On the up: Public investment continues to drive one of Latin America’s fastest-growing economies

Panama has leveraged its geostrategic position as the crossroads between the Americas throughout history, particularly over the past 15 years. Since 1999 – when the country finally gained control of the Panama Canal – economic progress has been all but unstoppable, with an average GDP growth of 6.8% from 2000 to 2012, according to data from the World Bank, and double-digit growth for four of the past seven years, according to government figures. Having significantly reduced the national debt, the government’s focus has shifted towards upgrading the national infrastructure system.

Public sector spending has emerged as the primary driver of economic growth in the past few years as the country prepares for the post-Panamax era of the canal. The canal’s impact, both domestically and internationally, will expand substantially upon the completion of a third set of locks scheduled for 2015. Putting exact figures on the domestic impact of the expanded waterway is a tall order, though further capitalising on the country’s status as a major trade route will most certainly be crucial to future economic progress.

Modern Development

Modern economic development began with the overthrow of military rule (and General Manuel Noriega) in 1989. Professor Reyes Valverde, a professor of economics and finance at the University of Panama, explained to OBG the significance of the re-democratisation of the country following the fall of Noriega, stating, “It is not a coincidence that we experienced macroeconomic growth in the 1990s following a return to democracy, though after the nationalisation of the Panama Canal, and in particular since the beginning of its expansion, that growth has been significantly amplified.”

More than three-quarters of economic production comes from service industries such as finance, logistics, commerce and tourism. In 2012, 91.6% of the country’s exports were derived from services, with goods accounting for the rest, according to figures from the Centre for National Competitiveness (CNC). Indeed, combined with consecutive pro-business, investor-friendly administrations, economic growth has been surging since the turn of the millennium, with GDP growth averaging 8.5% from 2003 to 2008, according to data from the CNC. Growth in 2009 slowed to 3.9% amidst the global financial collapse, before recovering to 7% in 2010, 10.6% in 2011 and 10.7% in 2012, with the figure through third-quarter 2013 at 8%, according to government figures.

Economic Oversight

The Ministry of Economy and Finance (Ministerio de Economía y Finanzas, MEF), along with the national comptroller, is charged with maintaining the government’s cheque book, as well as helping formulate administrative socioeconomic policy and implementing economic plans and programmes.

Panama lacks a central bank to oversee monetary policy. While this has relatively little impact on currency fluctuations given the dollarised economy, it does leave inflation to the whims of the market.

Economic Policy

Although incumbent President Ricardo Martinelli inherited a growing public investment programme when he took office in 2009, largely thanks to the canal expansion getting under way, the current administration has unveiled a long string of infrastructure projects that will shape the future of the country for years. Indeed, public investment in projects such as the Panama City metro, the expansion of Tocumen International Airport, reconstruction of the city’s Casco Antiguo (historic centre), and countless road construction and restoration jobs have been carried out under the current administration.

The current administration has also focused its efforts into improving four key industries: finance, logistics, tourism and agriculture, having identified these sectors as the future pillars of growth in the Strategic Government Plan 2010-14. The strategy seeks to rely on these sectors to maintain average economic growth of between 6% and 9% from 2010 to 2020, thus ensuring the creation of 860,000 new or better jobs.

The central government’s continued investment in infrastructure over the course of the past four years has kept the country on track towards achieving the above goals. Such high levels of public investment will be difficult to sustain, but Martinelli claims there will still be $19bn in funding available at the end of his term. The estimated budget for infrastructure during this time amounts to $9.6bn, equivalent to 70% of total planned investment from 2010 to 2014, $3.8bn of which will be directed towards the construction of social infrastructure, including hospitals and schools.

Public Finances

As a consequence, GDP growth in recent years has in no small part been driven by public sector investment in infrastructure. Indeed, from 2007 to 2013 both non-financial public sector (NFPS) and central government (CG) investment have been charging forward as the country continues to undergo a major overhaul of its infrastructure network. According to figures from the MEF from 2001 to 2006, NFPS and CG investments hovered just below $500m annually; however, since 2007 those figures have been climbing steadily, with more than 96% of the Ministry of Public Work’s 2014 budget of $918m earmarked for such infrastructure investments.

As a result, government balance sheets have been running a growing deficit, of 1% ($252.4m) of GDP in 2009, 1.9% ($507m) in 2010, 2.2% ($702.8m) in 2011 and 2.1% ($765.5m) in 2012. Moreover, the 2013 budget deficit is predicted to be its largest yet: the MEF forecasts 2.8% of GDP; the figure at mid-year was 2%.

Despite heavy governmental spending, the decline of public debt as a proportion of GDP continues, albeit at significantly slower rates. From 2004 to 2008 the debt-to-GDP ratio fell from 70.4% to 45.4% as GDP grew and the government consciously sought to reduce the national debt. The steady increase in public spending from 2008 onwards was indeed in large part made possible by the significant strides in reducing national debt prior to that. Even with the government’s aggressive investment, the debt-to-GDP ratio continued to fall from 45.4% in 2008 to 39.5% in 2012 and a forecast 39% in 2013. From 2014 to 2018 the MEF sees the ratio continuing its downward trend, falling from 38% of GDP to 31% of GDP, although in nominal terms Panama’s debt is expected to continue increasing to $20.4bn by 2018 from $14.3bn at the end of 2012.

Credit Ratings

Sustained economic growth and the huge reduction in national debt have provided enough rationale for all three major ratings agencies to grant Panama investment-grade status. Moody’s last upgraded Panama’s bond rating to Baa2 from Baa3 in October 2012, at which time it simultaneously altered its outlook from stable to positive. Meanwhile Fitch maintained its rating of BBB in May 2013, the same rating applied by Standard & Poor’s, both having been raised from BBB- in July 2012.

Tax Reform

Reform of the national tax code continued in May 2013 when the four-month transition of the duty of collecting taxes – from the Directorate General of Revenues (DGI) to the new National Revenue Authority (Autoridad Nacional de Ingresos Públicos, ANIP) – began. In April 2013 Law 24 passed the national legislature and in the process legally transferred the tax collecting authority from the DGI to the ANIP. Luis Cucalon, national manager of public revenues and head of ANIP, told OBG, “ANIP will keep the same basic structural setup as the DGI; the biggest change comes from the fact that Law 24 provides us complete autonomy, creating greater transparency and clearing any political encumbrances on the tax authority.” He added that reform of the tax code under the current administration has focused on lowering taxes while closing loopholes. The dual obstacles of income inequality and the forecast expansion of nominal public debt are key concerns to take into account when considering tax reform.

Sovereign Wealth Fund

The creation of a sovereign wealth fund using revenues from canal tolls, known as the Panama Savings Fund (Fondo de Ahorro de Panama, FAP), is intended to act as one buffer against external shocks. According to Jose Abbo, vice-president of the board of directors of the FAP, “Having an open economy very much tied into global markets has benefitted Panama immensely. However, although it weathered the recent global financial crisis fairly well, it remains susceptible to external shocks.” In addition to providing the government with an asset to use in case of disaster, be it economical, social or environmental, the FAP will also be used to help pay down national debt. A mechanism has been built into the legal framework to allow for the FAP to withdraw funds equivalent to a maximum 0.5% of the previous year’s GDP to pay down national debt once the fund reaches 5% of nominal GDP. Although not exclusively a rainy day fund, Panama’s FAP could help to mitigate the risks of being tied to an increasingly globalised economy, while also providing another fiscal outlet to pay down national debt. At the end of 2012 the fund amounted to $1.29bn, but once the expansion of the canal is completed as much as an additional $1.5bn could be added to the FAP on an annual basis, according to statements from the MEF.

Investment

Given its location at the centre of international trade, Panama is a popular foreign investment destination. Yet without the legal guarantees, attractive incentive framework and presence of large free trade zones, its magnetism for investment would assuredly be diminished. Indeed, investment from private sector entities, both foreign and domestic, has been equally responsible for the country’s strong macroeconomic growth as investment from the public sector. The Colón Free Trade Zone, for example, is the second-largest such zone in the world, following that of Hong Kong, and accounted for around 8% of GDP in 2013; it has attracted more than 3000 businesses (see analysis).

Inflation

Although strong economic growth is generally associated with its positive influences, rapid growth can also have negative consequences, including the exacerbation of inflationary tendencies. From 2003 to 2007 inflation rates averaged just 2.02%, though as GDP growth continued to accelerate so has the inflation rate, which averaged 5.26% from 2008 to 2012, according to data from the World Bank. The latest figures from the National Institute of Statistics and Census (Instituto Nacional de Estadística y Censo, INEC) show that in 2013 the urban consumer price index registered a 4% rise, driven primarily by increases in food and beverages, clothing and entertainment costs.

According to Valverde the recent rise in inflation has become a significant problem as its impacts are keenly felt by lower socioeconomic classes. An unequal distribution of income has compounded the issue; the country’s Gini index was last measured at 0.519 in 2010, comparing unfavourably with Peru (0.481), Ecuador (0.493) and Argentina (0.445). However, inflation has not been caused solely by rapid economic growth as several factors – including the strong influx of high-income foreign workers that has been streaming into the country – have also played a significant role. Valverde said government handouts via social programmes have fought to mitigate the damage caused by inflation, but it has not been enough. At the end of the day there are relatively few tools to combat inflation in Panama. Indeed, the lack of a central bank to combat inflation via monetary policy means inflation tends to be more or less a “self-correcting” issue.

Employment

Unemployment figures remain reasonably low, with the latest available figures registering 4.1% in August 2013, according to INEC. This represents a significant improvement from just a decade ago, when unemployment figures were mired in double digits and reached a high of 14% in 2001. Indeed, it took a few years for employment figures to improve following 1999, when the country wrested the control of its canal from the US. Unemployment dipped into single digits in 2005 and has been gradually trending downward ever since, largely thanks to a slew of jobs created by the government’s infrastructure development programme.

Retraining and placing the large number of construction workers once the heavy infrastructure investment finishes represents a significant medium-term challenge for the economy. Additionally, August 2012 figures from INEC indicate the country possesses a high level of invisible sub-employment (11.1%) and a large informal economy (37%), suggesting there is significant room for advancement in terms of improving the productivity of the national workforce.

Trade

Panama’s location has made it a natural centre of regional trade for centuries; however, it was the construction of the Panama Canal that created a global trade hub a century ago. In 2014 the canal celebrates its 100th anniversary, and the completion of a third set of locks will alter world trade routes and provide an additional boost to the economy (see Canal chapter).

Indeed, capitalising on a constant flow of goods has become a major focus within both the public and private sector as the country sets its sights on becoming the chief logistics centre in the region, while simultaneously luring multinational companies to “nearsource” management, back office, and value-added manufacturing to Panamanian shores (see analysis).

Liquid Banking

In addition to being a major trading centre, in 2012 Panama City gained recognition as one of the world’s 75 largest financial centres when it placed 67th in an annual study released by London-based think tank Z/Yen. In the 2014 edition of the study, Panama climbed up the ranking to 61st position. According to data published by the Superintendency of Banks of Panama (Superintendencia de Bancos de Panamá, SBP), the international financial centre in Panama City consists of 93 banks and in 2012 saw its assets grow 10% to close the year at $89.78bn – almost two and a half times the size of GDP – while the national banking system also grew 10% to $72.94bn. Indeed, Panama City is hot on the heels of its regional rivals Mexico City (55), Buenos Aires (53), Rio de Janeiro (48) and São Paolo (44) for the size of its financial centre.

The financial sector skated through the global financial crisis relatively unharmed. According to Abbo, “Conservative practices within our banking sector helped to limit the exposure of our financial markets to the risky investment vehicles which set off the crisis, though it was still severely hindered.”

On the private sector side, Panama City’s growing reputation as an international financial centre has pushed assets over $90bn as of November 2013, according to data from the SBP, and continues to provide significant liquidity to the market. Meanwhile, domestic credit within the national banking system grew 12.89% from $33.09bn in 2012 to $37.36bn as of November 2013, thanks in large part to private sector lending, which accounted for 86% of all credit. Excess liquidity in the financial markets has also resulted in extremely favourable interest rates, particularly when placed in a regional context. Panama’s 9.75% average rate for private consumption and 7.23% rate for commercial loans compare favourably to those found in regional neighbours such as Chile (36.83%, 10.57%), Colombia (21.83%, 10.02%), Peru (39%, 8.3%) and Nicaragua (13.89%, 8.47%). However, Abbo believes that not enough liquidity is making its way to small and medium-sized enterprises (SMEs) and the primary venue for excess liquidity in recent years has been found in the booming real estate market. As of September 2013 around a quarter, $9.8bn of $36.9bn, of the financial market’s credit portfolio was made up of mortgage loans, with an additional $3.65bn in credit in the construction sector.

Infrastructure & Construction

Maintaining pace with a rapidly expanding transport, logistics and communications sector has become a high priority as the government seeks to ensure the long-term sustainability of these industries. This is mainly a result of the transport, logistics and communications sector outpacing wider GDP growth in the past few years, contributing 24.3% of GDP at 1996 prices as of the third quarter of 2013, according to data from INEC. Though the flagship development is clearly the $5.25bn expansion of the Panama Canal, work is being done across the board to continue improving infrastructure networks. In Panama City $1.88bn is being used on the first phase of a new metro system, while a slew of road and highway projects are also under way. The clear beneficiary of broad economic growth and the government’s infrastructure development plan has been the construction industry, which has seen its economic growth average 18.3% from 2008 to 2012 and reached year-on-year (y-o-y) growth of more than 29% in third-quarter 2013, according to figures from INEC.

In addition to significant infrastructure development, increasing demand for residential, retail and commercial real estate has continued to draw significant investment. During the first semester of 2013 construction investment was focused on residential projects as they attracted 71% of all investments to total $438m, a figure that climbed from $311m y-o-y.

Mining

Though still a negligible part of the wider economy, the mining sector is poised to grow enormously in the coming years. From 2008 to 2012 it averaged annual growth of 18.9%, albeit from a relatively small base. Large deposits of copper and gold are being sought out by junior exploration companies. For example, Canadian mining outfit First Quantum is planning to construct the country’s first large mining project – a record-breaking $6.2bn investment – to develop a copper mine dubbed Cobre Panama.

The mine is expected to produce at least 255,000 tonnes of copper annually, as well as trace amounts of gold, molybdenum and silver. First Quantum acquired the project when it took over Inmet Mining Corporation in early 2013 and at the time of writing was seeking to lower project costs. It announced that it intends to publish the revised capital cost estimate and project schedule in the first quarter of 2014.

Apart from taking another look at the costs involved, the project faces further possible problems from the mine’s nearby communities. Large-scale protests erupted due to the perceived impacts of the project on the local environment and indigenous communities. Indeed, the lack of a responsible, developed mining sector means the industry faces an uphill climb in winning over the local populations, whose approval will be pivotal to the expansion of the sector.

Tourism

The growing tourism sector represents another industry with a potentially strong future, as suggested by its inclusion as one of the administration’s four pillars of economic growth. That potential will also require a lot of ground work, as Alicia Peschiera, vice-president for LatAm Business Development at the Panama-Peru Chamber of Commerce and CSA Group, explained. “Even if some infrastructure has been done to improve the tourism industry, there are many things still to be done, such as developing the image of Panama, improving touristic campaigns and creating a general policy regarding tourism,” she told OBG. A growing aviation and international business centre, Panama also boasts rich natural resources, including plenty of sun and sand, as well as a high degree of biodiversity.

Tocumen International Airport and Copa Airlines both currently have the largest international seating capacity in the region for airports and airlines, respectively, according to a study by international aviation consultancy CAPA Centre for Aviation. In fact, the rapidly growing number of tourists coming through Panama City has caused an even more dramatic rise in the supply of hotels in the city. However, Panama City currently has an oversupply of rooms, while many other regions of the country remain starkly undersupplied.

Nevertheless, the tourism industry remains an important aspect of the government’s plans to spread economic growth to rural areas. In 2012 the World Travel and Tourism Council measured the sector’s overall contribution to GDP, including direct and indirect contributions, to be equivalent to 13.1% of GDP.

Challenges

In terms of long-term socioeconomic development, a frequent observation in Panama is that the primary obstacle standing in the way of achieving the country’s goals is a faltering education and human resource development system. On top of improvement to labour qualifications, which were business respondents’ first concern for the country in the World Economic Forum’s “Global Competitiveness Report 2013-14” (GCR 2013-14), Panama’s labour costs are also increasingly uncompetitive with its regional neighbours.

This is of particular importance given the possibility of creating a value-added manufacturing sector to capitalise on the mass movement of goods through the canal. Panama is already at a disadvantage with the region’s large manufacturers Brazil and Mexico, which boast economies of scale not possible in Panama. Rising minimum wages to combat inflation have only exacerbated the problem. That being said, Valverde elucidated that Panama and Chile are the only Latin American countries to have already completed the UN’s Millennium Development Goals and that the country boasts a significant advantage with its infrastructure and, of course, the presence of the canal.

Other challenges to economic growth include bureaucratic inefficiency within the central government. Aida Michelle U. de Maduro, president of the Panama Industrial Association, told OBG, “Often times legislation is passed without the approval or revision of implementing ministries and agencies, and at times bureaucratic processes for taking advantage of incentives within legislation are overly complicated and difficult to complete.” Indeed, bureaucracy was cited as the second-most problematic factor for doing business in the GCR 2013-14. Maduro suggests greater attention in ensuring that implementing authorities are able to review legislation before its approval and creating an inter-ministerial committee or one-stop shop to help reduce inefficiency between government agencies.

Outlook

The CNC forecasts economic growth should stabilise to more sustainable rates over the coming decade as GDP growth decelerates to average 7-9% expansion from 2013 to 2015 and 6-8% through to 2020. The third quarter of 2013 registered 8% growth, only slightly below government expectations of annual growth of 8.5%. There is relatively little doubt that the already-established logistics and financial sectors will continue to play leading roles in the wider economy in the long term. Meanwhile the country’s more nascent sectors, such as tourism and mining, show tremendous propensity for growth.

However, a faltering education system will likely remain a liability across all sectors of the economy if not addressed quickly and thoroughly. And though the government is generally lauded for its pro-business legislation, it is also criticised for its below-par bureaucracy. Still, the country will remain a unique and exciting destination for investment in the short to medium term due to its solid macroeconomic record, importance to global trade and strong investment framework.