Peru’s new president, the first of Indian descent, faces daunting challenges as he tries to build a “market economy with a human face.”
By Lucy Conger
September 2001
Institutional Investor Magazine
Alejandro Toledo, Peru’s new president, made a pilgrimage to Machu Picchu in late July, the day after the conventional swearing-in ceremony in Lima. Looking out at the spectacular precipices of the ancient Incan citadel, Toledo - an Andean Indian shoeshine-boy-turned-Stanford-University-Ph.D. - thanked the Apus, the mountain gods, for “force and courage.” As local priests burned offerings - coca leaves, quinoa and flowers - Toledo bowed his head in prayer.
Maybe he was praying for time.
The new president will need all the time he can get to tackle Peru’s entrenched problems. After 20 years of economic hardship, terrorist warfare, authoritarian rule and corruption, the country’s citizens naturally clamor for change.
Where even to begin? Toledo, 55, presides over an economy in the fourth year of a grinding recession (GDP contracted 2.5 percent in the second quarter), hobbled by $20 billion in outstanding foreign debt and a fiscal deficit that is equivalent to more than 2 percent of the country’s total output. As always in Peru, unspeakable poverty endures. Some 15 million Peruvians out of a total population of 28 million each survive on $1.25 a day.
One of 16 children of a bricklayer father and fishmonger mother, Toledo earned a soccer scholarship to the University of San Francisco, received his Ph.D. in human resources economics at Stanford University and later worked for three years as a World Bank employee in charge of health and education programs in several Latin American countries.
“The challenge I have set for the government,” Toledo told Institutional Investor (see story below), “is to make it so that the 54 percent of Peruvians who are sentenced to live below the poverty line can have the opportunity I had to move up. That is my dream.”
On the campaign trail Toledo promised a “market economy with a human face.” As he told II, “A market economy means disciplined fiscal and monetary policy. A human face means that we need to generate jobs; we must invest in nutrition, health and education.”
The new president can draw upon support from the 80 percent of the population who, like Toledo, have Indian blood. But he can hardly claim a mandate. He won the June election with 53.08 percent of the vote, versus 46.92 percent for Alan García, the formidable, charismatic former president who heads the Alianza Popular Revolucionaria Americana, the leading opposition party and Peru’s oldest and most highly structured political force. Toledo’s ruling Perú Posible party won just 45 of 120 seats in Congress, and his alliances with three small political parties, which push him up to a five-vote majority, are tentative at best. “He has a very heterogeneous coalition, and it’s pretty shaky,” says Michael Shifter, vice president for policy and an Andean specialist at the Inter-American Dialogue, a Washington, D.C., think tank. “To pull it together requires political skill that is not part of Toledo’s experience.”
Investors cheered the victory of Toledo, who is more fiscally conservative than García. As president, García declared a ceiling on foreign debt payments and instituted populist policies that drove inflation up to 7,000 percent a year. Toledo’s cabinet appointments sent an especially reassuring signal to Wall Street.
The new prime minister, Roberto Dañino, earned a law degree at Harvard University and headed the Latin America practice at the prominent Washington, D.C.-based law firm Wilmer, Cutler & Pickering. Finance Minister Pedro Pablo Kuczynski is a former investment banker, who served for a decade as a managing director at First Boston Corp. Kuczynski and Dañino worked together in the government of former president Fernando Belaúnde 20 years ago as Energy minister and secretary general of the Finance and Economy Ministry, respectively. Joining Toledo’s team is Richard Webb, a respected economist who will head the central bank, a post he occupied from 1980-'85.
Still, some financial analysts worry that the ministers of Industry and Agriculture - Raúl Diez Canseco and Álvaro Quijandría, respectively - are not entirely friendly to the free market. “The cabinet could be a not very cohesive lot,” says Arturo Porzecanski, chief economist for Latin America at ABN Amro in New York. “It is more of a compromise team than a dream team.” Porzecanski warns that the mixture of political bents could cause flip-flops on privatizations, tariff policy, agricultural lending and government spending.
Toledo’s July 28 inauguration brought to a close a stormy chapter in Peruvian history. Last year a decade of rule by Alberto Fujimori and his éminence grise, spymaster Vladimiro Montesinos, ended in disgrace amid corruption scandals and a congressional denunciation of the administration’s “moral incapacity.” (Last November Fujimori fled to his native Japan, which recognized his citizenship.)
A successful eight-month transition government, led by interim president Valentín Paniagua, the former speaker of Congress, and his prime minister, former U.N. secretary general Javier Pérez de Cuéllar, laid the groundwork for a clean election and created a more stable macroeconomic environment. Paniagua also attacked corruption, launched investigations into human rights abuses and made some fiscal reforms. But to some extent, his strong leadership stole Toledo’s thunder. Now Peru’s first president of Indian descent must be more than a symbol of his country’s moral renewal. He must deliver real progress - and soon.
In fighting poverty Toledo promises to commit “the force of my dreams and my stubbornness.” The new administration’s social emergency production program, targeted at the 4.5 million Peruvians who live in extreme poverty, will draw on $800 million in multilateral grants that were blocked by donors during the late Fujimori years, as well as an additional $1 billion pledged by Europe and the U.S., to construct sewage systems and rural roads and create 400,000 temporary jobs. The poor “will do the work, but we will give them work,” Toledo says.
Most critically, Toledo aims to foster economic growth and the creation of new jobs. To stimulate domestic demand, he hopes to broaden the tax base and lower certain taxes. Some of these changes will require special powers for the executive that must be granted by Congress, but the opposition APRA party is likely to back the president in this one battle at least. Says Enrique Cornejo, chief adviser to the APRA congressional bloc, “We are of a mind to give them specific powers, but not a blank check, after we have heard their government program.”
Even without those reforms, analysts expect economic growth to revive during the fourth quarter because confidence will rebound, and investment, which sank during the period of political instability, will pick up, says Federico Kaune, senior economist for Latin America with Goldman, Sachs & Co. in New York. He projects growth of 4 percent for the quarter and perhaps 5 percent for 2002.
Boosting foreign investment, which fell from $500 million in the first quarter of 2000 to $100 million for each quarter since then, represents another important goal. Here Toledo can expect to find at least some market winds at his back. “Initially, Peru can get a quick capital response because quite a lot of foreign capital is on the sidelines,” says Mohamed El-Erian, portfolio manager for Pacific Investment Management Co.
Reducing the budget deficit will go a long way toward assuaging the fears of foreign investors. The government expects to lower the fiscal deficit to 2.2 percent of GDP for this year, down from 3.2 percent last year but well above the 1.5 percent target set with the IMF. A further reduction to 1.9 percent is projected for 2002. “I worry about the fiscal situation. I think they’ll have to go to the markets next year to finance it, and the market could punish a country with a relatively high deficit and a turbulent situation in the region,” says Luis Carranza, chief economist for BBVA Continental in Lima. For his deepest spending cuts, Toledo will most likely target the armed forces and the police. Together they absorb 18 percent of Peru’s annual budget, which last year totaled $10 billion.
A more immediate task: forging an agreement with the International Monetary Fund. Debt payments of about $2 billion fall due next year, and the government has to agree with the IMF on the fiscal deficit target and new lending.
New government funds could come from the privatization of state-owned companies, a program frozen in the later years of the Fujimori regime. Finance Minister Kuczynski has estimated that proceeds could reach $3 billion in three years with the sale of such businesses as oil refineries and electricity companies. The funds would be channeled into social assistance and antipoverty programs, he says. But most privatization schemes will prove politically controversial.
Tensions are already simmering within Toledo’s own party. In one corner are the supporters who founded Perú Posible in 1995, when Toledo launched his first presidential bid; they played a decisive role in Fujimori’s downfall. These longtime militants are drawn from a range of political camps. Opposite them are the technocrats and professionals who joined the party during the latest presidential campaign; they generally endorse a neoliberal economic agenda. Prime Minister Dañino is expected to be successful in building bridges with conservative Lourdes Flores Nano and her Unidad Nacional bloc.
The wider gap between Perú Posible and the opposition APRA will not be easily closed. APRA proclaims that it will not accept any appointments in the Toledo administration and is generally keeping its distance. The party will make a strong push toward the municipal and regional elections of November 2002, hoping to gain ground.
For the moment, though, Toledo embarks upon his historic journey with the spirited support of the Peruvian people. Says Carmen Ríos, 60, manager of a Lima clothing boutique: “Everything is in place for us to have a good government, to see that corruption has ended and the country can begin to move toward something of prosperity. It’s our last hope.”
Beating the odds
As the red-and-white presidential sash was placed across his chest, Alejandro Toledo secured his place in history. He is the first Peruvian of Indian descent to lead his country in 500 years. The question now is, What will his legacy be?
Toledo is setting off on a mission to revitalize Peru’s flagging economy and strengthen democratic institutions that were shattered during the ten-year authoritarian regime of former president Alberto Fujimori.
No one can doubt the determination Toledo brings to the challenge. He overcame a childhood of poverty to earn a Ph.D. in human resource economics at Stanford University and later worked for the World Bank.
In the presidential campaign, he labeled himself “El Cholo,” adopting the term that Peruvians use disparagingly for mixed-race citizens of Indian descent, and converted it into a badge of pride.
In his first interview in office, Toledo met with Institutional Investor Mexico correspondent Lucy Conger. Over the course of an hour, he talked economics and politics, described his plans and hopes for the future and contemplated the remarkable journey he has made.
Institutional Investor: You’ve referred to yourself as a “statistical error.” What do you mean by that?
Toledo: The probabilities are very remote that someone who comes from where I come from would have completed the path that I have. To start out in Chimbote [the coastal port where Toledo grew up], shining shoes, selling lottery tickets, and then to get to the University of San Francisco, to get a Ph.D. from Stanford, to get to the World Bank, the U.N., the Inter-American Development Bank, the OECD, to be a visiting scholar at Harvard - and now to become president of Peru. Obviously, in a society in which the channels of social mobility are very restricted, there is no doubt that my case is not within the norm. It is what would be called in statistics a statistical error.
The challenge I have set for the government is to make it so that the 54 percent of Peruvians who are sentenced to live below the poverty line, including the 17 percent in extreme poverty, can have the opportunity I had to move up, not as a statistical error but as a norm, having the right to health and education. That is my dream.
Peru has been in a protracted recession. What actions do you foresee for your first 100 days in office?
In the first 100 days, we are going to implement the program of economic reactivation. We will reactivate production, which today operates at less than 50 percent of its installed capacity; companies cannot pay their loans, the financial system is fragile, and, consequently, there are high rates of unemployment and underemployment, and poverty deepens. The reactivation program has six components: lower the value-added tax by 1 point, from 18 to 17 percent; gradually eliminate the solidarity tax, a tax on workers and businesses that previously served to provide resources to the Fujimori campaigns but now raises costs; within a market philosophy, we will reduce the reserves level [against savings] of the central bank from 34 percent to 30 percent to make interest rates lower; we will initiate a war against contraband, dumping and undervaluation [of imports]; we are going to continue with privatizations; and it is vital to have fiscal and monetary discipline - we are not going to fall into fiscal deficits that convert into inflation.
Will you take other immediate measures?
Parallel to the economic reactivation, we are implementing what we call the social emergency production program, which targets the extremely poor, 4.5 million Peruvians. We have obtained resources of $1.7 billion to fund the construction of water and sewage systems and rural roads for the poorest communities. They [the poor] will do the work, but we will give them work. We have $800 million frozen in the pipeline [blocked by donors during the Fujimori administration] that can be released.
You have pledged to build “a market economy with a human face.” What do you mean by that?
A market economy means disciplined fiscal and monetary policy, prices in their place, giving a boost to privatizations and national and foreign investment, production with value added for domestic consumption and export. A human face means that we need to generate jobs; we must invest in nutrition, health and education, because the most profitable enterprise is the minds of our people. A country is not rich because it has gold, silver, tin, fish meal or gas - and we have those. Our viability depends on how much we have invested in the knowledge business.
How would you finance the required increase in social spending?
First, it’s a matter of political will, and second, today you can make a reengineering of public investment. We are going to eliminate the Ministry of the Presidency [a Fujimori-era megaministry that grouped together all social spending] and reengineer defense spending. I have asked Latin America and my armed forces, in the name of the poor and future generations, in the name of a more integrated and stronger region: Let’s spend less on arms to spend more on education and win the war against poverty.
How much does Peru spend on arms?
Eighteen percent of the budget goes to the military and police. That doesn’t include arms purchases, which totaled $2.8 billion from 1997 to 2000 and were financed from privatization proceeds, independently of the budget. I am not willing to please the arms sellers.
At your inauguration, which was attended by South American presidents, you proposed an end to arms purchases. How did Brazil, an arms producer, react?
Some viewed it with skepticism. But today things are further along than the day I presented it. A first step is to freeze the purchase of offensive weapons, and a second is to make an inventory of stocks and progressively reduce the proportion of military spending. If we reach an agreement, my idea is it would have to be multilateral and have the backing of big countries and also the [Roman Catholic] Church to act as guarantors. I think this can be done while modernizing the armed forces and making them smaller. A country defends its borders when it has a strong economy and its people are nourished, healthy and educated. There is no defense without development, and there is no development without defense.
What are the next steps for Peru with the International Monetary Fund?
We are going to reach an agreement with the Fund. The Fund knows the conditions in which we received the economy. The Fund knows our spirit of managing the economy responsibly. The Fund knows that my concern is the social area. We will reactivate the economy with responsibility. We Peruvians make the economic policies. We have a very solid team. We will not evade our responsibility. We will sit down [to talk]; we will never make a unilateral decision.
What about your debt service burden?
The debt service is about $1.8 billion a year. It is very costly, and during a recession that is difficult. We will talk with our creditors, see what space we can get. We have asked J.P. Morgan and Citibank to prepare a reengineering of the management of our debt. We have found a willingness among bilateral creditors to convert debt into investment. Spain has voluntarily offered debt-for-investment swaps that would reduce the debt, and so has France. We have explored this in Germany and will do the same in the U.S.
Would these debt swaps fuel inflation by increasing the money supply?
To the extent that the debt is converted into productive investment that generates work, there is no problem. One has to be careful, yes.
You have been a consultant and, from 1979-'81, a staff member at the World Bank, working on health and education in Latin America. Now you will be sitting on the other side of the table, as a client of the Bank. What are your reflections about the Bank and its work?
The Bank and the Fund have evolved. Ten years ago the Fund would never have talked of poverty. I think [World Bank president James] Wolfensohn has injected a major dose of innovation by emphasizing the theme of poverty and the relationship between investment in human resources and development.
What could the Bank do to serve its clients better?
I’ll be frank, in the most constructive spirit. I would like it if the Bank invested more in an infrastructure of human resources and less in physical infrastructure. I would like it if the Bank would contribute to the reduction of extreme poverty in the world from a business perspective. Don’t do it out of sensitivity. Do it from a market orientation. If there were less poverty, there would be more consumers, and they would buy more products that businesses produce. I would like it if the Bank had more management capability in the logistical process of disbursements - they are too slow; it takes too long.
You won a soccer scholarship to college. What kind of a player were you?
I was an average soccer player on my high school team. At the University of San Francisco - a nice, clean-cut Jesuit university - they had a very strong soccer team because they recruited foreign students. I was a lead center forward, and I loved to score goals - even now I still do. But it wasn’t that we were very good - rather that the gringos were very bad. At that time.
