GROSS DOMESTIC PRODUCT

In 1999, the Peruvian economy began to recover from the negative effects of three severe external shocks: El Ni?o, the deterioration of the terms of trade that followed the Asian Financial Crisis, and the international financial market turbulence.

Gross domestic product (GDP) growth increased from -0.4 percent in 1998 to 1.4 percent in 1999, due to the expansion of agriculture, fishing and mining. The expansion registered in the primary sectors was mainly due to the favorable weather conditions, which had a positive effect on fishing and agriculture, and to the rise in gold production.

On the global supply and demand sides, GDP growth responded to an increase in exports of goods and services (5.4 percent), while domestic demand declined by 2.6 percent, mainly due to an 11.8 percent decrease in investment. However, in the last quarter of 1999, domestic demand rose by 3.7 percent due to the recovery of private consumption.

INFLATION

In 1999, the rate of inflation was 3.7 percent, the lowest since 1960 and the second lowest in the last 60 years. Also, this level is below the lower end of the inflation target range (5 ¨C 6 percent) established in the economic program signed with the International Monetary Fund (IMF).

EMPLOYMENT

Unemployment in urban areas was, at 7.7 percent, slightly lower than in the previous year.

CURRENT ACCOUNT

The current account deficit amounted to US$1,817 million, equivalent to 3.5 percent of GDP compared with 6.4 percent of GDP in 1998. The smaller current account deficit reflected a US$1,850 million drop in the trade balance deficit. This result was due to both the growth of exports (6.2 percent) and the fall of imports (-18.2 percent). The expansion of exports was mainly due to the rise of traditional exports (11.6 percent), such as mining and fishing exports, which grew by 9.5 and 46.5 percent, respectively, and non-traditional agricultural exports (34.2 percent). Mineral exports increased due to higher export volumes of gold (34.2 percent), despite the decline in international metal prices. Fishing and agricultural exports were influenced by the greater activity in these sectors due to better weather conditions. Imports declined basically due to the lower domestic demand.

CAPITAL INFLOWS

In 1999, net capital inflows amounted to US$778 million (1.5 percent of GDP), a US$1,305-million decrease from 1998, mainly due to the lower external financing needs of the banks (US$1,272 million) associated with a lower domestic demand. It should be stressed that long-term private capital inflows, excluding privatization revenues, continued to finance the current account deficit.

EXCHANGE RATE

Peru maintains a floating exchange rate regime. In 1999, the Peruvian currency (nuevo sol) depreciated by an average of 15.4 percent in nominal terms and 10.9 percent in real terms.

FISCAL POLICY

In 1999, the weakness in domestic demand led to a significant reduction in tax collections, and central government current revenue declined to 14.5 percent of GDP, compared with 15.7 percent of GDP in 1998. As a result, the fiscal deficit increased to 3.0 percent of GDP. In order to reinforce the fiscal balance, the government enacted the Fiscal Responsibility and Transparency Law in December 1999. The main features of this law are:

Limitations

• The fiscal deficit cannot be above 1 percent of GDP. In the transition period, the deficit shall not exceed 2 percent of GDP in 2000 and 1.5 percent in 2001.
  
  
• The rate of growth of general government expenditure cannot be above the rate of inflation plus 2 percentage points.
  
  
• In election years, the deficit of the first semester cannot exceed 50 percent of the deficit projected for the year. Also, the non-financial general government expenditure for the first 7 months cannot be above 60 percent of the expenditure foreseen for the year.
  

In order to moderate the expenditure in boom years, tax earnings in excess of 0.3 points of GDP above the average of the last three years will be deposited in a stabilization fund. Part of the earnings from privatization will also accrue to this fund.
These resources can be used in years in which tax earnings decline by more than 0.3 percent of GDP or in case of an emergency. The cap to the deficit can be raised only to 2 percent of GDP.
Transparency

The Ministry of Finance publishes a three-year Macroeconomic Framework three months before the presentation of the following year¡¯s budget draft.
The Central Bank issues an evaluation of the consistency of the Macroeconomic Framework with its objectives and the balance of payments outlook.
The Ministry of Finance issues every semester an assessment of the accomplishment of the objectives and targets established in the Macroeconomic Framework.
MONETARY POLICY

The monetary policy continued to focus on price stability and aimed at bringing inflation down to industrialized economy levels. Control of the intermediate target ¡the expansion of the monetary base¡ was conducted in the context of a floating exchange rate and market-based interest-rate determination.

Money supply growth (1.7 percent) was driven by the increase in the average monetary base (6.7 percent), which was partly offset by the decrease in the money multiplier (4.7 percent).

During 1999, total credit of the banking system to the private/business sector grew by 2.9 percent in real terms, down from 14.1 percent in 1998. The decrease in the total credit to the private/business sector reflects the conservative behavior of the banks caused by the credit risk and the weakness of the solvency indicators of the financial system.

Net international reserves (NIR) decreased by US$780 million during 1999, to US$8,404 million at the end of the year. This level is equivalent to 5 times the monetary base, 2.1 times the domestic liquidity, 63 percent of the total liquidity, 15 months of imports of goods, 1.2 times the debt due within a year and 1.8 times the short-term foreign debt.

In order to increase the transparency of the monetary policy, the Central Bank began publishing its Monetary Program, starting in January 2000.

MEDIUM-TERM OUTLOOK

Peru has completed the first year of its third Extended Fund Facility Agreement with the IMF. Given that 2000 is an election year, the government signed a letter of intent only for the first half of the year.

The economy is expected to grow between 4 and 5 percent in real terms in 2000 and 6 percent in the medium-run. The inflation target range for 2000 is 3.5 to 4.0 percent, and the inflation rate is expected to reach international levels in the following years.

The current account deficit, which is forecast at 4 percent of GDP for 2000, will continue to be financed by long-term capital inflows.

The fiscal target is to reduce the deficit to 1.9 percent of GDP in 2000 and to attain equilibrium in the medium-run.

PERU: OVERALL ECONOMIC PERFORMANCE