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

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

Fitch continues to expect mild economic growth in 2015 (1%), the first expansion in six years. Although tourism has been affected by downturn in key markets such as Russia, consumer confidence and investment have started to recover. Company registrations have picked up in 2H15, helped by recent improvements to the business environment. A modest recovery in the Italian economy, with GDP growth set to reach 0.7% this year, is also helping boost trade.

Growth over the medium term will be underpinned by rising private investment in the tertiary sector (a large retail project is in the pipeline), in addition to publicly-funded capital projects. However, San Marino's growth potential will remain below 2%, primarily as the financial sector continues to undergo structural changes.

Economic growth is having a positive effect on San Marino's public finances, with both tax and non-tax revenue set to over-perform original targets in 2015. Importantly, revenue income has been much more stable than in previous years, highlighting the benefits of a recent permanent tax revenue reform. Expenditure has been kept broadly in line with the budget, as rising transfers to public institutions have been offset by lower interest costs.

However, the general government balance (which includes the social security institute) is projected to deteriorate to a deficit of around 3% in 2015 from a surplus of 1% of GDP in 2014. This is due to the government's decree in November to inject an extra EUR40m in order to strengthen the regulatory capital of the country's main bank, Cassa di Risparmio della Repubblica di San Marino (CRSM). The authorities intend to complete the operation in the coming months. It is the third time the state has had to strengthen the troubled bank's capital adequacy since 2012, and demonstrates its status as a major fiscal liability for the state.

In the absence of further bank recapitalisations, public accounts should remain broadly in balance in 2016-17, with potential upside risks if certain reforms such as the implementation of VAT are approved. This will help stabilise public sector debt, which is forecast to rise to 23.2% of GDP by end-2015. Although public debt remains well below the 'BBB' median of 42.8%, a continuous rise in debt levels (the result of further capital injections) could erode the country's fiscal strengths and make financing flexibility even weaker.

The Central Bank of San Marino (CBSM) is continuing its efforts to improve the regulatory and supervisory framework in order to strengthen the banking sector in the wake of the country's major banking crisis. New reporting standards for liquidity provisions were implemented in July and a credit registry is likely to be in place by 1Q16, while portfolio supervision to identify new non-performing loans is coming to a close. Moreover, an Italian law on voluntary disclosure lapsed in November without any substantial decrease in liquidity in the Sammarinese banking system. There is still some risk of liquidity volatility in 2016 due to pending decisions by the Italian tax agency to determine taxes and penalties of Italian clients

On the downside, asset quality and provisioning remains weak, hindered by ongoing losses in the system, particularly at CRSM. The new capital injection should help CRSM reach adequate capital adequacy levels in 1Q16 but there is uncertainty about the bank's business strategy. In general, San Marino's finance industry is struggling to diversify from an outdated offshore model into more sophisticated service such as asset management and corporate finance.

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 population (32,000 inhabitants), limited economic diversification and high dependence on Italy. Data quality is also very weak, with limited national accounts and balance of payments figures.

RATING SENSITIVITIES
The main risk factors that, individually or collectively, could trigger positive rating action are:
-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, including improved asset quality and profitability.

The main risk factors that, individually or collectively, could trigger negative rating action are:
-A prolonged economic downturn.
-Fiscal slippage that leads to a marked rise in public debt.
-Renewed instability in the banking sector that would lead to deteriorating public debt dynamics via further capital injections and weaker GDP.

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.

Fitch expects Italy's economy to grow by 1.3% in 2016 and 1.5% in 2017, supporting investment and trade with San Marino.