Working Paper
Country Study 8

Peru ran out of cash in July 1984; a year later President Garcia rejected an IMF agreement and limited debt service payments to 10 per cent of export earnings; and in mid-1986 the President said that Peru would pay 'when it chose and when it could1.Creditors understandably tried to present Peru as a special case. This line wore thin, however, as other countries made clear in various ways that they were not willing to continue full debt service.Peru suffered in 1983 from an improbable and unfortunate combination of shocks: the terms of trade sinking to their lowest level in two decades, withdrawal of trade credit, and freak weather conditions that by themselves caused an estimated 5.4 per cent loss of GDP. For an economy already weakened by misuse of foreign borrowing, poorly managed state intervention and six or seven years of financial instability and capital flight, these shocks precipitated a crisis from which Peru has failed to recover.But this was all made worse by the blunt instruments used to effect adjustment - notably cuts in real government spending and generalized deflation. The economy seemed to be caught in a series of vicious circles in which further adjustment efforts had both positive and negative effects, exacting a high price in both inflation and recession, and in political erosion, for marginal fiscal and balance-of-payments improvements. Significantly, even such severe adjustment efforts could not prevent the breakdown of normal debt service.There was a clear failure to see the need for a major political input in the management of what had become an emergency. When it came to designing a political programme for dealing with the emergency, the Fund and Bank had no expertise.Peru has still not achieved stability, despite the energy of the 1985 anti-inflationary plan and the severity of balance of payments measures. Output growth over 1986-87 will total between 14 and 15 per cent, meaning a recovery of most of the 1983-85 loss, and a runaway inflation has been arrested and held at about 60 per cent per year. A radical position on debt servicing has created some room for manoeuvre. These short run gains, however, have been achieved through measures that are effective only in the short run. The costs of the debt stance, through reduced disbursements and higher import prices, will increase. The check on inflation is creating relative price distortions that cannot be sustained. The reduction of imports is so far based entirely on controls: the exchange rate appreciated substantially between 1985 and early 1987, and import pressures are building up rather than decreasing. All exports have been penalized by the exchange rate appreciation, despite higher export subsidies. Capital flight is increasing.