Fitch Affirms Panama's Sovereign Ratings; Outlook Negative.

Business Editors

NEW YORK--(BUSINESS WIRE)--Oct. 24, 2002

Fitch Ratings today affirmed Panama's long-term foreign and local currency ratings at 'BB+' following the completion of a full rating review. The Rating Watch assigned on Sept. 4, 2002 is removed; the Rating Outlook is Negative reflecting the risk that, should swift legislative action on tax and social security reform not be forthcoming, credit fundamentals could deteriorate in the near term.

Panama's credit fundamentals are characterized by a high level of public sector debt, and public finances have deteriorated in the last year, as growth has been subdued. On other hand, Panama's fiscal flexibility is bolstered by moderate debt service. The Government's gross financing needs will reach around 6% of GDP next year. Fitch is also encouraged by the better political environment in the country, characterized by the government's majority coalition in the legislature, which has rekindled hopes of renewed momentum for economic reforms in the country. However, the government has a short window of opportunity before the 2004 electoral season is under way to pass economic reforms, which comprise a tough 2003 budget, a tax reform, a social security reform, and a change in the labor code for the Howard Base area. In light of sluggish economic growth and private sector opposition on some of these measures, the timetable for implementing these reforms appears optimistic.

Panama incurred a non-financial public sector (NFPS) deficit of 1.3% of GDP last year, and meeting the NFPS target of 2% of GDP for this year will be challenging. Fiscal pressures remain high this year due to the economic slowdown and structural weakness of the tax system. In addition, the Government cannot rely on the transfer of front-loaded interest receipts from the Fiduciary Trust Fund this year, which was an important non-recurring revenue source used to reduce the 2001 deficit. Only realized earnings and interest earned will be used to support the Government's social and infrastructure projects. The surpluses of the social security agency (SSA) have also been hit by increased personnel costs, and if reforms are not undertaken, then the SSA will present an additional source of burden for public finances. Fitch estimates that public sector debt (excluding the Government debt held by the social security agency) could approach 70% of GDP by the end of 2002, which is among the highest in Fitch's realm of 'BB'-rated sovereigns. Even though the country has considerable financial assets, net external public debt, at 35% of GDP, is still more than double the 'BB' median.

Fitch believes that with the current global economic downturn, it will be difficult for Panama to improve its growth prospects in the short-term. The service-based economy is highly exposed to international trade conditions due to the Colon Free Zone and the Panama Canal. In light of dim global prospects for 2003, growth is not likely to strengthen significantly next year. The development of new sectors of growth such as tourism, ports, technological services, telecommunications and maritime industry is under way. However, a limited skilled labor force, cumbersome labor legislation, and slow productivity growth continue to hamper foreign investment in the country and hold back growth prospects. Nevertheless, when the global economy rebounds, Panama will experience a cyclical improvement in growth prospects.

Dollarization, a stable financial system and the Government's considerable financial and land assets support the sovereign's ratings. Dollarization has resulted in a long history of monetary and price stability unseen in other emerging markets. In addition, it limits the probability of a devaluation-induced increase in public debt ratios or a balance of payment crisis. The Government also passed the Fiscal Responsibility Law (FRL) that sets a ceiling on the NFPS deficit and establishes goals for total and external net public sector debt. The government intends to implement the FRL through tough application on the 2003 budget. Nevertheless, given Panama's high indebtedness the time frame for reaching these targets is relatively unambitious. The Fiduciary Trust Fund (FTF) has also been allowed to invest up to USD 1 bn of its assets in Panamanian Global bonds in order to improve its returns. In Fitch's view this is a positive development, although it is less desirable than the earlier proposition of the Government to use the funds of the FTF to cancel a part of the country's external debt.

Future rating changes will depend on the Government's ability to pass a tax reform, a prudent 2003 budget and a social security reform, all of which are necessary to prevent further fiscal account deterioration. Fitch cautions that the Government's inability to move on these fronts could put renewed pressure on Panama's sovereign creditworthiness.