Document of F111 COPYThe World Bank

FOR OMCIAL USE ONLY

Repot No. P-2856-PE

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED LOAN

TO THE

EMPRESA SIDERURGICA DEL PERU (SIDERPERU)

WITH THE

GUARANTEE OF THE REPUBLIC OF PERU

FOR THE

SIDERPERU TECHNICAL ASSISTANCE PROJECT

June 25, 1980

This dumt bhs a restricted distribution and miLy be sed by recipients only In the pefruance oftbeir ocll duties. Its Contents may not otherwise be disclosed without World Bank autborIatIon.

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CURRENCY EQUIVALENTS

The exchange rate is being adjusted daily roughly in line with thedifference between domestic and international inflation. The exchange rateand currency equivalents in effect on May 31, 1980 were as follows:

CURRENCY UNIT = Sol (SI.)

Calendar 1979 May 31, 1980

US$1 = SI. 224.55 SI. 278.0S/. 1 = US$0.0045 US$ 0.0036S/. 1,000 = US$4-45 US$ 3.60

FISCAL YEAR

January 1 to December 31

ABBREVIATIONS

DR Direct reduction process for the production of spongeiron used as a raw material in steelmaking

EAF Electric Arc Furnace

ERP Economic Recovery Program

SIDERPERU Empresa Siderurgica del Peru(State-owned Steel Company of Peru)

SLRN Stelco-Lurgi-Republic-National(a coal-based DR process)

SOFRESID Societe Francaise d'Etudes Siderurgiques(French Engineering Consultants)

tpy Metric tons per year

FOR OFFICIAL USE ONLY

REPUBLIC OF PERU

SIDERPERU TECHNICAL ASSISTANCE PROJECT

LOAN AND PROJECT SUMMARY

Borrower: Empresa Siderurgica del Peru (SIDERPERU)

Guarantor: Republic of Peru

Amount: US$5.0 million

Terms: Repayable in 10 years, including 3-1/2 years of grace, at8.25 percent per annum. The loan would be refinancedby any future loan that the Bank might make for thesecond stage of the SIDERPERU expansion program.

Project Description: The objective of the technical assistance projectis to strengthen SIDERPERU's project execution andplant operation capability to enable it to successfullyinstall and manage a two stage 400,000 tpy expansionof the Chimbote steel mill. The project would includethe following:

(i) assistance in project management and start-up forthe 200,000 tpy first stage of the expansionprogram which is now getting underway;

(ii) assistance in the operation of existing plantfacilities and initial operation of the firststage expansion facilities;

(iii) operational training for SIDERPERU personnel,partly on-the-job and partly in a plant withsimilar technology abroad; and

(iv) preparation of a feasibility study for the200,000 tpy second stage of the expansionprogram, including a technical and economicreview of the first stage and coal transpor-tation and electric system studies.

The SIDERPERU expansion project will involve theutilization of coal-based direct reduction technology.SIDERPERU's five year experience in the operationof a pilot plant, the testing done by bidders forthe direct reduction plant on the local iron ore andcoal to be used in the process and the technicalassistance SIDERPERU will receive under the projectare expected to minimize problems with the use ofthis technology.

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not othetwise be disclosed without World Bank authorization.

- ii -

Estimated Cost: The estimated cost of the project, exclusive oftaxes, is as follows:

Local Foreign Total----- (US$ millions)------

Project Management 0.40 1.70 2.10Operating Assistance 0.15 0.80 0.95Operational Training 0.20 0.90 1.10Studies 0.05 0.60 0.65

Sub-Total 0.80 4.00 4.80

Physical Contingencies 0.10 0.20 0.30Price Contingencies 0.10 0.80 0.90

Total 1.00 5.00 6.00

Financing Plan: Local Foreign Total-----(US$ million)-------

Bank Loan - 5.0 5.0SIDERPERU 1.0 - 1.0

1.0 5.0 6.0

Estimated Disbursements: Bank FY 1981 1982 1983 1984----(US$ millions)----

Annual 1.2 1.9 1.6 0.3Cumulative 1.2 3.1 4.7 5.0

Rate of Return: Not applicable.

Appraisal Report: None.

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

REPORT AND RECOMMENDATION OF THEPRESIDENT OF THE IBRD

TO THE EXECUTIVE DIRECTORS ON APROPOSED LOAN TO THE EKPRESA SIDERURGICA DEL PERU (SIDERPERU)

WITH THE GUARANTEE OF THE REPUBLIC OF PERU FOR THESIDERPERU TECHNICAL ASSISTANCE PROJECT

1. I submit the following report and recommendation on a proposed loanto the Empresa Siderurgica del Peru (SIDERPERU) for the equivalent of US$5.0million to help finance the SIDERPERU Technical Assistance Project. Theloan would have a term of 10 years, including 3-1/2 years of grace, withinterest at 8.25 percent per annum. In accordance with the normal procedurefor preinvestment loans, the loan would be refinanced under any later loan

that the Bank might make for the second stage of the SIDERPERU expansionprogram.

PART I - THE ECONOMY I/

2. A basic economic report entitled "Long-Term Development Issues:Peru" (Report No. 2204-PE) was distributed to the Executive Directors onApril 13, 1979. This part is based on the report's findings as well as thoseof more recent economic missions to Peru. Country data sheets are attached

as Annex I.

Resource Endowment

3. Peru, the fourth largest country in Latin America, is divided by

the Andes mountains into three distinct regions: the coastal region (Costa),with 46 percent of the population where modern economic activity is concen-trated; the mountain region (Sierra), with 44 percent of the country's popula-tion, which encompasses the highlands above 2,000 meters; and the sparselypopulated, tropical rain forests east of the Andes (Selva). The ruggedtopography limits trade between the three regions.

4. Peru's natural resources include large deposits of minerals,particularly copper, iron, silver and zinc, located mainly in the Sierra andthe southern Costa and phosphates on the northern Costa. Petroleum resources,

particularly in the jungle areas of the North and offshore, are believed tobe substantial but their full extent has not yet been ascertained. Anothermajor natural resource is the large fishing potential in coastal waters,although its magnitude is subject to sharp gyrations. Agricultural land islimited, and most of the soils suitable for intensive agriculture are already

being farmed.

5. As a result of three decades (1930-1960) of rapidly falling mortalityrates, population growth accelerated. In the early 1960's, birth rates started

a gradual fall, mainly caused by the urbanization process and by improvededucation. But with declining death rates, population has continued to growat about 2.8 percent p.a. It is expected that population growth will only

1/ This section is substantially unchanged from the Bayovar Phosphate

Engineering and Technical Assistance Project President's Report of June9, 1980 (Report No. P-2845-PE).

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slightly fall to about 2.6 percent p.a. over the next 20 years, unless aneffective demographic policy is adopted. Given the structure of Peru'spopulation, the labor force is expected to grow in excess of 3 percent peryear during the next 20 years.

6. Crude oil is the dominant source of energy in Peru, supplying approxi-mately 80 percent of Peru's commercial energy requirements. Although Peru'senergy resource base is relatively diverse with scope for expanding hydro andcoal based power generation, petroleum will provide the major part of Peru'senergy requirements throughout the rest of this century. After having beendependent on imported crude oil for many years, domestic oil productionincreased almost threefold between 1976 and 1979, enabling Peru to export oilin substantial quantities for the first time since 1958. Despite this encour-aging production trend, domestic consumption is likely to rebound afterseveral years of stagnation so that Peru may once again become a net importerof petroleum in the mid-1980's unless new oil reserves are discovered.

Past Development Policies

7. Since the military came to power in 1968, the Government has followeda development strategy directed at achieving economic growth and at narrowingthe sharp differences in wealth and opportunities among people in differentincome classes and geographical regions. The Government has tried to correctinterpersonal and interregional imbalances by expanding the role of the Statein the economy, changing the pattern of asset ownership, reducing foreignownership of national resources, orienting industry and agriculture towardproducing essential goods for the domestic market, stimulating the deconcentra-tion of economic activity out of Lima, and reforming the educational system tomake it more responsive to local economic and social needs. Through national-ization and creation of new enterprises, the State has taken direct control ofover 150 enterprises in key economic sectors, and its share in total capitalformation has risen from less than one-fourth in 1968-70 to over 40 percent in1974-1979. By imposing complex legislation, the Government has also strictlycontrolled the operations of the private sector.

8. As a result of these actions, the pattern of asset ownership inthe economy has changed drastically. Through nationalization, the shareof foreign-owned assets fell sharply. A sweeping land reform redistri-buted 43 percent of the country's best farmland to workers' cooperativesbenefitting some 25 percent of all rural families. Through other laws,industrial workers were given shares in their employers' firms and, in themining sector, a share in profits. The Government has also given a strongautarkic orientation to its agricultural and industrial sector policiesand strengthened the incentives for industries outside of Lima.

9. The Government's programs have benefitted large numbers of Peruvians,but hardly reached the poorest which continue to live in abject poverty. Itis estimated, for example, that about three quarters of rural families, mostly"minifundistas" (those farming less than 2 ha) and the landless seasonalworkers, have not been reached by social programs. The Government imposedcontrols on prices of a number of domestically produced goods and heavilysubsidized imported petroleum and foodstuffs. Most of the subsidized products,

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however, were more important in the consumption basket of high and middle-

income Peruvians than in that of the poorest groups. Moreover, artificially

low prices for some products--such as mutton and cereals--actually hurt the

poor who produced these items, and affected production negatively.

10. In the final account, one of the most significant achievementsof the Government was the promotion of the cultural and political integrationof the country. Owing in great part to the land reform, an important segment

of the rural population has become better organized and is able to communicateits priorities in a more forceful and articulate way. Unfortunately, although

many of the policies and structural changes carried out since 1968 were meant

to achieve rapid growth and more equality, the cost of these measures proved

to be excessive and their implementation inefficient.

The Economic Crisis

11. For ten years, 1968-77, the military Government followed expan-

sionary fiscal and credit policies. A rapid increase in expenditures (includ-

ing large defense outlays) was not matched by a parallel increase in revenues.Pricing, interest rate, and foreign exchange policies encouraged consumption

and discouraged savings, exports and, sometimes, overall production. As a

result, aggregate demand considerably exceeded aggregate supply. Excessdemand, in turn, led to strong inflationary pressures and widening external

gaps, with a loss of international reserves and a massive build-up of external

debt.

12. The problems were exacerbated by circumstances beyond the control

of the authorities. Anchovies, the fishing industry's principal resource,virtually disappeared as the annual catch dropped from around ten million

tons in 1968-71 to an average of 2.3 million tons in 1975-78. Furthermore,Peru's terms of trade worsened sharply between 1974 and 1978. Export prices,particularly for copper and sugar (which together accounted for almost one-

fourth of merchandise exports), fell from their high 1974 levels at a timewhen import prices soared. Petroleum reserves, which in the early 1970'swere predicted to lead to a quick expansion in export earnings, have takenmuch longer to come on line.

13. Public sector savings dropped steadily in relation to GDP from4.4 percent in 1970 to dissavings of 2.6 percent in 1977. Major causeswere the erosion of the tax base owing to excessive tax incentives, loopholesin the tax system, weak enforcement, rises in the budgetary cost of subsidiesfor foodstuffs and petroleum products, and sharp increases in defense outlays.

At the same time, public investment expanded rapidly and was increasinglyconcentrated on capital-intensive projects with long gestation periods and

little immediate contribution to the growth of output or employment.

14. Inflation accelerated from 5 percent per year in 1970 to 38 percent

in 1977. Interest rates, however, remained substantially negative in real

terms, discouraging financial savings and stimulating capital flight. Moreover,

the exchange rate remained practically constant between 1968 and 1975, thuscontributing to the overall disequilibrium. National savings fell dramatically

from 16 percent of GNP in 1970 to 8 percent in 1977, when they financed only

about one-half of investment. Following a period of rapid expansion in1968-74, during which GDP grew by more than 6 percent per year, the growthrate dropped progressively and became negative in 1977 and 1978.

15. The growing disequilibrium was reflected in the balance of payments.The current account deficit averaged US$1.1 billion per year in 1974-77,equivalent to nearly 9 percent of GNP. To finance this deficit, Peru accum-ulated a massive external debt. Peru's total private and public externaldebt-including short-term indebtedness--stood at almost US$8.3 billion byyear-end 1977, equivalent to two-thirds of GDP and four times exports of goodsand non-factor services. Much of this debt was contracted on fairly shortmaturities with three fourths of the public sector's long-term debt--which isestimated to have totaled US$6.4 billion--scheduled to be repaid over the1978-82 period.

16. Beginning in 1975, several unsuccessful attempts were made tocope with the mounting economic crisis. By mid-1978 the economic crisis hadreached grave proportions, with a drop in real GDP and inflation approaching100 percent. Moreover, the private sector was finding it increasingly diffi-cult to open letters of credit for new imports and the banking system's netinternational reserves had dropped to a negative level of US$800 million.Financial instability had reached the point where practically all economicactivities were adversely affected. The public sector was fast approachingthe point where it would no longer be able to fully service its external debt.Peru was no longer creditworthy.

Stabilization Measures

17. A new economic team was named in May 1978. Since then, the Govern-ment has adopted a number of important measures aimed at strengthening publicfinances, stimulating exports and stemming the loss of international reserves.By means of a crawling peg, the sol was devalued from S/. 130 per U.S. dollarin May 1978 to about S/. 266 at the end of March 1980. Most subsidies wereeliminated, thus closing an important drain on public savings. In addition, anumber of tax measures were adopted and Government expenditures restrained.Interest rates on bank loans were raised from 16 to 31.5 percent per year.Peru reached agreement with foreign commercial banks to reschedule US$185million of principal payments due in the second half of 1978 until January1979. The Government also negotiated a stand-by arrangement with the IMF forSDR 184 million. In July 1979, this stand-by was replaced by a new onefor SDR 285 million, in support of the same financial program. Peru's debtoutstanding to the IMF as of December 31, 1979 amounted to SDR 414 million.

18. The Government's financial stabilization program, supported by thestand-by, has resulted in a dramatic improvement in public sector finances in1979. Public sector current account savings rose from - 0.7 percent ofGDP in 1978 to about 3.6 percent of GDP in 1979 and the overall deficit wasreduced from 6.4 percent of GDP in 1978 to 2.9 percent in 1979. CentralGovernment revenues increased by 23 percent in real terms, while currentoutlays declined by 6 percent. Payments for wages and salaries alone fell bysome 7 percent in real terms, partly as a result of a reduction in excessivecivil service employment. The elimination of subsidies on food and petroleum

- 5 -

products, initiated in mid-1978, also contributed to the control of currentexpenditures. On the revenue side, several measures--including a 10 percentimport surcharge, a higher tax on traditional exports and an increased tax oninterest charged on bank loans--helped to achieve the revenue target. Inspite of good fiscal performance, however, inflationary pressures remainstrong, with consumer price increases of 67 percent in 1979 and over 50 per-cent (on an annual basis) during the first quarter of 1980.

Debt Restructuring

19. Major debt-relief operations carried out in late 1978 enabled Peruto reduce substantially the debt-service burden for 1979 and 1980, postponingrepayment to the 1982-1986 period. In May 1978, the Soviet Union rescheduledthe equivalent of about US$140 million of maturities originally due in 1978-80.These amounts are to be repaid over a 10-year period including three years ofgrace. In November, at a Paris Club meeting, the OECD countries agreed toreschedule 90 percent of principal payments due by the public sector togovernments and guaranteed suppliers in 1979 (US$250 million) and 1980 (US$263million). These amounts are to be repaid over a period of eight years, in-cluding three years of grace. The Paris Club creditors also agreed to re-schedule 90 percent of the principal payments due in 1979 and 1980 on privatesector debt guaranteed or insured in the creditor countries (about US$30million in each year). In addition, Peru has negotiated smaller amounts ofdebt relief with non-OECD countries. At the end of 1979, in view of theimproved balance-of-payments situation (para. 24), the Government decided toforego the Paris Club debt rescheduling option for 1980.

20. As regards the large medium-term public debt to commercial banks,in keeping with an agreement concluded in December 1978, Peru repaidin 1979 the bulk of the US$185 million rolled over from 1978 (para 17 above).The agreement gave the Government the option of refinancing up to 90 percentof the maturities due in 1979 and 1980. The Government, however, decidedearlier this year not to take advantage of the 1979 maturities, thus obtainingslightly better conditions for outstanding debts. It is likely that theoption to refinance 90 percent of the 1980 maturities will be taken.

Social Situation

21. The economic crisis has been reflected in two consecutive years ofnegative growth. Total Gross Domestic Income fell by 0.6 percent in 1977 anda further 4.1 percent in 1978. In this two-year period GDP per capita droppedby over 8 percent. Nearly one half of Peru's labor force is believed to beunemployed or underemployed, i.e., earning less than the minimum wage orworking less than 35 hours a week and wishing to work more. According togovernment estimates, the purchasing power of an average salary had fallen40 percent by 1978 compared to 1970 and that of an average wage by over16 percent. In these circumstances, the social situation has been unavoidablytense, and several general strikes took place during the past year.

22. In July, 1979, the military Government promulgated a new constitution,written by a popularly elected assembly. Elections were held in May 1980,and the transfer of authority to the government of President-elect FernandoBelaunde is scheduled to take place on July 28, 1980. While it is too earlyto assess future government policies it is most likely that the Belaunde

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Government -- in line with campaign pledges -- will give high priority tosocial and employment problems, particularly through housing and labor-intensive small-scale infrastructure programs.

The Economic Recovery Program

23. With the financial stabilization program and the debt restructuring,the Government has brought the fiscal and external gaps under control. Theseefforts, however, have not yet helped much in overcoming the deep economicrecession. To this end the Government conceived an Economic Recovery Program(ERP) which would reverse the decline in GDP and lay a basis for a financiallysound economic recovery. The ERP includes, in addition to the above-mentionedstabilization actions, measures to open up the economy, stimulate industrialsector efficiency, promote non-traditional exports, strengthen the tax systemby broadening its base, and generally improve the efficiency of resourceallocation in the private and public sectors. In this connection, the Govern-ment formulated a Public Sector Investment Program that aims at redirectingpublic investment towards projects of clear economic priority and positiveeffect on production and employment. In support of the ERP, the Bank approveda US$115 million program loan in May, 1979. Progress in carrying out the ERP,which is closely monitored by the Bank and periodically discussed with theAuthorities, is generally satisfactory with performance in some criticalareas--e.g., export promotion--actually exceeding expectations.

24. The Government's program led to a strong balance-of-payments perfor-mance in 1979, which is essential for economic recovery, and to restore netinternational reserves. This was achieved by maintaining an export-orientedforeign exchange policy, realistic interest rates, and the promotion ofnon-traditional exports; but it is also the result of low, recession proneimports. In addition, Peru benefitted from substantial price increases forsilver, copper, petroleum, and other commodities. The Government also intendsto improve foreign debt management by, inter alia, making greater use ofassistance from official bilateral and international sources. The short-termdebt, already sharply reduced from US$1.8 billion at year-end 1978 to US$1.1billion at year-end 1979, is expected to be further reduced as the graduallyimproving economic situation permits new trade-related credit lines to beopened. The trade balance is expected to be strengthened by favorable worldprices for minerals, and by the availability of a petroleum surplus for exportamounting to some US$950 million per year over the next few years. Eventhough about one third of the projected gross petroleum exports would leavethe country as profit remittances, this still implies a major improvementover recent years, when Peru was spending in excess of US$200 million peryear on fuel imports.

25. Based on assumptions that are cautiously optimistic, the country isexpected to show a strong balance-of-payments performance through the mid-eighties, with current account surpluses and a build up of foreign exchangereserves in spite of heavy debt repayment obligations. The balance-of-paymentssituation may, however, deteriorate in the second half of the eighties (oreven earlier), when the exportable surplus of oil is expected to decline. Thiswill eventually result in increasing current account deficits, particularlyif imports exceed the level now expected as a result of the recently startedimport liberalization process. Against this background and given Peru's largeoverhang of external indebtedness, there is a continuing need for officialdevelopment assistance. Considering the expected medium-term balance-of-payments performance and assuming that the authorities continue to carry outthe ERP and to maintain prudent financial policies, Peru is creditworthy forBank lending.

PART II - BANK GROUP OPERATIONS IN PERU 1/

26. In addition to the US$7.5 million Bayovar Engineering and Technical

Assistance Loan which the Executive Directors are expected to consider in June,

the Bank has approved 38 loans to Peru for a total amount of US$779.3 million,

net of cancellations. About 31 percent of the Bank's lending to Peru has been

for transportation (mainly highways and ports), 23 percent for agriculture, 15

percent for the US$115 million, May 1979 Program Loan, 15 percent for the

energy sector, 10 percent for mining and industry and about 6 percent for

education and urban development.

27. Of the US$332.8 million undisbursed as of April 30, 1980, over

50 percent is attributable to the five project loans made in the 1976-77

period. The slow start-up of these projects--only two of which were "repeater"

operations--as well as the slow progress of previous operations was due, in

large part, to weak project execution capacity and to a shortage of counterpart

funds that worsened as the economic situation deteriorated during this period.

As a result, disbursements have averaged about US$25 million per year over the

past few years (Annex II contains a summary statement of Bank loans as of

April 30, 1980, and notes on the execution of on-going projects). In an

effort to improve this situation: (i) the Bank opened a resident mission in

Peru; (ii) the Executive Directors approved modifications in the Education

and the Lima/Amazon Corridor Projects (see Annex II for further details);

(iii) adequate counterpart funds were provided by the Government for 1979 and

1980; and (iv) the Government set up a special commission to monitor loan

execution and resolve administrative problems. With these actions, the pace

of disbursement is now increasing; IJS$32.2 million has been disbursed on

project loans in the first nine months of FY 1980.

28. Program Loan disbursement started slowly because of the unforeseen

increase in foreign exchange availability in Peru as a result of booming

exports and continued depressed import levels, as well as substantial debt

rescheduling. In order to accelerate disbursements, the list of eligible

imports was expanded to include additional high priority industrial inputs.

As of May 31, 1980, US$109.6 million of the loan had been disbursed.

29. The main objectives of Bank lending to Peru have been to assist

in (i) the creation of the physical infrastructure needed to sustain and

foster development; (ii) the expansion of productive capacity in crucial

sectors; (iii) the consolidation of structural and institutional changes,

particularly land and education reforms; (iv) the strengthening through

technical assistance loans and regular operations of local capacity to prepare,

implement and operate projects effectively; and (v) improving living conditions

for the urban and rural poor. In the past, Bank lending concentrated on

infrastructure in the transportation and power sectors. More recently, the

Bank's emphasis has shifted to more directly productive fields -- mining,

agriculture and industry -- to aid Peru in surmounting its balance of payments

problems. Lending for social projects has also grown.

1/ This section is substantially unchanged from the Bayovar Phosphate

Engineering and Technical Assistance Project President's Report of June

9, 1980 (Report No. P-2845-PE).

- 8 -

30. Aside from the Bayovar loan mentioned above, the next operations thatwould be ready for the Executive Directors' consideration include a regionalairports project, a mining operation, a second industrial credit loan and ahighway maintenance project. This program would be reviewed with the newGovernment to assure its agreement.

31. It is estimated that Bank loans constituted about 4.4 percent ofPeru's total public external debt outstanding and disbursed, at the end of1979, and absorbed about 2.7 percent of the country's external debt service in1979. Assuming increased recourse to long-term bilateral and multilateral aidby Peru, the Bank's share in the country's outstanding public foreign debt by1985 could reach about 15 percent and its share of debt-service would bearound 8 percent.

32. IFC commitments to date have been US$29.7 million (including US$15million to the Southern Peru Copper Corporation for the Cuajone Copper MiningProject) of which US$17.2 million is held by the Corporation. A summarystatement of IFC investments as of April 30, 1980 is presented in Annex II.

33. The other principal official agencies lending to Peru -- IDB andUSAID -- are expected to continue giving special attention to agriculture withIDB emphasizing agricultural, industrial and mining credit, roads and smallscale irrigation and USAID stressing rural development. Total loan commitmentsas of December 31, 1979 by IDB and USAID were US$646.0 million and US$275.1million, respectively, and their shares of debt service as of end-1979 wereboth estimated at 0.6 percent.

PART III - INDUSTRY AND THE STEEL SUBSECTOR

A. Industry

34. The industrial sector in Peru (manufacturing and mining, excludingpetroleum) accounted for 32 percent of GDP in 1978 and employed 14 percent ofthe labor force. Manufacturing is the largest component of the industrialsector, responsible for about 80 and 90 percent, respectively, of its contribu-tion to GDP and employment. Mining, however, is critical to Peru's economicdevelopment because it generates 40-50 percent of Peru's foreign exchangeearnings and makes a significant fiscal contribution through exports taxes.

35. Until recently, the Government followed a policy of import sub-stitution and high tariff protection for development of the manufacturingsector. As a result, manufacturing absorbed a substantial amount of for-eign exchange, while its exports were insignificant. In 1976, importedindustrial inputs came to about US$750 million, representing over a thirdof merchandise imports and 24 percent of industrial value added. During the1971-1976 period, manufactured exports averaged only 6 percent of totalmerchandise exports.

36. This import substitution policy produced an inward oriented indus-trial sector with little interest and ability to compete in world markets.At the same time, however, the manufacturing sector in Peru diversified

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substantially. The share of traditional consumer goods industries nowaccounts for only about 40 percent of total manufacturing output, whileintermediate goods industries have grown in importance. The two largestsuch industries, chemicals and basic metals, now represent 17 and 11 percentof manufacturing output, respectively. The technical assistance loan proposedin this report would assist the preparation and execution of an importantexpansion of Peru's steel industry.

37. There has been growing recognition in recent years of the ineffi-ciency of the domestic manufacturing industry, its vulnerability to thecountry's recurrent foreign exchange difficulties as a result of dependence onimported inputs and its limited contribution to economic development becauseof its high net absorption of foreign exchange. The problems of the industrialsector became particularly evident during the economic crisis of the past fewyears. When Peru's economic activity began to slow down in 1975, industrialgrowth dropped from an average growth rate of 7 percent per annum during1960-75 to to 4.2 percent in 1976. As the economic crisis deepened in 1977and 1978, physical industrial production decreased by 3.9 and 2.4 percent,respectively. At the same time, the highly protected local market allowedoligopolistic industries to raise prices indiscriminately, thus fueling thehigh inflation of recent years.

38. The overall policy framework towards manufacturing began to changein mid-1976, with the adoption of a more realistic foreign exchange policy.In addition, a very generous set of export incentives was established inmid-1976 and strengthened in late 1978. These actions, together with asubstantial reduction in domestic demand, generated an unprecedented growth innon-traditional (mainly manufactured) exports. They include textiles, processedfish for human consumption and fishing boats. From a low of US$133 millionin 1976 (10 percent of merchandise exports), non-traditional exports increasedto almost US$680 million in 1979. They grew to about 20 percent of merchan-dise exports that year--not as great an increase as in the overall growthof non-traditional exports because of the increases in petroleum and metalexports in 1979.

39. The other significant policy change designed to improve industrialefficiency, the trade liberalization element of the ERP (see para. 23),has proceeded generally according to schedule. In particular, non-tariffprotection to industry through import prohibitions--the main feature ofPeru's industrial policy until 1978--has been dismantled to a large extentand the process is expected to be completed by mid-1980. A new tariffstructure was approved and has been in operation since last December, mosttariff exemptions and exonerations have been eliminated and the system ofexport promotion has been improved. Nevertheless, the trade liberalizationprogram is far from complete. Considerable efforts will have to be made inthe coming years to achieve the full transformation of Peru's industrialstructure.

B. The Steel Industry

40. Background. The beginnings of Peruvian iron and steelmaking can betraced back to the Incas. Peru's first modern steel mill was constructednear Chimbote on the Peruvian coast about 420 km north of Lima and beganoperations in 1956 under joint public/private ownership based on the use ofthe Marcona iron ore deposits located 480 km south of Lima. Chimbote was

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selected for its deep water port facilities and the hydroelectric potential ofthe near-by Santa River. In addition to Chimbote, there are two small privatelyowned rolling mills with a total production capacity of about 74,000 tpy, mostlyof steel bars, and several foundries which produce about 50,000 tpy of forgingsand castings. One of the private mills is now planning a 100,000 tpy steel-

making plant, which would go into operation in 1984.

41. SIDERPERU. Under the General Industries Law of 1970, the State was

given the exclusive right to ownership of "basic" industries, including steelproduction. This did not affect the small private mills, but as the country'smajor steel producer the Chimbote steel mill was transferred in 1970 to the

newly created, state-owned Empresa Siderurgica del Peru (SIDERPERU), whichpurchased the interests of the previous private shareholders in Chimbote.

42. SIDERPERU's Chimbote mill is the only integrated steel plant inPeru. It has an annual production capacity of about 500,000 tons of crudesteel, which represents 90 percent of Peru's steelmaking capacity. The plant,

however, is unbalanced, i.e., given the yield factor between crude andfinished steel, crude steel capacity would have to be increased to 920,000 tpy

to fully utilize Chimbote's 700,000 tpy rolling and finishing capacity.Because of the imbalance, SIDERPERU has had to rely partly on imported slabsand billets to feed its rolling mills. SIDERPERU produces both flat products --

hot and cold-rolled coil and sheet, galvanized sheet, tinplate -- and non-flat

products -- wire rod and and bars. About two-thirds of Chimbote's steeloutput is produced by the blast furnace/basic oxygen furnace process usingas inputs iron ore pellets from the Marcona mines and imported coke. Thebalance is produced by electric arc furnaces (EAFs) which process mostlyimported steel scrap.

43. Deficiencies in the original design of the Chimbote plant, thesmall scale of many plant units and Government price controls have causedserious operational and financial difficulties over the years. During thefirst half of the 1970's, a US$130 million program was carried out, whichreduced the imbalance between steelmaking and rolling capacity and improvedthe relationship between plant units. This program, together with the easingof Government price controls and a capital increase of US$80 million in 1979,greatly improved SIDERPERU's financial position. After losses in the mid-1960'sand early 1970's, SIDERPERU has shown a profit over the past few years. Its

cash generation is presently projected at US$100 million in the 1981-84 period.It is now in a healthy financial position with a long-term debt/equity ratio of13/87 and a current ratio of 1.6 at the end of 1979. The intended expansionprogram is expected to further strengthen SIDERPERU.

44. Prices of domestically produced steel products are now set at a levelclose to landed import prices before duties. For rebars (used primarily forhousing and other construction), which constitute about half of SIDERPERU'soutput, Peruvian prices are somewhat below landed import prices, while domestic

prices for other products are roughly 10-20% higher. These prices fully coverSIDERPERU's costs.

45. With the high cost of imported scrap and metallurgical coke and theuncertainty of scrap supply because of periodic shortages on the world market,SIDERPERU has been exploring steelmaking methods which utilize indigenous raw

materials. In this effort, SIDERPERU has been operating an experimental kilnsince 1975 to test the use of the SLRN coal-based direct reduction (DR)technology owned by Lurgi of Germany. This process was developed in the1960's by Stelco (Canada), Lurgi (Germany), Republic Steel (USA) and NationalLead (USA). It permits the use of anthracite coal located close toChimbote to produce sponge-iron from Marcona iron ore pellets. This spongeiron can be substituted for steel scrap in EAF steel production. The processthus provides an alternative and less expensive route to steelmaking forcountries that lack coking coal and steel scrap.

46. SIDERPERU's experimental kiln has so far produced 7,000 tons ofsponge iron which has been charged to the existing EAFs for the productionof steel. Based on this pilot operation, local anthracite coal and iron orehave been determined to be suitable for the production of sponge iron by thecoal-based DR process.

47. Steel Demand. Despite having one of the lowest per capita levelsof steel consumption in South America, Peru's domestic steel production hasnever been able to satisfy demand. In recent years the country has beenimporting about 30 percent of its steel requirements. As a result of Peru'seconomic growth and large investments in the early 1970s, steel consumption in1975 reached 624,000 tons (all demand and consumption figures given are in rawsteel terms and exclude seamless pipes, rails, forgings/castings and specialsteels for which demand is highly variable). As a result of the economicrecession after 1975, steel consumption dropped sharply to 420,000 tons in1978, the latest figure available. With economic recovery, the 1975 level ofsteel consumption could be exceeded by 1981. Thereafter, SIDERPERU expectsconsumption to grow at a rate of about 6 percent through 1986, and 8 percentafterward. These growth rates must be confirmed in the feasibility study tobe financed under the proposed loan but they are reasonable in light of thecurrent low level of steel consumption in Peru and projected GDP growth ratesof 5-6 percent in the 1980's. With the initial production from the SIDERPERUfirst stage expansion described below, 1984 domestic steel production wouldtotal about 630,000 tons compared to projected consumption of 777,000 tons.By 1990, production is expected to grow to 1.0 million tons compared to aconsumption estimate of 1.2 million tons.

48. SIDERPERU Expansion. In order to help meet this growth in demandand to eliminate its remaining Chimbote plant imbalances, SIDERPERU hasrecently begun implementing a balancing and expansion program that takesadvantage of DR technology. The US$22 million initial phase of this program,which has now been completed, includes a plant-wide elimination of bottlenecksand installation of a DR plant consisting of three medium-size SLRN kilns.These kilns are now in the start-up phase and at full production are designedto have a combined capacity of 100,000 tpy of sponge iron, which will replaceimported scrap. The operation of these kilns will enable SIDERPERU to obtainexperience with coal-based DR on an industrial scale. Although new steelmakingfacilities were not added, the initial phase is expected to increase SIDERPERU'ssteel production capacity from 500,000 tpy to 520,000 tpy, by permitting moreefficient use of its existing EAFs.

- 12 -

49. This phase will be followed by an increase in raw steelmakingcapacity of 400,000 tpy in two stages of 200,000 tpy each. Stage I is nowbeing initiated for completion in 1984. Plans are for Stage II to be imple-mented in the 1983-1987 period. The major equipment components of each stagewould include a DR plant with 200,000 tpy capacity, an 80 ton EAF, a 1,250 mmwide continuous slab caster and a 50 MW coal-fired power plant. In addition,Stage I would include a continuous billet caster for the existing steelmakingplant and Stage II would include a coal transport system.

50. Excluding working capital, financing charges, utility connectionsand pre-operating expenses, Stage I is estimated to cost US$185 million in 1980prices and Stage II US$135 million. Since it is an expansion, this averages alittle over US$800 per ton of annual capacity, which is low in comparison withgreenfield steel projects whose costs per ton are now at least US$1,000-1,200.

51. Procurement activities for Stage I are now being completed. TheIndo/German consulting firm Dastur Engineering helped design this stage andthe French consulting firm SOFRESID, acting on behalf of SIDERPERU, called forbids on the principal Stage I facilities. Offers were requested from a largenumber of equipment fabricators in major supplying countries and awardswere made to the lowest evaluated bidders on the basis of reasonable economicand technical criteria. All bids are on a turnkey basis and include financing,including interest during construction. Pre-operating expenses and additionalworking capital requirements, as well as the local cost component of thetechnical assistance project presented herein would be financed from SIDERPERU'scash generation. The proposed Bank technical assistance loan would financethe feasibility study for Stage II.

52. Although the Bank has not appraised the SIDERPERU expansion programin depth, a review of its technical, commercial and economic aspects indicatesthat it is well-conceived and economically attractive. Peru has the iron oreand coal resources to justify expansion of its steel industry to meet domesticdemand. Such demand exceeds production capacity and is expected to continueto do so even after completion of the above-described expansion program.Peruvian raw materials are well-adapted to the coal-based direct reductionprocess and this has been tested to the point where bidders for the DR packageare prepared to offer normal industry guarantees for the performance of theplants. The project appears to be economically justified. With inexpensivedomestic inputs, particularly coal (which will also reduce the cost of powergeneration for the project), sponge iron production will be low in cost(US$110/ton), compared with the cost of imported scrap (US$160/ton, c.i.f.).The use of direct reduction allows for an economically efficient projectscale to meet the needs of the relatively small domestic market.

53. SIDERPERU has been financially successful in recent years but stillrequires strengthening in a number of areas. A UNDP program has providedsome technical assistance to SIDERPERU in improving its financial and opera-tional management; however, further assistance is necessary in such operationalareas as maintenance and production planning. Also, SIDERPERU has littleexperience in project implementation and needs strong support to carry outits expansion program. The technical assistance project would provide SIDERPERUwith this support.

- 13 -

Previous Bank Activities in Industry and the Steel Subsector

54. Aside from a US$2.5 million loan (Ln. 116-PE of 1955) for develop-ment of a cement plant, which was successfully completed, the Bank's onlyindustrial sector project in Peru was a US$35 million DFC I operation.After a slow start as a result of the domestic recession, commitments underthis project have picked up recently and the credit line is over 70 percentcommitted. Full commitment is expected by December 1980. The President'sReport on the proposed US$7.5 million Bayovar Engineering and TechnicalAssistance Loan for a phosphate fertilizer project has been distributedfor Board consideration.

55. While the proposed Bank loan would be the first to the iron and steelsubsector in Peru, the Bank's dialogue with the Peruvian steel industry datesback to the early 1960's when a mission reviewed the technical assistancerequirements of the Chimbote steel plant. More recently, assistance is beingprovided to SIDERPERU through a cost sharing arrangement with the UNDP utilizingtechnical assistance funds from the 1979 Program Loan (Ln. 1693-PE of 1979)for two consultants who are assisting in the preparation of SIDERPERU'sexpansion program. Also, in 1979 SIDERPERU received a US$700,000 subloanunder the DFC I project to help finance the three medium-size SLRN kilnsmentioned in para 48.

PART IV - THE PROJECT

56. In May 1979, the Government requested Bank technical assistance forthe execution of the SIDERPERU expansion program. The first Bank missionvisited Peru in July 1979.

57. The technical assistance project was appraised in April 1980. Thereis no separate appraisal report for the project. Supplementary data arecontained in Annex III. Negotiations were held in Washington on June 13, 1980and the Peruvian delegation was headed by Mr. Rene Calderon, Technical Directorof SIDERPERU.

Project Objectives and Description

58. The objectives of the technical assistance project are to strengthenSIDERPERU's project execution and plant operation capability to enable it tosuccessfully install and manage its expanded facilities. The project wouldinclude the following:

(i) 230 man-months of consulting services to assist in project manage-ment for the installation and start-up of the 200,000 tpy Stage Iexpansion program;

(ii) 100 man-months of consulting services to provide assistancein the operation of existing plant facilities and initial operationof the Stage I facilities;

- 14 -

(iii) assistance from a steel company which uses coal-based DR technologyto provide training for SIDERPERU personnel both on-the-job and inits plant abroad and 20 man-months of consulting services toestablish a training program for SIDERPERU; and

(iv) 60 man-months of consulting services to prepare a feasibility studyfor Stage II of the expansion program, including a technical andeconomic review of the Stage I expansion, and coal transportation andelectric system studies.

59. Project Management Services. This component, which represents about44 percent of total project costs, would be carried out by a consulting firmand would include the provision of the services of a project manager. Theproject manager would lead an integrated team drawn from the staff of SIDERPERUand the selected consulting firm. He would be responsible for carrying outStage I of the expansion program, which will begin shortly, including suchaspects as overall coordination, control and direction of the works, scheduling,cost control, management information systems, site and erection coordination,and the provision of start-up assistance. He would report directly to theGeneral Manager of SIDERPERU. The project manager would be authorized to acton behalf of SIDERPERU on project related matters, including all dealings withcontractors and suppliers.

60. Operating Assistance. Under this component, consulting serviceswould be provided to strengthen SIDERPERU's operating practices, includingyield and quality standards, maintenance procedures, production planningand use of information systems. This would account for 20 percent of totalproject costs and would not only help SIDERPERU operate Stage I successfully,but would also enhance the performance of present facilities. AlthoughSIDERPERU has gained some experience in coal-based DR from the operation ofits pilot plant and will benefit from additional experience as its three newmedium-sized kilns go into operation, assistance will be necessary for thestart-up and initial operation of the larger Stage I kilns. This assistancewould be provided by an experienced operating steel company familiar withcoal-based DR technology.

61. Operational Training. This component accounts for 23 percent oftotal project costs and would include: (i) local on-the-job training forSIDERPERU staff; (ii) training of about 50 local staff for 3-6 months incoal-based DR operation abroad; and (iii) establishment of a training programin SIDERPERU. The first and second elements would be provided by the steelcompany selected to give operating assistance. For the third element, thecompany would contract a training advisor to assist in developing and insti-tuting a continuing training program for SIDERPERU staff.

62. Studies. This component, representing 13 percent of total cost,would finance a feasibility study for the 200,000 tpy Stage II expansionprogram, including a review of the Stage I expansion. The principal aim ofthe Stage I review would be to provide the information necessary for thedesign and economic evaluation of Stage II. It might also result in the

- 15 -

identification of possible design modifications that might improve the effi-ciency of Stage I. In addition to project design, the Stage II feasibilitystudy would include a market study, estimates of capital and operating costsand a financial and economic evaluation.

63. SIDERPERU will require increased supplies of anthracite coal start-ing about 1984/85. Until then it has large stocks of residual coke fines(powder), which have accumulated over the years and can supplement existingcoal supplies for use in the DR process. A study would be carried out toidentify the most appropriate means of transporting coal, which would comefrom the Santa area anthracite mines about 100 km from Chimbote. One solutionunder consideration is a coal slurry pipeline. In addition, SIDERPERU wouldcarry out a study of its electric generation and distribution system in orderto determine how it should be adapted to the needs of the Expansion Program.

Project Execution

64. The technical assistance project would be executed by SIDERPERU andwould take about three and one-half years to complete. The qualifications,terms of reference and conditions of employment of all consultants would haveto be acceptable to the Bank and SIDERPERU would advise the Bank of thecriteria to be used in the selection of consultants (Section 3.02(a) of thedraft Loan Agreement). Consultants for the project management and studiescomponents of the project would be appointed by September 30, 1980 and thosefor the operational assistance and training components would be appointed byDecember 31, 1980 (Section 3.02(b) of the draft Loan Agreement). SIDERPERUand the Government have agreed that after completion of the feasibility studyand before a decision is taken on whether to go ahead with Stage II, the Bankwould be afforded a reasonable opportunity to exchange views thereon (Sections3.02(e)(ii) of the draft Loan Agreement). The Bank would have the right tosuspend disbursements in the event that, for whatever reason, SIDERPERU ceasescarrying out the Stage I expansion (Section 6.01(a) of the draft Loan Agreement).

Project Costs, Financing and Disbursement

65. The total cost of the project is estimated at US$6.0 million net oftaxes, of which US$5.0 million are foreign costs to be financed by the proposedloan. The cost estimate is based on mid-1980 prices. Physical contingenciesof five percent have been added for all items, except studies. Price contingen-cies were based on an annual estimated worldwide inflation rate of 10 percent.SIDERPERU would finance the estimated US$1.0 million local costs of theproject from internal cash generation. About 385 man-months of foreignengineering and technical and other consultancy services would be required.The estimated cost per man-month would be about US$10,000 (including overheadsand subsistence allowances). The proposed Bank loan would be disbursed against100 percent of foreign expenditures.

- 16 -

Benefits and Risks

66. Although Peru has sizeable iron ore and coal reserves, domestic demand

for steel has been substantially in excess of production capacity. The size

of the local market, however, does not permit the construction of additional

conventional steelmaking facilities large enough to obtain satisfactory

economies of scale. SIDERPERU's proposed expansion program, based on the

direct reduction of iron ore to sponge iron with the use of local non-coking

coal, will provide additional steel making capacity economically.

67. The SIDERPERU steel expansion program would replace 500,000 tpy of

imported scrap with a current total cost of US$80 million per year with locally

produced sponge iron. The country would thus have a more reliable source of

steelmaking raw materials than imported scrap steel, whose supply has been

restricted at times. The expansion program would at the same time help develop

a local resource (anthracite coal) for which there would otherwise be little

use. Given the inexpensive coal supply, the low cost of the sponge iron

that would be produced compared to the cost of imported steel scrap and

the existence of excess rolling and finishing capacity that would be utilized

with the increase in steelmaking, the SIDERPERU expansion appears to be

economically justified. Overall, SIDERPERU's expansion would provide Peru

with steel products at competitive prices and on a reliable basis.

68. A primary reason for Bank involvement in this project is SIDERPERU's

lack of project management experience and capability. Though SIDERPERU has

highly qualified engineers in such areas as process development, it does

not--as an operating company--have sufficient manpower and experience in

construction supervision, project implementation and scheduling and cost

control. Without additional support, SIDERPERU is likely to encounter major

delays, cost overruns and operational difficulties in implementing its expan-

sion program. The selection of an experienced project management team under

the proposed Bank project would help to minimize this potential risk. The

technical assistance project would thus contribute to strengthening SIDERPERU

in terms of management, operation and project implementation. This responds

to the Government's objective of trying to ensure that major public investmentprojects, such as the SIDERPERU expansion, are well prepared and executed so

as to avoid the kind of poor quality projects that have hindered Peru's

development efforts in the past.

69. While the proposed coal-based DR process has been troublesome in a

number of projects, plants in New Zealand (1969), South Africa (1974) and

more recently in Brazil are successfully operating with this process. Given

SIDERPERU's experience with the process, the risk should be minimal and, as

pointed out above, the suppliers are prepared to guarantee the operation of

the DR plant.

70. One attractive aspect of the proposed project for the Bank would

be the experience it would gain in the execution of a coal-based DR project.

In view of the world energy situation there are several countries where a

coal-based DR process using non-coking coal might be utilized. Based on its

experience in Peru, the Bank could play an important role in assisting in the

introduction of this technology to these countries.

- 17 -

PART V - LEGAL INSTRUMENTS AND AUTHORITY

71. The draft Loan Agreement between SIDERPERU and the Bank, the draftGuarantee Agreement between the Republic of Peru and the Bank, and theReport of the Committee provided for in Article III, Section 4(iii) of theArticles of Agreement of the Bank are being distributed to the ExecutiveDirectors separately.

72. These draft agreements conform to the normal pattern for loansfor technical assistance projects. The main features of the Loan and GuaranteeAgreements are referred to in the text and the special conditions thereof arelisted in Section III of Annex III.

73. I am satisfied that the proposed loan would comply with the Articlesof Agreement of the Bank.

PART VI - RECOMMENDATION

74. I recommend that the Executive Directors approve the proposed loan.

Robert S. McNamaraPresident

AttachmentsJune 25, 1980Washington, D.C.

- 18- ANNEX Ip.,. 1 Page 1 of 5

TAJLU 3APtRg - SOC INDIGATU D4T4A SBEET

PERU RPENECE QOUPS (WEIGRTED AVEZESLAND AREA (THOUSAND So. MO.S -_____ T RECENT _STIVATE_

TOTAL 1285.2AGRICULTURAL 305.5 MOST RECENT MIDDLE INCME MIDDLE INCOE

1960 k 1970 ESTIMATE k LATIN AMIRICA A CAM7JJAN EUROPE

GNP PER CAPITA (USS) 250.0 420.0 740.0 1384.1 2381.1

ENERGY CONSUMPTION PER CAPITA(KIOGRAMS OP COAL EQUIVALENT) 445.0 619.0 649.0 1055.9 1641.4

POPULATION AND VIT AL STATISTICSTOPtLATION, IID-YEAR (MILLIONS) 10.2 13.5 16.8URBAN POPULATION (PERCENT OF TOTAL) 46.3 57.4 65.6 63.4 53.9

POPULATION PROJECTIONSPOPULATION IN YEAR 2000 (MILLIONS) 29.0STATIONARY POPULATION (MILLIONS) 57.0YEAR STATIONARY POPULATION IS REACHED 2090

POPULATION DENSITYPER SQ. DN. 6.0. 11.0 13.0 28.1 77.2PER SQ. KM. AGRICULTURAL LAND 33.0 44.0 55.0 81.7 129.5

POPULATION AGE STRUCTURE (PERCENT)0-14 YRS. 44.2 45.0 42.9 41.4 30.6

15-64 YRS. 52.0 51.9 53.4 54.7 61.165 YRS. AND ABOVE 3.8 3.1 3.7 3.9 8.2

POPULATION GROWTH RATE (PERCENT)TOTAL 2.6 2.8 2.7 2.7 1.6URBAN 4.7ye 5.0 4.5 4.1 3.3

CRUDE BIRTH RATE (PER THOUSAND) 47.0 43.0 39.0 34.8 22.8CRUDE DEATH RATE (PER THOUSAND) 19.0 15.0 12.0 8.9 8.9GRSS REPRODUCTION RATE 3.1/d 2.9 2.8 2.5 1.5FAhILY PLANNING

ACCEPTORS. ANNUAL (THOUSANDS)USERS (PERCENT OF MARRIED WOMXEN) .. ..

POOD AND NUTRITIONINDEX OF FOOD PRODUCTION

PER CAPITA (1969-71-100) 96.0 102.0 85.0 106.9 113.1

PER CAPITA SUPPLY OFCALORIES (PERCENT OF

REQUIREMENTS) 95.0 99.0 97.0 107.4 125.3PROTEINS (GRAMS PER DAY) 62.0 61.0 59.0 65.6 91.0

OF WHICH ANIMAL AND PULSE 27.0 25.0 24.0 33.7 39.6

CHILD (AGES 1-4) MDRTALITY RATE 28.0 20.0 16.0 8.4 4.3

HEALTHLIFE EXPECTANCY AT BIRTH (YEARS) 48.0 *53.0 56.0 63.1 67.8INFANT MORTALITY RATE (PERTHOUSAND) .. 122.0/ .. 66.5 55.9

ACCESS TO SAFE WATER (PERCENT OFPOPULATION)

TOTAL .. 35.0 47.0 65.9URBAN *- 58.0 72.0 80.4RURAL .. 8.0 15.0 44.0

ACCESS TO EXRETA DISPOSAL (PERCENTOF POPULATION)

TOTAL .. 36.0 .. 62.3URBAN *- 52.0 .. 79.4RURAL .. 16.0 .. 29.6

POPULATION PER PHYSICIAN 2251.0lf 1859.0 1556.0 1849.2 1030.1POPULATION PER NURSING PERSON 2205.Of 738.0 745.0 1227.5 929.4POPULATION PER HOSPITAL BED

TOTAL 424.01A 470.0 547.0 480.3 289.7URBAN .. 425.0RURAL .. 3144.0

ADMISSIONS PER HOSPITAL BED .. 19.0 .. .. 17.0

HOUSINGAVERGE SIZE OF HOUSEHOLD

TOTAL 4.9 4.9/hURBAN 4.8 5.1hRURAL 4.9 4.7/h

AVERAGE NUHBER OF PERSONS PER ROOMTOTAL 2.3 1 .URBAN 2.0 1.77 ..RURAL 2.7 2.4 .

ACCESS TO ELECTRICITY (PERCENTOF DWELLINGS)

TOTAL 26.0 32.1 .UREAN 50.7 54.37.RURAL 4.0 2. ..

- 19 - AMNEX IPage 2 Page 2 of 5

TABLE 3APERU - SOCIAL INDICATORS DATA SHEET

PERU REFERENCE GROUPS (URIGITED AVAffS- MDST RgCEIT ESTIMATE)

MOST RECENT MIDDLE INCOME MEDDLE INCOHE1960 /b 1970 k ESTIMATE k LATIN AMERICA & CARI3BEAN EUROPE

EDUCATIONADJUSTED ENROLLMENT RATIOS

PRIMARY: TOTAL 83.0 107.0 110.0 99.7 105.9MALE 95.0 114.0 115.0 101.0 109.3

FEMALE 71.0 99.0 106.0 99.4 103.0

SECONDARY: TOTAL 15.0 30.0 52.0 34.4 64.0MALE 18.0 34.0 56.0 33.5 71.1

FEMALE 13.0 26.0 48.0 34.7 56.9

VOCATIONAL ENROL. (: OF SECONDARY) 20.0 17.0 23.0 38.2 28.8

PUPIL-TEACHER RATIOPRIMARY 34.0 40.0 40.0 30.5 29.4

SECONDARY 12.0 23.0 23.0 14.5 26.1

ADULT LITERACY RATE (PERCENT) 61.0 .. 72.0 76.3

CONSUMPTIONPASSENGER CARS PER THOUSAND

POPULATION 8.0 17.0 18.4 43.0 84.6RADIO RECEIVERS PER THOUSAND

POPULATION 110.0 137.0 131.0 245.3 192.2TV RECEIVERS PER THOUSAND

POPULATION 3.0 30.0 38.0 84.2 118.5NEWSPAPER (-DAILY GENERALINTEREST") CIRCULATION PERTHOUSAND POPULATION .. 124.0 96.0 63.3 93.0

CINEMA ANNUAL ATTENDANCE PER CAPITA .. .. .. .. 5.7

LABOR FORCETOTAL LABOR FORCE (THOUSANDS) 3187.8 3909.3 4980.4

FEHALE (PERCENT) 21.0 20.7 23.9 22.2 30.4ArRICULTURE (PERCENT) 53.0 45.0 39.0 37.1 37.0

INDUSTRY (PERCENT) 19.0 20.0 21.0 23.5 29.3

PARTICIPATION RATE (PERCENT)TOTAL 31.3 29.1 29.2 31.5 40.9

MALE 49.2 45.8 45.3 48.9 55.9FEMALE 13.2 12.1 12.8 14.0 26.2

ECONOMIC DEPENDENCY RATIO 1.5 1.7 1.6 1.4 1.0

INCOME DISTRIBUTIONPERCENT OF PRIVATE INCOMERECEIVED BY

HIGHEST 5 PERCENT OF HOUSEHOLDS 39.0/i ..

HIGHEST 20 PERCENT OF HOUSEHOLDS 64.4/i 61.0/h .IOWEST 20 PERCENT OP HOUSEHOLDS 2.5Li 1.9/hLOWEST 40 PERCENT OF HOUSEHOLDS 8.0/Li 7.0/h

POVERTY TARGET GROUPSESTIMATED ABSOLUTE POVERTY INCOMELEVEL (USS PER CAPITA)

URBAN .. .. 235.0RURAL .. .. 180.0 190.8

ESTIMATED RELATIVE POVERTY INCOMELEVEL (USS PER CAPITA)

URBAN .. .. 293.0 474.0RURAL .. .. 200.0 332.5 385.8

ESTIMATED POPULATION BELOW POVERTYINCOME LEVEL (PERCENT)

URBAN .. .. 49.0RURAL .. ..

HNo availableNot applicable.

NOTES

/a The group averages for each indicator are population-ieighted arithmetic means. Coverage of countriesamong the indicators depends on availability of data and is not uniform.

/b Unless otherwise noted, data for 1960 refer to any year between 1959 and 1961; for 1970 between 1969

and 1971; and for Most Recent Estimte, between 1974 and 1978.

/c 1956-61; /d 1960-65; /e 1970-75; /f 1964; 1962; /h 1972; Li Personal income vithin laborforce.

April, 1980

- 20 - ANNEX I-~~~~~~ ~~Page 3 of 5

OtNiOTlpioN OF socIAL INPICATORS

Nots ii Aboh1

1 h ab dat- t dra'e from souce geneall u Itthe moa a-tiattead reial.t hul at lie noted chat clyma o beine-nscuochlyccsaoablrbecaus of th lack f stanardise defintions nd conepts ued by itiaret counbiesiil coil cotog he dat. The entate note

tIl halu,uei ootiaodr ofsg I -Pe, Indct trend,b an o-f,aracetiecena . .ajor dlfecehe ben-e. counitgiIes. I. .Il V

of th oiotcuty(ecp on"aia Ilopius Oil 1lpote`' 9t-pnhr "Middle Incom Norh Ott ica end Middle tan'iE becbeas fsrne

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forc- t ra,mre af.itisgadnso o c .ATo; 1977 dana 'male r. femalt graduate Atre,po cltre,olassatote

Gil' PER CgPITu 10511 - GNP per capita esimates sttures aket po-, .Is- ore,ad-ualdil y the it ..pei. nubrofhsit bdcu1aned by sn conerlo mehod aa hand isic Atlas (1976-7t basis); 1960 -oaabe t poblc and pricaim ge _ts an pnid P hasPita' end iY, ard170 dat. n_iitiorant '.fopnlat e .a.lsmen yer. nnn tdtf

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POIU-T~~~~.N AND "TAI, STATISTIUS -bet incude IjO totctfa gete-s ord oP-cli-ed boapftal, en _rra

cmyousiimid-beat lailtona -. A. of Joly 1; t9il, 1970, and 19708 dlsootrhsla e oa ubnc dlsooro discharges

data. Ironb. .-. pp..t.; - hos1

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aiciested on the basis P of l ice P ' pro .c...larc..io ic_s ofteppHton piu obo-uappltos notIy ohor chlde age iIl

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pp41

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- 23 -

ANNEX IIPage 1 of 5

THE STATUS OF BANK GROUP OPERATIONS IN PERU

A. STATEMENT OF BANK LOANS (as at April 30, 1980)--- US$ million ---

AmountLoan (less cancellations)Number Year Borrower Purpose Bank Undisbursed

25 loans fully disbursed 268.2

949 1973 Republic of Peru Education 24.0 12.91025 1974 Republic of Peru Roads 26.0 0.81196 1976 Republic of Peru Transport 76.5 59.01215 1976 Republic of Peru Power 36.0 15.31281 1976 CENTROMIN Mining 39.7 33.41283 1976 Banco Vivienda Urban Dev. 21.6 17.51358 1977 COFIDE Industry 35.0 21.41403 1977 Republic of Peru Agriculture 25.0 24.8S-11 1978 Republic of Peru Preinvestment 8.8 6.01693 1979 Republic of Peru Program Loan 115.0 38.21771 1979 Republic of Peru Irrigation 56.0 56.01806 1/ 1980 Petroleos del Peru Petroleum Prod. 32.5 32.51812 1/ 1980 Republic of Peru Rural Dev. 15.0 15.0

Total 779.3 332.8of which has been repaid 149.4

Total now outstanding 629.9

Amount sold 18.3of which has been repaid 18.3 -

Total now held by Bank 629.9

Total undisbursed 332.8

1/ Signed, but not effective

- 24 -

ANNEX IIPage 2 of 5

B. STATEMENT OF IFC INVESTMENTS (as at April 30, 1980)

Type of Amount in US$ millionYear Obligor Business Loan Equity Total

1960 Industrias Reunidas, S.A. Home Appliances 0.3 0.3

1960 Luren S.A. andLadrillos Calcareos, S.A. Bricks 0.3 0.3

1960 Durisol del Peru, S.A. BuildingMaterials 0.3 0.3

1960;1962 Fertilizantes Sinteticos, S.A. Fertilizers 4.1 4.1

1962;1968 Cemento Andino. S.A. Cement 2.2 0.2 2.4

1964;1967 Cia. de Cemento Pacasmayo Cement 1.1 0.5 1.6

1975 Southern Peru Copper Corp. Mining 15.0 15.0

1978 Cia. de Minas Buenaventura Mining 2.0 0.5 2.5

1980 Cia. Minera San Ignaciode Morococha, S.A. Mining 2.7 0.5 3.2

Total gross commitments 28.0 1.7 29.7less cancellations, terminations,repayments and sales 12.1 0.4 12.5

Total commitments now held by IFC 15.9 1.3 17.2

Total undisbursed 2.7 0.5 3.2

-25 -

ANNEX IIPage 3 of 5

C. PROJECTS IN EXECUTION 1/

Loan 949-PE: Education Project; US$24.0 million Loan of December 5, 1973;Effective Date: March 5. 1974; Closing Date: June 30, 1981.

The project has experienced serious difficulties and is now about40 months behind schedule. In the first 3-1/2 years after effectiveness,there was little progress owing to delays in establishing and staffing the

project unit, weaknesses in the unit itself and a long delay in adopting the

educational reform which was to determine curricula. This last difficulty was

resolved with the reform's implementation in 1977, but project execution was

still hampered by weaknesses in the project unit and cumbersome bureau-cratic procedures. In order to resolve these problems, the project has been

modified to reduce its scope, increase the Bank disbursement percentage,create a revolving fund and improve administrative procedures (see President's

memorandum R79-59 of March 27, 1979). As a result, the pace of project

execution has improved noticeably in recent months and disbursements now stand

at about US$10.7 million.

Loan 1025-PE: Sixth Highway Project; US$25.0 million Loan of July 1, 1974;Effective Date: August 21. 1974; Closing Date: June 30. 1980.

Loan 1025-PE finances improvement of the Lima-Pucallpa highway which

connects the Amazon basin to the Pacific Coast. In view of the unusuallydifficult terrain and limited government implementation capacity, the works

was divided into two stages which are financed by separate loans, 1025-PE and

1196-PE (see below). Because of initial delays and substantial cost increases,

the scope of the project was reduced in February 1978 (see President's Memo-

randum R78-360 of February 17, 1978) and the Closing Date postponed. Construc-

tion is now well advanced and should be completed this year; however, theClosing Date is being extended to permit the completion of studies beingdone under the project.

Loan 1196-PE: Lima-Amazon Transport Corridor Project: US$76.5 million Loan of

May 27, 1976; Effective Date: August 18, 1976; Closing Date:

December 31, 1982.

The project's river ports component has progressed slowly because

of technical problems which delayed completion of design, but it is now under

construction, although with some cost increases. There have been serious

delays in contracting for civil works under the road component because of

slow procedures and limited government implementation capacity. These

problems now appear to be largely overcome and construction is beginning on

most project components. The project has been modified so as to increase the

1/ These notes are designed to inform the Executive Directors regarding theprogress of projects in execution, and in particular to report anyproblems which are being encountered, and the action being taken toremedy them. They should be read in this sense, and with the understand-

ing that they do not purport to present a balanced evaluation of strengthsand weaknesses in project execution.

- 26 -

ANNEX IIPage 4 of 5

financing for urgently needed road maintenance and elimine a improvement ofthose road sections which cannot be completed within a reasonable time(see President's memorandum R79-88 of April 27, 1979).

Loan 1215-PE: Fifth Power Project; US$36.0 million Loan of September 20, 1979;Effective Date: November 18, 1976; Closing Date: December 31,1981.

The slowdown of demand in ELECTROLIMA's market in the wake of therecent economic difficulties, as well as procurement problems, have delayedthe project's power distribution component and completion is expectedabout a year behind schedule. Serious delays were also experienced ingetting the technical assistance program of the loan underway; however, someconsultants have now been retained, and with strong support from the currentstaff in the Ministry of Energy the program has begun to progress normally.Because of the delays, the closing date has been extended.

Loan 1283-PE: Urban Sites and Services Development Project; US$21.6 millionLoan of October 12, 1976; Effective Date: January 10, 1977;Closing Date: December 31, 1982.

Administrative difficulties, particularly the need to reconcilePeruvian procedures with Bank guidelines for procurement, have delayed theproject by about one year. Most design work has now been completed andconstruction of road components is underway. Because of past delays, however,the closing date has been extended.

Loan 1281-PE: CENTROMIN Mining Project; US$40.0 million Loan of December 61976; Effective Date: May 24, 1977; Closing Date: December 31,1982.

Initiation of the copper mining component, which the IDB is co-financing with the Bank and which amounts to about 90 percent of total projectcosts, has been delayed by about two years because of the lack of local counter-part funds. The Government is now proceeding with the project with supportfrom a supplementary IDB loan which will help cover part of the financingshortfall. Engineering, procurement and mine development activities on thispart of the project are well advanced. Construction of the mine-water treatmentplant has also experienced some delays but is now advancing satisfactorily.

Loan 1358-PE: Industrial Credit Project; US$35.0 million Loan of January 28,1977; Effective Date: March 30, 1977; Closing Date: June 30,1981.

Peru's economic recession led to a contraction of investmentand to lower than anticipated demand for the loan. In view of this, theBorrower--the National Development Bank (COFIDE)--has agreed to financeprojects identified by commercial banks and other financial institutions,

- 27 -

ANNEX IIPage 5 of 5

which would also guarantee these loans and provide some loar servicing.With this action and improving economic conditions over the past year,demand for the credit line has increased and it is now over 70 percentcommitted, with full commitment expected by December 1980.

Loan 1403-PE: Irrigation Rehabilitation Project; US$25.0 million Loan ofMay 20, 1977; Effective Date: August 2. 1977; Closing Date:June 30, 1983.

DEPERTC, the executing agency, has completed the design for civilworks in two of the six valleys where irrigation systems are to be improvedand construction has started. The project's implementation is behind schedulebut is expected to catch up over the next 12-18 months as constructionproceeds.

Loan S-11: Water Supply and Power Engineering Project; US$8.8 million Loanof December 22. 1978; Effective Date: June 27, 1979; ClosingDate: December 31, 1981.

Consultant's studies have commenced and are proceeding on schedule.

Loan 1693-PE: Program Loan; US$115 million Loan of May 17, 1979; EffectiveDate: May 24, 1979; Closing Date: June 30, 1980.

The economic recovery program supported by the program loan is pro-ceeding in a generally satisfactory manner. Because of better than expectedexport performance, Peru' foreign exchange constraint was relaxed resulting inan initial lag in disbursements of the program loan. Disbursements began topick-up markedly in September 1979, however, and stood at US$109.6 million asof May 31, 1980. The Closing Date is being extended to December 31, 1980 inorder to permit completion of the technical assistance component of the Loan.

Loan 1771-PE: Lower Piura Irrigation Rehabilitation Project; US$56 millionLoan of February 4, 1980; Effective Date: May 28, 1980:Closing Date: December 31, 1985.

Project execution is now getting underway.

Loan 1806-PE: Petroleum Rehabilitation Project; US$32.5 million Loan of-' March 11, 1980; Effective Date:

Closing Date: January 31, 1983.

This loan was signed April 28, 1980. The conditions of effectivenessfor the loan are in the process of being satisfied.

Loan 1812-PE: Puno Rural Development; US$15 million loan of March 18, 1980;Effective Date: ; Closing Date:June 30, 1985.

This loan was signed April 28, 1980. The conditions of effectivenessfor the loan are in the process of being satisfied.

- 28 -

ANNEX IIIPage 1 of 1

PERU

SIDERPERU PROJECT MANAGEMENT AND TECHNICAL ASSISTANCE PROJECT

SUPPLEMENTARY PROJECT DATA SHEET

SECTION I: TIMETABLE OF KEY EVENTS

(a) Time taken by the country to prepare project: Nine months

(b) Project prepared by: SIDERPERU and the Bank

(c) First presentation to the Bank and first Bank mission to considerproject: July 1979

(d) Departure of Appraisal Mission: April 1980

(e) Completion of Negotiations: June 13, 1980

(f) Planned Date of Effectiveness: August 1980

SECTION II: SPECIAL BANK IMPLEMENTATION ACTIONS

None

SECTION III: SPECIAL CONDITIONS

It has been agreed that:

(a) (i) the qualifications, terms of reference and conditions of employ-ment of all consultants would have to be acceptable to the Bank;(ii) the Bank would be advised in advance of the criteria proposedto be used for selection of consultants; and (iii) consultants forthe project management and studies' components would be appointedby September 30, 1980 and those for operational assistance andtraining would be appointed by December 31, 1980 (para 64); and

(b) after completion of the feasibility study and before a decisionis taken on whether to go ahead with Stage II, the Governmentand SIDERPERU would provide the Bank with a reasonable opportunityto exchange views thereon (para 64); and

(c) the Bank would have the right to suspend loan disbursements ifSIDERPERU ceases carrying out the Stage I expansion (para 64).

IBRD 15061

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