Abstract
2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of San Marino
The authorities of the Republic of San Marino reiterate their appreciation for the candid and cooperative discussions held with Fund staff during the Article IV consultation and very much value their recommendations, tailored advice and technical assistance. The authorities broadly concur with the staff’s analysis and will continue to rely on the Fund’s recommendations to safeguard financial stability and strengthen growth.
Economic growth slowed down in 2017 but is expected to recover in 2018, albeit at a moderate pace of around 1.1 percent, held back by subdued domestic and external demand. After peaking at 10 percent in early 2016, the unemployment rate has declined to around 8 percent, with important recent employment gains—4 percent in the private sector with respect to 2017, mostly for cross-border workers—supported by the approval of the “Development law” in 2017. There is evidence, albeit not yet captured by formal statistics, of increasing dynamism of the real economy. Local private investors continue to favor San Marino as their preferred location to do business, as proved by the increasing number of new investment projects.
The Sammarinese authorities broadly concur with the staff’s assessment of the economic outlook and related risks, although they see room for growth upsides. They are aware that overcoming the persistent vulnerabilities in the banking sector—while preserving fiscal sustainability—remain an urgent priority to remove impediments to faster growth. However, the authorities intend to act with extreme caution, as San Marino lacks an independent monetary policy and is extremely vulnerable to sudden capital outflows to neighboring Italy in case of a shock.
The authorities remain nevertheless confident that structural reforms – notably further steps to improve the business climate—as well as ongoing infrastructural investments—a 5G telecom network will be ready by the end of 2019—can help attract foreign investments and place the economy on a higher growth path. Structural reforms can also generate a positive effect on the State accounts, thus allowing the State to reimburse the Central Bank of San Marino’s (CBSM) loans and restore its reserves.
Besides, economic prospects are expected to receive a boost from the conclusion of the association agreement with the EU—which could be finalized before the end of 2019, as announced at the high-level meeting held on March 5th and 6th in Brussels—and the signing of a Memorandum of Understanding with the Bank of Italy. The authorities intend to accelerate the implementation of the reform agenda defined in the Financial Sector Strategy recommended by the IMF to boost competitiveness and place the economy on a sustainable growth path, thus avoiding the “muddling-through” scenario envisaged by the staff.
Financial Sector
The authorities recognize that delays in acting to repair the banking system endanger financial stability and that strengthening banks’ liquidity and capital positions remains an urgent priority. They agree that advancing NPL resolution is critical and that private banks should first attempt to raise capital from private sources. They encourage the finalization of systemic projects aimed at effective NPLs reduction in order to decrease banks’ credit risks.
The Government remains committed to supporting the CBSM’s role in the comprehensive Financial Sector Strategy aimed at restoring financial stability through banks’ recapitalization (following the Asset Quality Review-AQR results), their organizational and governance restructuring and effective NPL reduction. The authorities intend to boost the effectiveness of the Financial Sector Strategy by enhancing the CBSM’s supervisory powers and removing legal, regulatory and tax impediments to NPL resolution
The authorities emphasize that the staff’s inclusion of tax credits in computing the implicit public debt is a choice that contradicts standard accounting criteria: tax credits technically become public debt only if and when converted into government bonds and this is not the case for San Marino. The staff’s projections of the level of the implicit public debt are based on the assumption of public intervention to cover all the financial needs of the banking system, a scenario that the authorities do not consider as being applicable with certainty.
The authorities underscore that the ongoing AQR disclosure process, which will lead to the recapitalization of banks, and the measures adopted by the CBSM to improve the monitoring and management of the liquidity in the banking system are important steps towards restoring its health. Strengthening relations with the Bank of Italy would improve CBSM Supervision and lead to the signing of the Memorandum of Understanding (MoU).
As the main shareholder of Cassa di Risparmio della Repubblica di San Marino (CRSM), the Government is aware of the need to reduce losses, recapitalize and restructure the bank for it to regain its ability to finance the real economy. The authorities broadly agree with the staff’s approach on how to address capital shortfalls in the banking system. They also support a faster NPL resolution as a key step to restore long-term viability of banks: to this end, full liberalization of the real estate market and the new legislation to facilitate out-of-court debt restructuring are some of the initiatives already delivered by the Government.
The CBSM highlights the urgency of improved powers and tools to enhance the bank resolution framework in order to effectively deal with failing supervised entities and reduce potential fiscal costs.
The authorities acknowledge the impending need for banks to improve efficiency and restore viability, including by reducing operational costs substantially, including labor costs, and rationalizing the branch network.
The authorities have major concerns on the staff’s suggestion to apply burden sharing, including to subordinated debt, due to San Marino’s specificities, an enclave in Italy; they also believe that a full guarantee of the Institute of Social Security’s (ISS) pension deposits is necessary to boost confidence and relieve liquidity pressures.
San Marino’s authorities underscore the transposition of the 4th EU Anti-Money Laundering (AML) Directive into national laws and the strengthening of AML/CFT legal and regulatory frameworks. Following the results of the AML National Risk Assessment and Action Plan, the authorities indicate that they have adopted regulatory measures on sound management in relation to ML/TF risks, which contain provisions related to corporate governance and financial integrity, reiterating the importance of the “tone at the top”. The OECD Global Forum, in a recently published peer review report on the Exchange of Information on Request, has upgraded San Marino’s overall rating from “Largely Compliant” to “Compliant”. To continuously understand and mitigate financial integrity ML/TF risks, the authorities are currently undertaking a second National Risk Assessment, which is planned to be completed by the end of 2019.
Moreover, the EU has removed San Marino from its tax haven gray list, following the updating of the Annex 2 (Fair Taxation—2.1 Existence of harmful regimes) published by the EU Code of Conduct, on 20 December 2018. Among the criteria used by the EU, one is the fact that the minimum standards of the OECD’s Base Erosion and Profit Shifting (BEPS) project are being implemented. In 2016 San Marino joined the OECD’s new inclusive framework to tackle BEPS. The positive evaluation (as “Not Harmful”) obtained in October 2018 during the Forum on Harmful Tax Practices meeting for the Action 5’s BEPS peer review, was fundamental for the evaluation by the EU Code of Conduct.
Fiscal Policy
The authorities recognize the need to address the fiscal risks related to banking system repair and concur that growth-friendly fiscal reforms are needed to ensure debt sustainability. They note that, despite the State support to the CRSM, mainly to cover the 2017 loss, the overall fiscal deficit is projected to have narrowed in 2018 by about 1 percentage point—to 2.7 percent of GDP—on the back of adopted one-off measures.
The 2019 budget approved in December 2018 aims at achieving a broadly balanced position, net of government transfers to CRSM. To this end, the budget introduces new measures, which are projected to partly offset the measures expired in 2018.
The authorities agree that an ambitious fiscal adjustment, with measures on both the revenue and expenditure side, is needed to put public debt on a sustainable path and gradually build fiscal buffers. To this end, the authorities plan to replace the single-stage import tax (Monofase) with a value-added tax (VAT) in 2020 as a way to remove distortions and yield additional revenues.
The authorities are finalizing a pension reform that aims at containing transfers to the ISS, safeguarding the pension system’s sustainability and achieving budget savings. Elements of this reform include the postponement of the retirement age and the transition to a more sustainable system of pension calculation. The authorities are also developing a wealth indicator for households to facilitate a better targeting of social benefits and strengthen the ISS financial standing. They are conducting a spending review to improve efficiency across government units. In the health sector, which is based on the principle of universal coverage, the introduction of a new approach based on prevention and enhanced monitoring will set health expenditure on a more moderate rising trend.
The authorities also note the challenging political environment and the need to achieve broad agreement with social partners to ensure a successful implementation of indirect taxation and pension reforms.
Structural Reforms
In pursuing the objectives of internationalizing and diversifying the economy, the authorities remain committed to tackling structural impediments to faster growth; they underscore the improvement in San Marino’s Doing Business score in recent years and the role played by the Development Law in supporting employment. Further benefits are expected from the recently-established Office for Active Labor Market Policies, which will be instrumental in enhancing training and job searching as well as in better targeting social benefits.
The authorities place a particularly high value on making further progress towards integration with Italy and the EU, which would provide domestic companies with better opportunities to expand market access and operate abroad. To this end, an Economic Development Agency has been recently set up, also with a view to promoting foreign direct investments and tourism. The latter is deemed to be a sector with untapped potential and plans are being prepared to boost hotels’ capacity and develop skills.
In the face of tight budget constraints, the authorities have chosen to support higher private investment, including in innovative sectors, by alleviating firms’ loan interest payments, expanding tax incentives, reducing red tape, and utilizing public-private partnerships.
The authorities emphasize that important investments have already been made to upgrade infrastructure in telecommunication, which along with improved transportation will help increase the business connectivity with trading partners and promote competitiveness. Further benefits, notably a simplification of the operations of Sammarinese firms abroad, are expected from the conclusion of the Association Agreement with the EU.
Authorities are convinced that San Marino has an unexploited growth potential and intend to accelerate a rapid transformation of its economy. To this purpose, they are actively seeking financial partners that could support infrastructural and innovative projects and contribute as well to an upgrade of the industrial and financial sectors. Discussions are ongoing with several interested parties.
With a view to supporting sustainable and equitable growth in the long term, the Government intends to promote a reflection on the future of the Sammarinese economy that could serve beyond the terms of its mandate. This new initiative will be launched in the coming weeks and will engage the civil society at large, including representatives of the main productive sectors of the economy.
Finally, the authorities would like to once again thank Fund staff for the provision of relevant technical assistance, which has allowed to greatly improve the production of statistics on the balance of payment and International Investment position.