Journal Issue

Republic of San Marino

International Monetary Fund
Published Date:
March 2011
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I. Context

1. The tax haven model – intensifying pressure to change. For years, the Sammarinese economy benefited from its tax haven and bank secrecy status. Banks were able to attract substantial deposits from abroad, helping to propel system assets to around 900 percent of GDP by end-2008, while boosting income and employment growth. However, under pressure from larger economies, tax havens around the world have been forced to embrace greater transparency. In this context, San Marino is currently undergoing a strategic review of its business model and has made some progress on enhancing financial transparency. Italy has added to the pressure by increasing its crackdown on tax havens. It launched a tax amnesty in September 2009 and, in July 2010, extended the impact of an earlier inclusion of San Marino on a ‘blacklist’ of tax haven countries, further straining relations between the two countries.1

2. A fragile economic setting. The economy is struggling to recover from a long recession. The financial sector is still adjusting to the effects of Italy’s tax amnesty, which led to a significant outflow in bank deposits and, consequently, to a considerable decline in the size of Sammarinese banks’ balances sheets. The system has shown some resilience to the deposit outflow, but liquidity, profitability and asset quality have also been affected by the economic slowdown. The central bank of San Marino (CBSM) has been monitoring and responding to the effects of the tax amnesty and other developments, including the international pressure for greater economic and financial transparency and the resolution of Italy’s troubled Delta Group, which is owned by Cassa di Risparmio di San Marino (CRSM), San Marino’s largest bank. Certain other sectors, e.g., manufacturing, have begun to gradually recover from the spillovers of the global financial crisis, but overall investment remains dormant, as confidence is low and uncertainty looms large.

II. Recent Economic Developments and Outlook

3. A long recession may end this year. Following two years of economic contraction—1 percent in 2008 and 13 percent in 2009—led primarily by a 37 percent decline in fixed investment (Figure 1), the Sammarinese economy remains weak, with construction activity and employment in the manufacturing sector well below their levels in the period preceding the global financial crisis. Notwithstanding a moderate expansion in manufacturing and commercial activity during the first half of last year, rising unemployment, stagnant wage growth, and lower confidence have all contributed to a fall in consumption. As a result, real GDP is estimated to have declined by about 1 percent in 2010, while recent activity indicators suggest that the economy has been slow to recover (Figure 2). 2 This year, the economy could build some momentum, subject to normalization of relations with Italy, which accounts for 90 percent of San Marino’s exports (Figure 3), but growth is projected to be meager below 1 percent (Table 1).

Figure 1.San Marino: Output Developments, 1999-2012

Sources: IMF, World Economic Outlook, Sammarinese authorities; United Nations; UPECEDS; and IMF staff calculations and projections.

Note: Lines are smoothed between actual data points.

1/ The trend is constructed based on the average growth rate over 2000-2008.

Figure 2.San Marino: Recent Economic Activity Indicators, 2007-2010

Sources: Sammarinese authorities; UPECEDS; and IMF staff calculations and estimates.

Note: Lines are smoothed between actual data points.

1/ Constructed based on activity indicators for commerce, construction, financials, and manufacturing, weighted by each sector’s contribution to GDP.

Figure 3.San Marino: External Sector Indicators, 2000-2010

Sources: CBSM; IMF, Information Notice Systeml and International Financial Statistics; UPECEDS; and IMF staff calculations.

Note: Lines are smoothed between actual data points.

Table 1.San Marino: Selected Economic and Social Indicators, 2005-2011
Activity and prices
Real GDP (change in percent)
Domestic demand2.00.40.7-15.4-20.7
Final consumption2.
Fixed investment1.20.1-5.5-27.8-36.7
Net exports (contribution to growth)
Industrial production (change in percent)
Employment (change in percent)
Unemployment rate (average; percent)
Inflation rate (average; percent)
Nominal GDP (millions of euros)1,1061,1711,2331,2591,1021,1151,145
Public finances (percent of GDP)
Overall balance4.
Primary balance4.
Gross debt6.
Money and Credit
Bank lending (change in percent) 1/14.913.0-9.1
Private credit (change in percent) 2/16.222.619.410.48.7-12.5
Net foreign assets (percent of GDP) 2/99.349.257.943.55.0-12.3
Commercial banks72.
Central bank27.131.135.740.348.226.9
External accounts (percent of GDP)
Trade balance 3/-3.7-0.32.416.624.022.3
Exports 3/184197202223214166
Imports 3/188197200207190144
Gross international reserves (millions of U.S. dollars) 2/354479648707790391
Number of tourists (millions)
Exchange rate
Euros per U.S. dollar (average)0.800.800.730.680.720.76
Bilateral exchange rate wrt. Italy (average) 4/100100101101103104
Real effective exchange rate (Italy, average)10010010010210399
Financial Soundness Indicators (percent)
Regulatory capital to risk-weighted assets23.118.917.516.916.9
Nonperforming loans to total loans 2/5/4.28.510.0
Provisioning to total loans 1/
Social Indicators
GDP per capita (2009) 6/48,959U.S. dollar
Ratio of GDP per capital of:
Land area61.2sq km
Population (November 2010)31,871
Population density (November 2010)521per sq km
Life expectancy at birth, total (2006)82.2
Life expectancy at birth, male (2006)79.4
Life expectancy at birth, female (2006)85.1
Infant mortality rate per 1,000 live births (2008)1.2
Literacy, adult (2008)81.6
Sources: Sammarinese authorities; World Bank; and IMF staff estimates.

4. Employment declined steadily over the past two years, but a generous wage-supplemental system has kept the unemployment rate contained. Following strong employment growth during the pre-crisis period, the unemployment rate has risen from a low of 2.4 percent in mid-2008 to a high of 5.6 percent in late-2009. The unemployment rate fell steadily during the first half of last year, but has since increased again to 5.3 percent (November). While the unemployment rate more than doubled since 2008, the upward move was relatively modest, considering the sharp decline in output. This is largely explained by a substantial increase in the usage of the wage-supplemental system over the past two years (Figure 4).3 At the same time, the output collapse in 2009 translated into a sharp deterioration in productivity and a significant increase in unit labor costs, as average wage and overall labor cost remained roughly unchanged from a year earlier.

Figure 4.San Marino: Labor Market Developments, 1990-2010

Sources: IMF, World Economic Outlook; ISTAT; UPECEDS; and IMF staff calculations.

Note: Lines are smoothed between actual data points.

5. The financial sector is still adjusting, in the wake of the tax amnesty. The banking system was able to withstand a 35 percent deposit outflow in 2009-10, largely because of the previous substantial holdings of (mainly foreign) liquid assets. A large portion of these assets were sold to manage the deposit outflow. Balance sheets have shrunk accordingly and become less liquid (see Box 1, Table 2 and Table 3). Because of the economic slowdown, asset quality declined too. Nonperforming loans (NPLs) rose from about 4 percent of total loans at end-2008 to an estimated 10 percent in June-2010, while system profitability fell significantly over the same period. In view of the weak economic outlook, NPLs are expected to continue to increase in the near term, further squeezing banks’ profits.

Table 2.San Marino: Financial Soundness Indicators, 2004-2010
2004200520062007200820092010Latest Data
Capital adequacy ratios (percent)
Regulatory capital to risk-weighted assets22.823.118.917.516.916.9
Capital to assets12.111.610.910.810.711.1
Asset quality ratios (percent)
Nonperforming loans to total loans 1/4.28.510.1Jun-10
Nonperforming loans to capital 1/18.442.1
Provisioning to total loans5.
Provisioning to total NPLs77.234.441.4Jun-10
Earning and profitability (percent)
Return on assets (ROA) 2/
Return on equity (ROE) 2/
Return on equity (ROE) 3/
Return on equity (ROE) 4/
Interest margin to gross income48.247.846.943.943.536.839.2Jun-10
Non-interest expenses to gross income23.122.920.918.317.720.532.1Jun-10
Trading income to gross income2.82.40.3-4.2-
Administrative expenses to non-interest expenditures89.189.989.991.592.193.695.1Jun-10
Liquidity (percent)
Liquid assets to total assets 5/53.551.042.541.942.028.923.9Jun-10
Liquid assets to short-term liabilities 6/78.990.490.396.3103.581.074.1Jun-10
Loans to deposits54.855.668.866.975.288.597.6Oct-10
Interest rates (basis points)
Spread between lending and deposit rates496567478482Jun-10
Sources: CBSM; and IMF staff calculations.
Table 3.San Marino: Consolidated Balance Sheet of the Banking Sector, 2009-2010(millions of euros)
June 2009

Total Domestic-owned
Foreign-ownedJune 2010

Total Domestic-owned
Cash and other values493317301615
Loans to banks:1,0835944891,322951371
a) on demand827389438372169203
b) other loans25620551950782168
Loans to customers5,4343,8981,5364,6423,1691,473
Bond portfolio and other debt securities:3,9251,8382,0861,647926720
a) issued by public entities8419056134
b) issued by banks3,2191,039568471
c) issued by other financial entities48736629966
d) issued by other entities13552349
Shares, interests and other equity securities72601258508
Equity investment1791502915112229
Other assets737346391685356328
Accruals and prepayments573126362511
Total assets11,5376,9504,5878,5705,6152,956
Due to banks:16414322641469172
a) on demand52391315858101
b) on term or with notice113104848341172
Due to customers:3,9032,1161,7872,8951,6371,259
a) on demand3,6291,9851,6452,6081,5221,086
b) on term or with notice27455219287115172
Debt securities:5,5043,3352,1683,2132,293919
a) bonds668487180901710191
b) certificates of deposit3,6592,6521,0062,3111,583728
c) other instruments1,178196982000
Other liabilities546314232492276216
Accruals and deferred income41291222157
Retirement allowance202202
Funds for risk and charges:5138131931849
a) post-retirement benefit obligations2222023220
b) tax liabilities154111248
c) other provisions141221591571
Reserve for possible loan losses2828012102
Total liabilities10,2406,0044,2367,4704,8842,586
Fund for general banking risks261258447425
Subordinated debt000553817
Share capital678524154680513167
Share premium1221012210
a) ordinary reserve136419514948101
b) extraordinary reserve10451531135361
c) other reserves47361129272
Retained earnings-5-50220
Net profit6440241367
Total capital1,2979473501,101731370
Sources: CBSM; and IMF staff calculations.

6. Risks to the outlook are mainly on the downside. Given a moderate growth outlook for Italy, output expansion is projected to remain weak over the medium term. Moreover, financial sector profitability and employment are likely to be lower than in recent years, because of the compression in banks’ balance sheets, following the tax amnesty, as well as the need to adjust to new regulations and develop a new business model. In this context, staff projects output growth of 0.8 percent and 1.1 percent in 2011-12, compared with an average growth rate of about 3.5 percent in the pre-crisis period and over 7 percent during the 1990s. The central scenario assumes a normalization of relations with Italy. Risks to this scenario are tilted to the downside, not least because of the uncertainty surrounding San Marino’s strained relations with Italy.

Authorities’ views

7. The authorities concurred with staff’s views about the economic outlook. The government does not produce standard macroeconomic projections. However, the authorities agreed with the staff on its assessment of current macroeconomic conditions and shared staff’s view on the downside risks to the medium-term outlook. In particular, the authorities highlighted the strained relations with Italy as the primary downside risk to the outlook.

Box 1.San Marino’s Financial System in the Aftermath of Italy’s Tax Amnesty

The tax amnesty, which was in effect between September 2009 and April 2010, took a severe toll on San Marino’s financial sector. Bank deposits fell by 35 percent, while assets managed by financial companies dropped over half. The tax amnesty did not result in reducing the number Sammarinese banks, but quite a few non-bank financial institutions were forced to close down.

In light of the weak economy, profitability and asset quality have also been affected over the past year. Banking system profits were €47.3 million at end-2008 and €47.2 million at the end of 2009. By mid-2010, system profits dwindled to €13.2 million, while the CBSM estimates that profitability continued to fall since then. Asset quality declined too, with NPLs (including problem and doubtful loans) rising from about 4 percent of total loans at end-2008 to an estimated 10 percent at mid-2010.

Financial System(millions of euros)
Number of banks121212
Number of financial companies534937
Assets of banks11,5369,4478,570
Fiduciary activity by financial companies3,4601,9211,496
Banking System Deposits(millions of euros)
Total deposits7,1825,8434,985
of which: by nonresidents4,1803,0382,554
Banking System Deposits(millions of euros)
Loans to banks1,2511,2061,322
Bonds and other debt securities3,9172,3121,647
Loans to customers5,1294,8874,642
Fixed assets199185182
Other assets994814747
Total assets11,5369,4478,570
Sources: CBSM; IMF, International Financial Statistics; and IMF staff calculations and estimates.

Still, the banking system successfully withstood the sizable deposit outflows, in large part due to the nature of its old business model. Deposit rates offered by Sammarinese banks prior to the amnesty did not need to be particularly competitive, as it was confidentiality rather than the rate of return that attracted Italian deposits. Given that the cost of funds was relatively modest, Sammarinese banks could afford to invest substantial funds in relatively liquid securities with lower returns. These holdings of liquid securities were strength to the system when the banks had to manage the effects of the tax amnesty. By the middle of 2010, the extent of liquid resources was significantly reduced. Moreover, whereas previous tax amnesties only resulted in a temporary fall in deposits, the most recent amnesty is expected to reduce the deposit base permanently, as it coincides with the dilution of bank secrecy and the transformation of the business model.

Bank Funding and Lending

(millions of euros)

Bank Liquidity

Source: CBSM; IMF, International Financial Statistics; and IMF staff calculations.

III. Policy Discussions

A. Financial Sector

8. In the wake of rising system vulnerabilities, the central bank has taken measures to bolster liquidity. Following on the 2009 stepped-up liquidity reporting requirements, which were aimed at monitoring the effects of the tax amnesty, the central bank last year implemented a new reserve requirement system that helped spur the development of a domestic interbank lending market.4 In addition, the CBSM has proposed to implement a new arrangement whereby securities held by Sammarinese banks could be pooled and used by the CBSM as collateral for repo agreements with foreign counterparties, thereby obtaining added liquidity. The CBSM is further considering (i) new rules that would permit the securitization of bank loans, (ii) taking on a role in managing the supply and distribution of cash to banks, so as to increase efficiency, and (iii) introducing a central register of credit risks so as to ensure it is aware of the exposure of the banking system to single or connected borrowers. Some of these measures would require close cooperation with the Italian authorities.

9. A recapitalization plan is being considered in order to buttress the financial position of CRSM. The assets of CRSM account for close to 40 percent of the banking system and are the equivalent of about 300 percent of San Marino’s GDP. The resolution of Italy’s Delta Group, which is largely owned by CRSM and has been under special administration since mid-2009, may result in sizable losses to CRSM. Based on preliminary information, staff estimates that net losses from the Delta resolution to CRSM could result in recapitalization needs of about €160 million.5 However, losses from Delta could be higher, which would entail larger recapitalization needs.6 A final assessment of the scale of Delta’s losses is expected by end-March, although the final agreement with creditors and shareholders may not happen until June. The Central Bank is monitoring the resolution process and evaluating various contingency options.

10. Progress has been made on meeting the 2009 FSAP recommendations. The authorities secured passage of important legislation to buttress financial sector supervision. They have taken measures to enhance the independence and resources of the CBSM, fortify on-site and off-site supervisory functions, and enable the CBSM to assist in the provision of liquidity to banks. In addition, new regulations have circumscribed the activity of fiduciary companies, enhanced AML/CFT defenses, abolished the use of bearer shares, and tightened customer due diligence requirement (see Box 2). However, while supervision has been conducted by the strengthened supervisory staff under the direction of the Supervision Committee of the CBSM (Chaired by the Director General), the position of the Head of Supervision has remained vacant for over a year.7

11. The business model that sustained the rapid expansion of banks’ balance sheets is no longer viable. This has profound long-term implications for the Sammarinese financial sector. The scale of the deposit outflow that resulted from the tax amnesty gives an indication of the motivation of much of the Italian business handled by Sammarinese financial institutions. The CBSM fully understands that there could be no return to a business model based on bank secrecy and tax haven status. Indeed, the measures already taken to tighten regulations and increase transparency ruled this out.

12. The authorities and the private sector are undertaking a strategic review of the financial system’s prospects. Emerging ideas envisage the development of fee-based services (such as specialist asset management) that (i) do not rely on bank secrecy, (ii) provide genuine value added, and (iii) should not result in the expansion of banks’ balance sheets beyond the capacity of the limited lender of last resort (LOLR) facilities of the CBSM. Indeed, the CBSM’s capacity to act as a LOLR, particularly to domestically owned banks, is limited by its inability to create money, leaving liquidity pressures very difficult to manage. New financial activity within San Marino would be limited at first, perhaps confined to the administration of collective investment schemes, with portfolio management and depositary services initially outsourced. In time, however, and coinciding with the development of relevant new skills, San Marino may be able to increase the local value added of such services.8 In addition, strengthening relationships with reputable foreign banks, including through acquisition by foreign banking groups, would enable Sammarinese banks access to a LOLR with full powers.9

13. The new business model may involve mergers of banks, including with foreign participation, but normalizing relations with Italy is a key prerequisite. The CBSM is in favor of mergers and the Parliament had enacted a law to facilitate this. Mergers with foreign banks, while advantageous, would face obstacles, unless relations with Italy improve. Indeed, the main barrier to the development of a new business model and any consolidation of the financial system involving foreign participation is the state of relations with Italy. Currently it is not possible for Italian banks to invest in or acquire Sammarinese financial institutions until an appropriate bilateral agreement is in force. A financial cooperation agreement has been signed, but will not take effect until a double taxation treaty is also signed by the two countries. Moreover, Italy’s designation of San Marino as a tax haven will likely frustrate Sammarinese attempts to develop new, legitimate business lines with Italian entities.

Authorities’ views

14. The authorities acknowledged the challenges in developing an alternative business model under current circumstances. In particular, they recognize that San Marino was starting late in developing new skills and that there are a number of competitors which are well ahead of them. Nonetheless, the authorities argued that the financial sector could develop a modest asset management business, beginning with products sold to institutional investors, and that they had already established a committee comprising of the government, central bank, and private sector to consider strategic alternatives.

15. The CBSM recognized that the legacy of the past was inevitably affecting Italy’s position and that it would take time to reestablish a reputation. The authorities had demonstrated their good intentions by introducing tighter regulation and stronger AML/CFT defenses and had responded rapidly to the FSAP recommendations. In the meantime, San Marino remains relatively isolated and efforts to seek financial agreements or investments beyond Italy were frustrated by the inevitable suspicion of interlocutors of the inability of San Marino to conclude agreements with its most obvious partner. The CBSM accepted the need to develop its reputation over time but pointed out that it may need to take more immediate steps, including with respect to the provision of additional liquidity to the banking system.

Box 2.Actions taken to meet the 2009 FSAP recommendations

The authorities have taken action to address the FSAP recommendations, a detailed discussion of which is presented in Appendix I. In particular, the authorities:

  • Took measures to enable the CBSM to assist in the provision of liquidity to banks, through the implementation of a reserve requirement system and the development of a local interbank market, and with a voluntary scheme for banks to deposit excess liquidity.

  • Strengthened the independence and accountability of the CBSM by:

    • Removing the role of government in placing banks under special administration and withdrawing authorization;

    • Focusing all the CBSM powers on the Governing Council, to enhance accountability;

    • Transferring the power of appointment to the Governing Council from the government to the Parliament and extending the list of posts that are regarded as being incompatible with membership of the Governing Council;

    • Strengthening the protection of the Director General (DG) by requiring unanimity of the Governing Council before the person can be dismissed and establishing limited grounds for dismissal for the DG as a member of the Supervision Committee;

    • Agreeing to a three year budget with the government, which provides some stability in budget planning for the CBSM.

  • Amended the bank secrecy provisions in the law with the intention of permitting subsidiary banks to pass confidential information to their parent bank.

  • Strengthened the supervision resources of the CBSM, enabling it to complete the on-site supervision manual, increase the number of on-site inspections and take tougher action against those who breach the regulations.

  • Enhanced AML/CFT defenses, by strengthening coordination with the Financial Intelligence Agency (FIA) when making on-site inspections, including through sharing risk assessments and discussing findings.

  • Abolished bearer shares.

  • Issued new regulations on fiduciary companies that require some additional due diligence on customers and specify what activities are permitted.

By addressing these measures, the authorities have demonstrated willingness to take rapid action to meet international standards. Inevitably, a number of actions still need to be taken, including:

  • Legislative changes still leave the Government with the final say on licensing of new financial institutions, allowing it to refuse to grant a new license, even if the CBSM considers that an applicant meets the conditions. The legislation should remove this power from the government or, at the very least, specify criteria for any government decision to reject a license and allow for an appeal.

  • In view of the recent history, it is vital that CBSM’s Governing Council is strong enough to resist pressure from political and commercial interests. To buttress the protection against the appointment of Governing Council members with potential conflicts of interest, the authorities should publish more transparent nomination and appointment procedures. Moreover, in the event of dismissal of a member of CBSM’s senior management, it is important that the authority taking the decision to dismiss should be required to give reasons to show how the decision matches the specified criteria in the law.

  • The authorities should provide both CBSM and FIA with the additional resources they have sought to implement the new regulatory regime effectively.

B. Fiscal Policy

17. The fiscal position weakened significantly in 2009-10, mainly due to a sizable decline in revenues. Tax revenues fell by close to 1 percent of GDP in 2009, and are estimated to have dropped by almost 4 percent of GDP in 2010, largely as a result of the economic slowdown and the decline in revenues from the financial sector. Consequently, the fiscal deficit is expected to have widened from 3.4 percent of GDP in 2009 to 6.1 percent of GDP in 2010 (Table 4). Government revenue, as a share of GDP, is low by international standards. For example, during 2006-09 San Marino’s revenue/GDP ratio averaged about 30 percent, compared to Italy’s 45 percent (Figure 5). Moreover, in order to stimulate consumption, the government last September cut the import tax rate by 2 percentage points, to 15 percent, which may undermine the overall objective of increasing revenues.10

Table 4.San Marino: Public Finances, 2006–11 1/(Percent of GDP)



Central Administration Operations
Revenues 2/30.032.629.830.526.727.126.5
Direct 2/
Import tax 2/10.513.
Other indirect taxes4.
Non-Tax 2/3/
Current expenditure25.826.524.928.428.626.227.0
Wages & Salaries8.88.88.910.410.910.410.4
Transfers to Public Sector10.710.611.013.012.811.312.2
o/w ISS7.47.67.7
Transfers to Private Sector1.
Interest Payments0.
Others 4/
Capital expenditure2.
Transfers to Public Sector0.
Balance (including transfers)
Primary Balance2.02.60.3-3.2-6.0-2.9-4.4
Net Debt Financing-0.5-0.3-0.3-
Change in Deposits-4.9-1.8-
Change in Net Government Arrears 5/3.4-
Asset Sales0.
Consolidated Government
Overall balance of the consolidated government2.02.8-0.4-5.6-7.1
(excluding transfers)
Central administration operations (excluding transfers)
Public enterprises (excluding transfers)-2.8-3.0-4.8-5.6-3.8
Social security fund (excluding transfers)-7.3-7.3-7.6-11.1-10.5
Memorandum Items:
Public debt5.
Net government arrears 5/-12.4-11.1-14.8-20.0-21.2-21.7
Government deposits16.417.421.023.319.616.4
Nominal GDP (In millions of euros)1,1711,2331,2591,1021,1151,145
Real GDP growth (y-o-y percent change)3.83.5-1.1-13.0-0.90.8
Change in GDP deflator (y-o-y percent change)
Sources: Sammarinese authorities; and staff estimates.

Figure 5.San Marino: Fiscal Indicators, 1995-2011

Sources: IMF, World Economic Outlook; Sammarinese authorities; and IMF staff calculations.

1/ 2011 numbers are projections.

18. The authorities have taken steps to reduce the fiscal deficit. In the three-year rolling budget approved last December, the government introduced a number of consolidation measures, including cuts in transfers to the large public sector, a reduction in the public sector wage bill, and a one-time levy on income tax payers. With these measures, the authorities expect the central government deficit to decline to about 3.1 percent of GDP in 2011. In staff’s view, this projection seems to reflect rather optimistic assumptions about both the rebound in tax revenues and the containment of expenditure, especially with respect to the implementation of cuts in transfers to the rest of the public sector.11 Consequently, the staff projects a deficit of 4.6 percent of GDP this year.

19. There is scope to secure a more effective medium-term consolidation strategy. While public debt is low and the economy is still weak, there is a need to secure medium term debt sustainability, given that (i) as a micro-state, San Marino lacks access to a diversified investor base, (ii) revenues are likely to be permanently depressed by the financial sector downsizing, (iii) contingent liabilities from the financial sector are potentially very high and (iv) the current pension system is unsustainable in the long term.

20. Government debt sustainability analysis (DSA) points to a moderate upward trend in the debt profile over the medium term. Underlying the DSA’s baseline scenario, the fiscal deficit is projected to fall from 6.1 percent of GDP in 2010 to 1.7 percent of GDP in 2015. As a result of the slow decline in the deficit, public debt is projected to rise from 5.4 percent of GDP in 2010 to 10.6 percent of GDP in 2015. The baseline scenario incorporates staff’s estimates of the impact of the consolidation measures introduced in the latest three-year rolling budget. The baseline also reflects the following assumptions: (i) some permanent loss in revenues from the financial sector; (ii) a constant import tax rate throughout the period, at the reduced rate of 15 percent; (iii) no accumulations in governmental arrears from 2012; and (iv) half of the deficit financing occurs through a drawdown on government deposits, consistent with the financing policy mix in 2010. The debt dynamics are most sensitive to a shock to real GDP, the assumed fiscal adjustment effort, and a rise in contingent liabilities (Figure 6 and Table 5).12

Figure 6.San Marino: Central Government Debt Sustainability: Bound Tests, 2010-15 1/

(Public debt in percent of GDP)

Sources: IMF, country desk data; and IMF staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ Under this scenario, debt would fall to zero. However, historically, the government has not purchased back its debt; therefore, debt/GDP ratio is assumed to remain constant at the end -2010 level.

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance.

4/ 10 and 30 percent of GDP shock to contingent liabilities occur in 2011.

Table 5.San Marino: Central Government Debt Sustainability Framework, 2005-2015(In percent of GDP, unless otherwise indicated)


balance 9/
Baseline: central government debt 1/
o/w foreign-currency denominated0.
Change in central government debt-0.7-0.4-0.90.4-
Identified debt-creating flows (4+7+12)-4.9-2.3-2.7-
Primary deficit-4.5-2.0-2.6-
Revenue and grants30.030.032.629.830.526.726.525.925.725.725.7
Primary (noninterest) expenditure25.428.030.029.533.732.730.829.929.028.127.2
Automatic debt dynamics 2/0.0-
Contribution from interest rate/growth differential 3/0.0-
Of which contribution from real interest rate0.
Of which contribution from real GDP growth-0.2-0.2-
Contribution from exchange rate depreciation 4/
Other identified debt-creating flows-0.3-0.20.0-0.2-0.1-0.5-0.4-0.1-
Privatization receipts (negative)-0.3-0.20.0-0.2-0.1-0.5-0.4-0.1-
Recognition of implicit or contingent liabilities0.
Other (specify, e.g. bank recapitalization)
Residual, including asset changes (2-3) 5/
Central government debt-to-revenue ratio 1/20.318.914.617.415.520.221.829.535.639.842.2
Gross financing need 6/-0.1-0.8-
in billions of U.S. dollars-1.4-12.4-20.121.579.2118.596.094.693.585.777.3
Scenario with key variables at their historical averages 7/5.40.4-2.9-5.9-8.2-10.2-0.1
Scenario with no policy change (constant primary balance) in 2010-20155.47.411.215.420.325.60.4
Key Macroeconomic and Fiscal Assumptions Underlying Baseline
Real GDP growth (in percent)
Average nominal interest rate on public debt (in percent) 8/
Average real interest rate (nominal rate minus change in GDP deflator, in percent)
Nominal appreciation (increase in US dollar value of local currency, in percent)-11.611.410.3-6.67.2-6.1-1.8-0.5-0.5-0.5-0.5
Inflation rate (GDP deflator, in percent)
Growth of real primary spending (deflated by GDP deflator, in percent)-
Primary deficit-4.5-2.0-2.6-

21. Public administration and enterprise reforms are proceeding slowly. The government in 2009 introduced a number of laws aimed at addressing the large and bureaucratic structure of the public administration. Among other objectives, the laws envisaged greater labor mobility, enhanced autonomy and accountability for managers, and increased transparency in the hiring process. However, implementation has been slow, especially with respect to efforts to downsize and streamline the operations of public administration. At the same time, a number of reforms of state-owned enterprises were planned, but legislation has been protracted. For example, despite past considerations to adjust energy tariffs more in line with the market, subsidized utility prices have not been increased for more than a decade.

22. Pension reforms are being pursued, but the long-term sustainability of the pension funds is not secured. Building on the 2005 pension reforms, and in order to shore up the long-term position of the pension funds, the government plans to present to Parliament two new draft pension laws. The first law concerns the first pillar, and envisages higher contribution rates, greater harmonization in contribution rates across categories of independent workers, an increase in the retirement age, the consolidation of all independent workers’ pension funds in one, and lower replacement rates. The second draft law concerns the commencement of a second pillar system.13 These draft laws are steps in the right direction, albeit both still need to be approved by the Parliament. According to actuarial projections, the proposed reform to the first pillar would improve the pension funds’ future balances. However, it would not bring long-term sustainability to the system. The independent workers’ fund would remain in deficit over the entire projection period, thus requiring additional transfers from the state budget. Moreover, even after the reform, state transfers would continue to increase, albeit at a lower rate, due to an existing rule directly linking government transfers to overall contributions (Figure 7).

Figure 7.San Marino: Pension Funds Projections, 2010-2060

(Millions of euro)

Sources: Sammarinese authorities; and IMF staff calculations.

Authorities’ views

23. The government broadly shared staff’s views about the outlook for fiscal policy. They agreed with the staff’s assessment that the deficit implied by the 2011 budget is rather ambitious, considering the cyclical position and including the need to still approve a number of draft laws concerning public administration and pension reforms, let alone implement these legislations in a timely manner. The authorities also shared staff’s view on the need to embed the fiscal consolidation strategy in a more comprehensive framework of permanent fiscal reforms, rather than resort to ad-hoc temporary measures. In a move in that direction, the government plans to carry out a comprehensive reform of the tax system, with the aim of increasing the tax burden on certain groups that, primarily due to tax exemptions and tax evasion, have lagged in their contribution to overall revenues. With the tax reform the government also intends to provide incentives to encourage company mergers and the start up of new enterprises.

C. Structural and Other Policy Issues

24. Rigidities in product and labor markets have reduced San Marino’s competitive position. The government has taken some steps toward liberalizing and streamlining product markets, albeit cumbersome bureaucratic processes and complicated regulations create barriers to entry in certain non-tradable sectors.14 Substantial labor market distortions linger as well, including obstacles in hiring highly skilled non-resident workers and a fairly centralized hiring system in the domestic labor market, which hinders market-driven private sector employment. These distortions have contributed to reducing San Marino’s competitiveness in recent years, reflected in falling productivity and rising unit labor costs (see Box 3).15 In this regard, particular attention should be paid to relaxing the hurdles on firms to hire highly skilled non-resident workers. Indeed, in order to develop a new business model successfully, the financial sector needs to acquire rapidly the skills needed to offer a range of new services.

25. San Marino’s participation in the IMF’s General Data Dissemination System has strengthened the statistical system, but there is room for improvement. In line with the 2008 Guidance Note on Data Provision to the Fund for Surveillance Purposes, staff’s view is that San Marino’s data provision is broadly adequate for surveillance, but has important shortcomings. Indeed, notwithstanding important progress on compilation and dissemination of monetary and financial sector data, national account statistics and fiscal data do not have the detail required by best practice international standards and are only available with a considerable lag.

Authorities’ views

26. The authorities are cognizant of the highly centralized labor market. While currently there are no specific plans to introduce legislation to ease the hurdles on dismissal and hiring practices, certain elements in the government are mindful of the need to move quickly in this direction, if only to enable the successful transformation of the business model.

27. The government is keenly aware of the shortcomings in the central statistical system, and has expressed interest in Fund’s technical assistance, especially in the area of compilation and dissemination of national accounts statistics.

Box 3.Losing Competitiveness

A number of indicators point to a loss in competitiveness. San Marino’s payroll taxes, effectively amounting to 23 percent of gross pay, compared to Italy’s 40 percent, have made it able to maintain an average labor costs below that of Italy and the neighboring regions of Emilia-Romagna and Marche. However, while prior to the global financial crisis the economy had experienced a steady improvement in relative productivity, the substantial output contraction over the past three years led to a significant decline in productivity, and thus to a sharp increase in unit labor costs.

Average labor cost as the ratio of:

Real GDP per employment as the ratio of:

Unit labor cost as the ratio of:

Sources: ISTAT; Sammarinese authorities; UPECEDS; and IMF staff calculations.

Stiffer competition from abroad. In the manufacturing sector, which accounted for about 40 percent of pre-crisis GDP, relatively low-cost labor used to be the predominant incentive for Italian firms to set up factories in San Marino. However, these operating cost advantages are becoming insufficient to restore competitiveness, especially as manufacturing firms face stiffer competition from fast growing emerging markets, where low-cost labor is abundant. In the financial sector, which accounts for almost 20 percent of GDP and which has acted as a principal driver of San Marino’s economic growth for many years, labor productivity has been continually declining throughout the past decade.

A key obstacle is the Sammarinese labor market, which is plagued by severe rigidities, mainly resulting from a centralized employment system and extensive impediments on hiring nonresident workers. In particular, any hiring requires an involvement from the Labor Office, a body within the Ministry of Labor, where, for example, private sector firms are obliged to interview all candidates shortlisted by the Labor Office before an open search can be conducted. Similarly, dismissals of workers with an open-ended contract require an agreement among the Labor Office, the trade union and the employer’s association. Moreover, labor market practices are largely based on a 1961 law, which renders an outdated regulatory framework.

A successful repositioning of the economy is essential to achieve durable competitiveness gains. Prevailing labor market rigidities will need to be eased, as a remodeled financial system critically depends on the ability of financial institutions to promptly acquire new skills. Similarly, the manufacturing sector needs to restructure to boost productivity in the aftermath of the long recession.

Manufacturing’s unit labor cost as the ratio of:

Financial services’ productivity as the ratio of:

Sources: ISTAT; Sammarinese authorities; UPECEDS; and IMF staff calculations.

IV. Staff Appraisal

28. A long recession is expected to end this year, but downside risks remain. Real GDP might finally recover in 2011, but growth is projected to be meager at best. Risks to the outlook are mainly on the downside. Financial sector profitability and employment are likely to be depressed, due to the substantial compression in banks’ balance sheets and the need to continue to adjust to new regulations and develop a new business model. Strengthening economic and financial relations with Italy will be vital to support sustainable economic growth and to facilitate a successful repositioning of the economy.

29. In the aftermath of the tax amnesty, the central bank has taken steps to bolster liquidity. Sammarinese banks withstood the significant deposit outflow, but their liquid assets contracted. The introduction of a reserve requirement system and the development of a domestic interbank market have played an important role in building up liquidity. Moreover, the proposed implementation of a new arrangement whereby securities held by Sammarinese banks are pooled and used by the CBSM as collateral for repo agreements with foreign counterparties would further enhance system liquidity.

30. The authorities have made important strides in responding to the 2009 FSAP recommendations, but more should be done to strengthen the financial system. They have taken measures to enhance the independence and resources of the CBSM, buttress supervisory functions, strengthen AML/CFT defenses, and improve the central bank’s liquidity provisions. However, more needs to be done in order to fully meet international standards. The authorities should continue to bolster CBSM independence, including by appointing a new Head of Supervision. Moreover, they should provide both CBSM and FIA with the additional resources they have sought to implement the new regulatory regime effectively. The central bank should continue to seek to secure contingent credit lines with other central banks.

31. A key priority is to shore up the financial position of the largest bank. The authorities are properly monitoring the resolution process of the Delta Group, while a recapitalization plan for CRSM is being considered. In that regard, the authorities should proactively evaluate contingency plans to buttress the financial position of CRSM.

32. The financial system requires a new business model. The relaxation of strict bank secrecy and the adoption of tighter regulations mean that the old business model is no longer sustainable. The authorities and the private sector are right to undertake a strategic review of the financial system’s prospects. Priority should be given to the development of fee-based services that do not rely on bank secrecy, while containing the expansion of domestically-owned banks’ balance sheets beyond the capacity of the limited lender of last resort facilities of the central bank. This may be difficult to implement rapidly, but is worth considering as a longer-term solution. At the same time, strengthening relationships with reputable foreign banks would help Sammarinese banks better identify foreign investment opportunities.

33. The measures taken to contain the fiscal deficit are important, but the strategy needs to be strengthened. In particular, there is scope to embed the fiscal consolidation strategy in a more comprehensive framework of permanent reforms. For example, ongoing public administration and enterprise reforms should be accelerated and geared toward cuts in public sector employment through attrition, while the current system of subsidies, including on utility prices, needs to be revised. On the revenue side, comprehensive tax reforms should be considered, including through reductions in tax exemptions and tax evasion.

34. The proposed new pension reforms are steps in the right direction. But, more can be done to strengthen the long-term financial position of the pension funds. In this regard, quick legislative approval and full implementation of a second pillar framework will enhance the sustainability of the system. The authorities should also take advantage of the new reforms to revise the current rule under which state transfers are automatically linked to total contributions, which implies automatic increases in central government pension expenditure.

35. Easing rigidities in labor markets are vital to restore competitiveness. Particular attention should be paid to relaxing the obstacles on firms to hire highly skilled non-resident workers. This will be essential for San Marino to develop a sustainable business model and regain competitiveness.

36. Meeting international standards for national account statistics and general government accounts is a key priority. The availability of reliable statistics on current economic conditions and up-to-date transparent and comprehensive general government accounts is critical to designing appropriate economic policies and preparing realistic budgets. In particular, devoting additional resources to meet international standards for national account statistics should enable the production of timely and accurate GDP estimates and projections. This would also help San Marino achieve the aim of greater international integration. In this regard, the staff welcomes the authorities’ request for technical assistance.

37. It is recommended that the next Article IV consultation with San Marino be held on the standard 12-month cycle.

Appendix I. Action Taken in Response to FSAP Recommendations
RecommendationAction Taken
Secure contingent emergency lines of credit with other central banks.--Discussions held but no other central bank has yet agreed to provide such credit.
Recapitalize banks that do not meet prudential requirements.--No change to transitional measures allowing for departure from capital asset ratios, although in December 2010, all banks except one met the 11 percent minimum capital asset ratio.
Strengthen supervision, particularly full on-site inspections.--Total staff in supervision department of CBSM increased from 26 to 30, with 3 further posts agreed.

--Number of staff needed for supervision is being reduced as number of financial companies fell from 53 in 2008 to 37 in 2010.

--No change to restrictions on recruitment of staff from outside San Marino – holding back recruitment of senior experienced staff.

--Total number of inspections increased from 22 to 23), including for supervision (from 7 to 14, of which full scope inspections from 3 to 11).

--Total number of off-site preventative and remedial actions increased from 181 in 2009 to 327 in 2010. Sanctions increased from 7 in 2009 to 10 in 2010.
Facilitate cross-border flows of information and allow foreign supervisors to make on-site visits to foreign banks in San Marino.--Amendment made to Article 103 of Law 165 designed to permit banks to disclose information to parent banks.

--Article 7 of decree-law 36 (February 24, 2011) allows on-site visits by foreign supervisors, subject to a bilateral agreement between supervisory agencies.
Ensure that financial institutions, particularly fiduciary firms, are properly and effectively implementing the CDD requirements.--On-site inspections by CBSM concerning AML/CFT issues increased from 4 in 2009 to 13 in 2010. Special focus on AML/CFT obligations of financial companies (full inspections increased from 2 to 10).

--Comments on AML/CFT matters in CBSM inspection reports increased from 3 to 5 in 2009-10.

--64 reports on suspicious transactions by fiduciary companies made by CBSM to FIA.

--FIA inspections increased from 20 in 2009 to 27 in 2010.
Introduce a new governance model for the CBSM.Some changes made to Governance:

--CBSM Governing Council (GC) given greater responsibility for actions of CBSM;

--Role of State Congress in special administration removed;

--Unanimous vote of GC to remove Director General and grounds for dismissal specified in the law;

--Role of State Congress and Committee for Savings and Credit removed from appointment of GC;

--Added list of positions incompatible with membership of GC;

--Three-year budget agreed. However:

No change to State Congress ability to refuse a license approved by CBSM;

No change in transparency of appointment procedure of GC members.
Introduce prudential measures that

contain banks’ liquidity risks (such as

minimum liquidity ratios with the

--Reserve requirement of 8% of total deposits, waived for banks

that provide liquidity to other banks.

--Voluntary scheme for depositing excess liquidity with CBSM.

--New Decree-Law enacted to permit CBSM to act as lender of last resort.

--Measures prompted €300 million interbank lending in 2010.
Upgrade financial regulation, preferably

in line with the EU framework.
--No change to prudential regulations, pending agreement to

adopt EU acquis in return for use of Euro.
Take all possible steps to accelerate the

transition period to full compliance with the regulations on loan concentration.
--No change to transitional measures.
Increase staff of the Financial

Intelligence Agency (FIA), the CBSM supervision units and the Judiciary

responsible for AML/CFT.
--In April 2010, FIA requested increased staff, but no response

yet given to request.
Introduce measures to facilitate self-

insurance among banks.
--See description of liquidity measures above.

--No other action taken.
Finalize supervision manuals.--On-site supervision manual finalized. Other manuals being completed.
Seek to obtain access to the EU payment

system, and ECB refinancing facilities.
--Access sought but not yet achieved.
Undertake reform of fiduciary

companies in order to strengthen

transparency in corporate ownership and clarify the scope of activities in which these companies can engage.
--New laws prohibit bearer shares and introduce corporate

liabilities of legal persons.

--CBSM circulars impose prudential rules on financial companies, including the limitation of their role to 4 specified activities.

--Circulars also increase reporting requirements including details of the persons represented by fiduciary companies and identification of beneficial owners.

--Number of financial companies decreased from 53 at end-2008 to 37 in 2010. Assets under management by fiduciary companies reduced from €3.3 billion in mid-2009 to €1.5 billion by mid-2010.

--Article 12 of decree-law 36 (February 24, 2011) requires fiduciary companies that are shareholders of foreign companies to disclose information to the supervisory authorities.
Enhance collaboration between the FIA

and the CBSM in the area of financial sector AML/CFT supervision.
--Increased coordination between FIA and CBSM.

--Agreed risk assessment undertaken of institutions in respect of AML/CFT.

--Exchange of information on all AML/CFT matters found in inspections, including reporting findings during inspections.

--Review meetings held to reassess risk of institutions. --1 joint inspection undertaken. More planned.
Reconsider some of the FIA’s non-core

financial intelligence unit’s (FIU)

responsibilities (such as the power to act

as judicial police on delegation from the judicial authority) in the light of the

FIA’s limited human resources.
--No change to responsibilities.

The tax amnesty was in effect through April 2010 and led to a fall in bank deposits by more than a third. Since July, Italian firms doing business with Sammarinese companies are subject to enhanced scrutiny from the Italian authorities and are more likely to be inspected. As a result of increased burdensome, a number of Sammarinese companies have since moved their operations to Italy.

National account data are only available annually, and with a long lag; thus, staff’s near-term projections primarily rely on a new monthly economic activity indicator, constructed by staff, which comprised of high frequency indicators of manufacturing, retail, tourism, and financial services.

This government subsidy program essentially allows firms to continue to operate in an environment of rapidly falling demand without the need to either lay off employees or cut down on their salaries.

A reserve requirement ratio was initially set at 8 percent, which is waived proportionally for Sammarinese banks that lend to each other, hence encouraging an interbank market that did not exist before 2010.

Under such scenario, a recapitalization plan has been devised which would shore up CRSM’s regulatory risk weighted capital ratio back above the 11 percent minimum required by the CBSM.

In that event, an alternative could be to allow CRSM a transitional period, during which the bank would be permitted to operate with capital below the minimum, provided that it either raise further capital over a set timetable or find a reputable buyer.

In early 2010, the authorities dismissed the Head of Supervision, prompting the resignation of the Governor and Director General because the dismissal undermined CBSM independence. Although the posts of Governor and Director General have now been filled, there is as yet no Head of Supervision.

See accompanying Selected Issues Paper entitled: “The Development of a New Business Model for San Marino’s Financial Sector”

The acquisition by foreign banks may need to be accompanied by appropriate arrangements with the foreign country authorities, so as to ensure that LOLR can be given at certain conditions also to the Sammarinese entities, even if they are not deemed systemically significant by the foreign country.

The import tax accounts for about 40 percent of total tax revenues. The government plans to evaluate the effectiveness of this tax cut, and, if found to be ineffective in stimulating consumption and raising revenues, may increase it back to the previous rate.

Each year, the central government covers with ex-post transfers the deficit of the Social Security Institute, which is driven by the imbalance in the independent workers’ pension funds. The deficit will likely persist in the next few years, even after the pension reform currently under discussion is fully implemented.

If contingent liabilities associated with higher recapitalization needs for CRSM (e.g., on the order of €400 million) were to materialize, public debt could reach around 40 percent of GDP by 2015.

The second pillar system envisages compulsory participation and shared contributions from employers and employees.

For example, while there are no outright restrictions on foreign ownership of property in San Marino (albeit foreign ownership in the commercial sector is restricted), an authorization from the Council of Twelve, which consists of the two Captain Regents and other Parliamentarian members, is required.

See also accompanying Selected Issues Paper entitled: “Assessing San Marino’s Competiveness.”

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