The Big Idea
Panama | Stakes are high
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Panama’s fiscal deficit target of 3.9% of GDP this year is especially important after the blow out deficit of 7.35% of GDP last year. Panama needs to show a track record of fiscal discipline. It’s not just about policy credibility. It’s equally about reducing gross financing needs ahead of the threat of losing its investment grade rating and confronting worse supply and demand dynamics for Eurobonds. I am cautious on the credit, especially considering the recent relative outperformance. It’ll be important to watch for higher tax collection in Panama, with cuts to capital expenditure the only source of flexibility for spending restraint.
The revised 2025 financing program intends to mostly avoid the Eurobond markets this year. This is smart strategy, avoiding any market penalty and relying on either local or alternative bank credit alternatives. However, this funding strategy is only temporary with success highly dependent on meeting the fiscal target this year. This isn’t easy and appears more ambitious after the large deficit last year and heavy reliance on efficient tax collection instead of either tax reform or mining royalties.
It’s a tough marketing pitch after Panama’s Minister of the Economy and Finance Felipe Chapman confirmed a deficit of 7.35% of GDP in 2024 and revised the 2023 deficit higher. This must be the worst fiscal deficit in the region and much worse than the initial guidance of 4% to 4.5% of GDP. This does come as a negative surprise. Panama provides limited data transparency, without full historical monthly data and delayed publication of the last months of 2024. Our deficit forecast of 6.5% of GDP was still a miss and even a bigger miss for local analysts at sub 6% of GDP. It has proven difficult to identify the sources of financing and the unreported stock and flow of arrears payments. The 2024 fiscal performance will also then question the reliability of the 2025 fiscal target at 3.9% of GDP.
Is it feasible to expect such a sharp improvement without tax reform or mining royalties? There is yet no track record of spending restraint or more efficient tax collection, and Panama still has to finance pension reform. The full-year fiscal data in 2024 shows a 7% year-over-year decline in total revenues against an impressive 11.7% year-over-year increase in spending. The release of the January 2025 data doesn’t yet show enough improvement with a -6% year-over-year decline in revenues only partly offset with a -0.6% year-over-year decline in spending for still a higher deficit at -0.45% of GDP in January 2025 compared to the same period last year at -0.41% of GDP. There may be some budget flexibility by cutting capex spending from its high 5.25%-of-GDP pace in 2024. This will have to be the next obvious step if revenues continue to disappoint, and it still probably will be not enough if there isn’t at least a 5% year-over-year nominal increase in revenues.
It’s a more rational funding strategy to shift to alternative sources as a temporary strategy until Panama reduces its funding needs. The 2025 funding strategy shifts to short-maturity bank credit lines and domestic treasury bills as a substitute for typically dominant Eurobond issuance. The $7.6 billion funding targets only $1 billion in Eurobond issuance against my earlier estimates of $4 billion to $5 billion. The domestic funding capacity seems limited since banks prefer to maximize liquidity. These external and domestic bank credit lines may just reflect bridge financing for future Eurobond issuance. Eurobonds compromise the majority of the debt stock for the limited domestic funding capacity and limited reliance on multilaterals. The build-up on these future liabilities would also have to compete with the resale of the stock of Eurobonds if Panama loses the second investment grade rating. This de-indexation event would reduce the investment grade demand for annual Eurobond flow as well as force a one-off divestment of the Eurobond stock. This would further complicate the funding strategy if gross financing needs remain high and require a higher liquidity penalty on Eurobonds.
The markets didn’t respond to the “supply relief” of a smaller Eurobond issuance calendar this year, but instead weaker bond prices reflected skepticism about still high financing needs and potentially much larger Eurobond medium-term supply. The strategy for shorter maturity funding only intends to temporarily negate higher longer term funding costs until the economic team can lower the funding costs and improve the overall credit risks.
The stakes are high on the fiscal target this year. The track record has not been impressive considering the blowout deficit last year as well as the struggle to seek political collaboration on the reform agenda. The watering down of the pension reform may directly add to the fiscal stress and indirectly show minimal awareness or support of the political establishment to resolve the fiscal and financing stress. Will the Mulino administration reach consensus for the social and legal framework for re-opening the mine as the next steps on providing some minimal budget relief? The rating agencies are not only closely following the pension reform but also any progress on fiscal adjustment this year. The latest setbacks may increase the rating downgrade risks and may even accelerate the timeframe to later this year if the fiscal deficit doesn’t start to improve. This would only worsen the supply/demand dynamics, and ultimately, the liquidity penalty on ‘BB’ rated peers like Colombia.
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