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Panama: Caution! Men at Work

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Panama is on track to becoming a major logistics, transportation and tourism hub for Latin America.

BY WALTER T MOLANO

Panama is an active construction site. The widening of the canal, the knitting of a new highway network and the completion of mega-skyscrapers, requires one to wear a hard hat when walking out onto the street. With a GDP growth rate of almost 7 percent in 2010, and perhaps more than 9 percent in 2011, Panama shows no signs of slowing down. The government reported that the economy surged 9.7 percent y/y during the first quarter of the year. Many new projects are in the pipeline, such as the modernization of the airport, a new rail link, major international hotels and mega malls. The government, for example, is investing $200 million to build a new terminal at the main international airport, while converting the airfield at Howard Air Force Base into a charter hub and constructing a new arrivals facility in Colon. At the center of all of this frenzy is a drive to convert the country into a major service provider, with concentrations in shipping, logistics and tourism. The heady pace of economic activity is pushing Panama’s unemployment rate to the lowest level ever, approaching 6%. Indeed, the country’s level of economic activity expanded 150 percent over the course of the last 15 years. Panama’s annual GDP is now $26.7 billion. Of course, the large increase in economic activity is creating some problems.

One of the major concerns is the rise in consumer prices. Panama’s inflation rate surged 1.1 percent m/m in May, pushing the annual inflation rate to a 2-year high of 6.3 percent y/y. Although this pales in comparison with the 8.9 percent y/y inflation rate that was recorded in 2008, it is still reason for concern. Since its “independence” from Colombia in 1903, Panama used the dollar as its currency unit. An open economy, with a relatively flexible workforce and heavy ties to the U.S. allowed dollarization to work without the problems that were generated in some of the other Latin American economies that pegged their currencies to the greenback. Panama’s inflation rate was usually lower than the U.S., allowing it to keep a high degree of external competitiveness and equilibrium in its external accounts. Unfortunately, the acceleration of consumer prices is creating problems for the country’s balance of payments. Panama’s trade deficit more than doubled in 2010, reaching $4.6 billion from a level of $2.1 billion in 2009. The Panamanian economy usually runs a trade deficit, but it is typically offset by a service account surplus. In 2009, Panama’s service account surplus was $3.3 billion. However, it remained unchanged in 2010. Likewise, net transfers declined, as foreign workers increased their remittances abroad. Therefore, Panama experienced a current deficit of $2.9 billion in 2010. This was partially offset by $2.3 billion in Foreign Direct Investment (FDI). The rest of the gap was filled by portfolio investment and increases in foreign debt. The economic authorities must remain vigilant not to allow the country to lose competitiveness, because devaluation is not an option. Fortunately, gross fixed investment remains the main engine of economic growth, and most of it is directed into sectors that will generate more external earnings. Similar to other emerging market countries, Panama experienced a large increase in consumer credit. Nevertheless, consumption remains relatively subdued in comparison with fixed investment.

The fiscal account is another area of concern. During the first quarter of 2011, Panama’s fiscal deficit doubled to 0.9 percent of GDP. The government’s shortfall would have been larger had it not been for a tax reform that was implemented last year, which allowed tax revenues to jump 37 percent y/y. Among other items on the reform agenda was an increase in the sales tax to 7 percent from 5 percent. However, the increased government revenues were mainly used to fund the surge in capital spending, which jumped 55 percent y/y. The robust economic environment allowed President Ricardo Martinelli to remain extremely popular, despite his heavy-handed political approach and a series of high profile scandals. There are rumors that the president will introduce a constitutional reform to allow a second consecutive term for the executive. President Martinelli is very close to Colombia’s former President Alvaro Uribe, and he allowed several former cabinet members, who were under investigation in Bogota, to seek political exile in Panama. In sum, Panama is on track to becoming a major logistics, transportation and tourism hub for Latin America. In order to provide the skilled labor force needed to drive these sectors, the country needs to invest more in education and health. In the meantime, the country will be forced to import skilled workers from neighboring countries, such as Colombia and Venezuela. Fortunately, there will be ample work for all. Therefore, put on your hard hats. It’s time to get to work.

Walter Molano is head of research at BCP Securities.

 

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