In an attempt to stop the inflationary spiral, President García's administration implements price controls and promotes a generous wage increase before applying wage controls as well. The exchange rate is adjusted, and the government ends the process of continued devaluation. Taxes are cut.
Anti-inflation measures are moderately successful in the short term, with a drop from 163 percent in 1985 to 86 percent in 1987. Capital flight slows; private fixed investment rises. Reduced taxes result in deficit growth for the central government. The IMF makes Peru ineligible for new credit when García decides to stop paying its external debt service beyond 10 percent of the value of exports.
The dramatic increase in Central Bank credit required to uphold price controls and support agricultural expansion combined with the high rate of growth of demand brings renewed inflationary pressures. The currency is overvalued, making exports unprofitable.
President Fujimori's shock therapy program includes cutting subsidies, aggressively collecting taxes, raising prices, and ending two large streams of Central Bank credit. These drastic measures lower inflation from above 2,000 percent in 1990 to 139 percent in 1991. Fujimori renews negotiations with external creditors, but the IMF cuts off new adjustment lending when he suspends democracy in 1992.
The government eliminates restrictions on capital flows and opens the economy to foreign investment. Constitutional amendments in 1993 provide the basic legal structure for foreign investment, furthered in 1996 by an Investment Promotion Law. The economy becomes increasingly dollarized, with 80 percent of bank deposits and 85 percent of debts in U.S. dollars.
Political turbulence, international financial crises, and economic recession keep spending down and scare off foreign investors. A number of bank mergers and failures affect the financial system. Inflation, however, drops steadily, and the currency remains stable.
Inflation reaches a record low of 3.7 percent. In agreement with the IMF, the government maintains a floating currency, refusing to peg it to the U.S. dollar. Peru's financial sector remains relatively stable, but the country is burdened with foreign debt payments representing 56 percent of GDP.
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