Bahrain: Political developments to dominate

The high oil price and expansionary fiscal policy continue to support Bahrain's economic outlook. Government spending is forecast to increase robustly in 2006, with expenditure budgeted to increase to USD 4.1 bn, up 10.8% from actual spending in 2005. However, historically spending has tended to be higher than outlined in the budget. Actual spending in 2005 was 17% higher than planned, despite only half the slated development spending being implemented owing to a shortage of contractors. Given the high oil price, the upcoming municipal and parliamentary elections (planned for the end of the year) and the growing political tensions, the government is again likely to overspend.

In July, parliament passed the two-year budget for 2007 and 2008. Although details remain vague, the budget will again be expansionary in 2007, with spending slated to increase by 19.5% from the previous year's budget. Total expenditure has been set at USD 9.9bn for the two years (USD 4.9bn in each year). The focus of the combined 2007-2008 budget will be on social expenditure, especially on human resource development, in order to ease social tensions. Education will account for 15% of the total state budget, up from 12%. Meanwhile, the allocation for housing projects has increased by 40% and recurring expenditure is planned to increase by 25%.

Despite the increased spending in 2006, the budget surplus will strengthen on the back of higher oil and aluminium revenue. Total revenue is forecast to increase by 35.8%, with oil revenue increasing by around 30%. Meanwhile, Aluminium Bahrain (Alba) will enjoy its first full year of expanded production, after the commissioning the 5th potline. We forecast a surplus of 4.2% of GDP in 2006, up from 2.5% in 2005.

With the fall in oil price from 2007, the budget surplus will deteriorate going forward, although revenue from the government's diversification projects (such as the port development in Hidd) will increase. The government forecasts a budget deficit of USD 83.7bn for 2007 and 2008; however, the budget is based on a conservative oil price of USD 40 pb. Although we continue to forecast a surplus in 2007 and 2008, the budget will come under increasing pressure at the end of the decade as the oil price fall to around USD 40 pb. Consequently, the fiscal account is forecast to realise deficits in 2009 and 2010. In order to avoid this, the government will need to reduce spending.

Nevertheless, in the short- to medium-term a key priority of the government will be raising living standards, especially of the Shia population, and increasing employment opportunities in the economy. Negatively, there was an escalation in violence in April and May, with low-scale bombing and rioting in the capital. Although the situation remains under control and is not expected to return to the same levels a decade ago, this is nonetheless an unwelcome development. Civil society groups in Bahrain have highlighted the potential radicalisation of Shia youth over unemployment, poor housing and low living standards. There is a risk the political violence from within the Shia community will escalate ahead of the parliamentary election, provisionally scheduled for October.

Political developments amongst the Shia opposition are also leading to the splits with the group, radicalising certain elements within it. In April, Bahrain's leading opposition group, al-Wefaq National Islamic Society, announced its plans to contest the parliamentary election. Other, predominantly Shia opposition groups have also voted to take part in the election. The al-Wefaq party boycotted the 2002 election over its opposition to the division of power in the National Assembly, whereby the king appoints the upper house. Recently, the party indicated it can achieve its goal of constitutional reform better through the formal political system. By focusing on the constitution, al- Wefaq is in danger of losing its bedrock support in the Shi'a community, which is concerned with socioeconomic issues.

Indeed, al-Wefaq's decision to take part in the election has caused a split within the group, leading to the formation of the al-Haq movement. The splinter group has indicated it believes participation in the election amounts to the acceptance of the 2002 constitution. Negatively, al-Haq has advocated civil disobedience and violent protests.

Social tensions are also being fuelled by high unemployment levels, which according to official data stand at 14%. Negatively, recent government data shows a fall in the percentage of Bahraini nationals working in the private sector, despite the government's 'Bahrainisation' program. According to the data, locals accounted for 24% of all private-sector jobs in 2005, down from nearly 27% in 2004 and 29% in 2003. Although in absolute terms the number of Bahrainis employed in the private sector increased in 2005, foreign nationals took up 89% of the new jobs created.

Importantly, the rise in social tensions has not affected business or investment sentiment. However, it remains vital for the government to forge ahead with its reform and diversification program to continue to attract businesses, especially ones which will offer greater employment opportunities. This is especially in light of the fact that other regional countries have similar diversification plans. Positively, reforms designed to modernise the licensing framework for banks in Bahrain come into effect in July and complete the Bahrain Monetary Agency's drive to create a clearer and more modern bank licensing regime. A key feature of the revised framework for banks is the simplification of existing categories of onshore and offshore banking licences, enabling offshore banks to undertake onshore business in a controlled manner. The banking sector remains popular for Bahrainis owing to the high salaries.

In a further positive development, Bahrain's Free Trade Agreement (FTA) with the US is likely to be implemented in July. This follows the following parliamentary approval of six laws extending protection of intellectual property rights. The laws relate to commercial secrets, country of manufacture distinction, production and distribution of compact discs, trademarks, electronic dealings and innovations copyright. The trade deal should have major benefits for the access of Bahraini exports into the US market.