Bahrain: Subdued despite its outperformance

Compared to the stellar performance of its regional peers Bahrain's stock market has been subdued, up only 22% on the year. By contrast Kuwait's bourse has risen 80%, Saudi's by 60%.

Concerns about regional competition may be to blame. Bahrain's position as the region's primary service hub is coming under increasing pressure. Dubai and Doha are both in the midst of a construction boom as they invest heavily into infrastructure. Dubai in particular has aggressive plans for both tourism and financial services - two of Bahrain's traditional strengths. So far Bahrain's response has been low profile, prompting some domestic criticism of a lack of dynamism from the government.

There have been some worrying signs. Tourist numbers have been slow to recover from their Iraq low. Lingering concerns about regional stability may be partly to blame but occupancy rates are underperforming other regional destinations such as Dubai and Egypt. Last year's GDP numbers highlighted that while financial services was still the largest non oil contributor to the economy, it registered almost no growth. Nonetheless plans for the Bahrain Financial Harbour are gathering pace and Bahrain's reputation for the best regional financial regulation so far remains unchallenged.

The external side of the economy has driven growth in 2003, in particular the oil sector. Despite Bahrain's success in diversifying its economy the underlying momentum is still provided by oil revenues. Typically oil accounts for 20% of GDP, 60% of the government revenues and 70% of exports. But there tends to be a nine to twelve month lag between the change in oil prices and its impact on domestic consumption and investment. The wider economic impact of the oil sector's growth therefore has not yet been felt.

The implications of the big hike in government spending may also not be perceived immediately. Capital Spending was doubled from 2002 and is forecasted to remain strong over the next two years as the government overhauls the country's road, water and power infrastructure. State owned enterprises such as Bapco and Aluminum Bahrain have also embarked on large government backed modernisation plans. The latter is half way through a USD 1.7bn plan to double its capacity by 2005, which will make it the largest smelter in the world. The government's investment plan will no doubt place Bahrain on a stronger footing going forward and a better public infrastructure will help Bahrain's efforts to attract foreign investment. However because the spending is project related and will necessitate substantial increase of imported capital goods and foreign expertise there will be little immediate boost to domestic consumption.

Unemployment is another drag on sentiment. The recent strong performance of the economy has not yet translated into job creation among nationals. The current rate is estimated at 14% among the indigenous population. The government continues to direct funds at the problem but with limited success. The situation is compounded by Bahrain's demographic profile: almost fifty percent of the national population is below the age of 20. Bahrainisation of the workforce remains a priority.

Next year may be different. Despite a more challenging global backdrop, with lower oil prices and higher interest rates, Bahrainis may have more to cheer about. The first Formula 1 race in the Middle East is planned and should be a huge success. The US may conclude a free trade agreement and stability in Iraq could bring significant business opportunities. We expect real growth to be 6.5% in 2003 and 3% in 2004. Inflation should remain relatively muted below 1%.