Cablegate: Understanding Panama's Colon Free Zone

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

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

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.

--------------------------------------------- ------
A Bad Reputation; Few Resources; But Some Successes
--------------------------------------------- ------

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.

--------------------------------------------- --------------
The Black Market Peso Exchange: Narcotrafficking Connection
--------------------------------------------- --------------

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.

--------------------------------------------- --------
Multi-Modal Hub of the Americas: Caught in Corruption
--------------------------------------------- --------

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.

--------------------------------------------- --------
Comment: Embassy Actively Engaged; CFZ Future Unclear
--------------------------------------------- --------

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%


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