The Big Idea
Panama | Pension reform
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There isn’t any obvious resolution yet in Panama’s pension reform debate. Broad discussions continue across political parties. But this is a real test for the Mulino administration. It’s difficult to assess the policy options if there is no cooperation on economic reform. The only recourse in the face of large fiscal deficits is spending cutbacks and continuing dependence on Eurobond financing. Panama’s re-entry to Eurobond markets next year should test market demand for high yield credits and the extent of the liquidity penalty on bonds. This backdrop suggests more narrowing in the differential between Colombia and Panama.
Panama has underperformed other ‘BB’ rated credits over the past four weeks. This isn’t surprising considering the successive negative rating actions and the noise surrounding pension reform. It’s actually somewhat surprising that the underperformance hasn’t been more pronounced considering the high stakes in play with pension reform. It is the litmus test of political cooperation to address a structural fiscal deficit and underfunded pension system. The initial proposal was a compromise solution with contributions across the public sector, the corporate sector and individuals. The $1 billion in additional public sector contributions may have further added to the fiscal stress, but political cooperation on controversial reform would show promise for progress on re-opening the First Quantum mine or approving other reforms.
The recent pushback from the ruling RM party doesn’t provide clear guidelines for what comes next. The proposal of a bank transaction tax to substitute for a higher retirement age doesn’t seem politically feasible with serious opposition from the large banking sector. Other political parties like PRD have been outspoken about their opposition but without offering any specific proposals other than delaying debate into next year. President Mulino was targeting year-end approval through extraordinary sessions. The consultations continue into the first debate on December 17, but there is no political consensus on revisions or the outright rejection or approval for pension reform. Can President Mulino control the majority from former President Martinelli? This represents critical event risk to close the year. What’s the marketing pitch when Panama needs to come back to Eurobond markets without approval of pension reform or approval of a much weaker pension reform?
The attention soon shifts to the external financing program. The fiscal pressures remain challenging with a fiscal deficit running at 7% of GDP through September 2024 against the increasingly ambitious target deficit of 4% of GDP for 2025. There hasn’t yet been an important reduction in spending against continuing pension pressures and uncertain political commitment to resolve the fiscal stress. The burden then shift to bondholders with expectations of market re-entry next year after temporary respite from local markets. The investor demand should remain a function of broader external demand. It’s not clear that there will be similar appetite as the multi-tranche issuance last February when many investors covered underweight positions. The initial re-entry will set the stage on the new issue premium for the estimated $4.5 billion Eurobond funding program this year.
The negative credit rating action is less relevant than the liquidity penalty for a frequent issuer. The current valuations may already fully reflect the ‘BB+’ composite weightings, but valuations should be increasingly sensitive to new issuance as one of the larger issuers from a mid-sized country. Panama still trades at a spread discount to Colombia despite expectations of similar ratings and different funding flexibility. If the risk-on sentiment continues, then the Colombia spread premium should narrow to Panama. Colombia has already pre-funded this year, with Panama more vulnerable to the supply risk of new issuance next year. This should accelerate what has already been a narrowing spread differential since last month. The balance of risk and reward continues to favor Colombia relative to Panama, especially on the recent negative rating action and prospects of new issuance early next year.
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