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AmericasJanuary 18 2023

Panama faces an economic fight to preserve its status in Latam

While economic growth is back on track, the country needs to address the sustainability of its social security system, assure the viability of its mining sector and fix long-term challenges in its labour market. Barbara Pianese reports.
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Panama faces an economic fight to preserve its status in LatamImage: Getty Images

When the Covid-19 pandemic struck, Panama’s government implemented strict confinement measures to preserve the population’s health. That resulted in the country being the most affected in Central America, with a 17.9% shrinkage of gross domestic product (GDP) in 2020 and a 15.3% rebound the following year, according to World Bank data. 

“At the end of 2022, we estimate a growth of at least 9%,” says Héctor Alexander, Panama’s minister of economy and finance.

The pandemic is still showing its aftermath, bringing concerns regarding the long-term financial viability of the Caja del Seguro Social (CSS), which manages the social security system. 

The CSS showed a deficit in 2020, and by 2024 the disability, old age and death programme, known as ‘IVM’, is estimated to deplete its reserves. In 2021, the government set up a national dialogue to address the problems of the CSS, although a solution has yet to be reached. 

The deterioration of the financial position of the CSS is set to become another source of spending pressures for government finance, according to rating agency Moody’s. 

“We knew about this situation 10–12 years ago, so it’s not directly linked to the current government. I am sure the government will do whatever it takes in order for that not to happen, but it most likely will imply more debt,” says Carlos Araúz García, founder of Fidinem Financial Advisory Services.

The fundamental problems facing the pension system are demographic changes, along with increased unemployment and informal working. The Covid-19 pandemic has accentuated the issue as the number of people contributing to the fund has grown more slowly than the number drawing down their pensions. 

Panama’s unemployment level stood at 9.9%, with the informal labour force at 48.2% of the total population in April 2022, according to the Instituto Nacional de Estadística y Censo. 

“The tax to GDP ratio is about 14% here in Panama, while it is closer to 38% in developed nation members of the Organisation for Economic Co-operation and Development. So, when you combine unemployment, informality, social security, and a pre-electoral year, the next 12 months are going to be very challenging times,” says Mr Araúz. 

Betting on mining

Another relevant economic dossier is the future of the mining industry in the country, and its impact on GDP. At time of writing, the government is in talks with Canadian mining company First Quantum Minerals over a new contract that would increase royalties paid to the country.

Panama has demanded First Quantum pay a corporate tax of at least $375m a year, which represents a drastic increase on the $61m the company paid in 2021. The mine, which started exporting in 2019, supports 40,000 direct and indirect jobs. 

In December, Panamanian president Laurentino Cortizo ordered the halt of operations at the Cobre Panamá copper mine, which First Quantum operates, after the parties failed to agree on the terms for a new contract. Panama’s Supreme Court ruled in 2017 that the original contract was unconstitutional and annulled it. 

“I am in favour of the current mining operation, as a new area of activity and new export product,” says Domingo Latorraca, partner at planning and analytics firm Eleménte. “It is generating wellbeing in the area of production, which is one of extreme poverty. However, initially royalties were minuscule and must be reviewed,” he adds. 

“Strong regulation and supervision is required for mining, which has grown from 2% to 7% of GDP in the last few years, further diversifying Panama’s economy. Panama has to be compensated accordingly for its natural resources,” Mr Latorraca explains. 

Mr Araúz adds: “Panama depends on foreign direct investment. We need $4bn to $5bn dollars every year. Over the last 18 months, we have not broken the $2bn mark, so we need to send out the message that we respect the norms and rules.”

Labour informality — a long-term challenge

Panama has registered one of the fastest rates of economic growth in the region over the past 20 years. Between 2004 and 2018, the country had an average annual growth of 7%, compared to 3.3% for the Latin American region, according to the Inter-American Development Bank (IDB). 

In the 1990s, the country began a massive campaign to privatise much of Panama’s public sector, including the distribution of electricity, water and telecommunications. “These reforms have unleashed growth that has not necessarily been directed towards addressing issues in public health and education,” says Mr Araúz.

Poverty has been decreasing in the country over the past two decades, which stood at 36.8% in 2001. However, as it was still 15.6% of the total population in 2021, according to the Economic Commission for Latin America and the Caribbean, inequality still persists, with sharp regional disparities affecting the indigenous population in rural areas. 

“Panama is very integrated in world trade, but it has an education system of the mid-1900s,” says Mr Latorraca. “People are being left behind … because they lack the skills. All the governments since the end of the dictatorship in 1989 have not faced [up to] the challenge to restructure the public education system. Kids educated in public schools are unable to compete and get the best jobs at the many multinational companies headquartered in the country.”

Diversifying the economy

The Panama Canal is a very important part of the country’s economy, representing about 6% in terms of GDP, according to the International Monetary Fund (IMF). “But it does represent a lot more in terms of government finances. Before the pandemic, revenues from the canal represented about 20% of government revenue, but at the worst point of the pandemic, when revenue fell tremendously, they reached about 30%. We will eventually get back to 20%,” says Felipe Chapman, managing partner of Indesa, a Panamanian firm specialised in economic research, business intelligence and investment banking.

The debt-to-GDP ratio stood at about 58% in 2021, according to the IMF. “The fiscal deficit is around 4.5%. But since the economy’s growing way above that in 2022, you can finance it with external funds,” says Ignacio Vollmer, CEO of Mercantil Banco Panama.

However, over the past seven or eight years, construction and real estate have been close to representing an average of 13–15% of GDP, which is incredibly high and not sustainable, according to Mr Araúz.

It is an economic model that continues to rely on commerce, construction, finance and insurance — sectors that have generated employment, but not enough, Mr Araúz adds.

Opportunities ahead

Agriculture and manufacturing are two sectors that offer significant opportunities in further diversifying the economy. The nearshoring process going on in the US is also cause for attention. 

“Panama has to take advantage of that because we could easily double the manufacturing contribution to GDP. The same goes for the export of agricultural products,” says Mr Latorraca. 

Mr Chapman agrees: “We are far away from having achieved the economy’s full potential. Just to give you an idea, our specialty coffee is probably the most expensive in the world. There are a lot of things that we can do in other sectors of the [agricultural] industry to emulate the success of specialty coffees.”

We should start implementing structural economic changes to leverage the opportunities to accelerate growth

Felipe Chapman

Panama could also bet more on tourism. “We have an important infrastructure in this regard, and we have beautiful resources. A strong dollar has not helped attract tourists from Latin America; we could do more to attract people from North America and Europe,” says Mr Latorraca.

And as Mr Chapman notes, “Tourism represents scarcely 2% of the economy, when other countries with less to offer … represent 10% — that is five times more.”

The main challenge comes hand-in-hand with the main opportunities. “Panama is still far away from fully exploiting its geographical position. We’re not taking full advantage of the canal and activities that can be developed around it,” Mr Chapman adds.

Its politically stable institutions, having the dollar as official currency and its geographic position have already resulted in the development of a hub for international companies. 

“[Mercantil Banco Universal is a] 97-year-old company and we moved our headquarters to Panama in 2019,” says Mr Vollmer. “So, we’re a good example of a company that is investing long term and is bullish about the country.”

This should be a good year, Mr Chapman predicts. “We will probably have a soft landing. We should start implementing structural economic changes to leverage the opportunities to accelerate growth,” he adds

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Read more about:  Americas , Panama
Barbara Pianese is the Latin America editor at The Banker. She joined from Mergermarket, where she spent four years covering mergers and acquisitions across Europe with a focus on the consumer sector. She holds an MA in International and Diplomatic Affairs from the University of Bologna having studied in Brazil and France as well.
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