San Marino: Staff Concluding Statement of the 2019 Article IV Mission
IMF News, February 1, 2019
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- Published: February 1, 2019
Significant risks and overarching assessment
- San Marino’s key challenge: urgently return its economy to a sustainable path of growth and prosperity through a comprehensive package of policy actions aimed at stabilizing the banking system and restoring credit supply while safeguarding public finances.
- Growth prospects are weighed down by legacy problems and downside risks:
- Deep-rooted weaknesses in the banking system and ineffective, piecemeal responses to past bank failures have stalled credit growth and threaten financial stability and fiscal sustainability.
- The banking system’s ability to intermediates between savers and borrowers is extremely limited.
- Absent a swift and significant policy adjustment, economic growth is projected to remain subdued over the near and medium term due to continued banking system deleveraging and less favorable external conditions.
- Elevated financial and fiscal fragilities suggest the outlook is dominated by significant downside risks.
- Urgent need for a coherent strategy combining banking system restructuring and recapitalization, ambitious and growth-friendly fiscal consolidation, and structural reforms to boost competitiveness and potential growth.
- Full commitment of all stakeholders in San Marino is critically important for successful implementation.
Restore the banking system’s role in the economy
- Systemic diagnosis:
- The banking sector is over-sized and vulnerable on multiple fronts: deep capital, asset quality, governance, and profitability problems.
- Liquidity has fallen to low levels; banks’ ability to extend credit is undermined by unrecognized past losses and large recapitalization needs.
- With negative credit growth, high levels of NPLs and tax credits, and excessively high operating costs, the banking system is estimated to have recorded a loss in 2018, the ninth year in a row.
- CBSM and governance issues:
- The Central Bank of San Marino (CBSM) is making progress but lacks sufficient powers, autonomy, and consultation on financial sector related policies.
- Improved coordination among policy stakeholders is needed to design and implement a comprehensive financial sector strategy.
- Recommended multi-pronged measures:
- Improve liquidity management:
- CBSM liquidity buffers have declined to low levels due to continued lending to the government and the banking sector.
- CBSM should enhance liquidity management and restrict budget financing to only exceptional needs and on a temporary basis.
- Well-developed measures and carefully-crafted communication are urgently needed to respond to a potential resurgence in liquidity pressures and to safeguard the payment system.
- Recognize losses and recapitalize banks upfront:
- Capital shortfalls are largely concentrated in the state-owned Cassa di Risparmio della Repubblica di San Marino (CRSM).
- Laws that allow banks to spread losses should be repealed.
- State support should be provided only to systemically-important and viable banks, following burden sharing.
- Other undercapitalized banks that fail to raise fresh capital from private sources should be subject to corrective action.
- Improve efficiency and sustainability:
- Quickly reduce high operating costs, including by reviewing employees’ compensation and rationalizing the branch network.
- Converting tax credits into interest-bearing assets is critical to restore banks’ long-term sustainability.
- Speed up NPL resolution:
- Strengthen supervisory oversight and require banks to achieve ambitious, but realistic, NPL reduction targets.
- Modernize the insolvency regime, remove tax disincentives for NPL disposal, and streamline legal proceedings for liquidation and enforcement.
- The recent decision to fully liberalize the real estate market will help by improving collateral recovery values.
- Strengthen financial sector oversight and governance:
- CBSM bank intervention tools urgently need to be brought to international standards.
- Review the Central Bank law to enhance CBSM independence, governance, and accountability.
- Improve CBSM communication with local stakeholders to enhance transparency and credibility.
Safeguard public finances and reduce fiscal risks
- Fiscal stance and banking-related costs:
- The 2019 budget aims at achieving a small surplus, net of government support to CRSM.
- With inclusion of the expected transfers to CRSM, the mission projects the overall deficit at 2.4 percent of GDP in 2019, and about 3 percent of GDP over the medium term due to government’s gradual recapitalization of CRSM as well as expiration of temporary fiscal measures.
- Absent further adjustment, related financing needs will keep fiscal buffers low, undermining the economy’s resilience.
- Public debt and contingent liabilities:
- Official public debt—although increasing—is projected to remain low at 27.5 percent of GDP in 2018.
- A full and upfront cost recognition arising from past bank interventions—namely CRSM legacy losses and tax credits given to banks for acquiring failed ones—would increase public debt substantially, posing significant stability risks given current lack of market access, limited domestic financing options, and weak debt management capacity.
- Comprehensive fiscal strategy recommendations:
- Pursue ambitious fiscal adjustment relying on durable revenue and expenditure measures, alongside burden sharing in bank recapitalization.
- Revenue measures:
- Adopt the planned VAT with sufficiently-high rates and limited exemptions to boost revenue collection, and in a timeline consistent with the tax administration capacity.
- Rationalize wasteful tax rebates and maintain the wealth tax to help increase revenue.
- Expenditure measures:
- Implement a comprehensive pension reform to effectively address ageing pressures and ensure sustainability of the pension system.
- Target social policy so benefits are means-tested and linked to job search.
- Improve spending efficiency across government units.
- Introduce an income and wealth indicator to support means-testing and strengthen controls over budgeting of government units and state-owned enterprises.
- Improve debt management capacity and diversify sovereign financing:
- Set up a Treasury unit.
- Strengthen macro-fiscal planning.
- Establish access to external financing to enhance the government’s ability to respond to shocks and contain debt financing risks.
Sustain structural reforms to boost economic growth
- Reform momentum and priorities:
- Recent reforms have started to bear fruit, but additional measures are needed to address remaining structural impediments and improve medium-term growth prospects.
- Recommended focus areas:
- Further improve the business environment:
- Continue reforms to streamline judicial processes, enhance creditors’ and borrowers’ rights, and improve corporate governance.
- Recent progress includes removing several impediments for starting a business.
- Strengthen labor supply:
- Increase flexibility in hiring nonresidents to reduce skill mismatches and alleviate capacity constraints.
- The recently established Office for Active Labor Market Policies could support higher employment and growth through more targeted social benefits and enhanced training and job search.
- Increase economic integration and address infrastructure gaps:
- The new Economic Development Agency is expected to help expand market access for domestic firms, attract tourists, and promote higher foreign direct investments.
- Concluding the Association Agreement with the EU would bring further benefits, including by simplifying operations of Sammarinese firms abroad and potentially granting them passporting rights.
- Complement these efforts with higher investment in telecommunication and transportation to improve business connectivity with trading partners.
Further improve data provision for surveillance
- Progress and remaining needs:
- Welcome progress in reporting monetary and financial data regularly and in compiling balance of payment and international investment position statistics for the first time.
- Ensuring sufficient resources for the Statistical Office and the CBSM would help close remaining data gaps and improve the frequency, coverage, and reporting of relevant statistics.
- Better data provision would allow businesses and policymakers to better assess the state of the economy and make informed decisions.
IMF Communications Department — February 1, 2019