The Big Idea
Panama | Budget challenges
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Panama’s newly revised 2025 budget is not ideal. Spending rigidities are a problem for reducing the country’s fiscal deficit. The revised fiscal responsibility law stipulates a deficit of 2.5% of GDP for 2027. But it will require containing current fiscal deterioration and building credibility ahead of an ambitious budget for next year. This is what will determine the possibilities for sustaining the country’s investment grade rating. Progress on reducing gross financing needs would also improve market technicals, with a clear liquidity penalty as Eurobonds remain the primary funding market.
There are a lot of headlines about the amended 2025 budget and the fiscal responsibility law. Fiscal trajectory is critical for the rating agencies. The Moody’s outlook review should be imminent after fully assessing the information from their country trip and the release of the budget guidelines. It is not just the guidance on the fiscal targets but rather the specific trajectory on achieving these goals. The positive intentions alone may not be enough to sustain a neutral outlook. The revised budget still looks austere compared to prior budgets at only 29% of GDP. However, the budget was resubmitted at a slightly higher amount after criticism from the legislature on excluding mandated education spending. This is what is worrisome. The fiscal deficit target edged higher from 3% of GDP to 3.5% of GDP. There is obvious spending rigidity and (yet) no political collaboration to either reduce this mandated spending or source additional revenues. Do these budgetary rigidities imply higher execution risks? Is spending restraint alone sufficient to reduce the deficit to 3.5% of GDP? There is a clear vulnerability if the 5% increase in current revenues disappoint.
The fiscal rule targets a 2.5%-of-GDP deficit target in 2027 without committing on specific targets in 2025 and 2026. This provides maximum flexibility to bypass the budget restrictions but doesn’t provide much conviction for the undefined near-term fiscal targets. The fiscal rule also allows for opt-out clauses and more strict monitoring within the Finance Ministry as well as a more robust Fiscal Council. It’s not clear what the council will monitor if there aren’t specific near-term targets and no track record of any meetings from the prior council. There has also been criticism about a lengthy 15-year commitment towards the 40% of GDP debt ratios. This uncertainty risks a negative outlook from Moody’s and then maybe a longer review period to assess the progress through next year.
This year represents a critical starting point. The latest fiscal data through August are “ugly” as per the warning from Minister Chapman with a cumulative deficit of 6.4% of GDP. It will be important to contain the fiscal deficit at or below 5% of GDP this year. The fiscal performance this year will determine how ambitious is the target for next year. The announcement of the tax amnesty through year-end could maybe provide one-off revenues of 0.6% of GDP according to official estimates. This would provide additional buffers against the commitment of 1.5% of GDP in spending cutbacks. The spending restraint will be critical for compensating lower-than-expected revenues. The next challenge then shifts to pension reform to contain any deterioration on the 4%- to 5%-of-GDP structural fiscal deficit. President Mulino benefits from approval ratings around 75% but will have to counter still weak voter support for pension reform.
There has been a pullback on spreads in Panama’s debt on realization of the significant fiscal challenges ahead. Panama again offers a spread premium to liquid ‘BB’ peers like the Dominican Republic. The near-term technicals should prove supportive so long as gross financing needs remain contained and focused on the local markets. This would provide only temporary breathing room to establish a track record on fiscal credibility this year before coming back to Eurobond markets next year. These cheaper relative valuations should offer an anchor, but outperformance requires some progress on the fiscal agenda, maybe focused on the pension reform later this year.
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