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 
 
SIPDIS 
 
 
E.O. 12958: DECL: 10/05/2014 
TAGS: ECON ETRD EFIN PTER SNAR PM ECONOMIC AFFAIRS
SUBJECT: UNDERSTANDING PANAMA'S COLON FREE ZONE 
 
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 
products. 
 
 
--------------------------------------------- --------- 
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) 
 
 
Asia: 
--Hong Kong       23.4% 
--Taiwan          15.2% 
--Mainland China  13.0% 
--Japan            4.5% 
--South Korea      3.4% 
--Thailand         0.9% 
--Singapore        0.6% 
 
 
Europe: 
--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% 

WATT