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San Marino: Concluding Statement of the 2015 Article IV Mission
January 28, 2015
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
January 28, 2015
San Marino has made very significant progress to normalize international relations and emerge from a deep recession. On the back of the inclusion in Italy’s tax whitelist and the conclusion of financial and economic cooperation agreements with Italy, there are signs that the economy is stabilizing. Still, serious policy challenges remain. The fiscal efforts of the last two years represent important steps to begin rebuilding the buffers that served San Marino well during the crisis. The fiscal balance should improve further to adjust to the new post-crisis economic realities and to allow these buffers to be rebuilt over the medium term. In the banking system, liquidity conditions improved and steps were taken in an attempt to put Cassa di Risparmio della Repubblica di San Marino (CRSM) on sound footing. Nevertheless, important challenges with respect to CRSM and large non-performing loan (NPL) portfolios in the banking system — which grew mostly as a consequence of loan reclassification — remain to be dealt with. Continued commitment to openness, transparency, international cooperation, and further improvements in the business environment remain paramount to lay the foundations for future growth.
1. The Sammarinese economy is exhibiting signs of stabilization. High-frequency data and decreasing bank losses point to a moderate contraction in 2014. Looking forward, we project 1 percent growth for 2015 and modest growth over the medium term. Still, GDP will remain at a permanently lower level compared to before the crisis. Upside risks to the outlook stem from improved relations with Italy. Downside risks, however, remain larger. They include prolonged slow growth in Italy and the Euro area, high non-performing loans in the banking sector, and the incomplete restructuring of the largest bank in the country.
The banking system
More needs to be done to ensure that the banking system can support the recovery. The recapitalization of CRSM was important although its modalities did not follow best practice and the bank’s incomplete restructuring still poses a great challenge. Elsewhere in the banking system, high non-performing loans combined with relatively low provisions pose a risk for the economy.
2. CRSM needs a strong and credible business plan to limit the risk of further public support. The plan should show how, under a realistic but conservative scenario, the bank will become profitable and reach the minimum capital requirement within three years. Cutting costs and reducing the size of the balance sheet further should be part of the strategy. Adverse contingency plans should also be prepared to provide a “Plan B” if the business plan proves unsuccessful. As a matter of urgency, the bank needs seasoned experts to engineer a turnaround. The state should insist on the expeditious appointment of such experts to the Board and executive positions, without influence of the foundation on such appointments. Moreover, the agreement between the foundation and the state should be revised to give the state complete ownership and control of CRSM.
3. Banks need to do more to deal with their very large NPL portfolios. Only after these legacy portfolios are dealt with will banks be able to support the economic recovery. Concretely, banks should implement their NPL collection efforts more aggressively and explore the sale of portfolios of bad loans to third parties. At the same time, they will have to set aside more money to improve NPL provisioning. These steps would allow banks to channel credit to growth sectors and force unviable firms to restructure their loans or be closed, thus preventing larger losses down the road. Additional resources should be devoted to implementing the following plan:
4. The Central Bank plays a central role in this process. In order to be able to perform this role and deal with its growing set of national and international responsibilities, the CBSM needs additional resources and independence in their deployment. Furthermore, the role of the CBSM in both the operation and supervision of pension funds needs to be reviewed to avoid conflicts of interest. Constraints on hiring foreign experts to deal with bank restructuring should be reconsidered.
Fiscal issues
The fiscal buffers San Marino had before the crisis served the country well. Without them, the crisis would have been even deeper and the state could not have cushioned social expenditure. Gradually rebuilding these buffers as growth returns is important to be able to deal with future shocks. The recent well-designed income tax reform and the planned introduction of a Value Added Tax represent important steps in this direction.
5. Further fiscal effort is needed to rebuild buffers. Since the start of the crisis, the fiscal position has worsened as tax receipts declined due to a permanent fall in GDP. Furthermore, the balance of the social security institute has deteriorated significantly, particularly with regard to higher unemployment, an increased number of pensioners, and lower transfers from the central government. The projected gradual recovery of the economy presents an opportunity to strengthen the fiscal position. The design of a multi-year fiscal strategy should begin now, with implementation starting in 2016 once the economy is solidly growing again.
6. The fiscal strategy should aim to lower overall expenditure, while modestly increasing tax revenue. Overall, expenditure and revenue measures equivalent to around 2½ percent of GDP over five years are needed to rebuild buffers. Areas for action identified by a recent spending review include the public sector wage bill, pensions, and health costs. A real estate tax would be the optimal choice to increase tax revenue, as it provides an equitable and efficient source of income. Alternatively, the authorities could consider a slight increase in the envisaged VAT rate. This fiscal strategy would also create space for the authorities’ planned timely increase in capital spending related to infrastructure and the high-tech business incubator.
7. The authorities could consider modest borrowing in international capital markets. Establishing international market access for the sovereign will provide an important additional buffer to deal with shocks, as domestic banks may not be able to lend to the government in difficult times. Moreover, interest rates may prove attractive in the current international financial environment.
International cooperation and the business environment
8. San Marino has recently achieved very important milestones in international cooperation. The inclusion in Italy’s tax whitelist is a key step, as is MONEYVAL’s recognition of San Marino’s anti-money laundering efforts. Continued international cooperation building on these achievements is essential for a new growth model to emerge. Priority should be given to concluding the memorandum of understanding with the Bank of Italy.
9. Recent improvements in the business environment are a welcome development. Last year’s law speeding up the process of starting a business and the ongoing effort to simplify the registration of property should boost economic activity. Completion of the ongoing work to create a credit registry will improve access to credit. Further government initiatives such as the incubator for high-tech firms will foster the development of the non-bank sector and are positive as long as their fiscal costs are monitored closely.
We would like to thank the authorities and other interlocutors for the frank and open discussions and their warm hospitality.
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