Mission Concluding Statement 

San Marino: Staff Concluding Statement of the 2021 Article IV Mission

September 24, 2021

Washington, DC: The Covid-19 pandemic dealt a new blow to an economy that was yet to decisively recover from the global financial crisis. The introduction of mobility restrictions compounded by a large external shock led to a collapse in economic activity in the second quarter of 2020. As mobility restrictions were subsequently relaxed, exports surged, and tourism flows partially resumed. The strength of manufacturing exports—surpassing pre-pandemic levels by late 2020—proved a key source of resilience. Output is estimated to have fallen by 7.2 percent in 2020, in line with other countries in the region.

A targeted policy package was put in place that helped avoid major disruptions . Expansion of the wage supplement scheme, moratoria, and extension of tax deadlines to support private sector liquidity, were crucial to avoid bankruptcies, mass layoffs, and maintain confidence. But in the absence of fiscal buffers, the authorities were forced to reduce non-priority spending and delay some payment.

Once the economy stabilized, San Marino accessed international capital markets for the first time in the country’s history in late 2020. It first obtained a bilateral loan, and subsequently in early 2021 issued a Eurobond. This allowed San Marino to provide additional budgetary resources in the form of grants to the economic sectors most affected by the pandemic.

The recovery now underway is also underpinned by a successful vaccination campaign and a favorable external environment. San Marino has been a global leader in terms of the speed and coverage of the vaccination rollout. Exports, imports, domestic consumption, employment, and public revenues are now above pre-pandemic levels. We expect output to grow 5.5 percent this year followed by 3.7 percent next year, reaching the pre-pandemic level of GDP over the next few months. In this context, emergency support measures are being rightly unwound, while some targeted support, in the form of moratoria and wage supplements will continue for companies and households that continue to be affected by the crisis.

Ambitious steps have been undertaken to address legacy issues in the banking system. A perpetual bond of EUR 455 million (33 percent of GDP) was issued to compensate the public bank Cassa di Risparmio di San Marino (CRSM) for past losses. At the same time, CRSM’s liquidity was increased to a reasonable level by the early repayment of a €94 million bond by the government. The Central Bank of San Marino (CBSM) stepped up supervisory efforts, revised regulations of fit and proper tests, and revoked the license of Banca Nazionale Sammarinese (BNS), formerly Banca CIS, now converted into a public asset recovery entity with a government guarantee on all bondholders. While efforts have been made to improve the banking sector efficiency by reducing overall costs, the process has stalled, and cost-income ratios remain elevated. However, at the same time, confidence has been significantly strengthened, as evidenced by the recent increase in bank deposits.

There has been significant progress in improving the AML/CFT framework, although further actions are needed . A second national risk assessment was completed in 2019 and mitigation measures are being implemented with the recent MONEYVAL assessment acknowledging progress in several areas. However, challenges remain on some issues related to preventive measures and customer due diligence, transparency of legal persons and legal arrangements, and money laundering investigations.

The forceful response to the pandemic and especially the large public support to the financial system have significantly increased public debt. Official public debt increased from 32 percent of GDP at the end of 2019 to 105 percent of GDP. At the same time, central government deposits increased to 15 percent of GDP. Public debt is expected to peak this year and moderately decline thereafter. However, this path is not robust to most potential shocks.

The very large scale of the Eurobond poses new challenges in the event of less benign international financial conditions. While San Marino’s interest payments are expected to remain manageable, below 3 percent of GDP, the size of the Eurobond and its short 3-year maturity imply that San Marino’s gross financing needs will jump to a daunting 24 percent of GDP in 2024, a new, key challenge for the country. Without ambitious fiscal measures, such rollovers will have to be undertaken in a precarious fiscal situation consisting of persistent deficits, lower and declining government buffers, and stubbornly high public debt. And in an environment potentially characterized by a tightening of financial conditions and higher risk premia.

Higher sustainable growth in San Marino will require reinforcing the reform effort. A comprehensive reform strategy is needed to preserve recent gains in fiscal and financial sector liquidity, to implement an ambitious structural fiscal reform agenda that strengthens fiscal sustainability, and to complete the transformation of the banking sector into a stable and more profitable footing such that it does not need recourse to public finances. The recent access to international capital markets has increased market scrutiny and puts greater pressure on continuing the reform momentum.

Given the challenges ahead, the strong ongoing recovery is an opportunity to strengthen the fiscal position . This will require, besides the withdrawal of the COVID support measures, a combined consolidation of the central government balance and pension fund of about 4 percent of GDP in three years. The pension reform, if implemented without delay as currently being considered, will ensure the financial sustainability of the system, and partially cover the needed fiscal adjustment in coming years. However, lack of progress on other important revenue and spending reform risks shortfalls and/or delays in achieving the necessary consolidation.

There is room to improve revenue collection and make public spending more efficient. The attractiveness of San Marino’s tax system can be maintained while reducing exemptions and loopholes to make the system more progressive. Plans to introduce a Value Added Tax (VAT) should not be delayed, as this continues to also affect the ease of doing business for firms in San Marino. The intention to better target social spending by linking benefits to indicators of income and financial wealth is welcome. Continued enforcement of spending reviews across all public sector units is also essential to further contain government spending. Finalizing the Public Financial Management (PFM) reform will provide better control over public finances through better accounting, reporting and transparency.

The recommended fiscal strategy would put debt on a clear declining path. Given that progress on structural fiscal reforms has, historically, been slow, the recommended fiscal adjustment should be ambitious and frontloaded to be credible. This would also reassure markets ahead of the Eurobond rollover in 2024. At the same time, the planned repayment of the short-term external debt at the end of the year will reduce public sector liquidity to low levels. Thus, preserving part of this liquidity with some form of short-term debt instrument taking advantage of the current low interest rate environment should be considered. This highlights the importance of improving asset-liability management and establishing a full-fledged debt management office.

Tackling the large amount of Non-Performing Loans (NPLs) remains the fundamental challenge of the banking system. Plans to follow the ECB’s time-bound guidelines to resolve legacy NPLs are welcome and will ensure that, going forward, banks address NPL resolution in a timely manner. Similarly, legislation recently passed to create an asset management company (AMC) and improve insolvency procedures has the potential to expedite the resolution of legacy NPLs. While these legislative measures are a step in the right direction, the implementation should be carefully executed to avoid fiscal risks, including by establishing a conservative ceiling in the public guarantee envisaged in the scheme. At the same time, the institutional setup and regulatory decisions should be robust for the transfer of the NPLs to the AMC not to result in delays of the full recognition of legacy losses.

Additional efforts are needed to strengthen the banking system and safeguard taxpayers from further fiscal costs. CBSM should ensure banks speed up the much-needed cost reduction process, while simultaneously requiring a strengthening of banks’ capital, and internal controls to improve underwriting standards. This will help build a performing asset base and safeguard the large fiscal support provided to the banking system over the years.

The currently healthy level of liquidity buffers in the banking system presents an opportunity to increase and strictly enforce liquidity requirements. Given that CBSM cannot issue its own currency to perform the lender of last resort role, the liquidity buffers of the banking system need to be higher than peers. Against this background, it reserve requirements should be significantly increased from current 3.5 percent. Current high liquidity would allow banks to meet this requirement while still being able to support the recovery through new lending. In addition, liquidity requirements should be strictly enforced going forward.

Reforms that preserve and support macroeconomic stability should be complemented with structural reforms needed to boost long-term growth. An ambitious plan to improve the business climate, consisting of digitalization, streamlining bureaucracy, while advancing further integration with the EU, is being developed. The planned labor market reform should focus on further liberalizing restrictions on hiring, training, and re-skilling the unemployed to match firms’ needs. Further efforts are needed in improving an outdated insolvency framework. Overall, these reforms will support the domestic economy and allow San Marino to become more attractive vis-a-vis foreign investors.

San Marino has come through a unique shock after a prolonged period characterized by economic difficulties. In a difficult environment, the policy response was adequate, but the pandemic has brought to sharp focus long-standing challenges that now need to be addressed to secure sustainable growth in the future.

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