February 22, 2023

1. On behalf of our Panamanian authorities, we thank Management and the Executive Board for their continued support to Panama. We also thank Mr. Bakker and his team for their open dialogue during the Article IV consultation mission and for their informative report on Panama's economic outlook and policies. The authorities reiterate their appreciation for the Fund's continued technical assistance and valuable policy advice, which helped to support a strong post-pandemic recovery.

2. The authorities reaffirm their commitment to sound economic policies. Since the beginning of the pandemic, the authorities have maintained fiscal discipline through rigorous adherence to the Social and Fiscal Responsibility Law (SFRL), leading to a substantial consolidation process that helped to reduce the budget deficit from 10 percent of GDP in 2020 to the 4 percent of GDP threshold in 2022, thereby ensuring debt sustainability over the medium term. In addition, the authorities have redoubled their efforts to exit the FATF gray list in 2023, with significant progress since last October on the only remaining item in the FATF Action Plan.

Recent Developments and Economic Outlook

3. A strong post-pandemic recovery continues. The authorities expect Panama's real GDP growth in 2022 at around 9 percent, above staff estimates. Economic activity for the year is expected to have exceeded the level observed in 2019, driven mainly by domestic consumption, trade, and tourism. Inflation remains lower than regional peers and inflation expectations are well anchored. This good performance is supported by the government's fuel and food price subsidies aimed to shield particularly the most vulnerable population from high international food and energy prices caused by the residual effects of the global pandemic and the war in Ukraine. The authorities will maintain a proactive approach to social protection and will gradually phase out subsidies in line with their fiscal stability objectives.

4. Economic activity is expected to slow down in 2023. The authorities expect real GDP growth to reach 5 percent in 2023, in line with staff's estimates, amid protracted global supply chain disruptions and a slowdown in global trade. Economic activity will benefit from strong public investment, as infrastructure projects gather pace, and from steady growth in the services sector, especially tourism. The authorities plan to implement a long-overdue update in the GDP base year to reflect structural changes in the economy that took place before the pandemic.

Fiscal Policy and Public Financial Management

5. The authorities have responded with sound and decisive policies to significantly improve the overall fiscal balance. The government is on track to meeting the 4 percent of GDP fiscal deficit target, and between 90 percent and 97 percent of tax revenue goals for 2022. In addition, the creation of the Large Taxpayers Department at the National Tax Service is expected to increase tax contributions from larger companies by 4 percent to 9 percent over the next two years, with renewed focus on speedy processing, monitoring, and auditing. Large taxpayers account for more than 60 percent of total tax revenue in Panama. Higher tax collections will allow capital investments to be paid for with more limited reliance on debt financing.

6. Panama's public debt remains sustainable. Adherence to the amended fiscal rule continues to place public debt firmly on a declining path, supported by improved primary fiscal balances and a positive real growth-interest differential. Despite the challenging environment of rising global interest rates, only 18 percent of Panama's public debt is at floating rates. This provides a fiscal buffer against further monetary tightening. A recent 2035 bond was issued at a discount, with a coupon of 6.5 percent, 150 bps below regional peers. Amid volatile market conditions in the short-to medium-term, Panama's sovereign bonds are generally oversubscribed (by about 3 times based on recent experience), and the authorities expect to comfortably meet next year's financing needs of about US$ 4.1 billion, including US$ 1.9 billion to offset redemptions.

Financial Stability and AML/CFT regulation

7. The financial sector continues to show resilience. Banks remain well capitalized, liquid, and profitable, with only a modest increase in non-performing loans. The share of pandemic-modified loans fell from 48 percent of total loans at the peak of the pandemic to just 5 percent, with only about one-third of those considered high-risk accounts. In fact, most of these loans are expected to migrate to regular categories soon, as required by a recently-issued banking regulation. Moreover, the pass-through of higher interest rates to existing borrowers remains low. With ample sources of funding from depositors, most banks plan to narrow net interest margins to reduce external pressure on new lending rates. Indeed, stress tests suggest that banks have adequate capital buffers even under the most adverse scenarios.

8. The authorities have made substantial progress on the remaining items of the FATF Action Plan and have intensified their efforts to exit the gray list in 2023. In this process, they have maintained close contact with the IMF Legal Department (LEG) as a sounding board on their progress. There were resolutions in both investigations and convictions, with ten and two high-profile cases, respectively. Progress has also been made in providing timely information in line with Egmont Group standards. In addition, the Financial Intelligence Unit is currently working with FINCEN and other international institutions to respond promptly to requests for information well within the established timeframes for reporting suspicious activity, particularly in the areas of illicit trafficking and deforestation.

9. The process of uploading ultimate beneficial ownership information into the new system is progressing steadily. The Superintendency of Non-Financial Institutions has stepped up verification efforts, which have helped to reduce the universe of companies from over 755 thousand to nearly 235 thousand active entries. Data uploads now account for 32 percent of the total number of companies, a significant increase since October 2022. The four largest law firms with offshore operations are currently working with the Superintendency to scale up efforts. The authorities are confident that they can reach a much higher percentage of registered entities by April this year, ahead of the FATF plenary in June.

Structural reforms

10. Negotiations with Minera Panama continue. The authorities are working to find an amicable solution to the impasse with the mining company regarding taxes and royalties that are commensurate with the size and nature of the company's operations in the country. In addition to boosting exports and employment, the mining and construction sectors will benefit from Minera Panama while supporting the diversification of the economy.

11. The Social Security Administration is working to address the deficit in the pension system. The reserves in the defined-benefit component of the system are under pressure, as current revenues cover only 55 percent of annual pension expenditures (as of October 2022). The shortfall is now being covered by reserves, but these are expected to be depleted on a cash-flow basis in late 2024 or early 2025. The authorities reconvened the National Dialogue in January to build consensus to address this issue.

12. Finally, government agencies are finding new ways to address climate sustainability. The Panama Canal Authority plans to become carbon neutral by 2030 and replace its tugboat fleet with hybrid vehicles. They are also preparing to spend US$1.5 billion on water management and conservation projects as rainfall in the Panama Canal basin has decreased over the past 20 years. From the financial markets' perspective, the Superintendency of Banks approved Regulation 11-2022 to address climate risks in the sector. In addition, the National Bank of Panama inaugurated its National Climate Risk Management Department and will implement IFC performance standards for financial operations, particularly in agriculture.