San Marino—2016 Article IV Consultation Concluding Statement of the Mission

IMF News, March 16, 2016

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San Marino is emerging from a prolonged recession; high-frequency indicators suggest the economy stabilized in 2015, and a modest recovery with growth at about 1 percent is expected for 2016 and beyond.
Major challenges: turning the nascent recovery into sustainable growth; the unfinished restructuring of Cassa di Risparmio della Repubblica di San Marino (CRSM); reduction of the high stock of non-performing loans (NPLs) in the banking system.
Financial sector issues must be dealt with swiftly to enable the banking system to restart lending and minimize contingent fiscal liabilities.
Fiscal discipline to rebuild buffers, including through the introduction of the VAT, should be a fiscal policy priority.
Authorities should aim at gradual modest cuts to current expenditure to finance needed capital outlays.
Continued focus on international cooperation and improvements in the business environment and labor market flexibility are important to facilitate rebalancing and diversification of economic activity.

Recapitalization of CRSM should be contingent on a deeper reorganization that quickly brings the bank back to profitability; likely requires more aggressive downsizing.
Reorganization plan should be based on conservative assumptions and demonstrate profitability even under a downside scenario.
The current recapitalization is expected to bring the bank’s capital position in line with regulatory requirement; international best practice calls for further dilution of non-state shareholders.
The state as main shareholder should appoint experienced turnaround experts to CRSM’s board and executive management positions.

A comprehensive strategy is needed to clean up banks’ balance sheets; the large stock of NPLs drags on profitability and inhibits new credit extension.
The strategy should be properly sequenced and consist of two pillars:
- A stocktaking, provisioning and recapitalization exercise along the lines suggested by IMF staff last year:
- Forward-looking asset quality reviews for all banks to reduce uncertainty about asset quality.
- Raise provisions to bring currently relatively low NPL coverage ratios to adequate levels.
- Deal with likely capital shortfalls through market-based recapitalization plans or resolution.
- Address regulatory and legal impediments in the NPL management and resolution process:
- Remove tax disincentives to debt write-offs and restructuring.
- Explore additional flexibility in regulations governing asset management companies for nonperforming assets.
- Enhance the insolvency regime to facilitate reorganizations of viable companies, including mechanisms for pre-insolvency and fast-track court-approved restructuring agreements, ensuring protection of new financing, and better balancing the rights of the debtor and its creditors, in line with best practices.
- Explore scope for a limited opening of the Sammarinese real estate market to non-resident investors to improve market functioning and support asset value and sales.

Implementation requires close coordination and possibly additional resources:
- Intensive coordination among the government, the central bank (CBSM), and the banks is crucial.
- Ensure the CBSM is adequately resourced and can exercise its duties independently.

San Marino should gradually rebuild fiscal buffers that served it well in the past.
While current policies stabilize debt around this years’ level, an overall fiscal adjustment of 1 percent of GDP over four years would put debt on a clear downward path and create room to deal with large contingent liabilities looming in the banking system.
This modest fiscal adjustment should start next year.
The additional public capital expenditure from the budget of €10 million annually starting this year will help support the recovery; the resulting modest deficit should be accommodated this year.
Starting in 2017, the aim should be:
- Modestly increase revenue.
- Reduce current expenditure by ¼ percent of GDP per year in each of the years 2017-2020 to create room to permanently accommodate the higher capital expenditures.

Consider external financing options to diversify funding sources and break the bank-sovereign link:
- Given expected small size of potential financing needs, consider borrowing on international capital markets, an external private placement, or syndicated loan.
- Current low international interest rates present an opportunity as they limit additional cost.
- Agreeing on a contingent credit line with the Italian authorities would provide a welcome liquidity buffer.

Government steps to improve the business environment and labor markets include:
- Simplification of the process to establish a business and register property.
- Establishing an entry-level wage and temporary lower social security contributions when hiring unemployed workers.
- Piloting eased procedures to hire skilled nonresident workers for startups; consider scaling up such efforts more broadly.
- Setting up a technology and science park, where the first start ups are now operational and expanding.
These changes support rebalancing of the Sammarinese economy towards industry and nonfinancial services.

International cooperation progress and next steps:
- Italy’s decision to include San Marino in its tax whitelist in late 2014 and the conclusion of the bilateral economic cooperation agreement were major steps toward openness and transparency.
- Activation of the credit register should start as scheduled, facilitating cooperation with the Bank of Italy and helping banks assess credit risk.
- Mission welcomes the opening of negotiations with the European Union on an association agreement, the imminent completion of the national risk assessment, and the exchange of tax information starting in 2017.

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

Mission Concluding Statement — March 16, 2016. International Monetary Fund.