## 1. The Sammarinese Economy

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### Context and recent dynamics
- San Marino is a euroized microstate enclosed in Italy that experienced a severe recession during 2008–14, contracting by more than a third.
- The economy started to grow in 2015 and rebounded in 2016, but progress in bank balance sheet repair has been limited and financial sector legacy costs have burdened public finances.
- Prolonged weaknesses in the banking system continue to weigh on growth prospects.

### Macroeconomic developments and labor market
- GDP growth:
  - 2016: GDP grew by 2.2 percent.
  - 2017 (preliminary/high-frequency indicators): growth slowed to 1.5 percent.
- Employment and demand:
  - Employment growth decelerated slightly in 2017; manufacturing added most jobs while the financial sector continued to downsize.
  - Recovery in consumption and investment was weak in 2017; the number of enterprises, especially in wholesale and retail, continues to decline.
  - New car registrations stabilized but remain below the pre-crisis level.
- Inflation:
  - Headline inflation volatile from oil and food price swings.
  - Core inflation slowed year-on-year in 2017, suggesting weakening domestic demand pressures.
- External sector and competitiveness:
  - 2016 trade surplus around €460 million (32 percent of GDP).
  - CPI-based RER vis-à-vis Italy remains about 1.5 percent above the 10-year average; CPI-based REER (top five trade partners) remains 1 percent above the 10-year average.
  - Stagnant export market share and weak productivity growth signal competitiveness issues.
- Credit and real sector linkage:
  - Credit to the domestic economy declined further in 2017 as banks deleveraged across sectors, limiting private consumption growth and constraining business financing.
  - Banks deleveraged on both domestic and foreign loan portfolios, each accounting for about a half.

### Structure of the economy
- Public administration accounts for about 15 percent of gross value added.
- Principal production and export pillars:
  - Manufacturing: metal products, machinery, wood products and furniture, textile and leather, food products, and electronics.
  - Services: trade, repair, accommodation, professional, scientific, and technical services, and IT consultancy; advertising, design, tour operators, management services are significant export components.
- Non-tradables: construction, real estate activities, and financial services.

### Liquidity and reserves
- System liquidity fell close to historical lows due to non-resident-led deposit outflows in 2016 and resident outflows in 2017 following Asset Banca transfer and CRSM loss.
- Liquidity pressures eased from autumn 2017 after partial unfreezing of Asset Banca accounts.
- Despite declines, the overall level of reserves in the system appears adequate (Annex III).
- Reserve adequacy metrics:
  - Ratio of liquidity buffers to estimated liquidity needs: 1.9.
  - Liquidity drains estimate: close to €500 million.

### Outlook
- Growth projections:
  - 2018: growth expected at 1.3 percent, driven by domestic demand.
  - Projection assumes a creditless recovery with limited lending capacity due to CRSM recapitalization over 25 years.
  - Planned construction of a shopping mall with external funding expected to significantly boost investment.
- Deleveraging: corporate debt remains high, especially in construction; deleveraging has mainly occurred via loan repayments and bank writedowns and is likely to continue.

---

### Banking sector diagnostics, fragilities, and recent actions
- 2016 AQR findings (Boston Consulting Group):
  - Capital shortfalls of €266 million (19 percent of GDP) in April 2017 (based on domestic regulations).
  - Under international standards, shortfall rises to €486 million (34 percent of GDP).
- Asset Banca and CRSM:
  - Asset Banca intervened by CBSM in May 2017 and merged into Cassa di Risparmio della Repubblica di San Marino (CRSM).
  - CRSM reported a loss of €534 million (37 percent of GDP) for 2016 after an internal audit.
  - Government issued Bank Decree-Law 101 allowing banks to spread losses over up to 30 years and committed to guaranteeing all liabilities of CRSM except equity and to recapitalizing the bank with public money.
  - CRSM booked a loss of €54 million in 2016 under the decree, with the remaining loss to be amortized by the state over 25 years.
- Consequences and governance:
  - Transfer delay of Asset Banca left account holders without access to deposits until November 2017.
  - CBSM management saw significant turnover in 2017; key leadership positions changed multiple times.
- Liquidity developments:
  - Banks deleveraged domestically and externally; system liquidity was strained but eased after partial unfreezing of accounts.

### Banking policy measures issued June–October 2017
- Decree-Laws 72 and 80: reduce deposit guarantee to €50,000 and freeze remaining deposits for three years with 1.5 percent per annum interest; transfer Asset Banca in liquidation to CRSM.
- Decree-Laws 88 and 89: recognize tax credits for losses related to Asset Banca transfer.
- Decree-Law 93: enhance liquidity via state guarantees to facilitate emergency liquidity assistance by CBSM and allow banks to convert accumulated tax credits into government bonds.
- Decree-Laws 94 and 98: secure up to €200 million of state borrowing from pension fund deposits to recapitalize CRSM.
- Decree-Law 101: allow banks to spread losses over up to 30 years.

### Evaluations and concerns (staff assessment)
- Decree-Law 101 and conversion of tax credits into government bonds (Decree-Law 93) are not aligned with incentives to restructure banks; conversion may cost taxpayers up to an estimated about €300 million.
- Modalities of public intervention in CRSM fell short of international best practices: government assumed Asset Banca losses and folded them into CRSM despite potential for burden sharing with subordinated bond holders.
- CRSM recapitalization and loss treatment:
  - CRSM’s €54 million loss for 2016 partly addressed by converting €41.4 million hybrid bonds into equity and €8.5 million capital injection in December 2017, with the balance injected in Q1:2018.
  - Remaining loss (€480 million or 33 percent of GDP) initially planned to be amortized using public money over 25 years.
  - Total bill for CRSM recapitalization could rise to over €700 million (around 50 percent of GDP).
  - Spreading the loss over 25 years will not unlock resources for new lending and leaves CRSM vulnerable to liquidity shocks.
- Authorities are reviewing modalities and opted not to record the loss in the fiscal account until diagnostics and modalities are finalized.
- CBSM initiated an AQR update (external consulting firm) to finalize diagnostics; the 2016 AQR results became outdated due to management turnover.

### Bank-specific restructuring and resolution recommendations (staff)
- AQR update to identify capital shortfalls, followed by recapitalization within a short timeframe.
- Seek market-based solutions; public capital support limited to viable, systemically important banks, following burden sharing.
- Deep restructuring of CRSM to restore long-term viability:
  - Change business model, reduce high operating costs, ensure prudent lending.
  - Recognize additional loss upfront; shareholders and subordinated debt holders should absorb losses before new capital is injected.
  - Return CRSM to private management and ownership; first-best sell to a large foreign bank or establish a bridge bank and outsource management with option to purchase.
  - Liquidate residual assets via a competent NPL manager.
- Managing NPLs:
  - Ambitious, credible plans to significantly reduce NPLs over the medium term, including outsourcing loan collection and workout.
  - Supportive reforms: remove tax disincentives to NPL disposals; enhance insolvency and enforcement regimes.
  - Launch of a domestic credit registry is welcome; harmonization with Italy should be completed.
  - Consider formal asset classification and provisioning framework.

### Governance, oversight, and central bank capacity (staff)
- Preconditions to further use of state resources: improvements in accountability, governance, oversight, and communication.
  - Establish a financial stability committee (FSC) to improve coordination between government and CBSM.
  - Memorandum of understanding between government and CBSM to clarify responsibilities and information exchange.
- Strengthen CBSM and central bank infrastructure:
  - Establish a dedicated bank resolution unit; develop prompt corrective action framework, LOLR facilities, systemic impact assessments, and bank intervention/resolution processes.
  - Improve supervision and regulation: data collection, on-site visits, systemic risk monitoring, publish financial stability report in Italian and English.
  - Implement key suggestions of the 2016 internal audit; review CBSM powers and mandate; centralize supervisory data; create macro-analysis and communication units; adopt highest standards of central bank independence, governance, accountability, and transparency.

---

### Fiscal position, public debt, and DSA findings
- 2016 fiscal outcome:
  - Fiscal deficit contained at ¼ percent of GDP in 2016, driven by higher-than-expected non-tax revenue.
  - Public debt rose to 23 percent of GDP in 2016, reflecting CRSM recapitalization of €40 million in early 2016.
- State aid and contingent liabilities (summary figures reported):
  - Total recapitalization: €801 million; of which state funds €754 million representing 49.3 percent of GDP.
  - Contingent liability (Decree-Law 93 conversion option): 2017–19 contingent liability €119 million; state funds €119 million representing 7.9 percent of GDP.
  - Total including contingent liability: €920 million; state funds €873 million representing 57.3 percent of GDP.
- Public debt projections and DSA highlights:
  - Debt-to-GDP projected to rise to 57 percent in 2017 reflecting fiscal costs of banking sector intervention.
  - Central scenario: public debt projected to jump to 57 percent of GDP in 2017, and gradually come down to around 52 percent by 2022.
  - State bank loss amortization guaranteed: €493 million (34 percent of GDP) over 25 years.
  - Bond maturities: EUR 85 million (December 2023); EUR 50 million (2026).
- Stress test scenarios (impacts reported):
  - Real GDP growth shock (one standard deviation lower during 2018–19): debt-to-GDP increases to around 65 percent.
  - Real interest rate shock (interest rate increases by 300 basis points during 2018–22):
    - If no spillover to CRSM amortization: projected debt-to-GDP around 0.5 percent higher in 2022.
    - If spillover to CRSM amortization: debt-to-GDP will reach 56 percent by 2022.
  - Contingent liability shock (around 20 percent of GDP materializes in 2018): debt-to-GDP around 75 percent.
  - Combined shock (growth, contingent liability, and interest rate): debt-to-GDP jumps to around 90 percent.
- Policy implications from DSA:
  - Achieving a debt level around 50 percent in 2022 would require an annual fiscal adjustment of around 0.8–1.1 percent of GDP relative to the baseline scenario.
  - Public finances and debt trajectory highly sensitive to final banking sector repair costs and contingent liabilities.

### Fiscal policy measures and recommendations
- Revenue measures:
  - Re-introduction of a wealth tax estimated to generate €15 million additional revenue annually.
  - During 2006–09 financial sector contribution to tax revenues roughly €50 million annually; financial sector shrinkage reduced revenues.
  - Authorities aim to introduce a VAT by 2020; expert group to prepare reform with draft law to be discussed at Parliament by mid-2018 and approved by end-2018 (authorities plan transitional period).
- Expenditure and debt management:
  - Contain expenditure and improve quality of spending: modest reduction in the wage bill; spending review; ensure social security is self-financed.
  - Develop debt management capacity: enhance recording, monitoring, and managing higher public debt.
  - Diversify financing options: explore external private placement or syndicated loan.
- Budget adjustments and targets:
  - 2018 budget envisages fiscal adjustment measures including extraordinary tax measures and some current spending cuts; a close to balanced budget for 2018 and declining debt-to-GDP ratio in the medium-term are envisaged but outcomes depend on final bank recapitalization costs.
  - Government aims at cutting current expenditure by 2.5 percent during 2018, but only 0.6 percent has been included in the budget so far; remaining savings planned to be identified in coming months.

### Pension reform and structural reforms
- Pension reform proposals (30 measures under public consultation) include:
  - Part-time retirement mechanism.
  - Automatic adjustment of retirement age to life expectancy.
  - Abolish 20 percent tax exemption on pensions and limit it to pensions less than EUR 3,000.
  - Allow retirees to work and contribute.
  - Reduce redistributive element via cap on social security contributions.
  - Improve pension fund management to increase returns.
- Structural reforms enacted and recommended:
  - Measures approved August–October 2017: partial liberalization of real estate market and introduction of “elective residency” program; “Development Law” to increase labor market flexibility.
  - Further reforms: reduce red tape, ease hiring of non-residents, increase labor market flexibility supported by well-targeted social policy.
  - Create a one-stop-shop to reduce cost of doing business; reforms should improve efficiency and avoid additional fiscal costs.

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### International engagement, AML/CFT, and data
- International engagement and AML/CFT:
  - San Marino signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS in 2017.
  - Recently ratified AML/CFT regulatory update implements the AML/CFT Action plan; authorities plan to publish the National Risk Assessment in Spring 2018.
  - Priorities: bolster risk-based supervision and licensing requirements; develop due diligence for new residency program; continue cooperation with EU and Italy; consider memorandum of understanding with Bank of Italy.
- Data provision and statistics:
  - Priorities: compile balance of payments statistics; revise historical GDP data to reflect methodological change; ensure compliance with international standards.
  - Intersectoral working group for BOP statistics appointed January 2018; BOP data expected by the end of 2018.
  - Migration to SRFs and dissemination in IFS and national publications expected by October 2018.
  - Recommendation: allocate more resources to improve data provision and presentation and expedite compilation of basic data.

---

### Key risks (Risk Assessment Matrix highlights)
- Structurally weak growth in Italy and the Euro area:
  - Likelihood/concern: High; impact: large and direct.
  - Policy response: Let automatic stabilizers operate; postpone fiscal adjustment; reevaluate periodically.
- Tighter global financial conditions:
  - Likelihood/concern: High; impact: Medium.
  - Policy response: Carefully assess alternative options for external financing.
- Rapid increase in fiscal costs related to banking sector repair:
  - Likelihood/concern: High; impact: High.
  - Policy response: Time-bound banking sector strategy; capital shortfalls met primarily by the market.
- Failure to clean up bank balance sheets:
  - Likelihood/concern: Medium; impact: High.
- Significant delay in implementing indirect tax reform:
  - Likelihood/concern: Medium; impact: High.
  - Policy response: Expedite reform proposals; seek technical support.
- Contingent liability shock (around 20 percent of GDP):
  - Impact: debt-to-GDP around 75 percent if materialized in 2018.
- Combined adverse shocks (growth, liability, interest rate):
  - Impact: debt-to-GDP jumps to around 90 percent.

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### Staff appraisal — consolidated recommendations
- Banking sector repair and strategy:
  - Complete AQR update and follow with upfront loss recognition, prompt recapitalization, and NPL resolution.
  - Seek market-based recapitalization solutions; limit public support to viable, systemically important banks with burden sharing.
  - Deeply restructure CRSM aiming for re-privatization and private management; consider sale to a large foreign bank or bridge bank solution; liquidate residual assets via competent NPL manager.
  - Strengthen CBSM and bank oversight; establish bank resolution unit and financial stability committee; improve transparency and accountability.
- Fiscal strategy:
  - Implement sustained fiscal adjustments to ensure debt sustainability while securing pro-growth policies.
  - Increase tax revenues (VAT by 2020, wealth tax), contain and improve quality of spending, develop debt management capacity, and diversify sovereign financing options.
  - Pension reform prioritization could free resources.
- Structural and institutional reforms:
  - Reduce red tape; ease hiring of non-residents; create one-stop-shop and Development Agency; improve insolvency framework to facilitate NPL resolution.
  - Continue AML/CFT improvements and international cooperation; finalize National Risk Assessment and harmonize statistics with international standards.
- Data and consultation:
  - Strengthen data provision (BOP, SRFs, FSIs) and maintain Article IV consultations on a 12-month cycle.

---

### Selected exact figures and projections (selected)
- GDP per capita (2015): 46,185 U.S. dollars
- Population (2016): 34,267 persons
- Real GDP (percent change):
  - 2014: -0.9
  - 2015: 0.6
  - 2016: 2.2
  - 2017: 1.5
  - 2018: 1.3
  - 2019: 1.3
  - 2020: 1.3
- Unemployment rate (average; percent):
  - 2014: 8.7
  - 2015: 9.2
  - 2016: 8.6
  - 2017: 8.0
  - 2018: 7.4
  - 2019: 6.8
  - 2020: 6.8
- Inflation rate (average; percent):
  - 2014: 1.1
  - 2015: 0.2
  - 2016: 0.6
  - 2017: 0.9
  - 2018: 1.0
  - 2019: 1.1
  - 2020: 1.2
- Nominal GDP (millions of euros):
  - 2014: 1348.0
  - 2015: 1373.3
  - 2016: 1414.2
  - 2017: 1449.0
  - 2018: 1490.6
  - 2019: 1529.4
  - 2020: 1571.6
- Public finances (percent of GDP) highlights:
  - Revenues (2014–2020): 23.2, 21.4, 21.8, 21.1, 21.8, 21.2, 20.7
  - Expenditure (2014–2020): 22.4, 21.7, 22.1, 21.4, 22.1, 21.5, 20.1
  - Overall balance (2014–2020): 0.8, -0.3, -0.3, -0.3, -0.3, -0.2, 0.6
  - Government debt (percent of GDP) (2014–2020): 19.6, 20.3, 22.5, 56.6, 55.5, 54.6, 52.8
- Banking system indicators (selected):
  - Regulatory capital to risk-weighted assets: 11.4 (2014), 12.7 (2015), 13.6 (2016)
  - Bad loans to total loans: 16.1 (2014), 18.5 (2015), 18.7 (2016)
  - Loan loss provision to total loans: 30.3 (2014), 28.6 (2015), 26.6 (2016)
  - Return on equity (ROE): -21.4 (2014), -9.0 (2015), -10.5 (2016)
  - Liquid assets to total assets: 32.4 (2014), 29.8 (2015), 29.5 (2016)
- Banking system assets (millions of euros) and percent of GDP:
  - 2014: 9,447.2 (555.5 percent of GDP)
  - 2015: 8,090.9 (500.9 percent of GDP)
  - 2016: 6,721.2 (454.9 percent of GDP)
  - 2017: 6,569.8 (468.8 percent of GDP)

*Source: IMF staff report — "1. The Sammarinese Economy".*

### 1. The Sammarinese Economy _____________________________________________________________________5

### 1. The Sammarinese Economy

### Context: pressing need for lasting solutions
- San Marino is a euroized microstate enclosed in Italy that experienced a severe recession during 2008–14, contracting by more than a third, triggered by shocks that imploded a financial sector built upon bank secrecy and tax haven status.
- The economy started to grow in 2015 and rebounded in 2016, but progress in bank balance sheet repair has been limited and financial sector legacy costs have burdened public finances.
- Prolonged weaknesses in the banking system continue to weigh on growth prospects.

### Macroeconomic developments and labor market
- GDP growth:
  - 2016: GDP grew by 2.2 percent, supported by domestic demand; both consumption and investment contributed positively.
  - 2017 (preliminary/high-frequency indicators): growth slowed to 1.5 percent.
- Employment:
  - Employment growth decelerated slightly in 2017, partly due to a slowdown in retail trade; manufacturing added most jobs while the financial sector continued to downsize.
- Consumption and investment:
  - Recovery in consumption and investment has been weak in 2017; the number of enterprises, especially in wholesale and retail, continues to decline.
  - New car registrations stabilized but remain below the pre-crisis level.
- Inflation:
  - Headline inflation has been volatile from oil and food price swings.
  - Core inflation slowed year-on-year in 2017, suggesting weakening domestic demand pressures.

### Structure of the economy (Box 1)
- Public administration accounts for about 15 percent of gross value added.
- Principal production and export pillars:
  - Manufacturing: diversified across metal products, machinery, wood products and furniture, textile and leather, food products, and electronics.
  - Services: trade, repair, accommodation, professional, scientific, and technical services, and IT consultancy; many of these services are significant export components (advertising, design, tour operators, management services).
- Non-tradables: construction, real estate activities, and financial services.

### Credit and real sector linkage
- Credit to the domestic economy declined further in 2017, slowing real sector activity as banks deleveraged across sectors, limiting private consumption growth and constraining business financing.
- Banks have deleveraged on both domestic and foreign loan portfolios, each accounting for about a half, mitigating some impact on the economy.

### Banking system developments and fragilities
- Asset Quality Review (AQR) by Boston Consulting Group in late 2016 identified capital shortfalls of €266 million (19 percent of GDP) in April 2017 (based on domestic regulations).
  - Under international standards, the amount rises to €486 million (34 percent of GDP) due to differences in provisioning and capital requirement rules.
- Asset Banca was intervened by the Central Bank of San Marino (CBSM) in May 2017 and later merged into Cassa di Risparmio della Repubblica di San Marino (CRSM).
- CRSM reported a loss of €534 million (37 percent of GDP) for 2016 after a stricter internal audit; the government issued Bank Decree-Law 101 allowing banks to spread losses over up to 30 years and committed to guaranteeing all liabilities of CRSM except equity and to recapitalizing the bank with public money.
  - CRSM booked a loss of €54 million in 2016 under the decree, with the remaining loss to be amortized by the state over 25 years.
- Consequences:
  - Transfer delay of Asset Banca left account holders without access to deposits until November 2017.
  - CBSM management saw significant turnover in 2017: the director general was dismissed in August; the CBSM president resigned end-October; new director generals appointed in October, November (resigned), and nominated in December; the President position remained vacant.

### Liquidity and reserves
- System liquidity fell close to historical lows due to non-resident-led deposit outflows in 2016 (voluntary disclosure for Italian depositors) and resident outflows in 2017 following Asset Banca transfer and CRSM loss.
- Liquidity pressures eased from autumn 2017 after partial unfreezing of Asset Banca accounts.
- Despite declines, the overall level of reserves in the system appears adequate (Annex III).

### External sector and competitiveness (Box 2)
- Trade surplus:
  - 2016: trade surplus around €460 million (32 percent of GDP).
  - Exports and imports grew around 4 percent in 2016; more recent data point to some slowdown.
- Real exchange rates:
  - CPI-based RER vis-à-vis Italy depreciated marginally from the 2016 peak but remains about 1.5 percent above the 10-year average.
  - CPI-based REER (top five trade partners) remains 1 percent above the 10-year historical average.
- Competitiveness challenges:
  - Stagnant export market share and weak productivity growth signal competitiveness issues.
  - Export market share remains small compared to European peers and below pre-global financial crisis levels.
- Doing Business:
  - World Bank Doing Business ranking fell from 79 to 93 out of 190 countries (2018).
  - Main challenges relative to peers: “getting credit”, “protecting minority investors”, and “resolving insolvency”; “paying tax” ranking declined from the previous year.

### Fiscal position and public debt
- 2016 fiscal outcome:
  - Fiscal deficit contained at ¼ percent of GDP in 2016, driven by higher-than-expected non-tax revenue.
  - Public debt rose to 23 percent of GDP in 2016, reflecting CRSM recapitalization of €40 million in early 2016.
- Public support for banking sector increased debt and contingent liabilities related to banking sector repair could significantly affect fiscal outcomes.

### Outlook and risks
- Growth projections:
  - 2018: growth expected at 1.3 percent, driven by domestic demand.
  - Projection assumes a creditless recovery, with limited lending capacity due to CRSM recapitalization over 25 years.
  - Planned construction of a shopping mall with external funding expected to significantly boost investment.
- Deleveraging:
  - Corporate debt remains high, especially in construction; deleveraging has mainly occurred via loan repayments and bank writedowns and is likely to continue.
- Downside risks (Annex I):
  - Incomplete banking sector reforms or failure to properly restructure CRSM could further impair credit provision and necessitate additional recapitalization.
  - Rapid increases in fiscal costs from banking sector repair, including conversion of tax credits into government bonds, could pressure public finances.
  - Tighter global financial conditions or euro appreciation could raise borrowing costs and undermine external competitiveness.
- Authorities’ view:
  - Authorities broadly concur with the staff’s assessment but are more optimistic about 2018 growth due to important investments and increased capital spending in the 2018 budget; a luxury shopping mall project is expected to be operational by 2019.

### Policy discussion: time for action
- Priorities:
  - Maintain financial stability and restore banking sector soundness.
  - Public support for banks must be paired with improved accountability and oversight.
  - Fiscal adjustments are planned but public debt prospects depend on the final fiscal costs of banking system repair.
  - Structural reforms, including reducing red tape, are needed to support medium-term growth and reorganize the economy.

### Financial sector policy measures and assessment
- Decree-Laws issued June–October 2017:
  - Decree-Laws 72 and 80: address Asset Banca by reducing deposit guarantee to €50,000 and freezing remaining deposits for three years with 1.5 percent per annum interest; transfer Asset Banca in liquidation to CRSM with recognition of tax credits for losses (Decree-Laws 88 and 89).
  - Decree-Law 93: enhance liquidity via state guarantees to facilitate emergency liquidity assistance by CBSM and allow banks to convert accumulated tax credits into government bonds.
  - Decree-Laws 94 and 98: secure up to €200 million of state borrowing from pension fund deposits to recapitalize CRSM.
  - Decree-Law 101: allow banks to spread losses over up to 30 years.
- Evaluations and concerns:
  - Decree-Law 101 and conversion of tax credits into government bonds (Decree-Law 93) are not aligned with incentives to restructure banks; conversion may cost taxpayers up to an estimated about €300 million.
  - Modalities of public intervention in CRSM fell short of international best practices: government assumed Asset Banca losses and folded them into CRSM despite potential for burden sharing with subordinated bond holders.
  - CRSM recapitalization and loss treatment:
    - CRSM’s €54 million loss booked for 2016 was partly addressed by converting €41.4 million hybrid bonds into equity and €8.5 million capital injection in December 2017, with the balance injected in Q1:2018.
    - Remaining loss (€480 million or 33 percent of GDP) initially planned to be amortized using public money over 25 years.
    - Total bill for CRSM recapitalization could rise to over €700 million (around 50 percent of GDP) while shareholders would not be fully wiped out—this is not the most cost-effective solution and facilitates moral hazard.
    - Spreading the loss over 25 years will not unlock resources for new lending and leaves CRSM vulnerable to liquidity shocks because a large share of assets remains illiquid.
  - Authorities are reviewing modalities and opted not to record the loss in the fiscal account until diagnostics and modalities are finalized.
  - Authorities are considering purchasing CRSM subordinated debt held by the pension fund (€35 million) and remaining shares from one private shareholder (about €3 million).

### State aid and contingent liabilities (table summary)
- Recapitalization and contingent liability figures (as presented):
  - 2012: Recapitalization €80 million; state funds €60.4 million.
  - 2013: Recapitalization €40 million; state funds €52.5 million.
  - 2014: Recapitalization €85 million; state funds €56.1 million.
  - 2016: Recapitalization €24 million; state funds €2.8 million.
  - 2017 (planned): Recapitalization €54 million; state funds €43.7 million (hybrid bonds conversion and capital injection of €8.5 million out of €13 million took place in 2017).
  - 2018–42 (planned): Loss amortization €480 million; of which state funds €480 million representing 30.0 percent of GDP.
  - Total recapitalization: €801 million; of which state funds €754 million representing 49.3 percent of GDP.
  - Contingent liability (Decree-Law 93 conversion option): 2017–19 contingent liability €119 million; state funds €119 million representing 7.9 percent of GDP.
  - Total including contingent liability: €920 million; state funds €873 million representing 57.3 percent of GDP.

*Source: IMF staff report — "1. The Sammarinese Economy".*

### 15.      The CBSM initiated the process of updating the AQR to finalize the diagnostics of bank

### cr18101 - 15.      The CBSM initiated the process of updating the AQR to finalize the diagnostics of bank

### Banking sector diagnostics and immediate actions
- The CBSM initiated the process of updating the AQR to finalize the diagnostics of bank capital shortfalls.
- The post AQR process was significantly delayed due to turnover of central bank management and the original AQR results using data from mid-2016 became outdated.
- The AQR update will be conducted by an external consulting firm.
- A medium size bank, comprising about 10 percent of banking system assets, is in the process of being sold to a foreign investor from Saudi Arabia.
- Key elements needed to restore confidence and soundness:
  - Upfront loss recognition, prompt bank recapitalization, and NPL resolution.
  - Measures to improve transparency and accountability, and enhance financial sector infrastructure.
  - Strengthen bank governance, including risk management, and subjecting new and existing management to rigorous fit and proper tests.

### Bank-specific restructuring and resolution recommendations
- Bank balance sheet repair:
  - An AQR update is necessary to identify and address capital shortfalls, followed by recapitalization within a short timeframe.
  - Market-based solutions should be sought; public capital support should be limited to only viable, systemically important banks, following burden sharing.
- Deep restructuring of CRSM:
  - CRSM needs restructured to quickly restore long-term viability by changing its business model, reducing high operating costs, and ensuring prudent lending.
  - State aid provided during 2012–16 amounts to €220 million (about 16 percent of GDP) and will increase further due to a very large additional loss now being reported.
  - The additional loss needs to be recognized upfront; current shareholders and subordinated debt holders should absorb the loss before new capital is injected.
  - CRSM recapitalization and restructuring should aim to return the bank to private management and ownership to ensure sound governance and robust credit risk management.
  - First-best: sell the new CRSM to a large foreign bank; alternative: establish a bridge bank and outsource management to a large foreign bank with an option to purchase in the medium-term.
  - Residual assets arising from CRSM restructuring should be liquidated by a competent NPL manager.
- Managing NPLs:
  - Banks should be subject to ambitious and credible plans aimed at significantly reducing NPLs over the medium term, including through outsourcing loan collection and workout.
  - Supportive reforms: remove tax disincentives to NPL disposals; enhance insolvency and enforcement regimes.
  - Launch of a domestic credit registry is a welcome step; harmonization to facilitate information exchange with Italy should be completed.
  - Partial opening of the real estate market to nonresidents will help support collateral values during asset recovery.
  - Consider a formal asset classification and provisioning framework to ensure banks have adequate capital in the future to tackle NPLs.

### Governance, oversight, and central bank capacity
- Improvements in accountability, governance, oversight and communication should be prerequisites to further use of state resources for the banking system.
  - Establish a financial stability committee to improve coordination between the government and the central bank, clarify responsibilities, and improve communication and decision making.
  - A memorandum of understanding between the government and the central bank would help clarify responsibilities and a protocol for information exchange.
  - The recently established financial stability task force (government, central bank, and banks) is helpful to facilitate dialogue.
- Strengthening CBSM and central bank infrastructure:
  - Crisis response capability: establish a dedicated bank resolution unit to develop policies and processes for vulnerable banks, including prompt corrective action framework, lender of last resort facilities, systemic impact assessments, bank viability assessments, and bank intervention, resolution, and liquidation.
  - Supervision and regulation: improve data collection and oversight of bank lending standards during regular on-site visits; develop capacity to monitor systemic risks; publish a concise, well-targeted financial stability report in Italian and English.
  - Central bank reform: implement key suggestions of the 2016 internal audit of CBSM functions and structure; review CBSM powers and mandate; separate non-core activities; simplify supervision into off-site and on-site units; centralize supervisory data; unify legal and regulatory activities; create macro-analysis and communication units; adopt highest standards of central bank independence, governance, accountability and transparency as identified by the Bank of International Settlement.

### Authorities' views on banking sector
- Authorities agreed permanent solutions to banking sector vulnerabilities are needed and that drafting a financial sector strategy and establishing a decision-making financial sector committee will be key.
- The CBSM launched an AQR update to serve as a base for finding sustainable solutions for banks with shortcomings.
- The government, as main shareholder of CRSM, is aware of the need to recognize losses, recapitalize CRSM, and take steps to ensure independent commercial decisions and restructuring to bring the bank to profitability.
- Plans are under way to support a system-wide NPLs cleanup and information exchange with the Bank of Italy.
- Authorities recognized the need to reorganize the CBSM to enhance banking supervision, using findings from the CBSM internal audit.

### Fiscal implications and public debt projections
- Public finances have been managed to limit the deficit in recent years, but public debt is bound to rise further due to bank recapitalization costs.
- State’s assumption of the currently reported amount of CRSM legacy loss implies a substantial rise in public debt to 57 percent of GDP.
- If contingent liabilities from conversion of tax credits into government bonds materialize, public debt could rise even further.
- Adjustments in the 2017 revised budget included cancelling non-mandatory expenditure and strengthening tax collection efforts; planned capital spending of €10 million for 2017 was cancelled.
- The 2018 budget envisages fiscal adjustment measures, including extraordinary tax measures and some current spending cuts; these adjustments imply a close to balanced budget for 2018 and declining debt-to-GDP ratio in the medium-term—but outcomes depend on final costs of bank recapitalization clarified by the ongoing AQR update.
- Specific budget numeric notes:
  - The government aims at cutting current expenditure by 2.5 percent during 2018, but only 0.6 percent has been included in the budget so far. The remaining savings are planned to be identified in coming months.
- Selected table extracts and staff estimates (as presented):
  - CRSM capital injection 131
  - CRSM legacy loss48030
  - Subtotal49331
  - Contingent liability (estimate) from Bank Decree-Law 9330020
  - Total79351
  - Note: "This is based on currently available information and staff estimate. Total final costs are highly uncertain."

### Public Debt Dynamics and fiscal strategy
- Box 3 summary:
  - Based on the government’s current commitment to recapitalize CRSM with public money, San Marino’s public debt is projected to rise to more than 50 percent of GDP in 2017.
  - Targeting a debt level around 50 percent in 2022 would be manageable; projected interest payment would rise to around 4 percent of revenue from the current low level of 1.4 percent.
  - Achieving debt and deposit targets by 2022 will require an annual fiscal adjustment of around 0.8–1.1 percent of GDP relative to the baseline scenario.
  - If contingent liability of converting tax credits into bonds materializes, or if fiscal costs of banking sector repair are higher, more ambitious fiscal adjustments may be necessary.
  - Analysis assumes no impact on the GDP path of fiscal consolidation; a higher negative impact on growth would increase required consolidation.

### Fiscal policy measures and recommendations
- Revenue and expenditure measures:
  - Increasing tax revenues: San Marino lost significant revenue from the financial sector since the global financial crisis as banking system assets shrank significantly.
    - During 2006–09, financial sector contribution to tax revenues was roughly €50 million annually.
    - The wealth tax is estimated to generate €15 million additional revenue annually.
  - Re-introduction of a wealth tax and other planned tax measures should be complemented with permanent measures to mobilize revenues.
  - Authorities aim to introduce a VAT by 2020; an expert group has been appointed to prepare a specific reform proposal with a draft law to be discussed at Parliament by mid-2018 and approved by the end of the year.
  - Containing expenditure and improving quality of spending: explore modest reduction in the wage bill; spending review to identify further savings; ensure social security is self-financed.
  - Developing debt management capacity: enhance recording, monitoring, and managing higher public debt.
  - Diversifying financing options: establish access to external financing for the sovereign, including exploring external private placement or syndicated loan.

### Pension reform and structural reforms
- New pension reform proposals:
  - 30 potential measures under public consultation, including lowering the replacement rate and improving pension fund management to increase returns.
  - Selected pension reform proposals include: part-time retirement mechanism, automatic adjustment of retirement age to life expectancy, abolish 20 percent tax exemption on pensions and limit it to pensions less than EUR 3,000, allow retirees to work and contribute, reduce redistributive element via cap on social security contributions, allow reduced contributions to redundancy fund with no benefits eligibility, reduce social security contributions for new entrants, tighten requirements for "seniority pension", ensure intergenerational equity by lowering replacement rate of older generations, and improve pension fund management to increase returns.
- Structural reforms enacted and recommended:
  - Measures approved August–October 2017: partial liberalization of the real estate market and introduction of “elective residency” program; and the “Development Law” to increase labor market flexibility and support economic development.
  - Further reforms to reduce red tape, ease hiring of non-residents, increase labor market flexibility supported by well-targeted social policy (means-tested benefits linked to training and job search).
  - Create a one-stop-shop to reduce cost of doing business; reforms should improve efficiency and avoid additional fiscal costs.

*REPUBLIC OF SAN MARINO — INTERNATIONAL MONETARY FUND.*

### 27.      San Marino’s continued effort to engage with the international community, strengthen

### 27.      San Marino’s continued effort to engage with the international community, strengthen further the AML/CFT framework, and enhance transparency is crucial.

### International engagement, AML/CFT, and transparency
- San Marino signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS) in 2017, which transposes BEPS principles into existing bilateral tax treaties.
- The recently ratified AML/CFT regulatory update implements the AML/CFT Action plan; the authorities are planning to publish the National Risk Assessment in Spring 2018.
- Priorities to improve AML/CFT effectiveness:
  - Bolster risk based supervision and licensing requirements for banks based on robust fit and proper tests.
  - Develop a framework for due diligence for the new residency program to safeguard financial integrity.
  - Continue to build cooperation across Europe and beyond, including continued negotiations with the European Union (EU) on an association agreement.
  - Further cooperation with Italy, including establishing a memorandum of understanding with the Bank of Italy, to help strengthen institutional capacity.

### Data provision and statistics
- Data provision needs to be strengthened to enhance transparency and inform investors, businesses, and policy makers.
- Priorities include:
  - Compilation of balance of payments (BOP) statistics.
  - Revising historical GDP data to reflect the recent methodological change.
  - Ensuring compliance with international standards in existing statistics.
- A clear timeline for key milestones is needed.
- Recommendation: Allocate more resources to improve data provision and presentation and expedite compilation of basic data in priority areas.

### Parliament Approval Measures (selected)
- Partial opening of the domestic real estate market to non-residents up to 100 units.
- "Elective Residency" program grants a registered residency status to non-residents for purchasing a real estate worth at least €500,000 or depositing €600,000 in a non-interest bearing Sovereign Fund for 10 years.
- Labor and hiring measures:
  - Allow companies to directly hire non-resident workers by paying 4.5 percent of gross wage for the hiring positions.
  - Allow to grant open-ended contracts to non-resident workers after 18 months of fixed-term contracts.
  - Simplify rules for apprenticeship program application by automatically approving apprenticeship when companies request.
  - Provide subsidies through the Social Shock Absorber Fund to companies up to 48 months for recruiting and keeping the hired workers in the job-start lists.
- Investment for Residency scheme easing:
  - Reduce the minimum investment requirements to €75,000 annually and €150,000 over two years.
  - Minimum local hiring to 1 or 3 employees, depending on sectors.
- Source dates noted: August 2017; October 2017, "Development Law".

### Authorities’ views
- Continue to pursue a new business model built on transparency and openness to attract foreign investment.
- Reorganization of government agencies to create a Development Agency and a one-stop shop for companies to reduce red tape.
- Working to amend remaining preferential tax practices to meet BEPS standards.
- Committed to internationalization, including continued negotiations with the EU on the association agreement.
- Acknowledge importance of improving data provision and harmonization; will continue compilation of BOP statistics.

### Staff appraisal — key findings and recommendations
- Recent growth and banking sector context:
  - The economy rebounded in 2016, but momentum is slowing amid increased banking sector uncertainties in 2017.
  - Growth in 2016 was supported by the general recovery in Europe; decelerating employment growth suggests slower growth in 2017.
  - Banking sector deleveraging continues; credit to the domestic economy declined further in 2017.
  - Only moderate growth is expected in the near-and medium-term, partly due to lacking support from the deleveraging banking sector.
  - External position is moderately weaker than fundamentals and desired policy, highlighting need for policy adjustments.

- Banking sector repair and strategy:
  - Reform agenda is demanding and requires strong commitments of all stakeholders.
  - Recent efforts to identify problems, including completing the AQR, are welcome and should be followed by decisive actions guided by a coherent banking sector strategy.
  - Maintain financial stability and restore banking sector soundness via:
    - Upfront loss recognition, prompt bank recapitalization, and NPL resolution.
    - Seek market-based solutions for bank recapitalization; public capital support should be limited to only viable, systemically important banks, following burden sharing.
    - Banks should have ambitious and credible plans to significantly reduce NPLs over the medium-term; regulatory, tax and legal reforms are needed to facilitate NPL disposals.
    - Strengthen central bank functions and bank oversight, including crisis management capability, improved regulation and supervision, and adopting highest standards of central bank independence, governance, accountability, and transparency.

- CRSM (a state-related bank) recommendations:
  - CRSM needs deep restructuring to return to viability.
  - Restructuring likely requires changing its business model, reducing high operating costs, and ensuring prudent lending.
  - Re-privatization of the bank should be a priority.
  - Consider outsourcing some management functions, including to large foreign banks, to promote a sound business model.

- Public support, accountability, and coordination:
  - Public support of the banking sector needs to come with improvements in accountability and oversight.
  - Establish a financial stability committee (FSC) to improve coordination between the government and the central bank, especially for communication.
  - A memorandum of understanding between the government and the central bank would help clarify responsibilities and a protocol for information exchange.

- Fiscal strategy and debt sustainability:
  - A fiscal strategy is needed to ensure debt sustainability while securing resources for pro-growth, pro-employment policies.
  - Public intervention in the banking sector has created new debt management challenges.
  - The 2018 budget envisages fiscal adjustments, but the budget and level of public debt are highly uncertain and depend on final costs of bank recapitalization borne by the state.
  - Fiscal strategy should include sustained fiscal measures, including increasing tax revenues through a reform of indirect taxation and containing spending and improving its quality.
  - Pension reform could help free resources for other priority areas; the current proposal is complex and needs prioritization.
  - Develop debt management capacity and establish access to external financing for the sovereign to enhance ability to respond to shocks.

- Structural reforms and labor market:
  - Further structural reform will help diversify the economy.
  - Increased labor market flexibility will help with skills shortages but should be supported by a well-targeted social policy to help unemployed workers maintain skills and continue job search.
  - Ease costs of doing business by simplifying bureaucracy, aimed at improving efficiency while avoiding distortions and additional fiscal costs.

- Continued international cooperation and AML/CFT:
  - Continue efforts to enhance international cooperation, strengthen the AML/CFT framework and improve transparency.
  - Improve AML/CFT measures commensurate with the ML/TF risks, including strengthening AML/CFT risk-based supervision of banks and licensing requirements.
  - Develop due diligence framework for newly introduced residency programs.
  - Further cooperation with Italy and continued negotiations with the EU on an association agreement remain important.

- Data provision:
  - Data provision remains weak and needs strengthening.
  - More resources and emphasis should be devoted to strengthening data provision and presentation; lack of data can inhibit foreign investors.
  - The recently initiated work to compile BOP statistics is a welcome step; progress should also be made to ensure compliance with international standards in existing statistics.

- Consultation cycle recommendation:
  - It is recommended that the next Article IV consultations with the Republic of San Marino be held on the standard 12-month cycle.

### Key statistics and projections (selected exact figures)
- 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) by year:
  - 2014: -0.9
  - 2015: 0.6
  - 2016: 2.2
  - 2017: 1.5
  - 2018: 1.3
  - 2019: 1.3
  - 2020: 1.3
- Domestic demand (contribution / percent change shown in Table 1 and Table 3):
  - 2014: -4.3 (activity line), contribution to GDP -3.4
  - 2015: -3.6 (activity line), contribution to GDP -2.8
  - 2016: 4.0 (activity line), contribution to GDP 2.9
- Unemployment rate (average; percent):
  - 2014: 8.7
  - 2015: 9.2
  - 2016: 8.6
  - 2017: 8.0
  - 2018: 7.4
  - 2019: 6.8
  - 2020: 6.8
- Inflation rate (average; percent):
  - 2014: 1.1
  - 2015: 0.2
  - 2016: 0.6
  - 2017: 0.9
  - 2018: 1.0
  - 2019: 1.1
  - 2020: 1.2
- Nominal GDP (millions of euros):
  - 2014: 1348.0
  - 2015: 1373.3
  - 2016: 1414.2
  - 2017: 1449.0
  - 2018: 1490.6
  - 2019: 1529.4
  - 2020: 1571.6
- Public finances (percent of GDP) highlights:
  - Revenues (2014–2020): 23.2, 21.4, 21.8, 21.1, 21.8, 21.2, 20.7
  - Expenditure (2014–2020): 22.4, 21.7, 22.1, 21.4, 22.1, 21.5, 20.1
  - Overall balance (2014–2020): 0.8, -0.3, -0.3, -0.3, -0.3, -0.2, 0.6
  - Government debt (percent of GDP) (2014–2020): 19.6, 20.3, 22.5, 56.6, 55.5, 54.6, 52.8
- Banking system indicators (selected, latest available where noted):
  - Regulatory capital to risk-weighted assets: 11.4 (2014), 12.7 (2015), 13.6 (2016)
  - Bad loans to total loans: 16.1 (2014), 18.5 (2015), 18.7 (2016)
  - Loan loss provision to total loans: 30.3 (2014), 28.6 (2015), 26.6 (2016)
  - Return on equity (ROE): -21.4 (2014), -9.0 (2015), -10.5 (2016)
  - Liquid assets to total assets: 32.4 (2014), 29.8 (2015), 29.5 (2016)
  - Liquid assets to short-term liabilities: 65.4 (2014), 58.9 (2015), 59.1 (2016)
- Banking system assets (millions of euros) and percent of GDP:
  - 2014: 9,447.2 (555.5 percent of GDP)
  - 2015: 8,090.9 (500.9 percent of GDP)
  - 2016: 6,721.2 (454.9 percent of GDP)
  - 2017: 6,569.8 (468.8 percent of GDP)
  - Projections for 2018–2023 shown in Table 3.

*Source: IMF staff report text and tables as provided.*

### Annex I. Risk Assessment Matrix

### cr18101 - Annex I. Risk Assessment Matrix

### Risk Assessment Matrix — Major Risks, Impacts, and Policy Responses
- Structurally weak growth in Italy and the Euro area
  - Likelihood/concern: High
  - Impact if realized: Given extensive financial and real links with Italy and advanced Europe, the impact on the Sammarinese economy would be large and direct.
  - Policy response:
    - Let automatic stabilizers fully operate.
    - Postpone fiscal adjustment; reevaluate periodically.

- Tighter global financial conditions
  - Likelihood/concern: High
  - Impact if realized: Medium — could result in possibly higher costs of borrowing in the short-term if the sovereign seek external financing.
  - Policy response:
    - Carefully assess alternative options in seeking external financing.

- Rapid increase in fiscal costs related to banking sector repair, including further need for bank recapitalization
  - Likelihood/concern: High
  - Impact if realized: High — fiscal costs of banking sector clean-up could rise fast, leading to much higher government debt, undermining fiscal sustainability.
  - Policy response:
    - Banking sector strategy needs to be time-bound.
    - Capital shortfalls should be met primarily by the market to minimize the cost to the public.

- Failure to clean up bank balance sheets, leading to a loss of confidence in the system
  - Likelihood/concern: Medium
  - Impact if realized: High — a loss of confidence would likely lead to large public recapitalization needs and would have significant growth and fiscal implications.

- Significant delay in implementing indirect tax reform
  - Likelihood/concern: Medium
  - Impact if realized: High — continued low levels of revenue will inhibit rebuilding fiscal buffers and implementing pro-growth policies.
  - Policy response:
    - Expedite preparing reform proposals.
    - Seek technical support as needed.

- Inclusion in Italy’s tax whitelist
  - Likelihood/concern: Medium
  - Impact if realized: Medium — higher medium-term growth from inclusion; industrial and service sectors could bounce back, boosting growth, tax revenue, and banks’ margins.
  - Policy response:
    - Stick to reform plans despite upside.

- Loss of cross-border or domestic electronic payment services
  - Likelihood/concern: Low
  - Impact if realized: Medium — disruption of retail and wholesale electronic payment services leads to an abrupt adjustment in consumption and trade; a sudden shift to cash may cause short-term currency shortages.
  - Policy response:
    - A domestic electronic payment services provider has been licensed to put in place the required infrastructure, and the authorities continue to work on mitigating the risk.

- Tensions with neighboring Italy resurface
  - Likelihood/concern: Low
  - Impact if realized: High — persistent tensions would dissuade Italian corporates and banks from doing business with San Marino, thus affecting growth.
  - Policy response:
    - Enhance focus on international relations.
    - Start the credit register on schedule.
    - Continue to work towards early adoption of OECD initiative for exchange of tax information.

*Italic note: The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path. The relative likelihood of risks listed is staff’s subjective assessment as of the time of discussion with the authorities.*

---

### Annex II — Debt Sustainability Analysis (Key Findings and Scenarios)
- Summary headline projections and context
  - The debt-to-GDP ratio is projected to rise to 57 percent in 2017, reflecting fiscal costs of banking sector intervention.
  - The debt ratio is expected to edge down over time, but slower growth and/or a contingent liability shock could push the debt-to-GDP ratio above 70 percent.
  - Baseline real GDP growth: reaching at 1.3 percent in the medium term.
  - Overall balance: projected to improve towards 0.6 percent of GDP in 2020 before it deteriorates to -0.6 percent as temporary measures are phased out.
  - Primary balance: remains in surplus during the projection period.
  - The government guaranteed amortization of the state bank’s €493 million loss (34 percent of GDP) over 25 years.
  - In the central scenario, public debt is projected to jump to 57 percent of GDP in 2017, and gradually come down to around 52 percent by 2022.
  - Gross financing needs: expected to stay low given most debt is assumed to be structured as a bullet bond which falls due after the projection period; existing bonds only begin to mature after the end of the projection period.
  - Bond maturities noted: A bond of EUR 85 million falls due in December 2023, and two others of a total of EUR 50 million fall due in 2026.

- Stress test scenarios and impacts
  - Real GDP growth shock
    - Assumption: Real GDP growth is one standard deviation lower than the baseline during 2018–19.
    - Impact: Debt-to-GDP ratio increases to around 65 percent.
  - Real interest rate shock
    - Assumption: Interest rate increases by 300 basis points during 2018–22.
    - Impact: 
      - If these higher interest rates do not spillover to the amortization of the CRSM loss, the projected debt-to-GDP is around 0.5 percent higher in 2022.
      - If the higher interest rate spillover to the amortization of the CRSM loss, the debt-to-GDP ratio will reach 56 percent by 2022.
  - Real exchange rate shock
    - Assumption: Real exchange rate depreciates by 13 percent in 2018.
    - Impact: Delivers only a marginally higher debt trajectory.
  - Primary balance shock
    - Assumption: Primary balance widens by an accumulated 1.7 percent of GDP during the projection period.
    - Impact: Would lift the projected debt-to-GDP path by approximately 2 percentage points vis-à-vis the baseline.
  - Contingent liability shock
    - Assumption: Contingent liabilities of around 20 percent of GDP from the banking system materialize in 2018.
    - Impact: Would push the debt-to-GDP ratio up to a level around 75 percent.
  - Combined shock
    - Assumption: Real GDP growth, contingent liability, and real interest rate shocks all materialize simultaneously.
    - Impact: Debt-to-GDP ratio jumps to around 90 percent.

- Selected baseline quantitative points (as reported)
  - Debt-to-GDP: 57 percent in 2017; around 52 percent by 2022.
  - State bank loss amortization guaranteed: €493 million (34 percent of GDP) over 25 years.
  - Bond maturities: EUR 85 million (December 2023); EUR 50 million (2026).

- Key modeling and methodological notes
  - Public sector defined as central government.
  - Effective interest rate defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.
  - Automatic debt dynamics and contributions described by formal expression (see source definitions).

---

### San Marino Public DSA — Stress Test Summaries (Illustrative Assumption Sets)
- Baseline assumptions (examples reported)
  - Real GDP growth: 1.5 / 1.3 / 1.3 / 1.3 / 1.3 / 1.3 (2017–2022)
  - Inflation (GDP deflator): 0.9 / 1.6 / 1.3 / 1.4 / 1.4 / 1.4 (2017–2022)
  - Primary balance (baseline): 0.1 / 0.6 / 0.6 / 1.4 / 0.2 / 0.2 (2017–2022)
  - Effective interest rate (baseline): 1.4 / 1.5 / 1.6 / 1.6 / 1.6 / 1.6 (2017–2022)

- Representative alternative scenarios reported
  - Constant Primary Balance scenario: Primary Balance at 0.1 across projection years.
  - Contingent Liability shock: Primary Balance path includes a -22.6 in a shock year (reported in scenario table).
  - Combined rate, growth, and liability scenario: shows compounded adverse paths for growth, inflation, primary balance, and effective interest rate producing much higher debt outcomes.

---

### Key DSA Takeaway
- San Marino faces an unprecedented level of public debt and needs fiscal adjustments to ensure debt sustainability. Contingent liabilities from the banking sector and slower growth can materially and rapidly raise debt-to-GDP well above baseline projections.

---

### Annex III — Reserve Adequacy Assessment (Findings and Recommendations)
- Context and overall judgment
  - San Marino is an open economy that adopted the euro as legal tender but has no access to the lender of last resort (LOLR) and the external market. This calls for maintaining high reserve buffers.
  - Despite recent deterioration, the overall level of reserves seems adequate.
  - Recommendation: Establishing access to Eurosystem LOLR facilities should be explored and fiscal buffers should be enhanced.

- Liquidity needs and estimated drains
  - Liquidity drains estimate: close to €500 million, largely from bank deposits and export revenues.
  - Liquidity needs include buffers for loss of export income, short-term deposit withdrawals, and government roll-over needs.

- Composition and trends of reserves
  - Available reserves composed of decentralized liquidity buffers by commercial banks and centralized resources (government deposits and liquid assets of the Central Bank of San Marino).
  - Decentralized liquidity buffers represent the largest share of reserves but have been declining in recent years; further deterioration may lead to liquidity pressures.
  - Recommendation: Develop an institutional arrangement for LOLR and explore access to Eurosystem liquidity facilities for Sammarinese banks.

- Adequacy metrics and fiscal buffer observation
  - Ratio of liquidity buffers to estimated liquidity needs: 1.9 (declined but remains above the 1–1.5 range generally judged as adequate).
  - Coverage of commercial banks liquidity buffers of non-resident deposits: well above 100 percent.
  - Government deposits: barely cover one month of spending.
  - Recommendation: It would be appropriate to start rebuilding fiscal buffers during the ongoing economic recovery.

*Italic source attribution: IMF staff, Republic of San Marino — Annex I. Risk Assessment Matrix; Annex II. Debt Sustainability Analysis; Annex III. Reserve Adequacy Assessment.*

### Annex IV. Authorities’ Response to Past IMF Recommendations

### Annex IV. Authorities’ Response to Past IMF Recommendations

### Financial Sector Policy
- Fund recommendations:
  - Complete AQR and repair banks’ balance sheets.
  - Managing NPLs.
  - Remove remaining obstacles to NPL resolution.
  - Restructure CRSM.
  - Revamp bank supervision and develop a macroprudential policy framework.
- Authorities’ actions and developments:
  - The 2016 AQR became outdated due to delays caused by high turnover of central bank management. The central bank has recently initiated an update of the AQR to complete the diagnostic in coming months.
  - Unexpected turnover of the management of the CBSM delayed completion of the Asset Quality Review (AQR) launched in October 2016; a new Director General was appointed in December 2017 and a search for a new President is underway.
  - The AQR update has been extended to cover data through mid-2017 and will provide a basis for identifying the capital shortfall, recapitalizing and restructuring the banking system.
  - Management of the CRSM has been changed multiple times in 2017, but restructuring of CRSM is still pending. A new business plan based on realistic assumptions is yet to be prepared.
  - In April 2017 new management for Cassa di Risparmio della Repubblica di San Marino (CRSM) reported a loss of €534 million (37 percent of GDP) for the 2016 financial year.
  - In May 2017 Asset Banca was intervened by the Central Bank of San Marino (CBSM); Asset Banca was merged into CRSM in November 2017.
  - The government issued Bank Decree-Law 101, which allows banks to spread their losses over up to 30 years.
  - Taking advantage of this decree, CRSM booked a loss of €54 million in 2016, reducing immediate recapitalization needs, with the remaining loss to be amortized by the State over 25 years.
  - No burden sharing took place in dealing with the loss reported by CRSM and the merger of Asset Banca into CRSM.
  - The government committed to guaranteeing all liabilities of CRSM except equity and to recapitalizing the bank with public money; the modalities of addressing CRSM’s losses are being reassessed and are currently not reflected in the fiscal accounts.
  - A Financial Stability Committee (FSC) is being established, composed of representatives of the government and the CBSM, to develop a Financial Sector Strategy and a Financial Stability Plan including options to cover banks’ capital shortfall and support a system-wide NPLs cleanup.
  - The authorities plan to reform the central bank structure and operations to enhance banking supervision and are considering setting up a State Treasury Department to scale up debt management capacity.
  - Domestic credit registry was launched in 2017.
  - Real estate market was partially liberalized to non-residents; a Residency-by-Investment program was introduced in 2017 and the 2017 “Development Law” streamlined requisites for entrepreneurs to request residence.
  - The response stabilized liquidity; overall level of reserves is judged to be adequate.

### Fiscal Policy
- Fund recommendations:
  - Start a gradual fiscal adjustment to rebuild buffers including:
    1) Introducing a Value Added Tax (VAT) to increase tax revenue.
    2) Improving spending quality and relocating spending to more growth-friendly expenditure categories.
    3) Lowering current spending by a modest cut in wage bill and some rationalization of health care spending.
  - Advance pension reform.
  - Establish access to external financing.
- Authorities’ actions and developments:
  - The 2018 budget envisages fiscal adjustment measures, including extraordinary tax measures and some current spending cuts, but uncertainty remains in the fiscal account until the AQR update clarifies the final cost of banking sector repair.
  - Increased capital spending is envisaged in 2018 and 2019.
  - The 2018 budget envisages a balanced budget through corrective measures while allocating resources for spending to support job and growth.
  - In August 2017, legislation was passed committing the government to reducing current expenditure by 10 percent in three years (2.5 percent in 2018, of which 0.65 percent already budgeted and the remaining measures to be identified before autumn).
  - New pension reform proposals have been presented; the overhaul aims at improving medium-term sustainability and promoting a multi-pillar social security model. A draft reform bill is set to be presented during this year with entry into force currently envisaged for early 2019.
  - The VAT was not introduced yet; external experts were appointed to work on the VAT proposal. Preparatory analyses by an expert group are being finalized and a Law to introduce VAT is currently planned to be approved by end-2018, envisaging a transitional period in 2019 and entry into force in January 2020.
  - A reform of direct taxation is planned, including restructuring of tax incentives, a budgeted one-off wealth tax, and improvement of the tax audit system.

### Structural Reforms
- Fund recommendations:
  - Improve the business environment and increase labor market flexibility.
  - Enhance vocational training to improve productivity.
  - Continue to engage in international cooperation and improve transparency.
  - Strengthen data provision.
- Authorities’ actions and developments:
  - “Development Law” adopted in 2017 includes easing the hiring process of nonresidents in all sectors.
  - Initiatives underway to improve the business environment include creating the Agency for Development to promote and attract foreign investment, and a one-stop-shop for companies to have more efficient administration in establishing a business.
  - The 2018 Budget Law mandates creation of a Development Agency by merging the Chamber of Commerce to promote San Marino abroad and attract companies, elective residents, tourists, and investors.
  - San Marino Innovation Institute (former Techno Science Park) has new governance to foster innovation, attract start-ups and venture capital.
  - Several reforms being designed include Public Administration, the Statistical Office, establishment of a one-stop shop for companies, and changes in insolvency laws to make restructuring, bankruptcy and liquidation procedures clearer, faster, and more flexible—improving NPLs work-out.
  - Labor market: 2017 Development Law introduced partial workforce liberalization to facilitate hiring of non-resident workers; further liberalizations and reforms of employment contracts are under study.
  - AML/CFT framework has been recently updated; in 2015 MONEYVAL removed the country from regular follow-up and reclassified San Marino as a bi-annual follow-up case. Authorities are working to amend remaining preferential tax practices to meet BEPS standards.
  - Negotiations with EU on the association agreement continue; draft laws transposing about 1,000 EU acts have been adopted by the government and await parliamentary discussion; eight negotiating sessions are scheduled for 2018.

### Data and Statistical Issues
- Findings and actions:
  - Data provision is broadly adequate for surveillance, but data gaps exist and important weaknesses remain mainly due to resource constraints.
  - Balance of payments statistics are not yet available; producing BOP statistics is long overdue.
  - The State Congress appointed an intersectoral working group tasked with compiling BOP statistics in January 2018, with monthly reporting on progress. Data are expected to become available by the end of 2018.
  - National accounts: data for 1995 onward calculated in accordance with ESA95; compiled annually with about 10-months delay; methodological improvements starting 2015 led to historical series revision.
  - Government finance statistics: data provided for central government, state-owned enterprises, and social security fund for 2004–16, preliminary data for 2017 and the budget for 2018; some data not compiled in accordance with IMF standards.
  - Monetary and Financial Statistics: significant progress; preliminary SRF-based data provided to STA from 2015:Q2 through August 2017; migration to SRFs and dissemination in IFS and national publications expected by October 2018. Data for Other Financial Corporations are not available.
  - Financial soundness indicators (FSIs): eleven out of twelve core and five out of thirteen encouraged FSIs for deposit takers are disseminated quarterly; FSIs for other financial corporations, nonfinancial corporations, and households are not reported. Authorities should shift to a timelier provision of quarterly FSI data to the Fund with a time lag of no more than 4 months.
- Tabled and timeline items (as reported):
  - The authorities are expected to complete the migration to the SRFs and begin disseminating these data in International Financial Statistics (IFS) and national publications by October 2018.
  - The intersectoral working group for BOP statistics was appointed in January 2018; BOP data expected by the end of 2018.

### Macroeconomic Context and Authorities’ Strategy
- Recent macroeconomic indicators and outlook as stated by authorities:
  - After a cumulative loss of over a third of GDP over 2008–2014, the recovery continues and economic growth for 2018 is projected at around 1.3 percent, only slightly below its 2017 pace.
  - After peaking at 10 percent in early 2016, the unemployment rate decreased to around 8 percent by the end of 2017.
  - The trade surplus remains high (at 32 percent of GDP).
  - Authorities largely share staff’s forecast of moderate growth and related risks, while noting significant investment projects (notably the construction of a luxury shopping mall) as an appreciable upside risk to growth.
- National Stability Plan (NSP):
  - Authorities are finalizing a NSP that includes a Financial Sector Strategy and a Financial Stability Plan to stabilize the banking system and close its expected capital shortfall, along with structural reforms to improve ease of doing business, innovation, and quality of services.

*Prepared by IMF staff; authorities’ responses and actions as reported in the Annex IV text.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18101.pdf_