Country Report Bahrain
The largest country risks for Bahrain lie in the political and social spheres. We expect the social unrest originated in the Arab spring uprising to continue, but not on the large scale seen in 2011. The fiscal position is on a deteriorating trend and the budget balance is expected to post a 5% of GDP deficit in 2013. The current account balance is in healthy shape, but too dependent on hydrocarbon exports. The external position is moderately good, since the country’s liquidity indicators show stable levels. Economic growth is driven by the hydrocarbon sector and government expenditures and forecast at 3.5-4% in 2013.
Economic structure and growth
Bahrain is the smallest country in the Persian Gulf with just over 1 million inhabitants of which half is expatriate. The discovery of oil in 1932 brought rapid modernization to Bahrain. Also, it was the first Gulf state to take serious action in the late 1990’s to diversify its economy to prepare for the post-oil and post-gas period, and as such it is probably the most diversified economy in the region. Bahrain jointly extracts oil with Saudi Arabia from the Saudi Arabian owned Abu Saafa oil fields, which is then imported and processed further in Bahrain (and much is reexported to Saudi Arabia, but this is not adequately reflected in the export data). Production from these oil fields is expected to remain constant in the next decade, but the government’s efforts to increase the productivity of its Awali field should underpin economic activity. Thanks to ongoing investment into enhanced recovery methods, the Awali field could be producing over 100,000 barrels per day by 2016, compared with about 40,000 barrels per day in 2012. Petroleum processing and refining account for over 70% of Bahrain's export receipts, contribute over two-thirds of government revenues and the sector’s share in GDP amounts to 11%. The services sector is dominated by banking and finance. The latter represents some 25% of GDP, although also business conferencing and tourism contribute significantly to GDP too.
The impact of the Arab Spring protests to the overall economy was small. Except for a few days in March 2011, the unrest did not significantly affect business activity on the island. It did hamper private sector investment and hit the tourism sector. Tourism is still recovering, but only accounts for a small 5% of GDP. Fearing the social unrest, foreign banks had downsized their operations in Bahrain and moved their staff to Dubai and Abu Dhabi in 2011, but the domestic retail banks were basically unaffected. In the area of Islamic banking, Bahrain is only second to Malaysia, when measured by total assets. The highly developed banking, communication and transport facilities attracted many multinational firms and banks to choose Bahrain as its regional home. Helpful in its diversification plans was the implementation of a Free Trade Agreement (FTA) with the US in August 2006, which was the first of its kind with a Gulf state.
Going forward, the growth engines will remain the hydrocarbon sector and government expenditures. The government will channel funds into the economy through higher wages, subsidies and welfare grants, which will buffer consumption. The USD 1bn GCC development package is of greater importance in the medium-term since it will flow directly into public investment projects. These projects include the areas of residential housing, transport, power generation and distribution, water treatment and sewerage, education, and industrial infrastructure. Economic growth is forecast at around 3.5-4% in 2013.
Political and social situation
Bahrain is far more liberal and woman-friendly than found in politically rigid Sunnite Saudi Arabia and theocratic Shi’íte Iran. The Shi’a population is the largest ethnic group with 56% of the population, and non-religious and Christian minorities comprise almost 20% of the population. But political and economic power is effectively with the Sunnite minority, with the royal family having a dominant say. A constitutional reform in 2001 established a partly elected parliament with loose ‘societies’ acting as proxy for political parties, which are not allowed. It was expected that these moderate concessions would make it immune to the wave of unrest that hit the Arab world in 2011. This was not the case. By February 2011, calls for faster political reform emerged. While these calls initially encompassed all Bahraini communities, it quickly split along sectarian lines after several fatalities and a failed negotiation process. Sectarian divisions increased after Shi’a opposition raised demands for radical political change and the government decided to use force against protesters. The government also asked Saudi Arabia for assistance; on 15 March 2011, Saudi Arabian forces entered Bahrain to help suppress protests and a state of emergency was imposed.
The Bahraini government has made some important strides since. It lifted the state of emergency on 1 June 2011, announced the withdrawal of Saudi troops, set up an independent commission to investigate human rights abuses, held a national dialogue, moved trials to civilian courts and released several prisoners. In response, the Shi’a opposition did significantly moderate its demands. Even so, grievances remain as the Shi’a main opposition party Al-Wefaq resigned from parliament and boycotted by-elections in September 2011. In 2012, Al-Wefaq have continued spearheading opposition to the regime, since they see continued insufficient reforms by the
government. Furthermore, the lack of progress has alienated some in the Shi'a community, leading them to support proponents of a more radical agenda. As such, we believe that the prospects for reconciliation are very slim in the short term and that protests will continue this year, but not on the massive scale seen in early 2011.
The fiscal position has been worsening since 2009. In 2009, revenues fell due to a large decline in oil prices. In 2010, the budget deficit increased due to a costly economic stimulus package. In 2011 and 2012, due to costly social spending packages to quell social unrest, the budget balance again recorded deficits. For 2013, we estimate the budget deficit to increase to 5.2% of GDP, up from a deficit of 1.1% of GDP in 2012, as current expenditures will markedly increase this year. The budget of 2013 sees a 15% increase in public-sector wages and a 20% rise in pensions. These expenditures also have long-term implications, given the political difficulty of reversing the agreed salary rises. The parliament's call for higher salaries and pensions also comes on top of the massive increases announced in 2011, when the government handed out a pay rise of up to 36.5% to the civil service and the military, and a 37.5% rise for pensioners. In addition, the parliament does not seem to have taken on the challenge of reducing the massive subsidy burden, which is budgeted to reach USD 2.55bn, or 27% of total spending, in 2014. The rise in current expenditures will come at the expense of state investment in capital projects, a worrisome development. According to the Ministry of Finance's present budgetary projections current expenditure outlay will grow by over 60% between 2010 and 2014. In contrast, the allocation for capital projects will have shrunk by 30% in 2014. This is a negative development for both the health of the state finances and the country's productivity. Public debt is estimated to grow to 60% of GDP in 2013, up from 56% in 2012. A support to public finances is the inflow of large amounts of Gulf donor aid, which help mitigate the impact of lower capital spending to a certain degree.
Monetary policy is primarily geared to maintain the fixed peg to the US dollar, which has been unchanged for over two decades, without much direct intervention in the FX-markets. To help maintain the peg, interest rates will continue to follow the US policy rates. Inflation is thus largely imported through food and commodity prices, although price pressures are partly mitigated by subsidies. Inflation is benign, forecasted to average only 2.5% in 2013.
Balance of Payments
Bahrain's current account balance is structurally characterized by surpluses on the trade and services balance. These surpluses are largely oil and aluminium driven, but also driven by international services, mostly banking, business and tourism. Deficits occur in net transfers of around 6-7% of GDP in recent years. This is related to the country's large expatriate workforce, which is almost 50% of the population and sends home a portion of its earnings. The income balance shows a deficit of 10% of GDP in 2012, which reflects the outflow of profits, dividends and interest payments. Overall, the current account balance is expected to show a surplus of more than 6% of GDP in 2013. Downside risks to this forecast are lower global oil prices, which will rapidly decrease the surplus on the trade balance.
Bahrain's foreign exchange-reserves (FX-reserves) increased to USD 4.8bn at end-2012, from USD 4.2bn at end-2011. We forecast FX-reserves to rise to USD 5.1bn at end 2013. However, a large downside risk to this expectation is a prolonged and steep fall of global oil prices, if the currently uncertain global economy deteriorates and reduces external demand.
Overall, the external position of Bahrain is moderately good although foreign debt is rather high. Total foreign debt is forecast to decrease marginally to 59% of GDP in 2013, from 61% of GDP in 2012. Short-term debt is around 10% of total debt, which keeps refinancing needs at low levels. Most of the debt is guaranteed by the public sector, but owed to private sector creditors. There is no history of arrears.
The liquidity position of the country is moderately good. Annual debt service payments amount to a modest 14% of total current account revenues in 2013, where half of it is related to short term, presumably trade-related obligations and 4% is needed for interest payments. The debt service is more than covered by FX-reserves at138% and the liquidity ratio stands at 229%, which are sound levels. However, the level of FX-reserves only covers 3-4 months of imports, which is rather weak.