Source: Leland Baxter-Neal / The Tico Times
URL: http://www.ticotimes.net/businessarchive/2009_05/051509.htm

PANAMA CITY, Panama – President-elect Ricardo Martinelli will assume power July 1 with years of explosive economic growth at his back, hefty campaign promises on his shoulders and a daunting deceleration of the country's economy before him.

Fueled by booming construction – parti-cularly of high-rise apartment towers – a fl ush banking sector and commerce through the Panama Canal, the country's gross domestic product (GDP) has grown by an average of more than 8 percent annually since 2004, with growth spiking to 11.5 percent in 2007 and 9.2 percent in 2008.

Panama's economy has been one of the fastest growing in Latin America. However, as credit and commerce contract worldwide, the country has not been immune, and the slump will be one of the biggest challenges Martinelli faces as he begins his presidency.

Growth in Panama plummeted back to earth at the beginning of the year, and analysts predict a GDP growth in 2009 of only 3 percent. This is a rate that neighboring Costa Rica might envy, considering its predicted rate of 0.5 percent for this year.

“In the short term, maintaining positive GDP growth during the global recession will be key,” reads a post-election report from the international credit rating agency Standard & Poor's.

“Even though, as noted, Panama's is among the handful of economies that we expect to expand in 2009, growth will decelerate sharply,” the report continues. “This could make political alliances hard to maintain. Here is where we believe that Mr. Martinelli's proven ability as a successful business manager will come into play.”

The owner of one of the largest supermarket chains in Panama and founder of the Democratic Change Party, Martinelli was elected May 3 with 60 percent of the vote, the highest margin ever achieved in Panama's 20-year-old democracy. His nearest opponent, Balbina Herrera of the ruling Democratic Revolutionary Party (PRD), received less than 38 percent.

Martinelli also has worked in government, serving as chairman of the board of directors of the Panama Canal Authority, as Panama Canal minister and director of Panama's Social Security Administration.

“Frankly, the business sector is going to love Martinelli,” said Heather Berkman, a Latin America analyst for the consulting firm Eurasia Group. “He's planning on cutting corporate taxes to implement the flat tax, and he came out last week saying he would resist any legislation requiring more tax transparency and information sharing – which the U.S. Congress has been demanding as a precursor to movement on the Panama free-trade agreement.”

Trade and Taxes
The George W. Bush administration in the U. S. and Panama's reigning Martín Torrijos administration finished negations and signed a U.S. – Panama free trade agreement in December, 2006, and current U.S. President Barack Obama has said it is the first such agreement he wants to move through Congress.

But some key U.S. Democrats have said they will not vote for the deal unless Panama – recently mentioned on a tax haven list produced by the Organization for Economic Cooperation and Development (OECD) – agrees to share sensitive tax information with the United States.

“A tax information exchange agreement is the least of what we should get before the free trade agreement,” U.S. Sen. Carl Levin told the U.S. news service Bloomberg.

Though Martinelli has called the trade agreement his “number one priority,” his administration has denied that Panama is a tax haven and has rejected the possibility of giving up tax information.

“The free trade agreement and sharing tax information should be dealt with separately,” Martinelli's top economic advisor Frank de Lima told Bloomberg. “We are aware that times are changing, but we will not succumb to pressure from the U.S. so that they can start fishing expeditions to look for their citizens.”

Key Sectors Feeling Crunch
U.S. citizens have flocked to Panama in recent years, both for business and retirement, in part driving the real estate boom that has pushed dozens of high rise condo and apartment towers skyward. That too, however, is feeling the crunch.

“Local banks, though they maintain a high level of health, have restricted local credit because of the foreign banks' lack of liquidity,” said Fernando Duque, president of the real estate development company Buenaventura, in an e-mail. “Obtaining new credit for real estate projects in Panama City has almost entirely been paralyzed.”

Duque said that he expects the Martinelli administration to continue to invest in Panama's growing tourism industry.

“Panama has been betting on tourism as one of its fastest growing industries, and in this moment there are projects totaling about 1,500 rooms, principally in Panama City,” he said. “However, for tourism to develop in other areas, state infrastructure is necessary.”

Martinelli campaigned on promises to attract foreign investment and build better infrastructure and a subway system for the traffic-choked capital. He also inherits plans for an already partially funded $5.25 billion expansion of the Panama Canal.

Duque said he expects the canal expansion project to begin this year and “neutralize” the economic effects of the slowdown in new construction.

Source: Courtesy of Business Panama / written by Guillermo Chapman
http://www.fenixpanama.com/panama-economy.html

The much vaunted uniqueness of the Panamanian economy stands out in comparison with countries in the region. In other Latin-American economies manufacturing and agriculture represent two-fifths, or more, of GDP but in Panama these two activities amount to less than one-half, while services account for more than two-thirds, of total economic activity. The latter covers some traditional mature industries such as the Canal, the Colon Free Zone and banking, recent comers such as tourism, including cruise vessels, as well as fledgling and promising new activities like logistics (transshipment of containers and future value added operations thereof) and information technology communications (ITC). Differently from Hong Kong and Singapore - the leading service economies in Asia - Panama lacks competitiveness in manufacturing but, like them, it shows increasing productivity in logistics and good potential in ITC.

The other side of the coin is that the service sectors by themselves, in the absence of a modernization program, are not sufficient to lift the rate of growth of GDP to the level necessary to make employment grow at a fast pace and induce a noticeable spillover effect in the rest of the economy to enhance the welfare of the population.

The Panamanian economy is small, open and shows a high duality: The export-oriented service sectors exert a dominant role in the GDP accounts but have limited linkages to the rest of the economy, including their relatively poor contributions to tax revenues and employment. The exchange rate is fixed (the U.S. dollar is legal tender) and there is full financial integration of the banking system with the rest of the world. Deficits in the current account of the Balance of Payments – even as high as 10% or more of GDP which have not been infrequent - do not have the negative implications one finds in other economies since they cannot take place unless there are specific sources of financing, usually capital inflows associated with major foreign direct investment or bank lending. The monetary system imposes a large degree of fiscal discipline: public sector; deficits may not be sustained unless the Government obtains voluntary financing from third parties either external or local. The monetary system also implies that external shocks, like hikes in the price of oil or international financial crises, have to be absorbed in the real sectors by a decrease in production and employment and not through price changes.

During the past four decades the evolution of GDP was characterized by high real annual rates of growth in the sixties (8.3%) and substantially lower rates in the seventies (4.8%) and the nineties (4.6%). The eighties were indeed the “lost decade” in Panama, as in the rest of Latin America, with a GDP rate of growth of 0.5% per year. Some of the most remarkable factors were: the impact of the two oil shocks of the seventies, the positive effect of the implementation of the new Canal treaty in the early eighties followed by the Latin American debt crisis in 1982 and the Noriega crisis of 1987-1989. The first half of the nineties showed an initial recovery phase of GDP growth to 6.4 per cent annually in 1990-1994 and a slowing down to 3.6 per cent in 1995-1999. In the last three years (2000 to 2002) the rate of growth of real GDP has declined to about 2 per cent annually as a consequence of worldwide recession and very anemic foreign and local investment.

The long term decline in the dynamism of the Panamanian economy is closely associated with the performance of its exports of goods and services which show a very high correlation with the growth of its GDP; thus the higher the growth in exports implies a higher growth in GDP. In the sixties, revenues from the Canal expanded at a fast pace because of the Vietnam War and at the same time the export of bananas and shrimp also grew fast. During the seventies, new banking activity and the re-export of goods from the Colon Free Zone provided a boost to export earnings while the eighties was a mixed bag that did not provide any net gains. But in the first half of the nineties there were no new export activities and the existing industries began to show diminishing rates of growth. This was specially so in the second half of the last decade when traditional exports of services grew slowly, exports of merchandise declined, as a consequence of different local and external circumstances (bananas, sugar, coffee, shrimp and textiles) and new activities such as container ports, telecommunications and cruise vessels did not add enough to offset the losses in merchandise and the slow growth of traditional activities. This situation has been further complicated since 2001 because of the impact of the events of September 11 in the US, the concurrent world recession, the lack of new investment and the collapse of the Venezuelan economy which dealt a major blow to the Colon Free Zone.

Furthermore, the expansion of internal demand as an engine of short-term growth is limited by the high indebtedness of local agents. Therefore, my conclusion up to this point is that the export of goods and services is probably the most important force which makes the Panamanian economy tick. In general terms, strong growth in exports should result in parallel growth in GDP and to a lesser degree in employment, depending on the composition of the exports. A direct corollary is that in order to boost exports we need foreign investment not only to complement local savings but mainly to provide know-how in production technology, modern management techniques and knowledge of markets. This of course requires a friendly climate towards private investors, both local and foreign.

Another unique characteristic of the Panamanian economy is its banking system whose local loan portfolio to the private sector amounts to 88 per cent of GDP, the highest proportion in the region, followed by Chile with 82 per cent. Panama has a financial system which is fully integrated to the global markets, a fundamental difference with respect to other “dollarized” systems where foreign banks do not have a major presence and don’t play a stabilizing role when shocks do occur. The US dollar is the official currency and, with the exception of limited coinage, it is the numeration for personal and corporate transactions. Panama has no central bank, thus it is a perfect dollarized emerging economy. The system provides certain advantages to the Panamanian economy: 1) there is no foreign exchange risk that outside investors would have to take into account; 2) inflation is very low, usually below that of major countries; 3) there is absolute freedom of movement of capital in or out of the country; and 4) to a degree it limits the size of public sector deficits. On the other hand, the absence of a central bank and of reserves implies a loss of income for the authorities or seniorage, there is neither a lender of last resort nor any tools to fend off, at least in the short term, the impact of external shocks. On balance, the system has served the country well and is an effective mechanism for development.

At this juncture Panama has other assets that can provide a solid base to launch a sustained process of economic growth. These include the Canal itself and the opportunities that could be derived from its expansion as well as land and other assets of the former Canal Zone adjacent to the waterway. The modernization of Canal ports, privatized in the late nineties, and the network of broadband connections with the rest of the world and their local loops add to the potential for exploiting the geographic position of the country. These elements, jointly with the tradition of exports of goods and services, the banking industry and the monetary system are what make the Panamanian economy tick, actually and potentially.

The question then is: why isn’t real GDP growing at a faster pace? The short answer is that there are also obstacles to be taken into account which take the form of rigidities that still affect the economic structure of Panama.

These include the following: 1) Inflexibility of the labor market; 2) an inefficient, high-cost, internal transportation system; 3) relatively high cost of transactions (red tape); 4) lack of a comprehensive trade policy; 5) a structural fiscal imbalance where interest payments on public debt are about 30 per cent of current central Government revenue; 6) the lack of a clear strategy to integrate areas surrounding the Canal with the rest of the economy and develop new activities linked to the transit of vessels and Canal operations that would be a new source of long term growth.

In my view the opportunities clearly outweigh the obstacles and there is growing awareness in business and professional circles of the need to adopt a modernization program to capture the potentialities of the economy.