Beyond the canal: Panama's challenges

Participants:

• Frank de Lima, minister of economy and finance of Panama
• Diego Ferrer, deputy director of investment and concessions of the state at the Ministry of Economy and Finance of Panama
• Alejandro Abood Alfaro, head of the Superintendence of the Securities Market of Panama
• Jorge Vallarino Miranda, chief financial officer, Global Bank
• Daniel Vial, director of finance, Dell Latin America
• Juan Carlos Camargo, general counsel for Latin America, Procter & Gamble
• Silvia Pavoni, economics editor, The Banker

Panama’s economy grew by an impressive 10.6% in 2011, and on average over the past decade at about 8%. According to government estimates, there will be 10% and 8% gross domestic product (GDP) growth for 2012 and 2013, respectively. The International Monetary Fund predicts a more conservative GDP growth for this year, but has recently upgraded its initial 7.5% forecast to 8.5%. Furthermore, in July, rating agency Standard & Poor’s moved Panama further up the investment grade spectrum, by giving it a BBB rating – something that Fitch had already done in 2011.

Frank de Lima, Panama’s minister of economy and finance, says that such economic performance is driven by a combination of stronger internal demand, revenues from the Panama Canal and sustained foreign investment, which includes the recently signed $6.2bn mining project in the Donoso district by a Canadian copper and zinc producer Inmet – the largest ever foreign direct investment in the country.

“Several sectors of the economy are driving this growth,” says Mr de Lima. “The Panama Canal and all the logistical activity that has generated around [it], for example the ports, [through which] we expect to have close to 7 million container movements this year,; mining, which is a new industry in our country; our strong financial sector; [and] tourism, which is growing at 10% a year.”

Private sector enthusiasm

The private sector is equally optimistic about Panama. The country’s open economy is well regarded and a law introduced in 2007 has given further incentives to multinationals to base their regional headquarters in Panama. Juan Carlos Camargo, general counsel for Procter & Gamble’s Latin American operations, says that the company was one of the first to take advantage of this law and consolidated its regional headquarters in Panama from Caracas in Venezuel, and San Diego in the US.

Daniel Vial, director of finance for Dell’s Latin American operations, says: “We looked at things such as security, political and economic stability, and over the years we've seen that that has actually been sustained.” Dell has more than 2000 employees in Panama and plans to hire an additional 700 workers over the next two years. Panama is also very active as a large financial centre and many international banks have operations in the country. These institutions have brought know-how with them, says Jorge Vallarino Miranda, chief financial officer of locally owned Global Bank, something that is now ingrained throughout the whole of Panama’s financial sector.

Prudent management and good supervision have been credited with sparing the country from any major impact related to the global financial crisis and other crises that have affected Latin America. “If you look at the numbers, I think that Panama has demonstrated its ability to navigate through tumultuous waters during the successive financial crises that we've witnessed,” says Diego Ferrer, deputy director of investment and concessions of the state at Panama's Ministry of Economy and Finance. “And it is interesting to note that although Panama did take a hit in 2009 – growth slowed to 3.2%, which is still pretty good given the circumstances – the economy rebounded quite nicely [to] 7.5% growth in 2010, and 10.6% in 2011.” 

Public spending

Though Panama's recent story is a successful one, there are still some areas of concern. Its accelerating economy and the large influx of international firms means that the local labour pool is insufficient in both size and skills. While competition between employers to secure the best candidates is fierce and goes across industries, the education system is still unable to meet labour market demand.

“If you ask the private sector, the main problem that [it is] having is hiring qualified labour,” says Mr de Lima, who adds that until very recently, only half of enrolled students would finish secondary education. The government has therefore introduced a series of incentives to involve families in their children’s school life, as well as offering scholarships, free laptops to some students, and providing improved Wi-Fi internet connectivity in Panama City and other parts of the country.

Education is possibly Panama’s most pressing matter, but much investment is also needed in upgrading the country’s infrastructure. Here, spending has been committed towards developments ranging from the country’s first underground network, which will ease the highly congested traffic of Panama City, to the expansion of the capital’s Tocumen airport and other smaller airports in the country, to one of the largest and most significant infrastructure projects in the world: the expansion of the Panama Canal. This project is due for completion in 2014 and Mr de Lima says that it is on time and within the initial $5.25bn budget.

“The previous administration was able to execute $4.4bn in public investment,” says Mr de Lima. “This administration is going to be able to execute a little bit over $13bn. Thanks to the expansion of the Panama Canal and the extra revenue [it brings], the next administration... running the country from 2014 to 2019 is going to have the capacity to execute $19bn in public investment.” 

Canal importance

The Panama Canal has played a crucial role in the history of the country. For years under the ownership and administration of the US, the canal territory was handed to Panama in 1999. The government then immediately upgraded the canal, and received about $140m in revenues, according to official figures. “Last year, we received slightly over $1bn,” says Mr de Lima. “Now, with the Panama Canal extension, by 2025 the central government should be receiving $4.5bn in revenues.”

Panama’s economy has blossomed thanks to the canal, but Panamanian officials take issue with the view that their country is dependent on the waterway. They do recognise, however, that the canal is the focal point of the logistics hub created around it. “In reality, the canal contributes less than 10% directly to [Panama's] GDP,” says Mr Ferrer. “But the important thing to realise is that the Panama Canal is the cornerstone of a large sophisticated logistics platform. The canal has allowed Panama to develop two of the largest and most efficient ports in Latin America [and] have the second largest free-trade zone in the world after Hong Kong.” 

Controversy has also emerged on whether the expansion of the canal will attract as much revenue as Panama hopes, but such worries have been dismissed locally. Global Bank’s Mr Vallarino Miranda says that when looking at the size of the anticipated extra revenues, which can be up three times current figures, observers may be excused for feeling it is simply too large a figure. However, closer analysis on what the improved infrastructure can actually generate tends to cause these concerns to disappear. Mr Ferrer says that in the same way that road improvements will have a positive impact on productivity – workers in Panama City, for example, will not have to spend hours stuck in traffic – the canal expansion will push Panama’s economy to an even higher level. “It is an investment in productive infrastructure, and that productive infrastructure does a lot of things, including raising the potential GDP of the country,” he says.

The Panama Canal is integral to world trade and is still the most efficient way to cross from the Atlantic to the Pacific oceans and back. Yet, while its expansion is not yet completed and the project is halfway through building the third set of locks, rumours on alternative 'dry canals' have surfaced. These include possible rail links through Nicaragua or even Colombia. No plans have ever been formalised, however, and despite being obviously conscious of its geographical blessing, Panama guards against complacency on this score.

“We've waited close to 100 years to expand the Panama Canal,” says Mr de Lima. “Speaking with the canal administrator, it is looking already at the fourth set of locks that will be started in 2030. So it is looking at ways to maintain that competitive advantage [and] dissuade new players to come in – it's much easier to build a fourth set of locks using the main infrastructure that's already been completed than starting from zero and building something new.”

SWF appeal

To manage Panama’s economic success and the anticipated extra revenues from the canal, and prepare for any future downturn, the country has approved the creation of its first sovereign wealth fund. Of the revenue that the central government receives from the canal, up to 3.5% of GDP will be retained, and any additional income will be put in the fund, which Mr de Lima refers to as the Panamanian Savings Fund. The seed capital will be $1.2bn, which originated from the privatisation programmes of the 1990s, and the Ministry of Finance expects that capital will expand to $6bn by 2025. Mr de Lima says that the fund will be used in the event of any natural disasters that generate damage above 0.5% of GDP, or if real GDP growth falls below 2% for two consecutive quarters, which would give the government the ability to create stimulus programmes.

“If you look at the motivations behind creating the sovereign wealth fund, one of them is prudent management of resources which are coming in the direction of the government through the expansion of the Panama Canal,” says Mr Ferrer. “On the one hand, things are cyclical, 10% [GDP] growth isn't going to last for ever; on the other hand, Panama is, as is every other country in the world, susceptible to climate change. [We] used to be a country that had small recurrent climatic events; now you're seeing the frequency and the magnitude of those events becoming a bit more pronounced.” 

Global banking presence

Prudent management and the ability to invest in local infrastructure without aggravating the public debt burden were key to securing the rating upgrades over the past couple of years – the country was given investment grade status for the first time in 2010, first by Fitch and then by Standard & Poor’s and Moody’s later that year. This has helped Panama’s private sector too.

“[The upgrade to investment grade status] after the crisis has brought in a lot of international institutions and investors who are now interested in the country,” says Mr Vallarino Miranda. This has been of particular interest for Panama’s banks, as sustained high economic growth can put pressure on banks’ funding sources. “From a local financial institution point of view, [Panama’s investment grade status] has also helped with our funding sources because obviously [it attracts] a lot of investment, a lot of demand. There has always been a lot of liquidity in Panama, but when you're funding such high growth rates it is important to diversify the funding sources.”

Panama serves as Central America’s main hub and most international players have a presence there. When HSBC decided to focus on fewer, core markets and sold its Central American operations, the bank still retained its Panamanian business. HSBC is the largest lender by Tier 1 capital in the country, while other large foreign-owned banks include Citibank Panama, Spain’s BBVA, Venezuela’s Banesco and Bancolombia’s Panamanian operations.

Mr de Lima says: “This is not a financial overnight success [such as in] Iceland. We had our two lost decades, the 1970s and the 1980s, when we were under military rule, and we started blossoming in the 1990s. But the financial sector, as a financial hub, has existed since the 1970s and even prior to that. The legislation has improved over time [but this] hasn't been something that we just made up now.” 

Both local and foreign banks have taken advantage of Panama’s growing economy. The country's GDP expanded by 10.6% last year, and bank credit rose by about 12%, says Mr Vallarino Miranda. As well as growing internal demand, this is also a consequence of new multinationals setting up base in the country, requiring new office space, which may be financed by local lenders, and bringing with them employees from abroad, which are much-sought-after customers for banks. “[Multinationals coming in] need new office space; they're bringing employees from their regions, so from the consumer point of view those are individuals that have a relatively high purchasing power; [this] has been helping on the demand side as well,” says Mr Vallarino Miranda.

Banks in Panama did not suffer any major repercussions as a consequence of the global financial crisis, but greater focus was put on risk and liquidity levels, which contained the expansion and margins of credit products. Mr de Lima says that because of the conservative approach of the banking sector, and the fact that no government support was required by its lenders, Panama experienced relatively good economic growth even during the crisis – something that helped to push forward its public investment programmes.

Financial expansion

While the government has been busy with Panama's ongoing infrastructure projects, the private sector has been generating greater demand for real estate, with growing numbers of multinationals moving to the country and needing office and residential space. The global economic downturn did have an effect on some of the corporates, which had to downsize their international expansion, but much of the real estate originally built for North American and European businesses was taken up by fast-expanding Latin American companies, as well as a growing number of individuals relocating to Panama from Venezuela. “The real estate business and all these big projects were initially rented for Canadian and US retirees,” says Mr Camargo. “That didn't happen, but it was compensated by other Latin Americans coming to Panama. We have seen a Venezuelan influx [and] it's a big group of people coming to Panama with spending power.” 

High liquidity means that bank lending continues to be the main source of funding for corporates. Both the private sector and government intend to grow alternative sources and deepen the country’s capital markets.

“The government has made a strong push to develop the local capital markets,” says Mr de Lima. “Back in 2009, if you look at our debt portfolio, 92% was international debt and only 8% was local debt. Right now that figure is about 80/20. So what we've been doing is placing debt in the local capital markets and not so much in the international markets.” The latest international placement by the government was a $500m debt issue in Japan. Locally, it has placed a total of $1.4bn of which $500m has been traded in the secondary market, says Mr De Lima.

The challenge will be to attract international issuers to Panama. Alejandro Abood, head of the country's Superintendence of the Securities Market, says that because of Panama’s dollarised economy, investors   have the option to issue debt in US dollars on the local market, which is a benefit to the ones that wish to retain a dollar profile. On the other hand, low interest rate dollar loans from the local banking sector have helped in keeping this product competitive. “It's hard to get started and get the ball rolling, but we back inhave seen some foreign institutions coming to Panama and placing debt here,” says Mr Vallarino Miranda.

Panama has been blessed with a geographical location key to international trade, and has taken smart policy decisions over the years to attract foreign investments and sustain growth. It is not exempt from the issues that are typical for fast-developing economies, but it is taking steps to solve them. And it certainly does not lack in ambition. As Mr De Lima points out: “[There are] areas we have to improve: education, health, road infrastructure, logistical infrastructure, because we want to position ourselves as the main logistical hub of the continent.”