Panama’s economy has been the fastest growing in Latin America over the last two decades and is expected to remain among the most dynamic in the region, with stable and low inflation, sustainable public debt, a declining current account deficit, and a stable financial sector. Economic growth moderated to 4.9 percent in 2016 amid external headwinds, and inflation and unemployment remain subdued, although have risen slightly. Fiscal consolidation continues in line with the fiscal rule targets and public debt is sustainable. The current account deficit continued to narrow to 5.6 percent of GDP, primarily due to lower investment-related imports and weak fuel prices. Credit growth remains strong, though has begun to slow recently.
The outlook remains favorable, albeit set against the backdrop of heightened external uncertainty. Growth is projected to pick up slightly to 5.1 percent in 2017 and about 5.5 percent over the medium term, supported by the expanded Canal and the wide range of public and private investment projects. The overall NFPS deficit is projected to gradually decline to about 1 percent of GDP over the medium term, and public debt remains sustainable with net debt projected to remain below the SFRL target of 40 percent of GDP. Diversification of exports into primary commodities with the opening of a new mine will help further narrow the current account deficit to about 3 percent of GDP over the medium term. Key downside risks relate to progress in strengthening tax transparency and AML/CFT and a less favorable external environment, including weaker-than-expected global growth, a shift toward increasing trade restrictions, a faster-than-expected tightening of U.S. monetary policy and continued appreciation of the U.S. dollar.
Executive Board Assessment[3]
Economic activity remains among the most vibrant in the region. Medium-term growth prospects are strong, with sectors such as logistics and tourism providing potential to further boost activity. The policy environment should support future growth, especially with measures to address skill gaps, the quality of education, and high income inequality. Panama’s external position remains moderately weaker than suggested by fundamentals, but is on track to return to its norm over the medium-term. The current account deficit is expected to continue to benefit from stable financing, predominately from FDI. Risks relate mainly to progress with tax transparency and financial integrity and to heightened uncertainty in the external policy environment, primarily related to developments in global trade and interest rates.
Measures to strengthen tax transparency and ensure effective exchange of tax information must remain at the top of the policy agenda. Building on considerable progress over the last year, policy efforts should focus on addressing remaining deficiencies to preserve Panama’s position as a competitive and attractive destination for international financial and business services. In particular, it is essential to demonstrate the availability of ownership information and reliable accounting records for all relevant entities registered in Panama, and put in place an effective mechanism for exchange of tax information. Continued actions to strengthen the tax administration’s capacity are critical.
Enhancing financing integrity through effective implementation of Panama’s AML/CFT framework must remain a strategic priority to safeguard Panama’s role as a regional financial center. The legal framework needs to be fully aligned with international standards, including by making tax crimes a predicate offence to money laundering. The National Commission should continue to play a central role in coordinating Panama’s efforts to combat AML/CFT risks. Effective implementation of the strengthened AML/CFT framework will be critical to receiving a positive assessment by GAFILAT.
Efforts to further strengthen the fiscal framework should continue. The medium-term consolidation plan implies a downward trajectory for public debt, which helps build buffers to address possible fiscal risks. Adhering to this strategy will continue to demonstrate the authorities’ commitment to fiscal discipline and will strengthen the credibility of the fiscal framework. The authorities’ plan to establish a fiscal council could improve transparency, promote accountability of the fiscal framework, and encourage an informed public debate.
Assessment and management of public sector fiscal risks and contingent liabilities should be improved. A comprehensive assessment of public sector fiscal risks, such as those related to unfunded pension liabilities, turnkey projects, and contingent liabilities of public companies will help gauge the adequacy of fiscal buffers. With limited fiscal revenues, better management of these risks is essential to help avoid crowding out strategic public investment.
Building on recent progress, the tax administration should continue to be strengthened. Despite recent improvements, Panama’s tax revenues remain among the lowest in the region. Measures to further enhance tax administration need to be complemented with policy actions to streamline tax incentives and exemptions. Publishing estimates of foregone revenue from each of these incentives can subject them to public scrutiny and build momentum for reform.
The customs administration needs to address weaknesses in institutional capacity and governance. Tangible progress is essential in improving data quality and management, reforming control processes, enhancing human resources, limiting discretionary powers, and moving forward with trade facilitation.
Financial sector oversight, macroprudential policy, and crisis management should be strengthened to build resilience. The steps being taken to fully align prudential regulations with Basel III are welcome and will enhance the resiliency of the financial system. Resiliency will also be strengthened by ongoing efforts to improve oversight through enhanced coordination of microprudential supervision across supervisors and these efforts should be deepened to include the monitoring of systemic risks. To complement these efforts, macroprudential policy tools targeted toward addressing the risks presented by Panama’s financial conglomerates and household debt should be developed to provide more policy flexibility in managing macrofinancial risks. Finally, Panama’s crisis management framework should be strengthened by establishing a temporary liquidity facility for banks to address systemic shocks, improving the SBP’s bank resolution powers, introducing deposit insurance, and developing a framework to coordinate the response of supervisory agencies to risks to financial stability.