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Peru's paradox

In most countries, if the economy thrives, so does the president. Alejandro Toledo, whose economics are more astute than his politics, can only wish that were the case in Peru.

Alejandro Toledo made history when in April 2001 he took office as Peru's first president of indigenous descent. Recently, the 57-year-old Andean Indian set a less admirable precedent: Toledo, caught up in a corruption scandal involving one of his top aides, sank to an all-time-low approval rating of 7 percent and was forced to shuffle his cabinet for the fifth time in 30 months.

Paradoxically, the president's striking unpopularity is in stark contrast to his generally able management of the economy. Peru has been Latin America's leader in steady growth this decade, posting GDP increases of about 4 percent or more for each of the past three years. Most analysts see another year of solid growth in 2004. The Peruvian sol is stable. Lima's budget deficits have been nearly on target. Unemployment fell slightly last year. As Toledo, who has a Ph.D. in education with a specialty in international development economics from Stanford University, told Institutional Investor in late January, "I have managed the economy responsibly." (See interview, page 68.)

In Peru, however, economic success doesn't necessarily translate into political popularity. "There's a duality in Peru," observes José Cerritelli, senior Andean analyst for Bear, Stearns & Co. in New York. "You have the investment and business world and the political world, and they are very different. The economy is going well, but that doesn't rub off on Toledo, and the political problems do not affect the economy."

To be sure, the economy is not without its difficulties. "The economic achievements still have not yet trickled down to the lower levels," acknowledges Toledo. Unemployment and underemployment in urban areas total 45 percent, and 54 percent of Peruvians live on $2 or less a day.

Now scandal is dogging Toledo. On January 30 a cassette tape appeared to confirm that Toledo's former intelligence chief, Carlos Almeyda -- who was also the president's lawyer and trusted friend -- had held discussions about bribing judges with Oscar Villanueva, a general who was charged with various corrupt activities during the regime of Peru's disgraced former president Alberto Fujimori; Villanueva killed himself before he could be brought to trial. Prosecutors had contended that Villanueva was the cashier for Fujimori's notorious spy chief, Vladimiro Montesinos, who is serving a sentence for corruption and faces nearly 80 additional charges ranging from authorizing murder to trafficking in arms and drugs.

Toledo wasn't implicated in any of this, but opponents say that he only belatedly turned his back on Almeyda and that his disavowals have been weak. The president's slow reaction to the scandal provoked a public debate over his fitness to lead. "The government needs to be resolute, pro-active. We need a man who runs the country," asserts José Miguel Morales, president of the National Association of Mining, Petroleum and Energy, a trade group. In an extraordinary front-page editorial on February 11, Peru's influential business newspaper, El Comercio, called on the president to cede day-to-day authority to his prime minister, Carlos Ferrero.

Although financial markets didn't entirely shrug off the president's political woes, the spreads on Peruvian bonds widened only moderately vis-à-vis U.S. Treasuries. That show of stability no doubt reflects Peru's advantageous position as a major minerals exporter at a time of soaring commodity prices, but it also attests, ironically, to Toledo's reputation for sound economic management and to his reappointment of former Wall Street investment banker Pedro-Pablo Kuczynski as minister of Economy and Finance in his February 15 cabinet overhaul.

Will shaking up his cabinet allow Toledo to serve out the remaining two years of his term? Most political analysts think that the government can hold on. "The probability that he will finish his term has increased," concludes Carlos Janada, senior Andean analyst for Ideaglobal, an independent economic analysis company based in New York. Yet the same analysts caution that something could still go awry -- such as another corruption scandal -- and that although Toledo has won a reprieve, a cabinet shuffle won't be enough to save him next time.

The heat on Toledo intensified last month when the leading opposition politician, former president Alan García, unofficially launched his presidential campaign. On February 24 García's Alianza Popular Revolucionaria Americana (APRA), the most formidable opposition bloc in Congress, pressed a 30-point program on Toledo. It consists chiefly of market-friendly proposals that include auctioning off $900 million in government properties, finalizing private concession schemes for highways, relaunching a secondary mortgage market and imposing such austerity measures as cuts in the federal payroll.

García, a recent convert to free markets whose populist policies as president from 1985 to 1990 -- nationalizing the banks and capping foreign debt payments, to name two -- proved disastrous for Peru, also endorsed some more-socialist-sounding measures: paying "guarantee" prices on locally produced food, stimulating development banks and reducing interest rates. "It is a political gesture," says Alfredo Torres, a political analyst with Apoyo, Lima's foremost polling company. "García has to demonstrate that he has learned, that he is a serious, responsible politician." In any case, García must contend with his own popularity shortfall. No doubt recalling the hardships during his time in office, 60 percent of Peruvians disapprove of him (Institutional Investor, September 2003).

As president, Toledo has his own history of political missteps, which compound the gravity of the February crisis. Upon taking office he raised his salary to $18,000 a month; public outcry caused him to lower it to $12,000. And he stalled for 14 months before acknowledging that he had fathered a daughter, Zarai, now 15, out of wedlock.

Toledo has found it hard to share power with popular prime ministers. In December, Beatriz Merino -- a respected former tax official with a Harvard Law School degree who earned a 60 percent popularity rating as prime minister -- was driven out of office by a whisper campaign that suggested she had misused her influence and, what's more, was a lesbian (a particular stigma in conservative Peru). Though Merino denied both allegations, she resigned anyway.

Seven of the 16 members of Toledo's newest cabinet, including Kuczynski, are politically independent. Skeptics say this is plainly intended to divert attention from the encroaching corruption scandal. As a political gesture, however, Toledo's naming of a new cabinet is a bit of a puzzle. "This cabinet will solve nothing, because there was no problem with the former cabinet," says Mirko Lauer, a leading political analyst and columnist for center-left newspaper La República. Meanwhile, unions were expected to take to the streets this month to demand more jobs and better pay. "From now on, Toledo's real activity will be to crawl his way to the 2006 election year," says Lauer.

The new cabinet does, though, have real significance for the economy. It confirms that Peru will continue to toe the line on fiscal austerity, do more to open the country to trade -- Peru is in the midst of negotiating a bilateral agreement with the U.S. -- and revive a controversial privatization program. The plan provoked protests in June 2002 that led Kuczynski to resign from Toledo's first cabinet a month later.

Politics and economics aren't entirely separate spheres in Peru. "If the government hasn't fallen, it's because the economy is going pretty well," says Fritz Du Bois, director of the Instituto Peruano de Economía, a private analysis group in Lima. "The Finance ministers have always been good -- they are the underpinning of this government." Kuczynski, who was the president's first Economy and Finance minister, gave due credit to Toledo in a conversation with Institutional Investor a few weeks before his reappointment: The president, he said, "has been on the right side of the angels on all major economic issues."

Peru's inflation is just 2 percent. Its country risk, as measured by the J.P. Morgan Emerging Markets Bond index, dropped to a record low of 257 basis points above U.S. Treasuries in mid-January. Tax revenues rose by 22 percent in the first half of 2003. Exports are expected to jump by 17 percent this year, to $10.4 billion. Surging commodity prices will boost earnings from gold and copper; the Camisea gas pipeline for exporting gas to Mexico and the United States is supposed to come on line this August. "This is actually a conservative government that believes in honoring promises and contracts entered into by the country," says Bear Stearns' Cerritelli.

Toledo's decision to pursue a free-trade agreement with the U.S. should help Peru attract more foreign direct investment. "Before my term ends [in July 2006], I'll leave a signed agreement with the U.S.," he declares to II. Toledo is also working on an agreement with the European Union. "I personally have gotten involved in the contacts with chiefs of state in the U.S. and Europe," he says. "I've not wanted to leave trade negotiations solely in the hands of the technocrats." One quarter of Peru's exports goes to the U.S., and another quarter goes to Europe.

Despite its solid growth, Peru needs to do even better to be able to absorb new workers and alleviate poverty. Toledo is sensitive to the problem. "We need to build a climate of stability -- political, economic, social and judicial -- that allows for private investment to increase," he says. Since 1997 investment has fallen from 20 percent of GDP to 14 percent.

One potential source of investment dollars -- privatization -- has stagnated, bringing in less than $2 million last year. Most eligible properties were privatized during the past decade. Nevertheless, Toledo has pledged to proceed with concessions -- leasing some of Peru's ports and electricity companies to private interests -- and the presence of Kuczynski in the new cabinet could speed up the process. The first big concession of this year was awarded on February 6 to Tractebel of Belgium. The construction company bid $205 million for a 30-year lease contract to complete and operate the Yuncán hydroelectric plant in Peru's central highlands.

Now the federal budget is becoming an issue for Toledo. Revenues total about 12.5 percent of GDP, and close to 90 percent of the money raised is consumed by current spending, principally on salaries, pensions and debt service. "The growth of current expenses is mortgaging the future," says Du Bois. Yet as Nicolás Lynch, Education minister in Toledo's first cabinet, notes, the pressure for more social spending is enormous: "The Fujimori government had repressed social demands." Toledo increased the salaries of university professors and schoolteachers to $400 and $200 a month, respectively.

Increasing tax revenues, however, is a Herculean task. Back in January, when he was still CEO of the Latin America Enterprise Fund, a Miami-based asset management firm, Kuczynski told II: Peru "is a very poor country. You can't go from revenues of 13 percent of GDP to 18 percent when per capita income is $2,200. You need to raise exports, raise revenues. It's a process."

Toledo has been hard-pressed to deliver on his key campaign promise of more jobs. Peru's labor force grows 2.5 percent a year; even solid 4 percent GDP growth only creates enough jobs to accommodate a 2.3 percent increase in workers. And that 2.5 percent figure doesn't count the 60 percent of the population that is underemployed, creating an enormous backlog of demand for jobs. By Du Bois's estimate, to fully employ the country's constantly expanding supply of workers would require 7.5 percent economic growth.

"People say to me, 'Toledo, you gave me democracy; now I want work, and I want it now,'" says the president. "Well, I can't produce miracles, and for that I pay a political price."

Toledo talks politics

When Alejandro Toledo was a child, his Andean Indian family -- like so many other poor Peruvians -- migrated from the remote highlands to the Pacific coast. He was raised by his laborer father and fishmonger mother in the scruffy port of Chimbote. The young Toledo shined shoes to help feed the family, yet found time to excel at school. Winning a scholarship to the University of San Francisco in California, he went on to earn an MA in economics and a Ph.D. in education, with a specialty in international development economics, at Stanford University. From 1985 to 2000 he was a professor at Peru's Escuela Superior de Administración de Negocios, a graduate business school.

Toledo made his debut in politics in 1992 when he ran for president, polling only 3 percent of the vote. But he gained in political stature in 2000 when he led protests against Alberto Fujimori's tainted election to a third presidential term. Toledo took his battle against the authoritarian and corrupt Fujimori regime to the streets in massive demonstrations that rallied unions and civic groups.

In the process, he established himself as the main opposition leader going into the April 2001 elections that followed Fujimori's sudden resignation and the naming of an interim president. Toledo won the July runoffs, garnering 52 percent of the vote and becoming the first person of indigenous descent to become president of Peru, whose population is 47 percent Indian.

That may have been the high point of Toledo's political career. Although his stewardship of the economy has earned plaudits from foreign observers, his popularity at home has sunk to an abysmal 7 percent rating.

The 57-year-old president met with Contributing Editor Lucy Conger at the National Palace in Lima in late January.

Institutional Investor: With the economy doing so well, why are you doing so poorly in popularity polls?

Toledo: The challenge of my government is to make our achievements at the macroeconomic level felt at the micro level, in the pocket of the common citizen. I hear the applause of Wall Street, but I hear the catcalls of Main Street. This is not only an issue for Peru -- this is an issue of democratic governability in the region.

Today I met with the Council of Social Ministers [a committee of health, education and other social services ministers]. We are relaunching the social programs directed at urban poverty. We are investing nearly $1.2 billion this year alone in programs for the poor to translate growth into benefits for common people. This is the year of implementing social policies without disregarding responsible macroeconomic policies. It would be very easy to spend more, to give handouts to the poor, to break fiscal discipline. But if I did that, I would engender instability, increase country risk and drive away investments. I'm planting now because I want to harvest in 2005, 2006. It's necessary to pay a political price. There is no president in the history of Peru who has been more bombarded with surveys: 480 polls. I'm respectful of polls -- I come from the academic world. But many of them are manipulated.

Do you think certain groups are systematically trying to undermine your government?

Those who were involved in corruption with the dictatorship of Fujimori, who are in jail or on the lam, who received millions and millions of dollars from [Fujimori's spymaster] Vladimiro Montesinos are now fighting to save their necks. So they create destabilizing programs. And it's intensifying because the trials for their big crimes, such as arms trafficking, are coming up. Yet democracy is on the path to consolidation in Peru. It will take time, yes. To rebuild democratic institutions takes time. But I didn't fight in the streets to let someone undermine [democratic] power.

Peru's economy appears to be in pretty good shape. How can you maintain growth?

Yes, for the third consecutive year, the economy is growing. When we came into power, the economy was in recession. In 2002 we grew 5.2 percent; last year we grew 3.98 percent; and this year we'll grow more than 4 percent. But the most important thing is to look at the composition of growth. This is predominantly a raw materials -- minerals -- and export economy. But that is changing. Peru's growth, which is above the average for Latin America, is reflected in manufacturing, in the commercial sector, in construction and particularly in agriculture and ranching.

What more needs to be done?

We need to build a climate of stability -- political, economic, social and judicial -- that allows for private investment to increase from the current [low] level. But we need to maintain that level and grow even more. Because growth in the final analysis will depend on investment levels. If there is investment, there is growth; if there is growth, there is employment; if there is employment, there is income; if there is income, there is consumption -- and production continues.

What are you doing to stimulate private investment?

We need to give clear signals. We need to have greater stability in the democratic governability of the region because when there's turbulence, capital doesn't come.

What is on the privatization agenda?

Obviously, the majority of privatizations have been done. They were done under Fujimori, and lamentably, the majority of the $9 billion received is now in foreign banks. However, there are still items for concessions [leases]: ports, some electricity companies.

What is your strategy on trade?

For Peru to grow, we need markets. We continue to push the integration of the Andean Community and Latin America in Mercosur, of which Peru is a member. This is a process that will take time. We are working for a bilateral agreement with the European Union, and we have the backing of President Jacques Chirac of France and the governments of Spain, England, Italy, Greece and Portugal. We just signed with Thailand, giving us entrée to Asia.

How are your talks with the U.S. going?

Before my term ends I'll leave a signed agreement with the U.S. I've practiced what I call presidential diplomacy. I personally get involved in the contacts with chiefs of state in the U.S. and Europe. I've not wanted to leave trade negotiations solely in the hands of technocrats.

What terms have you personally sought?

In the case of the U.S., only to sign a free-trade agreement. The Andean Pact Trade and Drug Enforcement Agreement ends in 2006, and it's not renewable. The technocrats will negotiate tariffs for certain products. I don't foresee major difficulties with Europe. But there's a very asymmetrical trade relationship, particularly in agriculture. Europe gives $1 billion a day to its farmers in subsidies. Yet Europeans ask us to play by free-market rules without protecting our farmers. We say, "Don't you ask us to do something you don't practice." We need a two-way street in trade.

Do you expect U.S. trade negotiations to soften Washington's stance on Peru and drug trafficking?

A long road has been traveled with not always good results. We jointly have to be much more creative -- the producing and the consuming countries -- on drug trafficking. We are reducing from 130,000 hectares of coca plants now to 36,000, 35,000 hectares in ten years. But here's the problem: As long as there is demand, there will be supply. Substitution of alternative crops for coca has to be accompanied by price adjustments for those alternative crops in international markets. We have to make production of coffee, potatoes and sugarcane more attractive than growing coca leaf. Peasants who cultivate coca leaf are not drug traffickers; they are simply seeking jobs. It is no accident that in Peru the worst drug trafficking and terrorism and violations of human rights have taken place in the poorest places, where there was no government presence.

What can be done about the continuing political turbulence in Latin America?

There is turbulence because democracy hasn't produced results in Latin America -- and I'm a democrat. The structural adjustments of the past 20 years have not translated into economic growth rates capable of generating jobs. People cannot wait another 20 years. We need to invest more to generate jobs, to pacify this turbulence and make Main Street cross Wall Street. Combining my role as chief of state and economist, I have presented a proposal for innovative mechanisms for financing democratic governability that has three components: First, in our agreement with the International Monetary Fund, we must separate current spending from investment spending so that investment spending does not enter into calculating Peru's budget deficit target. Now we are in very tight straitjackets as to fiscal ceilings. The investment spending exception would permit us greater holgura [breathing room]. Latin American presidents are generally payroll presidents, because more than 90 percent of the budgets go to current spending: payment of debt service, pensions and salaries. Nothing is left for investment.

Another innovation concerns Latin American integration. The cost of connecting the five access highways that are meant to link the countries of South America is so great that they can't be accounted for as part of the fiscal deficits of individual countries. On this there's consensus here and in the financial organizations. This year, with President [Luiz Inácio] Lula da Silva, we will inaugurate a bridge that unifies Brazil with Peru, linking the state of Madre de Dios and Assis [capital of the state of Acre].

The third component of my innovations is that debt payment should be related to economic growth. When the economy is prosperous, we prepay. But when we are in recession, don't squeeze us, because you cause us social problems.

You have an interesting plan for reducing Peru's debt.

I have proposed to Unesco exchanging debt for investment in education, just as there's now swapping of debt for the environment. That has been accepted by the director general of Unesco and by President Chirac. A working group in Chile was charged by the United Nations to look into this possibility. Remember, this would be for country-to-country debt. Once this approach is approved and the pilot projects are completed in Latin America, I'm sure it will be done worldwide.

How do you see your country today?

Peru is much more solid, but it is a country in transition. We are coming from a decade when a corrupt dictatorship robbed its people of faith and hope. Our institutions are fragile today because the dictatorship controlled everything -- judicial and legislative power, election tribunals, the media, the armed forces. We are trying to rebuild and strengthen democratic institutions. This is a very arduous task. We are respectful of the right to expression, of human rights. And now that there is democracy, Peruvians can protest, because there is not a dictatorship that is putting its foot down.