Panama’s Canal is drying up and its bonds are getting hit hard

The Panama Canal is, in many ways, the Panama economy. It hands over about $1 out of every $4 the government takes in, generating a constant stream of cash that flows through all corners of the small country.

So when dozens of container ships began backing up outside the canal recently, the result of a drought so fierce that water levels have plunged to dangerously low levels, it got the attention of traders on Wall Street. 

For days, they’ve sold Panamanian government bonds, making them one of the worst performers in Latin America. Over the past month, the securities lost 3.3%, roughly twice the average decline for government bonds in the region, according to data compiled by Bloomberg. 

For investors, the long line of cargo vessels anchoring at the mouths of the 50-mile canal was confirmation that the effects of climate change were catching up with the canal — and the economy.

“The problem is that there’s no short-term solution — unless mother nature helps, and water levels rise,” said Fernando Losada, a managing director for fixed income at Oppenheimer & Co. “They can fix it with investment and infrastructure but it’s going to take time and it will weigh on the economy in the meantime.”

The authority that runs the canal has already called in the US Army Corps of Engineers to come up with a plan to divert rivers into Gatun Lake — the main source of water for the system of locks.  

The lake has long been suffering with erratic rainfall in what is normally one of the world’s wettest countries. Now, an El Nino weather pattern threatens to further reduce water levels. 

The canal authority has restricted the number of ships that can cross to about 32 and forced those that are allowed to enter to reduce their drafts, meaning they take less cargo. Typically about 38 vessels navigate it daily, according to the canal authority. 

The drop in traffic is forecast to shave roughly $200 million from the canal’s revenues, which hit $4.3 billion last year. About $2.5 billion was sent to the national Treasury, according to the authority’s annual report. 

The bond selloff was, in part, triggered by the broader rout in US Treasuries and debt securities across the globe. But in Panama’s case, the drought is adding to a growing list of factors that are clouding the outlook for the country, including an approaching election and the pending renewal of a contract for one of its biggest miners. 

Despite being rated investment grade, Panama has been dogged by questions of corruption and its reputation as a haven for tax evasion. 

Investors are concerned that spending will increase ahead of next year’s presidential election, said Jason Keene, a strategist with Barclays in New York. 

Former President Ricardo Martinelli is leading polls, but to run he must win an appeal after he was sentenced to 10 years in jail for money laundering last month. 

“There is a lot of uncertainty,” said Zulfi Ali, a money manager at PGIM Fixed Income, who is underweight on the debt. “Panama is not a clean story.”