Since his inauguration in July 2001, Peruvian President Alejandro Toledo has proposed to take actions in the areas of macroeconomic stabilization; reopening of country's access to international financial markets; budget modernization and state decentralization; social policy; revamping of the armed forces, police, and internal security services; and consolidation of Peru's democracy and social stability through consensus-building and transparent and participatory mechanisms. Currently, genuine efforts by the new administration to reinvigorate the momentum for reform are facing great social pressures for short-term, populist measures. An urgent need to build momentum for "second-generation" reforms exists, especially those in public expenditure, which would provide longer-term sustainability to the government's strategy of poverty reduction and growth. Achieving success to meet goals in the medium term depends on completing a public expenditure management agenda summarized in the main themes of this report: restoring fiscal discipline; reorienting the budget toward pro-poor expenditure; improving the efficiency of public expenditure; addressing the promises and risks of decentralization; upgrading the civil service; improving governance and reducing corruptions; and fine-tuning mining taxation and environmental policies. The report is the product of the analytical work of many experts, both Peruvian and non-Peruvian. It distills critical lessons and challenges that are relevant for policymakers in Peru, in Latin America, and in countries embarking on comprehensive public expenditure reform. Each of the eight chapters includes notes. Annexes include: (1) A Public Debt Sustainability Analysis for Peru; (2) The Fiscal Effort Required for Sustained Structural Deficit; (3) Questionnaire on Public Financial Management; (4) A Public Expenditure Tracking Survey: Methodological Issues; (5) Public Enterprise Reform in Peru: Introducing Management Contracts at FONAFE; (6) A Methodology for Functional Reviews and for Analyzing Functional Prospects; and (7) List of Background Papers. A statistical appendix and a map of Peru are also included. (Contains 77 references, 136 tables, 46 figures, and 17 boxes.) (BT)