1. MGM Mirage
Country Views
Credit Research | United States
Emerging Markets Research | Americas
Panama: Buyer beware
14 JUNE 2011
Although strong economic growth may help the cyclical fiscal situation, we are not
comfortable about medium-term trends. We recommend credit exposure to high Fixed Income Research
grade sovereigns in the region other than Panama. Contributing Strategist
Look beyond strong economic growth Boris Segura
+1 212 667 1375
We have long been positive on Panama. The development strategy championed by boris.segura@nomura.com
former President Martin Torrijos (2004-09) put the country on the path to economic
This report can be accessed electronically
and social development. After inheriting a difficult situation from the Moscoso via: www.nomura.com/research or on
administration (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 drive
by 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 taking
charge. Based on the short-term indicator of economic activity IMAE (Figure 1), we
expect Q1 GDP to rise close to 7% y-o-y, and growth in economic activity to
accelerate through the year. As such, we expect economic activity to grow
approximately by 7.5% in 2011-12.
This growth spurt is supported by the pace of domestic credit (Figure 2). The
banking sector is extending loans to various economic sectors, such as low-income
housing, tourism, commerce and infrastructure, which suggests strong growth
dynamic 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 as
headline 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 adversely
affect 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-11
Source: 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. Nomura | Country Views 14 June 2011
Political noise
The political environment has become noisier lately. Most notably, the ongoing
squabbles between the “Alliance for Change” senior partner Cambio Democratico
(CD) and junior partner Partido Panamenista (PP) risk unwinding the government
alliance.
The most recent dispute inside the alliance involves the possibility of introducing a
second round in the Presidential elections. Several reputable constitutional lawyers
have warned against the constitutionality of revising the Constitution via an
ordinary law. The Panamanian Constitution’s article 177 says: “The President of
the 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 the
same way and for the same period; a Vice President will replace him in his
absence, as prescribed in this Constitution”. We think it would not reflect well on
Panama’s institutions if its most important legal body is altered via an ordinary law
in Congress.
We believe that the government alliance’s is unlikely to survive for long. Current
Vice-President Juan Carlos Varela is up for re-election in his party; if he leaves the
alliance 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 agreement
between the PP and CD calls for an alternation in the Presidency of Congress.
However, there are two factors that are likely to motivate the Martinelli
administration to boost fiscal spending. On the one hand, because of these political
difficulties and other domestic factors, the President’s popularity is suffering (Figure
4). 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 a
Constitutional referendum, which could include the approval of a consecutive
Presidential re-election, benefiting the current incumbent (see Panama: Let the
Games 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 yet
postponing investment plans in the short term because of the ongoing political
noise. However, because of the frequency of this political noise, the political
situation could worsen. A rarified political environment in the medium term could
limit 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-11
Source: CGR, Nomura Global Economics Source: Ditchner & Neira, Nomura Global Economics.
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3. Nomura | Country Views 14 June 2011
Constant changes to the fiscal rule
The Fiscal Responsibility Law (FRL), introduced during the Moscoso administration,
was subject to several changes and non-transparent practices during that term. As
such, 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 a
percentage of GDP, the onset of the international debt crisis forced the Torrijos
administration to request a waiver, so the incoming government could keep
implementing an anti-cyclical fiscal stance.
However, after the natural disaster at the end of last year, the authorities requested
yet another waiver to the FRL (Figure 5). As the costs of reconstruction were
estimated at $150mn (0.5% of GDP), we felt a further change to the FRL was not
needed, as the authorities could have easily accommodated such extra spending
within the deficit limit provided (see Panama: Fiscally responsible? 25 March 2011).
Another concerning modification to the FRL included a change to the definition of
the non-financial public sector (NFPS), which is used for calculating the maximum
fiscal deficit figure. In particular, Ena (the highway authority), Etesa (the electricity
transmission company) and Tocumen airport are now excluded from the definition
of the NFPS.
Back in 2004, the Torrijos administration decided to exclude the Panama Canal
Authority (PCA) from the definition of non-financial public sector. The rationale was
clear – the PCA has strong corporate governance, insulating it from political
interference in its operations. But, more importantly from the fiscal responsibility
point of view, the authorities wanted to eliminate the likelihood of the PCA’s
accounts being altered to meet the FRL, as frequently occurred under the Moscoso
administration. 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, due
to this policy decision.
In the case of Ena, Etesa and Tocumen airport, corporate governance is much
weaker than that of the PCA’s and there are transparency issues with their
accounts. We suspect that they are excluded from the NFPS to avoid being subject
to the rigors of the FRL, as these entities are likely to incur heavy borrowing.
Fiscal creativity
The authorities are promoting a creative strategy (“turnkey projects”) to support
advance their ambitious capital expenditure program. The government
Figure 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 ‐ Clayton's 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.
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4. Nomura | Country Views 14 June 2011
commissions particular public works from a private company, but then does not
register them in the fiscal accounts, despite the fact that the General Comptroller’s
Office is paying “certificates of partial payment” to those contractors as the project
reaches several stages of construction. The authorities claim that, as they have not
received an asset, they should not register a corresponding liability. Another
controversial issue is that most of these projects are awarded directly (i.e., without
competitive bidding).
We would not be concerned about this arrangement if it were not for its size. An
admittedly incomplete list of “turnkey projects” currently amounts to more than
$5bn, or 17% of GDP (Figure 6). These projects do constitute a claim against
future government revenues; in fact, several deadlines for final payment fall during
the next administration, which begins in 2014. Debt is debt, irrespective of when
you record it.
In response to these doubts, the authorities have indicated that they will eventually
include a 20% limit on “turnkey projects” as a percentage of the current year’s
public investment program. In the meantime, the market should welcome further
transparency on these projects, particularly on the size and timing of these items.
White elephant projects
The aggressive public investment program raises questions not only about the
proper stance of fiscal policy, but also about its efficiency. In particular, there is
concern in Panama City about the “white elephant” status of several high-profile
projects. These include the airports in Rio Hato and Colon, the third phase of the
Cinta Costera project, the Financial Tower and the Panama Subway. Several of
these projects are of the turnkey variety as well, and locals are worried about
significant cost overruns.
It is interesting to take a closer look, for example, at the Panama Subway. This
type of urban rapid transit system is better suited to large cities (Figure 7). It is very
telling that a large city such as Bogotá (Colombia), which has a population of
8.3mn, decided not to build an underground metro system and, instead, employed
a 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 daily
users.
We are concerned not only about the Metro’s construction cost overruns, but also
about the running subsidy once it begins operations. The Santo Domingo Metro
clearly demonstrates this issue, as the Dominican Republic’s public purse has
Figure 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 Gov't 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) na
Santo 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 Gov't 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, urbanrail.net, Nomura Global Economics Source: MEF, Nomura Global Economics.
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5. Nomura | Country Views 14 June 2011
incurred significant costs overruns and subsidies when building and running this
mass transit system.
Effect on fiscal accounts
We would not be concerned about the constant changes to the FRL and the
associated lack of transparency in fiscal accounts if it were not for their marked
deterioration. First quarter fiscal results were not auspicious. Revenues posted
strong growth versus last year (16%), but primary spending grew 27% in the
quarter, led by a 55% increase in capital expenditure (Figure 8). We see little
evidence of fiscal responsibility in these numbers.
Unless the authorities introduce some expenditure control, we are forecasting a
full-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 fiscal
consolidation, 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 think
the fiscal consolidation process should be more ambitious. This is precisely the
proper role of fiscal policy in a dollarized economy.
Strategy implications
Panama has outperformed other BBB peers such as Chile, Peru, Colombia, Brazil
and Mexico, particularly since late last year (Figure 10). We think this
outperformance is related to the fact that Panama is unlikely to come to market for
this year (see Panama: No dollar supply in 2011, 07 January 2011).
However, because of the non-trivial risks we see in the Panamanian political and
fiscal situation, we recommend that investors take on risk in LatAm’s high grade
space via credits other than Panama. We think there is a degree of mispricing in
Panama’s sovereign bonds that needs to be worked out to make it a compelling
investment 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 6/13/11
Source: MEF, Nomura Global Economics Source: Bloomberg, Nomura Global Economics.
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6. Nomura | Country Views 14 June 2011
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7. Nomura | Country Views 14 June 2011
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