Fitch Confirms Panama's Risk Rating

Because of its strong and stable macroeconomic performance, Fitch confirmed the long-term foreign currency rating at 'BBB', with a stable outlook.

Friday, February 15, 2019

For the risk qualifier, the country's macroeconomic performance has driven a sustained increase in per capita income, and it also forecasts that GDP growth will recover to 5.8% in 2019 and 5.5% in 2020, above countries with similar ratings.

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From the Fitch Ratings report:

Fitch Ratings-New York-13 February 2019: Fitch Ratings has affirmed Panama's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook. 

A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS 
Panama's ratings are supported by its strong and stable macroeconomic performance, which has driven a sustained rise in per-capita income and reflects policies and a strategic location and asset (the Panama Canal) that underpin a high investment rate. This is counterbalanced by a relatively narrow government revenue base and an uneven track record of meeting fiscal consolidation targets that has kept the government debt burden on an upward trend. 

Macroeconomic imbalances are low in the context of high growth reflected by low inflation (0.8% in 2018) and a high current account deficit (8% of GDP in 2018) but fully funded by robust FDI inflows.

Fitch forecasts GDP growth will recover to 5.8% in 2019 and 5.5% in 2020, above similar rated countries. The 'Minera Panama' copper mine, scheduled to start operations in February, is a key driver behind economic recovery this year. Ongoing and pending infrastructure projects, including a new subway line and a fourth Canal bridge, will continue to underpin growth. A slowdown in growth to 4% in 2018 reflected a weakening of construction activity due to a month-long strike, although this sector also appears to be experiencing a secular moderation amid oversupply in some sectors. This was partly mitigated by a recovery of re-export activity in the Colon Free Zone and transit performance in the recently expanded Panama Canal.

Key near-term risk for economic activity remains a protracted trade dispute between the U.S. and China that could affect transit going through the Panama Canal and reputational risks surrounding financial transparency issues, including possible re-introduction of Panama into the Financial Action Task Force (FATF) 'grey' list in the upcoming revision. 

In Fitch's view, relaxation of near-term deficit limits under the Fiscal Responsibility Law (LRSF) hinder improvement in fiscal policy credibility. In October 2018, the government modified the LRSF to simplify its framework and ease fiscal restrictions in the context of slower growth. This change allows for higher fiscal deficits compared with the previous rule through 2021, repeating a pattern seen over the past decade of postponement of consolidation targets that has weighed on policy credibility. The previous version of the LRSF set a limit of the non-financial public sector (NFPS) deficit and allowed any shortfall in Canal transfers below the 3.5% of GDP to count as an additional "let-out" above the deficit limit. The modified LRSF sets clean limits on the NFPS deficit of 2.0% of GDP in 2018 and 2019, 1.75% in 2020 and 2021 and 1.5% thereafter. 

Panama's NFPS deficit was 2.0% of GDP in 2018, exactly in line with the modified deficit ceiling. Fiscal performance had deteriorated earlier in the year due to significant revenue underperformance, but this trend was offset late in the year by several large one-off receipts, including those from a tax amnesty applied to taxes on properties. Fitch expects the NFPS deficit will remain at 2% of GDP in 2019 and gradually fall in line with the new deficit ceilings.

The central government deficit - relevant for sovereign borrowing - was 2.8% of GDP for 2018, below 3.1% in 2017, and down from 3.9% in 2014. The deficit decline has not been enough to put debt-to-GDP on a downward path, as previously expected, despite strong economic performance. Central government debt rose to an estimated 39.2% of GDP in 2018, from 37.5% in 2017, and is expected to gradually increase in 2019 and 2020. Fitch estimates net government debt rose to 37.3% of GDP in 2018 from 35.4% in 2017, inching closer to the 40.0% legal limit. General government debt (net of the social security government debt holdings) at 34.9% is slightly below the historical 'BBB' median of 36.2% in 2018.

Government revenues have persistently fallen short of economic activity. Tax collections grew 4.3% on average in the five years through 2018, compared with nominal GDP of 7.5%. Panama's VAT rate of 7% is among the lowest in the region and investment, a key growth driver, benefits from relatively low taxes. The revenue underperformance may reflect structural issues in the tax agency as well as broader issues regarding tax evasion. The new law criminalizing tax offences could help tackling this issue, but frequent tax amnesties continue to pose a challenge toward improving tax compliance.

General elections - electing the president, local governments and 71 seats in the unicameral legislature - are scheduled to be held in Panama in May 2019. Fitch expects policy continuity from the incoming administration given the lead of candidates from well-established political parties in the latest presidential polls. The electoral campaign period is now limited to two months prior to the election date as per the electoral reform approved in 2017. Presidential candidates will be allowed to publish their campaign platform until March 4, resulting in limited visibility on the policy stance from major contenders at this time.

Reputational risks are an important issue in Panama because of its sizable international banking sector; total banking assets account for 180% of GDP. The government has made substantial progress strengthening its Anti-Money Laundering and Combatting the Financing of Terrorism (AML/CFT) framework. According to the FATF report published early 2018, the government was compliant or mostly compliant with 35 of its 40 recommendations up from only five recommendations in 2012. In early 2019, Panama's legislative assembly also approved the criminalization of tax evasion, included in the list of deficiencies signalled by the FATF. Despite technical compliance, perceived deficiencies in the implementation of the AML/CFT framework pose risks of Panama being included in the FATF's "grey list". 

Overall banking system liquidity remains high and well above minimum requirements, reflecting conservative policies in the absence of a lender of last resort. A USD500 million liquidity facility being created by the Banco Nacional de Panama, while small in size, will provide some additional support. Credit growth has moderated reflecting weaker demand in key sectors, particularly construction, and supply-side restraint amid slower deposit growth (Bank's main funding source) and higher Basel III capital requirements. 

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Panama a score equivalent to a rating of 'BBB' on the Long-Term Foreign-Currency (LT FC) IDR scale. 

Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:

- Macro: -1 notch, to reflect uneven track record of fiscal consolidation at the central government level that has hindered improvement in policy credibility and kept debt metrics on an upward path, a key consideration given absence of monetary policy. 

- Public Finances: +1 notch, to reflect that the SRM classifies public debt as fully denominated in foreign currency due to Panama's use of the U.S. dollar, but the century-old and well entrenched dollarization regime fully mitigates FX risk on the sovereign balance sheet. 

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES

The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main factors that, individually or collectively, could lead to a positive rating action are:
--Improvement in fiscal policy credibility leading to a decrease of fiscal deficits and reduction of the debt burden over time;
--Sustained improvements in tax collection that enhances fiscal policy flexibility. 

The main factors that, individually or collectively, could lead to a negative rating action are:
--Fiscal deterioration leading to weakening in public debt dynamics;
--Deterioration in medium-term growth prospects.

KEY ASSUMPTIONS
-Fitch base case assumes that the expanded canal will continue to perform as expected, with no meaningful deviations from current projections due to external or technical factors. 

-The global economy performs largely in line with Fitch's Global Economic Outlook (December 2018).



More on this topic

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February 2020

The rating agency maintained BBB's long-term issuer default rating, but decided to change the risk outlook from stable to negative, arguing that the debt burden will continue to increase in 2020.

KEY RATING DRIVERS


The revision of Panama's Outlook to Negative reflects a marked deterioration in fiscal deficits and a significant increase of the government's debt burden, related to accumulation of arrears by previous administration and higher fiscal deficit targets under the modified Fiscal Responsibility Law. In addition, the recent greater-than-anticipated growth deceleration creates additional challenges for fiscal consolidation.

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