (45) (10) (S0) 0 20 34 42 60 8t 106Factor Ratelpts Net 62 122 142 145 191 231 265 289 323 361 405Private & Short-Term Interest 8_ (146) (127) (102) (122) (113) (130) (4?) (tS8) (171) (184) (199)Other Faetor Pa)yents (48) (40) (50) (3) (78) (81) (85) (88) (92) (96) (500)

Net Current Trasferf 247 260 283 338 312 295 316 338 361 38r 414Current Acceunt eJ (210) (666) (1,092) (1,025) (952) (960) (884) (868) (855) (861) (775)

Nom Items (aml chande)

Export Volu3 -9.9 2.0 -0.7 2.0 10.9 10.1 9.S 9.0 9.S 9.6 9.7tqort Volue 14.4 17.5 7.3 -1.4 6.3 7.4 7.5 8.1 9.0 9.1 9.3Term of trade -1.7 -11.0 -1.2 -1.8 -1.2 -0.4 1.4 1.3 1.S 1.4 1.4Rest Exchange Rate bj -2B.0 -21.4 10.8 14.0 14.0 0.0 0.0 0.0 0.0 0.0 0.0.............................................................................................................. ................................................................................................................... ...............................

ej Exctding lnterest on pAblc .T debt.bj 8eore Augut of 1990, it's averge effective exchange rate.

_~~~~~~~~~~~~~~~

Table 3 * flAb Stemry Batance of Paymnts: Capitat Accourt d Financing Requirements.

(USS NIt ion)........ ............ ....................................................... .......................................................................................................

.................................................. .............

1990 991 1992 1994 1995 1996 1997 1998 1999 2000,.................... ...................................... .................................................................................................... ......................................................................................

Finacing Requirements.......................

1. Current Account Deficit 210 666 1,092 1,025 952 960 8Q4 868 855 ai? 77r2. P"tlic Sector Debt service

obligations : 2,619 2,928 2,205 2,482 2,265 2,401 2,431 2,43? 2.702 2,66 2,946Multilaterat 650 876 496 493 482 S36 566 583 90? 926 93TOilaterst 1,01S 1,263 1,186 1,357 1,221 1,207 1,B06 1,027 868 69? 853Private 954 790 523 622 534 613 696 741 89 an9 095Unidentitfied 0 0 0 9 28 45 65 96 138 207 2613. Arroes to be Settled in

Current Ter 0 5,706 37 9,725 0 0 0 0 0 0 0multilateral 0 379 37 l.799 0 0 0 0 0 0 0Bi laterat 0 5,327 0 0 0 0 0 0 0 0 0Private 0 0 0 ?,926 0 0 0 0 0 0 0

4. Cange in Gross Reserves 102 1,211 294 324 314 314 202 417 486 S52 631 tIS. Gross Finaning Requirements (14243*4) 2,931 10,511 3.62t 13,557 3,531 3,67S 3,5r? 3,723 4.0t3 4,038 4,351..... ...... ..... . ..... . ...... ..... . ..... ..... . ..... ..... . . *...... ..

6. Pipeline Loon Disbursements 24S 215 280 283 34 289 280 331 407 48l 562(ProJect-related)

7. Private Capital Flow 436 1,303 1,73S 1,45 1,340 1,488 1,864 1,646 1,321 1,457 1.519

S. Finencing ReAuirmnts (5-6-7) 2,250 8,993 1,612 11,82. 1,847 1,898 1,372 1,5S4 2,315 2,095 2,270

Soures of Financing.....................

9. Debt Rescheduing and Defterral 2,250 7,858 1,289 9,147 1,216 1,256 1,152 1,169 1.206 1,24S ,565*ilaterat 0 6,3S2 616 692 70? 673 490 44 456 447 7t4Private 0 0 473 8,45 509 583 2 m 750 796 851Incrse tn Arr ars 2,250 1,50S 0 0 0 0 0 0 0 0 0

10. Additfonal Disbursments 0 1,135 324 2,272 470 393 0 0 0 0 0Multilateral 0 696 164 2,M 470 393 0 0 0 0 cFLA 0 325 0 0 0 0 0 0 0 0 CIMIID ID, IMF 0 373 164 2,m 470 393 0 0 0 0' Bilateral 0 437 160 0 0 0 0 0 0 0 0tt. Aitfeaml Finxacing 2equired (0) 0 0 410 16t 249 220 376 1,109 250 7e 12. Total Sources of Financing (90+1011) 2,250 8,9"3 1,612 11,829 1,84T 1,898 1,372 1,545 2,315 2,095 2,270

NM ttemGross International Reserves USS milttion) 61S 2,026 2,320 2,644 2,958 3,m 3,474 3,891 4,37 4,929 S,560(Months of laports of GNFS) 2.2 4.8 5.0 5.6 5.7 5.8 5.5 S.5 5.S S.s 5.s...........................................................................................................................................

Table 4 - PERU : Extit Financing e lr4drments end Pessibte sources of FInanctg

CUS S titon)............................................................................................................................................................................

1990 1991 1992 13 194 1M5 1996 19W7 199 199 am.........................................................................................................................................................................

FIe ng Reeirements.......................

1. Nwittm t CLwrrt Accouwt Deflfet 210 6 1,092 1,025 952 960 S6u 8 o65 * 17 m152. Pi4Ale Sector Debt Svice Oblltatn 2,619 2,928 2,205 2,462 2.26S 2.401 2,431 2,437 2,702 2,46 2,94

Artlittien t 1,204 1,35 70 960 am2 69 93 620 1,1125 00 1,090ruAtilaterel 351 Sl 227 219 215 231 259 264 59 426 46

vortd Si* 119 87 99 75 so 64 5 S2 119 132 139100 171 110 81 12 149 167 201 212 230 207 16IMF 61 49 47 1? 0 0 0 0 250 297 329fULt 0 325 0 0 0 0 0 0 0 0 0

Bilateral 496 544 9 469 627 439 SS7 53S 407 25t 436Parles Ctb Creditor * 392 367 22 413 376 396 362 354 238 93 391Otber liteterat Ceditor lS 177 267 256 2S1 243 195 181 169 16 47

Pr"Ovte 357 210 69 92 40 26 22 21 19 1? 16Ceincfal Bans 276 224 18 17 11 a 5 S 4 4 4Sptiers el 56 S2 76 29 18 17 16 IS 13 12

intter t : 1,415 1,533 1.415 1,5 1363 1S.05 1,59 1.616 1.67 1.769 1.156lultoteret 29 305 269 275 267 305 32? 320 30 300 301

world 8am 92 lS 9g 91 89 111 125 128 1s2 138 149tO 9 46 9 90 84 99 109 109 109 110 114IN, 108 106 72 94 94 93 67 52 36FLAIt 0 0 0 0 0 0 0 0 0 0 0

Cltstwet 519 718 692 686 S94 568 527 492 61 440 415Peres Clb Creditors 456 59 S99 531 S30 51r 489 463 440 427 40Other Bilaterol Creditor 63 159 93 157 64 51 36 29 21 13 12

Private S9 S10 454 S30 494 -q? 476 720 769 622 7Caristl flefs 499 413 366 427 396 4-_ S43 580 420 46 70sl fr. 96 97 87 103 96 114 131 140 ISO 160 171

Finssin of Sp 0 0 0 9 26 4S 6S a6 131 207 261............................................................................................................................................................................

(cant I ad

teble 4 (contimad) - PW: External Financing teqpuiroents and Poseible Sources of Finanttin

(US$ mlllian).................................................................................................. .........................................................................................................................................................................

1990 1991 1992 1993 1994 t95 1996 I9" 1998 19o 2000............................................................................................................................................................................

3. Arr to b Settled In Currente 0 5,706 37 9,25 0 0 0 0 0 0 0aWtilateral 0 319 37 1*79 o 0 0 0 0 0 0llwld 8" 0 0 3S 929 0 0 0 0 0 0 0VoIn nk0 379 0 0 0 0 0 0 0 0 0I 0 0 0 870 0 0 0 0 0 0 0ofltetel 0 S,327 0 0 0 0 0 0 0 0 0Paris Cl Creditors 5,222 0 0 0 0 0 0 0 0 0Otht rg lateral Cr.ditwe 0 105 0 0 0 0 0 0 0 0 0Private 0 0 0 7,926 0 0 0 0 0 0 0Cscolel *s 0 0 0 6,551 0 0 0 0 0 0 0SvaIi. 0 0 0 1,375 0 0 0 0 0 0 0

4. hu s in ros4 Roesrw 102 1,211 294 324 314 314 202 417 48 ss2 431S. Gee" Finawing Dequiremnts (1.2*3#4) 2,931 10,5l 3,627 13S,557 3,531 3,675 3,ST 3,m 4,043 6,030 4,3516. Pipline Loan OlibursemAntt 245 215 260 283 344 269 2W 331 407 485 562

multilaterat bJ 40 13 1t9 202 249 237 260 "3 407 6 562Uootd Sank 0 0 0 4 17 32 68 112 t80 252 321too 40 13 119 198 232 20 212 220 227 234 241Bllateral 197 191 152 79 93 52 0 0 0 0 0Private a II 9 2 2 0 0 0 0 0 0CCuiercilSuns 4 0 1 2 2 0 0 0 0 0 0sWtie*rs 4 11 a 0 0 0 0 0 0 0 0T. Private Capital Flow 436 1,303 ,7M 1,445 1,340 1,488 1,864 1,S66 1,321 ,45S? 1,5191St ODrect Investment 41 (7) 122 21S 333 498 t14 654 7S 170 1t5Short-Ten (37) 141 1S7 17 49 SO 54 sT 61 46 70Private Setor 12 (1) 27 136 27 (16) 10B 11I 12a 131 1481rrorsm A iasis 420 1,170 1,429 1,077 931 956 969 1,024 t,057 1,091 1.126

8. treiciw Raq wbomtaF5-in g 2,250 6,9 1,612 11,829 1,047 1,88 1,372 1,S45 2,31S5 2,095 2,270

...................................................... = ....... ......... .......................................................................................maaeS 199 figu incl re= t of arrows of prlncipa USS 519.8 million),Interest cm 39.S ml11.n), and cemitmat fee (uC 9 .9 miltion)bj Project-related die _wets.

IeN

Tsble 4 (catimud) - PERU t External Finacing fteiremsnts Vd Possible Sources of firmtlIe

............................................................................................................................................................................

1990 1991 1992 149S 1994 1995 1996 199? 1996 19 200.......... .......................................................................................................... .. ..............................................................................................................

Sources of Financtig......... ............

9. Debt Rescheduting and Deferral 2,250 7.8S8 1,289 9,147 1,216 1,256 1,152 1.169 1,206 1,245 1,545Siateral 0 6,352 816 692 707 673 490 466 46 447 7t14Private 0 0 473 8,455 509W SOS 62 705 n5 798 851Conrcial Banks 0 0 348 6.919 389 45S 521 556 5 433 67S&tliera 0 0 12S 1,S3S 120 t26 141 149 1S? 16S 174Increae in Arrears 2.2S0 1,506 0 0 0 0 0 0 0 0 0

10. Addfitional Dsbursements (Adj. loans) 0 1. 35 324 2,m2 470 39 0 0 0 0 0nultitaterat 0 698 164 2,272 470 39 0 0 0 0 0FIAt 0 325 0 0 0 0 0 0 0 0 0 4Vtdrla nk 0 0 0 1,079 275 17S 0 0 0 0 0log 0 373 164 161 10 to 0 0 0 0 0INF 0 0 0 1,032 185 208 0 0 0 0 0lilateral 0 437 160 0 0 0 0 0 0 0 011. AddHtionl Financing Required (0) 0 (0) 410 161 249 220 376 t,109 850 7012. Total Sources of Financing 2.250 8.993 1,612 11,82 1,847 1,898 1,372 1545 2,315 2,095 2,270(9.10.11) us.-a. na .=. sea...= ass... srarnsa *usan u.s.a. a..... "55a5= atsaus 55505

em Item ..........

Debt Sevice Alltevition a-) 0 0 0 547 461 405 296 197 176 150 124sj Provides an Indication of the caa flow relief uere Peru to be granted Paris Cltb terms similar to those forPoland (Aprit 1991) and E t (Na 1991). such relief is caltculated to aerage MS 471 mllion amually over1993-95. Additional finwncing required (tine 11) anmnts to USS 273 million per amsA over 1993-95.

'-4

TAble S - PEU t Projectla of Key 1eaumc ildceatae.............................................................................................................................................................................

AM ........... ......................---------------------------------------------------------------- **o*oo1965-9 1990 19" l to 1993 19 199 19 16 19 am......................................................................................................................................... ..............................................................................................................

Debt t<dleatar (pecent) :...........................

Oebtlspe =ts MA 43.l 513.3 540.6 540.6 5n.0 540.2 50.2 454.7 3E6.4 MA74 30.4Debt/P " 73.0 123.4 130.3 121.1 156.9 174.6 160.9 171.4 1t5.9 152.6 147.8t1R Debt / total 00 2.9 7.1 6.3 5.7 5.6 6.2 6.4 6.2 6.0 6.0 6.2Debt eavice/Eperts OSS *J 72.7 70.1 212.7 SS.6 2M.7 48.4 45.7 40.6 34.7 30.1 29.0Odebt ervtce/lP Si 12.1 15.9 49.S 12.0 76.8 15.6 16.4 1S.3 14.2 12.9 13.0Inteat /Exw tr ONFS 34.7 38.4 39.9 36.0 37.0 30.4 29.S 27.4 22.3 20.6 t9.0Interest /g* 5.8 8.7 9.3 7.8 10.1 9.8 10.6 10.3 9.1 8.8 8.S130/ Ceuntry P"blic Debt n.8 8.0 7.1 6.4 6.4 7.0 7.3 7.1 6.8 6.7 6.9If/ Cowntry Pubtfc Debt Servtce ej n.a 8.1 2.3 10.4 9.0 6.8 7.3 7.5 9.3 W0.t 9.6 .ISD Debt Sevice / EWts GIIFS n.a 5.1 4.7 5.4 24.1 3.0 3.0 2.8 2.9 2.8 2.6 Preered Crod./P&ile Debt Service a_ n.e 24.8 14.5 23.8 18.8 21.3 22.3 24.1 33.6 34.7 31.8Ccmtrv Sowo n.e 1.7 1.S 1.4 1.6 1.5 1.S 1.4 1.3 1.4 1.4

no t

otetl External Debt (Billion USO 16.6 22.1 23.3 23.6 25.2 26.6 27.9 28.9 32.0 33.8 35.8so =g me" o" Ve go tn"eas" Ikirdentifled (f i raing of pp) n.e 0.0 0.0 0.0 0.4 0.6 0.8 1.0 2.5 3.4 4.1Cnetrc1at S*c n.e S.6 6.1 6.3 6.7 7.0 7.5 8.0 9.2 9.6 10.5srldSm * n.e 1.6 1.S 1.3 1.4 1.6 1. 1.6 1.9 2.0 2.2136 n.e 1.1 1.1 1.2 1.4 1.S 1.5 1.6 1.6 1.6 1.7llateratl n.e 9.8 10.7 10.6 10.7 10.9 11.0 10.9 10.9 11.1 11.4Supifws n.e 1.3 1.4 1.S 1.6 1.7 1.8 1.9 2.2 2.4 2.5~~~~~~~~~~.... .... .... .... . .... .... . .... ..... ....... ..... .. ..... ..... .......Public WLI Dbt 13.1 19.4 20.8 21.0 22.2 23.4 24.4 5.2 28.3 30.2 32.3Private 111 1.2 0.3 0.2 0.2 0.3 0.4 0.4 0.S 0.r 0.8 1.0Central Bank 0.9 1.2 0.9 0.9 1.0 1.2 1.4 1.4 1.2 0.9 0.6short-Term 1.4 1.1 1.4 1.5 1.6 1.6 1.7 1.7 1.8 1.9 2.0............................................................................................................................................................................

*j Pblic debt servfce fIrlt repqumt of arres to ntltilaterss Institutiona (1991 ar 199)an resecbcdling oe wrre owed to bilaterats, ecercisl bans, amd supliers.

46 ANNEX II

PRIu - alor AsumAogyptAa UorvlInA Profxections

The projections illustrate a feasible path for the economy underthe stabilization and structural reforms initiated by the Fujimori Government.The koy country assumptions behind the forecasts are as followas

1. gross Domestic Product (CDP) declined 3.0 per cent during 1992.However, starting in 1993 GDP should growth at a rate of about 3.5per cent, increasing steadily to reach 6.0 per cent in 2000 (anaverage of 5.4 per cent for the period).

2. Population is assumed to grow at 2.5 per cent a year up to 1991,declining to 2.2 per cent by 1997.

3. Exports of goods and non-factor services are expected, because ofthe trade reforms, to be a major contributor to GDP growth. Afteran initial decline of 0.7 per cent in 1992, reflecting theappreciation of the real exchange rate, export growth will recoverby about 2.0 per cent during 1993. Between 1993 and 2000 exportsare assumed to grow at an average of 8.7 per cent per year,increasing their share in GDP from 8.5 per cent in 1992 to about17.6 per cent in 2000.

4. Imports of goods and non-factor services are assumed to grow at anaverage of about 6.9 per cent between 1993 and 2000, to reach alevel of 19.7 per cent of GDP in 2000 (up from 11.6 per cent in1991).

5. The ratio of investment to GDP is expected to increase from 15.5per cent in 1992 to about 19.4 per cent in 2000, with an averageratio of 18.1 per cent during this period, a level comparable toother middle-income economies. During the same period, public grosscapital formation would rise to 4.S per cent of GDP from 3.5 percent.

6. Between 1993 and 2000, growth of GDP would result in a growth Ginconsumption of 3.7 per cent a year, consistent with an averagelevel of total consumption of 84.7 per cent of GDP. This expectedgrowth would be enough to allow an increase in per capitaconsumption from 1994 onwards.

7. For the period as a whole, these trends would result in an increasein domestic savings from 13.6 per cent to 17.3 per cent of GDP.Similarly, national savings, because of the increasing level ofinvestment and improvements in the current account, would increaseto 15.2 per cent from 10.6 per cent of GDP.

8. Increases in Gross Reserves are estimated targets for increases inCentral Bank reserves.

9. Loan Disbursements s estimated disbursoments already in thepipeline and expected new disbursements from the IDB, bilateralcreditors, and unguaranteed private creditors.

10 Direct foreign investment assumes long time delayed investments ingas and oil projects will take place.

11. Debt Rescheduling and Deferral: in 1991 and 1992 all officialbilateral debt is assumed to be rescheduled on the terms secured inthe September 1991 Paris Club negotiations (see below). In 1993and beyond, pre-cutoff debt service due to the Paris Club ofcreditors is assumed to be rescheduled. Other official bilateral

47 ANNEX II

debt is assumed to be serviced. Private debt service is assumed tobe rescheduled every year for 1993-2000 with the exception ofsymbolic interest payments. Starting in 1993, these payments willbe 5 per cent of accrued interest.

The terms of the September 1991 Paris Club agreement are asfollows.

p "choduledsi'

Current maturities due during the consolidation periodW and arrearson short, medium and long-term debt on pre-cutoff debt,F includingpreviously rescheduled debt:

* ODA loans rescheduled at 20 years including 10 years grace,with concessional intereot rate.

* Commercial credits rescheduled at 15 years including 8 yearsgrace, with market interest rate.

Deftrrsdt

1) Moratorium interest due during the consolidation period onrescheduled debts

* 30 per cent to be repaid in four equal semi-annualinstallments beginning November 15, 1992 and ending May1S, 1994.

* 70 per cent to be repaid in six equal semi-annualinstallments beginning May 1S, 1995 and ending November15, 1997.

2) Arrears on post-cutoff debt:

* 100 per cent to be repaid in 12 equal semi-annualinstallments beginning June 30, 1993 and ending December31, 1998 (deferment contingent on performance under theIMF's RAP).

Current maturities due during the consolidation period on postcutoff debt:

* SDR1S million will be deposited into a special accountmonthly during 1992.

In addition, it is assumed that pre-cutoff debt service owed toParis Club creditors will continually be rescheduled through 2000.

Rescheded on terms,erved for havy iebted lower middle income counri.

2/ The consolidation peod is firm October 1,1991 to Dcembe 31, 1992.

Prooff debt is ebt conbrcted before January 1,1983, the timeof the first Pas Cub

48 ANNEX

PERUPRIVATIZATION ADJU LOAN

Mr. Lewis T. PrestonPresident,The World Bank

Dear Mr. Preston:

This Policy Letter sets out the Government's medium-term program for privaization andrelated sectoral legal, policy and regulatory reforms, to be implemented under the PrivatizationAdjustment Loan. This progrm is an integral part of the Government's overall developmentstrategy, which is aimed at liberalizing the economy and enhancing responsiveness to market forces.

A.

Upon taking office in August 1990, the new Goverment launched a major reformprogram to correct fundamental problems in Peru's economy. Key elements of this initial reformpackage involved trade, price and exchange rate liberalization, together with fiscal and monetarymeasures to reduce the deficit and inflation. These measures have resulted in substantia improvementIn major economic Indicators. The rate of inlation fel from 7640% in 1990 to 139% in 1991, andfiuther declined to 56% in 1992. Fiscal performance has also Improved sharply: public sectorborrowing requement fell from 6.4% of GDP in 1990 to 3.0% in 1991 and to 2.5% in 1992. Iherewas no domestic financing of the Consolidated Public Sector Balance. Also, tax collections rose from7.4% in 1990 to 8.4% of GDP in 1991 and to 9.3% in 1992.

B. Qter Struc Regn

A second stage of policy reform began when the Initial economic measures weresupported by a series of broad-based structura reforms, commencing in March 1991. Thesemeasures were aimed at further strengthening fiscal adjustment, promoting domestic and extencompetitiveness, and deregulatng economic activity to promote private sector investment. Keyrefrms implemented in 1991 included: (a) reorganizion of the tax adminion office,simplification of the tax structure, and elimination of taxes on exports; (b) major adjustments in utilityprices and eldiination of wage indexion in public enterprises; (c) elkrination of remg nongtariffbarriers and adoption of a two-tier tariff system (15% and 25%); (d) elimination of most entry/exitrestrictions and monopoly rights of state-owned companies; (e) enactment of a new banking law,s ening of prudtial regulations, and openimg of commercial banking to foreign investment; (f)amendment of the labor stability laws to broaden provisions for layoffs and temporary employment;(g) liberalization of foreign investment legislation to pe foreign investors to remit abroad all netprofts and royalties and to invest under any corporate form or joint venture; and (h) expanding andstrenghening of land property rights.

Ihe Goverment is commited to maintinig and deepening, where neesary, thereform program. Ihe Govement intends to continue the macroeconomic policies and programlaunched In late 1990. We are presenly working with the mulilateal agencies and the SupportGrm at put in place a medium-term macroeconomic progrm and financing plan. Once agreed,m_aoecnomic performance will be monitored in 1993-94 on the basis of the agreed program and

49 ANN

C. - mL1s1RIHfl zjRd

In addition to economy-wide reforms, the Govemment is implementing new policy, legand regulatry reforms in all sectors to promote competition and private Investment and to faciuiprivaization. Priority has been given to those sectors with greatest economic potential (e.g.hydrocarbons, mining, fishenes) or which provide essential public services (e.g. water,telcommunications, electicity). Major sectoral retorms to date, and the agenda of further measuresto be implemented under the Privatization Adjustment Loan, are summaized below.

Hydrocarbons. Despite its potential, the hydrocarbons sector's perforancedeteriorated sharply through the 1980s, as Peru became a net petroleum importer. Many of theproblems stemmed from the heavily controlled policy environment and the monopoly position held byPetroperu. iTis Governmentes objectives are to deregulate the sector, encourage private investment,and privatize Petperu and its subsidiaies. Measures taken to date include: (a) issuane of a 1991decree eliminating Petroperu's downstream monopoly and modifying procedures to facilitateconing out of exploration/ development to the private sector; (b) issuance of a decree deregulatingpstroleum product prices; and (c) preparation of a draft hydrocarbons law, which would fulyibelze the sector and transfer the policy/regulatory functions from Petroperu to the GovenmentMhis law is currently being finalized and we expect to enact it, and the associated regulations, during1993. A new taxv regime for petroleum products, combiing an excise tax with a vaue-added tax(wonsistent with the economy-wide VAT) is being developed and will be implemented during 1993. Inparlel with these reforms, we will transfer Petroperu's policy/regulatory functions to theGovernment during 1993, and we intend to privatize Petroperu and its subsidiaies over the next 24monts, in a nminer that will ensure fill and effective competiion in all petroleum actes andprices. We will also maintain on a contimous basis price deregulaton for all products In the sector.

ing. The Goverment has enacted a series of measures to deregulate mining (whichaccounts for 5% of GDP and 45% of merchadise export) and open the sector to private invesmenThese measures include: (a) issuance of a decree in July 1991 authrizing private sector ownehip ofa minimum of 51% of the major goverment holdings (Centrmn, Hierro Peru and Minero Peru); (b)release, for private sector exploration, of more than two milion hectares of land previously reservedfor the state companies; (c) ination of the reorganization and streamliing of the sector agncies tofacilitate granting concessions for private exploration/development; and (d) enactmt in November1991 of a new Mining Law (Decree 708) which: 'stablished transparent rules for graning concessionsfor exploration and exploitation of minerals and metals; ensure miniW companies the right to remitprofits, free access to foreign exchamge and the right to feely market their production, both abroadand localy. Regulations for the law are cumentiy being prepared and we expect these to be issued byMarch 1993.

Tdeleommunlcatlons. Telecommunications service is underdeveloped in Peru. Taelack of svice reflects several fictors: prior k --1 restrictiDons on prie and for investnt;erosion of real tariffs from 1980-90; and the sector organizaon and revenue-haring arrgementsbetween Ent and CPT. To address these problems, the new Governmet hiroduced a mnuber ofreforms. Telephone rates were inrased by 1000% in August 1990 and have been pedodicalyadjusted since then. In November 1991, a new Telecommunications Law was enacted, establishing aliberalized framework to pr compettion and private (Imcluding forgn) investmen The Lawalso steamlnes the existing reguatory agency, consistent with liblization of the sector.

Futher reforms are necessary to improve and implement the new regime. Revisions tothe cufrent service and revenue-sharing arangements between Entel and CPT a required to ensureconcy with the sector's liberalization, and to facilitate privazation of the Govemen'sholdings. Adjusment of the tariff structure is also requred to reduce iternational rates to ecomic

SO A50N

levels. As next steps in the process, the Government will, by April 1993, prepare a new competitionregime, tariff structure and privatization plan for the telecom sector. We intend to implement thesereforms during 1993-94, as part of the process of privatizing the Government's holdings in the sector.We will also, during 1993, issue regulations for the Telecommunicons Law, pertaining to the newregulatory agency, the various classes of telecom service, the tariff-setting process/methodology, andgranting of concessions.

Flsheries. Fisheries is a key sector, contributing roughly $500 million annually inexport earnings (15% of total Peruvian exports). Anchovy and sardines account for 90% of fishmealand fish-oil production. However, there is a serious over-fishing problem in both species due to theabsence of an effective fisheries resources management regime. To ensure biological sustainability aswell as to help optimize economic benefits for the country, we will enact during 1993 a new fisherieslaw and fisheries resource management regime. We will also reorganize the sector agencies during1993, consistent with the new legal and regulatory framework.

Water. The water sector, particularly in Lima, has serious problems, includingshortages (there is currenly rationing), inadequate access to clean water (over 30% of Lima residentsare not connected to the distribution system), poor water quality, with related health problems, andinadequate access to safe sanitation (50% of Lima residents have access to safe sanitation). TheGovernment is implemening a number of reforms: (a) rates were increased 100% in August 1990 andhave been periodically adjusted since; (b) a special privatization committee was appointed in May1992 for privatizing the Lima company (Sedapal) and technical preparatory work is well underway;and (c) a new water sector law and water resources management regime are being developed toensure adequate water quality and access to service, and to foster private sector participation. Thiswill also entail the establishment of an autonomous regulatory agency for the sector. TheGovermment expects to enact the new water sector law and reguladons, and implement a new tariff-setting process and methodology, during 1993, in parallel with the privatization of Sedapal.

D. tization

Background. Privatization Is a cornerstone of this Government's structral reformprogram. A large-scale privatizadon program is essential to reverse two decades of statistdevelopment policies. Under previous governments, the number of state-owned enterprises (SOEs)increased from 29 in 1968 to 177 by 1990. This development strateg failed. SOE losses and debtsescalated in the second half of the 1980s, as successive governments sought to contain inflationarypressures by controlling prices of SOE goods/services. Immediately upon taking office, the newGovernment implemented significant price increases in key public services to arrest the financialdeterioration of major SOEs. In parallel, trade liberalization and competition reforms were enacted,which exposed SOEs to market forces.

Objectlves/Framework. In mid-1991, in a second phase of strucural reforms, theGovernment decided to launch a large-scale privatization program with the objective of privatizing allholdings by mid-1995. Decree Law 674 was enacted in September 1991, setting out the legal andinstitutional framework for a broad privatization program. Ihe decree set up an iter-ministerialcommission (COPRI), under the direct supervision of the President, to oversee the privatizationprogram. The technical preparatory work is to be carried out in a decentralized manner by specialcommittees which are designated by COPRI for either one or a group of SOEs.

A small technical secretariat to support COPRI was established in February 1992. Aswell, more than 30 special committees have been appointed to prepare/implement individualprivatizations; these commitees are now fully operational. COPRI has established a process for

S1 ANNEX M

special committee reporting. Under this proces, privzatlon plas prepared by the specialcommitt have been approved by COPRI for roughly 20 SOEs.

Agenda. Since late May, eleven privutizations have been completed (yielding US$250million), including holdings in mining (Hierto Peru, Minera Condestable, Minpeco USA, andQuellaveco), banking (Banco de Comercio), chemicals (Quimpac), ship repair (lasa), transport(Aeroperu and Enatru), and hydrocarbons (Solgas and 78 of Petopeu's 82 gas stations). Over thenext four months, we expect to offer for sale several other holdings, Including: the petroleumshipping company (Petrolera Transoceanica), the remaining Petroperu gas stai, hree indusrialcompanies (Cementos Lima, Reactivos Nac6onales, Bayer Indus ), a rice trding company (Ecasa),and the remaining ships of the shipping company (CPV).

In 1993-94, the Governm epects to pvaze I larger, more complex holdings,including the remaining mining SOEs (Cenuomin and Minero Peru, which wil be privaized inseverai units), the telecom holdings (Entel and CP7), the oil company (Pe,roperu) the major fishprocessing company (Pescaperu), the major elecicity SOEs (Electrolima, Electroperu), the Limawater company (SEDAPAL), the steel company (Sideperu), the pulp and paper company(Paramonga), and the remaining stateowned banks. Special privatization committees have beenappointed for all these holdings and preliminuy technical work is well underway. Theseprivazations are exet to require a longer preparatory period to address policy and regulatoryissues and/or sensitive labor and political issues.

Operational Guidelnes. To ensure coordinaton and consisency In the overallprogram, COPRI has issued detailed guidelines to the special commite setig out the process to befollowed in preparing and implementng all privons. hese guidines set out the process for,inter alia:

- designation by COPRI of SOEs to be privatized;

- establishment of special commite;

preparation of the special committee work programs and budgets;

preparation of privatization plans by the special committees;

- technical preparatory studies to be undertaken (audit, valuadon, lega opinion) and theprocedures for hiring consultants and hvestment banks;

- public announcemets and promotional cmpaigns;

- process and criteria for pre-qualification of bidders (where appropriate);

- the format and content of biig docmen;

- determining the base price for the public bidding;

- the sales methods and process; and

- employee pardcipaion.

52 ANNEX m

Under the framework of the Privatizadon Law (DL 674), COPRI and the specialcommittees will follow these guidelines in implementing the privatization program. This will alsoensure that the process is fully transparent and that each company will initially be offered for salethrough a public bidding process. In addition to setting out detailed procedures to be followed by thespecial committees in preparing and implementing privatizations, the guidelines specify that: (a) onlyminimal essential investments should be undertaken in SOEs to be privatized; any restructuring shouldbe limited to workforce and cost reductions and settlement of debts with the Government orgovernment-owned entities; and (b) no monopoly protection or privileges should be granted to thenew owners; in cases where there are natural monopoly aspects, the concessions for the privateoperators should be designed to increase competition to the extent possible.

Social Impact. As part of a cost reduction program, SOEs have reduced theirworkforce by roughly 10,000 workers over the last two years. It is expected that further reductionsof approximately 15,000 employees will be implemented by SOEs prior to their privatization.Payments to displaced workers will be limited primarily to contractual obligations for social benefits.The legal obligation for payment of these social benefits lies with the SOEs, not the Government.Nevertheless, we will monitor this process closely to ensure that all efforts are being made to meetthese obligations.

The impact of labor reductions may be particularly adverse in communities where SOEsare the major employer (e.g. Hierro Peru in San Juan de Marcona, Siderperu in Chimbote, Centrominin La Oroya). Hierro Peru has implemented a program whereby displaced employees, in addition toreceiving severance pay, have been provided with counselling on investment and employmentopportunities, in-house vocational training, and advice on setting up micro-enterprises. The programalso facilitates the subcontracting of some SOE non-core activities to dismissed workers. As well,social services, previously provided by Hierro Peru, have been transferred to other public agencies.Given the apparent success to date of this program, we will work with other SOEs, where SOEworkforce reductions may adversely affect the communities, to develop and implement similarprograms. We expect that UNDP and the World Bank, through the Privatization TechnicalAssistance Loan, will provide financial assistance in developing these programs.

Environmental Impact. Some of the enterprises being privatized, particularly in themining sector, have environmental problems. Potential investors are seeking clarification from theGoverment concerning the scope of the problems and the environmental standards and enforcementmeasures to be applied. To address these concerns, the Government is carrying out environmentalaudits, where necessary, as part of the technical preparation for privatization. These audits willspecify: the extent of environmental problems; the estimated cost of cleaning up past problems and ofimproving operations to comply with environmental standards. On the basis of the environmentalaudits, the Government will clarify for potential investors their environmental responsibilities (if any).In all cases, privatized firms will be subject to the same environmental laws and standards as othercompanies.

(NPoJorge Camet DickmanMinister of Economy and FinanceLima, PeruMarch 24, 1993

53 AN Y

PERUPRIVATIZATION ADJUSTMENT LOAN

Sectoral lRegulator Reforms and Privatization

A. Mining

Backrund

1. The mining sector is one of the main components of the Peruvian economy, contributing5% of GDP and 45% of total merchandise exports. The sector's poor performance in recent yearshad a significant impact on the overall economy. The three major state-owned mining companies,Centromin, Hierro Peru, Minero Peru, and their subsidiaries, produce 40% of the lead mined inPeru, 38% of the zinc, and 100% of the iron ore. The state mining companies are responsible for40% of total sector output. Production declined by 25% in the second half of the 1980s, duringwhich time the overall net investment was negative. Inadequate investment inhibited the expansion ofproduction and exploration as well as the ability to repair and replace equipment. By 1990, the majorstate-owned mining companies were operating at an average of 75% of their installed capacity. Thedeterioration of the state mining companies was due to several factors, including unfavorableexchange rates, increasing labor costs and overstaffing, energy shortages and the unreliability of thepower supply, inadequate investment for replacement, and insufficient maintenance of machinery andequipment.

2. Centromin, the largest state mining company, was established in 1975 through thenationalization of the former US-owned Cerro de Pasco Corporation. The operations of Centrominconsist of seven mines - six of which are polymetallic - and one metallurgical complex at La Oroya.In 1991, Centromin was operating at 20-25% below production capacity and reporting losses of up toUS$ 1 - 2 million per month.

3. Hierro Peru, an iron ore company, was obtained by the Government of Peru in 1975through nationalization of the former US-owned Marcona Company. Although the financialperformance of Hierro Peru has been poor in recent years, the company was successful beforenationalization and continues to have profit potential.

4. Minero Peru was established by the Government in 1970 as the vehicle for new miningdevelopment and was granted the right to mineral deposits in the reserved areas. Its main operationsinclude the Cerro Verde copper mine, the copper refinery of Ilo, and the zinc refinery ofCajamarquilla. The operating condition of Minero Peru has deteriorated over the last five years, withonly the Ilo copper refinery having maintained 1985 production capacity. The Cerro Verde mineproduction decreased by 60 percent and the Cajamarquilla refinery declined by 20 percent. Inaddition to its core operations, Minero Peru owned (until recendy) Minpeco, the trading company forthe state mining companies, and a smaller mining operation, Minera Condestable.

Recent Reforms and Government Strategy

5. Privatization. Privatization has been moving rapidly in the mining sector. In July 1991,the Government issued Decree Law 647 authorizing private sector ownership of a minimum of 51%of the shares in Centromin, Hierro Peru, and Minero Peru. Ihis was followed by Decree 675 inOctober 1991 which authorized the privatization of Minpeco. Although Decree 647 was neverratified, the privatization program continued under Decree Law 674, which established the legal and

54 ANHXE

institutional framework for the Goverment's overall privatizadon program. By March 1992, specialcommiuees had, been established to manage the privatization of sevea mining companies, includingHierro Peru, Centomin, lno Peu and Mimnra Condestable. These committees hired consultingfirms to undertake valuatons, prepare the biddig/sales docments, and assist with sales promotion.

6. By end-1992, the Govenment had privated four holdings in the mining sector, includingHierro Peru ($120 million in cash plus $150 million In investent commitments), Minera Condestable($1.3 million), MinpeO ($4.1 million), and Qudlaveco (an undeveloped mining project belonging toMinero Peru: $12 million plus $570 million in Investmen com en).

7. The other major holdins - Centromin and Minero Peru - will be privadzed in 1993/94,likely in several componens. Valuation are undeway for both companies and investment bankshave been hired to analyze the opto for breaking up the companies and to assist in the preparationand execution of the sales. A key issue for potenta Investors, particularly in Centromin, will be itsenvironmental problems and the respective responsibilities of the new owners and the Govermment forcleanup of past problems and improvement of opeations to comply wih environmental standards.Environment audis are being undetaken to asses the problems and provide cost estims forcleanup and operational impements. Based on these audits, the Government will clarify in thebidding/sales documents the xtent of the problems and the responsibilities of the new owners (ifany). In all cases, privatized firms will be subject to the same enviromnental laws and standards asother companies.

8. Fraylw or On November 14, 1991, the Government enacted a newM ng Law (Decre Law 708 for the Promotion of Private Investment in the Mining Sector). hsnew minin law guaratee mining companies tax bility and the right to operate under the sameforeign exchange law offecti at the time op started. Concessions will be granted for theexploration and exploiation of miners and metals. A draw back system will be effective as ofJanuary 1, 1993, allowIng mWing companies to deduct local ae (cluding inect taxes) from theirincome taxes. In addition, the law miing companies the same treatment as othercompaoies rega th dght to remit profts, fee access to fireln exchange and free marketing ofproduction, boh abroad and locally.

9. Sector hnsttutdons. The sector situtions are presenly under reorganization to reducepersonnel and reorient fucions and responsibities consistent with a lieralized, privatzed sector.The sector institutions cude: (a) General Mining Directorate: personnel have been reduced andoperations streamlined into two units, the Promon and Devlpment Directorate and theFisaization D ireorate; (b) Directorat: this is a newly creaed unit within theMistry, responsible for the forunlation of sectoral enironmental policy and enforcement ofregulton; (c) Public Mining Registry: this has bee stmin o the two main functions ofhdling the legal asp incudn registration of all mining rigb, documents, contracts, etc, and ofadministtion of concessio; (d) Geological Mning _is : this agency is responsible forgeological surveys, public research, d technology; it has siplified its structre and reducedpersonnd. While ee cges hv b significa, fiuher Improvemets i be required to allowthe Institutions to execute their mandates and activities more efficietly, consisten with a fullyliberalized mining sector. his Istiion wil be sorted by the Bank through aplanned Enr and Minng TA Loan

55 ANNEX IV

Further Reforms to be Supported by Xt Loan

10. In order to ensure the success of the privatization and the continued development of thesector, issuance of regulations for the Mining Law is a condition of second tranche release.

1B. Hydrocarbons

akgQUond

11. Peru's oil and gas sector declined sharply during the 1980s. Domestic productiondeclined from 195,000 baTrels per day (bpd) in 1982 to 110,000 bpd in 1992, and the country shiftedfrom being a petroleum exporw to a net importer ($186 million in 1991). Known reserves droppedby 50% from their peak level in 1982 to 300 million barrels (enough for less than 9 years at currentconsumption levels). Investments in exploration and development also declined sharply over the sameperiod.

12. The sector has been heavily state-controlled. 'he major state-owned company, Petroperu,is directly responsible for 36% of Peruvian oil production (40,000 bpd) and for the supervision of theremaining 64% which is produced by foreign companies under concession agreements with Petroperu.until 1991, Petroperu had a monopoly on all trade (export and import), transport, storage, refiningand retail distribution of all petroleum products. Many of these activities are carried out by wholly-owned subsidiaries, including Petromar (operating the ex Belco offshore fields producing 20,000bpd), Petrolera Transoceanica (oil shipping), Solgas (iquefied petroleum gas (LPG) distribution, with40% of the market), and Serpetro (drilling service). Retail istribution is carried out primarily byprivate operators under Petroperu franchise. In addition to its dominance in upstream anddownstream activities, Petroperu also carries out many policy/regulatory functions normally handledby government ministries/agencies in other countries, including: direct negotiaing and signing of allcontracts and concessions with foreign oil companies for exploration/development; and collecingtaxes from private operators on behalf of Government

13. The sharp decline in the sector was a direct result of an inadequate policy, legal, andregulatory framework implemented by prior governmn, which precluded competition and privateinvestment, and controlled product prices below economic levels, thereby contributing to a severedeterioration in the financial position of Petroperu. Petroperu has negative net worth and accumulatedlosses of $2 billion over the three-year period 1989-91, with the result that it has been unable tofinance normal maintenance and exploration expenditures.

Recent Reforms and Government S

14. Ihe new Government's objectives are to deregulate the sector, encourage competition andprivate invesmen, and privatize Petroperu and its subsidiaries. This will require a series of legal,policy, regulatory and tax reforms, given tha the prior regime reflected Petroperu's monopolyposition in upstream/downstream markets and its role as fiscal agent for the Government in collectingpetroleum product taxes. Several transitional measures have been implemented by the newGoverment, though full dereguion and competition can only be adcieved through the enac ofa new hydrocarbons law (under preparation), implementation of a new contractual framework forexploration/production by private firms, and the privatzatlon of Petroperu.

56 ANNX IV

15. The transitional measures taken to date include: (a) issuance of a decree in 1991eliminating Petroperu's monopoly on downstream activities (importing, refining, storage,transportation, distribution) and modifying procedures to facilitate contracting out, to the privatesector, of upstream activities (exploration and production); (b) the new Government increaseddomestic petroleum product prices by 3000% in August 1990. Retail prices for 84 octane gasolineare roughly $2/gallon, though the bulk of this reflects special taxes; ex-refinery prices net of taxes areactually below international levels (roughly 17% on average at end-1992) for most products; and (c)issuance of a decree in June 1992 formally deregulating petroleum product prices. However, theGovermment has maintained de facto control over Petroperu's prices, pending the implementation ofthe new legal framework for the sector which will redefine Petroperu's relationship with theGovernment.

16. In parallel with the policy/regulatory reforms, the Government has been implementing theprivatzation of Petroperu's gas stations, a small refinery (Conchan), and four subsidiaries - PetroleraTransoceanica, Solgas, Serpetro, and Petrolera Transoceanica. Implementation of these privatizationsis underway, through special privatization committees. To date, Solgas and 78 of Petroperu's 82 gassions have been sold. Ihe Conchan refinery, Serpetro, Petromar, and Petrolera Transoceanica areexpected to be sold by the end of the first quarter of 1993.

17. The Government expects to privatize all of Petroperu by end-1994. Given the size andcomplexity of Petroperu's remaining upstream and downstream operations, COPRI has recently hiredexal consultants to assess in greater detail the structura options (i.e. how to break it up) andsequencing for the privaization of Petroperu, consistent with the Government's objective to privatizeaUl of Petroperu by end-1994. Ihis study will be finalized by mid-1993 and provide the basis forpreparing a detailed implentadon plan for privatization of Petroperu.

Further Rers to be Suported by the Loan

18. iegislation. While the measures taken to date are aimed at deregulation/liberalization, anew legal framework for the sector is required to complete and implement the sectoral reforms. Adraft of a new hydrocarbons law has been prepared, which would fully liberalize the sector, transferthe policy/regulatory fumctions from Petroperu to the Government (e.g. the grandng of concessions toprivate companies for oil exploration and production), and establish new legal/contramalarrangements between the Government and petroleum companies. Within the new legal framework,Petroperu's relations with the Govarnment would be on a fully commercial basis (identical to privatefirms), while it is being privadzed. Prices would be fully liberalized. Royalties and concession feesfor exploration and production would be established on an identical basis for private petroleumcompanies and Petroperu. Similarly, the existing special consumption taxes on petroleum products(currently collected from Petroperu) would be progressively replaced by excise taxes and a value-added tax applied to all downstream products (consistent with the economy-wide VAT). These taxrefomns are necessary in a deregulated/competitive market and would bring petroleum producttaxation in line with the overall tax system, while maintaining fiscal revenues from petroleumproducts during the macroeconomic adjustment period.

19. Given the importance of this new legal famework and tax regime for deregulation,compeitdn and private investment in the hydrocarbons sector, submission to Congress of a draft lawon hydrocafons and a draft law establishing the tax regime for petroleum products, and preparationof draft regulations for these laws is a condition of second tranche release. Enactment of thehydrocarbons law and legislation establishing the tax regime for petroleum products, and issuance of

57 AN

the regulations for these laws is a condition of third tranche release. (Note: this condition has beenpartially fulfilled wit the enactment in December 1992 of legislation establishing the new tax regimefor petroleum products.)

20. Privadtlon. Preparaion of an implementation plan and timetable for the privatizationof Petroperu is a condition of second tranche release. On the basis of the implementation plan forPetroperu, the Bank and the Government will agree on the assets of Petroperu to be offered for saleby third tranche.

C. Telecommunications

21. Telecommunication service Is very undeveloped in Peru. The country has only 575,000lines or 2.6 lines per 100 population, compared to 10.2 in Argentina and 9.1 in Venezuela. Demandfor new lines is estimated at 1.1 million, though real unmet demand is likely much higher given thelong waiting period (1 112 years) and high installation cost. Service is provided by two companies:ENTEL, which is responsible for all regional phone operations (outside Lima), as well as longdistae and inernational service; and CPT, which serves the Lima metropolitan area. ENTEL is100% stae-owned and was created in 1969 when it absorbed services previously provided byGovernment commissions and foreign companies which were nationalized. CPT, which was createdin 1970 when 1T&T was Lationalized, Is mainly subscriber-owned (69%), with the Governmentholding 21% of the remaining shares and private shareholders holding 10%. ENTEL and CPT haveassets totalling US$689 million (1991 book value). In addition to these basic services, a private firmhas been providing cellular service in Lima for the last two years.

22. Several factors have contributed to the very low level of telecommunication service inPeru: (i) prior legal restrictions on private and foreign participation in telecommunication services; (ii)erosion of real tariffs from 1980-1990; and (iHl) the sector organization and revenue sharingarrangements, whereby ENTEL receives the bulk of the long distance and international call revenue(although CPT customers account for 87% of the traffic). Originally, it was intended that these fundswould be used by ENTEL for network expansion outside Lima, but in practice these funds havesubsidized major inefficiency within ENTEL.

Recen Refbn ad Gov e

23. The new Government has taken some important steps to reform the sector. A 1000%tariff increase was introduced in August 1990 and rates have been periodically adjusted since.Second, a new Telecommunication Law was enacted in November 1991 to promote competition andprivate and foreign investment in all services, and to establish a new regulatory regime. Third, newPresidents have been appointed in both CPT and Entel to manage the companies during the transitionperiod prior to privatization.

24. The Government's objective for the sector, is extremely ambitious - a target of 10 lineeper 100 population by the year 2000. This would require massive investment though preliminaryfigures suggest that a major portion of this could be financed from internal cashflow with modesttariff rebalancing, assuming an efficient operator and major efficiency improvements. This can likelyonly be realized through privadzation to an experienced international operator. While the Lima-basedcompany (CPI1) would likely be atratve to investors, ENTEL in its current form would not. Some

58

changes in the sector organization or revenue-sharing arrangements betweea CPT and Entel may benecessary to facilitate pvaion, while ensu network development and efficient service outsideLima. The special committee for telecom privatizatdon was appointed in May 1992 and has recentlyhired international consultants, legal advisers, and investment bankers to assist with the sectorreorganization and privatization. lhe committee, with the assistance of the consultants, will initialyfocus on reviewing structl options for sector reorganization and privatzation.

Further Reforms tQ be uprted Xt Lon

25. Ihe Loan will support the preparadon and implementation of a sector reorganization andprivatization plan, as wel as Implementation of the new regulatory regime. As a condition for secondtranche release, the Government will prepare a new competition regime, tariff structure andprivatization plan for the telecommunications sector. As a condition of third tranche release, theGovernment wil implement the competition regime, tariff structure and privatization plan, and issueregulations for the Telecommunications Law with respect to: (a) the operation of the new regulatoryagency; (b) the major classes of service; (c) the process and methodology for seting tariffs; and (d)the process for granting of concessions.

D. Pisheris

26. The marine waters off Peru are among the richest in the world, and prior to the 1970s,Peru was one of the world's top fishing nations. However, the sector has declined significandy overthe last twenty years as a result of increased government intervention and the losses caused by the ElNiflo warm water current of 1972-73 which dissipated the Important anchovy catch. Ihe fisheriessector represents roughly 15% of total merchandise expots, with foreign exchange earnings of $500million annually. In the upstream fishing activity, the main species have been anchovy and sardines,which are used predominantly (over 90% of all catches) for fisbmeal and fish-oil. Peru currendyproduces roughly 26% of world fishmeal and fishoil; onetW of Peru's production (8% of worldproduction) is handled by the state-owned fish processiog company, Pescaperu.

27. Oveall efficiency in the sector is low, with an average fish to fish meal ratio of 5.13:1,as compared to the worldwide average of 4.78:1. Government involvement has been one of themajor obstacles in the sector's development, particulary due to unfair competition with privateinitiative and inefficiency in business management, which hurts Peruvian fisheries competitiveness ininternational trade. Apart from the ineficiency of the sector, there is a serious problem of over-fishing, due to the absence of an effective fishetk resources mana8ement regime tbat would ensurebiological sustainability as well as opdmize economic benes for the country.

28. The Government owns six enterprises in the fishery sector. Ihe primary entprise,Pescaperu, was created in the early 1970s and soon thereafter acquired a monopoly in the fishmealindustry through the takeover of 99 fishmed plants. The company is presely losing US$16 forevery ton of fishmeal produced. Pecaperu produces lower qult products, from the same rawm rials, than its international competitors (principally Chile) and therefore receives 10-20% lowerprices for its fishmeal. The company is highly inefficient, with rougly 1500 excess employees of atotal workforce of 3500. It presently owns 20 operational procesng units, 16 redndat unitks, guano ferdlizer plant, and 4 oil refineries. Seven of Its plant could handle 70% of its capacity.

59

Another major state-owned enterprise, Epsep, was established in 1970 with the moopoly fordomestic fish distnbution, to ensure the supply of fish for human COnsUmptiOn, espely tO lowincome groups. The Government maintained support of Epsep, despite Its losses, because of thecompany's social role. Audits from 1980 to 1988 reveal poor fanci managemen reflected In nonprofitable investments, uncontrolled expenses and poor centralized management of the operationalunits. Epsep is overstaffed, with 1,100 workers, wbile its needs are estimated to be 400 workes.In the mid 1980s, the Government created Flopesca, with a fleet of fishing boats, as a subidiary toEpsep, with the objective of supplying the domestic market with frozen fish. This company has nevergenerated a profit. Copes is a mixed company created in 1974 between Epsep, in representon ofthe Government, and Star Kist, a private tuna canning company. The company has been unilatrallymanaged by Epsep in the last five years, during which time it has suffered major losses ($8 million In1988). Caper, a previously privately owned firm, was expropriated in 1970 and given a monopolyover fish product certification. Over the last few years, its managerial and financial conditon hasalso deteriorated.

Reforms nd CYmCL Stey

29. The Government has recently accelerated structural reforms in the sector. Aninterational conference was held in June 1992 to review the experiences of other countries infisheries resource management and to provide the basis for the preparation of a new fisheries law andregulatory regime for Peru. A Govermnent committee subsequently prepared a draft Fisheries Lawwhich, inter alia, establishes a modern legal framework for the fishery sector and will enable theintroduction of a workable fisheries resource management regime. It is expected that the Governmentwill adopt a regime which creates catching rights - expressed as shares in total allowable catch -which constiute transferable property rights. This system, referred to as Individual TransferableQuota system, is currently being implemented, with positive results, in several major fishing nationsincluding Iceland, Norway, and New Zealand.

30. Privatization of the state fishery companies Is progressing quickly. Flopesca is currentlyunder liquidaton. A subsidiary of Pescaperu, Inasa, which is responsible for boat mantenance, wassold to the private sector in July 1992. Special committees have been appointed for the privatizationof Pescaperu, Epsep and Cerper. International consultants, financed by a Canadian grant, havecommenced the valuation of Pescaperu's plants. The Government has eliminad Epsep's monopolyof fish distribution and Cerper's monopoly on the supervision of the quality of fish products. Inaddition, cargo handling has been liberalized, allowing for a decrease in the cost of port serviceswhich had been among the most expensive in the world.

Eur Reforis to be S9pord by the Loan:

31. The Loan will require, as a condition for second tranche release, the submission toCongress of a fisheries law and preparation of draft regulations establishing the fisheries resourcemanagement regime. Enactment of the fisheries law and issuance of the regulations establishing thefisheries resource management regime is a condition of third tranche release. (Note: this conditionhas been partally fulfilled with the enactment in December 1992 of the new fisheries law.)

60

E. Water

32. Through a system of 13 state-owned municipal companies, the Government controls 100%of all water and sewage operations and distribution. At present , only 73% of the urban population hasaccess to water and 50% to sanitation. In the rural areas, only 22% have access to water and 6% tosanitation. Average annual investment in this sector for the 1985-1989 period represented approximately0.15% of GDP - one of the lowest investment levels in Latin America. The quality of service hasdeteriorated steadily during the last two decades. In Lima, water pressure in 70% of the districts is belowthe minimum recommended pressure. Water service is not provided on a continual basis in Lima, andwater rationing is on the rise. Although there are still about 30% of existing connections in Lima withmeters in good working condition, most of these customers are billed assuming that their monthlyconsumption is 50 cubic meters. The problems are compounded by the scarcity of water resources in theLima area and the poor quality of the water: the raw water arriving at La Atarea - the water treatmentplant for 75% of Lima's supply - is so poor that all samples analyzed during a Bank mission in May1991 tested positive for cholera.

Le s Refo and the Goverment Strategy

33. In November 1991, the Government issued Legislative Decres No. 697, promoting privatesector investment in water and sewage activities. Also in November 1991, the Government issuedSupreme Decree No. 171, which declared Senapa, the national water and sewerage enterptise, andCortapa, the commission which regulates tariffs in the sector, to be in a state of emergency andauthorized their directors to conduct an economic and financial stabilization as well as an administrativerationalization, including staff reduction with a program of incentives for voluntary retirement. In June1992, the Special Privatization Committee for Sedapal (the Lima company) was established. Thecommittee, with support from a Japanese grant for the water sector, is currendy hiring consultants toassist with the technical analyses and preparation of bidding/sales documents for the privatization ofSedapal. It is expected that the public tender process will be held by end-1993. In parallel, the Bankis condminug preparation of the Lima Water Privadzation and Rehabilitation Project to support neededinvestments. The design of the project will depend upon the results of the privatization and the firm'srequirements following privaftzation.

uther Reforms be uMorted by the Loan

34. Ihe Loan will require, as a condition for second tranche release, the submission to Congressof a water sector law and preparation of draft regulations for the law. Enactment of the water sector law,issuance of the associated regulations, and establishment of the new regulatory agency are conditions ofthird tranche release.

61

PERUPRIVAIUATION ADJUS wLOAN

Suhnlentary Ltn Da Shetd

Section I: Timetable of Ke Event

(a) Time taken to prepare: 11 months

(b) Program prepared by: Ministry of Economy and Finance, and COPRItechnical secretariat

(c) Appraisal mission departure: October 1992

(d) Completion of Negotiations: December 1992

(e) Planned date of effectiveness: May 1993

Section H: Special Bank Implementation Actions

None

Section m: Special Cgnditions

1. 'MTe condition of effectiveness is:

(a) maintenance of a macroeconomic policy framework and a financing plan consistent withthe objectives of the reform program.

2. The conditions of second tranche release are:

(a) maintenance of a macroeconomic policy framework and a financing plan consistent withthe objectives of the reform program;

(b) submission to Congress of a draft law on hydrocarbons and a draft law establishing thetax regime for petroleum products, and preparation of draft regulations for these laws;

(c) issuance of the regulations for the Mining Law;

(d) preparation of a new competition regime, tariff structure, and privatization plan for thetelecommunications sector;

(e) submission to Congress of a draft water sector law and preparation of draft regulationsfor the law;

(f) submission to Congress of a draft fisheries law and preparation of draft regulationsestablishing the new fisheries resource management regime;

62 AK=V

(g) offer for sale of at least $450 million in assets from the privatization agenda, with aminimum of $275 million in assets from two of the three sectors of mining,hydrocarbons, and telecommunications; and

(h) preparation of an implementation plan and timetable for the privatization of Petroperu.

3. Tbe conditions of third trandce release are:

(a) mntenance of a macroeconomic policy framework and a financing plan consistent withthe objectives of the reform program;

(b) enactment of the hydrocarbons law and legislation establishing the tax regime forpetroleum products, and issuance of the regulations for these laws;

(c) implementation of the competition regime, tariff structure and privatization plan for thetelecommuications sector, and issuance of regulations for the Telecommunications Lawwith respect to: (a) the operation of the new regulatory agency; (b) the major classes ofservice; (c) the process and methodology for setting tariffs; and (d) the proccss forgrantng of concessions;

(d) enactment of the water sector law, issuance of the regulations for this law, andestablishment of the regulatory agency for the sector;

(e) enacuent of the fisheries law and issuance of the regulations establishing the fisheriesresource meement regime;

(f) offer for sale of at least $1200 million in assets from the privatization agenda, with: (a)a minimum of $300 million in assets of companies from each of the mining andtelecommuInications sectors; and (b) assets from Petroperu in accordance with the agreedimplementtion plan and timetable; and

(g) actual sale tb the private sector of at least $600 million in assets from the privatzationagenda

63 ANNEX

THE STATUS OP BANK GROUP OPERATIONS IN PERIA'

A. SUMMARY IAEIMENT OF LOANS

(As of Deenmber 31, 1992)

Amount lessLAW No ]EX Borrower Pfrm concolatin Undisbunsk d

(US$ million)

Sixty (60) Loans fidly disbursed 1201.69

of which Program Loan' Z

*1693 1979 Peru Program Loan 115.

3437 1992 Peru Trade Policy Reform 300.00 300.003452 1992 Peru Structral Adjustment 300.00 300.003489 1992 Peru Finanial Sector Adjutdment 400.00 400.003452-1 1993 Peru Strctrl Adjustment 150.00 150.003540' 1993 Peru Privatizaton T. A. 2= 30.00

TOTAL 2381.69

of which has been repgud 13.

Total now outtandng 1867.85

Amount sold 18.31of which has been repaid 1. 3

Total now held by Bank 1849254

Total undisbursed 118MJO

4SECAL, SAL or Program Loan

V This report mill be updated as of Narch 31 1993. It will reflect the following: (a) principal repayments byPeru of US$24.9 million from January 1 to March 15 1993; (b) principal repayments of USS482.6 million on March 181993; (c) Bank disbursements of USS 900 million under the Trade Policy Reform Loan (US$300 million), the StructuralAdjustment Loan (USS300 million) and the Financial Sector Adjustmznt Loan (US$300 million); and Cd) cancellation ofthe supplemental amount approved under the SAL (USS150 million).

N Approved during 1979.

m Not yet signed.

MOTE: The status of the projects listed in Part A ts described in a separate report en all BanknIDA financedprojects in execution, which is updated twice yearly and circulated to the Executive Oirectors on April30 and October 31.

64 ANNEX.Vl

B. STATEMENT OF IFC INVESTMENTS(As of December 31, 1992)

US$ MillionDate Borrower Tvpe of Business La= Eauitv i3ig

1979/83/86/90 Buenaventura Metal Ore Mining 6.00 2.97 8.971986 CARISA Non-Ferrous Ore Mining 6.00 0.50 6.501962 Cemento Andino Cement Lime & Plaster 2.46 0.20 2.661982 Conenhua Electric Light & Power 4.50 - 4.501975 Peru Copper Non-Ferrous Ore Mining 15.00 - 15.001960 Durisol Fabric Metal Products 0.30 - 0.301960/62 Fertilizantes Fettilizers & Pesticides 4.09 - 4.091960 Luren Non-Metallic Mineral PR 0.28 - 0.281985 Minera Regina Non-Ferrous Ore Mining 6.08 0.24 6.321986 Orcopampa Non-Ferrous Ore Mining 9.00 - 9.001964/67 Pacasmayo Cement Lime & Plaster 1.60 0.50 2.101983 Palmesa Vegetable & Animal Oil 15.00 - 15.001986 Poderosa Non-Ferrous Ore Mining 3.30 - 3.301960 Reunidas Fabric Metal Products 0.25 - 0.251980/85 SIMSA Non-Ferrous Ore Mining 6.70 0.50 7.201982/92 SOGEWIESE Leasing Companies 13.00 1.57 14.57

Total Gross Commitment 93.56 6.47 100.03Less Cancellations, Terminations

and Sales 84.19 2.77

Total Commitments now held by IFC 9.36 3.70 13.82

Total Undisbursed 0.31