Public Information Notice No. 05/50

Public Information Notice: IMF Executive Board Concludes Article IV Consultation with Panama

April 12, 2005

On March 23, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Panama.¹

Background

For the second consecutive year, real GDP growth was strong. In 2004, real GDP grew about 6 percent led by a boom in construction (stimulated by temporary tax incentives) and by export-oriented services (in particular the Colon Free Zone and ports). Unemployment declined modestly in 2004, despite high real GDP growth. Though 2004 was a year of high oil prices, inflation remains low as has been traditional in Panama.

The nonfinancial public sector deficit (excluding the Panama Canal Authority) increased slightly, to 5 percent of GDP in 2004 from 4.7 percent in 2003. The new administration took revenue and expenditure measures starting in September 2004 to contain the deficit. Aspects of fiscal accounting methods were also reviewed to improve fiscal transparency.

The banking system experienced a second year of recovery, after the financial markets turmoil in financial markets in South America during 2002. Domestic deposits rose by 9 percent and nonresident deposits remained stable in 2004. Domestic credit to the private sector grew 9 percent in 2004 because of rapid growth of credit in commerce and mortgages fuelled by the economic expansion.

The financial system remains sound. Nonperforming loans ratios averaged 2 percent and capital adequacy ratios were 19 percent at end-September 2004. Liquidity remains ample despite pressures on the liquidity of the National Bank of Panama resulting from increased credit to the government and a reduction in deposits from the social security fund.

Panama remains focused on concluding free trade agreements. After reaching agreements with Taiwan and El Salvador, Panama is now pursuing negotiations with the United States, Costa Rica, and Nicaragua. Negotiations with the United States are at an advanced stage.

In 2005, GDP growth is likely to slow down. Construction sector activity will decelerate, though the level of activity will remain high because tax incentives were extended until end-2005. The ontribution to growth from the external sector, though positive, is likely to be smaller than in 2004 as a result of a less favorable, though still positive, external environment. The administration is committed to reducing the nonfinancial public sector deficit in 2005. Inflation is expected to remain low.

Executive Board Assessment

Executive Directors welcomed Panama's strong economic growth performance, which has helped lower unemployment in a setting of continued low inflation. Noting the progress made in reducing extreme poverty, Directors encouraged the authorities to continue with the development of a well-targeted program for rural poverty reduction and the achievement of the Millennium Development Goals. Directors commended the authorities' emphasis on fiscal discipline and transparency in their economic program, and concurred that fiscal deficit reduction and the related improvement in public debt dynamics are key for sustaining economic growth and lowering poverty. They noted that, in moving forward, the main challenges are to strengthen government finances and to restore the long-term viability of the public pension system, while fostering medium-term growth prospects by enhancing the competitiveness of the private sector.

Directors commended the authorities' commitment to strengthening the fiscal position, as reflected in the budget for 2005 and in the recently adopted fiscal reform. They supported envisaged reductions in current expenditure and the recently adopted reforms to the tax system, which could underpin a stronger-than-targeted fiscal performance in 2005. In this regard, Directors encouraged the authorities to make use of stronger-than-budgeted revenues to further reduce unpaid bills to domestic suppliers.

Directors welcomed the emphasis of the fiscal reform on equity considerations, and the focus of the tax reform on increasing the buoyancy of tax collections and enhancing its efficiency. They concurred that the focus of the authorities' fiscal program on expenditure restraint appropriately targets overstaffing and improved efficiency in other spending areas, including public investment.

Directors commended the authorities' efforts to launch an information campaign on the reform of social security. They noted that, given the fundamental imbalance between pension contributions and benefits, substantial efforts will be necessary to restore long-term equilibrium to the public pension system. Directors agreed with the importance of the authorities' actions to improve portfolio management and eliminate inefficiencies of the social security system.

Directors, observing that the fiscal responsibility law had not functioned well, recommended that revisions incorporate procedural as well as numeric rules, and emphasized that the revised rules be well-defined, transparent, and supported by sound policies. In this context, Directors agreed that the presentation of fiscal accounts both excluding and including the accounts of the Panama Canal Authority is appropriate, and they welcomed the authorities' decision to assess fiscal transparency practices through a fiscal ROSC.

Directors commended the soundness of Panama's financial system. They observed that the expansion of regional banking heightens the need for effective supervision, and supported the efforts of the Superintendency of Banks to enhance coordination across countries in the region. Directors encouraged the authorities to strengthen governance in the National Bank of Panama and the Savings Bank. The business plans for these banks should be based on sound commercial banking practices and include mechanisms to ensure that the National Bank's credit to the government remains short-term in nature.

Directors noted the importance of strengthening the competitiveness of the export-oriented service sector for Panama's medium-term outlook. They welcomed Panama's commitment to further integration with the regional and global economy and observed that the prospective free trade agreement with the United States could help attract foreign direct investment by providing greater assurance of a stable legal framework, and stimulate resources to move to the more productive sectors of the Panamanian economy. Directors supported the authorities' strategy for fostering greater competitiveness and productivity by strengthening the business climate, streamlining business procedures, and enhancing the quality of human capital through sustained investment in education. They encouraged the authorities to enhance labor market flexibility by extending flexible employment practices from the special economic zones to other sectors.

Directors welcomed the authorities' emphasis on good governance and supported their efforts to fight corruption. They encouraged the authorities to adopt an integrated approach to addressing governance problems, including in the civil service and in government procurement. Directors noted that the Panama Canal Authority could potentially provide an anchor for institution building, and noted that a prospective expansion of the canal, if approved in a referendum and well-managed, could yield important benefits for the Panamanian economy. In view of the project's prospectively large financing costs, Directors supported the authorities' aim of minimizing fiscal risks, in particular by ensuring that the Canal Authority is run on a commercial basis.

Directors encouraged the authorities to improve the quality, timeliness and coverage of economic data. They welcomed the authorities' interest in a data ROSC, which would assess strengths and identify weaknesses in economic statistics, and supported the authorities' intention to request a follow-up to the Offshore Financial Center assessment.