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R 182214Z MAR 08
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INFO RUEHBO/AMEMBASSY BOGOTA 5614
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RUEHCV/AMEMBASSY CARACAS 1097
RUEHQT/AMEMBASSY QUITO 1825
RUEHLP/AMEMBASSY LA PAZ MAR SANTIAGO 1811
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHDC
RHMFIUU/CDR USSOUTHCOM MIAMI FL
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC

UNCLAS LIMA 000488 
 
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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.