Fitch Ratings has affirmed Panama’s sovereign ratings as follows: –Long-term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at ‘BBB’, Outlook Stable; –Senior unsecured Foreign- and Local-Currency bonds at ‘BBB’; –Country Ceiling at ‘A’; –Short-Term Foreign- and Local-Currency IDR at ‘F2’. KEY RATING DRIVERS Panama’s ratings are supported by continued strong and stable macroeconomic performance, which has driven a sustained rise in per-capita income and reflects policies and a strategic location and asset (the Panama Canal) that underpin a high investment rate. This is counterbalanced by institutional constraints and weak policy credibility, as the administration has improved compliance with legal deficit limits but has not yet been able to lower the central government deficit from high levels despite strong growth. Fitch estimates that Panama’s real GDP growth moderated to around 5% in 2016, below its prior five-year average of 8% due to an ebb in regional trade activity affecting its key logistics sector. Fitch forecasts that GDP growth will remain above 5% in 2017 to 2018, one of the highest rates in the ‘BBB’ category, as the recent Canal expansion supports a rise in traffic and spill-overs into surrounding logistics activities. A large infrastructure project pipeline and a major mining project should also sustain high rates of investment and growth into the medium term. Reputational damage related to the ‘Mossack Fonseca Papers’ has not had a discernible impact macroeconomic performance thus far. While the legal services implicated in the leak represent a small share of the economy, these developments could pose risks to the large banking and professional services sector. Transparency-enhancing measures undertaken by the Varela administration could help mitigate these risks, and progress on implementation of these will be needed for a favourable review by the Financial Action Task Force (FATF) scheduled for mid-year. Corruption revelations involving constructor Odebrecht could pose execution risks to its local projects, but Fitch’s baseline currently assumes they will not be derailed. A rise in Canal throughput and wind-down in expansion-related capital expenditures are contributing to a narrowing of the current account deficit, which Fitch projects to be 5% of GDP in 2017. Foreign direct investment comfortably covered the deficit in 2016 and should remain robust and broad-based during the forecast period. Credit growth slowed from double-digit rates to around 7% in 2016, broadly in line with nominal GDP growth. In Fitch’s view, a more moderate pace of credit growth coupled with ample liquidity and adequate capitalization among systemically important banks mitigates systemic risks in the absence of a lender of last resort. Inflation of 0.7% on average in 2016 is consistent with the preservation of macro stability in the context of dollarization. The central government fiscal deficit (the relevant metric for sovereign borrowing) reached a 10-year high of 4.3% of GDP in 2016 (under Fitch GDP estimates), as higher capital budget execution and current spending pressures outweighed a recovery in tax collections. The non-financial public sector deficit subject to the fiscal rule was 2.4% of GDP in 2016, in line with 2.3% in 2015, but below the effective limit of 3.1% of GDP (1.5% plus a 1.6pp allowance given a shortfall in Canal transfers below the legal threshold). Fitch expects that the rise in Canal contributions will lower deficits in the coming years, as effectively required under the current fiscal rule, and that sufficient control of current spending and capex execution will support compliance with lower NFPS deficit ceilings. The path for the central government deficit remains less clear, however, as it has exceeded prior government and Fitch forecasts due to spending increases well above previous projections (especially in salaries). The widening of the central government deficit in 2016 did not produce a commensurate rise in the public debt burden, as the sovereign has been able to draw upon a sizeable pool of cash made available with implementation of a single treasury account (CUT). General government debt remained stable at 38% of GDP in 2016, below the ‘BBB’ median of 40%. Fitch projects that further cash drawdown to meet financing needs will keep debt stable in 2017, and the expected fiscal consolidation should set debt-to-GDP on a gradual downward trajectory thereafter. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch’s proprietary SRM assigns Panama a score equivalent to a rating of BBB on the Long-term FC IDR scale. Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows: –Macro: -1 notch, to reflect an uneven record of compliance with budget ceilings that has weighed on policy credibility, an issue underscored in the absence of monetary policy. In recent years, the administration has met legal ceilings set at the NFPS level, but the deficit at the CG level relevant for debt dynamics has risen. –Public Finances: +1 notch, to reflect that the SRM classifies public debt as fully denominated in foreign currency due to Panama’s use of the U.S. dollar, but the century-old and well-entrenched dollarization regime fully mitigates FX risk on the sovereign balance sheet. RATING SENSITIVITIES The Stable Outlook reflects Fitch’s assessment that upside and downside risks to the rating are currently balanced. The main factors that, individually or collectively, could lead to a positive rating action are: –Fiscal consolidation consistent with improvement in fiscal policy credibility and the public debt trajectory; –Maintenance of favorable growth rates and rising per-capita income amidst moderate inflation and financial stability. The main factors that, individually or collectively, could lead to a negative rating action are: –Fiscal deterioration or crystallization of contingent liabilities leading to weakening in public debt dynamics; –A deterioration in medium-term growth prospects. KEY ASSUMPTIONS –Fitch base case assumes that the expanded Canal will perform broadly as expected, with no meaningful deviations from current projections due to external or technical factors. –Fitch assumes that the impact on the economy and financial system of unresolved arrears with the Colon Free Zone (CFZ) and other corporates, as well as execution risks surrounding major public works projects, will remain manageable.

Source : Reuters