SECRETARY GUTIERREZ'S VISIT TO PERU - SCENESETTER

UNCLAS LIMA 002839

SIPDIS

SENSITIVE
SIPDIS

COMMERCE FOR SECRETARY GUTIERREZ FROM AMBASSADOR STRUBLE

E.O. 12958: N/A
TAGS: PREL ECON PGOV ETRD PE
SUBJECT: SECRETARY GUTIERREZ'S VISIT TO PERU - SCENESETTER


Sensitive But Unclassified, please handle accordingly.


1. (SBU) Mr. Secretary, I welcome your July 27-28 visit to
participate in the inauguration of President-elect Alan
GARCIA Perez. This presidential transition is historic--for
the first time in modern Peruvian history one elected leader
will transfer authority to another without the backdrop of an
economic or political crisis. That notwithstanding, the
close presidential election on June 4 showed a deep
geographic fault line in Peru between the more prosperous
coast and more backward mountain and jungle regions. Despite
a strong economy, Peru suffers from a weak and fractured
political system. U.S. engagement will be critical to the
Garcia government's efforts to overcome political, economic
and social challenges.


Strong Economic Growth and Macroeconomic Achievements
-------------- --------------


2. (U) The Garcia Administration will inherit one of the
strongest economies in Latin America. The current expansion
began in 2001, following the political crisis that ended the
Fujimori Administration, and has gained momentum over the
last several years. GDP growth in 2005, at 6.7 percent, was
the fastest since 1997. The economic expansion has continued
into this year, despite the uncertainty created by the
presidential elections. Analysts recently began raising
their estimates for growth in 2006 from 5 percent to 5.5-6
percent. The 12-month average growth ending in May was 6.5
percent.


3. (U) The strong growth has been propelled by increased
private investment, an export boom (triggered initially by
the Andean Drug Eradication and Trade Promotion Act (ATPDEA)
and aided later by high mineral prices),prudent fiscal
management, and, more recently, strong domestic consumption
and construction. Exports will have tripled by the end of
this year compared to when President Toledo took office,
rising from $7 billion in 2001 to an estimated $21 billion.
Minerals make up just over half the exports, but
non-traditional goods like textiles, apparel and agricultural
products have grown significantly.


4. (U) The sustained economic expansion and, in particular,
the agricultural export boom, have led to a moderate but
significant reduction in poverty. The poverty rate - those
living on less than $2 per day - declined from 54 percent in
2001 to an estimated 48 percent today. Extreme poverty -
those living on less than $1 per day - declined more
dramatically, from 24 percent to 18 percent, a 25 percent
drop in four years. The areas that have seen the greatest
reductions in poverty have been those participating in the
agricultural export boom, (such as Ica where companies are
reporting a labor shortage),and those that have been areas
of focus for USAID programs. Analysts expect unemployment,
underemployment and poverty to decline at a faster pace in
the near-to-mid term as the expansion continues.


5. (U) Inflation has been tame despite the economic
expansion, 1.5 percent in 2005 and an annualized rate of 2.5
percent in May 2006. The Toledo Administration wisely
allocated some of its current account surplus to pay down the
public debt, lowering the debt-to-GDP ratio from 50 percent
to 38 percent. The federal government may have a small
surplus in 2006, due to fiscal restraint, greater tax
revenues generated by the economic expansion and increased
efficiency in tax collection.


Despite Past Record, the Country Is Optimistic
-------------- -


6. (SBU) When Garcia was last elected President in 1985 at
the age of 35, the government was weak, the terrorist war
with the Shining Path was spreading, inflation was rampant,
and the international debt burden was very high. Garcia's
policy decisions made matters worse - he restricted
international debt payments to 10 percent of exports
earnings, attempted to nationalize Peruvian banks and
insurance companies and launched large public works projects
without adequate financing. By the end of his term,
inflation had gone from 87 percent to 7,649 percent, per
capita income had dropped to below the 1960 level, the GDP
had fallen 20 percent, poverty had grown from 41 percent to
55 percent, and the Shining Path was staging attacks in the
capital.


7. (SBU) Despite this record, the business community and the
population as a whole continue to express confidence in
Garcia's ability to manage the country and the economy during
this second presidency. The President-elect understands that
this confidence is tenuous. He has sent reassuring signals
to the business community that he will respect contracts,
show macroeconomic discipline, and welcome public-private
partnerships for infrastructure needs. His center-left APRA
party has intentionally tried to cast a wide embrace to bring
in people from the center and center-right. Amongst Garcia's
challenges as President will be keeping this informal
coalition intact.


8. (U) Garcia's near term priorities include promoting
agricultural modernization in the Andes through his "Sierra
Exportadora" program and improving water quality and
delivery. These programs should begin shortly after the
inauguration, and if seen as credible, will help APRA leaders
in the upcoming November regional and municipal elections.
In the medium term, Garcia is looking to maintain
macroeconomic growth while encouraging new investment.


Early Challenges
--------------


9. (SBU) The election results (52.6 percent for Garcia and
47.4 percent for leftist/nationalist Humala) show a clear
fracturing of the vote between those areas that benefit from
international commerce and those that have thus far been
excluded from national and global markets. In the coming
months, President-elect Alan Garcia will face greater
pressure to strike a careful balance: to reassure foreign
investors that his policies can sustain the current
macroeconomic boom and improve Peru's investment climate,
while winning over the pro-Humala opposition with tangible
results of his poverty reduction policies. Specifically:

-- Garcia must implement a credible program to attack the
high levels of poverty.

-- Given that the Peru Trade Promotion Agreement (PTPA) has
not been approved by the U.S. Congress, Garcia must assume
full responsibility for ratification of an agreement
negotiated by the outgoing government. The President-elect
has tried to suggest that he could have gotten a better deal,
but he realizes that PTPA is central to many of his proposed
economic programs (e.g., "Sierra Exportadora.")


Issues That Garcia May Raise
--------------


10. (SBU) Garcia may raise with you:

-- His appreciation for President Bush's invitation to visit
the White House on October 10.

-- His government's urgent focus on poverty and the desire
for 1) increased U.S. assistance in linking sierra and jungle
producers to international markets, and 2) increased
assistance for priority initiatives like clean drinking water
programs.

-- Concern regarding U.S. counter-narcotics assistance
levels. Garcia believes there should be increased support
from the U.S. and international donors. (Note: U.S.
counter-narcotics aid in 2006 dipped slightly to $108 million
but remains twice as high as the average level during the
1990s. End Note.)

-- The role that the U.S. can play in helping build and
maintain investor confidence in his administration.


Demographic/Political Overview
--------------

11. (U) Peru is a country of 27.2 million people, of whom 30
percent live in the Lima/Callao metropolitan area. Most
Peruvians are either Amerindians (45 percent, largely
Quechua-speaking but also many Amazon languages) or
Spanish-speaking mestizos (37 percent, a mixture of
indigenous and European roots). The remainder of the
population includes persons of European (15 percent),
African, Japanese, and Chinese ancestry. Peru's distinct
geographical regions are mirrored in a socioeconomic divide
between the coast's mestizo-Hispanic culture and the more
diverse, traditional cultures of the highlands and jungle
area.


12. (SBU) Twenty-four candidates competed in the first round
presidential elections on April 9, and the two top
vote-getters, Garcia of the APRA party and Ollanta Humala of
the Union for Peru (UPP) party, faced off in a June 4 runoff.
This runoff offered voters a clear choice between two quite
different alternatives. Garcia stood for the continuation of
policies that brought Peru nearly five years of five percent
annual economic growth, respect for human rights, job
creation and poverty reduction through market-based economic
growth, and good relations with the U.S. Humala, an ally of
Venezuelan President Chavez and Bolivian President Morales,
advanced policies that resemble theirs: a stronger executive
promoting state intervention in the economy, suspicion of
foreign trade and investment, and populist social programs.
Garcia, who placed second in the first round, won the runoff
election with a 5.2 percent spread.


13. (SBU) The new 120-member Congress elected on April 9
consists of seven parties. Humala's UPP party currently
controls over a third of the seats. (Note: The UPP
congressional caucus has shown signs of fracturing into
smaller groups. End Note.) The APRA has the second largest
block with just under a third of the seats. The fragmented
nature of the incoming Congress will be another challenge for
the Garcia Administration.
STRUBLE