Country Report Panama
Supported by multiple large infrastructure projects economic growth in Panama is strong. Whether these projects will boost growth structurally, to an extent that it will outweigh a loss of short-term infrastructural investment-driven growth in the future, remains to be seen.
Strengths (+) and weaknesses (-)
(+) Favorable geographical location
Panama is exploiting its favorable geographical location. Due to large infrastructural investments Panama is becoming one of the most important trade hubs in the region.
(+) Long-standing monetary stability
Due to the full adoption of the US dollar, Panama does not have its own currency or a central bank, which has contributed to monetary stability for a long time.
(-) Corruption and rule of law
Corruption is problematic, also at the highest levels. Besides, indigenous communities are not fully protected against land expropriation (for mining purposes).
(-) Lack of an educated workforce
Panama’s education system is weak and its workforce is relatively low educated as a result.
1. Economic growth still high and expected to ‘slowdown’ further
Economic growth remained strong in 2013, despite the fact that GDP growth decelerated from to 8.4%, from 10.8% in 2012. The slowdown reflected a decline in the value of goods traded in the Colon Free Zone, as demand fell from Venezuela, which implemented foreign exchange controls and from Colombia, which imposed import tariffs on textiles. For this year the economy is expected to decelerate again to 6.5% before slowing down further to 5% à 6% in the period thereafter, as some major infrastructural projects are closing completion. Despite the expected slowdown, the IMF still sees signs of overheating and a loss of competitiveness given a combination of “strong domestic demand, robust credit growth, negative structural primary balance, positive output gap, tight labor market, an appreciating real exchange rate (reflecting persistently higher inflation than that of major trading partners), and a large current account deficit.” With regards to inflation, the IMF warns for an inflation-wage spiral, as both public and private wages increased in 2012, by 11.6% and 9.3% respectively. This risk exacerbated as the government raised the minimum wage per 1 January 2014 by 13% to USD 488 per month and by 27% to USD 624 per month, depending on the region.
Next to having a large impact on economic growth, the construction projects also explain Panama’s large current account deficit of 11.8% of GDP in 2013. The risks of a large current account deficit are mitigated by the fact that the deficit is largely financed by FDI. Since some construction works are close to completion in the coming years, the current account deficit and the inflow of FDI is likely to decline.
2. Panama Canal expansion delayed
In recent years, the government of Panama has invested substantially in infrastructure projects to improve Panama’s position as a regional trade hub. The most prominent project is the expansion of the Panama Canal. In the first half year of 2014 the construction of the Canal was delayed two times. In February, the Panamanian Canal Authority (PCA) got into a dispute over cost overruns with the Grupos Unidos por El Canal (GUPC), the consortium that is in charge of the construction. GUPC claimed that the government was responsible for a cost overrun of USD 1.6bn. The total cost of the Canal expansion was originally budgeted at USD 5.2bn, but has risen to an estimated USD 7bn. After two weeks, the PCA and GUPC reached a deal and agreed that they would both finance an additional USD100m. In addition, Zurich insurance company provided a USD 400m loan. This was enough to keep the project going. However, arbitration proceedings will ultimately determine who will be paying the cost overruns. In May, there was again a two week delay, as workers from the National Union of Workers of Construction and Similar Industries (SUNTRACS) demanded a wage increase. The project is now expected to be finished at the end of 2015/the beginning of 2016. One of the other main infrastructure projects is the building of a metro network in Panama City, which consists of four lines. The first line was completed at the beginning of this year, while the second line is expected to be finished in 2017.
The chance that the Panama Canal will get competition from a Canal in Nicaragua is rising. In July, the government of Nicaragua and a China-based consortium, HKND Group, revealed the route of a new canal that will link the Pacific Ocean with the Caribbean Sea via Nicaragua. Its construction is scheduled to start in December 2014 and will take an estimated 5 years to build. However, there are doubts whether the canal will be completed in 2019, as there is still opposition against the construction. The critics mostly focus on the ownership ratio between the government and the Chinese consortium, the impact on the environment and doubts whether there will be enough employment opportunities for Nicaraguans. In addition, the Panama Canal will keep a natural advantage, as the canal through Nicaragua will be three times longer than Panama’s, prolonging the shipping time.
3. New president is business friendly, despite some price controls
On 4 May, Juan Carlos Varela (Partido Panameñista) was elected as president, receiving 39.1% of the votes. The outcome came as a surprise, as Varela was running behind in the polls. Varela is a former businessmen and has been vice-president in former president Ricardo Martinelli’s cabinet and a minister of foreign affairs. Varela is likely to maintain the business-friendly policies of Martinelli. That said, during his campaign Varela promised to implement price control on 22 basic items to fight inflation, which he implemented just after his inauguration on 1 July. Although only a few goods have been affected, the directive contradicts with free market policies. In addition, similar policies have in other countries (eventually) led to shortages of goods.
In recent years, the Panamanian government has focused on increasing the country’s importance as a regional trade hub. To this end, large infrastructural projects have been undertaken, such as the expansion of the Panama Canal, which is expected to be completed at the end of 2015/beginning 2016. Mainly due to these projects economic growth averaged almost 9% in the last five years, the highest rate in Latin America. When these projects are completed Panama’s economy will be even more open and be more integrated in international trade. The high growth figures are, however, not accompanied by a substantial increase of the skills of the workforce, leading to an inflow of workers from abroad. In addition, not all Panamanians seem to have benefited from the increase in welfare; youth unemployment is substantially higher than the overall unemployment rate and social indicators have been improving only slowly. An important characteristic of Panama’s economy is that it is fully dollarized, and therefore does not have its own central bank. This also implies that there is no lender of last resort. In addition, Panama has no deposit insurance scheme. For monetary stability; the stability of the US dollar exchange rate; Panama’s competitiveness; and the difference between the inflation rates of both countries, are important.
Panama’s political system is relatively stable, especially when it is compared to other countries in the region. For instance, strong checks and balances in the political system are in place. That said, there are regular report about corruption and not all indigenous groups are well represented in parliament.