San Marino—2010 Article IV Consultation Concluding Statement of the Mission

January 14, 2011

Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.

San Marino, January 14, 2011

After two years of contraction, the economy is struggling to recover from recession. The financial sector is adjusting to the effects of Italy’s tax amnesty, which led to a significant decline in the size of banks’ balance sheets. A long period of fiscal surpluses has ended, as revenues fell sharply in 2009-10, mainly due to the cyclical downturn and lower revenues from the financial sector. San Marino has strengthened financial regulation, diluted bank secrecy, and tightened anti money-laundering defenses. Discussions with the authorities focused on the need to develop a new business model for the financial system, and on measures to contain the fiscal deficit and enhance the economy’s flexibility. There was broad agreement that strengthening economic and financial relations with Italy will be vital to facilitate a sustainable repositioning of the economy.

Economic Outlook

1. A long recession is expected to end this year, but uncertainty looms large. Following two years of economic contraction―1 percent in 2008 and 13 percent in 2009―led primarily by a sharp decline in investment, the Sammarinese economy remains weak, with construction activity and employment in the manufacturing sector well below their levels in the period preceding the global financial crisis. Notwithstanding a moderate expansion in manufacturing and commercial activity during the first half of last year, rising unemployment, stagnant wage growth, and lower confidence have all contributed to a fall in consumption. Therefore, we expect that real GDP in 2010 will be found to have declined by about 1 percent. This year, the economy could build some momentum, subject to normalization of relations with Italy, which accounts for 90 percent of San Marino’s exports, but growth, if any, is projected to be meager.

2. Risks to the outlook are mainly on the downside. Given a moderate growth outlook for Italy, output expansion is projected to remain weak over the medium term. Moreover, financial sector profitability and employment are likely to be lower than in recent years, because of the compression in banks’ balance sheets, following the tax amnesty, as well as the need to adjust to new regulations and develop a new business model. There are mainly downside risks to the economic outlook, not least because of the uncertainty surrounding San Marino’s strained relations with Italy.

Financial Sector

3. Following the tax amnesty, the financial sector is still adjusting. The banking system was able to withstand a 35 percent deposit outflow in 2009-10, largely because of the previous substantial holdings of, mainly foreign, liquid assets. Many of these assets were sold to manage the deposit outflow. Balance sheets have shrunk accordingly and become less liquid. Because of the economic slowdown, asset quality declined too, with nonperforming loans (NPLs) rising from about 4 percent of total loans at end-2008 to an estimated 10 percent in June-2010, while system profitability fell significantly over the same period. In view of the weak economic outlook, NPLs are expected to continue to increase in the near term, further squeezing banks’ profits. The central bank of San Marino (CBSM) is currently monitoring and responding to the effects of the tax amnesty and other developments, including international pressure for greater economic and financial transparency and the resolution of Italy’s troubled Delta Group, which is owned by San Marino’s largest bank. The CBSM has limited capacity to assist the banking system in managing its capital and liquidity risks, and thus we support the efforts it has made to develop additional tools for managing liquidity within the system.

4. Progress has been made on meeting the 2009 FSAP recommendations, though more could be done to strengthen the financial system. The authorities secured passage of important legislation to buttress financial sector supervision. They have taken measures to enhance the independence and resources of the CBSM, fortify on-site and off-site supervisory functions, and enable the CBSM to assist in the provision of liquidity to banks, including through the recent implementation of a reserve requirement system and the development of a local interbank market. In addition, new regulations have circumscribed the activity of fiduciary companies, abolished the use of bearer shares, and tightened customer due diligence requirement. However, more work needs to be done. In particular, the authorities should provide both CBSM and the Financial Intelligence Agency with the additional resources they have sought to implement the new regulatory regime effectively, and continue to strengthen CBSM independence. Finally, the authorities should continue to seek to secure contingent credit lines with other central banks.

5. The financial system requires a new business model. The relaxation of strict bank secrecy and tighter regulations mean that the old business model is no longer sustainable. The authorities and the private sector are undertaking a strategic review of the financial system’s prospects. Emerging ideas appear sensible, especially as they envisage the development of fee-based services (such as specialist asset management) that (i) do not rely on bank secrecy, (ii) provide genuine value added, and (iii) should not result in the expansion of banks’ balance sheets beyond the capacity of the limited lender of last resort facilities of the CBSM. This may be difficult to implement rapidly, but is worth considering as a longer-term solution. At the same time, strengthening relationships with reputable foreign banks would help Sammarinese banks better identify foreign investment opportunities.

Fiscal Policy

6. The fiscal position deteriorated sharply in 2009-10, mainly due to a significant decline in revenues. In 2009, the central government balance turned negative for the first time since 2002, reaching -3.4 percent of GDP, due to a fall in tax revenues of around 1 percent of GDP. In 2010, we expect that the outturn will show tax revenues to have dropped by almost 4 percent of GDP, largely as a result of the economic slowdown and the decline in revenues from the financial sector. Consequently, the 2010 fiscal deficit is expected to have widened to just over 6 percent of GDP.

7. The authorities have taken steps to reduce the fiscal deficit. In the three-year rolling budget approved last month, the government introduced a number of consolidation measures, including cuts in transfers to the enlarged public sector, a reduction in the public sector wage bill, and a one-time levy on income tax payers. However, in order to stimulate consumption, the government also cut the import tax rate by 2 percentage points, which may undermine the overall objective of increasing revenues. With these measures, according to the authorities, the central government deficit is set to decline to about 3 percent of GDP in 2011. However, this projection seems to reflect rather optimistic assumptions about both the rebound in tax revenues and the containment of expenditure. Indeed, we expect a deficit of over 4 percent of GDP this year.

8. There is scope to embark on more comprehensive reforms to secure an effective medium-term fiscal consolidation strategy. We welcome the aforementioned adjustment measures. We press the authorities to carry out the planned spending reductions, and, in particular, to resist pressures for wage increases in the public sector. The ongoing public administration reform should be accelerated and especially geared toward cuts in public sector employment through attrition. On the revenue side, the authorities should consider more comprehensive and permanent reforms, rather than resorting to ad-hoc temporary measures. The current system of exemptions and subsidies, including on utility prices, needs to be revised.

9. The authorities are appropriately pursuing pension reforms. Two draft laws expected to be presented soon to parliament envisage higher contribution rates, greater harmonization in contribution rates across categories of independent workers, an increase in the retirement age, lower replacement rates, and the commencement of a second pillar system. These are steps in the right direction, and we urge the authorities to approve and fully implement the legislation expeditiously. However, we also encourage the authorities to use this reform as an opportunity to revise the current rule under which state transfers are automatically linked to total contributions, which implies automatic increases in central government pension expenditure.

Product and Labor Markets

10. Rigidities in product and labor markets have reduced San Marino’s competitive position. The government has taken some steps toward liberalizing and streamlining product markets, albeit barriers to entry in certain non-tradable sectors remain. Labor market distortions linger as well, including obstacles in hiring highly-skilled non-resident workers and a fairly centralized hiring system in the domestic labor market, which hinders market-driven private sector employment. These distortions have contributed to reducing San Marino’s competitiveness in recent years, reflected in falling productivity and rising unit labor costs. In this regard, particular attention should be paid to relaxing the hurdles on firms to hire highly-skilled non-resident workers. Indeed, in order to develop a new business model successfully, the financial sector needs to acquire rapidly the skills needed to offer a range of new services.

Statistical System

11. San Marino’s participation in the IMF’s General Data Dissemination System has strengthened the statistical system, but there is still room for improvement. Notwithstanding important progress on compilation and dissemination of monetary and financial sector data, national account statistics and fiscal data do not have the detail required by best practice international standards and are only available with a considerable lag. The availability of reliable statistics on current economic conditions and up-to-date transparent government accounts is vital to designing appropriate economic policies and preparing realistic budgets. We urge the authorities to devote additional resources to meet international standards for national account statistics and general government accounts, which will enable the production of GDP estimates and projections. This would also help San Marino achieve the aim of greater international integration.

We would like to thank the authorities and other interlocutors for the productive discussions and their warm hospitality.


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