Reference ID: 04PANAMA2524

Created: 2004-10-12 18:14

Released: 2011-08-30 01:44

Classification: CONFIDENTIAL

Origin: Embassy Panama

This record is a partial extract of the original cable. The full text of the original cable is not available.

    C O N F I D E N T I A L SECTION 01 OF 07 PANAMA 002524


E.O. 12958: DECL: 10/05/2014



Classified By: Ambassador Linda E. Watt, Reasons 1.4(b) and (e)

1. (C) Summary: An important pillar of Panama's service-based

economy, the Colon Free Zone (CFZ) is the largest duty free

zone in the hemisphere and the second largest in the world.

Offering much more than just duty-free wholesale shopping,

however, the CFZ draws upon the strengths of Panama's

world-class shipping and financial services to offer cargo

services and credit to its customers throughout Latin

America. The 'value added' provided by Zone merchants has

frequently amounted to helping customers skirt customs duties

and exchange rate laws in the importing country, and law

enforcement in the zone is weak. In such an environment, it

can be easy to turn a blind eye to more serious criminal

activities. In order to improve its prospects for future

growth, the CFZ must address its security and law enforcement

weaknesses as well as re-examine its entrepot service

offering in the context of today's more liberal and globally

integrated business environment. The incoming Torrijos

administration has already begun to focus on the CFZ's

weaknesses by naming a highly respected community activist to

the top slot at the Zone, and the Embassy is focusing assets

on better understanding CFZ financial flows and exploring

ways to work with the CFZ administration to strengthen

enforcement. End summary.


Background and Introduction


2. (U) In 1948, the GOP set aside a 370-acre area adjacent to

the Atlantic port city of Colon for the creation of a free

trade zone. Half a century later, the Colon Free Zone (CFZ)

is the largest of its kind in the Western Hemisphere and

second only to Hong Kong in the world. Originally conceived

as a way to modernize Panama's economic infrastructure and

encourage regional trade, the CFZ has since developed into a

major international merchandise distribution center and a

pillar of Panama's service-based economy. Today, the CFZ

covers 1,000 acres full of showrooms and warehouses run by

hundreds of individual companies. Although the CFZ

contributes 7.4% of Panama's GDP, CFZ businesses employ less

than 2% of Panama's labor force (17,760 people directly and

another 7,000 indirectly). Exempt from many taxes, the CFZ

also contributes little to GOP revenues. Zone merchants have

vociferously opposed recent proposals to apply even nominal

business taxes to CFZ firms.

3. (U) In 2003, the CFZ imported $3.990 billion worth of

merchandise and exported $4.478 billion. By comparison, the

rest of Panama imported 3.070 billion and exported $808

million. The vast majority of CFZ merchandise comes from

Asia for distribution throughout Latin America. Broken down

by individual countries, the United States is the third most

important supplier (9.8% of CFZ imports by value), but a

minor customer (4.5% of CFZ exports). Electronics and

clothing are the main exports, followed by a wide range of

products, including watches, cosmetics, shoes, jewelry, and

textiles. Unlike export processing zones which proliferated

in Latin America during the 1990s, or truly modern logistics

centers like Puerto Rico, the CFZ contributes very little

value-added to the physical products it sells, aside from

some packaging and labeling for mainly pharmaceutical


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More than Duty-Free Shopping: Logistics is Now the Key

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4. (SBU) Currently some 30% of CFZ cargo comes from large

logistics operations, and this sector is steadily growing.

These are companies who use the CFZ to consolidate products

in one place from all their production facilities. For

example, NIKE brings shoes from various manufacturing centers

in Asia and Latin America to the CFZ, and then ships onward

to Europe or the United States. However, the CFZ has grown

by drawing on the strengths of the financial sector and

providing services to smaller merchants in the region. A

major international banking center for Latin America, Panama

offers CFZ customers unparalleled access to credit in a

stable, U.S.-dollar based economy. Likewise, CFZ commerce

benefits from Panama's strengths in shipping, including four

world-class container ports, shipping agents, freight

forwarders, and, of course, the canal. Adjacent to the CFZ,

Manzanillo International Terminal (MIT) is now the largest

container port in all of Latin America (in 2003 over 1

million containers in terms of twenty-foot equivalent units,

or TEUs passed through MIT). Also nearby are Hong Kong-based

Hutchison-Whampoa's Cristobal facility and Taiwan-based

Evergreen's Colon Container Terminal. Approximately 60% of

CFZ businesses specialize in cargo consolidation, which means

that customers can tailor their purchases by buying smaller

quantities at wholesale prices and packing them together into

single container loads. By comparison, a Bogota merchant

buying directly from a Taipei factory would typically

confront significant challenges: language barrier, exchange

rate risk, no credit, and container lots only.


Financial Woes Lead to Criminal Activities?


5. (SBU) There is a symbiotic relationship between the CFZ

and Panama's well-developed banking center. Between 80% and

90% of all CFZ business is done on credit of some kind.

Twenty-five banks have physical branches in the CFZ. In

2003, banks issued approximately $742 million in credit lines

to CFZ companies and buyers. Leaders include HSBC Bank,s

portfolio at $133.5 million, Banco Aliado at $62.3 million,

BNP Paribas at $60 million, Bank Leum-Le Israel at $50

million, and Bank Boston at $44 million. Accumulated debts

within the CFZ approach $1 billion. Buyers from Cuba are

most likely to default with more than $200 million in

outstanding loans, and Venezuelan merchants have $100 million

in CFZ-related debts. As banks have started to tighten their

lending controls because of the danger of default, the

250,000 buyers that visit the Zone every year have

increasingly looked to other finance channels. CFZ merchants

commonly offer the advantage of "flexible invoicing" and

90-day, direct &merchant to merchant8 interest-free credit

to help customers to evade import duties and exchange rate

laws at the final destination. Anecdotal evidence points to

some companies receiving payments in large amounts of

cash*no questions asked. Indeed, much of the 'value added'

provided by Zone merchants frequently amounts to helping

customers skirt customs duties and exchange rate laws in the

importing country. In such an environment, it becomes easy

to turn a blind eye to more serious criminal activities.


Company and Religious/Ethnic Compositions


6. (C) There are 2388 registered companies in the CFZ, and

1716 of those are owner operated. The other 672 are

represented by those owner-operated companies. Though no

official statistics exist, most observers agree that the

companies are broken down along ethnic/religious lines as

follows: 30-40% Jewish, 40-50% Muslim Arab, and the remaining

20% equally between Indians/Pakistanis, Chinese, and

Panamanian Christians. In general, Arab and Chinese

businessmen live in Colon, while Jews and Christians live in

Panama City and commute to Colon daily. The Arab businessmen

in the CFZ also have maintained historical ties to Arabs in

Isla Margarita, Venezuela, Maicao, Colombia, and the

Tri-Border Region of Brazil, Argentina, and Paraguay. These

ties have raised concerns about possible terrorist financing

links, an issue that the Embassy has focused on in the past

year. In fact, the Embassy recently created an inter-agency

task force to analyze these ties to see if there are

terrorist finance links.

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A Bad Reputation; Few Resources; But Some Successes

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7. (SBU) CFZ businesses have grown and prospered with little

GOP supervision. The GOP's Colon Free Zone Administration

has traditionally done the merchants' bidding and lacked

resources to implement serious security, law-enforcement, and

intellectual property programs, had it been so inclined. In

practice, the strongest deterrent to crime--particularly

trademark violations or counterfeiting--has been pressure by

legitimate merchants in the Zone whose business is affected

by illicit activity. Since 2002, the CFZ administration has

tried to implement reforms on the law-enforcement and

security fronts however, despite counting on just a small

staff of lawyers, with only one dedicated full-time to

investigating money-laundering and intellectual property

rights (IPR) violations and a security department that

numbers only some 80 full time patrollers (four groups of 20

plus 4 bikes and 3 motorcycles), which must control 12

entrances during business hours. Nevertheless, they have

played a role in several significant cases, in collaboration

with other GOP law enforcement entities and with USG

assistance. On the money-laundering front, in the 1999

landmark 'Speed Joyeros' case developed jointly by the GOP

and USG over two years, a CFZ jewelry merchant pled guilty to

U.S. money laundering charges, forfeited $16 million in

seized assets, and opened the door to dozens of arrests in

Colombia and elsewhere. The CFZ has also been the source of

some very large IPR cases, including the seizure of seven

million pirated music and Sony 'Playstation' CDs which were

destroyed in December 2003 and nine containers of counterfeit

Marlboro cigarettes--over 400,000 cartons valued at $5

million--seized in November 2003. In both cases, counterfeit

goods came from Asia transiting the CFZ for distribution

throughout Latin America. The large volumes of merchandise

trade combined with weak local law enforcement capabilities

have made the CFZ an ideal place to conceal criminal activity.

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The Black Market Peso Exchange: Narcotrafficking Connection

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8. (C) According to Panama's Customs Authority, every year

travelers declare more than $400 million in U.S. currency at

Panama's main port of entry, Tocumen International Airport.

This number represents declared, "legitimate" currency, and

does not/not include smuggled cash. Colombia is the main

source of these U.S. dollars at $5 million per month,

followed closely by Mexico at $4 million per month, then by

other countries in Central American and the Caribbean. The

Embassy believes that most of this cash ultimately comes from

the United States, possibly in large part as drug proceeds,

and is destined to pay off credit lines in the CFZ, and could

form part of the Black Market Peso Exchange (BMPE). In this

system, a Colombian merchant buys goods in the CFZ on credit

in dollars and sells those goods in Colombia in pesos. The

merchant then approaches a currency dealer in Colombia who

receives the pesos on very favorable terms and arranges for

payment of the merchant's debt in the CFZ in dollars from

drug proceeds in the United States.


Little Diversification Means Tough Times


9. (U) Lack of diversification in its supplier and customer

base is a serious concern for the CFZ. Two-thirds of CFZ

merchandise comes from Asia, particularly Hong Kong (23.8%),

Taiwan (15.2%), and Mainland China (13.0%). The CFZ's

customer base is even more concentrated, with most CFZ

exports going to Latin American countries, particularly

Andean countries: Colombia (14.1%), Ecuador (7.9%), and

Venezuela (5.6%). As these Colombia and Venezuela have faced

political and economic challenges, so has the CFZ--exports to

Venezuela have dwindled by two-thirds since 2001. The

relative stability in the past few months in the Andean

region has led to a strong rebound in the first half of 2004

for the CFZ however, as exports and imports in the first half

of 2004 are up almost 18% and 20% respectively over the same

period last year.

10. (C) A particular sore spot is Cuba, which is a

disproportionately large customer. Cuban government

businesses bought $208 million worth of merchandise in 2003

from the CFZ. Recently, CFZ merchants have paid dearly for

doing business with Cuba in the form of large overdue

accounts receivable, now officially at $200 million, although

some unofficial estimates peg the debt as high as $500

million. These debts are so large and touch so many

businesses in Panama that CFZ merchants pressure the GoP to

restrain its criticism of Castro's policies and even

cooperate with the regime in some limited ways, including a

bilateral investment agreement, just to ensure continued

interest payments and to stave off a Cuban default. In fact,

the late August 2004 break of diplomatic relations between

the two countries led to immediate protest from CFZ merchants

who feared the non-payment of outstanding debts.

11. (U) Weaknesses in its supplier and customer base caused

the CFZ to shrink by 20% in 1999 after the Asian financial

crisis and the Mexican peso crisis. The CFZ is still far

from recovering to previous levels due to economic downturns

in its principal customer countries like Venezuela and

Colombia. In 2003, imports decreased by 10.4% and exports by

7.1%, resulting in an overall 9% contraction on 2002. So

far, attempts to promote the CFZ among potential users in the

U.S., Canada, and Europe have met with little success, in

part due to its reputation for weak law enforcement.

12. (U) Since much of CFZ trade is from Asia to Latin

America, the Free Trade Area of the Americas (FTAA) and the

ever-increasing sub-regional FTAs do not constitute an

immediate threat to the CFZ. Moreover, as the duty-free

nature of the CFZ,s trade with regional customers is only

one of various CFZ attractions (easy credit and cargo

consolidation being more important), a general lowering of

tariffs across the region should not hurt the CFZ terribly.

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Multi-Modal Hub of the Americas: Caught in Corruption

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13. (SBU) In 2000, CFZ Administrator Jorge Fernandez began

promoting an ambitious plan to double the size of the CFZ to

include the adjacent MIT and Evergreen ports, the

newly-opened Panama Canal Railway cargo terminal, and an

international airport with a high-tech industrial park to be

developed on the site of the current France Field municipal

airstrip -- all in one duty-free customs area. Eschewing

normal competitive bidding procedures, the GOP drafted a

concession through direct negotiations with the San Lorenzo

Consortium (CSL) to develop both the industrial park (CEMIS)

and a major international airport (CIASA) that would

eventually require over $400 million in new private

investment. The CSL concession sparked much controversy.

Shortly after it was given final approval by the National

Assembly in 2002, a legislator publicly accused the project

promoters of bribing a handful of his colleagues (including

himself!) in the legislative Assembly. The resulting

investigations and media frenzy have all but halted project

implementation, and more than two years later the case is no

closer to real resolution.

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Comment: Embassy Actively Engaged; CFZ Future Unclear

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14. (C) The Embassy has increasingly focused on the CFZ;

making it a key part of our broader initiative to engage the

Colon community in the past year. We have assisted with law

enforcement training, resources, and help with police

expenses related to IPR court cases. NAS has donated

computer equipment to help the CFZ administration to

computerize all transactions and thus more effectively screen

for suspicious activity. As noted, the Embassy's recently

formed, interagency financial task force is focused on

getting a better understanding of the monetary transactions

that take place in the Zone.

15. The CFZ remains an important pillar of Panama's

service-based economy, but its future is uncertain. The CFZ

has been slow to change old business patterns that rely on

unstable markets and has turned a blind eye to possible

criminal activities. Surely, most of CFZ's multi-billion

dollar commerce is legitimate, but the temptations are great

when CFZ merchants sell on razor-thin margins and so much CFZ

trade comes from Asian countries (adept at mass production of

counterfeit goods) and goes to Andean countries (eager to

launder their illicit drug proceeds). CFZ merchants will

continue to give into these temptations until the perceived

risk is greater than the very lucrative payoffs. Indeed, CFZ

merchants have staunchly resisted proposals to reduce

criminal activity by increasing security, claiming that they

cannot afford the increased user fees that such security

improvements would require. That is changing though*in 2003

the CFZ opened doors to the Business Anti-Smuggling Coalition

(BASC), as the zone recognizes that without transparency,

companies may be further exposed to liability. Also helping

is the new PRD Torrijos administration,s anti-corruption

efforts, and naming of highly respected Colon activist Nilda

Quijano to the administrator post at the CFZ. Finally, the

relative stability of Venezuela and Colombia in recent months

is leading to rebounding imports and export. Until the CFZ

merchants overhaul their business model and the CFZ

administration addresses its security and law enforcement

weaknesses, the Zone,s reputation for lawlessness will cloud

its future by discouraging potential new customers and

investors needed for expansion.




ANNEX: Selected CFZ Statistics




(Sources: Ministry of Economy and Finance, Comptroller of the

Republic, CFZ Administration)



In $ millions  1997  1998  1999  2000  2001   2002   2003e

CFZ imports   5,398 5,211 4,166 4,630 4,760  4,410  3,990

CFZ reexports 6,276 5,985 4,950 5,318 5,451  4,820  4,478



(In millions, 1996 as base year)

Panama GDP  9,916 10,648 11,071 11,374 11,440 11,697 12,172

CFZ Contrib.  810    803    694    805    894    855    895

As a pct      8.2    7.5    6.3    7.1    7.8    7.3    7.4



Top sellers to the CFZ:

(% of total 2003 CFZ imports by value)




--Hong Kong       23.4%

--Taiwan          15.2%

--Mainland China  13.0%

--Japan            4.5%

--South Korea      3.4%

--Thailand         0.9%

--Singapore        0.6%




--Italy           2.5%

--France          2.4%

--Switzerland     2.1%



North America:

--USA             9.8%

--Mexico          2.0%



Top buyers from the CFZ:

(% of total 2003 CFZ re-exports by value)



South America

--Colombia   14.1%

--Ecuador     7.9%

--Venezuela   5.6%

--Chile       3.1%

--Brazil      2.0%

--Paraguay    0.4%



Central America/Caribbean

--Panama      8.4%

--Guatemala   6.9%

--Costa Rica  5.4%

--Cuba        5.2%

--El Salvador 3.6%

--Nicaragua   3.4%



North America:

--USA         4.5%

--Mexico      2.6%