The Big Idea
Panama | Creeping optimism
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.
The popularity and expertise of the Mulino administration, on display during a recent trip to Panama City, is good reason for optimism. There is a lot of work to do, and timing is uncertain. And there is still risk of rating downgrades. Success will depend on sustaining popularity as the Mulino administration tackles Panama’s structural fiscal deficit and controversial reforms. There are also the influences of the US rate cut cycle and optimism on business surveys for upside to economic growth. But ultimately it depends on budget efficiency and the reform agenda later this year.
Although President Mulino won with marginal support on the first round of elections, he benefits from the relief of the departure of the unpopular Cortizo administration. The public has also responded favorably to the administration’s open communication with weekly press conferences and higher policy transparency. There is also high expectations for the strong technocrat team’s plans to tackle the fiscal and financing stress inherited from the prior administration.
The first phase on damage control should be successful. There should be sufficient budget flexibility for cutbacks to offset lower-than-programmed revenues. However, these efforts would only contain the fiscal deficit around 4% of GDP. The next challenge focuses on financing, with Finance Minister Chapman promising a shift to local markets for the remainder of the year. This would bring some welcome relief after chronic Eurobond issuance. There has already been a pickup in monthly Treasury bill auctions from $30 million to $100 million, $200 million in additional loans from Banco Nacional de Panama and the most recent 5-year $189 million Treasury note. There are different estimates on domestic funding needs. The latest assumption is now closer to $1.3 billion after the recent domestic issuance and under the assumption of full execution of $1.4 billion in spending cutbacks to contain the fiscal deficit near 4% of GDP.
Prospects for developing the local markets
Panama is not El Salvador. The Treasury exposure is quite low at 3% of domestic bank assets with huge capacity to reach a regional average of 10% to 13%. However, the appetite may hinge on offering a premium to the Eurobond curve from a highly competitive and independent banking system. This suggests a slow process to increase domestic exposure and no quick substitute from Eurobond financing.
The larger Treasury bill auctions is a natural area to expand on core demand while the incremental increase in notes and bonds should eventually reduce the illiquidity premium to the offshore curve. It certainly looks manageable near term on sourcing incremental demand, especially if launching a larger international panote or pabonte bond. This could maybe deter Eurobond issuance until next year. The successful spending cutbacks and diversification on financing may provide some welcome near-term relief. However, domestic financing is not a solution. Panama needs to reduce its funding needs with a lower structural fiscal deficit.
The next phase of controversial reforms is much harder since it tackles the structural fiscal deficit. The initial guidance starts with the presentation of the 2025 budget next month and the medium-term fiscal framework introduced either coincident or later this year (December deadline). The challenge is how to commit to more aggressive fiscal consolidation from a deficit of 4% of GDP to around 2% of GDP. There are no plans for shock therapy.
The policy menu includes pension reform, mine reopening and maybe even tax reform. The success hinges on active communication, social awareness and ultimately the resiliency of the approval rating of President Mulino. Even under the best case scenarios of moderate pension reform and a (temporary) mine reopening, it’s still a struggle to tackle the fiscal deficit. Pension reform would only address the emerging pension deficit while any royalties from the mine remain uncertain and depend on resolving political and legal issues.
Budget consolidation solely focuses on spending cutbacks with budget rigidity requiring legislation to loosen mandated spending or subsidies. The government would need to start first on reducing the size of the state with voters requiring a leaner government. It should require maximum efficiency in identifying spending for cutbacks as well as sourcing higher tax collection. However, the low revenue base remains a clear vulnerability with high execution risks on complying with fiscal rule of trend 2% of GDP fiscal deficit.
The pecking order starts first with pension reform. This isn’t easy with parametric reform clearly unpopular. If politically feasible, then the administration could tackle the reopening of the mine with tax reform the most controversial and probably last on the list. The initial debate on tax reform seems to take a tentative approach for an adjustment below 1% of GDP and only partial relief on the growing cash flow deficit. The mine reopening maybe offers the most upside potential. It will require first tackling a political agenda and then shifting to the legal agenda. It seems the obvious policy choice and offers huge medium-term potential on jobs, investment, growth and fiscal revenues. The initial plan is to open to “close”, however there is a clear path for a political and legal compromise considering the risk/reward on policy options. This would be a game changer for credit risk.
Political capital for reforms
The working coalition in congress is untested and maybe unreliable. The markets would welcome a realistic approach, but policy gradualism may not coincide with rating agency reviews. It’s difficult to restore policy credibility on unilateral adjustment, especially under a gradual trajectory with only quarterly fiscal data. It’s not under consideration from the Mulino administration but a precautionary IMF program could provide a positive shock of instant credibility that could provide goodwill to the markets and rating agencies alike. Otherwise, it’s uncertain whether policy gradualism will prevent against another rating downgrade over the next 12 months. It’ll be important to monitor the ambition on the reform agenda, the popularity of the Mulino administration and the tolerance from the rating agencies. There is particular focus on the annual review from Moody’s in October-November. If the outlook remains stable, then there should be more breathing room for the gradual adjustment. It’s only early phase but there is some latent optimism that maybe Panama averts the second critical downgrade from Moody’s to junk status (maybe now fat tail risk).
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