panama: country strategy with the idb (2005-2009)

DOCUMENT OF THE INTER-AMERICAN DEVELOPMENT BANK

PANAMA

IDB: COUNTRY STRATEGY WITH PANAMA

OCTOBER 2005

This document was coordinated by the Country Office in Panama and prepared by a project team consisting of: Rafaela Varela, Project Team Leader (COF/CPN); Jeremy Gould (COF/CPN); Carlos Galvis (COF/CPN); Manuel Agosín (RE2); Charles Smith (RE2/OD3); Ronán Le Berre (RE2/OD3); Mario Umaña; and Ana Silvia Aguilera (RE2/OD3).

Contributions to the team’s work were made by: Carola Álvarez (RE2); Ennio Rodríguez (RE2/OD3); Gilberto Chona (RE2/OD3); Mariana Wettstein (RE2/OD3); Kurt Focke (RE2/FI2); Martin Chrisney (RE2/FI2); Carlos Trujillo (RE2/FI2); Helí Nessim (RE2/EN2); Paul Trapido (RE2/EN2); Catherine Fox (RE2/SO2); Claudia Uribe (RE2/SO2); Stéfano Tinari (RE2/SC2); COF/CPN specialists; Carolyn Robert (INT/ITD); Lorena Mejicanos (MIF); Lori Kerr (PRI); Javier Molina (PRI); Angela Marcarino Paris (SDS); María Teresa Villanueva, (SDS); Gustavo Romero (IIC); and Ricardo Montenegro, consultant (COF/CPN). Sara Bojorge-Saénz, Cecilia Bernedo, and Magda Matamoros (RE2/OD3) helped to produce this document.

CONTENTS

EXECUTIVE SUMMARY MATRIX OF THE BANK’S COUNTRY STRATEGY WITH PANAMA INTRODUCTION I.

COUNTRY CONTEXT AND MAIN DEVELOPMENT CHALLENGES ......................................... 1 A. The country context .................................................................................................... 1 B. Principal development challenges.............................................................................. 3 1. Speeding up growth on a sustainable basis while incorporating other production options............................................................................................... 3 2. Reducing poverty ................................................................................................ 7 3. Ensuring the sustainability of the country’s natural and cultural wealth.......... 8 4. Producing public goods more efficiently........................................................... 9 C. The government program ......................................................................................... 10 D. Macroeconomic prospects and debt sustainability .................................................. 11

II. LESSONS LEARNED FROM THE PRECEDING STRATEGY AND PORTFOLIO ......................... 13 A. Strategy for 2000-2004 ............................................................................................. 13 1. Achievements.................................................................................................... 13 2. Lessons learned from the preceding strategy................................................... 14 B. The portfolio.............................................................................................................. 15 1. Trends and performance ................................................................................... 15 2. Lessons learned from the portfolio................................................................... 15 3. Current status and role of the portfolio in the new strategy ............................ 16 III. IDB COUNTRY STRATEGY WITH PANAMA, 2005-2009.................................................... 16 A. Elements involved in the strategy’s formulation..................................................... 16 B. Strategy objectives .................................................................................................... 17 1. Boosting the economy’s competitiveness........................................................ 17 2. Building human and productive capital ........................................................... 23 3. Cross-cutting element: Strengthening governance and transparency............. 25 C. The program: Size, sequencing, financial flows, instruments, and country financing parameters (CFPs) .................................................................................... 26 D. Coordination of international cooperation ............................................................... 29 E. Risks involved in strategy implementation.............................................................. 31 F. Monitoring the strategy............................................................................................. 32 IV. AN AGENDA FOR DIALOGUE ............................................................................................. 32

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ANNEXES

Annex I

IDB group Operations Program, 2005-2009

ELECTRONIC LINKS TO TECHNICAL ANNEXES

Annex II

The Bank’s toolkit for the strategy’s implementation http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=520752

Annex III

Consultation process related to the Bank’s strategy with Panama

Annex IV

Millennium Development Goals for Panama

Annex V

Impact of free trade agreements (FTAs) on Panama

http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=570769 http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=603263 http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=570771

Annex VI

Macroeconomic projections, 2005-2009

Annex VII

Public-sector debt sensitivity analysis

http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=533234 http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=520769

Annex VIII

Active portfolio in support of the strategy

Annex IX

Incorporation of recommendations made by the Office of Evaluation and Oversight concerning the Bank’s country strategy with Panama

http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=520760

http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=520776

Annex X

Proposal on strategic lines of action in support of the private sector in Panama http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=570772

Annex XI

Projections of undisbursed balances, Panama portfolio, 2005-2009

Annex XII

Indicators of the Bank’s exposure in Panama

http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=534084 http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=520774

Annex XIII

Country financing parameters (CFPs)

Annex XIV

Participation of other donor agencies in the Bank’s country strategy with Panama

Annex XV

Strategy indicators

Annex XVI

References

http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=570773

http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=520784 http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=601207 http://idbdocs.iadb.org/WSDocs/getDocument.aspx?DOCNUM=520787

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ABBREVIATIONS

ACP AECI AMP ANAM BCI BNP CAF CAN CFAA CGR CPAR CSS CUT DGA DGI EAP ECLAC ECN EU FTA GDP ICA IDAAN IFAD IIC IMF ITBM ITBMS IVM JICA MEF MIDA MIF MSMEs

Autoridad del Canal de Panamá [Panama Canal Authority] Agencia Española de Cooperación Internacional [Spanish Agency for International Cooperation] Autoridad Marítima de Panamá [Panamanian Maritime Authority] Autoridad Nacional del Ambiente [National Environmental Authority] Business Climate Initiative Banco Nacional de Panamá [National Bank of Panama] Corporación Andina de Fomento / Andean Development Corporation Comunidad Andina de Naciones / Andean Community Country Financial Accountability Analysis Contraloría General de la República [Office of the Comptroller-General] Country Procurement Assessment Report Caja de Seguro Social [Social Security Fund] Cuenta Única del Tesoro [Unified Account System] Dirección General de Aduanas [General Customs Bureau] Dirección General de Ingresos [General Revenues Bureau] Economically active population Economic Commission for Latin America and the Caribbean Estrategia Competitiva Nacional [National Competitive Strategy] European Union Free trade agreement Gross domestic product Investment Climate Assessment Instituto de Acueductos y Alcantarillados Nacionales [National Water Works and Sewerage Services Board] International Fund for Agricultural Development Inter-American Investment Corporation International Monetary Fund Impuesto de Transferencia de Bienes Muebles [tax on transfers of movable goods] Impuesto de Transferencia de Bienes Muebles y Servicios [tax on transfers of movable goods and services] Programa de Invalidez, Vejez y Muerte de la Caja del Seguro Social [Disability, Old Age, and Death Benefits Program of the Social Security Fund] Japan International Cooperation Agency Ministerio de Economía y Finanzas [Ministry of Economic Affairs and Finance] Ministerio de Desarrollo Agropecuario [Ministry of Agricultural Development] Multilateral Investment Fund Micro, small, and medium-sized enterprises

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NFP NFPS NGOS OVE PCR PDL PER PPP PRI PRODEV PRONAT R&D SEP SIAFPA SMEs SWAP TC UNDP USAID

Nonfinancial product Nonfinancial public sector Nongovernmental organizations Office of Evaluation and Oversight Project completion report Performance Driven Loan (results-based projects) Public Expenditure Review Plan Puebla Panamá [Puebla-Panama Plan] Private Sector Department Programa de Ejecución del Pilar Externo del Plan de Acción a Mediano Plazo para la Efectividad en el Desarrollo [Implementation Program for the External Pillar of the Medium-Term Plan for Effective Development] Programa Nacional de Administración de Tierras [National Land Management Program] Research and development Social Entrepreneurship Program Sistema de Administración Financiera de Panamá [Financial Administration System of Panama] Small and medium-sized enterprises Sector-Wide Approach Technical cooperation United Nations Development Programme United States Agency for International Development

EXECUTIVE SUMMARY

The Bank’s country strategy with Panama is in step with the country’s 2004-2009 political cycle. This cycle began with the election of President Martín Torrijos Espino. During the May 2004 elections which brought President Torrijos to office, the country also elected deputies to serve in the National Assembly and municipal government representatives. The Patria Nueva (“new country”) political alliance, formed by the Partido Revolucionario Democrático [Democratic Revolutionary Party] (PRD) and the Partido Popular [People’s Party] (PP), won a majority in the National Assembly (42 of 78 seats). Although this majority paves the way for the passage of reforms, in view of the difficulties that the country has faced in the past, the government will have to work to build the consensus needed to implement those reforms successfully.

Panama is classified as an upper-middle-income country. Its economic environment is marked by a downward trend in growth. Over the past two decades, a substantial portion of that growth has been concentrated in the services sector, which has few linkages with the rest of the economy and makes limited use of labor inputs. The country’s social framework is marked by sharp inequalities and a concentration of poverty in rural areas, with the same situation in areas inhabited by indigenous peoples being the most alarming. Within this context, the main development challenges faced by Panama are: (i) to speed up a sustainable growth process while incorporating other production options; (ii) to reduce poverty; (iii) to safeguard the country’s natural and cultural wealth on a sustainable basis; and (iv) to produce public goods more efficiently.

Consideration is given to the following elements in the Bank’s country strategy with Panama: (i) fiscal sustainability is a prerequisite for the implementation of the strategy, whose viability hinges on the country’s success in building a consensus for reform; (ii) it takes into account both the active portfolio and new operations, and places a high priority on institution-strengthening in order to build up the country’s absorption capacity; (iii) it assigns an important role to the private sector; (iv) a strong sector-analysis component is included with a view to delving more deeply into some of the issues in the current policy dialogue; (v) it is designed to promote increased coordination and harmonization of international cooperation; (vi) it provides for a midterm review; and (vii) it incorporates the recommendations made by the Office of Evaluation and Oversight in its evaluation of the Bank’s country program in Panama over the period 1991-2003.

The main objective of the Bank’s country strategy with Panama for 2005-2009 is to support sustainable economic growth and the reduction of poverty. To achieve these aims, two strategic objectives have been formulated: (i) to boost the economy’s competitiveness; and (ii) to develop the country’s human and productive capital. In addition, the strategy incorporates efforts to strengthen governance and transparency as a crosscutting dimension. This strategy is in line with the Government Plan, which seeks to attain a socially inclusive form of sustainable economic development by enhancing the competitiveness of Panama’s production apparatus and by creating and maintaining a climate that is conducive to private investment.

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The size of the operations program was determined on the basis of two different scenarios that reflect the country’s absorption and implementation capacity, the lending instruments to be used, and the financing needs associated with the public sector’s financial position. The Bank’s operations program for the implementation of the 2005-2009 country strategy uses two lending scenarios—base scenario and high—corresponding to the two proposed macroeconomic scenarios. The operations program initially places priority on support for fiscal sustainability, social protection, and the creation of the conditions necessary for sustainable economic growth (an improved investment climate, support for the development of greater competitiveness in the rural economy in light of the adaptations required for trade liberalization, development of transportation infrastructure, and the strengthening of the sector framework for the development of production activities with potential). It also supports the strengthening of governance, which, in addition to increasing the effectiveness and efficiency of government spending, will also allow for the use of more flexible lending instruments. At a later stage, efforts already begun in the social sectors will be consolidated together with areas where the Bank has proven comparative advantages, such as rural electrification, sustainable development, and the financial sector.

The low and high scenarios are US$575 million and US$870 million, respectively. The high scenario, which encompasses the low scenario plus an additional US$295 million, reflects: (i) the country’s attainment of a greater absorption capacity thanks to improvements in its fiscal position and institution-strengthening, all of which translates into significant improvements in the active portfolio; and (ii) progress in applying the reforms to implement of the Estrategia Competitiva Nacional [National Competitive Strategy] (ECN). The triggers for the high scenario are: (i) a nonfinancial public-sector deficit of no more than 2% of GDP, in line with the targets established in the Fiscal Responsibility Act; (ii) startup of the “control tower” in the Ministry of Economic Affairs and Finance (MEF); and (iii) disbursement projections for 2007 of at least 25% of the undisbursed balances of the eligible IDB investment loan portfolio, as reflected in the State budget.

Given the active portfolio’s relevance to the strategy’s goals, steps need to be taken to improve its execution, monitoring, and supervision, as well as the institutional factors involved in its implementation. To this end, the Bank will undertake technical-cooperation actions (PRODEV) to support the “control tower”. This MEF office will provide support by monitoring project execution and reinforcing the executing units, along with closer coordination with the MEF’s Dirección de Inversiones Públicas [Public Investment Division] and Dirección de Cooperación Internacional [International Cooperation Division].

The risks associated with this strategy are primarily of three types: (i) Political risks: difficulties in building the necessary consensus for the approval and implementation of reforms. This risk will be minimized by the make-up of the National Assembly, in which the government holds 42 (54%) out of 78 seats. The Bank will also support the technical strengthening of the executive and legislative branches as a means of contributing to dialogue and consensus-building; (ii) Economic risks: restrictions established under the Fiscal Responsibility Act could be undermined by external factors or by a relaxation of fiscal discipline. Potential temporary shocks affecting key parameters (economic growth, inflation, import growth, the balance-of-payments current account, or nondebt capital flows)

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could be managed under both scenarios with a two- or three-year delay in the downward trend in public-debt reduction as a percentage of GDP. The effect of a relaxation of fiscal discipline, on the other hand, could only be mitigated by economic growth rates of over 4%, which would translate into an increase in the tax burden similar to the result of a relaxation in fiscal discipline; and (iii) External factors: such as higher oil prices, higher interest rates, or a downturn in world economic growth. In order to mitigate the impact of possible external shocks, the Bank will support the government’s efforts to maintain a sound fiscal position, as well as promote diversification and the consolidation of financial reforms in ways designed to safeguard Panama’s sovereign debt risk rating.

The supervision and evaluation of the strategy’s implementation will be conducted with the help of mechanisms regularly used by the Bank for these purposes, such as annual strategy updates, program and portfolio reviews, and project completion reports (PCRs). A midterm review of the strategy’s progress will also be conducted two years after its approval. In addition, the MEF will receive support from the Bank in order to develop/strengthen its monitoring and supervision systems as applied to both the strategy and individual projects.

The policy dialogue will focus on: (i) progress in applying governance reforms; (ii) implementation of a rural development agenda; (iii) measures to support a sustained improvement in the business climate and the trade liberalization process; and (iv) implementation of the loan portfolio with a view to continued efforts to improve the country’s absorption capacity, its institutional capacity, and the relevance of the Bank’s work.

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MATRIX OF THE BANK’S COUNTRY STRATEGY WITH PANAMA IDB objectives and strategy

Country objectives and strategy

IDB action

Actions of other agencies

Portfolio*

Proposals

Performance indicators IDB** Country***

Principal Objective: To support sustainable economic growth and the reduction of poverty Estimated trend in macroeconomic variables. Per capita GDP growth in 2009: 2%-3%. 2003-2004 baseline: 3.4%. Extreme poverty in 2009: 10%%. 2003 baseline: 14.2%.

First strategic objective: Boost the economy’s competitiveness I.A Specific objective

Objective

Governance

Loans

Loans

Support fiscal sustainability.

Place public finances on a sound footing. Reduce the fiscal deficit, increase current saving, and enhance the productivity of government disbursements.

World Bank, UNDP, EU, USAID

Fiscal Management II (84%)

Strengthening Governance

Strategy Support fiscal reform through the implementation of the Fiscal Responsibility Act, the Fiscal Equity Act, and the Caja de Seguro Social [Social Security Fund] (CSS) reform bill. (i)

(ii)

Revenues: Strengthening the Dirección General de Ingresos [General Revenues Bureau] (DGI), the Dirección General de Aduanas [General Customs Bureau] (DGA), the Dirección de Catastro [Cadastre Division] (DC), and the Public Registry.

Expenditures: Promoting the sustainability of the CSS; strengthening the budgetary process; modernizing the public contracting system; improving the programming of public investment; consolidating the Sistema de Administración Financiera de Panamá [Financial Administration System of Panama] (SIAFPA); strengthening the Dirección Nacional de Contabilidad [National Accounting Division] (DNC); implementing civil service career paths; and developing a strategy for the management and use of the State’s physical assets.

Strategy Rationalize current expenditure by means of transparent, effective, and efficient public-sector procurement and contracting.

Improve the budgetary system’s management.

Make financial adjustments in the CSS. Implement tax reforms with a view to promoting an equitable and efficient tax structure.

TC

Support for the Financial Sector Program (47%)

PRODEV appraisal

National Land Management Program (Provisional Cadastre and Registry System) (89%)

Strengthening of Internal Tax Administration Control Services (Reg.)

PRODEV implementation

MIF Improvement of the Customs System NFP Fiscal Sustainability and Public Borrowing / PER (IDB/World Bank)/ CFAA (IDB/World Bank)/ CPAR (IDB/World Bank)

Nonfinancial publicsector deficits no greater than 2% of GDP. 2004 baseline: 5%.

Nonfinancial publicsector deficits no greater than 2% of GDP. 2004 baseline: 5%.

Risk rating in 2009: Investment grade.

2004 baseline: below investment grade.

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IDB objectives and strategy

Country objectives and strategy

IDB action

Actions of other agencies

Portfolio*

I.B Specific objective

Objective

CAF

Loans

Develop basic infrastructure.

Develop infrastructure that will allow the country to compete in the international export and tourism markets.

Roadways

Electricity Expansion Program (19%)

Strategy (i)

Increase electricity service coverage in rural areas and provide incentives for hydroelectric power generation. (ii) Increase water and sanitation service coverage to support the achievement of the Millennium Development Goals (MDGs). (iii) Improve roadway infrastructure, establish a road maintenance fund, and strengthen the sector’s institutions. (iv) Implement a mass transit solution for Panama City. (v) Promote physical and energy integration with Central America (PPP) and with the Andean Community. (vi) Increase telecommunications coverage, especially in rural areas. (vii) Support the consolidation of reforms in the infrastructure sector and promote private-sector and local-government participation.

Strategy Reform the regulatory systems for the electric power and transportation sectors.

Implement a medium- and long-term national sanitation program to achieve coverage for all urban dwellings in the country; conduct a survey of sewage collection and treatment needs.

Maintain and expand the road network.

Build sewerage networks in critical areas, with emphasis on the recovery of the Bay of Panama.

Proposals Loans

Enhancing the Investment Climate and Adapting to Trade Liberalization/Rural Reconstruction Support for Electrification/Panama City IDAAN (20%) Sanitation/ PPP Roads for Feeder Roads and Bridges Competitiveness/Priority Activities (19%) in Panama Canal Watershed PPP Improvement Road PRI Integration Corridor (87%) Bonyic Hydroelectric Project/ Bajo Central American Mina Hydroelectric Project/ Electrical Power Thermal Conversion/Colón Interconnection (100%) International Airport transportation project TC Accelerating Rural Energy TC Coverage National Transp. Plan./Urban Design of Interception and Planning System/ Support for procompetitiveness road infrastructure Treatment System prog. under the Puebla-Panama Plan (sanitation) / Bin. Sixaola Basin Dev./Harmon.

MIF of Regulatory Regime - Electricity Strengthening SME Bus MIF Operations Ident. Mech. for Private Participation in Expansion of the Canal/ Job Skills Expansion of Canal/ Airport Security/ Review of Regulatory Framework for Energy Sector/ Support for Private Sector Partic. in Infrastructure Service Delivery/ Infrast.

Concession Agreements. (ports)/ Solid Waste Collection, Transport, and Treatment system Barú (Chiriquí) NFP Strategic Guidelines in Support of the Private Sector

Performance indicators IDB** Country*** By 2009, 6,358 GWh and 1,304 MW of energy demand will be met efficiently, and the country’s electrification index will have reached 90%. 2004 baseline: 5,200 GWh and 861 MW of demand, and an electrification index of 81%.

New sewerage connections in outlying districts by 2009.

Baseline: N/A. Definition of target now under way.

By 2007 transport costs on rehabilitated routes will have been lowered by between 5% and 10%. Baseline: to be estimated in the final evaluation.

By 2009, increase in rural household units with drinking water to 82%. 2004 baseline: 75%.

By 2009, 80% of the network of paved main highways and secondary roads will be in good condition.

2002 baseline: 67%.

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IDB objectives and strategy

Country objectives and strategy

IDB action

Actions of other agencies

Portfolio*

I. C Specific objective

Objective

Competitiv.

Loans

Expand sources of sustainable growth

Boost the economy’s productivity and competitiveness. Bring indigenous communities into the national development process.

JICA

Program to Foster Competitiveness (77%)

Proposals Loans

Enhancing the Investment Climate and Adapting to Trade Strategy Rural and Local Liberalization/ Foreign Trade Tourism Support Program Dev. (i) Improve the country’s position in the global Management / Dev. of (39%) marketplace by fostering the development of USAID, UNDP, Competitiveness in the Rural Strategy sectors with comparative advantages, World Bank, Central American Economy / Tourism in Protected strengthening the management of foreign trade in Promote international market access AECI, IFAD Electricity Interconnection Areas and Marine and Coastal order to facilitate the implementation of trade under favorable conditions and create (100%) Zones/Sustainable Dev. of BarúLand agreements and promote investment, and conditions conducive to domestic PPP Highway Integration Divalá River/ Sustainable Dev. of Management stimulating integration with Central America efficiency and competitiveness.

Bocas del Toro II/ Dev. of Panama Corridor Improvement World Bank through the PPP and with the CAN. Canal Watershed/ Priority Activities Promote exports based on development (87%) (ii) Support the inclusion of the rural sector, in the Panama Canal Watershed / of economic clusters.

Tourism National Land indigenous peoples, and women by incorporating Strengthening the Panama City Provide indigenous communities with AECI Management Program them into productive development and by Mayor’s Office/ Consolidation of basic services and with credit and (89%) Science and promoting new economic opportunities for Financial Sector Reforms/ Tech. financing for self-managed Technology sectors of the population adversely affected by Sustainable Development Transf. / Enhancing the Quality of microenterprises and small businesses trade liberalization.

Education / Support for AMP and of Darién (61%) EU in the agricultural, tourism, and Marine and Coastal Areas (iii) Foster the development of MSMEs in formal Environmental Sustainable Development handicrafts sectors.

Management /Decentralized economic sectors. of Bocas del Toro (95%) Sustainability Environmental Management (iv) Enhance the business climate and strengthen the World Bank, Financial Sector Support private sector’s capacity to contribute to UNDP, JICA Program (47%) economic growth with equity.

Watershed Mgmt.

World Bank, USAID, JICA

Performance indicators IDB** Country*** Panama’s score in the Growth Competitiveness Index in 2009 surpasses its highest score ever; to achieve this, its score must increase at an average of 5% annually.2005 baseline: 3.55.

Real net per capita exports by 2009: B 1,650 (32% increase). 2004 baseline: B 1,250.

National fixed capital investment by 2009: 25% of GDP. 2004 baseline: 17% of GDP.

Urban and rural job 10 percentage-point creation by 2008. 2004 reduction in poverty baseline: urban rate for indigenous employed EAP of groups by 2009. 2004 781,482; rural employed baseline: 98%.

EAP of 416,013.

Annual average growth in formalsector jobs over three years by 2009: 2.9%.

2004 baseline: 2.3%.

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IDB objectives and strategy (v)

Consolidate the financial sector’s development by enhancing transparency, promoting the development of capital markets, strengthening the regulatory framework for the insurance and reinsurance industries, cooperatives, and financial enterprises, improving credit access for, in particular, MSMEs and women, and boosting the efficiency of government banks. (vi) Promote technological innovation by tailoring policies to the country’s needs, boosting private R&D investment, strengthening the job skills training system, and reducing labor-market rigidities. (vii) Develop natural resources on a sustainable basis by consolidating the institutional, legal, and regulatory systems for their management and encouraging decentralization. (viii) Develop an institutional, financial, and physical strategy for reducing the country’s vulnerability to natural disasters.

Country objectives and strategy Organize cooperative access to capital goods and economic infrastructure for small businesses, access to credit guarantee programs, and technical assistance at a reasonable cost.

Establish a regional securities exchange.

Promote and develop tourism of all sorts, especially cruise ship tourism.

Adapt and strengthen the technological research and innovation system in order to support areas of activity having the strongest export potential through the creation of a fund to promote agricultural innovation and creativity.

Create incentives for the development of the software industry.

IDB action

Actions of other agencies Natural Disaster Mitigation and Risk Mgmt.

UNDP, JICA

Portfolio*

Proposals

Science, Technology, and PRI Innovation Center (24%) Partial Credit Guarantee Training and Employment Central Securities Depository Center System Development IIC (78%) Global Bank Line of Credit/ Banco National Environmental Continental Line of Credit/ Banco Program (32%) Universal Line of Credit MIF TC E-Commerce Dev./Dev. Agric. Sector Strategy/Tourism in and Promotion of Protected Areas and Marine and Intellectual Property / Coastal Zones/ Development of Technology Business Accelerator / Support for Barú-Divalá River/Strengthening AMP/ National Water Resources the Dev. of Job Skills / Plan/ Hydrometeorological Network Business Participation/ Clean Production MIF SEP Support for Rural Microcredit

Customs Clearance/ Support for Tourism Microenterprises/Strengthen.

Agribusiness/Introduction Corporate Responsibility/ Business Ethics Cert. / Dev. of Job Skills, Panama Canal/ Enhancing the Business Climate/ Cooperative sector Regulatory Framework/ Bank Superv., Regional Cons./ Improvement of the Customs System/ One-Stop Window for Business startup// Clean Prod. and Certif.

SEP Support for Small Agribusiness Producers/ Financial Services for Microenterprises and Small Businesses in Rural Areas NFP Rural Dev. and Competitiveness/ Labor Market Rigidities/ Investment Analysis / Investment climate Assessment (ICA, IDB/World Bank)/ Strategic guidelines in Support of the Private Sector/ Proposal for Government Bank Reforms/ Financial Enterprises and the Rural Sector

Performance indicators IDB** Country*** Urban < 30 female unemployment rate by 2009: 23%. 2004 baseline: 32%.

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IDB objectives and strategy

Country objectives and strategy

IDB action

Actions of other agencies

Portfolio*

Proposals

Performance indicators IDB** Country***

Second strategic objective: Develop human and productive capital II.A Specific objective

Objective

Increase the efficiency and progressiveness of social spending and augment the coverage and quality of social services on a sustainable basis.

Replace the existing educational model World Bank, EU, with a high-quality, modern, AECI participatory, and efficient model.

Health Set up a program for the efficient World Bank, delivery of health services.

UNDP, JICA, AECI Strategy

Strategy Improve financial management by: (i)

(ii)

(iii) (iv)

Safeguarding the levels of expenditure (and particularly investment) of programs having the greatest impact in terms of poverty reduction.

Increasing coordination among social sector institutions and building up their management capacity.

Reducing the centralization of public expenditure.

Establishing a system for monitoring and evaluating the impact of social programs.

Education

Incorporate quality and performance indicators and set minimum targets for investment in projects providing social returns.

Health: Comprehensive, community, and environmental health; managerialbased human resources development.

Education: Expand coverage of preschool and secondary education.

Health: Basic maternal and child health care services; Implement national learning evaluation preventive nutritional care for children under two years system. Update teacher-training, of age residing in rural or indigenous areas; services to refresher courses, and teacher meet nutritional needs of pregnant women, infants, and performance evaluations. Introduce children; reproductive health services. incentives for excellence in teaching.

Education: Expand coverage of quality preschool and Social protection: Implement a secondary education, and raise quality in the remaining protection system based on conditional levels, including post-secondary education. direct subsidies for extremely poor households.

Implementation of comprehensive intervention strategy focused on the most vulnerable areas via social protection mechanisms and mechanisms for decentralizing public social spending.

Increase in % of poor people covered under social protection Improvement of Educational Quality program by 2009.

Poverty Alleviation and Baseline and goal to be Social Protection I Community Dev. (45%) defined in the Poverty Social Protection II Assessment.

Sustainable Dev. of Darién Strengthening of Public (61%) Coverage of basic Management primary health care Sustainable Dev. of Bocas Sustainable Development of Barú- services expanded to del Toro (95%) include at least 450,000 Divalá Urban Poverty Reduction new beneficiaries in TC in Colón (98%) poor and vulnerable Education Dev. Program Pilot Project on the Social Protection areas by 2009. MI: 257,000 in 2007. 2001 System (64%) baseline: currently Diagnostic Appraisal and Plan of Institutional Transf. – being determined.

Action for Effective Dev - PRODEV Health Sector (70%) Net coverage of Implementation - PRODEV TC preschool education (4 NFP and 5 years) increased Emergency due to to 75% and that of Torrential Rains in Bocas Dev. Focus in Health Program secondary school (15 del Toro Education Sector Study 17 years) to 70% by Institutional Strengthening 2009. 2003 baseline: PER (IDB/World Bank) of the Dept. of National preschool: 51%; Indigenous Policy Poverty Assessment (IDB/World secondary: 61%.

Bank) Loans

Loans

Fiscal Management II (84%)

Instit. Transform. of Health Sector II

II.B Specific objective

Objective

Housing

Loans

Loans

Improve access to housing and land.

Promote social mobility as a means of making a significant improvement in income distribution.

AECI

Housing Program (9%)

Land Mgmt.

National Land Management Program (89%)

Development of New Operational Instruments for Low-income housing

Strategy (i)

(ii)

Strengthen the housing sector’s legal and institutional framework; develop instruments for complementing and deepening the bank financing available to lower-middle-income groups; and broaden and target existing subsidy programs.

Expedite the regularization of land tenure while promoting private-sector participation in the provision of land to low-income households, and strengthen the land registry and cadastre system.

Strategy

World Bank

Low-income Housing Program

Reduce the time and costs involved in land transactions.

NFP

Implement a direct housing subsidy program. Modernize the regulatory functions of the Ministry of Housing in order to strengthen the implementation of projects for low-income beneficiaries.

Poverty Assessment (IDB/World Bank)

PER (IDB/World Bank)

Rural Development and Competitiveness

Delivery care coverage in rural areas by 2009: 90%.

2004 baseline: 80%.

National infant mortality rate by 2009: 15 per 1,000 live births. 2004 baseline: 20.6 per 1,000 live births.

Preschool education coverage by 2009: 75%. 2003 baseline: 51%.

Secondary education coverage by 2009: 70%. 2003 baseline: 61%.

Increase the percentage Reduction in housing of urban households deficit. 2005 baseline: with access to mortgage credit to 75% by 2009.

2004 baseline: 70%.

An increase of approximately 85,000 rural plots and 35,000 ejidos (850,000 inhabitants.) included in cadastres and public registry in program areas by 2008. Baseline: 39,010 farms.

Page 6 of 6

IDB objectives and strategy

Country objectives and strategy

IDB action

Actions of other agencies

Portfolio*

Proposals

Performance indicators IDB** Country***

III. Cross-cutting element: Strengthen governance and transparency.

III.A Specific objective

Objective

Judicial Reform

Loans

Loans

Strengthen the institutions that underpin the country’s Create a less bureaucratic and more UNDP, AECI democratic system and maintain public order and transparent, effective, and professional safety as well as legal certainty; increase efficiency in State that is closer to the people. the production of public goods and services.

Municipal Development Strengthening Public Safety and Strengthening (100%) Strengthening Governance Strengthening the Judiciary II

Strategy

Governance

TC

World Bank, UNDP, EU, USAID, AECI

Municipal Development Support Program

(i)

(ii)

(iii) (iv)

Strategy

Support the modernization and institutional Review and simplify the Public strengthening of the legislative and judicial Procurement Act with a view to branches. establishing a policy of open bidding exercises.

Support measures for strengthening the regulatory framework to enhance transparency in Strengthen municipal administration governance, including the system for awarding and finances through legal reforms and contracts. ongoing training.

Promote public safety and peaceful coexistence.

Engage communities, citizens, and the Improve governance at the central and local private sector in projects through levels while strengthening decentralization by partnerships, with the State acting as a transferring areas of jurisdiction, modernizing facilitator. local government administration, building the management capacity of municipal governments, Promote community training, with emphasis on women and youth, in the building the capacity of civil society, and operation and maintenance of State promoting local economic development. facilities.

Public Safety AECI

Raising public institutions’ index rankings to at least 6.25.

2004 baseline: 4.26.

Start-up of the MEF control tower to improve project monitoring and execution.

Strengthening the Panama City Mayor’s Office

Plan of Action for Public Sector Modernization

Enhancing the Business Climate and Decrease in municipios Adapting to Trade Liberalization with current expenditure subsidies to 25% by TC 2009. 2004 baseline: Support for the Development of a 75%.

Public Safety Program

Support for e-Government Information Technol. Strengthening for a Public Safety Program Diagnostic assessment – PRODEV Implementation – PRODEV MIF Intern. Standards – Financial Reports NFP Workshop on Municipal Finances/ CFAA (IDB/World Bank)/ CPAR (IDB/World Bank)/ PER (IDB/World Bank)/ Strategic guidelines for private-sector support.

*Figures shown in parentheses correspond to the percentage that remains to be disbursed. **In the process of being defined. ***Triggers of the high scenario are shown in bold. Country monitoring indicators will be reviewed with the Panamanian authorities.

INTRODUCTION

Panama is a small country. It has a total area of 75,512 square kilometers and a population of 3,172,360, with 50% of that number residing in the Province of Panama; 38% of the population lives in rural areas and 10.5% is made up of indigenous peoples.

Panama’s per capita GDP (US$4,130)1 places it in the category of upper-middle-income countries.2 Panama’s economic development has been closely linked to its very fortunate location and to the existence of three service enclaves: the Canal, the Colón Free Trade Zone (CFZ), and the international banking center. Interaction among these enclaves and the country’s distinctive monetary regime have afforded it an unusual degree of price stability and allowed for the development of complementary service activities, including, in particular, international business services.3 Thus, over time, the Panamanian economy has developed a dual structure which still exists today. This structure is divided between a modern, dynamic, competitive sector based on exportable services which is integrated into the international economy, but which has little connection to the national economy, and a production sector oriented toward agricultural or industrial activities that are not internationally competitive and that cater primarily to the domestic market.

Because of the duality of its economic structure, Panama is a very unusual case: even though it has a fairly small population, has posted an above-average economic growth rate in terms of the Latin American and Caribbean region for the past 20 years, and has one of Latin America’s highest social spending levels, this is a country with high unemployment and poverty rates and a very unequal income distribution. The lack of job opportunities in the formal sector of the economy has also fueled a headlong expansion of the informal sector.4 The Bank’s country strategy with Panama is in step with the five-year term of President Martín Torrijos Espino, who took office on 1 September 2004. His political coalition, Patria Nueva (“new country”), formed by the Partido Revolucionario Democrático [Democratic Revolutionary Party] (PRD) and the Partido Popular [People’s Party] (PP), won a majority in the National Assembly (42 of 78 seats). The PRD has thus returned to power with the support of a large majority in the wake of an opposition administration.

Despite this majority position, which paves the way for the passage of reforms, the government will have to work to build the necessary consensus to make their successful implementation possible, given the difficulties faced in the past.

1

Current dollars. IDB estimates for 2003.

2

World Bank. World Development Indicators Database, 2005.

3

The services sector accounted for an average of 76% of GDP in 1991-2003 (one of the highest percentages in Latin America), while the primary sector’s share amounted to around 9%, and the industrial sector’s to 11%-8%.

4

The share of the nonfarm labor structure represented by the informal labor market climbed from 36% in 1991 to 42.6% in 2002. International Labour Organization (ILO), 2003.

- ii -

The present country strategy is set within the framework of the Bank’s institutional strategy. The government program, the Country Program Evaluation (1991-2003) for Panama, portfolio review reports, prior programming exercises, and the evaluation of the progress being made toward the Millennium Development Goals have all been incorporated into the strategy as elements of central importance. The operations program also takes into account the fiscal aspects of the government’s macroeconomic program, as well as such considerations as public debt sustainability, the impact of Bank action and its comparative advantages, and participation by the private sector, as well as other multilateral and bilateral lenders.

The country strategy is based on a series of Bank studies (on the tax system, the social security system, public spending, growth, and the regulatory framework and its implications in terms of competitiveness) and draws upon the analytical work done by Panama and by other agencies and institutions. A broad range of consultations were also carried out in order to provide inputs for the strategy’s formulation, and included: (i) the portfolio review mission; (ii) meetings with the Office of Evaluation and Oversight to share information and analyses regarding the previous strategy; (iii) sector review missions and meetings at which the Bank and the relevant authorities analyzed the challenges facing the country, the options for dealing with them, strategy objectives and priorities, and the operations program; and (iv) consultations with civil society (see Annex III).

In the course of the strategy’s formulation, the Bank engaged in an active dialogue with the new administration, the International Monetary Fund (IMF), the World Bank, the United Nations Development Programme (UNDP), and the other donor agencies.

This document is composed of four chapters. The first identifies development challenges and describes the government program. The second analyzes the main outcomes and lessons learned from the previous strategy, as well as the active portfolio, the lessons to be learned from it, and its ties to the new strategy. Chapter three presents the proposed strategy, outlining its objectives, the tools to be used, monitoring arrangements, and risks.

The fourth and final chapter puts forth the agenda for a policy dialogue.

I.

COUNTRY CONTEXT AND MAIN DEVELOPMENT CHALLENGES

A.

The country context

1.1

Notwithstanding a slump between 2001 and 2002, Panama’s economic performance has been fairly robust when viewed within the framework of the Latin American and Caribbean region. Its long-term growth rate of 4.5% per annum (2% in per capita terms) for the 1961-2004 period is the fifth highest in the region; the country maintained that ranking during the 1991-2000 period, when it posted a growth rate of 5% (4% in per capita terms). Investment as a percentage of GDP (29% in 2001-2003) also exceeds the Latin American average (18%). However, growth was concentrated in the service sectors, with few linkages with the rest of the economy and makes limited use of labor inputs. Exports of goods have remained very low (at around 6% of GDP) for the last decade and manufactured goods account for less than 15% of total exports. On the other hand, labor productivity has not risen fast enough to enable the new activities that are set up in Panama to pay formal-economy wages, which are significantly higher than in other Central American countries.

1.2

The slowdown in economic growth has also had an impact on tax revenues, which have been falling since 1997 and amounted to just 8.7% of GDP in 2004. Another factor affecting the tax burden is the high level of evasion and a small sales tax base (5%).5 Until February 2005, this tax did not even apply to most services, which account for a large share of economic activity. This low tax burden, in combination with the rigidities in current expenditure stemming from the large share of spending on wages and public debt servicing, has driven up the nonfinancial public sector’s deficit, which reached 5% of GDP in 2004. This sector’s deficit has translated into a substantial increase in the public debt, which amounted to 68% of GDP in 2004.

1.3

The fiscal situation prompted the previous administration to take corrective measures, such as the tax reforms contained in Law 61 of 20026 and the sanctions included in the Fiscal Responsibility Act (Law 20 of 2002). The new administration also introduced a new tax reform bill (the Fiscal Equity Act), which includes (i) spending cuts in non-priority areas in order to achieve levels of public employment equal to 1999 levels in the same areas; and (ii) a restructuring of the tax system that is to include the introduction of a tax on gross corporate earnings as a minimum advance payment on corporate profit taxes, as well as the elimination of a sizeable number of preferential regimes.

5

The value added tax (VAT) is known as the Impuesto sobre la Transmisión de Bienes Muebles y Servicios [tax on transfers of movable goods and services] (ITBMS).

6

This law was designed to simplify the tax system and broaden the tax base of the ITBM (a tax on the transfer of movable goods) to include services, at which point it became known as the ITBMS tax.

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1.4

Under the Fiscal Responsibility Act, the country is required to obtain a primary surplus, the nonfinancial public sector’s deficit may not exceed 2% of GDP, the total public debt may not exceed 50% of GDP in 2017, and the external public debt must be held to 35% of GDP or less.

1.5

The public sector is also grappling with a problem in connection to its contingent liabilities as a result of growing actuarial deficits, particularly in the case of the Programa de Invalidez, Vejez y Muerte [Disability, Old Age, and Death Benefits Program] (IVM) of the Caja del Seguro Social [Social Security Fund] (CSS). It is estimated that the pension system’s reserves will be depleted in less than 10 years; this is clearly a dangerous situation in that the State would have to assume this obligation and increase its current debt level by US$13.1 billion, or roughly 120% of current GDP. In view of the CSS’s financial troubles, the authorities prepared reforms in June, which have been postponed until a second national debate on social security concludes.

1.6

On the social front, it should be noted that Panama’s poverty levels are fairly high, although they have declined over the last decade. The country’s poverty rates are influenced by its high degree of inequality (one of the highest in the world); the richest 20% of the population receives 62.7% of total income, whereas the poorest quintile accounts for just 1.5%. Poverty is concentrated in rural areas, where 75% of the country’s poor and 88% of its extremely poor inhabitants live. Poverty is even higher and more severe in indigenous communities, where population growth rates are higher7 and where 95% of the residents are poor and 86% are extremely poor.8 While extreme poverty is largely a rural problem, non-extreme poverty is found in urban households whose members are unemployed. This significant regional disparity reflects the duality of the economy and biases in the tax and industrial and agricultural protection systems. This situation is exacerbated by a failure to target social policy, where the lack of efficiency and equity in public spending has held back the achievement of better outcomes for the rural and indigenous population despite Panama’s levels of social spending (20.2% of GDP and 40.5% of total public spending),9 which are among the highest in all of Latin America.

1.7

Panama is also faced with the challenge of generating the necessary human capital (a skilled and flexible labor force) to continue to compete in the economic globalization process and in world trade. In order to do so, the country will need to raise its population’s educational level, strengthen and diversify

7

An annual growth rate of 3.9%, versus 2% for the population as a whole (Demographic Analysis Department of the CGR).

8

World Bank. Panama. Poverty Study, 2000.

9

Social Policy Division of the Ministry of Economic and Financial Affairs (MEF), 2004 (using figures for 2001).

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technical/vocational courses of study in secondary education, technical training, and higher education, and foster scientific and technological research.

1.8

Although Panama has been improving its social indicators, and its ranking on the Human Development Index is higher than would be expected based on its income level,10 gaps between the rural and urban sectors remain, and it is unlikely to reach a number of the Millennium Development Goals (MDGs) (see Annex IV). Given this situation, Panama will have to target its efforts in rural areas if it is to achieve the MDGs.

B.

Principal development challenges

1.9

The progress of Panama’s medium-term economic and social development process is linked to advances in meeting four different challenges: (i) speeding up growth on a sustainable basis while incorporating other production options; (ii) reducing poverty; (iii) ensuring the sustainability of its natural and cultural wealth; and (iv) producing public goods more efficiently.

1. Speeding up growth on a sustainable basis while incorporating other production options

1.10

In order to meet the challenges entailed in opening up its markets, Panama must work to boost its aggregate productivity and expand job creation in formal sectors of the economy. To this end, it should implement a strategy aimed at making its protected sectors’ more competitive and at bringing excluded sectors into the economic development process, making thorough, sustainable changes in the production structure, and absorbing labor. To hasten growth on a sustainable basis, it must: (i) maintain a stable macroeconomic framework; (ii) restore dynamism in key sectors; and (iii) create new production options for growth. a. Maintain a stable macroeconomic framework

1.11

Effective implementation of the Fiscal Equity Act and the amendment of the Fiscal Responsibility Act are necessary in order to begin addressing fiscal problems that could worsen due to tax revenue losses expected once the free trade agreements11 are implemented. In addition, the enforcement of the Fiscal Responsibility Act beginning in 2006 will lay the groundwork for the initiation of a plan to reduce the public debt. Although both laws mark the beginning of profound changes in Panama’s fiscal policy, the authorities must engage in an ongoing effort to collect taxes efficiently and rationalize public spending. The efficiency of tax collection is

10

Panama is ranked sixth out of 85 middle-income countries (18 points above its per capita GDP ranking).

(Human Development Report, 2004).

11

Revenues from tariffs accounted for 1.7% of GDP in 2004. Imports from the United States represent 39% of the total (including imports from the Colón Free Trade Zone, 2003).

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hindered by the limited management capacity of the Dirección General de Ingresos [General Revenues Bureau] (DGI). It is therefore essential to make fiscal management more efficient and effective. In order to proceed with the rationalization of public spending, the country should, in addition to the reform of the CSS, conduct a comprehensive evaluation of human resource issues in the public sector. This assessment should look at civil service reform, the formulation of a law on civil service wages, and the modernization of civil service career paths.

Efforts should also be made to promote greater private-sector participation in investment financing. b. Restore dynamism in key sectors 1.12

Modern sectors’ potential effectiveness as engines of economic growth has been diminished by various factors. Because of the ways in which world trade and shipping technology have evolved, the Panama Canal’s infrastructure needs to be modernized and expanded by, among other things still being considered, building a third set of locks in order to meet post-Panamax world shipping demand.

Meanwhile, Colón Free Trade Zone (CFZ) reexports fell by over 30% between 1997 and 2003,12 chiefly as a result of the financial crises in Asia and Latin America. Because of imminent trade liberalization, it would be beneficial for the CFZ to shift toward increased delivery of modern services. Panama’s financial system is one of the most modern systems in Latin America,13 and its assets are almost three times the size of GDP. It has two major components: an offshore component and another that serves the domestic economy. The latter has contributed little to the development of goods-producing sectors, since a major part of the banking system’s loan portfolio is devoted to commerce and consumption.

The financial system reflects the absence of financing for long-term investments. It is also necessary to revise the role of the public development banking system.

Lastly, although a sector of cooperation institutions and financial enterprises with a great deal of potential for meeting credit needs in the rural sector does exist, its regulatory system needs to be consolidated in order to ensure effective supervision of its operations. c. Create new production options for growth

1.13

The challenges that Panama faces in promoting new sources of growth include the following: (i) galvanizing the rural economy’s development while ensuring the participation of women, indigenous peoples, and Afro-descendents; (ii) improving the supply of public services and of transportation and telecommunications infrastructure, and lowering logistical costs by encouraging private-sector and localgovernment involvement; (iii) strengthening private-sector development; (iv) helping businesses to incorporate technologies that exist in developed

12

From US$5.8 billion in 1997 to US$4 billion in 2003.

13

It includes 70 banks, 39 general license banks, 29 international license banks, and two public banks.

-5-

countries; and (v) changing the country’s pattern of involvement in the regional and world economies. The main features of these challenges are described below. (i)

Galvanizing the rural economy’s development

1.14

The expansion of sources of growth for Panama is linked to the increased participation of the rural economy, which is home to 38% of the population and 75% of its poor people, and which generates 8.4% of GDP and 47% of its exports of goods. In order to forge a new pattern of inclusive growth and pave the way for a reduction in poverty, sources of growth need to be developed that incorporate the country’s natural and cultural endowments and expand them to include sectors such as tourism, fisheries, forestry, and mining. Steps also need to be taken to help mainstream the excluded population into the production process by creating linkages and by providing these people with training and access to development opportunities.

1.15

Support for changes in the rural sector is made all the more necessary by the entry into effect of the FTA with the United States, since, in order to utilize the opportunities opened up by such agreements, the country needs to modernize its agricultural sector so that it can compete. (ii)

Improving the supply of public services and of transportation and telecommunications infrastructure, and lowering logistical costs

1.16

Panama needs to increase the economic efficiency and sustainability of its electrical power system by making improvements in the regulatory framework that will open the door to more private investment, a reduction in production costs, and increased coverage, particularly in rural areas. With respect to transportation infrastructure, 33% of the highway network and 77% of rural roads are in fair or poor condition, inland ports are of poor quality, and the coverage and quality of rural overland, river, and air transportation infrastructure and infrastructure for the country’s rural airports need to be improved.

1.17

In the telecommunications sector, service quality and reliability indicators have improved considerably. Only 40% of all households have fixed-line service, however; this reflects the low coverage rates existing in more remote rural areas and an increase in the use of cell phones. The failure to develop rural telecommunications is attributable to the fact that no policy to provide subsidies for remote areas was implemented.

1.18

The water and sanitation sector has limited coverage, particularly in rural and indigenous areas, poor service quality, and low maintenance levels. This situation is associated with the institutional weakness of service providers and low rate schedules which, together with heavy losses and high consumption rates, prevent

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the recovery of the system’s operating costs. The sector’s institutional and regulatory structure and service delivery need to be improved. (iii) 1.19

Strengthening private-sector development

The private sector plays a predominant role in the economy in terms of both production and investment. This sector faces a range of challenges, including the conclusion of various trade agreements, increased competition in such areas as financial services, and the impact of regional integration. In order to mitigate the adverse effects that these factors could have on the domestic economy, institutional and legal constraints on the growth of the private sector will need to be removed.

THE BUSINESS CLIMATE IN PANAMA The main factors having an adverse effect on the business climate in Panama are: (i) the high levels of informal activity in the economy (60% of GNP in 2004); (ii) imperfections in the labor market and human capital; (iii) weaknesses in the legal and institutional framework for the private sector; (iv) low percentages of equity recovery when firms close down their operations; (v) high energy, domestic transportation, and telecommunications costs, in addition to the low rural coverage of these services; (vi) the scattered efforts to incorporate technology in the absence of a policy to serve as a base; (vii) the existence of conditions that restrict competition in the domestic market (retail trade, professions and crafts, cross-border insurance sales, insurance brokering, travel agencies, transportation, etc.); (viii) problems of governance, which are reflected in the inefficiency of public institutions; and (ix) diminishing levels of public safety. These factors are compounded by the uncertainty generated by the fiscal situation. One of the government program’s central aims is to improve the business climate.

Source: World Economic Forum, INDESA, Gestoría del Programa de Competitividad [Management of the Competitiveness Program]

1.20

Most local firms in Panama are small companies that do not have the resources to compete internationally and are not linked to value chains that would tie them in with the export service platform that dominates the economy. Around 80% of the companies in Panama are micro, small and medium-sized enterprises (MSMEs).

They cater to the domestic market, particularly in the services sector, and those whose activities are related to the export sector (mainly food products) account for a limited share of total exports. One of the main barriers to the development of these MSMEs is the absence of comprehensive government policies aimed at providing them with support. It is important for Panama to improve its business climate if it is to bring many of these small and medium-sized enterprises into the modern sector of its economy.

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(iv) 1.21

Helping businesses to incorporate technologies that exist in developed countries

Panama is ranked fifty-third out of 104 countries in technological development.

Technological innovation in unmodernized sectors has been limited by low levels of research and development (R&D) investment and by shortcomings in the educational and vocational training system. In view of the greater demand for technological advances associated with the globalization process, Panama should implement a strategy for developing a technology policy that is tailored to the countryâ&#x20AC;&#x2122;s needs and will incorporate sectors that have lagged behind, thus promoting productivity gains. To this end, the country needs to: (i) raise the level of private investment in R&D, particularly in unmodernized sectors; and (ii) reform its educational and vocational training system in order to align supply with demand in the labor market and increase its coverage. (v)

Changing the countryâ&#x20AC;&#x2122;s pattern of involvement in the regional and world economies

1.22

In order to establish a competitive position as an international supplier of certain goods and services, Panama must improve its international profile. In order to accomplish this, it should: (i) aggressively seek market access and expand its share of markets in which it is already active; and (ii) create the necessary conditions to ensure an orderly transition to free trade and market integration.

1.23

Aggressively seek market access and expand its share of markets in which it is already active. In order to maximize the benefits of trade liberalization, Panama should capitalize upon its comparative advantages in profitable traditional sectors and broaden its export base in promising sectors such as tourism, agricultural export products, fisheries, and information technology. To this end, it should modify the core elements of its trade strategy and learn more about the demand and market characteristics of those sectors.

1.24

Create the necessary conditions to ensure an orderly transition to free trade and market integration. The negotiation of an FTA with the United States poses major challenges for the country in areas in which it has no previous experience. In order to honor the commitments it is taking on, Panama will have to implement a series of regulatory, institutional and sector-specific policy changes in a wide range of areas (see Annex V).

2. Reducing poverty

1.25

Although there has been a decline in poverty, especially in the case of extreme poverty (from 31.4% in 1990 to 14.2% in 2003), this reduction is a modest one when considered in conjunction with the growth rates registered during the decade.

Panamaâ&#x20AC;&#x2122;s poverty/growth elasticity between 1991 and 2003 was below 0.26, both

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for overall poverty and for extreme poverty, which is significantly lower than the coefficient of 1.6 estimated by ECLAC for Latin America as a whole.14 This indicates that the country’s slow pace of progress in reducing poverty is the result of the large poverty gaps existing in rural areas (54.6%, versus 21% nationwide).

These gaps are a consequence of the level of inequality in the country.

1.26

The country’s high levels of inequality reflect the disparity that exists in the distribution of productive assets: human capital (education and health), physical assets (housing and land tenure) and financial assets (savings and credit). A more rapid reduction in poverty will therefore require a combination of per capita GDP growth and decreases in inequality. This, in turn, calls for greater efficiency in government social spending and the targeting of that expenditure via innovative programs focusing on sectors of the population living in poverty.

1.27

The State should play a key role in expanding opportunities for poor sectors of the population, reducing their vulnerability, and promoting their participation in the economy and in society. Social policy should be channeled in two strategic directions: toward increased efficiency in current levels of social spending; and toward blocking the intergenerational transmission of poverty by providing social safety nets that make the development of human capital possible and that foster the inclusion of the poor in the economy. Social policy should therefore be directed toward: (i) improving the efficiency and targeting of social spending; and (ii) increasing poor sectors’ access to physical and financial assets.

3. Ensuring the sustainability of the country’s natural and cultural wealth

1.28

Panama has a natural and cultural endowment that places it in a strong position for competing with the supply offered by other countries of the region and that provides its economy with other productive options that can benefit its rural communities.

1.29

The problems relating to the use of these resources include: (i) the Panama Canal watershed15 is becoming increasing polluted as a result of urban growth and the lack of a management plan; (ii) natural resource and environmental management is impaired by the legal and institutional shortcomings the agencies that regulate it; (iii) there is no appropriate regulatory system for managing the country’s mineral resources, which have a strong potential to serve as an engine of growth; (iv) forestry resources are under strong pressure and are not covered by a management plan or certification processes; (v) marine/coastal ecosystems are being degraded by inappropriate use and pollution; (vi) fishery resources are being overexploited; (vii) the supply and quality of water resources are coming under

14

Office of Evaluation and Oversight (OVE). Country Program Evaluation, Panama, 1991-2003.

15

The Canal watershed provides 70% of the country’s population with drinking water and uses approximately 85 billion cubic feet of water per year.

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pressure due to an increased demand for goods and services, and a need therefore exists for the regulation of water use; and (viii) the country is becoming increasingly vulnerable to natural disasters, and appropriate mitigation measures and tools to address this situation are not in place.

1.30

The aforementioned problems, together with the exponential increase in activities such as fisheries, tourism, mining, and the development of megaprojects (including an eventual expansion of the Canal), have overarching implications for sustainable natural resource use. In order to tap into Panama’s natural wealth and ensure its sustainability, efforts to improve the country’s environmental and natural-resource management need to be consolidated.

4. Producing public goods more efficiently

1.31

In Panama, support for democracy as a system of government is the stronger than in any other Central American country and is above the Latin American average. Even so, only one third of the population says it is satisfied with the way that system operates.16 This situation attests to shortcomings in the political parties’ ability to address the needs of the various social groups satisfactorily and of the legislature’s ability to represent the country’s citizens in drafting legislation and keeping the executive branch in check. Reforms are therefore needed to build up the National Assembly’s capacities in these areas.

1.32

Agencies in the judicial branch, which are still in the midst of a consolidation process, also exhibit institutional failings. The prevailing level of confidence in the judicial branch is very low, as is the legal structure’s level of efficiency in upholding legal certainty. Panama needs to reinforce the rule of law by strengthening the justice system and providing greater access to it.

1.33

Measures for promoting transparency in government decision-making in relation to contracts, concessions, and tax collection are especially important. The delivery of quasi-public basic goods for economic development also has to be improved in areas where the State has a major role to play (scientific research, the application of technology, national statistics, export promotion, census records, job training).

1.34

The fragmentation resulting from the existence of overlapping management units has an adverse effect in terms of governance, and this situation is reflected, in turn, in serious institutional weaknesses. A strategic plan that includes the formulation of plans and management indicators at the Ministry level is called for, as is the extension of the Sistema de Administración Financiera de Panamá [Financial Administration System of Panama] (SIAFPA) to all levels of government, including the municipios.

16

Latinobarómetro, 2004, and Daniel Kaufmann (Governance Indicators for 1996-2002).

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1.35

The public sector’s procurement and contracting system also needs to be strengthened. Some of the provisions governing this system, whose legal framework is set out primarily in Law 56, are too specific and thus give rise to rigidities in the procurement process. Furthermore, there has been a proliferation of additional laws and decrees which have led to regulatory duplications and conflicting interpretations of the relevant laws. It would also be helpful to review the role played by the Contraloría General de la República [Office of the Comptroller-General] (CGR) in the supervision of the procurement process. The modernization of the public contracting system, including the integration of an e-contracting system into the SIAFPA, would allow procurement to be linked directly with financial and budgetary control and accounting systems. This would make contracting and procurement procedures more efficient and transparent and would lower the State’s administrative costs.

1.36

Panama is one of the most centralized countries in Latin America. The institutional processes involved in the delivery of basic public services, as well as infrastructure and urban development planning, are in the hands of central government agencies, while the municipios have few specific responsibilities. Panama thus needs to explore ways of utilizing the potential of municipal governments and decentralization in order to expand the range of opportunities for reducing poverty.

C.

The government program

1.37

The economic policy of President Torrijos’s administration, as set out in the government program, seeks to achieve a sustainable and socially inclusive form of economic development by making the country’s productive apparatus more competitive and by creating and maintaining an environment conducive to productive investment. It also calls for measures to promote organized social participation and to build individual and community capacity, together with social investment programs that guarantee equitable access to basic services, particularly for the more vulnerable groups. The program is underpinned by five main pillars, which are described below.

1.38

The first pillar is the reorganization of public finances, whose main components include a commitment to hold the NFPS deficit to below 2% of GDP and to steadily reduce the public debt and the external public debt, bringing them down to 50% and 35% of GDP, respectively, by 2017 under the terms of the Fiscal Responsibility Act. In addition to the implementation of the Fiscal Responsibility Act and the Fiscal Equity Act, efforts will be aimed at boosting the public sector’s efficiency, effectiveness, and transparency. In the area of tax collection, the authorities intend to employ a strategy aimed at increasing the DGI’s efficiency while reducing evasion and raising tax revenues.

1.39

The second pillar is poverty reduction and an improvement in income distribution, with measures being designed to further: (i) a social development

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process that reduces poverty by building human capital; (ii) the promotion of productive capacities in rural areas; and (iii) development of a framework that fosters responsible social participation.

1.40

The third pillar is the reform and modernization of the State and the creation of effective, efficient, and transparent public institutions. This initiative is directed toward providing unrestricted access to State information and opening up institutions to public oversight and scrutiny. This also involves promoting citizen participation and local development as a means of moving toward an effective decentralization process.

1.41

The fourth pillar is economic growth and employment, aimed at ensuring a better allocation of resources and greater economic growth based on the development of an economic liberalization model that is geared toward international markets and fosters productivity gains. Steps will be taken to improve the climate for private investment and the development of basic infrastructure.

1.42

The fifth pillar is the development of human capital, which aims to provide knowledge, health care, and education in order to have better citizens and improve competitiveness. The activities planned are designed to reform the education system at all levels and develop an efficient health services program.

1.43

The program’s strategic components are also in line with the country’s commitment to the sustainable use of natural resources and environmental protection. The Government of Panama’s priorities fit in with the diagnostic assessments conducted by the IDB and the World Bank for the country in recent years.

D.

Macroeconomic prospects and debt sustainability

1.44

The macroeconomic outlook for 2005-2009 is shaped by three main factors: (i) the fiscal deficit and the status of the CSS’s IVM pension program; (ii) the business climate and its implications for national and foreign investment; and (iii) the external environment and the entry into force of FTAs with the United States and other countries.

1.45

Debt sustainability hinges upon the implementation of existing fiscal measures that have already been approved in conjunction with pension system reforms. These reforms will have an impact not only on the fiscal deficit but also on growth and on the interest rates that the government will have to pay on the public debt.

1.46

This strategy sets out two feasible scenarios (as shown in Table I-2). The base scenario is based on the assumption that the authorities will not undertake any further tax reforms. It also assumes that the government will succeed in deferring CSS insolvency by modifying its parameters to fit existing profits and contributions rates. These reforms will pave the way for a strong enough improvement in the government’s fiscal status to shrink the NFPS deficit (excluding the Panama Canal

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Authority) to less than 2% of GDP by 2007, in accordance with the Fiscal Responsibility Act. The primary NFPS deficit would also level off at around 2.7% of GDP. This would be enough to generate an annual reduction in the public debt of around 1.5 percentage points of GDP starting in 2006, which would put the country on track to meet the target of 50% of GDP set for 2017. It is also assumed that the FTA with the United States will be approved, but that no major reforms relating to the business climate will be instituted. Under these circumstances, the growth rate during the period when this strategy will be in effect (2005-2009) is projected at around 4%.

1.47

Under the high scenario, tax measures would be implemented that would raise collection rates from 2 to 3 percentage points of GDP to 11 to 12 points by 2007.

These measures may include improvements in tax administration aimed at reducing tax evasion levels and a continuation of the effort underway to eliminate special regimes benefiting specific clusters or groups of companies. It also assumes that the State will embark on an effort to improve the efficiency, transparency, and targeting of public expenditure and will begin to remove barriers to private investment. It is estimated that these fiscal efforts would allow the country to bring the NFPS deficit (excluding the Panama Canal Authority) down to the target level (2% of GDP) set in the Fiscal Responsibility Act as early as 2006 and then to achieve continued reductions, lowering it to 0.5% of GDP by 2008. The primary surplus would level off at about 3.5% of GDP, permitting the public debt to be reduced by nearly three percentage points of GDP per year. Under this scenario, the public debt would be cut to less than 50% of GDP and the external public debt would be lowered to below 40% of GDP by 2010.

1.48

If this high scenario actually materializes, Panama may be able to raise its growth rate substantially (to 5%-5.5% in real terms) toward the end of the period covered by this strategy. The improvement in its fiscal accounts, which would also lift the sword of Damocles represented by the CSS deficit, would help to lower the country risk premium from its observed level in 2004-2005 (400-320 basis points) to perhaps 250-200 points (see Annexes VI and VII).

Table I-2. Macroeconomic Outlook, 2005-2009 Indicators

GDP (growth rate) Nominal interest rate (av.) on public debt Real interest rate (av.) on public debt Primary deficit (-) / surplus (+) (% of GDP) NFPS deficit (excl. ACP) (% of GDP) NFPS deficit (incl. ACP) (% of GDP)

Public debt as % of GDP External Public debt as % of GDP Source: IDB and IMF estimates.

2002 2.2 6.8 5.6 1.0 -3.3 -2.7 63.7 51.7

2003 4.3 7.2 6.2 -0.3 -4.7 -3.8 63.3 50.6

2004 6.2 7.8 6.6 -0.5 -5.0 -3.3 68.1 52.6

2005 4.5 7.4 5.6 1.1 -3.6 -2.1 63.7 49.5

Base Scenario 2006 2007 2008 4.0 4.0 4.0 7.6 7.5 7.4 5.2 5.6 5.8 2.5 2.8 2.8 -2.1 -1.6 -1.6 0.0 0.7 0.7 61.8 60.0 58.5 48.4 47.4 46.5

2009 4.0 7.4 5.8 2.6 -1.5 0.6 57.2 45.2

2005 4.5 7.4 5.6 1.1 -3.6 -2.1 63.7 49.5

High Scenario 2006 2007 2008 4.5 4.5 5.0 7.5 7.3 7.1 5.1 5.3 5.4 2.9 3.4 3.5 -1.6 -0.8 -0.5 0.4 1.5 1.7 61.1 58.4 55.6 47.8 45.8 43.7

2009 5.5 7.0 5.3 3.4 -0.2 1.8 52.9 40.8

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II. LESSONS LEARNED FROM THE PRECEDING STRATEGY AND PORTFOLIO A.

Strategy for 2000-2004

2.1

The Bank’s country strategy with Panama for 2000-2004 focused on providing operational responses in support of equity and competitiveness and was built around four major priorities: (i) backing up a frontal attack on poverty and an increase in equity; (ii) promoting economic reforms to boost competitiveness and growth; (iii) assisting the country to consolidate its regulatory, legal, and institutional framework for sustainable growth; and (iv) helping to develop institutional reforms aimed at enhancing governance and transparency. The base scenario for this strategy called for a US$414 million project pipeline.

2.2

This strategy’s implementation was hindered by: (i) a weak macroeconomic environment involving an economic slowdown, a shrinkage of the tax burden, and mounting fiscal deficits that hit public investment; (ii) the existence of very little maneuvering room for policymakers because the party in office did not have a majority in the National Assembly; (iii) frequent changes in government officials, as well as problems with coordination among the various government departments; and (iv) as a consequence of all the above, a slow pace of progress in portfolio execution.

1. Achievements

2.3

As a result of these problems, the strategy’s objectives were only partially fulfilled.

Nonetheless, in reviewing the impacts of the Bank’s actions, it should be noted that the progress made in implementing financial-sector reforms helped to put that sector on a more solid footing and was a contributing factor in Panama’s removal from the list of countries considered to be tax havens or centers for money laundering.

2.4

The infrastructure investments financed by the Bank have led to increased private investment in energy, telecommunications, and road transportation, have lowered vehicle operation costs, have improved telecommunications access and effectiveness, and have reduced electricity rates and net energy losses during generation. Although infrastructure sectors were opened up, with the exception of the MIF, fairly little use was made of the Bank windows that provide direct support for the private sector (Private Sector Department, Multilateral Investment Fund (MIF), Social Entrepreneurship Program (SEP), and the Inter-American Investment Corporation (IIC)).

2.5

On the social front, the decline in extreme poverty continued, and progress was made in expanding the coverage of education and health services, particularly in rural areas. The inroads made in reducing poverty fell short of expectations, however, given the high levels of inequality prevailing during the period covered by

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the strategy. On the other hand, the promotion of social investment at the rural level did permit an expansion in the coverage of basic public services, which stimulated both employment and community organization.

2.6

To promote governance and the modernization of the State, the Bank has worked to help increase access to the justice system. State financial management has been strengthened through the development of the SIAFPA and the Treasury Department’s Sistema de Cuenta Única [Unified Account System] (CUT), despite the slow pace at which CGR responsibilities were transferred to the MEF.

2.7

As for the instruments used to implement the strategy, technical-cooperation operations (TCs) played an important role in backing up these initiatives by providing an opportunity for projects to mature and for the preparation of future operations, while at the same time continuing to focus attention on issues of importance to the country. Examples include the Environmental law and strategy, Management and protection of the Panama Canal watershed, the Bocas del Toro development strategy, and the Accelerating rural energy coverage in Panama operation. In addition, strong synergies were achieved between these loan operations and MIF projects. Examples, in this case, include the Employment and training system project, the Project to strengthen the Securities Commission, and the Panama technology business accelerator operation.

2. Lessons learned from the preceding strategy

2.8

A review of the 2000–2004 strategy and of project execution during that period offers the following lessons for consideration in developing the new strategy: (i) policy-based loans should be approved early on in the political cycle in order to ensure that the associated measures can be implemented during the term of the administration with which they were negotiated; reform projects should be designed with sufficient flexibility to assimilate changes that may arise in the political environment; (ii) the new strategy should incorporate targeted programs and mechanisms for reducing inequality; (iii) the new strategy should maximize the use of Bank windows that provide direct support for the private sector with a view to steadily increasing the economy’s competitiveness; (iv) tools are needed to minimize the impact of institutional weaknesses on the portfolio’s execution in order to ensure an increase in the country’s absorption capacity; and (v) the new strategy should offer the authorities a number of different politically viable options for moving ahead with the strengthening of the water and sanitation sector’s regulatory framework.

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B.

The portfolio 1. Trends and performance

2.9

The 2000-2004 loan portfolio for Panama shrank from US$1,173,400,000 (US$696.4 million to be disbursed) to US$626.4 million (US$311.9 million to be disbursed). This represents a 46.6% reduction in the approved amount and a 55.2% in the undisbursed balance.

2.10

At the start of the preceding strategy’s implementation, there were 30 projects being executed, of which 17 were completed. In line with that strategy’s objective, projects that were not priorities for the new administration were cancelled. During that period, 10 new projects were added to the portfolio. At the end of 2004, the portfolio included 23 operations and 25 loans, including one policy-based loan.

2.11

Portfolio performance was hampered by the following factors: (i) The CGR’s delay in signing off on the contracts and delays in the fulfillment of eligibility requirements; (ii) changes in government policy; (iii) the executing agency’s weak institutional capacity; and (iv) problems with coordination between the government and donors.

2. Lessons learned from the portfolio

2.12

A number of lessons can be drawn from an analysis of the portfolio and its performance which can be applied to the present strategy: (i) steps should be taken to ensure that the execution period and the deadline for the final disbursement are realistic and compatible with fiscal conditions and with the executing agency’s installed capacity, and that an analysis of the executing agency’s institutional capacity is available, along with an adequately funded plan for strengthening it, as are a clearly delineated and viable execution mechanism; (ii) in order to serve as effective planning tools, annual work plans (AWPs) should provide for a pace of implementation that reflects the government’s fiscal viability and the executing agency’s actual institutional capacity; (iii) community groups’ participation in program execution is an effective tool for local supervision and accountability.

Whether they become involved in social audits of primary health service delivery or local supervision of environmentally sustainable projects, organized communities are a support tool that can be used to an advantage. It is important, in any case, to note that community participation often has invisible direct costs and opportunity costs that should be taken into account in the feasibility studies for Bank operations; (iv) multi-component operations, operations involving a number of coexecuting agencies, or ones that call for interagency coordination are often very challenging during the implementation stage, possibly because they are over-ambitious; and (v) it is best to have a single government agency or unit act as the Bank’s counterpart in the coordination and analysis of portfolio performance and in the supervision and monitoring of the portfolio’s implementation. This agency or unit

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should be well placed to provide incentives for executing agencies that fulfill contractual requirements and recommendations as a means of improving program performance and increasing the likelihood of meeting development objectives.

3. Current status and role of the portfolio in the new strategy 2.13

The active portfolio17 includes 25 loans that are funding 23 operations; US$333 million remain to be disbursed, with 13.6% of that amount corresponding to three projects approved in 2003-2004.

2.14

The programs making up the active portfolio (see Annex VIII) tie in closely with the Bank’s new strategy with the country and are an important source of support for the achievement of its objectives. During the sector portfolio review missions conducted in the third quarter of 2004 and the country portfolio review mission of December 2004, current operations were analyzed in detail with the government, and action plans for each one were agreed upon. The disbursement periods for five operations were extended, and it was agreed that one other (the education program) would be restructured.

III. IDB COUNTRY STRATEGY WITH PANAMA, 2005-2009

A.

Elements involved in the strategy’s formulation

3.1

Consideration is given to the following elements in the Bank’s country strategy with Panama: (i) fiscal sustainability is a prerequisite for the strategy’s implementation, whose viability hinges on the country’s success in building a consensus for reform. These two elements determine the scale of the operations program and the particular toolkit to be used; (ii) the strategy takes into account both the active portfolio and new operations to ensure continuity and complement the efforts made under the preceding strategy. A high priority is also placed on institution-strengthening in order to build up the country’s absorption capacity; (iii) it assigns an important role to the private sector in establishing an enabling macroeconomic environment and in seeking the implementation of legal and institutional reforms to promote competitiveness and capitalize upon the synergies offered by the various Bank windows for private-sector development (Private Sector Department, MIF, IIC, SEP); (iv) it includes a strong component of sectorbased analyses with a view to delving more deeply into some of the issues involved in the policy dialogue. This component provides for studies to be coordinated with other core IDB departments and with the World Bank; (v) it is designed to promote increased coordination and harmonization of international cooperation by supporting the development of sector-based approaches; (vi) it provides for a midterm review to permit the identification of problems and the introduction of any

17

As of 15 May 2005.

- 17 -

adjustments needed to ensure achievement of the established objectives; and (vii) it incorporates the recommendations made by the Office of Evaluation and Oversight in its evaluation of the Bank’s program in Panama over the period 1991-2003, whose linkages with the new proposed strategy are outlined in detail in Annex IX. B.

Strategy objectives

3.2

The chief objective of the Bank’s country strategy with Panama is to support sustainable economic growth and poverty reduction. The country strategy focuses Bank programs on two strategic objectives: (i) boosting the economy’s competitiveness; and (ii) building human and productive capital. It also incorporates the cross-cutting objective of strengthening governance and transparency as a necessary condition for progress in these two areas.

Speed sustainable growth while incorporating other productive options

Challenges

Strategy’s core objective

Strategic objectives

Cross-cutting element

Reduce poverty

Safeguard natural and cultural wealth on a sustainable basis

Produce public goods more efficiently

Support sustainable economic growth and poverty reduction

Boost the economy’s competitiveness

Build human and productive capital

Strengthen governance and transparency

1. Boosting the economy’s competitiveness 3.3

In order to achieve sustained economic growth that will foster diversification and the formalization of the economy, steps should be taken to create the conditions needed to integrate the various sectors and boost competitiveness. In order to backstop this process, Bank actions will be directed toward: (a) supporting fiscal sustainability; (b) promoting basic infrastructure development; and (c) expanding the range of sources of sustainable growth.

3.4

The actions provided for in the country strategy in order to achieve the proposed objectives are described below:

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a. Supporting fiscal sustainability 3.5

The strategy provides support measures for strengthening the government’s financial position at the central and local levels in order to improve the management of public spending, the country’s repayment capacity, and its external public debt position, while at the same time promoting competitiveness.

3.6

The Bank will contribute to fiscal reform by supporting implementation of the fiscal responsibility, fiscal equity, and social security reform laws. Revenues will be bolstered by strengthening the Dirección General de Ingresos [General Revenues Bureau] (DGI), the Dirección General de Aduanas [General Customs Bureau] (DGA), the Dirección de Catastro [Cadastre Division] (DC), and the Public Registry. Measures to be taken in the area of public expenditure will include actions designed to: ensure the sustainability of the Caja de Seguro Social [Social Security Fund] (CSS); reinforce the budgetary process, including the implementation of the Cuenta Única del Tesoro [Unified Account System] (CUT); modernize the public contracting system while incorporating the relevant institutions (ministries, the Contraloría General de la República [Office of the Comptroller-General] (CGR), and local governments); improve the programming of public investment, including the strengthening of procedures for results-based management; consolidate the SIAFPA’s implementation at both the central and local levels; strengthen the Dirección Nacional de Contabilidad [National Accounting Division] (DNC); implement civil service career paths; and develop and implement a strategy for the organization and use of the State’s physical assets.

3.7

Programs included in the active portfolio will be used to strengthen fiscal and financial management (domestic and external taxes, the cadastre and registry offices, SIAFPA, the CUT, accounting, public investments).18 The strategy also provides for a program to strengthen governance; phase II of the program to strengthen the judiciary; and a program to strengthen the Panama City Mayor’s Office; technical-cooperation operations focusing on the diagnostic assessment and a medium-term action plan for development effectiveness (PRODEV) and on specific actions and aspects involved in the implementation of the PRODEV; a regional technical-cooperation operation focused on strengthening the tax bureau’s internal control services; and a MIF operation designed to upgrade the customs system. In addition, four studies are to be undertaken that will be central to the strategy’s execution: a study on fiscal sustainability and public indebtedness, and three nonfinancial products (NFPs) that the IDB will develop in conjunction with the World Bank (a Public Expenditure Review (PER), a Country Financial Accountability Analysis (CFAA), and a Country Procurement Assessment Report (CPAR)). The results of these three NFPs and the outcomes of the PRODEV’s

18

Fiscal management II; Support for the financial sector program, and the National land management program [PRONAT] (Provisional cadastre and registry system).

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implementation will lay the groundwork for the use of more flexible loan instruments. b. Promoting basic infrastructure development 3.8

The strategy seeks to support the expansion of infrastructure and the reduction of the logistical costs of doing business in the country by implementing measures to: (i) expand the coverage of electrical power service in rural areas and provide incentives for hydroelectric power generation; (ii) increase the coverage of drinking water service, particularly in rural and indigenous areas, and the coverage of sanitation services, with special emphasis on urban centers, rural areas, and indigenous areas, in order to support efforts to achieve the Millennium Development Goals (MDGs); (iii) improve road infrastructure, set up a road maintenance fund, and strengthen the sector’s institutional structure; (iv) develop and implement a mass-transportation solution for Panama City; (v) promote physical and energy integration with Central America under the Puebla-Panama Plan and with the Andean Community; (vi) increase telecommunications coverage, particularly in the rural sector; and (vii) support the consolidation of reforms in infrastructure sectors while promoting participation by the private sector and local governments.

3.9

Operations included in the Bank’s portfolio will be used to support the expansion of electricity, water, and sanitation coverage, as well as improvements in road infrastructure and Central American integration of overland transport and electrical power systems.19 These initiatives will be complemented by new operations in the following areas: rural electrification; phase I of a sanitation project in Panama City; a pro-competitiveness road infrastructure program within the framework of the Puebla-Panama Plan; a program aimed at enhancing the investment climate and adapting to trade liberalization; six technical-cooperation operations (a national transportation plan, an urban planning system, support for the procompetitiveness road infrastructure program under the Puebla-Panama Plan, and three regional initiatives to support the harmonization of the energy regulation scheme and the development of the Sixaola binational watershed), and MIF operations focusing on a comprehensive review of the energy sector’s regulatory scheme and policy framework; identification of mechanisms for promoting privatesector participation in the Canal’s expansion; skills training for the Canal expansion project; the strengthening of airport security; support for private-sector participation in infrastructure service delivery; infrastructure concession agreements (ports); and the implementation of a solid waste collection, transport, and treatment system in Barú (Chiriquí). The Private Sector Department also has

19

Electric power expansion program; Support for the restructuring of IDAAN; Feeder roads and bridges; PPP road integration corridor; Central American electricity interconnection program; the MIF technicalcooperation project strengthening SME bus operations; and the technical-cooperation projects Accelerating rural energy coverage, and Design of interception and treatment system (sanitation).

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five operations planned: the Bonyic hydroelectric project; the Bajo de Mina hydroelectric project; a thermal energy conversion project; a project focusing on the Colón International Airport; and a transportation project. In support of these activities, a number of NFPs have been programmed: an investment sector analysis; an investment climate assessment (ICA, IDB/World Bank); and strategic lines of support for the private sector. c. Expanding the range of sources of sustainable growth 3.10

In order to support the economy’s diversification, the country strategy will focus on promoting the development of sectors that can stimulate gains in competitiveness and open up opportunities for mainstreaming rural and indigenous sectors of the population. To this end, the strategy will seek to: (i) improve the economy’s position in the global marketplace by developing sectors with comparative advantages (tourism, agricultural exports, information technologies, and other clusters to be identified by the Competitiveness Promotion Program), strengthening the management of foreign trade with a view to the implementation of trade agreements and investment promotion, and fostering integration within Central America under the Puebla-Panama Plan (PPP) and with the Andean Community; (ii) support the inclusion of the rural sector, indigenous peoples, and women by mainstreaming them into the development of the productive sector and promoting new economic opportunities for sectors of the population adversely affected by economic liberalization; (iii) foster the development of MSMEs in formal sectors of the economy; (iv) enhance the business climate and strengthen the private sector’s capacity to contribute to economic growth with equity; (v) consolidate the financial sector’s development by increasing its transparency, promoting the development of the capital market, strengthening the regulatory framework for the insurance and reinsurance industries, for cooperatives, and for financial enterprises, increasing access to credit (particularly for MSMEs and women), and making the public banking sector more efficient; (vi) promote technological innovation by developing a policy tailored to the country’s needs, increasing private R&D investment, strengthening the vocational training system, and reducing rigidities in the labor market; (vii) develop natural resources on a sustainable basis while consolidating the institutional, legal, and regulatory framework for their management and promoting decentralization; and (viii) develop an institutional, financial, and physical strategy for reducing the country’s vulnerability to natural disasters.

3.11

Within the context of the strategic lines of action developed in support of the private sector, a preliminary proposal has been prepared that focuses on priority areas of action for the various units of the IDB group that provide direct support for the private sector (the Private Sector Department, IIC, MIF, and the SEP), as well as the specific issues to be addressed by the Business Climate Initiative (BCI). This proposal is based on an in-house workshop for these units and was discussed with the Panamanian authorities and members of its private sector during the consultation process relating to the country strategy.

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3.12

Bank action in support of the private sector will be aimed at eliminating growth constraints. Its efforts in this connection will target the following areas: (a) promotion of macroeconomic stability; (b) development of a sector-based approach; and (c) promotion of trade and investment. The need to provide support for macroeconomic stability is clear, given the constraints that the fiscal situation places on public investment. The sector-based approach is designed to respond to the need to expand the export base by promoting sectors with strong export potential while at the same time removing these growth constraints. The component focusing on the promotion of trade and investment will complement activities designed for specific sectors and companies.

Table III-1. Proposed strategic lines of action in support of the private sector in Panama The strategic priorities proposed include actions in the following areas: (a.1) development of public/private partnerships in infrastructure and basic service delivery; (a.2) increased participation by private enterprise in energy, transportation, telecommunications, and water and sanitation infrastructure; (a.3) institutional strengthening of nongovernmental organizations capable of providing training and other services to the private sector on a more cost-efficient basis than the government can; (b.1) support for selected infrastructure investments and reforms affecting the business climate that generate cross-cutting benefits for existing firms (agribusiness, logistics); (b.2) identification and promotion of supply chains with linkages to export platforms for services; (b.3) promotion of foreign direct investment (FDI) in sectors with growth potential (tourism, technology services); (b.4) improvements in corporate governance, accounting and management practices, and the adoption of socially responsible corporate practices; (b.5) development and implementation of technical assistance and financing schemes to support high value-added corporate innovation; (c.1) support for FTA-based trade liberalization; (c.2) attraction of FDI having linkages to the local economy and offering potential for technology transfer; (c.3) support for linkages between local firms and export platforms for services; and (c.4) review of national innovation and training systems in the light of sector-based approaches and FDI promotion requirements.

Source: Annex X

3.13

Programs that already figure in the active portfolio will provide support for the promotion of competitiveness, the development of tourism, the sustainable development of rural/indigenous areas, development of the financial sector, the promotion of e-commerce, the job skills training system, the incorporation of technology into production processes, protection of intellectual property, the

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physical and energy integration of Central America, and environmental management.20.

3.14

These actions will be backstopped by a series of new loan operations: Priority activities in the Panama Canal watershed; International trade capacity building; Development of competitiveness in the rural economy; Sustainable development of the Barú-Divalá River (Chiriquí); Sustainable development of Bocas del Toro, Phase II; Development of tourism in protected areas and in marine and coastal zones; Building the management capacity of the Panamanian Maritime Authority; Development of the Panama Canal watershed; Decentralization of environmental management; Enhancing the investment climate and Adapting to trade liberalization; Consolidation of reforms in the financial sector; transformation in technology and competitiveness, phase II; Enhancing the quality of education; and Strengthening the Panama City Mayor’s Office.

3.15

The following MIF technical-cooperation operations are also planned: Regulatory framework for supervision of the cooperation sector; Regional consolidated banking supervision; Skills training for the Canal Expansion Project; Support for tourism microenterprises; Strengthening of the agribusiness industry; Introduction of corporate responsibility; Business ethics certification; Clean production: Production linkages and Certification procedures. Three other MIF operations are planned as part of the Business Climate Initiative: Strengthening the business climate; Development of a one-stop corporate window; and Improvement of the customs system. Under the SEP, two operations will be implemented: Support for small-scale agribusiness producers; and Delivery of financial services for microenterprises and small businesses in rural areas. The Private Sector Department is planning an operation entitled Partial credit guarantees: Regional securities depository center, and the IIC is preparing three operations: Global Bank line of credit, Banco Continental line of credit, and Banco Universal line of credit.

3.16

The following technical-cooperation operations are planned: Development of tourism in protected areas and in marine and coastal zones; Strategy for the agricultural sector; Building the management capacity of the Panamanian

20

Program to foster competitiveness; Program to support the competitiveness of productive sectors; Tourism sector support program; Sustainable development program for Darién; Multiphase program for the sustainable development of Bocas del Toro Province; Program to support the financial sector; Project to support the implementation of a science, technology, and innovation center of excellence; Training and employment system development; Central America electric interconnection; PPP road integration corridor program; and the National environmental program. MIF technical-cooperation operations: Technology business accelerator; Project to support the development of job skills; Electronic commerce support program; Development and promotion of intellectual property; and the Partnership with industry for clean production program. Two regional programs administered by the Private Sector Department: Program on foreign trade financing; and Partial credit guarantees program; and a technical-cooperation operation entitled Program to support rural microcredit.

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Maritime Authority; National water resources plan; Development strategy for the Barú-Divalá River (Chiriquí); and Hydrometeorological network.

3.17

The following NFPs will also be implemented: Investment sector analysis; Investment climate assessment (ICA, IDB/World Bank); Strategic lines of action in support of the private sector; Rural development and competitiveness; Financial enterprises and the rural sector; Proposal for public banking reforms; and Labor market rigidity, job creation and unemployment issues.

2. Building human and productive capital

3.18

The strategy seeks to enhance human and productive capital as a means of spurring productivity gains and income-generating potential, with special attention being focused on the population in rural and indigenous areas. The strategy will channel its activities toward the following objectives: (a) heightening the efficiency of social spending, making it more progressive, and increasing the coverage and quality of social services on a sustained basis; and (b) improving access to housing and land. a. Heightening the efficiency of social spending, making it more progressive, and increasing the coverage and quality of social services on a sustained basis

3.19

The Bank will support the government’s efforts to focus State action on the poorest and most vulnerable segments of the population with a view to reducing extreme poverty. To that end, support will be provided for a comprehensive strategy targeting the most vulnerable areas based on social protection mechanisms and the decentralization of public social spending.

3.20

The strategy will involve actions in social sectors to complement the improvements made in the management of public-sector finances. These actions will be directed toward: (i) safeguarding spending (and particularly investment) levels of programs having the greatest impact in terms of poverty reduction; (ii) increasing coordination among institutions working in social sectors and building their management capacity; (iii) reducing the centralization of public spending; and (iv) establishing a system for monitoring and evaluating the impact of social programs.

3.21

In order to help the country achieve the Millennium Development Goals relating to health and nutrition, the strategy will focus on basic maternal and child health care services, including preventive nutritional services for children under two years of age in rural and indigenous areas; services to meet the nutritional needs of pregnant women, infants, and children; and reproductive health services. To support the development of poor people’s greatest asset (labor), the strategy will focus on expanding the coverage of quality services, particularly in preschool and secondary

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education, and on upgrading services at the other levels, including post-secondary education.

3.22

Operations in the active portfolio will provide support for basic preschool, secondary education, and preventive health services, poverty reduction in rural and urban areas, social investments, measures to strengthen public investment programming and its coordination with financial management functions, and the development of a national policy on issues of concern to indigenous peoples.21 These operations will be supplemented by two SWAps (Social Protection I and Social Protection II); the Program on enhancing the quality of education; the Multiphase program for the institutional transformation of the health sector, Phase II; the Program on strengthening governance; the Program for the sustainable development of the Barú-Divalá River (Chiriquí); and three technical-cooperation projects: Diagnostic assessment and a medium-term action plan for development effectiveness (PRODEV); Specific actions and aspects involved in the implementation of the PRODEV; and the Pilot Project on the social protection system. The strategy also calls for the following NFPs: (i) Support for the development of a programmatic approach in the health sector; (ii) Sector study on the education system; and (iii) two NFPs to be implemented jointly with the World Bank: a Public Expenditure Review and a Poverty Assessment. b. Improving access to housing and land

3.23

In order to help reduce the housing deficit and enable people to use their housing units as physical assets, the country strategy will contribute to the consolidation of the legal and institutional structure for this sector, the development of instruments to supplement and deepen the supply of bank financing available to lower-middleincome groups, and the expansion and targeting of existing subsidies in order to fully meet the needs of low-income groups, including those living in unregulated, spontaneous settlements.

3.24

The strategy will also provide for actions aimed at: (i) expediting the regularization of land tenure while promoting private-sector participation in the provision of land to low-income households; and (ii) strengthening the land registry and survey system at both the central and local levels.

3.25

Operations in the active portfolio will be used to support the provision of low-cost housing and the issuance of land titles.22 These actions will be supplemented by an

21

Educational development program; Institutional transformation of the health sector; Poverty alleviation and community development; Sustainable development program for Darién; Sustainable development of Bocas del Toro; Urban poverty in Colón; Fiscal management II; and two technical-cooperation projects: Emergency due to torrential rains in Bocas del Toro; and Institutional strengthening of the National Indigenous Policy Department.

22

Housing program and national land management program (PRONAT).

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initiative for the Development of new operational instruments for low-cost housing and the Low-cost housing program. The strategy also provides for NFPs (Public Expenditure Review and a Poverty Assessment) that will be implemented jointly with the World Bank and for a rural development and competitiveness program.

3. Cross-cutting element: Strengthening governance and transparency 3.26

In order to make headway in these two strategic areas, Panama must make meaningful progress in strengthening the institutions that underpin its democratic system, keep the peace, and uphold legal certainty and public safety. In addition to designing and implementing a broad-based institutional development strategy encompassing the three main branches of government, support will be provided for measures to strengthen the democratic system and the rule of law, thereby helping the country to produce public goods and services more efficiently. It will also promote a dialogue with civil society and its engagement in public policymaking.

3.27

The strategy includes actions aimed at: (i) helping to deepen the democratic process by supporting modernization and measures to strengthen the institutions of the legislative and judicial branches of government; (ii) supporting efforts to strengthen the regulatory framework with a view to enhancing the transparency of government affairs, including the public sectorâ&#x20AC;&#x2122;s procurement system; (iii) promoting public safety and peaceful coexistence; and (iv) improving governance at both the central and local levels. In order to help expand the range of opportunities for reducing poverty and lay the foundations for improved governance and greater transparency, steps will be taken to bolster the decentralization and municipal development process by transferring areas of responsibility, modernizing local government procedures, upgrading municipal governmentsâ&#x20AC;&#x2122; management capacity, building up civil society capacities, and fostering local economic development.

3.28

Programs that are already underway will help to strengthen the legal framework and the municipal development process, contribute to the modernization of the State, and prepare a diagnostic assessment of the situation with respect to public safety and security.23 These efforts will be backed up by new programs designed to strengthen public safety, governance, the judiciary, and the Panama City Mayorâ&#x20AC;&#x2122;s Office, as well as by the MIF Program for the Adoption of international standards for financial reporting; technical-cooperation operations aimed at Supporting the development of the public safety program and at Strengthening information technology for the public safety program; and the NFP Workshop on municipal financing.

23

Municipal strengthening and development, and three technical-cooperation projects: (i) Program to support municipal development; (ii) Plan of action for the modernization of the public sector; and (iii) Support for the establishment of e-government.

- 26 -

3.29

The strategy will devote particular attention to supporting contracting and fiduciary capacity, the budgetary process (as a means of linking resource allocation to results), and monitoring and evaluation functions. This will be accomplished through the Program for strengthening governance, two technical-cooperation projects (Diagnostic assessment and a medium-term action plan for development effectiveness (PRODEV); specific actions and aspects involved in the implementation of the PRODEV), and the three NFPs to be implemented in conjunction with the World Bank: the CFAA, CPAR, and PER. The State’s capacity to regulate markets and promote economic activity effectively will be supported by the Program for enhancing the investment climate and adapting to trade liberalization and by the NFP Strategic lines of action in support of the private sector.

C.

The program: Size, sequencing, financial flows, instruments, and country financing parameters (CFPs) a. Size and sequencing

3.30

The operations program designed by the Bank for implementation under the country strategy for 2005-2009 includes two loan scenarios: a base scenario and a high scenario (see Chapter 1 and Annex I). The first stage of the operations program places priority on supporting fiscal sustainability, promoting social protection, and building the foundations for sustainable economic growth (an improvement in the investment climate, support for the development of competitiveness in the rural economy in light of the adaptations required by the trade liberalization process, development of transportation infrastructure, and measures to strengthen the sector’s framework for production activities having growth potential). It also seeks to strengthen governance, which, in addition to increasing the effectiveness and efficiency of expenditure, will permit the use of more flexible loan instruments. The second stage of the program will focus on consolidated initiatives already launched in the country’s social sectors and in areas where the Bank has proven comparative advantages, such as rural electrification, sustainable development, and the financial sector.

3.31

The base scenario, involving a total of US$575 million, is based on the assumption that the country portfolio will be executed as planned. This scenario reflects a public sector financial situation that leaves little room for new investments in 2005, the first year of this strategy.

3.32

The high scenario, which includes the base scenario and an additional US$295 million, for a total of US$870 million, is the projected outcome of: (i) an increase in the country’s absorption capacity thanks to improvements in its fiscal position and institution-strengthening, all of which would translate into a noticeable improvement in the active portfolio; and (ii) progress in the application of reforms

- 27 -

aimed at paving the way for the Estrategia Competitiva Nacional [National Competitive Strategy] (ECN).

3.33

3.34

24

Activation of the high scenario hinges on meeting the following macroeconomic, institutional, and portfolio targets: •

An annual NFPS deficit (excluding the Panama Canal Authority) of no more than 2% of GDP, in accordance with the target levels set forth in the Fiscal Responsibility Act (Law 20) of 2002, which would permit a reduction in the public debt greater than that of the base scenario (see the high macroeconomic scenario).

•

Start-up of the “Control Tower”. This office, under the MEF, will provide support by monitoring project execution and strengthening executing units, as well as stepping up coordination with the Dirección de Inversiones Públicas [Public Investment Division] and the Dirección de Cooperación Internacional [International Cooperation Division]. The aim of this mechanism is to improve the execution of externally funded operations.

•

Projected disbursements up to 2007 cover at least 25% of the undisbursed balance of the eligible Bank loan portfolio and are reflected in the government’s budget for that fiscal year. This would point to a reduction in the average time span (from between eight and nine years to six years) for execution of the Bank’s portfolio, which would signal a substantial improvement in the country’s absorption capacity and permit an increase in the average level of disbursements (US$155 million) to a level slightly higher than the sum recorded in 1997 (US$145 million).24

In order to help improve the portfolio’s implementation, the Bank has embarked upon a review of the portfolio aimed at aligning it with the priorities set out in the government’s program and, hence, the strategic areas identified in the Bank’s strategy with Panama. In addition to the annual Bank portfolio reviews, quarterly meetings will be held with the MEF. Steps will also be taken to streamline Bank procedures and introduce greater flexibility in the management of Bank operations.

In parallel with this line of action, an effort will be made to streamline the project design process and support the development of programmatic approaches that will facilitate investment coordination and planning within the framework provided by Bank policy. Actions to strengthen the institutional structures of executing agencies will also be undertaken, both via individual programs and via the PRODEV. Within this context, Bank support will be crucial in promoting the “Control Tower” as a means of strengthening the Public Investment Division and the International Cooperation Division of the MEF.

See Annex XI.

- 28 -

b. Financial effects of resource flows25 3.35

Although the country’s debt with the IDB ranges between 11.6% and 13.6% of its external public debt under the base scenario and reaches a peak of around 16.5% under the high scenario, the exposure indicators are below the limit set by the IDB for the two scenarios: (i) the IDB’s exposure is less than 2% in both scenarios (the level set for this indicator is 18%); (ii) IDB debt service, measured as a percentage of exports of goods and services, is under 3% in both cases, whereas the limit is 8% (even if reexports are excluded, IDB debt service would still be 6% or less in both scenarios); and (iii) IDB debt service amounts to a maximum of 18.5% of the total service on the external debt in the base scenario and 19.4% in the high scenario, which is well under the ceiling set for this indicator (30%).

3.36

The Bank’s net financial flows with Panama will not have a negative effect on debt sustainability or its future repayment capacity. In fact, under the base scenario, both the public debt and the external public debt will decrease as a percentage of GDP until they reach the targets established in the Fiscal Responsibility Act: 50% and 35% of GDP, respectively, by 2017 (see Annex VI). The new instruments made available to the authorities will allow them to retire existing debt by replacing it with multilateral debt under more favorable terms and on a less volatile basis. c. Instruments

3.37

In order to achieve greater flexibility, the Bank’s strategy with Panama will seek to make greater use of the available financial instruments (investment loans, policy-based loans, multiphase lending, and reimbursable and nonreimbursable technical-cooperation funding) and nonfinancial instruments (studies, technical support, and workshops). All of this will be reinforced by actions undertaken by the Private Sector Group (PRI, IIC, MIF, and SEP). Initially, the sector programmatic approach will be promoted through the use of traditional investment instruments and policy-based loans. Then, as local institutional capacity grows and coordination with donor institutions improves, more flexible instruments, such as performancedriven loans (PDLs), will be brought in. Annexes I and II contain tentative lists of proposed instruments and mechanisms.

3.38

As the Bank introduces new policies and practices that broaden the scope for the use of investment loan proceeds, the design of new operations can be made more flexible; at that point consideration might be given to the possibility of reviewing the portfolio and increasing its overall flexibility as well. The strategy will place emphasis on achieving the necessary institutional improvements to permit the use of more flexible loan instruments that will allow the country to employ the loan funds in a more timely manner. Technical-cooperation funds (PRODEV) will be

25

See Annex XII.

- 29 -

used to achieve the necessary degree of institutional development, and an effort will be made to ensure that new operations include Bank financing for this purpose.

3.39

As part of the reforms associated with the plan of action for the ECN, which the Bank will support through the National competitiveness program, and with Panama’s FTA with the United States, a programmatic policy-based loan will be used to promote an improvement in the investment climate. This instrument will also be used in implementing the government’s financial reforms, which are being designed with the help of an IDB technical-cooperation project focused on providing support for the financial sector. In view of these two areas’ importance in boosting the economy’s competitiveness, a programmatic approach to this strategic objective will be adopted in the future.

3.40

The government’s interest in developing comprehensive sector-based approaches to rural development and to poverty reduction and social protection may prompt it to consider using SWAps in these sectors. While progress is being made in building up the country’s capacity to act as a fiduciary entity, efforts will initially be focused on rules agreed upon with donor agencies. On another front, in striving to overcome the challenges it faces in ensuring the coverage of electrical power in rural areas, the government is exploring, with the Bank’s support, mechanisms for financing incentives for private investment in rural electrification. Performance-drive loans could be used to fund such mechanisms. d. Country financing parameters

3.41

Now that policy measures have been approved that modify specific provisions which had restricted the use of IDB resources in investment loans, a series of risks relating to their implementation now need to be managed. To this end, country financing parameters were established for each borrowing country. These parameters are set on the basis of each country’s situation and represent an effort to tailor eligibility criteria for expenditures to countries’ specific needs, rather than applying a “one-size-fits-all” approach. These parameters are intended to provide each country with an overall framework for Bank-funded projects. The country financing parameters for Panama and their corresponding note of support are presented in Annex XIII.

D.

Coordination of international cooperation

3.42

The bulk of the external assistance received by Panama comes from three multilateral sources (the IDB, the World Bank, and the UNDP) and six bilateral sources (European Union, USAID, Andean Development Corporation, Japan International Cooperation Agency (JICA), Spanish International Cooperation Agency (AECI), and International Fund for Agricultural Development (IFAD)).

Cooperation is furnished in nine different sectors, but is concentrated in rural and agricultural development, environmental protection, social sectors, and

- 30 -

modernization of the State. The wide range covered by existing international cooperation initiatives opens up opportunities for closer coordination that should be seized in order to support the Panama via a programmatic approach focusing on certain key sectors. The sector distribution of actions to be undertaken by the various agencies in implementing existing and future operations is outlined in Table III-3. Annex XIV provides a detailed description of the different agenciesâ&#x20AC;&#x2122; involvement in international cooperation activities dealing with areas included in the strategy.

Table III-3. International cooperation in Panama: Main areas of activity

Judicial reform

Governance Modernization of the State

Social sectors

Human capital Pov. reduction and social protection

Environmental protection

Rural and agricultural dev.

Competitiveness and trade

Financial markets

Donor agency

Transport and infrastructure

Economic competitiveness

Area

Strategy area

IDB World Bank UNDP European Union USAID CAF JICA AECI IFAD

Areas of participation

3.43

Areas of greatest emphasis

The strategy will support the steps taken by the government to coordinate the work of donor agencies by strengthening the MEFâ&#x20AC;&#x2122;s International Cooperation Division under the PRODEV initiative. As part of this effort and as a means of strengthening coordination with major sources of international cooperation for Panama, as well as possible co-lenders, assistance will be provided for the organization of periodic meetings for the purpose of defining strategic priorities that can then serve as a basis for programmatic approaches and follow-up. These steps will help to enhance the complementarity and harmonization of the various activities undertaken by donor agencies. At the same time, the strategy will support improvements in governance that will heighten the impact of public investment and pave the way for the use of more flexible loan and cooperation instruments.

- 31 -

E.

Risks involved in strategy implementation

3.44

The risks entailed in the strategy’s implementation primarily concern political, economic, and external factors.

26

(i)

In the political arena, difficulties could arise in building the necessary consensus for the passage and implementation of reforms. This risk will be mitigated by the make-up of the National Assembly, in which the current administration holds 42 (54%) of the 78 seats.26 The Bank will support technical measures designed to strengthen the executive and legislative branches of government in order to foster dialogue and consensus-building.

(ii)

In the economic sphere, external factors or a relaxation of fiscal discipline could interfere with the restrictions established in the Fiscal Responsibility Act. Temporary shocks affecting key parameters (economic growth, inflation, increased imports, the current-account balance or nondebt capital flows) could be managed under both scenarios with a two- or three-year delay in the downward trend in public-debt reduction as a percentage of GDP. A relaxation of fiscal discipline could only be mitigated, however, by economic growth rates of over 4%, since this would be the level required to produce an offsetting increase in the tax burden. In order to achieve sustained growth, the Bank will support the government in developing alternative sources of growth that will help to expand the formal sector of the economy and thus boost tax revenues.

(iii)

The external situation could have a negative impact on Panama that would hamper efforts to achieve the strategy’s objectives. Possible risks on the external front include: an increase in oil prices and in interest rates, or a downturn in world economic growth. The effect of these three factors on export growth, domestic and foreign private investment, and the direction of capital flows could have a significant impact on Panama’s chances of achieving the strategy’s objectives. To mitigate the effect of possible exogenous shocks, the Bank will support the government’s efforts to maintain a sound fiscal position while promoting the consolidation of financial reforms so as to safeguard the country’s sovereign risk rating.

Of these 42 seats, 41 are held by the Partido Revolucionario Democrático [Democratic Revolutionary Party] (PRD) and one by the Partido Popular [People’s Party] (PP). The representatives holding seats in the National Assembly are elected to five-year terms that are synchronized with the President’s term in office (September 2004 to June 2009).

- 32 -

F.

Monitoring the strategy

3.45

In order to monitor fulfillment of the strategy’s objectives and facilitate the evaluation process, the Bank and the relevant country authorities have developed performance indicators for each of the specified objectives. These indicators, which are set out in the Bank’s strategy matrix and in Annex XV, are intended to measure the quantity and quality of the outcomes of Bank actions.

3.46

The supervision and evaluation of the strategy’s implementation will be conducted with the help of mechanisms regularly used by the Bank for these purposes, such as annual strategy updates, planning and portfolio reviews, and project completion reports (PCRs). A midterm review of the strategy’s progress will also be conducted two years after its approval. Project monitoring will be conducted in close collaboration with the MEF and, through it, with the various executing agencies. In addition, the MEF will receive support from the Bank in order to develop/strengthen its monitoring and supervision systems as applied to both the strategy and individual projects.

3.47

Once the strategy has been approved, a follow-up plan will be drafted in coordination with the Panamanian authorities as a basis for the strategy’s updating and its midterm review.

IV. AN AGENDA FOR DIALOGUE

4.1

The agenda for dialogue will be a useful instrument for focusing strategic actions while progress is made in solving operational issues.

4.2

This dialogue will focus on: •

Progress in implementing governance reforms, with emphasis on fiscal sustainability and transparency. These reforms include measures focusing on strengthening the justice system, modernizing the Contraloría General de la República [Office of the Comptroller-General] (CGR), and implementing the recommendations of the public expenditure review (PER), the country financial accountability analysis (CFAA), and the country procurement assessment report (CPAR). Given the fiscal significance of the Caja de Seguro Social [Social Security Fund] (CSS), at the start the Bank will concentrate its efforts on defining the toolkit to be used to support the authorities in this area, which will include studies, technical assistance, and financial backing.

•

Fostering a rural development agenda, to include the formulation of an institutional framework for that sector that provides for the participation of local governments.

- 33 -

•

Efforts to support a sustained improvement in the business climate and the trade liberalization process, which will include: measures for bolstering the development of human capital; labor-market reforms; implementation of the Strategic lines of action in support of the private sector; measures designed to open up the domestic transportation and the water and sanitation sectors and to promote the development of an energy policy; actions to increase the public banking system’s efficiency; the Bank’s contribution to the effort to deepen the regional integration process and implement free trade agreements; and the role to be played by the Bank in widening the Canal and developing what are known as the “restored areas”.

•

Execution of the loan portfolio with a view to carrying forward efforts to enhance the country’s absorption capacity, its institutional capacity, and the relevance of Bank actions in the country. Institutional factors relating to improvements in execution will also be reviewed, and a monitoring and follow-up plan for the strategy will be designed and implemented.

Annex I Page 1 of 4

IDB GROUP OPERATIONS PROGRAM, 2005-2009 LOAN PROGRAM (US$ MILLION) Operation no.

Boosting the economy’s competitiveness Priority Activities in Panama Canal Watershed (*) Panama City Sanitation Project, Phase I International Trade Capacity Building for Panama Building the Management Capacity of the Panamanian Maritime Authority Sustainable Development of the Barú-Divalá River (Chiriquí) Enhancing the Investment Climate and Adapting to Trade Liberalization Subtotal Building human and productive capital Development of New Operational Instruments for Low-cost Housing Subtotal TOTAL 2005 Boosting the economy’s competitiveness Development of Competitiveness in the Rural Economy Decentralization of Environmental Management Pro-Competitiveness Road Infrastructure Program under the Puebla-Panama Plan TC Support for Enhancing the Business Climate and Adapting to Trade Liberalization Subtotal Building human and productive capital Social Protection, Phase I Subtotal Strengthening governance and transparency Strengthening Governance Strengthening Public Safety Strengthening the Judiciary II Subtotal TOTAL 2006 Boosting the economy’s competitiveness Rural Electrification Sustainable Development of Bocas del Toro, Phase II Development of Tourism in Protected Areas and in Marine and Coastal Zones Development of the Panama Canal Watershed Consolidation of Reforms in the Financial Sector Transformation in Technology and Competitiveness, Phase II Subtotal Building human and productive capital Multiphase Program for the Institutional Transformation of the Health Sector, Phase II Enhancing the Quality of Education Social Protection, Phase II Low-cost Housing Subtotal Strengthening governance and transparency Strengthening the Panama City Mayor’s Office Subtotal TOTAL 2007-2009

(*) Approved

Scenarios Basic

High

PN-0139 PN-0062 PN-L1001 PN-0152 PN-L1005 PN-0160

20.0 45.0 5.0 5.0 20.0 100.0 195.0

20.0 45.0 5.0 5.0 20.0 100.0 195.0

PN-L1004

10.0 10.0 205.0

10.0 10.0 205.0

PN-0141 PN/NN PN/NN PN/NN

70.0 15.0 70.0 5.0 160.0

70.0 15.0 70.0 5.0 160.0

PN/NN

40.0 40.0

40.0 40.0

PN/NN PN-L1003 PN/NN

20.0 20.0 20.0 60.0 260.0

20.0 20.0 20.0 60.0 260.0

PN-0150 PN/NN PN/NN PN/NN PN/NN PN/NN

30.0 35.0 0.0 0.0 0.0 0.0 65.0

30.0 35.0 15.0 40.0 100.0 20.0 240.0

PN/NN PN/NN PN/NN PN-L1002

35.0 0.0 0.0 0.0 35.0

35.0 40.0 40.0 40.0 155.0

PN/NN

10.0 10.0 110.0

10.0 10.0 405.0

575.0

870.0

Annex I Page 2 of 4

PRIVATE SECTOR GROUP, 2005-2009 (US$ MILLION) Number and name of Operation PRI PN-0155 Bonyic Hydroelectric Project PN (N/N) Bajo de Mina Hydroelectric Project PN (N/N) Thermal Conversion Project PN-0154 Colón International Airport PN (N/N) Transportation Project PN (N/N) Partial Credit Guarantees: Regional Securities Depository Center TOTAL – PRI IIC (N/N) Global Bank Line of Credit (N/N) Banco Continental Line of Credit (N/N) Banco Universal Line of Credit TOTAL – IIC MIF TC (N/N) Improvement of the Customs System (BCI) PN-M1002 Comprehensive Review of the Energy Sector’s Regulatory Scheme and Policy Framework TC (N/N) Identification of Mechanisms for Private-Sector Participation in the Expansion of the Canal TC (N/N) Skills Training for the Canal Expansion Project TC-02-05-040 Strengthening Airport Security TC (N/N) Support for Private-Sector Participation in the Delivery of Infrastructure Services TC (N/N) Line of Activity for Infrastructure Concession Agreements (Ports) TC (N/N) Regulatory Framework for Supervision of the Cooperation Sector TC-03-04-008 Consolidated Regional Banking Supervision TC (N/N) Support for Tourism Microenterprises TC (N/N) Clean Production: Production Linkages and Certification Procedures TC (N/N) Enhancing the Business Climate (BCI) TC (N/N) Development of a One-Stop Corporate Window (BCI) PN-M1001 Adoption of International Standards for Financial Reporting TC (N/N) Implementation of a Solid Waste Collection, Transport, and Treatment System in Barú (Chiriquí) TC (N/N) Strengthening the Agribusiness Industry TC (N/N) Introducing the Concept of Corporate Responsibility TC (N/N) Business Ethics Certification TOTAL – MIF SEP TC (N/N) Support for Small-Scale Agribusiness Producers TC/SP Delivery of Financial Services for Microenterprises and Small Businesses in Rural Areas TOTAL – SEP

Amount

15.0 15.0 39.0 35.0 20.0 25.0 149.0 10.0 15.0 1.0 26.0 0.500 0.500 1.200 2.000 0.500 0.500 0.500 1.200 1.150 0.750 1.600 0.400 0.500 0.490 0.100 0.100 0.100 1.500 13.590 0.600 0.400 1.000

Annex I Page 3 of 4

TECHNICAL COOPERATION PROGRAM (US$ THOUSANDS) Number and Name of Operation Diagnostic Assessment and Medium-Term Plan for Development Effectiveness (PRODEV) Specific Actions and Elements for Implementing the Medium-Term Plan for Development Effectiveness (PRODEV) RG-T1079 Strengthening of Internal Tax Administration Control Services TC (N/N) Support for the Regional Harmonization of the Energy Sector’s Regulatory Framework TC/RG (GEF) Sixaola Binational Watershed – PDFB TC (N/N) National Transportation Plan TC (N/N) Urban Planning System TC/RG (GEF) Sixaola Binational Watershed – IDB Support for the Pro-competitiveness Road Infrastructure Program under the Puebla-Panama Plan TC (N/N) Tourism in Protected Areas and in Marine and Coastal Zones TC (N/N) Strategy for the Agricultural Sector (Strengthening of MIDA) PN-T1008 Building the Management Capacity of the Panamanian Maritime Authority TC (N/N) National Water Resources Plan (ANAM) PN-T1007 Development of the Barú-Divalá River (Chiriquí) (Office of the President) TC (N/N) Hydrometeorological Network (ANAM) PN-T1011 Pilot Project on the Social Protection System PN-T1009 Support for the Development of a Public Safety Program PN-T1010 Strengthening of Information and Communication Technology for the Public Safety Program TOTAL

Amount 450,000 1,600,000 243,000 500,000 500,000 800,000 1,000,000 3,000,000 400,000 150,000 500,000 150,000 300,000 550,000 150,000 142,000 294,420 78.540 10,807,960

Annex I Page 4 of 4

NONFINANCIAL PRODUCTS AND ANALYSES

Name

Year

Unit

Boosting the economyâ&#x20AC;&#x2122;s competitiveness Fiscal and Public Debt Sustainability Investment Sector Analysis Investment Climate Assessment (ICA, IDB/World Bank) Strategic Lines of Action in Support of the Private Sector Rural Development and Competitiveness Proposal for Public Banking Reforms Labor Market Rigidity, Job Creation, and Unemployment Issues Financial Enterprises and the Rural Sector

2005 2005 2005/2006 2005 2006 2006 2006 2006

RE2 FI2 FI2 FI2 EN2 FI2 COF/CPN FI2

Building human and productive capital Public Expenditure Review (PER, IDB/World Bank) Support for the Development of a Programmatic Approach in the Health Sector Sector Study on the Education System Poverty Assessment (IDB/World Bank)

2005/2006 2006 2006 2005/2006

SC2 SO2 SO2 SO2

Strengthening governance and transparency Country Financial Accountability Analysis (CFAA, IDB/World Bank) Country Procurement Assessment Report (CPAR, IDB/World Bank) Workshop on Municipal Financing

2005/2006 2005/2006 2005

SC2 SC2 EN2