$Unique_ID{COW02863} $Pretitle{242} $Title{Peru Chapter 3E. Balance of Payments} $Subtitle{} $Author{Darrel R. Eglin} $Affiliation{HQ, Department of the Army} $Subject{economic balance government payments debt export international new public prices} $Date{1980} $Log{} Country: Peru Book: Peru, A Country Study Author: Darrel R. Eglin Affiliation: HQ, Department of the Army Date: 1980 Chapter 3E. Balance of Payments Peru frequently has had serious balance of payments problems. The country's relatively diversified exports, although highly concentrated in primary commodities, were usually the cause as well as the solution of the problem. During periods of rapid export expansion (because of exploitation of new products such as guano after the 1840s and fish meal after 1950, completion of investments permitting greater production for export, and higher world prices for primary commodities) the flow of funds increased from foreign financial institutions and multinational corporations. When the export boom slowed or collapsed, most often because of shrinking international demand and lower world prices, the country was left with a substantial debt to service. At various times the foreign loans had financed productive investments that helped to repay the debt, but funds borrowed abroad at times went into investments that were slow to produce a return (such as the railroads in the late 1800s) or financed domestic consumption and capital flight. The country has had several financial crises when the foreign debt could not be serviced under the original terms. Default on international obligations has been avoided by rescheduling the debt, and repayment was accomplished by the eventual recovery of export earnings. As of mid-1980 the most recent and most serious balance of payments crisis began appearing in the mid-1970s. The previous crisis occurred in 1968, resulting in a stabilization program and a much improved balance of payments situation by 1970. At the same time, however, the government was becoming much more active in the economy; while national savings declined, interest rates became negative because of inflation, and a fixed exchange rate was being maintained. Between 1971 and 1975 the government stimulated the economy with massive consumption subsidies, measures to redistribute income, and large increases in public investment that averaged 25 percent a year. Imports rose faster than export earnings, requiring rapid expansion of foreign borrowing. Between 1971 and 1975 the resource gap increased from 0.4 percent to over 11 percent of GDP, and the external public debt more than tripled. The adverse trade balance peaked in 1975 at US $1.1 billion partly because of a deterioration of the terms of trade of nearly 30 percent (see table 11, Appendix). While import prices were rising, export prices declined, particularly for copper and sugar. Even though the adverse trade balance improved, the current account deficit remained high between 1975 and 1977, averaging US $1.2 billion a year-equivalent to 9.5 percent of GDP. Drawings on international reserves and foreign borrowing, much of it on short-term from foreign banks, financed the current account deficit. By the end of 1977 the country faced a severe financial crisis. Net international reserves had a negative balance of over US $700 million, international cash reserves were sufficient for only a few days of imports, and the total external debt was nearly US $8.3 billion (see Role of Government, this ch.). After 1974 the government began measures to reduce fiscal deficits and the loss of reserves. Imports were restricted, subsidies on imported commodities were reduced, interest rates were raised, and the fixed exchange rate policy was abandoned in favor of a series of devaluations-most of which were frequent mini-devaluations. The measures, endorsed by the IMF, helped the balance of payments, but contributed to a fall in real wages of workers; they were insufficient, however, to avoid the financial crisis of late 1977 and early 1978. In May 1978 new officials were installed to restore economic equilibrium. Improved economic management contributed to a turnaround in the balance of payments. In 1978 the trade balance became positive, largely through a reduction of imports because of the country's economic recession and small military imports. Officials negotiated a restructuring of the external debt, which along with the repatriation of some Peruvian capital provided a small increase in international reserves. The balance of payments improved tremendously in 1979. Exports exceeded imports by nearly US $1.4 billion as large increases in world commodity prices along with expanded petroleum exports boosted export earnings while imports expanded slowly. Much of the favorable trade balance went abroad as interest payments on the external debt. Nonetheless, large foreign loans to the public sector along with debt relief permitted net international reserves to increase by nearly US $1.6 billion. As the balance of payments improved during the year, authorities decided not to use part of the debt relief they had negotiated. As civilians again took over the government in mid-1980, the country's balance of payments position was strong. How long it would remain so would partially depend on the management abilities of new economic officials. Debt repayment would remain a serious burden until 1986. Imports were expected to rise as the economy recovered. The substantial help that petroleum provided in export earnings by the late 1970s was expected to disappear before the mid-1980s unless new fields compensated for depletion of older fields and expanded domestic consumption. Moreover, the high export prices for primary commodities in 1980 could be quickly reversed as had happened often in the past. The boom and bust cycles would continue with another financial crisis in the not too distant future unless officials improved on past economic management and accomplished some structural reforms. Economic Legacy of Military Rule When on July 28, 1980 elected civilian officials began heading the government, they were confronted with the same long-term problems that had been present when they were removed by the military in 1968. The high rate of population growth meant an expanding labor force requiring more rapid creation of new jobs than in the previous several decades. A process of elimination indicated manufacturing had to be the main source of new employment. Mining could not absorb many workers even if massive new mining projects could be financed and instituted quickly. Because of the limited land resources, agriculture was not capable of absorbing many additional workers, particularly if the goals of raising rural incomes were retained. Services could provide some new jobs, especially in such labor-intensive activities as transportation, warehousing, and tourism, but the service sector could only share the burden with manufacturing if productive work with adequate wages were provided. Other long-term problems included rapid urbanization with an increased demand for housing, utilities, and other services (see Urbanization, ch. 2). Although the country as a whole possesses a plentiful supply of water, the increasing concentration of the population in the Costa will require costly projects to bring it from the eastern side of the Andes. The country's 1980 crude oil surplus will be short-lived unless new fields are discovered; if large oil imports become necessary after the mid-1980s, close attention to energy matters will be required if deterioration of the balance of payments is to be avoided. The considerable success of the military government in altering the ownership pattern in the economy left relatively untouched the skewed income distribution and problems of the poor. The expansion of the public sector, however, had developed institutions and personnel experienced in large-scale management and had placed the country in a better position to benefit from future development. Some progress had been made toward integration of the various sectors, areas, and groups, but much more needed to be accomplished. The country was still excessively dependent on the export of a few primary commodities, the international prices of which will undoubtedly fluctuate in the future. An important legacy from the military government was the effort to correct deficiencies in economic management and to attempt some structural reforms before the return to civilian rule. When forming the stabilization program in 1978 for IMF approval to reduce public sector deficits and the loss of international reserves, the planners also drew up an economic recovery program (1978-80) far more extensive than the requirements of the IMF to achieve rapid growth and increased employment. Under the circumstances, the task was extraordinarily ambitious and noteworthy. The economic recovery program was comprehensive, incorporating the stabilization goals as well as remedial measures for nearly all of the deficiencies noted earlier. The general goal was to stimulate public savings, increase the efficiency of resource use, improve public sector management and operation of state enterprises, concentrate investments on quick-return projects, and increase output of agriculture and mining. In 1970, for example, the government began to introduce several tax measures aimed at broadening the tax base, achieving greater equity, improving the allocative functions, and strengthening tax administration and enforcement. Other measures adopted under the economic recovery program included increased prices of goods and services of state enterprises to eliminate the budget drain and to make the public sector more financially independent and efficient. Efficiency in other sectors was promoted by the sharp rise in interest rates, efforts to maintain a realistic exchange rate, and the decontrol of a number of commodity prices. A start was made toward lowering tariff and quantitative barriers shielding domestic manufacturers. Incentives for nontraditional exports were increased. By mid-1980 it was too early to evaluate the recovery program, partly because of the lack of data and partly because the success of reform measures would take time to emerge. In 1979 there was a favorable sharp rise in tax revenues and public savings and a turnaround in the balance of payments. But by mid-1980 there were unfavorable signs as well. Subsidies were reintroduced for basic imported foods, substantial pay increases were granted government workers, purchase of military equipment increased, and the costly tax rebate incentives for nontraditional exports were raised. Collectively and individually, these measures may be expected to lower public savings. Most investments in agriculture were being made in large, long-gestation irrigation projects (some of which had questionable economic justification) despite the stated intention of concentrating on quick-return investments to raise farm output. In 1979 exchange rate adjustments were allowed to fall behind the rate of inflation. The unfavorable indicators created doubts about the thoroughness and effectiveness of the reforms. By mid-1980 little was known about the economic plans of the incoming civilian government. During the presidential campaign candidate Belaunde promised to create 1 million new jobs and to increase food production. It remained to be seen how the promise would be implemented. The new civilian government was starting under advantageous economic conditions. Economic growth was expected to increase and the favorable balance of payments to continue in 1980. An improving economy would perhaps ease the demands of organized labor that some observers anticipated. The 1978 economic recovery program provided a detailed analysis of the economy's problems and made a start on needed reforms. The opportunity existed to continue the restructuring to achieve more balanced growth. If the opportunity was not seized, the boom-bust cycles would continue. Some of the high export prices already had weakened in 1980. Another contractionary phase posed more than just economic difficulties, for many disadvantaged groups had higher expectations and might decide to express their discontent. The ability of the civilian government to improve on management of the economy now that the public sector was such an important element could well be decisive to much more than the population's economic future. * * * Numerous books and articles have been written about Peru's development problems and the military junta's efforts to alter the socioeconomic system in the 1968-80 period. Peru 1890-1977 by Rosemary Thorp and Geoffrey Bertram is an excellent recent book that provides a wealth of detail and explores the links, and the lack of them, between sectors. The State and Economic Development: Peru Since 1968 and an article, "The Limitations of State Capitalism as a Model of Economic Development," both by Edmund Fitzgerald, focus on the increased role of government after 1968 and the problems encountered. Those interested in land reform and formation of cooperatives should see Douglas Horton's writings, such as Haciendas and Cooperatives, which are based on his field work. The Organization of American States' Short-Term Economic Reports, Vol. VII, Peru presents a detailed summary of economic developments and government programs with statistical tables for the years of 1976-79. The International Monetary Fund's monthly International Financial Statistics contains considerable current data in English and in a readily available publication. The Peruvian government's various statistical publications provide a broad range of data. (For further information, see Bibliography.)