Fitch Ratings – New York – 28 Mar 2024: FitchRatings has downgraded Panama’s Long-Term Foreign Currency Issuer Default Rating (IDR) to ‘BB+’ from ‘BBB-‘. The Rating Outlook is Stable. A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
Ratings Downgrade: Panama’s downgrade to ‘BB+’ reflects fiscal and governance challenges that have been aggravated by the events surrounding closure of the country’s largest mine. Large fiscal deficits and revenue underperformance have driven some of the largest rises in government debt/GDP and interest/revenues among peers since 2019 before the pandemic. This has constrained counter-cyclical policy space that was already more limited in the context of dollarization, and poses a greater vulnerability in light of the sovereign’s heavy reliance on external markets for funding. The Minera Panama copper mine closure further complicates the fiscal outlook and highlights growing governance challenges, in Fitch’s view.
Fitch expects most of the likely winners of the May 2024 elections to make some efforts to address these fiscal challenges. However, an expected growth slowdown, a tense social backdrop and party fragmentation is likely to constrain the scope for assertive action, and re-building fiscal space and credibility would take time.
Counterbalancing these fiscal and institutional weaknesses, and supporting the Stable Outlook, are Panama’s robust medium-term growth prospects, which Fitch does not presently expect to be greatly impaired by the mining episode, and are centered around logistics activities and the strategic asset of the Panama Canal. They are also supported by high per-capita GDP, and low inflation and macro-financial stability anchored by dollarization.
Mine Closure: In November 2023, Panama’s Supreme Court overturned a contract with First Quantum Minerals for operation of the Minera Panama copper mine, following social backlash to congressional approval of the contract. The shutdown of the mine will significantly dent growth this year, given it represents around 5% of GDP (via direct and indirect effects) and 7% of current external receipts. It will also deprive the government of 0.5%-of-GDP in expected annual royalties and raises the threat of a costly arbitration.
No matter the outcome of the election, it remains uncertain if and when the mine could reopen. And this is unlikely to happen quickly, as it would require a new administration to achieve a major shift in popular sentiment and overcome legal hurdles, such as overturning a recently enacted mining moratorium.
Fiscal Pressures Persist: The non-financial public sector deficit fell to 3% of GDP in 2023, in line with the fiscal rule (LRSF) limit, but was around 4.5% of GDP net of large extraordinary receipts. The 2024 budget projects resilient revenues despite slower growth and drought affecting the Canal, and authorizes large spending increases to comply with legal mandates for education and salaries, with an implicit deficit of 5.6%.
The authorities hope to heavily under-execute the budget to comply with the 2% LRSF limit, but this appears doubtful in Fitch’s view. Fitch projects the deficit will rise to 4.7% on the loss of the one-offs, weaker Canal revenues due to the drought, higher interest costs, and other spending increases (with less under-execution than assumed by the authorities). These pressures are partially balanced by cuts to fuel and social subsidies (0.8% of GDP).
Fiscal Consolidation Challenges: Consolidation prospects will hinge on the next government’s plans. Tax underperformance has been a key fiscal challenge, driving a 3pp fall in the tax/GDP ratio to 7.0% in the decade through 2023. Efforts to tackle tax evasion are underway that could help, but rate increases or cuts in exemptions might be necessary for major improvement, and would be politically difficult, in our view.
Most candidates have pledged efforts to trim operating expenditures, but if may be difficult to achieve large savings given demands for improved public services. Capex could be difficult to reduce significantly given outlays for ongoing projects, those already completed under “deferred payment” mechanisms, and new projects being pledged by most candidates.
The social security system (CSS) has a growing deficit, and focus has mainly been on ways to fund a sub-regime (SEBD) set to exhaust its reserves soon, with little appetite for parametric reforms to contain the underlying pressures.
External Market Reliance: Meeting relatively high financing needs will rely heavily on external bond markets and multilaterals, given the local market is relatively shallow and represented just 9% of net borrowing in the last five years. Panama saw strong demand for a recent USD3.1 billion issuance, but at much higher costs, highlighting a vulnerability to further adverse shifts in investor confidence. A sovereign wealth fund (with equity of 1.7% of GDP) and cash reserves (mostly held by social security) offer some financing flexibility.
Rising Interest Burden: Fitch projects gross general government debt will resume an upward path in 2024 as growth slows and the fiscal deficit widens, jumping to 60.7% of GDP. On a consolidated basis (net of CSS holdings), Fitch projects debt to rise to 56.0%, above the 53.9% ‘BB’ median, and to over 330% as a share of revenues, well above the ‘BB’ median of 190%.
Further risks could arise from additional borrowing that may be needed to settle arrears reported by the private sector, or a rescue of the SEBD should this rely on borrowing as opposed to asset transfers. Interest/revenue is projected to rise to around 17.5% this year, one of the highest among ‘BB’ and BBB’ peers and nearly double the level of a decade ago, due to rising interest costs and erosion in the revenue base.
Fiscal Credibility Challenges: Shortcomings in Panama’s fiscal framework persist. The authorities have not altered fiscal targets since a major relaxation in 2020, but compliance has depended on some one-off items and accounting maneuvers. Budgets are not well anchored around fiscal targets, as seen in the 2024 budget, which authorizes a major spending increase while also assuming this will not be executed to achieve consolidation goals.
Other legal mandates are not being delivered, including updated medium-term fiscal frameworks and audits by an independent fiscal council. Data shortcomings, historical revisions, and episodes of arrears also cloud visibility on the fiscal picture.
Governance Challenges: Issues around governance represent a growing credit challenge, having hindered progress on needed fiscal reforms (e.g. pension) and manifested in major social protests in 2022 and 2023. Panama’s Worldwide Governance Score has slipped from the 55th to 48th percentile in the five years through 2022, with large falls in sub-scores for “government effectiveness” and “control of corruption”, and may not yet fully reflect the upheaval surrounding Minera Panama. However, Panama’s efforts to strengthen its anti-money-laundering regime enabled it to exit several “grey lists” in recent months.
Favorable Growth Outlook: Real GDP grew 7.3% in 2023, broadly closing the large output gap left by the pandemic. The mine protests had a major impact on activity, but this was offset by strong performance otherwise. Fitch expects growth to slow to 1.5% in 2024, reflecting a direct hit (3pp) from the mine closure and a moderate impact from the drought. Second-round effects from the mine closure pose some further downside risk, but Panama’s better-than-expected performance in recent years poses an upside.
Fitch’s base case is for growth returning to 4.5% in 2025. However, it is uncertain where Panama’s post-pandemic trend growth will settle given the higher interest rate environment (affecting the key construction sector), narrower space for public works projects, and the effect the dispute around the mine (a flagship FDI project) could have on confidence and the business environment. Fitch does not expect the mine dispute to undermine growth potential, as it affects an enclave of the economy rather than the mainstay logistics activities, but this represents a risk.
Rising External Debt: The current account deficit rose to an estimated 7.4% of GDP in 2023 from 4.4% in 2022, although this was due to the build-up of inventories at free-trade-zones. This should unwind in 2024, helping the current account deficit. However, there will be some offsetting pressure from loss of the export receipts from the mine. Panama’s current account deficit has a record of adjusting smoothly and quickly, but has lifted net external debt to an estimated 50% of GDP at end-2023. This is one of the highest in the ‘BB’ and ‘BBB’ categories, posing some vulnerability to shifts in external financing conditions.
Elections Loom: The May 5 elections will determine a new president and congress for the next five-year term. Recent polls show voter support spread widely among many candidates, with Jose Raul Mulino of the Realizando Metas party recently emerging as the front-runner after taking over the candidacy of ex-president Ricardo Martinelli, who was disqualified. Broad policy continuity appears likely given narrow divergence among parties in Panama on economic matters. However, the political and social backdrop for addressing difficult issues appears challenging given party fragmentation, recent social tensions and an economic slowdown.
ESG – Governance: Panama has ESG Relevance Scores (RS) of ‘5 [+]’ for Political Stability and Rights, and ‘5’ for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in Fitch’s proprietary Sovereign Rating Model (SRM). Panama has a medium WBGI percentile score of 48.1, reflecting a recent track record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity and rule of law, and a high level of corruption.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
–Public Finances: A significant increase in the government debt/GDP and interest/revenue burdens, or material further erosion in market borrowing conditions;
–Macro: Reduced confidence in Panama’s ability to sustain relatively high economic growth rates;
–Structural: Further social instability or political gridlock that adversely affect the economy and public finances.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
–Public Finances: Structural fiscal consolidation that puts government debt/GDP and interest/revenues on a firm downward path;
–Structural: Evidence of improving governance, for example via enhancements in fiscal policy credibility and predictability.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Panama a score equivalent to a rating of ‘BB’ 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 the Long-Term Foreign-Currency LT FC IDR by applying its Qualitative Overlay (QO), relative to SRM data and output, as follows:
–Structural: Fitch has introduced a -1 notch to reflect shortcomings in governance that are not fully captured in the Worldwide Governance Indicators that feed into the SRM. These have been reflected by the mine closure, recent social protests, and weaknesses in fiscal policy management that is of greater relevance in the absence of independent monetary policy.
–Macro: +1 notch, to offset the deterioration of GDP growth volatility variable in the SRM due to the impact of the pandemic, which Fitch expects will be temporary, and would otherwise add excess volatility to the rating.
–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 well-entrenched dollarization regime mitigates foreign exchange 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 centered 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.
COUNTRY CEILING
The Country Ceiling for Panama has been downgraded to ‘A+’ from ‘AA-‘, +6 notches above the LT FC IDR. This uplift reflects Fitch’s view Panama’s full dollarization is a longstanding and entrenched part of its economic model, which has encouraged private-sector entities to maintain strong liquidity buffers of their own in the absence of a lender-of-last-resort, and reduces the sovereign’s incentives to impose transfer restrictions.
Fitch’s Country Ceiling Model produced a starting point uplift of +2 notches above the IDR. Fitch’s rating committee applied a +4-notch qualitative adjustment to this, under the Long-Term Institutional Characteristics, reflecting Panama’s fully dollarized economy.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
Panama has an ESG Relevance Score of ‘5 [+]’ for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As Panama has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
Panama has an ESG Relevance Score of ‘5’ for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As Panama has a percentile rank below 50 for the respective Governance Indicators, this has a negative impact on the credit profile.
Panama has an ESG Relevance Score of ‘4 [+]’ for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As Panama has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
Panama has an ESG Relevance Score of ‘4 [+]’ for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Panama, as for all sovereigns. As Panama has a track record of 20+ years without a restructuring of public debt and captured in Fitch’s SRM variable, this has a positive impact on the credit profile.
The highest level of ESG credit relevance is a score of ‘3’, unless otherwise disclosed in this section. A score of ‘3’ means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch’s ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch’s ESG Relevance Scores, visithttps://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
ENTITY / DEBT
RATING
PRIOR
Panama
LT IDR
BB+
Downgrade
BBB-
ST IDR
B
Downgrade
F3
Country Ceiling
A+
Downgrade
AA-
- senior unsecured
LT
BB+
Downgrade
BBB- PREVIOUS
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Additional information is available on www.fitchratings.com
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.
APPLICABLE CRITERIA
- Sovereign Rating Criteria (pub. 06 Apr 2023) (including rating assumption sensitivity)
- Country Ceiling Criteria (pub. 24 Jul 2023)
APPLICABLE MODELS
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
- Country Ceiling Model, v2.0.1 (1)
- Debt Dynamics Model, v1.3.2 (1)
- Macro-Prudential Indicator Model, v1.5.0 (1)
- Sovereign Rating Model, v3.14.1 (1)
ADDITIONAL DISCLOSURES
ENDORSEMENT STATUS
| Panama | EU Endorsed, UK Endorsed |
