MGM MirageCountry ViewsCredit Research | United StatesEmerging Markets Research | AmericasPanama: Buyer beware            ...
Nomura | Country Views                                                                                                    ...
Nomura | Country Views                                                                                                    ...
Nomura | Country Views                                                                                                    ...
Nomura | Country Views                                                                                          14 June 20...
Nomura | Country Views                                                                                                    ...
Nomura | Country Views                                                                                                    ...
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  1. 1. MGM MirageCountry ViewsCredit Research | United StatesEmerging Markets Research | AmericasPanama: Buyer beware 14 JUNE 2011Although strong economic growth may help the cyclical fiscal situation, we are notcomfortable about medium-term trends. We recommend credit exposure to high Fixed Income Researchgrade sovereigns in the region other than Panama. Contributing StrategistLook beyond strong economic growth Boris Segura +1 212 667 1375We have long been positive on Panama. The development strategy championed by boris.segura@nomura.comformer President Martin Torrijos (2004-09) put the country on the path to economic This report can be accessed electronicallyand social development. After inheriting a difficult situation from the Moscoso via: or onadministration (1999-2004), Mr. Torrijos took the difficult decisions that put Panama Bloomberg (NOMR)on the radar of international investors, which also led to a strong investment driveby locals and foreigners alike.One of Panama’s most encouraging features has been its fast economic growth.Unlike previous episodes, it is now widely spread, with a variety of sectors takingcharge. Based on the short-term indicator of economic activity IMAE (Figure 1), weexpect Q1 GDP to rise close to 7% y-o-y, and growth in economic activity toaccelerate through the year. As such, we expect economic activity to growapproximately by 7.5% in 2011-12.This growth spurt is supported by the pace of domestic credit (Figure 2). Thebanking sector is extending loans to various economic sectors, such as low-incomehousing, tourism, commerce and infrastructure, which suggests strong growthdynamic going forward.This strong economic growth leads to questions of overheating. Headline and core(excluding food and beverage) inflations are running at 6.4% and 6.1% y-o-y,respectively, in May (Figure 3). The fact that core inflation is running as fast asheadline is a sign of overall price pressures. Local wages are also rising quickly,with labor shortages arising in several sectors.We suggest that investors look beyond these glowing economic growth figures.There are several issues that merit the market’s attention, which could adverselyaffect Panama’s fiscal standing.Figure 1. Panama: IMAE Figure 2. Panama: Domestic credit %, y-o-y %, y-o-y, 12mma 12 18 10 8 13 6 8 4 Headline Cycle trend 2 3 0 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 -2Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11Source: CGR, Nomura Global Economics Source: SB, Nomura Global Economics. Nomura Securities International Inc.See Disclosure Appendix A1 for the Analyst Certification and Other Important Disclosures
  2. 2. Nomura | Country Views 14 June 2011Political noiseThe political environment has become noisier lately. Most notably, the ongoingsquabbles between the “Alliance for Change” senior partner Cambio Democratico(CD) and junior partner Partido Panamenista (PP) risk unwinding the governmentalliance.The most recent dispute inside the alliance involves the possibility of introducing asecond round in the Presidential elections. Several reputable constitutional lawyershave warned against the constitutionality of revising the Constitution via anordinary law. The Panamanian Constitution’s article 177 says: “The President ofthe Republic will be elected by direct popular vote and by a majority of the votes,for a period of five years. Only the President of the Republic will be elected in thesame way and for the same period; a Vice President will replace him in hisabsence, as prescribed in this Constitution”. We think it would not reflect well onPanama’s institutions if its most important legal body is altered via an ordinary lawin Congress.We believe that the government alliance’s is unlikely to survive for long. CurrentVice-President Juan Carlos Varela is up for re-election in his party; if he leaves thealliance now, all the PP’s officeholders in the Executive would be fired,undermining his own standing within the PP. The 1 July election of the Congress’board is likely to provide more clarity as to the alliance’s future, as the agreementbetween the PP and CD calls for an alternation in the Presidency of Congress.However, there are two factors that are likely to motivate the Martinelliadministration to boost fiscal spending. On the one hand, because of these politicaldifficulties and other domestic factors, the President’s popularity is suffering (Figure4). Although President Martinelli popularity is still high, it is on a sustained decline.On the other hand, the government is still interested in pushing through aConstitutional referendum, which could include the approval of a consecutivePresidential re-election, benefiting the current incumbent (see Panama: Let theGames Begin, 03 January 2011). It would be convenient to extend the “feel good”factor for a while via strong public expenditure.Anecdotal evidence in the private sector suggests that companies are not yetpostponing investment plans in the short term because of the ongoing politicalnoise. However, because of the frequency of this political noise, the politicalsituation could worsen. A rarified political environment in the medium term couldlimit potential growth and disrupt an otherwise positive credit story.Figure 3. Panama: Headline and core inflation Figure 4. Panama: Presidential approval ratings %, y-o-y % 90 12 Favorable Unfavorable Headline inflation 80 10 Core inflation 70 8 60 6 50 4 40 2 30 0 20 May-07 May-08 May-09 May-10 May-11 10 -2 Nov-09 May-10 Nov-10 May-11Source: CGR, Nomura Global Economics Source: Ditchner & Neira, Nomura Global Economics. 2
  3. 3. Nomura | Country Views 14 June 2011Constant changes to the fiscal ruleThe Fiscal Responsibility Law (FRL), introduced during the Moscoso administration,was subject to several changes and non-transparent practices during that term. Assuch, the Torrijos administration, in the name of fiscal rectitude and transparency,decided to suspend it shortly after taking office.A new FRL was enacted in 2008. As it defined a fiscal deficit target as apercentage of GDP, the onset of the international debt crisis forced the Torrijosadministration to request a waiver, so the incoming government could keepimplementing an anti-cyclical fiscal stance.However, after the natural disaster at the end of last year, the authorities requestedyet another waiver to the FRL (Figure 5). As the costs of reconstruction wereestimated at $150mn (0.5% of GDP), we felt a further change to the FRL was notneeded, as the authorities could have easily accommodated such extra spendingwithin the deficit limit provided (see Panama: Fiscally responsible? 25 March 2011).Another concerning modification to the FRL included a change to the definition ofthe non-financial public sector (NFPS), which is used for calculating the maximumfiscal deficit figure. In particular, Ena (the highway authority), Etesa (the electricitytransmission company) and Tocumen airport are now excluded from the definitionof the NFPS.Back in 2004, the Torrijos administration decided to exclude the Panama CanalAuthority (PCA) from the definition of non-financial public sector. The rationale wasclear – the PCA has strong corporate governance, insulating it from politicalinterference in its operations. But, more importantly from the fiscal responsibilitypoint of view, the authorities wanted to eliminate the likelihood of the PCA’saccounts being altered to meet the FRL, as frequently occurred under the Moscosoadministration. In the end, the PCA was allowed to borrow on a standalone basis(without the Republic’s guarantee) for the Canal expansion project, in big part, dueto this policy decision.In the case of Ena, Etesa and Tocumen airport, corporate governance is muchweaker than that of the PCA’s and there are transparency issues with theiraccounts. We suspect that they are excluded from the NFPS to avoid being subjectto the rigors of the FRL, as these entities are likely to incur heavy borrowing.Fiscal creativityThe authorities are promoting a creative strategy (“turnkey projects”) to supportadvance their ambitious capital expenditure program. The governmentFigure 5. Panama: Deficit limits in the FRL  Figure 6. Panama: List of “turnkey projects”  Amount (USDmn)  % of GDP City road infrastructure 792.0  2 Cinta Costera ‐ Phase III 777.0  Highway Santiago‐David 700.0  Current Limits Water development projects 530.0  1 Emergency Limits CSS ‐ Claytons City Hospital 450.0  Northern Highway Colón‐Bocas del Toro 450.0  Public security equipment 255.0  0 Amador landfill 200.0  Rio Hato International Airport and Tunnel 175.0  Primary Healthcare Facilities (Minsa‐Capsi)  300.0  -1 Hospital Chicho Fábrega 121.0  Hospital Manuel Amador Guerrero 110.5  -2 Panama Market ‐ Ciudad Alimentaria  110.0  Anita Moreno Regional Hospital  59.5  City of the Arts 40.0  -3 Cold Chain Market 38.3  Hospital Metetí 36.6  Hospital Bugaba 30.6  -4 Direct connection for cargo ‐ Tocumen 30.0  2011 2012 2013 2014 National Archives, Public Registry  15.0  TOTAL $5,220.5 Source: MEF, Nomura Global Economics Source: Platinum Consulting, Nomura Global Economics. 3
  4. 4. Nomura | Country Views 14 June 2011commissions particular public works from a private company, but then does notregister them in the fiscal accounts, despite the fact that the General Comptroller’sOffice is paying “certificates of partial payment” to those contractors as the projectreaches several stages of construction. The authorities claim that, as they have notreceived an asset, they should not register a corresponding liability. Anothercontroversial issue is that most of these projects are awarded directly (i.e., withoutcompetitive bidding).We would not be concerned about this arrangement if it were not for its size. Anadmittedly incomplete list of “turnkey projects” currently amounts to more than$5bn, or 17% of GDP (Figure 6). These projects do constitute a claim againstfuture government revenues; in fact, several deadlines for final payment fall duringthe next administration, which begins in 2014. Debt is debt, irrespective of whenyou record it.In response to these doubts, the authorities have indicated that they will eventuallyinclude a 20% limit on “turnkey projects” as a percentage of the current year’spublic investment program. In the meantime, the market should welcome furthertransparency on these projects, particularly on the size and timing of these items.White elephant projectsThe aggressive public investment program raises questions not only about theproper stance of fiscal policy, but also about its efficiency. In particular, there isconcern in Panama City about the “white elephant” status of several high-profileprojects. These include the airports in Rio Hato and Colon, the third phase of theCinta Costera project, the Financial Tower and the Panama Subway. Several ofthese projects are of the turnkey variety as well, and locals are worried aboutsignificant cost overruns.It is interesting to take a closer look, for example, at the Panama Subway. Thistype of urban rapid transit system is better suited to large cities (Figure 7). It is verytelling that a large city such as Bogotá (Colombia), which has a population of8.3mn, decided not to build an underground metro system and, instead, employeda cheaper bus-based mass transit system (Transmilenio). In contrast, Panama,which has a population of 1.3mn, is building a metro system, for only 60,000 dailyusers.We are concerned not only about the Metro’s construction cost overruns, but alsoabout the running subsidy once it begins operations. The Santo Domingo Metroclearly demonstrates this issue, as the Dominican Republic’s public purse hasFigure 7. Latin America: Rapid transit systems Figure 8. Panama: NFPS first quarter fiscal results (USDmn) Population Daily Length IQ-10 1Q-11 d%City Total revenue 1,545.7 1,800.4 16.5% (mn) users (mn) (km) Current revenue of the Govt 1,336.2 1,710.2 28.0%Mexico City, Mexico 19.3 5.00 201.7 Balance of public institutions 89.2 75.6 -15.2% Agencies and others 0.1 (4.7) naSanto Domingo, Dominican Rep. 2.1 0.10 14.5 Capital revenue 112.7 18.8 -83.3%Caracas, Venezuela 3.1 2.00 27.0 Grants 7.5 0.5 -93.3%Brasilia, Brazil 3.8 0.15 14.1 Total expenditure 1660.7 2064.4 24.3% Current expenditure of the Govt 953.5 1,101.4 15.5%Rio de Janeiro, Brazil 11.8 0.58 47.0 Interest payments on debt 290.5 315.8 8.7%Sao Paulo, Brazil 20.0 3.60 42.7 Capital expenditure 416.7 647.2 55.3%Porto Alegre, Brazil 4.0 0.13 34.5 Primary expenditure 1,370.2 1,748.6 27.6%Buenos Aires, Argentina 13.0 1.70 52.3 Primary balance 175.5 51.8 -70.5%Santiago, Chile 5.9 2.30 88.4 Overall balance (115.0) (264.0) 129.6%Source: CIA,, Nomura Global Economics Source: MEF, Nomura Global Economics. 4
  5. 5. Nomura | Country Views 14 June 2011incurred significant costs overruns and subsidies when building and running thismass transit system.Effect on fiscal accountsWe would not be concerned about the constant changes to the FRL and theassociated lack of transparency in fiscal accounts if it were not for their markeddeterioration. First quarter fiscal results were not auspicious. Revenues postedstrong growth versus last year (16%), but primary spending grew 27% in thequarter, led by a 55% increase in capital expenditure (Figure 8). We see littleevidence of fiscal responsibility in these numbers.Unless the authorities introduce some expenditure control, we are forecasting afull-year deficit of 2.9% of GDP, close to the limit embedded under the altered FRL.This could be precisely why the FRL was changed to begin with. In terms of fiscalconsolidation, Panama’s public sector debt to GDP ratio keeps falling (Figure 9).However, in the context of an economy with clear signs of overheating, we thinkthe fiscal consolidation process should be more ambitious. This is precisely theproper role of fiscal policy in a dollarized economy.Strategy implicationsPanama has outperformed other BBB peers such as Chile, Peru, Colombia, Braziland Mexico, particularly since late last year (Figure 10). We think thisoutperformance is related to the fact that Panama is unlikely to come to market forthis year (see Panama: No dollar supply in 2011, 07 January 2011).However, because of the non-trivial risks we see in the Panamanian political andfiscal situation, we recommend that investors take on risk in LatAm’s high gradespace via credits other than Panama. We think there is a degree of mispricing inPanama’s sovereign bonds that needs to be worked out to make it a compellinginvestment again.Figure 9. Panama: NFPS debt Figure 10. LatAm high grade: 5yr CDS % of GDP bp 80 190 Panama Brazil 70 170 Mexico Peru 60 Colombia 150 Chile 50 130 40 110 30 90 20 10 70 0 50 2004 2005 2006 2007 2008 2009 2010 2011F 6/13/10 9/13/10 12/13/10 3/13/11 6/13/11Source: MEF, Nomura Global Economics Source: Bloomberg, Nomura Global Economics. 5
  6. 6. Nomura | Country Views 14 June 2011 Disclosure Appendix A1ANALYST CERTIFICATIONSI, Boris Segura, hereby certify (1) that the views expressed in this report accurately reflect our personal views about any or all of the subjectsecurities or issuers referred to in this report, (2) no part of our compensation was, is or will be directly or indirectly related to the specificrecommendations or views expressed in this report and (3) no part of our compensation is tied to any specific investment banking transactionsperformed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.Additional Disclosures required in the U.S.Principal Trading: Nomura Securities International, Inc and its affiliates will usually trade as principal in the fixed income securities (or in relatedderivatives) that are the subject of this research report. Analyst Interactions with other Nomura Securities International, Inc Personnel: Thefixed income research analysts of Nomura Securities International, Inc and its affiliates regularly interact with sales and trading desk personnelin connection with obtaining liquidity and pricing information for their respective coverage universe.VALUATION METHODOLOGYNomura’s fixed income credit strategists and analysts use relative value as their primary approach for forming the basis of buy, hold and sellrecommendations. This valuation methodology analyzes spread differences between an appropriate benchmark security or index and thesecurity being discussed. Relative value can compare different maturities within the same capital structure, different collateral/seniority structurewithin the same capital structure or a unique opportunity associated with a debt security. It is also common for a strategist/analyst to recommendan asset swap—a buy and sell recommendation between two securities from the same issuer, tranche or sector based on the relative value ofwhere the securities trade at a given point in time.A buy recommendation on an individual security reflects the analyst’s belief that the price/spread on the security will outperform selectedsecurities in the same industry as the issuer (peers). Outperformance can be the result of, but not limited to, improving fundamentals, tradingactivity, a major rating agency upgrade, or the acquisition by an issuer with a higher credit rating. Similarly, hold and sell recommendationsrepresent the analyst’s belief that the security in question will perform in-line or substantially worse than its peers.Online availability of research and additional conflict-of-interest disclosures:Nomura Japanese Equity Research is available electronically for clients in the US on NOMURA.COM, REUTERS, BLOOMBERG andTHOMSON ONE ANALYTICS. For clients in Europe, Japan and elsewhere in Asia it is available on NOMURA.COM, REUTERS andBLOOMBERG.Important disclosures may be accessed through the left hand side of the Nomura Disclosure web page orrequested from Nomura Securities International, Inc., on 1-877-865-5752. If you have any difficulties with the website, please for technical assistance.The analysts responsible for preparing this report have received compensation based upon various factors including the firms total revenues, aportion of which is generated by Investment Banking activities.Unless otherwise noted, the non-US analysts listed at the front of this report are not registered/qualified as research analysts underFINRA/NYSE rules, may not be associated persons of NSI, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions oncommunications with covered companies, public appearances, and trading securities held by a research analyst account.DISCLAIMERSThis publication contains material that has been prepared by the Nomura entity identified at the top or bottom of page 1 herein, if any, and/or,with the sole or joint contributions of one or more Nomura entities whose employees and their respective affiliations are specified on page 1herein or elsewhere identified in the publication. 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