The Panamanian economy expanded 5.6% over the same quarter of the previous year in Q3, which marked a slight deceleration from Q2’s 5.8% growth. Growth in Q3 was driven by a notable expansion in the industrial sector, while the all-important service sector tallied modest growth as international commerce and trade in the Colon Free Trade Zone was constrained by subdued demand from Panama’s trading partners. Meanwhile, the legal disputes between the Panama Canal Authority (ACP) and GUPC—the four-company consortium expanding the Canal—have not dissipated. GUPC accused the ACP of recurring payment delays and stated that the expansion could be further delayed until October if the ACP fails to deliver the latest USD 190 million payment installment. Despite this panorama, the Panamanian president reiterated that he expects the expanded Canal to be inaugurated in May.

Panama Economic Overview

Panama has been one of the fastest growing economies in Latin America over the past decade, with real GDP expanding an average of 8.4% between 2004 and 2013. Moreover, Panama performed relatively well during the global financial crisis, including 4.0% growth in 2009 when many other countries in the region suffered a contraction. The Panamanian economy accelerated in the following years, reaching double-digit growth rates in 2010 and 2011.

The economy of Panama is centered on a highly-developed services sector, which represents more than 75% of gross domestic product (GDP). The Panama Canal and use of the U.S. dollar have promoted the strengthening of a globally-oriented services economy. The Panama Canal is essential to global trade and accounts for almost 10% of the country’s GDP. Other important components of the service economy are the Colon Free Trade Zone (CFZ), which is the second largest free port in the world, and the Trans-Panama Pipeline, which allows for the transport of crude oil between the Pacific and Atlantic coasts. The license and registry of the Panama flag to merchant ships is another source of economic activity. Panama also has a large logistics and storage services sector, as well as a modern banking and insurance industry. The agricultural sector has lost importance over the years, accounting for less than 10% of GDP today. The main cash crops produced in the country are bananas, corn, coffee and sugar.

Expansion of the Panama Canal has been a major source of economic activity since the project began in 2007. Estimated at a cost of USD 5.5 billion, the construction of wider locks and deeper channels will allow for passage of larger container freight ships, help the canal remain competitive in the realm of global trade and therefore sustain toll revenues. Other large public spending infrastructure projects have also driven economic growth in recent years and solidified Panama’s standing as a major logistical hub in the region. This includes the building of a metro line in Panama City, which was inaugurated in April 2014 and is the first in Central America, as well as a new metrobus system, an improved highway network and enhancements to Tocumen International Airport.

While the Panama Canal and related activity were historically the main economic engines, growth is now also being driven by a modern banking and financial services sector. This sector, which features more than 80 established banking and financial institutions, including insurance and re-insurance companies, has expanded greatly thanks to the free flow of capital, adherence to international regulation standards, the dollarized economy and a stable political environment.

Economic History

While the fact that Panama is moving toward developing a sophisticated, service-based economy distinguishes it from many other Latin American economies, the country also has similarities to other countries in the region, particularly from a historical perspective. During the 1980s, Panama was plagued by sluggish economic growth and political instability, as well as soaring fiscal deficits and public debt. Structural adjustment packages, adopted in exchange for assistance from international institutions, were aimed at increasing competitiveness, diversification and financial stability. Further structural reforms, including trade and market liberalization, privatization of state-owned-enterprises and fiscal reform were implemented in the 1990s. These measures helped secure new sources of financing and international investment and proved to be crucial for economic recovery. Average growth during the 1990s was greater than 5.0%.

Panama’s Balance of Payments

Panama usually records a current account deficit on the balance of payments, due in large part to a negative trade balance. The current account has widened recently as imports for government infrastructure projects increase. However, foreign direct investment, which has been an essential contributor to recent growth, has helped offset current account imbalances. In 2013, foreign direct investment in Panama reached its highest level in history with USD 4 billion in total inflows.

Panama’s Trade Structure

The external sector is a crucial component of the Panamanian economy, and Panama has become increasingly integrated in the global trade system in recent years. Panama signed a free trade agreement with the United States in 2012, which further boosted investment and trade flows. An association agreement with the European Union (EU) was signed in 2013. A free trade agreement was reached with Mexico in 2014 and is seen as the first step in Panama’s objective of joining the Pacific Alliance, which would strengthen trade ties with Asia.

Exports from Panama

Exports of goods and services always have represented a major portion of Panama’s GDP. In 2013, Panama exported USD 17.5 billion worth of goods, plus an additional USD 9.8 billion in services, for a total of USD 27.3 billion, which represents almost 65% of GDP. The majority of Panama’s exported services are related either directly or indirectly to the Panama Canal and the CFZ.

The main goods that Panama exports are medicines, petroleum products, ships and agricultural commodities. The United States, Ecuador and Venezuela are the main recipients of these exports. The CFZ, which accounts for more than 7.0% of the national economy, also serves as a major distribution point for re-exported goods. A large amount of merchandise arriving from North America, Asia and Europe is then re-exported to other countries, primarily in the Western Hemisphere. Goods either exported or re-exported through the CFZ represent upward of USD 10 billion annually.

According to FocusEconomics Consensus Forecast panelists’ June 2014 projections, exports are expected to increase to USD 19.4 billion in 2014 and to tally an annual pace of growth of 10.6%. In 2015, panelists expect exports to rise to USD 19.9 billion.

Imports to Panama

While Panama is a net exporter of services, it is also a net importer of goods. Panama is self-sufficient in some domestically-produced agricultural products such as bananas, sugar and rice, but imports large quantities of other foods. Import growth of food products and merchandise goods has accelerated in recent years in unison with growing domestic demand. The Panama Canal expansion project has led to an increase in imports of materials and machinery. Moreover, Panama is the top energy consumer in Central America, and must import more than 80% of its energy to meet its needs.

Panama’s Economic Policy

The Panamanian government has promoted economic growth over the past decade in large part through open market policies and by supporting free trade. Moreover, the government actively encourages foreign direct investment through lax regulation and by guaranteeing ease of business.

During his tenure as president from 2009 to 2014, Ricardo Martinelli implemented a USD 15 billion strategic spending plan in key sectors, such as financial services, agriculture, logistics and tourism, as well as in airport, port and road infrastructure to consolidate Panama as a major global trade hub. This was in addition to the USD 5.5 billion spent on the Panama Canal expansion project, which has been the main part of the economic growth agenda. This strategic government plan also included policies to boost investments in hospitals, education, sanitation and other basic services, particularly in rural areas where poverty rates are much higher.

Panama’s Fiscal Policy

While in power, President Martinelli signed a series of fiscal reform packages designed to simplify tax collection, increase revenues and attract investment. Most importantly, the reforms broadened the tax base, reduced the number of tax brackets, lowered personal and corporate income rates, increased the VAT rate, and enhanced tax administration. The new fiscal structure has been effective in providing funds for large infrastructure projects around the country. These reforms have helped drive public debt down to less than 40% of GDP.

The Panama Savings Fund (FAP), a long-term government wealth fund, was created in 2012 using the surplus revenues from the Panama Canal. Payments made by the Panama Canal Authority to the Treasury in excess of 3.5% of GDP will be channeled to the FAP. The fund is designed with the objective of setting aside national savings for future generations and economic stabilization in case of extreme situations, such as natural disasters or economic crises.

As of the June 2014 FocusEconomics Consensus Forecast report, panelists surveyed expect Panama’s public debt to settle at 38.4% of GDP in 2014, and to decrease steadily toward 33.3% by the end of 2018. Meanwhile, panelists project that the government’s fiscal balance will register a deficit of 2.6% of GDP in 2014 and narrow slightly to a deficit of 2.3% in 2015.

Panama’s Monetary Policy

Officially known as the Balboa, the currency of Panama has been pegged to the U.S. dollar at parity since the country gained independence in 1903. Today, the U.S. dollar is still the primary legal tender. While dollarization spurred the development of a strong external-facing services sector, Panama does not have a central bank and does not issue any paper currency to be put into circulation. Without the ability to implement its own monetary policy or exchange rate adjustments, it is difficult for the government to control inflationary pressures. In fact, the monetary stimulus policies that the United States has introduced in recent years have produced direct currency inflows into Panama as well as higher commodity prices. With inflation trending above historically-low levels, the Panamanian government has begun minting its own coins in an attempt to sustain public spending. However, circulation of coins in the domestic economy is more of a symbolic measure and will not really offset the challenges of dollarization.