It's been pretty hard to get a clear picture of what's going on down here. As far as I can tell the MRTA (Tupak Amaru Revolutionary Movement) has been scoring all the points: not only did they pull off capturing the bulk of the foreign diplomatic corps, but they managed to treat them well and present them with a clear and well thought out ideology. If this had been the Sendero Luminoso, everyone would be dead by now, but the MRTA are no where near as extreme.
The feeling amongst liberals here and many foreigners is that the MRTA's position, apart from demanding the release of prisoners, is fairly reasonable: they don't seem to be looking for a new Cuba, but rather support for labor, a bit of protectionism, and some improvements in human rights, all areas Fujimori is weak on.
The government and most Peruvians are very conservative, however, and are taking a hard line. Since everything the MRTA is asking for is contrary to what Fujimori wants, it doesn't bode well for how the situation will be resolved. Fujimori hasn't been visible at all during the crisis, nor has he apparently been involved in negotiations; this might indicate that the intense foreign involvement has kept the situation from becoming violent.
What's confusing is that despite the apparent lack of negotiations, the MRTA has let go a significant number of hostages. Whether this means that someone is striking deals, or the MRTA is just trying to get the number down to something manageable, it's hard to say.
A grim possibility for the outcome is that the number of hostages will be reduced to the point where there are few enough lives at stake that someone will try something very stupid. The Peruvian government has a very bad track record in cases like these: a big green building near my house was the site of one of Peru's worst prison massacres.
After the prisoners there took hostages in the late '80's, President Alan Garcia swore that bloodshed wouldn't occur and that he'd negotiate. The night after the promise, the military stormed the prison and killed everyone.
Given Peru's current hard line against terrorism and record of human rights abuses by the military, my sense is that however the embassy situation plays itself out, the military will make life very hard on any one with leftist leanings in Peru. Whether this means they'll go back to murdering villagers in the highlands and jungle is hard to say, but it's a possibility. The terrorists have asked for a helicopter to take them into the central-eastern jungle. If this occurs, it would likely make that region extremely unsafe as the military goes in after them and they try to hold their ground there.
Another consideration is that the Shining Path could rear it's ugly head as well. Their leader is currently alive and in jail, as well as a large number of it's members, so it's conceivable that they could try the same
thing as the MRTA. The consesus is that if it had been the Shining Path in the ambassadors residence, everyone would be dead by now.
In terms of how this situation is affecting life here, the effect is minimal. I have friends who live near the ambassador's residence, and things are definitely tense, with snipers on the roofs, soldiers everywhere, etc. etc. one friend was actually invited to the party, but couldn't make it, and the person who had invited him is currently a hostage.
Two researchers down here who were interviewing Peruvians of Japanese ancestry have had to put their research on hold while the Japanese community tries to recover. Outside of this, life continues as normal, and we've heard nothing unusual from outside Lima. I will say, however, that I've noticed and increase in police activity in general: more sirens at night, etc. Whether this is just normal for the holidays, or something else has been going on, it's hard to say.
We haven't seen any effect on tourism so far, and at this point I wouldn't warn any body about coming to Peru. I think it's more a question how the hostage crisis ends, and what happens to Peru's economy over the next several months.
That's about the long and short of the situation so far. I hope that gives you a clearer picture of what's happening. I'll keep you posted if I learn anything new.