PANAMA ECONOMY INSIGHT MONITOR

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Wednesday, March 24, 2010

Panama achieved investment grade

On March 23rd, Fitch Ratings improved the Panama’s sovereign credit rating to investment-grade. Recently Standard & Poor improved Panama debt risk rating from BB+ with stable perspective to BB+ with positive perspective. Standard & Poor and Mody’s could also improve the Panama debt risk rating to investment grade in next months.

Panama’s investment grade could reduce the debt cost and to boost the country's attractiveness to the foreign investor. Panama debt cost could decrease because lower interest rates of global bonds as a result of Panama would be sees as a low-risk sovereign country.

The key factors that helped to achieve the investment grade were:

• The government fiscal performance
• The tax reform
• Economic growth despite the global downturn
• The economic outlook

The government fiscal performance

On February 11st 2010, Panama Government announced that, despite the global downturn, the fiscal deficit of Non Financial Public Sector (NFPS) was by only 1% of GDP in 2009. Government achieved to down the NFPS deficit from 2.3% (US$575.2 million) from January to September to 1% (US$253.3 million) from January to December. Government explained that collected almost US$200 million plus due to “ley de moratoria” (a fiscal law that allow to pay taxes without penalty by delay), which allowed to down the NFPS deficit to 1%. Government fiscal performance was better than Panama Economy Insight forecasted; Panama Economy Insight forecasted the NFPS deficit by 2.3%, but this was by only 1% due to “ley de moratoria” among others factors.





In previous years the NFPS showed surplus, which allowed to down the public debt as percent of GDP, which also contributed to achieve the investment grade. Public debt as percent of GDP fell from 70.4 in 2004 to 46.4 in 2009.

The tax reform

In March of 2010, Legislative Assembly approved a second phase of the tax reform. This second phase of the tax reform includes a higher contribution of the banking sectors among other activities. The first phase occurred successfully a few months ago, when achieved a greater contribution from Colon Free Trade Zone and container transshipment ports, among others economic sectors.

All those who earn US$9,500 and less per year do not pay income tax; they are 80% of the worker population. The tax reform extended this range to US$11,000. Workers with incomes between US$11,000 and US$50,000 will pay 15% on the surplus of US$11,000. Those with incomes between US$50,000 and more will pay 25% on the surplus of US$50,000. This tax reform reduced the effective rate for all workers that currently pay taxes.

Tax structure is progressive, based on the principle that those who earn most are those who must pay more taxes. This progressive structure remained with the tax reform, but the effective rates were reduced substantially for all workers. This progressive structure is appropriate in Panama where wages are relatively low and income distribution is very unequal. This tax reform will improve the situation of workers that pay taxes.

An aspiration of the Government since the electoral campaign was to become the progressive tax structure in a flat tax. A flat tax is a tax structure with a single rate. Theoretically, this single rate should be chosen of manner such that the sum of tax collected is at least equivalent to the sum collected currently. However, the problem is that will appear winners and losers, because for some its current effective rate would be at the top, while for others would be by below. The complexity of a flat tax in Panama is that 80% of workers do not pay income tax. In other words, only 20% of the workers contribute to income tax. Panama Economy Insight estimated that a flat tax of 6% on wage would collect the same amount of current tax structure. However, 50% of the collection would come of the 80% currently do not pay tax. Therefore, it is very complex to become current tax progressive structure in a flat tax.

Nevertheless, ITBMS (a tax on sales) was increased from 5% to 7% to compensate the reduction of income tax. In consequences, those workers that earn US$9,000 per year and do not pay income taxes, with the tax reform should pay an increase of two percent of ITBMS. However, foods, non-alcoholic beverages, electricity consumption, water, books and supplies for students do not pay ITBMS and Government has explained that the negative impact on low income household will be not strong. This increase will affect to consumption of cell phone, Internet, , clothes, shoes and cars purchases among others goods and services.

Economic growth despite the global downturn

On March 2nd 2010, the Government announced that the GDP grew by 2.4% in 2009. This economic growth occurred despite of the global economic downturn.



Economic activities linked to external demand plummeted, because to connection with world markets, but economic activities linked to domestic demand grew, and helped to offset of GDP contraction. Economic sectors linked to external markets that contracted were agricultural and seafood exports, Colon Free Trade Zone exports, railway, container transshipment ports, Panama Canal, bunker sales to ships, air transport, travel agencies, banking and real estate. Economic activities linked to domestic demand that grew were electric power generation, retail, restaurants, domestic transport by road, telecommunications, teaching, private health care and social services.

The agriculture and fishing value added contracted by 8.6% and 2.9% in 2009 respectively, according to GDP report published by the General Comptroller of the Republic of Panama on its website on March 2nd 2009, as a result of sharp contraction of U.S. and European Union export demand.

The wholesale and retail value added contracted 3.7% in 2009, according GDP report published by General Comptroller, as a result of Colon Free Trade Zone value added contraction by 9.2%. Colon Free Trade Zone (CFTZ) was affected by fell of Venezuela and Ecuador oil prices. Moreover, Ecuador imposed commercial restrictions against CFTZ imports to protect the foreign reserve.

Panama Canal, railway and air transport value added fell by 10.5%, 9%, 22.6% and 3.7% in 2009 respectively. Nevertheless, “transport, warehousing and communication” sector (which includes to Panama Canal, ports, railway and air transport) expanded by 8.3%, due to growth sudden and extraordinary of the telecommunications sector by 38.5%. This extraordinary increase of telecommunications was due to entry of two new competitors companies (Digicel and Claro) which expanded the cell phone supply and disputed this market to incumbent companies (Cable & Wireless and Movistar).

Banking value added fell by 2.2% in 2009, because the credit banks restricted the credit and sacrificed profits how measure to offset the global financial downturn. However, bank profits were substantially positives. National Banking System continues been one of most strong in Latin America and the better faced the global financial downturn.

Real estate value added contracted by 4.6% in 2009, as a result of collapse of the U.S. house prices. Baby boomer’s real estate demand contracted sharply as a result of collapse of the U.S house prices. The baby boomers could not sale your houses in United States and move them to Panama.

Public administrations value added expanded by 2.4% in 2009.

The economic outlook

Demand sectors linked to external market yet is weak, however Panama Economy Insight expect to recovery in 2010. Panama Economy Insight forecast that the economic growth will be by only 2.3%, despite Panama Canal is expanding. However, Ministry of Economy and Finance, ECLAC and IMF forecast that Panama economy will grow by 5%, 4.5% and 3.7% respectively.

Panama Economy Insight expects a strong growth in 2011 and 2012 by 9.4% and 8.6% respectively, as a result of external demand expansion, the recovery of the baby boomer real estate market , Canal expansion, construction a subway in Panama City, among others private and public investment. This growth will allow the unemployment rate down to 4.8% and 4.6 % in 2011 and 2012 respectively.

IMF forecasts that economic growth will be 6.1% and 7% in 2011 and 2012 respectively.

By 2010, Panama Economy Insight forecasts that the NFPS will experience another deficit by 2.1%, because economic growth of just 2.3%, but this deficit would fall to less than one percentage point of GDP in 2011 and 2012 and the public debt as percentage of GDP will reduce to 38.9% of GDP in 2012 because rapid economic expansion.

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