Fitch upgrades Bahrain to long-term FCIDR 'A'; outlook stable

Following the upgrade, the Outlooks on both IDRs are now Stable. The Country Ceiling is also upgraded to 'A+' from 'A'. The Short-term foreign currency IDR is affirmed at 'F1'.

"Improvements in domestic and external solvency ratios, continued strong non-oil growth and advances in economic and political reform explain the rating upgrade," said Charles Seville, Associate Director in Fitch's Middle East and Africa Sovereign team.

Low and falling public debt is one of Bahrain's rating strengths. General government debt was 24% of GDP in 2006, five percentage points down on the previous year, and below the median for A-rated sovereigns. Taking account of its domestic bank deposits, the sovereign is a sizeable net domestic creditor. Bahrain is also a net public external creditor to the tune of 9% of current external receipts, although its position is slightly weaker than the 'A' category median as its public sector external assets are smaller.

"Unlike the majority of A-rated sovereigns, the public finances are forecast to remain in surplus, allowing the government to both increase deposits and reduce debt," said Mr. Seville. Moreover, this is despite Fitch's assumption of lower oil prices in 2008-2009. Oil accounts for a quarter of Bahrain's GDP but three-quarters of government revenue - a similar share to other GCC countries. Bahrain's breakeven oil price on the budget is higher than some other Gulf states, but the government has a good track record of adjusting to revenue shocks.

GDP growth reached 7.1% in 2006, and continues to be driven by the non-oil sector, where growth has exceeded 8% for the last four years. By contrast, output in the oil sector has contracted in real terms in each of the last three years, although it has probably now stabilised. With inflation at just 2.1% in 2006 (although this includes some subsidised goods) Bahrain is growing rapidly without the overheating observed in some other Gulf states.

As a regional financial centre, Bahrain is well placed to benefit from the higher liquidity in the region. Investors from the Gulf and outside the region increased their deposits in wholesale banks by around a third last year and purchased more financial services. At 24% of GDP, the size of the financial sector almost equals the hydrocarbon sector. The quality of the financial system and its regulation should allow it to take on competition from emerging financial centres elsewhere in the Gulf.

The government continues to take advantage of the favourable external environment to pursue structural reforms. State firms, including the oil company Bapco and the aluminium producer Alba, account for a large share of output. However, the government has placed most of its investments in a new holding company - 'Mumtalakat' - which promises improvements in management and transparency. The government continues with landmark labour reforms and has begun to address unemployment via a job matching and training scheme. The private sector is becoming more involved in infrastructure provision.

The main political society representing the Shia majority, Al Wefaq, decided to participate in elections to the lower house of the National Assembly in November 2006 and became the official opposition block. While relations between the opposition and the executive have not been trouble-free, the presence of an elected voice in parliament for the Shia majority is positive for the political climate. Tensions between the US and Iran are a concern for local and regional politics, but Bahrain's firm alliances with Saudi Arabia and the US mitigate risks.