PERU: A COUNTRY PROFILE
By the late 1980s, Peru in many ways had reached its nadir. The country
was in shambles: GDP had contracted by 20 percent over the previous two
years; annual inflation was more than 2,700 percent; its international
reserves were depleted; it was in arrears on two-thirds of its foreign debt
and thus ostracized as a pariah state by the international financial
community. Further, it was in the midst of a bloody war with a home-grown
terrorist organization bent on overthrowing the state. Onto this chaotic
scene stepped an obscure rector from Lima's Agrarian University.
Campaigning on a platform of adjustment without shock measures, Alberto
Fujimori, a first generation Peruvian of Japanese descent, scored a
surprising victory over the famous novelist Mario Vargas Llosa who was
calling for more orthodox changes to Peru's economic structure.
In a surprising shift, shortly after the election, Fujimori changed tacks
and adopted the orthodox economic philosophies of his opponents and began
the challenging process of reintegrating Peru into the world economy.
During the course of the 1990s, Fujimori, often using very heavy-handed
tactics, managed to end the hyperinflation and guerilla threat that were
decimating Peru, and at the same time foster economic growth, prompting
many to call the transformation a "miracle."
Now that Peru is on the brink of the next century, and possibly a brighter
future, it is appropriate to briefly review the history of Peru's
economic/political nexus, as well as the present day situation. This
country profile will provide a sketch of how Peru has coped with its
reintegration into the world economy, and thus globalization. The profile
will also take a special look at the financial sector, especially the
banking industry.
Brief Economic and Political History:
Historian Paul Gootenberg once characterized Peru as having "...long
served as regional exemplar of growth without development, ill served by
its myopic ruling cliques." In many ways this quote is quite apt. After
independence from Spain in 1821, Peru was a nation by geography only, with
many strongmen (caudillos) battling each other for supremacy. In the
1840s, Peru experienced an export boom based on guano, and during this time
even managed to elect its first civilian president in 1862. However, by
the mid-1880s the guano reserves had been exhausted and poor economic
management during this period left the country with nothing but a crushing
foreign debt (on which it defaulted) and a return to caudillo rule.
During the first half of the 20th century, Peru very much followed a
laissez faire approach to economic policy. Beginning in the 1960s, however,
Peru began to exchange its liberal economic policies for those of import
substitution. In 1968, the military, which often inserted itself into
Peruvian politics, overthrew President Fernando Belaunde and tightened
state control over the economy. The 12-year rule was characterized first
by populism which quickly alienated the business elites, and then by a more
conservative regime which sparked labor unrest. Military infighting,
unimpressive economic growth, and repression ultimately forced the armed
forces to negotiate a return to civilian rule in the late 1970s.
Peruvians had high hopes for both the moderate Belaunde (1980-1985) and
the more populist Garcia (1985-1990). However, global recession, the debt
crisis, and periods of severe weather made the task extremely difficult.
Garcia had limited short-term success early in his Presidency, but his
recalcitrance in dealing with the IMF, and other creditors (e.g., limiting
debt payments to a fixed percentage of exports) had a high price. The
"last straw" was his failed attempt to nationalize the banking system. The
country became more fractured, with a business sector that was estranged
from the government, and an increase in urban and rural violence from the
Shining Path. The impact on Peru's economy was disastrous.
Peru in the 1990s
Government:
In the eyes of many, President Fujimori is the government. He has been
described as a "19th Century caudillo for the 21st Century." During both
the Belaunde and Garcia administrations, the legislature showed strong
signs of both fractionalization and polarization as defined in the
Haggard-Kauffman model. Fujimori exploited this situation in April of 1992
when he carried out his famous autogolpe, arguing that Peru's problems
could only be addressed through quick and decisive action. Since that
time, key policy decisions have been made by the President and a small
circle of key advisers. This governing style received a boost when the
1993 Constitution (Peru's fifth this century) significantly strengthened an
already powerful executive. A pro-Fujimori coalition (Cambio 90/Nuevo
Mayoria), holds 69 of the 120 congressional seats, with the next largest
party holding 12 seats. Any legislative opposition is therefore of little
real consequence. Even the judiciary which is defined as autonomous in the
new Constitution is often overruled when an "anti-Fujimori" decision is
made. A recent example is the dismissal of the three Constitutional Court
justices who blocked a constitutional amendment that would allow Fujimori
to seek a third term as President. The Supreme Court, which according to
some is not empowered to rule on Constitutional Court decisions, ultimately
overturned the verdict.
With no formal political party, Fujimori's main support base has been the
military, a group which he has taken pains not to alienate. The Director
of State Intelligence (and principal liaison with the military), Vladimiro
Montesinos, is likely the President's closest advisor. However, there are
still occasional tensions. In 1992, a faction of the armed forces failed
in a coup attempt shortly after the golpe. More recently, in August 1998,
Fujimori (in a surprise move) dismissed the long time armed forces chief
and then quickly deployed a marine unit in front of the Presidential Palace
until it was certain that the military leaders were happy with the
replacement choice.
Fujimori's autocratic style has been both a strength and weakness for
Peru. The majority of Peruvians favored the autogolpe in 1992 because they
recognized that drastic measures were needed to address the economic and
political problems plaguing the country. Now, however, the mood is less
sanguine. The highly centralized decision making structure is viewed by
many to be too opaque. The lack of any debate over policy can invite
criticism of "arbitrary decision making," as well as confusion. The
remarkable turnover rate in Fujimori's cabinet is one example. In June
1998, President Fujimori replaced Alberto Pandolfi, his prime minister,
with Javier Valle Riestra. By September, Sr. Valle Riestra was dismissed,
and Mr. Pandolfi was asked to return. Upon his removal, Valle Riestra
announced he would run for President in 2000. The constant shuffling,
combined with back room policy formulation, undermines confidence in the
system.
Economy:
Peru's economy is a fairly diversified one for Latin America. The
services sector accounts for the largest proportion of GDP, but mining,
manufacturing, fishing, and agriculture are also important. The structure
of Peru's economy invites some obvious difficulties. Some 30 to 40 percent
of Peru's economically active population is supported by agriculture, but
the sector has been significantly affected by both human and non-human
factors. The leftist Velasco regime, engaged in extensive land reform,
dividing up large farms into smaller minifundios, thus creating an
inefficient production system. The sector has seen very little investment
since that time. Adding to this, the Shining Path's terrorist campaign of
forced many farmers off their lands in the 1980s. Finally, Peru's
well-known susceptibility for catastrophic climatic events (e.g., El Niņo)
has also had very severe effects on agricultural output. The fishing
industry is another which has been severely impacted by weather-induced
problems. In the mid-1990s, Peru's fish catch was second only to China's.
However, between February 1997 and February 1998 the catch plummeted by 88
percent while export earnings dropped 75 percent.
Mining is also very important to Peru. Mineral exports accounted for some
45 percent of Peru's export earnings in 1996, and are therefore generally
crucial for balance of payments purposes. Given, the enormous potential in
this sector (some estimates indicate that only 10 percent of Peru's
mineral wealth has been identified) and the large capital investments
required for extraction, mining has been a prime target for investment from
abroad. The sometimes volatile nature of the commodity markets, however,
often sets the pace for development of the projects.
Fujimori 's election saw a swift return to liberal economic policies for
Peru. Tariffs were slashed from rates as high as 100 percent to an average
of 15 percent. Capital controls were eliminated, and foreign investment
was actively sought, especially through a massive privatization program.
Its merchandise trade to GDP and investment to GDP ratios for 1996 were
22.6 and 5.8 respectively. These reforms were further supported with other
"structural adjustments" under the close supervision of the IMF. Subsidies
and price controls were eliminated, a new tax system was developed, and
laws were passed making it easier to hire and fire workers. These policy
shifts have transformed Peru. GDP growth has been over 7 percent from
1993-1997 (with the exception of 1996), billions of dollars of foreign
investment have poured into the country, and Peru has regained
respectability in the eyes of the international financial community,
something very important given the country's high level of indebtedness.
There has also been a flip side to these market-oriented reforms. The
adjustments, known collectively as "Fujishock," have resulted in a wicked
rationalization of the Peruvian economy. Many former state-owned companies
have been either abolished or privatized forcing many out of work. Lower
tariff levels, and less restrictive labor laws have spawned a similar
development in some private industries. Some economists estimate that
two-thirds of Peruvian workers are either unemployed or underemployed.
Real wage growth has been inconsistent resulting in per capita income that
by end 1995 was back at 1968 levels. Even swallowing IMF medicine has not
always produced expected results. As one official in the economy ministry
explained trying to understand the 1996 downturn, "Our role has been
reduced to sending a monthly spreadsheet to Washington. All we do is
follow IMF directives."
Like for many emerging markets, growth has been a double-edged sword for
Peru, bringing gains for a small middle and upper class, and pain for the
rest. A former World Bank official summarized it thus, "There is a good
economy for 5 percent of Peruvians, so-so for 20 percent and a disaster for
everyone else." While there are reasons for long-term optimism, there are
a number of areas of which provide reason for immediate concern. Peru's
dynamic GDP growth over the last several years is largely as a result of
the collapse of the economy in the late 1980s. In other words it is mostly
"catch up" from a low base. This year, private sector forecasters have
continued to revise GDP estimates downward, with some now calling for
growth as low as 3 percent. A rapidly growing current account deficit
which is expected to reach more than 7 percent of GDP is perhaps the
biggest cause for concern. While no stranger to current account deficits,
Peru has been able to rely on capital inflows for its financing. This
problem has been compounded in 1998, by a number of factors, including
reduced export earnings in several sectors because of El Niņo, cheaper
imports from Asia, and some significant setbacks in planned foreign direct
investment. This has begun to place pressure on the sol, and inflation is
already beginning to creep upwards from last year's record low.
Compounding these concerns is the September 30, 1998 anti-government rally
during which 5,000 protestors broke through a barricade surrounding the
Presidential Palace, and a smaller number caused damage inside the
residence. The main participants were union workers complaining about high
levels of unemployment and calling for an end to privatization, and
students who were protesting for democracy. There were similar
demonstrations in other Peruvian cities. The largess and violence of the
march were surprising given the drastically weakened power of unions since
the 1980s when mass protests were a regular occurrence. While perhaps an
isolated event, continued demonstrations would inevitably serve to further
"spook the market."
Private Sector:
"For decades in Peru, the private sector was viewed as the enemy. Marxist
ideology had branded business as a conspirator against national development
in general and the poor in particular. The State, on the other hand, was
the public defender, responsible for society's welfare and protection."
This quote captures the antagonistic relationship that flourished between
business and government beginning in the late 1960s. As Thorp and Dutrand
discuss, the lack of formal communication between these two groups (and
within the business community itself) resulted in a situation where
individual companies would seek to protect their own interests without
consideration to policies that could help the business sector as a whole.
It was only with a crisis, the attempted bank nationalization by Garcia,
that saw the business community unite behind a common goal.
While the Fujimori administration makes decisions within a tight circle,
private sector interests have been represented because of the seemingly
constant placement of "businessmen" in important posts. Probably the best
example is the tenure of Jorge Camet Dickman, who served as the in the key
position of Economy Minister from 1993-1998. Prior to his appointment into
the Fujimori administration, Mr. Camet had served as head of CONFIEP, a
business umbrella organization. The result has been that business elites
are often key backers of Fujimori policies.
Financial Sector:
Central Bank:
The Banco Central de Reserva Peruano (BCRP) was founded in 1922 and is
charged with managing monetary policy, and maintaining financial stability
(especially price stability). The institution's lowest point came during
the Garcia administration when two of its officers were charged with having
secretly deposited $250 million (about 25 percent of the reserves at the
time) from the central bank's coffers with the now defunct BCCI. The 1993
Constitution guaranteed the Central Bank's autonomy, although the
institution is not completely immune from political pressure. The bank
will intervene in the currency market to ensure "exchange rate stability,"
and since 1993 has operated an informal currency board requiring all
domestic currency to be fully backed by foreign reserves. At year end 1997,
reserves stood at just above $10 billion.
Stockmarket:
Peru's stock market has witnessed significant growth during much of the
1990s, although from a low base. In 1990, the market capitalization stood
at $812 million, about 2.5 percent of GDP, while by 1996 it had reached
$12.3 billion or just over 20 percent of GDP. Perhaps even more surprising
is the fact that the number of listed domestic companies on the exchange
fell from 294 to 246 during this same period. The market is heavily
reliant on foreign capital which has predominantly been invested in a
handful of key stocks. In 1995, foreign transactions accounted for more
than 60 percent of the market's activity. In an effort to stimulate
domestic savings and growth of the domestic capital market, the Fujimori
government established six private pension funds (a la Chile) in 1993.
Recent events have shown just how vulnerable Peru's market is to shifts in
the patterns of global capital. Like many Latin stock markets, Peru's
bolsa has plunged this year, falling 36 percent in dollar terms.
Banking Sector:
The years 1970 to 1987 witnessed an increase in the level of state
intervention in Peru's banking system. In 1970, the military government
under General Velasco nationalized three foreign-controlled banks, and
restricted the movement of foreign accounts to the state-controlled Banco
de la Nacion. At its peak, the government controlled nearly 75 percent of
the country's financial resources. Over time, the distortions in resource
allocation and interest rates that these policies caused served to
undermine public confidence in the banking system. In 1987, President
Garcia, no longer able to manage this situation, attempted to nationalize
the domestic commercial banking system. Garcia badly miscalculated his
support for the initiative, and there was an immediate outcry from
businesses and opposition politicians. While Garcia literally attempted to
"stick to his guns" (using the police to place some banks in state hands
more quickly), the opposition also stood firm. For example, the country's
largest private bank, Banco Credito del Peru, refused to serve customers
or turn on the computer link to its branch offices. Ultimately, Garcia had
to back down. The end result of these interventionist policies (including
pre-Garcia) was a disaster. Foreign banks withdrew from Peru due to a
discriminatory legal structure; capital flight, and hyperinflation caused
volumes intermediated by the commercial banks to plunge to one-third of the
levels reached in the mid-1980s; and non-performing loans had increased to
about 25 percent of total loan portfolios. By, 1988, nearly all
state-owned banks were bankrupt.
The economic policies of Fujimori, while drastically transforming the
economy, have had an especially significant effect on Peru's banking
system. After a period in which the easiest way to maintain earnings was
from "float" income from inflation, in 1991 the banks were forced to deal
with a number of policy adjustments. Some of the major changes included;
liberalized interest rates, more stringent oversight regulations, and free
entry into the banking sector, including from abroad. Peruvian banks are
regulated by the Superintendency of Banks and Insurance (SBS) which is
charged with defending the public interest and ensuring the financial
stability of those banks and finance companies under its purview. The SBS
has introduced a number of rigorous regulations designed to ensure the
health of the banking system. While many have applauded these tough rules,
critics have observed that some measures give the SBS too much power. One
of the most important regulations is that total bank assets, adjusted for
credit risk, cannot exceed 11.5 times their regulatory capital (this will
fall to 11 in 1999). This is primarily to reduce banks' exposure to bad
debt. Another recent change limits loans from banks to companies with
direct links to those same banks, though the absence of conglomerates in
Peru likely will not make the economic effect as stark as it would in other
countries. Finally, reserve requirements are 15 percent for sight deposits
and 6 percent for term deposits, with a 50 percent marginal reserve
requirement for deposits in U.S. dollars.
Since, the early 1990s foreign participation in the financial sector
broadly, and the banking industry in particular, has grown by leaps and
bounds. According to Peru's foreign investment commission (CONITE), the
stock of foreign direct investment in the financial sector has grown nearly
640 percent from $106.5 million in 1991 to $784.03 million as of June 1998.
Further, by the end of 1997, foreign investment in the banking sector
alone reached $445 million. There are two principal reasons for the
increase in FDI, privatization and new entrants (especially through
acquisition). Early in Fujimori's first-term, the state-owned development
banks were abolished, and the process of privatizing state interests in the
commercial banking sector began. A number of foreign banks have entered
Peru over the last several years, but none have been more active than the
Spanish giants, Banco Bilbao Vizcaya, and Banco Santander. As in other
countries throughout the region, both, through privatization or
acquisition, these two banks have invested millions in Peru. Chilean,
French, U.S., and even Italian banking interests have also become
increasingly active in the market, believing that there is long-term
potential in this sector. As of December 1997, 13 of the 24 existing banks
were controlled by foreign capital, placing 57 percent ($578 million) of
the banking system's equity in foreign hands.
Lower inflation, and therefore lower interest rates, an increase in
foreign investment, and the growth of the stock market as a source of
financing for Peru's major corporations, have sent spreads on commercial
loans tumbling and forced banks to scramble to increase their share of the
retail market. Competition has been fierce with banks aggressively
pursuing new customers through various promotion campaigns. By many
measures these changes in Peru's policies have been viewed as having
promoted growth and stability in the banking system. In March 1998, Duff
and Phelps Credit Rating Co. assigned a BB long-term foreign currency
rating to Peru, citing among other factors, "A highly capitalized, very
liquid and well provisioned banking system. A solid regulatory system and
a capable and appropriately staffed supervisory agency reinforce the
banking system's relative strength." More efficient operating procedures,
many of which are due to new technologies introduced by foreign investors,
have also helped to bring down internal costs and thus improve
profitability. In 1997, the average ROA was 1.6 percent while ROE reached
17.5 percent. This compares with an ROA of 1 percent and a ROE of 6.5
percent in 1993. The ratios for the larger banks have generally been even
better.
In general, there seems to be a quiet sense of confidence among some
Peruvian banks. The system escaped virtually unscathed from the 1995
"tequila effect" that rippled through Latin American, and the steady
increases in assets, deposits and loans through 1997 have contributed to
the cautiously optimistic attitude. The fact that Peru is still woefully
underbanked with only 10 percent of the population holding a bank account
or using bank services, provides an indication of growth potential.
This past performance could be threatened, however, by a number of recent
events. The one-two punch of El Niņo and the continued shocks from the
Asian crisis will severely test the mettle of the Peruvian banking system.
In the first quarter of 1998, past due loans increased by a startling 29
percent, largely due to El Niņo. Despite precautions taken by the SBS,
this figure is likely to increase later this year as the effects of the
Asian crisis are felt. In some ways, the rapid growth in the sector has
contributed to these problems by increasing earnings pressure. This could
make it especially difficult for some of the smaller banks to make it
through 1998 in one piece. The system is also heavily reliant on foreign
capital, should this begin to dry up the results could be devastating. As
perhaps one indication of the perceived strength of the Peruvian banking
system by U.S. investors, Banco Weisse, Peru's third largest bank, which in
1994 floated a very successful offering on the New York Stock Exchange, is
now trading below $3.00 (ADRs).
The Peruvian banking system has undergone some very fundamental shifts
over the past several decades. Beginning in the 1960s the system
increasingly came under the heavy influence, if not control, of the state.
By the end of the 1980s this system was no longer workable and it
collapsed. Throughout the 1990s, the sector has been characterized by a
high level of concentration. In 1996 the top four banks accounted for
nearly 70 percent of deposits and assets. At the same time, however, there
has been in a concerted effort to induce competition both internally, by
opening the sector to outside investors, and externally through a more
developed stockmarket. The next several years will determine whether the
system becomes more like the Anglo-Saxon model in which there are many
competitive banks and a "deep" stockmarket, or if a more open and
competitive banking system in the short-term fosters increased
consolidation in the sector, coupled with a "thin" stockmarket. A third
possibility could be some combination of the two.
In the short-term (and perhaps for much longer), much will be up to
President Fujimori. Clearly, there are many problems, both economic and
social that still need to be addressed. Balancing sustainable economic
policies while addressing the concerns of those who feel increasingly
disenfranchised with the current system will be no easy task. Over the
last few years several rating agencies have expressed concerns about the
high level of concentration in hands of the President because it is unknown
what would happen in the event of a transition, democratic or otherwise.
If Mr. Fujimori's population ratings remain in the thirties, we will likely
find out in 2000.
Plans for Future Work:
The next country examined will be Chile. While continuing my research, I
hope to find more specific information about the views of the banking
community on the liberalization of Peru's economy. For example, are there
any tensions? It would seem that the smaller bankers might not have the
same "optimistic outlook" that the larger ones have. Additionally, it
would be interesting to learn if the immense presence of foreign banks in
Peru is seen as threatening to groups inside or outside the financial
community.
End Notes
Bibliography
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