Panama
Recent Economic Developments
Author: International Monetary Fund
Publication Date:
06 Sep 1996
eISBN:
9781451830781
Language:
English
Keywords:
ISCR; CR; U.S. dollar; enterprise; income tax; tax rate
Download PDF (5.2 MB)

This paper provides background information to the IMF staff report for the 1996 Article IV Consultation discussions with Panama. It presents an overview of economic developments in Panama during 1995, focusing on areas of interest in Panama’s medium-term economic strategy. It describes the changes in labor legislation aimed at increasing labor market flexibility. The paper summarizes developments in the tax system, focusing on the changes brought about by the Tax Incentives Harmonization Law of June 1995. The issues confronting the Panamanian social security system are also described.

Abstract

This paper provides background information to the IMF staff report for the 1996 Article IV Consultation discussions with Panama. It presents an overview of economic developments in Panama during 1995, focusing on areas of interest in Panama’s medium-term economic strategy. It describes the changes in labor legislation aimed at increasing labor market flexibility. The paper summarizes developments in the tax system, focusing on the changes brought about by the Tax Incentives Harmonization Law of June 1995. The issues confronting the Panamanian social security system are also described.

Panama—Basic Data

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Including capital revenues.

In relation to liabilities to the private sector at the beginning of the period.

Includes external arrears and debt rescheduling, and divestment proceeds.

Includes Savings Bank.

This report provides background information to the staff report for the 1996 Article IV consultation discussions with Panama. It presents an overview of recent developments and a series of chapters focusing on areas of interest in Panama’s medium-term economic strategy. The first chapter gives a broad overview of economic developments with emphasis on 1995. The second chapter describes the recent changes in labor legislation aimed at increasing labor market flexibility. The third chapter summarizes recent developments in the tax system, focusing on the changes brought about by the Tax Incentives Harmonization Law of June 1995. The fourth chapter examines the issues confronting the Panamanian social security system. The fifth chapter describes the structure of Panama’s financial sector. The sixth chapter focuses on the reversion of the Canal Zone areas to Panama. The seventh chapter reviews the features and performance of the Colon Free Zone. The eighth chapter analyzes steps in the ongoing trade reform.

I. Macroeconomic Trends

Following the political and economic crisis of 1988–89, when real GDP fell by a cumulative 18 percent, the Panamanian economy experienced a broad-based recovery with high rates of real GDP growth. The recovery was facilitated by the lifting of economic sanctions and large aid flows, and was sustained by an economic program that succeeded in restoring financial stability and began to address structural distortions. However, progress with respect to deregulation, privatization, and public sector reform was limited. In order to improve conditions for achieving satisfactory longer-term growth and a marked reduction in unemployment and poverty, the Administration that took office in September 1994 recast the adjustment strategy within a medium-term framework. This framework emphasizes continued fiscal consolidation, and public sector restructuring and regulatory reforms to increase efficiency throughout the economy and encourage the private sector to lead the needed modernization of the economy.

1. Developments during 1990–94

Reform policies initiated in 1990 were supported by a stand-by arrangement from the Fund, an Economic Recovery Loan from the IBRD, a Public Enterprise Reform Loan from the IDB, and grants from USAID. 1/ Although public finances improved significantly, several reforms aimed at creating a strong footing for the medium term ran into legal, political, and technical problems. Only three relatively small public enterprises were privatized during 1992–93, the coverage of the voluntary retirement program for civil servants was much smaller than anticipated, and some newly instituted petroleum taxes had to be eliminated because they lacked a legal basis. In addition, in 1991 the Supreme Court reactivated special labor laws that were suspended since 1988, thus reinstating the payment of automatic wage increases to more than 50 percent of civil servants.

Selected Economic Indicators

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Sources: Office of the Accountant General; and Fund staff estimates.

Data on national accounts and the balance of payments have been revised by the authorities, reflecting methodological changes and more comprehensive compilation of data.

Including inventory changes.

Includes unexplained residual in 1995.

Real GDP grew by an average of 8 percent over the period 1990–92, led by activities in construction, the Colon Free Zone, and financial intermediation. However, following the initial surge, real GDP growth decelerated in 1993–94 to an average of 4.7 percent (Chart 1). Unemployment declined from a rate of 16 percent in 1990 to 13.3 percent in 1993, but increased again to 14 percent in 1994.

CHART 1
CHART 1

PANAMA: REAL SECTOR DEVELOPMENTS

Citation: IMF Staff Country Reports 1996, 082; 10.5089/9781451830781.002.A001

Source: Panamania authorities; and Fund staff.1/ Includes changes in inventories.

Domestic demand increased at a rapid, although decelerating, pace in 1990–94 on the strength of rising private investment (mainly related to construction). Private investment reached 18.5 percent of GDP by 1994, or about two and a half times its level of 1990. Public investment also increased, but at a much slower pace. As gross domestic investment increased faster than gross national savings, the external current account deficit more than doubled from 2.1 percent of GDP in 1990 to 4.4 percent of GDP in 1994. Domestic consumption as a ratio to GDP averaged 80 percent in 1991–92, and stabilized at 77 percent thereafter.

Inflation as measured by the consumer price index (which refers to a relatively small number of imported goods) remained in the 1–2 percent range during 1990–94, i.e., below international inflation. Panama does not have an independent exchange rate policy since the U.S. dollar serves as legal tender and the balboa is only used as a unit of account. The absence of domestic currency issue has contributed to the maintenance of price stability.

After a sharp increase in 1991, wages rose by an average of less than 2 percent a year during 1992–94. In the public sector, the resumption of automatic wage increases propelled adjustments (with retroactive payments) above those in the private sector beginning in 1993.

Adjustment efforts coupled with the economic recovery improved the public sector balance from a deficit of 10 percent of GDP a year on average in 1988–89 to 1.3 percent of GDP in 1991 and to a surplus of similar magnitude in 1992. Public sector savings shifted from a negative 1.8 percent of GDP in 1990 to a positive 4.5 percent of GDP in 1992. This improvement reflected better tax administration 2/ and stronger operations of the Social Security Agency (CSS) and public enterprises, following measures to improve the contribution/benefits relationship and enhance efficiency. The deterioration in the public finances in 1993 mainly resulted from a weakening of tax enforcement, an increase in current outlays (especially the wage bill), and a lower surplus of the CSS. In 1994, a strengthening of expenditure control was the major factor underlying the improvement in the public finances (Chart 2).

CHART 2
CHART 2

PANAMA: PUBLIC SECTOR OPERATIONS

(In percent of GDP)

Citation: IMF Staff Country Reports 1996, 082; 10.5089/9781451830781.002.A001

Sources: Panamanian authorities; and Fund staff estimates.1/ Includes Central Government non-tax revenue, and revenues of the Social Security Agency (CSS) and the decontrolied ogencies.

Throughout the 1990–93 period, the public sector was able to build up sizable deposits with the banking system, facilitated by the accumulation of sizable external arrears in most years. A small fiscal surplus and inflows related to divestment allowed for a further buildup of deposits in 1994.

The recovery of confidence and economic activity contributed to a rapid growth of the banking system in 1990–94, especially in the first few years. Broad money as a ratio to GDP increased from 36.4 percent in 1990 to almost 60 percent in 1994. Deposits grew faster than private sector credit which, together with a drop in net credit to the public sector, allowed for a sharp increase in net foreign assets of the banking system (Chart 3).

CHART 3
CHART 3

PANAMA: MONETARY DEVELOPMENTS

Citation: IMF Staff Country Reports 1996, 082; 10.5089/9781451830781.002.A001

Sources: Panamanian authorities; and Fund staff estimates.

Panama’s external current account deficit widened from 2.1 percent of GDP in 1990 to 4.4 percent of GDP in 1994 mainly because of a sizable increase in imports. The deterioration in the trade balance was only partly offset by improvements in the services balance, mainly brought about by the Colon Free Zone and transportation services, which include receipts of the Panama Canal. Net capital outflows in 1990–91 gave way to large inflows beginning in 1992, mainly because of large private capital inflows (Chart 4).

CHART 4
CHART 4

PANAMA: EXTERNAL DEVELOPMENTS

(In percent of GDP)

Citation: IMF Staff Country Reports 1996, 082; 10.5089/9781451830781.002.A001

Sources: Panamanian authorites; and Fund staff estimates.

Since 1992, Panama has made substantial progress in normalizing relations with its external creditors. In 1992 it settled arrears with multilateral institutions and reached agreement to reschedule a substantial part of the debt owed to Paris Club creditors. In 1994, the Government completed an external bond exchange, settling arrears of about US$425 million, while the BNP settled US$103 million in interbank deposit arrears that had been outstanding since 1984.

There was some progress in liberalizing the trade system in 1990–94: price controls on gasoline and other petroleum products were eliminated in 1992, and some specific import duties were converted into ad valorem rates (see also chapter VIII).

2. Developments in 1995

The Government’s medium-term economic program emphasizes structural adjustment and a strong fiscal position that would permit the servicing of Panama’s external debt after relief has been obtained from debt-restructuring operations and accommodate the needed increase in domestic investment. Public savings are targeted to help finance both public and private upgrading of physical and social infrastructure, taking also into account the requirements of the reverting areas. 3/ Soon after taking office in September 1994, the new Administration began to implement its program by maintaining tight expenditure control, introducing major legislative changes, and preparing reforms geared to improve efficiency in the public sector and remove impediments to private sector growth, and expediting negotiations on external debt restructuring.

Reforms implemented in 1995 and early 1996 include legislation that: simplifies public sector procurement procedures; allows for divestment and private sector participation in the electricity, water, and telecommunications sectors; phases out tax breaks and subsidies for import-substituting activities while unifying the corporate income tax (Tax Incentives Harmonization Law); significantly amends the Labor Code; introduces more flexible labor regulations for export-processing zones; and eliminates remaining price controls while instituting antitrust norms and antidumping provisions in line with World Trade Organization (WTO) standards. In addition, Panama completed bilateral negotiations required for joining the WTO, and in December 1995 implemented a reduction in the protection of some agricultural products. 4/

With the recovery having run its course, real GDP growth decelerated from 4.8 percent in 1994 to 2.3 percent in 1995. Economic activity also was adversely affected by the effects of lower regional growth on the international financial sector and the Colon Free Zone, 5/ a slowdown in residential construction associated with saturation of the market for middle-income housing, and a decline in agricultural output due to bad weather. Uncertainties about planned changes in business, tax, and labor legislation may have accentuated investors’ reticence, and both gross domestic investment and national savings are estimated to have declined by 1 percentage point of GDP each in 1995.

Inflation remained below 1 percent in 1995 and the unemployment rate dropped from 14 percent to 13.7 percent. Urban unemployment, which is viewed as one of the major causes of poverty in Panama, tends to be 2–3 percentage points higher than the national average. The persistence of high unemployment is associated with rigidities in the labor market and reflects the low labor absorption of some of the more dynamic sectors in the economy. 6/

a. Public sector

The public sector maintained a small surplus in 1995 with savings remaining at 3.5 percent of GDP and investment at 3.3 percent of GDP. Net external financing (including the deferment of debt service on obligations under rescheduling) amounting to 2.5 percent of GDP, allowed the public sector to further increase its net claims on the banking system.

The central government deficit declined from 3 percent of GDP to 1.8 percent of GDP in 1995. Revenue increased by 8.7 percent while expenditure growth was limited to 1.8 percent, despite an increase in external interest obligations, and for the first time since the 1988–89 crisis the Central Government registered positive, albeit small, savings. Revenue growth was achieved through strengthening of tax administration, whereas the Tax Incentives Harmonization Law of June 1995 was virtually revenue-neutral, 7/ Control over current noninterest expenditure was achieved through a hiring freeze for civil servants (excluding the health, education, and security sectors); restricting wage increases to those public sector employees for whom special laws stipulate automatic wage increases; and close monitoring of outlays for goods and services. For the second year in a row, capital expenditure decreased as a result of implementation problems, but in late 1995 the authorities simplified procurement procedures to expedite project execution.

Despite administrative improvements which supported a 12 percent revenue increase, the operating deficit of the Social Security Agency (CSS) remained at 1.6 percent of GDP in 1995 as higher pension payments and improvements in the provision of medical services prompted a 10 percent increase in current expenditure. The overall surplus continued to deteriorate, declining to 0.9 percent of GDP in 1995, as both fixed and financial investment (mortgage loans) increased. To safeguard the CSS’ actuarial integrity, the authorities, in cooperation with the International Labor Organization (ILO), are currently reviewing the long-term funding aspects of the pension scheme and other benefit programs of the CSS. 8/ In addition, a new investment strategy under preparation aims at improving the yield and security of CSS’ investments by giving it more scope in the acquisition of financial assets.

The decentralized agencies, the largest of which is the University of Panama, continued to incur operating deficits that needed to be financed through central government transfers of almost 1 percent of GDP.

The operating balance of the public enterprises dropped from 4.6 percent of GDP in 1994 to 4.1 percent of GDP in 1995 as current revenue declined to 9.1 percent of GDP while operating expenditure increased to 5 percent of GDP. Increased competition from private sector entities (ports and telecommunications) and difficulties in collecting revenue (especially from other public entities) explain the drop in receipts, while higher technical losses in the water and electricity companies account for the expenditure increase. As a result of continued technical and administrative bottlenecks, public enterprise investment continued on its declining trend by falling to 1.2 percent of GDP in 1995.

b. Monetary sector

Broad money and the net domestic assets of the banking system grew by 8 percent in 1995. Net credit to the public sector declined by 3.6 percent in 1995 (in relation to liabilities to the private sector at the beginning of the period), while credit to the private sector slowed from 14 percent in 1994 to 12 percent, reflecting lower activity growth. The net foreign assets of the banking system increased marginally to US$2.5 billion, or 44 percent of deposit liabilities. Domestic deposit rates rose from an average of 5.5 percent in 1994 to 6.5 percent in 1995, in line with international rates. This increase was only partially passed on in domestic lending rates, which moved up by 0.2–0.3 percentage point to 10.1–10.6 percent. The income velocity of money declined steadily in recent years and now has returned to the level prevailing before the 1988–89 crisis.

Activity in the international banking sector (which includes the offshore operations of the international license banks) never fully recovered from the 1988–89 crisis, hampered by constraints from existing legislation which has not permitted the introduction of new financial instruments such swaps, options and futures. Also, prudential regulations have not yet evolved to international standards. 9/

The financial position of the National Bank of Panama (BNP) further improved in 1995 reflecting higher net interest receipts associated with the continued accumulation of public sector deposits and containment of operating expenditure. The Savings Bank recorded the third (albeit declining) operating surplus since 1993. There has been no improvement with respect to the loss-making activities of the Agricultural Development Bank (BDA).

c. External sector

The external current account deficit remained at 4.4 percent of GDP in 1995. With slower import growth and a small pickup in export growth, the trade deficit stabilized at around 19 percent of GDP. Sharp increases in exports of coffee (130 percent) and shrimp (17 percent) were partly offset by an 8 percent decline in banana exports (Panama’s most important export item). The surplus on the services account was maintained, with higher receipts from travel and transportation (reflecting record high activity in the Panama Canal) being offset by lower receipts in the Colon Free Zone and higher investment income obligations. The surplus on the capital account declined to an estimated 1.3 percent of GDP, as public sector disbursements remained below repayment obligations and private inflows (including errors and omissions) diminished. The overall balance of payments deficit of US$253 million, up from US$99 million in 1994, was mainly financed by a further accumulation of arrears on commercial bank and petroleum debt pending the completion of debt restructuring. The balboa depreciated in real effective terms by 2.3 percent in 1995, resulting in a cumulative depreciation of 11 percent since 1990 (Chart 5).

CHART 5
CHART 5

PANAMA: EXCHANGE RATE DEVELOPMENTS

(1960=100)

Citation: IMF Staff Country Reports 1996, 082; 10.5089/9781451830781.002.A001

Source: IMF Information Notice System (unless otherwise noted).1/ Relative prices measured by seasonally adjusted consumer price Indices.2/ Trade-weighted index of nominal exchange rates deflated by seasonally adjusted relative consumer prices; Increase means appreciation.3/ Trade-weighted Index of nominal exchange rates; Increase means appreciation.

Panama made significant progress in normalizing relations with its external creditors in 1995. In October, agreement was reached with commercial banks on a debt and debt-service reduction (DDSR) operation covering US$3.8 billion or two thirds of public external debt. The DDSR operation is scheduled to be concluded in July 1996. The up-front cost on the order of US$193 million will be financed in approximately equal parts by multilateral creditors and Panama’s own resources. This operation will provide interest relief of about 2 percentage points of GDP a year and will reduce the outstanding debt by 6 percentage points of GDP. In 1995 Panama also restructured US$61 million of enterprise debt owed to banks that had fallen into arrears. In March 1996, Panama settled arrears on its petroleum debt with Mexico (US$146 million). Negotiations on the oil debt with Venezuela are ongoing and expected to be completed before end-1996, by which time Panama would have cleared all its external payments arrears (except those with Libya).

Panama’s public external debt amounted to US$5.9 billion at the end of 1995, about two thirds of which was in arrears. Total external debt-service obligations in 1995 equalled 8 percent of GDP (23.1 percent of exports of goods and nonfactor services), of which about 60 percent constituted interest obligations. Panama has continued to service on time its debt to multilateral agencies, Paris Club creditors, suppliers, and external bond holders. Reflecting the above-noted debt-restructuring operations, Panama’s public external debt is estimated to decline to 61 percent of GDP in 1996.

II. Labor Market Reforms

1. The Labor Code of 1972

The Labor Code of 1972 (with modifications in 1981) has strongly influenced the labor market in Panama. Although the 1972 Labor Code improved workers’ rights, it also introduced rigidities that have contributed to increased labor costs and high unemployment rates. Chart 1 suggests that the Labor Code did not contribute to increasing the rate of job creation or to reducing unemployment rates. The most problematic provisions of the 1972 Labor Code were those that (i) deterred labor mobility through high dismissal cost and (ii) restricted productivity-related compensation. The Labor Code established that after two years a worker could not be dismissed without a supporting court decision. If the dismissal was ruled unjustified, the employer had to pay monthly salaries covering the period from the dismissal to the date of the judicial decision (salarios caidos). In case the employer chose not to reinstate the worker, he had to pay a 50 percent penalty beyond the severance pay stated in the Labor Code.

CHART 1
CHART 1

PANAMA: Employment Indicators

Citation: IMF Staff Country Reports 1996, 082; 10.5089/9781451830781.002.A001

Source: Panamanian authorites.

2. The labor reforms of 1995 and 1996

Recently enacted labor reforms aim at enhancing the flexibility of labor in the economy, including the export-processing zones (Boxes 1 and 2 summarize the major changes). An important aspect of the reforms is the introduction of a severance pay fund. The reforms are part of the Government’s efforts to modernize the economy and attract foreign investment.

Special Labor Regulations for Export-Processing Zones (EPZ)

Decree-Law No. 1 (January 1, 1996), modified by Decree-Law No. 2 (February 28, 1996), supplemented provisions of Law No. 26 (November 1992) that created a special regime for the establishment of EPZ. The Decree instituted administrative procedures to speed up the creation of EPZ. It also established temporary exemptions to certain labor regulations prevailing in Panama. The special labor regime applicable to the EPZ includes the following key provisions:

• Enterprises operating in the EPZ will become subject to collective agreements, if requested by the workers, within a period of two years after the start of operations. The Decree stipulates, however, that collective agreements should consider the need for an adequate return on capital of the enterprises operating in the EPZ.

• Workers are entitled to a permanent labor contract in enterprises operating in the EPZ after the third year of employment (for other enterprises in Panama this applies after two years of employment).

• Labor disputes concerning workers and enterprises operating in the EPZ will be arbitrated by the Ministry of Labor assisted by a tripartite committee consisting of one representative each of EPZ operators, the workers, and the Government.

• The Decree adds a new economic or financial reason for fair dismissal: fluctuations in international markets that result in a reduction of exports.

The severance pay fund established under the modified Labor Code of August 1995 reduces the risk of confiscation of enterprise assets in dismissal disputes. The severance pay fund is a contingency fund that guarantees permanent workers the right to severance pay (in cases of unfair dismissal, justified resignations, and termination of a permanent contract based on mutual agreement), and payment of a long-term service bonus. This fund will be financed with quarterly employers’ contributions of 2.25 percent of the annual wage bill (only for permanent workers). Every company will have its own severance pay fund which will be administered by a private entity subject to Law 10 of 1993, which regulates savings and trust institutions. Total contributions to severance pay funds are expected to amount to US$18 million (about 0.2 percent of GDP) in the first year.

Contributions to the fund consist of two elements: a reserve to finance the severance pay equivalent to 0.33 percent of the wage bill and a reserve to finance the long-term service bonus equivalent to 1.92 percent of the wage bill. The reserve for the severance pay was established assuming a probability of 5 percent of repaying the 3.4 weeks of the yearly wage established in the reform ([0.05]*[1/52]*[3.4] = 0.33). The reserve for the long-term service bonus was established as equivalent to a one-week wage payment per year of service as enacted in the reform ([1/52]*[1] - 1.92). For income tax purposes, contributions to the fund will be a deductible expense and accrued interest will not be counted as income.

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The law exempts small enterprises and cooperatives from contributing to the severance pay fund. Small enterprises are defined as agricultural concerns of no more than 10 workers, agroindustrial enterprises of no more than 20 workers, and commercial enterprises (except financial, wholesale, and real estate enterprises) of no more than 5 workers.

III. Developments in the Tax System

1. Background

In the second half of 1994, the Panamanian Government examined the consistency of the tax system with respect to its medium-term economic program that seeks to promote private sector led growth. It was found that a proliferation of tax exemptions had led to costs (in terms of forgone revenue) of about B 100 million (1.2 percent of GDP) a year, while there were no tangible effects on employment or the pace of economic growth.

Following the review of the tax system, the authorities initiated the process of eliminating, reducing, or harmonizing existing tax exemptions, which culminated in the adoption by the Legislative Assembly of the Tax Incentives Harmonization Law (TIHL) in June 1995. 10/ Implementation of the TIHL is expected to be revenue neutral in the short term, but to yield positive returns in the medium term as the removal of distortions stimulates private investment. The following synopsis of the Panamanian tax system incorporates the TIHL, and the appendix to this chapter explains the most important changes introduced by the TIHL.

2. Synopsis of the tax system

During 1990–95, tax revenue amounted to 11.5 percent of GDP a year on average, of which 44 percent related to direct taxes and 56 percent to indirect taxes (see Chart 1 and table on page 14). Revenue collection reached a relative peak of 11.7 percent of GDP in 1991–92, following a tax reform in 1991 which, in addition to improving tax administration, made the tax system more equitable through a reduction in the number and dispersion of income tax rates. 11/ This level could not be maintained as there was some weakening in tax enforcement. In addition, some consumption taxes are specific rather than ad valorem and their yield declined. In 1993–94, tax revenue averaged 11.4 percent of GDP. In 1995, renewed efforts to strengthen tax administration boosted tax collections to 12 percent of GDP.

Chart 1
Chart 1

Panama: Composition of Central Government Tax Revenue

(1990–95)

Citation: IMF Staff Country Reports 1996, 082; 10.5089/9781451830781.002.A001

a. Direct taxes

In terms of revenue, the largest single tax is the income tax, which generated an average yearly revenue equivalent to 4.5 percent of GDP in 1990–95. Corporations pay a flat rate of 30 percent, with corporate income of less than B 100,000 taxed at personal income tax rates, which are lower than corporate rates, thus favoring small businesses. Corporations included in the “Registro Oficial de la Industria Nacional” 12/ continue to pay income tax rates of 30 percent for taxable income up to B 500,000 and 34 percent for taxable income in excess of B 500,000. With the adoption of the TIHL, the corporate income tax rate applying to income derived from external operations of enterprises in the Colon Free Zone was raised from a range of 2.5–8.5 percent to 15 percent.

The personal income tax rate varies from 4 percent (starting at taxable income of B 3,000) to 33 percent for taxable income of up to B 200,000. Income in excess of B 200,000 is taxed at a flat rate of 30 percent. The greater part of the personal income tax is collected through monthly payroll deductions that the employer pays, together with social security contributions, to the CSS. The latter transfers the payroll deductions to the Treasury.

A withholding tax of 10 percent (for registered securities) or 20 percent (for bearer securities) applies to dividends received by shareholders.

The Wealth (Real Estate) Tax generated 0.6 percent of GDP a year on average in 1990–95. This tax is levied on items with a value in excess of B 20,000. Rates increase from 1.75 percent to 2.1 percent (for items with a value of B 75,000 or more). Included under wealth tax in the table below is the commercial and industrial license tax (“Licencia Comercial”), which is levied once a year at a rate of 1 percent of a company’s capital. The minimum amount payable is B 10 and the maximum amount is B 20,000 per year.

b. Indirect taxes

Revenue from indirect taxes averaged 6.4 percent of GDP a year in 1990–95. The most important indirect taxes are import duties and the sales tax (ITBM). 13/

Import duties generated revenue of 2.1 percent of GDP a year on average during 1990–95. Ad valorem rates range from 3–90 percent, although many items, especially agricultural and agro industrial products, still carry specific or mixed tariffs. Exceptions abound and have changed over time as the Executive is empowered to set and modify import duties. With Panama’s accession to the World Trade Organization scheduled to take place in the last quarter of 1996, import duties (with the exception of agricultural products) will be brought within a 3–40 percent range, while all specific and mixed tariffs will be abolished. 14/

The sales tax generated revenue of 1.7 percent of GDP a year on average in 1990–95. The base rate is 5 percent, but a rate of 10 percent applies to alcoholic beverages and cigarettes. By comparison with other countries, the scope of this tax is limited because most services are exempted.

Other indirect taxes generated revenue of 2.6 percent of GDP a year on average in 1990–95. This category includes the export tax (to be phased out by end-1998), 15/ the special consumption tax (on petroleum products and alcoholic and nonalcoholic beverages), stamp duties, and a ship registration tax of B 0.10 per ton, which is levied annually. Discounts apply to shipowners that have more than one ship registered in Panama.

Panama: Central Government Tax Revenue

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Source: Office of the Accountant General.
Appendix: Panama—Tax Incentives Harmonization Law (TIHL) 28/

The TIHL, which was approved by the Legislative Assembly in June 1995, aims at reducing distortions and increasing the flexibility of the Panamanian economy. The law is based on the following principles: the incentive system would need to be equitable and should encourage higher productivity and expansion of output and employment. Also, any modification of existing incentives should be gradual so as to maintain a climate of predictability.

In essence, the TIHL phases out or scales back a number of tax breaks and subsidies, reduces the difference in income tax treatment between enterprises operating in the Colon Free Zone and those in other sectors of the economy, generalizes a tax credit of up to 25 percent of income tax liabilities for investment in modernization or expansion of production until the year 2000, extends to the whole manufacturing sector the preferential import tariff of 3 percent, and reduces home mortgage and housing subsidies through more narrow targeting. The main provisions of the TIHL are discussed below.

1. Elimination or scaling back of incentives

Article 3, first paragraph: The deductibility of 30 percent of investment in agriculture with resources generated outside the agricultural sector (capped at 40 percent of taxable income) will be eliminated on December 31, 2002, thus reducing the tax-preferred status of the agricultural sector.

Article 3, second paragraph: Prior to the reform, interest paid on back-to-back credits (loans secured by deposits of equal amount) was deducted as a cost to determine the corporate and personal income tax base. Under the TIHL, deduction of interest costs associated with the use of back-to-back credits will be limited to the difference between interest paid on loans and interest received on deposits. The limited deductibility would broaden the tax base by reducing the demand for back-to-back loans taken solely for the purpose of reducing tax liabilities.

Article 5: Before the adoption of the TIHL, income generated in free trade zones (in practice: the Colon Free Zone) was taxed at rates ranging from 2.5 percent (for taxable income of less than B 15,000) to 8.5 percent (for taxable income in excess of B 100,000). Under the new regime, a uniform rate of 15 percent applies for income derived from international operations. Based on export values for the past year, companies have to make three equal advance payments in June, September, and December, with final settlement in March of the following year. Domestic operations of the free zone entities attract the full income tax rate, i.e., 30 percent. This increase in income tax rates deriving from activities undertaken in the Colon Free Zone reduces the discrepancy with income tax rates related to other economic activities. The administrative procedures embodied in Article 5 also are expected to reduce tax evasion.

Article 9: Private individuals involved in agriculture with an annual gross income of less than B 100,000 did not have to file a tax return. This exemption will continue under the TIHL. However, by strictly defining the activities that comprise agriculture, the scope of the exemption has been reduced.

Article 13: Since 1974, certificates to cancel tax obligations (“Certificados de Abono Tributario”) have been issued to exporters of nontraditional items for up to 20 percent of the domestic value added. In 1995, the tax draw-back system applied to 2 percent of total exports, with revenue foregone amounting to B 14 million. With the coming into force of the TIHL, the maximum value of the certificates will be reduced to 15 percent of the domestic value added as of December 31, 2001, and certificates will cease to be issued after December 31, 2002.

Article 14: Subsidized mortgage loans will be scaled back. The maximum subsidy of 5 percentage points, which used to apply to loans of up to B 62,500, henceforth only will apply to loans of up to B 25,000. A subsidy of 3 percentage points will apply to loans with a value of B 25,000-B 40,000, and a subsidy of 2 percentage points to loans of B 40,000-B 62,500. The purpose of this change is to redirect construction activity toward low-cost housing.

Articles 19 and 20: Consumer and commercial loan rates include a surcharge of 1 percentage point to provide resources for the Special Fund for the Compensation of Interest (FECI, administered by the National Banking Commission), which subsidizes loans by the Agricultural Development Bank (BDA) and commercial banks to the agricultural sector. These subsidized loans carry an interest rate equivalent to the market-reference rate less 4 percentage points. Under the TIHL one half of the surcharge will be used to augment the capital of the BDA while the other half will continue to flow into FECI (Article 20). Article 19 limits access to subsidized agricultural credit by capping the loan amount (B 200,000), number of loans (one per productive cycle), and number of credits per debtor (one).

Article 21: Prior to the reform, capital gains from real estate transactions were exempted from income tax, provided that these gains were invested in new housing construction. Under the TIHL, only capital gains reinvested in new dwellings with a value of no more than B 200,000 in 1996, B 100,000 in 1997, and B 62,500 from 1998, will be eligible. The new dwellings must have a value of at least four times the capital gain and reinvestment must take place within two years upon realization of the capital gain. This modification, like the one stipulated in Article 14, is intended to redirect construction to low-cost housing.

2. Harmonization of incentives

Articles 1 and 2: Under the old system, exporters of industrial goods received a tax rebate equivalent to 95 percent of the amount of import taxes paid on the imported goods used as inputs. Under the TIHL all exporters will receive a tax rebate equivalent to the full amount of import taxes paid on imported goods used as inputs. This broadening eliminates differences in treatment among sectors.

Article 6: The existing tax credit of 25 percent of income tax obligations applied to investments that created new positions in enterprises included in the “Registro Oficial de la Industria Nacional” was extended to all corporations that invest in research and development, transportation, communications and any expansion of capacity. However, this incentive will expire in the year 2000.

Article 25: Certain inputs and capital goods used by industrial enterprises that are included in the “Registro Oficial de la Industria Nacional” were subject to an import tariff of 3 percent. Under the TIHL all enterprises can import these items at the 3 percent tariff.

3. Other

Article 4: Before the adoption of the TIHL, the income tax rate was 30 percent for corporate income of up to B 500,000 and 34 percent for higher income. As a result of the adoption of the TIHL, a uniform corporate income tax rate of 30 percent will apply. As before, corporate income of less than B 100,000 will be taxed at personal income tax rates, which are lower than corporate rates. Enterprises that opt to remain in the “Registro Oficial de la Industria Nacional” continue to be subject to the 34/30 percent rate structure.

Articles 15, 16, 17, and 18: Some quantitative import restrictions were based on loosely defined health criteria. As definitions have been sharpened, the number of quantitative restrictions has declined and been brought in line with international practice, with the effect of opening up the economy.

Article 23: All industrial enterprises (approximately 1,100) that are included in the “Registro Oficial de la Industria Nacional” will continue to enjoy their current tax benefits (mainly a five-year income tax holiday).

IV. Social Security System: Issues and Reform Options

Social security benefits (for old age, disability or death, health care, and work injury) are provided by the Social Security Agency (CSS) and the Complementary Pension Fund for Civil Servants (CPF). 16/ 17/ Since the 1980s, the finances of Panama’s social security system have weakened and the quality of its services reportedly has deteriorated. One of the objectives of the Government’s medium-term adjustment program is to develop a financially sound social security system that would provide adequate medical care and pensions.

1. Social Security Agency

a. The organization

The CSS is an autonomous state entity operating Panama’s social security programs that, by law, cover all employees in the public and private sectors. 18/ The agency was founded in 1943 and its present organic law dates back to 1954. Its main sources of revenue are contributions (“cuota”) equivalent to 18 percent of contributors’ wages (7.25 percent paid by employees and 10.75 percent by employers), central government transfers, and investment income (Statistical Appendix Table 22). Over the 1990–95 period, CSS’ revenues (including transfers from Central Government) amounted to 9.0 percent of GDP and its expenditures to 8.3 percent of GDP, making it the second largest entity (after the Central Government) in the public sector. At end-1995, the CSS had 523,000 contributors (out of an economically active workforce of 868,000), 97,000 retirees, and employed a staff of 13,800 persons (Box 1).

Social Security System: Selected Variables

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The CSS comprises four separate schemes: the Administration Scheme, the Health Scheme, the Pensions and Disability Scheme (IVM), and the Workman’s Compensation Scheme (Box 2). By law, each scheme has to be operated independently and, consequently, has its own income and expenditure statements. Thus far, each of the four schemes has recorded annual surpluses. In the case of the IVM, these surpluses have been shrinking and increasingly been derived from investment income. The IVM accounts for about half of the revenues of CSS and almost 60 percent of its expenditures, making it the largest of the four schemes and the key determinant of the CSS’ overall financial position.

Organization of the Social Security Agency

ADMINISTRATION SCHEME

  • • Functions: Record keeping and treasury functions.

  • • Sources of revenue: Central government transfers on the basis of Article 31 of CSS’ Organic Law:

    • - equivalent to 0.8 percent of the wage bill of all (public as well as private) contributors (B 19 million or 0.2 percent of GDP in 1995);

    • - equivalent to 0.3 percent of the public sector wage bill to cover administrative expenses of the Complementary Pension Fund (CPF).

  • • Financial situation: Reflecting surpluses over the years, the scheme’s reserves amounted to B 113 million (1.4 percent of GDP) at the end of 1995.

HEALTH SCHEME

  • • Functions: Provision of health and maternity services to contributors and their dependents.

  • • Sources of revenue: 8.5 percent of the wage bill of contributors (8 percentage points paid by employer and 0.5 percentage point by employee).

  • • Financial situation: At end-1995, the Health Scheme had reserves of B 218 million (2.6 percent of GDP).

WORKMAN’S COMPENSATION SCHEME

  • • Functions: To cover medical expenses associated with work-related sickness or accidents.

  • • Sources of revenue: Employer contribution of about 1.7 percent of the wage bill (actual contributions vary from 0.5 percent to 5.7 percent depending on risk).

  • • Financial situation: At end-1995, this scheme had reserves of B 166 million (2 percent of GDP).

PENSION AND DISABILITY SCHEME (IVM) 1/

  • • Functions: To provide retirement, survivor, and disability benefits to retirees, contributors, and their dependents.

  • • Sources of revenue: 9.5 percent of the wage bill of contributors (6.75 percentage points paid by employee and 2.75 percent paid by employer). Until recently, all investment proceeds, i.e., also income generated by the reserves of the three other schemes, accrued to the IVM.

  • • Financial situation: As of end-1995, the IVM’s reserves amounted to about B 1.3 billion (15.8 percent of GDP). At the same time, its actuarial deficit was calculated at B 1.8 billion.

1/In Spanish: Programs de Invalidez, Vejez, y Muerte (IVM).

b. Financial problems of the IVM

The deterioration in the financial position of the IVM relates to demographic trends and the characteristics of the system itself. As life expectancy increased and birth rates declined, the ratio of contributors to pensioners has declined. In 1986 there were seven contributors for every pensioner; by 1993 this ratio had dropped to just over five. In addition, the CSS faces problems of evasion. The ratio of contributors to the economically active labor force fell from 64 percent in 1987 to about 55 percent in the early 1990s before recovering to 60 percent in 1995, when the CSS started to strengthen its administrative capacity. Concerning the system’s characteristics, contributions to the IVM (9.5 percent of contributors’ wage bill) are slightly lower than the average for countries in Latin America and the Caribbean, while pension benefits are among the highest compared with a number of countries in the region. 19/

c. Current investment policy

As indicated above, the IVM has become increasingly dependent on investment income to generate an overall surplus. CSS’ investment portfolio has increased every year with the generation of financial surpluses and amounted to B 1.6 billion at the end of 1995. CSS’ investment policy is stipulated by law (Organic Law, Articles 36 and 37), which in essence limits its investments to government paper (not: direct loans to Government) and deposits with public banks, i.e., the National Bank of Panama (BNP) and the Savings Bank. However, these banks tend to pay lower deposit rates than commercial banks, thus affecting the overall return of CSS’ investments. The share of central government paper in CSS’ investment portfolio dropped from about two thirds in 1991 to about 40 percent in 1995, while time deposits with public banks increased from 13 to 50 percent over the period. Relatively small amounts are invested in mortgage loans, most of which are being extended to CSS contributors. Investment income in 1995 amounted to B 126 million (1.5 percent of GDP), representing an average yield of 7.7 percent (see Box 1).

d. Past reform efforts

To strengthen the financial position of the IVM, in 1991 the authorities implemented the following amendments to the IVM regime: (i) early retirement was eliminated in 1993; (ii) early retirement pensions were reduced; (iii) the regular retirement age was raised from 55 to 57 for women and from 60 to 62 for men as of January 1995; (iv) the formula for calculating pensions was changed from 60 percent of the base salary plus 1.25 percent for every year of service after 10 years and 1.5 percent after 20 years, to 60 percent plus 1.25 percent after 15 years; and (v) the calculation of the base salary was changed from the highest 3 years’ salary out of the last 15 years to the average of the last 7 years. Also, in early 1991 pensions were capped at B 1,500 a month and the payment of the 13th month salary was incorporated in the calculation of payable contributions.

Although these amendments helped improve the IVM’s finances, they did not bring about actuarial soundness. On present trends, 20/ the IVM will start incurring deficits by the year 2004. Its actuarial deficit was calculated at B 1.8 billion at end-1995.

2. The Complementary Pension Fund

The Complementary Pension Fund (CPF) was created in 1975 to: (a) facilitate payments to those eligible to receive pensions on the basis of the so-called special laws, and (b) provide a supplement to the pensions provided by the CSS to public sector employees not covered by these laws. The CPF is administered by the CSS,

a. Eligibility under special laws

The special laws date back to the 1930s when the Government decided to grant pension benefits to certain categories of public sector employees like policemen, firemen, and teachers. 21/ As of 1995, there were some 15 special laws for as many different groups of public sector employees, covering about half of public sector employees. These laws have in common that they allow retirement before the CSS’ statutory retirement ages of 62 (men) and 57 (women) with pensions of up to 100 percent of the most recently earned salary. In addition, once the statutory retirement age is reached and CSS pensions are received, the special laws provide additional pensions so as to maintain the 100 percent of the most recently earned salary (up to a maximum of B 1,500 per month).

The group covered by special laws is heterogeneous, as each special law differs regarding minimum retirement age and years of service required to be eligible for retirement. For instance, firemen can retire after 25 years of service without having a minimum retirement age, and staff of the Accountant General’s Office can retire at the age of 55 after 28 years of service.

b. Supplementary pensions

Eligibility requirements for a supplementary pension for those not covered by special laws include the completion of 25 years of service and receiving a pension from the CSS.

c. The financial situation

To finance the CPF’s pension payments, it was decided in 1975 that public sector employees contribute 2 percent of their salaries to the CPF while their employers had to pay 0.3 percent of the wage bill to cover the CPF’s administrative costs. In addition, the CPF was to receive a capital transfer of B 200 million (about 5.5 percent of 1976 GDP) from the Central Government, to create the reserves needed to cover its obligations. This transfer was never made, and from year to year larger budgetary transfers to the CPF became necessary to cover its growing obligations.

The number of retirees covered by the CPF has continued to increase, from 8,300 in 1985 to 20,000 in 1995. Also, modifications to existing special laws since 1975 have increased benefit payments. As a result, the CPF’s expenditure growth outstripped revenue increases. The CPF’s deficit rose from B 12 million (0.2 percent of GDP) in 1991 to B 36 million (0.4 percent of GDP) in 1995. In the absence of measures, the deficit is estimated to increase to 1 1/5 percent of GDP by the year 2005.

3. Options for reform

The CSS is in the process of upgrading its administrative capacity, which should increase revenue (by reducing arrears and evasion) and reduce expenditure (e.g, better inventory management). So far, results in revenue collection have been encouraging. Also, with a view to maximizing the return and security of its investments, the authorities are redefining the investment strategy of the CSS, allowing it more scope in selecting investment instruments. To preserve the IVM’s actuarial soundness over the medium term, the authorities are preparing, with ILO assistance, reform proposals for the social security system.

For the resolution of the CPF’s financial problems, which are more pressing than those of the CSS, there are basically two options (which have been examined in some studies). One option would target financial viability, which would require an increase in contribution rates and/or reductions in benefits, e.g., changes in the special laws that would narrow the range and the level of the retirement age. Since CPF’s actuarial deficit is calculated at B 870 million or 11 percent of GDP (at end-1994), substantial increases in contributions and major reductions in entitlements would be required.

The other option would be liquidation of the CPF. In this case, the Central Government would continue to finance pension payments to current recipients. Estimates indicate that if the CPF were to be liquidated as of January 1, 1997, government transfers to beneficiaries would amount to B 74 million in that year but would gradually decline over time. In addition, those contributors who would not be receiving any benefits from the CPF at the time of liquidation could expect compensation for their contributions, totalling an estimated B 250 million. This amount could be discharged in the form of cash, bonds, or a combination of both.

V. Financial Sector

The financial sector performed well during the 1970s and early 1980s. In 1981–83 it was the largest contributor to GDP growth, its share in GDP reached 19 percent in 1983, and it created spillover demand in other sectors. Subsequently, however, the sector was severely affected by several internal and external factors (mentioned below) and activity fell by a cumulative 76 percent in 1988–89. In 1990–94, activity recovered at an average annual rate of about 16 percent, and growth slowed to 6 percent in 1995. Reflecting these developments, the financial sector’s contribution to GDP dropped to around 6 percent in 1989 and recuperated only to 8.6 percent of GDP in 1995. The sector employed an average of 2 percent of the labor force in 1990–95, compared with 4 percent in 1983.

1. Institutional framework

The financial sector in Panama comprises the banks, the stock exchange, insurance and reinsurance companies, finance houses, and leasing companies. The most important component of the sector is the banking system 22/ which accounts for more than 90 percent of its assets and net worth.

The banking system consists of four public banks, and 102 private banks. The public banks are the National Bank of Panama (BNP), the Savings Bank, the National Mortgage Bank (BHN) and the Agricultural Development Bank (BDA). However, the BHN and the BDA are excluded from the IBC, as they do not take deposits from the public. The BNP is the largest banking institution in terms of domestic credit and deposits, and has 49 branches. It acts as financial agent for the public sector, manages legal minimum reserve requirements for domestic banks, performs the functions of clearing house, and ensures an adequate supply of U.S. currency to the banks. The Savings Bank is a mortgage bank, specializing in financing medium-income customers, and has 37 branches around the country. As the Savings Bank has been very liquid in the last few years, it also has promoted personal loans. Private banks operate under three types of licenses: general, international and representative office. Of the 102 private banks, 21 banks are incorporated locally and 81 abroad.

The stock exchange, established in 1990, has developed at a rapid pace but the market is still small (accounting for around 5 percent of total lending by the banking system) and highly concentrated in domestic private sector fixed-income securities. Factors that have limited the expansion of the stock market include the ownership structure of Panamanian companies, lack of an automated trading system and adequate procedures for effecting securitization, close links between bank shareholders and entrepreneurs in other sectors, regulations that restrict financial innovations, and absence of institutional investors.

A01s5ufig01

STRUCTURE OF THE INTERNATIONAL BANKING CENTER (IBC)

Citation: IMF Staff Country Reports 1996, 082; 10.5089/9781451830781.002.A001

Insurance and reinsurance companies have not developed as expected. The legal framework for this industry is provided in Laws 54 and 55 of 1984, which established the “Insurance and Reinsurance Center” to foster offshore insurance activity. 23/ At present, there are 27 companies and total assets amount to around B 417 million.

Finance houses in Panama specialize in small-scale financing, including credit for consumer durables. All finance houses are incorporated locally and some are affiliated with nonfinancial business enterprises. They are not authorized to accept deposits from the public. Their main source of funds (80 percent) is borrowing from commercial banks. There are 102 companies, whose total assets amounted to B 414 million at the end of 1994. Of the 102 companies, 42 are engaged in leasing.

2. Supervision and regulation

Supervision of the financial system is divided among several government agencies based on the type of institutions.

In the absence of a central bank, the National Banking Commission (NBC) is the most important regulatory agency in the financial sector. The NBC was established by Cabinet Decree No. 238 of July 2, 1970, which also amended the Panamanian banking legislation to create the International Banking Center (IBC).

A01s5ufig02

REGULATION AND SUPERVISION OF THE FINANCIAL SECTOR

Citation: IMF Staff Country Reports 1996, 082; 10.5089/9781451830781.002.A001

1/ Administratively, the National Banking Commission is part of the Ministry of Planning and Economic Policy.2/ Some of the National Banking Commission’s regulations, e.g. those on reserve requirements, also apply to public banks.3/ Operates within the Ministry of Commerce and Industry.

The NBC is administered by a seven-member Board chaired by the Minister of Planning and Economic Policy. The other members are the Minister of Finance, the General Manager of the BNP, three representatives of the banks appointed by the Executive from a list of names submitted by the National Banking Association and the Panamanian Association of Banks, and a member appointed by the Executive drawn from outside the banking industry.

Private banks operate under the following conditions: bank secrecy and numbered accounts; broad freedom of operations; absence of capital controls; freedom to withdraw capital and retained profits; low costs of supervision; low minimum capital requirements; and relatively low capital-asset ratios. Also, interest earned on savings and term deposits is exempt from income tax.

3. Evolution of the International Banking Center

a. Overview

The foundation for commercial banking in Panama was laid with the U.S. Panama Monetary Agreement of 1904. In that year the first public bank (BNP) and the first foreign bank (Citibank) were established. To date, they have remained the oldest banks in Panama.

In the 1960s more foreign banks set up offices in Panama, mainly to take advantage of Panama’s tax haven status for worldwide funds. Offshore banking activities in Panama expanded considerably during the 1970s, triggered by the liberal banking regulations enacted in 1970 and advantages over other important offshore banking centers in the region—the dollar as legal tender since 1904, and absence of capital and exchange controls while restrictive policies predominated elsewhere. Banks also benefitted from the increase in Colon Free Zone activities.

In the 1980s, offshore banking activities in Panama were affected adversely by: (i) the Latin American debt crisis (particularly after August 1982) with reduced lending to and deposit-taking from Latin America; (ii) the liberalization of offshore banking activities in the United States through the authorization of the International Banking Facilities (IBF) in December 1981, which resulted in the transfer of some deposits to the United States; (iii) legislation enacted in Japan in April 1988 that led Japanese banks to reduce their operations or to close their Panamanian branches; and (iv) the political and economic crisis of 1988–89, which has been a major disruptive factor.

b. The crisis in 1988–89

Economic sanctions imposed by the United States in March-April 1988 against the Noriega government precipitated a crisis in Panamanian banking. The U.S. Government froze BNP’s deposits in the United States, the U.S. Federal Reserve System suspended the clearing arrangement with BNP, and U.S. companies restricted tax and other payments to the Panamanian public sector.

These factors led to the transfer of deposits and loans from nonresidents to other financial centers and the withdrawal of deposits in significant amounts by Panamanian residents, weakening the liquidity of the banking system and disrupting the country’s payments system.

Consolidated Assets end Liabilities of the International Banking Center

(In billions of balboas)

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Source: National Banking Commission.

Commercial Banks Classified by Type of License

(Number of bonks; end of period)

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Source: National Banking Commission.

General License Banks Consolidated Assets and Liabilities of Panamanian Private Banks

(In buttons of balboas)

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Source: National Banking Commission.

Refers to March 1981.

General License Banks Consolidated Assets and Liabilities of Foreign Private Banks

(In biillons of balboas)

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Source: National Banking Commission.

Refers to March 1981.

c. Emergency actions

To address this situation and discourage capital flight, the National Banking Commission took several measures that are listed below.

MAJOR CHANGES IN BANKING LEGISLATION DURING 1988–90

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d. Normalization and developments in 1990–95

The lifting of the deposit freeze started in 1990, proceeded smoothly, and was completed in 1991. Since then, domestic banking activity has recovered, but offshore operations have remained subdued. A key factor that has prevented a stronger recovery of the banking system has been the absence of new financial instruments and banking operations in line with innovations in the industry over the years, such as swaps, options and futures. 24/ Since 1994, offshore activities have been affected by the Mexican financial crisis and also by weaker demand for Colon Free Zone services by several Latin American countries. Similarly, prudential regulations have not evolved to ensure the solvency of the financial system and its standing abroad. At the same time, concerns about money laundering and lack of transparency have emerged, while other major international financial centers have developed.

Reforms are needed to deepen and diversify the securities market. Legal limitations impede issuing of securities at a discount; there is no legal basis for trading repurchase agreements nor for auctions as a mechanism to regularly place securities or other financial instruments; also, there is no legal backing for issuing securities in book-entry form.

4. Reform of the financial sector

The Government of Panama is preparing a financial sector reform that focuses on the improvement of prudential regulations and the modernization of the banking system so as to make it more competitive. The banking law is being revised also with a view to strengthen bank supervision. In a second phase, the Government plans to modernize regulations that apply to the stock exchange and the insurance industry, and to rationalize the state-owned banking institutions.

VI. Reversion of the Panama Canal and Related Areas

1. Overview

Following its declaration of independence from Colombia, Panama ratified the Hay/Bunau-Varilla Treaty with the United States on December 2, 1903, which gave in concession to the United States part of Panama’s territory (called Canal Zone) to build, operate, and protect an interoceanic canal across the Isthmus. In September 1977, the Governments of Panama and the United States signed new treaties (Torrijos-Carter Treaties) which entered into force on October 1, 1979, whereby Panama assumed general territorial jurisdiction over the Canal Zone. The Panama Canal Treaty of 1977 governs the operations, management, and protection of the Canal through noon, December 31, 1999. The Treaty on the Permanent Neutrality and Operation of the Canal commits Panama and the United States to continue to protect the Canal and to ensure its permanent neutrality beyond the expiration of the Panama Canal Treaty. The two governments envisaged a gradual transfer of land and facilities during 1979–99 concerning an area of 147,400 hectares with military bases, ports, airports, schools, hospitals, and housing units bordering the Canal.

2. Institutional setup

Institutional arrangements have been made for the implementation of the Treaty of 1977. The Canal Zone Government was dissolved; the Panama Canal Company was replaced by a bi-national Panama Canal Commission; and the following entities were established in the past few years to facilitate the process of reversion: the Transition Commission for the Transfer of the Panama Canal, and the Interoceanic Region Authority.

The Panama Canal Commission (PCC) is in charge of managing, operating, and maintaining the Canal until the expiration of the Treaty on December 31, 1999. Since 1990, the Administrator of the PCC has been a Panamanian. The PCC is supervised by a nine-member Board of Directors. Five members are nationals of the United States and four are Panamanian citizens proposed by the Panamanian Government and appointed by the U.S. Government. The legal status of the PCC recently has been changed. Originally it was created as a U.S. government agency, but in February 1996 its status was modified to become a U.S. government corporation (Public Law 104–106). The new status will give the PCC greater autonomy and flexibility and smooth the process of transferring the Canal to Panamanian authority and administration by the year 2000.

The Transition Commission for the Transfer of the Panama Canal (TCTPC) was created in January 1995 to prepare Panama for assuming the administration, operation, and maintenance of the Panama Canal by end-1999. The TCTPC has been working closely with the PCC to modify the present legislation concerning the Canal to make it consistent with Panamanian law, which is to be enacted before end-1999. The TCTPC is preparing a draft bill regulating the functions of the authority that will manage the Canal as an autonomous state entity after the year 2000.

The Interoceanic Region Authority (ARI) is an autonomous government agency, created in February 1993 whose main task is to integrate the reverted and reverting areas into the Panamanian economy. To this end, ARI is responsible for administering the reverting areas and for issuing the required regulations for lease, sale, concessions, and management contracts.

3. Main features of the Canal and assets being transferred in 1995–99

The Canal was inaugurated on August 15, 1914. It measures 50 miles from the Atlantic to the Pacific side, and it takes about 8 to 10 hours for an average ship to transit the Canal. Ships are raised and lowered 85 feet from sea level to sea level, by a system of three sets of locks: the Gatun, Pedro Miguel, and Miraflores locks.

In the 1980s and 1990s, the Canal’s activities accounted on average for 6 percent of GDP. In 1994, its gross contribution to the economy was estimated at about US$415 million, which includes wages and salaries, retirement and disability pensions, procurement of goods and services, and payments to the Government. In 1995, commercial ocean cargo registered the highest volume in the Canal’s history and toll revenue reached a record US$460 million. At the end of fiscal year 1994, the Canal employed 8,758 persons, of which 7,421 were regular staff (6,586 Panamanians) and 1,337 temporary.

Panama Canal - Commercial Ocean Traffic 1/

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Source: Panama Canal Commission.

Includes ships of 300 Panama Canal net tons and over. (1 Panama Canal net ton = 100 cubic feet of cargo-carrying space).

In accordance with the timetable stipulated by the Panama Canal Treaty, key assets in the reverting areas have been handed back to Panama during 1979–94, such as the ports of Balboa on the Pacific side and Cristobal on the Atlantic side, and the trans-isthmus railway. In addition, 6,478 hectares of land and 420 buildings, including 113 housing units, have been transferred to Panama. During 1995–99, about 4,200 buildings and approximately 32,500 hectares of land will be handed over to Panama. The value of land and facilities is estimated at US$4.6 billion (see table below), excluding the value of the hydrographic basin in the Canal Area.

Currently, 91 percent of the physical surface consists of national parks, ecological reserves, and some contaminated areas, while 9 percent is urbanized. The area set aside for national parks constitutes around 40 percent of the Canal Area and includes five national parks; the operational area of the Canal and military bases are located in the remaining 60 percent. Although there are no specific dates mandated by the Treaty, the remaining major military installations and associated properties will be transferred on the dates shown in Attachment I.

Sites That are Being Transferred Unitl End-1999 - Estimated Value of Land and Facilities

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Source: “Evaluación Económica del Retiro de las Bases Militares,” Marco A. Fernández B. and José Galán Ponce, March 1996.

U.S. dollars per square meter.

In millions of U.S. dollars.

4. The Canal’s investment program

The PCC’s long-term investment planning is regularly adapted in light of traffic prospects and guided by the objective to provide reliable and efficient service. Investment has been financed with the PCC’s own resources. In the last year and a half, the Canal has been operating close to capacity, and the PCC’s goal is to increase its capacity to avoid backlog and permit overhaul work. In this connection, the Board of Directors decided to accelerate the investment program, increasing the original capital budget for fiscal years 1996–2000 from US$247 million to US$377 million. The investment projects that are being accelerated include: Gaillard cut widening and straightening, addition and replacement of tugboats, modernization and replacement of towing locomotives, enhancement of the Vessel Traffic Management System, and modernization of the Locks Machinery Control System.

The Government of Panama is planning to update and conclude previous studies on the expansion of the Panama Canal. This project would be financed with external grants. Furthermore, the Government is organizing an international congress in September 1997 to discuss the development strategy for the Canal beyond the year 2000.

5. Development strategy for the reverted areas

In July 1995, ARI contracted a private consultant firm to assist in the design of a comprehensive plan for the development of the reverted areas. In the meantime, ARI is applying four criteria for project evaluation in the reverted areas: (1) economic criteria, with emphasis on job creation and value added; (2) habitat criteria, especially functional urban zoning in the Colon and Panama City regions; (3) environmental criteria, geared to protect lakes from sedimentation and preserve the hydrographic basin; and (4) technical criteria related to the preservation, expansion, and security of the Canal.

The inventory of property (including telecommunications, water supply, roads, etc.) shows a concentration of infrastructure in military areas and weak infrastructural linkages with the adjacent Panamanian areas. Therefore, the integration of these areas into the Panamanian economy will require significant upgrading and expansion of infrastructure. The quantitative work commissioned by ARI for the assessment of investment requirements will be finished by the end of 1996. Maintenance costs of the facilities that are being transferred until 1999 are around US$20 million per year.

6. Economic impact of the withdrawal of U.S. troops

As noted above, the phased withdrawal of about 9,000 U.S. troops from Panama is to be concluded by end-1999. Following the initial departure of 1,400 servicemen in 1995, military personnel is to be reduced to 5,650 by 1998. The U.S. military presence contributes to the Panamanian economy through wages and salaries, procurement of goods and services, and expenditures related to the Treaty implementation (estimated around US$342 million in 1996), and the withdrawal will have an adverse impact on the economy.

ATTACHMENT I

SITES THAT ARE BEING TRANSFERRED UNTIL END-1999

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Source: Center for Treaty Implementation; ARI; “Evaluaclon Economlca del Retiro de las Bases Millteres,” Marco A. Fernandez and Jose Galen Ponce, March 1996.

A portion of this Fort was transferred to Panama on October 1, 1979.

A portion of this Fort was transferred to Panama on October 1, 1984 (previously known as Fort Qulick).

ATTACHMENT II

att02ufig01

PANAMA CANAL AREA

Citation: IMF Staff Country Reports 1996, 082; 10.5089/9781451830781.002.A001

Source: “The Panama Canal,” brochure published by tha Panama Canal Office of Public Affairs.Note: Designation of tha various areas following Implementation of the Panama Canal Treaties. The broken lines indicate the boundaries of the former Canal Zone, which was under U.S. jurisdiction until October 1, 1979.

VII. Colon Free Zone

1. Background

In 1948, the Government created the Colon Free Zone (CFZ) seeking to exploit Panama’s geographic position and boost activity in the Colon Province. The CFZ, located at the Atlantic entrance of the Panama Canal, has developed into the largest duty-free zone in the Western Hemisphere occupying nearly 240 hectares. Currently, more than 1,600 companies are using the CFZ service facilities (Box 1). Companies perform four types of economic activities: (i) undertake merchandise trade (importing large quantities for re-export to Western Hemisphere countries), (ii) operate as distribution center for goods of well-known multinational companies, (iii) provide shipment and transportation services, and, to a small extent, (iv) process goods for export to third countries. The main products traded in the CFZ are textiles and clothing (26 percent), equipment, machinery, and electrical material (22 percent), electronic and photographic equipment (13 percent), chemical products (10 percent), and footwear, hats, and umbrellas (6 percent). Not all merchandise traded in the CFZ involves the physical entry of goods. For large quantities, CFZ companies can arrange direct shipments from the source to the customer.

Operating Within the CFZ

There are four ways for a company to set up operations in the CFZ. Any person or company can apply to the CFZ Administration by supplying commercial and bank references, and the articles of incorporation for a company. The only condition is that a minimum of five Panamanians should be employed.

• Land lease contracts. The CFZ leases parcels of land to companies for construction of warehouses and office space for own use or lease to third parties. Land leases are negotiated for a minimum of 5 years to a maximum of 20 years, and may be renewed for a similar period.

• Building lease contracts. The CFZ leases its own building space to companies for a minimum of 1 year and up to 20 years. Alternatively, building space can be rented from companies already established in the CFZ.

• Public warehouse operation contracts. Companies interested in using the CFZ warehouse facilities must have a warehouse contract with the Administration of the CFZ. The fee for using public warehousing is 0.5 percent of the f.o.b. value of the merchandise.

• Representation contracts with established companies. The CFZ regulations allow companies to be represented by another company already established in the CFZ. These contracts must be authorized by the CFZ Administration. The representative or agent company offers storage, packing, handling of documents, loading, inventory control, and sales service; makes transport arrangements; receives goods, prepares the documentation, packs and repacks, re-exports, and makes and collects payments. The company that delegates its representation retains title of the merchandise.

The labor regime in the CFZ is the same as that for other enterprises operating in Panama. Therefore, the minimum wage and the labor code regulations apply.

2. Economic indicators of the CFZ

Panama’s economy is oriented toward the production of services. Services account for about three fourths of the total value added, of which a high portion relates to international transactions. Activities associated with the CFZ increased as a ratio to GDP from 6.8 to 7.8 percent between 1980 and 1995. In real terms, the value added of the CFZ expanded at an average of 4.8 percent a year throughout this period. In the early 1980s, growth in the CFZ was depressed by the economic and financial difficulties in many of its Latin American customer countries but recovered strongly in the early 1990s with the rebound and economic liberalization in the region (Charts 1 and 2).

CHART 1
CHART 1

PANAMA: COLON FREE ZONE

Citation: IMF Staff Country Reports 1996, 082; 10.5089/9781451830781.002.A001

Source: Panamanian authorities and Fund staff estimates.
CHART 2