Fitch Ratings – New York – 03 Feb 2021: Fitch Ratings has downgraded Panama’s Long-Term Foreign Currency Issuer Default Rating (IDR) to ‘BBB-‘ from ‘BBB’. The Rating Outlook is Negative.

KEY RATING DRIVERS

Panama’s downgrade to ‘BBB-‘ reflects the severe weakening of public finances due to the economic disruption caused by the coronavirus pandemic, which has exacerbated underlying weakening fiscal trends predating 2020. The unprecedented GDP contraction and government revenue loss has prompted a material rise in public debt. A low and falling revenue to GDP ratio signals limited fiscal space to respond to economic shocks.

The Negative Outlook reflects risks to the government debt trajectory and uncertainty that the fiscal consolidation path set out in the revised Fiscal Responsibility Law can be achieved, given underlying fiscal challenges. A prolonged pandemic and delays in vaccination distribution are the main risks to economic recovery, which will underpin fiscal consolidation over the coming years.

Fitch estimates Panama’s Non-Financial Public Sector (NFPS) deficit have reached 9.6% of GDP in 2020, driven by a revenue contraction of 23% compared to 2019. Indirect taxes, including taxes on consumption and imports, were the most affected, declining by 33.7% relative to 2019. Expenditures declined by 3.1% as of the 3Q20 (latest available) compared to 2019. The government implemented a support package worth 3% of GDP, which included health-related expenses, income transfers to vulnerable population and extensions to tax payment deadlines. However, capital expenditures declined as mobility restrictions delayed public infrastructure projects.

The 2021 budget targets a deficit just above 7% of GDP, which Fitch believes is achievable in light of the partial economic recovery. Reduction in the budget deficit will be revenue-led; the government plans to reassign expenditures items rather than reduce the 2020 pandemic-related fiscal support. Structural fiscal consolidation beyond 2021 will confront entrenched weaknesses and we do not expect the government to hit fiscal targets in 2022.

Government revenue growth has persistently fallen short of growth in economic activity (revenues were 18.4% of GDP in 2019 down from 20% in 2014, despite the revenue increase from the Panama Canal expansion). Fitch believes that mobilising revenues will prove challenging. Private investment, the most dynamic growth driver, benefits from relatively low taxes, while Panama’s VAT rate of 7% is among the lowest in the region. Private sector revenue loss in 2020 and lower profitability this year will weigh on income tax receipts, while the unemployment surge will affect consumption-based tax collection.

The Panama Canal continues to be a steady source of income despite the pandemic. A switch in global demand from services to goods offset the loss of transit through the canal due to the global economic crisis. The new water usage surcharge also helped toll collection through 2020.

Panama’s legislative assembly approved changes to its Fiscal Responsibility Law (LRSF) in late 2020, marking the third consecutive year the deficit ceilings have been modified. Raising the deficit ceilings accommodates for the pandemic’s fiscal impact but follows a decade of postponing consolidation goals, which weighed on policy credibility. The modified rule targets a gradual deficit reduction over five years, setting the NFPS deficit ceilings between 9% and 10.5% of GDP in 2020, 7% and 7.5% in 2021, 4% in 2022, 3% in 2023, 2% in 2024, and 1.5% thereafter.

Fitch estimates central government debt rose to 68% of GDP in 2020 from 46.4% in 2019. The rise of the debt stock includes a USD1 billion (1.8% of GDP) pre-financing operation to cover amortization payments in January and February 2021. General government debt (net of social security government debt holdings) reached 60.5% of GDP surpassing the ‘BBB’ category median of 52.9%. Fitch project’s the consolidated general government debt burden will continue to rise gradually and peak at 64% of GDP by 2024. Panama’s debt and interest burdens as a share of revenues are well above the ‘BBB’ medians and rapidly rising, highlighting low and falling revenue base and the limited fiscal space to confront future shocks.

Pension liabilities-related risks have become a key challenge to the medium-term fiscal outlook. The unfunded defined-benefit component of Panama’s mixed pension system is entering into a cash deficit. Reserves are expected to be depleted by 2025 absent a pension reform, according to the latest actuarial estimates. The government organized a national dialogue to discuss potential solutions, which started in January 2021. The dialogue is expected to present a proposal by the second half of 2021, after which the government will submit a final reform proposal to congress. The government has softened its initial rejection of a parametric reform and the scope and pace of implementation of any reform remains uncertain.

Real GDP is expected to have contracted by 17.7% in 2020, according to Fitch estimates. This marks the fourth deepest economic contraction compared to Fitch’s rated sovereigns (only above Macao, Maldives and Lebanon), and more than twice the 6.9% estimate for the current ‘BBB’ median. Panama’s strict and prolonged lockdown measures resulted in the deep economic activity reduction.

Fitch expects real GDP growth will reach 9.2% in 2021 followed by 7.3% in 2022. The economic recovery will be driven by a base effect following the deep contraction of 2020 (although lockdown measures will weigh on the first quarter of 2021), consumption recovery following the easing of mobility restrictions, government-led infrastructure projects (including Panama’s subway ‘Linea 3’) and a close-to -full production year at Minera Panama copper mine. This is conditioned on Fitch’s expectation of a receding pandemic and widespread distribution of vaccines to prevent further containment measures beyond the first quarter of 2021, as well as recovering global demand for Panama’s service exports. Economic growth in the next two years will not be sufficient to reach pre-pandemic GDP levels.

Banking system liquidity is robust as mobility restrictions led to lower consumption, higher deposits and lower lending. Domestic credit contracted by 1.8% yoy in 2020 (as of November 2020, latest data available), while deposits increased by 9.9% over the same period. Profitability will remain affected by credit contraction and higher loan loss provision expenses. The Superintendency of Banks authorized financial institutions to modify loan conditions without considering them as restructured until June 30, 2021, which has reduced the impact on reported asset quality metrics through the pandemic.

Panama’s ratings are supported its high per capita income, fruit of a track record of strong and stable macroeconomic performance exploiting a strategic location and asset (the Panama Canal). Governance indicators are in line with the ‘BBB’ median. This is counterbalanced by a relatively narrow government revenue base and an uneven track record of meeting fiscal consolidation targets. Government debt/GDP is higher than the BBB median.

ESG – Governance:

Panama has an ESG Relevance Score (RS) of ‘5’ for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Panama has a medium WBGI ranking at 54.4%, reflecting a recent track record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.

 

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

–Public Finances – Failure to achieve a credible structural fiscal consolidation that is consistent with a sustained stabilization of the government debt burden;

Macroeconomic – Evidence that the coronavirus shock is having a persistent impact on medium-term growth prospects.

Factors that could, individually or collectively, lead to positive rating action/upgrade are:

Public Finances – Implementation of structural fiscal consolidation measures consistent with stabilization of the debt burden, for example driven by improvements in tax collection and reforms to address the growing deficit in the pension system;

Macroeconomic – A faster-than-expected economic recovery and evidence that the pandemic has not had a material impact on medium-term growth prospects.

 

SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)

Fitch’s proprietary SRM assigns Panama a score equivalent to ‘BB’ on the Long-Term Foreign Currency IDR scale. This is two notches lower than the SRM score at the time of the previous committee, which was equivalent to a ‘BBB-‘ rating.

Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign Currency IDR by applying its QO, relative to SRM data and output, as follows:

–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 well-entrenched dollarization regime fully mitigates FX risk on the sovereign balance sheet.

–Macro: +1 notch added to offset the deterioration of GDP growth and volatility variables in the SRM due to the impact of the pandemic, which Fitch expects will be temporary, and would otherwise add excess volatility to the rating.

Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centered averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign Currency IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

 

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579].

 

KEY ASSUMPTIONS

The global economy performs largely in line with Fitch’s Global Economic Outlook (December 2020).

 

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

Panama has an ESG Relevance Score of ‘5’ for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and a key rating driver with a high weight.

Panama has an ESG Relevance Score of ‘5’ for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight.

Panama has an ESG Relevance Score of ‘4’ for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver.

Panama has an ESG Relevance Score of ‘4’ for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Panama, as for all sovereigns.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.