By: Erasmo C.
Published: March, 2014
During the Latin American World Economic Forum, which took place last April in Peruâ€™s capital city Lima, Panamaâ€™s President Ricardo Martinelli addressed the forum by saying: â€śPanama is not just a canal; allow us to show you all what we have done and how weâ€™ve done itâ€ť. These words were part of the invitation that president Martinelli was extending to the world, for the upcoming edition of the Latin American World Economic Forum, to be hosted by Panama next April, 2014. This invitation becomes especially attractive after taking a glance to the extraordinary economic track record that Panama has been delivering during the last decade.
Despite the fact that Panama has a U.S. dollar based economy, and that geographically is part of a traditionally convulsed region both in terms of politics and economics, this relatively small country has kept minding its own business while growing at an accelerated pace. The so-called Tango, Tequila and Zamba effects, in addition to the worst U.S. economic crisis in years, evidently have had no negative effect on the excellent country performance for many years now. Here are some facts on Panama:
- Annual average GDP growth of 6% in the last ten years (twice the Latin American average). Specifically, the period 2010-2013 the economy grew 9.1% annually, vs. a 4.3% growth in Latin America.
- Per capita GDP (almost reaching the 17,000 dollars) bigger that those of Brazil, Chile or Mexico.
- Annual average inflation rate of 1% in the last 20 years, with a peak year of 3.4% and three periods when Panama in fact experienced deflation rates. Definitely a unique case in Latin America.
- According to country-credit official raters, Panamaâ€™s grade is BBB, same level as Mexico had until a few weeks ago.
- The economy carries a moderate and manageable deficit of less than 3% of GDP.
- Panamaâ€™s external debt is only 25% of GDP.
How They Do it
After president Noriegaâ€™s regime, starting 1990, the country has been going through a political evolution towards democratic principles. And just like in any other young democracy, the process has not been trouble-free. Panama, however, is rapidly finding its way out towards a solid democracy and, in fact, political pressures have eventually yield to the creation of several new parties, as well as alliances and coalitions. This has also led to Panamaâ€™s overall stability, internal peace and credibility outside the country.
But when you come down to it, there are two distinctive factors in Panama, which have been there for many years, to make possible the macro-economic scenario accomplished to date: The existence and operation of the Canal of course, on one hand, and the unique financial structure built by Panama-based private banks on the other.
Since the very first ship that crossed the Panama Canal back in 1914, the country started receiving its share of income, despite the fact that the ownership and operation of the Canal was in the hands of the U.S. This, right there, represented additional flows that other countries in the region could not enjoy to complement its traditional exports of agricultural products, some minerals and services.
Starting January 1st 2000, Panama was granted full ownership and control over the Canal. Since then, the country unveiled a new unlimited horizon, which immediately triggered expansion plans for the Canal, in terms of capacity and collateral services, as well as the funneling of additional budgets for the country infrastructure. In fact, 2006 marked the start of a 5.3 billion dollars expansion project of the Canal Zone to be concluded in 2015.
No question that the countryâ€™s overall economy has benefited from this boom in domestic investment while, the works at the Canal have been in progress. And once the expansion works have been completed, the new capacity will allow the crossing of ships of any size, increasing traffic and long term profitability.
Today, the canal operation, logistic and maritime services, in addition to insurance, financial services, and tourism, represent 78% of Panamaâ€™s GDP.
The Financial Structure
At the beginning of the 70â€™s, Panamaâ€™s congress issued a series of regulations which encouraged a much more liberal banking system. Mainly, the new rules came to eliminate all taxes on interest and other transactions performed by Panama-based banks. The immediate effect was a sharp increase of international banks opening branches in Panama, from little more than 20 to more tan 120 banks. International banks operating from Panama would also have the same tax treatment for all operations abroad.
A major benefit for the country, among others, was that this big pool of banks, eventually came to ensure the integration of Panamaâ€™s internal financials with the international system:
Since there is no official centralized control on the flow of capital funds in Panama, the private banks themselves have been taking care of the â€ścleaningâ€ť of the excess flow of foreign capitals whenever they appear. They accomplish this by simply placing off-shore loans which are tax free on the interest gained. The countryâ€™s financial system is then freed from monetary pressures which normally lead to the raise of inflation rates, etc. In most other countries in the world, the â€ścleaningâ€ť task is performed by the countryâ€™s Central Bank who has the authority to â€ścorrectâ€ť the unbalances which occur from time to time. Also very positive to the system, is the fact that the large number of banks operating in Panama, makes it very difficult for a small group of them to pull about interest rates to their benefit.
In this way, the ideal of maintaining a market-driven money supply, is achieved without the need of a central bank. This has been so, since the countryâ€™s independence from Spain back in the 19th. century.
It is evident then, that the existence of the Canal, coupled with Panamaâ€™s Financial Structure, has been distinctive fundamentals for this countryâ€™s sustained growth with no monetary pressures for decades.
For sure president Martinelli acknowledges all the above; but he must be also aware of the challenges that Panama must still face. Here are some of them.
As in the case of several other Latin American countries, Panamaâ€™s sound macroeconomic performance has been rather slow in reaching the people in the street and rural areas. In fact, close to one third of the population still live below the poverty line. This is in spite of recent large funds being channeled for peopleâ€™s well being.
But Panama has other major concerns too. The country has a permanent pressure to gain its daily foreign exchange (US dollars) to be able to pay for its imports, which include basically everything they consume: Oil-based finished products, natural gas, electricity, as well as most manufactured goods such as cars, trucks, machinery, grocery and toiletry products, computers, medicines, etc.
For many years, Panamaâ€™s industrial activity has been centered around primary products such as shrimp, sugar, bananas, pineapples, recently honey, and little more. It is clear that Panama is not prepared now, to compete in todayâ€™s technology-led world markets.
Although the Industrial and construction sectors have shown signs of good growth lately (mostly driven by the Canal expansion project), there is a huge amount of work to be completed still, in the process of providing Panama with a â€śthird legâ€ť to its economy, which is currently based on the Canal and Financial Infrastructure.
And whatever this â€śthird legâ€ť may be in the future, it is imperative to the country to have foreign investment as a major long term source of funds. Incidentally, foreign investment in Panama is only 10% of GDP, which appears low for a small country with a solid platform for future growth.
The Ministry of Commerce and Industry headed by Ricardo Quijano, has evidently understood the importance of foreign investment for his country. Several initiatives have already been put in place to accelerate the process: With the purpose of building the framework to attract investment, a Free Trade Agreement was signed with Peru in 2012; A Promotional Commerce Treaty with the US went into effect that same year; work in process is also reported for FTAâ€™s with Colombia and Mexico, as well as an Association Agreement with the European Union.
Further evidence of Panamaâ€™s eagerness for foreign investment, is found when taking a closer look at the Ministry of Commerce and Industryâ€™s organizational structure. Two high ranked General Directions which leave no doubt of their mission, are â€śInvestor Serviceâ€ť, and â€śMarketing and Sales for Investmentâ€ť both reporting to the Foreign Investment Promotion Director. These two Directions have already been responsible for promoting Panama`s participation and sponsorship of recent events such as â€śPanama Investâ€ť and the Latin American World Economic Forum. Also, they were a key factor when the â€śFree Zone Lawâ€ť was passed in 2011, for the establishing of diversified industries in the country. At this time, they are aggressively pursuing the â€śSpecial Regulation for the Establishment of Headquarters of Multinational Corporationsâ€ť. This â€śnew productâ€ť allows for important tax benefits for corporations who choose Panama as their Latin American headquarters base. Specifically all income and dividend taxes are eliminated for services rendered to companies outside Panama. The established objective is to attract 100 multinational corporations to be based in Panama under this regulation. Achievement of more than 40% is reported so far.
It will be very interesting to listen to President Martinelli addressing the Latin American World Economic Forum in Panama next spring. Possibly it may be one of his last public appearances as President of his country, since presidential elections are due on May of that same year.
Most surely, president Martinelliâ€™s main objective will be to convince his audience that he is leaving his post, having positioned Panama as ready-to-be much more than just a Canal.
All opinions expressed are those of the author. Strategy Business Group Blog is an independent and neutral platform dedicated to generating debate around the key topics that shape global, regional and industry agendas.