The downgrade of San Marino’s IDRs reflects the following key rating drivers and their relative weights:
High
Fitch expects San Marino’s public finances to deteriorate significantly in 2020-2021 in light of the COVID-19 pandemic’s significant impact on the economy and the government’s support measures. The government intends to adopt EUR150 million-EUR200 million (11-14% of GDP) in measures to support businesses and households through the crisis, but are yet to be detailed. The support package could worsen the general government deficit to 24.4% of GDP in 2020 from an estimated deficit of 2.4% in 2019. Our 2020 deficit forecast also includes the assumption of 11pp of GDP in recapitalisation costs for government guarantees of Cassa di Risparmio’s (CRSM) bank legacy losses, which Fitch has incorporated into our forecast for San Marino’s public finances since 2018. Recovery in GDP growth and continued but narrowing fiscal support for the economy in 2021 should result in the fiscal deficit narrowing to 15.9% of GDP (including a further 11pp of implicit debt for CRSM legacy losses).
Emergency support measures announced so far include deferral of statutory, utilities and tax payments and we expect the bulk of the measures to be in the form of automatic stabilisers. The government expects to announce new budget measures in May 2020, and to finance the support package with budget reallocations and expenditure rationalisation.
General government debt is forecast to rise rapidly to 87% of GDP by end-2022 under these baseline assumptions, from 32.2% at end-2019 (current ‘BB’ median: 47%). This projection has increased by more than 24pp of GDP since our out last October 2019 review, reflecting the impact of the COVID-19 crisis on growth and fiscal accounts. Fitch maintains the view that large public recapitalisation of the banks is likely, but the size, timing and modalities remain uncertain. Hence, since our June 2018 review, we have assumed a front-loading of bank recapitalisation costs to implicit government debt over three years amounting to EUR455 million (32% of GDP) in government-guaranteed CRSM legacy losses. This excludes a further 15% of GDP of tax credits issued to banks and 7% of GDP in commitments to repay Banca CIS pension fund deposits.
Fitch expects the COVID-19 crisis to lead to a further deterioration of the banking sector asset quality due to economic contraction in 2020 and debt amortisation holidays for households and businesses. Sammarinese banks are already very weak with nonperforming loans (NPL) and a decade of negative profitability. NPLs rose to 57% of loans (32% net of provisions) in November 2019 from 53% at end-2018 (32% net basis) due to recognition of hidden losses at the failed bank Banca CIS, which was resolved under new resolution powers in June 2019. The IMF estimates that bank recapitalisation needs could total 51% of GDP, and a further 13pp to align with EU standards.
A combination of weak asset quality, prolonged forbearance, high cost structures and limited burden-sharing in the resolution framework, hampers effective banking sector restructuring resulting in weak financial intermediation and a fragile banking system. Data as of 6 March 2020 show banks’ seven-day liquidity coverage ratio improved slightly to 30% (September 2019: 28%), but remains low from a historical perspective. The lack of a lender-of-last-resort remains a key weakness for the banking system.
Medium
Fitch forecasts San Marino’s economy will contract by 9.5% in 2020, from growth of 1.0% in 2019, due to the impact of the COVID-19 pandemic. This is a downward revision of 10.3pp since our last review in October 2019. San Marino is heavily reliant on tourism, recording 1.9 million visitors and 204 thousand hotel nights in 2019, with tourism-related sectors accounting for roughly 19% of GDP and 31% of employment.
Widespread domestic and international travel restrictions affecting San Marino and Italy will adversely affect consumption, investments, exports and employment, with the restrictive lockdown currently extended to 20 April. Fitch expects the economy to rebound strongly in 2021, growing by 5.5% due to base effects and as regional tourism demand and manufacturing exports recover. We forecast medium-term growth in San Marino to average 1.2%.
San Marino’s ‘BB+’ IDRs also reflect the following key rating drivers:
The Central Bank of San Marino (CBSM) has taken some measures to support liquidity in the banking system and provide some relief to the households and businesses through the COVID-19 crisis. Key measures include supporting banks in delaying loan amortisation payments to 2021, temporary forbearance of recent trading losses in the securities portfolio and emergency credit lines for banks.
External finances are a key rating strength, with San Marino being a large net external creditor and a net international investment position of 247% of GDP in 2018. San Marino estimates the current account balance to have worsened slightly to -1.6% of GDP in 2018, from -0.1% of GDP in 2017. The IMF expects the current account balance to have improved to 0.7% of GDP in 2019, but to narrow to 0% by 2021. The progress in producing balance of payments data is a significant improvement in data availability for San Marino, but Fitch believes that there is significant uncertainty and quality issues surrounding these estimates and we believe the current account is likely to be in much larger surplus.
Government financing is predominantly domestic, including bank loans and roughly 9.5% of GDP in central government debt held by the state social security fund and the CBSM that has not been consolidated in our general government figures. The government is actively pursuing an expanded solution to obtain liquidity financing through the eurosystem. Meaningful IMF liquidity support might require further adjustments to the bank restructuring plan to anchor public debt sustainability.
A new coalition government took office in December 2019 with intentions to accelerate banking sector restructuring, conclusion of the EU association agreement and to utilise external financing sources, in addition to broad continuity on structural reforms covering the pension system, tax system and NPL management. The ongoing impact of the COVID-19 crisis on public health and the economy would likely alter the government’s policy priorities and delay implementation of these reforms.
Negotiations for an EU association agreement have been delayed by the EU elections in summer 2019 and the COVID-19 crisis, since the EU parliament announced its recommendations for an agreement that gives Sammarinese banks full passporting rights and access to the single market, with the possibility of access to eurosystem liquidity. Fitch believes access to the single market for San Marino’s goods and services would unlock significantly higher potential growth and that potential supervision and liquidity from the eurosystem could anchor financial stability in the banking system.
ESG – Governance: San Marino has an ESG Relevance Score of 5 for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. San Marino has a high WBGI ranking at 72 percentile, reflecting its long track record of stable and peaceful political transitions, well established rights for participation in the political process, effective rule of law and a low level of corruption. Due to limited availability of just two of the six WBGI components for San Marino, Fitch has used Italy’s WBGI indicators to proxy for the other four components. Due to the small size of its economy and population, institutional capacity is weak.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns San Marino a score equivalent to a rating of ‘BBB-‘ on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
– Structural factors: -1 notch, to reflect banking sector risk, and specifically the likelihood that further state recapitalisations of the sector will be required, the very high level of NPLs relative to the size of the economy, lack of profitability, weak financial sector policy response as well as bank regulatory and supervision framework weaknesses, and the absence of an effective ‘lender of last resort’. Part of these risks is captured in our public finance forecasts.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
RATING SENSITIVITIES
The main factors that could, individually or collectively, lead to negative rating action/downgrade:
– Worsening banking sector asset quality and liquidity leading to increased contingent liability risks for the sovereign.
– Sustained deterioration in structural fiscal balances and growth prospects resulting in a faster increase in the government debt-to-GDP ratio.
The main factors that could, individually or collectively, lead to positive rating action/upgrade are:
– Strengthening of banking sector, e.g. asset quality, liquidity and capital, reducing contingent liability costs for the sovereign.
– Reduction of public debt in the medium term for example through stronger economic growth or fiscal adjustment.
BEST/WORST CASE RATING SCENARIO
Ratings of Public Finance issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings https://www.fitchratings.com/site/re/10111579.
KEY ASSUMPTIONS
Fitch expects the global economy to go through a deep but short-lived recession in 2020 due to the COVID-19 pandemic. In particular, eurozone GDP is expected to fall by 4.2% in 2020, followed by 2.9% growth in 2021. Fitch notes that there is an unusually high level of uncertainty around them and that risks are firmly to the downside.
SUMMARY OF DATA ADJUSTMENTS
The World Bank governance indicators are only available for two of the six input factors for San Marino. For the remaining four input factors, Fitch has used Italy’s score as a proxy, with reasonable confidence that the expected margin of error would not be material.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Current account balance estimates by the authorities & IMF are only available for 2017 and 2018. Fitch has estimated historic and latest data to with reasonable confidence using national accounts data and IFS international liquidity data.
ESG CONSIDERATIONS
San Marino has an ESG Relevance Score of 5 for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are highly relevant to the rating and a key rating driver with a high weight.
San Marino has an ESG Relevance Score of 5 for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight.
San Marino has an ESG Relevance Score of 4 for Human Rights and Political Freedoms as strong social stability and voice and accountability are reflected in the World Bank Governance Indicators that have the highest weight in the SRM. They are relevant to the rating and a rating driver.
San Marino has an ESG Relevance Score of 4 for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for San Marino, as for all sovereigns.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.
