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Challenging Year for Peru's Risky Economic Gamble

By Michael L. Smith

The Washington Post, February 22, 1987

Peruvian President Alan Garcia's high-stakes gamble that his country can grow its way out of financial difficulties before reaching agreement with its international creditors will be put to its maximum test this year.

In his year-and-a-half in office, Garcia has flouted international financial conventions by refusing to pay more than 10 percent of Peru's exports to service its $14 billion debt. The international banking community responded by saying that the market would punish Peru by reducing access to fresh loans and stunting its economic growth.

Only half of that prediction has come true. In the past year, Peru received only $220 million in new loans, less than one-tenth of what it received five years ago. But the country's economic growth has rarely been stronger: the gross domestic product grew by 9 percent last year, 2 percentage points more than Garcia's economic team had targeted.

The key to the 1986 success was the idle capacity in Peruvian manufacturing, which was coming out of the country's deepest recession since the 1930s. The government pushed up consumer demand through a series of measures, including wage increases and cash advances.

Consumer demand, stimulated by the government policy, has outstripped all expectations. To satisfy that demand, manufacturing jumped 20 percent. The Coca Cola franchise holder, for example, saw its output rise by 162 percent. Poultry raisers increased their monthly production from 9 million kilograms of chicken in January to 13 million kilos in December, according to government officials. In the 1983 recession, chicken output was 1.5 million kilograms per month.

The Garcia administration also has brought down inflation from 158 percent in 1985 to 63 percent last year.

"Garcia has controlled production costs more than prices," economic consultant Claudio Herzka said. The government has held down inflation for producers by keeping the exchange devaluation and interest rates low and energy prices fixed, and by reducing some taxes.

Critics say the growth has been so fast, confined mainly to the second half of 1986, that producers have been hard pressed to keep pace with demand. "The economy is dangerously overheated now," said banker Juan Francisco Raffo.

Exports totaled $2.4 billion last year, a drop of 20 percent, mainly due to the fall in petroleum prices and poor prospects for other commodity exports. Until December, the government showed few signs of being worried about falling export income. "They have been learning what the breaking point for exports was," a textile manufacturer said.

The government now acknowledges that Peru has to start exporting much more if it expects to generate the hard cash to supply its productive apparatus, feed its people and invest in new factories, not to mention returning to more normal servicing of its foreign debt.

Government planners say that unless they can increase exports sharply and hold down imports to essential minimums, Peru will face a severe balance of payments crisis in early 1988.

At the end of last month, net international reserves stood at $836 million, down $125 million from the month before. The economic boom has eaten up some $700 million in reserves, which reached a record high $1.5 billion last March. Garcia has termed the reserves "national strategic resources" because they finance Peru's economic activities and its trade and development programs.

Government finance officials say that gross reserves, a more accurate indicator of available funds, stand at $1.55 billion, sufficient to finance seven months of imports.

The government has taken measures to promote exports, especially of manufactured goods. For instance, exporters of cotton garments are now paid an exchange rate of 21 Peruvian intis per U.S. dollar, a 60 percent bonus over the official rate.

Stronger import controls are also being moved into place. Government advisers say the middle class may have to do without the luxury of imported meat, which costs about $50 million a year, and even new cars.

However, these measures are deemed insufficient unless fresh investment can expand Peru's export capacity. "We have to rely on private investment to pull the country forward because the government does not have the resources or the management," said Daniel Carbonetto, the chief presidential economic advisor.

This private sector-oriented policy also is needed to prevent capital flight by providing alternatives to companies with historically high profits, presidential aides said.

Since July, Garcia has been engaged in talks with a group of 12 leading businesses, called the Twelve Apostles or the Twelve Hostages. These businesses were picked because they were thought to have had the most investment, profits and enlightened managements.

A National Council of Investment is to approve letters of intent setting conditions for new industries and guaranteeing access to credit. Import permits for capital goods and other facilities will be speeded to get them underway quickly.

Government officials say that they are looking for agreements for investments that are export-oriented and are located outside of Lima. Special emphasis also is being given to agriculture and agribusiness, opening up an area which has been off limits for large private investment since an agrarian reform expropriated large coastal and sierra holdings in the early 1970s.

Business leaders involved in the talks say these investment projects, representing about $400 million, are meant to be pace setters and to promote investment opportunities that have been neglected.

"There is a sense of euphoria now, but the question is how long it can last," a business consultant said. Businessmen and analysts still have reservations about the government's capacity to fulfill its promises that stable economic policies can be maintained under extremely harsh conditions and that obstacles to carrying out investment plans, like bureaucratic bottlenecks, can be removed.

The government's economic strategy requires sophisticated management and coordination. Although policy decisions are frequently made at the top, it takes too long for regulations and other measures to be implemented, critics say, given the urgency and timing of the government's high-risk program.

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