First let’s put the deficit spending here in Panama in perspective.

Reported by Don Winner of the Panama Guide. An International Monetary Fund (IMF) mission, headed by Corinne Deléchat, visited Panama between November 6-16 to conduct the country’s annual Article IV consultation.1 At the end of the discussions, Ms. Deléchat issued the following statement in Panama City:

“Panama’s growth performance continues to exceed expectations, buoyed by the Panama Canal expansion and large public infrastructure projects. Annual real Gross Domestic Product (GDP) growth averaged about 9 percent over the past five years, the highest in Latin America. Panama’s financial sector is solid; banks remain well-capitalized, liquid and profitable. Recent and upcoming Free-Trade Agreements (FTAs) should help sustain foreign direct investment flows once public investment spending starts to unwind. The mission welcomes the creation of the Panama Savings Fund, which will further strengthen the economy’s resilience to external shocks over the medium term.

“The near-term outlook is favorable. Real GDP growth could exceed 9½ percent in 2012. Easy credit and fiscal conditions should support public and private consumption through 2013. Headline and core inflation have started to decline thanks to a moderation in world food prices, but domestic demand pressures should keep average inflation at about 5½-6 percent in 2012-13.

“In this context, the near-term fiscal policy challenge is to preserve fiscal space and avoid overheating. With the economy growing above capacity, further fiscal stimulus should be avoided, by keeping fiscal deficits below the revised Social and Fiscal Responsibility Law (SFRL) ceilings. A more neutral fiscal stance would help contain inflation and reduce public debt faster.

“At the same time, the global economy remains weak, and downside risks have intensified. Panama’s trade and financial openness increases the country’s vulnerability to external shocks, though strong domestic fundamentals would mitigate their impact. Nonetheless, a decline in U.S. output and international financial markets turmoil associated with the “fiscal cliff” could have a significant impact on Panama, through both trade and financial channels. Low direct trade and financial linkages with Europe would minimize the direct impact of a worsening of the European debt crisis.

“Ongoing efforts to upgrade financial sector supervision including by strengthening the capacity to monitor systemic risks and to enhance the financial safety net in line with best international practices are welcome and should be accelerated. While the banking system is healthy, strong credit growth, particularly in commercial real estate, tourism, and the Colón Free zone should be closely monitored, together with rising household and corporate leverage.

“Medium-term discussions focused on structural policies to ensure a smooth transition to sustainable growth once the public investment projects are completed. Ensuring that public investment is of high quality and complements private investment will require improvements to budget planning, accounting, and monitoring to enhance the effectiveness of public spending. Better targeting of subsidies and improvements in tax administration would help preserve social and capital expenditure within lower deficit limits.

“The mission welcomes recent improvements in the business environment. Efforts to address remaining bottlenecks in the logistics chain should continue to ensure that Panama can reap the full benefits of the FTAs and of the Canal expansion. The government’s initiatives to improve the quality of public education and the availability of vocational training in partnership with the private sector should help develop the mix of skills required by a modern, service-based economy and raise living standards of all Panamanians.”

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. (Press Release)

Now on the Fiscal Deficit

Servicing Panama’s accumulated public debt during the first nine months of 2012 amounted to $2.147 billion, an amount which, at this time of year, has already surpassed previous completed payments. For all of 2011, the debt service was $2.186 billion and in 2010 it was $2.034 billion. The debt service costs are growing, as is the the total outstanding balance. In October, the total public debt reached $14.449 billion, according to the Directorate of Public Credit.

In the last year, the government of Ricardo Martinelli increased the State’s commitments by $1.483 billion, a figure comparable to the contract with the Line One Consortium, to build the new Panama Metro subway system. During the more than three years that Martinelli has been in office, the Government has increased the debt balance by $3.647 billion, an amount that far exceeds the cost of the design and construction of the third set of locks of the Panama Canal.

And this comes when the government is collecting more money than ever. Between January and October, the state’s current revenues were $4.741 billion, or $733 million (18.3%) more than during the same period last year. To this debt balance already on the government’s books, one should add some of the “turn key” projects that have already been let on contract, which exceed another $3.4 billion dollars in total.

The Government justifies this increase in debt with the infrastructure plan they are executing in the country, with the promise of increased productivity. They also argue that, in relative terms, the total Panamanian debt is being reduced due to the growth of the economy. (Prensa)

Winner’s comment The administration of Ricardo Martinelli has borrowed more money, and the cost of “debt service” (interest) is higher than ever, that’s true. It’s also true that the government of Panama is held back by strictly enforced debt ceilings, which are keyed to the total GDP and limited to about 41% of GDP or so. The government of Ricardo Martinelli has operated below those debt ceilings.

They have also done some debt restructuring over the years to refinance at lower interest rates, to reduce the costs of debt servicing. They have been able to do this because Panama achieved “investor grade” status under Martinelli, and also interest rates have dropped to historic lows since the global financial crisis started in 2008.

What’s more, it’s also true that Martinelli has been using this “turn key” or “key in hand” approach more frequently as their time in office slowly draws to a close. With these types of contracts, the builder has to obtain their own financing, and they only get paid when the project is built and delivered to the government. This means Martinelli can sign contacts now, and commit the Panamanian government to projects that will be built during the administration of the next president – whoever that turns out to be.

Opposition politicians will be trying to use these sorts of issues against the Cambio Democratico candidate between now and the 2014 elections – raising specters of “big, bad, scary debt” to instill fear in the electorate. Martinelli’s crew will have to handle the task of explaining themselves, and educating the public on these issues of public debt policy. If handled correctly, they can make it a positive.

Concern amongst the business sector

From the Panamanian Association of Business Executives (APEDE):

The projected deficit in the state budget approved for 2013 is close to the legal limit, and is causing concern in business sectors.  The Panamanian Association of Business Executives is concerned about the projected budget deficit for 2013, according to figures presented by the Ministry of Finance this week to its membership.

This deficit will be at more than $1.1 billion, or 2.8%, ie “the razor’s edge”, because it coincides with the maximum limit allowed by the Fiscal Responsibility Act. It will be the highest deficit in balboas in the republic’s history, which means a similar increase in the amount of public debt. This also means that any unanticipated budget gap could involve a breach of the law, which could affect the country’s sovereign credit rating, affecting the level of investment.

The projected fiscal deficit is a cause for concern to APEDE, because:

(i) it increases the possibilities of the sale of state assets to raise revenue or under some unanticipated format.

(ii) it means that the deficit can continue to be covered with more public debt, increasing the latter which will eventually be paid by all Panamanians through spending cuts or through higher taxes and,

(iii) it increases the chances of having to once again amend the Fiscal Responsibility Law. The latter would create another bad precedent, since it would reflect a change in the rules, which may affect the country’s image, as occurred in June this year, where the ceilings were increased several times, which affects the country’s credibility and creditworthiness.