PERU 2007 INVESTMENT CLIMATE STATEMENT (PART 2/2)

UNCLAS LIMA 000222

SIPDIS

SIPDIS

DEPT FOR EB/IFD/OIA, WHA/AND, WHA/EPSC
PASS EXIM, OPIC, TDA
COMMERCE FOR 4331/MAC/WH/MCAMERON
USTR FOR BHARMAN AND MCARRILLO
GENEVA FOR USTR

E.O. 12958: N/A
TAGS: EINV EFIN ETRD KTDB ELAB PGOV OPIC USTR PE
SUBJECT: PERU 2007 INVESTMENT CLIMATE STATEMENT (PART 2/2)

REF: 06 STATE 178303

The following is Part 2 of Embassy Lima's submission of the 2007
Investment Climate Statement for Peru.

Transparency of the Regulatory System
--------------

The transparency and independence of regulatory processes
have become central issues for foreign investors in Peru.
Many of the central government entities with which foreign
firms must deal -- including the entities that maintain the
company registry and supervise securities and exchanges
(CONASEV),handle privatization and investment issues
(ProInversion),and handle competition policy and
intellectual property matters (INDECOPI) -- have procedures
that are relatively transparent and predictable. Banks,
insurance companies and private pension funds are regulated
primarily by the Superintendency of Banking and Insurance
(SBS),which is charged with determining the qualifications
of potential market entrants and regulating firms once they
have begun operations. SBS regulations are also seen as
being transparent.

When the GOP privatized state-owned monopolies in the areas
of telecommunications, electrical generation and
distribution, and the hydrocarbons sector in the late
1990s, the GOP established regulatory institutions to
oversee the newly private sectors. Delays and lack of
predictability in the rulings of these institutions,
including OSIPTEL (telecom) and OSINERG (energy),have at
times in the past been notable impediments to doing
business in Peru.

In December 2005, OSIPTEL published a new law that lowers
Peru's high mobile termination rates to levels comparable
to international rates over a 3-year period. Several U.S.
companies have encountered problems with the energy sector
regulator (OSINERG) over its hesitancy to provide clear
regulation for the energy sector. Some regulatory agencies
have in the past been subject to politically motivated
government intervention in their technical operations.

U.S. firms have complained that SUNAT's aggressive behaior
and interpretation of law are often contrary to the spirit
of the law and intent of government policies, complicating
normal business operations. The remuneration of SUNAT
employees is determined, in part, by the theoretical tax
liability they uncover in audits.

Businesses point out that SUNAT's retroactive
reinterpretation of regulations and laws, its levying of
disproportionate fines, and initiation of full company
audits when companies request a refund or legal revaluation
of assets for depreciation purposes, create additional
investment and trade barriers. In one case, a U.S. firm
requested an improper drawback of USD 1,345, only to face
SUNAT fines of USD 645,000. Although the case was
resolved, new legislation was needed to correct the
problem. In instances involving airline fuels, certain
minerals, and other products, SUNAT declared that these
goods sold abroad, which under Peruvian government policy
are exempted from taxes, were not considered exports and
were therefore subject to VAT. Two recent laws were
necessary to correct this practice for airline fuels and
services. SUNAT often does not follow standard
international practice in the way it taxes new activities.
To correct these problems, the independent tax tribunals
act to check any abuses by SUNAT. In 2004, the GOP
established a tax ombudsman who must approve SUNAT's
request to appeal adverse tax tribunal decisions. In the
past two years, the tax ombudsman has acted in several
cases to end unwarranted litigation of disputed
assessments. In 2005, a U.S. company won long-standing tax
cases against SUNAT as a result of these improvements.

A 2006 World Bank study found that Peru has significantly
lowered the average amount of days it takes to start a
business from 98 (2005 study) to 72. Various procedures --
such as obtaining buildng licenses or certificates of
occupancy -- require many steps. Municipal authorities
issue most licenses and requirements vary widely by
locality. As a result, information on necessary procedures
is often difficult to obtain. Business people often
complain of excessive red tape; one major foreign investor
found that starting project construction and a business
required several hundred permits, many of which the
responsible government entities were unaware they had to
issue. Other investors argue that local governments and
municipalities, which are seeking new revenue sources,
sometimes withhold licenses or create regulations, thus
hindering the ability to do business or making it costlier.
Even though import tariffs are substantially lower than
previously (the simple average tariff is 8.3 percent ad
valorem plus surcharges as of January 2007; the trade-
weighted average using 2005 import figures is 5.6 percent),
import duties, together with the 19 percent value added tax
on goods, high social security tax rates, and certain labor
laws, increase investment costs significantly and hinder
the efficient mobilization and allocation of investment
capital. Businesses can apply for VAT reimbursement.

Efficient Capital Markets and Portfolio Investment
-------------- --------------

Credit is allocated on market terms and the banking
industry in Peru is generally considered to be competitive
in offering services to business customers. Private
pension funds have competed in recent years with financial
companies for bonds issued by companies, as demand for
securities greatly exceeds supply. Foreign investors can
obtain credit on the local market and several of them have
done so in the last few years as terms were more
competitive than those of the usual international centers.
The private sector has access to a variety of credit
instruments. From January through early December 2006,
firms placed USD 1.55 billion on the local bond market
(compared with USD 1.47 billion in CY 2005),which has been
propelled in recent years by demand for investment
instruments by private pension fund companies. By October
2006, pension funds managed a total of USD 13.4 billion, a
43 percent surge over the October 2005 level (USD 9.4
billion),thus creating a huge and growing appetite for
financial instruments by pension funds. The low 12 percent
cap placed by the Central Bank on what the pension funds
can invest abroad provides local bond issuers (including
the government) and loan seekers with a captive capital
market.

All firms listed on the Lima Stock Exchange (Bolsa de
Valores de Lima) or the Public Registry of Securities must
be vetted by CONASEV, the National Commission for the
Supervision of Companies, Securities and Exchanges, which
maintains the Public Registry of Securities and Stock
Brokers. CONASEV is the Peruvian government entity charged
with the study, promotion, and regulation of the securities
and commodities markets, the control of market
participants, the maintenance of a transparent and orderly
market, the setting of accounting standards and the
publication of financial information about covered
companies. As part of CONASEV's goal to promote market
transparency, to prevent monopolies, and to prevent fraud,
issuers of stock are required to inform CONASEV and the
relevant stock exchange or body in charge of supervising
the centralized trading mechanism, of events that affect or
might affect the stock, the company, or any public
offerings. Although trading on insider information is
technically a crime, no one has been charged and punished
under the law.

Total assets of the commercial banks were USD 24.1 billion
at the end of October 2006, 16 percQt above the same
period of 2005. The banking system is considered generally
sound, as it weathered rather well a severe El Nino and
global financial turmoil in 1997-98. Sound supervision,
combined with competition, led to a significant
consolidation in the sector, which still continues.
Consequently, 12 commercial banks comprise the system, of
which 3 banks account for just over three-fourths of loans
and almost four-fifths of deposits. Banks have revamped
operations, increased capitalization, and reduced costs in
recent years. As of November 2006, foreigners had
significant shares in nine banks, of which they were
majority owners of four commercial banks (including two of
the country's largest). Under the SBS's conservative
criteria, 1.9 percent of total loans were assessed as non-
performing as of October 2006, down from a high of 11
percent in early 2001. The system also has 3 specialized
institutions ("financieras") and 39 thriving micro-lenders
and savings banks.

Larger private firms often use "cross-shareholding" and
"stable shareholder" arrangements to restrict investment by
outsiders -- not necessarily foreigners -- in their firms.
As close families or associates generally control ownership
of Peruvian corporations, hostile takeovers are practically
non-existent. Peruvian law and regulations do not
authorize or encourage private firms to adopt articles of
incorporation or association to limit or restrict foreign
participation; nor are there any private or public sector
efforts to restrict foreign participation in industry
standards-setting organizations.

In 2006, SBS approved a license for the first U.S. company
to provide retail credit services, thus increasing
competition for incumbent banks and Chilean finance
companies.

Foreign direct investment registered with ProInversion as
of the end of 2005 was USD 14.3 billion, compared with USD
13.9 billion a year earlier. Foreign portfolio investment
(dematerialized holdings of securities only) totaled USD
9.6 billion in October 2006, up from USD 7.7 billion at the
end of December 2005.

Political Violence
--------------

Although political violence against investors is not a
common practice, the mining and petroleum communities
witnessed an increase in protests, some violent, in 2005.
These leveled off in 2006. These protests caused several
foreign companies to significantly delay or abandon plans
to establish operations. Protests against the mining
industry occurred for various reasons. Although
environmental concerns were often the cited pretext, in
many cases protestors were seeking social infrastructure
investments not provided by the government. Often times,
well-organized groups, such as the Ronderos (local self-
defense groups established during the Shining Path
terrorist attacks) or NGOs, exaggerated a local community's
concerns, bringing in protestors from outside the local
community to foment protests against the companies. In at
least two incidents in 2005 and 2006, the local mayor and
other local authorities led strikes against two large
foreign mining companies in an effort to secure additional
funds or development promises from the companies. During
2005 and 2006, there were road blockages and acts of
vandalism by groups protesting mining operations, coca
growers protesting the Government's eradication policies,
and farmers seeking increased government tariff protections
and financial support. Some indigenous communities in an
oil production area used river and road blockages as a way
to press for their demands on a long-standing pollution
case. A common thread for many protests is the lack of
government provision of basic services such as health and
education. Another complaint that can underlie what appear
to be environmental protests is a lack of access by local
communities to the various "canons," the funds set aside by
the government out of the taxes or royalties paid by the
oil, gas and mining firms for local community development.
In some mining areas, firms and local leaders have alleged
that narcotraffickers are fomenting protests as a way to
keep prying eyes away from their activities.

When significant conflicts developed in the first few
months of the Garcia Administration, cabinet ministers and
often the Prime Minister became personally involved in
successfully resolving the protests. The government
established a commission in late 2006 to prevent and
resolve social conflicts in the extractive industries. In
addition, various NGOs have become involved in conflict
resolution activities. At the same time, the National
Society of Mining and Petroleum (SNMPE),as well as the
government, have become involved in assisting local
communities to access the extractive industry canons as a
way to both stimulate local development and head off social
conflicts. It is reasonable to posit that many of these
efforts should pay off to reduce social conflicts for
investors in 2007.

Political violence remains a concern in the coca-growing
regions. The Shining Path (Sendero Luminoso) terrorist
organization has become increasingly aggressive and
involved in narcotrafficking in these areas. The Shining
Path killed eight civilians and five police officers in
2006, and were responsible for 92 serious terrorist
incidents that year. In December 2005, the Shining Path
killed 13 police officers in several ambushes in coca-going
areas of Huanuco and Apurimac. President Garcia continues
to reauthorize 60-day states of emergency in parts of
Peru's five departments where the Shining Path operates,
suspending some civil liberties and giving the armed forces
authority to maintain public order.

There is little government presence in the remote coca-
growing zones of the Monzon and the Apurimac-Ene River
valleys. The U.S. Embassy in Lima restricts visits by
official personnel to these areas because of the threat of
violence by narcotics traffickers and remaining columns of
the Shining Path. Information about insecure areas and
recommended personal security practices can be found at
http://www.ds-osac.org/.

Corruption
--------------

It is illegal in Peru for a public official or employee to
accept any type of outside remuneration for the performance
of his or her official duties. Peru has ratified both the
UN Convention Against Corruption and the Organization of
American States' Inter-American Convention Against
Corruption. Peru is not a member of the Organization of
Economic Cooperation and Development, and has not signed
the OECD Convention on Combating Bribery.

Peru is one of four nations worldwide participating as a
pilot country in the G8 anti-corruption and transparency
initiative. The U.S., other G8 partners and NGOs helped
the Peruvian government develop an action plan that
includes activities in six areas: a) citizen
information/internet connectivity; b) improving central
government fiscal transparency; c) development of GOP
procurement systems; d) improving regional/local government
transparency and management; e) improvement of transparency
of extractive industry revenues; and f) development of
asset forfeiture systems and legislation.

The G8 initiative has already shown some positive results.
A hemisphere-wide state procurement organization Q the
Inter-American Organization of Government Procurement
Institutions Q was created under the leadership of Peru's
State Procurement Council (CONSUCODE). As of January 2007,
eight countries are in the process of adopting the network
agreement, prior to its signature (Bolivia, Colombia,
Ecuador, Honduras, Mexico, Paraguay, Peru and Paraguay).
Also, efforts are underway to provide Internet connections
to approximately 90 municipal governments located in areas
most affected by terrorism and poverty. The rural
connectivity project will allow these governments access to
national systems, part of the GOP's E-government
initiatives, aimed at creating greater transparency and
citizen access to public information.

U.S. firms have reported only a small number of problems
directly resulting from corruption, usually in government
procurement processes and in the judicial sector, but the
revelation in late 2000 of a broad and deep corruption ring
organized by former presidential advisor Vladimiro
Montesinos heightened awareness of the problem.
Transparency International ranked Peru number 70 (out of
163 countries) in its 2006 Corruption Perception Index.
While anti-corruption efforts have been a stated priority
of both the Toledo and Garcia Governments, in practice most
resources are directed at investigating Fujimori-era
corruption. In 2001, President Toledo appointed an anti-
corruption "czar" to lead government efforts, but this
official resigned in 2002 and has yet to be replaced.
Private sector groups have increased efforts to combat
corruption through an NGO called "ProEtica," which
represents Transparency International in Peru.

Bilateral Investment Agreements
--------------

Peru has signed bilateral investment agreements with 29
countries (listed below),but not with the United States.
The U.S.-Peru Trade Promotion Agreement (PTPA),pending
approval by the U.S. Congress, would eliminate the need for
a bilateral investment agreement. Peru's Current Bilateral
Investment Agreements:

Argentina (1994)
Australia (1995)
Bolivia (1993)
Chile (2000)
China (1994)
Colombia (1994)
Cuba (2000)
Czech Republic (1994)
Denmark (1994)
Ecuador (1999)
El Salvador (1997)
Finland (1995)
France (1993)
Germany (1995)
Italy (1994)
Korea (1993)
Malaysia (1995)
The Netherlands (1994)
Norway (1995)
Paraguay (1994)
Portugal (1994)
Romania (1994)
Singapore (2003)
Spain (1994)
Sweden (1994)
Switzerland (1991)
Thailand (1991)
United Kingdom (1993)
Venezuela (1996)

OPIC and Other Investment Insurance Programs
--------------

The Overseas Private Investment Corporation (OPIC),an
independent U.S. Government agency, offers medium- to long-
term financing and political risk insurance. OPIC signed
agreements with Peru in December 1992, and in July 1994,
OPIC began approving requests for political risk insurance
(including for inconvertibility of currency). In 2001,
OPIC provided project finance loans of USD 108.4 million.
In 2005, OPIC provided USD 800 million worth of insurance
coverage for a copper mine and a startup finance company
received USD 27 million worth of OPIC insurance coverage.
Because of the free convertibility of currency, the U.S.
Embassy purchases Peruvian currency for expenses on an as-
needed basis, at the market exchange rate. The risk of
significant depreciation of the exchange rate over the next
year is negligible. Peru is a member of the Multilateral
Investment Guarantee Agency.

Labor
--------------

Labor is abundant and trainable, although there are
shortages of highly skilled workers in some fields and
wages for professional staff are high (sometimes higher
than U.S. wages in the mining sector for positions in the
managerial and consulting fields). The presence of
organized labor in the Peruvian economy has declined; in
2005, 8.6 percent of the labor force was organized.
Unemployment in Lima officially stood at 7.2 percent in
October 2006, compared with 7.9 percent a year earlier.
Surveys show that 53.5 percent of Lima's economically
active population was underemployed in the third quarter of
2006, mostly working in the informal sector for below
subsistence wages. The statutory monthly minimum wage was
raised in January 2006 to 500 soles (about USD 155). Some
workers, like miners, are highly paid and also (per
statute) receive a share of company profits.

In 1991-1992, a new labor law and other related statutes
replaced extremely inflexible old statutes and regulations.
The new laws allow for multiple forms of unions across
company or occupational lines, thus permitting multiple
unions in the same company. Workers in probation status or
on short-term contracts are not eligible for union
membership. Bargaining agreements are considered
contractual agreements, valid only for the life of the
contract. Productivity provisions must be included in any
collective bargaining agreement. The number of officials
and the amount of time union officials may devote to union
work with pay is limited to 30 days per year. Unless there
is a pre-existing labor contract covering an occupation or
industry as a whole, unions must negotiate with each
company individually. A labor law passed in July 1995
liberalized hiring. Business leaders lauded the above
changes, saying they led to greater efficiency. Labor
leaders disagreed, arguing that the new labor laws eroded
labor protections and encouraged outsourcing in a way that
undercut union activity.

With Peru's return to democracy in 2000, Peruvian organized
labor regained some, but by no means all, of the
protections enjoyed in the pre-Fujimori era. A decision by
the Constitutional Tribunal in 2004, for example,
legitimized collective industry-wide bargaining in the
civil construction industry. Labor leaders saw this as a
potential precedent to be applied to other activities, but
that has not yet happened. Furthermore, new laws added to
labor inflexibility because the restrictions for
termination and downsizing have made businesses reluctant
to hire new employees and have created incentives to
outsource.

Either unions or management can request binding arbitration
in contract negotiations. Strikes can be called only after
approval by a majority of all workers (union and non-union)
voting by secret ballot and only in defense of labor
rights. Unions in essential public services, as determined
by the government, must provide a sufficient number of
workers during a strike to maintain operations.

The 1993 Constitution provides for a maximum workday of
eight hours, with 48 hours as the maximum week. The labor
code also sets 24 hours rest per week and 30 days paid
annual vacation for all workers. Workers readily sacrifice
these and other benefits in exchange for regular
employment. Strike activity declined markedly over the
ensuing nine years and since new labor laws were passed,
worker efficiency rose substantially. However, strikes and
militant industrial action increased again in late 2002 and
early 2003, with additional strikes in 2004. The overall
number of strikes fell in 2005. Through October 2005,
there were 58 strikes with a loss of 442,586 man-hours,
compared with 91 strikes and a loss of 515,480 man-hours in
the same period of 2004.

Congress continues to debate a comprehensive labor law
reform, which may result in a return to inflexibility of
the conditions of dismissal for employees.

Foreign Trade Zones/Free Ports
--------------

Peruvian law currently covers two types of free trade
zones: export, transformation, industry, trade and
services zones (CETICOS),and a free trade zone
(ZOFRATACNA) in Tacna. The rules and tax benefits applying
to these zones are the same for foreign and national
investors.

Companies established at the CETICOS and ZOFRATACNA, which
export no less than 92 percent of their output (more than
80 percent of production for the Loreto CETICOS and more
than 50 percent for ZOFRATACNA),are exempted until 2012
from all taxes, dues and contributions to the central
government and municipalities, particularly income, sales
(IGV),Municipal Promotion (IPM) and excise (ISC) taxes.
CETICOS exist at Ilo, Matarani and Paita, with one
authorized but not operating at Loreto. There is a concern
that the Peruvian Government does not have the proper WTO
waivers to validate the CETICOS export requirement. The
U.S. automotive industry has expressed a specific concern
that U.S. brands are unable to compete with used Japanese
vehicles that enter the Peruvian market duty-free through
the CETICOS. Importers located in ZOFRATACNA pay only 8
percent customs duties (normal rates are 12 or 20 percent)
on 1,086 items sold to retailers in the city of Tacna.

Foreign Direct Investment Statistics
--------------

The stock of registered foreign direct investment in Peru
was USD 14.3 billion in December 2006, according to
ProInversion, versus USD 13.9 billion at the end of 2005.
ProInversion data place Spanish investors as holding the
largest share (33 percent),with USD 4.7 billion invested.
The United States is the second largest investor, with USD
2.3 billion, and the United Kingdom is third, with USD 2.2
billion. However, according to the U.S. Department of
Commerce, U.S. registered investment in Peru through
December 2006 totaled USD 3.9 billion on a replacement-cost
basis. The statistics are skewed because ProInversion
records investments on the basis of country registry,
rather than control. Thus, an investor registered in the
Bahamas, for example, is recorded as British even if the
parent is a U.S. company. As a result, U.S.-controlled
investment represents a much higher share than the official
15.8 percent. By sector, communications received 34.7
percent of foreign direct investment in 2006, followed by
the manufacturing industry (15.3 percent),mining (14.8
percent),and finance (12.5 percent).

As of the end of 2006, investors had signed 640 legal
stability contracts with the Government of Peru through
ProInversion. Legal stability contracts commit the
government not to apply any future changes in the income
tax, labor and other laws governing a specific investment
in exchange for commitments to invest a given amount. In
addition to these contracts, the Government of Peru has
signed numerous tax, foreign exchange and administrative
stability contracts through several ministries, mainly the
Ministry of Energy and Mines.
POWERS