The skyline in Panama City, Panama

How will the Panama Canal drought affect the economy and global trade?

Weather disruptions:

Panama, the fifth-wettest country in the world, is going through one of the driest seasons on record due to climate change and inefficient water management. Underwhelming rainfall this year has brought the water level of the Panama Canal to near-historic lows. Immediate consequences: In response, authorities have slapped restrictions on the number of vessels passing through the canal and their maximum capacity. Ship owners now have to carry less cargo, opt for longer and more expensive alternative routes, and face staggering bottlenecks. In the past month, transit queues reached 160 vessels on some days—nearly 80% above average—and delayed some ships by up to 21 days.

El Niño darkens the outlook:

In July, the World Meteorological Organization declared the onset of the El Niño weather pattern, which will bring hotter and drier conditions to Panama. As a result, the current drought will likely worsen in the coming months, with water and electricity shortages spelling trouble for canal activity. Meanwhile, the waters that feed the canal also supply Panama City with drinking water, so resource rationing and renewed civil unrest ahead could push authorities to divert water to consumption and impose even stricter restrictions on shipping activity.

Local economic impact:

Disruptions in the canal will likely have a limited effect on Panama’s economy. Since the turn of the century, Canal activity has accounted for less than 8% of nominal GDP, and previous droughts—such as during the 2015–2016 El Niño event—dented revenues only marginally. Our Consensus Forecast is for the economy to grow comfortably by about 5% year on year in 2023—the strongest pace in Central America—supported by robust domestic activity. That said, the economy will still feel somewhat of a pinch from lower tax revenues from the canal and potentially weaker-than-expected government spending growth in turn.

Global spillovers:

An estimated 5% of international trade and 40% of all U.S. container traffic pass through the Panama Canal. China-U.S. spot shipping prices have already surged over 30% following recent restrictions. Shipping charges may spike further if the drought extends and more restrictions are put in place, as vessels are rerouted through less efficient and more expensive routes. Meanwhile, logistical disruptions could reignite global price pressures, particularly for food and energy, as perishable items from South America and energy exports from the U.S. get stuck in the canal.

Insight from our analysts

Analysts at the EIU commented on the potential impact of El Niño later this year:

“A strong El Niño could lead to water and/or electricity rationing, and would therefore have a more severe impact on businesses than our short‑term forecasts currently suggest. A particular risk is that a strong El Niño exacerbates the 2024 dry season, resulting in record‑low water levels in lakes and constraining Canal operations next year.”

On disruptions in the Panama Canal, JPMorgan analyst Steven Palacio said:

“The situation is relevant both domestically—as transportation accounts for a large share of GDP—and internationally, as the canal is an important trade route, particularly for the US. On the domestic side, this would pose downside risks to our 2023 GDP growth forecast of 5%y/y, but upside risks had been building elsewhere in the economy, so we see risks balanced.”

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