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Peru Macroeconomic Imbalance: Domestic and External
Whatever the promises and the costs of the many kinds
of
reform attempted by the Velasco government, the ship sank
because
of inadequate attention to balances between spending and
productive capacity, and between export incentives and
import
demand. The Velasco government inherited recessionary
conditions
in 1968, with a positive external balance and productive
capacity
readily available for expansion. It maintained effective
restraint on spending and deficits for several years but
then let
things get out of control. The central government's
deficit was
no more than 1 percent of gross national product
(GNP--see Glossary)
in 1970, but its own deficit plus that of the
greatly
expanded group of state firms reached 10 percent of GNP by
1975.
Correspondingly, the external current-account balance was
positive in the period 1968-70 but showed a deficit equal
to 10
percent of GNP by 1975.
The external deficit was driven up primarily by high
rates of
growth of domestic demand and production through 1974. But
in
addition, the government's policy of holding to a fixed
nominal
exchange rate, in an increasingly inflationary context,
allowed
the real exchange rate to fall steadily from 1969 to 1975.
The
government refused to consider devaluation for fear it
would
worsen inflation and managed to avoid it by borrowing
abroad to
finance the continuing deficit. By 1975 external creditors
had
lost confidence in Peru's ability to repay its debts and
began to
put on the brakes. Whether because of such external
pressure or
because of growing internal opposition to the increasingly
arbitrary decisions of the government, the Peruvian
military
decided to replace Velasco in 1975. The experiment ended
on a
note of defeat, not so much of its objectives as of its
methods.
Data as of September 1992
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