Bahrain: Competition to increase (page 1 of 2)

The near-term economic outlook remains avourable. High oil prices and continued diversification efforts are expected to boost economic activity by 6% in 2006 after an estimated 6.8% in 2005.

On the latter, the government is expanding downstream activities such as aluminium production with a sixth podline capable of producing 300,00 tonnes a year under consideration after an expansion has just been completed.

Other projects include the construction of the KFH Industrial Oasis and the expansion of the independent water and power project at Hidd. Meanwhile, Bahrain is also trying to further leverage its position as a service provider for Saudi Arabia. Such efforts include the building of the Financial Harbour and the opening of the Hidd port.

The Bahrain Financial Harbour is a key project to propel the country as the Islamic banking hub of the world, a position Bahrain has cultivated in recent years. This space is growing faster than conventional banking sector. Meanwhile, it has just been announced that the world's largest Islamic bank, Al Masref Bank, should soon be created with a start-up capital base of USD 5bn compared to the next largest, Saudi Islamic Bank, with paid-up capital of USD 1.8bn. With most of the investors apparently being from Bahrain, and given the country's leading role in this niche segment, it would appear to be a good assumption that the bank will be based in Bahrain.

All this sounds positive. However, there are still longer term risks to the economic outlook. The key question being asked is whether the economy is going to create sufficient jobs for the fast-growing labour force. While this is a problem for the region as a whole, the more populous countries such as Egypt, Iran and Saudi Arabia are of more concern. That said, unemployment is already a problem in Bahrain and is causing some, albeit relatively minor, social and political tensions.

Looking at some of the diversification efforts does not alleviate these concerns. For instance, one has to question just how many jobs will be created by Alba's expansion as this is a capital intensive rather than a labour intensive industry. Meanwhile, the expansion of the financial sector will create jobs, but whether they will be filled by the local workforce rather than by expatriates remains uncertain.

Of course, any expansion in the economy and in the population creates spin-off jobs in other areas. And the good news is that the local workforce is generally happy to take the jobs that are available. However, whether job creation will be sufficient to satisfy the country's needs is doubtful.

In some of the GCC countries, e.g. Kuwait, this is not seen as a huge problem. Huge hydrocarbon revenues and the associated fiscal surpluses have meant that any failure to create jobs could be offset by increased public sector jobs and welfare state spending.

However, for Bahrain this is less of a policy option. While high oil prices have pushed the fiscal accounts into a surplus, the surplus as a percentage of GDP is lower than elsewhere and some estimates of the breakeven level of oil prices from a fiscal perspective is USD 36 per barrel, compared to below USD 30pb for its GCC counterparts.

The good news is that we expect oil prices to average USD 40pb over the long-run which should allow the government room to maneuver on spending while also allowing a gradual reduction in the level of government debt, particularly as a percentage of GDP.