Peru has embarked on significant market reforms in the past year. What remains to be done?
We are trying to provide more liquidity to the secondary market. We are in the process of developing a repo market, which still has some fundamental problems that need to be sorted out. One is that ownership of the repo contract is not transferable yet. We still need to make some adjustments to the regulation on this, and other things like reducing counterparty risk. We’re working on these things and expect the repo market to be ready by the end of the first quarter.

Secondly, we’re in the midst of a banking sector reform and are implementing all the recommendations under Basel II, which will involve a change in the laws that govern banks. We are currently in talks with the private sector and the banks are commenting on our proposal for the changes. These are mainly measures relating to banks’ risk exposure and operational risk, among many other things. We expect to have this at the latest by the end of the first half.

What initiatives are there for the buyside?
We’ll be looking at the policies that govern institutional investors, basically pension funds and insurance companies. The idea is to give them more flexibility on their investment decisions, in other words, what kind of assets they can invest in. And the idea here is to help finance the strong growth that the economy is demanding – especially in infrastructure. We want to offer a wide range of instruments that institutional investors can buy.

In the current pension fund regulatory system we have a minimum profitability requirement that is subject to the performance of the pension fund industry. But this industry is made up of only four funds. So we want this minimum profitability be subject to a benchmark that is set by the entire financial system and not only by the investments that the other funds make. If that’s not the case, we’d be encouraging herd-like behavior. We’re going to give pension funds the possibility of investing in other instruments that aren’t necessarily what their peers are investing in.

When is this reform set to take place?
We’re eyeing the first half of 2008 for the pension fund regulation. I’m waiting for the private sector to return the proposal document with their comments.

We’ve recently seen the beginnings of a mortgage-backed market in Peru. How is that developing?
We’re getting to a point where issuance backed by mortgages will begin to grow aggressively. The fundamental thing here is to have a critical mass and also have a sufficiently deep market. We’ve made some important advances on this front. Last year we issued a 30-year local currency bond. Once we’ve established a local currency yield curve that stretches out to 30-years, corporates will begin to be able to increase the maturities of their issuances. And banks will also begin to provide mortgages denominated in local currency at longer tenors.

On this topic, we’ve recently passed a law that permits the establishment of mortgage management companies. So it’s not only a bank that can issue mortgages but perhaps an insurance company as well. They’d be essentially finance companies that can underwrite and manage mortgages. The point of this is to generate more competition in this segment of the market in both tenors and rates.

How is the derivatives market developing?
In Peru, we are admittedly still in diapers. But this will also be part of the capital markets reform. The goal is to have a highway that works well and moves the private sector along at the speed at which it wants to move. And we’re in discussions with the market on how to best do this. We’re talking here about derivatives on the currency and commodities, but also we’d look at other types as well. We’re looking at perhaps the end of the year for that.

Would these be traded on their own exchange?
It’s an option we’re considering, but it’s more likely we’d consider having them traded on the Bolsa. We’re seeing if we’ll go for a model of a centralized market or not. This is still in discussion which is why I say we still need to have more definition on this. Another goal of the reform is that we have to fortify our regulators. We need to improve the institutional nature of Conacef.

What has Peru done in terms of liability management?
We’ve entered into a very strong liability management exercise over the past year. We’ve managed public liabilities worth over $5 billion in 2007. For an economy with external debt of $20 billion, this is a significant amount. We’ve prepaid our Paris club debt. And as part of this prepayment we issued a 30 year bond worth $1.5 billion. In general, what we’ve done is raise soles to pay down dollars and euros.

How will that process be different this year?
What we’re doing is seeing how market conditions are developing to pick an opportune moment and continue with these prepayment operations. In the short term we’re removing debt from the market without issuing new bonds. We’re using the public treasury’s resources. On January 15, one of our bonds worth $500 million matured [which we paid down with treasury funds.] We’ve called more than $800 million of our Brady bonds due in March [2008], and will also use public resources for that.

As for new issuance, we’ll be monitoring the markets and consider the best time to do a deal. We’ll continue exploring the possibility of swapping our debt into soles and also do some prepayments and swaps. The debt we’re swapping out is debt we have with multilaterals like the World Bank and the IDB. The Peruvian market is not very big, so we’ll do them in small bits like $50 million here and $100 million there.

What is the target for rotating into local currency? At the beginning of 2007 we had 18% of our debt soles and we ended 2007 with 34% of it in local currency. In the worse case scenario for the market you could see that level move up to 35% or 36% at the end of the year. If things go very well, we could get to 40%. LF