Despite Panama's current account deficit, the economy seeing solid expansion

Diversified across various sectors, over recent years Panama’s economy has been notable for its resilience in face of problems in key trading partners such as Venezuela and comparatively rapid growth in a regional context. In 2014 Panama’s GDP was $43.8bn, while its per capita income reached $11,147, according to the IMF. Panama’s real GDP expanded by 7.8% annually over the six years to the end of 2014, compared with an average of 2.8% for the Latin American and Caribbean region as a whole. This period included two years – 2011 and 2012 – during which the Panamanian economy expanded at a double-digit pace. According to the Ministry of Economy and Finance (Ministerio de Economía y Finanzas, MEF), real growth in 2014 was 6.2%, while the region as a whole expanded by 1.3%.

Slower Growth

The growth rate of Panama’s diversified economy has been slowing, however. The deceleration through 2014 was partly due to the impact of a weaker global economy on trade and commerce, partly due to the completion of infrastructure projects (such as the Panama City metro) and partly because of slowing public sector spending following the general election of May 2014. The unemployment rate rose from 4.1% to 4.8% over the course of the year. However, average monthly salaries grew by 6.5%, due principally to an increase in the minimum wage that came into effect in January 2014. According to MEF figures, the important transport, storage and communications sector grew by 6% in 2014, marginally less than the economy as a whole, reflecting an increase in fees generated by the Tocumen International Airport, the ports and the Panama Canal. The real estate and services sector expanded by 9.7%, thanks significantly to an increase in the number of properties for sale or rent. Meanwhile, Panama’s construction sector, which grew by 14.9%, has continued to boom. This is partly because of works associated with the new sets of locks for the Panama Canal and partly because of new residential and commercial construction. The mining sector, including nonmetals, grew by 12.5%. This growth was closely linked to the rise in the construction sector and was in spite of a fall in demand for concrete in the Panama Canal expansion project. The output of the country’s fisheries grew by almost 20% in 2014.

The openness of the economy means that inflation is largely a function of global trends over which the authorities do not have control. Inflation in 2014 was 2.6%, lower than in 2013 (4%) and 2012 (5.7%), and the MEF expects it to be just 1.7% in 2015. This is the result of several factors, including lower global prices for energy and foodstuffs, the appreciation of the US dollar relative to other currencies and official price controls in relation to 22 basic household items. Panama is unusual in that it does not have a central bank; the US dollar serves as the national currency, although the balboa serves as the unit of account and exists in the form of coins. Monetary policy is thus determined by the US Federal Reserve. Banco Nacional de Panamá, one of two state-owned commercial banks, serves as banker to the government. The banking sector is overseen by the Superintendency of Banks of Panama.

Doing Business

Positive developments in the various sectors of Panama’s economy highlight how, in many ways, it is a fairly easy country in which to do business. According to the World Bank’s “Doing Business 2015” report, Panama was ranked 52nd out of 189 countries reviewed. Unsurprisingly, given the regional and global importance of the Tocumen International Airport, the ports and the Panama Canal, Panama is ranked ninth for trading across borders. It also rates highly in access to credit (17th), access to electricity (29th) and the procedures for starting a business (38th). Panama is ranked 61st for registering property and 63rd for dealing with construction permits.

Nonetheless, Panama’s legal system does not appear to have kept pace with the rest of the economy. The country is ranked 76th for the protection of minority investors, 84th for the enforcement of contracts, and 132nd for resolution of insolvency. Finally, Panama is ranked 166th globally for ease of paying of taxes.

Global Competitiveness

The World Economic Forum (WEF) considers Panama to be a country in which institutions have not developed at quite the same pace as the economy as a whole. In its “Global Competitiveness Report 2014-15”, the WEF considers Panama to be an economy that is in transition between being efficiency-driven and innovation-driven (i.e. a developed economy). It is the 48th-most-competitive country of the 144 rated by the WEF. By this measure, Panama has slipped slightly relative to 2013-14 and 2012-13, but not in relation to 2011-12.

In addition, its performance varies considerably from category to category. Panama is ranked seventh globally for the quality of its port and air transport infrastructure in the latest report. However, its rankings for institutions (71st) and health and primary education (79th) are significantly lower. Panama is also held back by the efficiency of its labour market (87th). The ranking for institutions is worsened by elements such as public trust in politicians (102nd), judicial independence (116th), and the business costs of crime and violence (95th). The WEF’s survey of firms that are operating in Panama found that the most problematic factors for doing business are corruption (a weighted 16.8% of responses), an inadequately trained workforce (15.2%) and inefficient government bureaucracy (14.3%).

Softness in the External Sector

Panama ran a current account deficit of $5.3bn in 2014, according to the IMF. This was equivalent to 12% of GDP, and was 6.9% larger than the previous year’s current account deficit. The main reason for this was a 10% fall in exports of goods, from $17.2bn in 2013 to $15.3bn in 2014, data from the National Institute of Statistics and Census (Instituto Nacional de Estadística y Censo, INEC) shows. Much of the fall was due to a contraction in reexports through the Colón Free Zone (CFZ), from $13.3bn to $11.5bn. Re-exports from the CFZ to Puerto Rico fell by 31.5% to $2.1bn, due mainly to the general weakness of that territory’s economy (which is also constrained by a high level of government debt). Re-exports to Venezuela fell 15.3% to $1.5bn, the consequence of the further deterioration in what had already been a very challenging economic environment. Re-exports to Colombia also declined – by 3.6% to $1.8bn – due to the Colombian government’s imposition of a new tariff regime, which militated against importers from countries which had not signed free trade agreements with Colombia. These countries included several Asian nations whose trading companies operate through the CFZ.

Conversely, the surplus on trade in services rose by 18.6% to $6bn in 2014. Services receipts rose from $9.9bn in 2013 to $10.9bn in 2014. Receipts from the Panama Canal (which rose from $2.2bn to $2.3bn), Tocumen International Airport (which grew from $2.1bn to $2.2bn) and ports (from $775m to $866m) each grew by around $100m. Revenues from the tourism sector increased by a little over $200m to a total of $3.5bn. The largest increase, though, was in receipts for “other commercial services”, which grew from $267m in 2013 to $653m in 2014. Foreign revenues of the insurance sector remained unchanged at $146m, while those of the rest of the financial services sector slipped from $566m in 2013 to $521m in 2014.

Regional Logistics Hub

These figures highlight the development of Panama as a regional logistics hub. Mauricio Rodríguez, an economist and analyst with Banistmo, a financial services group with a presence throughout Central America, told OBG that Lufthansa, for instance, has set up a freight operation in Panama City and that the country’s ports are, collectively, larger than Santos in Brazil in terms of volumes of freight handled. He also noted that the last census, conducted in 2010, had found that around 10% of the population had been born outside the country. Panama is benefitting from the flow of people and money through the country, if not necessarily from net immigration.

Investment in Panama has long exceeded savings by a large margin. The latest current account deficit is not particularly large in the context of recent years such as 2013 (12.2% of GDP), 2011 (15.9%) or 2010 (11.4%). The current account deficit was somewhat smaller relative to the overall economy in 2012 (9.8% of GDP) and 2009 (6.7%). Consequently, the country naturally runs a deficit in terms of factor income payments such as interest and dividends. In 2014 Panama’s deficit for factor income payments was $3.2bn, up 5.5% year-on-year. Receipts slipped by 7% to $2.1bn, while payments increased marginally to $5.4bn.

Meanwhile, net transfers jumped from $63m in 2013 to $120m in 2014. Inwards transfers rose by 31.7% to $1.1bn, while outwards transfers increased by 26.8% to $1bn. Transfers in both directions are dominated by workers’ remittances. Inwards remittances rose from $424m in 2013 to $652m in 2014 and were mainly from Colombia, the US, Mexico and Costa Rica.

Outwards remittances, from expatriates working in Panama, rose from $644m in 2013 to $812m in 2014: the main destinations were Colombia, the US, China, Nicaragua and Mexico. Growth in outwards remittances was due to the increased numbers of expatriate workers in Panama, given that job opportunities were better than in most countries in the region. The rise in inwards remittances may be a reflection of the ongoing economic growth in Colombia, the US and Mexico.

Foreign Direct Investment

Inwards foreign direct investment (FDI) increased by 1.4% to just over $4.7bn in 2014, INEC figures show, partially thanks to Law 41 making Panama a significant destination in regional terms. FDI increased by $1.7bn, or 32.2%, during the first quarter of 2015, making Panama the main FDI recipient in Central America. Across Latin America and the Caribbean, inwards FDI dropped by 16.4% to $159bn, according to the Economic Commission for Latin America and the Caribbean. Four large economies – Brazil, Mexico, Colombia and Chile – accounted for $123bn of this. Flows to Argentina and Peru amounted to $7bn and $8bn, respectively. This near stagnation in flows into Panama followed a surge in inwards FDI, from just under $3bn in 2012 to a little under $4.7bn in 2013. Inwards FDI had been $2.7bn in 2010 and $3.1bn in 2011. The slowing in growth in 2014 was due to two factors. One was lower investment into the CFZ, because of the general decrease in activity there. The other was the inflation of the total for 2013 by deal-making, which resulted in an increase in foreign investment (mainly from Colombia) in the banking sector.

The largest component of inwards FDI in 2014 was reinvestment of profits, which rose from $2.8bn to just under $3bn. Most of this was accounted for by enterprises that are not banks and that are not operating in the CFZ. Reinvestment of profits by banks in 2014 amounted to $339m. Over recent years, reinvestment of profits has increased dramatically. Through the three years to the end of 2012, it was, on average, less than $1bn. Investment in equity participations rose by 4.6% in 2014 to $1.4bn. This was driven by companies operating in the electricity, mining and real estate sectors.

FDI has been diversified in terms of both sector and source country. Over the course of the three years to 2013 the main sectors receiving funds were: wholesale and retail trade (36%); financial services (17%); transport and storage (15%); and manufacturing (8%). Roughly a quarter each of inwards FDI over this period came from North America (mainly the US) and South America (mainly Colombia). Europe (and, in particular, Switzerland) accounted for around a fifth of inwards FDI. In Asia, the source of around 11% of inwards FDI, South Korea was a leading contributor.

Fiscal Slippage

According to preliminary figures from MEF, the deficit of the non-financial public sector amounted to $1.9bn in 2014. This represents around 4% of GDP, and compares with a deficit of around $1bn in 2013. The primary deficit (i.e., prior to interest payments) has increased from $202m in 2013 to just over $1bn in 2014, or from 0.5% to 2.2% of GDP. While total revenues have risen by 1.1% to a little under $10.1bn, expenditure has grown by 8.8% to $11.9bn. The main contributors to revenues are taxes and concession incomes received by the central government (up 1.9% to $6.8bn) and contributions to the Social Security Fund (Caja de Seguridad Social, CSS), which increased by 4.4% to $2.8bn. CSS payments rose by 6.4% to $2.6bn. However, general expenses of the central government (i.e. excluding interest payments) surged by 17.8% to nearly $4.2bn. The wages bill rose by 12.2% to just under $2bn. About a quarter of the rise in the wages bill was due to new laws, while another quarter was due to higher pay for teachers. An increase in bonus payments (equal to a 13th month of pay each year) accounted for 8% of the total rise in the wages bill. Purchases of other goods and services rose by 16.7% to $600m. Transfers increased by 23.8% to $1.9bn. The rises in energy subsidies and bus fare subsidies accounted for 34% and 14%, respectively, of the total rise in transfers. Interest payments of the non-financial public sector increased by 2.3% to $843m.

A key piece of legislation is the Social and Fiscal Responsibility Law (SFRL – Law No. 34 of 2008). This originally set a ceiling of the total deficit for the non-financial public sector at 3.7% of GDP. It was modified several times during the Ricardo Martinelli administration, with the result that there was some loss of credibility. Law No. 25 of 2014 was subsequently passed, which permitted a target of 4.1% of GDP. It also set the maximum net debt ratio at 40% of GDP – higher than many in the international investment community would like. Net debt is equal to gross debt less the net assets of the sovereign wealth fund, Panama Savings Fund.

Luca Antonio Ricci, IMF mission chief for Panama, said the government should work to strengthen the fiscal framework over the medium term, following past revisions to the SFRL’s deficit ceilings. He also noted that the government could make other changes to strengthen its fiscal position (see analysis). Banistmo’s Rodríguez also told OBG that the CSS has an actuarial deficit of approximately $10bn relative to its long-term liabilities. Significant progress made in consolidating public finances has seen Panama maintain a stable investment grade with Standard & Poors, Fitch Ratings and Moody’s.

Five-Year Plan

The government’s capital spending fell by 5.1% to just over $3.6bn in 2014. Six items accounted for about half of the spending: the Panama City metro; further development of the country’s road network; improvement of the water quality in the Bay of Panama; the Colón Corridor; the medical city, referred to locally as Ciudad Hospitalaria; and other non-specified infrastructural works. The government’s strategic five-year plan for 2015-19 envisages investment of $19.5bn over that period. As noted by Rodríguez in discussions with OBG, the plan differs from its predecessor in that it emphasises social projects. Some $10.7bn in investment – or more than half of the total – will be allocated to projects such as basic sanitation ($2.9bn), Ceilings of Hope ($636m), the urban renewal of Colón ($410m) and Bilingual Panama ($125m). Some $6.4bn will be invested over the period in physical infrastructure such as the extension of Line 1 of the Panama City metro; construction of Line 2; the fourth bridge over the Panama Canal; and development of mass public transport in Panamá Oeste. Also planned is investment in irrigation systems to support the agricultural sector and the construction of 200 km of roads to connect farmers with markets. In the electricity sector, there will be investment in the third and fourth power transmission lines, connection with the electricity grid of Colombia and the CHAN2 hydro-electric power station.

Rodríguez told OBG that, unlike in some Asian countries, Panama’s education system has not kept up with the development of the overall economy. The IMF’s Concluding Statement of the 2015 Article IV Mission noted that economic growth in the future will depend much more on increased productivity, given that the accumulation of capital in the public sector is likely to slow. “It will be essential to continue efforts on improving the quality of public education and health, addressing skill mismatches, promoting greater female labour force participation and strengthening institutions.”

Combatting Poverty

Over the year to August 2014 the number of people living in poverty in Panama fell from 25.8% of the population to 25.6%, according to MEF. However, the number of people living in extreme poverty – a sub-set of this group – rose from 10.6% to 10.8%. Conditions remain a lot worse in rural areas, where the rates of poverty and extreme poverty rose, respectively, from 49.4% to 49.5% and from 26.2% to 26.6%. Rates of extreme poverty in the indigenous areas are particularly high, at 61% in Kuna Yala, 40.5% in Emberá and 69.7% in Ngäbe Buglé. In urban areas, overall poverty remained unchanged at 13.8%. However, the number of people living in extreme poverty increased from 2.7% to 3%. Delays in payments of benefits through the government’s various poverty reduction programmes – such as Red de Oportunidades, the 120 a los 65 pension scheme and the Beca Universal education grant – contributed to the rise.

Development Focus

Long-term trends have generally been positive. The UN Development Programme (UNDP) assessed the human development index (HDI) of Panama at 0.7654 in 2013. This is the 65th highest of the 187 countries reviewed. By this measure, Panama rates favourably with other “high human development” states. In the region, the countries that are more highly rated are Chile (41st), Cuba (44th), Argentina (49th), Uruguay (50th), Bahamas (51st), Barbados (59th), Antigua and Barbuda (61st), and Trinidad and Tobago (64th). In terms of life expectancy (77.6 versus 74.5 for all high development nations) and mean number of years of schooling (9.4 versus 8.1), Panama is well placed. However, it lags on the number of expected years of schooling (12.4 versus 13.4).

Panama’s HDI has been rising consistently, if at a slower pace than those of other high human development countries in recent years. For its part, the UNDP’s priorities for 2015 include further cooperation with the government, greater inclusion for targeted groups (including the 25% of the population under six years of age and between 15 and 24 years) and development in local communities. On the latter it is being assisted by the government’s Red Nacional Internet (RNI) programme, which aims to provide free internet access to all Panamanians with speeds of up to 1 Mbps.

Reyes Valverde, an adjunct professor in the economics faculty of the University of Panama and head of project planning for the National Authority for Government Innovation, told OBG that total investment in the programme from 2010 to 2014 amounted to $32m. The economic benefits in 2013 and 2014 alone were estimated at $93m and $129m, respectively. The benefits in those two years were driven by a surge in the number of broadband internet users, by 42% in 2013 and 39% in 2014. In theory, the RNI could represent a technological revolution for much of the country. It makes life easier for small businesses and facilitates improvements to the public education programme, which is an important theme in the government’s five-year plan. As of early 2015, free access to high-speed internet was available in all provinces though not to all communities.

Outlook

The government looks for the economy to achieve real growth of around 6.5% annually over the coming five years. So too does the IMF. Although Panamanian exporters – and in the CFZ in particular – are exposed to the economic problems of particular countries in the immediate vicinity (e.g. Venezuela and, to a lesser extent, Puerto Rico), the growth is broadly based.

Activity in the construction sector and in other parts of the economy remains robust. Further, overall growth is underpinned by investment by the private sector and through the government’s five-year plan. Although poverty remains a challenge, especially outside the main urban centres, the authorities are working constructively, and in conjunction with multi-lateral agencies such as the UNDP, to maximise the probability that the growth will be inclusive. Thanks to the moderation in global prices of energy and other commodities – and the general strength of the US dollar – inflationary pressures should remain moderate.

Although the budget and current account deficit deficits are substantial, it appears that they will both be financed with ease. Recent sharp increases in government spending have not been matched by similar growth in interest payments. Perceptions should improve as a result of efforts to ensure Panama’s departure from the grey list of the Financial Action Task Force and other changes to strengthen the banking sector. The expansion of the Panama Canal, further development of the country as a regional logistics centre and improvements to education should continue to drive growth.

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The Report: Panama 2015

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