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Panama risk: Macroeconomic risk
(RiskWire Via Thomson Dialog NewsEdge) COUNTRY BRIEFING
FROM THE ECONOMIST INTELLIGENCE UNIT
RISK RATINGSCurrentCurrentPreviousPreviousRatingScoreRatingScoreOverall assessmentB36B37Macroeconomic riskB30B35Note: E=most risky; 100=most risky.SUMMARY
As a provider of export-oriented services, such as transport and financial services, Panama's fortunes are highly geared to developments in the world economy. Dollarisation, established for a century, reduces macroeconomic risk by ensuring price stability and low interest rates. However, it does mean that Panama is unable to use monetary policy as a tool to manage demand. The large integrated (domestic and offshore) financial system also foments stability, reducing the risk of domestic credit booms and busts. Fiscal policy assumes particular importance in the absence of an autonomous monetary policy. Here Panama scores less well owing to high public indebtedness. Panama has one of the highest levels of debt relative to the size of its economy in Latin America. The government has introduced legislation tightening fiscal policy, but failure to consolidate on fiscal reform would risk a deterioration in Panama's country risk premium, raising doubts about medium-term debt sustainability.
SCENARIOS
Disappointing world growth damages Panamanian economic prospects (Moderate Risk)
The Panamanian economy is small and open. The dominance of the export-oriented services sector makes the country vulnerable to fluctuations in the world economy. Much economic activity is dependent on world trade trends, owing to the strategic importance of the Panama Canal and the large part played by shipping, ports and other transport-related services to the performance of the economy. As a result Panamas economic asset at times of strong global demand represents a structural weakness at times of slow or declining global activity. The upturn in the world economy since 2003 has helped Panama post above trend rates of growth. As a result of the exceptionally favourable external conditions prevailing, real GDP growth has averaged 7.5% over the past three years, with Panama benefiting from strong demand for its services exports. Although our forecast is for the world economy to remain robust in 2007-08, doubts as to the sustainability of global growth imply significant risks to this positive outlook. Slowing growth in the US and monetary tightening in some OECD countries risks precipitating a sudden unwinding of longstanding imbalances in the world economy, such as record levels of OECD indebtedness and the huge US current-account deficit. There are also concerns about the sustainability of the rapid pace of growth in China. A sharp correction of these imbalances would have a severely negative impact on global demand and on the prospects for Panama. Businesses should bear in mind the dependence of Panama's economy on the health of global demand when making investment decisions.
A recession triggers deflation (Low Risk)
The openness of the economy and the use of the US dollar mean that Panamanian prices largely follow international prices. Although the risk of deflation in the US, or more generally on a global level, is slight, it would directly affect Panama. In addition, domestic demand could stall if the global recovery is not sustained. This could also put downward pressure on domestic prices. Foreign firms selling in Panama, especially retailers, would see their profits squeezed in a deflationary environment.
BACKGROUND
(Updated: July 2nd, 2007)
Economic structure
Main economic indicators, 2006(Actual unless otherwise indicated)Real GDP growth (%)8.1Consumer price inflation (av; %)2.5Current-account balance (US$ )-377.9Exchange rate (av; B:US$)1.00Population (m)3.3(a)External debt (year-end; US$ m)9,971.9(a)(a) Economist Intelligence Unit estimates.Source: Economist Intelligence Unit, CountryData.The Panama Canal, the Zona Libre de Colon (ZLC, the Colon Free Zone) and the Centro Bancario Internacional (CBI, the International Banking Centre) give Panama's economy a strong bias towards the services sector, which contributed 78.4% of total GDP in 2006. Although these subsectors account for the relatively high level of GDP per head by regional standardswhich stood at an estimated US$5,386 in 2006they also result in a highly skewed income distribution, as they generate comparatively little employment.
Panama's share of private consumption in GDP is relatively low at 60%. Investment as a percentage of GDP at around 17% is also very low. However, Panama's position as one of the most open economies in the region is illustrated by export/GDP and import/GDP ratios both averaging around 70%.
Wholesale and retail commerce and financial services, including those within the ZLC, account for around 40% of GDP and are heavily concentrated in urban areas, as is construction activity, which accounted for 4.1% of GDP in 2005. Compared with neighbouring Costa Rica, the manufacturing sector is of relatively little importance, contributing 7.3% of GDP in 2005. Most manufacturing production is agro-industrial and is scattered in the provinces to the south and west of the Canal, designated "special economic zones" that enjoy privileged tax treatment on inputs for export in a bid to encourage investment.
Unlike its Central American neighbours, Panama's agriculture, livestock and fisheries industries make only a small contribution to GDPjust 4.4% in 2005. Most farming takes place in "the interior", an area contains massive copper resources and smaller deposits of gold. Although production of minerals is low, record high copper prices in 2005-06 have lead to renewed interest in developing the sector. Tourism has strong potential nationwide and is slowly being developed.
Comparative economic indicators, 2006Panama(a)Costa Rica(a)El Salvador(a)Nicaragua(a)Honduras(b)GDP (US$ bn)17.722.1(b)18.6(b)5.39.3GDP per head (US$)5,3865,0212,6548881,265(a)GDP per head (US$ at PPP)12,17710,3943,7972,8383,102(a)Consumer price inflation (av; %)2.5(b)11.5(b)4.0(b)9.1(b)5.6Current-account balance (US$ bn)-0.4(b)-1.1-0.9-0.9-0.2Current-account balance (% of GDP)-2.1-4.9-5.0-17.3-1.9Exports of goods fob (US$ bn)8.5(b)8.33.5(b)1.92.0Imports of goods fob (US$ bn)-10.3(b)-10.9-7.2-3.4-5.0External debt (US$ bn)10.06.47.53.93.9(a)Debt-service ratio, paid (%)18.75.411.25.17.5(a)(a) Economist Intelligence Unit estimates. (b) Actual.Source: Economist Intelligence Unit, CountryData.Economic Policy
Economic policy over the past decade has focused on efforts to improve international competitiveness and build capacity in Canal-related services and place the public debt dynamics on a sustainable path. Import substitution in industry and agriculture, and a pervasive system of administered prices, had introduced distortions and inefficiencies in product markets in the 1970s and 1980s. The 1970 labour code created labour market rigidity, and the use of the US dollar as the local currency ruled out devaluation as a means of gaining competitiveness. Alongside this over-regulated domestic economy was a largely unregulated international services sector, comprising the Panama Canal, the CBI and the ZLC. These activities were more capital-intensive and competitive, and the productivity gap between the services sector, on the one hand, and industry and agriculture, on the other, contributed to wide income and wealth disparities between their respective labour forces.
A structural adjustment programme, supported by the IMF and other multilateral organisations, was implement by the government led by Ernesto Perez Balladares (1994-99), in a bid to improve efficiency and competitiveness. Panama joined the World Trade Organisation (WTO) in September 1997 and began to reduce its import tariffs. The government privatised the ports of Balboa and Cristobal, sold a 49% interest in the Instituto Nacional de Telecomunicaciones (Intel, the state telecommunications company), and broke up and sold parts of the Instituto de Recursos Hidraulicos y Electrificacion (IRHE, the state electricity company). Casinos and a racecourse were also sold off. Privatisation proceeds of more than US$1.3bn were channelled into a social development trust fund, interest from which is used for social investment.
In an attempt to increase services exports, the Balladares government developed a national maritime strategy based on a multimodal transport system involving the Canal, ports, airports, the railway and road links. The governments led by Mireya Moscoso and Martin Torrijos have sought to further develop the national maritime strategy. The success of the plan will depend largely on the long-term development of the land, buildings and installations adjacent to the Canal, which were vacated by US forces in 1999, and on the expansion of the Canal, which will be a determining factor in the sector's future.
Social spending per head is already high by Latin American standards, but almost 40% of the population continues to live below the poverty line, suggesting that the spending is inefficient. The Torrijos administration initially had to concentrate on tackling the fiscal imbalance and stabilising the technically bankrupt Caja de Seguridad Social (CSS, social security fund). The former was addressed by the comprehensive fiscal reform introduced by the government at the start of 2005; new arrangements put in place to tackle the latter will prevent the immediate collapse of the CSS, whose actuarial deficit is estimated at US$4.3bn, but still leave the government liable for large subsidies to support the CSS. These will reach an estimated US$20.5m per year under the current administration, but are scheduled to rise to US$100m per year from 2009 and US$140m per year from 2012.
The Autoridad de la Region Interoceanica (ARI, the Interoceanic Regional Authority) was set up in 1993 to take charge of the reverted areas and has sought foreign investment to integrate them into the national economy. The ARI's mandate expired at the end of 2005 and the administration of the outstanding buildings and offices was transferred to the Ministry of Housing. One of the aims of the ARI was to make Panama an international transport hub. The businesses attracted to the reverted areas to date include a consortium supplying bunker fuel to ships; Evergreen (Taiwan), which has constructed a container port near Colon; SSA Marine (US), a joint venture that has established the Manzanillo International Terminal, another container port at Cristobal and the port of Balboa, both administrated by Hutchison Whampoa (Hong Kong); and Kansas City Southern Railways (US), which rebuilt the former Panama railway to transport containers and passengers across the isthmus. Further progress has been made as a result of the designation of certain of the reverted areas as "special economic zones", which enjoy favourable tax treatment and a relaxation of the rigid labour laws that prevail outside these areas. The last remaining property, the former Howard Air Force base, was put to international tender in 2005. In 2006 UK-based London & Regional Properties was awarded the 50-year concession to develop the site and has committed to invest US$405m in the first seven years of the concession.
As a means of increasing the attractiveness of Panama to foreign retirees, the authorities exempt foreign pensions from income tax. Added to the country's natural beauty and relatively low living costs, this has proved attractive. Over 2,500 residence visas were granted in 2005 to US citizens, and there is also a growing inflow of Canadian pensioners choosing to reside in Panama. Combined with a 20-year tax holiday on new properties, this has contributed to a construction boom, with the emergence of luxury developments such as Punta Pacifica, Avenida Balboa and Costa del Este, where apartments cost up to US$1m. To reinforce this trend, ignoring objections by environmental groups, the government passed controversial legislation in January 2006 to enable the sale of private concessions on beaches and islands in declared tourism zones.
Protectionist postures to favour its farming and manufacturing sectors has slowed talks on economic integration with Central America, but free-trade agreements (FTAs) have been signed with El Salvador (in 2003) and Honduras (2007). An FTA with Taiwan came into force in 2004, an FTA with Singapore in 2006 and an FTA with the US was signed in 2006. In addition, Panama signed an FTA with Chile on June 27th 2006. The agreement with Singapore is expected to boost bilateral maritime co-operation. The government has also renewed its efforts towards bilateral FTAs with Costa Rica, Guatemala, Honduras and Nicaragua. Membership of the Mercado Comun Centroamericano or Central American Common Market (CACM)which currently comprises Costa Rica, El Salvador, Guatemala, Honduras and Nicaraguawould enable Panama to negotiate jointly with its Central American neighbours towards a trade and co-operation agreement with the EU.
The FTA with the US, Panama's main trading partner and accounting for around 40% of the country's total foreign investment, was achieved only after lengthy negotiations. Negotiations were virtually completed at their ninth round in January 2006, but the authorities decided to backtrack at the last moment in the face of pressure from the powerful cattle ranchers' lobby. Further talks were postponed to give priority to securing approval for the Panama Canal's expansion project, but both sides finally signed a treaty in December 2006. Failure to put in place an FTA with the US would have put at risk 50% of Panamanian exports, since their access to the US market will face restrictions after 2008 when the trading concessions enjoyed under the US's unilateral Caribbean Basin Initiative will come to an end.
As the US dollar is used as the local currency, Panama has no independent monetary policy and cannot print money to cover fiscal deficits. Fiscal laxity on the part of several governments has left Panama with a high level of external public indebtedness. At the end of 2006 the total public-sector debt stock (domestic and external) was US$10.5bn, equal to 61% of 2006 GDP. To tackle the problem, the Ley de Responsabilidad Fiscal (Ley 20, the fiscal responsibility law) was introduced in May 2002. It stipulated that the non-financial public sector (NFPS) deficit could not exceed 2% of GDP in a given year, and targets for the public debt/GDP (50%) and external public debt/GDP (35%) ratios are to be achieved within a maximum of 15 years.
Shortly after it took office in September 2005, the effects of fiscal laxity under the outgoing administration led the Torrijos government to suspend the fiscal responsibility law. The previous government failed to cut public expenditure by US$362m, as agreed, and left an additional US$334m in unpaid bills, making it impossible for the incoming government to meet the fiscal responsibility target. As a result, the full-year NFPS deficit rose to US$691m, 4.9% of GDP, in 2004, from a revised deficit of US$623m, or 4.8% of GDP, in 2003 on an accrued basis.
The government's response to the fiscal imbalance was to introduce a comprehensive fiscal reform, the Ley de Equidad Fiscal (fiscal fairness law) in January 2005, four months after taking office, although some of the main tax-raising measures contained in the bill only came into effect in 2006. The 2005 fiscal reform is the centrepiece of the government's strategy to narrow the NFPS deficit to 1% of GDP by the end of its term in office in 2009. The government's tighter fiscal stance, combined with a 15.8% increase in revenue, helped to reduce the NFPS deficitmeasured on a cash basis and excluding the Autoridad del Canal de Panama (ACP, the Panama Canal Authority), which the Moscoso government had controversially included in the fiscal accounts to boost performanceto 3.2% of GDP in 2005, and to record an NFPS surplus in 2006 for the first time in ten years.
Non-financial public-sector finances, 2006(US$ m unless otherwise indicated)Total revenue4,283General government4,016Total expenditure4,195General government current2,920General government capital530Overall balance88% of GDP0.5Source: Ministerio de Economia y Finanzas, Direccion de Analisis y Politicas Economicas.Economic Performance
Panama posted its strongest years of growth during the 1960s, when, boosted by import-substituting industrialisation (ISI), the rate of growth averaged almost 8% per year. The 1970s saw the ISI development model run out of steam, with annual GDP growth slowing to below 4%. In the 1980s, growth was even weaker, and the decade ended with a crisis in 1987 as the US imposed economic sanctions, leading to a collapse in investment and a 16% fall in GDP.
An economic recovery in 1990-93 was driven by construction, financial services and the ZLC. Sales to US military bases resumed and the government payroll increased. Gross fixed capital formation, which had fallen to below 6% of GDP during the crisis of the late 1980s, almost returned to historical levels, at an average of 21% of GDP in 1990-94. The resumption of payments and grant aid from the US also helped to narrow the fiscal deficit and foreign direct investment (FDI) began to grow. In the second half of the 1990s growth was propelled primarily by external trends, but was also influenced by the opening of the economy to foreign trade and investment. Inflows of foreign investment to transport infrastructure and utilities generated a mini-investment boom and raised consumer spending power. The banking and commercial sectors expanded in response to strong domestic credit-fuelled demand.
Gross domestic productAnnual average20062000-05GDP (% change at constant 1982 prices)8.15.2Source: Contraloria General de la Republica.Following a period of weak growth in 2000-02 caused by retrenchment by banks, greater competition in the regional financial sector and difficulties in the global economy, growth picked up once more in 2003. A stronger global economy, combined with a regional economic recovery, a local construction boom and pre-election spending by the outgoing Moscoso administration, lifted GDP growth to 4.2% in 2003 and 7.6% in 2004. Extremely favourable external conditions kept growth strong in 2005, at 6.9%, despite the tighter fiscal stance adopted by the new government, and lifted growth to 8.1% in 2006.
The upturn since 2003 has been broad-based: export-oriented services (the Canal, the ports and the ZLC) have benefited from robust external demand; primary sector activity, with agriculture and fishing production, has benefited from strong domestic and external demand; and construction activity has benefited from a pick-up in investment as well as strong foreign demand, largely from North Americans keen to take advantage of Panama's favourable tax regime for second and retirement homes. On the back of the return to economic growth, financial intermediation experienced a sharp rebound in 2005, following a sustained contraction in the previous four years.
A significant structural weakness of the economy is that the services sectors, such as the Canal, ports and banking, generate relatively little employment. The rate of unemployment averaged 7.3% in the 1970s. The slowdown and subsequent crisis of the 1980s swelled the rate to more than 16%. After some improvement in the 1990s, unemployment increased markedly at the turn of the century, from a rate of 11.8% in 1999 to 14.7% in 2001, before easing once more as a result of the subsequent pick-up in economic growth. With the pick-up in economic activity since 2003, when the unemployment rate was 13.4%, unemployment has fallen steadily, to 11.8% in 2004, 9.8% in 2005 and 8.6% in 2006, although it remains a structural obstacle to the government's goal of reducing overall poverty rates.
The official unemployment rate is higher in urban than rural areas, where livelihoods depend on subsistence agriculture rather than employment: in 2005 the urban rate was 12.1% and the rural rate 5.1%. The highest unemployment rates in 2005 were recorded in Colon (13.8%), Bocas del Toro (12.4%) and the capital, Panama City (11.2%), and the lowest in the indigenous areas (1%). The relatively poor performance of the agricultural sector, which has suffered from increased exposure to foreign competition, is reflected less in the rural unemployment figures than in declines in rural incomes and migration to urban areas, where new arrivals swell the ranks of the urban unemployed.
Historically, domestic inflation rates have been well below OECD levels, helped by Panama's use of the US dollar. Changes in prices tend to reflect world inflation, although they are also hit when climatic conditions adversely affect food production, as the heavy trade protection on certain food items prevents the substitution by consumers to cheaper imports. Recently, high oil prices, together with US dollar weakness, have resulted in an increase in price pressures. Year-end inflation reached 3.4% in 2005, the highest rate for more than two decades, before moderating to 2.5% in 2006, still around 1% above trend. High oil prices are the largest single factor contributing to the pick-up in inflation, both through the effect on energy prices and through cost pressures on the prices of many domestically produced goods and services, despite the government's seeking to limit the impact of high fuel costs by reducing the import tariff applied to petrol and diesel.
InflationAnnual average20062000-05Consumer prices (av; % change)2.51.4Source: Contraloria General de la Republica.
Copyright 2007 Economist Intelligence Unit
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