The Big Idea
Panama | Mean reversion
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Panama has nearly converged with ‘BB’ peers like Colombia, especially in the shortest and longest tenors. This convergence has been one of my core expectations, but I cannot ignore technicals. There has been a slight bounce for Panama after favorable external developments and as investors chase its lagging performance. But Panama’s fundamentals remain worrisome. Pension reform is still vulnerable to revisions, the fiscal deficit and spending is beyond expectations and there are still risk from new supply and Trump policy. My preference remains for Colombia if trading with a spread premium to Panama.
Pension reform is in the middle of a first-round vote. There isn’t yet consensus on the final draft. There also isn’t any discussion on how to fund any shortfall in contributions. There is no margin for error with stretched public sector finances. It is difficult to interpret what is a political win. Is any version of pension reform progress?
There would be a boost to governability from reform, but weak reform with declining approval ratings does not the stage for the more important second phase on re-opening the First Quantum mine. The latest Vea Panama polls show a marked decline in approval ratings from a peak of 84% in November to January approval ratings of 57%. This is still quite impressive support but maybe insufficient to tackle the controversial and unpopular re-opening of the mine.
The Mulino administration needs to first socialize the importance of the mine before clarifying the legal framework. The same poll shows no voter focus on mining, at less than 1%, and it sits at the bottom of the pack on policy priorities of the Mulino administration. The top concerns focus on employment, corruption, and the high cost of living.
There isn’t any obvious voter focus on the fiscal and financing stress despite the lengthy debate on the 2025 budget and the fiscal rule late last year. This remains the main policy concern for bondholders, especially since they remain the core investors for the financing program. The available fiscal data through October show a fiscal deficit of 7.88% of GDP, which may close the year near 6.5% of GDP based on the available sources of financing. This is still far from the 4%-of-GDP target originally programmed for 2024 but now an ambitious target for 2025. It shows the challenge of reducing spending with a rigid budget and low tax revenues, and it shifts analysis to the liquidity penalty for chronic Eurobond issuance. It is this supply risk premium that bondholders have to next monitor with prospects for imminent market re-entry. The estimated $4.5 billion financing program in 2025 depends on several assumptions: 1) meeting fiscal deficit target of 4% of GDP, 2) ability to access local markets for $2 billion and, 3) the $1 billion payback of the bridge bond financing. This gross funding could bias higher on lower domestic financing or higher fiscal deficit or bias lower if bridge bank loans substitute Eurobond issuance.
The other part of the equation is investor demand. The track record on fiscal performance and economic reforms may disappoint, but the recent surge in risk appetite is beneficial for credits with high 8% yields. The’ debate then shifts to the supply risk premium for a ‘BB’ credit and whether that premium should be higher or lower depending on the still uncertain fiscal performance, Trump contagion and the reform agenda (mine re-opening). The high carry is only tangible under the context of price stability from stable fundamentals (remember the disappointment of Colombia credit performance through 2024). The market may require some additional premium either flat or slightly wider to Colombia to offer a buffer on the still latent risks heading into 2025. This is not too different from the analysis when Panama last came to Eurobond markets in February 2024. Colombia may increasingly serve as a reference to both upside and downside risks, with the mean reversion trade referencing early 2024 as opposed to the third quarter of 2024. There hasn’t yet been yet a track record of progress on still high spending, restricted domestic issuance capacity and overall uncertainty on the structural fiscal deficit and chronic Eurobond issuance.
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