Publish in Perspectives - Wednesday, March 25, 2015
President Juan Carlos Varela (left) and his predecessor, Ricardo Martinelli. (Photo: Panama's Foreign Ministry).
With more than 85 percent of the expansion completed, the Canal Authority expects the expanded Canal to be operational in late March or early April 2016. (Photo: ACP)
Corruption crackdown expected to yield positive long-term results for the country.
BY FRANCO UCCELLI
Corruption scandals implicating the previous government are not expected to be a major destabilizing factor. While the magnitude of the corruption problem, which has generated copious negative headlines, appears to be quite sizable, locals believe the Varela administration’s determination to address the issue swiftly and forcefully will yield positive long-term results for the country. Indeed, far from destabilizing Panama, the expectation is that the ongoing crack down on corruption will considerably eliminate it from government. With social pressures to tackle corruption mounting, and with a strong message to politicians that it will no longer be tolerated, the hope is that, harsh as it may be, the cleansing of the political system will result in more transparent and scrupulous governments in the future.
Growth is projected to remain relatively high, in line with potential. After reaching double-digit levels in 2011-2012 and raising concerns about the possibility of overheating, economic growth has converged toward potential, which is estimated in the 6.0-6.5 percent range. Indeed, real GDP moderated to 8.4 percent in 2013 and to 6.2 percent in 2014. While the slowdown has led some people to question whether the Panamanian economy may be losing some of its impressive momentum, local observers warn that growth still remains quite robust, adding that a rate of 6.0-6.5 percent (6.3 percent is the current forecast for 2015) is a lot healthier and more sustainable than significantly higher prints. The bottom line is that very few people in Panama are concerned about the recent cooling in growth. In fact, locals appeared to be a lot more concerned when growth exceeded 10 percent and consumer prices were consistently running above historical averages, than now that it is in line with potential. The sectors expected to drive overall economic activity in the near term include the continued expansion of the Canal and its knock on effects on ancillary industries/services, the government’s considerable (approximately $19 billion over five years) infrastructure (both social and physical) development plan, and tourism and other services, such as transportation and logistics.
APPRECIATION: LITTLE IMPACT
USD appreciation may impact tourism flows somewhat, but not much else. USD strength and related weakness in EM FX markets has sparked a fair amount of concern about currency stability in Latin America. The opposite can be said about Panama, where the USD has been legal tender since 1903, and where the debate is whether a strong dollar is actually positive or negative for the country. While locals acknowledge that USD strength may adversely affect the tourism industry, making its prices less competitive relative to other regional tourist destinations, they are quick to note that the recent increase in tourism infrastructure (notably in the hotel industry) has kept prices relatively low, and hence has kept tourists coming. According to preliminary estimates, tourism revenues surged 4.6 percent y/y to nearly $3.5 billion (7.5 percent of GDP) in 2014 and are projected to rise by another 5 percent to more than $3.6 billion this year. Apart from tourism, the appreciation of the USD is not expected to significantly impact Canal traffic/volumes (total revenues represented 5.7 percent of GDP in 2014), nor is it expected to materially affect re-exports from the Colon free zone, the second largest in the world after Hong Kong, as less competitive export prices are largely offset by more competitive import prices.
Expanded Canal is likely to be fully operational in March/April 2016. With more than 85 percent of the expansion completed, the Canal Authority (ACP) expects the new locks to start being tested, a process that would take a few months, in July/August. If everything goes according to plan, this means that the expanded Canal would be operational in late March or early April 2016, more than one full year later than expected. As for cost overruns, a great source of contention between the ACP and the consortium of mostly foreign firms working on the project, the ACP is currently estimating that they will be relatively small, at least as regards the portion for which it will ultimately be liable. Assuming that no major claims are awarded to the contractors, the ACP is anticipating having to pay between $5.5 billion and $5.7 billion for the total project, only a tad higher than the original $5.25 billion budget, with the excess ($250-500 million) comfortably covered with resources from a contingency fund established by the ACP for that purpose. If the ACP estimates are correct, and with cost overrun claims presented by the contractors totaling more than $3 billion thus far, this means that the contractors may be in for a very unpleasant surprise. Once the expanded Canal is operational, the expectation is that while the number of vessels navigating through the waterway may remain roughly the same, their size and cargo capacity, upon which tolls are assessed, will significantly expand. This, added to the fact that toll rates are due to increase on April 1, 2016 (they were last raised in 2012), should boost Canal revenues by as much as 3 percent of GDP per year, a sizable increase by any measure.
Adjusted deficit is set to narrow, but only gradually. When the Varela administration assumed office in July 2014, it estimated that, under a passive scenario, the fiscal deficit would close last year at 5.2 percent of GDP. However, thanks to a combination of expenditure containment and revenue measures it managed to limit the size of the shortfall to 4.1 percent of GDP, still a significant deterioration on the 2.4 percent of GDP deficit posted in 2013. To be fair, a big portion of Panama’s deficit has been related to massive capex, which at nearly 9 percent of GDP has made Panama one of the largest, if not the largest, spenders in infrastructure in Latin America, and this trend is unlikely to change in the near term. While the current Fiscal Responsibility Law (FRL) caps the size of the fiscal gap for 2015 at 2 percent of GDP, accounting adjustments permissible under the law (i.e. the difference between a 3.5 percent of GDP threshold and ACP transfers to the government as a percentage of GDP), would allow for a deficit of as much as 3.7 percent of GDP (2 percent base + 1.7 percent allowed adjustment) for 2015 without being in violation of the FRL. Accordingly, 3.7 percent of GDP has become the effective new fiscal deficit target for this year, and a relatively small moderation to 3.2 percent of GDP (1.5 percent base + 1.7 percent allowed adjustment) is now being officially projected for 2016. Despite the relatively high fiscal deficits forecasted in the near term, the government is committed to the FRL and has indicated that it does not intend to revise the deficit ceilings, which envisage a moderation in the base deficit of 0.5 percent of GDP per annum over the next few years.
Subsidy bill is poised to remain a drag on the fiscal. Subsidies paid out by the government totaled approximately $1.6 billion in 2014, and a comparable tally is projected for 2015. There are four major types of subsidies in Panama: energy, cooking gas, fuel for public transportation, and direct payments to people of retirement age who have not properly contributed to the pension system. Whereas of the four categories listed above the first three stand to benefit from lower international fuel prices (Panama does not produce any oil), transfers to people of retirement age have been increased and the qualification age has been lowered to 65 from 70, effectively neutralizing the benefits resulting from lower oil prices. At roughly 3.4 percent of GDP, the total subsidy bill is likely to continue to be a significant drag on the country’s fiscal performance.
Further international market issuance is planned for 2015. To finance its 3.7 percent-of-GDP fiscal deficit and roll over maturing debt, Panama needs to borrow $3.5 billion in 2015. Of the total, $700-800 million are likely to be raised domestically, $1.75-2.00 billion in the international market, and the remainder from multilateral lending institutions, such the IDB, World Bank, CAF, among others, but not the IMF, with which Panama has no formal agreement. The government recently issued a 10-year, $1.25 billion global bond carrying a coupon on 3.75 percent, the lowest in the country’s history, suggesting that it has $500-750 million to go in the international market during the remainder of the year (likely to be issued in 2H15). Despite sizable demand for the recent international bond (there were $5.7 billion in market orders), the government opted to cap the size at $1.25 billion after recognizing that its capex execution has been moving slowly and decided not to upsize the issue so as not to start paying for funds not being put to good use immediately; a prudent decision, in our view.
Franco Uccelli is Executive Director of Emerging Markets Research at JP Morgan. This column is based on a recent trip report. Republished with permission.