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Country Report Bahrain

Country Report

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Economic growth in Bahrain is estimated to slow to around 3% in 2014. Government finances are strained due high social spending and large energy subsidies. 

Strengths (+) and weaknesses (-)

(+) Strong external position

Bahrain has been running current account surpluses for over a decade and large net foreign asset holdings of the banking sector means Bahrain enjoys a substantial net external creditor position.

 (+) Sound monetary policy

The long-standing and credible exchange rate peg to the US dollar has kept inflation and the volatility of inflation very low.

 (-) Narrow economic base

The oil sector dominates the economy, as it contributes 20% to GDP, accounts for 88% of total government revenues and for 67% of total export revenues. 

(-)  Deep divide between Sunni elite and Shi’a opposition

This long-standing divide has spurred frequent protests and violent confrontations in the past three years and the conflict is unlikely to be resolved in the near term. 

Key developments

1. Economic growth slows

Economic growth is expected to slow to around 3% this year, down from 5.5% in 2013. Economic growth was driven by the hydrocarbon sector, which strengthened last year after a pronounced fall in production of the offshore Abu Saafa oilfield due to maintenance work in 2012. The hydrocarbon sector is the largest contributor to GDP (22%). Growth in this sector is expected to slow this year. No further expansion in oil production capacity is expected and a significant round of maintenance is due, which means production will halt for several weeks in May 2014. The financial sector is the second largest contributor to GDP (17%), and grew by only 1.5% year-on-year (yoy) in 2013. It highlights the extent to which Bahrain faces tough and increasing competition from other financial centres in the region such as Dubai and Qatar. This sluggish growth also highlights the challenges that Bahrain still faces in convincing investors that stability has returned to the country. As a result, growth is expected to remain weak in this sector. The country’s third largest sector, the manufacturing sector, which contributes 14.2% to GDP, grew soundly by 7.4% in 2013. This was largely attributable to output growth at Aluminium Bahrain (Alba), the state-owned aluminium producer. As production capacity upgrades are planned for Alba from 2014-2018, this sector is likely to continue to grow robustly in the coming years. 

Figure 1: Economic growth slow
Figure 1: Economic growth slowSource: EIU
Figure 2: Fiscal position weakens
Figure 2: Fiscal position weakensSource: EIU

2. Higher gas prices will strain fiscal position

Bahrain is struggling with fast-rising liquefied natural gas (LNG) demand that is outstripping its production capacity. Bahrain's gas consumption has grown strongly over the past decade, at an average annual rate of 4.1%, with industrial and population growth driving demand. Currently, all of Bahrain's gas is supplied by the onshore Awali field, but the lifespan of Bahrain's gas reserves at 2012 production levels is only 11 years. As such, Bahrain will need to import LNG to secure its domestic gas needs. LNG import sources are still being considered, but the fact of the matter is that imported LNG will be much more expensive than domestic gas. Estimates are in the range of USD 14-16 per cubic meter, while for example, Alba currently pays USD 2.25 per cubic meter. The higher cost would imply a marked deterioration of competitiveness for Alba and other gas-intensive industries in Bahrain. Furthermore, if the new terminal, which is being constructed especially for LNG imports, runs at full capacity, LNG imports would cost around USD 2bn a year, a cost that would have to be shared between industry, consumers and the government. Public finances are already strained by heavy electricity and fuel subsidies and will be further weakened by increased subsidies to compensate for the higher prices of imported gas in the future. Fiscal expenditures on oil and gas subsidies are projected in Bahrain's budget to rise from USD 2.3bn in 2013 to USD 2.5bn in 2014. As such, the budget deficit is expected to increase from 2.8% of GDP in 2013 to 5.4% of GDP in 2014, which is also attributable to high social spending to stem the social unrest.    

3. Continued unrest keeps social spending high

Three yearsafter unrest came to a head during the Arab Spring in 2011, regular protests continue, frequently resulting in violentconfrontations between protesters and security forces. The unrest stems from longstanding issues related to the dominance of a minority-Sunni ruling class within a country in which the majority of the population is Shi’a. Effortstowards dialogue between the government and opposition have been hampered by the sporadic detention of opposition figures by the government anddetonation of improvised explosive devices by protestors, usually targetingsecurity forces. Tensions remain elevated following multiple attacks by Shi’a militants this year. Given the government's failure to implement sufficient reforms and the perceived failings of the Shi’a opposition parties to extract meaningful concessions from the government, attacks are likely to continue in the near term. The Shi’a continue to feel disadvantaged on the socio-economical front and politically marginalised by the Sunni Muslim ruling family, which holds most of the important cabinet posts. The government has maintained high levels of social spending since the start of the Arab Spring protests, which has resulted in higher budget deficits since 2011. Although the trend in public finances is negative and a cause for concern, there are some mitigating factors. International capital markets seemingly shrugged off the social unrest by showing strong demand for the Kingdom's USD 1.5bn sovereign bond issue in July 2013 and Saudi Arabia's implicit financial backing of Bahrain is also playing a large role in keeping the kingdom's borrowing costs manageable. 

Factsheet of Bahrein
Factsheet of BahreinSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Bahrain is the smallest country in the Persian Gulf with just over 1 million inhabitants, half of which being expatriates. 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 one of the more diversified economies in the region. Bahrain jointly extracts oil with Saudi Arabia from the Saudi Arabian owned Abu Saafa oil fields, which is subsequently imported and processed further in Bahrain. 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 accounts for 67% of Bahrain's total export receipts, contributes over two-thirds of total 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 business conferencing and tourism contribute significantly to GDP too. Bahrain’s political and economic power effectively lies with the Sunni 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. Bahrain is far more liberal and woman-friendly than Saudi Arabia and 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.

Economic indicators of Bahrein
Economic indicators of BahreinSource: EIU
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