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Country Report

Peru

April 2007

The Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom

Peru at a glance: 2007-08

OVERVIEW The president, Alan García of the centre-left Partido Aprista Peruano (Apra), took office in July 2006 for a four-year term. Having gained the backing of the country’s business sector, unlike in his ruinous first term as president (1985-90), Mr García will continue to implement the investor-friendly policies of the past decade. Mr García, whose approval ratings have remained at around 50%, has inherited a strong economy and is fortunate to be in power at a time of record-high mineral prices. Strong fiscal revenue growth will provide scope for him to implement his social policies, but will also raise expectations. With over half of the population living in poverty, Mr García will, within the constraints of maintaining hard-won fiscal stability, attempt to reduce inequalities by boosting public investment in basic infrastructure, such as water connections, sanitation and road construction. Economic growth will be driven by investment related to the Camisea natural-gas project, as well as by growing exports of minerals, textiles and agricultural produce. Vigilant monetary policy and a stable currency will help to keep year-end inflation anchored around the 2% Central Bank target. The current-account surplus will rise in 2007-08, although expansion will slow as softening commodity prices contribute to an erosion of the trade surplus.

Key changes from last month

Political outlook • Mr García vowed to resume coca-eradication efforts, suspended in March,

with increased force. The government finds itself in an increasingly difficult position in its efforts to combat coca production; its existing policy shows signs of futility and the cocalero sympathisers in Congress are becoming more vocal.

Economic policy outlook • A series of new tax laws were enacted in March, with the aim of

streamlining the investment process and eliminating tax exemptions.

Economic forecast • The Economist Intelligence Unit has made no substantive changes to its

economic forecast since its March report.

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Peru 1

Country Report April 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007

Contents

Peru

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2007-08 7 Political outlook 8 Economic policy outlook 9 Economic forecast

12 The political scene

15 Economic policy

17 The domestic economy 17 Economic trends 20 Sectoral trends 20 Mining 21 Oil and gas 22 Manufacturing 23 Agriculture 24 Infrastructure

25 Foreign trade and payments

List of tables 9 International assumptions summary 11 Forecast summary 16 Non-financial public sector operations 17 Gross domestic product by expenditure, 2006 18 Gross domestic product growth by sector, 2006 19 Consumer price inflation 20 Mining and fuels production 23 Manufacturing activity, 2006 23 Agriculture and livestock production, 2006 24 Crop production 25 Merchandise exports 26 Merchandise imports 27 Current-account balance

2 Peru


List of figures 12 Gross domestic product 12 Consumer price inflation 14 Mr Garcia’s approval rate 19 Commodity prices 20 Exchange rate 26 Export and import prices

Peru 3


Peru April 2007

Summary

The president, Alan García of the centre-left Partido Aprista Peruano (Apra), took office in June 2006 for a four-year term. Having gained the backing of the country’s business sector, Mr García will maintain policy continuity and continue to implement the investor-friendly policies of the past decade. He has inherited a strong economy and is fortunate to be in power at a time of record-high mineral prices. Strong revenue growth will enable him to implement his social policies, but will also raise expectations. With over half of the population living in poverty, Mr García will focus on attempting to reduce inequalities by boosting public spending, primarily through investment in basic infrastructure. Nevertheless, Mr García will pursue a broadly pro-market economic policy and will not jeopardise Peru’s hard-won fiscal stability. Economic growth will be driven by the Camisea natural-gas project, as well as by growing exports of minerals, textiles and agricultural produce. Vigilant monetary policy and a stable currency will help to keep year-end inflation anchored around the 2% target. The current-account surplus will rise in 2007-08, although expansion will slow as softening commodity prices contribute to erosion of the trade surplus.

Mr García remains popular, despite the resignation of his interior minister and charges of Apra favouritism in choosing her replacement. Questionable procurements by several ministries have prompted inquiries. Disagreement within the government on its coca-eradication policy has exposed vulnerabilities. Both of Mr García’s predecessors are facing criminal charges.

Peru posted its highest fiscal surplus ever in 2006, at US$1.9bn (2.1% of GDP), as revenue growth outpaced spending growth. Corporate tax revenue rose to 3.7% of GDP, owing primarily to the increased profitability of the mining companies. Spending growth was constrained, owing to weak implementation capacity.

Real GDP grew by 8% in 2006, the largest increase since 1995. In 2006, unlike in previous years, domestic demand, rather than exports, was the main driver of growth, rising by 10.4% year on year.

Commodity prices in 2006 were among the most favourable for Peru since the 1950s. Despite weak volume growth, export earnings rose by 37%, rising from US$23.7bn in 2006. As a result, the current account posted a surplus of US$2.5bn (2.6% of GDP) in 2006, the second-highest surplus since data was first collected in 1950 and a year-on-year increase of 122.2%.

Editors: Bronwen Brown (editor); Justine Thody (consulting editor) Editorial closing date: April 5th 2007 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

The political scene

Economic policy

The domestic economy

Foreign trade and payments

Outlook for 2007-08

4 Peru


Political structure

Republic of Peru

Presidential democracy

The president, who is directly elected for a five-year term, may not be re-elected to a second consecutive term; he appoints a Council of Ministers

Elected president, currently Alan García, who was inaugurated as president in July 2006

Congress consists of a 120-member single chamber, which can be dissolved once during a presidential term

Courts of first instance in the provincial capitals; the Supreme Court sits in Lima

April 2011 (presidential and congressional)

Alan García leads the government; his party, the Partido Aprista Peruano (Apra), has 36 of 120 seats in Congress

Government: Partido Aprista Peruano (Apra) Opposition: Unión por el Perú (UPP); Unidad Nacional (UN); Partido Nacionalista Peruano (PNP); Alianza por el Futuro, Frente del Centro; Perú Posible; Restauración Nacional

President Alan García President of the Council of Ministers & prime minister Jorge del Castillo

Agriculture José Salazar Defence Allan Wagner Economy & finance Luis Carranza Education José Antonio Chang Energy & mining Juan Valdivia Foreign relations José García Belaunde Health Carlos Vallejos Housing, construction & sanitation Hernán Garrido Lecca Interior Luis Alva Castro International trade & tourism Mercedes Aráoz Justice María Zavala Labour Susana Pinilla Production Rafael Rey Transport & communications Verónica Zavala Women & social development Virginia Borra

Julio Velarde

Official name

Form of state

The executive

Legal system

National elections

National government

Main political organisations

Key ministers

Central Bank president

Head of state

National legislature

Peru 5


Economic structure

Annual indicators

2002a 2003a 2004 a 2005 a 2006a

GDP at market prices (Ns bn) 200.6 213.9 237.8 261.6 305.3

GDP (US$ bn) 57.1 61.5 69.7 79.4 93.3

Real GDP growth (%) 5.2 3.9 5.2 6.4 8.0

Consumer price inflation (av; %) 0.2 2.3 3.7 1.6 2.0

Population (m) 26.7 27.1 27.5 27.9 28.4b

Exports of goods fob (US$ m) 7,713.9 9,090.7 12,809.2 17,336.3 23,749.5

Imports of goods fob (US$ m) 7,421.8 8,237.8 9,804.8 12,076.1 14,896.8

Current-account balance (US$ m) -1,150.9 -957.9 19.3 1,105.1 2,456.1

Foreign-exchange reserves excl gold (US$ m) 9,339.1 9,776.8 12,176.4 13,599.4 16,733.3

Total external debt (US$ bn) 28.1 29.6 31.2 28.7 28.2b

Debt-service ratio, paid (%) 32.9 21.1 16.7 25.8 11.0b

Exchange rate (av) Ns:US$ 3.52 3.48 3.41 3.30 3.27

a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2005 % of total Components of gross domestic product 2006 % of total

Agriculture, livestock & forestry 8.4 Private consumption 61.2

Fisheries 0.5 Government consumption 9.6

Mining & hydrocarbons 6.6 Gross fixed investment 21.0

Construction 4.9 Stockbuilding 0.1

Manufacturing 15.3 Exports of goods & services 27.4

Services 52.9 Imports of goods & services -19.2

Principal exports 2006 US$ m Principal imports 2006 US$ m

Gold 4,011 Intermediate goods 7,989

Copper 6,007 Capital goods 4,145

Fishmeal 1,331 Consumer goods 2,613

Zinc 1,991 Other goods 150

Total exports fob 23,750 Total imports fob 14,897

Main destinations of exports 2005 % of total Main origins of imports 2005 % of total

US 31.0 US 19.9

China 10.8 China 9.3

Chile 6.6 Brazil 8.7

Canada 5.9 Ecuador 8.1

6 Peru


Quarterly indicators 2005 2006 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 QtrNon-financial public sector finance (Ns m) Central government revenue 9,356 11,283 9,788 10,619 12,130 14,651 12,890 13,044Central government expenditure 8,276 8,712 9,755 11,629 9,602 9,594 11,239 12,230Other entities 1,422 772 1,383 456 1,390 1,147 1,772 614Capital revenue 37 61 119 91 78 82 77 86Capital expenditure 1,179 1,518 1,901 3,207 1,301 1,739 2,347 3,645Overall balance 1,360 1,887 -366 -3,669 2,694 4,547 1,153 -2,132Overall balance (% of GDP) 2.3 2.7 -0.6 -5.3 3.9 5.7 1.5 -2.6

Output Manufacturing production index (2000=100) 116.3 127.7 120.2 125.1 128.1 134.4 133.0 140.1Manufacturing production index (% change, year on year) 6.5 8.5 7.0 5.3 10.2 5.2 10.7 12.0GDP at constant 1994 prices (Ns m) 34,464 39,187 36,262 38,546 37,237 41,723 39,596 41,827GDP at constant 1994 prices (% change, year on year) 5.9 5.9 6.3 7.7 8.0 6.5 9.2 8.5Employment, wages and prices Unemployment rate (end-period; % of the labour force) 11.3 9.7 9.3 8.0 9.0 8.9 8.5 7.7Average nominal wages (Ns per month) n/a 999 n/a 954 n/a 1,026 n/a n/aAverage nominal wages (% change, year on year) n/a 2.4 n/a -3.1 n/a 2.7 n/a n/aConsumer prices (Dec 2001=100) 107.8 108.5 108.7 108.9 110.4 111.0 110.7 110.6Consumer prices (% change, year on year) 2.2 1.8 1.2 1.3 2.4 2.3 1.8 1.5Wholesale prices (1994=100) 165.6 166.3 167.7 170.2 172.0 172.9 173.1 173.3Wholesale prices (% change, year on year) 3.3 1.4 1.5 2.9 3.9 3.9 3.2 1.9Financial indicators Exchange rate Ns:US$ (av) 3.26 3.26 3.27 3.39 3.34 3.29 3.24 3.22Exchange rate Ns:US$ (end-period) 3.26 3.25 3.34 3.43 3.36 3.26 3.25 3.20Deposit rate (av; %) 3.2 3.4 3.5 3.6 4.3 5.2 5.0 3.3Lending rate (av; %) 26.2 25.9 25.8 24.2 24.2 24.3 24.0 23.2M1 (end-period; Ns m) 23,327 23,709 24,785 26,338 28,109 28,160 30,017 32,694M1 (% change, year on year) 6.1 8.6 13.3 11.0 20.5 18.8 21.1 24.1M2 (end-period; Ns m) 64,857 67,389 69,806 75,518 79,315 76,208 78,746 84,395M2 (% change, year on year) 4.7 6.9 11.6 16.8 22.3 13.1 12.8 11.8IGBVL stockmarket index (end-period, 1991=100) 4,159.9 4,038.1 5,070.8 4,802.3 4,803.3 4,804.3 4,805.3 4,806.3IGBVL stockmarket index (% change, year on year) 37.0 39.9 54.7 29.4 15.5 19.0 -5.2 0.1Foreign trade & payments (US$ m) Exports fob 3,749 4,063 4,544 4,980 4,639 5,830 6,572 6,709 Gold 643 652 808 1,062 958 1,067 1,042 944 Copper 684 706 832 1,135 925 1,442 1,884 1,757 Fishmeal 250 357 369 171 307 289 359 180Imports fob -2,660 -3,004 -3,158 -3,254 -3,386 -3,648 -3,683 -4,180Merchandise trade balance fob-fob 1,089 1,059 1,386 1,726 1,253 2,182 2,889 2,529Services balance -213 -220 -133 -267 -216 -228 -186 -302Income balance -1,117 -1,131 -1,322 -1,506 -1,726 -2,070 -1,978 -1,875Net transfer payments 384 434 449 488 474 541 564 605Current-account balance 143 142 380 440 -217 425 1,290 957Reserves excl gold (end-period) 13,116 13,380 13,209 13,599 13,892 13,828 14,607 16,733

Sources: IMF, International Financial Statistics; Banco Central de Reserva del Perú, Nota Semanal; Bolsa de Valores de Lima.

Peru 7


Outlook for 2007-08

Political outlook

Although the president, Alan García of the centre-left Partido Aprista Peruano (Apra), remains popular (50% national approval rating in March 2007) and his defeated populist rival, Ollanta Humala, weak, he faces a range of challenges to governability, stemming not least from the high expectations of improved social conditions that he has fostered. Having gained the backing of the country’s business sector, something he did not have during his disastrous first term (1985-90), Mr García will continue to implement the investor-friendly policies of the past decade. He has inherited a strong economy and is fortunate to be in power at a time of record-high mineral prices. The extra revenue provided by strong economic growth will enable him to implement his social policies, but will also raise expectations. With over half of the population living in poverty, Mr García will focus on reducing inequalities by boosting public spending on infrastructure, such as water connections, sanitation and road construction.

Mr García has sought to project an image of austerity by slashing the salaries of public servants and cutting costs at the Presidential Palace and some executive offices. These measures have been well received by the public, especially after the perceived extravagances of the Toledo administration (2001-06). It remains to be seen, however, if they will be enough to soothe the discontent reflected in the strong showing of Mr Humala in the April 2006 presidential election and of independent local candidates in November’s regional elections. The government will continue to invest in social and economic programmes to ease poverty in the southern highlands, where Mr García’s support is lowest. The extent to which Peruvians in poor, remote areas, who have often shown strong support for populist and anti-system alternatives, support the new government will be determined by whether the government is able to communicate that it is actively pursuing these programmes. Mr García will face the challenge of maintaining the momentum of these programmes beyond the first year of his government. With divisions deep, discontent could flare at any time, potentially undermining governability.

Against this backdrop, Mr García’s government will remain vulnerable and the president may be tempted to opt for populist measures. Apra, which controls only 36 seats in the 120-member Congress, is a disciplined party and should also, given the inclusive nature of Mr García’s government, be able to garner enough support to pass legislation. The opposition in Congress is weak and divided. The political alliance formed by Mr Humala has disintegrated and his popularity has dwindled. The central government will need to manage relations with the regional governments carefully. There remains the risk that mismanagement of regional government will herald a new period of public disaffection, social unrest and civil disobedience in the regions, and potentially the emergence of another maverick radical leader.

Although the Peruvian Congress ratified a bilateral trade-promotion agreement (TPA) with the US in June 2006, the current US Congress failed to consider the

Domestic politics

International relations

8 Peru


agreement before the end of its term. The Democrats, who took control of the US Congress in January, have threatened to vote against the agreement unless it is modified to include new provisions on labour standards. The TPA is designed to replace the Andean Trade-Promotion and Drug-Eradication Act (ATPDEA), which allows tariff-free entry to the US of around 6,000 products. Although scheduled to expire at the end of 2006, the ATPDEA was extended by the US Congress in early December for a period of one year. The Economist Intelligence Unit’s forecast is premised on the assumption that if the US Congress fails to ratify the free-trade agreement (FTA), the ATPDEA would again be extended through 2008. However, if the FTA is not passed, there is a risk that investment could fall below forecast levels.

The construction of a major road link with Brazil is expected to strengthen commercial relations and boost investment in both countries. Mr García visited Brazil in mid-2006, when he and the Brazilian president, Luiz Inácio Lula da Silva, pledged to forge closer economic and political ties. The governments of Peru and Chile will work more closely following the signing in August 2006 of a bilateral TPA.

Economic policy outlook

Mr García’s government will seek to consolidate the sound policy framework established by the previous administration. This consists of a disciplined fiscal stance, an inflation-targeting regime and a managed float of the currency. Mr García has emphasised that fiscal responsibility is paramount, and his appointment of a fiscal conservative, Luis Carranza, as minister of finance, suggests that this will be a priority. However, there will be more of an emphasis on policies to tackle high levels of poverty and raise living standards. With fiscal revenue growth forecast to remain strong in 2007-08, Mr García should have the resources he needs to implement his social investment programme without jeopardising fiscal stability. In addition to increasing public investments, Mr García’s government will continue to seek private investment in productive sectors, as well as in transport infrastructure, through a concessions programme.

Under the Ley de Responsabilidad y Transparencia Fiscal (LRTF, the Fiscal Responsibility and Transparency Law) passed in 2003, the non-financial public sector (NFPS) deficit should not exceed 1% of GDP and annual spending growth should not exceed 3% in real terms. We expect Mr García to abide by this rule. Following a large fiscal surplus in 2006, with booming corporate tax revenue outweighing rising expenditure, we expect fiscal policy to become significantly more expansionary in 2007-08, with the government using revenue to fund spending on infrastructure and social programmes. This will be reflected in a narrower surplus of 0.3% of GDP in 2007, reflecting a gradual drop in commodity prices and continued strong spending. Although we expect fiscal discipline to be maintained in 2008, the fiscal position will weaken somewhat as commodity prices soften further, although we do not expect the fiscal balance to fall into deficit.

Policy trends

Fiscal policy

Peru 9


The Banco Central de Reserva del Perú (BCRP, the Central Bank) has successfully pursued a formal inflation-targeting regime since 2002, prompting it to reduce its inflation target by 0.5% in January to its current level of 2%, plus or minus 1 percentage point. Since May 2006 the BCRP has kept its benchmark reference interest rate at 4.5%. This followed a period of steady monetary tightening. With inflation currently on target, we expect the BCRP to remain on hold, though given strong demand growth in 2007 a further tightening of policy is possible. The BCRP will probably seek to keep real rates at around 3% in 2007-08, which is considered a neutral level.

Economic forecast

International assumptions summary (% unless otherwise indicated)

2005 2006 2007 2008

Real GDP growth World 4.7 5.3 4.7 4.6

US 3.2 3.3 2.2 2.6

EU27 1.7 3.0 2.4 2.3

Exchange rates ¥:US$ 110.1 116.2 114.0 103.0

US$:€ 1.25 1.26 1.33 1.35

SDR:US$ 0.68 0.68 0.66 0.65

Financial indicators US$ 3-month commercial paper rate 3.38 5.04 5.15 5.00

US$ 3-month Libor 3.56 5.19 5.31 5.15

Commodity prices Gold (US$/troy oz) 445.0 604.5 652.5 642.5

Copper (US cents/lb) 166.8 305.6 296.8 250.0

Oil (Brent; US$/b) 54.7 65.3 61.0 58.0

Food, feedstuffs & beverages (% change in US$ terms) -0.5 16.1 5.3 -2.0

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

Global economic growth measured at purchasing power parity (PPP) exchange rates is forecast to moderate to 4.7% in 2007 and 4.6% in 2008 as global policy tightens. The Federal Reserve (the US central bank) appears to have reached a peak rate at 5.25%, but the Fed Funds rate may need to respond to the possibility of renewed inflationary pressures. Longer-term rates, which have only now begun to react to the steady increase in short-term rates, are likely to rise, and this will probably reduce portfolio flows to emerging markets. The cost of servicing Peru’s variable-rate debt will increase as a result. A forecast slowdown in the economy of the US, Peru’s largest export market, will constrain export dynamism, but we expect exports to increase steadily, taking advantage of preferential market access and continued strong demand from Asia, particularly China. We expect Peru’s terms of trade to strengthen further in 2007, helped by continued high copper prices. Tight supply and threats of industrial action, combined with strong global demand, kept the international price of copper at an average US$3.06/lb in 2006, and the market fundamentals are not expected to change quickly. Continued strong demand is expected to keep copper prices

International assumptions

Monetary policy

10 Peru


high, at an average US$2.97/lb in 2007, before moderating to a still-high US$2.50/lb in 2008.

The risks to our global assumptions still emanate predominantly from the US. A slide in the US dollar could prompt an aggressive rise in interest rates, or the US economy could decelerate more sharply than forecast, reducing external demand. In the context of tightening global liquidity, such developments could increase the risk of stress in international capital markets, where abundant global liquidity has been leading to a mispricing of risk by highly leveraged investors. Although risk appetite may again recover quickly following the latest spate of turbulence to hit the global finance markets in late February, the outlook is for greater volatility.

Having increased by 8% in 2006, real GDP, driven by strong growth in private consumption, investment and exports, will moderate to a still robust 6.8% in 2007 and 5.4% in 2008. Our forecast acceleration in private consumption is premised on a continued high level of consumer confidence and the growth of employment in export-oriented industries, which, in the context of stable low inflation, will underpin continued growth in real incomes. Investment, which has been a major contributor to growth since 2005, will moderate, following a particularly strong surge in 2006. Average growth in investment in the outlook period is nevertheless projected to remain at double-digit levels, underpinned by the second phase of the Camisea natural-gas project and several major mining investments. Taking advantage of a strong fiscal position, the government will substantially increase public spending on social programmes and infrastructure investments in 2007. Public investment in transport infrastructure and a low-cost housing programme will stimulate construction.

Real export growth was compressed in 2006, owing to flat growth in the volume of mineral exports and a sharp decline in fishmeal exports. In 2007, as these supply-side conditions are normalised, we expect export volumes to rebound to more normal levels. Export volumes will therefore accelerate strongly in 2007 and 2008, even as global demand moderates. We expect export agriculture and textiles to continue to benefit from preferential access to the US market; the free-trade agreement (FTA) between Peru and the US should spur investment in export sectors once it is ratified by the US Congress. Real import growth will remain strong, in line with firm private consumption and investment. However, the rebound in real exports will cause the negative contribution of the external balance, which emerged as a result of problems in the export sector, to diminish in the outlook period.

The BCRP is on course to keep consumer price inflation within its medium-term target range of 1-3% in the forecast period. In 2006 year-average inflation rose slightly on 2005 levels, to 2%, but has remained one of the lowest inflation rates in Latin America and well below levels in the US. Adherence to an inflation-targeting regime within the context of a stable exchange rate has been effective in containing price pressures. The BCRP is expected to remain vigilant and inflation is forecast to remain below US levels. The credibility of the Central Bank on this issue is extremely high, having secured an average inflation rate of 1.9% in 2001-05.

Economic growth

Inflation

Peru 11


The currency was trading at Ns3.18:US$1 in early April, a nominal appreciation of 5.3% over the past 12 months. The current-account surplus is keeping upward pressure on the currency and we expect this trend to continue in 2007, but we anticipate a gentle depreciation in 2008 as the current-account expansion slows. The BCRP, which operates a managed float, will seek to maintain the competitiveness of the exchange rate, intervening periodically to smooth episodes of volatility. Our projections envisage an average exchange rate of Ns3.21:US$1 in 2007 and Ns3.24:US$1 in 2008, representing a modest real depreciation from current levels.

Peru will run a trade surplus throughout the forecast period, based on the strong performance of mining, agricultural and manufactured export earnings. However, the surplus will narrow steadily, owing to rapid growth in import spending as a result of strong investment and private consumption. Income debits, which grew strongly in 2006, will continue to rise in 2007 in line with profit remittances from mining companies, limiting the extent to which strong export earnings feed through to a current-account surplus. The continued steady increase of family remittances from Peruvians abroad will ensure an increasing trend in net current transfer inflows. Overall, we expect the current account to stay in surplus in 2007-08. We currently assume that annual foreign direct investment (FDI) will average around US$2bn in 2007-08. This will be equivalent to an average of just over 2% of GDP, which is below the average of the previous few years, when inflows were boosted by several mega-projects in the mining and energy sectors. During the outlook period, FDI will be mainly directed into mining, energy and transport projects.

Forecast summary (% unless otherwise indicated)

2005 a 2006 a 2007b 2008b

Real GDP growth 6.4 8.0 6.8 5.4

Industrial production growth 6.9 9.5 6.0 5.5

Gross fixed investment growth 13.6 19.0 15.6 9.3

Unemployment rate (av) 7.6 7.5 7.4 7.3

Consumer price inflation (av) 1.6 2.0 1.1 2.4

Consumer price inflation (year-end) 1.5 1.1 2.4 2.4

Short-term interbank rate 25.5 23.9 17.0 16.0

NFPS balance (% of GDP)c -0.3 2.1 0.3 0.1

Exports of goods fob (US$ bn) 17.3 23.7 26.0 26.9

Imports of goods fob (US$ bn) 12.1 14.9 17.3 19.5

Current-account balance (US$ bn) 1.1 2.5 3.0 3.3

Current-account balance (% of GDP) 1.4 2.6 2.9 3.0

External debt (year-end; US$ bn) 28.7 28.2 d 27.5 27.3

Exchange rate Ns:US$ (av) 3.30 3.27 3.21 3.24

Exchange rate Ns:US$ (year-end) 3.43 3.20 3.22 3.26

Exchange rate Ns:¥100 (av) 2.99 2.82 2.81 3.15

Exchange rate Ns:R (av) 4.87 4.82 4.87 5.02

a Actual. b Economist Intelligence Unit forecasts. c Non-financial public sector, excluding privatisation receipts. d Economist Intelligence Unit estimates.

Exchange rates

External sector

12 Peru


Peru Latin America

Gross domestic product(% change, year on year)

Peru Latin America

Consumer price inflation(av; %)

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

20

02

03

04

05

06

07

08

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

20

02

03

04

05

06

07

08

The political scene

In late February the president, Alan García, suffered his first loss of a cabinet member since taking office in July 2006. Pilar Mazzetti, the interior minister, was forced out following allegations of improprieties stemming from the purchase of police vehicles. The contract price for the purchase of the 469 vehicles, made with Automotores Gildemeister, a Chilean company, was found to have been inflated by millions of dollars. Mr García initially defended Ms Mazzetti, whom he had appointed with the intention of rooting out endemic corruption in the interior ministry, insisting that she was innocent. Although Ms Mazzetti was never openly accused of corruption, she was branded a poor manager for failing to oversee adequately such a large procurement. Ms Mazzetti, who had built a reputation for honesty while serving as health minister in the Toledo government (2001-06) eventually lost the support of Mr García and the prime minister, Jorge del Castillo, and was forced to submit her resignation.

Ms Mazzetti’s tenure as interior ministry was turbulent. She was routinely involved in internal disputes with high-ranking officers in the Policía Nacional del Perú (PNP, the Peruvian national police), which has been plagued by corruption scandals since its creation during Mr García’s first presidency (1985-90). She tried to reduce lucrative fuel allocations for police vehicles and to reform the PNP’s healthcare system; she also estimated publicly that at least 20% of Peru’s police officers were involved in some form of corruption. Her openly thorny relationship with powerful forces within the ministry prompted widespread speculation that she was forced out to frustrate her attempts at reform.

With his decision to appoint Luis Alva Castro, a congressman and a long-time Apra stalwart who served as a cabinet minister in Mr García’s first term, to the post of interior minister, Mr García has received widespread criticism for succumbing to party pressure and going back on an implicit pledge not to stack the cabinet with party members. Mr Alva Castro is not known for his management skills or for a having a strong commitment to fighting corruption.

The minister of interior resigns

Mr García faces accusations of Apra favouritism

Peru 13


He has faced accusations by party colleagues of rigging the primary election for legislative candidates in his home province of La Libertad. Mr Alva Castro has sought to portray a willingness to fight corruption and pledged to have outside committees oversee ministry tenders, a politically sensitive move.

The criticism that Mr García received over the appointment of Mr Alva Castro underscores his potential vulnerability in managing his relationship with Apra, which was linked to corruption and party favouritism during Mr García’s first term as president. In a move to reassert his neutral position, Mr García has fired several prominent Apra members from their government posts during the past few months. In March Mr García sacked Carlos Arana, an Apra party militant, as head of the Agua para Todos (Water for All) programme after Mr Arana made public accusations of blackmail against the head of the government’s contracts and acquisitions department, Ricardo Salazar. Benedicto Jiménez, a prominent former police officer and Apra’s Lima mayoral candidate in November 2006, was forced to resign as head of the Instituto Nacional de Penitencaria (INPE, the national prison system) after media reports that he tipped off Fernando Zevallos, the former owner of the now-defunct Peruvian airline, Aero Continente, that an undercover investigation was being carried out against him.

Irregularities in government purchases at the Ministry of the Interior have prompted investigations at a variety of other ministries. After a congressional commission launched an investigation into the purchase of ambulances from Automotores Gildemeister by the Ministry of Health, the company and the government came to an agreement to cancel the procurement owing to irregularities. A tender for school supplies, which was part of the government’s emergency social investment programme, was also cancelled by the minister of education, Antonio Chang, after it was discovered that prices had been inflated. In February Mr García asked the Inter-American Development Bank (IDB) and United Nations Development Programme (UNDP) to take charge of government purchasing in a bid to avoid corruption. Both organisations agreed to provide assistance in the form of training government officials. Mr del Castillo also announced that a new law of government purchasing is under development.

Despite recent political setbacks, Mr García’s popularity remains high. A poll conducted in mid-March by Apoyo, a local firm that monitors public opinion, showed his approval rating at 63% in Lima and at 50% nationwide. His popularity is mainly attributed to strong economic growth and his skills as a communicator. Mr García has effectively distanced himself from political scandals and has managed to portray himself as a mediator of conflicts. In February he successfully sidestepped allegations that he was involved in the decision to storm the El Frontón prison in 1986 during his first term in office, which led to the killing of more than 100 prisoners. When he was called as a witness in an investigation into the massacre, he took the opportunity to say in a televised address from the government palace that he had nothing to hide and had been cleared of any wrongdoing several times. By regularly using the government palace as a backdrop for events and speeches, Mr García has kept his exposure high in the national media. Unlike his predecessor, Alejandro

Mr García’s popularity remains high

Procurement irregularities prompt reform

14 Peru


Toledo (2001-06), Mr García takes questions from reporters and communicates with the public through the media. Although at times he has had to backtrack on his comments, he has managed to do so without affecting his popularity.

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

Jul

2006

Aug Sep Oct Dec Feb

07

Mar

Approves

Disapproves

Mr Garcia's approval rate

(%)

Source: Apoyo Opinion y Mercado SA.

A controversial agreement reached between Peru’s minister of agriculture, Juan José Salazar, and coca growers has exposed the failures of the country’s forced eradication efforts, as well as the rising influence of the cocaleros in Congress. The agreement was reached after coca growers in Tocache, located in the northern jungle department of San Martín’s Upper Huallaga Valley, clashed violently with police after blocking a main highway in protest at the government’s forced eradication efforts in the area. The agreement, which has since been overturned by Mr García, allowed coca farmers from Tocache to grow their crops if they followed specific conditions and stipulations, such as the detailed registration of all coca crops grown and their sales activity. When news of the agreement was made public, Mr Salazar was criticised for caving in to pressure from the coca growers, who now enjoy representation in Congress. However, the episode also focused attention on Peru’s poor track record in eradicating coca. The area under coca cultivation has increased rapidly, particularly in the Ene-Apurimac Valley, now the country’s main coca-producing area. According to government estimates, around 90% of the coca grown in Peru is used to make cocaine. Violence could flare again, particularly if the government continues to strengthen its efforts to directly confront drug trafficking activity. In the first three months of 2007, the national police destroyed 142 laboratories, seized 106 tonnes of coca leaves, eradicated 651 hectares of coca under cultivation, and destroyed around 9,500 marijuana plants.

In late December Mr Toledo was charged with falsifying signatures to register his party, Perú Posible, for the 2000 election. A witness testified that Mr Toledo was personally involved and paid people for the fake signatures. Mr Toledo, who has denied any wrongdoing, failed to appear in mid-January before the investigating judge, Carolina Lizarraga. Mr Toledo, who is now teaching at Stanford University in the US, has alleged political persecution by “obscure alliances”, referring to a vote in which both Apra and members of Alianza por

Coca-eradication efforts temporarily suspended

Mr Toledo is charged with election fraud

Peru 15


el Future (Alliance for the Future), the party of disgraced former president, Alberto Fujimori (1990-2000), to create a commission to investigate allegations that he misspent public money while entertaining guests at the government palace. Mr Toledo’s wife, Eliane Karp, is also facing an investigation by anti-corruption prosecutors for misuse of funds while presiding over a government indigenous rights commission.

The head prosecutor from the Chilean Supreme Court, Monica Maldonado, announced in late March that a decision could be made about the extradition of Mr Fujimori by mid-April. Although the final decision lies with a Chilean judge, Mr Fujimori could be returned to Peru in the next few months. This has the potential to increase tensions in Congress, which has a small, but vocal, group of Fujimori supporters who have formed a tacit alliance with Apra. In the event of his extradition, Mr García’s party, which has 36 members in the 120-member Congress, would be obliged to distance itself from the 13-member Fujimorista bloc, which includes Mr Fujimori’s brother, Santiago, and his daughter, Keiko. Mr Fujimori’s return to Peru would have a destabilising effect, increasing social unrest and renewing political divisions.

Economic policy

In 2006 the non-financial public sector (NFPS) posted the highest surplus since data on the fiscal accounts were first collected in 1950. At 2.1% of GDP, or Ns$6.3bn (US$1.9bn), the result well outperformed the official target of a deficit of 1% of GDP as established in the Marco Macroecónomico Multianual (MMM, multi-annual macroeconomic framework). One of the main reasons for this improvement was an increase in the primary surplus of the NFPS, which rose to 3.9% of GDP in 2006 from 1.6% in 2005, as revenue growth outpaced spending growth. This was aided by improved tax collection, primarily in the form of higher income tax, owing to the increased profitability of the mining companies. Corporate tax revenue rose from 2.3% of GDP in 2005 to 3.7% of GDP in 2006.

Although central government current expenditure rose by 11.2% in nominal terms in 2006, it fell slightly in real terms, from 14.7% of GDP in 2005 to 14.2% in 2006. There was an increase of 0.1% of GDP on investment expenditure and a 0.6% decrease in current expenditure. The decrease in current expenditure was owing primarily to the government’s inability to spend allocated money quickly enough on several programmes, including a US$32m agricultural guarantee programme, a US$200m regional investment programme, a US$63m fund for competitiveness research and development and a US$15m scholarship fund.

Large fiscal surplus posted in 2006

A decision on Mr Fujimori’s extradition is imminent

16 Peru


Non-financial public sector operations (Ns m)

4 Qtr Year 2005 2006 % change 2005 2006 % changeCentral government current revenue 10,619 13,044 22.8 41,046 52,715 28.4Central government current expenditure 11,629 12,230 5.2 38,371 42,665 11.2 Non-financial 10,359 10,975 5.9 33,577 37,252 10.9 Financial 1,269 1,255 -1.1 4,794 5,413 12.9

Central government current balance -1,010 814 - 2,675 10,050 275.7Other entities 456 614 34.5 4,033 4,922 22.0Capital revenue 91 86 -5.6 308 323 5.1

Capital expenditure 3,207 3,645 13.7 7,805 9,032 15.7 Public investment 3,171 3,604 13.7 7,468 8,576 14.8 Other capital costs 36 41 15.9 338 456 35.1Primary balance -2,321 -842 -63.7 4,277 11,956 179.6(% of GDP) -3.4 -1.0 -70.6 1.6 3.9 143.8

Overall balance -3,669 -2,132 -41.9 -789 6,263 -(% of GDP) -5.3 -2.6 -50.3 -0.3 2.1 -Net financing: 3,669 2,132 -41.9 789 -6,263 -External 7 306 4,495.9 -3,813 -2,178 -42.9Domestic 3,609 1,763 -51.1 4,417 -4,389 - Privatisation 53 63 19.1 185 304 64.5

Source: Banco Central de Reserva del Perú.

In March the Ministry of Economy and Finance announced that it had approved a series of new tax laws with the aim of streamlining the investment process and eliminating tax exemptions. The government began work on the reform in December 2006 after receiving special legislative powers from Congress. One of the laws eliminates the current tax exemption on capital gains from January 1st 2009, with income earned to be taxed at a rate of 5%. The other law extends the special regime for early return of the value-added tax (VAT) to all industries during the initial investment stage on investments over US$5m (with an exception for agriculture). The early return of the tax is already available to investors in the mining and hydrocarbon sectors. Also included in the reform package is the elimination of a series of complex tax exemptions in the jungle departments of San Martín, Amazonas, Ucayali, and Madre de Dios that have been in effect for over 30 years. The decision was made primarily to combat tax evasion and illegal overland smuggling. The existing exemptions will continue in the city of Iquitos, as it can only be reached by air or river.

In addition to eliminating tax breaks, the new laws make several changes to the tax code with regard to streamlining payments and other processes by reducing tax loopholes. The rates of the Impuesto Temporal de los Activos Netos (ITAN, a temporary tax on net assets), and the Impuesto de Transacciones Financieras (ITF, a financial transactions tax), both important sources of revenue, were lowered. The taxes, which were established in 2004 and were designed to expire after three years, have been extended several times by Congress. The new reform means that they will stay in effect at least through to the end of Mr García’s term in 2011, but will be charged at a lower rate. The rate of the ITAN was lowered only slightly, from 0.5% currently, to 0.4% by 2009. The ITF

Tax reform eliminates exemptions

Peru 17


will fall more dramatically, from 0.08% currently to 0.5% by 2010. According to MEF estimates, the reduction of the ITF will cost the treasury around US$35m in 2007.

The domestic economy

Economic trends

Having lasted 23 consecutive quarters, the current economic expansion is the longest sustained period of output growth since quarterly data were first collected in 1970. Real GDP grew by 8% in 2006, the largest increase since 1995. In 2006, unlike previous years, domestic demand, rather than real exports, was the main driver of growth, increasing by 10.4% year on year. Following growth of 7.2% year on year in the fourth quarter, private consumption grew by 6.3% in 2006, pushed up by higher disposable income (up 12%) and rising employment, consumer credit and remittances from abroad. Owing mainly to capital investments in the mining and industrial sector, private investment increased by 22% year on year in the fourth quarter and grew by a total of 20.1% during 2006, the greatest increase since 1995. The high rate of private investment reflected the widespread optimism among members of the business community; higher profit reinvestments, updating of equipment and plant expansions led to a 35.4% increase in capital goods imports in 2006.

Public-sector domestic demand increased by 9.7% in real terms in 2006 as public consumption rose by 8.7% and public investment grew by 13%. The main driver of public investment in the fourth quarter was the launching of the García government’s US$600m “investment shock”. Owing to bottlenecks in public procurement, however, only around half of the allocated amount was spent.

For the year, real exports of goods and services were the weakest component of aggregate demand, increasing by only 1% year on year. This was owing mainly to a decline in primary exports, such as fishmeal (down 34%), gold (down 8.4%) and copper (down 3.7%). Following minimal growth in the first nine months of 2006, exports barely rose in the fourth quarter. Imports surged during the fourth quarter, rising by 18.5% year on year. For the year, imports increased by 12.4%, owing mainly to higher domestic demand for raw materials and capital goods. As a result of these trends, the external balance made a negative contribution to growth for the first time since 1997.

Gross domestic product by expenditure, 2006 (% change, year on year)

1 Qtr 2 Qtr 3 Qtr 4 Qtr YearPrivate consumption 5.6 5.8 6.6 7.2 6.3Government consumption 8.6 9.1 8.7 8.4 8.7

Gross domestic investmenta 36.5 12.5 28.2 31.5 26.3 Private 24.3 17.6 16.8 22.0 20.1 Public 8.4 13.3 17.1 12.4 13.0

GDP growth is led by strong domestic demand

18 Peru


Gross domestic product by expenditure, 2006 (% change, year on year)

1 Qtr 2 Qtr 3 Qtr 4 Qtr YearExports, goods & services 1.0 2.2 1.0 0.1 1.0Imports, goods & services 16.4 7.7 7.1 18.5 12.4

Domestic demand 11.2 7.5 10.8 12.5 10.4GDP 8.0 6.5 9.2 8.5 8.0

a Includes change in stocks.


Non-primary sectors of the economy grew by 9.3% year on year in 2006, compared with primary sector growth of 4% year on year. The construction, commerce and non-primary manufacturing sectors were the most buoyant. The launch of operations at the Cerro Verde copper mine and the Southern Peru Copper Company (SPCC) smelter in Ilo, coupled with an increase in residential building and local government infrastructure development projects, led to year-on-year growth of 13.5% in the construction sector. Non-primary manufacturing output grew by 7.7% as demand for consumer products such as processed food items and personal care products rose. Construction-related non-primary manufacturing also increased.

Growth in the primary sectors in 2006 was led by agriculture and livestock (up by 7.2% year on year). Agriculture production, which increased by 12.1% in the fourth quarter, grew by 7.7% for the year, owing to favourable weather conditions. Owing to higher domestic demand, livestock production grew by 6.6% year on year in 2006. Fishing output, which is typically volatile and depends on climate patterns, grew by just 2.7% in 2006 after a seasonal anchovy harvesting ban was imposed in the second half of the year.

Mining and fuels output fell in the second half of the year, owing mainly to a decline in gold production at the Yanacocha mine as the result of both supply constraints and social unrest at the mine.

Gross domestic product growth by sector, 2006 (% change, year on year)

1 Qtr 2 Qtr 3 Qtr 4 Qtr YearAgriculture & livestock 4.7 5.8 11.2 7.6 7.2

Fishing 31.9 -12.3 18.2 -8.5 2.7Mining & fuel 6.1 7.6 -0.6 -7.6 1.0 Metals 6.4 8.2 -1.9 -8.9 0.5 Fuel 0.4 2.7 10.0 9.1 5.7Manufacturing 7.3 3.0 8.1 8.2 6.6 Primary resource processing 9.0 -2.1 3.6 -0.6 2.1 Non-primary industry 6.9 4.3 9.0 10.4 7.7Electricity & water 7.2 4.9 7.6 7.8 6.9

Construction 16.3 13.2 16.0 13.5 14.7Commerce 11.7 9.0 14.0 14.4 12.1

Other services 7.2 7.1 8.9 9.6 8.2GDP 8.0 6.5 9.2 8.5 8.0 Primary sectors 6.6 4.3 5.6 -0.4 4.0 Non-primary sectors 8.7 7.4 10.4 10.9 9.3


Peru 19


Commodity prices(US$/lb; monthly averages)

0

100

200

300

400

500

600CopperTinZinc

FebJan07

DecNovOctSepAugJulJunMayAprMarFebJan06

DecNovOctSepAugJulJunMayAprMarFeb2005

At 1.14%, inflation ended 2006 below the 1.5%-3.5% target set by the Banco Central de Reserva del Perú (BCRP, the Central Bank) for only the second time since the BCRP began targeting inflation, in 2002. As a result, BCRP lowered its inflation target for 2007, from 2.5% plus or minus 1 percentage point to 2% plus or minus 1 percentage point. Peru’s good inflation performance in recent years has been underpinned by the steady appreciation of the nuevo sol since mid-2002. Monthly inflation reached 0.25% in February 2007, as the cost of food and beverages remained low. The core inflation index, which strips out the most volatile products, such as food, fuel, transport and public services, rose by 0.36% during February.

Consumer price inflation (% change)

2005 2006 2007 Monthly Annual Monthly Annual Monthly AnnualJan 0.10 3.03 0.50 1.90 0.01 2.56

Feb -0.23 1.68 0.55 2.70 0.25 2.51Mar 0.65 1.88 0.46 2.50 - -

Apr 0.12 2.02 0.51 2.90 - -May 0.13 1.79 -0.53 2.23 - -Jun 0.26 1.49 -0.13 1.83 - -

Jul 0.10 1.40 -0.17 1.55 - -Aug -0.18 1.22 0.14 1.87 - -

Sep -0.09 1.11 0.03 1.99 - -Oct 0.14 1.28 0.04 1.89 - -

Nov 0.07 1.06 -0.28 1.54 - -Dec 0.42 1.49 0.03 1.14 - -Annual average - 1.62 - 2.00 - -


Peru’s strong macroeconomic fundamentals, including a large current-account surplus, low inflation, high international reserves, a fiscal surplus and lowering levels of debt, have underpinned the appreciation of the nuevo sol, which, in early April, was trading at Ns3.184:US$1, a nominal appreciation of around 5.3% year on year. In an attempt to alleviate pressure on the exchange rate, the BCRP purchased nearly US$1.2bn in foreign exchange between January and March

The nuevo sol continues to strengthen

Inflation is below target in 2006

20 Peru


2007. As a result, net international reserves reached a record high of US$18.2bn in late March.

3.15

3.20

3.25

3.30

3.35

3.40

3.45

3.50

3.55

Jan2004

Mar May Jul Sep Nov Jan05



AverageEnd-period

Exchange rate

(Ns:US$1)

Sectoral trends

Mining

Owing to mining supply constraints, output from the mining and fuels sector was flat in 2006, increasing by just 1% year on year. The impact of low supply was most evident in October and December, when mining output fell by 9.6% and 9.1% year on year respectively. Despite weak output, mining export earnings grew by 41.8% in 2006 owing to continued high international prices. Export earnings from copper grew by 54.8% year on year, zinc by 218.8%, and silver by 71.9%, even as export volume growth slowed relative to 2005. Gold output fell by 2.3% year on year, as Peru’s largest gold mine, Yanacocha (operated by Newmont Mining Corporation of the US), experienced supply constraints in the second half of the year, leading to a 10.2% drop in gold export earnings for the year. Zinc output from the Antamina zinc-copper mine, the second-largest copper mine in Peru, increased by 79.6% year on year. Copper production rose by 3.6% year on year, with the largest growth taking place at Cerro Verde Mining Company (US), the Tintaya mine (operated by Xstrata of Switzerland) and Antamina.

Mining and fuels production ('000 tonnes unless otherwise indicated)

Jan Jan Year Year 2006 2007 % change 2005 2006 % changeMetals - - -1.9 - - 0.5 Copper 69.0 63.9 -7.4 790.4 818.9 3.6 Tin 3.0 2.9 -4.3 36.6 33.4 -8.7 Iron 433.8 447.0 3.0 4,638.0 4,861.2 4.8 Gold ('000 kg) 18.1 14.0 -22.5 202.0 197.3 -2.3 Silver ('000 kg) 247.5 266.1 7.5 3,001.2 3,250.3 8.3 Lead 22.9 26.6 16.3 294.0 288.4 -1.9 Zinc 72.8 98.8 35.7 1,018.3 1,028.5 1.0

Growth of mining output slows

Peru 21


Mining and fuels production ('000 tonnes unless otherwise indicated)

Jan Jan Year Year 2006 2007 % change 2005 2006 % changeFuels - - 10.4 - - 5.7 Crude oil (m barrels) 3,501 3,711 6.0 40,622.6 42,187.0 3.9 Natural gas (m cu ft) 4,000 5,698 42.5 53,582.2 62,691.1 17.0


Mining production is forecast to rebound in 2007 as new supply comes on stream. In June Milpo Mining Company will launch operations of its US$106m Cerro Lindo mine, located south of Lima in the department of Ica, which will produce zinc, copper, silver and lead. A US$30m investment by Pan American Silver (Canada) will boost silver production at its Huaron, Morococha and Quiruvilca mines. In March Xstrata announced that it had discovered additional reserves at its two wholly owned holdings, Tintaya and Las Bambas. The company has been test drilling at the Antapaccay site in Tintaya and has established reserves of 472m tonnes of copper. This will add years of operation to Tintaya, which Xstrata acquired from BHP Billiton (Australia) in 2006. At Las Bambas, for which Xstrata won the concession in 2004, the company announced that it had confirmed the existence of 69% more copper than last year. Operations at Peru Copper’s Toromocho mine, which has estimated copper and molybdenum reserves of nearly 2bn tonnes, are expected to launch by 2010.

The government anticipates that the mining sector will continue to grow rapidly, with investments totalling nearly $10bn over the next five years. The main investments are expected to be made in the Toromocho (US$1.5bn), Las Bambas (US$1bn), La Granja (US$1bn), Michiquillay (US$1bn), Rio Blanco (US$785m), Quellaveco (US$850m) and Conga (US$980m) mining projects. Bidding on the long-awaited concession for the Michiquillay copper deposit, in the northern department of Cajamarca, is scheduled to begin at the end of April. According to the Agencia de Promoción de la Inversión Privada (ProInversión), there are 12 mining companies interested in seeking the concession, including Southern Peru Copper Corporation and a Chinese company, Zijin Mining Group.

Oil and gas

Oil and gas production grew by 10.4% in the fourth quarter of 2006, owing to a 42.5% year-on-year increase in the extraction of liquefied natural gas (LNG) as new supply came on-stream. Overall, the hydrocarbons sector grew by 5.7% in 2006, owing to output growth of 17% in natural gas and 3.9% in crude oil. Production of natural gas was boosted by higher output from Camisea’s lot 88 (operated by Pluspetrol of Argentina), as well as from wells owned by Petrotech (US).

High international oil and gas prices boosted interest in the sector from investors during 2006. According to the Ministry of Energy and Mines,

Mining investment will remain buoyant

New supply will boost output

Oil and gas output grew in 2006

22 Peru


investments in the sector reached US$420m in operations and another US$95m in exploration. A total of 16 new contracts were signed. Investment activity is expected to remain buoyant in 2007. In March Perupetro (Peru’s state oil company) signed an agreement with UK-based Gold Oil and Plectrum Petroleum (Scotland) for the exploration and production of the Talara basin’s Z-34 offshore block, a project valued at US$49m. Concessions for an additional 18 lots are expected to be awarded during 2007.

PetroPerú, the government agency responsible for promoting investment in Peru’s energy sector, signed a Memorandum of Understanding (MoU) with Petroleo Brasileiro (Petrobras, the Brazilian state oil company) and Suez Energy International (Belgium) to lay the groundwork for a major petrochemicals complex in the south of Peru that would operate using gas from Camisea. The two companies agreed to carry out feasibility studies during the next six months before deciding on the specifics of the investment and where the plants would be built. Once approved, the plants would produce urea and ammonia for use as fertilisers. The investment to construct such a plant has been estimated at around US$800m. Proposals have also been floated to build a plant to produce polyethylene, an investment that would near US$2bn.

ProInversión plans to award a 30-year contract for the construction of the regional natural-gas pipeline network in late April. As part of a plan to encourage the consumption of natural gas by homes and businesses, as well as transport, the pipeline network will be built from Camisea and will include two sections: one linking the departments of Ica, Junin and Ayacucho; and another linking Camisea with Cuzco. ProInversión estimates that the cost of the project will be US$200m. Two Colombian companies have expressed interest in the project.

Manufacturing

Manufacturing output increased by 8.4% in the fourth quarter of 2006 and by 6.6% in 2006 as a whole, owing primarily to rising domestic demand. The non-primary industries were the most dynamic, increasing by 7.7% for the year, owing mainly to strong growth in output of beer and malt beverages, pharmaceuticals, cement, and metallic products, machinery and equipment. The summer season and increased competition between breweries boosted beer and malt production by 24.6% year on year in the fourth quarter. Higher cement sales, owing to increased demand from the government housing programme, MiVivienda, boosted output from the non-metallic manufacturing sector. Output of primary resource-processing industries increased by 2.1% in 2006, reflecting increased output of canned and frozen fish and sugar. Fishmeal production fell by 28.3% year on year as the result of supply constraints and a temporary fishing ban imposed in the fourth quarter in order to conserve stocks.

Growth is led by non-primary manufacturing

Peru could receive a major petrochemicals investment

Camisea pipeline contract to be awarded

Peru 23


Manufacturing activity, 2006 (% growth year on year)

Jul Aug Sep Oct Nov Dec YearPrimary resource processing -3.3 7.7 7.8 6.4 -17.1 15.3 2.1 Sugar 9.5 20.7 16.1 28.8 11.3 14.3 15.8 Meat products 8.3 8.7 5.8 4.8 4.3 3.5 7.2 Fishmeal -83.0 -40.8 100.0 3,900.0 -57.6 321.2 -28.3 Canned & frozen fish 149.9 63.5 91.9 57.8 34.3 -7.4 56.2 Non-ferrous metals 5.2 0.3 1.5 -0.7 -0.8 -4.0 2.0 Refined petroleum -7.7 1.0 4.3 0.5 0.0 1.4 -2.2Non-primary industries 8.0 10.7 8.4 10.2 9.8 11.2 7.7 Food, drinks & tobacco 5.9 13.0 12.5 14.5 11.5 8.9 9.3 Textile & leather -2.3 1.0 -3.2 0.2 1.1 2.0 -2.1 Paper & paper products 9.4 16.2 7.9 6.3 11.9 10.1 6.9 Chemical, rubber & plastic products 25.3 14.6 7.5 14.9 16.9 19.1 12.1 Non-metallic minerals 3.5 9.0 18.3 10.8 13.9 8.2 12.8 Iron & steel 15.1 3.6 8.6 9.8 1.3 11.8 12.3 Metallic products, machinery & equipment 11.3 27.8 29.5 22.2 16.5 14.4 19.2 Miscellaneous manufacturing products 10.4 7.1 10.0 11.3 14.7 38.1 5.3Total 5.8 10.2 8.3 9.6 3.6 11.9 6.6


Agriculture

The strong growth trend in the agricultural sector, which has been consistent since mid-1998, continued in 2006 as agricultural production rose by 7.2% year on year. In the fourth quarter, agricultural output grew by 12.1% year on year, boosted by good weather conditions. Harvests of coffee, sugar cane, yellow corn and potato were all higher than in the fourth quarter of 2005, whereas cotton, rice, beans, maize and wheat output was lower. For the year, crops for domestic use (such as coffee, sugarcane, and beans) and for export (cacao, asparagus, and mangoes) posted dynamic growth owing to favourable weather conditions, an abundant water supply, a wider area of cultivation, and the incorporation of new technologies by farmers. Led by strong growth in the poultry sector, livestock production rose by 3.8% in the fourth quarter. The sector’s annual growth rate was 6.6% in 2006, owing mainly to continued strong sales of chickens to Japan, a major destination for Peruvian poultry exports.

Agriculture and livestock production, 2006 (% change, year on year; constant 1994 prices)

4 Qtr YearAgriculture 12.1 7.7

Livestock 3.8 6.6Total 7.6 7.2


Agricultural output increased in 2006

24 Peru


Crop production ('000 tonnes)

Sep Jan-Sep 2005 2006 % change 2005 2006 % changeCotton 8.2 11.2 36.6 166.8 201.7 20.9Rice 74.5 75.6 1.5 2,100.0 2,012.5 -4.2

Coffee 2.2 4.4 100.0 146.1 232.3 59.0Sugar cane 586.7 658.6 12.3 4,401.3 4,988.3 13.3

Beans 8.9 7.8 -12.4 60.5 70.4 16.4Yellow corn 81.2 78.6 -3.2 820.5 786.9 -4.1Maize 3.3 1.9 -42.4 242.9 245.9 1.2

Potato 112.7 113.3 0.5 2,782.7 2,682.1 -3.6Wheat 14.7 20.1 36.7 155.1 171.6 10.6


Rising global interest in bio-fuels is expected to boost investment in production of sugarcane and palm-oil-based ethanol. In January Maple (US) announced its intention to build a US$100m ethanol distillery in northern Peru, to be operational by 2009. The project includes the construction and operation of the distillery, port and shipping facilities, as well as sugarcane planting and harvesting. The company estimates that the plant will produce 30-40m gallons of ethanol per year, growing to 100m gallons per year after five years. Pure Biofuels (US) is building a US$130m bio-diesel production plant at the Callao Port facility, near to Lima. Once completed, the facility will have an annual production capacity of 52.5m gallons of bio-diesel, which is produced from crude palm oil. Both projects will provide for international market.

The fishing industry managed to post positive output growth in 2006, despite an 8% drop in production in the fourth quarter. This decline was primarily the result of a 23.4% drop in the anchovy catch, caused by a temporary ban on anchovy fishing in order to preserve stocks. Although production of fish for human consumption jumped 26.2% in 2006, this was offset by a drop of 33.2% in the production of fish for industrial consumption, mainly fishmeal. The value of fishmeal exports declined by 1.1% year on year, despite a 48% rise in price, as output was low. Exports of fish for direct human consumption rose by 65.6% in 2006.

Infrastructure

ProInversión will move ahead with infrastructure concessions in 2007. Having announced the first set of concession awards for the management of several regional airports in December 2006, ProInversión plans to announce the second set of regional airport concessions during the third quarter of 2007. Concession awards on offer in this round include those for the airports of Tacna, Juliaca, Arequipa, Madre de Dios, Ayacucho, Nazca, and Apurimac, an estimated total investment of US$150m. The aviation and airports sector is growing rapidly in Peru, owing both to rising tourism and increased domestic airline travel.

High demand for bio-fuels prompts new investments

Fishing output increases, despite supply constraints

Several concessions to be awarded in 2007

Peru 25


Amid high levels of investment, the mobile phone sector is expanding rapidly. In March ProInversión approved bidding rules for the 20-year concession of Peru’s fifth mobile band. Once awarded, the project, which is estimated to require a US$200m investment, will add to the three mobile concession licences held by Movistar Perú, Claro Perú and a digital operator, Nextel Perú. An auction process for a fourth mobile licence in the 800mhz band is currently underway. That spectrum was reclaimed by the government as part of the merger agreement between Bellsouth and Movistar. Claro Perú plans to invest US$280m in 2007 in its network, expanding coverage to include 600 additional districts and expanding its customer base to over 5m subscribers by the end of the year.

Foreign trade and payments

In 2006 the global context was one of the best for Peru since the 1950s, as its terms of trade improved by 26%. Export earnings grew strongly in 2006, increasing by 37% year on year. Export earnings have nearly doubled in the past two years, from US$12.6bn in 2004 to US$23.7bn in 2006. Growth was led by traditional exports, earnings from which increased by 41.9%, mostly owing to high metals prices. Export earnings from mining, which accounted for 62% of total exports in 2006, increased by 50.8% year on year, to US$14.7bn, driven by increased demand from China and the US for copper and gold. Owing to buoyant global commodity prices, export earnings from zinc grew by 147.3%, from copper by 79.6%, from silver by 70.6%, and from gold by 27.9% year on year. The value of hydrocarbons exports, which accounted for 7.2% of the total, increased by 12.2%, owing to continued high global prices. Earnings from non-traditional exports grew by 23%; non-traditional agriculture export earnings grew by 20.1% year on year, owing primarily to increased exports of livestock artichokes and asparagus. Textiles export earnings reached around US$1.5bn, boosted by the ATPDEA, which allows duty-free access to the US market.

Merchandise exports (US$ m)

4 Qtr Full year 2005 2006 % change 2005 2006 % changeTraditional exports 3,707.6 5,109.8 37.8 12,918.7 18,332.1 41.9 Fisheries 185.2 215.6 16.4 1,303.0 1,331.3 2.2 Agricultural products 102.8 235.1 128.7 330.6 572.6 73.2 Minerals 3,033.9 4,311.7 42.1 9,759.5 14,715.7 50.8 Petroleum & derivatives 385.7 347.4 -9.9 1,525.6 1,712.5 12.2

Non-traditional exports 1,180.8 1,565.2 32.6 4,276.5 5,262.1 23.0 Agriculture & livestock 325.5 400.2 22.9 1,008.7 1,211.9 20.1 Textiles 342.5 419.3 22.4 1,275.0 1,469.1 15.2 Fisheries 78.2 113.4 45.0 322.5 432.1 34.0Total, including others 4,923.6 6,709.0 36.3 17,336.3 23,749.5 37.0


The total import bill grew by 23.4% year on year, less rapidly than export earnings, to reach US$14.9bn. Dynamic growth in private consumption and

The export boom continues

Imports rise by 23.4%

Mobile sector expanding

26 Peru


investment spending has led to higher imports of consumer and capital goods. In the fourth quarter, imports rose by 28.7% year on year, boosted by strong sales ahead of the Christmas season.

Merchandise imports (US$ m)

4 Qtr Full year 2005 2006 % change 2005 2006 % changeConsumer goods 640.0 790.8 23.6 2,318.2 2,613.1 12.7Intermediate goods 1,730.8 2,123.9 22.7 6,602.6 7,989.3 21.0Capital goods 853.7 1,236.2 44.8 3,060.3 4,144.8 35.4

Other 23.4 29.1 24.4 95.0 149.7 57.5Total 3,247.9 4,180.0 28.7 12,076.1 14,896.8 23.4


Export and import prices(1994=100)

120

140

160

180

200

220

240Export pricesImport prices

Jan07



Dec2004

The current account posted a surplus of US$2.5bn (2.1% of GDP) in 2006, the second-highest surplus since data was first collected in 1950 and a year-on-year increase of 122.2%. Although the trade surplus as measured on the current account rose by 68% year on year, it was partly offset by a sharp rise in the income deficit (from US$5bn in 2005 to US$7.6bn in 2006). Most mining companies and other export-oriented companies are foreign-owned and remit a share of their profits abroad. Net current transfers, mostly remittances from Peruvians living abroad, reached nearly US$2.2bn, a year-on-year increase of 24.4%.

In late March net international reserves (NIR) held by the Banco Central de Reserva del Perú (BCRP, the Central Bank) reached a historic high of US$18.2bn, US$86m higher than at the end of February and US$1.5bn higher than at the end of 2006. The increase in the balance of reserves was mainly owing to exchange operations carried out by the BCRP worth US$550m.

Current-account surplus reaches 2.1% of GDP

International reserves reach historic high in March

Peru 27


Current-account balance (US$ m)

4 Qtr Year 2005 2006 % change 2005 2006 % changeMerchandise exports 4,980.0 6,709.0 34.7 17,336.3 23,749.5 37.0Merchandise imports -3,254.1 -4,180.0 28.5 -12,076.1 -14,896.8 23.4Trade balance 1,726.0 2,529.0 46.5 5,260.2 8,852.7 68.3Services: credits 572.5 630.4 10.1 2,289.2 2,451.2 7.1Services: debits -840.4 -931.9 10.9 -3,123.5 -3,382.8 8.3Services balance -267.9 -301.5 12.5 -834.3 -931.5 11.7Net investment income -1,506.1 -1,875.0 24.5 -5,076.1 -7,648.7 50.7

Net current transfers 487.8 604.8 24.0 1,755.4 2,183.7 24.4Current-account balance 439.8 957.4 117.7 1,105.1 2,456.1 122.2 % of GDP 2.2 3.8 72.7 1.4 2.6 85.7


peru - iuj.ac.jptook office in july 2006 for a four-year term .h aving gained the backing of the...

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