Principality of Andorra: 2023 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Principality of Andorra

1. Following the strong recovery, the Andorra economy continues to grow slightly above its potential rate of growth. The recovery closed the output gap in 2022 after a deep COVID recession. Despite external headwinds, the economy is growing at an estimated 2.3 percent in 2023, driven by the service sector and a record number of visitors.

Abstract

1. Following the strong recovery, the Andorra economy continues to grow slightly above its potential rate of growth. The recovery closed the output gap in 2022 after a deep COVID recession. Despite external headwinds, the economy is growing at an estimated 2.3 percent in 2023, driven by the service sector and a record number of visitors.

Recent Developments

1. Following the strong recovery, the Andorra economy continues to grow slightly above its potential rate of growth. The recovery closed the output gap in 2022 after a deep COVID recession. Despite external headwinds, the economy is growing at an estimated 2.3 percent in 2023, driven by the service sector and a record number of visitors.

2. Inflation accelerated and has remained elevated amidst persistent core inflation. Inflation rose sharply to 6.2 percent in 2022, propelled by soaring energy and food prices in the region and, to a lesser extent, by supply constraints and a mildly positive output gap. In 2023, headline inflation was influenced by global fuel prices, declining to 4.6 percent in December. After rising gradually up to the end-2022, core inflation stabilized at elevated levels—ending at 5.5 percent in December 2023—driven by second-round effects from wage increases and generalized price pressure in services and imported goods. Headline inflation reached 5.6 percent on average in 2023.

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

3. The economy is experiencing a tight labor market—especially in the service sector. A steady increase in workforce demand pushed domestic labor force participation and employment above pre-pandemic levels. A large increase in residents (almost 8 percent over two years), driven by immigration, helped match high labor demand. This only partially addressed labor demand, with vacancies rising across sectors, in the hospitality industry in particular. While unemployment has historically been low (around 2 percent) in Andorra, this labor market tightness has been compounded recently by labor shortages, especially in the service sector, in neighboring countries. Unemployment declined to 1.2 percent at 2023Q3, or 266 individuals—among the lowest in Europe and in line with historical levels in Andorra. An increasing shortage of affordable housing reduces the attractiveness of Andorra for immigrant labor. To relieve labor market pressures, the authorities eased regulations for the employment of seasonal workers. Government mandated increases (close to 15 percent cumulatively) in the minimum wage in 2022–23 aimed at compensating workers for the loss of purchasing power but also at keeping the Andorran labor market competitive.

4. On the back of the strong growth momentum, fiscal consolidation proceeded promptly, and fiscal buffers were rebuilt. Fiscal performance surprised on the upside, with a primary surplus of 3.6 percent of GDP in 2022 and public debt down to 37.1 percent of GDP—below the 40 percent fiscal rule. Given the persistent inflation and the positive output gap, the government balanced primary fiscal surpluses with a moderate expansion in public investment (notably in social housing) in 2023. The primary balance surplus is estimated at 0.9 percent of GDP and the overall surplus at 0.4 percent of GDP. In 2022, the government introduced tourist and carbon taxes to diversify revenues and green the economy. A law on the effective tax rate was adopted in January 2023. It stipulates a minimum effective tax rate of 3 percent on the current year profits and will be applied from 2024. The government also introduced a 10 percent capital gains tax on resold properties to limit housing speculation on luxury real estate and incentivize the development of more affordable housing. Andorra completed in 2022 its debt management strategy issuing €1.2 billion in Eurobonds. This allowed the government to extend the maturity of its debt at favorable rates and diversify financing sources.

Andorra: Euro Medium Term Notes Program Summary

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5. The banking sector strengthened, with a marked improvement in profitability. Despite traditionally lower returns in private banking, Andorran banks profitability rose to an annualized ROA of 0.8 percent in 2023Q3, up from 0.6 percent in 2022 and 0.5 percent in 2021. An increase in interest margins drove profitability above European peers. Faster amortization of variable rate loans also resulted in a 4.7 percent decline in domestic credit during the first 9 months of 2023. After declining substantially in 2022, nonperforming loans stabilized above 3 percent in 2023. Andorra passed into law a Lender of Last Resort facility in December 2022 to provide emergency liquidity assistance to distressed but solvent banks. With a Tier 1 capital ratio at 19.4 percent and an LCR at around 200 percent at 2023Q3, Andorran banks remained significantly above regulatory requirements and European averages.

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Banking Sector: Profitability, Capitalization, Liquidity and Asset Quality

Citation: IMF Staff Country Reports 2024, 057; 10.5089/9798400267680.002.A001

Sources: Andorran Financial Authority, EBA Risk Dashboard 2023Q1 and IMF staff calculations.Note: The whiskers correspond to the 25th and 75th percentiles. Data for 2023 for Andorra are preliminary and unaudited, and subject to revisions.

6. The current account surplus remains large. Net exports and net primary income on average contribute almost equally to Andorra’s large current account surplus. Driven primarily by tourism exports, Andorra maintains a larger trade surplus in services than its trade deficit in goods, resulting in a positive overall trade balance. The goods and services balance recovered in 2022 with the resumption of tourism and a contained rise in energy prices due to long-term supply contracts. Tourist expenditure recovered, driven by a sharp increase in expenditure per visitor. The current account balance rose to 17.3 percent of GDP in 2022, with the normalization of the tourism sector compensating the increase in both the volume and price of imported goods. The number of visitors reached a record 9.2 million during January to October of 2023, a 13 percent increase from the same period in 2022. Staff assesses the external position to be substantially stronger than the level implied by fundamentals and desirable policies (Annex I)—suggesting an imbalance in the savings-investment balance.

Outlook and Risks

7. Growth is slowing to its lower long-term potential level, with inflation receding gradually. The lower level of potential growth reflects constraints of the country’s geography, the small domestic market, and low investment. Andorra has a high-income level (€39,000 GDP per capita in 2022), with a well-established business model relying on a competitive winter tourism sector. Under the staff’s baseline, growth is forecasted at 1.8 percent in 2024 and at 1.5 percent from 2025 onwards, comparable to average growth in the euro area. Investment is projected to remain low. Consumption is expected to be the main driver of growth, supported by developments in the services and hospitality sectors. Headline inflation will continue to stabilize in 2024 but will remain persistently higher than previously anticipated, at a projected 4.3 percent, due to higher imported prices. The labor market is projected to remain tight and second-round effects from higher wages will also feed into inflation. Price pressure persistence suggests that both headline and core inflation are expected to stay high for longer in line with the global environment. Inflation is projected to subside to 2 percent only by end-2025 and remain slightly below 2 percent thereafter, as in the pre-COVID period.

8. Risks to the outlook are balanced, though subject to substantial uncertainty and bottlenecks (Annex II). Andorra is an open economy exposed to external challenges and its baseline forecast reflects projections for the global economy with slowing growth and prolonged inflation. Downside risks are substantial. Slower than expected global economic growth would negatively impact external demand and the number of visitors coming to Andorra and/or their spending, while more persistent inflation would dampen external and domestic demand by lowering real incomes. Tighter for longer monetary policy would also affect credit growth and credit quality, with negative effects on growth and banking soundness. In the medium term, the high reliance on winter tourism exposes the economy to climate-related risks. Emerging fault lines and structural bottlenecks—as housing affordability issues, labor shortages, and climate change—cloud the medium-term outlook. On the upside, Andorra, like other service-oriented economies in Europe, could benefit from stronger demand, and grow faster than projected. Greater than expected regional growth and lower inflation would increase tourist flows and investments, while the adoption of the EU Association Agreement would open up new markets over the medium-term. Prudent macroeconomic policies have resulted in solid macroeconomic buffers—low debt and fiscal space, newly constituted foreign reserves, a large current account surplus, and well capitalized and liquid banks—useful to mitigate downside risks should they materialize.

Andorra: IMF Baseline Forecasts 2021–28

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Sources: Govern d’Andorra Department of Statistics, World Economic Outlook database, 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 central government comprises Govern d’Andorra, as well as nanmarket, nonprofit institutional units.

The sharp increases of debt in 2020–21 are partly explained by a pre-financing strategy t0 caver large amortization due in 2021–22,

Authorities’ Views

9. The authorities agreed with the staff assessment of the economic outlook and balance of risks. Their near-term outlook is in line with staff estimates, but their medium-term outlook is slightly more positive. The authorities remain more optimistic than staff on the impact of diversification of the tourism sector and private investment. The authorities concur with staff on risks to the outlook and believe that tighter for longer global financial conditions would be detrimental to private credit and investment. They anticipate that the negotiated EU Association Agreement will support the diversification of the economy. Regarding the external sector assessment, the authorities see Andorra’s large current account surplus as a strength of the country’s economic structure while recognizing the need to continue to diversify the economy to remain competitive.

Policy Discussions

Public investment and ambitious structural reforms can address emerging bottlenecks and lift longer-term growth. Banks, while profitable and well capitalized, are very large and require continued close surveillance to limit financial stability risks. Diversifying the economy, increasing digitalization, strengthening governance and data reporting will help to strengthen economic resilience, improve efficiency, and empower policy making. The recently finalized EU Association Agreement should bring opportunities to Andorra with the appropriate measures for a smooth transition.

A. Fiscal Policy

10. After a rapid fiscal consolidation, the authorities have room within the fiscal framework to implement needed growth-enhancing investments, address structural bottlenecks, while maintaining appropriate fiscal discipline. The effective functioning of automatic stabilizers enabled the authorities to restore fiscal space and to decrease the debt level back to below the fiscal rule threshold in 2022. Given the positive output gap and the persistent inflation, tight fiscal policy in 2023 and 2024 is appropriate. The government is expected to continue running primary balance surpluses of about 1 percent of GDP over the medium term, resulting in a reduction of debt to about 30 percent of GDP by 2027. The fiscal framework—with a central government debt ceiling of 40 percent of GDP and an overall deficit limit of 1 percent 1—has worked well to anchor the credibility of fiscal policy. In the absence of monetary policy tools, maintaining fiscal policy space, relying mostly on automatic stabilizers, and reducing public sector liabilities is warranted for a microstate vulnerable to external shocks. However, the fiscal rules also provide room for higher public spending, targeted towards growth-enhancing investment in social and affordable housing, in upskilling the workforce and addressing labor shortages, and in improving the connectivity of the country to support economic diversification, resilience, and lift potential growth. 2 The 2024 budget projects a welcome increase in public investment in affordable housing and infrastructure. Climate change is gaining more significance for the Andorran economy and will require stepped up adaptation measures from both the public and private sectors.

11. The authorities should continue to strengthen the public sector balance sheet through debt and reserve management. The government helpfully plans to use future surpluses to decrease the stock of outstanding debt and increase international reserves.

  • The authorities took steps to build up international reserves on a precautionary basis—adding funds from debt issuance to the 2021 allocation of IMF Special Drawing Rights (SDRs) to bring reserves up to 10 percent of GDP (Annex I).

  • The authorities’ debt management strategy has focused on reducing costs and lengthening maturities by tapping the international market. The average maturity of debt increased from 2.7 years in 2019 to about 8 years by end-2022. The authorities should continue the policy of diversifying debt and extending its maturity to decrease rollover risks and mitigate consequences from potential increases in interest rates.

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

12. Over the medium term, population aging creates substantial contingent liabilities, and the pension reform should be a priority. Andorra’s aging population will increase healthcare and pension costs going forward. The authorities are considering a necessary healthcare reform to address this over the medium-term. After months of discussion, concluding the reform in an expeditious and comprehensive manner is needed to ensure the sustainability of the social security fund in the long run. Andorra’s aging population and its generous pension system create an unsustainable dynamic for the Andorran social security fund in the long-term. The fund is projected to accumulate deficits starting from 2026 rising to 8.2 percent of GDP by 2042 by which point its reserve fund will be depleted. 3 Public pension expenditure as a share of GDP is expected to see one of the largest increases in the region. A comprehensive reform package is needed to prevent the build-up of large contingent liabilities. There is a consensus among political parties on the need for a reform but the appropriate balance between adjustment of the contribution rate, the conversion factor, and the retirement age, together with considerations around pension adequacy and intergenerational equity, is still to be determined.

Authorities’ Views

13. The authorities concurred with the staff’s assessment of the fiscal policy. They view the 2024 budget as an important expansion of public investment to support key policy objectives, including housing, while preserving fiscal responsibility. The Parliamentary majority is taking the lead on the reform of the pension system, working to build a political consensus with the objective to have it approved by mid-2025. To address population aging and the associated demands on the budget, the authorities are preparing the ground for a healthcare reform over the medium-term. They also plan to invest in renewable energy and transportation to mitigate carbon emissions.

B. Financial Sector Policies

14. With a largely private banking model, banks enjoy a robust financial position, but their size and international exposure calls for vigilance. The main source of income for Andorran banks comes from private banking—a relatively lower risk business where banks earn commissions for custody and wealth management services (see a selected issues paper). However, their size is a potential risk. At the end of 2022, bank consolidated assets were 5.5 times GDP, while their off-balance sheet assets under management, largely outside Andorra, were 20 times GDP, with each of the three banks’ assets exceeding the country’s GDP. Bank funding significantly relies on nonresident deposits that were about 109 percent of GDP in 2022. Given the size of banks, especially compared to the domestic economy and to existing safety nets, and the large nonresident deposits, high capitalization and liquidity ratios are needed for self-insurance. The lender of the last resort facility (LOLR) put in place in 2022, allows the Andorran Financial Authority (AFA) to provide emergency liquidity assistance to viable and solvent banks against adequate collateral. 4 The introduction of the LOLR is welcome and it will help to mitigate a temporary liquidity shock to a bank. Given the systemic size of the banking sector, it is important for available tools to complement each other, i.e., for the LOLR to be supported by continued close supervision and a well-designed resolution framework to ensure that critical problems are identified and addressed early.

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Sources: Annual bank reports and IMF staff calculations.

15. Interest rate increases helped to boost banks’ profitability but can put some borrowers under pressure. Tighter monetary conditions helped to boost banks’ interest margins and profitability in 2022 and 2023. The recent consolidation in the sector (reducing the number of banks from 5 to 3) should help banks cut expenses and improve their cost-to-income ratio, which reached a high average above 70 percent in 2022. Credit risks are mitigated by moderate financial intermediation and limited leverage (for corporates, retained earnings are a major source of financing). In the real estate market, the recent surge in construction and associated price increases was mostly driven by the luxury residential market targeted to foreign clients, with limited bank exposures. However, higher financing costs could increase credit risks and nonperforming loans. The AFA should monitor the effect of interest rate increases on the banks’ asset quality and require banks to act proactively in case of a significant deterioration. Large exposures and connected lending, typical in a very small economy, should be closely monitored and resolved.

16. The changing financial landscape brings opportunities and risks for banks. Andorran banks have been expanding in the EU and the US where they run independent subsidiaries focused on private banking services. Expansion abroad diversifies revenues and profits but subjects banks to additional country and reputational risks. The March 2023 banking turmoil in the US and Europe revealed how bank stress can propagate quickly due to abrupt shifts in market sentiment and customer (especially high net worth individuals) and counterparty behaviors. It also illustrated the increased speed of bank runs due to 24/7 payments, mobile banking, and the use of social media. Lessons for supervisors—relevant for the AFA—include the need to reinforce resolution planning requirements, explore the implications for deposit insurance, and work closely with foreign supervisors. Given the systemic risks associated with the banking sector, ensuring that the AFA is an autonomous, fully resourced supervisor that has the power to conduct in-depth, risk-based assessments, enforce its findings, and deploy a solid crisis management capacity if needed, is paramount. The AFA should continue its close cooperation with supervisory authorities from jurisdictions where Andorran banks operate.

17. The impact on the banking sector of the recently negotiated EU Association Agreement (among other issues raised below) is one area of attention. The agreement will simplify entrance to EU countries for Andorran banks but will also allow foreign banks expanding in Andorra and competing with domestic banks. Financial sector integration incorporates a transitional period of 15 years over which Andorra should fully adopt the EU financial sector legislation, supervision, and regulation. The agreement gives significant flexibility on the timing of the integration of each of the four subsectors covered (banking, insurance, asset management, and financial services). Implementation of the agreement will depend on an assessment of the successful transposition of the EU framework for each subsector. Ensuring that the banking system continues to provide financial services to the economy should be a key objective in the upcoming transition.

Authorities’ Views

18. The authorities agreed with the thrust of staff’s assessment of the financial sector and policy advice. They highlighted that the financial sector continues to be a strong and profitable part of the economy. They noted that banks are benefiting from the interest rate increase which should help to increase banks’ capital further. The authorities, however, acknowledged that interest rate increases can negatively affect borrowers’ ability to pay but noted that there has not been a significant deterioration in credit quality so far and that stress tests show that banks are able to withstand substantial shocks. The authorities viewed the EU Association Agreement as an opportunity to develop and integrate the financial sector within the single European market.

C. Structural Policies

19. Economic diversification and improvements in relative terms-of-trade would support real GDP and real income growth. The deep recession in 2020 illustrated the economy’s exposure to the hospitality sector, and to external demand mostly coming from its two neighbors—France and Spain. The country faces multiple structural challenges, such as difficult geographic accessibility, a limited stock of affordable housing, and a small internal market. The authorities and the private sector are taking steps to extend the tourist season by offering varied summer activities and cultural and sports experiences throughout the year. Better infrastructure, notably the planned heliport, projects for tram and cable transportation and the construction of a multi-purpose arena, will enhance the attractiveness of Andorra as a tourist destination beyond the immediate neighbors. Diversification would both mitigate the country’s exposure to winter tourism and reduce the seasonality of the country’s economy—but remains a challenging endeavor for a microstate. Providing higher quality services and raising hospitality standards would generate higher revenues and support real income growth.

20. Creating an environment favorable to higher investment is important to raise potential growth. Investment suffers from high red tape, and difficulties to attract talent and build human capital. Reducing administrative rigidities associated with starting a business in Andorra, favoring access to alternative sources of financing, and implementing measures to attract and retain talent would support investment, notably by foreigners. Fostering coordination between the central and local governments and the ongoing digitalization of public administration will help in this direction.

21. Policies to increase digitalization are welcome steps towards diversification and greater economic efficiency. As part of Andorra’s digital transformation plan, the government adopted a business digitalization program for Andorran private companies in June 2022. The December 2022 law on digital economy, entrepreneurship and innovation allows for the creation of a special economic zone where companies can develop and test digital and innovative products and creates a legal framework for incubators and digital nomads and entrepreneurs.

22. Housing affordability is an increasing social and economic concern for Andorra. In a recent survey, 5 housing affordability was noted as the most pressing economic issue for 57 percent of respondents in Andorra. A fast-growing population and increasing real estate prices and rents combine to create a housing affordability issue in Andorra—unaddressed by the recent construction boom that focused on luxury housing. Affordability tends to be lower for renters, and Andorra is an outlier in Europe with a renter-dominated real estate market— 70 percent of households are tenants (see selected issues paper for details). The seasonal demand for temporary housing—for tourists and seasonal workers alike—compounds this concern and complicates the hiring of foreign workers. Furthermore, low-skilled workers and low-income households are disproportionately affected by affordability concerns. Raising the stock of rental housing is essential to improve affordability for tenants and public investment in affordable housing is a direct answer to this issue. The authorities have started taking actions to address the issue such as easing requirements for housing support, temporary caps on rent increases, increasing the stock of social apartments, repurposing of buildings for residential housing, and slowing down construction permits for housing that is built to be sold rather to be rented. It is essential for the government to focus on temporary and well-targeted measures that minimize distortions in the housing market and restore the proper market incentives to invest in rental property development. Furthermore, measures to curb real estate speculation may redirect investment towards more affordable housing but should be consistent with other economic priorities, such as attracting foreign investment, diversifying the economy towards new sectors, and attracting highly qualified workers, such as digital nomads.

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Population, 2010–22

(Thousands)

Citation: IMF Staff Country Reports 2024, 057; 10.5089/9798400267680.002.A001

Source: Govern d’Andorra Department of Statistics.

23. Climate change is macro-critical to Andorra given its dependence on winter tourism, making adaptation policies a priority. With (mostly winter) tourism accounting for one third of its economy, Andorra is directly exposed to climate change—shorter winter seasons, declining snow falls, higher costs from artificial snow making are all negatively affecting the economy’s main business. 6 Because of its higher altitude, Andorra is more resilient than other winter tourism locations in the region and should use this window of opportunity to enact needed policies. The authorities’ climate change strategy—with ambitious goals—is focused on mitigation but its adaptation component needs to be accelerated. The strategy seeks to reduce 37 percent of non-absorbed emissions compared to 2005 levels by 2030, and to achieve carbon neutrality by 2050. The promotion of renewable and high energy efficiency technologies, and of efficient energy use across sectors is welcome. According to the staff calculations (see selected issues paper), achieving the decarbonization objectives would require a considerable increase in the carbon tax and very substantial efficiency gains in the power, transport, and residential sectors.

24. The EU Association Agreement could bring substantial benefits to Andorra and support its diversification strategy by opening up new markets. The government chose to submit its approval to a referendum, planned for the first half of 2025, subject to adoption by the Council of the European Union in 2024. The Agreement will then come into effect in 2025 or 2026. It will allow Andorra to participate in the EU’s internal market alongside Norway, Iceland, Liechtenstein, and San Marino (which just finalized EU accession agreements alongside Andorra). Transitional arrangements ensure a gradual adoption of the agreement that is not disruptive, particularly in the sensitive areas of the telecom and tobacco sectors, and the financial sector. The agreement does not impose restrictions on Andorra’s taxation system. On the sensitive issue of the free movement of people, a quota system for active residents, passive residents and seasonal or cross-border workers will be established. The authorities need to use the transition periods to prepare the economy to reap the benefits of the agreement while minimizing distortions.

Authorities’ Views

25. The authorities agreed on the importance of addressing structural bottlenecks and underscored the multiple actions they are taking. Beyond a wide range of measures to support economic diversification and bring high value-added foreign investment to the country, they noted that affordable housing is at the core of the government’s priorities. They recognized that housing policies are difficult, notably because of the high price of land and construction, and that distortionary actions may be needed in the short-term until the supply of affordable housing increases in the medium-term. Addressing climate change is another priority for the authorities, which remain committed to fulfilling decarbonization objectives. On mitigation, they remain optimistic and are exploring additional financing options to scale up existing measures, possibly in cooperation with the European Investment Bank. On adaptation, the authorities acknowledged the need to accelerate the pace and welcomed the small gains achieved so far to deseasonalize the tourism sector. The EU Association Agreement was presented by the authorities as a major step forward in opening up the economy to new opportunities, while minimizing the risks of distortions thanks to substantial transition periods. The authorities recognized the need to communicate well the implications of the agreement, and to prepare the economy for a smooth transition.

D. Governance, Corruption and Data Gaps

26. Measures to counter corruption and to strengthen the transparency and accountability of public spending are critical to improve economic governance. Ratifying the United Nations Convention Against Corruption (UNCAC) and developing an anti-corruption strategy that systematizes the efforts to combat corruption should be key priorities. The reform of the public procurement framework introduced a new contracting platform and electronic invoicing for the entire public sector. This streamlines and modernizes public procurement in Andorra, in line with European standards. In September 2022, the government launched a website, open to the public, with information on the procurement contracts made by the public sector. While this is a step in the right direction, more efforts are needed to increase transparency and accountability of public spending, notably the publication of beneficial ownership information of companies awarded procurement contracts. This information is only available for Andorran companies from the Registry of Commerce and is disclosed upon justified request. It is recommended that beneficial ownership information is requested directly to the bidding companies (including foreigners) and made publicly available.

27. Further improving the effectiveness of the AML/CFT framework is necessary to ensure financial stability. Building on significant progress made in recent years, Andorra should continue to enhance the AML/CFT framework, particularly in managing the ML/TF risks related to cross-border flows and virtual assets. Efforts underway to develop the understanding of risks associated with cross border flows, the misuse of legal persons, and the provision of services related to virtual assets are critical to make supervision more effective. The AFA has enhanced the monitoring of cross-border flows by introducing a new quarterly reporting requirement for cross-border transactions of the supervised Andorran entities and their subsidiaries. The supervisor should continue to carefully analyze data reported by supervised entities, including on nonresident deposits, and exchange information with counterparts in relevant originating countries so as to further improve its understanding of ML/TF risks. Resources for AML/CFT supervision should be increasingly focused on higher risk areas, and sanctions for breach of regulatory requirements should be effectively imposed.

28. Continued progress in closing data gaps will support policymaking. Andorra has made significant progress in improving its data reporting since joining the IMF. Starting in 2022, Andorra maintains the National Summary Data Page that is regularly updated with macroeconomic data. With help from the IMF, the authorities are developing capacity across all macroeconomic sectors. In fiscal accounts, the authorities started producing annual time series for the general government in 2023. In the external sector, the authorities are working on improving the timeliness and frequency of the International Investments Position and the balance of payment statistics. In the monetary sector, the authorities plan to continue their work on producing the monetary and financial statistics. GDP by expenditure is not yet available and the authorities aim to start compiling it. The IMF stands ready to continue working with Andorra on strengthening its data reporting to enhance transparency and improve inputs for the decision makers.

Authorities’ Views

29. The authorities underscored their commitment to improving governance, strengthening the AML/CFT framework and continuing progress in economic statistics. The authorities emphasized the solid ranking of Andorra in various governance assessments—Andorra is ranked 4th of 152 countries by the Basel AML index, and positively assessed by Moneyval. They noted political commitment to ratifying the UNCAC within the legislative term. They plan to develop an anti-corruption strategy in 2024 using an upcoming GRECO assessment in June. The authorities noted their progress in strengthening the AML/CFT framework. They agreed on the importance of continuing progress in macroeconomic data compilation and reporting, and plan to continue closing data gaps including with the IMF’s technical assistance.

Staff Appraisal

30. The Andorran economy continues to experience solid growth. Strong growth in 2022 closed the output gap after a deep COVID recession. Despite external headwinds, the economy is growing slightly above potential, driven by the service sector and a record number of visitors. With limited economic slack, the labor market is tight with almost no unemployment. Over the medium-term, growth is projected to converge to potential growth at around 1.5 percent. Risks to the outlook are balanced but there are concerns about still high inflation and housing affordability. Solid macroeconomic buffers serve as buffers to mitigate downside risks should they materialize.

31. The authorities should use available fiscal space to address structural bottlenecks. In the absence of monetary policy tools, maintaining fiscal policy space and reducing public sector liabilities is warranted for a microstate vulnerable to external shocks. Given the persistent inflation and the positive output gap, maintaining fiscal discipline is appropriate. Public debt is expected to fall below 30 percent of GDP by 2028. However, the fiscal framework has worked well to anchor the credibility of fiscal policy. It provides room for growth-enhancing public spending that can support economic growth and diversification.

32. Over the medium-term, population aging creates substantial contingent liabilities and pension reform should proceed without further delay. Andorra’s aging population will increase healthcare and pensions costs going forward. Public pension expenditure as a share of GDP is expected to see one of the largest increases in the region and to create an unsustainable dynamic for the Andorran social security fund. Concluding the reform in an expeditious and comprehensive manner is needed to ensure its sustainability.

33. The supervisor should continue close monitoring of banking activities. While the main source of income for Andorran banks is the relatively low-risk private banking business, banks are of systemic importance. Continued closed supervision and a well-designed resolution framework are paramount to ensure that critical problems are addressed early, while the lender of the last resort facility introduced in 2022 is a useful addition to the authorities’ toolkit. The supervisor should monitor the effect of interest rate increases on the banks’ asset quality and require banks to act proactively in case of a significant deterioration. Ensuring that the AFA is an autonomous, fully resourced supervisor is key for financial stability.

34. Improving connectivity, addressing housing affordability, and enhancing the climate strategy can help resolve bottlenecks and lift growth. Andorra remains highly dependent on the hospitality sector. Better connectivity and infrastructure will enhance the attractiveness of Andorra for tourism and for the development of new economic activities. To tackle housing affordability, it is essential for the government to focus on temporary and well-targeted measures that minimize distortions in the housing market, restore proper market incentives to invest in rental property development, and ensure consistency with other economic priorities, such as attracting foreign investment. Climate change is a long-term challenge for Andorra and its adaptation strategy should be accelerated.

35. The recently negotiated EU Association Agreement has the potential to unlock substantial benefits by opening markets for a more diversified economy. If approved by referendum in the first half of 2025, the agreement will take effect after that and eventually result in full access to the EU market without imposing restrictions on tax policy. Significant transition periods for various sectors allow the government to prepare the economy to take full advantage of the access to the single market and to avoid disruptions, particularly in the financial sector.

36. The progress in transparency and accountability of public spending, countering corruption, and improving data should continue. The reform of the public procurement framework and the introduction of an electronic contracting and invoicing platform are welcome. Ratifying the United Nations Convention Against Corruption and developing an anti-corruption strategy are key priorities for improving governance. Further improving the effectiveness of the AML/CFT framework will reinforce financial stability. Progress in developing macroeconomic statistics, including better information exchange between central and local governments, should continue.

37. It is recommended that the next Article IV consultation with the Principality of Andorra take place on the standard 12-month cycle.

Table 1.

Andorra: Selected Economic and Financial Indicators

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Sources: Govern d'Andorra Department of Statistics, Andorran authorities, Eurostat, and IMF staff calculations.1/ 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.2/ Balance of Payments data are only available starting from 2019, with the exception of the goods and services balance, which are available starting from 2017. Data for 2021 are an estimate.3/ The increase of gross international reserves in 2021 is due to the general SDR allocation made in August 2021 to all IMF members. The 2021 SDR allocation for Andorra was of SDR 79.1 million. In 2022 €100 million were deposited at the Bank of Spain as gross international reserves. In addition, €40 million have been deposited at the Banque de France, and €60 million at the, Nederlandsche Bank as gross interdenominational reserves.4/ The general government comprises the central government, local governments and the social security fund.5/ The central government comprises Govern d'Andorra, as well as nonmarket nonprofit institutional units.6/ 2023 data refers to 2023Q3, which is preliminary and not audited.7/ The table reports the exchange rate €/USD because. Andorra is a euroiad economy.
Table 2.

Andorra: General Government Operations1

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Sources Govern d’Andorra Department cf Statistics, Andorran authorities and IMF staff calculations

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

2/ Other revenue includes property income, sales of goods and services, voluntary transfers other than grants, and fines, penalties, and forfeits.
Table 3.

Andorra: Central Government Operations1

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

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

Other revenue includes property income, sales of goods and services, voluntary transfers other than grants, and fines, penalties, and forfeits.

Table 4.

Andorra: Balance of Payments1

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Sources: Andorran authorities and IMF staff calculations

Balance of Payments data are only available starting from 2019, with the exception of the goods and services balance, which is available starting from 2017.

2/ The increase of gross international reserves in 2021 is due to the general SDR allocation made in August 2021 to all IMF members, The 2021 SDR allocation for Andorra was of SDR 79.1 mill! on. In 2022 €100 million were deposited at the Bank of Spain as gross international reserves. In addition, €40 million have been deposited at the Banque de France, and €60 million at the Nederlandsdie Bank as gross international reserves.
Table 5.

Andorra: Financial Soundness Indicators

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Source: Andorran authorities.Note: Data for 2023 are preliminary and unaudited, and subject to revisions.

The LCR is defined as the ratio between high-quality liquid assets and net liquidity outflows in a 30-day stress period.

Annex I. External Sector Assessment

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Annex II. Risk Assessment Matrix 1

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Annex III. Sovereign Risk and Debt Sustainability Assessment

Andorra’s overall risk of sovereign stress is low. Public debt is expected to decline to about 30 percent of GDP on the back of primary surpluses over the medium term. A proactive debt management strategy strengthened the government’s balance sheet—extending the average maturity of public debt and taking advantage of favorable international financial conditions. The risk from gross financing needs is low. Given that Andorra is a small, open euroized economy that is exposed to external shocks, fiscal buffers are important to build resilience against potential shocks. Fiscal policy is anchored to an effective fiscal framework that prescribes a central government public debt ceiling of 40 percent of GDP.

1. Public debt decreased after rising during the pandemic. Andorra’s public debt increased during the pandemic primarily reflecting the deterioration of the primary balance and the authorities’ pre-financing strategy. The 2021–22 Euro Medium Term Notes issuance program allowed the government to borrow €1.175 billion at favorable rates. The program allowed to substitute short-term debt for longer term notes with 5 to 20 years maturity, extending average debt maturity from 2.7 years in 2019 to 8 years at the end of 2022. Steady fiscal consolidation during the rapid recovery from the pandemic and accumulation of primary surpluses allowed to decrease both the general government and the central government debt level to below 40 percent of GDP in 2022, in line with the fiscal framework (under the fiscal rules, established debt ceilings are 40 percent of GDP for the central government debt and 55 percent of GDP for the general government debt).

2. Debt is projected to decrease further. Under the baseline scenario, growth will continue at a slower pace over the medium-term, down to a long-term potential of 1.5 percent. Projected primary surpluses will allow the government to decrease public debt further to about 31 percent of GDP by 2028. The proactive debt strategy during the pandemic allowed to lock in favorable rates and reduce debt service. The first large rollover comes in 2027 for €500 million notes. The assumption is that the government will roll over its maturing debt into the same instruments with some uncertainty about the rollover rates. The authorities borrowed €17 million from the Council of Europe Development Bank during 2020–22 for infrastructural needs.

3. Risks to the debt profile are manageable. The modules of the Sovereign Risk and Debt Sustainability Framework suggest that the risks to the public debt trajectory are low at all time horizons. The major risk comes from refinancing of notes in 2027 and 2031 at potentially higher rates than when borrowed in 2021–22. Baseline macroeconomic assumptions forecast a gradual reduction in interest rates globally over the medium-term, making the debt rollover in 2027 manageable. The fiscal framework anchors fiscal policy credibility, and the authorities proved their commitment to fiscal discipline by reducing debt level 48.6 percent of GDP in 2021 to below 40 percent of GDP in 2022. In the longer term, Andorran social security fund is projected to be depleted by 2040 due to an unsustainable pension system that could affect fiscal position and borrowing needs. The pension reform, currently under debate, needs to be approved soon to prevent spillovers to the otherwise solid debt profile of the country.

Figure 1.
Figure 1.

Andorra: Risk of Sovereign Stress

Citation: IMF Staff Country Reports 2024, 057; 10.5089/9798400267680.002.A001

Source: Fund staff.Note: The risk of sovereign stress is a broader concept than debt sustainability. Unsustainable debt can only be resolved through exceptional measures (such as debt restructuring). In contrast, a sovereign can face stress without its debt necessarily being unsustainable, and there can be various measures—that do not involve a debt restructuring—to remedy such a situation, such as fiscal adjustment and new financing.1/ The near-term assessment is not applicable in cases where there is a disbursing IMF arrangement. In surveillance-only cases or in cases with precautionary IMF arrangements, the near-term assessment is performed but not published.2/ Adebt sustainability assessment is optional for surveillance-only cases and mandatory in cases where there is a Fund arrangement. The mechanical signal of the debt sustainability assessment is deleted before publication. In surveillance-only cases or cases with IMF arrangements with normal access, the qualifier indicating probability of sustainable debt (“with high probability” or “but not with high probability”) is deleted before publication.
Figure 2.
Figure 2.

Andorra: Debt Coverage and Disclosures

Citation: IMF Staff Country Reports 2024, 057; 10.5089/9798400267680.002.A001

Figure 3.
Figure 3.

Andorra: Public Debt Structure Indicators

Citation: IMF Staff Country Reports 2024, 057; 10.5089/9798400267680.002.A001

Figure 4.
Figure 4.

Andorra: Baseline Scenario

(Percent of GDP unless indicated otherwise)

Citation: IMF Staff Country Reports 2024, 057; 10.5089/9798400267680.002.A001

Figure 5.
Figure 5.

Andorra: Medium-Term Risk Assessment

Citation: IMF Staff Country Reports 2024, 057; 10.5089/9798400267680.002.A001

1/ See Annex IV of IMF, 2022, Staff Guidance Note on the Sovereign Risk and Debt Sustainability Framework for details on index calculation.2/ The comparison group is advanced economies, non-commodity exporter, surveillance.3/ The signal is low risk if the DFI is below 1.13; high risk if the DFI is above 2.08; and otherwise, it is moderate risk.4/ The signal is low risk if the GFI is below 7.6; high risk if the DFI is above 17.9; and otherwise, it is moderate risk.5/ The signal is low risk if the GFI is below 0.26; high risk if the DFI is above 0.40; and otherwise, it is moderate risk.
Figure 6.
Figure 6.

Andorra: Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2024, 057; 10.5089/9798400267680.002.A001

Source: IMF Staff.1/ Projections made in the October and April WEO vintage. Program status not used in creating comparator group due to lack of data.2/ Calculated as the percentile rank of the country’s output gap revisions (defined as the difference between real time/period ahead estimates3/ Data cover annual obervations from 1990 to 2019 for MAC advanced and emerging economies. Percent of sample on vertical axis.4/ The Laubach (2009) rule is a linear rule assuming bond spreads increase by about 4 bps in response to a 1 ppt increase in the projected debt-to-GDP ratio.
Figure 7.
Figure 7.

Andorra: Triggered Modules

Citation: IMF Staff Country Reports 2024, 057; 10.5089/9798400267680.002.A001

Annex IV. Authorities’ Response to Past IMF Policy Recommendations

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1

For details on fiscal rules, see IMF Country Report No. 2022/179.

2

For an assessment of the potential growth impact of public investment, see IMF Country Report No.21/108 Selected Issues Paper.

3

For background, please see IMF Country Report No. 22/180: Principality of Andorra: Selected Issues (imf.org).

4

Law 36/2022 established the Lender of Last Resort facility, to be activated by a special technical commission chaired by the Minister of Finance to provide temporary and exceptional liquidity to a solvent and viable bank in the event of a liquidity stress. The LOLR facility was developed in line with IMF technical assistance.

6

Trade and hospitality activity account for about 30 percent of the economy’s gross value added (GVA) and 40 percent of employment. However, with various other sectors connected to tourism, the share of the latter could be more than half of the economy.

1

The Risk Assessment Matrix shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of the staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline. “Low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more.

Principality of Andorra: 2023 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Principality of Andorra
Author: International Monetary Fund. African Dept.