FOR OFFICIAL USE ONLY Report No: PD000018 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT FOR A PROPOSED LOAN IN THE AMOUNT OF US$500 MILLION TO THE REPUBLIC OF PERU FOR THE PERU FIRST FISCAL POLICY AND SUSTAINABLE GROWTH DPF-DDO July 15, 2024 Macroeconomics, Trade and Investment Global Practice Finance, Competitiveness and Innovation Global Practice Latin America And Caribbean This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) Republic of Peru GOVERNMENT FISCAL YEAR January 1 – December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as of July 15, 2024) Peruvian Soles (PEN) 3.80 = United States Dollars US$1.00 ABBREVIATIONS AND ACRONYMS AM Accountability Mechanism IFC International Finance Corporation ASA Advisory Services and Analytics IMF International Monetary Fund Instituto Nacional de Defensa de la BCRP Central Reserve Bank of Peru INDECOPI Competencia y de la Protección de la Propiedad Intelectual Country Climate and Development CCDR LAC Latin America and Caribbean Report Peru’s bank-owned clearinghouse for CCE MEF Ministry of Economy and Finance credit transfers CIT Corporate Income Tax MFD Maximizing Finance for Development Consejo Nacional de Ciencia, CONCYTEC MSME Micro, Small and Medium Enterprise Tecnología e Innovación Tecnológica CPF Country Partnership Framework MINAM Ministry of Environment GDP Gross Domestic Product MMF Multiannual Macroeconomic Framework DDO Deferred Drawdown Option NDC Nationally determined contributions General Directorate of the Public Organisation for Economic Co-operation DGTP OECD Treasury and Development Specialized project preparation and DPF Development Policy Financing OEGEP implementation departments ESG Environmental Social and Governance PA Prior action EU European Union PCE Private Capital Enabling EU regulation on deforestation-free EUDR PEDN Strategic Plan for National Development products FAO Food and Agriculture Organization PFM Public Financial Management Register of Agricultural Producers and their Organizations in the Value Chains FCL Flexible Credit Line PPA (Padrón de Productores Agrarios y sus Organizaciones en las Cadenas de Valor) Fondo Nacional de Financiamiento de FONAFE PPP Public-Private Partnership la Actividad Empresarial FOREX Foreign Exchange SCD Systematic Country Diagnostic Swiss State Secretariat for Economic FRS Fiscal Risk Statements SECO Affairs GFR Green Finance Roadmap SIAF Financial Management System National Science, Technology, and GoP Government of Peru SINACTI Innovation System GRS Grievance Redress Service SOE State-owned enterprise HLO High Level Outcomes STI Science, technology, and innovation International Bank for Reconstruction Superintendencia Nacional de Aduanas y IBRD SUNAT and Development de Administración Tributaria IADB Inter-American Development Bank WB World Bank WBG World Bank Group Regional Vice President: Carlos Felipe Jaramillo Regional Director: Oscar Calvo-Gonzalez Country Director: Issam A. Abousleiman Practice Manager: Doerte Doemeland, Yira Mascaró Task Team Leaders: Bledi Celiku, Thomas Haven REPUBLIC OF PERU Peru First Fiscal Policy and Sustainable Growth DPF-DDO TABLE OF CONTENTS SUMMARY OF PROPOSED FINANCING AND PROGRAM .......................................................................1 1. INTRODUCTION AND COUNTRY CONTEXT ...................................................................................3 2. MACROECONOMIC POLICY FRAMEWORK....................................................................................5 2.1. RECENT ECONOMIC DEVELOPMENTS ............................................................................................ 5 2.2. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY........................................................... 9 2.3. IMF RELATIONS ............................................................................................................................ 10 3. GOVERNMENT PROGRAM ........................................................................................................ 11 4. PROPOSED OPERATION ............................................................................................................ 12 4.1. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION........................................... 12 4.2. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS................................................... 12 4.3. LINK TO CPF, OTHER BANK OPERATIONS AND THE WBG STRATEGY .......................................... 26 4.4. CONSULTATIONS AND COLLABORATION WITH DEVELOPMENT PARTNERS ............................... 26 5. OTHER DESIGN AND APPRAISAL ISSUES .................................................................................... 26 5.1. POVERTY AND SOCIAL IMPACT .................................................................................................... 26 5.2. ENVIRONMENTAL, FORESTS, AND OTHER NATURAL RESOURCE ASPECTS ................................. 27 5.3. PFM, BUDGET, AND FOREX ASPECTS ........................................................................................... 27 5.4. MONITORING, EVALUATION AND ACCOUNTABILITY .................................................................. 29 6. SUMMARY OF RISKS AND MITIGATION ..................................................................................... 29 ANNEX 1: POLICY AND RESULTS MATRIX ........................................................................................ 31 ANNEX 2: FUND RELATIONS ANNEX ................................................................................................ 36 ANNEX 3: LETTER OF DEVELOPMENT POLICY................................................................................... 39 ANNEX 4: ENVIRONMENT AND POVERTY/SOCIAL ANALYSIS TABLE ................................................ 48 ANNEX 5: PARIS ALIGNMENT ASSESSMENT TABLE .......................................................................... 50 The Peru Fiscal Policy and Growth Loan was prepared by an International Bank for Reconstruction and Development (IBRD) team led by Bledi Celiku (Senior Economist, ELCMU) and Thomas Haven (Senior Private Sector Specialist, ELCFN); and consisting of Tanja Goodwin (Senior Country Economist, ELCDR), Fausto Andres Patiño (Economist, ELCMU), Nelly Ikeda (Senior Financial Management Specialist, ELCG1), Kevin McCall (Senior Environmental Specialist, SLCEN), Mark Christian Sigrist (Senior Counsel, LEGLE), Mellany Pintado (Senior Economist, EMFMD), Diego Rivetti (Senior Debt Specialist, EMFMD), Rodrigo Silveira Veiga Cabral (Senior Financial Officer, TRECI), Maria de Gracia Vizeu (ET Consultant, SLCEN), Lorena Meco (Program Officer, IPGPQ), Alvaro Enrique Quijandria (Consultant, CASPU, IFC), Ana Maria Torres (Senior Operations Officer, CASAE, IFC), John Martin Wilson (Senior Operations Officer, CF1UA, IFC), Samantha Jane Cook (Senior Financial Specialist, ELCFN), Claudia Lucia Vargas (Public Sector Specialist, EMFTX), Xingjun Ye (Governance Specialist, ELCG2), Graciela Miralles Murciego (Senior Economist, ETIMT), Guillermo Arenas (Economist, ETIRI), Roberto Echandi (Senior Trade Specialist, ETIRI), Douglas Randall (Senior Financial Sector Specialist, ELCFN), Juan Jose Miranda Montero (Senior Environmental Economist, SLCEN), Soulange Fatima Gramegna (Consultant, ETIMT), Francisco Javier Arias (Senior Economist, EMFTX), Maria Virginia Hormazabal (Finance Officer, WFACS), Eliana Carolina Rubiano (Senior Economist, ELCPV), Martin Carbajal Vega (Consultant, ELCPV), Griselle Felicita Vega (Senior Agriculture Specialist, SLCAG), Gonzalo Martinez Torres (Senior Financial Sector Specialist, EFNLT), Paola Buitrago Hernandez (Economist, ELCPV), Daniela Gayraud (Operations Analyst, SLCEN), Aurelie Rossignol (Senior Environmental Specialist, SLCEN), Jiang Ru (Senior Environmental Specialist, SLCEN), Laura Higuera Ardila (Environmental Specialist, SLCEN), and Anjali Kishore Shahani (Operations Officer, ELCMU), Daria Yurlova (ET Consultant, IPGPP), Shyamala Shukla (Senior Public Private Partnerships Specialist, IPGPP), Luisa Yesquen (Program Assistant, LCCC6C), Benjamin Vuilleminroy (Program Assistant, ELCMU), Douglas J. Graham (ET Consultant, LAC ENR PM) and Afua Ayew Entsuah (Consultant, IPGPP). The following colleagues provided useful comments and insights to inform the design of the project: Ana Maria Aviles (Program Leader, ELCDR), Florian Michael Blum (Senior Economist, EECM2), Richard Record (Lead Country Economist and EFI Program Leader, EECDR), and Stefka Slavova (Lead Economist EECF2). The operation was prepared under the overall guidance of Issam A. Abousleiman (Country Director, LCC6C), Oscar Calvo-Gonzalez (Regional Director, ELCDR), Doerte Doemeland (Practice Manager, ELCMU) and Yira Mascaro (Practice Manager, ELCFN). @#&OPS~Doctype~OPS^dynamics@paddpfbasicinformation#doctemplate SUMMARY OF PROPOSED FINANCING AND PROGRAM BASIC INFORMATION Operation ID Programmatic If programmatic, position in series P180554 Yes 1st in a series of 2 Proposed Development Objective(s) The Program Development Objective is to support Government reforms to a) strengthen fiscal management, and b) foster a more productive and greener economy. @#&OPS~Doctype~OPS^dynamics@padborrower#doctemplate Organizations Borrower: Republic of Peru Implementing Agency: Ministry of Economy and Finance @#&OPS~Doctype~OPS^dynamics@padfinancingsummary#doctemplate PROJECT FINANCING DATA (US$, Millions) Maximizing Finance for Development Is this an MFD-Enabling Project (MFD-EP)? Yes Is this project Private Capital Enabling (PCE)? Yes SUMMARY Total Financing 500.00 DETAILS World Bank Group Financing International Bank for Reconstruction and Development (IBRD) 500.00 @#&OPS~Doctype~OPS^dynamics@padclimatechange#doctemplate PRACTICE AREA(S) Practice Area (Lead) Contributing Practice Areas Macroeconomics, Trade and Investment Finance, Competitiveness and Innovation 1 CLIMATE Climate Change and Disaster Screening Yes, it has been screened and the results are discussed in the Operation Document @#&OPS~Doctype~OPS^dynamics@padoverallrisk#doctemplate OVERALL RISK RATING Overall Risk ⚫ Moderate RESULTS Indicator Name Baseline Target Pillar A: Strengthen fiscal management Results Indicator 1: Share of technical Fiscal Council staff that are 0 (2023) 100 (2026) incorporated in the Civil Service regime (percent). Results Indicator 2: Share of SOEs under FONAFE with an assigned risk 0 (2024) 100 (2026) rating informing the Fiscal Risk Statement (percent). Results Indicator 3a: Corporate income taxpayers with a tax compliance 0 (2024) 1.2 million (2026) profile (number) Results Indicator 3b: SUNAT identifies and publishes companies that are No (2024) Yes (2026) “subjects without operational capacity”. Results Indicator 3c: Revenues from VAT for digital services/products from 0 (2023) 0.1 (2026) foreign suppliers (percent of GDP). Results Indicator 4: PPP project preparation time in planning and 18 (2024) 11 (2026) formulation stages (months). Pillar B: Foster a more productive and greener economy Results Indicator 5: Share of regional governments that have an 0 (2024) 25 (2026) operational STI unit (percent). Results Indicator 6: Increase in number of anticompetitive practices 0 (2024) 30 (2026) eliminated (percent). Results Indicator 7. Population using digital payments (adults ages 15+) 12.4 million (2021) 16.0 million (2026) (number) Results Indicator 8: Financial sector assets that are green according to the 0 (2024) USD 7.4 billion (2026) Green Taxonomy (USD). Results Indicator 9: Producers registered in the PPA that are geolocated 1,800,000, of which 30% are 0 (2024) with a verified location, % of which women (number). women (2026) 2 IBRD PROGRAM DOCUMENT FOR A PROPOSED LOAN TO THE REPUBLIC OF PERU 1. INTRODUCTION AND COUNTRY CONTEXT 1. The proposed First Fiscal Policy and Sustainable Growth Development Policy Financing with a Deferred Drawdown Option (DPF-DDO) supports reforms to strengthen fiscal management and foster a more productive and greener economy. It advances development areas that are prioritized in the Peru Country Partnership Framework (CPF) objectives and the Systematic Country Diagnostic (SCD) Update High Level Outcomes (HLOs).1 Reforms supported by this operation benefit from broad policy consensus, are aligned with the government’s strategic plans and help advance Peru’s OECD accession.2 This DPF-DDO complements the World Bank Group’s (WBG) ongoing and pipeline program of investment projects, particularly in innovation. It has been closely coordinated with the IFC and builds on the WBG’s longstanding policy dialogue and technical assistance with the Government of Peru. Finally, in the context of high uncertainty and financial market volatility, the authorities value the DDO instrument as an important part of their debt management strategy and a hedge against increasing global interest rates and international capital markets’ volatility, and climate shocks. The proposed loan of US$500 million is the first in a programmatic series of two DPFs. 2. Peru’s overall living standards have significantly improved over the last two decades, but its historically low labor productivity has prevented it from significantly closing the income gaps with advanced economies. From 2000, to 2019, Peru’s economy more than quadrupled, with annual real GDP growth averaging 5 percent. This strong growth contributed to a substantial reduction in poverty rates from 59 percent in 2013 to 20 percent in 2019. The middle class more than doubled, growing from 14 percent to 34 percent over the same period3. Despite these achievements, Peru’s labor productivity remained stagnant at only 20 percent of that of the US (OECD 2019).4 The average firm in Peru is only 5 percent as productive as the global productivity frontier. Peru also remains the most unequal country of Latin America in terms of territorial income gap between the richest and the poorest region. For all Peruvians to achieve the OECD standards of well-being, structural reforms are essential. These reforms should focus on significantly increasing the number of formal, well-paid jobs, generating sufficient fiscal revenues, and using these revenues to provide high-quality public services that reduce spatial disparities while accelerating overall growth. Achieving this vision requires fostering a dynamic business environment driven by innovation, competition, regional integration, and well-managed natural resources. 3. Peru has a history of strong macroeconomic policies but improvements in fiscal management are critical in the context of low growth and increasing social demands. Peru has one of the lowest debt-to-GDP ratios, lowest sovereign bond spreads, and most favorable access to international capital markets in the region. However, the slowdown in economic growth and rising social demands are putting a greater pressure on fiscal management. Peru waived its fiscal rule between 2020 and 2022 to enable greater emergency spending. In 2023, it missed the fiscal rule target by 0.4 percentage points. In addition, fiscal risks from state-owned enterprises (SOEs) are on the rise and government transfers to SOEs, particularly for PetroPeru5, have significantly increased since 2022. Despite significant spending on infrastructure, progress on closing Peru’s infrastructure gap has been limited. Confidence in Peru’s re-adherence to its fiscal rule is important for the country’s sovereign risk, financing costs, and private investment. This will require reforms to strengthen the credibility and transparency of fiscal policy and the implementation of fiscal consolidation over the medium term. 1 Specifically progress will be made on all three HLOs of the 2022 SCD Update and CPF objectives 1-5. 2 The reforms contribute to the OECD Accession Core Principles for Peru. In particular, PAs 3-6, 8 and 9 support policy actions prioritized by the government to address OECD recommendations. 3 Based on the middle-class definition of living with a daily income between US$14 and US$81 (2017 PPP). Peru Poverty and Equity Assessment (2023). 4Defined as the top 25 percent of firms in the United States. World Bank 2015. Peru. Building on Success. Boosting Productivity for Faster Growth. 5 PetroPeru accounts for 26 percent of total assets and 25 percent of total liabilities from the central government financial and non-financial SOEs. Since losing access to its credit lines Petroperu received support by the central government of US$2.3 billion or almost 1 percent of GDP. In addition, on Feb 27th, the government published an emergency decree granting financial support to PetroPeru mainly as one-year guarantees for up to US$800 million to back up a trade-related facility from Banco de la Nación to secure oil supply for the company. 3 4. Low growth, though exacerbated in recent years by a series of exogenous shocks, is also the result of declining productivity growth linked to low investment in research and development (R&D) and innovation, as well as barriers to competition among firms, limited dynamism in the financial services markets, and cross-cutting institutional challenges. Between 2002 and 2020, spending on R&D was just 0.1 percent of GDP in Peru, well below the average of 0.7 percent for LAC and 1.2 percent for upper-middle-income countries (2022 SCD Update). To unleash this innovation potential, sound public policies and support mechanisms are essential. However, Peru’s National Science, Technology, and Innovation System (SINACTI) faces significant shortcomings. A public expenditure review of innovation programs revealed overlapping instruments and poor governance.6 In addition, significant shortfalls persist in the competition regulatory framework, although recent empirical evidence for Peru indicates that improvements in competition policy can significantly impact innovation and productivity growth. Moreover, competitive and diversified financial systems are a key enabler of sustainable growth but Peru’s financial sector lacks contestability and nearly half of Peruvians adults remain financially excluded.7 Finally, given Peru’s high exposure to climate change and related disasters, the economy needs to adapt better to maintain competitiveness, and access green growth opportunities. This is particularly important for the competitiveness of agriculture value chains, which face challenges in accessing productivity-enhancing public services and must adjust to international regulations mandating deforestation-free production. 5. Climate risks and natural hazards expose Peru to severe economic and welfare losses, threatening its development and sustainable growth. The country faces earthquakes, landslides, droughts, and floods, causing annual asset losses of 2 percent of GDP and welfare losses of 5.2 percent. Peru's economic structure and reliance on agriculture and fisheries exports heighten its climate vulnerabilities. The agriculture sector can no longer depend on deforestation in a decarbonizing world. Water supply from glacier melts is expected to significantly reduce by 2030, and more frequent droughts, floods, frost, and cold waves will heavily impact agriculture. Climate change is also expected to intensify El Niño events, increasing flooding, landslides, and agricultural disruptions, affecting livelihoods, infrastructure, and ecosystems. These impacts negatively affect the economy's tax and productive structures. Climate change will disproportionately affect the poor, as agriculture employs 56 percent of household heads living in poverty. Peru’s Country Climate Development Report (CCDR) outlines opportunities in developing and implementing climate policies to innovate, increase productivity, and reduce poverty.8 6. Despite the current political volatility, the Government of Peru (GoP) remains committed to reforms aimed at boosting sustainable growth and productivity while maintaining fiscal prudence, anchoring its efforts in the OECD accession process. The country’s Strategic Plan for National Development (PEDN 2050), launched in September 2023, with a 2050 horizon aims at achieving sustainable development, boosting productivity, competitiveness, and innovation, fostering science and technology, and implementing measures to tackle climate change. In June 2022, the OECD Council adopted an individual Accession Roadmap for Peru, setting out the terms, conditions, and process for accession. In June 2023, Peru submitted an Initial Memorandum which provided a first self-assessment of the alignment of Peru’s legislation, policies, and practices with OECD standards. While there is currently a lack of political consensus around reforms to make the labor market more flexible, reduce informality, address regulatory uncertainty, and make the tax system more growth friendly, the OECD accession benefits from broad popular support. The government’s commitment to the OECD accession process is expected to provide a clear roadmap for ambitious structural reforms to boost sustainable growth and strengthen institutions. 7. In this context, this DPF supports policies and institutions to strengthen fiscal management and foster a more productive and greener economy. Pillar A supports reforms to strengthen fiscal management by safeguarding the independence and effectiveness of the fiscal council, enhancing monitoring and management of fiscal risks, addressing tax evasion, and accelerating the preparation of PPPs (Public Private Partnerships) to improve the efficiency of infrastructure spending. An independent and effective fiscal council can help promote fiscal responsibility and sustainable public finance by assessing, monitoring, and publishing information about the consistency and sustainability of fiscal 6 https://proyectofortalecimientodelsinacti.prociencia.gob.pe/gasto-publico/ 7 World Bank’s Global Findex survey. 8 World Bank Group. 2022. Peru Country Climate and Development Report. CCDR Series. http://hdl.handle.net/10986/38251 4 The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) policy. Strengthening fiscal risks management of SOEs will improve the efficiency of public spending, promote fiscal sustainability, and help safeguard fiscal buffers. Combating tax evasion is critical for tax collection and tax fairness, especially in a country – like Peru- with a very large informal sector. Making Peru’s PPP framework much more efficient is critical to making progress in closing the infrastructure gap in a fiscally constrained environment. Pillar B fosters a more productive and greener economy by strengthening Peru’s innovation system, enhancing the competition framework, promoting digital transformation, supporting the Green Finance Roadmap for Peru and Green Taxonomy, and improving the competitiveness of agricultural value chains.9 Strengthening the national innovation system would help mobilize more financing for innovation and ensure that public innovation resources are spent efficiently. A reinforced anticartel policy would facilitate robust and enforceable actions against anti-competitive practices. Allowing non-bank e-money issuers to participate in retail payments’ infrastructure will remove anti-competitive barriers in the digital financial services ecosystem, boosting market contestability, enabling innovations in product design that promote digital transformation. Better provision and targeting of agricultural support services for all producers will improve the competitiveness of agricultural value chains and promote deforestation-free production. 2. MACROECONOMIC POLICY FRAMEWORK 2.1. RECENT ECONOMIC DEVELOPMENTS 8. In 2023, real GDP contracted by 0.6 percent, impacted by the combination of adverse weather, social unrest, and faltering business confidence. The El Niño weather pattern, coupled with road blockades, significantly disrupted production in several regions, particularly affecting agriculture, fishing, and critical manufacturing sectors. In contrast, the mining sector expanded by 9.5 percent, bolstered by the Quellaveco mine, which helped to offset the broader economic downturn. The service sector registered a marginal growth of 0.3 percent. Domestic demand witnessed a downturn, as investment decreased by 12.5 percent due to the negative impact of social and climatic disturbances on business sentiment. Consumption growth slowed to 0.1 percent (from 3.5 percent in 2022), suffering from diminished business and consumer confidence, China’s economic slowdown, domestic political instability, tighter financial conditions, and rising inflation. The labor market reflected the economic deceleration, with total employment (formal plus informal) declining by 0.9 percent. Notably, small firms reported a 3.3 percent reduction in employment. As a result, the poverty rate, defined by the US$6.85 daily income threshold, is estimated to have increased to 33.8 percent in 2023, up from 32.2 percent in 2022. 9. In 2023, Peru missed its fiscal rule target as the fiscal deficit widened to 2.8 percent of GDP. This increase meant that it surpassed the fiscal rule target of 2.4 percent of GDP by 0.4 percentage points. Government revenue declined by 2.3 percentage points of GDP compared to 2022, primarily due to a decrease in corporate income and value-added tax collections, which mirrored the downturn in economic activity. Government spending decreased by 1.1 percentage points of GDP, partially mitigating the impact of the revenue shortfall. This reduction reflected largely the phasing-out of the emergency COVID-19 relief measures, although additional spending of 0.2 percent of GDP was allocated to address the adverse effects of El Niño-related flooding. Peru’s public debt, at 32.9 percent of GDP, and sovereign bond spread (EMBIG), at 170 basis points, remained among the lowest in the region. In 2023, Moody’s revised its outlook to negative, and in April 2024, S&P Global Ratings lowered Peru’s local and foreign currency sovereign credit ratings, citing political instability as a key factor contributing to increased fiscal risks amid subdued economic activity.10 9 As outlined by Peru’s Country Climate Development Report (CCDR), developing, and implementing climate policies presents oppor tunities to innovate, increase productivity, and reduce poverty. 10 S&P Global Ratings downgraded Peru´s long-term foreign currency sovereign credit rating from BBB to BBB- and its long-term local currency rating from BBB+ to BBB. Notwithstanding, Peru still possesses among the highest ratings in Latin America. 5 10. The current account achieved a 0.6 percent surplus in 2023, a 4.6 percentage point improvement from the previous year. Subdued domestic demand contributed to a decline in imports, leading to an enlarged trade balance surplus by the end of 2023, which – together with higher remittances - helped achieve a current account surplus. The local currency appreciated by nearly 2.6 percent over the year, as the exchange rate in Peru is flexible and has remained relatively stable over the past decade. Net international reserves stood at 26.5 percent of GDP in 2023 (US$ 71 billion), down from 29.3 percent in 2022, due to increased foreign exchange sales operations by the Central Bank to mitigate exchange rate pressure arising from hikes in the US Federal Funds rate between 2022 and 2023. External debt, public and private, remained broadly stable at around 40 percent of GDP. Gross external financing needs were low at around 5 percent of GDP in 2023. 11. Year-to-year inflation consistently declined throughout the year, reaching 3.0 percent in January 2024, thus returning to the Central Bank's target band of 1-3 percent. Core inflation, which excludes food and energy prices, was recorded at 2.9 percent. Inflation expectations stabilized at 2.6 percent in the first months of 2024, supported by the Central Bank’s effectiveness in curbing inflationary pressures in 2023 and a reduction in global fuel prices. To stimulate the real sector, the Central Bank lowered its reference policy rate from 7.75 percent in August 2023 to 5.75 percent in May 2024. 12. Despite subdued economic activity, the financial sector demonstrated resilience. Credit to the private sector grew by 1.3 percent between December 2022 and 2023, with credit to families increasing by 7.1 percent. This expansion was offset by a reduction in credit to large firms (2.7 percent) and medium enterprises (13.7 percent decrease), in line with the overall decline in aggregate investment for the year. The decline in credit dollarization, which decreased from 49 percent to 22 percent between 2013 and 2022, stagnated afterwards. As of December 2023, the capital adequacy ratio was a robust 16.5 percent, well above the 8.5 percent regulator minimum, indicating a strong buffer against insolvency risks. The non-performing loan ratio in the banking sector was a moderate 4.3 percent. However, profitability in the sector declined compared to 2022, with the return on equity (ROE) decreasing by 2.7 percentage points. Table 1. Selected Economic and Financial Indicators11 2021 2022 2023 2024p 2025p 2026p 2027p Annual percentage change, unless otherwise indicated National accounts GDP at constant prices 13.4 2.7 -0.6 2.9 2.6 2.4 2.4 Private consumption 12.5 3.6 0.1 2.8 2.5 2.3 2.3 Government consumption 5.0 -0.2 3.2 2.2 2.0 2.0 1.8 Gross fixed investment 37.3 1.7 -12.5 4.9 2.8 2.8 2.8 Exports of goods and services 14.4 4.5 5.1 3.5 3.4 3.2 3.2 Imports of goods and services 25.6 4.0 -1.8 4.2 3.0 3.0 3.0 Sectoral contribution to growth Agriculture (ppts) 0.3 0.2 -0.3 0.2 0.2 0.1 0.1 Industry (ppts) 5.5 0.5 -0.4 0.9 0.7 0.7 0.7 Services (ppts) 7.5 2.0 0.1 1.6 1.6 1.6 1.6 Inflation GDP deflator 10.1 4.8 6.6 2.8 2.6 2.4 2.4 Consumer prices (average) 4.0 7.9 6.3 2.6 2.3 2.3 2.3 Selected monetary accounts Credit to private sector 4.1 4.5 1.3 3.5 5.0 5.2 5.2 Broad money (M2) -0.9 0.6 3.5 4.0 5.0 5.0 5.0 11 Cutoff date for the macro framework is May 31,2024. 6 The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) Percent of GDP, unless otherwise indicated External sector Current account balance -2.2 -4.0 0.6 -1.3 -1.2 -1.2 -1.2 (including grants) Exports (goods and services) 29.1 29.0 27.2 26.0 25.5 25.1 24.7 Imports (goods and services) 26.0 28.3 23.8 23.7 23.1 22.6 22.2 Foreign direct investment (net 2.5 4.6 1.0 2.6 2.5 2.5 2.5 inflow) Terms of trade (pct change) 13.0 -9.1 4.2 -4.8 0.7 0.1 0.1 Percent of GDP, unless otherwise indicated Debt Public debt 35.9 33.8 32.9 33.5 33.4 33.3 33.2 External 19.4 17.5 15.8 15.7 15.4 15.0 14.6 Domestic 16.5 16.3 17.1 17.8 18.0 18.3 18.6 Fiscal accounts Total revenues 25.6 27.4 24.0 24.4 24.4 24.5 24.6 Total expenditures 28.1 29.1 26.7 26.8 26.4 26.0 25.6 Overall fiscal balance -2.5 -1.7 -2.8 -2.4 -2.0 -1.5 -1.0 Memorandum items GDP per capita (In US$ Atlas 6,420 6,770 6,672 6,791 6,896 7,000 7,104 Method) Gross reserves (US$ millions, 78,495 71,883 71,033 75,606 75,911 76,235 76,574 EOP) In months of next year's 13.5 13.5 12.6 12.9 12.4 12.1 -- imports Nominal GDP (millions of soles) 878,380 945,329 1,001,860 1,057,607 1,111,463 1,165,955 1,222,557 Nominal GDP (US$ millions) 226,304 246,740 267,582 285,840 304,510 323,876 339,599 Source: Central Bank, Ministry of Finance and World Bank staff projections. Table 2. Key Fiscal Indicators (percent of GDP) 2021 2022 2023 2024P 2025P 2026P 2027P Total revenues 25.6 27.4 24.0 24.4 24.4 24.5 24.6 Tax revenue 16.3 17.2 15.1 15.3 15.4 15.4 15.5 Direct taxes 6.6 7.8 6.6 6.8 6.9 6.9 6.9 Indirect taxes 10.1 10.6 9.4 9.6 9.7 9.7 9.7 Taxes on goods and services 9.9 10.4 9.3 9.4 9.5 9.5 9.5 Taxes on international trade 0.2 0.2 0.2 0.2 0.2 0.2 0.2 Other taxes2 -0.4 -1.2 -1.0 -1.1 -1.1 -1.1 -1.1 Non-tax revenue3 9.3 10.2 8.9 9.1 9.0 9.1 9.0 Total expenditures 28.1 29.1 26.7 26.8 26.4 26.0 25.6 Current expenditures 18.6 17.5 17.2 16.9 16.6 16.2 15.8 Wages and salaries 6.2 5.9 6.2 6.3 6.3 6.3 6.3 Goods and services 6.8 6.4 6.3 6.1 6.0 5.8 5.6 Current Transfers 4.2 3.6 3.0 2.9 2.8 2.7 2.6 Interest expense 1.5 1.6 1.7 1.6 1.5 1.4 1.3 Capital expenditures 5.0 6.1 5.3 5.3 5.4 5.4 5.4 Other expenditures4 4.5 5.5 4.2 4.6 4.3 4.4 4.3 7 Overall Fiscal balance1 -2.5 -1.7 -2.8 -2.4 -2.0 -1.5 -1.0 Primary balance -1.0 -0.1 -1.1 -0.8 -0.4 -0.1 0.3 Financing 2.5 1.7 2.8 2.4 2.0 1.5 1.0 Net foreign financing 6.1 0.5 -0.2 0.4 0.1 -0.1 -0.5 Net domestic financing -3.6 1.2 2.9 2.0 1.9 1.6 1.5 of which: privatization 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Source: Central Bank, Ministry of Finance and World Bank staff projections. 1/ Non-Financial Public Sector. 2/ Includes revenues from the tax on financial transactions (ITF), the temporary tax on net assets (ITAN), among others. Negative values are due to tax refunds. 3/ Includes General Government non-tax revenue, Capital revenue and Revenues from SOE. 4/ Includes SOE expenditures. Table 3. External Financing Needs and Sources (millions of US$) 2021 2022 2023 2024P 2025P 2026P 2027P Financing requirements (US$) -8,996 -13,996 -4,287 -7,964 -8,955 -9,257 -9,766 Current account -5,068 -9,970 1,515 -3,608 -3,617 -3,751 -3,992 Medium and long-term debt amortization -3,928 -4,026 -5,802 -4,356 -5,338 -5,506 -5,773 Financing Sources (US$) 8,996 13,996 4,287 7,964 8,955 9,257 9,766 FDI and portfolio investments (net) 17,186 12,994 -1,574 2,882 5,024 -5,182 -5,434 Capital grants 0 0 0 0 0 0 0 Medium & long-term debt disbursements (excl. IMF) -10,506 -10,037 1,583 9,655 4,235 14,763 15,539 Change in reserves (- = Increase) -3,788 6,612 850 -4,573 -305 -324 -340 Net Errors and Omissions 6,105 4,427 3,427 0 0 0 0 Source: Central Bank, Ministry of Finance and World Bank staff projections. Table 4. Public and Publicly Guaranteed Debt Stock and Debt Service, 2023-26 Debt stock (end of period) Debt service 2023 2024 2025 2026 2024 2025 2026 in (% (% of million total in million US$ (% of GDP) GDP) US$ debt) Total Debt 88,067 100.0 32.9 12,569 9,938 14,329 4.4 3.3 4.4 External Debt 42,365 48.1 15.8 3,565 4,594 4,768 1.2 1.5 1.5 Credits 12,460 14.1 4.6 1,853.1 2,000.2 1,657.6 0.6 0.7 0.5 Multilateral creditors 10,231 11.6 3.8 1,401.0 1,540.1 1,213.6 0.5 0.5 0.4 Paris Club 1,225 1.4 0.5 210.5 213.3 203.9 0.1 0.1 0.1 Commercial creditors 1,004 1.1 0.4 241.6 246.9 240.0 0.1 0.1 0.1 Other creditors 0 0 0 0 0 0 0 0 0 Bonds 29,906 34.0 11.2 1,712.2 2,593.7 3,110.0 0.6 0.9 1.0 Domestic Debt 45,701 51.9 17.1 9,004 5,344 9,562 3.2 1.8 3.0 Long term 42,339.2 48.1 15.8 4,502.1 2,672.2 4,780.9 1.6 0.9 1.5 Credits 382.4 0.4 0.1 115.4 51.5 49.6 0.0 0.0 0.0 Treasury Bonds 41,956.9 47.6 15.7 4,386.7 2,620.6 4,731.3 1.5 0.9 1.5 Short term 3,361.9 3.8 1.3 - - - - - - Credits 3,361.9 3.8 1.3 - - - - - - Treasury Bills - - - - - - - - - Memo items Non-Financial Public Sector Net 60,049.0 68.2 22.4 - - - - - - Debt PPP Liabilities 193.8 0.2 0.1 - - - - - - Fuel Prices Stabilization Fund 162.9 0.2 0.1 - - - - - - Source: Central Bank and Ministry of Finance projections 8 The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) 2.2. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY 13. Peru’s GDP growth is projected at 2.9 percent for 2024, bouncing back from the previous year’s downturn. Although ongoing political uncertainty will continue to dampen consumer and business confidence, growth is expected to accelerate due to strong mining growth, as the Quellaveco and Toromocho mines reach full production capacity, and a significant recovery of non-primary sectors, including construction and non-primary manufacturing. Additionally, the agricultural and fishing sector will receive a boost as the risk of a strong El Niño weather pattern has diminished. As inflation continues to decline from more accommodating monetary policies and purchasing power of households improves, domestic consumption is expected to increase. Additionally, after a steep decline in 2023, investment is projected to rise in 2024. Economic activity is also expected to increase further due to a new pension fund withdrawal equivalent to more than 3 percent of GDP, positively impacting both private consumption and imports. Over the medium term, annual growth is projected to converge to its potential rate of around 2.4 percent, below pre-pandemic levels. This lower rate reflects Peru’s structurally low productivity growth and institutional challenges. Nevertheless, the gradual easing of monetary policy, diminished social and climate risks, and the acceleration of PPPs should support growth in domestic production and private absorption. Lastly, a boost in mining exports is expected. 14. The non-financial public sector fiscal deficit is projected to narrow to 2.4 percent in 2024, and then gradually converge to the medium-term fiscal rule target of 1 percent by 2027. Consistent with the fiscal rule, the 2024 Budget envisages a fiscal deficit of 2 percent to GDP. However, the specific measures to achieve this target have not yet been announced, and the budget’s growth projections for estimating government revenues were optimistic, as highlighted by the MEF’s Multiannual Macroeconomic Framework (MMF) 2024-2027.12 The budget also accounts for improved budget execution by subnational governments, and capital expenditures associated with investment in education, health, and transport infrastructure. The fiscal deficit is projected to decrease to around 2.4 percent in 2024, though it remains 0.4 percentage points above the fiscal rule target. This fiscal consolidation will be driven by reduced expenditures due to spending efficiency-improving measures and the phasing out of transfer programs, such as Con Punche Peru, as well as other pandemic- and weather-related assistance. Additionally, revenues are expected to increase from the expiration of temporary tax relief measures, historically high mining prices, and efforts to combat tax evasion. However, the shortfall in the fiscal deficit will reflect a slower recovery of revenues relative to the Budget’s initial projections. Furthermore, given the low projected potential growth rate, the projections assume a one-year delay in reaching the medium-term fiscal target.13 Nevertheless, fiscal consolidation will continue in the coming years, driven by the phasing out of extraordinary expenses, rising tax revenues from increased economic activity and reform-led reduced tax evasion. 15. Peru’s public sector debt is sustainable and resilient to various shocks. The public debt-to-GDP ratio is projected to decline slowly, staying above pre-pandemic levels but under the 38 percent fiscal rule debt ceiling. A deterioration of the primary fiscal balance or lower GDP growth by one standard deviation at the beginning of 2024 could result in an increase of over 4 percentage points in the ratio. Shocks to real interest rates and exchange rates would have more moderate effects. Only a combined shock (all previous shocks simultaneously) would elevate the public debt-to-GDP ratio temporarily above the 38 percent ceiling. Higher GDP growth than the projected 2.4 percent average could expedite the decline of the public debt-to-GDP ratio. Total external debt is projected to continue to decrease to around 34 percent of GDP by 2027, with both public and private debt exhibiting a downward trajectory. In the medium term, gross external financing will remain low, below 5 percent of GDP. 12 As the initial government revenue estimates for the budget were too optimistic at the beginning of 2024, the MEF revised its projected revenues and changed its fiscal deficit projection to 2.5 percent for 2024 in the Multiannual Macroeconomic Framework (MMF) 2024-2027, released in April 2024. 13 According to Law Nº 31541, approved in August 2022, the fiscal deficit rules for 2024, 2025, and 2026 were set at 2.0, 1.5, and 1.0 percent of GDP, respectively, to achieve the long-term objective of maintaining a public debt-to-GDP ratio of at most 30 percent. 9 Figure 1. Public Debt Sustainability 5 0 3 .5 35 33. 33. 3 . 30.3 30 2 . 25 20 2023 2025 2033 2035 202 202 202 203 20 Primary Balance Shock Real GDP Growth Shock 2 Real Interest Rate Shock 3 Exchange Rate Shock Combined Shock 5 Baseline Source: World Bank staff calculations. Notes: All shocks consist of a reduction/increase of one standard deviation of their base values. 1/ Primary balance shock consists of a reduction of 2.2 percentage points in the variable for two years. 2/Real GDP shock consists of a reduction of 5.9 percent in GDP for two years. This also increases primary balance and the interest rate on debt. 3/Real interest rate shock consists of an increase of 275 basis points in the interest rate paid on domestic debt and 201 basis points on the interest rate on external debt. 4/ Exchange rate shock consists of a one-off 7.1 percent depreciation. 5/Combined shock consists in the worst scenario combining the size and duration of the shocks under 2/, 3/ and 4/. 16. The current account deficit is forecasted to increase to 1.3 percent of GDP in 2024 . This increase will reflect a diminished trade balance surplus resulting from increased import growth from rising internal demand. Primary income outflows (6 percent of GDP) will continue to drown the positive effect of net remittances inflows (2 percent of GDP) on the current account deficit. In terms of financing sources, FDI inflows are expected to rise initially as some medium-size projects (Zafranal, Antamina reposition, Taromocho expansion phase II) enter their execution phase and are projected to converge to 2.5 percent of GDP over the medium term. 17. The economic outlook for Peru carries significant but manageable risks. Domestically, continued political uncertainty could undermine private investment. Fiscal consolidation efforts are tilted towards reducing expenditures rather than increasing revenues. This, combined with ad-hoc spending or tax relief measures and underperformance by SOEs, poses fiscal risks that could undermine consolidation efforts and weaken investor confidence in a context of slower potential growth. A stronger-than-expected El Niño could slow growth of agriculture and fishing and slow the anticipated reduction in inflation, depressing consumption. Lack of progress on growth-enhancing structural reforms to address Peru’s productivity and institutional challenges could lead to lower than projected potential growth. External risks have declined but include lower-than-anticipated growth in China, which absorbs 34 percent of Peru’s exports, falling commodity prices, rising interest rates, and escalating climate change threats. These risks, however, seem manageable given Peru’s solid macroeconomic buffers. 18. Peru’s macroeconomic policy framework is considered adequate. The Central Bank of Peru’s (BCRP) decisive monetary policy response to the food and fuel price inflation shocks has brought inflation within the target band. The BRCP has now started to lower the policy rate cautiously to boost demand. The exchange rate remains flexible with limited foreign exchange intervention to reduce volatility. International reserves are high at US$71 billion. The financial sector is sound, supported by appropriate macroprudential policy and strong supervision. Peru’s public debt is low and sustainable, and the country was able to maintain a low and stable EMBI spread during a period of high political uncertainty, providing access to international capital markets on favorable terms. The government’s commitment to the OECD accession process, is expected to provide a clear roadmap for ambitious structural reforms to boost growth and strengthen institutions. 2.3. IMF RELATIONS 19. The GoP maintains an active dialogue with the International Monetary Fund (IMF) on macroeconomic policy. In May 2024, Peru exited the Flexible Credit Line (FCL) Arrangement with the IMF against a background of reduced external risks and ample international reserves. In addition, in May 2024, the IMF concluded its annual Article IV Consultation with Peru. The Article IV noted that despite a slight contraction in 2023, the economy is expected to rebound in 2024 with 10 The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) growth converging towards its potential over the medium term. Risks are broadly balanced, and Peru has ample buffers to cope with shocks. Peru’s proven macroeconomic resilience is reinforced by very strong buffers , including low public debt, abundant international reserves, access to international capital markets on favorable terms, and access to the Flexible Credit Line (FCL). The IMF also recognizes that structural reforms are urgently needed to lift potential growth. The IMF and WB team engage in regular dialogue around macroeconomic issues related to growth and fiscal policy. The IMF is providing TA on Tax Administration to SUNAT, which assesses management and disclosure of fiscal risks and evaluates improvements of public financial management, complementing the WBG’s TA on domestic and international tax policy with SUNAT and MEF. 3. GOVERNMENT PROGRAM 20. The government has reaffirmed its commitment to foster faster economic growth by publishing various strategies. The “Con Punche Peru 2” Plan, launched in May 2023, is founded on three economic policy priorities: (i) economic recovery and emergency response; (ii) promoting private investment; and (iii) strengthening competitiveness and the productivity of the economy. It also includes measures to promote public investment, finance the recovery from climate and natural disaster-related events, and promote new growth engines while consolidating existing ones like mining, tourism, and agriculture. The “Plan Unidos”, announced in November 2023, as a continuation to “Con Punche Peru 2” is designed to stimulate potential growth through 25 measures, including the promotion of private investment, the development of key economic sectors, and providing financing to protect supply chains. In addition, the Multiannual Macroeconomic Framework (MMF) for 2024-2027, published by MEF in August 2023, and updated in April 2024, acknowledges the strong fiscal position of Peru, but also the need to strengthen fiscal management, revenue administration reforms, including a comprehensive assessment of fiscal risks. In terms of medium to long term vision, the GoP has updated its Strategic Plan for National Development (PEDN) with a 2050 horizon. The PEDN 2050 guided the formulation of the current General Government Policy and global commitments such as the United Nations’ 2030 agenda and the OECD accession process. Box 1: The OECD and Latin America & the Caribbean The OECD includes 4 member countries from the LAC region and three more (including Peru) have started the accession process. Chile, Costa Rica, Colombia, and Mexico are OECD members. In January 2022, the OECD council decided to open accession discussions with Argentina, Brazil, and Peru. All these countries, as well as the Dominican Republic, Ecuador, El Salvador, Guatemala, Panama, Paraguay, and Uruguay, are members of the OECD Development Centre and LAC Regional Programme Steering Group (in addition to Honduras). The OECD accession process boosted the momentum for structural reforms in Colombia. The process, which started with the invitation to open accession talks in 2013, was completed in June 2018, when Colombia became the 37th member of OECD. As part of this accession process Colombia undertook a series of reforms to align with OECD standards, including improvements in tax policy, the fight against tax evasion, strengthening SOE management, and competition policy. In addition, to having continued access to the OECD policy guidance and capacity building activities, the accession process contributed to international credibility of Colombia’s reform commitment which was linked to improved credit ratings and higher investor confidence. Similar to Colombia, the OECD accession process provides a clear roadmap of structural reforms for Peru . In June 2022, the OECD Council adopted an individual Accession Roadmap for Peru, setting out the terms, conditions, and process for accession. In June 2023, Peru submitted an Initial Memorandum setting out a first self-assessment of the alignment of Peru’s legislation, policies, and practices with OECD standards. Considering the current lack of political consensus for reforms to make labor market more flexible, reduce informality, address regulatory uncertainty, and make the tax system more growth friendly, the government’s commitment to the OECD accession process, is expected to provide a clear roadmap for ambitious structural reforms to boost growth and strengthen institutions. This operation is not only aligned in all its reforms with the OECD accession process but in some reforms (PAs 3-6, 8, 9) it more directly supports policy actions prioritized by the government to address OECD recommendations. 11 4. PROPOSED OPERATION 4.1. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION 21. The proposed operation is closely aligned with government strategies to foster economic growth and supports the OECD accession process. The operation is aligned with the MMF in its areas of fiscal management reforms. This operation also contributes to the pillars of “Con Punche Peru 2” Plan and the PEDN 2050, particularly in the areas of promoting growth, competition, and the mitigation of climate change. The reforms also contribute to the OECD Accession Core Principles for Peru, including those covered by the OECD committees on fiscal affairs, economic development review, senior budget officials, financial markets, competition, scientific and technological policy, and environment policy (Box 1). Specifically, in some reforms (PAs 3-6, 8, 9) the operation supports more directly policy actions that the GoP is prioritizing to address OECD recommendations. 22. The proposed DPF-DDO complements the Green and Resilient Development DPF-DDO series, builds on previous successful DPF-DDO engagements, and benefits from longstanding policy dialogue and TA engagements. The pipeline “Green and Resilient Development for a Decarbonized Economy in Peru” DPF-DDO series focuses on complementary aspects of the green growth agenda in Peru, such as decarbonizing infrastructure sectors and improving disaster risk planning. Specific reforms of that operation are expected to foster renewable energy, efficiency in water-use, resilient social housing, non-motorized transport, and strengthening of institutions necessary to unlock infrastructure investments. Peru has benefitted from DPF-DDOs in the past to weather key crises, including the impact of “El Niño Costero” in 20 and 2023, and the COVID-19 pandemic in 2020-2021. In the context of high uncertainty and financial market volatility, the authorities see the DPF-DDO as an important part of their debt management strategy and a hedge against increasing global interest rates and international capital markets volatility. The reform agenda supported by this DPF-DDO prioritizes policy actions with broad political consensus for their implementation and supports the government’s fiscal management and growth efforts. The agenda also benefited from previous and ongoing WBG engagement—including technical assistance on fiscal risks (Government Debt and Risk Management Program), tax, PPPs, green finance (JCAP Sustainable Finance Facility), competition, and EU Deforestation-free Regulation, as well as IPF on innovation—which helped identify reform needs and is providing selected reform implementation support. The reform agenda has synergies with support provided by development partners such as the IMF, Inter-American Development Bank (IADB), GIZ, UNEP-FI, the UK Embassy, and the Swiss State Secretariat for Economic Affairs (SECO). 23. This operation aligns with the goals of the Paris Agreement, in particular the updated NDC (December 2020) and the National Adaptation Plan (June 202 ), and it considers the climate analysis in Peru’s Country Climate and Development Report (CCDR, November 2022). Examples of supported reforms that are aligned with the CCDR include PPPs (PA 4), Green Finance Roadmap (PA 8) and Green Taxonomy (Trigger 7), and deforestation-free exports (PA 9). Regarding mitigation goals, none of the prior actions are likely to cause a significant increase in GHG emissions or any persistent barriers to transition to the country’s low-GHG emissions development pathways. Regarding the adaptation and resilience goals, none of the prior actions are expected to be at risk from climate hazards. 24. This DPF reform program is consistent with the Maximizing Finance for Development (MFD) principles and is private capital enabling (PCE). The following reforms are aligned with MFD principles: PPPs (PA 4 and Trigger 3); Green Finance Roadmap (PA 8) and Green Taxonomy (Trigger 7); innovation (PA 5 and Trigger 4), and competition (PA 6 and Trigger 5). The following reform is PCE: PA 8 and Trigger 7 on green finance. 4.2. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS PILLAR A: STRENGTHEN FISCAL MANAGEMENT 25. Pillar A supports Peru to strengthen fiscal management. Peru has a history of strong macroeconomic policies but could benefit from structural reforms to enhance its fiscal management, especially in a low-growth environment. Pillar A supports reforms to strengthen fiscal management by safeguarding the independence and effectiveness of the fiscal 12 The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) council, improving monitoring and management of fiscal risks, addressing tax evasion, and accelerating the preparation of PPPs to improve the efficiency of infrastructure spending. All reforms proposed under this pillar are aligned with Peru’s OECD Accession Roadmap and several benefitted from World Bank TA, including on fiscal risks, and PPPs. Prior Action 1. To enhance the effectiveness of the Fiscal Council, the Borrower has a) enacted the Law for the Strengthening of the Fiscal Council and (b) approved a decree that enhances its transparency protocols. Evidence: (a) Law No. 31681 published in the Official Gazette on February 3, 2023, and (b) Supreme Decree Nº 037-2023-EF, as published in the Official Gazette on March 17, 2023. 25. Rationale. An independent and effective fiscal council can help promote fiscal responsibility and sustainable public finance, by monitoring, assessing, and publishing information about the consistency and sustainability of government fiscal policies. (IMF [2013]14 and OECD [2024])15. Peru’s Fiscal Council was established in 20 3 and its technical secretariat has since then regularly issued 2-5 technical reports per year that evaluate the consistency of the government’s fiscal policies and adherence to the fiscal rule, including scenarios of extreme climate events which can have large fiscal impacts. The GoP decided not to renew the President of the Fiscal Council, at a time when the Council raised awareness about the country’s fiscal policy slippages, prompting calls for a more “deficit friendly” Council president. Also, funding for the Council technical staff was not guaranteed. In this context, it became critical to implement a law that ensures the independence, expertise, and credibility and that the technical secretariat can attract appropriately qualified staff.16 26. Substance of the Prior Action. The approved Law and associated decree strengthen the Council’s independence and its technical capacity. It enhances the technical capacity of the Fiscal Council as the law permits the integration of the Council’s Technical Secretariat staff into the Civil Service, ensuring the competitive remuneration to attract and retain qualified personnel and budget stability. In addition, the amendment stipulates that the Council must have five members instead of “at least three”, thereby removing the possibility for arbitrary expansion of its membership. The appointment of new Council members has been confined to candidates shortlisted by the Council to diminish the incidence of politically motivated appointments. The Council’s president is to be selected from within its existing members. Complementing these legislative changes, the Supreme Decree introduced additional transparency protocols, including the obligatory public disclosures of the Council’s technical reports and the implementation of regular internal and independent evaluations of its assessments, in line with international sound practice. The Law and Supreme Decree also align with the transparent and accountable public spending principles of Peru’s OECD accession process. 27. Expected Results. A more effective Fiscal Council will improve fiscal oversight in Peru, promoting fiscal transparency, responsibility, and sustainability. The integration of the Council’s Technical Secretariat staff into the Civil Service, will ensure competitive remuneration and stable funding, enabling the Council to attract and retain qualified personnel and therefore increase the rigor and impact of the technical assessments of proposed or recently implemented policy changes as well as the fiscal risks associated with SOEs and climate and natural disasters.17 The reform is expected to increase the share of the Fiscal Council’s Technical Secretariat staff incorporated in the Civil Service regime, from 0 in 2024 to 100 percent by 2026. 14 Debrun, Xavier, et al. "The functions and impact of Fiscal Councils. IMF policy paper." International Monetary Fund 196 (2013). 15 Sánchez, Aida Caldera, et al. "Independent fiscal institutions: A typology of OECD institutions and a roadmap for Latin America." OECD (2024). 16 The IMF’s Article IV consultation report recommends that to enhance confidence in Peru’s fiscal framework the Fiscal Council’s operational independence, transparency, and accountability needs to increase. 13 Prior Action 2. To strengthen the fiscal risk framework, the Borrower, through DGTP, has mandated the assignment of risk ratings of all SOEs under FONAFE for MEF to manage the related risks. Evidence: Directorial Resolution No. 012-2023-EF/52.01 published in the Official Gazette on January 1, 2024. 28. Rationale. Assessing, monitoring, and managing fiscal risks of SOEs is critical for macroeconomic and financial stability, market confidence, and efficiency (IADB, 2018; IMF, 2020). Peru has a sizeable SOE sector and is subject to significant macroeconomic volatility. The operating income of the SOE sector under FONAFE (National Fund for the Financing of State Business Activities) and PetroPeru accounted for about 5 percent of the GDP, of which only PetroPeru contributes 2.3 percent of the GDP.18 SOEs under FONAFE are required to transfer annual dividends to the Treasury. SOE net profits were largely hit during COVID, decreasing by 39 percent, and their financial situation remains weak as the revenues have not yet reached pre-pandemic levels. PetroPeru received transfers of US$2.3 billion or almost 1 percent of GDP since 2022, after losing access to its credit lines following delays in the presentation of audited financial statements. On February 27, 2024, the government granted additional financial support to PetroPeru in the form of one-year guarantees for up to US$800 million (0.3 percent of GDP) to back up a trade-related facility from Banco de la Nacion to secure oil supply for the company. As a result, the GoP instructed FONAFE to supervise the restructuring and evaluate the financial situation of PetroPeru. A new Board recently informed the Treasury that further support of US$2.2 billion (0.8 percent of GDP) will be needed. Peru prepares annual and periodic Fiscal Risk Statements (FRS)19 which include risks from macroeconomic developments, lawsuits (excluding SOEs), Public-Private Partnership (PPPs), natural disasters, and guarantees to the private sector, but do not identify and quantify fiscal risks from SOEs. Quantification of some of these risks is, however, incomplete. Improvements are needed for the methodologies to quantify risks from PPPs and court cases. The explicit contingent liabilities from PPPs reached 1.6 percent of GDP in 2022. In addition, liabilities (maximum exposure) from legal cases reached 6.19 percent of the GDP in 2022.20 29. Substance of the Prior Action. The General Directorate of the Public Treasury (DGTP) has mandated the assignment of risk ratings of all SOEs under FONAFE for a comprehensive management of fiscal risks of Financial and Non- financial SOEs under the scope of FONAFE. This obligates FONAFE to prepare and assign risk ratings to all 35 SOEs under its ambit and establishes the methodology for calculating such scores21. Moreover, it obligates all SOEs to provide the information that FONAFE needs for the assignment of the risk scores. The reform is at the forefront of the fiscal risk analysis. Risk ratings, based on audited financial statements, assess the profitability, solvency, leverage, liquidity, revenues/costs, and operational performance of SOEs to identify if SOEs are in a precarious fiscal situation (Florian et al 2019, IMF, 2020; World Bank 2022) and many countries have started to implement them.22 The reform and the proposed trigger are supported by WB TA under the Government Debt Management and Risks Program. The DGTP within MEF plans to publish regulations to quantify fiscal risks from PPPs and legal cases (Trigger 1) to strengthen the fiscal risk framework. 30. Expected Results. The reform is expected to improve the assessment and management of fiscal risks from SOEs, PPPs, and legal cases in Peru. It will ensure that the Ministry of Finance receive regularly detailed information from SOEs to assess the financial and operational performance, and degree of quasi-fiscal activities and classify SOEs through ratings that will enable the government to design early and targeted interventions where necessary. Moreover, it will enhance the predictability of the budget execution by including ex-ante provisions in the budget for high-risk SOEs. All 35 SOEs under FONAFE will have an assigned risk rating which will inform the Fiscal Risk Statement. 18 Such SOEs are relevant to the provision of public services as they represent 62.5 percent of the total share of electric distribution, 51 percent of water production, 31 percent of the fuel market, and 90 percent of counties with access to financial services. Subnational SOEs’ operating income is 1 percent of GDP. 19 Through Legislative Decree No. 1441, published in 2018, DGTP has the responsibility to prepare annual and periodic Fiscal Risk Statements (FRS) with inputs from MEF, Fondo Nacional de Financiamiento de la Actividad Empresarial del Estado (FONAFE), and the prime minister's office. 20 According to the Marco Macroeconomico Multianual 2024-2027 (MEF, 2024). 21 Only 8 SOEs under FONAFE have a credit risk rating assigned by credit rating agencies. Such ratings, however, assume financial support by the sovereign in the case of a distress event. 22 Ghana, Indonesia, Mozambique, South Africa, Sweden, and Thailand. 14 The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) Prior Action 3. To facilitate the reduction of tax evasion and promote a better management of government revenues, the Borrower has approved the regulations establishing (a) the methodology for assigning tax compliance profiles to taxpayers, and (b) the procedure for identifying companies as “subjects without operational capacity”, whose invoices are ineligible to be used for VAT credits or income tax deductions. Evidence: (a) Supreme Decree No. 320-2023-EF published in the Official Gazette on December 30, 2023, and (b) Supreme Decree No. 319-2023-EF published in the official Gazette on December 30, 2023. 31. Rationale. Due to high levels of tax evasion, Peru only collected 15 percent of GDP in tax revenues, which is significantly below the Latin American average and that of other peer countries. The low level of tax revenues makes the country highly dependent on non-tax revenues. The evasion rates for CIT and VAT reached 33.1 percent and 28.0 percent of potential collections in 2021, respectively, amounting to around 5.5 percent of GDP.23 Improving tax compliance, broadening the tax base, and strengthening permanent revenue collection is fundamental to safeguarding the country’s macroeconomic stability and essential for scaling up the provision of infrastructure and public services (OECD 2022). Peru has taken several steps to improve tax compliance, introducing the Good Taxpayers Regime in 2001, which, though a step in the right direction, turned out to be ineffective since it did not differentiate between high-compliance and low- compliance taxpayers. Peru also struggles with a high number of so-called ghost firms and the issuance of fake invoices to obtain tax credits for reducing VAT payments and to underreport accounting profits to lower CIT payments. Currently, the tax administration, SUNAT, can only disregard false invoices on a case-by-case basis but cannot address fake invoices at the entity level, many of which have been specifically created to facilitate evasion. In Peru, VAT is the largest source of tax revenue. With the rapid growth of online sales of services and digital products to private consumers, as well as the significant increase in online sales of low value imported goods often sold by foreign sellers, there is a high risk of potential VAT loss since it is not effectively collected under current regulations. 32. Substance of the Prior Action. Through Supreme Decree No. 320-2023-EF, the Borrower has approved the regulations of Legislative Decree No. 1535. The regulations mandate compliance profiles for all taxpayers to encourage voluntary compliance with tax and non-tax obligations collected by SUNAT. They establish a clear and transparent methodology for determining each taxpayer’s compliance profile, which is graded on a five -scale system. Taxpayers with higher compliance levels will receive benefits, such as expedited refund processing, special schedules for filing tax returns and payments, while those with lower compliance levels will face specific control measures or limitations related to tax return deadlines and will be mandated to route payments through the Peruvian banking system (“bancarization”). Some countries (e.g. Norway, Philippines, Denmark, Pakistan) have taken similar measures to Peru and in countries where evidence exists, reported income or taxes paid go up 3-9 percent post-reform (Nakayama, 2021). Additionally, Supreme Decree No. 319-2023-EF approves the regulation of the procedure for designating a "subject without operating capacity" to prevent tax evasion. This measure is fundamental for addressing fake invoices at the entity level (“ghost firms”). A similar measure has been applied in Ecuador, with an estimated effect of increasing taxable income by US$20 million (Carrillo et al. 2020).24 To facilitate better management of government revenues, as indicative Trigger 2, the Borrower is expected to establish a collection mechanism for VAT operations carried out with suppliers or intermediaries of non- domiciled goods and services within the framework of the digital economy. This reform will require non-resident vendors of digital services/goods to consumers (B2C) in Peru to register for and collect VAT, regardless of the sales amount, through a simplified process, following the recommendations established by the OECD. 33. Expected Results. By the end of 2026, it is expected that at least 1.2 million taxpayers with business income – who represent the entirety of those filing CIT tax returns with positive income- will have tax compliance profiles on SUNAT's website. In addition, SUNAT will identify and publish companies that are “subjects without operational capacity”, effectively identifying “ghost firms” and invalidating fake invoices at scale. This would not only help reduce tax evasion 23MEF, SUNAT, The World Bank and OECD. Building Strong Tax Foundations to Enhance Domestic Resource Mobilization in Peru. 2021. 24Carrillo, P, D Donaldson, D Pomeranz and M Singhal (2022), “Ghosting the tax authority: Fake firms and tax fraud”, CEPR Discussion Paper No. 17453. 15 but also improve access to credit for MSMEs since confirmed invoices are recognized as digital financial assets within the Peruvian factoring framework. The VAT reform will secure VAT revenues and ensure a level playing field between domestic providers and foreign online sellers, adhering to the destination principle and the neutrality of VAT. In addition, the VAT reform on digital services is expected to raise 0.1 percent of GDP, annually, by 2026. Prior Action 4. To enhance the efficiency of PPPs, the Borrower, through MEF, has enhanced budget predictability for PPP projects by requiring contracting authorities to declare up-front the required budget allocation through project completion. Evidence: Supreme Decree No. 182-2023-EF published in the Official Gazette on August 23, 2023. 34. Rationale. Since 2008, the Peruvian government has actively engaged in Public-Private Partnerships (PPPs) to enhance essential infrastructure services. In the past two decades, these PPP projects have attracted more than USD 20 billion in investment. The 2022-2025 National Sustainable Infrastructure Plan for Competitiveness (PNISC) identified 72 infrastructure projects, nearly half of which are PPPs. PPPs would be contributing USD 20 billion towards addressing about 20 percent of Peru's estimated USD 110 billion long-term infrastructure gap. However, the implementation of PPP projects in Peru has been much slower than in other countries (World Bank, 2020). In 2020, an IFC TA and a subsequent World Bank review of Peru’s PPP projects from 20 0 to 2020, identified opportunities to streamline the project preparation process and accelerate project delivery while maintaining critical control functions. Currently due to lack of budget allocation processes in the early phases of investment planning, the MEF is mandated to emit opinions on budget availability at each phase of the project preparation process (planning, formulation, structuring) which takes about 7 months each time, rendering the projects stale and delaying PPP program implementation. 35. Substance of the Prior Action. The reforms seek to strengthen oversight and responsible use of public funds within PPP projects.25 It requires that the public contracting entity conduct a thorough evaluation of budgetary capacity through a “declaration of use of public resources” at the planning and programming, and formulation stages of the project preparation process. By doing so the public entity confirms that it has secured budget, and it pledges to allocate in its budget, the necessary resources to fulfill its obligations under the PPP until project completion. This reform maintains the MEF’s gatekeeper role, as it must still issue an opinion during later stages (structuring and tendering) when mo re details about potential government support or contingent liabilities related to the project preparation become available. The proposed indicative Trigger 3 will establish specialized project preparation and implementation departments (Spanish acronym is OEGEP) in the relevant contracting authorities, which is expected to increase the authorities’ capacity to prepare and implement PPP projects. Such increased capacity would also improve the authorities’ ability to integrate climate resilience (i.e., nature-based solutions) and climate mitigation (low carbon technologies, energy efficiency, alternative sources of energy) considerations in project design. In parallel, the trigger related to PA 2 supports the quantification of PPP related contingent liabilities. 36. Expected Results. This reform is expected to reduce the preparation time of new PPP projects. By having the contracting authorities establish intent of use of public funds in the earlier phases of project preparation, it removes the need for the MEF to confirm budget availability each phase of project preparation. As a result, this reduces preparation time and improves predictability of the infrastructure program, while ensuring that PPP projects are aligned with available budgetary resources and sustainability principles. As a result of the reforms supported in this DPF series, a reduction of 40 percent is expected in PPP preparation time, lowering it from 18 to 11 months by 202626. In addition, the proposed reform will also help improve budget planning by allocating resources to the investments early.27 25 Supreme Decree No. 182-2023-EF modifies articles 5, 40, 41, 44, and 45 of the Regulation of Legislative Decree No. 1362. 26 The sectors whose projects are being tracked for improved efficiencies are education, health, and water and sanitation. These are comparable projects all under co-financing track of the PPP framework (therefore identical approval processes) and are also the sectors that have most delays in relative terms due to lack of capacity. 27 OECD standards suggest that by establishing budget requirements early, policymakers can ensure that sufficient resources are allocated to the project. 16 The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) PILLAR B: FOSTER A MORE PRODUCTIVE AND GREENER ECONOMY 37. Pillar B supports a more productive and greener economy. It supports structural reforms that will help boost productivity growth, adapt the economy better to, and mitigate climate change. The country needs to advance reforms that foster a more productive economy through progress in innovation, competition, digital transformation, regional integration, and well-managed natural resources. In the context of climate change, mobilizing private sector financing to green the economy and improving the competitiveness of agricultural exports will also be critical. All reforms proposed under this pillar are aligned with Peru’s OECD Accession Roadmap, and several benefitted from World Bank TA, including on innovation, competition, digital and green finance, and agricultural competitiveness. Prior Action 5. To strengthen the National Science, Technology, and Innovation System (SINACTI), the Borrower, through the Presidency of the Council of Ministers, has issued the SINACTI Law’s implementing regulations, bringing that law into force, establishing CONCY TEC as the national STI governing body, and articulating SINACTI’s governance and coordination mechanisms, including the roles and responsibiliti es of regional governments. Evidence: Supreme Decree No. 062-2024-PCM published in the Official Gazette on June 23, 2024. 39. Rationale. Peru significantly lags behind peers and advanced economies in innovation, a key driver of productivity growth. Between 2002 and 2020, Peru’s R&D spending was just 0. percent of GDP, compared to 0.7 percent for LAC and 1.2 percent for upper-middle-income countries. Additionally, only 7 percent of Peruvian firms have licensed technology from abroad (a proxy of technology adoption), half the LAC average and 2.5 times less than in OECD countries. (WIPO, 2021; Kim and Loayza, 2019) This is clearly insufficient: approximately half of country-level productivity growth is driven by firm innovation through the adoption of new technologies and development of high value-added products (Cirera and Maloney, 2017). However, innovation in Peru is further hindered by large regional disparities, with high-quality R&D and disruptive innovation largely concentrated in the Lima-Callao area.28 Boosting innovation outside of Lima can drive productivity growth in lagging regions and reduce regional disparities. Innovation is also crucial in addressing climate challenges, which will require innovation-based solutions to enhance Peru’s competitiveness. To increase innovation in Peru, sound public policies and support mechanisms are essential. However, Peru’s National Science, Technology, and Innovation System (STI) suffers from unclear governance, fragmented efforts, and inadequate funding. Improving the governance of the national innovation system would ensure a better allocation of public financing for innovation projects, while catalyzing private sector R&D spending. Strengthening the mandate of the National STI governing agency, CONCYTEC (Consejo Nacional de Ciencia, Tecnología e Innovación Tecnológica) and improving coordination with other innovation stakeholders are critical reforms identified by the government, World Bank, and OECD. Enhanced governance in the innovation ecosystem is part of Peru’s OECD accession roadmap (OECD, 2011; World Bank, 2016; World Bank, 2022). 40. Substance of the Prior Action. The regulation of the National SINACTI Law29 brings that law into force and strengthens governance and coordination across all entities of the SINACTI. It establishes CONCYTEC as the National STI governing body, strengthening its strategic mandate, and defining its functions. The reform defines roles and responsibilities for STI within regional governments, overseen by CONCYTEC, and expands the type of financing sources and instruments for STI programs, including the role of CONCYTEC in facilitating such financing. It also institutes multisectoral and consultative STI commissions to ensure coordination across ministries and with academia and the private sector. To effectively implement its expanded mandate, amendments to CONCYTEC’s Reglamento de Organización y Funciones are needed (Trigger 4). The amendments are expected to create a Financing Directorate to boost public and private financing for innovation and an Articulation Directorate to strengthen regional STI activities. The second part of the trigger is the publication of the National STI Policy (Política Nacional de Ciencia, Tecnología e Innovación, POLCTI), 28 As highlighted in the Peru CEM (forthcoming) and Peru Country Private Sector Diagnostic (2023), regional economic disparities are significantly higher than OECD averages and among the highest in LAC. 29 Ley Nº 31250, 2021. 17 which includes priority services related to climate change. Implementing the POLCTI is a core element of the National STI regulation and Law. These reforms are part of a long-term strategy to build a coherent and effective innovation ecosystem—including tighter links between research and the private sector—with support from the World Bank and the IDB. This includes a series of WB IPFs that are strengthening the capacity of CONCYTEC and other elements of the innovation ecosystem to fulfill the objectives of the SINACTI Law, regulation, and POLCTI.30 41. Expected results. The results indicator is the share of regional governments that have an operational STI unit.31 Creating a regional STI unit (Gerencia Regional de CTI or similar) provides a clear signal of the willingness of a region to promote STI. The units will serve as the regional counterparts to CONCYTEC, identify regional STI priorities and activities, and help orient public and private financing to R&D focused on the economic, social, and environmental needs of each region.32 For example, an STI unit in Amazonas is expected to help the regional government promote the adoption of technologies (which are being developed by the local university, with support from the WB IPFs) to improve the productivity of the agriculture and livestock value chains. More broadly, the supported reforms aim to enhance coordination among line ministries (e.g., education, health, production, trade), regional governments, academia, research institutes, and the private sector. Additionally, the reforms are expected to increase financing for STI initiatives and align them with the country's economic, social, and environmental objectives. Overall, this should lead to a more efficient, effective, and better-financed innovation ecosystem, with stronger links between supply and demand for innovation. The reforms are also anticipated to increase R&D on climate adaptation and mitigation, attract private investment in innovation (in line with MFD principles), and help foster firm productivity and sustainable growth. Prior Action 6. To strengthen competition, the Borrower has enabled courts to exempt from criminal sanctions the first cartel member uncovering the cartel. Evidence: First Final Complementary Provision of Law No. 31775, published in the Official Gazette on June 7, 2023. 42. Rationale. Competition is a crucial driver of productivity growth and innovation in Peru.33 Empirical evidence suggest that better enforcement of competition policy can substantially impact productivity growth in Peru (Schiffbauer and Sampi, 2022).34 Yet, important shortfalls in Peru’s competition regulatory and institutional framework remain (World Bank, Peru SCD Update, 2022), particularly regarding to the treatment of cartels. Cartels, which are among the most harmful competition violations (OECD, 1998), have a significant impact on the poor, with over 20 percent of cartels in Latin America involving basic consumption products and global estimates suggesting price overcharges of 49-80 percent (WBG 2021, Fixing markets, not prices). Addressing economic cartels in Latin America requires a robust leniency program (World Bank 2024, LAC Economic Review). The leniency program is based on granting immunity from antitrust sanctions to the first cartel member informing the authorities of the violation while sanctioning the rest. While countries like Germany base up to 95 percent of their cartel decisions on leniency applications, LAC is still catching up to OECD members and other regions (World Bank 2024, OECD 2022). Effective leniency programs not only increase detection and reduce cartel formation by around 60 percent (Miller, 2009) shortening investigations (Brenner, 2009), but also severely destabilize cartels (prisoners dilemma) leading to lower price overcharges (Chen and Harrington, 2005) and shorter cartel lifecycles (Choi and Hahn, 2014). A leniency program existed in Peru until 2020. This program had increased by more than six-fold the total value of fines imposed by the competition authority, INDECOPI, in cartel cases since its implementation and 30 Strengthening Peru’s National Science, Technology, and Innovation System (P 2 , 2022 -2027, 1st in a series of 3 projects) and Strengthening the Science, Technology, and Innovation System in Peru (P156250, 2017-2021). Both operations support knowledge generation (supply side) and productive innovation / technology transfer (demand side), in addition to strengthening the governance of the innovation ecosystem. 31 The indicator would be measured by a regional STI strategic document registered with CONCYTEC, which identifies the responsible department and regional STI activities. 32 The prior action regulation specifies that regional governments should assign STI functions to an organizational unit and communicate it to CONCYTEC. For this unit to identify regional STI activities, align their activities with the POLCTI, etc., TA from CONCYTEC will be needed, as envisioned in the regulation. 33 World Bank (2024) provides strong empirical evidence that more competition fosters productivity growth. 34 Eliminating an illegal entry barrier to local markets has raised the TFP of firms operating in these local markets by 11 percent. 18 The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) generated significant cost savings for Peruvian households.35 However, a legal reform by the executive in 2020 (Law 31040) made all competition violations criminal without recognizing the role of the leniency program. Such an approach was at odds with regional and international experience and de facto nullified the leniency program since applicants were no longer assured immunity if criminal charges followed the administrative decision of the competition authority. The WBG has supported stronger antitrust enforcement in Peru for almost a decade, including the design of a leniency program between 2015-2017, prior to the criminalization of cartels. 43. Substance of the Prior Action. The supported reform limits the scope of criminal competition conduct to cartels only as per international sound practice36 and ensures that the technical decision of the competition authority granting leniency to the first applicant is respected by the criminal court (Chilean model). The reform places Peru at the frontier of antitrust enforcement by making the leniency program operative again and aligning the criminalization of cartels with both regional peers (US, Brazil and Mexico) and international best practice (OECD accession roadmap). The law follows the path of OECD regional peers with advanced competition enforcement jurisdictions such as Chile and Mexico where the decision of the competition authority, including confidentiality guarantees, will be respected by the criminal court, should there be further prosecution. In this sense, although this PA pertains to the criminal justice sector, in essence it focuses on ensuring that the decision taken at the technical level by INDECOPI will be respected by the criminal court thus limiting potential risks of political interference.37 To further strengthen anticartel policy, reforms are needed to better understand which type of agreements will be considered lawful, including those geared towards promoting climate sustainability goals that could otherwise be prohibited under the competition law.38 Strengthening the link between competition and climate sustainability goals has become a trend since the 2020 EU Green Deal published by the European Commission called for an alignment of all EU policies, including competition policy, with green objectives.39 INDECOPI’s publication of mandatory regulation to cooperate, including on the climate change agenda, while respecting competition safeguards (Trigger 5) will be critical to leveraging competition enforcement as a tool to fight climate change. A key dimension of Peru’s OECD accession roadmap is improving the effectiveness of competition policies, particularly on anticartel enforcement. The prior action and trigger benefit from joint WB-IFC technical assistance. 44. Expected Results. A reinforced regulatory framework for competition and anticartel policy should facilitate robust and enforceable actions against anticompetitive practices, building on evidence received through the leniency 35 In 2017 alone, the competition authority generated savings for households of an estimated US$250 million by dismantling cartels. Detected cartels affected essential consumer goods (e.g., pharmaceuticals, toilet paper, fuel, and transportation services) and were mostly prosecuted following leniency applications, which more than doubled between 2007 and 2019. As a result, the Peruvian anticartel program has had direct impact on the well-being of the Peruvian families and has made Peru an international benchmark and leader in the region on par with OECD member countries. 36 The previous text of Article 232 of the Criminal Code penalized a broad set of conducts including abuses of dominance and agreements that restricted competition. Instead, the new text of Article 232 penalizes only practices considered absolute prohibitions by the Competition law (DL 1034). Absolute prohibitions as per Art. 11.2 of DL 1034 are cartels (price fixing, market allocation/output restriction and bid rigging). This is the approach followed by other countries in the region where cartels are criminal as well as among EU member states. Countries following this approach include Australia, Austria, Brazil, Canada, Denmark, Germany, Hungary, Ireland, Israel, Japan, Mexico, the Netherlands, and the United Kingdom. 37 INDECOPI’s decision on leniency is based on the Guia del Programa de Clemencia published in 2017 which resulted from TA by the WBG team (PE RAS Effectiveness of Competition Policy, P152834) and are aligned with international best practice. These ensure predictability, transparency, and due process in the implementation of the leniency policy by (1) insulating INDECOPI from external interference or discretionary decision-making; and (2) assuring that the decision will be objective, based on the merits of the information provided to INDECOPI to break the cartel and subject to the effective cooperation of the leniency applicant during the investigation of the cartel. See Guia del Programa de Clemencia, published by INDECOPI in August 2017 available at: https://cdn.www.gob.pe/uploads/document/file/2078926/Gu%C3%ADa%20del%20Programa%20de%20Clemencia.pdf.pdf?v=1628807342 38 For instance, based on a similar approach, in July 2022, the competition authority of the Netherlands approved an agreement between soft-drinks suppliers and supermarket chains to discontinue plastic handles on all soft-drinks and water multipacks that could have otherwise been considered a cartel under the competition law. 39 In the EU, this resulted in the reform of analytical tools applied to cooperation among market players to consider not only overall efficiency but also sustainability impact. Regulatory changes followed at the EU and national levels (e.g., legal changes and competition and sustainability reference framework issued in Austria and the Netherlands). Other countries are now following the EU’s lead and approving similar documents. 19 applications. In the absence of an effective leniency policy, fewer cartel cases would be detected and decided upon. As a results indicator, INDECOPI should increase the average annual number of decisions on anticompetitive practices by 30 percent.40 The indicator captures effective implementation of the PA and indicative trigger as both will strengthen the robustness of INDECOPI’s tools to fight anticompetitive practices, including providing incentives for market players to align their practices with the competition law. Fewer anticompetitive practices should lead to more competitive markets, meaning more firm entry and investment and higher productivity, making this reform consistent with MFD principles. Prior Action 7. To promote digital transformation, BCRP has issued regulations that allow non-bank e-money issuers and financial cooperatives to participate in retail payment infrastructure. Evidence: Circular No. 0010-2023-BCRP published in the Official Gazette on June 28, 2023, and Circular No. 0021-2023-BCRP published in the Official Gazette on November 8, 2023. 45. Rationale. Competitive and diversified financial systems enable households and firms to access the financial services necessary for productive economic activity (World Bank 2020, Global Financial Development Report; World Bank 2017, Peru SCD). Digital payment systems, a key pillar of digital public infrastructure, are crucial for Peru’s transition to a digital economy by facilitating e-commerce and providing entry points to a broader array of financial services like credit and savings products.41 However, only 49 percent of Peruvian adults have made or received a digital payment, well below the regional average of 65 percent (2021 Global Findex). Peru’s financial sector is dominated by a large and concentrated banking sector which owns key financial infrastructures. The bank-owned clearinghouse for credit transfers, the Camara de Compensación Electronica (CCE), has historically had low interoperability, excluding key non-bank providers from direct participation. Interoperability, which allows consumers to transact across various providers, channels, and products, enhances competition and improves affordability, accessibility, and product design of digital payments.4243 The lack of interoperability has constrained competition and innovation leading to high costs for consumers—65 percent of unbanked adults in Peru cite high costs as a barrier to financial inclusion, the third highest rate among 98 countries.44 Limited interoperability has been flagged as a barrier to digital transformation and digital financial inclusion in several World Bank diagnostics (e.g., the 2018 Financial Sector Assessment Program) as well as in studies by the national competition authority (INDECOPI). Improving interoperability is a priority in Peru’s Política Nacional de Inclusión Financiera. BCRP has begun an interoperability reform agenda, including a November 2022 regulation mandating interoperability between mobile wallets. However, sustained efforts are needed to address anti-competitive practices and ensure fair access to market infrastructures. 46. Substance of the prior action. The reform enables non-bank e-money issuers and financial cooperatives— representing a combined 3.2 million consumers—to participate in Peru’s CCE, provided they comply with relevant requirements. Non-bank e-money issuers are Fintechs offering innovative digital payments products and can play a key role in the business models of e-commerce firms and digital start-ups. Financial cooperatives in rural areas are closely integrated with agricultural value chains, facilitating payments between suppliers and providers, and offering productive credit.45 Clients of these institutions will now be able to make direct, affordable digital transactions with clients of the 30+ 40 The average number of decisions issued by INDECOPI on anticompetitive practices in 2022 and 2023 was 3. This number is expected to increase to an average of 4 in 2024-2025. Antitrust cases are complex and take time. As reported by the OECD, the average number of antitrust cases decided per year by European competition authorities, including cartels and abuses, from 2015 to 2021 was 8-9. See OECD CompStats available at https://www.oecd-ilibrary.org/sites/bcd8f8f8-en/1/3/2/index.html?itemId=/content/publication/bcd8f8f8- en&_csp_=b148dc50553e47ca3c91c1218642b454&itemIGO=oecd&itemContentType=book#figure-d1e650-29c52fbfc2 41 G20 High-Level Principles for Digital Financial Inclusion 42 World Bank Finance and the Future of Fintech Report, 2022 43 Furthermore, it can play a critical role in terms of climate resilience by ensuring consumers have seamless access to a broad range of financial services, and to ensure quick access to funds, during periods of extreme weather events when access to funds and the ability to make transactions can be critical. This is particularly important for populations located in remote, rural, or underserved areas, which can have less access to traditional banks. 44 World Bank Global Findex, 2021 45 There are currently four licensed non-bank e-money providers ( Empresas Emisores de Dinero Electrónico) providing approximately one million clients and 265 financial cooperatives (Cooperativas de Ahorro y Crédito No Autorizados a Captar Recursos al Publico) serving approximately 2.2 million members. 20 The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) other CCE participants, including banks and other non-bank participants. Following the reform, several such institutions are now in the process of joining the CCE. The indicative trigger consists of measures that enhance the legal/regulatory framework for payment service providers to encompass Fintech innovations and facilitate the entry of new players into the market (Trigger 6). These measures are expected to establish operational requirements—including related to transparency and risk management—for all payment service providers and require these providers to register with BCRP. The measures are also expected to enable the Central Bank to develop further regulation and operational reforms on issues related to interoperability, competition, and fast payments. The prior action and indicative trigger are aligned with recommendations from WB diagnostics and are key elements in the implementation of BCRP's digital payments strategy, which the WB is supporting via a multi-year technical assistance program funded by the Finance for Development Trust Fund. 47. Expected results. The reform is expected to lead to a more productive economy by removing anti-competitive barriers in the digital financial services ecosystem, thereby improving market contestability, and enabling innovations in product design that promote Peru’s digital transformation. The reform is also critical for financial inclusion and is expected to increase the resilience of vulnerable populations during economic and climatic shocks by enabling them to access financial support from social networks and governments, therefore improving the immediate response to crises. The expected reforms under the indicative trigger are expected to further contribute to creating a contestable and competitive digital payments market by facilitating the market entry of new Fintech providers operating outside the current regulatory framework. Overall, it is expected that the reforms will contribute to an increase in the number of Peruvian adults using digital payments from 12.4 million (2021, latest available data, equivalent to 49 percent of the 15+ population) to 16.0 million (2026, around 60 percent of the population).46 The indicator will be measured via the World Bank’s Global Findex survey, a triennial survey of adults (age 15+) in 140+ economies worldwide.47 Prior Action 8. To facilitate private investment in climate mitigation and adaptation, the Borrower has approved the Green Finance Roadmap for Peru, a tool for aligning public and private financial sector stakeholders’ policies, regulations, and incentives with national c limate goals through the execution of a series of concrete proposed activities. Evidence: Supreme Decree N° 007-2023-MINAM published in the Official Gazette on June 21, 2023. 48. Rationale. Peru’s investment needs related to climate adaptation and mitigation are estimated to be $ 5 billion between 2023 and 2030, with a financing gap of $27 billion to achieve the NDCs (Peru CCDR). Mobilizing private capital is crucial for supporting Peru’s national climate goals and transition. A green taxonomy is essential for this, as the incorporation of climate risks and opportunities in Peru’s financial sector has been limited (Peru CCDR). Despite deepening capital markets and a growing sustainable finance agenda, Peru offers few financial instruments for environmentally sustainable economic activities. Green finance roadmaps provide the strategic framework to meet climate goals with a green taxonomy as a clean element. A green taxonomy aligns capital flows with climate objectives by defining which economic activities contribute to climate mitigation and adaptation. This facilitates informed decisions, reduces ambiguity, prevents greenwashing, guides investments towards sustainable projects, supports consistent reporting and transparency, encourages green finance market growth, and drives corporate sustainability strategies. Internationally, country-level green taxonomies are best practice for promoting climate finance. While not legally binding, tools like the Green Finance Roadmap and Green Taxonomy significantly influence private sector decisions and policymaking. For instance, in Colombia, these tools led to regulations on green bonds, ESG/climate disclosure, and ESG regulations for pension funds, as well as changes in the governance, strategy and risk management systems of banks and other financial 46 Measured by multiplying adults who "Made or received digital payments in the past year (% age 15+)” (according to Findex 2021) by the Peru 2021 and 2026 population estimates from INEI. This contributes to the WB corporate scorecard indicator on “People using digitally enabled services”. 47 Complementary data sources, including INEI household surveys, may be used as well. 21 institutions. In Mexico, the Pension Funds Supervisor introduced a phased regulation for 2026, requiring pension fund administrators to adopt a Sustainability Disclosure Framework (e.g., SASB-IFRS); and align investments with the Sustainable Taxonomy (Taxonomia Sostenible de Mexico). In the EU, regulations require nonfinancial undertakings to disclose taxonomy-eligible and taxonomy aligned activities in terms of turnover; capital expenditures (CapEx), and operating expenditures (OpEx). 49. Substance of the Prior Action. Peru has approved and published a national Green Finance Roadmap (GFR, Hoja de Ruta de Financiamiento Verde), which is a tool for aligning financial sector policies, regulations, and incentives with national climate and environmental goals. The GFR mainly addresses financial sector capacity, governance, regulatory and market gaps. Under the GFR, activities include developing a Green Taxonomy (including governance mechanisms, technical committees, conducting awareness-raising and dissemination activities, and a legal instrument to formalize its contributions); conducting a regulatory gap assessment and recommending improvements to green finance regulations; developing new green finance instruments; measuring the participation of private financial sector entities in green finance; and implementing programs to increase their participation. The government has made considerable progress in all of these areas. Examples include conducting environmental sustainability surveys of financial institutions, creating a green protocol with 8 financial sector associations, and piloting financial instruments with municipal savings banks and a “bionegocios” program for the Amazon. The publication of the Green Taxonomy is the indicative trigger (Trigger 7), and 6 of 9 chapters of the taxonomy have been drafted to date. The GFR also strengthens coordination across public and private sector entities, which is critical given the complexities of strengthening the green finance ecosystem. The joint signing of the GFR decree by the MEF and Ministry of Environment reflects the commitment of both ministries to the GFR’s activities and coordination and reporting mechanisms. The GFR was prepared through a robust public-private consultation process and is receiving strong support from a joint WB-IFC team through the JCAP Sustainable Finance Facility (working on the taxonomy) and from other development partners including the Inter-American Development Bank, GIZ, the European Commission, UNEP-FI, and the UK Embassy. Moreover, the reform is aligned with the OECD accession roadmap, which includes ensuring policies with respect to sustainable finance, including ESG, climate transition, and other environmental considerations. Going forward, the GFR will continue to play a critical role as the anchor of Peru’s green finance policies, and it will keep being updated with activities and initiatives in support of a greener economy. 50. Expected Results. The execution of the activities in the GFR is expected to catalyze financial sector contributions to climate change adaptation and mitigation, including by: a) providing investors and bond-issuers with guidance (through the taxonomy) for identifying investments that contribute to climate change adaptation and mitigation, which can be used as a basis to create new financial products, such as green bonds or labelled exchange traded funds; b) raising awareness among financial sector firms about how green their current portfolios are and future investment opportunities; and c) facilitating the creation of financial instruments (with public sector involvement) for investing in green firms, among other things. This increased private investment should ultimately lead to a more productive and greener economy, and thus low carbon and climate resilient growth. The taxonomy could also be included in future regulatory measures on green bonds and financial sector disclosures, like the experience of Colombia, the EU, and other countries. The results indicator is the volume of financial sector assets that are considered green according to the green taxonomy, from a baseline of 0 in 2024, given there is no green taxonomy in place, to a target of $7.4 billion in 2026, an amount equivalent to 3.5 percent of financial sector assets, making this a PCE indicator.48 The target will be measured by MINAM and the Peruvian Financial Sector regulator (SBS) through the National Survey for Environmental Sustainability for Financial Institutions, another key activity of the GFR in which 60 entities participated in 2021 and 86 participated in 2023. Prior Action 9. To foster agricultural competitiveness and deforestation-free exports, the Borrower has established the mandatory methodology for the registration and geolocation of agricultural producers, enabling better targeting of agricultural support services by MIDAGRI. Evidence: Ministerial Resolution No. 0049-2024-MIDAGRI dated March 18, 2024. 51. Rationale. Boosting productivity in Peru’s agricultural sector will be critical for improving economy-wide living 48 This is classified as a PCE non-monetary indicator, since the target includes a mix of existing and new green assets. 22 The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) standards and reducing regional disparities. In Peru, weaknesses in agricultural technology adoption and innovation, land administration, agricultural health and food safety services, credit constraints, and connectivity and access to markets are key factors limiting agricultural productivity (World Bank 2022, Peru SCD Update). For instance, only 12 percent of farmers benefit from technology transfer through technical assistance. A major constraint to effectively targeting productivity- enhancing services to agricultural producers is the lack of geolocation data for these producers. This lack of information hampers the government's ability to accurately quantify producers' needs for water, infrastructure, seeds, fertilizers, training, and credit and to target support programs to enhance their productivity. The challenges that impact agricultural productivity also hinder climate resilience, as farmers struggle to adopt resilience-building agricultural technologies and good farming practices. Agricultural practices, which are responsible for 90 percent of deforested land, will need to change to stem deforestation. Additionally, the recent introduction of the Regulation on Deforestation-Free Products (EUDR) by the European Union (EU) aims to minimize the EU’s contribution to global deforestation by promoting the consumption of 'deforestation-free' commodities.49 For this, the EUDR requires companies to provide precise geolocation coordinates (latitude and longitude) for all plots of land where the relevant commodities are produced, a condition that can be also be fulfilled by geolocation data of agricultural producers.50 In the absence of appropriate targeting of public services, this regulation will disproportionately affect small farm-holders.51 Finally, inadequate service provision disproportionately affects female agricultural producers who face additional disadvantages in the sector compared to men. Women are less likely than men to receive monetary compensation for their agricultural production, less likely to head agricultural production units, have lower access to land, and lag behind men in access to technical assistance and credit from the public sector.52 52. Substance of the Prior Action. MIDAGRI has issued the mandatory methodology for the registration and geolocation of all agricultural producers. The reform outlines the operation of the Registry of Agricultural Producers and their Organizations in the Value Chains (Padrón de Productores Agrarios y sus Organizaciones en las Cadenas de Valor, PPA) which will be applied to the entire population of agricultural producers in the country.53 The establishment and operation of the PPA is a prerequisite to effectively providing agricultural producers with productivity-enhancing public services, as it will help to improve MIDAGRI’s design of government interventions in the sector, including financial support programs, as well as to accurately quantify the impact of these programs. For this, the reform enables the PPA to register all agricultural producers through a unique digital producer ID54, collect and verify the geolocation coordinates of their plots, identify their service needs to enhance agricultural performance, continuously update the gathered information, and help to assess the performance and climate risks of agricultural value chains. Also, mandated interoperability with other government databases, such as GeoBosques, will help to verify whether plots are deforestation-free and to monitor 49 Regulation (EU) 2023/1115 of the European Parliament and of the Council of 31 May 2023 on the making available on the Union market and the export from the Union of certain commodities and products associated with deforestation and forest degradation and repealing Regulation (EU) No 995/2010. Accessed: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32023R1115&qid=1687867231461. This regulation seeks to minimize the EU’s contribution to global deforestation, greenhouse gas emissions, and biodiversity loss driven by reducing the consumption of specific commodities that are produced in deforested land. Article 3 of the EUDR mandates that companies involved in the trading of cocoa, coffee, palm oil, livestock, rubber, soy, and timber—of which cocoa, coffee, and palm oil are the most relevant for Peruvian exports to the EU —conduct a due diligence assessment throughout their supply chains to ensure that relevant commodities do not originate from land deforested after December 31, 2020. 50 EUDR. Article 9 1(d). World Bank (2023) identified the main gaps in compliance with the EUDR and provided detailed recommendations for closing those gaps, including the need to establish a national database with geolocation data for EUDR relevant commodities. 51 85 percent of agricultural producers are small farmers with plots under 5 hectares. 52 According to MIDAGRI, 58 percent of all non-remunerated workers in agriculture are women and 31 percent of heads of agricultural production units are female. On average the size of men-led agricultural production units is 2.1 hectares while only 1.3 hectares for women. Although only 12 percent of male producers receive technical assistance support, the female share is lower at 8 percent. Of all the loans provided to agricultural producers by AGROBANCO, 36 percent were to women producers. 53 According to Section 7.1.5, personal data is required to be collected and shared in accordance with applicable national data privacy protection laws and regulations, must be used solely for statistical purposes and anonymized, and may not be used for police or tax purposes. 54 Section 7.2.2.7 23 for their deforestation risks.55 In turn, the PPA will help farmers, intermediaries, and exporters comply with the EUDR by providing readily available data to adhere to the regulation’s deforestation requirements. For women producers, the reform takes a step toward addressing some of the disadvantages they face in the sector by collecting data to accurately quantify gender gaps in public service access. This reform is aligned with the Peru's OECD accession roadmap, which covers agriculture policies to foster sustainability, including with respect to deforestation. The indicative trigger (Trigger 8) is additional regulatory reforms to prevent deforestation and support the competitiveness of the agroforestry sector. 53. Expected results. This reform is expected to enhance Peru's competitiveness in its agricultural value chains by improving productivity and promoting deforestation-free production. The data collected and processed by the PPA will allow the government to improve the provision and targeting of goods and services (e.g., seeds, fertilizers, extension services, training, credit) to all agricultural producers. In turn, enhanced provision of public services and support programs will help boost agricultural productivity of farmers by increasing their access to inputs, including financial resources, and promoting technology transfer, particularly benefiting disadvantaged producers like women farmers and small-holders. The PPA’s plot geolocation data and tree cover satellite imagery will verify that products come from non-deforested plots. This will also allow for better monitoring of deforestation by government authorities and private stakeholders in the value chains, enabling them to take early action to prevent further deforestation. In turn, this information collected in the PPA will facilitate Peru’s compliance with key EUDR requirements. The results indicator is that ,800,000 producers registered in the PPA will be geolocated with a verified location. Importantly, 30 percent of beneficiaries will be women, which correspond to the share they represent in the PPA universe.56 Table 5: DPF Prior Actions and Analytical Underpinnings Prior Actions Analytical Underpinnings Pillar A: Strengthen fiscal management • Beetsma, Roel, et al. "Independent fiscal councils: Recent trends and performance." European Journal of Political Economy 57 (2019): 53-69. • Davoodi, Hamid, et al. "Fiscal rules and fiscal councils: Recent trends and performance during the COVID-19 pandemic." IMF policy paper. International Monetary Fund (2022). Prior action #1 • Debrun, Xavier, et al. "The functions and impact of Fiscal Councils. IMF policy paper." International Monetary Fund 196 (2013). • Rivetti, D. (2021). Debt transparency in developing economies. World Bank. • Sánchez, Aida Caldera, et al. "Independent fiscal institutions: A typology of OECD institutions and a roadmap for Latin America." OECD (2024). • Interamerican Development Bank (2018). State-Owned Enterprises and Fiscal Risks in Peru. • International Monetary Fund (2020). Managing Fiscal Risks from State-Owned Enterprises Prior action #2 • Florian et al (20 ). Managing South Africa’s Exposure to Eskom. • World Bank (2022). Credit Rating Tool to Assess and Quantify Credit Risk from Public Corporations. • International Monetary Fund (2019). Tax revenues in Peru: Recent trends, policies and prospects. • Kiyoshi Nakayama (2021). Public disclosure of taxpayer information as a measure of to improve tax Prior action #3 compliance. IMF policy paper. • OECD (2022). Building strong tax foundations to enhance domestic resource mobilization in Peru. Tax and Development Case Study. 55 Section 7.2.2.8. GeoBosques is the Peruvian government online platform for monitoring changes in forest cover. The interoperability of the PPA with GeoBosques will allow the geolocated plots to be overlaid with tree cover satellite images to verify whether they are deforestation-free and to be monitored for deforestation risks. https://geobosques.minam.gob.pe/geobosque/view/index.php 56 Women represent close to 30 percent of producers in all agricultural value chains. As the PPA is a registry for all agricultural producers, all women producers are expected to be registered within the PPA, hence 30 percent of the total of 1.8 million producers. 24 The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) • OECD (2004). Information note on Compliance Risk Management: Audit Case Selection Systems. Prepared by the Forum on Tax Administration. • WBG’s Joint Capital Market Program (J-CAP) Sustainable Long-Term Finance Facility to support PPPs—including greening the PPP portfolio—in Peru. Prior action #4 • World Bank (2020) Policy Note on Attracting Private Investment to Infrastructure in Peru: Achievements, Challenges and a Way Forward. Pillar B: Foster a more productive and greener economy • Cirera, Xavier, and William F. Maloney (2017). The Innovation Paradox: Developing-Country Capabilities and the Unrealized Promise of Technological Catch-Up. Washington, DC: World Bank. • OECD (2022) Competition trends in Latin America and the Caribbean • OECD (2011), OECD Reviews of Innovation Policy, Peru • World Bank (2016), Strengthening the Science, Technology and Innovation System in Peru, Project Prior action #5 Appraisal Document • World Bank (2022), Strengthening Peru’s National Science, Technology and Innovation System, Project Appraisal Document • WIPO (2021) Global Innovation Index 2021, Geneva. • Kim, Young Eun and Loayza, Norman (2019), Productivity Growth: Patterns and Determinants Across the World, World Bank Policy Research Working Paper No. 8852. • World Bank (2024), Competition: The Missing Ingredient for Growth? Latin America and the Caribbean Economic Review. • Schiffbauer, Sampi, and Coronado (2022), Competition and Productivity: Evidence from Peruvian Municipalities, The Review of Economics and Statistics 1–45. • IMF 2022: Macroeconomic Effects of Market Structure Distortions: Evidence from French Cartels (2022) Prior action #6 • WB 2021 a: Repensar el futuro del Perú. Notas de política para transformar al Estado en un gestor del bienestar y el desarrollo (2021). • WB 2021 b: Fixing Markets Not Prices: Policy Options to Tackle Economic Cartels in Latin America (2021). • OECD 2018 a: OECD-IDB Peer Reviews of Competition Law and Policy: Peru (2018) • OECD 2018 b: Challenges and Co-Ordination of Leniency Programmes - Background Note by the Secretariat. DAF/COMP/WP3(2018) • World Bank – IMF (2018) Financial Sector Assessment Program (FSAP) in Peru. • World Bank (2020) Competition in Retail Banking Services in Latin America • World Bank (2022) Fintech and the Future of Finance Prior action #7 • World Bank (2023) Country Private Sector Diagnostic: Creating Markets in Peru • World Bank (forthcoming) Benchmarking Assessment of Fast Payments in Peru • INDECOPI (2023) Fintech Market Study • World Bank (2020), Developing a National Green Taxonomy, A World Bank Guide. Prior action #8 • Colombia Taxonomía Verde, (www.taxonomiaverde.gov.co), which was prepared by a joint WB-IFC team • World Bank (2023). Informe de resultados – Asistencia Técnica a Perú: Regulación europea sobre Prior Action #9 productos libres de deforestación. Lima, November 2023. 25 • OECD/FAO (2023). OECD-FAO Business Handbook on Deforestation and Due Diligence in Agricultural Supply Chains, OECD Publishing, Paris, https://doi.org/10.1787/c0d4bca7-en. 4.3. LINK TO CPF, OTHER BANK OPERATIONS AND THE WBG STRATEGY 54. The proposed operation is aligned with the WBG Country Partnership Framework for Peru FY23-FY27, discussed by the Board of Executive Directors on January 31, 2023 (Report No. 179046), and WBG corporate priorities. It addresses challenges related to promoting increased resilience against the impacts of natural disasters and other shocks through facilitating private investment in climate change adaptation and mitigation (PA 8). Moreover, it is linked to the CPF pillar on increasing access to economic opportunities by fostering competition and strengthening anticartel policy (PA 6) and strengthening the innovation ecosystem (PA 5). The WBG’s corporate priorities are also central in the operation by supporting reforms aimed at addressing climate change mitigation and adaptation (Trigger 4, PA 8 and Trigger 7, PA 9, and Trigger 8,) and the Maximizing Finance for Development agenda, including enabling private capital (as described in section 4.1). 55. Various projects under implementation complement the objectives of this operation. These include the Sustainable Growth and Finance DPF-DDO (P178591); Enabling a Green and Resilient Development DPF-DDO (P179214); Green and Resilient Development for a Decarbonized Economy in Peru (P181263); and Strengthening Peru’s National Science, Technology and Innovation System IPF (P176297, PA 9). Several WBG technical assistance activities also underpin the reforms supported by the operation, including on fiscal risk (PA 2), tax (PA 3), PPPs (PA 4), competition (PA 6), green finance (PA 8), and sustainable production for agroexports (PA 9). 4.4. CONSULTATIONS AND COLLABORATION WITH DEVELOPMENT PARTNERS 56. The objectives, pillars, policy actions and expected results of the operation have been defined in collaboration with the GoP’s key sectoral entities through a consultation process led by the MEF, which is the implementing agency for the DPL operation. In addition, the operation’s task team maintained a close dialogue with representatives from key line ministries, agencies, and sectoral entities, including Fiscal Council, MINAM, PCM, SUNAT, INDECOPI, CONCYTEC, BCRP, and MIDAGRI. For instance, for PA 9, MIDAGRI has had PPA awareness campaigns with producers. 57. Consultations. According to article 14 of Supreme Decree N º 001-2009-JUS, public agencies must publish the draft bills in the official gazette, in their electronic portals (websites) or by any other means, within a period of no less than thirty days before the date scheduled for the bill’s entry into force, except in exceptional cases, to enable citizens to comment on the proposed measures. The supported prior actions went through various consultation processes. For instance, the draft regulation for the innovation law (PA 5) was published on the CONCYTEC website in October 2023 to receive suggestions, comments and/or recommendations from public and/or private entities and citizens. It was also made available to all vice-ministries for comment through the Vice-ministerial Coordination Commission in May 2024 as part of the standard governmental process before being published as a Supreme. Another example is Parliamentary Law 31775 reforming the leniency policy to strengthen anticartel enforcement, which benefited from consultations with INDECOPI, the competition agency. The Green Finance Roadmap went through extensive consultations with key financial sector entities and development partners. 58. The operation, as part of the WBG’s broader program of support to Peru has benefited from close coordination with development partners. These include the IMF, Inter-American Development Bank (IADB), GIZ, UNEP-FI, and the UK Embassy and the Swiss State Secretariat for Economic Affairs (SECO). Several of the prior actions supported by this program are informed by long-standing technical assistance by the Bank and other development partners. 5. OTHER DESIGN AND APPRAISAL ISSUES 5.1. POVERTY AND SOCIAL IMPACT 26 The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) 59. Actions under Pillar A are expected to have positive indirect effects on poverty reduction. Maintaining and strengthening fiscal responsibility (PA 1) can contribute to poverty reduction by decreasing spending inefficiencies and ensuring that public savings increase during economic upturns to support the vulnerable population during downturns. Enhancing risk management (PA 2) is expected to positively impact social indicators through improved budget management, assuming better targeting of public spending. Promoting good practices in PPP management (PA 4) is expected to have indirect positive effects on poverty reduction through enhanced institutional capacity, more efficient allocation of public resources (e.g., investments to narrow gaps in infrastructure and the provision of public services) and attracting long-term investments that can create jobs and stimulate growth. 60. Actions under Pillar B are expected to have positive indirect effects on poverty reduction by fostering more inclusive growth and creating opportunities for disadvantaged populations. Research and innovation can raise productivity and promote more inclusive and resilient growth, which is key for poverty reduction (PA 5). Fostering competition can benefit the poor by reducing relative prices on essential goods and promote innovation (IMF, 2021) (PA 6). Enhancing financial inclusion can reduce poverty by facilitating digital payments (World Bank, 2023), smoothing consumption, supporting productive activities (Park & Mercado, 2015), and improving risk management and coping strategies, particularly in rural areas (Frisancho & Valdivia, 2020) (PA 7). Geolocating smallholder farmers can contribute to poverty reduction by connecting with reliable markets for their products. This link between small-scale farmers and buyers can lead to increased consumption of locally produced food, resulting in higher income for farmers (FAO, 2017) (PA 9). 5.2. ENVIRONMENTAL, FORESTS, AND OTHER NATURAL RESOURCE ASPECTS 61. The policies and measures supported through this operation are expected to have an overall significantly positive impact on Peru’s environment, forests, and other natural resources. There is no likely negative effect expected from this operation. In the event negative environmental impacts arise, Peru has a robust system for their adequate management, as explained below. Prior Actions 1, 2, 3, 7 and 8 are anticipated to have a neutral impact on Peru’s environment and natural resources. PA 4 is expected to yield a positive impact by aligning PPPs resources with sustainability principles. Similar positive impacts could come from PA 5, which aims to align STI initiatives with environmental needs, ultimately leading to more sustainable growth. PA 8 is likely to have a positive impact as Peru’s Green Finance Roadmap and Green Taxonomy is expected to enhance the alignment of financial sector policies, regulations, and incentives with national environmental goals, and therefore result in increased capital flows towards the achievement of environmental goals while increasing tracking and measuring systems. Lastly, PA 9, which promotes the use of 'deforestation-free' labeled products for exports, is expected to contribute to the reduction of deforestation by improving product traceability and due diligence. It should help facilitate introducing comprehensive assessments throughout the supply chain, including localizing data and enhancing information accessibility. 62. The Ministry of Environment (MINAM) was created in 2008, and since that time, the GoP has adopted several policy measures to curb environmental pollution and address environmental vulnerabilities. At the same time, Peru has invested in developing institutional capacity to monitor and enforce compliance with national environmental legislation through MINAM and the Environmental Assessment Control Agency, including through previous and ongoing World Bank support. To manage any potential impacts, Peru’s environmental regulation incorporates the necessary mitigation measures and is accompanied by enforcement capacity to adequately manage such risks. Investments with potential adverse impacts will be managed mainly through SEIA Law Nº 27446 and its Decree Nº 019-2009-MINAM, which require the developing an environmental impact assessment for projects that may cause negative environmental impacts. 5.3. PFM, BUDGET, AND FOREX ASPECTS 27 63. Peru’s PFM framework is aligned with best international practices. The use of budget resources, and its foreign exchange (FOREX) internal control environment as managed by the Central Bank do not pose material risks to the development objectives of the operation. Peru’s budgeting practices meet most of the principles of the IMF Fiscal Transparency Code at a good or advanced level, and it ranks 61 out of 100 in the Open Budget Survey.57 Although moderate shortcomings exist, they do not pose material risks to the operation’s development objectives. The areas for improvement include challenges in the medium-term budget planning, which are reflected in constant incremental changes in the initially approved budget compared to the executed budget. 64. Budget credibility, comprehensiveness, transparency, and control in budget execution are reflected in the budget policy which is formulated using a Multiannual Macroeconomic Framework. The legal framework sets clear procedures for the preparation, approval, and execution of the budget. The transparency section of the MEF’s website allows access to information on budget execution and reports which can be obtained on programmatic, functional, and administrative classifications. Budget execution, STA, and monitoring is done through the integrated financial management system (SIAF). 65. Foreign exchange management. The published audited financial statements of the Central Bank for 2022 were reviewed and they are aligned with International Financial Reporting Standards.58 The audit was carried out in accordance with the International Standards on Auditing by an audit firm acceptable to the World Bank. Unmodified audit opinions did not reveal significant issues related to the internal control environment, and the FOREX internal control environment does not pose risks to the development objectives of this operation. 66. Disbursement and auditing arrangements. Upon effectiveness of the Loan Agreement, and satisfaction of the applicable withdrawal conditions, the Borrower may submit a disbursement application requesting the loan proceeds to be disbursed into an account at the Central Bank, which is part of the country’s Foreign Exchange Reserves. The withdrawal applications may be submitted up to Closing Date. The funds will then be transferred into the Single Treasury Account managed by MEF at Banco de la Nación. Transactions and balances will be fully incorporated into the GoP’s accounting records and financial statements through SIAF. The GoP, within 45 days after the withdrawal of the funds from the financing account, shall report to the Bank: (i) the exact sum received into the account referred to in Section 2.03 (a) of the General Conditions; (ii) the details of the account to which the local currency equivalent of the Loan proceeds was credited; and (iii) the record that an equivalent amount has been accounted for in the GoP’s budget management systems. Given that the control environment into which the DPFs proceeds would flow is adequate, the World Bank will not require a dedicated account at the Central Bank for managing loan proceeds. On this basis, no specific audit of the deposit of the credit proceeds will be required and no additional fiduciary arrangements are considered necessary. 67. Public Procurement System. Public procurement is governed by the Ley de Contrataciones del Estado (“Public Procurement Law”), its amendments and rulings, which establish the criteria to carry out procurement with transparency, efficiency, competitivity, equality and integrity. The Public Procurement Law complies with good international practices related to the control of public procurement regarding independent control institutions and the existence of defined mechanisms to control under the direction of the General Comptroller. The electronic public procurement system (Sistema Electrónico de Adquisiciones y Contrataciones del Estado, SEACE) is mandatory, easily accessible, and free for all user levels, providing information on contracting procedures. Therefore, no major procurement risks related to the implementation of the Prior Actions are expected. Moreover, modifications to the regulation of the public procurement law were approved in April 2024, and a draft new public procurement law is in the process of discussion/approval between Congress and the Executive. 57 https://internationalbudget.org/open-budget-survey/country-results/2021/peru 58 Given that an IMF Safeguard Assessment Report has not been done since 2007. 28 The World Bank Peru First Fiscal Policy and Sustainable Growth DPF-DDO (P180554) 5.4. MONITORING, EVALUATION AND ACCOUNTABILITY 68. As implementing entities, MEF is responsible for collecting and monitoring information related to program implementation and progress towards the achievement of results for this DPL operation. MEF is further responsible for coordinating necessary actions among the agencies involved in the reform program supported by this DPL operation, which include MEF, Fiscal Council, MINAM, PCM, INDECOPI, CONCYTEC, BCRP, and MIDAGRI. The World Bank has worked closely with MEF and relevant sectoral entities to define results indicators that are clear and measurable. The Bank will focus on monitoring progress towards the expected results of the program development objectives. 69. Grievance Redress. Communities and individuals who believe that they are adversely affected by specific country policies supported as Prior Actions or tranche release conditions under a World Bank Development Policy Financing may submit complaints to the responsible country authorities, appropriate local national grievance mechanisms, or the Bank’s Grievance Redress Service (GRS). The GRS ensures that complaints received are promptly reviewed to address pertinent concerns. Project affected communities and individuals may submit their complaints to the Bank’s independent Accountability Mechanism (AM). The AM houses the Inspection Panel, which determines whether harm occurred, or could occur, as a result of Bank's non-compliance with its policies and procedures, and the Dispute Resolution Service, which provides communities and borrowers with the opportunity to address complaints through dispute resolution. Complaints may be submitted at any time after concerns have been brought directly to the World Bank’s att ention, and Bank Management has been given an opportunity to respond. For information on how to submit complaints to the World Bank’s corporate Grievance Redress Service (GRS), please visit http://www.worldbank.org/GRS. For information on how to submit complaints to the Bank’s Accountability Mechanism, please visit https://accountability.worldbank.org. 6. SUMMARY OF RISKS AND MITIGATION 70. The overall risk rating for the proposed operation is assessed as Moderate. The key risk ratings are included in the table below. The major risk identified is political and governance. 71. Political and Governance Risks are considered Substantial. Peru is undergoing a period of substantial political uncertainty. Low popular support both for the executive and Congress, along with high political fragmentation and lack of strong political parties in Peru, underscores the uncertainty of its political institutions and lack of political consensus. The frequent turnover at the Ministerial level may persist during the implementation period of the proposed program, posing a risk of slower program implementation and/or changes to government priorities. To mitigate these risks, the following measures have been established: (i) securing a high-level of commitment of the administration to the proposed reforms through ongoing policy dialogue; (ii) having a continuous engagement with key Government bodies, including through ongoing TA, to assure that new Government officials are aware of the Program’s objectives and intended results; and (iii) closely monitoring potential political and governance risks related to the operation throughout implementation. Since political turnover cannot be foreseen or fully mitigated, its impact on achieving the operation’s development outcome is considered Substantial (residual risk). Table 1: Summary Risk Ratings @#&OPS~Doctype~OPS^dynamics@padrisk#doctemplate Risk Categories Rating 1. Political and Governance ⚫ Substantial 29 2. Macroeconomic ⚫ Moderate 3. Sector Strategies and Policies ⚫ Moderate 4. Technical Design of Project or Program ⚫ Moderate 5. Institutional Capacity for Implementation and Sustainability ⚫ Moderate 6. Fiduciary ⚫ Moderate 7. Environment and Social ⚫ Moderate 8. Stakeholders ⚫ Moderate 9. Other ⚫ Overall ⚫ Moderate 30 The World Bank Peru First Fiscal Policy and Growth DPF-DDO (P180554) ANNEX 1: POLICY AND RESULTS MATRIX DETAILED RESULTS FRAMEWORK Prior actions and Triggers Results Prior Actions under DPF 1 Triggers for DPF 2 Indicator Name Baseline Target Pillar A: strengthen fiscal management Prior Action 1. To enhance the effectiveness of the Fiscal Council, the Borrower has a) enacted the Law for the Strengthening of the Fiscal Council and (b) approved a decree that enhances its Results Indicator 1: Share of the transparency protocols. Fiscal Council’s Technical Secretariat staff that are 0 (2023) 100 (2026) incorporated in the Civil Service Evidence: (a) Law No. 31681 published in the regime (percent). Official Gazette on February 3, 2023, and (b) Supreme Decree Nº 037-2023-EF, as published in the Official Gazette on March 17, 2023. Prior Action 2. To strengthen the fiscal risk framework, the Borrower, through DGTP, has mandated the assignment of risk ratings of all SOEs Trigger 1. To continue strengthening the Results Indicator 2: Share of SOEs under FONAFE for MEF to manage the related fiscal risk framework, the Borrower has under FONAFE with an assigned risks. approved regulations to quantify fiscal risks credit risk rating informing the 0 (2024) 100 (2026) from PPPs and legal cases. Fiscal Risk Statement (percent). Evidence: Directorial Resolution No. 012-2023- EF/52.01 published in the Official Gazette on January 1, 2024. 31 Prior actions and Triggers Results Prior Action 3. To facilitate the reduction of tax Results Indicator 3a: Corporate evasion and promote a better management of 1.2 million income taxpayers with a tax 0 (2024) government revenues, the Borrower has approved (2026) compliance profile (number). the regulations establishing (a) the methodology for assigning tax compliance profiles to taxpayers, Trigger 2. To facilitate better management of and (b) the procedure for identifying companies as government revenues, the Borrower has “subjects without operational capacity ”, whose established a mechanism to collect VAT for invoices are ineligible to be used for VAT credits or digital services/products from foreign Results Indicator 3b: SUNAT income tax deductions. suppliers. identifies and publishes No (2024) Yes (2026) companies that are “subjects without operational capacity”. Evidence: (a) Supreme Decree No. 320-2023-EF published in the Official Gazette on December 30, 2023, and (b) Supreme Decree No. 319-2023-EF Results Indicator 3c: Revenues published in the official Gazette on December 30, from VAT for digital 2023. services/products from foreign 0 (2023) 0.1 (2026) suppliers (percent of GDP). Prior Action 4. To enhance the efficiency of PPPs, the Borrower, through MEF, has enhanced budget predictability for PPP projects by requiring Trigger 3. To enhance the efficiency and contracting authorities to declare up-front the sustainability of investments, the Borrower required budget allocation through project has amended the Reglamento de Results Indicator 4. PPP project completion. preparation time in planning and 18 (2024) 11 (2026) Organización y Funciones that dictates the establishment of the OEGEP within the formulation stages (months). Evidence: Supreme Decree No. 182-2023-EF ministry or contracting authority. published in the Official Gazette on August 23, 2023. Pillar B: Foster a more productive and greener economy 32 The World Bank Peru First Fiscal Policy and Growth DPF-DDO (P180554) Prior actions and Triggers Results Prior Action 5. To strengthen the National Science, Technology, and Innovation System (SINACTI), the Borrower, through the Presidency of the Council of Ministers, has issued the SINACTI Law’s implementing Trigger 4. To strengthen the innovation regulations, bringing that law into force, establishing ecosystem, the Borrower has amended Results Indicator 5. Share of CONCYTEC as the national STI governing body, and CONCYTEC’s Reglamento de Organización y regional governments that have 0 (2024) 25 (2026) articulating SINACTI’s governance and coordination Funciones and approved the National STI an operational STI unit (percent). mechanisms, including the roles and responsibilities Policy, which includes priority services of regional governments. related to climate change. Evidence: Supreme Decree No. 062-2024-PCM published in the Official Gazette on June 23, 2024. Prior Action 6. To strengthen competition, the Trigger 5. To enable efficiency enhancing Borrower has enabled courts to exempt from criminal agreements among market players including sanctions the first cartel member uncovering the those geared towards promoting Results Indicator 6. Increase in cartel. sustainability goals, the Borrower has number of anticompetitive 0 (2024) 30% (2026) published a resolution with a framework for practices eliminated (percent). Evidence: First Final Complementary Provision of Law firms to cooperate while respecting No. 31775, published in the Official Gazette on June competition safeguards in accordance with 7, 2023. the Competition Law. Prior Action 7: To promote digital transformation, BCRP has issued regulations that allow non-bank e- money issuers and financial cooperatives to Trigger 6. To promote digital financial inclusion, participate in retail payments infrastructures. the Borrower has enhanced the legal framework Results Indicator 7. Population 12.4 million 16.0 million for payment service providers to encompass using digital payments (adults (2021) (2026) Evidence: Circular No. 0010-2023-BCRP published in Fintech innovations and facilitate the entry of ages 15+) (number) the Official Gazette on June 28, 2023, and Circular No. new players into the market. 0021-2023-BCRP published in the Official Gazette on November 8, 2023. Prior Action 8. To facilitate private investment in climate mitigation and adaptation, the Borrower has Trigger 7. To facilitate private investment in Results Indicator 8. Financial USD 7.4 approved the Green Finance Roadmap for Peru, a tool climate mitigation and adaptation, the Borrower sector assets that are green 0 (2024) billion for aligning public and private financial sector has adopted the Green Taxonomy. according to the Green (2026) stakeholders’ policies, regulations, and incentives 33 Prior actions and Triggers Results with national climate goals through the execution of a Taxonomy (USD).59 series of concrete proposed activities. Evidence: Supreme Decree N° 007-2023-MINAM published in the Official Gazette on June 21, 2023. Prior Action 9. To foster agricultural competitiveness and deforestation-free exports, the Borrower has established the mandatory methodology for the Results Indicator 9. Number of 1,800,000, registration and geolocation of agricultural producers, Trigger 8. The Borrower has improved sectoral producers registered in the PPA of which enabling better targeting of agricultural support regulations to reduce deforestation and support that are geolocated with a 0 (2024) 30% are services by MIDAGRI. the competitiveness of the agroforestry sector. verified location, % of which women women. (2026) Evidence: Ministerial Resolution No. 0049-2024- MIDAGRI dated March 18, 2024. @#&OPS~Doctype~OPS^dynamics@paddpfannexpolicyandresult#doctemplate RESULTS INDICATORS BY PILLAR Baseline Closing Period Strengthen fiscal management Share of technical Fiscal Council staff that are incorporated in the Civil Service regime (Percentage) Nov/2023 Jun/2026 0 100 Share of SOEs under FONAFE with an assigned credit risk rating informing the Fiscal Risk Statement. (Percentage) Jan/2024 Jun/2026 0 100 Corporate income taxpayers with a tax compliance profile (Number) Jan/2024 Jun/2026 59 Includes banks, pension funds, and insurance companies. 34 The World Bank Peru First Fiscal Policy and Growth DPF-DDO (P180554) 0 1.2 million SUNAT identifies and publishes companies that are “subjects without operational capacity” (Yes/No) Jan/2024 Jun/2026 No Yes Revenues from VAT for digital services/products from foreign suppliers (percent of GDP) (Percentage) Jul/2024 Jun/2026 0 0.1 PPP project preparation time in planning and formulation stages (Months) Jan/2024 Jun/2026 18 11 Foster a more productive and greener economy Share of regional governments that have an operational STI unit (Percentage) Jan/2024 Jun/2026 0 25 Increase in number of anticompetitive practices eliminated (Percentage) Nov/2023 Jun/2026 0 30 Population using digital payments (adults ages 15+) (Number) Dec/2021 Jun/2026 12.4 million 16.0 million Financial sector assets that are green according to the Green Taxonomy (Amount(USD)) May/2024 Jun/2026 0 7.4 billion Producers registered in the PPA that are geolocated with a verified location, % of which women (Number) Jan/2024 Jun/2026 0 1,800,000, of which 30% are women (2026) 35 ANNEX 2: FUND RELATIONS ANNEX 36 The World Bank Peru First Fiscal Policy and Growth DPF-DDO (P180554) 37 38 The World Bank Peru First Fiscal Policy and Growth DPF-DDO (P180554) ANNEX 3: LETTER OF DEVELOPMENT POLICY 39 40 The World Bank Peru First Fiscal Policy and Growth DPF-DDO (P180554) 41 42 The World Bank Peru First Fiscal Policy and Growth DPF-DDO (P180554) 43 44 The World Bank Peru First Fiscal Policy and Growth DPF-DDO (P180554) 45 46 The World Bank Peru First Fiscal Policy and Growth DPF-DDO (P180554) 47 ANNEX 4: ENVIRONMENT AND POVERTY/SOCIAL ANALYSIS TABLE Significant poverty, social or Prior Actions Significant positive or negative environment effects distributional effects positive or negative Operation Pillar A: Strengthen fiscal management Positive/indirect impact by decreasing Neutral impact. The Law Nº 31681 and Supreme spending inefficiencies and ensuring Decree Nº 037-2023-EF to fortify the institutional Prior action #1 that public savings increase in good framework of the Fiscal Council are expected to have a times to support the vulnerable neutral impact on natural resources. population during crises. Neutral impact. The Directorial Resolution No. 012- Positive/indirect impact through 2023-EF/52.01 to strengthen the fiscal risk framework Prior action #2 improved budget management, is expected to have a neutral impact on natural assuming better targeting of the poor. resources. Positive/indirect impact through Neutral impact. The incentives for reduction of tax improved redistribution in the medium evasion related with approving the methodology for term. In the short term, enhanced tax assigning tax compliance profiles to taxpayers, and (b) compliance may increase operating Prior action #3 the procedure for identifying companies as “subjects costs for MSMEs, and reduce without operational capacity” e are expected to have a employment opportunities of the poor neutral impact on natural resources. (overrepresented in these firms). Positive impact. A positive impact is expected from the alignment of PPPs resources with sustainability principles. PA 4 trigger related with ¨The Sustainability- Positive/indirect impact through Prior action #4 Linked Bond Framework¨ is expected to mobilized enhanced institutional capacity, more resources to achieve environmental goals. efficient allocation of public resources Operation Pillar B: Foster a more productive and greener economy Positive/indirect impact through Positive impact. This PA aims to align STI initiatives increased productivity and more Prior action #5 with environmental needs, ultimately leading to more inclusive and resilient growth, which is sustainable growth. key for poverty reduction. Neutral impact. Regulatory framework for Positive impact by reducing relative Prior action #6 competition and anticartel policy is expected to result prices on essential goods and in neutral impacts for the environment. promoting innovation. Neutral impact. Issuing regulation to advance Positive impact by facilitating digital Prior action #7 interoperability by allowing non-bank e-money issuers payments, smoothing consumption, 48 The World Bank Peru First Fiscal Policy and Growth DPF-DDO (P180554) and financial cooperatives to participate in retail supporting productive activities, and payments infrastructures is expected to result in improving risk management and coping neutral impacts for the environment. strategies, particularly in rural areas. Positive impact. Peru’s Green Finance Roadmap is expected to increase alignment of financial sector policies, regulations, and incentives with national Positive/indirect impact by increasing Prior action #8 environmental goals, and therefore result in an the investment in climate mitigation increased capital flows towards the achievement of environmental goals. Positive impact. PA 9, which promotes the use of 'deforestation-free' labeled products for exports, is anticipated to positively impact the environment. This Positive impact by facilitating the action is expected to contribute to the reduction of connection of smallholder coffee, Prior action #9 deforestation by improving product traceability and cacao, and palm farmers to reliable due diligence. It will involve the introduction of markets, leading to increase local food comprehensive assessments throughout the supply consumption and higher incomes. chain, which includes the localization of data and the enhancement of information accessibility. 49 ANNEX 5: PARIS ALIGNMENT ASSESSMENT TABLE Program Development Objective: The Program Development Objective is to support Government reforms to a) strengthen fiscal management, and b) foster a more productive and greener economy. Taking into account our The DPF reform program is consistent with the country’s climate climate analysis (e.g., Country commitments, including the updated NDC (December 2020) and the National Climate and Development Adaptation Plan (June 202 ), and it considers the climate analysis in Peru’s Reports or CCDRs), is the CCDR (November 2022). Namely, the program seeks to enhance the operation consistent with the efficiency and sustainability of investments, align public finance with climate, country climate as well as facilitate private investment in climate mitigation and adaptation. commitments, including for instance, the NDC, NAP, LTS, and other relevant strategies? Mitigation goals: assessing and reducing the risks Pillar A: STRENGTHEN FISCAL MANAGEMENT Prior Action 1: Strengthening the Fiscal Council Step M2.1: Is the prior action Answer: No Explanation: The prior action supports the reinforcement of the likely to cause a significant Fiscal Council’s independence and the strengthening of its technical capacity. increase in GHG emissions? It does not involve any activities that would cause significant increase in GHG emissions. Conclusion for PA 1: The measure supported by the prior action is not likely to have any direct mitigation or emissions generating impacts, consequently, it can be considered aligned on mitigation. Prior Action 2: Strengthening the fiscal risk framework Step M2.1: Is the prior action Answer: No. Explanation: This prior action focuses on enhancing likely to cause a significant management and monitoring of fiscal risks to ensure macroeconomic increase in GHG emissions? sustainability and underpin market confidence. Conclusion for PA 2: The measure supported by the prior action is not likely to have any direct mitigation or emissions generating impacts, consequently, it can be considered aligned on mitigation. Prior Action 3: Reducing tax evasion Step M2.1: Is the prior action Answer: No. Explanation: The prior action supports regulation to encourage likely to cause a significant voluntary compliance with tax and non-tax obligations, to avoid tax evasion. increase in GHG emissions? It does not involve any significant increase in GHG emissions. Conclusion for PA 3: The measure supported by the prior action is not likely to have any direct mitigation or emissions generating impacts, consequently, it can be considered aligned on mitigation. 50 The World Bank Peru First Fiscal Policy and Growth DPF-DDO (P180554) Prior Action 4: Enhancing the efficiency of PPPs Step M2.1: Is the prior action Answer: No. Explanation: This prior action focuses on bringing more likely to cause a significant efficiency in the PPP project preparation process, to ensure thorough increase in GHG emissions? oversight and responsible use of public funds. The modifications are expected to enhance transparency and prudent management of public resources within PPP projects, aligning them with sustainability principles. It does not involve any significant increase in GHG emissions. Conclusion for PA 4: The measure supported by the prior action is not likely to have any direct mitigation or emissions generating impacts, consequently, it can be considered aligned on mitigation. Pillar B: FOSTER A MORE PRODUCTIVE AND GREENER ECONOMY Prior Action 5: Strengthening the innovation system Step M2.1: Is the prior action Answer: No. Explanation: The prior action strengthens the governance and likely to cause a significant coordination across the elements of Peru’s National Science, Technology and increase in GHG emissions? Innovation System, with the purpose of promoting research and innovation. Conclusion for PA 5: The measure supported by the prior action is not likely to have any direct mitigation or emissions generating impacts in the short term and has potential of supporting GHG reduction in the longer term. Consequently, it can be considered aligned on mitigation. Prior Action 6: Fostering competition and strengthening anticartel policy Step M2.1: Is the prior action Answer: No. Explanation: The prior action is focused on exempting the first likely to cause a significant successful leniency applicant from criminal liability, thus incentivizing increase in GHG emissions? collaboration with the Competition authority. Conclusion for PA 6: The measure supported by the prior action is not likely to have any direct mitigation or emissions generating impacts, consequently, it can be considered aligned on mitigation. Prior Action 7: Promoting digital transformation Answer: No. Explanation: The prior action is expected to foster greater digital Step M2.1: Is the prior action financial inclusion by enhancing the accessibility and utility of digital likely to cause a significant payments, enabling innovations in product design, and helping to foster a shift increase in GHG emissions? away from cash. Digital activities are considered universally aligned according to current regulations. Conclusion for PA7: The measure supported by the prior action is not likely to have any direct mitigation or emissions generating impacts, consequently, it can be considered aligned on mitigation. Prior Action 8: Facilitating private investment in climate mitigation and adaptation 51 Step M2.1: Is the prior action Answer: No. Explanation: On the contrary, this prior action focuses on likely to cause a significant mobilizing private capital for investments linked to addressing climate change. increase in GHG emissions? The Green Finance Roadmap is a tool for aligning efforts with climate and environmental goals. Examples of activities proposed by the GFR include developing a Green Taxonomy conducting a regulatory gap assessment and recommending improvements to green finance regulations; developing new green finance instruments; measuring the participation of private financial sector entities in green finance; and implementing programs to increase their participation. Conclusion for PA 8: The measure supported by the prior action is intended to reduce GHG emissions and can be considered aligned on mitigation. Prior Action 9. Fostering agricultural competitiveness and deforestation-free exports Step M2.1: Is the prior action Answer: No. Explanation: The prior action is intended to improve monitoring likely to cause a significant to avoid emissions from deforestation and be able to comply with the EU’s increase in GHG emissions? Regulation on deforestation-free products (EUDR). Conclusion for PA 9: The measure supported by the prior action is not likely to cause an increase in GHG emissions but rather intended to reduce them, consequently, it can be considered aligned on mitigation. Mitigation goals: All prior actions are aligned on mitigation. Adaptation and resilience goals: assessing and managing the risks Pillar A: STRENGTHEN FISCAL MANAGEMENT Prior Action 1: Strengthening the Fiscal Council Step A2: Are risks from Answer: No. Explanation: This prior action’s development impact is not climate hazards likely to have expected to be threatened by climate risks. On the contrary, the prior action an adverse effect on the prior strengthens the country’s fiscal sustainability in the context of adverse action’s contribution to the climate events by ensuring that the Fiscal Council can appropriately measure Development Objective(s)? and assess the fiscal impacts and risks of these events. Conclusion for Prior Action 1: This prior action’s development impact is not expected to be threatened by climate risks. Prior Action 2: Strengthening the fiscal risk framework Step A2: Are risks from Answer: No. Explanation: This prior action’s development impact is not climate hazards likely to have expected to be threatened by climate risks. On the contrary, strengthening an adverse effect on the prior the fiscal risk management framework will help reduce Peru’s vulnerability to 52 The World Bank Peru First Fiscal Policy and Growth DPF-DDO (P180554) action’s contribution to the external shocks by creating fiscal buffers to respond to shocks and maintain Development Objective(s)? fiscal stability in the face of shocks. Conclusion for Prior Action 2: This prior action’s development impact is not expected to be threatened by climate risks. Prior Action 3: Reducing tax evasion Step A2: Are risks from Answer: No. Explanation: This prior action’s development impact is not climate hazards likely to have expected to be threatened by climate risks. The measure is constrained to an adverse effect on the prior the provision of incentives for tax compliance, hence material and physical action’s contribution to the climatic risks are not expected to hinder its execution. Development Objective(s)? Conclusion for Prior Action 3: This prior action’s development impact is not expected to be threatened by climate risks. Consequently, it can be considered aligned on adaptation. Prior Action 4: Enhancing the efficiency of PPPs Answer: No. Explanation: The measures are expected to enhance Step A2: Are risks from transparency and prudent management of public resources within PPP climate hazards likely to have projects, aligning them closely with national budget requirements and an adverse effect on the prior sustainability principles. Hence material and physical climatic risks are not action’s contribution to the expected to hinder its execution. In addition, as per the sustainability Development Objective(s)? principles adopted by the government, PPPs must take into account climate considerations, whether mitigation or adaptation, in every project. Conclusion for Prior Action 4: This prior action’s development impact is not expected to be threatened by climate risks. Consequently, it can be considered aligned on adaptation. Pillar B: FOSTER A MORE PRODUCTIVE AND GREENER ECONOMY Prior Action 5: Strengthening the innovation system Step A2: Are risks from Answer: No. Explanation: Research and innovation are powerful drivers of climate hazards likely to have competitiveness and productivity, as well as critical contributors to solutions an adverse effect on the prior for climate change. The prior action is constrained to the strengthening action’s contribution to the governance and coordination across elements of the Innovation authority. Development Objective(s)? Thus, climate risks are not expected to hinder its execution. 53 Conclusion for Prior Action 5: This prior action’s development impact is not expected to be threatened by climate risks. Consequently, it can be considered aligned on adaptation. Prior Action 6: Fostering competition and strengthening anticartel policy Step A2: Are risks from Answer: No. Explanation: The measure is constrained to the provision of climate hazards likely to have incentives for collaboration with the Competition authority, hence material an adverse effect on the prior and physical climatic risks are not expected to hinder its execution. action’s contribution to the Development Objective(s)? Conclusion for Prior Action 6: This prior action’s development impact is not expected to be threatened by climate risks. Consequently, it can be considered aligned on adaptation. Prior Action 7: Promoting digital transformation Answer: No. Explanation: Climate hazards are not expected to impact the implementation of the regulations to advance interoperability. Furthermore, Step A2: Are risks from the prior action is expected to foster greater digital financial inclusion by climate hazards likely to have enhancing the accessibility and utility of digital payments, enabling an adverse effect on the prior innovations in product design, and helping to foster a shift away from cash. action’s contribution to the In fact, greater digital financial inclusion is expected to increase the resilience Development Objective(s)? of vulnerable populations during economic and climatic shocks by enabling them to access financial support from social networks and governments at times of most need. Conclusion for Prior Action 7: This prior action’s development impact is not expected to be threatened by climate risks. Consequently, it can be considered aligned on adaptation. Prior Action 8: Facilitating private investment in climate mitigation and adaptation Step A2: Are risks from Answer: No. Explanation: The measure supported by this prior action climate hazards likely to have includes raising awareness among financial sector firms and regulators about an adverse effect on the prior climate-related risks and opportunities. Ultimately, the goal is to meet Peru’s action’s contribution to the investment needs related to climate adaptation and mitigation, which are Development Objective(s)? large and critical for addressing climate change. Conclusion for Prior Action 8: This prior action’s development impact is not expected to be threatened by climate risks. Consequently, it can be considered aligned on adaptation. Prior Action 9. Fostering agricultural competitiveness and deforestation-free exports 54 The World Bank Peru First Fiscal Policy and Growth DPF-DDO (P180554) Step A2: Are risks from Answer: No Explanation: Climate hazards are not likely to have an adverse climate hazards likely to have effect on the operationalization of the geolocation technology. In addition, an adverse effect on the prior this could be helpful to identify damages on the ground in the face of an action’s contribution to the extreme weather event. Development Objective(s)? Conclusion for Prior Action 9: This prior action’s development impact is not expected to be threatened by climate risks. Consequently, it can be considered aligned on adaptation. Adaptation and resilience: All prior actions are aligned on adaptation and resilience. The adaptation risks are low. OVERALL CONCLUSION OF PARIS ALIGNMENT ASSESSMENT: The operation is aligned with the goals of the Paris Agreement. 55