Jul24th2008From the Economist Intelligence Unit ViewsWire
Inflation has reached a 28-year high
Panama, with its dollarised economy, sophisticated financial sector and years of solid economic growth, is not used to dealing with the macroeconomic instability and inflationary woes typical of other Latin American countries in the past. But inflation in Panama, as in the rest of the region, has picked up sharply since 2007 and is now at a 28-year high—and this is having both social and political repercussions.
Despite administrative measures, such as reduced import tariffs and indirect price subsidies, fuel and food prices continue to make an increasing contribution to Panamanian inflation and were the major cause of the spike in the annual rate to 9.6% in June. It looks likely that inflation will break into double digits in July.
Consumers are already feeling the pinch, and given Panama’s heavy reliance on imports, the weak dollar is also contributing to sharply rising wholesale prices, which jumped by 17.1% in the 12 months to March. This suggests further difficulties for consumers ahead. The impact of soaring international oil and food prices will continue to be compounded by a weak dollar and demand-side factors in 2008-09. Heavy tariff protection of domestic agricultural production will be another factor sustaining food-price pressures.
With the government lacking an effective policy tool to address rising prices, the Economist Intelligence Unit expects inflation to continue to rise through the third quarter of 2008 before decelerating thereafter. We forecast year-end inflation of 9.7% in 2008 and of 7.8% in 2009, on the assumption of a softening of commodity prices and some recovery of the dollar. However, with domestic demand set to remain strong, labour shortages emerging in some economic sectors, the government continuing with pro-cyclical spending in order to raise real incomes, and our dollar forecast subject to uncertainty, the risks to Panama’s forecast inflation rate are weighted on the upside.
Government pays the price
The inflation problem is causing headaches for the governing Partido Revolucionario Democrático (PRD) at a time when elections are less than just 10 months away (slated for May 2009). Indeed, the government of President Martín Torrijos has suffered one of its sharpest declines in public support since coming to office in September 2004. According to regional polling organisation Unimer, support for Mr Torrijos fell to 34% in mid-June, 17 percentage points lower than in April and less than half the rating he enjoyed at the mid-point of his term. This is despite his having presided over an unprecedented period of economic growth.
The Torrijos administration is struggling to formulate effective policies to confront high inflation as well as an increase in incidences of violent crime. The only time the government has seen a more severe fall in popularity was amid a three-month-long strike by unionised workers in mid-2005 that accompanied its initial attempt to push through a reform of the social security and pension system against strong opposition.
Although in the past Mr Torrijos has used his political acumen and a calculated willingness to compromise on unpopular measures to win support, at this late stage in his term his touch seems less sure and the public less willing to be swayed. Most recently the president also has faced growing criticism for his failure to deliver on a much vaunted comprehensive solution to the capital's ailing public transportation system, the increasing use of subsidies to tackle rising food costs during a pre-election period and plans to restructure the security services.
Policy dilemmas
In the context of rising inflation the government will find it challenging to make the additional investment needed to deliver on its promises in terms of crime prevention, tackling poverty and addressing shortcomings in infrastructure and public services. This is because of the limited capacity of the economy to accommodate additional stimulus without exacerbating inflationary pressures and because of slowing government revenue growth as economic activity cools.The result will be a further erosion of the PRD’s political capital ahead of the May elections. Still, because the opposition parties are unlikely to form a cohesive alliance before the vote, the Economist Intelligence Unit's view remains that the PRD will eke out a historic second term in 2009
