June 28, 2024
On June 3, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Panama.[1] The Board considered and endorsed the staff appraisal without a meeting, on lapse-of-time basis.
Panama grew very rapidly in the two decades preceding COVID-19 but was hit very hard by the pandemic. Between 1994 and 2019, GDP per capita increased from 33 percent of US GDP per capita to 48 percent. Rapid growth was driven by an unprecedented construction and investment boom that included major construction projects, such as the enlargement of the Panama Canal and the Tocumen airport, and the expansion of the services and logistics sectors that benefited from those projects. From the supply side, convergence was in large part supported by a sharp increase in the employment-to-population rate. This was the result of a demographic transition, an increase in female labor force participation, and a significant drop in unemployment. In 2020, GDP fell by 17.7 percent, a much larger decline than in other countries. A strict lockdown, with a six-month shutdown of the construction sector resulting in a 50 percent decline in investment, was a key factor behind the sharp decline.
The strong post-pandemic rebound continued in 2023. For the third year in a row, real GDP growth surprised on the upside, reaching 7.3 percent in 2023. Rapid growth was driven by a rebound in construction, retail and wholesale trade, transportation, and logistics. From the expenditure side, growth was driven by very strong fixed capital information, while private consumption growth lagged GDP growth. GDP is now well above pre-COVID 19 levels, and unemployment is near pre-crisis levels. GDP has grown by 39 percent since 2020 and 14 percent since 2019 and surpassed pre-crisis levels in 2022. However, private consumption is still below 2019 levels. Unemployment, which had surged from 7.1 percent in 2019 to 18½ percent in 2020, has since fallen back to 7.4 percent in August 2023. The fiscal deficit declined from 10.0 percent of GDP in 2020 to 3.0 percent in 2023, in line with the Social and Fiscal Responsibility Law. Panama exited the FATF grey list in November 2023.
Amidst several headwinds, the economy is expected to slow and the outlook is uncertain. GDP growth is projected to decrease to 2.5 percent in 2024, largely as a result of the closure of the Cobre Panamá copper mine. The mine contributed, directly and indirectly, about 5 percent of Panama’s GDP. Growth in the non-mining sector is likely to slow as well, as the strong rebound from the pandemic has likely run its course and Panama faces higher financing costs. The near-term economic outlook is subject to a large degree of uncertainty and the balance of risks is tilted to the downside. Key risks include the loss of investment grade, further social unrest, the fallout from the end of copper production (including from international arbitration proceedings), and external risks. Over the medium term, GDP is expected to grow by around 4 percent, subject to considerable uncertainty, as construction and investment are unlikely to provide the same support as they did before the pandemic. In addition, the scope for a significant increase in the employment-to-population ratio (which was an important driver of rapid growth during the boom years) is limited.
Executive Board Assessment[2]
Panama has recovered strongly from the pandemic, but growth in 2024 is projected to decline and the balance of risks is titled to the downside. Key risks include the loss of investment grade status and a further rise in financing costs. Being a dollarized economy adds to the importance of maintaining fiscal sustainability and financial stability. The external position is assessed to be broadly in line with the level implied by fundamentals and desirable policies.
Panama has made significant progress in reducing its fiscal deficit. The fiscal deficit declined from 10.0 percent in 2020 to 3.0 percent of GDP in 2023, in line with the targets of the SFRL albeit also helped by one-off revenue sources.
Meeting the 2024 fiscal deficit target of 2.0 percent of GDP will require an unduly large compression of public investment. A fiscal deficit of 4 percent of GDP in 2024 would be adequate from a cyclical perspective, avoiding an overly large investment compression and allowing a more gradual adjustment to the permanent loss of fiscal revenues from Minera.
The SFRL goal of reducing the fiscal deficit over time to 1.5 percent of GDP remains appropriate. If the deficit stays around 4 percent of GDP in coming years, there would be no further decline in the debt ratio, leaving public finances vulnerable to renewed shocks. To ensure that public debt is on a firm downward trend, the public finances strategy for 2025 should contain a credible multi-year fiscal consolidation plan to reduce the deficit to the SFRL target of 1.5 percent of GDP by 2027. Without a credible plan, the risk of further sovereign downgrades is high, which would increase financing costs and exacerbate possible adverse debt dynamics.
With no lender of last resort and deposit insurance, it is imperative that the banking system remains well-capitalized and liquid. The Panamanian banking system appears broadly resilient against severe downturn scenarios, but risks have increased amidst higher interest rates and a slowing economy. Current capital adequacy and liquidity indicators in the banking system are well above regulatory minima, and continued intensive supervision and monitoring and expanding the macroprudential policy toolkit will help mitigate future asset quality and liquidity risks. The recent FSAP outlined a reform agenda that will help underpin financial stability and foster further financial development. All Fintech companies that carry out financial activities as defined by the FATF should be subject to AML/CFT regulation and supervision.
For income convergence to continue, labor productivity growth will need to accelerate. The demographic transition has largely run its course, and labor force participation in Panama already exceeds the average in the region and in high-income countries. Continuing to attract FDI, improving the quality of education and governance, and reducing the share of informal employment will be key to foster labor productivity and growth.
[1] Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
[2] The Executive Board takes decisions under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussions.