Panama 2010-2014 Country Program Evaluation

June, 2015

Context

Panama is a small, high-middle-income country with a highly open economy whose strategic location and integration into the global economy have put it on track to become a regional logistics hub. The country has an estimated population of 3.8 million people, of which 75% is urban. It is the fastest growing economy in Latin America and the Caribbean, with an average GDP growth rate of 8.6% between 2008 and 2013, and a GDP per capita of US$16,658 in 2013. The Panama Canal and a diversified services sector related to trade and finance activities explain the successful performance of the economy. In addition, the country integrated rapidly into the global economy through a number of Free Trade Agreements and the growing activity of the Colon Free Zone.

Panama is characterized by stable macroeconomic conditions anchored by full dollarization, a solid banking system, and the implementation of sound fiscal policies. Public debt declined from 71.2% of GDP in 2001 to about 45.4% in 2008 and to an estimated 41.1% of GDP in 2013. This decline reflected strong growth, tax reforms, and tighter current spending (offset by considerable increases in public investment), as well as larger transfers from the Panama Canal Authority. The strong adjustment effort over the past decade created the fiscal space for the implementation of countercyclical measures to mitigate the impact of the global crisis. Furthermore, Panama formalized its commitment to sound fiscal policies by enacting the Social and Fiscal Responsibility Law (SFRL) in 2008 and creating a Sovereign Wealth Fund in 2012. The SFRL established a limit of 1% of GDP on the overall deficit of the non-financial public sector, combined with a limit of 40% of GDP on public debt. The Sovereign Wealth Fund was a major step toward sound management of public resources in the future, and toward limiting the “Dutch Disease” effect that could be triggered by spending the expected larger revenue inflow from the expansion of the Canal.

Despite this progress, Panama also has a dual economic structure: the dynamic sectors that drive growth have left the rest of the economy behind. There are significant gaps between the living standards in the Panama City-Colon Corridor and those in the rest of the country, and particularly those of indigenous peoples. Unequal access to economic and social infrastructure within the metropolitan region is also a pressing issue. More generally, while the combination of strong growth and direct government programs has helped reduce poverty, the reduction occurred at a slower pace than expected given the very high growth rates. Inequality persists, with large disparities based on income, wealth, geography, and ethnicity.

While the overall fiscal policy has been strong, weak management capacity in most public sector entities has hindered the efficient use of public resources. This weakness is clearly evidenced in the area of public expenditure planning and execution. Although the SFRL requires the formulation of a medium-term fiscal framework to increase the efficiency and monitoring of public spending, Panama has not developed either an integrated system to design, assess, and monitor public investment projects, or a results-based budgeting framework.

Panama’s financial sector –a pillar of the country’s strength– weathered the global financial crisis well, and its oversight is being strengthened, although further progress is needed. The Superintendence of Banks has adopted risk-based supervision and dynamic (cyclical-based) provisioning. Also, in the absence of a Central Bank, progress is being made toward establishing a lender-of-last-resort facility. However, there are concerns about poor supervision of non-bank financial institutions, particularly cooperatives. Although this evaluation covers the period 2010-2014, it is important to note that in April 2015, Panama approved Law 23 which expands the number of sectors subject to regulation and supervision, and addresses weaknesses in the areas of anti-money-laundering and combatting the financing of terrorism previously identified by the International Monetary Fund.

The Bank’s country program for 2010-2014

Since 2010, the Bank has concentrated its country program with Panama on deepening economic reforms, strengthening economic and social infrastructure, and addressing service delivery in key sectors, notably in water and sanitation, education, and health. In accordance with its diagnostic assessments, the Bank structured its 2010-2014 Country Strategy (CS) (GN-2596) around three core development challenges: “(i) strengthening public finances, increasing revenue, and making expenditures more efficient in core sectors under a framework of medium-term fiscal sustainability; (ii) developing basic infrastructure, with a focus on the provinces outside of the Panama and Colon Corridor, thus expanding economic and social opportunities to reduce high levels of poverty; and (iii) facilitating access to quality services in education, health, and nutrition, particularly in the indigenous territories and in rural communities.” The CS also committed the Bank to endeavor to strengthen country systems in the areas of financial management, public procurement, and the environment. The Bank’s strategy was generally consistent with Panama’s development challenges and the thrust of the Strategic Government Plan 2010-2014.

This evaluation observed a general lack of coherence between the Bank’s strategic planning and programming exercises and the de facto operational portfolio. This discrepancy reflects an inherent weakness in the Bank’s strategy and programming guidelines, which do not require that the Bank account for the sectors in which it has an active portfolio, despite the size or relevance of that portfolio. The programming of the portfolio was also weakly linked to the CS. Operations were approved in nearly twice the number of sectors as had been included in the strategy, and the share of loans that were eliminated from the work plan on an annual basis was significant.

Between January 1, 2010, and December 31, 2014, the Bank approved approximately US$2.1 billion in new financial operations—an increase of 60% in volume over the previous CS and substantially higher than the envelope envisioned in the CS. This amount comprised 16 sovereign-guaranteed (SG) loans totaling US$1,754 million, 15 non-sovereign-guaranteed (NSG) loans for US$193 million, and 47 technical cooperations and investment grants for an additional US$56 million. The legacy portfolio included 35 active loans (27 SG and 8 NSG) in 13 sectors, which were approved before the current evaluation period and remained active at the beginning of 2010, with an undisbursed balance of roughly US$955 million.

The lending portfolio relied heavily on fast-disbursing instruments for budget support. Seventy-two percent (US$1,250 million) of all SG loan approvals were in the form of fast-disbursing loans: five policy-based programmatic (PBP) loans to strengthen public finances and financial sector supervision, and develop policy frameworks for integrated disaster risk management, and one PBP guarantee to strengthen macro financial and fiscal management. This budget support was instrumental in aiding Panama’s efforts to build a strong macroeconomic policy framework for growth. The Ministry of Economics and Finance counts on the Bank to continue providing policy advice and fast-disbursing resources, which are now an important and reliable source of government funding. Nonetheless, successive changes in focus in the Bank’s programmatic lending prompted the truncation of three of Panama’s four programmatic series. As a consequence, five of 11 planned PBLs of significant structural depth did not materialize, thus diminishing the relevance of the proposed lending series.

Although IDB’s engagement pivoted around budget support, the Bank also provided more limited support to other sectors through investment lending. Panama requested Bank support to strengthen economic and social infrastructure and to address critical market failures in the social sector. In this context, eight investment loans totaling US$384 million were approved. These operations offered an opportunity to concentrate financial and technical resources in areas outside of the Panama City–Colon Corridor, including in the indigenous regions, and to ensure that important social programs and processes, which can take time to evolve, were moved forward. In general, the portfolio of investment projects demonstrated the Bank’s capacity to partner with government officials in identifying solutions to some of the country’s most difficult problems.

By sector, public sector financial management (reform and modernization of the state) and financial markets received the highest concentration of loan financing (62%), followed by environment and natural disasters (17%), which was not identified as a priority sector in the CS. The remaining 21% of total Bank financing was divided among the priority sectors that most directly addressed the challenge of a dual economy: infrastructure (water and sanitation, transport, and energy) comprised roughly 10% of total approved loan volume; the social sector (including education and health) 8%; and the private sector 3%.

The Bank was responsive to the Government’s evolving needs in sectors that were not explicitly part of the CS for 2010-2014. In the area of natural disasters and climate change, the Bank approved an emergency facility to address the damages of severe flooding and mudslides (PN-L1071). It also approved a flexible ex ante contingency loan that is immediately accessible for emergency expenditures in cases of catastrophic natural disasters. And although the Bank chose not to single out the financial sector in its CS for the period, there were a significant number of NSG operations in support of individual banks.

Implementation, effectiveness, and sustainability

During the evaluation period the distribution of lending across sectors was highly skewed towards PBLs in areas that were not directly related to addressing the dual nature of Panama’s economy. This bias resulted in a program with a pro poor investment component, but overall not on a scale commensurate with the social and economic disparities of a dual economy. According to the Operations Update System (OPUS), just 7 of the 16 SG loans approved over the review period targeted poverty, social equity, or similar lending priority indicators in GCI-9. In terms of volume, just 16% of the US$1.754 billion approved for SG lending targeted poverty or social equity.

The Bank’s investment portfolio added value, despite implementation delays. For the most part, investment loans focused largely on social and economic infrastructure in provinces outside the Panama–Colon Corridor. Nonetheless, many of these operations have experienced significant implementation delays, reflecting varying degrees of institutional capacity within executing ministries at the central and regional levels, fiscal constraints stemming from the SFRL, and inefficient country systems. More specific implementation problems found during the evaluation include lack of ownership by key stakeholders (fiscal PBLs); problems with contractors (transport sector); lack of political will (water and sanitation and competitiveness); procurement issues (energy sector); complexity of design, high personnel turnover, and insufficient funds to move forward (education and health sectors); and excessive requirements for execution of activities (natural disaster emergency response). Low inter-institutional coordination and inefficient country systems affected multiple sectors.

Recommendations

1. Work with the client to structure the new CS and background analytic work around key cross-cutting issues such as duality, poverty, productivity, and inequity, rather than by narrow sectors.
    
2. Given the high levels of inequality in the country and the slow reduction of poverty, seek ways to redouble IDB’s efforts to support Government’s pro-poor development agenda by focusing budget support more on issues relevant to poverty reduction and by continuing targeting investment lending more toward poor beneficiaries.
    
3. In the context of the overall strengthening of country systems and project management capacity, continue to support the client with strong institutional components. Support to the client should also include strengthening of municipal and regional development institutions and their capacity to more efficiently and effectively deliver basic services.
    
4. Strengthen the design, monitoring, and completion of future policy-based programmatic series to avoid interruptions in the Bank’s comprehensive support for priority sectors and to ensure the achievement of durable policy reform. When a PBP series is interrupted, it is recommended that the remaining operations be removed from the lending pipeline and a project completion report be prepared for the truncated series.
    
5. Strengthen risk analysis during project design and periodically reevaluate and reprioritize the lending program based on dialogue between the Bank and the Government of Panama, with a view to lowering the cost of projects prepared but later removed from the pipeline or canceled. Major deviations in the scope or focus of the country program from that envisioned in the CS should be justified and reported to the Board.