For 2020, the deficit will likely surpass the limit under the fiscal rule of 2.75 percent of GDP as there will be a need to support the economy and increase public health spending in view of the current situation with COVID-19.

Executive Board Assessment ^[3]

In concluding the 2020 Article IV Consultation with Panama, Executive Directors endorsed staff’s appraisal, as follows:

Growth is expected to rebound in 2020. Economic activity is projected to recover after a slowdown in 2018-19, supported by full-scale copper production and robust private investment. Growth over the medium-term is expected to remain at its potential. Key risks relate to setbacks in exiting the FATF grey list and complying with SFRL deficit ceilings as well as a slowdown in Canal traffic amid escalating trade tensions, weak growth in key trade partner countries, and the coronavirus outbreak. While external imbalances are expected to decline over the medium-term, the external position is moderately weaker than fundamentals and desirable policy settings.

Sustained fiscal discipline is required for fiscal policy credibility and to keep public debt on a downward trajectory. Amid a relatively high deficit exacerbated by newly discovered unrecorded arrears, Central Administration debt reached 46.2 percent of GDP in 2019. The modified gradual adjustment of the deficit ceiling under the SFRL is appropriate to smooth the pace of necessary fiscal consolidation. In addition, the authorities should consider using a “shadow” structural rule in the future to build fiscal buffers.

A realignment of fiscal revenue and expenditures is imperative to sustain growth. In addition to improving the capacity of tax and customs administrations, action is required to review Panama’s complex tax exemptions that continually erode the tax base. On the expenditure side, realigning current spending with social needs—including by investing more in education—and improving the effectiveness of social spending will be crucial to achieve sustainable and inclusive growth. Capital projects need to be carefully assessed and prioritized going forward.

The pension system needs to be strengthened. Faced with slowing population growth, the authorities need to gradually align pension contributions with expected payouts, to avoid creating an undue burden to the public finances in the long run. Given the politically sensitive nature of such adjustments, a slow-paced approach is recommended.

Strengthening the fiscal framework is essential to improving the macroeconomic policy toolkit. The emergence of sizable unrecorded arrears highlights the need to strengthen budgetary execution rules and misuse penalties as well as to streamline the recording of fiscal accounts by limiting the use of turnkey projects and deferred payment contracts in public investment projects.

Exiting the FATF grey list must remain a priority. Building on the momentum of recent legislative action, the authorities should continue addressing the deficiencies in Panama’s AML/CFT regime and legal framework identified by the FATF. In addition, the authorities should address the shortcomings identified in the 2019 Global Forum review on global tax transparency, including by responding to exchange-of-information requests in a timely manner.

The financial sector remains robust, but macrofinancial risks warrant continued monitoring. Addressing data gaps with respect to household and corporate balance sheets and property prices remains a priority. Specifically, improving housing price indices would facilitate financial-sector surveillance.

The alignment of prudential regulations with Basel III is welcome. The authorities should focus on macroprudential tools and further upgrading the regulatory toolkit. It will also be important to put in place robust frameworks for crisis management, including by adequate liquidity support for banks and enhancing the range of resolution tools available to failed banks.

The fintech sector holds potential in the presence of an appropriate regulatory framework. Adopting cybersecurity and fintech regulatory frameworks while capitalizing on Panama’s digital and mobile connectivity could place the country as a regional fintech hub, enhancing financial inclusion, and lowering intermediation costs.

A reinforcement of the structural reform agenda will be necessary to maintain high potential growth. Sustaining high rates of growth will require continued improvements in productivity and competitiveness, a strengthening of policies related to labor mobility, governance and institutional capacity, and enhancing the innovation and technological sophistication in key industries. To remain an attractive destination for doing business, Panama needs to upgrade the skill level of its workforce, streamline the insolvency framework and improve the functioning of the judicial system.

Addressing social inequities is urgent. Revamping social policies is imperative to maintain broad-based and inclusive growth and requires strategic policy action in the areas of education, gender equality, social protection programs, and poverty reduction in the comarcas.

Panama’s climate change mitigation strategy and commitments are welcome. Beyond “green” energy provision, the authorities should be mindful of natural resource preservation, especially in view of the country’s susceptibility to extreme weather events. Most notably, the pressure for better water management is mounting both from the expanded Canal operations and a growing population.