A runner stumbles: caught off guard by protest, Peru downshifts on privatization. (Currents: Economy).

Peru's privatization drive used to be quite a cash cow. Since 1993, more than US $5.5 billion has poured into the country from the sale of state properties ranging from telephone services to electricity and mining assets.

Now it has come to this: A petting zoo sell-off has become the government's model, at least for when it comes to convincing voters, that state asset sales have a future in Peru.

Protests hobbled efforts to tender two electric distributors, Empresa de Generacion Electrica de Arequipa (Egasa) and Empresa de Generacion Electrica del Sur (Egesur)--expected to go for $167 million--and sent the government's finance team packing. Peru's next big deal was to pick up 35% in entrance fees over 20 years at the tattered Huachipa zoo and recreational center near Lima, in exchange for $3 million in improvements from a concession to a Peruvian-Argentine group.

But the collapse of the distributors sale, in mid-June, had a larger, far-reaching effect. It reshaped the face of Peruvian privatization from a top-down, sell-it-off drive that usually characterizes Latin American government privatization into a softer, consensus-seeking domestic political campaign. The risk, investors say, is that a slowdown could delay the government's once-optimistic privatization plan--expected to rake in $700 million this year that the Peruvian economy badly needs.

"Right now there is a complete lack of credibility on behalf of investors, and therefore there is an unacceptably high level of regulatory risk," says Mickey Peters, CEO of Duke Energy in Peru. "You never look for things to be perfect, but you do look for specific steps that things are improving to give you confidence to invest, acquire and develop. And unfortunately that hasn't happened."

During 2002, the government managed to complete one other significant sale, control of two power transmission companies to Colombia's Interconexion Electrica (ISA), a public utilities financial group, bringing in $261 million--a 58% decline from the past nine years' average of $618 million. A third deal--a hydroelectric project worth nearly $300 million--is slated before year-end, if protests don't derail it, too.

The proposed sale of Egasa and Egesur, in the southern towns of Arequipa and Tacna, brought out scores of angry demonstrators--rallied by union leaders who claimed that the sale would result in higher tariffs and fewer jobs--to attack government offices and private businesses just as the government announced sole bidder Tractebel's winning offer for both companies.

The highly-publicized debacle in Arequipa later drew criticism from domestic business leaders and foreign investors, who charge the government caved in to popular pressure, and led to the resignations of former Prime Minister Roberto Danino and Finance Minister Pedro Pablo Kuczynski, the heart of President Alejandro Toledo's free-market dream team.

Soft sell. The government has pinned its hopes now on a so-called "investment promotion" scheme, one that seeks joint ventures, management contracts and concessions in place of outright sales. It expects that this will help rekindle bidders' interest for the handful of potentially attractive assets, like ports, airports, and utility companies, that remain in state hands and could generate millions if sold.

"We need to demonstrate that we can promote investment through other schemes," says Alberto Pasco-Font, acting head of Proinversion, the government's investment promotion entity. "If you take out the component that we are selling an asset and say that what we want are new investments, no one will be opposed to that."

Such is the case of the Olmos project, for which the government has already formed civil society groups to lobby, defend, and seek popular approval. Olmos, a hydroelectric project scheduled to have been sold in November, is key for the government, as it involves investments of up to $297 million. "[This method] will take us longer, but it will be a more solid process," Pasco-Font says.

While the government's new capitalization plan may indeed help subdue privatization opponents by masking sell-offs under concession titles, observers say the government must incorporate certain key elements in order to create interest from bidders.

"No one is going to invest a significant amount of money until the government gives a clear idea as to what it wants and shows its commitment to the [investment] process," says Felipe Ortiz de Zevallos, president of consulting firm Apoyo.

Lack of clear rules can hurt. Rumors of the collapse of the ISA deal, for example, forced the nuevo sol to yearly lows. Although the deal, signed in June, did go through, it showed how closely outsiders are following the government's every move.

"If Arequipa marked the end of the old scheme, and the sale to ISA the beginning of the new one, letting it fall through the cracks would have shown that privatizations were not going to happen one way or the other," says Ismael Rodriguez, director of business development for U.S. energy company PSEG Global. In December 2001, PSEG paid $227 million for power utility ElectroAndes--well above the minimum bid price of $120 million. Belgium's Tractebel and the United States' Duke and AES also bid for the company.

With straight privatization off the political agenda for now--and with the government's new investment scheme not expected to bring in significant money to the state coffers any time soon--the Finance Ministry is scrambling to find ways to finance the country's fiscal shortfall.

Cash crunch. Its immediate goal is to close the year with a deficit of no more than 2.2% of GDP--a figure that is well above the 1.7% mutually agreed upon with the International Monetary Fund earlier in the year. But even hitting its target will be difficult, given the lack of incoming funds.

Among Finance Minister Javier Silva Ruete's cash-raising techniques is the emission of $500 million in bonds at the end of October, backed by the Andean Economic Promotion Corporation (CAF).

If the Finance Ministry's most recent bond issue serves as an indicator, however, there may be something to worry about. In August, Silva Ruete offered $20 million worth in bonds and managed to attract only $14.1 million.

Peru might attract buyers--and even encourage additional foreign investment--given the country's strong economic indicators, according to Instituto Peruano de Economia (IPE) General Manager Fritz Du Bois.

Peru's economy is expected to expand by 3.5% this year, one of the fastest growth rates in the region. "In an economy as small as Peru's you don't have the luxury of saying, 'Let's just forget about privatizations,'" says Du Bois.

Silva Ruete has also announced a series of new taxes to secure additional financing in 2002. One option is increasing income tax to 30% from 27% for people earning more than $4,100 a month and applying income tax to pensions higher than $1,400 a month. The Finance Ministry also announced new taxes on gasoline and beer as a way to increase receipts.

Another cash-raising mechanism is Silva Ruete's decision to extend a 2% payroll tax, known as the "solidarity" tax, into 2003. Business leaders say the tax negatively affects growth and employment. Even if the tax lasts just one year, some argue, the cost could be strung out for quite a while longer if it stalls the domestic economy. And that could hurt come election time.

"Peru has a unique opportunity now to jump into stardom because it has strong macroeconomic fundamentals," says Mario Kohler, head of investment consulting company Orion. "However, because of the country's political immaturity, it may miss the opportunity to transcend."

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