The Big Idea
Panama | Election risk
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Panama’s elections arrive on May 5 with the markets waiting for clarity on the policies of the next administration. The stakes are high since inaction equals downgrade. The country’s debt is already trades closer to ‘BB’ levels after the March downgrade by Fitch. And the loss of a second investment grade rating would trigger de-indexation and forced selling from crossover investment grade investors. This is less about fundamentals and more so about technicals. Valuations could be vulnerable. Liquidity premiums could rise if lower credit ratings weakened demand and created higher secondary market supply. And primary markets could also add to supply since Panama relies on Eurobond markets to fund the fiscal deficit to the tune of $3 billion to $5 billion a year.
The scarce polls in Panama may suggest some surprise. RM candidate Mulino has a dominant frontrunner position at around 30% support in a splintered race of eight candidates. Only one round determines the outcome with scrutiny on the strength of the win and the breakdown of the congress. The political capital represents the critical pre-requisite for stronger governability and unpopular economic reform.
The fractured race would only allow for, say, a maximum 20% to 30% vote for the first-round winner and a much weaker mandate compared to a 50% win in a second round. The fractured political structure also forces a coalition approach within the legislature. The frontrunner Mulino may benefit from a larger political party, but it’ll be important to monitor the breakdown of the congressional elections. It’s worrisome that polls show majority support for independent candidates with an anti-establishment backlash. This would not only complicate the coalition building process but would also complicate the economic agenda. It’s not even clear that a surprise win with even 40% support would be enough political clout. The fractured political structure typically reinforces the complacency of status quo and a weaker executive branch. These protest voters may further complicate governability with a pushback against austerity or unpopular measures.
It’s not just the political capital but also the political commitment to economic reform and debt sustainability. The frontrunner Mulino did not participate in any of the election debates with none of the candidates recognizing or committing to unpopular measures through a highly contested election campaign. It’s unusual for a rating agency to pre-emptively downgrade from an investment to junk rating ahead of an election cycle. However, it’s maybe the reality of the even weaker political framework that would complicate a pro-reform agenda.
If there is no sense of urgency, then there are no obvious checks or balances to reinforce responsible policy management. This is even more the case under the complacency of dollarization. There is no awareness of fiscal and financing stress when the majority of the funding is sourced offshore. There is no domestic financial pressure on under-developed local markets and the price stability of dollarization. If there isn’t a backlash of policy mismanagement on the domestic economy, then why would politicians address macro imbalances? It’s always politically easier to finance than reduce the fiscal deficit, especially after the $20 billion Eurobond demand of the last issuance. The tax haven status makes it difficult to propose tax reform, especially on the cyclical and structural economic deceleration.
What if the Minera Panama copper mine stays open on a passive or even active approach under the practical budget reality? There could be broader debate about the tradeoff between mine royalties (plus huge contingent ICSID claim) and tax hikes. However, the annual mining revenues at 0.4% of GDP are not enough to reduce the structural 4%-of-GDP fiscal deficit to the 2%-of-GDP necessary to stabilize debt dynamics and maintain the investment grade rating.
The forward guidance from Moody’s is more relevant for the low ‘Baa3’ rating and the fourth quarter 2024 outlook review with their last update reaffirming that “fiscal deterioration will drive the sovereign’s credit outlook.” There is no honeymoon with the rating agencies looking for quick announcements soon after the elections. If not, then negative rating action suggest risk of crossover divestment and increasing liquidity penalty on bonds. Not only from the $3 billion to $4 billion estimated secondary supply from crossover sellers but also the risk of primary supply of $2 billion to finalize the financing program on a higher 4% of GDP fiscal deficit this year. This should require an increasing liquidity penalty to peers, especially for the worrisome concentration of liquidity risk with Eurobond holders. The rating downgrade may already be discounted in current valuations; however, Panama should require a liquidity penalty to peers like Colombia. Colombia 10-year sector still trades at 30 bp to 50 bp wide to Panama. The risk-reward appears biased to the downside ahead of the event risks with inaction translating into rating/supply risks.
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