III. ECONOMIC TRENDS AND OUTLOOK A. MAJOR TRENDS AND OUTLOOK During 1993, Panama's economy continued the strong growth it has exhibited since 1990, albeit at a slower pace than previous years. The Panamanian Comptroller-General's office estimates Panama's real Gross Domestic Product (GDP) grew 5.9 percent in 1993 to US$ 2.35 billion (1970 prices), down from 8.6 percent growth in 1992 and 9.6 percent growth in 1991. Nominal GDP rose to an estimated US$ 6.6 billion. Construction and Colon Free Zone activity continued to fuel the economy. Non-factor services exports -- transportation-related services, and tourism -- also expanded in 1993. Projections for 1994-95 are for continued but slower growth in most sectors. Real GDP growth of about 5 percent is currently projected in 1994 and 1995. During its tenure, the Endara government did not fully implement key economic policy reforms to reduce the public sector payroll, liberalize the trade regime, privatize state-owned enterprises, and foster job-creation through labor code reforms as proposed in the first years of the administration. As a result, the rate of economic growth declined and anticipated strong growth in goods and services exports did not materialize. Private construction and capital goods spending will be the main sources of growth in the near-term. Decisive policy reforms to change the balance of incentives in the economy and lay the foundation for sustainable long term growth through 1995 and beyond, has been left to the newly elected government of Ernesto Perez Balladares, which took office on September 1, 1994. Many of the needed reforms are expected to be taken in the context of Panama's accession to the GATT, which began in earnest in April 1994. The two greatest challenges facing the Perez Balladares administration as it begins its five year term will be to utilize efficiently the 70,000 acres of land and roughly 4800 buildings which will be reverting to Panama from the U.S. military during the 1994-1999 period and to lay the groundwork for assuming full control of the Panama canal in the twenty-first century. The second Working Party Meeting is to take place in mid-September 1994. Also, the first bilateral negotiations between the U.S. and Panamanian governments are anticipated to take place sometime in October 1994. B. PRINCIPAL GROWTH SECTORS Panama's economy is primarily based on a well-developed services sector that accounts for 72 percent of GDP. Services include the Panama Canal, banking, insurance, government, the transisthmian oil pipeline, and the Colon Free Zone. Manufacturing, mining, utilities, and construction together account for 19 percent of GDP. Manufacturing is principally geared to production of items such as processed foods, clothing, chemical products, and construction materials for the domestic market. Agriculture, forestry and fisheries account for about 11 percent of GDP. Principal primary products include bananas, shrimp, sugar, coffee, meat, dairy products, tropical fruits, rice, corn, and beans. The sectors of the Panamanian economy with the greatest potential for substantial growth are mining, tourism and maritime services. The Primary Sector Agriculture, livestock, forestry, fisheries and mining -- grew 1.4 percent in 1993. Agricultural production declined 1.1 percent; value added in banana production dropped 7.2 percent as import restrictions by the European Union were enacted. Flooding in one banana growing area also affected production. Despite this drop, bananas remain Panama's primary agricultural product and export, accounting for 43.5 percent of agricultural value-added. Exports of non-traditional products, especially melons, have increased substantially, and continue to show significant potential for growth. Production, however, is small scale. Panama's mining sector has the potential for substantial growth. Panama has large copper reserves and is host to two of the largest undeveloped copper deposits in the world. Other minerals with commercial potential are gold, silver, and manganese. During December 1993, a new manganese mine entered production, and in early 1994 an abandoned gold mine was returned to service. Mining investments in Panama are aided by a favorable mining law, which encourages participation by foreign investors. Manufacturing and Construction Geared largely for domestic consumption, manufacturing activity is concentrated in the production of food products, beverages, construction materials, clothing, consumer products, and intermediate goods. Production of food products and beverages accounted for 72 percent of 1993 value added in manufacturing. Overall manufacturing output increased by 8.1 percent in 1993, led by strong demand for construction materials. Construction activity grew 39 percent in 1993, down from 56 percent growth in 1992. New construction permits issued in the Panama city area, however, grew by nearly 70 percent in 1993. The rate of growth of construction is expected to slow in 1994, but will remain significant. Continuing demand for construction materials will stimulate manufacturing output. Banking and Finance Panama's international banking center consists of 106 banks, of which 60 are general license banks, 28 are international license (offshore) banks, and 18 are representative offices. Two of the general license banks -- the National Bank of Panama and the National Savings Bank -- are government-owned. U.S. banks with a presence in Panama include Citibank, Chase Manhattan, and First National Bank of Boston. The National Banking Commission estimates Panama's banking center employed 8,560 people and had a direct payroll of approximately US$ 100 million in 1993, up from 7,326 people and a direct payroll of about US$ 72 million in 1991. Total banking center deposits increased by US$ 2.2 billion (11.8 percent) to US$ 21 billion in 1993; external deposits increased by US$ 1.1 billion, internal deposits by a similar amount. Total assets expanded by US$ 3 billion (13.2 percent) to US$ 26 billion; external loans increased by US$ 1.5 billion (18 percent) and domestic lending expanded by US$ 794 million. Lending to the private sector increased by US$ 919 million (24 percent). The largest increases in private sector lending went to finance commerce (US$ 411 million), consumer spending (US$ 195 million) and housing (US$ 160 million). Total assets of Panama's offshore banks declined by 1.2 billion (-22 percent) as both deposits and loan portfolios declined. In the first two months of 1994, total assets of the banking center increased by an additional US$ 231 million. Total deposits of the banking center are expected to expand by 10-11 percent in 1994; total assets are expected to reach US$ 28.3 billion by year end- 1994. Panama Canal Panama Canal business declined slightly in calendar year 1993 compared to 1992. Oceangoing transits fell 3 percent to 12,257 or 33.6 vessels daily, and Panama Canal net tonnage, on which tolls are assessed, fell 1.3 percent. Tolls revenue, however, rose 8.7 percent to US$ 400.9 million due to an October 1, 1992, toll rate hike. During the first four months of 1994, oceangoing transits increased 1.7 percent and toll revenue was up by 2.6 percent relative to the same period of 1993, reflecting economic recovery in Japan and Europe. The outlook for 1994 and 1995 is of slow growth (1-3 percent) in both tonnage and tolls revenues. Oil Pipeline Panama's transisthmian oil pipeline (Petroterminales de Panama, S.A.) is a joint U.S.- Panama venture. Forty percent is owned by the Government of Panama while 60 percent is owned by two U.S. companies. Pipeline revenues declined 46 percent to US$ 30 million in 1993 from US$ 55 million in 1992; its contribution to real GDP fell to 0.8 percent in 1993 from 3.0 percent in 1990. Declining revenues reflect a decrease in Alaskan oil production, an increase in consumption of Alaskan oil in California and some competition from U.S. pipelines. The outlook for 1995 and beyond is for further decline. Petroterminales de Panama is attempting to diversify into other activities, including plans to build a general cargo port at the pipeline's Caribbean terminal. Colon Free Trade Zone Established in 1948, the Colon Free Zone (CFZ) is the largest of its kind in Latin America and rivals Hong Kong in overall activity. Total imports to the CFZ reached US$ 4.5 billion in 1993, an increase of 3.6 percent over 1992; total re-exports climbed 5.1 percent to US$ 5.13 billion, up from US$ 4.88 billion in 1992. CFZ trade continues to grow in 1994, though at a slower pace than in 1993. The rate of CFZ growth will continue to decline from the spectacular percentages of 1991-1992 as it adjusts to changing patterns of trade caused by market liberalization in Latin America. U.S. exports to the Colon Free Zone totaled US$ 500 million in 1993. Data for the first five months of 1994 show imports of US$ 1.88 billion and total re-exports of US$ 2.25 billion, an increase of 14.1 percent over imports during the same period of 1993 and of 16.4 percent in exports over the same period of 1993. Net CFZ contributions to the Panamanian economy (re-exports less imports and operating costs) increased to US$ 611 million in 1993 from US$ 518 million in 1992 (net CFZ shipments reflect movements in exchange rates and inventories as well as market conditions). The CFZ's contribution to real GDP increased to 8.6 percent in 1993 from 8.1 percent in 1992. It is expected to contribute roughly 9 percent of GDP in 1994. Commerce and Tourism Commerce and tourism, which include restaurants, hotels, and wholesale and retail activities, grew 6.7 percent in 1993. Increases in personal consumption were reflected in brisk sales by business. The average hotel occupancy rate increased to 49.6 percent in 1993 from 45 percent in 1992, as hotels benefited from continued influx of tourists (up 7.2 percent) and tourist expenditures (up 10 percent to US$ 224.6 million in 1992). The tourism industry in Panama has substantial potential. In May 1994, the National Assembly passed a law granting incentives (primarily tax exemptions and long leaseholds) to new investment in tourism. C. GOVERNMENT ROLE IN THE ECONOMY From 1968 until 1989, Panama was governed by a military regime which implemented a statist plan of economic development. The government nationalized various private enterprises, including among others, utilities companies, sugar mills and cement companies. Price controls on many goods existed, and are still applied to several staple products considered part of a basic "market basket." The level of state involvement, however, was generally less pervasive than that in many countries that pursued a statist, import substitution model of economic development. In 1990, under the Endara government, Panama embarked on a policy reform program to liberalize trade and modernize government operations. The government re-negotiated its debt with the International Financial Institutions (IFIs) and bilateral creditors. A new tax law was enacted in December 1991 and a privatization framework law in July 1992. The tax reform act reduced corporate income tax rates to 30 percent by 1994. The privatization law, however, does not allow for debt for equity swaps and actual privatization of eligible state enterprises under the framework act is proceeding very slowly. In addition, the Legislative Assembly in the spring of 1993 rejected a bill which would have permitted privatization of the state telecommunications company. The use of the U.S. dollar as Panama's currency means that fiscal policy is the government's principal macroeconomic policy instrument. Because Panama does not "print" a national currency, government spending and investment are strictly bound by tax and non-tax revenues (including Panama canal receipts) and the government's ability to borrow. The government's ability to use fiscal policy as a tool has been further constrained by declining resources. Lending from the IFIs has dried up as Panama has failed to meet the loan programs' policy reform requirements. The general state budget (including various public enterprises) for 1994 totals US$ 4.38 billion, US$ 1.9 billion of which is allocated to the central government, and US$ 2.45 billion to various decentralized agencies (i.e. the port authority, state owned telephone company, electricity utility, national mortgage bank). The central government projects current (tax and non-tax) revenues of US$ 1.4 billion in 1994, up from US$ 1.3 billion in 1993. Capital revenues were projected at US$ 512 million for 1994, including US$ 326 million in income from credit. In June of 1994, the government had to reduce budgeted outlays by US$ 266 million when the International Financial Institutions decided that Panama had not yet met the policy reform conditions for further loan disbursements. Given the prospect of continued decline in oil pipeline earnings and the U.S. military withdrawal from now until 1999, Panama is under pressure to implement structural adjustment measures that will both strengthen exports of non-factor services based on its comparative advantage -- such as international transportation (ports) and related services (ship supplies and tourism) -- and encourage efficient substitution of high value-added industrial and/or commercial activity for U.S. military revenue. The government has implemented such measures slowly thus far, however, and exports of goods and non-factor services exports are expected to grow less than 5 percent in 1994. D. BALANCE OF PAYMENTS Panama's goods and non-factor services export earnings have traditionally been among the largest in the world relative to GDP (35-40 percent). This is because the country profited from its geographical location and dollar-based economy to develop a strong services sector. Net non-factor services surpluses have traditionally financed large merchandise trade deficits. In 1993, a net non-factor services surplus of about US$ 1.0 billion partially offset a US$ 1.7 billion merchandise trade deficit. Services: After the crisis years of 1988 - 1989, non-factor services exports have shown strong growth, increasing 18 percent in 1990, 5.3 percent in 1991 and 5.9 percent in 1992. In 1993 non-factor services exports increased by US$ 97.8 million (4.4 percent) to US$ 2.34 billion: Canal toll earnings increased 8.7 percent, net Colon Free Zone shipments rose 18 percent; U.S. Department of Defense (DOD) expenditures in Panama (for the purchases of local goods and services) grew 31 percent from US$ 117 million to US$ 153 million; and, earnings from tourism grew 10 percent to US$ 224 million. By contrast, oil pipeline earnings declined 46 percent to about US$ 30 million and external earnings by the banking sector declined slightly due to falling interest rates. Merchandise: Panama's merchandise imports grew in 1993 by 7.6 percent over 1992 to a total of US$ 2,173 million, down significantly from the yearly growth rate of 19 percent registered in 1992. The value of Panama's total merchandise exports in 1993 climbed 7 percent over 1992 to a total of US$ 507.6 million. Increased export earnings from meat, fishmeal, shrimp and sugar accounted for 58 percent of the increased exports. Banana exports fell by US$ 6.3 million (4.5 percent) to US$ 199.5 million. Bananas accounted for 35 percent of total merchandise exports. Debt: Panama is current on interest and principal payments due to the International Monetary Fund (IMF), World Bank, Inter-American Development Bank, and International Fund for Agricultural Development. It cleared US$ 645.8 million in arrears with these institutions during February/March 1992. Panama also remains current on interest and principal payments to U.S. Government creditor agencies. The GOP is now current in its obligations to its foreign bondholders, after a May 1994 bond-swap agreement. Panama has yet to normalize relations with foreign commercial banks, though negotiations continue. Panama budgeted US$ 493 million to debt service in its 1994 budget. Panama's current account has remained slightly positive in 1992 and 1993. In 1993, income from official transfers (credit from the International Financial Institutions and bilateral creditors) offset a deficit of US$ 166 million in merchandise, services and investment income. E. TRADE AND INVESTMENT BARRIERS The Government of Panama has declared its policy commitment to trade liberalization, but liberalization proceeded slowly under the outgoing government of President Guillermo Endara. Incoming President Ernesto Perez Balladares, has publicly acknowledged the need for Panama to continue trade liberalization, especially in the context of Panama's accession to the GATT. The economic reform program, begun in 1990 after agreement with the International Financial Institutions, has faced legal obstacles. The Legislative Assembly and private sector interest groups have initiated legal challenges to several of the trade liberalization measures and other government actions removing nontariff barriers on agricultural products. Despite these challenges, certain steps have been taken, such as the elimination of specific tariffs and their replacement with ad valorem tariffs on 261 products in 1993. Ad valorem tariff rates on some 227 product classifications have also been lowered (to 40 percent for industrial products and 50 percent on agroindustrial products). The Panamanian agricultural sector is protected by significant nontariff barriers. Agricultural products such as corn, beef, dairy products, soybeans, and wheat are controlled by the Ministry of Agriculture and the Agricultural Marketing Institute (IMA). Import permits are required from the Ministry of Agriculture for imports of animal products, animal by-products, and seeds. In 1993, the government passed a law restricting imports of poultry products based on phytosanitary restrictions and trade reciprocity. IMA maintains a list of 48 agricultural products under import quota and 30 products under import permit. Recently, the government issued several decrees (effective December 1, 1993) eliminating seven products from the list of products under quota and two from the list of products under import permit. Product registration requirements, which were previously applied prior to market entry (by customs authorities) now become effective six months after initial product entry. Thus, importers can establish product sales potential prior to an investment of financial and staff resources in the registration process. Panama continued its progress towards GATT membership by holding its first working group with GATT contracting parties in April 1994, after submitting its Foreign Trade Memorandum to the GATT in May 1993. Although we can negotiate for lower tariffs below that of the applied rate, we can only establish ceiling bindings. Hence, most of the products will not necessarily continue to decline, as many of the items will be bound at the applied rate. The Panamanian government officially promotes foreign investment and affords foreign investors national treatment, as well as actively promoting specific investment opportunities in agriculture, industry, tourism, and an expanded range of services. A limitation in Panamanian law on foreign government ownership of land affects a few U.S. Government investment insurance programs, but places no legal limitations on foreign private investment or ownership; Panamanian authorities are working on nullifying this legal provision. While the Government of Panama does not officially present any barriers to U.S. suppliers of banking, insurance, travel/ticket, motion picture, and air courier services, some professionals can expect certain technical/procedural requirements, i.e., architects, engineers, and lawyers have to be certified by Panamanian boards. Panama does not have an investment screening mechanism, and the Panama Trade Development Institute (IPCE) works to attract investment to priority areas. Under the terms of its Bilateral Investment Treaty with the United States, Panama places no restrictions on the nationality of senior management. Panama does restrict foreign nationals to 10 percent of the blue-collar work force, however, and specialized foreign or technical workers may number no more than 15 percent of all employees in a business. Disinvestment may be difficult for foreign (and Panamanian) companies because of labor code regulations, which restrict dismissal of employees and require large severance payments. F. LABOR FORCE In 1993, Panama's labor force was 949,400, of which 830,700 were employed, and 118,700 (12.5 percent) were unemployed. Panama's population is expected to grow at 1.8 percent per year, the working age population by 2.45 percent per year, and the labor force by 3.8 percent per year during the 1990's. Employment growth in the 1990's will depend on how fast the economy grows and how efficient the labor markets become. The minimum wage in Panama City and Colon (which has the highest rate of unemployment in the country) is US$ 0.94 per hour. When social security benefits and required bonuses are taken into account, the basic labor cost is US$ 1.34 per hour. A 1993 poll of local business reveals many companies face a shortage of highly qualified labor. Semi-skilled workers are in adequate supply; unskilled, largely young, workers are in excess supply, and make up most of the chronic unemployed. (Refer to Section VII for information on Panama's Labor Code). G. MAJOR LOCAL AND THIRD COUNTRY COMPETITORS The major competitors in the Panamanian market are foreign companies. In telecommunications, France's Alcatel and Canada's Northern Telecom have competed successfully for contracts with the state owned telecommunications company. In consumer goods, the Japanese are the largest competitors. American automobiles, however, do have a market presence and sell well in Panama. The Swedish construction consortium Skanska has been active in Panamanian hydroelectric generation projects in the past. H. INFRASTRUCTURE SITUATION In comparison to many Third World countries, Panama has a quite well- developed infrastructure. Goods and services are able to move with relative ease, electrical power generation is sufficient to meet current demand and port facilities, while aging and somewhat inefficient, are able to cope with current usage. However, Panama is in need of massive public sector investment in new roads, sewer and water treatment systems and more education and health facilities. It has been estimated that the cost of cleaning up the Bay of Panama alone will exceed one billion dollars. Presently, semi-treated sewage flows directly into the bay at one of its most picturesque points, damaging prospects for increased tourism. The basic services of Panama City and Colon and the country's major highways (the Pan-American and the Trans-Isthmian) as well as its biggest bridge (across the Panama Canal) were built either directly by the U.S. or with substantial financial assistance from it. Highways: No major new road construction has been done since the 1970's, while in the last few years about one thousand additional vehicles per month have been added to the nation's fleet. The inadequate road into town from Tocumen Airport and the congested, rough road between Panama City and Colon are probably the two most in need of immediate expansion or replacement with new routes. Ports and Airports: Panama has 13 ports, four of which are equipped to handle containerized cargo. The principal ones, Cristobal on the Atlantic and Balboa on the Pacific, are at either end of the Canal. Built by the United States in conjunction with the canal, the ports reverted to Panamanian control in 1979 under the Panama Canal Treaties. The port of Cristobal is the most active, handling approximately 62 percent of Panama's 1992 container cargo and 31 percent of all cargo tonnage. 79 percent of Cristobal's containerized cargo was destined to or originated from the Colon Free Zone, the largest single user of the Panamanian port system. Panama's principal international airport, Tocumen, is underutilized. Finished in the early 80's, it has a modern passenger terminal and two runways. An older passenger terminal is now used for cargo operations. Due to Panama's strategic geographic position and Tocumen Airport's current underutilization, Panama has potential for development as a regional passenger and cargo hub. Telecommunications: Panamanian law grants a telecommunications monopoly to the state-owned National Institute of Telecommunications (INTEL). INTEL's services are modern by Third World standards, but dated by First World standards. Efforts at modernization have run up against government budgetary constraints. A 1991 law allows for private sector involvement in cellular telephony. The Government of Panama is working to resolve legal restrictions that currently block plans to place a cellular telephone operating concession up for bids. The newly elected government of Ernesto Perez Balladares, installed September 1, is under significant pressure to invest in improving the country's infrastructure (one of Perez Balladares' campaign promises). How to finance the needed investment in infrastructure is an open question. The outgoing Endara government relied on funding from the International Financial Institutions (IFI's), which in large part never materialized because of lack of progress by Panama on the conditions of the loans. The new government, like its counterparts in Mexico and other Latin American countries, is studying creative financing techniques such as toll concessions to private developers of new roads. Major Infrastructure Projects Planned or Underway Several major infrastructure projects are currently or soon to be underway in Panama: Ports: Construction of a container port in the Bay of Manzanillo, adjacent to the Caribbean city of Colon has been underway since 1993. The US$ 150 million project will provide the Colon Free Zone with a modern alternate to the dated port facilities at Cristobal. The transisthmian pipeline company, Petroterminales de Panama, is planning to expand its current oil terminal port on the Caribbean into a US$ 100 million general cargo port. The project will provide western Panama with an Atlantic-side port for exporting agricultural and forestry products. Plans for a major container port and transshipment center on Telfer's Island (adjacent to the Atlantic entrance to the Canal) have also been discussed. Environment: The cleanup of Panama Bay would entail the construction of sewage treatment plants, as well as cleaning bay waters. Transportation: One of the major road projects for the near future is the construction of a highway bypass (known as the "Northern Corridor") around Panama City, which will exploit the existing runway at Albrook field. The highway would extend 58 kilometers and have an estimated value of US$ 190 million. Several road rehabilitation projects are also planned in connection with an Inter-American Development Bank loan for road repair and expansion. Japan's technical cooperation agency (JICA) recently studied the construction of a highway between Panama City and Colon along the current road. The Government of Panama has acknowledged that this is a high priority project and is currently examining options for financing the $400 million project. One option under consideration is to finance the project via a toll concession: the builder would administer the road and recoup the investment through toll revenues. Telecommunications: Panama has a law which allows a private company to hold and operate a cellular telephone concession. The Government of Panama will likely put the concession out for bids once a few remaining legal questions have been addressed. INTEL, the state-owned telephone company, is also involved in a modernization effort, involving the purchase of 124,000 digital telephone lines. Reverted Areas: The development of areas reverting to Panama under the Panama Canal Treaties will present many opportunities for investors. Projects in tourism, industry, environmental areas will be possible. The exact nature of these projects is dependent on a development plan to be prepared by Panama's Interoceanic Regional Authority (ARI). The reverting areas have special potential for use in tourism and maritime services. (Refer to Appendix C for ARI contact information). Potential Future Projects Transportation: Plans exist for the construction of a highway bypass around the southern edge of Panama city, along the Bay of Panama. The proejct would involve extensive land fills. Additionally, plans for the bypass also mesh with plans to build a second bridge across the Panama Canal. Plans for the construction of a 4-lane highway between Panama City and the province of Chiriqui continue to be mooted. Interest in an estimated $50 million project to rehabilitate the Panama Railroad for high speed commuter rail service between Panama City and Colon was recently revivied after the crash of a commuter plane travelling the same route.