A boom at odds with world gloom

Panama has been capitalising on its prime location between the Americas to attract foreign companies, and has been ramping up its infrastructure to support growth. So how will it be affected by the global slowdown?

One might expect the US banking crisis to send a shiver through Panama, until recently a virtual fiefdom of its northern neighbour. Instead, it is full of optimism as it positions itself as the heart of Central America and, more ambitiously, as a Singapore-style entrepôt, between north and south.

The strategy has been going well, but it is unclear how a menu of massive infrastructure projects will be financed as the rest of the world slumps and credit evaporates. There were already signs of strain, manifested in unexpectedly high inflation. This decade may end in project delays and a slowdown that arrives sooner than expected.

Panama’s economy has been going at high speed for several years, thanks largely to its unique location. Gross domestic product (GDP) hit 9.4% last year, is expected to be 8.5% this year and a soft landing is expected with 7.5% next year, at least according to the United Nations Economic Commission for Latin America and the Caribbean (ECLAC).

Much of the next stage of growth should come directly from long-term, expensive infrastructure projects of which the $5.5bn widening of the Panama Canal is the most high profile. It should be financed primarily through $2bn in multilateral debt, and revenues from the canal. For other projects, given current markets, it is less clear if sponsors will be able to raise funding. At the Atlantic end of the canal, a plan to build two giant refineries with a price tag of close to $15bn was to be financed by foreign investors, including the government of Qatar. That now looks highly ambitious. The long-delayed $700m redevelopment of the Howard air base by London and Regional Properties is still incipient.

Panama urgently needs better infrastructure, much to be financed initially through commercial loans. These include: a coast road in Panama City and expanding the highway to the free trade zone in Colón; airport expansion; power generation; better sanitation; and more low-income housing in a country where 37% of the population live below the poverty line.

Wealthy migrants
Migration of the wealthy to Panama may help it weather the storm. The country was being driven not just by organic economic growth, but individuals, typically retirees, and large companies that set up shop in the country, large infrastructure projects, foreign direct investment and a strong focus on tourism, points out Francisco Conto, Panama country head of Citigroup. They are consuming and driving growth.

But even before the credit crunch, the problem was that all these projects were converging in a small country with a limited and generally poorly educated workforce and the highest rate of investment to GDP in Latin America. With global credit virtually non-existent, these hopes look much harder to achieve in the short term.

The government had also been pushing to make Panama not just the regional banking centre but the preferred location for Central American corporate headquarters. Law 41 was passed last August to woo foreign corporates just as many are scouting for regional headquarters, says Terry McCoy, country head for Scotiabank in Panama.

The law, which provides tax and labour incentives and simplifies existing legislation, has persuaded Procter & Gamble to move 300 staff to the country. Hewlett-Packard, Caterpillar and 3M are also setting up there, joining the likes of Sony, Maersk and Dell, says Mr McCoy. Still, weak global conditions mean that most multinationals are likely to take a wait-and-see approach. “It will be months before we see more companies wanting to come in,” says Jaime Rivera, CEO of trade financing bank Bladex.

Meanwhile, global inflation has taken off, and dollarised Panama – long immune – has been badly affected. Consumer price inflation hit 9.8% at the end of August – the highest the country has seen in 30 years, says Alessandra Alecci, senior analyst and VP at rating agency Moody’s. Inflation has sparked some labour unrest. Wage protests led the government to extend a one-time bonus to workers and there is pressure on the private sector to do the same, she says.

“Inflation is the one element that was not factored into projections a year ago. Everyone was more worried about the US recession. Inflation has turned out to be the driving factor on the macro picture for the region. What makes it yet more difficult is that it’s exogenous,” says Mr Rivera.

Inflation is having many effects. For one, it is sapping purchasing power, particularly for the poor. Last year, Multibank’s charitable foundation gave out 1500 free meals a day. That’s risen substantially and now includes working women with children, says Alberto Btesh, president of the local, family-owned entity.

Inflation is also causing opportunistic hiring, with bankers complaining about a rash of attempted poaching. One banker said Citigroup offered a 30% pay rise to one of his mid-level staffers. He stayed for 5% because of fears over the future of the US bank in Panama, the banker says. Multinational newcomers are also putting pressure on wages and services. Mr McCoy is on the board of his children’s school and says it needs to expand 50% to cope with the expected influx of new pupils.

Inflation adds further complexity to projects. The Panama Canal has included provisions that should protect it from inflationary and perhaps credit shocks (see box overleaf), but other projects face a toxic mixture of the credit crunch, higher prices for basic materials and wages and possibly difficult labour relations.

Banking competition
Economic growth had encouraged banks to expand, particularly in plain vanilla lending products. That was a worry even before the credit crunch, but it is important to underline that local banks had negligible exposure to the kind of assets that have undone more sophisticated banks, says Jeanne del Casino, vice-president, regional credit officer for Latin American banks at Moody’s. Local banks didn’t have excess liquidity to invest overseas. Instead, they have been investing in their own markets with locally raised funds.

Even so, competition was becoming more heated in basic products leading to a credit boom. Indeed, Panama’s consumer debt level to GDP is the highest in the region at more than 100%, compared with 40% overall in Central America. Two years ago, consumer credit was growing at 40% a year and has only recently slowed as banks reassess their exposure to real estate and other lending, says a senior banker. “Most banks have been growing their balance sheet too fast and consumers are starting to worry about their own debt levels.” If unemployment rises or, more probably, inflation eats away at purchasing power, the ability to service debt will diminish, the banker believes. The bright spot is that margins, which have suffered over the past few years as banks chased retail clients, have recovered, a feature likely to accelerate, he adds.

Some frothier areas have already wobbled. Luxury real estate asset prices had been rising fast, but have plateaued recently. Now other real estate sectors are generating fears. Hotels could be affected by the US downturn; the office market is volatile and it’s easy to lose money; residential property has some room for growth, but you need to watch quality and location, says Anantol Von Hahn, executive vice-president for Latin America at Scotiabank. Again, this may not affect Panamanian banks, which are less exposed to luxury real estate as they have focused on more stable, lower income housing, where buyers are eligible for government assistance.

Today’s downturn follows a period of expansion with banks diversifying products, acquiring each other and the arrival of many new entrants. Well-established Bladex is just one bank that has been developing more, and more sophisticated, products. “We have a window of opportunity. It may only be six months – but it could be as many as 24 – to grow and strengthen our franchise. We will be upgrading our product mix in response to changes in trade flows,” says Mr Rivera.

Foreign buyers
Other banks grew through acquisitions in the boom years. The most acquisitive banks in Panama to date have been foreign, particularly HSBC and Citigroup, through region-wide purchases. HSBC took over Banistmo and Citigroup bought Banco Uno and Banco Cuscatlán. Both banks are still digesting these acquisitions though system integration and rebranding. Local giant Banco General also merged with Banco Industrial.

Citigroup aims to create a universal bank, combining the credit card business of Uno, the commercial banking contacts of Cuscatlán and the more sophisticated home-grown products of its parent. It will offer additional commercial products to Cuscatlán customers and an expanded branch network for Citi customers, which has increased from four branches to 42, says Mr Conto.

HSBC’s acquisition of Banistmo proved more difficult than initially thought because of the latter’s aggressive trail of acquisitions, which provided a legacy of different systems and management, say competitors. However, it was rebranded late last year and now both HSBC and Citigroup are ready to turn their full attention on clients (if their parent banks are still interested, that is).

New banks continue to arrive. Chronic political instability at home, coupled with high profits from a fast-growing oil economy, is pushing Venezuela’s banks to diversify. Banesco has opened 14 branches in Panama. Building a local, regional platform is a driver for Mexico’s Banco Azteca, which has been expanding since opening in the country in 2005. Local Banco Panama opened in April with $30m, and niche banks are springing up in areas such as project finance, trade financing and wealth management.

Banks are also rolling out region-wide operations or integrating regional acquisitions. Scotiabank, which is growing with a mix of small acquisitions and organic growth in the region, is seeking to build a more integrated Central America platform. That includes building a single operating system and using shared services to supply better services faster, says Mr Von Hahn.

Even smaller local banks are expanding regionally. Multibank’s assets have gone from $450m to $1.2bn in two years and it is growing its international business, especially in Latin America, buying a financing company in Colombia, says Mr Btesh. Individually, this regional expansion for banks looks sensible but the speed of the credit crunch calls into question continued commitment to such plans and the sagacity of timing.

Until recently, the idea was that local banks were going to find it hard to compete. “If you are a local institution with $200m in capital and look at international banks, you have to hope that international banks don’t move into micro, small and medium-sized enterprises and basic banking, deposit, personal loans, payroll loans,” says Ms del Casino.

That now looks less certain. Foreign-owned banks that rely on the pockets of foreign parents to grow are unsure how much support they will get. Indeed, rumours of a possible sale of Citigroup’s Central American businesses were rife in Panama in September. The bank declined to comment on the plan and it seems unlikely since the bank has only just finished the acquisitions and its value is paltry for a bank of Citi’s size.

But local banks cannot relax. Although they have funded locally in the past and access to capital markets in Central America was tentative, many planned to use capital markets to fund future growth. Ms del Casino witnessed more local companies seek a rating to raise debt funds internationally. That has clearly come to an abrupt halt. That will affect banks such as Multibank, which is looking to sell a 5% to 6% stake to increase lending capacity.

Credit dries up
Meanwhile, credit lines from correspondent banks are likely to be cut, particularly in regions marginal to business, such as Central America. And as banks are forced to merge in the developed world, credit lines will be consolidated, exacerbating the problem.

Most bankers agreed that Panama looked overbanked before the global crisis. Forty onshore banks for a population of 3.4 million and GDP of $18bn to $19bn is probably too many, says Mr McCoy. Many believe further consolidation needs to take place. “Banks need to become competitive. To do that, you need to reduce costs and you need to have critical mass. Consolidation should happen,” says Mr Conto. But he wonders if Panamanians’ confidence may lead them to price what they have too highly. The credit crisis may force them to think again.

Jorge L. Quijano, Panama Canal Authority (PCA) executive vice-president of engineering and programme management.

Panama’s inflation and thriving construction sector should not have a major impact on the cost of materials because costs were estimated under the assumption that most materials would be imported due to the quantities required. Global inflation could hit the cost of materials and imports so substantial cost increases for materials were included in our estimated contingencies. One such example is the sudden rise in the price of oil, which almost reached $150 per barrel in July of this year.
However, since then we have seen oil prices fall, leaving contingencies in this commodity. There are still many materials in the estimate that have a significant margin of contingencies. There were also contingencies for labour shortages.

The contractors of the first three major expansion projects also increased their productivity, using heavy equipment almost three times as large as outlined in our estimates. This reduced both labour and fuel requirements so the three fixed lump sum contracts that have been awarded were well within budget. There are four major contracts still to be awarded: the third and fourth dry excavation projects, the locks and the Atlantic entrance channel dredging.

In July 2008, the PCA extended the new locks proposal due date to December 10. Requests were received from the consortia to extend the proposal due date and the PCA listened to their needs. Additional time given to consortia will result in better bids, with regard to both the technical and price proposals.

This extension is well within the overall timeline of the expansion project, with an expected completion of 2014. And the PCA had allocated some ‘cushion time’ for such requests.

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