Fitch affirms Bahrain's long-term FCIDR at 'A'; outlook stable

The Short-term foreign currency IDR is affirmed at 'F1'.

Bahrain has benefited from high oil prices and a buoyant regional economy, growing by an average of 7% over the past five years, and recording fiscal and current account surpluses. It enters a more challenging period less indebted than the 'A' median. Consolidated general government debt is estimated at 16% of GDP in 2008, and net general government debt (taking into account government deposits in domestic banks) is estimated at around 3% of GDP.

However, Bahrain's economy is less diversified than many 'A'-rated sovereigns, belying its relatively high income per capita, and its public finances are exposed to the oil price.

"The external environment has become much more challenging. Bahrain faces two external shocks - a steep fall in oil prices, and a slowdown in activity in the wholesale banking sector," said Charles Seville, Associate Director in Fitch's Middle East and Africa Sovereign team.

The main impact of falling oil prices will be on the public finances. Lower oil revenue will push the budget into deficit in 2009, from an estimated surplus of 5% of GDP in 2008. A draft 2009-2010 budget, under discussion by lawmakers, included large cuts in investment spending to keep the deficit to around 2% of GDP, based on an oil price assumption of $60/barrel. If the oil price turns out lower, Fitch expects the authorities to prove willing to adjust, as demonstrated in the past.

Bahrain is one of the main financial centres in the GCC, and a hub for Islamic finance. After a period of rapid expansion, the balance sheets of wholesale banks (formerly known as offshore banks) have contracted in Q308. Weaker financial sector activity will have a knock-on effect on economic growth. Fitch forecasts that overall economic growth in 2009 will halve from the 6% expected in 2008.

The risks to sovereign creditworthiness from wholesale banks remain low. In case of difficulty, Fitch would expect these to be supported by foreign shareholders; the Central Bank of Bahrain is not obliged to support them.

Past rapid growth in domestic lending by the retail banking sector, which has begun to level off, could lead to higher rates of non-performing loans in the future. Around one quarter of the loan book is related to real estate. However, the domestic banking system had a capital adequacy ratio of 15.5% of risk-weighted assets in September 2008, with a Banking System Indicator of 'B' (based on the average Individual ratings of Fitch-rated retail banks), signalling a solid banking system leading to no major concerns.

The retail banking sector has not required support over and above enhanced liquidity provision from the Central Bank of Bahrain designed to address short-term liquidity needs.

Geopolitical risks remain a constraint on the ratings. 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.