San Marino: Staff Concluding Statement of the 2017 Article IV Mission

February 9, 2017

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

San Marino is on a path to a slow recovery, but the challenges ahead are still considerable. Restoring the health of the banking sector and creating fiscal space are paramount to lay a solid foundation for more robust and sustained growth. Well-designed structural reforms aiming at creating a business-friendly and open environment will help enhance growth potential. The reform agenda is demanding, and should be anchored by medium-term objectives with appropriate sequencing and prioritization.

Outlook and Risks

  1. San Marino is slowly recovering after a long recession. The economy grew at slow pace in 2015, at 0.5 percent. High frequency indicators, including gains in employment, point to continued recovery in 2016, with expected growth of close to 1 percent. Nevertheless, bank credit continues to contract, as banks face considerable challenges with high nonperforming loans (NPLs).

  2. Moderate growth is expected in the near- and medium-term. The baseline outlook, assuming no change in policies, is for moderately strengthening growth to just over 1 percent this year and 1.3 percent in the medium term. With improved employment and some recovery in wages, domestic demand is expected to start supporting growth in the medium term. However, the pace of growth is well below what is needed to regain the lost ground since 2009, highlighting the need for reforms.

  3. This central scenario is subject to risks, which are tilted to the downside. Lingering weakness in the domestic banking system, if left unaddressed, could cloud San Marino’s medium-term growth prospects. Structurally weak growth in Italy and the euro area would slow the Sammarinese economy and delay its recovery. On the other hand, higher medium-term growth could result from improved international relations through larger than expected increase in economic activity.

Financial Sector Policy

4. A multifaceted approach is needed to deal effectively with banking sector challenges . High NPLs are a drag on banks’ profitability and inhibit credit intermediation. To support San Marino’s economic recovery and safeguard financial stability, advancing the cleanup of the banks’ balance sheets is crucial. In this respect, the mission welcomes the ongoing Asset Quality Review (AQR), launched by the Central Bank of San Marino (CBSM) late last year, that is instrumental in the process of bringing the banking sector on a sound footing. Key elements of the process should include:

  • Repairing banks’ balance sheets. Applying common asset valuation standards to all banks through the AQR will provide a consistent and reliable picture of the state of banks’ balance sheets. This should clarify target provisions and facilitate NPL resolution, including transferring NPLs off banks’ balance sheets, hereby unlocking the market for distressed assets. If capital shortfalls arise in the process, they should be dealt with through market-based recapitalization plans, restructuring or resolution. Systemic importance of troubled banks should be carefully assessed, and state support, if needed, should be limited to systemic banks with appropriate reorganization plans to minimize cost to the public.

  • Managing NPLs. The AQR also helps banks refocus on enhancing collateral and improve credit risk management practices. Taking advantage of gradually improving economic conditions, banks should enforce collateral to enhance value recovery, and consider selective write-downs for fully provisioned bad loans. Banks’ business plans should contain quarterly targets for NPL operations, aimed at significantly reducing NPLs over the medium term. To reduce high operating costs related to management of NPLs, establishing an appropriate vehicle for selected asset class such as real estate loans could be considered. For NPLs outside San Marino, outsourcing arrangements with distressed asset companies active in Italy may be explored.

  • Removing remaining obstacles to NPL resolution. Supporting regulatory, tax and legal reforms are needed to facilitate the NPL resolution process. Removing remaining tax disincentives to NPL disposals should be considered. At the same time, some opening of the real estate market to nonresidents may help avoid declines in collateral valuations during asset recovery. Enhancing effectiveness of the insolvency regime, including pre-insolvency and out-of-court procedures, would help restructure viable companies. Launching the credit registry can also help.

5. A credible strategy for CRSM should take into account AQR findings. Any restructuring plan should be based on realistic assumptions and ensure long-term viability. The plan should also include the appointment of both experienced turnaround experts and bank management.

6. Looking ahead, a robust framework for macroprudential policy needs to be developed while revamping bank supervision to ensure financial stability. An internal audit of the central bank has been completed, aiming at strengthening the quality of supervision and compliance within the banking sector. The authorities are encouraged to further identify and close any data and regulatory gaps and strengthen capacity to monitor systemic risks. A regular publication of a short and well-targeted financial stability report would be a useful platform to communicate CBSM’s assessment and policy intentions to the public. A streamlined mandate and independence of the CBSM are also key.

Fiscal Policy

7. Fiscal policy is the main policy tool available for San Marino to stabilize the economy. In the aftermath of the crisis, the authorities used fiscal buffers to support the economy and minimize the effects of the crisis. These buffers have now been almost depleted. To create space to tackle future shocks, the authorities should embark on rebuilding fiscal buffers.

8. A gradual fiscal adjustment should start this year, targeting a modest surplus by 2019. This objective can be achieved by an annual reduction of deficit by about ½ percent of GDP in coming years. Tax measures should play a key role in the adjustment given San Marino’s relatively low tax revenues and high needs for pro-growth, pro-employment investment. In particular:

  • The authorities should introduce a Value Added Tax (VAT) system as early as end-2017. Considerable preparatory work has been already made. Implementing a VAT will help expand the tax base and secure a steady source of income to the government while making the tax regime more compatible with the EU system. The VAT rate should be set to safeguard fiscal objectives and sustainability. Tax collection efforts should be also stepped up to improve tax compliance and collection.

  • Fiscal adjustment should also entail improving spending quality and reallocating current spending to more growth-friendly expenditure categories to enhance growth prospects. In view of this, the planned increase in capital investment by €10 million annually for the coming few years are appropriate, and expanding resources for education and vocational training could be considered. Any further investment would require additional tax revenues.

  • To achieve fiscal objectives, a further modest reduction in the wage bill should be explored as its share in current spending is among the highest compared with euro area peers. Some rationalization of health care spending could be also considered. Plans to reform the pension system should be adopted in 2017. Ensuring the social security fund is self-financed would allow the government to allocate resources to other priority areas.

9. A more ambitious fiscal adjustment may be required if contingent liabilities from the banking system were to materialize. Although bank recapitalization needs should be met with market-based solutions, if some costs were to be borne by the state, public debt could rise to higher levels. The government should work closely with the CBSM and prepare measures to ensure the integrity of public finances.

10. Establishing access to external financing for the sovereign, in the context of reduced buffers, would help enhance the government’s ability to respond to shocks. The authorities should start to explore external financing options, including through an external private placement of syndicated loan. Access to external market would also introduce market discipline, while diversifying funding sources and breaking the bank-sovereign loop. To the extent San Marino has access to external financing, the need to hold sizable deposit buffers would decline, and such buffers may be used only when market access is limited.

Structural Reforms

11. Improving the business environment and labor market flexibility will help achieve higher medium-term growth potential for San Marino. The government’s plan to create a one-stop-shop to simplify administration will help reduce cost of doing business. Labor market reforms are currently under consideration, including simplified procedures to hire nonresidents. These reforms should be guided by the principle of improving efficiency and avoid distortions and limit additional fiscal costs.

12. San Marino’s engagement in international cooperation remains crucial. Improved international relations should help revive cross-border economic activity and support the recovery. The mission welcomes the completed AML/CFT national risk assessment and encourage the authorities to implement the AML/CFT Action Plan. San Marino continues the negotiations with the European Union on an association agreement and the dialogue with other countries to improve economic cooperation.

13. San Marino should strengthen data provision, both its timeliness and availability. Economic data are essential for businesses, households, and policy makers to make informed economic and policy decisions. Disseminating data in an easily accessible format on-line would greatly improve transparency and help policy makers as well as potential investors. The authorities should consider allocating more resources to improve data provision and set this as a key priority in their reform agenda.

The mission would like to thank the authorities and representatives from the private sector and social partners for open and productive discussions and their warm hospitality.

IMF Communications Department

PRESS OFFICER: Andreas Adriano

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