San Marino: Staff Concluding Statement of the 2022 Article IV Mission
IMF News, October 7, 2022
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- Published: October 7, 2022
Economic performance and outlook
- San Marino’s economic performance has been remarkable over the last two years.
- Growth and labor market:
- Growth projected at 8.3 percent for 2021.
- Employment reached the highest level in over a decade; tight domestic labor market led authorities to liberalize cross-border employment.
- Drivers of recent strength:
- Strong external demand boosted manufacturing.
- A rebound in tourism led to strong economic activity.
- Increased confidence led to higher government and banking sector deposits and international reserves.
- Near-term risks and outlook:
- Higher energy prices —below neighboring countries— weakening external demand and tighter international financial conditions will affect growth going forward.
- Activity is expected to slow down due to energy price increases eroding households’ real income and firms’ profit margins.
- Weaker external demand expected to contribute to a marked deceleration of economic activity and deterioration of the current account surplus and international reserves.
- Downside risks related to Russia’s invasion of Ukraine, particularly a further disruption of energy supplies in Europe, continue to dominate the outlook.
- The rollover of the Eurobond in early 2024 remains a risk.
- Policy buffer recommendation:
- Preserving healthy levels of fiscal and financial sector buffers is key to preserve stability and confidence in a euroized economy like San Marino.
- Ambitious fiscal consolidation, and further efforts to address high nonperforming loans and improvements in banks’ capitalization should be approved and implemented without delay.
Energy price response and implications
- Authorities’ actions:
- Combination of a long-term gas contract signed last year, timely electricity contracts, and hedging operations just before prices surged secured significantly lower gas and electricity import price increases than those in Europe for this year and next.
- Authorities adjusted tariffs to cost recovery levels but well below neighboring countries, at minimum fiscal costs.
- Policy implications:
- Plans to pass-through import energy prices to consumers next year will continue to avoid fiscal costs and preserve the financial soundness of the state-owned utility company (AASS).
- The response allows price signals to operate, supports vulnerable groups and mitigates macroeconomic disruption.
Fiscal policy, revenues, spending, and pensions
- Fiscal stance and needs:
- Increasing global interest rates, elevated public debt, and the Eurobond rollover in 2024 call for an ambitious path for fiscal policy notwithstanding weakening economic activity.
- Authorities should be ready to take advantage of favorable market conditions and rollover the Eurobond whenever the opportunity arises starting early next year.
- Given the weakening outlook, authorities should save revenue over-performance this year to build up government deposits while resisting spending pressures.
- Strengthening the fiscal position will require a fiscal adjustment by the central government of 2 percent of GDP over the next three years to reach a central government primary balance of 2.5 percent of GDP complemented by pension reform.
- Revenues (recommendations):
- The proposed income tax law amendments should be promptly approved and be more ambitious in simplifying the system and reducing exemptions and loopholes.
- Delay in implementing it this year could leave San Marino in a vulnerable fiscal position with a debt path that is declining but not robust to most shocks.
- Introducing a Value Added Tax should also be considered particularly in the context of closer EU integration.
- Room to improve revenues by repealing discounts on petroleum products and expanding the use of excise duties that would help address environmental externalities.
- Spending (recommendations):
- Public sector wage and pension increases in line with recently agreed private sector collective bargaining agreements could contain expenditure permanently and support needed fiscal consolidation in the near term.
- Further improvement in spending efficiency and spending review across all public sector units is essential to contain government spending.
- Finalizing the Public Financial Management reform will enhance control over public finances through better accounting, reporting and transparency.
- Pensions (analysis and recommendations):
- The pension reform under parliamentary discussion stabilizes the system’s deficit over the next decade but further recalibration of pension spending will be needed to ensure long-term sustainability.
- Approval of this reform, expected this year, is a key priority that cannot be delayed given increasing deficits of the Social Security.
- By increasing contribution rates, the reform reduces projected deficits and stabilizes pension fund assets in the near-term.
- In the absence of more ambitious measures—linking the retirement age to life expectancy, increasing penalties for early retirement, and calculating benefits based on the entire career—deficits will reemerge requiring depletion of pension fund assets.
- The current limit on government transfers to the Social Security should be preserved.
Debt management and Eurobond rollover
- Need for comprehensive debt management strategy:
- With limited fiscal space, San Marino needs a strong, medium-term debt management framework to reduce rollover risk and financial cost, that incorporates plans for international and domestic issuances, and increases predictability.
- Publish a medium-term debt strategy, an issuance calendar and an annual public debt report.
- Domestic market development:
- Conversion of ex-BNS uninsured depositors’ bonds will help develop the domestic debt market and reduce the burden on taxpayers.
- Conversion would also smooth financing needs in a challenging period.
- Operational advice on Eurobond:
- Authorities should be ready to rollover the Eurobond early next year if market conditions permit.
Banking sector, NPLs, and financial buffers
- Banking sector recent performance:
- In 2021, banks have achieved profitability for the first time since the Global Financial Crisis and their capital base was strengthened.
- Continued deposit increase and improved liquidity, profitability, and capitalization noted.
- Remaining challenges:
- Extraordinary high nonperforming loans (NPLs) and the recent halt of efficiency improvements keep profitability limited and fragile.
- Falling bond valuations and weakening activity create new pressures on the capital base.
- Regulatory and operational measures:
- The Central Bank of San Marino (CBSM) allowed banks to transfer assets from the trading to the investment portfolio that is held until maturity; plan to report these operations transparently is welcome.
- Delay in implementation of the strategy to reduce NPLs noted; lack of implementation more than two years after design has delayed NPL resolution.
- Progress made: by-laws for the servicer, supervisory framework for treatment of vehicle assets received by banks, pre-selection of reputable external arrangers with final selection currently underway.
- An asset management company could create economies of scale to address system-wide NPLs efficiently, provide fresh liquidity to banks, and provide external valuation of NPLs.
- If NPLs are found to have real economic value below net book value, their transfer should transparently result in a reduction of capital ratios; any undercapitalization should be promptly addressed with credible capitalization plans.
- Clear expectation and incentive structure should exist for most NPLs to be transferred.
- NPLs remaining on banks’ books should be subject to progressive recognition of past losses (calendar provisioning), following European standards.
- Financial buffers and reserves:
- In a euroized economy without independent monetary policy, preserving healthy levels of financial sector liquid buffers is key to preserve stability and confidence.
- International reserves have fallen as banks’ deposits at CBSM moved abroad to take advantage of higher rates; this trend is expected to continue in the near term.
AML/CFT and structural reforms
- AML/CFT:
- The AML/CFT assessment report by MONEVYAL indicated satisfying levels of effectiveness in many areas but highlighted areas needing further efforts including supervision, preventive measures (i.e. customer due diligence), transparency of legal persons and legal arrangements, money laundering investigations, and targeted financial sanctions for terrorism and proliferation financing.
- Authorities are in the process of transposing the V AML directive into the domestic legal framework.
- Structural reforms for long-term growth:
- Progress towards the EU association agreement and the labor market reform are welcome but should be completed and implemented.
- Labor market reform should make permanent the recent liberalization of cross-border workers and increase flexibility of temporary employment.
- Plans to improve the business climate are critical; further efforts are needed to improve an outdated insolvency framework.
Mission closing
- The mission would like to thank the authorities and other counterparts for their warm hospitality as well as open and productive discussions.
San Marino: Staff Concluding Statement of the 2022 Article IV Mission (October 7, 2022).