The Big Idea

Panama | Gearing up

| August 2, 2024

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 President Jose Mulino has ordered a reconciliation of the 2024 budget, and it looks like a serious effort to identify potential savings and rationalize overall spending. This is a great first step to compensate for lost revenues. But there hasn’t yet been any reference to tax reform. The spending cutbacks only aim to offset lost revenues instead of reducing Panama’s structural fiscal deficit from around 4% of GDP toward 2% of GDP. The next phase shifts to the 2025 budget and the medium-term fiscal program. In the background, rating reviews loom.

It’s unclear if there is sufficient budget flexibility to close the fiscal gap without tax reform. Moody’s reviews the ‘Baa3’ credit rating at year end with clear focus on the follow-through of cutbacks to the 2024 budget and intentions to stabilize the debt dynamics. The threat of rating downgrades is not a surprise with credit spreads already aligned with ‘BB’ comparable credits.  However, it is the technicals that are worrisome if de-indexation spurs divestment from crossover investors while Eurobonds remain the primary funding vehicle for a structural fiscal deficit.

The cabinet has announced a hefty $1.387 billion or 1.6%-of-GDP reduction in the 2024 budget. The markets should welcome any commitment to fiscal discipline. The structural fiscal deficit of 4% of GDP is edging higher, driven by a structural slowdown in revenues from lower trend GDP growth and the shutdown this year of the Cobre Panama mine. The Mulino administration has made it clear that a re-opening of the mine is only to finance the shutdown, not the budget. This will minimize a contingent liability but not replace the 0.5%-of-GDP in annual royalties for the budget. The slowdown in tax revenues also may reflect the economic deceleration from 7% GDP trend growth to maybe 2% this year and 4% trend growth. The targeted spending cuts reflect an estimated 18% decline in budgeted revenues this year including back payments of $853 million to public providers.

The Mulino administration has committed to spending cutbacks. However, the targeted cutbacks seem aggressive with the five months remaining this year and a rigid budget. The budget isn’t overly flexible across most spending categories compared to similar levels in 2019. It’s also unclear whether there is sufficient political and social support for this pro-cyclical austerity through economic slowdown and with a weak political mandate. The budget revisions will require legislative approval and represent a litmus test for the support of the Mulino administration and the commitment of the political establishment to fiscal discipline. The alternative is not ideal: risk under-executing the budget and building up a larger stock of arrears.

The 1.6%-of-GDP cutbacks seem intended to offset the revenue shortfall as opposed to tackle the structural fiscal deficit. It would require maybe an additional 3% of GDP in fiscal consolidation to finance the 1%-of-GDP in pension shortfall and reach a targeted 2%-of-GDP fiscal deficit target. This also doesn’t fully address the payment arrears. There has been no clarity on the “adjustment” factor in the 2024 budget of 2.2%-of-GDP of spending that would bring the 4.9%-of-GDP deficit to 2.7%-of-GDP. The proposed spending cutbacks seems intended to compensate for lost revenues as opposed to target a more aggressive fiscal consolidation that aligns with the ambitious fiscal rule.

Fiscal consolidation is typically harder to do with cutbacks than with tax reform. This is why the latest International Monetary Fund Article IV recognizes that capex cannot withstand the burden of cutbacks and instead recommends tax reform. There has been no reference to controversial tax reform or parametric pension reform.  The bottom line is that it could take some time to resolve the structural fiscal deficit. The fiscal gradualism, similar to former President Macri, would reinforce still chronic Eurobond issuance and maybe still another $1.5 billion to $2 billion issuance this year depending upon the extent of cutbacks—slightly lower after loans from National Bank of Panama.

The next rating downgrade would raise the risk of deindexation of Panama from investment grade indices. Crossover divestment would worsen the supply and demand dynamics. Moody’s is first to watch on their low investment grade rating at ‘Baa3’ and the annual review on their outlook at year end. The initial announcements are quite relevant not only for the revisions to the 2024 budget but also the presentation of the 2025 budget. The shift to a negative outlook may hinge on the fiscal performance through 2024; however, any outlook revision is non-committal on the 6- to 12-month review before to any rating revision. The initial market reaction has been positive with credit risk sensitive to any proactive fiscal management, especially with a risk-on appetite for yield.  However, it will require a track record for conviction of successful fiscal adjustment with high execution risks. There would be another six to 12 months to review the policy mix and see whether the Mulino administration successfully reduces Panama’s structural fiscal deficit.

Siobhan Morden
siobhan.morden@santander.us
1 (212) 692-2539

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