Bahrain: Structural adjustments are necessary to mitigate the impact of low oil prices
Low oil prices and ongoing social unrest have slowed economic growth, severely affected public finances, and weakened external balances. Solid austerity measures are necessary, but require sufficient public support to avoid more social unrest.
Strengths (+) and weaknesses (-)
(+) Sound monetary policy
The long standing and credible exchange rate peg to the US dollar has kept inflation low.
(-) Weak fiscal position
Due to strong dependence on the hydrocarbon sector and continuing low commodity prices, the fiscal situation has deteriorated significantly and will become unsustainable without strong structural reforms.
(-) Narrow economic base
The oil sector dominates the economy, as it contributes 20% to GDP, accounts for 90% of total government revenues and for 67% of total export revenues.
(-) Social unrest
This long-standing divide between Sunni elite and Shia opposition has spurred frequent protests and violent confrontations in the past five years and the conflict is unlikely to be resolved in the near term.
1. Economic growth affected by lower oil prices
Despite the fact that Bahrain’s economy is fairly diversified compared to other Gulf Cooperation Council (GCC) countries, with non-oil sectors as main drivers of economic growth, the decline in oil prices and the continuing social and political unrest is hampering Bahrain’s strong economic growth seen the last couple of years. Real GDP growth has declined from an average of 5% over the last ten years to 2.9% in 2015 and is expected to further decelerate in 2016 (1.0%) (Figure 1). The hydrocarbon sector, the largest contributor to GDP (20%) has stagnated in recent years. In addition, Bahrain’s sound financial sector, the second largest contributor to GDP (15% of GDP), has mainly suffered from the ongoing social and political unrest, lasted since 2011. This turmoil stems from the longstanding issues related to the dominance of a minority Sunni ruling class in a Shia majority country. In addition, the steadily increasing competition of other rising financial centres in the region, such as Dubai and Qatar, which are relatively politically and socially stable, are also a challenge for Bahrain’s financial sector. Other important sectors contributing to economic growth – i.e. manufacturing, construction, transportation and the tourism sector – proved resilient. Expected investments (including financial support of the GCC Development Program) and expansion of these sectors will help to stabilize Bahrain’s economy in the short and medium term.
2. Deteriorating public finances and increasing current account deficit
Bahrain’s fiscal balances have been heavily affected by the continuing low oil prices, and this deterioration is expected to continue in the next years. This also applies to the external balance sheet which is narrowing. The current account dived into the red (-3.1% of GDP in 2015) after years of surpluses, and financial outflows have increased. It is not expected that the current account deficit will decrease in the upcoming two years. The fiscal break-even oil price (the price per barrel the country needs to balance its government budget) of Bahrain has increased rapidly to $120.6 per barrel in 2014, up from an average of $56 per barrel between 2000 and 2011. It is the highest break-even price compared to other GCC countries. For example, the break-even oil price of Qatar is $56.2 per barrel, of Kuwait $57.4, and of Saudi Arabia $102.3. Bahrain’s public finances are thus highly dependent on the oil sector. In addition, Bahrain’s government finances have a low shock absorptive capacity, given its relatively limited reserve buffers. Bahrain could only finance two years of its budget deficit with its sovereign wealth fund (Mumtalakat Holding Company), while the United Arab Emirates and Qatar, for example, could cover about 30 years of their deficit with their reserves. As a consequence, the fiscal deficit of Bahrain has been nearly quadrupled to an estimated -13.4% of GDP in 2015 from -3.6% in 2014. It is expected to worsen to -14.3% of GDP in 2016, before a modest recovery to -9.2% in 2017 (Figure 2). The increase of the public deficit has led to a rapid rise of the government debt, which is currently the highest in the GCC (it is forecasted to reach 73% of GDP in 2016, from 29% in 2011). Bahrain needs to implement drastic structural measures and reforms in the short term to rebalance its public finances and prevent an unsustainable situation (see development 3).
3. Unavoidable substantial structural economic and fiscal adjustments are planned
After a period of high levels of social spending to stem social unrest, the Bahraini government had no other choice than to reduce social expenditure and increase (non-oil) revenues to ensure macro-economic stability. Although the Bahraini government has implemented several austerity measures, including reforms of energy prices, cut in meat subsidies, and an increase of tobacco and alcohol taxes, public finances will remain weak and expected to deteriorate further. The government is therefore willing to take more necessary steps in the coming years to balance its finances. Bahrain’s authorities have announced in 2016 a series of measures to implement in medium-term, which could be divided into a few pillars: fiscal reforms to widen its fiscal base, including the introduction of a GCC wide value-added tax (VAT) within a few years, and the reduction and redistributing of government subsidies, such as further cutting of energy subsidies; streamlining government expenditure; and a series of economic reforms and infrastructure projects to further diversify and strengthen its economy. It will be politically a significant challenge to implement all the planned measures and reforms, as Bahrain has little experience with austerity and there is a need of strong public support to avoid more social and political unrest. On the other hand, financial and political support from mainly Saudi Arabia and other GCC countries will support the reform plans of Bahrain.
Bahrain is the smallest country on 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. The country was also the first Gulf state to take serious action in the late 1990s to diversify its economy to prepare for the post-oil and post-gas period. It is therefore 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. Oil produced there is subsequently imported and processed further in Bahrain. Petroleum processing and refining accounts for 68% of Bahrain's total export receipts and contributes about 90% to total government revenues in 2014. The services sector is dominated by banking and finance and represent around 25% of GDP. Manufacturing 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. The Shia population is the largest ethnic group with 56% of the population, while Sunnites make up 25% of the population, and non-religious, and Christian minorities comprise almost 20% of the population.