An economy on the mend

It all looked very different in mid-January. Spreads on Peru's debt widened by more than 100 basis points as investors wondered whether Toledo's two-and-a-half-year-old government was on its way out amid corruption scandals. Four ministers lost their jobs in just three months and Toledo, who has a popularity rating of just 9%, struggled to distance himself from corruption scandals.

But a cabinet reshuffle in February calmed bondholders' nerves. It brought in seven independent ministers, and it brought back fund manager and Wall Street darling Pedro Pablo Kuczynski as finance minister. He had held the same post in Toledo's first cabinet between July 2001 and July 2002. "I
am committed, as I always have been, to sound fiscal policies," said Kuczynski, on taking office.

Even before these political moves, Peru's economy certainly helped, analysts say. "Investors are deaf to the political noise. They are looking at the numbers, which are solid," says Bear Stearns debt strategist in New York Jose Cerritelli.

According to Peru's central bank, economic growth of 4% will be posted in 2004, after 3.97% in 2003. Internal demand is expected to grow by 3.7% in 2004 after expanding 3.6% last year, while Peru closed the year with a budget deficit of 1.9% in 2003 and should end 2004 with a more austere 1.5% deficit. Tax revenues are also increasing. Latin America's seventh-largest economy should collect taxes worth 13.4% of GDP in 2004 compared with 12.9% in 2003.

A landmark

On the back of these prospects, in November Peru launched a $500 million, 30-year global bond priced at 375 basis points over 30-year treasuries ? the first time it had issued such long-dated paper. The government issued $1.25 billion in 2003 after returning to the markets in 2002 with Peru's first issue in 72 years. The country's bonds and Brady debt stands at $5.6 billion and makes up 2.6% of JPMorgan's EMBI Plus. Peru's total foreign debt is $22.8 billion, up from $20.7 billion in 2002, amounting to 37% of GDP.

More bond issues could be on the way, as finance minister Kuczynski says he wants to negotiate a partial buy-back of Peru's $8.6 billion Paris Club debt by issuing longer-term bonds.

Progress in Peru's first round of talks with the IMF for a new line of credit is seen as another positive signal to investors. The global lender is expected to approve a stand-by loan to Peru within the next six months. Officials say this will be similar to the $380 million stand-by agreement that the global lender approved in 2002, which Peru has not drawn on.

"Discussions have advanced significantly and the mission will continue to work extensively with the authorities towards the successful conclusion of talks in the coming weeks," the IMF's Gilbert Terrier says.

But Peru still has work to do on its economy in the medium term and needs to generate jobs and depend less on mining, analysts say. "The economy is not growing enough to absorb the workforce. It is a structural problem," says Juan Carlos Odar at Peru's biggest bank, Banco de Crédito, which expects growth in 2004 to be below the government's target at between 3.5% and 3.8%.

One of president Toledo's biggest headaches is the economy's failure to create jobs, a symptom of a heavy reliance on the powerful mining sector, which contributes 50% of exports but is a relatively small employer. Textile exports are surging, but growth in agriculture and manufacturing is weak, according to the national statistics institute. Manufacturing grew 2.1% in 2003 while the mining sector expanded 6.7%, lifted by high international metal prices.
"The political turbulence [around Toledo] is also limiting economic growth in the medium term because it holds back investment," says economist Pablo Nano of Lima-based bank Banco Wiese.