Panama: Risk Assessment

Country Rating¹

Rating: A4

Business Climate Rating¹

Rating: A4

Risk Assessment²

Strong economy driven by domestic demand
Although very exposed to external shocks, the economy proved resilient to the crisis and benefited from a strong recovery in 2010. Economic activity was underpinned by an investment rebound and strong household consumption facilitated by the declining unemployment. In 2011, the economy is expected to remain among the most dynamic in the region with infrastructure projects associated with the canal enlargement, even though budget constraints could impede public-sector investment. Economic activity will also receive a boost from foreign direct investment now in the process of returning to its pre-crisis levels.  Investor confidence has been bolstered by the resilience of the economy to the crisis and by the prudent policies pursued by President Martinelli. Foreign direct investment has been particularly focused on tourism and energy, which offer good growth potential. Foreign trade, meanwhile, is expected to continue to make a negative contribution to growth as a result of the acceleration of imports associated with investments and activity in customs free areas. The sectors likely to continue to grow notably include transport, communications and retailing. The canal and financial services could continue to suffer from low activity.
The banking sector is well capitalized and oversight has improved since the regulatory changes made in 2008. The sector remains nonetheless exposed to external shocks due to the preponderance of foreign banks (60% of the total) and Panama's role as a regional financial hub.

Prudence on fiscal policy but dependence on foreign capital
The reforms adopted late 2009 and early 2010 to increase fiscal revenues (increases in tax rates and improvement in public administration to limit tax evasion) have produced results. Fiscal revenues will benefit moreover from increased income associated with economic growth. The authorities are thus expected to be able to keep the public sector deficit under control at 2% of GDP in 2011 and reduce the size of the public debt to under 40% of GDP. To achieve those goals, the budgetary execution of large public investment projects could be partly postponed.
The current account deficit, which had contracted in 2009, widened in 2010. The rise of imports, associated with the economic growth and the investment recovery, resulted in a larger trade deficit. Meanwhile, despite the upward trend of tourism revenues, the increase in service imports and profit repatriation by foreign companies reduce the invisibles surplus. Foreign direct investment, now making a strong comeback, has facilitated covering most of Panama's financing needs while foreign-exchange reserves have served as an adjustment variable. The current account deficit is expected to continue to deteriorate in 2011 in the wake of the increase in imports needed in carrying out the canal enlargement work and other investment projects. In conjunction with financing from abroad, foreign direct investment is expected to suffice in covering the country's financing needs.

Political stability
President Ricardo Martinelli (of the centre-right Democratic Change Party) was elected in 2009 for a five-year term. With his party claiming only 13 congressional seats out of a total of 71, he is dependent on a coalition with a large majority constituency. Although his interventionist proclivities have drawn criticism and his popularity has been in decline, the president has nonetheless remained very popular.

Strengths

• Strategic activity of the canal whose enlargement is to be completed by 2014
• Dollarisation of the economy
• Policy of maintaining major macroeconomic equilibriums
• International banking center and regional financial hub
• Colon, the second-largest free trade area behind Hong-Kong

Weaknesses

• Exposed to fluctuations in world trade
• Structural trade deficit and heavy dependence on foreign capital, especially dependent on the US, economically and financially
• Major inequalities and poverty affecting half the population
• Weakness of judicial institutions and extensive corruption
• Included on the tax haven grey list of the OECD