A philosophical budget
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Emerging Markets

A philosophical budget

Peru’s finance minister Luis Carranza thinks the administration’s financial plan will revolutionize the way the state bureaucracy thinks. Yet the government’s long-term priorities remain opaque


Back in office after years in the political wilderness, Peru’s president Alan Garcia has found himself at the helm of a country whose fortunes look wildly different from the one he ran – disastrously – two decades ago. Since his re-election last July, Garcia has mixed a dash of populist swagger with the industry-friendly policies of his predecessor, Alejandro Toledo, to apparently winning effect: the approval ratings of the reborn moderate leader have remained consistently high. It is hard to find an analyst in Peru or abroad who is not upbeat about the country’s economic performance heading into the latter part of the decade.


The figures, on the face of it, are encouraging. The economy expanded slightly more than 8% in 2006, while recording inflation near 1%, a trade surplus of $8.8 billion, foreign reserves close to $18 billion and a tax base close at 15% to GDP, the best it has been for more than two decades. GDP has gone from $53.3 billion in 2000 to $92.2 billion in 2006, according to Scotiabank, while GDP per capita rose from $2,085 to $3,337 over the same period. Of course, it’s helped that the international environment has been favourable, particularly given record prices for raw materials such as gold, copper, zinc and other metals that Peru produces in abundance.


But analysts also give credit to Garcia and his predecessor with having managed the economy to take advantage of the positive international climate. “There is now a foundation in place to build structures for the long term to avoid the economic cycles that have always held back sustained growth,” says Jorge Luis Rodriguez, head of research at Centura SAB, a brokerage firm in Lima. With the economy growing and prospects for the coming years looking up, the Garcia government has begun implementing sweeping changes aimed at reforming the state to tackle poverty, which affects nearly 50% of Peru’s 27 million people. .


Next step

 

“We have made progress on macroeconomic stability. Now we must begin implementing profound economic and social changes in this country,” finance minister Luis Carranza tells Emerging Markets in an interview. Reducing poverty is contingent on making the state more efficient. Carranza says that under current conditions the country will reduce poverty by one point annually if the economy grows by 6%. He says this is totally unacceptable. “We have an extremely inefficient system of public spending. The goal is to increase efficiency in order to reduce poverty by two points a year to reach 2011 with poverty levels at 40% or less,” adds Carranza, a former banker and deputy finance minister, who is also one of Peru’s most orthodox economists.


Traditionally, Peru has had a low percentage of GDP earmarked for social programmes. The country is second to last in South America, ranking just above Ecuador, spending an equivalent of 8% of GDP on social programmes. Uruguay is in first place, with 20.9%. A 2006 study by Unicef, for example, found that Peru would need to add $940 million to the education budget and $1.3 billion in healthcare just to reach regional levels in South America. Part of the Garcia government’s plan for tackling this problem is to reduce decentralized public agencies from 69 to 32 and to fuse or merge 82 social programmes to get the number down to between 20 and 30 on increased efficiency. “We are in process of fusing public agencies to reduce bureaucracy, which means fewer costs to the state and more resources for these programmes,” says Carranza.


Shock tactics

 

Another major plank is an “investment shock” that was launched in October 2006 to increase public spending on productive and social programmes, as well as infrastructure projects. Supplementary budget allotments of close to $900 million have been approved for this emergency investment plan. According to Carranza, the investment shock and reprioritizing the budget will dramatically increase public investment. He says that public investment should increase by close to 60% this year compared to the 2006 budget.


Altogether, public investment this year should be around $4 billion. The government is also working on changing the way the state is financed. Congress granted the cabinet legislative powers to revamp the country’s tax laws. A first batch of norms, which included the framework for financial derivatives, was launched in late December, and the cabinet has until the end of March to make additional changes. Carranza says that the toughest changes to come – politically not technically – involve eliminating tax breaks and creating a capital gains tax. Another important move came on February 15 with the announcement that the government would exchange or buy back its global bonds due 2012 and part of its Brady Bonds in a $3.63 billion operation. The idea is to exchange the bonds for new paper that will come due in 2037. This is the second major debt management operation in the past two years. Toledo’s government pre-paid $2 billion to the Paris Club in mid-2005. Carranza says that many more changes are much less glamorous, such as reforming the state’s acquisitions and purchasing processes.


The agencies that oversee public investment are being completely overhauled, and a new legal framework is being produced. The administration has already tested one case, combining the purchases of medicines and medical supplies by different state agencies. The savings amounted to slightly more than $12 million and has $22.4 billion external debt outstanding.


Tinkering

 

While not criticizing the need to make the state more efficient, critics charge that the administration is trying to sell administrative restructuring as state reform to avoid making difficult choices. Javier Azpur, who runs a consortium of non-governmental organizations that focus on state reform and decentralization, says the administration is only tinkering with the most obvious examples of bloated bureaucracy but not the reason why there is bureaucracy to begin with. “There is no clear notion of what the Government has in mind about reform. State reform means setting national priorities for the next two decades and organizing them around results. There is no talk of this,” he says.


This criticism is repeated by Garcia’s opponents on the right and left. His two major political challengers from the 2006 presidential race – Ollanta Humala and Lourdes Flores Nano – have argued that the president has limited reform to headline-grabbing moves that skirt the tough issues. Carranza responds that it is the critics who are short sighted, because state reform cannot happen in only a few months. He says the most lasting change underway is moving from a budget based on programmes to one based on results. “Changing the budget from one based on programmes to one based on results is changing the way that bureaucracy thinks. You have to change the chip, the philosophy. The essence of this kind of budget is the objective, and this implies profound changes. This is a very long process,” he says

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