INTELLIGENCE MEMORANDUM PERU: ECONOMIC TRENDS AND PROSPECTS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001700040002-4
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 16
• Document Creation Date: December 20, 2016
• Document Release Date: March 27, 2006
• Sequence Number: 2
• Publication Date: July 1, 1972
• Content Type: IM

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Confidential
DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
Confidential
ER IM 72-119
July 1972
Copy No.
CIA-RDP85T00875R001700040002-4.
74
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CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
July 1972
INTELLIGENCE MEMORANDUM
PERU: ECONOMIC TRENDS AND PROSPECTS
Introduction
1. Over the last year or so, Peru's military government has modified
its earlier, more radical posture to encourage investors to help develop the
country's resources. More flexible policies have partly restored foreign
investors' confidence, and ten major oil companies now have contracted
to follow up on OccidEatal Petroleum Corporation's promising discoveries
in the remote northeastern jungles. Domestic investors, after holding capital
outlays to low levels for several years, began to restock and expand
operations in 1971. Fallout from the uncompensated expropriation of a
US-owned oil company four years ago continues to block some official
foreign loans, however, and further difficult choices between socio-political
and economic goals loom ah?ad. This memorandum reviews the economic
difficulties deriving from the government's initial policies and describes
subsequent efforts to stimulate the return of foreign capital and gain the
confidence of domestic entrepreneurs. It also assesses the modified
revolution's chances for economic success in the face of continuing thorny
problems.
Background: Early Revolutionary Policies 4nd Their Effects
2. Upon seizing power in October 1968, the new government headed
by General Juan Velasco moved quickly to strengthen the state's economic
control and redistribute income at the expense of both foreign investors
and the domestic elite. One of its first official acts was to expropriate the
Note: This memorandum was prepared by the Office of Economic Research
and coordinated within the Directorate of Intelligence.
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properties of the International Petroleum Company (IPC) - a Standard Oil
of New Jersey subsidiary. The new regime then initiated a far-reaching
agrarian reform program by nationalizing the large coastal sugar estates and
organizing them into worker cooperatives. It also charged state enterprises -
some of them newly created - with primary responsibility for developing
Peru's extensive natural resources and imposed strict investment schedules
on foreign firms wishing to participate in the process. Foreign ownership
in some fields was severely restricted and, in others, was subjected to terms
stiffer than those subsequently called for under the Andean Foreign
Investment Code. Finally, "worker participation" in the ownership and
management of manufacturing, fishing, and mining companies was launched
with the 1970 Industrial Reform Law. Under this law, each manufacturing
firm was required to distribute a 25% share of annual pre-tax profits to
its employees - 10% in direct cash benefits and 15% to be held in trust
by an "industrial community" representing the workers. This latter share
was to be used to purchase company stock until the community ultimately
acquired 50% of the firm's equity and a concomitant role in managerial
decision-making.
3. Because of the climate of abrasiveness and uncertainty produced
by these moves, official foreign credits as well as foreign and domestic
private investment declined dramatically. Although the Hickenlooper
Amendment never was formally invoked in response to the IPC takeover,
no new project loans were extended by the US Government after 1968
and disbursement of funds already in the pipeline slowed markedly.
Similarly, no new project financing .,;as extended by the International Bank
for Reconstruction and Development (IBRD) during 1969-71, and new
Inter-American Development Bank (IDB) loans totaled only US $56
million.* Net official capital inflows declined from an average $145 million
annually in 1966-67 to an average $30 million in 1970-71, including
earthquake relief loans (see Table 1). Even if disinvestment directly caused
by nationalization is excluded, Peru suffered net losses of long-term private
capital until 1971. Moreover, because of continued recession and uncertain
business prospects, domestic private capital outlays plummeted some 17%
between 1966 and 1968 and then virtually stagnated through 1970 (see
Figure 1).
4. Despite the falloff in private investment and the avowed aims
of expanding the state's economic role and effecting profound social reform,
the Velasco government adopted highly conservative financial policies. By
1970 it had virtually eliminated the budget deficit - which equaled 27%
* Immediately following the 1970 earthquake, the US Government, IBRD, and IDB
extended some $80 million in relief aid, part of which could be considered development
assistance.
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Private
Year Flows
Official Flows
With Debt
Servicing
as Scheduled
Gained
From Debt
Renego-
tiation
Total
Official
Flows
Total
+143
+143
+178
+147
+147
+174
+54
+51
+105
+90
+71
+59
+130
+120
+22
+7
+29
+19
+43
-13
+30
+37
Excluding disinvestment through nationa ization,
of expenditures in 1967 - and had cut the inflation rate from the 1968
high of 20% to only 5%. Fiscal austerity and sharply curtailed foreign
assistance combined, to keep public investment at very low levels through
1969. The spurt in public capital outlays in 1970-71 and re-emergence of
a substantial budget d,,'Icit in 1971 had little inflationary effect. The high
degree of domestic liquidity created by the forced repatriation of private
foreign currency holdings in 1970 permitted financing of the deficit through
bond issues.
5. Although its foreign capital account steadily deteriorated, Peru
added, some $300 million to its net foreign reserves during 1969-70 (see
Figure 2), The trade balance improved considerably because of (a) generally
weak import demand, (b) continued government restraints on luxury goods
imports, and (c) a jump in exports in 1970 - reflecting good crop weather,
a record fish catch, and high world prices for minerals and fishmeal. These
factors, combined with a surge in domestic demand for manufactured goods,
generated a 7.3% rise in real gross domestic product (GDP) in 1970 (see
Figure 1). Revived economic growth, however, spurred import demand in
.1971, while exports declined to more normal levels. As a result, a
$70 million balance-of-payments deficit was incurred, and net foreign
reserves by the. end of the year had declined to $340 million - a level
still sufficient to finance about six months' imports.
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Peru: Selected Economic Indicators
Indexes of Consumption, Investment, and GDP Percent Change in Real GDP
Public Fixed
Capital Formation
1965 66 67 68 69 70 71 1966 67 68 69 70 71 66 67 68 69 70 71
Percent Increase in Consumer Prices Budget Deficit as a Percent of Expenditures
Figure 1
1966 67 68 69 70 71 1966 67 68 69 70 71
(est.)
17~~N~f
i.A71
}1
'f
..
t
k
l1'
~:i,laJr~y'Yb`:h
Private Fixed 2
Capital
mation
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Peru: Exports, Imports, and Net Foreign Reserves
Million US $
Figure 2
6. Private investment, which had not responded markedly to the
1970 boom, jumped 177o in 1971 as rising demand pressed against
production capacity. Although the investment trend indicated private
industry's growing confidence in its ability to operate within the system,
few if any new enterprises were created. Capital expenditures - financed
by amply available credit - went mainly to refurbish concerns that had
stagnated since the investment boom of the mid-1960s. At the same time,
dwindling public savings threatened to reduce the growth in public
investment. After rising by almost one-fifth in 1970, government revenues
declined slightly in 1971 because export earnings dropped and economic
growth slipped to 5%. Although a somewhat rejuvenated privat: sector
boosted manufacturing output by 9%, less favorable weather and the threat
of expropriation limited agricultural growth, and labor unrest cut mineral
production substar. tiaily.
Phase Two: A Modified Revolution
7. The Velasco government began to modify its policies in 1971
because of the economic slowdown and a more pragmatic appraisal of how
social and economic goals should be balanced. The military rulers from
the beginning had recognized that both domestic private investment and
foreign capital were essential to reach their development goals. They almost
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certainly, however, underestimated the negative impact their new rules
would have on these capital sources. Once some of the easier social reforms
were under way and the economic development task had to be faced, the
Velasco government apparently decided that a change in both rules and
rhetoric was necessary to attract the large resources required.
8. Amendment of the Industrial Reform Law is perhaps the most
difficult and significant compromise made thus far. In 1971 the highly
criticized provision regarding workers' managerial rights was modified
substantially. Under the amended law, worker communities in key
manufacturing industries and joint state-private manufacturing firms
declared "strategic" will purchase company bonds or bonds issued by the
government's newly established Development Finance Corporation
(COFIDE) instead of company shares, thus avoiding a dilution in
management control. Because the firrrs still must fund these purchases,
ho::ever, the amendment does not soften the adverse impact of the original
law on their profitability nor does it exempt them from what is in effect
a forced re-investment of 15% of pre-tax earnings.
9. Although the Velasco government still is deeply committed to
agrarian reform, it has minimized the economic costs involved. To help
preserve private landowners' incentives, the government has emphasized that
future expropriations will affect only those holdiiigs exceeding 370 acres
in the irrigated coastal area or their productive equivalent in other areas.
The large coastal agro-industrial complexes expropriated early in the
program have been kept intact, and their output of sugar and cotton has
held up well. Some 88,000 families were settled on these and other
expropriated properties by December 1971. The reform pace has slowed
during the last year or so, however, as the program shifted to the interior,
where the breaking up of large, und.erused ranches entails much higher
investment costs. Originally scheduled to be completed in 1973, land
redistribution now is considered a much longer-term program.
10. Recent efforts to stimulate private foreign investment have taken
various forms. The government recognized that settling outstanding
investment disputes would be highly important in luring new investors.
Except for IPC, mutually agreeable compensation arrangements had been
worked out by the end of 1971 for those few foreign properties that had
been nationalized outright and sec: et negotiations had been undertaken in
an attempt to settle the sensitive IPC problem.
11. The government also made special efforts in 1971 to stimulate
new foreign investments in mining and petroleum exploration. It exempted
private foreign firms in these sectors from the Andean Foreign Investment
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Code provisions requiring them to sell 51% of their equity to Peruvian
citizens by 1986. Moreover, the Mining Law issued in June 1971 provided
that mine employees are to receive only a 10% share of pre-tax profits
(compared with 25% in manufacturing), and, in the case of joint state-private
ventures, the workers' communities are to purchase bonds rather than
company shares. The Mining Law also offers tax and credit incentives for
new mining investments that are particularly liberal for joint ventures. To
further encourage private foreign investors, the government opened to oil
exploration by joint ventures much of the western Amazon basin, where
large oil deposits have been discovered in an area previously reserved to
the State Petroleum Company (Petroperu). The new oil ventures will not
be required to pay their employees a share of pre-tax profits.
Foreign Investor Response
12. Foreign investor confidence has been partly restored by these
policy changes, and the government has been able to sign a number of
joint-venture contracts with major foreign corporations. For example,
Holiday Inns, Marriott, and Braniff agreed to invest some $15 million in
constructing six new hotels in a joint-venture with the State Tourist Agency.
Bayer Company of Germany decided to double its acrylic 'fiber plant
capacity when the government agreed to declare the enterprise "strategic,"
thus exempting it from Industrial Reform Law provisions requiring workers'
equity and management participation. The limits of the new foreign
investment policy are being further tested by ongoing negotiations between
the US-owned Dresser Industries Inc. and COFIDE for a mixed company
to manufacture drill bits for the Andean market. Final agreement, which
apparently is contingent on the new firm's being declared "strategic," would
usher in Peru's first totally new foreign manufacturing investment in several
years.
13. The favorable response of major foreign petroleum companies to
new government initiatives has unquestionably generated the most
excitement in Peru. In June 1971 the Occidental Petroleum Corporation
and Petroperu signed a long-term contract that has served as a model for
subsequent agreements involving ten other foreign oil companies and for
current negotiations with firms competing for the remaining 2.4 million
acre exploitation areas. Under the Occidental contract, the company pays
all exploration and development costs and receives one-half of the oil and
gas recovered, while Petroperu pays all taxes and receives the remaining
one-half of output. At the end of 35 years, the developed areas revert to
the state without additional compensation to Occidental. These terms are
relatively favorable to the company, reflecting the substantial costs and risks
of oil exploration in the remote jungle region. All equipment must be flown
in by helicopter and, in addition to other infrastructure projects, a $250
million pipeline will have to be constructed across the Andes.
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14. No official estimates of Peru's oil reserves have been made, but
the government optimistically forecasts the country's emergence as a major
exporter by the late 1970s. The basin is adjacent to large Ecuadorean
deposits that went into production last month, and Petroperu - which has
reserved a substantial area for its own operations - has struck oil with
its first three wells. Estimated investment in oil development in the area
over the next five years now exceeds $700 million.
15. The response of foreign mining companies is far less encouraging
to the Velasco regime. The Southern Peru Copper Company has committed
$48 million to cover the next phase of its Cuajone copper project,
completion of which would rPci1!ire $355 million. On the other hang,
Mineroperu - the State Mining Company - has had little success in securing
foreign financing for its $600 million, five-year investment program to
develop. US-held concessions takeri over in December 1970, when the
companies failed to meet the government's development deadline. Thus far,
it has made only one firm agreement. A British-led consortium has
committed $55 million to finance the first stage of the Cerro Verde copper
project, a concession given up by the Anaconda Company. Mineroperu has
signed preliminary agreements to develop two of the smaller properties in
joint-ventures with the Swedish Granges Company and the Romanian foreign
commerce agency Geomin, but some important issues still are unsettled.
The Cerro Corporation wants to pull out of Peru because of labor unrest
and bleak profit prospects; it thus has offered to sell Mineroperu its
properties, valued at $110 million. Cerro, at the same time, is willing to
provide technical assistance and help find funds for a proposed $185 million
expansion of its facilities if Peru can finance the initial purchase.
Foreign Creditor Response
16. Peru's more moderate stance also helped in obtaining new
long-term credits from European and Japanese sources in 1971. These
included a number of government-guaranteed credits to finance more than
$150 million in work on two major irrigation projects designed to transform
large desert areas into productive farmland. Moreover, improved relations
with the United States, in part because of the Peruvian government's
agreement to compensate W.R. Grace and Company for expropriated sugar
properties and its restraint on fishing vessel seizures, led to a presumption
in late 1971 that increased assistance from the US Government and
international lending agencies would soon he forthcoming. The path toward
substantial expanded assistance. was further cleared in February 1972 at
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a meeting of an international consultative group sponsored by IBRD.*
Although no funds were committed, the member nations agreed in principle
to support Peru's proposed $1.8 billion investment program for 1972-74
with up to $780 million in new project loans.
17. Peru's hopes for large new official credits were substantially
dimmed, however, by two related events in early 1972: a press leak
concerning the secret IPC talks in Peru and passage of the Gonzalez
Amendment in the US Congress. In political defense against the brouhaha
caused by the press leak, the Peruvian government "officially" expropriated
IPC, in effect without compensation - thus virtually eliminating any chance
for a negotiated settlement. At the same time, flexibility in US aid policy
was limited substantially by the Gonzalez Amendment, which requires a
negative US vote in international financial agencies' deliberations on
assistance to any nation that has expropriated US property without
compensation.
18. Despite these setbacks, Peru has lined up in recent months some
$320 million in project financing from other member nations of the IBRD
consultative group (see Table 2), and negotiations for other loans are in
progress. In addition, one small IDB loan recently was extended to help
finance agricultural cooperatives. Other non-concessional loans from
international financial agencies also can be authorized because the US
Government has no veto on financial operations of this type. A negative
US vote, however, does block soft-term loans of the sort normally extended
for project assistance to Latin America.
Prospects
19.' Peru's ability to match its earlier long-term growth record will
depend heavily on its success in attracting large-scale foreign assistance in
developing its resources, particularly its still-untapped mineral and petroleum
deposits. For nearly two decades preceding the onset of recession in 1967,
Peru's economy grew an average of 6% annually, thanks initially to sizable
direct foreign investments and later to substantial investment-financing by
the US Government, international agencies, and foreign private banks.
Unlike its predecessor, the Velasco government has maintained a degree
of fiscal responsibility that helps to inspire investor confidence both at home
* Countries represented at the meeting were Belgium, Canada, Finland, France,
Germany, Italy, Japan, the Netherlands, Spain, and the United Kingdom. Representatives
of the International Monetary Fund, IDB, the Inter-American Committee for the Alliance
for Progress, the UN Development Program, and the international Coffee Organization
also attended. The United States, Switzerland, and the Organization for Economic
Cooperation and Development were represented by observers.
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Peru: Official Foreign Loans
Extended Since the February IBRD
Consultative Group Meeting
Million
Country US $ Projects Under Consideration
Finland 6 Transportation and communications
equipment
France 60 Canon del Pato hydroelectric center
Chimbote steel complex
Polyethelene plant
Tele-education service
Spain 37 Majes irrigation project
Tuna boats
Bulk carrier construction
West Germany 23 Tinajones irrigation project
Chimbote fishing port
Chimbote hospital
Solvents complex
Zinc concentration plant
Tacna fishing port
National Telex Service
United Kingdom 55 Chiefly Cerro Verde copper
(international
consortium)
Italy 65 Mantaro hydroelectric plant
Japan 72 Talara fertilizer plant
Lima-Chimbote powerline
Microwave system
Total
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and abroad. Its moral commitment to radical change and its inability to
resolve the IPC issue, however, will probably continue to seriously deter
capital inflows of the type and in the amounts being sought. The military
regime's apparent willingness to give economic goals precedence over social
reforms - and to adjust its policies accordingly - will aid in obtaining
private foreign capital and official loans from Western Europe and Japan.
But because of the prohibitive political costs involved, it is unlikely that
this or any succeeding government will pay compensation for the IPC
property - even if failure to do so bars important loans from the US
Government and international financial agencies.
20. Peru's National Development Plan, approved in May 1971, reflects
both the Velasco government's commitment to rapid economic development
and its recognition that the task requires large foreign capital inputs. The
highly ambitious plan projects growth rates of 7.5% for GDP and 19% for
investment and, thus, a rise in the investment share of GDP from 14%
to about 20% during 11972-75. Because accelerated public sector spending
is viewed as a catalyst to more rapid economic growth, such expenditures
are scheduled to rise from about 19% of GDP in i970 to some 26% by
1975. - still not an abnormally high share by Latin American standards.
Public investment outlays, slated to rise by 32% annually, are to be
re-directed to some extent from social and infrastructure projects into the
vital manufacturing and mining sectors. Private investment, which now
accounts for two-thirds of total fixed capital formation, is expected to grow
10% annually during the period. Foreign capital is counted on to fin:;.cc
an important share of both private and public investment.
21. If foreign capital in the required amounts is available to Peru,
these goals probably are not grossly unrealistic. IBRD's recent appraisal of
Peru's likely economic achievements over the next few years - which served
as the basis for economic assistance deliberations by the consultative
group - projected growth rates of 16% for investment and almost 6% for
GDP. A crucial assumption in, this appraisal is that Peru will have available
$1.1 bi!'ion in gross foreign capital resources during 1972-74. The sources
of this financing are assumed to be as follows (in million US $):
Direct foreign investment
258
Official project assistance
668
Foreign reserves drawdown
100
Other (debt refinancing,
non-project loans, etc.)
92
Total
1,118
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22. The slippage on the IBRD's projected official capital inflows
during this period could be very great, however. After several years of
relatively small commitments, the project loan pipeline is badly depleted
and at best could yield disbursements of only about $275 million during
1972-74. Thus, in order to meet projected official assistance levels, new
project loans would have to yield almost $400 million during this period.
According to IBRD estimates, the $780 million package approved in
principle at the . ebruary consultative group meeting would allow
disbursements of this magnitude during 1972-74, if acted upon promptly.
Thus far, however, only minor lending commitments have been made by
international financial agencies that were expected to fund a major share
of this package. Projected direct investment inflows during this period also
may be somewhat optimistic. They assume that the Cuajone copper project
will move ahead as originally scheduled, but the Southern Peru Copper
Company in fact has not yet secured financing for the period after 1972.
On the other hand, annual capital inflows for oil exploration could
considerably exceed the $20 million now estimated. It is also possible that
Peru's creditors will agree to renegotiate part of the foreign debt, on which
scheduled amortization payments during 1972-74 now total some $485
million. Peru's still large foreign reserves also would permit substantially
more than the $100 million drawdown now contemplated.
23. Peru also certainly will not be able to mobilize domestic financial
resources sufficient to offset any major shortfall in hoped-for foreign capital
assistance. Increases in government tax revenues will be limited in part by
the relatively slow growth in export earnings expected over the next few
years. Price prospects for Peru's mineral and agricultural exports are mixed,
and, under the best of circumstances, volume increases will not permit a
recovery in earnings to. the exceptionally high 1970 level. New oil and
mining'investments, even if they proceed apace, will not help export earnings
over the next few years, because of the long lead times required to initiate
production.
24. Although the government is considering various new tax proposals
designed to channel a larger share of domestic financial resources into the
public investment effort, there are limits to its ability to capture such funds
without a counter-productive impact on private capital formation. Moreover,
the recovery in private investment activity in 1971 was aided by
extraordinarily free credit availability which is not expected to continue.
This liquidity was largely a carry-over from the forced capital repatriation
and high export earnings of 1970 and, because government credit
requirements were low, benefited mainly the private sector. To the extent
that the government does finance its investment effort through increased
domestic borrowing, private outlays probably will be depressed by financial
stringencies. Given its conservative financial philosophy, the Peruvian
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Government is unlikely to opt for an expansionary monetary policy at the
cost of accelerated inflation.
25. The Velasco government can, however, postpone a substantial
portion of its ambitious investment program and still maintain a respectable
growth ratV. over the next few years. To an important extent, performar ce
will depend on its continued ability to pursue a non-doctrinaire approach
to Peru's economic realities. Although land redistribution, industrial reform,
and labor unrest are, inhibiting factors, private producers - still the mainstay
of the Peruvian economy -- have been encouraged by pragmatic government
efforts to release thein from the more onerous provisions of extant reform
laws and to crack down on disruptive labor union activity. The 1971 private
investment spurt will improve industrial capability to fill rising consumer
demand in 1972-73, while remaining capacity limitations provide an
incentive to further expansion. Thus, given reasonable policies and favorable
weather, economic output probably will rise by some 5% annually despite
moderate balance-of-payments and other financial constraints.
26. Because economic growth apparently is being given primary
consideration in government resource allocation policy, some social reform
goals will have to be postponed. Despite mounting public expectations -
some of them prematurely fueled by Peru's "oil boom" - such a shift in
priorities seems feasible because of the absence of any serious threat to
the military regime. To maintain its populist credentials, however, the regime
will have to raise social welfare expenditures at least moderately over the
next few years. Peru's ability to pursue both goals will be significantly
affected by its ability to attract external support for its development
process.
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