OREANDA-NEWS. June 24, 2015. Fitch Ratings has affirmed San Marino's Long-term Issuer Default Rating (IDR) at 'BBB+' with a Stable Outlook. The Country Ceiling has been affirmed at 'A+' and the Short-term IDR at 'F2'.

KEY RATING DRIVERS
San Marino's 'BBB+' IDR reflects the following key rating drivers:

San Marino has achieved some success in fiscal consolidation, with the central government posting an estimated surplus of 0.7% of GDP in 2014 (revised from our previous forecast of 0.2% deficit). This reflects a combination of an income tax reform to boost revenue and ongoing cuts to current expenditure.

Fitch expects the central government balance to remain in surplus over the medium term, helped by higher revenue from international trade. The general government balance (which includes the social security institute), is forecast to post a mild deficit in 2015-16, averaging 0.5% of GDP. Although the government may have to further inject further capital into the country's largest bank, Fitch's forecasts for public debt do not assume this, in line with the authorities' forecast.

After rising markedly from 2011 to 2013, total public debt fell slightly in 2014, to an estimated 20% of GDP. This is well below the median of 'BBB' countries. Fitch expects public debt to remain broadly stable in 2015-16, with the government focusing on rebuilding deposits (which fell to a low of 3% of GDP at end-2014) to ensure greater financial flexibility. The government tapped the domestic banking sector in 2013 to finance the deficit and could do so in the future.

Macroeconomic performance remains a key constraint on the rating, with GDP contracting by an average of 4.3% in the five years to 2014. Although the number of visitors and approved construction projects recovered last year, economic performance is weighed down by a contraction in credit, higher unemployment and insufficient investment.

Fitch expects GDP to expand 1% in 2015, boosted by improved business and consumer confidence, following the inclusion of San Marino on Italy's tax whitelist in late 2014. Medium-term growth prospects are modest, and will become increasingly dependent on Italy's performance, in particular of the Emilia-Romagna region. The external sector will provide some support, with San Marino continuing to post a large surplus on its trade and services balance.

The banking sector, whose severe crisis in 2009-2013 undermined sovereign creditworthiness, is showing further signs of stabilisation. Deposits increased 3% in 2014, and liquidity buffers continue to improve (the coverage ratio stood at 50.8% at end-2014, compared with 37.9% at end-2012).

The Central Bank of San Marino (CBSM) is strengthening its supervisory capabilities. Efforts are underway to identify further non-performing assets, while there has been marked progress in establishing a fiscally transparent regulatory environment for the banking sector. A forthcoming memorandum of understanding (MoU) between CBSM and Italy's Central Bank proposes integration between the two countries' financial sectors and could help make San Marino's banking industry more competitive and profitable in the medium term.

However, the banking sector is still hindered by a number of factors, including significant losses, low provisioning for non-performing loans (NPLs averaged 48.8% of total gross loans in 2014) and risks stemming from Italy's law on voluntary disclosure, which expires in September this year and could trigger a bout of deposit outflows.

A key risk remains the outlook of Cassa di Risparmio della Repubblica di San Marino (CRSM), San Marino's biggest bank (30% of system assets), which still has a capital adequacy ratio below minimum regulatory levels despite recent injections of state capital. The authorities see the rebuilding of CRSM's capital base and improvement in the bank's business strategy as a priority but significant progress is only likely over the medium term.

San Marino's rating also reflects strong governance and development indicators, which are well above 'BBB' peers. However, resilience to shocks is greatly curtailed by the small size of the country (32,000 inhabitants), limited economic diversification and high dependence on neighbouring Italy. Moreover, data quality remains weak, with limited national accounts and balance of payments figures.

RATING SENSITIVITIES

The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main risk factors that, individually or collectively, could trigger a rating action are:

Positive:
-Sustained economic growth reflecting diversification of the economy.
-Improvement in public debt dynamics and rebuilding of fiscal buffers over time.
-Strengthening of the banking sector's soundness, including improved asset quality, CRSM capitalisation and reduced risk of deposit outflows.

Negative:
-A prolonged economic downturn.
-Fiscal slippage that leads to a marked rise in public debt.
-Renewed instability in the banking sector that would affect macroeconomic performance or require further capital injections from the state.

KEY ASSUMPTIONS

Fitch assumes that San Marino will continue to strengthen its international cooperation agreements in economic, tax and political areas, reducing the risks from external policy shocks, particularly from Italy.

Italy's economy will grow 0.6% in 2015 and 1% in 2016 after three consecutive years of recession, supporting investment and trade with San Marino.

The European Central Bank's asset purchase programme should help underpin inflation expectations, and supports our base case that in the context of a modest economic recovery, the eurozone will avoid prolonged deflation. Fitch also assumes gradual progress in deepening financial integration at the eurozone level and that eurozone governments will tighten fiscal policy over the medium term.