Principality of Andorra: 2021 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Principality of Andorra
Author: International Monetary Fund. European Dept.
Publication Date:
11 Jun 2021
eISBN:
9781513573151
Language:
English
Keywords:
Andorran authorities; liquidity needs; general government debt; government effectiveness; General government operation; COVID-19
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1. The Principality of Andorra, the IMF’s newest member since October 2020, participated in its first Article IV consultation. The authorities are committed to further enhance transparency as they integrate into the international financial community. A coalition government took office in April 2019 with Prime Minister Xavier Espot Zamora from the Democrats for Andorra at the helm. The country enjoys political stability and has a good track-record of fiscal discipline, a gender-balanced work force, and ski resorts not dependent on air travel. The authorities successfully tested the appetite of foreign investors through successful private debt placements in 2020 and issued its first public international bond in late April 2021.

Abstract

1. The Principality of Andorra, the IMF’s newest member since October 2020, participated in its first Article IV consultation. The authorities are committed to further enhance transparency as they integrate into the international financial community. A coalition government took office in April 2019 with Prime Minister Xavier Espot Zamora from the Democrats for Andorra at the helm. The country enjoys political stability and has a good track-record of fiscal discipline, a gender-balanced work force, and ski resorts not dependent on air travel. The authorities successfully tested the appetite of foreign investors through successful private debt placements in 2020 and issued its first public international bond in late April 2021.

Macroeconomic Background

1. The Principality of Andorra, the IMF’s newest member since October 2020, participated in its first Article IV consultation. The authorities are committed to further enhance transparency as they integrate into the international financial community. A coalition government took office in April 2019 with Prime Minister Xavier Espot Zamora from the Democrats for Andorra at the helm. The country enjoys political stability and has a good track-record of fiscal discipline, a gender-balanced work force, and ski resorts not dependent on air travel. The authorities successfully tested the appetite of foreign investors through successful private debt placements in 2020 and issued its first public international bond in late April 2021.

2. Banking services and tourism dominate economic activity and employment. With consolidated bank assets over 500 percent of GDP, jobs in finance and real estate comprise 20 percent of employment, a disproportionate size compared to the region (Figure 1). Trade and tourism activity, accounting for a fifth of the economy’s gross value added (GVA) and 40 percent of employment, is comparable to Spain’s. However, with various other sectors connected to tourism, the share of the latter could be more than half of the economy.

Figure 1.
Figure 1.

Employment Shares, 2019

(Percent of total employment)

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Sources: Govern d’Andorra, Eurostat, and IMF staff estimates.Note: The figure for Finance and Real Estate for Andorra may be overstated due to the inclusion of ‘business services’ that are not included in that category for other countries.

3. The euro has served well as a monetary anchor as the economy trades extensively with the eurozone, especially Spain. The formal use of the euro is enshrined in a Monetary Agreement with the EU—that allows for a limited circulation of euro coins with Andorran themes in exchange for strict laws against counterfeiting and money-laundering, and for full adoption of EU’s financial sector legislations—while Andorra negotiates an Association Agreement to gain full access to the EU’s single market (Annex I). The economy imports two thirds of the value of goods from Spain, ranging from food to electricity. Spaniards accounted for half of the 8.2 million people visiting Andorra in 2019, followed by the French. Reflecting the close integration, annual GDP growth since 2013 has averaged 1.5 percent, similar to that of the euro area. Inflation is in line with neighbors’, not only in the headline rate but also in tourism-related services. The unemployment rate is the lowest in the region—averaging 3.4 percent in 2013–2019—and cross-border workers from France and Spain help meet the high demand for labor during the busy tourist season.

4. Fiscal policy, the main lever in the euroized country without a central bank, is prudent and anchored in a medium-term framework. The size of the general government seems small by European comparisons, with both expenditure and revenue below 40 percent of GDP in 2019 (Figure 2). Refinancing needs have been high, averaging 13 percent of GDP in 2018–19, with average maturity of debt falling over the years, reaching 2½ years by end-2019. The authorities have stayed within the remit of the “fiscal rule”—limits on debt, deficit, current spending and revenue—since its inception in 2014 (Annex II). The central government has been running primary surpluses, averaging 0.7 percent of GDP in 2015–2019. With interest payments averaging 0.6 percent of GDP during this period, the overall deficit and debt were well within the fiscal rule limits. Since the local government also ran surpluses, the general government had positive overall balances in the past seven years (Figure 3).

Figure 2.
Figure 2.

Size of the General Government, 2019

(Percent of GDP)

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Sources: Eurostat, Haver Analytics, Govern d’Andorra Department of Statistics, and IMF staff calculations.Note: San Marino numbers reflect central government revenue and expenditure.
Figure 3.
Figure 3.

General Government Debt and Overall Balance, 2013–19

(Percent of GDP)

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Sources: Govern d’Andorra Department of Statistics and IMF staff calculations.

5. The broader public sector operates well and a reform of the pensions system is about to begin. The two largest state-owned enterprises (SOEs)—the electricity company (FEDA) and Andorra Telecom—are profitable with investment strategies mostly financed from retained earnings. The SOEs have a revenue-sharing policy with the central government. The Andorran social security fund—under the mandatory “first pillar” defined contribution pension system—is, however, in need of reform as a depletion of the reserves fund by 2038 is projected in the latest actuarial study. The government has announced a public consultation aiming to enact a new law within a year to restore the pension fund to long-term sustainability.

6. Banks entered the pandemic with high reported capital and profits, but with increasing nonperforming loans. The banking system—four Andorran banks and one Spanish subsidiary—is diversified both geographically and in income models. Almost 60 percent of assets operate in 13 other countries—including Spain and Luxembourg—and almost 80 percent of income is based on non-interest income sources, which is typical in private banking. The diversification has served the sector well, delivering higher profits than in eurozone banks (Figure 4). Capitalization has grown over time, partly due to falling private sector loans due to domestic deleveraging. Nonperforming loans (NPLs) are, however, high—partly due to a large stock of legacy NPLs from a bank undergoing resolution after an anti-money laundering (AML)/Countering Financing of Terrorism (CFT) breach—and projected to increase further as the pandemic-related policies expire.

Figure 4.
Figure 4.

Banking Sector—Profitability, Capitalization, and Nonperforming Loans

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Sources: Govern d’Andorra Department of Statistics and IMF staff calculations.

7. On the eve of the COVID-19 pandemic, economic growth bucked regional trends. Real GDP grew by 2 percent in 2019 even as growth in the euro area and Spain slowed. On the production side, services contributed significantly, particularly in the financial sector that recovered after two years of declining performance, and construction continued to contribute sizably to the growth in industry (Figure 5). While data on real expenditure components are not available, nominal growth seemed to have been broad-based. Private consumption, in particular, grew with higher minimum and real public sector wages, and was supported by bank credit. However, staff estimates in the absence of data show that private investment seems to have fallen along with banks’ business lending (Tables 2 and 3). Even though the stock of domestic private sector credit is high, at 136 percent of GDP in 2019, banks cited lack of demand from firms as the main reason for low credit growth.

Figure 5.
Figure 5.

Real Economic Activity in Andorra

(Annual growth, percentage points)

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Sources: Govern d’Andorra Department of Statistics and IMF staff calculations.
Table 1.

Andorra: 2020–21 COVID-19 Fiscal and Financial Measures

article image

ERTO stands for ‘temporary employment regulation’ and comprises the temporary suspension of work contracts and the reduction of working hours.

In 2020, the government made available €230 million (equivalent to 9 percent of GDP) of loan guarantees to businesses. The table shows the amount taken up in 2020, and the amount that remains available from the total envelope in 2021 (the actual takeup could be lower).

Table 2.

Andorra: IMF Baseline Forecasts

article image
Sources: Govern d’Andorra Department of Statistics, and IMF staff calculations.

The contribution of private investment is derived as a residual. Since the fiscal accounts are covered at the general government level, investments of state-owned enterprises are subsumed under private investment.

Table 3.

Andorra: Selected Economic and Financial Indicators

article image
Sources: Govern d’Andorra Department of Statistics, Andorran authorities, Eurostat, and IMF staff calculations.

The contribution of private investment is derived as a residual. Since the fiscal accounts are covered at the general government level, investments of state-owned enterprises are subsumed under private investment.

The general government comprises the central government, local governments and the social security fund.

The central government The central government comprises Govern d’Andorra, as well as non-market public corporations and nonprofits.

8. The current account surplus is estimated to be large. The Statistical agency started producing balance of payments data with technical assistance from IMF’s Statistics Department. The estimates show that the current account balance was close to 18 percent of GDP in 2019, with net exports and net investment income contributing almost equally (see Selected Issues Paper (SIP): Current Account Balance and External Competitiveness). While not all components are available for earlier years, net exports had remained stable from 2018. In line with the current account surplus in 2019 and historically large surpluses in net exports, staff estimates of the international investment position shows a positive net asset position, but with a fairly high gross other investment liabilities stemming from banks’ dependence on foreign depositors.

Impact of the Pandemic

9. Andorra has been hit hard by the pandemic, but the authorities managed the health crisis well with universal testing and revamped hospital capacity. Tourism and domestic services fell with the stringency of containment measures in the first half of 2020 but rebounded strongly during the summer with the arrival of tourists and a temporary ease of stringency (Figure 6 and Annex III). With French and Spanish borders closed until recently, especially during the height of the ski season in the first quarter of 2021, hotels and ski resorts have already lost a major share of their annual revenue. In comparison to neighboring regions though, universal testing might have enabled more targeted containment measures (Annex III). Despite the very high prevalence of COVID-19 cases per capita (Figure 6), fatality rates are among the lowest in the world as hospital capacity and protective equipment were quickly scaled up in response to the pandemic. So far, the pace of vaccination has been comparable to that of EU countries facing similar problems of supply, and doses for half the population have arrived. About 35 percent of the population have received at least one dose so far [May 12].

Figure 6.
Figure 6.

The Impact of the Pandemic and Lockdowns on Health and Activity

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

10. In response to the outbreak, the authorities undertook mitigating fiscal measures anchored in their medium-term framework. Expenditure measures worth 2.2 percent of GDP and revenue measures worth 0.4 percent of GDP were lower than neighbors owing to fear of financing constraints during the pandemic’s first wave (Figure 7). The measures included healthcare spending and financial support for pandemic-affected sectors and households (Table 1). In addition, government guarantees worth 9 percent of GDP were made available for bank loans to liquidity-strapped companies. A 60 percent take-up of guarantees enabled a sharp increase of bank credit to firms by about 11½ percent y/y in 2020:Q2 but offset by a decline in credit to households and the public sector, as the central government diverted to other funding sources later in the year (Figure 8). The COVID-related measures and lower revenues reduced the central government balance to -4.3 percent of GDP in 2020. The measures provided about one percentage point boost to GDP growth last year, assuming an average multiplier of one across COVID-related spending categories.

Figure 7.
Figure 7.

Fiscal Response to COVID-19, in Comparison to EU

(Percent of 2020 GDP)

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Sources: IMF Database of Country Fiscal Measures in Response to the COVID-19 Pandemic (April 2021); Andorran authorities, and IMF staff estimates.Note: The timeframe for the announced measures is country-specific, but the bulk of the measures announced so far are short-term crisis-response measures implemented in 2020 and planned for 2021.
Figure 8.
Figure 8.

Bank Credit Growth to Domestic Nonfinancial Sector

(Contributions to y/y growth, percent)

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Sources: Andorran authorities and IMF staff calculations.

11. Inflation moved into negative territory in mid-2020 as the unemployment rate increased. Sharp declines in energy prices led to negative inflation in transport and recreation sectors that account for a third of the weight in the consumer price index (CPI) (Figure 9). Moreover, restrictions on services activities and social distancing further slowed inflation in restaurants and hotels through the end of 2020. Meanwhile, the unemployment rate increased to 3.2 percent in 2020:Q4, a sharp increase over 2019 but was buffered by the introduction of job retention schemes (“ERTO”). Even though the ERTO benefitted 10,181 workers in May-December, employment in hospitality and personal services sectors declined by 7.3 percent in 2020.

Figure 9.
Figure 9.

Inflation and Unemployment Rate

(Percent)

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Sources: Andorran authorities, Govern d’Andorra Department of Statistics, and IMF staff calculations.

Outlook and Risks

12. In the near-term, despite the projected rebound, economic activity is likely to remain subdued and well below 2019 levels. Under staff’s baseline, real GDP is projected to rise by 5.8 percent in 2021, from an estimated drop of 11.8 percent in 2020 (Table 2). Private consumption will recover as lockdowns ease and vaccinations for more than half of the Andorran population reduces local transmission by mid-2021. Furthermore, higher minimum wages announced for 2021 and the availability of unemployment benefits and salary support at least until June will stabilize real incomes despite record-high unemployment. Tourism, and thus net exports, are projected to recover sooner than in other countries once mobility at the borders is fully restored, since most tourists do not travel to Andorra by air. Pent-up demand for tourism and ski vacations is expected to add back to tourism receipts later this year. But, the lasting effects of the reduction in public investment in 2020, together with the planned rollback of some COVID-19 measures after June 2021, will work toward a slightly slower recovery in GDP growth than its neighbors (Table 2). Real GDP is projected to remain almost 7 percent below 2019 levels in 2021.

13. Banks are expected to be resilient in the baseline, supporting credit growth, although they face risks. On the credit supply side, even though bank profitability initially is expected to fall due to higher loan-loss provisions and lower noninterest earnings through 2021, reducing banks’ ability to grow capital organically, banks would remain sufficiently capitalized to continue lending. However, beyond the immediate liquidity needs of some nonfinancial corporates, firms’ credit demand for private investment is likely to remain lackluster. Under staff’s baseline, NPLs are expected to grow to about 9 percent of loans due to the pandemic (Figure 10). This baseline assessment is, however, subject to considerable risks (see below and policy section).

Figure 10.
Figure 10.

Capital and Nonperforming Loans

(IMF Baseline Projections; percent)

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Source: Andorran Authorities; IMF staff estimates.Note: Impact of GDP growth, unemployment rate and NPL projection on capital-to-assets via impact on return-on-assets is based on IMF European Departmental Paper “COVID-19--How will European Banks Fare?” Since policy measures are in place, the trough in capital ratio and the peak in the NPL ratio could occur later in 2021 or beyond. The leverage ratio (proxied by the capital-to-asset ratio) floor of 3 percent--even though it Is not applicable for Andorra as yet--has been taken as the “prudent level”.

14. In the medium-term, under significant uncertainty, GDP growth is expected to converge to the euro area average by 2026. Growth is projected to remain strong as the world economy recovers fully from the pandemic and consumer confidence continues to improve with lower unemployment. In keeping with its per capita income higher than the eurozone average, Andorran growth is expected to eventually converge near the euro area’s by 2026. Inflation is projected to remain subdued, slowly rising toward EA levels by 2026.

15. The current account balance seems to have moderated slightly in 2020 but is expected to rise to pre-pandemic levels by 2026. The current account surplus—based on newly produced statistics by the Andorran authorities—was 18 percent of GDP in 2019 (see SIP: Current Account Balance and External Competitiveness). High frequency indicators show that while the number of tourists fell by almost 40 percent in 2020, the large share of imported food and other necessity items, including medical supplies, have kept imports persistently high, reducing the current account balance to about 14.2 percent of GDP in 2020. With a full resumption of tourism, and a fairly flat demand for imports of necessary goods, the current account surplus is projected to increase to 19.1 percent of GDP by 2026.

16. The tourism sector in Andorra is competitive, especially in skiing. While a norm for the current account cannot be established, various measures of the real exchange rate suggest that Andorra fares well in external competitiveness, with low relative prices of exportable services and rising export market shares of tourism. A new index, developed by staff, shows that the relative price of a ski vacation in Andorra is on the lower side among European peers (Figure 11). The ongoing increase in higher minimum wages and plans to create luxury ski-tourism products are not expected to reduce the competitiveness of this sector over the medium-term.

Figure 11.
Figure 11.

“1-Week Cost of Ski Vacation” Index, 2019

(Total cost of a Swiss resort vacation=100)

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Sources: UK Post Office Travel Money Ski Resort Report 2019; US Department of State; and IMF staff estimates.Note: See SIP: Current Account Balance and External Competitiveness.

17. Risks to the outlook are substantially skewed to the downside in the near-term (Annex IV):

  • Resurgence of the virus. Vaccination efforts may falter with inadequate supply of doses or if the number of new cases and strains exceeds the vaccination rate in Andorra and its neighbors. These possibilities would entail protracted lockdowns in 2021 and a slower economic recovery in the region and in tourism. Increased firm bankruptcies and unemployment in the retail and tourism sectors would lead to additional scarring in the medium term.

  • Banking stress. Banks’ capitalization could come under intense pressure as loan and insolvency moratoria are lifted, and fiscal measures in the corporate sector expire to reveal sizeable loan losses for banks. While banks are assumed to weather losses well using analysis based on euro area loan-loss sensitivities of capital, these sensitivities could be more acute in Andorra due to its structural features (see policy section). Sizeable increases in NPLs in the banking sector and reduced capital buffers could make banks reluctant to lend sufficiently for recovery in private domestic demand.

  • Sovereign stress. Most debt is short-term and gross financing needs are high in the near-term (see policy section). Increasing stress in the real sector could entail a large call on government guarantees, substantially increasing gross financing needs in 2021 (Annex V). Moreover, banking sector stress could further increase contingent liabilities of the government—due to the systemic nature of banks and absence of lender of last resort facilities—and could raise the risk of sharply higher refinancing costs for the private and public sectors. Sudden increases in gross financing needs could put temporary stops to government programs leading to a weaker recovery.

18. Upside risks are related to both Andorra and the region. A successful deployment of vaccines covering the entire adult population in Andorra and neighbors is a clear upside risk. Moreover, policies that lead to a more rapid recovery in the eurozone and Spain would help Andorran GDP growth through a stronger rebound in tourism.

Authorities’ Views

19. The authorities broadly shared staff’s views on the economic outlook and balance of risks. While their forecast for 2021 is more pessimistic than staff’s, they are currently assessing the full outturn of the first quarter of 2021 and might revise their projections accordingly. They are optimistic about another summer rebound in tourism as they expect that 60–70 percent of the Andorran as well as the regional population (as projected by the EU authorities) will be vaccinated by the summer.

Policies: from Pandemic Support to Steering the New Economy

A. Fiscal Policy

Staff supports the fiscal rule as a medium-term anchor. However, the authorities’ ambitious consolidation plans could be costly for the recovery. The fiscal measures related to the pandemic provided strong support to household incomes and firms’ liquidity, while maintaining debt sustainability Public support will need to continue until the recovery firmly sets in, and public investment, at least on maintenance projects, could increase while the authorities diversify funding sources. Investing in tourism, electricity, and environmentally-sustainable projects will not only lift growth but also boost private investment while bringing the unemployment rate half-way down to 2019 levels. Andorran public debt would remain sustainable in such a higher-public-investment scenario. In the medium-term, as primary fiscal balances turn positive, the authorities will need to build international reserves on a precautionary basis.

20. Public debt increased beyond the fiscal rule limit in 2020 but remains sustainable. The worsening of the fiscal balance and large debt repayments resulted in gross financing needs of the central government of 18 percent of GDP in 2020. The gross financing needs are lower for the general government since the local government and the social security administration run surpluses. To cover these needs, but also as a pre-financing strategy partly to cover large amortizations due in 2022, the central government issued new debt accessing both domestic and external sources. As a result, central government debt increased to 48.4 percent of GDP in 2020 (Figure 12), supported by activation of the escape clause embedded in the fiscal rule (Annex II). Higher revenues during the recovery and roll-back of COVID-19 measures will lead to primary surpluses from 2023 (Figure 13). Furthermore, the 10-year maturity of the €500 million Eurobond issuances will reduce debt service substantially in the short-to-medium term. The combined effects will see debt reaching the fiscal rule target of 40 percent of GDP by 2024

Figure 12.
Figure 12.

Central Government Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Source: Andorran authorities, 2020 and 2021 Budgets, and IMF staff calculations.Note: The ‘Pre-COVID19’ scenario is based on the 2020 Budget. The ‘Post-COVID19 (Authorities)’ scenario is based on the 2021 Budget and discussions with the auhotirities. The ‘Post-COVID19 (IMF staff)’ scenario is the staff’s baseline. The Post-COVID 19+ Investment scenario assumes that public investment increases by 1 percent of GDP per year in 2021–23 relative to the baseline, and it is financed with an additional €100 million Eurobond issuance in 2022. The Maximum allowed corresponds to the fiscal rule target of 40 percent of GDP.
Figure 13.
Figure 13.

Central Government Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Sources: Andorran authorities, 2020 Budget and IMF staff calculations.Notes: The Pre-COVID19’ scenario is based on the 2020 Budget The Post-COVID19 (Authorities)’ scenario is based on the 2021 Budget. The Post-COVID19 (IMF staff)’ scenario is the staff’s baseline.

21. In the near-term, fiscal policy should evolve in line with the demands of the pandemic, and the authorities should not prematurely withdraw stimulus. The authorities are planning to maintain the healthcare spending to finance the purchase of vaccines and tests, and the operation of the COVID Office (Table 1). They are also keeping in place most support measures to households, while those to firms—particularly ERTO—are being rolled back as the economy is projected to recover. The risk of renewed lockdowns and uncertainty with various virus strains call for maintaining emergency lifelines, particularly for firms. These could only be rolled back gradually, reducing the coverage and generosity of programs if local transmission is low and activity has begun to normalize. Acquisition of vaccines for the entire population is necessary.

22. The scaling back of public investment in 2020 could hurt the recovery and should be reversed as soon as feasible. Planned public investment spending was cut back by about 0.4 percentage points of GDP in 2020, while it increased on average in the EU (See SIP: Public Investment to Catalyze Andorra’s Recovery). Even though there were some offsetting investments in digital and sustainable-energy infrastructure, the cuts in a few construction projects could reduce growth prospects assuming reasonable multiplier effects (October 2020 IMF Fiscal Monitor). Furthermore, in the 2021 budget, public investment is projected to stall in 2021–2023, which could significantly drag down medium-term growth. Staff analysis shows that a modest increase in public investment—around 1 percent of GDP per year in 2021–23, financed by issuing €100 million extra debt—could raise real GDP level by 3 to 6 percent in the medium-term, compared to staff’s baseline projections (Figure 14). Moreover, greater job-creating capacities of climate-mitigating green investments—such as adopting renewable energy sources and retrofitting buildings—would enable a faster return to the precrisis unemployment rate (Figure 14 and SIP: Public Investment to Catalyze Andorra’s Recovery), while boosting private investment. Public debt is expected to remain sustainable in this higher public investment scenario (Annex V).

Figure 14.
Figure 14.

Impact of Higher Public Investment on Real GDP and Unemployment in Andorra

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

23. In the medium-term, more infrastructure spending could increase long-term growth by strengthening Andorra’s position in tourism and adapting to climate change. The authorities already have plans to diversify the tourism season by offering varied summer activities. While planned investments in climate mitigation are welcome, the authorities will need to adapt to climate change as ski slopes become warmer. Additional investments in artificial snow-making machines—either directly or through incentivizing private investment—could help Andorra’s competitiveness in tourism even further and lead to more sustainable fiscal revenues. Moreover, the authorities have been weighing the costs and benefits of train connections with Barcelona and French cities as a form of green investment. The authorities should continue to carefully assess the viability of these investment strategies along with costs and ensure proper governance arrangements on public procurement.

24. The authorities should continue diversifying funding sources and lengthening debt maturities. In the midst of the pandemic, the authorities borrowed externally for the first time in 2020, with Spanish and French banks as lenders and as intermediaries for private debt placement, which was oversubscribed. The government is also trying to secure long-term financing from multilateral banks such as the European Investment Bank and the Council of Europe Development Bank. Importantly, the government successfully floated Andorra’s first international bond on April 27, with a rating of BBB+ (Fitch) and BBB (S&P), worth €500 million with a maturity of 10 years. At a yield of 1.25 percent, this bond was oversubscribed.

25. Over time, the fiscal authorities will need to build international reserves to cover their liquidity needs on a precautionary basis. Staff assesses such reserves needs to be about 12 percent of GDP or €334 million in the baseline scenario (Figure 15 and SIP: Gross International Reserves), provided that the banking system is liquid and its liquidity risks are well supervised. Using detailed bank-by-bank data on liquidity, staff assessed the liquidity gap to be zero based on the definition of liquidity coverage ratio (LCR) adopted from EU regulations. According to this metric, high-quality liquid assets are more than sufficient to cover net outflows of liabilities over a 30-day period. Against the government’s liquidity needs, available reserve assets with the IMF amount to 2 percent of GDP, equivalent to €62 million. The “shortfall” of €273 million could be built up over time. The allocation of IMF Special Drawing Rights (SDRs), expected later this year, would increase available reserves by almost 4 percentage points of GDP.

Figure 15.
Figure 15.

International Reserves

(Percent of 2019 GDP; end-2019 unless otherwise stated)

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Sources: Andorran authorities and IMF staff calculations.1/ As of end-2020.2/ The banks’ liquidity gap is the difference between the banks’ liquidity buffer and the net liquidity outflows in a 30-day stress period under a more adverse scenario. The net outflows are calculated by subtracting haircut-adjusted liquidity inflows from gross liquidity outflows. The gross outflows correspond to the available stock of funding sources multiplied by their corresponding outflow rates in a 30-day stress period. The baseline scenario assumes that the eligibility of liquid assets for the buffer, the haircuts on 30-day inflows and the 30-day outflow rates are consistent with the LCR regulation. In such scenario, the liquidity buffer exceeds the net outflows and there is no liquidity gap.3/ The fiscal buffer is equivalent to one month of total government spending.

26. Different options are available for accumulating reserves, which need to meet certain qualifications. The government could increase the contribution rate to the compensation account under the fiscal rule, save all future fiscal surpluses starting in 2023, or issue debt. To qualify as international reserves, these assets need to be under the legal and managerial control of the central government and invested abroad in highly liquid assets (SIP: Gross International Reserves).

Authorities’ Views

27. The authorities broadly agreed with the assessment and policy recommendations on the fiscal front. They reiterated their commitment to fiscal discipline and to bring the debt level below their fiscal debt limits, while taking advantage of the favorable financial conditions and exploring alternatives to build international reserves. The authorities highlighted that the COVID-related measures limited the loss in households’ income and businesses’ bankruptcies. The authorities welcomed staff assessment on the need to boost public investment to support the economic recovery and aid the economic transformation. They noted that, despite the investment cuts in 2020–21, the government has well-developed public investment plans for the coming years that can be fast-tracked. However, they would like to balance the implementation pace with their medium-term fiscal goals. They also noted that the public investment multiplier in Andorra could be lower than in peer countries given the small size and openness of the economy.

B. Financial Sector Policies

Banks have weathered the pandemic well so far, with high levels of profitability and capital buffers and pandemic policies in place. However, reliance on foreign deposit funding, loans to banks’ own shareholders and other related parties, as well as large exposures to the domestic economy carry substantial risks. The Andorran Financial Authority (AFA) should carefully assess the capital needs in light of the structural risks and the impact of the policy measures adopted during the pandemic. Technical assistance from IMF’s Monetary and Capital Markets Department will take a close look at the structural risks and provide detailed recommendations on bank supervision later this year.

28. The banking sector seems to be weathering the pandemic well, while fiscal and financial sector policies are still in place, amid a lack of credit demand for investment purposes. The emergency fiscal measures are providing substantial support to household incomes and firms’ expenses during the pandemic. Still, borrowers took up the offer of moratoria on about 8 percent of GDP worth of loans. Similarly, firms have accessed credit from banks using loan guarantees from the government to tide over liquidity needs. However, in such an uncertain environment, businesses—especially in the tourism sector—are reluctant to borrow more for investment purposes. Bank capital has been holding up well so far due to very few loan losses in the pandemic and the presence of the insolvency moratoria.

29. The stock of NPLs remains high and is concentrated in the services sector. The high ratio of NPLs is partly due to legacy loans from Banco Privada d’Andorra, which is under resolution since 2015 after an AML/CFT breach. When adjusted for these legacy assets, the NPL ratio is close to 3 percent of gross loans, and near the regional average. Part of the recent increase in NPLs is also due to the adoption of new regulation that modified the classification of such loans. The nominal stock of NPLs remain concentrated in services and construction/real estate sectors and a market for NPLs do not exist (Figure 16). The NPLs usually are resolved by prolonged work-outs.

Figure 16.
Figure 16.

Stock of Nonperforming Loans

(Millions of euros)

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

Source: Andorran authorities.

30. Banks’ capital adequacy needs to be assessed in light of related party lending and large exposures. As in many small countries with a non-diversified economic base and large banking sector, Andorran banks are exposed to domestic credit risks from large exposures to a few clients. These features could lead to a higher sensitivity of loan losses to the economic downturn. Moreover, a considerable share of loans goes to banks’ “related parties” such as shareholders (Figure 17). This poses risks to the measurement of bank capital, which needs to be adjusted for such transactions. To illustrate the issue, staff analysis shows that deducting the full amount of related party loans from total capital would reduce the capital-to-asset ratio by almost 3 percentage points. This adjustment would decrease the projected capital-to-asset ratio of a portion of the banking sector below the 3 percent threshold—used in the illustrative analysis as a proxy for the leverage ratio floor—exposing a capital ratio gap of about 2 percent of GDP.

Figure 17.
Figure 17.

Banking Sector—Related Party Loans and Bank Capital

Citation: IMF Staff Country Reports 2021, 107; 10.5089/9781513573151.002.A001

31. Banks remain highly liquid, but dependence on foreign funding requires continuous vigilance. Due to the adoption of the EU’s bank liquidity rules, Andorran banks need to have an LCR of 100 percent since January 2021. Against this requirement, Andorran banks have an LCR close to 200 percent, assuming liquidity outflows specified in the regulation and consistent with regional crisis scenarios. Staff’s liquidity stress test based on detailed bank-by-bank data suggests, however, that banking system’s liquidity gap could go up to 6.8 percent of GDP in an extremely adverse scenario where liquidity outflows of stable and unstable deposits occur at up to thrice the rate assumed in the baseline. The Andorran Financial Authority (AFA) will need to monitor the liquidity situation very closely, paying special attention to banks that are most exposed to this risk.

32. In the near-term, the AFA should assess the impact of the pandemic on bank capital. The temporary moratoria on debt service might have made bank balance sheets less transparent, even though the take-up was limited, and AFA should ensure that loan classifications and provisioning are continuing in a proper manner. Good provisioning practices are also needed in the absence of an NPL resolution market since banks would eventually need to mostly absorb the cost through write-offs. If the economic outlook worsens, loan moratoria should only be extended by banks on a case-by-case basis to eligible clients. Borrowers would seem to meet loan commitments if the fiscal support to households and firms is extended. Blanket moratoria would reduce bank income prospects and regulatory forbearance on loan classification would obscure bank balance sheets.

33. In the medium-term, AFA needs to manage three key risks. First, it needs strengthened rules on related party lending aiming to disincentivize banks from such loans. It could consider additional capital in the form of “Pillar II” on related party exposures of specific banks. Second, it needs to continue vigilance on liquidity risks to ensure an adequate level of liquid assets to meet short-term runs from foreign depositors. Third, the authorities should strengthen the monitoring of cross-border flows, including through cooperation with foreign counterparts, and continue deepening the understanding of money-laundering risks.

Authorities’ Views

34. The authorities concurred with the assessment of the financial sector risks highlighted by staff and offered important nuances. The AFA closely monitors loans to related parties and acknowledged that an increase in capital requirements might be necessary to mitigate the associated risk. The supervisor stressed that NPLs declined in 2020 and that it did not expect them to increase when the COVID measures are lifted, arguing that most firms faced liquidity issues but not solvency problems. On NPL resolution, the AFA explained that there is a good share of restructuring to support the companies’ deleveraging process and that, as a result, foreclosures are not usual. And, even when these happen, it is easy and profitable to sell a foreclosed property, given the current conditions in the real estate market. They attributed falling corporate credit growth over the years to low demand, and the reluctance of firms to accumulate debt in an uncertain environment, and instead preferring to use their own resources to finance investments.

C. Governance and Transparency

Indicators of government effectiveness, such as voice and accountability, rule of law, and political stability, compare or exceed those in the region. But Andorra is yet to ratify the United Nations convention against corruption. The authorities should build on the important progress made on the production of balance of payments statistics to close remaining data gaps.

Governance

35. Further efforts to improve good governance are encouraged. While a reform of the public procurement framework is underway, information on the beneficial ownership of entities— that were awarded contracts, including COVID-related ones—should be collected and published to increase transparency and accountability of public spending. In the absence of an anti-corruption strategy, the authorities should further strengthen the coordination of measures to combat corruption and identify areas for priority action. Andorra should ratify the United Nations Convention against Corruption (UNCAC) and adopt the bills on asset declaration and public access to information.

36. The effectiveness of the AML/CFT framework needs to build on the important progress made so far. Since 2018, the understanding of ML risks in the banking sector has been improving. An update of the national risk assessment is being finalized. UIFAND’s AML/CFT supervision is risk-sensitive, but it mostly focuses on risks related to crimes committed in Andorra. To deepen the understanding of ML risks, the monitoring of cross-border flows, including through cooperation with foreign counterparts, should be further developed. Moreover, focusing the allocation of resources to higher risk areas would increase the effectiveness of AML/CFT supervision.

Data Gaps

37. Closing data gaps and publishing statistics according to international standards are key to achieving transparency. There is room for improving Andorra’s statistical system in several dimensions. Various data gaps need to be closed, including in real expenditure components of GDP, international investment position, and data on financial soundness for banks and the private sector (see Informational Annex). Preparing an advance release calendar containing release dates for major macroeconomic statistics would also help transparency and surveillance. The authorities may benefit from using the Enhanced General Data Dissemination System (e-GDDS), which is the first tier of IMF data sharing standard for macroeconomic data essential for policy making and surveillance, to further develop Andorra’s statistical system and improve data transparency. The IMF can provide technical assistance on the various areas if requested.

Authorities’ Views

38. The authorities consider the risk of corruption in Andorra to be moderate. They also concur with the view that the publication of information on beneficial ownership of entities that were awarded procurement contracts would strengthen transparency. AML/CFT supervisors agree that the understanding of ML/TF risks of cross-border flows in banking sector need to be properly evaluated.

39. The authorities plan to continue working with the IMF in further developing Andorra’s statistical system and to participate in e-GDDS. They are interested in requesting further technical assistance from the IMF to improve their data transparency.

Staff Appraisal

40. The pandemic has taken a considerable economic toll but the authorities managed the health crisis well. Universal testing and expanded hospital capacity kept fatality rates very low despite a high number of cases. This strategy helped Andorra implement more targeted internal restrictions than the neighboring countries. At the same time, emergency fiscal measures stabilized real incomes and supported firms. The authorities are highly engaged in transitioning to a green and digitalized economy and more diversified tourism services.

41. Fiscal policy should remain supportive in the near-term and allow for higher public investment in the medium-term. The fiscal rule has served well as a medium-term anchor and offers space for a slower consolidation than the authorities’ plans. The risk of renewed lockdowns and uncertainty with various virus strains call for maintaining emergency lifelines. These should only be rolled back gradually, reducing the coverage and generosity of programs if local transmission is low and activity begins to normalize. Some of the planned investments in digital technologies and in climate adaptation and mitigation could be brought forward in 2021 to support the recovery. Frontloading the planned public investment could boost private investment in tourism-related sectors, which are reluctant to invest during uncertain times.

42. Over time, the fiscal authorities will need to build international reserves to cover their liquidity needs in the event of future crises. IMF staff assess such reserves needs to be about 12 percent of GDP, which would be sufficient to cover one month of imports, fiscal revenue fluctuations, and short-term external debt service. Against these liquidity needs, the currently available liquidity is limited to the reserve assets with the IMF, worth two percent of GDP at this stage. Various options are available to build up the remaining 10 percent of GDP over time. Bank liquidity risks need to be intensely supervised to make sure reserve needs of the government do not rise.

43. AFA should ensure banks’ sound health in the near-term and manage three structural risks in the medium-term. The supervisors should assess the impact of the pandemic on bank capital so that banks are strong enough to support the recovery and respond to increased demand for credit. Moratoria should be extended only to eligible clients, if needed. In the medium-term, AFA needs to consider stronger rules against related party lending and additional capital in the form of “Pillar II” on related party exposures of specific banks. It should continue to ensure that there are no liquidity gaps in banks. Moreover, the authorities should strengthen the monitoring of cross-border flows and continue deepening the understanding of money-laundering risks.

44. The authorities should develop a strategy to increase the effectiveness of measures to counter corruption. To strengthen the anti-corruption legal framework, Andorra should ratify the UNCAC, establish an assets declaration framework for politically exposed persons, and ensure appropriate public access to information in line with the UNCAC.

45. The authorities already recognize the importance of publishing statistics according to international standards. They are making rapid strides in further developing more comprehensive data on Andorra’s economy to help policy-making and to improve surveillance. They produced balance of payments statistics, with support from the IMF, within a few months of membership. Other external, real, fiscal, and financial sector statistics need to be compiled and reported according to international standards. The authorities plan to work with the IMF in this area and participate in the Enhanced General Data Dissemination System.

46. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Table 4.

Andorra: General Government Operations

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Sources: Govern d’Andorra Department of Statistics, Andorran authorities and IMF staff calculations.Note: The general government comprises the central government, local governments and the social security fund.
Table 5.

Andorra: Central Government Operations

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Sources: Govern d’Andorra Department of Statistics, Andorran authorities and IMF staff calculations.Note: The central government comprises Govern d’Andorra, as well as non-market public corporations and nonprofits.