Panama: Mid-Year Update

Panama’s external environment could not be better. With global GDP growth running at an annual pace of 5% y/y and global trade flows expanding 8% y/y, there is ample demand for Panama’s various services. The Panamanian economy grew 8.1% y/y in 2006, and it is on track to grow more than 6% y/y in 2007. The construction sector is moving at full tilt. The Canal Free Zone is doing a booming business, thanks to the high level of economic activity in Colombia and Venezuela. The government is moving ahead with the post-Panamax locks, and the tourism sector is taking off. The booming economy is creating an environment of political stability, despite the fact that President Torrijos is moving into the latter half of his term. The Panamanian President enjoys a popularity of 65%, and his PRD party has a solid congressional majority. The robust picture is one of the reasons why the rating agencies are indicating that Panama could be upgraded before the end of the year. Nevertheless, Panama is very much dependent on the external environment. The construction and tourism sectors are functions of domestic demand in the U.S. The activity in the Canal Free Zone is contingent on the level of GDP growth in Colombia and Venezuela, and the prospects for the post-Panamax locks depends on the future of global trade flows. Therefore, a play on Panama is a play on the regional and international environments.

The Panama Canal Authorities (ACP) reported revenue increases of 16.5% y/y during the first quarter of 2007. There was a 4.9% y/y increase in the number of transits, and a 6.3% y/y increase in tonnage. However, more importantly, the ACP reported a 16.7% y/y increase in the volume of freight processed in Panamanian ports. As we argued before, there is more value in logistical services than in toll collection. The ACP’s revenues are benefiting from the development of new ports on the Pacific and the Atlantic. The trans-isthmus railroad is working at full capacity, and the modernization of the highway system will allow more cargo to transit over land. At the same time, the Canal Free Zone reported a 25.3% y/y increase in revenues. The Canal Free Zone is a major marketplace for wholesalers in Central America and the Andean region. The large increase in Colombia’s and Venezuela’s domestic demand represented a greater part of the improvement in sales. The Free Zone reported revenues of $3 billion year-to-date, with $1.5 billion destined for Venezuela and $1.2 billion for Colombia. As a result, Panama increased total exports by 16.7% y/y during the first five months of 2007. Although the improvement in economic activity and exports raised tax revenues, the Panamanian government reported a fiscal deficit of 0.4% of GDP during the first five months of this year—due to large increases in government outlays.

The heady expansion of the Panamanian economy is grinding on the nation’s resources. The increase in electricity demand is putting a strain on the national grid, and there are fears that Panama may soon have to ration power or face blackouts. The construction of new buildings and the arrival of immigrants are forcing the government to improve infrastructure projects, such as water treatment and sewage, as well as providing additional services, such as public security and health. All of these outlays are putting pressure on the fiscal accounts. The ACP is scheduled to increase tolls in July, and the additional funds were supposed to help finance the construction of the new locks. However, the government may be forced to tap into these funds to meet current expenditures.

In other words, Panama may be growing too fast. The progress on the new locks is moving ahead, with the ACP calling bids for the first excavation projects. International firms are lining up, and Panama is realizing that it may not have enough domestic cement production to meet the project’s demands. At the same time, the expansion of the housing sectors in Panama City and the northern provinces are bringing in hordes of retirees, many which require additional services. The Panamanian health system was recently challenged with a crisis associated with tainted consumer products. The additional strains of attending a larger (and needier) population base could bring the system close to the breaking point. Therefore, Panama is a tenuous place. Panama’s external environment may be optimal, but unbridled expansion, as well as a complete dependency on external factors, could put the country in a very vulnerable position.