Public Information Notice No. 01/14

Public Information Notice: IMF Concludes Article IV Consultation with Panama

February 16, 2001

On January 22, 2001 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Panama.¹

Background

Real GDP is estimated to have grown by 2.3 percent in 2000, compared with the program's rate of growth of 3.8 percent and below the 3.0 percent growth rate achieved in 1999. Large declines in construction, farming and fishing and related food-processing industries account for most of the shortfall. The service sector, which accounts for about 80 percent of GDP, is estimated to have grown by 4.7 percent in real terms in 2000. The slowdown in the growth of real GDP contributed to an increase in unemployment from 11.8 percent in August 1999 to 13.3 percent in August 2000, the rate that prevailed from 1995-98.

On the basis of estimates through the third quarter of 2000, the PSBR for that year is projected to reach US$110 million, slightly exceeding its target of US$100 million under the Stand-By Arrangement approved on June 30, 2000. The budget for 2001 approved by the legislative assembly at end-2000 implies a PSBR of 2.5 percent of GDP if fully executed. Historically, the budget has been underexecuted in Panama.

The rate of growth of bank credit to the private sector declined from 16 percent in the 12 months ending in September 1999 to 14 percent in September 2000, and is projected to decline to 12 percent at end-December. The slower growth results in part from more cautious lending in light of banks' need to conform to the new regulations for loan classification starting January 1, 2001. The short-term lending rate has remained at about 10 percent for the past 15 months, and the spread with respect to the U.S. prime rate has narrowed somewhat.

Indicators of bank system soundness remain robust. The banking system reported an annualized return on assets of 1.5 percent through September 30, 2000, and an equity to asset ratio of 9.1 percent, up from 8.6 percent at end-1999. Panama-headquartered banks reported an equity to asset ratio of 11.7 percent, well above the regulatory minimum of 8 percent. Nonperforming loans (NPLs) were 2.9 percent of loans at end-September 2000 and provisions against loan losses amounted to 62 percent of NPLs.

The deficit on external current account is estimated to have declined from US$1.4 billion (14.4 percent of GDP) in 1999 to US$1 billion (10.4 percent of GDP) in 2000. Direct foreign investment financed about 33 percent of the current account deficit. A net decline in the foreign assets of the Panamanian banking system of about US$380 million covered most of the rest.

The real effective exchange rate appreciated by 1.6 percent in the first nine months of 2000, and has risen by 3.3 percent since December 1998. An appreciation of the nominal effective rate resulting from the appreciation of the U.S. dollar (Panama's currency) against other major currencies outweighed the impact of a favorable inflation differential. The 12-month consumer price inflation in November 2000 was 1.1 percent.

The authorities are persevering with the efforts begun in 1998 to modernize the supervisory and regulatory environment of the banking system and to put in place a system that conforms to internationally accepted standards. In the past six months, a concerted effort has been made to address concerns over the effectiveness of the anti-money-laundering regime. In October 2000 the Banking Superintendency completed a self-assessment (with Fund assistance) of its adherence to the Basel Core Principles for Effective Banking Supervision. The authorities have committed themselves to undertaking an assessment to be led by the Fund under its initiative for OFCs beginning in April 2001. The Superintendency has completed consolidated inspections of 30 of 80 general and international licensed banks, and is currently reviewing the quality of its onsite supervision and offsite monitoring.

To strengthen the anti-money laundering regime, the authorities submitted two new laws to the assembly that were promptly approved and promulgated in early October 2000. These laws broaden the concept of money-laundering crime to include the laundering of proceeds from fraud, extortion, embezzlement, corruption of public officials, kidnapping, acts of terrorism and theft or trafficking in vehicles or illegal weapons. (Previously it covered only drug-related offenses.) The new laws also facilitate both the transmittal of reports on suspicious transactions to the competent authorities and the exchange of information with other jurisdictions.

As regards other areas of reform, the submission of legislation to the assembly that would broaden substantially the base of the value added tax and increase substantially the effective rate of tax on bank income to the assembly was delayed. The submission of legislation to close the National Mortgage Bank has also been delayed, although both bills are expected to be presented to the assembly shortly. A commission has been appointed to study ways of improving the finances of the social security system, and some progress has been achieved with the expansion of the coverage of the automated financial management system.

Executive Board Assessment

Executive Directors welcomed Panama's generally good economic performance, and in particular its stable financial environment and consistently low inflation rate. Directors remarked that economic growth in 2000 had been below expectations, largely due to the impact of various temporary negative external shocks. They noted that, while substantial progress has been made with financial sector reforms, progress in other areas of structural reform was slower than expected, which could reverse the progress achieved with fiscal consolidation. Directors therefore urged the authorities to maintain a prudent fiscal stance and to persevere with the reform program, especially with respect to the tax system, public expenditure management, and social security. The restoration of momentum to the structural reform program and the setting of appropriate budgetary targets for 2001 would facilitate continued international financial support to Panama, including from the Fund.

Directors strongly supported the authorities' decision to eliminate the fiscal deficit in 2001. They regretted the delay in submission of legislation to the assembly to broaden the value added tax and increase the effective rate of tax on bank income. In order to minimize compression of expenditure, they urged the authorities to submit the necessary legislation as soon as possible. Improvements in tax administration would further enhance the revenue impact of these measures. Directors urged the authorities to prepare detailed and comprehensive ceilings on expenditure for 2001 that are consistent with realistic revenue projections and the deficit target for the central government. Directors encouraged the authorities to expand the coverage of the automated financial management system (SIAFPA). Progress with this reform would be needed to keep the fiscal program on track and to allow an increase in budgetary allocations to social programs. Improvements to SIAFPA could also help the targeting of social expenditure, thereby contributing to poverty alleviation. Directors also encouraged the authorities to formulate soon a plan with concrete proposals to deal with the growing imbalances in the social security system.

Directors welcomed the rapid progress that had been made since the creation of the Banking Superintendency in 1998 with reform of the regulatory and supervisory framework for banks. In particular, they commended the Superintendency for completing in October 2000 a self-assessment of adherence to the Basel Principles for Effective Banking Supervision, and for the progress it had achieved with its program of consolidated inspections of both general and international license (offshore) banks. Directors welcomed the authorities' commitment to undertake a Module 2 assessment—led by the Fund—under the Fund's program for OFCs, beginning in April 2001. They also praised Panama's recent efforts to strengthen its anti-money laundering regime. Directors urged the authorities to address promptly the supervisory and regulatory weaknesses relating to the finance companies.

Directors supported the authorities' intention to submit legislation to the assembly that would enable the closing of the National Mortgage Bank. They encouraged the authorities to reflect the quasi-fiscal operations of the Agricultural Development Bank in the budget and to rationalize its operations.

Directors noted that the reduction in the pace of increase in credit to the domestic economy in 2000 was desirable, given the very rapid rate of growth of credit in 1998-99. They stressed, however, that the rate of growth of bank system credit to the economy, and standard indicators of bank soundness, should continue to be monitored closely.

While Panama's statistics are generally adequate for surveillance purposes, the authorities were encouraged to address remaining weaknesses, especially in the balance of payments and national accounts.