Peru’s new finance minister Luis Carranza is one of the luckiest men to hold the post in the country’s recent history. He does not have to deal with hyperinflation, shrinking gross domestic product or a fiscal situation that leaves little room to manoeuvre.
Instead, he has inherited an economy growing at around 6%, low inflation, falling unemployment and export earnings that have more than tripled in the past five years.
Carranza says the solid economic footing will allow the government to move ahead with second-tier reforms that include streamlining the public sector and fostering competitiveness.
“We need to consolidate macroeconomic stability, which implies an institutionalization of fiscal responsibility. We will begin producing a report on public finances, which, like monthly reports on inflation, will further transparency and allow for corrective measures to be made,” he says.
shock tactics
Before getting to that, however, Carranza and his boss, president Alan Garcia, have announced that the government will implement an “investment shock” of about $625 million starting in October, aimed at improving the situation of half of Peru’s 27 million people who live in poverty. The bulk of the spending will focus on common-sense projects that include maintenance of highways, repair of schools and clinics, and small water and waste disposal projects.
“We have calculated a maintenance deficit of about $500 million annually. Highways are built but no money is budgeted for maintenance, and within four years they are collapsing. In education, 10% of the schools at the national level have been declared in a state of emergency and should not be used, because of lack of maintenance,” says Carranza.
The government also plans to turn to the World Bank, Inter-American Development Bank and Andean Development Corporation for loans for infrastructure projects. These three entities have pledged fresh loans totalling more than $4 billion to the administration.
Despite being labelled as an ultra-orthodox economist, Carranza, 39, has also signed off on a number of tax incentives and spending initiatives targeting Peru’s poorest areas. The administration will provide tax breaks to any company, with the exception of mining companies, investing at altitudes above 3,200 metres and has signed into legislation creating a free-trade zone for Puno, a poor area on the border with Bolivia.
He says the government will have no problems paying for new programmes, because his ministry is already in the process of examining existing government programmes and eliminating duplicity. In addition, the austerity measures announced by President Garcia will save about $400 million annually starting in 2007, and the high international prices for raw materials, particularly copper and gold (Peru is among the top six worldwide producers of both metals), means more exports and, therefore, more taxes, “giving us a cushion to commence with priority projects for the poorest sectors,” he says.
Tax reform
One of the trickiest tasks facing Carranza will be tax reform, which is already generating resistance even before it gets started. Former president Alejandro Toledo’s government tried to implement tax changes twice, but was rebuffed by Congress both times. The administration settled on temporary taxes that should be eliminated at the end of this year, but Carranza has other ideas.
To begin with, he plans on maintaining the Financial Transaction Tax (ITF), which was implemented in 2004 and is currently at 0.08%. He says the percentage will drop, but it will remain into 2007 as a way of combating tax evasion. “Financial transactions leave a trail and can be traced back to the individual or company.” He also plans to keep the Temporary Tax on Net Assets (ITAN), another tax on the books since 2004.
To appease businesses and help industry, the government plans to eliminate the tariff on capital goods, which is currently 4%. The business community wholly supports this and is pushing for lower taxes and an elimination of exonerations – except in areas that affect them. The umbrella business group CONFIEP is hotly opposed to the eliminating exonerations on income earned on savings or investment in the Lima stock market. CONFIEP argues this would weaken the banking system and undercut the bourse. Lima’s stock exchange was the second fastest growing in the world, after Cyprus, in the first six months of this year.
Luis Vega, president of the Exporters’ Association, says eliminating these exonerations will hurt businesses and investors, while not generating much money for the state. The government should focus on erasing the anti-technical taxes, such as the ITF and ITAN.”
Tax collection as a percentage of gross domestic product was 13.6% in 2006 and is forecast to hit 15% this year.