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UNITED STATES INTERNATIOIW. DEVELOPMENT COOPERATION AGENCY AGENCY FOR INTERNTIONAL DEVELOPMENT Wahngton," D. C. 20523
PANAMA
PROJzCT Pon
PRIVAT SECIR REALVIVATIC PMMGMZ
AIDILAC/P*-522 Project Notmer: 525-0304 Grant Nmurler: 525-K-605
UII rllI D €.GNCV fow ,.VER9ATIONAL 0CVCLOP.'tMk 525-0304 Z5-K-gUn 2. Counthy PROGRAM ASSISTANCE PANAM 3. Category APPROVAL DOCUMENT CASH TRANSFER (PAAD) 4. Date _JLY 12, 1990 TO 6. OYS a=F Number N/A Ak/LC, JaMues H. ?ihel LOYIncreae From N TTo btau from: LC/_, Jeffrey_ W. Evans__ _c awp FUNDS (ESP) A.pproval RNUa for Commitmt of 10. AppropdaasU Budget rm Code S 107,900,000 L090-3552 5-1G31 72-110/11037 Tylpe Funding 2!.UW' Cumc Awwgem 13. Esd~aWa Delivery eriod 14. Transacim ElIgibnty Daft -1 Lo E Gm- I Imformul 0 Formal MI Peoge 7/90",.7/92 5.Commodities Fbxaced
6. Pemmied Souw=e 17. Etialaed Source u.S in, u.s. Umied F.W. IaWdslaiM C..nius Fv Wld L 107.900.000 c€, 107.,OO;000 oh
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The purpose of this program is to assist the Government of Panama (GOP) to provide immediate liquidity to reactivate the banking system and to permit an increase in credit to the private sector in Panama. Upon GOP compliance with conditionality, the ESF will be disbursed into and maintained in an interest bearing separate account until needed for eligible end-use transactions (i.e., the purchase of certificates of deposit and rediscounting banNing assets or entering into repurchase agreements for short-term liquidity) to provide funds to the Panamanian banks.
Funds will be disbursed in tbree tranches. The first tranche of $36 million will be disbursed upon meeting Conditions Precedent to disbursement noted in Section V of the PAAD. The second tranche of $36 million and the third tranche of $35.9 million will be disbursed upon evidence that the preceding tranches have been fully committed in accordance with the objectives of the program.
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) This PAAD complies with current Agency guidance on methods of financing and has provided for adequate audit coverage in accordance with the Payment Verification Policy Implementation Guidance.
E. Cecile Adams, Controller LAC USA ID USAID
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PANAMA PANAMA USAID/PANAMA PROGRAM ASSISTANCE APPROVAL DOCUMENT PRIVATE SECTOR REACTIVATION PROGRAM, NO. 525-0304
TABLE OF CONTENTS
Page
I. SUMMARY AND RECOMMENDATIONS A. Summary 1 B. Recommendations 4
II. PROGRAM STRATEGY AND RATIONALE
A. U.S. Interests and Objectives 5 B. Rationale for Program Assistance 5 C. Linkages with Other Program and Project Assist 7 D. Coordination with Assistance Efforts of Other Donors 7
III. RECENT ECONOMIC PERFORMANCE AND FUTURE PROSPECTS OF THE PANAMANIAN ECONOMY
A. Structure of the Panamanian Economy 9 B. The Panamanian Economy in the 1980s 10 C. Prospects for the Panamanian Economy in 1990 12
IV. THE BANKING SYSTEM
A. Institutionsl Setting of the International Banking Center 13 B. The National Banking System 14 C. The Banking Crisis 15 D. Recent Banking Developments 16 V. PROGRAM DESCRIPTION
A. Objectives of the Program 20 B. Introduction 20 C. Risk Analysis 21 D. Mechanism to Provide Liquidity to Private 9anks 27 1. Policy Guidance 27 2. Financing and Management of Funds 27 3. Financial Agent 29 4. Participating Banks (PBs) 29 5. Types of Operations under the Program 29 6. Administration and Audit 31 7. Reflows 32
Iv E. Monitoring 34 F. Duration of Program 34 G. Program Conditionality 34 1. Conditions Precedent to Disbursement 34 2. Covenants 35 3. Conditions Precedent to Disbursement of Funds from the BNP Separate Account After Year 2 36
H. Program Accountability 36 I. The Separate Account 36 2. Program Audits 37 3. Reports 37 4. Adherence to Guidance 37 I. Status of Negotiations and Program Timetable 38 1. Status of Negotiations 38 2. Program Timetable 38 USAID/PANAMA PROGRAM ASSISTANCE APPROVAL DOCUMENT PRIVATE SECTOR REACTIVATION PROGRAM, NO. 525-0304
I. SUMMARY AND RECOMMENDATIONS
A. Summary Panama is crisis emerging from a severe which culminated political and economic United in the December military States, necessary to action by the had been trapped restore democracy to in a ruinous dictatorship. a country that now faces the formidable The new government December task of reactivating of 1989, was an economy that, in the midst of its in loss of national income worst recession, with and employment comparable a sustained by the U.S. to the losses two during the Great years, the GDP declined Depression. In the by nearly one-fifth, last unemployment rate and the national jumped to over 20 percent, the urban areas with higher rates of Panama City and in government's task Colon. The urgency is heightened by of the expectations of high, perhaps unrealistic, the Panamanian people living, substantially that their standards eroded over the past of quickly several years, and tangibly improve. will A major constraint to rapid weakened banking sector, economic reactivation restrictions the result of the is a under which different types of March, that sector has been 1988. Today, 43 percent operating since deposits of domestic private in the banking system sector term significantly the remain restricted, liquidity in the economy. reducing the private sector Loans outstanding declined by more than to end of 1987 and the 23 percent between ei-iterprises. end of March, 1990. the are at very Accounts payable of public high levels, and the all sector increased sharply floating debt of the what could since late 1987. be termed a financial Panama is facing gridlock that only the liquidity is affecting not solvency. of enterprises and Although the banks but also their and private sector is the economy is clearly showing great resiliency be on the rebound, achieved until banking rapid growth will not lack system operations of a lender of are normalized. The last resort for the deposit insurance increases banking system and the lack of of makes the full reactivation confidence and therefore of the banking system more difficult. -2-
After two years of political and economic crisis, there is an urgent need to reactivate the private sector, and this can only be achieved with a fully functioning banking sector. The Government of Panama (GOP) intends to lift restrictions on term deposits on July 10, 1990. Although the most recent analysis of the situation of the banking system carried out by the National Banking Commission (Comision Bancaria Nacional, CBN) suggests that a systemic liquidity crisis has a low probability, problems in some banks could trigger a bank run, and this would negate the progress made in the past several months. Therefore, the GOP must minimize the risks associated with the ending of restrictions on time deposits. As Panama does not have a central bank that can serve as a lender of last resort to provide liquidity to the banking system, the GOP must have a flexible mechanism that could provide temporary liquidity to some banks should they require it. Additionally, the demands for restocking and rebuilding the economy will require a significant and rapid injection of resources over the next 24 months. Such resources to finance incremental investment by the private sector will be channeled through private banks.
A resumption of strong external financial flows coupled with institutional strengthening will be a key factor in the economic recovery of Panama. Financial and technical assistance, however, can achieve its maximum benefit only in a supportive policy environment. Long unattended weaknesses in Panamanian economic policy must now quickly be addressed by the new government lest they constrain the economic recovery. The United States will provide $420 million in assistance to Panama in FY 1990 to give the country, in concert with resources of other international institutions and donors, the capital it needs to address the policy weaknesses and help return Panama to a path of sustainable growth.
This PAAD for the Private Sector Reactivation Program (the Program) provides the rationale and framework for a subset of the U.S. assistance - $107.9 million in Economic Support Funds to be provided in FY 1990 as cash transfer assistance to increase bank credit to the private sector in Panama. This Program complements and reinforces the recently approved Economic Recovery Program (525-0303) which is a policy-based cash transfer program for support to the public sector. Together, the two programs are designed to create the desired policy environment to support Panama's economic recovery. In that the Economic Recovery Program already contains considerable, substantive conditionality to achieve this objective, and given the urgency for making funds available to the private sector for investment purposes, requiring more conditionality via the Private Sector Reactivation Program would simply be duplicative and would not contribute anything additional to the policy environment that can be achieved by the overall USAID program. Therefore, disbursement of the cash transfer under the Private Sector Reactivation Program will not be subject to specific policy conditions. -3-
The is purpose of the Private to assist the GOP to Sector Reactivation and provide immediate Program to reactivate the liquidity to the economy banking system to credit to the private permit an increase sectcr in Panama. in substantive conditionality As just noted,. Recovery has been addressed Program. In addition, in the Economic instituting plans to include measures to control conditionality on because the money laundering have GOP has already taken been dropped banking transactions the step of requiring over $10,000 that all authorities. be reported to The Private Sector the proper however, include Reactivation covenants related Program will, system and to modernizing enhancing the supervisory the banking Banking Commission. powers of the Also, GOP use of the National for other than repayment reflows from the program be conditioned of U.S. bilateral non-military on progress in debt will implementing its economic program. reform The ESF disbursed dollars provided in three tranches by the Program will in and will be kept be the name of the GOP in a Separate Account until in the Federal Reserve needed for eligible Bank of New York purchase end-use transactions, of inter-bank which will be the provision certificates of deposits of short term liquidity (ICDs) or Upon receiving to the private banking instructions from system. (BNP), Program the National Bank funds will be disbursed of Panama Reserve to directly from the private banks to the Federal increased their provide liquidity after lending to the private they have new plant and sector for investments equipment, for incremental in finance of construction, working capital, and for mortgages for the houses and buildings. for newly constructed The Program has the resources rapidly, been designed to provide to leverage funds possible, and to to the maximum have the greatest effect extent Additionally, on employment creation. the Program is sufficiently short-term liquidity flexible to to banks that face provide problem through a temporary liquidity discounting bank assets. From the outset, proposed program the reader is advised for Panama will that this transfers be different from which utilize ESF most cash dollar-denominated dollars for external payments to finance U.S. debt service. Panama's imports and nonmilitary As national currency the country's Constitution is called the Balboa. (i.e., forbids issuance money not fully backed of fiat money tender, by hard currency Panama has chosen or gold) as legal money, to use the U.S. while issuing its dollar as its paper the own coins. Thus, the uses of dollars provided Agency's policy on anticipate under an ESF cash a case like transfer did not practical Panama, where the U.S. purposes, the dollar is, for all external currency used for payments. Although both domestic and the credit expansion also be done by A.I.D. subprogram as project assistance, could because of the -4 unique and system-wide problems the program is intended to resolve, and taking into account U.S. interests Panama, and objectives in the Mission proposes that the assistance be provided quick-disbursing as a cash transfer within the context of the broader policy objectives of the overall ESF program. USAIDPanama designed has this program taking into account not only the needs Panama to reactivate of private sector economic activity, but also (1) the representations made to the Congress assistance in justifying to Panama, (2) the guidance received fcom Bureau which the LAC recognizes that the Agency's policy on uses of cash transfer assistance does not neatly fit the Panama, specific case of and (3) consultations with the Regional Inspector General's Office on program accountability and audits. B. Recommendations
USAID/Panama recommends $107.9 authorization of a million Economic Support Fund grant to be disbursed three tranches in to the Government of Panama to assist in country's economic that recovery. The eligible uses of the ESF are to provide funds for: (1) purchasing ICDs to provide permit liquidity to the financing of incremental investment by sector, the private and (2) discounting bank assets or through repurchase agreements to provide temporary liquidity to associated minimize the risk with the lifting of restrictions on term deposits. To implement the program, USAID/Panama requests that the $107.9 million program be authorized as a cash transfer. -5-
II. PROCRAM STRATEGY AND RATIONALE
A. U.S. Interests and C) jectives
As the site of a associated key interoceanic canal U.S. military bases, and of Panama is of great strategic importance to the United States. The U.S.-Panamanian partnership in operating the canal as established Panama Canal Treaties in the 1977 has worked well. This relationship will continue positive to be crucial as we turn complete control of the canal over to Panama, of the a process which by virtue Treaties is to be completed on economic interests December 31, 1999. U.S. in Panama apart from the canal strong: U.S. private investment are also ranking in the country is substantial, among the largest in all objectives of Latin America. U.S. are to assist the GOP to restructure policy and administration government in order to allow functioning of the proper a market economy and political democracy. The U.S. is committed improvement to supporting Panama in the of the country's medium-term growth improvement requires prospects. Such both the immediate reconstruction economy as well of the as the adoption of policies that private sector from will free the the constraints imposed by governments. Some of these previous Panama tasks can be achieved quickly has a skilled and dynamic private as rapidly to sector that can respond incentives. Other tasks may timeframe. Policy require a longer reform - with special attention structure, banking reforms, to tax the labor code, trade and tariff policies, and privatization of designed public enterprise must be well and then implemented over the some areas medium term. Moreover, of policy reform must be institutional strengthening. reinforced through public Care must be taken to ensure that sector activities do not facilitate,.private interfere with, but rather sector initiatives and possibilities.
B. Rationale for Program Assistance The fastest possible economy will recovery of the Panamanian help solidify the country's political stability. It and social is essential that the high unemployment reduced and that the level be erosion of family income be reversed. public perceives the The new Endara government to effectively to address the many be acting political, serious problems it faces in the economic and social spheres. the positive It is essential that public perception be sustained. made a visible The new GOP has departure from the past in debate and consensus-building fostering national as its approach problem-solving. All levels of to democratic society are embracing their new freedoms and have expressed a willingness the economic sacrifices implied to share in in restructuring the economy and -6
its institutions. The strong national goodwill existing at present represents an extremely favorable opportunity for the GOP to make a running start on its economic reform agenda. The GOP needs to take advantage of this opportunity, and it needs to do so quickly. The process of change will encounter increasing difficulties if public support for the GOP is eroded by lack of results and rising social tensions.
The overriding priority for the Panamanian recovery of the economy is judicious injection of additional resources to external revitalize private enterprise and bolster sector investment, public thus stimulating economic activity generating employment. and Quick-disbursing ESF assistance, especially for public sector investment, pressing can address the problem of urban unemployment arid demonstrate population to the that its new government is capahle results. of delivering Public sector investment alone, however, carry the will not day. The resumpcion of private financial central flows is to rebuilding private sector confiden~ce in the and investment Panamanian economy. By pumping liquidity Panamanian into the financial system, quick disbursing assistance non-project will help resuscitate Panama's center. . dynamic banking It is important to note here that were provided if this assistance throuh a traditional project mode, the of injection liquidity into the system would be significantly would seriously slower and compromise our ability to take advantage unique and historical of a opportunity. It was for this reason discussions with tl,.,: the Congress on this program emphasized need to move rapidly the through the use of non-project assistance.
Another essential ingredient in Panama's other donor support. recovery is Panama's relations with IFIs need normalized through to be payment of arrears to trigger a resumption assistance in of support of the GOP's economic program. availability of quick-disbursing The ESF will permit the U.S. to participate in a Support Group to encourage implement the GOP to adopt and its medium-term economic restructuring resolve program and the arrears problem. Thus, the constraints nature of the to the recovery of the Panamanian economy near and - in the longer term - calls for quick relief transfer through cash assistance to alleviate the short-term budgetary liquidity and resource shortages and to encourage adoption reforms of policy to ensure sustained growth in the future. -7-
C. Linkages with Other Program and Project Assistance In analyzing the constraints to the recovery of the Panamanian economy, the Mission, in consultation with the LAC Bureau, determined that the proposed non-project assistance should be authorized and provided under two agreements: one to provide productive liquidity for private sector revitalization (presented in this PAAD), and another (presented in the PAAD for the Economic Reform Program) to provide resources for payment of arrears to the IFIs and budget support for the public sector investment budget. The two progrjms, however, are interrelated and mutually reinforcing which, as noted above, allows for substantive conditionality to be attached only to the Economic Reform Program. They have been separated because of differing arrangements for managing and monitoring the assistance.
The Mission is currently providing project assistance under the Immediate Recovery Project which finances housing for families who lost their homes during the U.S. military action, credit to small businesses that were damaged during that action and subsequent looting, a public works program to repair infrastructure public and generate temporary jobs,-technical assistance in financial management and economic policy formulation, and commodity assistance for several GOP entities. With Supplemental funding, the Mission will also provide project assistance to reinforce long term change in several priority areas. The project portfolio will thus include assistance for improving Panama's police services; strengthening its public administration, focusing on implementation of reforms in the judicial, financial management, and economic policy areas; human resource development; export and investment promotion; and protection of the Panama Canal watershed. These longer term efforts will sustain support for policy reforms, thereby contributing to the longer term development goals in Panama. D. Coordination with Assistance Efforts of Other Donors Panama's mid-term recovery program will require the participation of the IFIs and bilateral donors, preferably within the context of a Consultative Group. Before a formal Consultative Group can be formed, a Support Group will need be brought to together to pledge support for the GOP's economic program, thereby providing some of the resources for the cleparing of approximately $540 million in arrears to the IFIs. Repayment of amounts in arrears will pave the way for normalizing the GOP's relations with the IFIs and subsequently with bilateral donors and commercial creditors. The IMF, which made its preliminary recommendations to the Panamanian authorities during a visit in March and reviewed the GOP's performance again in June, is optimistic that a Stand-by can be agreed to relatively quickly. The conservative budget passed by the Panamanian legislature consistent is with nearly all of the IMF recommendations. The IMF believes the GOP will move forward quickly on the policy agenda unde ,inning a Stand-by and also on measures necessary for an economic recovery loan under consideration for co-financing by the IDB and IBRD. The clearance of arrears should go forward a matter in a months, depending on how quickly the Support Group can be brought together and come forward with the needed amounts.
The plan is for Panama to go directly into a Stand-by once the arrears are cleared. There will be no "shadow program" intermediate step. A Paris Club rescheduling of bilateral official debt will take place after the signing of the Stand-by, as will negotiations with commercial banks to adjust service debt payments to Panama's ability to service its external commercial debt. The GOP has already initiated discussions with its commercial creditors.
An IBRD mission visited Panama in mid-May and left policy agenda a matrix for consideration of GOP officials. That agenda is comprehensive, encompassing measures related to labor the code, a long-term plan for debt management and national recovery, the financial sector, public expenditure, trade and commerce, prices, the tax system, the social security and poverty system, and social sectors. The IBRD will send another mission to Panama later this year to move the policy agenda towards definition of conditionality for the $200 million economic recovery loan to be co-financed by the IBRD and IDB.
The negotiation of the IBRD-IDB program is a key part of the arrears clearing process. One source of resources repayment for of the $540 milliot, in IFI arrears is L $160 million U.S. Treasury bridge loan - a short-term credit likely to extend no more than 180 days. As understood by the Mission, arrears-clearing the plan is for the IMF, the IBRD, and the IDB to disburse a first tranche of $50 million each from respective their new programs to permit timely repayment of the Treasury bridge loan. This plan was discussed briefly with IMF staff during their June visit and remains on the table for further discussion.
The proposed A.I.D. assistance to Panama comrplement will ano reinforce the policy measures of IMF and assistance IBRD-IDB efforts to provide consistent support for Panama's recovery program. As the GOP's policy agenda becomes better defined, USAID/Panama will coordinate with other donors and IFIs to ensure consistency of efforts. -9-
III. RECENT ECONOMIC PERFORMANCE AND FUTURE PROSPECTS OF THE PANAMANIAN ECONOMY
A. Structure of the Panamanian Economy
Panama's economic history is rooted in geography. Situated on a narrow isthmus between North and South America, the country has served as a hub of international business activity, whether commodity trade in Spanish colonial days or banking and transport at present. Panama's success in services providing to the international market is evident in achievement its - despite a narrow resource base - of a per capita income (about $1,649 in 1989) well above those of its Central American neighbors.
The construction of the Panama Canal in 1904 transport the made leading sector of the economy well into the early 1970s. Two additional centers of growth then emerged. Banking services grew rapidly once favorable banking legislation passed was in 1970. According to the World Bank, the sector 11 percent grew by per year during the decade, so that by the early 1980s there were 130 banks active in Panama employing people. over 7,000 Similar growth was seen for economic activity associated with the Colon Free Zone. Warehousing, transshipment and related free zone activities grew by 14 percent per annum during the same period. By 1989, shipping, banking and other private sector services amounted to about eighty percent of GDP. Agriculture and manufacturing are less important than elsewhere in Central America, and only contribute about ten percent each to GDP. The small size of these two sectors results from Panama's comparative advantage for service exports as well as a restrictive policy environment, a commercial policy designed to promote import substitution, price controls, and government intrusion into marketing and production.
The early 1970s were years of relative Panama, prosperity for but the decade ended in recession due to soaring petroleum prics and uncertainties over the renegotiation Canal of the Treaty. By the early eighties, standards of improved living had at all levels including the poorest. Infant mortality, a key indicator of health standards, fell from 59 infant deaths per 1000 live births in 1965 to only 21 in 1981. The number of doctors per inhabitant increased by more than 60 percent in the 1970s. Secondary school enrollment rose over the same period from 39 percent in 1970 to 63 percent by 1981. Economic growth slowed during the decade of the eighties, and further improvement in social indicators was modest. -10-
B. The Panamanian Economy in the 1980s
A feature of the Panamanian economy key to understanding its macroeconomic performance is that the country has no central bank and uses the U.S. dollar as its paper currency. This arrangement means that the number of macroeconomic management tools the country has at its disposal is limited. Monetary policy is restricted to actions by the state to regulate banking, principally through interest rate policy and reserve requirements, but central bank "creation of money" does not occur. Public sector options for financing its deficit from domestic sources are limited to borrowing from local banks or individuals. On the balance of payments side, the government cannot use exchange rate adjustments to bring outflows in line with inflows. Inflation at home is a direct consequence of price movements in international markets.
As was the case throughout Central America, Panama responded to the adverse events in the world economy of the late seventies through expansionary fiscal policy designed to buffer the impact of higher oil prices and the world recession on its population. As also was the experience elsewhere, this strategy did preserve GDP growth for a few years, but at a cost. The deficit of the nonfinancial public sector jumped from marginal levels in the late 1970s to over ten percent in 1982, and increased foreign borrowing led to a public sector debt to GDP ratio of more than 80 percent by 1983.
The increased level of foreign borrowing needed to maintain growth proved unsustainable, and Panama was forced to adopt a strong adjustment program in 1983. Reduction of the public sector deficit accompanied by structural reforms in the areas of agricultural, industrial and labor policy served to increase efficiency and expand output over the next few years. Panama also alleviated its heavy public sector debt burden through reschedulings of commercial and official debt. The adjustment effort was successful, and the economy experienced growth and stability through 1987.
Political developments in the latter half of the decade reversed these hard-won gains. Growing civil unrest and popular demands fuz elections precipitated a political crisis in 1987 which led to the suspension of A.I.D.'s programs with the public sector and the subsequent GOP decision to ask A.I.D. to leave Panama. In February of 1988, the Noriega regime replaced President del Valle after the latter tried to retire General Noriega. The United States imposed econbmic sanctions in April of 1988 to protest the Noriega government's derailing of the democratic process, a step which greatly exacerbated the country's economic troubles. Included in the sanctions were (1) the freezing of payments to the GOP arising from tax -11
revenues of U.S. companies and canal fees, (2) the freezing of the National Bank of Panama (BNP) deposits in the Reserve Federal Bank, and (3) the suspension of the Federal Reserve's check clearing arrangement with the BNP.
Banking center activities quickly collapsed. Beginning in 1987, residents and non-residents withdrew from deposits banks in large amounts. Deposits declined by 11 percent ($300 million) in the period June-December 1987. A detailed more azcount of the banking crisis is given in Section IV of this PAAD.
The impact of the crisis can be seen just in the public as easily finance and balance of payments accounts. On the public sector side, total revenue fell from 31 percent (1985-87) of GDP to 23 percent in 1988. Total current expenditure was only marginally reduced, while capital expenditures were to less slashed than 40 percent of their 1987 level. The public sector deficit ballooned from only 1.0 percent of GDP (1985-87) 10.5 to percent. With no central bank to tap, the only means GOP had the to finance the deficit was nonpayment of external and domestic debt - during 1988, $460 million in external and domestic interest payments arrears accumulated, equal to more than ten percent of GDP.
The external sector accounts tell a similar tale. Panama normally finances its large trade balance deficit with a positive balance on the service and capital accounts. sharp In 1988, drops in inflows from these two sources by necessity caused a reduction in imports. Scarce credit and contraction business of activity led imports to drop from $1,054 million in 1987 to $666 million in 1988. Export earnings also slowed to $305 million in 1988, from $367 million the previous Large capital year. outflows due to the crisis of confidence ir banking, coupled with a shut-off of credit lines and assistance foreign inflows, left Panama with an overall balance of payments deficit of $1.7 billion, or 38 percent The of GDP in 1988. deficit was financed with an accumulation of external payments arrears and, to a lesser extent, with a draw-down of reserves.
In "1989, Panama's economic improve. situation did not Preliminary data suggest that real growth in GDP was just above zero (some estimates are as low as with -3.0 percent), the most positive factor a slight recovery of agricultural the sector. Value-added from mnufacturing and the Colon Free Zone also expanded slightly in real compensating terms, for continued slowdowns in construction, mining and transport services (particularly the oil pipeline). -12-
A small reduction in the deficit of the nonfinancia public sector was achieved in 1989, reflecting furthel contractions of noninterest current expenditures anc investment. As was the case in 1988, the GOP operated without z formal budget. Although state enterprises are engaged in thE provision of critical services including power generation, watez supply and sanitation, the financial constraints imposed by thE economic crisis of 1988 and 1989 precluded maintenance or repair of the capital stock of such enterprises. The deficit was nonetheless large in 1989, at 9.6 percent of GDP, and was again financed through accumulation of external arrears.
On the balance of payments side, the trade deficit grew to $611 million, as businesses restocked their depleted inventories. Net earnings from services fell by about twenty percent, as greater value-added from Colon Free Zone activities was more than offset by further declines in Canal Zone income and other services. Again in 1989 Panama financed its overall balance of payments deficit through accumulation of external payments arrears. By the end of 1989, external payments arrears (principal and interest) totalled $2.4 billion.
In December of 1989, with the surrender of General Noriega, the U.S. government lifted its economic sanctions against Panama. The incoming Endara government inherited an economy in recession and with its public finances in disarray. Civil disturbances and looting that occurred in late December damaged the country's private sector productive capacity (the looting is estimated to have caused losses of over $400 million), while public sector infrastructure was already in bad shape due to several years' neglected maintenance. in addition, the process of structural adjustment and policy reform, begun in the mid-1980s, had been left incomplete and with some backsliding. The new Panamanian leadership has made rapid resumption ..of the unfinished policy reform agenda one of its imperatives.
C. Prospects for the Panamanian Economy in 1990 With its democratic government restored and private sector confidence on the upswing, Panama is poised to achieve rapid economic growth this year and well into the 1990s. Successful reactivation of the economy depends on the ability of the Panamanian leadership to take immediate and decisive action on several key areas of economic policy weakness. These areas are: weak public sector finances; large debt service arrears and a large external debt; lack of international competitiveness for non-traditional commodities; and a banking sector that is not functioning properly and which constitutes a serious constraint to the reactivation of the private sector. The first three problems are discussed in the PAAD for the Economic Recovery Program (525-0303). An analysis of the situation of the banking sector is presented below. -13-
IV. THE BANKING SYSTEM
A. Institutional Setting of the International Banking Center
The national unit of account is the Balboa, par valued at with the U.S. dollar. The Panamanian Constitution forbids the issuance of fiat money as legal tender volume and, although a small of Balboa coins circulate, no Balboa notes are issued. The medium of exchange is the U.S. doliar which is legal tender in Panama.
Panama does not have a central bank, and some of the normal operations of a central bank are divided between state-owned the National Bank of Panama (Banco Nacional de Panama, BNP) and the National Banking Comm.ssion (Comision Nacional, Bancaria CBN). The BNP perEorms normal commercial bank functions but it also carries out a number of the functions of a central bank: it acts as the check clearing house, serves as the fiscal agent for the public sector, holds required the legally minimum reserves of other banks, and handles currency issue via transfers of U.S. dollars to. and from States. the United An important consequence of the monetary system Panama is of that the ability of the authorities to influence the money supply is quite limited. Changes in the monetary base are almost entirely the result of movements in the balance of payments.
The CBN was established in 1970 and is responsible for bank inspection and supervision, and for the licensing of banks. It grants three types of licenses:
1. General banking license, which allows full banking functions.
2. International banking license, which allows only the taking of foreign deposits and the provision of foreign loans. International license banks operate exclusively outside Panama and are subject to minimal regulation. The main requirement for international license banks is to have a paid-in capital of $1.0 million, of which $500,000 must be maintained as a restricted deposit at the BNP. -14
3. Representative banking license, which does not permit any type of banking activity in Panama. The use of the U.S. dollar as a medium of exchange plus an attractive tax environment that does not tax income earned outside Panama (territoriality income tax) and a banking regulatory system established by the Banking Law of 1970 encouraged the creation and rapid growth in Panama of the International Banking Center (IBC). In the early 1980s, the assets of the IBC reached almost $50 billion, which placed it among the 20 largest banking centers in the world. The IBC contributed to the Panamanian economy in two important ways. First, employment in international activities was estimated at 1,300 in 1983, with a total wage bill of about $30 million. Second, the presence of the IBC increased Panama's access to the international capital market.
B. The National Banking System
The National Banking System governn;t-owned consists of two banks, the BNP and the Caja de Ahorros, 14 Panamania-.owned private banks, of which four are basically mortgage banks and about 50 foreign-owned commercial banks. All private ban;,- operate under general licenses, while the BNP and the Caja dz A.. "ros operate under separate legislation. The requirements for getw.al license banks are:
1. Paid-in capital of at least $1.0 million. 2. Reserve funds, including paid-in capital of at least four percent of assets. The CBN is responsible for setting the reserve levels subject to the minimum established in the legislation.
3. Maintenance of minimum reserve requirements established by the CBN for domestic deposits within range a of 5-25 percent. Reserve requirements were set at 12 percent for demand deposits and at 6 percent for time deposits and have never been changed.
4. There are no reserve requirements for foreign deposits. 5. Banks must hold assets in Panama equal to 85 percent of their domestic deposits.
6. Vault cash must be equal~to at least 30 percent of total reserves. -15
7. Reserves must be held as non-interest bearing demand deposits at the BNP, as vault cash and/or as Treasury Bills earning three percent interest.
8. Banks must maintain a contingency credit with a bank outside Panama equal to 10 percent -" earning assets.
9. If a bank exhausts the contingency credit, the CBN can require other banks with general licenses in Panama to participate in a loan to the bank facing liquidity problems in proportion to each banks' earning assets.
These latter two points represent an attempt to establish a lender of last resort within a system that lacks a central bank. In the past, temporary liquidity problems have been accommodated, but the present situation is totally different from past experience. The present situation is different for two reasons. First, the length of restrictions (over two years) on term deposits may result in rapid withdrawals, particularly by foreigners, when those restrictions are ended. Second, the economy is depressed, making it difficult for banks to liquidate assets rapidly.
C. The Banking Crisis
In 1987, after years of steady growth, the banking system was affected seriously by a sustained loss of deposits stemming from political uncertainty and an increasing loss of confidence. In March 1988, the deposits of the BNP at the Federal Reserve were frozen. This action precipitated rapid withdrawals of bank deposits, forcing the authorities to close the banks on March 4, 1988. The banks remained closed for nine and a half weeks.
On March 22, 1988, general license banks with significant offshore operations were permitted to request an additional international license that permitted them total freedom to conduct international operations while the banks remained closed. Additionally, checks and money orders drawn on demand deposits payable to the National Treasury were permitted to be cashed without any restrictions.
On March 28, 1988, the CBN established the withdrawal restrictions that were to be in effect at the reopening of the banks. The guidelines included: withdfawal of demand deposits were limited to 25 percent of the balance as of March 3, 1988, up to $10,000; savings deposit withdrawals were limited to $50 per month; and withdrawals of time deposits were restricted. Restricted deposits could be. used to discharge obligations to the bank holding the deposit. -16-
On April 18, 1988, banks were allowed to open to receive deposits only, and on May 9, 1988, they were allowed to resume all normal banking activities, subject to the restrictions mentioned above. Restrictions were eased steadily during 1988, and on January 1, 1989 all restrictions on demand deposits were lifted.
D. Recent Banking Developments
On April 25, 1990, all restricted savings deposits were freed. These savings deposits totalled $280 million, of which 98 percent were held by Panamanian residents. The reaction of the depositors after the lifting of restrictions represented a clear demonstration of the confidence of the depositors in the system. In the three weeks following the lifting of restrictions, savings deposits dropped by $19 million. They have since recovered by some $3 million which currently puts them at $16 million below what they were on April 25, 1990.
It is quite significant and important that the total level of deposits in the banking system increased during this time period. Therefore eliminating the restrictions on the withdrawal of savings deposits did not result in a reduction of liquidity for the banking system.
The only financial instruments that remain restricted are the term deposits that were in the banking system before March 4, 1988 which amount to $1,263 million. Of this amount, $876 million are held by residents and $387 million are held by non- residents. The restricted term deposLts held by residents are equal to 43 percent of the liabilities of the banking system to the Panamanian private sector. Therefore, continuing to restrict these time deposits results in an important reduction in the liquidity to the private sector.
On May 28, 1990, GOP authorities met with all the bankers to discuss the elimination of all restrictions on time deposits. Bankers were encouraged to prepare for the lifting of restrictions in the very near future and were asked to find market solutions to their liquidity problems. After the meeting, the Banking Commission began visiting each bank to determine if the system was in a position to handle the lifting of restrictions without having a liquidity fund in place. -17-
It was found that banks funds had already estimated the that potentially could be withdrawn once the restrictions are lifted and that those that anticipated liquidity problems were taking the necessary steps to resolve them, including: 1. Negotiating with their depositors to increase the maturity of term deposits.
2. Classifying their portfolio and positioning part of it with foreign banks so that they could have a immediate source of liquidity if needed.
3. Making loans using restricted time deposits as collateral and in this way, locking up a deposit for a longer period of time.
With the knowledge that private banks were already taking the necessary steps to be ready for operating without restrictions any on withdrawal of time deposits, the encouraging news that, between December 1989 and April 1990, private deposits of the banking system had increased by $215 million (11%), and the fact that liquidity had 'also increased 24 percent from at the end of 1989 to 30 percent at the end of April 1990, the GOP announced in early June that restrictions on term deposits would be lifted on July 10, 1990.
In addition to addressing the issue restrictions of lifting on time deposits, there is also a need to provide incremental funding to the banking system which will in turn help "jump start" the economy. During Lhe crisis of 1987-1989, all credit to the private sector was severely restricted. Outstanding loans to the private sector dropped 27% from $3,300 million in December 31, 1987 to $2,400 million on December 31, 1989.
During the first four months of 1990, the level banks' outstanding of loans to the private sector stabilized even though private deposits increased by $215 million. The why there reason has been essentially no increase in lending, despite an increase in deposits, is that banks have been using their incremental deposits to enhance their liquidity positions to be able to confront a potential large draw-down of funds restrictions when on the withdrawals of time deposits are lifted. Any lending that is occurring is secondary and of a short nature, term as banks are matching the. maturities of their liabilities (which are short term) to assets. -18-
Nonetheless, business activity is steadily picking up. Because bank loans have been difficult to obtain, businessmen for the most part have financed the losses that they incurred from the looting that took place in December well 1989, as as their increased inventories and other activities, from suppliers credits and their own resources. The lack of credit, however, imposes a major constraint on the speed of economic recovery.
In order for the economy to grow, the banks will have to carry out their customary function of providing loans to creditworthy clients. There is a pent-up demand for credits since, for some firms, plant and equipment purchases as well as maintenance programs were put on hold during the last two years of crisis. For other firms, plant capacity is sufficient but there is a need for incremental working capital. For reason, this it is important for banks to be able to provide not only working capital but medium and long term credits as well.
Thus, two eligible activities can be carried out the funds with that are provided in this PAAD: (1) the purchase of ICDs to to provide liquidity to permit, the financing of incremental investment by the private sector, and (2) providing liquidity to the banking system through discounting assets or repurchase agreements to minimize the risks associated with the lifting of restrictions on term deposits. -19-
Table I
LIQUID ASSETS AND TOTAL DEPOSITS (B/000,000)
Dec. Dec. April Change Banking Group 1986 1989 1990 12/89-4/90 Banking System Liquid Assets 9,852 1,877 2,636 40% Deposits 26,665 7,830 8,716 11% (Liquidity) 37% 24% 30% State-Owned Banks Liquid Assets 408 170 539 217% Deposits 1,180 1,342 1,726 29% (Liquidity) 35% 13% 31% Foreign-Owned Banks wI General License Liquid Assets 8,812 1,450 1,801 24% Deposits 23,964 5,443 5,917 9% (Liquidity) 37% 27% 30% Private Panamanian Banks Liquid Assets 632 257 295 15% Deposits 1,521 1,045 1,073 3% (Liquidity) 42% 25% 27% Mortgage Banks Liquid Assets 351 95 171 80% Deposits 994 744 805 8% (Liquidity) 35% 13% 21%
Source: Comision Bancaria Nacional -20-
V. PROGRAM DESCRIPTION
A. Objectives of the Program
The economy of Panama has been under severe strain during the last three years, and particularly since the banks closed in March, 1988. Significant progress has been made since the Endaia government took office, but rapid self-sustained growth will depend on the reactivation of the private sector, and this will require an increase in the liquidity available to the economy and a fully functioning banking sector. The purpose of the program is to provide immediate liquidity to the economy and to reactivate the banking system to permit an increase in credit to the private sector in Panama.
B. Introduction
The money supply in Panama must increase in order to have sufficient liquidity to finance the higher level of transactions needed for economic growth to resume. The $876 million in restricted deposits of Panamanian nationals represents 43% percent of the total private deposits (deposits of the Panamanian non-bank public) in the banking system. This reduction in liquidity of the private sector constrains the reactivation of the private sector in a critical way. In addition, bankers are acting to enhance theiL liquidity positions (and thus reduce or maintain the r loan portfolio unchanged) in order to have sufficient liquidity to meet the demands of their depositors when the restrictions are eliminated on July 10, 1990.
The risk that this entails is that withdrawals by depositors in some banks could exceed liquid assets and could trigger a run on some of the banks. As Panama does not have a central bank Lhat can perform the role of a lender of last resort, a bank run could only be stopped by establishing new restrictions on withdrawals, and the restrictions might have to be extended to all deposits in the system. This risk is even greater because Panama does not have deposit insurance. A resumption of restrictions on deposits would be the only policy tool available to the authorities, but restricting deposits again could bring dire political and economic consequences. Therefore, it would not be prudent to lift restrictions on time deposits without having a mechanism designed to inject liquidity to the system rapidly. At the same time, it is important to increase the loanable funds in the banking system to permit an increase in the lending activity of the b5anks. Data on the banking of system for the first four 1990 shows a scenario that months Panamanian is cautiously optimistic. deposits have increased Private increase by $215 million, an from December 1989, and 11% banking liquidity ratios of the overall system have increased from 30% 24% on December 31, on April 30, 1990. The 1989 to in former demonstrates that the banking system is returning confidence while the latter demonstrates the prudent practice that bankers are taking to maintain a level of liquidity as as high possible until the banking stabilizes. system
C. Risk Analysis Re:.tricted $1,263 term deposits presently million. Of this amount, total loans $302 million are guaranteeing in the banks where the deposits are not subject are being held and thus to withdrawal. Therefore, are "free" for withdrawal term deposits that amount to $961 million. summarized in The data are Tables 2, 3, and 4, presented $961 million in "free" below. Of the deposits, $766 million are banks and $195 in private million in state-owned banks.
The GOP, using its own liquidity to the state-owned resources, will provide banks (the BNP and Ahorros) when the restrictions the Caja de on time deposits are This approach would be similar lifted. to the one taken when deposits were freed and the savings the GOP stood ready to provide to the liquidity Caja de Ahorros and the BNP. Some private banks when the restrictions may require temporary liquidity on deposits are lifted. restricted deposits in Total "free" private banks amount to which $429 million are $766 million, of in private Panamanian banks the CBN 1/ as (defined by banks that do not have headquarters in another their corporate country) and $337 foreign-owned banks. million in We believe that foreign-owned be supported by their headquarters banks will if there is a the liquidity of their need to enhance banking operations in Panama want to keep their operations as they will need in the country. Therefore, for liquidity will be limited the holding to private Panamanian banks $429 million in "free" restricted deposits (see Table 4).
1/ The CBN will empower its Executive Director to carry out all the implementation activities that have been assigned to it under this Program. -22-
If the period during which restrictions on time deposits have been in place is considered a stand-still and restrictions are eliminated in early July 1990, then, as shown in Table 5 below, about $295 million of deposits in private Panamanian banks would be subject to withdrawal through October 31, 1990 (the first 120 days after restrictions are lifted). -23-
TABLE 2 TOTAL RESTRICTED TERM DEPOSITS IN GENERAL LICENSE BANKS (8.000,000) (AS OF APRIL 30, 1990) 5/1/90 to 8/1/90 to 11/1/90 4NAMANIAN OWNED & Of which 7/31/90 10/31/90 Beyond TOTAL Resident Non-Resider rivate Commercial 141.3 rivate Mortgage 98.8 80.7 320.8 56.6 92.9 170.1 150.7 104.5 254.0 237.4 Total Private 16.6 9. .16. tateowned 94.2 81.8 40.2 216.1 208.5 3TAL PANAMANIAN 7.6 7.54 6. ]REIGN OWNED 239.1 188.6 44.8 472.5 )TAL 258.1 214.4 ======531.2 = = ...472===. ."5. 462.1 270.2 ------1,263.4 875.7 )TAL PRIVATE ------387.7 437.0 380.3 -- 230.0 1,047.3 666.6 380.7 iurce : Comision Bancaria Nacional - -...... -- -24-
TABLE 3
DEPOSITS USED AS COLLATERAL IN GENERAL LICENSE BANKS (B.,000000) (AS OF APRIL 30, 1990)
5/1/90 to 8/1/90 to 11/1/90 & Of which 7/31/90 10/31/90 Beyond TOTAL Resident Non-Resident kNAMANIAN OWNED :ivate Commercial 45.9 41.5 50.5 137.8 110.2 27.6 ivate Mortgage 4.4 2.9 0.5 7.8 6.3 1.6 Total Private 50.2 44.4 51.0 145.6 116.5 29.1 :ate-owned 4.0 11.4 5.8 21.2 17.0 4.2 )TAL PANAMANIAN 54.3 55.8 56.8 166.8 133.5 33.4 )REIGN OWNED 85.2 46.0 4.4 135.6 108.5 27.1
)TAL 139.4 101.8 61.2 302.4 241.9 60.5 ------m------m------M------)TAL PRIVATE 135.4 M--- 90.4 55.4 281.2 225.0 56.2 ate: Assumes that 80% of deposits used as collateral is by residents. )urce: Comision Bancaria Nacional -25-
TABLE 4 FREE TERMS DEPOSITS IN GENERAL LICENSE BANKS (B.000,000) (AS OF APRIL 30, 1990) 5/1/90 to 8/1/90 to 11/1/90 & Of which 7/31/90 10/31/90 Beyond TOTAL Resident Non-Residen PrivatePANAMANIAN OWNED Commercial 95.5 57.3 Private Mortgage 30.2 183.0 59.9 52.2 90.0 104.0 123.1 246.2 231.1 15.0 Total Private 147.7 147.3 134.3 429.2 291.9 137.3 State-owned 90.1 70.4 34.3 194.9 191.6 3.3 TOTAL PANAMANIAN 237.8 217.7 168.6 624.1 484.1 140.0 FOREIGN OWNED 153.9 142.6 40.3 336.9 149.7 187.2 TOTAL 391.7 360.3 208.9 961.0 TOTAL PRIVATE 633.8 327.2 301.6 289.9 174.6 766.1 441.6 324.5
Source: Comision Bancaria Nacional TABLE 5 STRUCTURE OF RESTRICTED TERM DEPOSITS IN PANAMANIAN BANKS (B.000,000) (AS OF APRIL 30, 1990)
5/1/90 to 8/1/90 to 11/1/90 & 7/31/90 10/31/90 Beyond TOTAL TOTAL RESTRICTED DEPOSITS Private Commercial 57.3 30.2 Private Mortgage 183.0 90.0 104.0 246.2 231.1 Total Private 197.9 191.7 185.2 574.8
State-owned 90.1 70.4 34.3 194.9 TOTAL 217.7 168.6 624.1 484.1 DEPOSITS USED AS COLLATERAL Private Commercial 45.9 41.5 50.5 Private Mortgage 137.8 4.4 2.9 0.5 7.8 Total Private 50.2 44.4 51.0 145.6 State-owned 4.0 11.4 5.8 21.2 TOTAL 54.3 55.8 56.8 166.8
"FREE" DEPOSITS Private Commercial 95.5 57.3 30.2 Private Mortgage 183.0 52.2 90.0 104.0 246.2 Total Private 147.7 147.3 134.3 429.2 State-owned 90.1 70.4 34.3 194.9 TOTAL 237.8 217.7 168.6 624.1 ------
Source: Comision Bancaria Nacional -27-
Data available do not permit a segregation of domestic foreign from depositors according to the term structure of the deposits. If it is assumed that the structure is the same both for types of depositors, then the deposits due in 120 days can be broken down into about $200 million held by residents $100 million and held by non-residents. The CBN has carried out a survey of the potential needs of each bank and a reassessment of any potential solvency problems, and has concluded that have banks enough liquidity to meet the demands for withdrawals from their depositors. Nevertheless, GOP authorities believe that the Private Sector Reactivation Program must flexible be sufficiently to provide temporary liquidity to those private banks that require it. The Mission supports this position.
D. Mechanism to Provide Li iidity to Private Banks Although the liquidity of the banking system has increased since December, 1989, anC a reasonably high level of confidence exists, it might be necessary to provide liquidity some to private Panamanian banks to avcid a bank run. Even if there are no massive withdrawals of funds when the restriction on time deposits is lifted, there is alsb an urgent increase need to the lending activity of banks. The GOP has proposed to begin a Private Sector Reactivation Program (the Program) strengthen to the banking system and to provide resources to the private sector. U.S. support for this program is essential stabilize to the banking system and to mitigate against the possible run on banking deposits. The Program would have the following characteristics:
1. Policy Guidance
Policy guidance, including eligibility and criteria terms and conditions of participation in the program, will be provided by the Consejo Economico Nacional (CENA) following the guidelines laid out in the Program Agreement. The CENA is composed of the Minister of Planning, the Minister of Finance, the Comptroller General of the Republic, the General Manager of the BNP, and a representative of the President of the Republic (at this time the President's representative is the Minister of Commerce and Industry).
2. Financing and Management of Funds
An interest bearing account will be opened at the Federal Reserve Bank of New York in the name of the Republic Panama. of Funds for this account will be provided by the $107.9 million grant proposed in this PAAD and will not commingled be with other funds. The grant will be disbursed to this account in three tranches after the respective conditions precedent are met. The flow of funds from this account is shown in Diagram 1. -?8-
Diagram No. 1
FLOW OF FUNDS - PRIVATE SECTOR REACTIVATION PROGRAM
U.. rsury
Conditions precedent to disbursement met
I Federal Reserve Bank Separate Account
Semiannual -- --. Concurrent audits by financial RIG ------review by private CPA firm contracted by USAID/P
Disbursement Disbursement on exception basis for incremental lending
End UseI End Umes Short Term Purchase IC~s to finance Repurchase Agreements _ new credits to the private for High Quality Rflow credits to the private Assets used as sector for investments ins Collateral
(Private Panamnian Banks) - Agriculture - Cderce - Industry - Construction - Privatization
(Participating Bank)
------e------
Banking system Increased credit normalized and Fullfillment of flows to reactivated the - - - Program Purpose -- - private sector for new. investment -29
3. Financial Agent
The Banco Nacional de Panama will be the financial agent for the Republic of Panama. Withdrawals the account from. at the Federal Reserve Bank of New York will be carried out only under instructions from the BNP
4. Participating Banks (PBs) All private banks with general will participate licenses in Panama in the credit expansion sub-program, while only Panamanian private banks will participate in the liquidity sub-program. Before entering into each transaction, will the PBs sign the legal documents designed by the GOP for purpose this and adhere to the regulations laid out in the Operations Manual.
5. Types of Operations under the Program Two types of activities will be main activity carried out. The will support to the banking system which will permit an increase in credit by the private Additionally, banking system. as an exception, the Program may provide short term liquidity to banks that may require additional liquidity to meet the demands of their depositors. Access to the program the two types for of activities will be limited for each bank to a level equal to the bank's paid-in capital (see Table 6)
a Credit Expansion Sub-program: Criteria and Procedures
Banks that plan to expand their medium and long term loan portfolio (loans of between one and will five years) submit to the BNP a description of the incremental lending that they plan to make within the next 30 days. This lending must be for investments in new plant and equipment, construction, for for mortgages for newly constructed buildings, or for incremental working capital. If the proposed loan meets the portfolio eligibility requirements of the Program, the BNP will agree to purchase interbank certificates of deposit (ICDs) from the PB equal to one half the value of the portfolio. commitment A fee of 0.5% will be charged to those PBs wanting assurances that funds will be available when they submit packages. their The period cf commitment will not exceed 30 days. After the PB makes the a(iitional loans, it will submit all documentation to the BNP arid the BNP will purchase ICDs amount in an equivalent to one half of the value of the loan portfolio. These ICDs will pay an interest LIBOR rate of six-month plus at least one percent (LIBOR plus one percent historically has hppn s-ha r-,m -=24A -30-
Table 6 PAID-IN CAPITAL OF GENERAL LICENSE AND OFFICIAL BANKS (B/.000,000) (As of April 30, 1990)
------Type of Bank Paid-In Capital
OFFICIAL 51 PRIVATE Foreign-Owned 261
Panamanian Owced 87
TOTAL 399
Source: Comision Bancaria Nacional for interbank deposits in Panama), and will match the average the maturity of the ICDs repayment period of the portfolio package. The respective loan agreement PB issuing the ICD will that it will meet enter into an the terms of the ICD regardless any claims that it may have of against the BNP or the GOP. If CENA may the funds are not being instruct the BNP to increase used rapidly, the the PB the proportional value ICD from 50% of new loans of This to up to 80% of new change would require the loans. prior approval of the USAID. b. Short Term Liquidity Sub-program: Criteria and Procedure,
deposits, With the lifting of restrictions some banks may require on time demands temporary liquidity to of their depositors. As meet the the GOP discussed above, the USAID agree that it will be important and the flexibility for this Program to to help meet that demand. have exception basis, Therefore, on an the Program will make funds short-term liquidity needs. available to meet liquidity In order to receive this support, banks will temporary The BNP discount portfolio with will be responsible for the BNP. for these assuring that the assets transactions are of the used provide resources highest quality, and will equal to a maximum of 50% of the asset. Access of the market value to the funds of the purpose will follow the Program for this modalities eligibility criteria, and guarantees established conditions, of these by the CBN. The objective procedures will be to ensure, that the funds of to the extent possible, the Program are not lost failure. The interest rate because of a bank to for these transactions will 90-day LIBOR plus at least be equal 13 percent, five percent, or a minimum whichever is higher. This of will establish "penalty" interest rate this sub-program as a "lender The maximum time period of last resort". for which funds will particular Panamanian bank be lent to a under this subprogram will days. be 120
6. Administration and Audit A Program Management established at the Banco Unit (PMU) will be will Nacional de Panama (BNP). be headed by a senior This unit assistants. credit specialist and These individuals will by two staff and will be drawn from existing BNP be transferred from their fill these positions current assignments to on a full time basis. As of the BNP, they will regular employees have the experience necessary the functions of the unit. to carry out access They will also have the other expertise within the ability to formal financial BNP should it be necessary. assessment of the A local CPA firm PMU will be performed and reviewed by the USAID by a Controller prior to the first disbursement of funds. -32-
The unit will be responsible for the activities: determining following if a loan meets the guidelines of Program; guaranteeing the the purchase of ICDs for banks that require that guarantee and that pay a instructing commitment fee; the Federal Reserve Bank of New York to disburse funds; and maintaining the accounting records of the unit. a bank requests When liquidity support, the PMU will carry out an analysis of the asset(s) that will be discounted. The PMU will carry out the analysis of the asset(s) using its using own staff or credit analysts from other units within the BNP. BNP acquires If the an asset because a PB does not meet the terms of liquidity support a activity, the PMU will also be in charge of disposing of the asset. The PMU will providing be responsible for periodic progress reports to the USAID. The costs the of PMU, which will be approved by the CENA anc the USAID be financed will from a portion of the interest paid on the ICDs purchased by the BNP.
7. Reflows
Reflows from the program interest will be kept in an bearing separate account at the BNP and, for a period of two years from the date of signing the Program will be Agreement, used in their entirety, including principal, interest and commitment fees earned, to purchase ICDs under the Program. Beginning in year 3, the funds may be used non-military to: (1) pay USG bilateral debt, (2) pay IFI debt (3) purchase and/or additional ICDs. Funds can be used to pay IFI debt only if the size of the reflows exceed the annual requirement debt service of U.S. bilateral non-military debt. The CENA, with USAID concurrence, will be responsible for proportion deciding what of reflows will be used for each of these eligible uses.
The rate of transfer of the reflows back to the GOP will depend on the maturity dates of the ICDs outstanding the end of at year 2, as well as on the number of new ICDs purchased after year 2. Such purchases, however, will be programmed so that, by the end of year 7, all funds will be returned to the GOP and used to pay debt.
Uses other than those described above will require A.I.D. approval. Further, prior to any withdrawls the separate from account in the BNP after the second year, (except for payment of U.S. bilateral non-military debt) A.I.D. and the GOP will carry out a review of progress made on of the Government Panama's economic program. Withdrawls will be subject joint to a determination of satisfactory progress on the economic program. -33
8. End Use and Tracking of A.I.D. Funds Section requires 592 of the FY 1990 that if A.I.D. provides Appropriations Act sector assistance, cash transfer or nonproject the recipient country "maintain such funds will be required to with in a separate account and any other funds." Because not cmmingle them to provide the purpose of this program immediate liquidity to is the cash transfer the economy, the end uses dollars are the purchase of deposit or the rediscounting of certificates of of commercial paper. track and monitor the dollars A.I.D. will receiving only to their end uses; private banks will immediately and the with other resources commingle these dollars of those banks. In other will require that the words, A.I.D. uncommingled dollars be maintained accounts only before in separate the funds are used to purchase CD's or to rediscount paper. A.I.D. any individual dollars cannot be traced loans, groups of or tracked into participating loans or other uses made banks. Accordingly, A.I.D. by GOP to apply any of will not require the the requirements (such as nationality rules; restricted source ,origin and lending commodities- rules; and policies) normally applied insider intermediate credit to A.I.D. financed projects. To do otherwise convert this cash transfer would in effect program into project thwart achievement of and thereby liquidity. the purpose of providing An ICI project would immediate disburse. probably take years Such a delay would be inconsistent to objectives of with the goals and this program. Thus, A.I.D. monitor, audit, or account cannot and will not for any of the loans made private banking system. by the
Section 592 (b) (2) and nonproject assistance provides that cash transfers nontwithstanding may be obligated provisions of and expended of this law inconsistent with the assistance. As noted above, nature A.I.D. ICI the application of project regulations to normal achievement of this program would thwart the purposes of this assistance inconsistent with and would thus be the nature of this assistance. E. Monitoring
The effect of the Program on the level outstanding of loans at a given bank will depend on each bank's liquidity position. The effect on the banking system and on the economy must be measured by the medium term effect of the total level of loans outstanding. Therefore, program success will be measured on the basis of the annual increase in loans outstanding to the private sector. The base line for comparison will June be 30, 1990. Evaluations of the Program impact on credit availability will be carried out at the end of years one and two.
F. Duration of Program
The length of the program, in terms of purchasing ICDs with funds from the Separate Account, will be 24 months. If there are any undisbursed funds remaining in the Account Separate in the Federal Reserve Bank after this time period, the GSOP and A.I.D. will jointly agree on uses for these Potential funds. uses include providing additional liquidity to the private sector or paying arrears on U.S. non-military bilateral debt or debt to IFIs.
G. Program Conditionality
Significant conditionality, including policy reforms that will impact favorably on private production attached and trade, is to the Economic Recovery Program (525-0303). Because of that conditionality and given that there is an urgent need to provide incremental credit to the banking and private immediately, sectors the Private Sector Reactivation Program will have significantly less conditionality attached to it.
1. Conditions Precedent to Disbursement
The Grant Agreement for this program will contain the following conditions precedent to each disbursement: (a) First Disbursement ($36 million)
(1) Establishment of a separate, interest-bearing dollar account in the Federal Reserve Bank of New York;
(2) Establishment and staffing of the Program Management Unit in the BNP; -35
(3) Presentation of a legal opinion that the ESF agreement is a binding agreement for the GOP, and of specimen signatures of the designated Panamanian officials who will sign grant-related documentation.
(b) Second Disbursement ($36 million)
Evidence that funds from the first tranche have been fully committed in accordance with the objectives of the Program.
(c) Third Disbursement ($35.9 million)
Evidence that funds from the second tranche have been fully committed in accordance with the objectives of the Program.
As discussed elsewhere in this PAAD, conditions other previously contemplated for this program -- e.g., GOP commitment to measures to prevent money laundering and agreeing to a date to lift restrictions on time deposits -- have already been satisfied by the GOP and, therefore, need not be included as conditions to disbursement. However the GOP will be asked to provide A.I.D. with an analysis of the availability and use of medium and long term credit in the banking system as part of their submission to meet the conditions to disbursement of the second and third tranches of the grant.
2. Covenants
The grant agreement for this program will also contain the following program-specific covenants:
(a) The GOP will agree to take the necessary actions to modernize banking regulations to permit greater flexibility in areas such as maximum interest rates that can be paid on certain accounts, interest rate futures and other financial innovations that have been adopted in international financial markets since 1970.
(b) The GOP will agree to take the necessary actions to strengthen the bank supervisory role of the National Banking Commission in areas such as bank auditing and ability to examine and determine the quality of banks' portfolios. -36
3. Condition Precedent to Disbursement of Funds from the BNP Separate Account After Year 2:
Prior to disbursement of funds from the BNP separate account after two years from the date of signing of the Grant Agreement, A.I.D. and the GOP will carry out a joint review of progress on implementation of the GOP's Economic Recovery Program. Disbursements of reflows held in the separate account in the BNP established for this purpose will be subject to a determination by A.I.D. of satisfactory progress on the Economic Recovery Program.
H. Program Accountability
1. The Separate Account
Once the respective conditions precedent to each disbursement have been met, A.I.D. will disburse the corresponding amounts of the cash transfer into an interest-bearing Separate Account opened by the GOP in the Federal Reserve Bank of New York. Interest earnings of the Separate Account will be used for the same authorized purposes of the ESF grant. The grant agreement will specify that the ESF grant funds and any interest earned on those funds will not be commingled with any other funds in the Separate Account.
Upon instructions to the Federal Reserve Bank by the BNP, the ESF dollars will be drawn down, as needed, to finance eligible uses (i.e., to purchase ICDs to provide funds for incremental financing by private banks, or for entering into repurchase agreements or discounting bank assets). Withdrawals from the Separate Account will go directly, via electronic transfer, to the recipient bank. The use of ESF dollars for purchasing ICDs or discounting bank assets/or entering into repurchasing agreements with the BNP will constitute the identifiable end uses of the ESF. In other words, the ESF funds, once withdrawn from the Separate Account for the eligible uses will have accomplished their end use purpose. At that point, the funds will become commingled with other resources of the recipient banks and, thus, further tracking will not be possible. Because of the need to inject resources into the banking system rapidly, A.I.D. will not approve a priori the withdrawals from the Separate Account. However, as indicated below, USAID/Panama will make arrangements for a concurrent non-federal audit of withdrawals from the Separate Account. -37
2. Program Audits
The supplemental appropriations legislation, P.L. 101-302, requires the Inspector General Office to carry out semiannual audits of the ESF grant funds used for cash transfer assistance to Panama. In addition to such audits, USAID/Panama proposes to use approximately $100,000 in ESF funds to finance a concurrent non-federal audit of withdrawals from the Separate Account and corresponding ESF-financed transactions. This non-federal audit will be done under a USAID direct contract with a CPA firm in Panama and will assist USAID's monitoring and tracking efforts.
3. Reports
The GOP will provide USAID/Panama with a monthly statement on the Separate Account, copies of telex orders relating to withdrawals from the Account which indicate the recipient bank, the number of ICDs opened, any repurchase agreements or discounting of bank assets that have been carried out, and copies of telex receipt of funds from the recipient bank. With this documentation, USAID will track and monitor that funds are being used only for eligible transactions. The grant agreement will contain a redeposit clause in the event that a withdrawal from the Separate Account is made for an ineligible use.
4. Adherence to Guidance
The financial management system USAID/Panama proposing is was reviewed with staff of the Regional Inspector General Office for its conformity with the foreign assistance legislation and A.I.D. policy. In reviewing the Mission's approach to financial accountability of the proposed eligible uses of this ESF program, the RIG staff considered that since the ESF dollars would be kept in a Separate Account, the use of the ESF for financing transactions designated as eligible uses would be identifiable and further tracking would not be possible or necessary. In accordance with P.L. 101-302, A.I.D.'s financial management and administrative system consists of: the Separate Account, program audits (both federal and non-federal), GOP financial reports, and USAID/Panama program monitoring. Through the use of these tools, the Mission will have reasonable assurance that this cash transfer will reach participating banks and fund the activities for which it is intended. -38
in addition, preliminary discussions between the Mission and the LAC recognized the proposed non-project transfer cash mode of assistance to be appropriate because of the unique and system-wide liquidity problems the program intended is to resolve, and because Congress intended the assistance to be quick-disbursing ESF resources for reactivating the private sector. While the Bureau noted that providing assistance the as a cash transfer might require a policy exception by the Agency to permit the use of ESF dollars for import other than financing or servicing of external debt, further review by LAC and PPC concluded that the proposed use of the ESF cash transfer is not inconsistent with agency cash transfer policy. I. Status of Negotiations and Program Timetable 1. Status of Negotiations
The GOP intends to lift restrictions on time deposits on July 10, 1990, hence the program arrangements implementation and resources have to be put in place as quickly as possible. USAID/Panama and the GOP, including the developed CBN, have the mechanism for providing this assistance as described above in Section V.D. The GOP has also engaged banking the sector in the discussions and parameters for addressing the risks inherent in lifting restrictions on Therefore, time deposits. implementation of the program is ready to proceed. Once the PAAD has been authorized, the ESF grant agreement will be signed. USAID/Panama estimates that signing can take place within a few days of program authorization.
2. Program Timetable
USAID/Panama has prepared the following illustrative timetable of the likely timing of the signing implementation and of the program. The schedule as shown represents an optimistic scenario where the steps that A.I.D. (PAAD must take review and authorization) as well as the GOP (meeting conditions precedent to disbursement) are handled as expeditiously as possible.
DATE ACTIONS
5/30/90 USAID/Panama cables the Congressional Notification for this program and ESF apportionment request to AID/W. 6/1/90 ESF funds apportioned by OMB.
AID/W sends Congressional Notification forward to Hill. -39
6/7/90 USAID/Panama sends Program Assistance Approval Document to AID/W. 6/16/90 Congressional Notification Expires. USAID/Panama identifies CPA firm concurrent to carry out non-federal audit of ESF-financed transactions. 6/29/90 USAID/Panama sends revised Program Assistance Approval Document to AID/W. 7/6/90 Program Assistance Approval Document reviewed and approved in AID/W. 7/10/90 USAID/Panama receives cable authorizing program.
Contract ready for signing with CPA firm for concurrent non-federal audit. 7/11/90 Grant agreement is signed. 7/12/90 Conditions precedent to disbursement are met and request for disbursement is made.
Contract with CPA firm signed. 7/12/90 First tranche of ESF disbursed into Separate Account. Concurrent non-federal audit ESF-financed of transactions begins. 7/15/90 Contract ready for signing with CPA firm for concurrent non-federal audit. 1/91 RIG initiates first semiannual audit of the ESF program. 7/91 RIG initiates second semiannual audit of the ESF program. 1/92 Program ends. 1/92 RIG initiates final semiannual audit of the ESF program. AGENCY FOR INTERNATIONAL DEVELOPMENT
WASHINGTON DC 20523 '
LAC-IEE-90-41
ENVIRONMENTAL THRESHOLD DECISION
Project Location : Panama Project Title Private Sector Reactivation Program Project Number . 525-0304 Funding $107.9 million (ESF) Life of Project 2 years (FY 90-92) IEE Prepared by John 0. Wilson LAC Deputy Environmental Officer Recommended Threshold Decision Categorical Exclusion Bureau Threshold Decision Concur with Recommendation Comments . None Copy to Jeffrey Evans, Acting Director LAC Office of Development Resources Copy to : Toni Wagner, LAC/CEN Copy to Mark Silverman, LAC/DR/CEN Copy to : Lawrence Odle, LAC/DR/CEN Copy to IEE File
A4p. c(t Date JUL 10 1990 John 0. Wilson Deputy Environmental Officer Bureau for Latin America and the Caribbean
.4/ AGENCY FOR INTERNATIONAL DEVELOPMENT WASHINGTON. D C 20523
INITIAL ENVIRONMENTAL EXAMINATION
Project Location: Panama
Project Title: Private Sector Reactivation Program
Project Number: 525-0304
Funding: $107.9 million (ESF)
Life of Project: 2 years (FY 90-92)
IEE Prepared by: John 0. Wilson LAC Deputy Environmental Officer
Recommended Threshold Decision:
a. Recommendation:
The Private Sector Reactivation (PSR) program consists of $107.9 million in Economic Support Funds to be provided in FY 1990 as cash transfer assistance. The purpose of the program is to provide immediate liquidity to the economy and to reactivate the banking system to permit an increase in credit to the private sector in Panama. This program complements and reinforces the recently approved Economic Recovery Program, which provided balance of payment support to the public sector. Under the PSR program, once the respective conditions precedent to each disbursement have been met, A.I.D. will disburse the cash transfer into an interest bearing separate account in the name of the GOP in the Federal Reserve Bank of New York until needed for eligible end-use transactions. Two types of activities will be carried out. The main activity will support credit expansion by the private banking system. Additionally, as an exception, the PSR program may provide short-term liquidity to banks that may require additional liquidity to meet the demands of their depositors. Tracking of dollars will end with their disbursement from the Federal Reserve Bank of New York to the participating banks to support eligible uses approved under the program. i.e. to purchase certificates of deposit or provide short-term liquidity to private banks. Under this program assistance, A.I.D. will not have approval rights over specific projects or activities to be financed by banks nor will A.I.D. provide guidelines for prioritization, but will rely on the normal activity selection process established by the banks. Pursuant to A.I.D. environmental regulations [22 CFR 216.2(c)(i)(ii)], no further environmental review is required and a categorical exclusion applies when:
"A.I.D. does not have knowledge of or control over, and the objective of A.I.D. in furnishing assistance does not require, either prior to approval of financing or prior to implementation of specific activities, knowledge of or control over, the details of the specific activities that have an effect on the physical and natural environment for which financing is approved by A.I.D."
Based on A.I.D. regulations in Handbook 3, Chapter 2, it is recommended that no further environmental study be undertaken for this PAAD and that a "Categorical Exclusion" be approved.
Concurrence: \ b, " ._ Jeffre / Vtns; Acting Director
Officeof'Development Resources
470