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Staff Concluding Statement of the 2022 Article IV Mission

San Marino: Staff Concluding Statement of the 2022 Article IV Mission

October 7, 2022

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

San Marino’s economic performance has been remarkable over the last two
years. However, higher energy prices

below neighboring countries

weakening external demand and tighter international financial
conditions will affect growth going forward. This challenging context
combined with the rollover of the Eurobond, calls for further building
up of buffers. Preserving healthy levels of fiscal and financial sector
buffers is key to preserve stability and confidence in a euroized
economy like San Marino. In particular, an ambitious fiscal
consolidation, and further efforts to address high nonperforming loans
and improvements in banks’ capitalization should be approved and
implemented without delay.

The Sammarinese economy has experienced robust growth with a tight
labor market, increased confidence, and remarkable stability over the
last two years.

With growth projected at 8.3 percent for 2021, the strong momentum has been
kept so far this year resulting in a level of economic activity
significantly above pre-pandemic heights. Strong external demand boosted
manufacturing and a rebound in tourism led to strong economic activity that
combined with increased confidence, led to higher government and banking
sector deposits and international reserves. In this context, employment
reached the highest level in over a decade and the tight domestic labor
market led the authorities to liberalize cross-border employment. At the
same time, the banking sector experienced a continued deposit increase and
improved liquidity, profitability, and capitalization.

With higher energy prices, tightening financial conditions, and growing
global uncertainty, activity is expected to slow down.

The energy price increases are eroding households’ real income and firms’
profit margins. Combined with weakening external demand, these developments
are expected to contribute to a marked deceleration of economic activity
and deterioration of the current account surplus and international reserves
as the economy adjusts to the negative terms of trade shock. As activity
slows down, fiscal revenues will be impacted while inflation can increase
spending pressures adding to pre-existing fiscal challenges. Downside risks
related to Russia’s invasion of Ukraine, particularly a further disruption
of energy supplies in Europe, continue to dominate the outlook although the
remarkable resilience of the economy in the last few years could provide
some upside risk. In this connection, the cautious wage increases agreed in
the recent collective bargaining agreement in the industrial sector will
help preserve employment as the economy weakens, providing welcome
flexibility to the labor market. The rollover of the Eurobond in early 2024
remains a risk.

The authorities’ response to high energy prices allows price signals to
operate, supports vulnerable groups and mitigates the macroeconomic

By a combination of a long-term gas contract signed last year and timely
electricity contracts, complemented with hedging operations just before
prices surged, San Marino was able to secure significantly lower gas and
electricity import price increases than those in Europe for this year and
next. This has allowed the authorities to adjust tariffs to cost recovery
levels but well below neighboring countries, at minimum fiscal costs,
avoiding the potentially disruptive macroeconomic impact associated with
unprecedentedly large tariff increases. The authorities’ plans to
pass-through import energy prices to consumers next year will continue to
avoid fiscal costs and preserve the financial soundness of the state-owned
utility company (AASS).

Increasing global interest rates, elevated public debt, and the
Eurobond rollover in 2024, call for an ambitious path for fiscal policy
notwithstanding weakening economic activity.

With increased global financial uncertainty, the authorities should be
ready to take advantage of favorable market conditions and rollover the
Eurobond whenever the opportunity arises starting early next year. Strong
economic activity so far this year has temporarily boosted revenues, while
the impact of the energy crisis on the budget has been limited. Given the
weakening outlook, the authorities should save revenue over-performance
this year to build up government deposits while resisting spending
pressures. Going forward, strengthening the fiscal position will require a
fiscal adjustment by the central government of 2 percent of GDP over the
next three years to reach a central government primary balance of 2.5
percent of GDP complemented by pension reform. In particular,

  • Revenues.
    The proposed income tax law amendments should be promptly approved and
    be more ambitious in simplifying the system and reducing exemptions and
    loopholes. The delay in implementing it this year
    could leave San Marino in a vulnerable fiscal position with a debt path
    that is declining but not robust to most shocks. Furthermore,
    introducing a Value Added Tax should also be considered particularly in
    the context of closer EU integration. Finally, there is also room to
    improve revenues by repealing discounts on petroleum products and
    expanding the use of excise duties that would, at the same time, help
    address environmental externalities.
  • Spending.
    Public sector wage and pension increase in line with recently agreed
    private sector collective bargaining agreements could contain
    expenditure permanently and support the needed fiscal consolidation in
    the near term. More broadly, further improvement in spending efficiency
    will be needed and spending review across all public sector units is
    essential to contain government spending. Finalizing the Public
    Financial Management reform will enhance control over public finances
    through better accounting, reporting and transparency.
  • Pensions.
    The pension reform under parliamentary discussion, stabilizes the
    system’s deficit over the next decade but further recalibration of
    pension spending will be needed to ensure long-term sustainability. The
    approval of this reform, expected this year, is a key priority that
    cannot be delayed given increasing deficits of the Social Security. By
    increasing contribution rates, the reform reduces projected deficits
    and stabilizes pension fund assets in the near-term. However, in the
    absence of more ambitious measures to contain pension spending—linking
    the retirement age to life expectancy, increasing penalties for early
    retirement, and calculating benefits based on the entire
    career—deficits will reemerge requiring a depletion of pension fund
    assets. Finally, the current limit on government transfers to the
    Social Security should be preserved.

There is a need to develop a comprehensive debt management strategy
that will support debt sustainability and help develop a domestic debt
market over the medium-term.

With limited fiscal space, San Marino needs a strong, medium-term debt
management framework to reduce rollover risk and financial cost, that
incorporates plans for international and domestic issuances, and increases
predictability. Publishing a medium-term debt strategy, an issuance
calendar and an annual public debt report will help in this regard. In this
context, the conversion of ex-BNS uninsured depositors’ bonds will help
develop the domestic debt market and reduce the burden on taxpayers.
Importantly, it will also smooth financing needs in a challenging period.

Banks’ profitability and capitalization have improved, but significant
challenges remain.

In 2021, banks have achieved profitability for the first time since the
Global Financial Crisis and their capital base was strengthened. However,
with extraordinarily high nonperforming loans (NPLs) and the recent halt of
efficiency improvements, profitability remains limited and fragile. In the
context of falling bond valuations and weakening activity, new pressures on
the capital base have arisen. The Central Bank of San Marino (CBSM) allowed
banks to transfer assets from the trading to the investment portfolio that
is held until maturity. The plan to report these operations transparently
is welcome.

There has been a delay in the implementation of the strategy to reduce

NPLs tie up administrative resources and banks’ capital, limiting the
capacity of new lending to support economic activity. An asset management
company could create the economies of scale to address system wide NPLs
more efficiently, while providing fresh liquidity to banks and the
opportunity of having an external valuation of NPLs. However, the lack of
implementation more than two years after having been designed, has delayed
banks own NPL resolution. Progress has been made establishing the by-laws
for the servicer, the supervisory framework for the treatment of vehicle
assets received by banks, and pre-selecting reputable external arrangers,
with the final selection currently underway. If NPLs are found to have a
real economic value below the net book value, their transfer should
transparently result in a reduction of capital ratios. Any
undercapitalization that could arise should be promptly addressed with
credible capitalization plans. There should be a clear expectation and
incentive structure for most NPLs to be transferred. NPLs remaining in
banks’ book should be subject to progressive recognition of past losses
(calendar provisioning), following European standards.

In a euroized economy without independent monetary policy, preserving
healthy levels of financial sector liquid buffers is key to preserve
stability and confidence.

This is more so given the limited tools available to absorb shocks,
heightened international uncertainty and increased volatility in financial
markets. As expected, international reserves have fallen as banks deposits
at CBSM moved abroad to take advantage of higher rates, a trend that is
expected to continue in the near term..

San Marino should continue to make progress in strengthening
implementation of the AML/CFT framework

. The AML/CFT assessment report by MONEVYAL indicated satisfying levels of
effectiveness in many areas but highlighted some areas where further
efforts are needed including supervision, preventive measures (i.e.
customer due diligence), transparency of legal persons and legal
arrangements, money laundering investigations, and targeted financial
sanctions for terrorism and proliferation financing. Taking this into
account, the authorities are in the process of transposing the V AML
directive into the domestic legal framework.

Reforms that preserve and support macroeconomic stability should be
complemented with structural reforms needed to boost long-term growth.

Progress towards the EU association agreement and the labor market reform
are welcome but should be completed and implemented. In particular, labor
market reform should make permanent the recent liberalization of
cross-border workers and increase flexibility of temporary employment.
Plans to improve the business climate are critical and further efforts are
needed to improve an outdated insolvency framework.

The mission would like to thank the authorities and other counterparts
for their warm hospitality as well as open and productive discussions.

IMF Communications Department


Phone: +1 202 623-7100Email: MEDIA@IMF.org


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