## cr1786 - 1.3 percent in the medium term, driven by continued expansion in non-financial industries and ## Source details **Canonical URL:** [cr1786 - 1.3 percent in the medium term, driven by continued expansion in non-financial industries and](https://www.imf.org/-/media/files/publications/cr/2017/cr1786.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr1786.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr1786.pdf.json) --- ### Outlook and growth prospects - Staff projects growth of 1.3 percent in the medium term, driven by continued expansion in non-financial industries and services. - On current trends, the pace of growth would not be strong enough to bring output to precrisis levels over the next five years. - Risks to the outlook remain tilted to the downside. ### Key macroeconomic indicators (selected) - GDP per capita (2015): 46,185 U.S. dollars - Population (2016): 34,267 persons - Life expectancy at birth (2011): 83.3 years - Literacy, adult (2008): 96 percent - Real GDP (percent change): 2013: -3.0; 2014: -0.9; 2015: 0.5; 2016: 1.0; 2017 (projection): 1.2 - Unemployment rate (average; percent): 2013: 8.1; 2014: 8.7; 2015: 9.2; 2016: 8.6; 2017 (projection): 8.0 - Inflation rate (average; percent): 2013: 1.3; 2014: 1.1; 2015: 0.1; 2016: 0.6; 2017 (projection): 0.7 ### Public finances (central government) — selected indicators (percent of GDP) - Revenues: 2013: 20.2; 2014: 22.5; 2015: 20.8; 2016: 22.1; 2017 (projection): 20.9 - Expenditure: 2013: 21.1; 2014: 21.7; 2015: 21.0; 2016: 22.7; 2017 (projection): 21.9 - Overall balance: 2013: -0.9; 2014: 0.8; 2015: -0.2; 2016: -0.6; 2017 (projection): -1.0 - Government debt: 2013: 20.8; 2014: 19.0; 2015: 19.7; 2016: 21.6; 2017 (projection): 21.8 ### Financial soundness indicators (latest available) - Regulatory capital to risk-weighted assets: 2013: 13.6; 2014: 11.4; 2015: 12.7; 2016: 13.6 - Bad loans to total loans: 2013: 13.9; 2014: 16.1; 2015: 18.5; 2016: 18.7 - Loan loss provision to total loans: 2013: 26.7; 2014: 30.3; 2015: 28.6; 2016: 26.6 - Return on equity (ROE): 2013: -7.8; 2014: -21.4; 2015: -9.0; 2016: -10.5 - Liquid assets to total assets: 2013: 29.6; 2014: 32.4; 2015: 29.8; 2016: 29.5 - Liquid assets to short-term liabilities: 2013: 60.6; 2014: 65.4; 2015: 58.9; 2016: 59.1 ### Financial sector: diagnosis and recommended actions — Findings - Banking system assets about 370 percent of GDP as of December 2016. - The three largest banks account for about 70 percent of total bank assets and deposits. - Reported capital adequacy ratio of the banking system was 13.6 percent in September 2016 after the recapitalization of Cassa di Risparmio della Repubblica di San Marino (CRSM). - Gross NPLs about 43 percent of total loans (about 113 percent of GDP) at end-2016; about 36 percent net of provisions. - NPL coverage ratio is relatively low at 26 percent. - Net losses of about €47 million as of December 2016. - Bank liquidity buffers cover about 60 percent of short-term liabilities and about 30 percent of total liabilities; buffers worsened slightly in the first half of 2016. - About half of NPLs belong to nonresident clients; about half of loans are vis-à-vis nonresidents (mostly Italian); about a quarter of deposits are from nonresidents. ### Financial sector: diagnosis and recommended actions — Policy recommendations - Complete the ongoing Asset Quality Review (AQR) of the banking system and follow with appropriate plans to repair bank balance sheets. - Accelerate the resolution of NPLs by removing legal, regulatory, and tax obstacles. - Anchor the restructuring strategy for CRSM on AQR findings and ensure any restructuring plans secure long-term viability. - Strengthen bank oversight, including revamping supervision and developing a robust macroprudential framework. ### Traction on financial sector actions - Authorities launched an AQR of all banks in November 2016. - Central Bank completed an internal audit to enhance supervision and compliance and started collecting more granular information on NPLs. ### Budget outcome and near-term outlook - 2016 budget points to a small deficit of about ½ percent of GDP, following a broadly balanced budget in 2015; drivers include increased infrastructure spending and spending related to early elections. - Public debt as a share of GDP increased to 21½ percent at end-2016 (from 19.7 percent in 2015), reflecting mostly the recent recapitalization of CRSM. - Banking sector vulnerabilities pose significant fiscal risks. ### Outlook and growth projections (summarized) - GDP growth projections: - 2017: 1.2 percent. - Medium term: around 1¼ percent. - Inflation: expected to remain low in the near term and only gradually rise in line with recovery in domestic demand and inflation in Italy. - San Marino is not expected to reach the pre-2009 GDP level until the end-2020s. - Drivers of growth expected to rotate from net exports towards domestic demand, especially consumption, with corporate profitability expected to improve gradually despite limited credit growth. ### Risks to the central scenario (tilted to the downside) - Lingering weakness in the domestic banking system (high NPLs) could undermine credit provision and growth and could lead to loss of confidence if not addressed. - Structurally weak growth in Italy and the euro area could slow San Marino through weakened external demand and deterioration in Sammarinese banks’ assets located in Italy. - Upside: improved international relations could boost cross-border activity, growth, tax revenue, and banks’ profitability. ### Financial sector policy to restore stability — status and past measures - Three closed funds were set up to deal with impaired assets of weak banks absorbed by other Sammarinese credit institutions. - A tax credit (deferred tax asset, DTA) has been used since 2013 to facilitate transfers of assets and liabilities of significantly under-capitalized banks to healthy ones. - Transferring NPLs to a closed fund reduces banks’ risk profile as investments in such funds carry a lower risk weight. - Including the DTA in regulatory capital overstates banks’ financial soundness relative to Basel III and EU Capital Directive frameworks. - Progress in NPL resolution has been slow, partly due to lack of common valuation criteria. ### CRSM recapitalization (2016) — operations and outcomes - State subscribed CRSM tier-2 hybrid bond: €40 million (2.7 percent of GDP). - Real estate revaluation: €13 million. - €9 million reserve creation through merger of a state-controlled real estate company and the foundation into CRSM. - These operations brought CRSM’s capital ratio to the minimum requirement of 11 percent. - The state now holds about 46.5 percent of the share capital with rights to appoint a majority of the bank’s board members. - The state has injected €220 million (about 16 percent of GDP) in efforts to rescue the bank, making it the majority shareholder. - CRSM’s NPLs remain high, with a large part originating from Italian assets held by Delta, CRSM’s liquidated subsidiary in Italy; CRSM’s 2016 business plan was optimistic with key targets lagging. ### Financial sector policy to restore stability — Recommended multifaceted approach - Repair banks’ balance sheets via an AQR applying common asset valuation standards; market-based recapitalization if shortfalls arise, with safeguards (no dividend payments, strengthened governance). - Limit state support to systemic banks subject to appropriate reorganization plans; resolve other banks that cannot meet solvency requirements within a reasonable period. - Upgrade legal framework to international standards, including introducing a permanent bank resolution framework in the medium term. - Manage NPLs: AQR should clarify target provisions, facilitate transfers of NPLs off banks’ balance sheets, and unlock the market for distressed assets; enforce collateral, consider selective write-downs of fully-provisioned bad loans; include quarterly targets for NPL operations in banks’ business plans. - Explore outsourcing arrangements with distressed assets companies active in Italy to reduce high operating costs of NPL management outside San Marino. - Remove tax and regulatory disincentives to NPL disposals and consider opening the real estate market to nonresidents to support collateral valuations. - Enhance insolvency regime effectiveness (including pre-insolvency and out-of-court procedures) and launch the credit registry to increase transparency and reduce strategic defaults. - Strengthen coordination between the central bank (CBSM) and the government; plan and prepare to deal with possible AQR outcomes, including developing crisis response capability. ### Supervision and macroprudential framework — recommended actions - Improve data collection and harmonize NPL definitions with international standards. - Launch the credit registry. - Strengthen monitoring of bank lending standards through regular surveys and capacity to monitor systemic risks. - Regular publication of a short, well-targeted financial stability report in Italian and English is suggested. - Appropriate institutional arrangements, including a streamlined mandate and independence of the CBSM, are important. ### Authorities’ views on banking measures - Authorities view the ongoing AQR as crucial and are preparing to address capital, viability, and governance issues; prepared to support NPL resolution with legislative reforms (insolvency, securitization, resolution); work underway to launch a credit registry and enhance supervision and compliance. ### Banking sector indicators (Loans to Customers, 2016, Percent) - Performing loans: 51% - Bad loans: 18% - Problem loans: 7% - Restructured loans: 23% - Past due and overdue: 0% - Unsecured to countries at risk: 1% ### Fiscal policy to safeguard sustainability and rebuild buffers — constraints and near-term financing - Fiscal policy is the main tool to stabilize the economy but is constrained by limited access to financing. - Pre-2008–09 fiscal surpluses were saved as accumulated government deposits that reached 16 percent of GDP; these buffers are now almost depleted. - 2017 budget envisages a small deficit of 1 percent of GDP; it is under review by the new government. - Revenue expected to decline mainly due to lower fees and one-off collections. - Capital spending expected to be around 2 percent of GDP, financed by bond issuance of €10 million annually for 2017–18. - Government debt as a share of GDP is projected to increase slightly in the coming years assuming no further bank recapitalization needs. - Authorities plan to prepare a revised budget by mid-year to reflect policy priorities and lower the deficit. ### Fiscal adjustment path and targets (quantified) - Gradual fiscal adjustment should start in 2017 assuming continued recovery. - Aim: achieve a small surplus of ½ percent of GDP by 2019 to allow fiscal buffers to increase to around 3–4 percent of GDP (or equivalently reduce debt to 19 percent) by 2021. - Policy actions: - Expenditure cuts of 0.2 percent of GDP (relative to the baseline) should start immediately. - Additional adjustment of 0.3 percent of GDP through increased revenue starting in 2018. - Focus on tax policy measures given relatively low tax revenues and high needs for pro-growth, pro-employment investment. ### VAT recommendation and tax policy - Authorities should introduce a Value Added Tax (VAT) by end-2017; considerable preparatory work has been made, including draft legislation for the VAT regime. - Draft legislation envisaged introduction of a VAT with a standard rate of 12 percent and reduced rate of 5 percent after a transitional period of 5-6 years. - The introduction of the VAT was meant to be revenue-neutral as it would replace the 3 percent service tax paid by service businesses and a standard 17 percent import tax. - The VAT rate should be set to increase revenue while accounting for spending priorities; additional tax revenues will be needed for further investment increases. - Tax collection efforts should be stepped up to improve compliance and collection. ### Spending-side measures - Improve spending quality and reallocate spending to more growth-friendly categories; authorities’ intention to increase capital investment is appropriate. - Consider expanding education and vocational training. - Expenditure consolidation should come from lower current spending; modest reduction in the wage bill should be explored given its high share in current spending versus euro area peers. - Consider rationalization of health care spending. - Authorities are assessing pension reform proposals with a view to implementing them by end-2017; ensuring the social security fund is self-financed would allow reallocation of resources. ### Contingent liabilities and stress scenario - If contingent liabilities from the banking system were to materialize and some costs were borne by the state, public debt could rise significantly. - Illustration: a contingent liability shock of 30 percent of GDP would increase public debt to 51 percent of GDP and set it on an upward trajectory under current policies; a more ambitious fiscal adjustment would be required in that scenario. ### Access to external financing - Establishing access to external financing (including an external private placement or syndicated loan) while advancing fiscal sustainability would enhance the government’s ability to respond to shocks. - Market access would introduce market discipline, diversify funding sources, and help break the bank-sovereign loop. - To the extent external financing is available, the need to hold sizable deposit buffers would decline and such buffers could be used only when market access is limited. ### Fiscal policy and rebuilding buffers — authorities’ commitments - Authorities are working on a revised budget to reflect priorities and reduce the deficit to be adopted by June/July this year. - Commitment to pursue pro-growth fiscal policies to revive growth while starting to rebuild buffers gradually. - Recommendation: a gradual fiscal adjustment starting this year, targeting a modest surplus by 2019. - Quantified path: an annual, phased reduction of deficit by about ½ percent of GDP in coming years. - Key fiscal measures highlighted: - Introduction of a VAT system by the end of this year to play a key role in adjustment. - Contain public wage bill and reform the pension system. - Caveat: potential fiscal contingencies related to banks’ public recapitalization needs remain significant; if realized, a deeper fiscal adjustment would be needed and the authorities should be ready to take additional measures. ### Structural reforms to increase growth potential and business environment - Progress to date: - High-tech business incubator established to facilitate a scientific and technological park. - Simple and fast online process to establish a business put in place. - Labor market adjustments, including exempting small high-tech businesses in the incubator from slow procedures to hire skilled nonresident workers. - Measures supported activity in manufacturing with an increasing number of new firms and employment. - Priority reforms under consideration: - Introduce a one-stop-shop for businesses to simplify administration. - Further streamline procedures to hire nonresidents. - Reform insolvency and debt restructuring regimes and improve availability of credit. - Measures to improve productivity, including enhancing vocational training. - Guiding principle: reforms should improve efficiency and avoid distortions and additional fiscal costs. - Expected outcome: diversification beyond the financial sector, supporting growth in industrial and services sectors. ### Financial sector, banking challenges, and oversight — priorities - Vulnerabilities in the banking system continue to hamper medium-term growth prospects. - Ongoing AQR is important to restore banking system health and needs to be followed by efforts to repair banks’ balance sheets. - Recommended actions: - Deal with capital shortfalls via market-based solutions, restructuring, or resolution; limit state support to systemic banks and make it contingent on reorganization plans. - Credible strategy for CRSM should be guided by AQR findings and ensure long-term viability based on realistic assumptions. - Strategy to significantly reduce high stock of NPL over the medium term, including supportive regulatory, tax and legal reforms. - Plan and prepare for possible AQR outcomes by upgrading the legal framework and enhancing inter-governmental coordination. ### Strengthening oversight - Revamp bank supervision and develop a robust macroprudential framework. - Use the completed internal audit of the central bank as a basis to enhance supervision and compliance. - Identify and close data and regulatory gaps and develop capacity to monitor systemic risks. - Produce a regular financial stability report to communicate CBSM’s financial sector assessment and policy intentions. - Streamline mandate and ensure independence of the CBSM. ### International cooperation and liquidity access - Engagement in international cooperation remains crucial. - Recent steps: - AML/CFT national risk assessment completed last year; authorities encouraged to implement the AML/CFT Action plan. - Multidisciplinary group established in July 2016 to discuss BEPS measures implementation. - Recommended actions: - Continue to build cooperation across Europe and beyond, including continued negotiations with the European Union on an association agreement. - Explore ways to gain access to ECB liquidity facilities to help domestic banks against potential liquidity shocks (Note: currently, there is no legal basis for such access to ECB credit operations). - In promoting investment, consider tapping expertise of the EBRD and IFC. ### Data provision and transparency - Current weaknesses: gaps in data coverage and timeliness primarily in balance of payments, national accounts and to a lesser extent public finance statistics; some high frequency indicators available but accessibility relatively limited. - Recommendation: strengthen data provision — timeliness, availability, and accessibility — and disseminate data in an easily accessible online format. - Authorities should consider allocating more resources to improve data provision and set this as a key priority in the reform agenda. ### Authorities’ stated views on reforms and labor market - Considering near-term labor market reforms, including internationalization of the labor market and labor contract reforms, with caution to avoid new distortions. - Labor market reforms will consider small domestic market size and need to create employment for the internal labor force. - Emphasis on internationalization across Europe and beyond to achieve higher growth potential. - Acknowledged need to improve data availability and timeliness to improve policymaking and transparency. ### Staff appraisal — key findings and recommendations - Macroeconomic context: - Slow recovery after a long recession; growth returned in 2015 with continued recovery in 2016, but expected to be subdued and insufficient to restore output to pre-crisis levels within the next decade. - Existing buffers almost depleted and no access to external financing; limited fiscal space to respond to shocks and mobilize resources for pro-growth spending. - External position moderately weaker than fundamentals and desired policy. - Reform agenda: developing a comprehensive, medium-term growth strategy with prioritization and sequencing is key given binding capacity and resource constraints. - Banking sector priority: address banking challenges decisively; reduce NPLs; ensure bank oversight and macroprudential framework strengthened. - Fiscal recommendation: phased deficit reduction of about ½ percent of GDP annually to reach modest surplus by 2019; VAT introduction by end of this year; contain wage bill and reform pensions. - External financing: authorities should start exploring external financing options to enhance shock response capacity, diversify funding sources, and help break bank-sovereign loop. - Structural reforms: continue improving business environment and labor market flexibility while avoiding distortions and fiscal costs. - International cooperation: maintain focus on cooperation and transparency; implement AML/CFT Action Plan and pursue EU association agreement negotiations. - Data provision: strengthen data as a key goal in reform agenda. - Procedural recommendation: next Article IV consultations with the Republic of San Marino be held on the standard 12-month cycle. ### Box: Economic Crisis in San Marino — selected statistics and chronology - San Marino has lost a third of the country’s output since 2008. - Banking sector assets have fallen by more than 200 percent of GDP since then. - Between 2000 and 2008, credit growth averaged at around 20 percent. - Key shocks beginning in 2008 included: - Increased international scrutiny on tax havens; 2008 MONEYVAL critical AML/CFT assessment; 2009 OECD “gray list” placement. - Italian tax amnesty in 2009 and reporting obligations in 2010 led to massive deposit outflows, reducing bank liabilities by a third. - CRSM was hit by losses from investments and advances to Delta when Italian authorities seized Delta’s assets and put it into liquidation. - Global financial crisis weakened external demand and increased nonperforming loans. - Post-crisis adjustments: increased transparency and exchange of information for tax purposes; OECD and Italy included San Marino in their white lists; bilateral economic cooperation agreement with Italy entered into force in January 2015; negotiations (with Andorra and Monaco) on an association agreement with the EU started in early 2015. ### Box 2. Managing and Resolving Nonperforming Loans (NPLs) — NPL stock and recent developments - The gross NPLs to customers have increased sharply from 15 percent of total loans to customers in 2010 to above 50 percent in 2015, equivalent to 125 percent of GDP. - NPLs to banks are currently below one percent of total loans to banks. - Banks increased forbearance and the restructuring of loans (the restructured loans category, however, mostly reflects banks’ exposure to the Delta group). - Lower-quality tiers of NPLs have also increased. - Banks have continued restructuring, bad loan write-offs, and selected securitization of NPLs, in part supported by the incipient economic recovery. As a result, the NPL ratio has improved slightly in 2016. ### Box 2 — Impact on profitability and impediments to resolution - The surge in NPLs has dented operating profits by reduced net interest income and increased expenses, and through increased other administrative costs, write-downs, and provisioning. - Noninterest and extraordinary income provided some buffer, but losses across the banking sector have continued through 2016, albeit gradually diminishing. - Key impediments: - Banks manage their NPLs internally in closed funds because difficulties in agreeing common valuation criteria for transferred assets so far precluded finding a system-wide solution for NPLs. - Legal obstacles to managing and resolving nonresident NPLs (75% of NPLs) that are secured by collateral mostly in Italy increase administrative costs. - The Sammarinese property market is not very active and lacks potential buyers, impeding timely and effective debt recovery. - Slightly more than one-third of NPLs are collateralized, about half of which by real estate (a quarter of which located abroad). ### Box 2 — Policy recommendations and operational measures - Seek a system-wide solution (once common valuation criteria can be agreed) to reduce administrative costs through economies of scale. - Address legal obstacles to managing and resolving nonresident NPLs secured by collateral mostly in Italy. - A gradual opening of the real estate market to nonresidents could reinvigorate the debt recovery process. - Banks should update their NPL resolution plans by setting quarterly targets for loan restructuring, cure rate, cash collection, and operating expenses. - Continued loan restructuring, bad loan write-offs, and selected securitization of NPLs have taken place, supported in part by the incipient economic recovery. ### Annex II. Debt Sustainability Analysis — Baseline scenario (selected) - Real GDP growth reaching at 1.3 percent in the medium term. - The overall balance is projected to remain at a small deficit of around -0.2 percent of GDP. - The primary balance is projected to be broadly balanced in the medium term. - Public debt projected to stabilize at around 21 percent of GDP by 2021. - Gross financing needs expected to remain stable at around 9–10 percent of GDP during the projection period. ### Annex II — Selected projected indicators (DSA figures) - Nominal gross public debt: 16.6 (2014), 19.0 (2015), 19.7 (2016), 21.6 (2017), 21.8 (2018), 22.0 (2019), 21.6 (2020), 21.3 (2021), 21.3 (projection). - Public gross financing needs: 3.8 (2014), 7.4 (2015), 4.1 (2016), 5.4 (2017), 7.6 (2018), 7.2 (2019), 6.5 (2020), 6.0 (2021), 5.8 (projection). - Real GDP growth (in percent): -6.0 (2014), -0.9 (2015), 0.5 (2016), 1.0 (2017), 1.2 (2018), 1.3 (2019), 1.3 (2020), 1.3 (2021), 1.3 (projection). - Effective interest rate (in percent): 0.7 (2014), 1.0 (2015), 1.2 (2016), 1.2 (2017), 1.8 (2018), 2.1 (2019), 2.4 (2020), 2.8 (2021), 3.0 (projection). - Primary (noninterest) revenue and grants: 19.7 (2014), 22.5 (2015), 20.8 (2016), 22.1 (2017), 20.9 (2018), 20.8 (2019), 20.5 (2020), 20.4 (2021), 20.4 (cumulative 2014-21: 125.1). - Primary (noninterest) expenditure: 21.4 (2014), 21.5 (2015), 20.8 (2016), 22.4 (2017), 21.6 (2018), 21.2 (2019), 20.2 (2020), 20.2 (2021), 20.2 (cumulative 2014-21: 125.9). - Change in gross public sector debt (2014–21 cumulative): 1.5 (cumulative). ### Annex II — Stress tests and impacts (highlights) - Real GDP growth shock (one standard deviation, 4.9 percent lower than baseline during 2017–18): debt-to-GDP ratio rises to 29 percent in 2018 (about 7 percentage points higher than baseline) and stays elevated afterwards. - Primary balance shock (primary deficit widens by 0.7 percent of GDP in 2017–18): debt-to-GDP ratio is 2 percentage points higher than baseline during 2018-21. - Real interest rate shock (nominal interest rate increases by 150 basis points during 2017–21): debt-to-GDP ratio remains the same as baseline with a slight upward trend in 2020–21. - Real exchange rate shock (real exchange rate depreciates by 13 percent in 2017): negligible impact on debt-to-GDP trajectory. - Combined shock (Real GDP, Primary balance, Real interest rate): debt-to-GDP approaches 29 percent in 2018 and stabilizes around 30 percent by 2021. - Contingent liabilities shock (30 percent of GDP materializes in 2017): debt-to-GDP increases to 51 percent in 2017 and reaches 56 percent by 2021 under unchanged fiscal policy; such dynamics may be unsustainable given limited access to external financing. ### Annex V. Reserve Adequacy — Fiscal reserves and key figures - Fiscal reserves rule of thumb: cover at least one month of spending. - One month of spending in San Marino implies about €25 million (1.8 percent of GDP). - Current government deposits are just at one month of spending. - Staff recommendation: rebuild fiscal buffers; note government deposits may also be used as bank backstops and not fully correspond to fiscal reserves. ### Annex V — Emergency liquidity and liquidity metrics - First line of defense: banks’ own liquid assets. - Ratio of liquid assets to short-term liabilities: 60 percent. - Banks’ liquid assets cover about 155 percent of nonresident deposits as of August 2016. - Banks hold reserves valued at about €88 million at the CBSM (4 percent reserve requirement). - Institutional constraint: CBSM’s ability to provide liquidity assistance is constrained due to euroization; no legal basis for access to Eurosystem liquidity. - Staff recommendation: improve institutional framework for the LOLR function and explore feasibility of access to Eurosystem liquidity. ### San Marino and BEPS - San Marino recently joined the OECD’s new inclusive framework to tackle Base Erosion and Profit Shifting (BEPS). - A multidisciplinary group of authorities was established to facilitate implementation of the BEPS package. *International Monetary Fund. Staff report for the 2017 Article IV consultation with the Republic of San Marino.* ### 1.3 percent in the medium term, driven by continued expansion in non-financial industries and ### cr1786 - 1.3 percent in the medium term, driven by continued expansion in non-financial industries and ### Outlook and growth prospects - Staff projects growth of 1.3 percent in the medium term, driven by continued expansion in non-financial industries and services. - On current trends, the pace of growth would not be strong enough to bring output to precrisis levels over the next five years. - Risks to the outlook remain tilted to the downside. ### Key macroeconomic indicators (selected) - GDP per capita (2015): 46,185 U.S. dollars - Population (2016): 34,267 persons - Life expectancy at birth (2011): 83.3 years - Literacy, adult (2008): 96 percent - Real GDP (percent change): 2013: -3.0; 2014: -0.9; 2015: 0.5; 2016: 1.0; 2017 (projection): 1.2 - Unemployment rate (average; percent): 2013: 8.1; 2014: 8.7; 2015: 9.2; 2016: 8.6; 2017 (projection): 8.0 - Inflation rate (average; percent): 2013: 1.3; 2014: 1.1; 2015: 0.1; 2016: 0.6; 2017 (projection): 0.7 - Public finances (percent of GDP), central government: - Revenues: 2013: 20.2; 2014: 22.5; 2015: 20.8; 2016: 22.1; 2017 (projection): 20.9 - Expenditure: 2013: 21.1; 2014: 21.7; 2015: 21.0; 2016: 22.7; 2017 (projection): 21.9 - Overall balance: 2013: -0.9; 2014: 0.8; 2015: -0.2; 2016: -0.6; 2017 (projection): -1.0 - Government debt: 2013: 20.8; 2014: 19.0; 2015: 19.7; 2016: 21.6; 2017 (projection): 21.8 - Financial soundness indicators (latest available): - Regulatory capital to risk-weighted assets: 2013: 13.6; 2014: 11.4; 2015: 12.7; 2016: 13.6 - Bad loans to total loans: 2013: 13.9; 2014: 16.1; 2015: 18.5; 2016: 18.7 - Loan loss provision to total loans: 2013: 26.7; 2014: 30.3; 2015: 28.6; 2016: 26.6 - Return on equity (ROE): 2013: -7.8; 2014: -21.4; 2015: -9.0; 2016: -10.5 - Liquid assets to total assets: 2013: 29.6; 2014: 32.4; 2015: 29.8; 2016: 29.5 - Liquid assets to short-term liabilities: 2013: 60.6; 2014: 65.4; 2015: 58.9; 2016: 59.1 ### Financial sector: diagnosis and recommended actions Findings - Banking system assets about 370 percent of GDP as of December 2016. - The three largest banks account for about 70 percent of total bank assets and deposits. - Reported capital adequacy ratio of the banking system was 13.6 percent in September 2016 after the recapitalization of Cassa di Risparmio della Repubblica di San Marino (CRSM). - Gross NPLs about 43 percent of total loans (about 113 percent of GDP) at end-2016; about 36 percent net of provisions. - NPL coverage ratio is relatively low at 26 percent. - Net losses of about €47 million as of December 2016. - Bank liquidity buffers cover about 60 percent of short-term liabilities and about 30 percent of total liabilities; buffers worsened slightly in the first half of 2016. - About half of NPLs belong to nonresident clients; about half of loans are vis-à-vis nonresidents (mostly Italian); about a quarter of deposits are from nonresidents. Policy recommendations - Complete the ongoing Asset Quality Review (AQR) of the banking system and follow with appropriate plans to repair bank balance sheets. - Accelerate the resolution of NPLs by removing legal, regulatory, and tax obstacles. - Anchor the restructuring strategy for CRSM on AQR findings and ensure any restructuring plans secure long-term viability. - Strengthen bank oversight, including revamping supervision and developing a robust macroprudential framework. Traction - Authorities launched an AQR of all banks in November 2016. - Central Bank completed an internal audit to enhance supervision and compliance and started collecting more granular information on NPLs. ### Fiscal policy: current stance and recommendations Findings - Public debt and deficit have been relatively low but public finances have limited space to respond to shocks given limited buffers and no access to external financing. - Fiscal deficits contained; some increase in public investment expected in 2016 onward. Policy recommendations - Rebuild fiscal buffers through a gradual fiscal adjustment targeting a modest surplus by 2019. - Introduce a VAT system with a revenue-increasing rate. - Implement pension reforms to contain pension spending over the medium-term. - Contain the public wage bill. - Prepare contingency plans for potential fiscal costs related to bank balance sheet repair. - Continue efforts to establish sovereign access to external financing to diversify funding sources and break the bank-sovereign loop. ### Structural reforms and other policies Findings - A moderate recovery underway, supported by increasing number of new firms and rising employment; still considerable challenges to restore financial stability, create fiscal space, and achieve sustainable growth. - High-frequency indicators: expansion of enterprises through Q3 2016, especially manufacturing (about one third of total employment); wholesale and retail sectors expanding; car registrations increased since mid-2015; construction approvals leveled off. - Unemployment declined to 8.5 percent in December 2016 after peaking at 10 percent in February 2016. - CPI inflation low; core inflation close to 0.5 percent (September 2016). Policy recommendations - Improve the business environment and increase labor market flexibility to reallocate resources to nonbank sectors. - Maintain focus on international cooperation and implement the AML/CFT Action Plan following the 2016 AML/CFT national risk assessment. - Invest in long-term education and vocational training. - Strengthen data provision to enhance transparency and facilitate more informed decision-making. ### Executive Board and Directors’ views - Directors welcomed the ongoing recovery but noted the challenging outlook. - Emphasized rehabilitating the banking system, dealing with very high NPLs, and the importance of the AQR. - Endorsed a multifaceted approach: repair bank balance sheets based on AQR results; remove obstacles to NPL resolution (regulatory, tax, legal); strengthen oversight. - Supported gradual fiscal adjustment aiming for a modest surplus by 2019 and noted the role of tax policy, particularly VAT introduction. - Supported diversification efforts, business environment improvements, labor market flexibility, and long-term investments in education and vocational training. - Encouraged implementation of the AML/CFT Action Plan and strengthening data provision. *International Monetary Fund. Staff report for the 2017 Article IV consultation with the Republic of San Marino.* ### 8. A small budget deficit is expected in 2016. ### 8. A small budget deficit is expected in 2016. ### Budget outcome and near-term outlook - 2016 budget points to a small deficit of about ½ percent of GDP, following a broadly balanced budget in 2015; drivers include increased infrastructure spending and spending related to early elections. - Public debt as a share of GDP increased to 21½ percent at end-2016 (from 19.7 percent in 2015), reflecting mostly the recent recapitalization of CRSM. - Banking sector vulnerabilities pose significant fiscal risks. ### Outlook and growth projections - GDP growth projections: - 2017: 1.2 percent. - Medium term: around 1¼ percent. - Inflation: expected to remain low in the near term and only gradually rise in line with recovery in domestic demand and inflation in Italy. - Pace of growth is well below what is needed to regain the lost ground since 2009; San Marino is not expected to reach the pre-2009 GDP level until the end-2020s. - Drivers of growth are expected to rotate from net exports towards domestic demand, especially consumption, supported by employment growth; corporate profitability expected to improve gradually and finance modest recovery in investment despite limited credit growth. ### Risks to the central scenario (tilted to the downside) - Lingering weakness in the domestic banking system (high NPLs) could undermine credit provision and growth and could lead to loss of confidence if not addressed. - Structurally weak growth in Italy and the euro area could slow San Marino through weakened external demand and deterioration in Sammarinese banks’ assets located in Italy. - Upside: improved international relations could boost cross-border activity, growth, tax revenue, and banks’ profitability. ### Financial sector policy to restore stability - Status and past measures: - Three closed funds were set up to deal with impaired assets of weak banks absorbed by other Sammarinese credit institutions. - A tax credit (deferred tax asset, DTA) has been used since 2013 to facilitate transfers of assets and liabilities of significantly under-capitalized banks to healthy ones. - Transferring NPLs to a closed fund reduces banks’ risk profile as investments in such funds carry a lower risk weight. - Including the DTA in regulatory capital overstates banks’ financial soundness relative to Basel III and EU Capital Directive frameworks. - Progress in NPL resolution has been slow, partly due to lack of common valuation criteria. - CRSM recapitalization (2016): - State subscribed CRSM tier-2 hybrid bond: €40 million (2.7 percent of GDP). - Real estate revaluation: €13 million. - €9 million reserve creation through merger of a state-controlled real estate company and the foundation into CRSM. - These operations brought CRSM’s capital ratio to the minimum requirement of 11 percent. - The state now holds about 46.5 percent of the share capital with rights to appoint a majority of the bank’s board members. - The state has injected €220 million (about 16 percent of GDP) in efforts to rescue the bank, making it the majority shareholder. - CRSM’s NPLs remain high, with a large part originating from Italian assets held by Delta, CRSM’s liquidated subsidiary in Italy; CRSM’s 2016 business plan was optimistic with key targets lagging. - Recommended multifaceted approach: - Repair banks’ balance sheets via an AQR applying common asset valuation standards; market-based recapitalization if shortfalls arise, with safeguards (no dividend payments, strengthened governance). - Limit state support to systemic banks subject to appropriate reorganization plans; resolve other banks that cannot meet solvency requirements within a reasonable period. - Upgrade legal framework to international standards, including introducing a permanent bank resolution framework in the medium term. - Manage NPLs: AQR should clarify target provisions, facilitate transfers of NPLs off banks’ balance sheets, and unlock the market for distressed assets; enforce collateral, consider selective write-downs of fully-provisioned bad loans; include quarterly targets for NPL operations in banks’ business plans. - Explore outsourcing arrangements with distressed assets companies active in Italy to reduce high operating costs of NPL management outside San Marino. - Remove tax and regulatory disincentives to NPL disposals and consider opening the real estate market to nonresidents to support collateral valuations. - Enhance insolvency regime effectiveness (including pre-insolvency and out-of-court procedures) and launch the credit registry to increase transparency and reduce strategic defaults. - Strengthen coordination between the central bank (CBSM) and the government; plan and prepare to deal with possible AQR outcomes, including developing crisis response capability. - Supervision and macroprudential framework: - Improve data collection and harmonize NPL definitions with international standards. - Launch the credit registry. - Strengthen monitoring of bank lending standards through regular surveys and capacity to monitor systemic risks. - Regular publication of a short, well-targeted financial stability report in Italian and English is suggested. - Appropriate institutional arrangements, including a streamlined mandate and independence of the CBSM, are important. - Authorities’ views on banking measures: - Authorities view the ongoing AQR as crucial and are preparing to address capital, viability, and governance issues; prepared to support NPL resolution with legislative reforms (insolvency, securitization, resolution); work underway to launch a credit registry and enhance supervision and compliance. ### Banking sector indicators (Loans to Customers, 2016, Percent) - Performing loans: 51% - Bad loans: 18% - Problem loans: 7% - Restructured loans: 23% - Past due and overdue: 0% - Unsecured to countries at risk: 1% ### Fiscal policy to safeguard sustainability and rebuild buffers - Fiscal position and constraints: - Fiscal policy is the main tool to stabilize the economy but is constrained by limited access to financing. - Pre-2008–09 fiscal surpluses were saved as accumulated government deposits that reached 16 percent of GDP; these buffers are now almost depleted. - 2017 budget and near-term financing: - 2017 budget envisages a small deficit of 1 percent of GDP; it is under review by the new government. - Revenue expected to decline mainly due to lower fees and one-off collections. - Capital spending expected to be around 2 percent of GDP, financed by bond issuance of €10 million annually for 2017–18. - Government debt as a share of GDP is projected to increase slightly in the coming years assuming no further bank recapitalization needs. - Authorities plan to prepare a revised budget by mid-year to reflect policy priorities and lower the deficit. - Fiscal adjustment path and targets: - Gradual fiscal adjustment should start in 2017 assuming continued recovery. - Aim: achieve a small surplus of ½ percent of GDP by 2019 to allow fiscal buffers to increase to around 3–4 percent of GDP (or equivalently reduce debt to 19 percent) by 2021. - Policy actions: - Expenditure cuts of 0.2 percent of GDP (relative to the baseline) should start immediately. - Additional adjustment of 0.3 percent of GDP through increased revenue starting in 2018. - Focus on tax policy measures given relatively low tax revenues and high needs for pro-growth, pro-employment investment. - VAT recommendation: - Authorities should introduce a Value Added Tax (VAT) by end-2017; considerable preparatory work has been made, including draft legislation for the VAT regime. - Draft legislation envisaged introduction of a VAT with a standard rate of 12 percent and reduced rate of 5 percent after a transitional period of 5-6 years. - The introduction of the VAT was meant to be revenue-neutral as it would replace the 3 percent service tax paid by service businesses and a standard 17 percent import tax. - The VAT rate should be set to increase revenue while accounting for spending priorities; additional tax revenues will be needed for further investment increases. - Tax collection efforts should be stepped up to improve compliance and collection. - Spending-side measures: - Improve spending quality and reallocate spending to more growth-friendly categories; authorities’ intention to increase capital investment is appropriate. - Consider expanding education and vocational training. - Expenditure consolidation should come from lower current spending; modest reduction in the wage bill should be explored given its high share in current spending versus euro area peers. - Consider rationalization of health care spending. - Authorities are assessing pension reform proposals with a view to implementing them by end-2017; ensuring the social security fund is self-financed would allow reallocation of resources. - Contingent liabilities and stress scenario: - If contingent liabilities from the banking system were to materialize and some costs were borne by the state, public debt could rise significantly. - Illustration: a contingent liability shock of 30 percent of GDP would increase public debt to 51 percent of GDP and set it on an upward trajectory under current policies; a more ambitious fiscal adjustment would be required in that scenario. - Access to external financing: - Establishing access to external financing (including an external private placement or syndicated loan) while advancing fiscal sustainability would enhance the government’s ability to respond to shocks. - Market access would introduce market discipline, diversify funding sources, and help break the bank-sovereign loop. - To the extent external financing is available, the need to hold sizable deposit buffers would decline and such buffers could be used only when market access is limited. *Source: IMF staff report excerpt (Republic of San Marino).* ### 23. The authorities agreed on the need to start rebuilding buffers gradually. They are ### cr1786 - 23. The authorities agreed on the need to start rebuilding buffers gradually. They are ### Fiscal policy and rebuilding buffers - Authorities are working on a revised budget to reflect priorities and reduce the deficit to be adopted by June/July this year. - Commitment to pursue pro-growth fiscal policies to revive growth while starting to rebuild buffers gradually. - Recommendation: a gradual fiscal adjustment starting this year, targeting a modest surplus by 2019. - Quantified path: an annual, phased reduction of deficit by about ½ percent of GDP in coming years. - Key fiscal measures highlighted: - Introduction of a VAT system by the end of this year to play a key role in adjustment. - Contain public wage bill and reform the pension system. - Caveat: potential fiscal contingencies related to banks’ public recapitalization needs remain significant; if realized, a deeper fiscal adjustment would be needed and the authorities should be ready to take additional measures. ### Structural reforms to increase growth potential and business environment - Progress to date: - High-tech business incubator established to facilitate a scientific and technological park. - Simple and fast online process to establish a business put in place. - Labor market adjustments, including exempting small high-tech businesses in the incubator from slow procedures to hire skilled nonresident workers. - These measures supported activity in manufacturing with an increasing number of new firms and employment. - Priority reforms under consideration: - Introduce a one-stop-shop for businesses to simplify administration. - Further streamline procedures to hire nonresidents. - Reform insolvency and debt restructuring regimes and improve availability of credit (Doing Business indicators; see Annex III). - Measures to improve productivity, including enhancing vocational training. - Guiding principle: reforms should improve efficiency and avoid distortions and additional fiscal costs. - Expected outcome: diversification beyond the financial sector, supporting growth in industrial and services sectors. ### Financial sector, banking challenges, and oversight - Assessment of banking sector: - Vulnerabilities in the banking system continue to hamper medium-term growth prospects. - Ongoing AQR is important to restore banking system health and needs to be followed by efforts to repair banks’ balance sheets. - Recommended actions: - Deal with capital shortfalls via market-based solutions, restructuring, or resolution; limit state support to systemic banks and make it contingent on reorganization plans. - Credible strategy for CRSM should be guided by AQR findings and ensure long-term viability based on realistic assumptions. - Strategy to significantly reduce high stock of NPL over the medium term, including supportive regulatory, tax and legal reforms. - Plan and prepare for possible AQR outcomes by upgrading the legal framework and enhancing inter-governmental coordination. - Strengthening oversight: - Revamp bank supervision and develop a robust macroprudential framework. - Use the completed internal audit of the central bank as a basis to enhance supervision and compliance. - Identify and close data and regulatory gaps and develop capacity to monitor systemic risks. - Produce a regular financial stability report to communicate CBSM’s financial sector assessment and policy intentions. - Streamline mandate and ensure independence of the CBSM. ### International cooperation and liquidity access - Engagement in international cooperation remains crucial (Annex IV). - Recent steps: - AML/CFT national risk assessment completed last year; authorities encouraged to implement the AML/CFT Action plan. - Multidisciplinary group established in July 2016 to discuss BEPS measures implementation. - Recommended actions: - Continue to build cooperation across Europe and beyond, including continued negotiations with the European Union on an association agreement. - Explore ways to gain access to ECB liquidity facilities to help domestic banks against potential liquidity shocks (Annex V). (Note: currently, there is no legal basis for such access to ECB credit operations.) - In promoting investment, consider tapping expertise of the EBRD and IFC. ### Data provision and transparency - Current weaknesses: gaps in data coverage and timeliness primarily in balance of payments, national accounts and to a lesser extent public finance statistics; some high frequency indicators available but accessibility relatively limited. - Recommendation: strengthen data provision — timeliness, availability, and accessibility — and disseminate data in an easily accessible online format. - Authorities should consider allocating more resources to improve data provision and set this as a key priority in the reform agenda. ### Authorities’ stated views - Considering near-term labor market reforms, including internationalization of the labor market and labor contract reforms, with caution to avoid new distortions. - Labor market reforms will consider small domestic market size and need to create employment for the internal labor force. - Emphasis on internationalization across Europe and beyond to achieve higher growth potential. - Acknowledged need to improve data availability and timeliness to improve policymaking and transparency. ### Staff appraisal — key findings and recommendations - Macroeconomic context: - Slow recovery after a long recession; growth returned in 2015 with continued recovery in 2016, but expected to be subdued and insufficient to restore output to pre-crisis levels within the next decade. - Existing buffers almost depleted and no access to external financing; limited fiscal space to respond to shocks and mobilize resources for pro-growth spending. - External position moderately weaker than fundamentals and desired policy. - Reform agenda: developing a comprehensive, medium-term growth strategy with prioritization and sequencing is key given binding capacity and resource constraints. - Banking sector priority: address banking challenges decisively; reduce NPLs; ensure bank oversight and macroprudential framework strengthened. - Fiscal recommendation: phased deficit reduction of about ½ percent of GDP annually to reach modest surplus by 2019; VAT introduction by end of this year; contain wage bill and reform pensions. - External financing: authorities should start exploring external financing options to enhance shock response capacity, diversify funding sources, and help break bank-sovereign loop. - Structural reforms: continue improving business environment and labor market flexibility while avoiding distortions and fiscal costs. - International cooperation: maintain focus on cooperation and transparency; implement AML/CFT Action Plan and pursue EU association agreement negotiations. - Data provision: strengthen data as a key goal in reform agenda. - Procedural recommendation: next Article IV consultations with the Republic of San Marino be held on the standard 12-month cycle. ### Box: Economic Crisis in San Marino — selected statistics and chronology - San Marino has lost a third of the country’s output since 2008. - Banking sector assets have fallen by more than 200 percent of GDP since then. - Between 2000 and 2008, credit growth averaged at around 20 percent. - Key shocks beginning in 2008 included: - Increased international scrutiny on tax havens; 2008 MONEYVAL critical AML/CFT assessment; 2009 OECD “gray list” placement. - Italian tax amnesty in 2009 and reporting obligations in 2010 led to massive deposit outflows, reducing bank liabilities by a third. - CRSM was hit by losses from investments and advances to Delta when Italian authorities seized Delta’s assets and put it into liquidation. - Global financial crisis weakened external demand and increased nonperforming loans. - Post-crisis adjustments: increased transparency and exchange of information for tax purposes; OECD and Italy included San Marino in their white lists; bilateral economic cooperation agreement with Italy entered into force in January 2015; negotiations (with Andorra and Monaco) on an association agreement with the EU started in early 2015. *International Monetary Fund — staff summary of Republic of San Marino chapter content* ### Box 2. Managing and Resolving Nonperforming Loans (NPLs) ### Box 2. Managing and Resolving Nonperforming Loans (NPLs) ### NPL stock and recent developments - The gross NPLs to customers have increased sharply from 15 percent of total loans to customers in 2010 to above 50 percent in 2015, equivalent to 125 percent of GDP. - NPLs to banks are currently below one percent of total loans to banks. - Banks increased forbearance and the restructuring of loans (the restructured loans category, however, mostly reflects banks’ exposure to the Delta group). - Lower-quality tiers of NPLs have also increased. - Banks have continued restructuring, bad loan write-offs, and selected securitization of NPLs, in part supported by the incipient economic recovery. As a result, the NPL ratio has improved slightly in 2016. ### Impact on profitability and bank performance - The surge in NPLs has dented operating profits by reduced net interest income and increased expenses, and through increased other administrative costs, write-downs, and provisioning. - Noninterest and extraordinary income provided some buffer, but losses across the banking sector have continued through 2016, albeit gradually diminishing. ### Key impediments to NPL resolution - Banks manage their NPLs internally in closed funds because difficulties in agreeing common valuation criteria for transferred assets so far precluded finding a system-wide solution for NPLs. - Legal obstacles to managing and resolving nonresident NPLs (75% of NPLs) that are secured by collateral mostly in Italy increase administrative costs. - The Sammarinese property market is not very active and lacks potential buyers, impeding timely and effective debt recovery. - Slightly more than one-third of NPLs are collateralized, about half of which by real estate (a quarter of which located abroad). ### Policy recommendations and operational measures - Reducing administrative costs and obstacles related to NPLs: - Seek a system-wide solution (once common valuation criteria can be agreed) to reduce administrative costs through economies of scale. - Address legal obstacles to managing and resolving nonresident NPLs secured by collateral mostly in Italy. - Gradual opening up of the real estate market: - A gradual opening of the real estate market to nonresidents could reinvigorate the debt recovery process. - Upgrading NPL resolution strategies: - Banks should update their NPL resolution plans by setting quarterly targets for loan restructuring, cure rate, cash collection, and operating expenses. ### Additional operational actions observed - Continued loan restructuring, bad loan write-offs, and selected securitization of NPLs have taken place, supported in part by the incipient economic recovery. *Source: IMF staff summary of "Box 2. Managing and Resolving Nonperforming Loans (NPLs)" in the IMF report on the Republic of San Marino.* ### Annex II. Debt Sustainability Analysis ### Annex II. Debt Sustainability Analysis ### Baseline scenario - Macroeconomic and fiscal outlook: - Real GDP growth reaching at 1.3 percent in the medium term. - The overall balance is projected to remain at a small deficit of around -0.2 percent of GDP. - The primary balance is projected to be broadly balanced in the medium term. - Public debt and financing: - Public debt is projected to rise slightly but start declining and stabilize at around 21 percent of GDP by 2021. - Gross financing needs are expected to remain stable at around 9–10 percent of GDP during the projection period. - Selected projected indicators (as presented in the DSA): - Nominal gross public debt: 16.6 (2014), 19.0 (2015), 19.7 (2016), 21.6 (2017), 21.8 (2018), 22.0 (2019), 21.6 (2020), 21.3 (2021), 21.3 (projection). - Public gross financing needs: 3.8 (2014), 7.4 (2015), 4.1 (2016), 5.4 (2017), 7.6 (2018), 7.2 (2019), 6.5 (2020), 6.0 (2021), 5.8 (projection). - Real GDP growth (in percent): -6.0 (2014), -0.9 (2015), 0.5 (2016), 1.0 (2017), 1.2 (2018), 1.3 (2019), 1.3 (2020), 1.3 (2021), 1.3 (projection). - Effective interest rate (in percent): 0.7 (2014), 1.0 (2015), 1.2 (2016), 1.2 (2017), 1.8 (2018), 2.1 (2019), 2.4 (2020), 2.8 (2021), 3.0 (projection). - Primary (noninterest) revenue and grants: 19.7 (2014), 22.5 (2015), 20.8 (2016), 22.1 (2017), 20.9 (2018), 20.8 (2019), 20.5 (2020), 20.4 (2021), 20.4 (cumulative 2014-21: 125.1). - Primary (noninterest) expenditure: 21.4 (2014), 21.5 (2015), 20.8 (2016), 22.4 (2017), 21.6 (2018), 21.2 (2019), 20.2 (2020), 20.2 (2021), 20.2 (cumulative 2014-21: 125.9). - Change in gross public sector debt (2014–21 cumulative): 1.5 (cumulative). ### Stress tests — scenarios and impacts - Real GDP growth shock: - Assumption: Real GDP growth rates are one standard deviation (4.9 percent) lower than the baseline during 2017–18. - Impact: Debt-to-GDP ratio will rise to 29 percent in 2018 (about 7 percentage points higher than the baseline) and stay elevated afterwards. - Primary balance shock: - Assumption: The primary deficit is assumed to widen by 0.7 percent of GDP in 2017–18. - Impact: Debt-to-GDP ratio is only 2 percentage points higher than the baseline scenario during 2018-21. - Real interest rate shock: - Assumption: The nominal interest rate increases by 150 basis points during 2017–21. - Impact: The debt-to-GDP ratio will remain the same as the baseline with a slight upward trend in 2020–21. - Real exchange rate shock: - Assumption: Real exchange rate depreciates by 13 percent in 2017. - Impact: The impact on the trajectory of the debt-to-GDP ratio is negligible. - Combined shock: - Assumption: Simultaneous combination of the first three shocks (Real GDP, Primary balance, Real interest rate). - Impact: Debt-to-GDP ratio will approach 29 percent in 2018 (roughly 7 percentage points higher than the baseline). After 2018, debt will slightly rise but stabilize at around 30 percent of GDP by 2021. - Contingent liabilities shock: - Assumption: Contingent liabilities from the banking system materialize in 2017. - Scenario tested: A contingent liabilities shock of 30 percent of GDP. - Impact: Debt-to-GDP ratio would increase to 51 percent in 2017, reaching 56 percent by 2021, assuming the same fiscal policy stance as the baselines scenario. - Policy-relevance note: Such debt dynamics may prove not sustainable in a country with untested ability to access external financing. ### Alternative scenarios and underlying assumptions (selected) - Underlying baseline assumptions summarized in DSA tables: - Real GDP growth (baseline projections): 1.0 (2016), 1.2 (2017), 1.3 (2018), 1.3 (2019), 1.3 (2020), 1.3 (2021). - Inflation: 0.6 (2016), 1.1 (2017), 1.6 (2018), 1.3 (2019), 1.4 (2020), 1.4 (2021). - Primary balance (baseline): -0.3 (2016), -0.7 (2017), -0.4 (2018), 0.2 (2019), 0.2 (2020), 0.1 (2021). - Selected alternative scenarios presented include: Historical, Constant Primary Balance, Contingent Liability Shock, Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Shock — with scenario-specific paths for real GDP growth, inflation, primary balance, and effective interest rate as tabulated in the DSA. ### Key takeaways - Under the baseline, public debt stabilizes at around 21 percent of GDP by 2021 with gross financing needs around 9–10 percent of GDP. - Macro-fiscal shocks (single shocks such as a primary balance or interest rate shock) have limited impact on debt sustainability in the projections. - A large contingent liabilities shock (e.g., 30 percent of GDP materializing from the banking system) would dramatically raise debt-to-GDP to levels (51 percent in 2017, 56 percent by 2021) that could be unsustainable given limited proven access to external financing. - Combined macro-fiscal shocks can raise debt-to-GDP notably (approaching 29 percent in 2018 and stabilizing around 30 percent by 2021), underscoring vulnerability to simultaneous adverse developments. *Source: IMF staff. As of December 14, 2016.* ### Annex V. Reserve Adequacy ### Annex V. Reserve Adequacy ### Fiscal reserves: definition, assessment, and key figures - Definition: Fiscal reserves are defined as funds needed to allow spending to continue in the temporary absence of debt financing options. - Rule of thumb: Fiscal reserves should be able to cover at least one month of spending. - San Marino implication: One month of spending would imply about €25 million (1.8 percent of GDP) is needed as fiscal reserves. - Current situation: Government deposits have declined significantly in recent years, and the current level of government deposits is just at one month of spending. - Staff observation/recommendation: - Spending needs are likely to rise when negative shocks hit the economy, suggesting a need for rebuilding fiscal buffers. - The analysis assumes fiscal reserves are captured by government deposits, but government deposits may not necessarily correspond to fiscal reserves as they could also be used as bank backstops. ### Emergency liquidity assistance (ELA) and lender-of-last-resort (LOLR) considerations - First line of defense: Banks’ own liquid assets are the first line of defense against liquidity shocks. - Liquidity ratios and holdings: - Ratio of liquid assets to short-term liabilities: 60 percent. - Banks’ liquid assets cover about 155 percent of nonresident deposits as of August 2016. - Banks hold reserves valued at about €88 million at the CBSM (4 percent reserve requirement). - Institutional constraint: - The CBSM’s ability to provide liquidity assistance is constrained due to euroization. - Currently, there is no legal basis for access to Eurosystem liquidity. - Staff recommendation: - The institutional framework for the LOLR function needs to be improved. - Explore the feasibility to secure access to Eurosystem liquidity for San Marino banks. ### Comparative and contextual points - Liquid assets to short-term liabilities (percent) comparison shown for selected economies includes San Marino, El Salvador, Kosovo, Panama, with San Marino at 60 percent (data source: IMF Financial Soundness Indicators). - Coverage of nonresident deposits: banks’ liquid assets cover about 155 percent of nonresident deposits as of August 2016. - Reserve holdings at CBSM: about €88 million (4 percent reserve requirement). *Source: cr1786 - Annex V. Reserve Adequacy* ### 2017. Moreover, San Marino recently joined the OECD’s new inclusive framework to tackle ### cr1786 - 2017. Moreover, San Marino recently joined the OECD’s new inclusive framework to tackle ### San Marino and BEPS - San Marino recently joined the OECD’s new inclusive framework to tackle Base Erosion and Profit Shifting (BEPS). ### Implementation arrangements - To facilitate the implementation of the BEPS package established in 2016 a multidisciplinary group of authorities. *Source: cr1786 - 2017. Moreover, San Marino recently joined the OECD’s new inclusive framework to tackle* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr1786.pdf_