Public Information Notice No. 07/33

Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with Panama

March 15, 2007

On February 16, 2007, the Executive Board of the International Monetary Fund (IMF) concluded

the Article IV consultation with Panama.¹

Background

Real GDP growth averaged 7¼ percent in 2004-05 and is estimated to have continued at that pace in 2006, led by exports of services, construction, and investment. Unemployment fell significantly. Although annual inflation crept up to 3.4 percent at end-2005 on account of high fuel and electricity prices, it dropped to 2.2 percent at end-2006. Despite a rising oil bill, the external position improved.

Aided by the strong economy, enhanced tax collections, and spending restraint, the balance of the nonfinancial public sector (NFPS) excluding the Panama Canal Authority (PCA) is estimated to have improved to a surplus of 0.5 percent of GDP in 2006 (from a deficit of 2½ percent in 2005). Higher transfers from the PCA and one-off revenues contributed to the improvement. Reflecting fast economic growth and fiscal consolidation, public debt has fallen from 66 percent of GDP in 2004 to an estimated 60 percent in 2006. This refers to the gross NFPS debt, without deducting holdings of financial assets (proceeds from privatization) of about 7 percent of GDP.

Banking system soundness indicators remain solid. Although liquidity ratios had declined as a result of rapid consumer and housing lending growth, they recovered in the last quarter of 2006. The country largely complies with the Basel core principles of effective banking supervision, but a recent IMF assessment noted the need for improving nonbank financial supervision. Taking advantage of favorable conditions in international financial markets, the government engaged in several debt exchange and buyback operations that extended average debt maturity and lowered interest rates on external liabilities.

Nearly 80 percent of voters backed the Panama Canal expansion in the recent referendum, thus providing the PCA with a clear mandate to proceed with the construction, planned for 2007-14 at a cost of US$5.2 billion (some 30 percent of current GDP). The project is expected to boost GDP growth and job creation, both directly and by stimulating related industries.

The medium-term outlook is promising, supported by the canal expansion and other large construction projects. For 2007-10, staff projects average annual real GDP growth of about 6½ percent , inflation of 2¼-2¾ percent, and a temporary widening of the external current account deficit.

Executive Board Assessment

Executive Directors commended the Panamanian authorities for their sound macroeconomic management, marked by another year of strong economic performance, with robust growth, subdued inflation, and declining unemployment. They welcomed the progress in strengthening public finances, which has helped reduce the debt burden. Directors saw the planned expansion of the Panama Canal as bringing substantial potential economic and social benefits—including stronger growth and employment and encouraged the authorities to ensure that the expansion is judiciously managed and accompanied by appropriate fiscal and structural policies.

Directors welcomed the efforts of the authorities in managing the domestic impact of the canal expansion project, so that it does not create financial or economic imbalances. Directors supported, in particular, the authorities' intention to monitor implementation carefully and coordinate closely expenditure and borrowing strategies of the government and the PCA. They noted the need to remain vigilant, maintain adequate contingency reserves, and take action if expansion costs exceed projections or if domestic demand pressures build up. Directors recommended continued transparent bidding and procurement practices during the canal expansion.

Directors noted that the authorities' deficit target of 1 percent of GDP by 2009 for the nonfinancial public sector (excluding PCA) will enhance Panama's ability to adjust to possible shocks and lower its country risk even further. To achieve this target, Directors recommended streamlining subsidies by better targeting them to the poor, reducing tax exemptions, continuing to combat tax evasion, and further enhancing fiscal transparency.

Observing that the public debt-to-GDP ratio is still high, Directors encouraged the authorities to anchor policies in a medium- to long-term framework that keeps the fiscal deficit at 1 percent of GDP after 2009, while allowing an expansion of much needed poverty-related and infrastructure spending. Directors also recommended that this framework be explicitly contained in the Fiscal Responsibility Law under preparation. More generally, Directors considered that a challenging project like the canal expansion, as well as the limited policy tools available under the dollarization regime, are both factors that reinforce the need for continued fiscal discipline and structural reform.

Directors commended the authorities' commitment to preserve the soundness of the banking system. They supported the decision to strengthen the legal liquidity requirement and improve market risk management, while cautioning that fast credit growth and possibly rising real estate prices suggest the need for vigilance over the quality of loans. Directors stressed the need to improve the institutional framework for supervision and regulation of insurance and securities, and further strengthen anti-money laundering practices.

Directors welcomed the recent gains in competitiveness and improvements in the business environment. They added that sustained investment will be enhanced by improved infrastructure and governance, greater flexibility in the labor market, a more efficient public sector, and strengthened market relations with trading partners. Continued reforms to upgrade education and health services will solidify prospects for poverty reduction. Future canal revenues should be used prudently in supporting well-targeted social reforms and economic diversification, and benefit all segments of society.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.