On May 3, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with San Marino.¹

Background

San Marino is experiencing a deep and prolonged recession, with the decline in GDP since 2007 amounting to a cumulative 28 percent. The global financial crisis put an end to the traditional business model built around bank and tax secrecy, bringing about a large outflow of non-resident deposits and an associated compression of banks’ balance sheets. Weak external demand and the difficulties faced by many Sammarinese firms due to the country’s continued inclusion in Italy’s tax black list have also contributed to the recession.

System-wide deposit outflows have now abated, and preliminary indications point to an increase in deposits in some institutions in recent months. This is allowing banks to gradually rebuild their liquidity buffers. However, Cassa di Risparmio della Repubblica di San Marino, the largest bank, remains undercapitalized following heavy losses from its investment in the Italian Delta group. Moreover, the economic recession is leading to mounting non-performing loans across all banks, with the gross non-performing loan ratio now close to 25 percent for the system as a whole.

The global crisis has led to a significant decline in budget revenues. However, San Marino’s sizable pre-2008 budget surplus, combined with recent tax measures and efforts to restrain expenditures, have helped contain the deficit at some 3 percent of GDP. Fiscal reserves accumulated before the crisis have been used to finance recent budget deficits thereby keeping public debt low, but these reserves are now largely exhausted.

International assessments have recognized the progress made by San Marino in unwinding laws protecting bank and tax secrecy, while the exchange of information with other jurisdictions has also been stepped up. San Marino has recently ratified key agreements with Italy on double taxation and prevention of tax fraud, financial cooperation, and economic cooperation, which now await ratification by the Italian parliament.

Executive Board Assessment

Executive Directors noted that San Marino’s economy is facing financial and fiscal challenges in the near term, as well as uncertain medium-term prospects. Accordingly, Directors emphasized the need to preserve financial stability, rebuild fiscal buffers, and push ahead with structural reforms to develop new sources of growth.

Directors considered that, notwithstanding the recent recapitalization, the largest bank will need more capital to meet prudential requirements. They agreed that, if public capital is injected, the state should acquire equity in the bank commensurate with its share in the recapitalization, and take control of its management and board. A credible restructuring plan will also be needed to bring the bank back to profitability.

Directors noted with satisfaction that the banks’ large liquidity buffers should accommodate further potential deposit outflows, and that their capital positions are generally strong—the largest bank excepted. Nonetheless, they cautioned against complacency given rising non-performing loans, and welcomed the authorities’ heightened oversight of the banking system. Although bank resolution tools are generally effective, Directors stressed the importance of establishing the central bank as the sole authority for bank resolution.

Directors welcomed the authorities’ intention to rebuild fiscal buffers, in view of the economic uncertainties and large contingent liabilities from the banking system. Although the planned tax reform would make the tax system more efficient, Directors felt that fiscal adjustment in the period ahead would be more effective if some tax exemptions in the plan are reversed or the decline in personal income tax rates is more limited. Directors also noted that the current level of public wages, pensions, and health spending is unsustainable, and recommended cutting back outlays in these areas, while protecting the most disadvantaged.

Directors welcomed the steps taken to dismantle tax and bank secrecy, and the increased exchange of information with other jurisdictions. Recent cooperation agreements with Italy, once ratified, will further entrench San Marino’s commitment toward openness and transparency. Directors agreed that further improvement of relations with Italy is a necessary condition for a revival of the Sammarinese economy and its growth drivers.

Directors noted the critical challenge of finding new growth sectors to replace lost activities in San Marino. They stressed the need to improve cost competitiveness and looked forward to implementation of planned labor market reforms.