FINANCE MINISTER, CENTRAL BANKER TALK TO TREASURY DAS

UNCLAS LIMA 000488 SIPDIS SIPDIS DEPT FOR WHA/AND, EB/IEP COMMERCE FOR 4331/MAC/WH/MCAMERON TREASURY FOR AJEWELL AND MMALLOY DEPT PASS TO OPIC FOR J BRACHE DEPT PASS TO EXIM FOR DON HULTMAN USDA FOR FAS/OCRA E.O. 12958: N/A TAGS: ECON EINV EFIN PGOV PE SUBJECT: FINANCE MINISTER, CENTRAL BANKER TALK TO TREASURY DAS O'NEILL ¶1. SUMMARY. Finance Minister Luis Carranza and Central Bank President Julio Velarde told Treasury Deputy Assistant Secretary Brian O'Neill March 8 that they were concerned about the appreciation of the Nuevo sol vis a vis the weakening dollar, and the inflation that they attributed to increases in global food and energy prices. Carranza said he believed the GOP had the right approach in promoting both a tighter fiscal policy and a laxer monetary policy. The GOP would continue to oppose calls for capital controls. Velarde's analysis showed that inflation was virtually 100% imported and based largely on rising food prices. END SUMMARY. ¶2. Treasury Deputy Assistant Secretary Brian O'Neill met separately with Finance Minister Luis Carranza and Central Bank President Julio Velarde March 8 in Lima. He also met bank CEOs and economists (septel) and was accompanied by Economic Counselor and Econ Specialist. TIGHT FISCAL POLICY & APPRECIATING SOL -------------- ¶3. Economy and Finance (MEF) Minister Luis Carranza told DAS O'Neill that his prescription for Peru's economy in the current situation was a laxer monetary policy and a tighter fiscal policy. Recent media coverage has been helpful in this regard by demanding more restrictive fiscal policies (lower current expenditures). Carranza is aiming at an over 3% fiscal surplus in 2008. He said the GOP is containing current expenditures but is also prioritizing capital expenditures. He fully disagrees with calls for capital controls to prevent a further appreciation of the Nuevo sol, which has appreciated from over 3.04 per dollar in February 2007 to 2.82. However, Carranza asseted that the GOP cannot let the dollar fall abruptly as the GOP does not know where the exchange rate could end up. ¶4. On February's relatively high inflation rates, Carranza maintained that almost 100% is explained by local food items, whose normal supply has been affected by road blockages caused by seasonal landslides. To counter inflationary pressures, the GOP lowered import tariffs last year but will have to continue these cuts in ¶2008. The Fuels Stabilization Fund (currently at $400 million), whereby the GOP pays refiners the difference between the crude oil purchase price and the stabilized domestic fuels prices, has been a very important measure to contain inflation. DEBT REDUCTION -------------- ¶5. One thing Peru is doing, Carranza explained, is buying out debt, like the recent Brady bonds operation. This helps to contain the Nuevo sol's appreciation as it means genuine domestic demand for dollars. To supplement this operation, the GOP will add 1 billion dollars in 2008 -- thus creating demand for dollars -- to the Fiscal Stabilization Fund, so that the Fund will total $1.5 billion at year's end. (Note: This fund's purpose is to have the means to respond to major fiscal revenue decreases, domestic emergencies or international crises that could seriously affect the national economy. End note.) Another policy action will be the sale of the remaining shares in several privatized companies, about 30% of their capital, to generate funds for pensions. 85% of the labor force has no health, pension or fringe benefits. CREDIT FOR SMES? -------------- ¶6. Carranza suggested that both governments could cooperate in facilitating credit to enable small and micro-enterprises to export. This way, society's lower classes could feel the benefits of the U.S.-Peru Trade Promotion Agreement (PTPA) as well as Peru's opening to trade. O'Neill informed Carranza that OPIC, MIF and Treasury will attend the early April IDB meeting in Miami, when they could talk about this subject. Carranza confirmed that he will participate in the Regional Finance Ministers meeting. CENTRAL BANK: WE ARE IMPORTING INFLATION -------------- ¶8. Central Bank President Julio Velarde expressed satisfaction over the good situation of the Peruvian economy, but contended it is being complicated by imported inflation of food items. After Bolivia, Velarde said Peru has the heaviest weight of food in its Consumer Price Index (CPI),mainly wheat, soy beans and corn, as well as petroleum-related materials like plastics and fertilizers. Velarde expressed concern about ethanol in the U.S. and its inflationary effect on corn, which is poultry's main feedstock in Peru. He also explained that in the first two months of 2008, inflation in Peru was zero if food inflation was excluded. So the Central Bank is maintaining its inflation target range of 2% +/- 1%. ¶9. On the dollar/Nuevo sol exchange rate, Velarde said the Bank is prepared to counter any currency attack, like the one of January (which tried to force a sudden, major appreciation of the Nuevo sol). He added that there is consensus in the GOP that foreign exchange controls are not advisable. ECONOMISTS GENERALLY RATE GOP WELL -------------- ¶10. Generally, economists support the government's strategy. Chief economists from banks with large foreign equity Hugo Perea (BBVA-Banco Continental) and Guillermo Arbe (Scotiabank),and think-tank director and former Economy vice-minister Roberto Abusada agreed that policies pursued by the GOP are generally good. Arbe contended, however, that there is some question as to how farsighted reduction of current expenditures is, when in an important part of the country there is still what locals call "absence of the state" (e.g., insufficient police forces to fight common crime; lack of or insufficient health services or education; etc.). They expected the pressure on the Nuevo sol against the dollar to continue, most expecting the dollar to decline 10-15% by the end of 2008. The only tool left to the GOP to turn that trend might be Nuevo sol devaluation, as suggested by Abusada. ¶11. Deputy Assistant Secretary O'Neill was unable to clear this message.