OREANDA-NEWS. March 18, 2016. 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 emerging from a prolonged recession. The authorities are to be commended for maintaining a prudent fiscal stance throughout, improving international cooperation significantly, and strengthening bank oversight and supervision. Going forward, the major challenges remain turning the nascent recovery into sustainable growth, the unfinished restructuring of Cassa di Risparmio della Repubblica di San Marino (CRSM), as well as the reduction of the high stock of non-performing loans in the banking system. Financial sector issues should be dealt with swiftly to enable the banking system to restart lending to the economy and minimize contingent fiscal liabilities. Fiscal discipline to rebuild buffers, including through the introduction of the VAT, should be a fiscal policy priority. In this regard, the government should also aim at gradual modest cuts to current expenditure to finance needed capital outlays. Further improvements in the business environment and labor market flexibility would facilitate rebalancing the economy, thus enabling a diversification of economic activity. Meanwhile, a continued focus on international cooperation remains paramount.

1. San Marino’s economy is bottoming out after six years of recession. High-frequency indicators suggest the economy stabilized in 2015, and a modest recovery with growth at about 1 percent is expected for 2016 and beyond. Yet, headwinds from high nonperforming loans in the banking sector and the still incomplete restructuring of Cassa di Risparmio della Repubblica di San Marino continue to cloud this outlook. On the upside, stronger growth in Europe and Italy and the normalization of economic relations with Italy could stimulate bilateral economic activity more than expected. However, prolonged slow growth in Italy and the euro area remain further downside risks.

The banking system

2. The recapitalization of CRSM should be contingent on a deeper reorganization that quickly brings the bank back to profitability. This will likely require more aggressive downsizing of the bank. The reorganization plan should be based on conservative assumptions and show how the banks regains profitability even under a downside scenario. The current recapitalization is expected to bring the bank’s capital position in line with regulatory requirement. However, international best practice calls for further dilution of non-state shareholders. In addition, the state as main shareholder should appoint experienced turnaround experts to CRSM’s board and executive management positions.

3. A comprehensive strategy is needed to clean up banks’ balance sheets. The current large stock of nonperforming assets is a drag on banks’ profitability and inhibits their capacity to intermediate and extend new credit. Therefore, addressing the sheer level of non-performing loans is crucial to safeguard financial stability and support San Marino’s nascent economic recovery. The strategy should be properly sequenced and consist of two pillars:

  • A stocktaking, provisioning and recapitalization exercise along the lines suggested by IMF staff last year. At the start, forward-looking asset quality reviews for all banks should reduce uncertainty about asset quality. At the same time, provisions should be raised in order to bring the currently relatively low NPL coverage ratios to adequate levels. Likely capital shortfalls should be dealt with through market-based recapitalization plans or resolution.
  • Addressing regulatory and legal impediments in the NPL management and resolution process. The tax disincentives to debt write-offs and restructuring should be removed. Additional flexibility in the regulations governing asset management companies for nonperforming assets should be explored. The insolvency regime should be enhanced to facilitate reorganizations of viable companies, including by providing mechanisms for pre-insolvency and fast-track court-approved restructuring agreements, ensuring protection of new financing, and better balancing the rights of the debtor and its creditors, in line with the best practices. Lastly, to improve the functioning of the underlying market and hence support asset value and sales, the authorities should explore the scope for a limited opening of the Sammarinese real estate market to non-resident investors.

4. Implementing the strategy quickly and thoroughly requires close coordination and possibly additional resources. Intensive coordination among the government, the central bank (CBSM), and the banks as the main stakeholders is crucial for the success of the strategy. In this regard, the CBSM’s attention to the NPL problem and to policies addressing it is welcome. It remains important to ensure the CBSM is adequately resourced for this task and can exercise its duties independently.

Fiscal policies

5. San Marino should gradually rebuild the fiscal buffers that served it well in the past. These buffers have allowed the state to cushion social expenditure during the crisis and its aftermath, and would be needed again to be able to respond in similar fashion to future shocks. While current policies stabilize debt around this years’ level, an overall fiscal adjustment of 1 percent of GDP over four years would put debt on a clear downward path and create room to deal with large contingent liabilities looming in the banking system.

6. This modest fiscal adjustment should start next year. The additional public capital expenditure from the budget of €10 million annually starting this year will help support the recovery. The resulting modest deficit should be accommodated this year. Starting in 2017, the aim should be to modestly increase revenue, while reducing current expenditure by ? percent of GDP per year in each of the years 2017-2020. This would create room to permanently accommodate the higher capital expenditures.

7. The scheduled introduction of the Value Added Tax (VAT) in 2017 remains a priority, while containing the public sector wage bill and reforming the pension system are also important. The introduction of VAT should aim to increase revenues by ? - 1 percent of GDP by setting the VAT rate a bit higher than the revenue-neutral rate. Expenditure policies should aim to decrease the public sector wage bill somewhat further–even as the authorities’ policies have already shrunk these expenditures by ? percent of GDP over the last few years–, as well as rationalize and modestly reduce expenditure on public pensions and publicly financed health care benefits. In this context, the IMF mission welcomes the authorities’ commitment to reform of the public pension system and the recent setup of a working group to explore options to ensure the system’s long-term sustainability.

8. The authorities should consider external financing options. This would help diversify funding sources and break the bank-sovereign link. Given the expected small size of potential financing needs, either borrowing on international capital markets or an external private placement or syndicated loan could be considered. The current low international interest rates present an opportunity, as they limit the additional cost. In addition, agreeing on a contingent credit line with the Italian authorities would provide a welcome liquidity buffer.

The Business Environment and International Cooperation

9. The government took important steps to improve the business environment and labor markets. Examples include simplification of the process to establish a business and register property, as well as establishing an entry-level wage and temporary lower social security contributions when hiring unemployed workers. The government has piloted easing procedures to hire skilled nonresident workers for startups, and should consider scaling up such efforts to the economy more generally. It has also set up a technology and science park, where the first start ups are now operational and expanding. Such changes are important to support rebalancing of the Sammarinese economy towards industry and nonfinancial services.

10. San Marino’s focus on improving international cooperation has paid off, and should be maintained. Italy’s decision to include San Marino in its tax whitelist in late 2014 and the conclusion of the bilateral economic cooperation agreement were major steps toward openness and transparency. The activation of the credit register should start as scheduled, facilitating the cooperation with the Bank of Italy and helping banks assess credit risk. Lastly, the IMF mission welcomes the opening of negotiations with the European Union on an association agreement, the imminent completion of the national risk assessment, and the exchange of tax information starting in 2017.

We would like to thank the authorities and other interlocutors for the frank and open discussions and their warm hospitality.