The economic recession is likely to persist into 2013, with growth hampered by weak external demand and the continued effects of San Marino’s inclusion in Italy’s tax black list. While most banks appear to have reasonably strong capital and liquidity, the State should stand ready to further recapitalize Cassa di Risparmio (CRSM) as needed, for CRSM is a key element of the Sammarinese economy. It will be important for the government to rebuild strong fiscal reserves, and this will require setting more ambitious targets for the planned tax reform and expenditure review. Finally, San Marino has, in recent years, unwound many laws protecting bank and tax secrecy and stepped up exchange of information regarding tax and money laundering matters. Continued commitment to this more open and transparent course is the best way for San Marino to regain trust abroad.
1. Over the last few years, San Marino has faced a confluence of shocks: Italian tax amnesties have led to a large outflow of banking sector deposits; depressed incomes abroad have meant fewer tourists visiting the country and lesser demand for Sammarinese products; and, last but not least, San Marino’s inclusion in Italy’s tax black list has caused difficulties for financial and non-financial companies doing business in and with San Marino. In these circumstances, it is hardly a surprise that the economy has suffered a very large contraction, and that unemployment and social hardship are on the rise.
2. Still, it is remarkable that San Marino managed to avoid a full blown crisis. The reasons for this are clear: prudent policies and practices had allowed banks and the government to accumulate reserves that proved critical when the crisis came. Specifically, banks had sufficient liquidity to meet the large deposit outflows, while prompt action by the central bank helped preserve financial stability. Similarly, the government entered the crisis with a significant budget surplus, which helped limit the ensuing deficits; in turn, large accumulated reserves helped finance these deficits with little issuance of debt. The last few years should serve as a lesson that a small country like San Marino, so vulnerable to external shocks, can never be too prudent.
3. Recent months have provided some measure of optimism and comfort, but the economic situation remains very difficult. Deposits in the banks have stabilized and are increasing modestly in some cases, giving banks breathing room to improve their liquidity. CRSM, the largest bank in the system, has been shored up with much needed capital, and was able to repay loans outstanding to other banks. Nonetheless, the overall economic situation is far from positive, and the mission sees a high probability that the economy will contract again this year. This is because external demand will be weak as long as Italy remains mired in recession, while more Sammarinese businesses will reach breaking point as a result of the de facto isolation imposed by the black list. At this stage, we forecast an economic contraction of 3─4 percent, but things could be worse particularly if financial turbulence were to again grip the eurozone.
4. In this context, the financial system continues to face challenges. While the extent of Cassa di Risparmio’s total losses on its Delta investment remains uncertain at this stage, the bank will need more capital if it is to serve the Sammarinese community from a position of strength. So, the State should stand ready to further recapitalize the bank because investment by reputable private investors, which is the preferred course of action, seems very unlikely at this stage. This being said, public recapitalization of the bank should, in line with international best practice, require meaningful restructuring of the bank to return it to profitability expeditiously; it should also ensure that the State is entitled to a share in future profits that is commensurate with its share in the bank’s capital. Therefore, legal provisions that protect the Fondazione San Marino Cassa di Risparmio’s majority stake must be removed.
5. In the other banks, the economic crisis is leading to mounting losses on their credit portfolios, though in the view of the mission capital positions in these banks should be enough to absorb current and future credit losses in a variety of scenarios. Liquidity also appears sufficient, a key consideration given the size of the banks relative to the economy. But there is no room for complacency, and the mission commends the central bank’s intensified supervision aimed at ensuring that banks are provisioning adequate amounts against expected losses, and that they remain liquid and well capitalized. The mission also notes that the central bank has the tools and stands ready to put in place preventive remedial actions, should these be needed to ensure financial stability.
6. A key lesson from the recent crisis is the importance for San Marino to rebuild strong fiscal reserves. To do so, the fiscal balance will need to gradually return to the surpluses enjoyed in the past. In this context, the government did the right thing when it put in place extraordinary fiscal measures, such as the real estate tax and the surtax on general income. Yet these measures, as painful as they are for many, only helped contain the state fiscal deficit at a still high level (by San Marino’s standards) of some 2─3 percent of GDP. Thus, substantial additional budgetary savings will have to be found over the next few years to reach the goal of a surplus.
7. The planned tax reform and expenditure review constitute a great opportunity to reach this goal. In the view of the mission, the government’s tax reform will lead to a more modern, efficient, and equitable tax system. At the same time, the quantitative goals of the reform should be more ambitious: effective tax rates, which remain very low by European standards, need to be raised further than contemplated in the plan, starting with a more comprehensive elimination of exemptions; in addition, the real estate tax needs to be made permanent, as this tax is relatively non-distortionary and a good source of revenue. Similarly, if meaningful savings are to be achieved via the expenditure review, some cuts in public wages, pensions, and/or social benefits appear unavoidable, though attention will need to be paid to ensure the cuts are equitable. One should note that social security spending has increased sharply relative to the size of the economy, reaching levels that can no longer be afforded.
8. Ultimately, San Marino’s economy cannot return to a robust growth path without a full normalization of relations with Italy. In this regard, the mission notes and welcomes the significant progress achieved in recent years to unwind laws protecting bank and tax secrecy; anti money laundering laws have also been significantly tightened. Existing laws are also more thoroughly enforced and the exchange of information on tax and money laundering matters has been stepped up. Continued commitment to this more open and transparent path will be the best way for San Marino to strengthen its relations with the international community.
We would like to thank the authorities and other interlocutors for the very frank and open discussions and their warm hospitality.