OREANDA-NEWS. Fitch Ratings has affirmed Panama's Long-term foreign- and local-currency Issuer Default Ratings (IDRs) at 'BBB'. The issue ratings for Panama's senior unsecured foreign and local currency bonds are also affirmed at 'BBB'. The Outlooks for the Long-term IDRs are Stable. The Country Ceiling has been affirmed at 'A' and the Short-term foreign currency IDR at 'F3'.

KEY RATING DRIVERS

Panama's rating affirmation and Stable Outlook reflects the following factors:

Panama's ratings are supported by the continued outperformance of its dynamic and diversified service-based economy. Fitch forecasts that growth will average around 6% in 2014 - 2015, the highest rate in the 'BBB' category, supported by the Panama Canal expansion and its spillovers into other logistics activities. Rising foreign direct investment into mining, energy and tourism sectors could further diversify the economy. Trade openness and a favourable business climate underpin prospects for the private sector, though Panama's designation on the OECD 'grey list' for inadequate controls on illicit financial activity poses reputational risks for some globally-integrated financial and business services.

Growth moderation has mitigated risks of overheating. Inflation has slowed to a pace in line with peers and thus more favourable for the dollarisation regime. However, real wage increases in recent years could sustain pressure on domestic demand and inflation. Rising food prices led authorities to impose price controls in mid-2014, though these are temporary and limited in scope. Credit growth remains in line with nominal GDP, and risks of asset bubbles are mitigated by prudent bank lending practices. The current account deficit remains relatively high, though it continues to be financed by broad-based foreign direct investment and should decline on lower oil prices and conclusion of the Canal expansion.

The fiscal deficit has widened in recent years, reflecting an ambitious public investment program that is putting increasing pressure on current spending. Election-related expenditure and revenue underperformance amidst administrative shakeups at the tax agency led to a hike in the deficit ceiling from 2.7% to 4.1% of GDP in 2014. Fitch notes that Panama's repeated hikes in deficit limits and these recent issues in tax administration have weakened the credibility of fiscal policy.

Fitch expects the authorities will be able to narrow the non-financial public sector deficit to 3.7% of GDP in 2015 and 3.3% in 2016. This is a slower consolidation than previously anticipated as the fiscal law will allow higher deficits to compensate for the delayed revenue windfall from the Canal. The authorities intend to reduce the deficit though rationalisation of electricity subsidies, under-execution of some investment projects and improved tax collections. Faster consolidation will be inhibited by rising current spending commitments, the new administration's social spending priorities, and payments due on 'turnkey' infrastructure projects. The expanded Canal will boost fiscal revenues by a projected 1% of GDP by 2018, though this windfall is much lower than originally expected, posing a challenge to medium-term fiscal planning.

General government debt inched upward to 38.3% of GDP in 2014 from 36.7% in 2013 amidst higher primary fiscal deficits and slower growth. Fitch expects the debt burden to stabilize in line with the 'BBB' median of 40% in 2015 - 2016, assuming authorities are able to comply with the gradual consolidation path in the fiscal law. Refinancing and market risks are mitigated by a long-dated debt profile and solid access to multilateral lenders and global capital markets. Panama's sovereign wealth fund, with 3% of GDP in assets, represents a fiscal buffer uncommon for a non-commodity exporter, though its framework may need to be amended to ensure further build-up of assets from the Canal revenues as originally intended.

Panama ranks below peers in governance indicators of rule of law and control of corruption, issues that have weighed on government effectiveness and contributed to fiscal slippage. President Juan Carlos Varela won the 2014 election on a platform of improving accountability, rule of law, control of corruption, and transparency in public contracting. Major institutional reforms requiring legislative approval will be challenging given the small representation of the ruling party in the National Assembly and the internal divisions within an allied party.

RATING SENSITIVITIES

The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently well balanced. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a rating change.

The main factors that, individually or collectively, could lead to positive rating action are:

--Fiscal consolidation and adherence to budget targets consistent with improved fiscal policy credibility and sustained reduction in government indebtedness.
--Maintenance of a favourable growth trajectory amidst moderate inflation and financial stability.

The main factors that, individually or collectively, could lead to negative rating action are:

--Continued fiscal deterioration leading to persistent weakening in public debt dynamics.
--A marked deterioration in the business and political environment that materially impairs growth and investment prospects.

KEY ASSUMPTIONS

The ratings and Outlooks are sensitive to a number of assumptions:

--Fitch base case assumes that the canal expansion will be completed by December 2015.
--Fitch assumes that the impact on the economy and financial system of the OECD "grey list" designation and unresolved Colon Free Zone (CFZ) suppliers' arrears from Venezuela will be manageable.