Complex Made Simple

S&P Global: Bahrain economic growth to average 2.4% over next 3 years

Financial support from other sovereigns in the Gulf Cooperation Council (GCC) will help Bahrain implement budgetary consolidation.

S&P project real economic growth will average 2.4% over 2019-2022, supported by infrastructure investment Bahrain has received pledges of US$10 billion in financial support over the next four years from GCC sovereigns, which will partially cover the government's funding needs while it enacts fiscal consolidation measures S&P expect the fiscal deficit will reduce to 4.6% in 2022, falling short of the government's balanced budget target

(Report by S&P Global Ratings)

The stable outlook reflects S&P Global Ratings' expectation that the Bahraini government will use the window of opportunity provided by the pledged financial support from other GCC sovereigns to narrow its large fiscal deficits against remaining external risks, exacerbated by the very low central bank reserves.

We could raise the ratings if Bahrain's budgetary position improves significantly beyond our current expectations. We would also consider raising the ratings if GDP per capita trend growth strengthens.

We could lower the ratings if external pressures intensify, for example, if the exchange rate peg were to come under pressure due to a sharp increase in demand for foreign currency.

key rating factors s & P global june bahrain 2019Table: S & P Global

Rationale

Our ratings on Bahrain are supported by our expectation that it will receive financial assistance from other GCC sovereigns, US$10 billion of which was announced in October 2018. We expect this support will partly meet the Bahraini government's funding needs over the coming years, partly replacing other external funding. Our ratings are also supported by Bahrain's high wealth levels relative to rated peers, and the country's net external asset position, resulting from its large wholesale banking sector.

Our ratings are constrained by our view of Bahrain's continued budgetary dependence on oil revenues, its high stock of government debt, and its unresolved domestic political tensions, which hamper the effectiveness of the sovereign's policymaking. The ratings are also limited by the weak trend in economic growth, as measured by real GDP per capita. 

Institutional and economic profile: A delicate political situation has constrained the government's ability to narrow sizable fiscal deficits in recent years

We anticipate that Bahrain's political and domestic tensions will continue, constraining the government's policy choices. In our opinion, there are still risks from the entrenched polarization between the Shia and Sunni communities, and internal communal divisions.

As a result, although we note progress with regard to the government's aim at balancing the budget by 2022, we expect the deficit to average about 5.5% of GDP over our forecast. The government's plan includes revenue and expenditure-side measures. Two large components of the fiscal balance program, the introduction of VAT and a voluntary retirement scheme, are underway.

Bahrain is a member of the coalition of Arab states, which imposed a boycott on Qatar, cutting diplomatic ties as well as trade and transport links with the country on June 5, 2017. The boycott has had a minimal impact on Bahrain's economy (except for the forgone US$2.5 billion in capital investment formerly pledged to Bahrain from Qatar). Overall, we believe political tensions within the GCC and Gulf region will persist, including the latest flare-up in tension between the U.S. and Iran.

Bahrain's economy slowed in 2018 to 1.8% because of a reduction in oil production and a lull in the financial services sector. Bahrain's relatively diversified economy still benefits from its proximity to the large market of Saudi Arabia, strong regulatory oversight of the financial sector, relatively well-educated work force, and low-cost environment.

However, fiscal consolidation could weigh on growth over the forecast period.

Our forecast for average real GDP growth over 2019-2022 is 2.4%. We expect the government's plans to promote infrastructure development, including several large projects like the refinery modernization program, to support growth. Funding will come from the private sector (US$15 billion), government-owned companies (US$10 billion) and GCC funds for infrastructure investment (US$7.5 billion). As of year-end 2018, about US$2.5 billion (6% of 2018 GDP) of the US$7.5 billion GCC infrastructure support fund had been disbursed. We expect about US$870 million will be disbursed over 2019, and further annual disbursements of about the same over the next three years.

Population growth was flat in 2018 due to a government exercise to clear old and inactive employment visas from population statistics. Nevertheless, when GDP performance during 2013-2022 is adjusted for population levels, real growth is negative, suggesting that labor supply, rather than capital investment or innovation, is a key growth driver.

Flexibility and performance profile: Financial support from other GCC sovereigns will help Bahrain implement budgetary consolidation

The government is implementing an ambitious plan to balance its budget by 2022. The plan includes measures focusing on increasing revenue capture from the non-oil sector of the economy. The plan depends heavily on expenditure reduction efforts, including cuts in the public sector workforce and fewer transfers to the Electricity and Water Authority. Taking into account the government's new plan, we now expect Bahrain's fiscal imbalance will narrow at a faster pace, reaching 4.6% of GDP by 2022 from close to 10% of GDP in 2017.

We expect increases in non-oil revenues, especially from the introduction of VAT in 2019. Though implementation will be gradual, we assume on average that VAT introduction could have a revenue-raising effect equal to about 1% of GDP a year. Currently, fiscal revenues are heavily oil-dependent, despite the oil sector contributing less than 20% to GDP. We believe that government revenues will remain dependent on oil over the forecast period. For our base case, we assume an oil price of US$60 per barrel in 2019 and 2020 and US$55 thereafter (see related research).

We expect expenditures will continue to decline over our forecast period. The government began reducing the public sector workforce in 2019, with the majority of voluntary retirements taking place in January and February. We estimate that the initial outlay required to fund this scheme at about 2% of 2019 GDP. We expect that the cost of the scheme will not be funded from the state budget, and assume it will be paid for with government assets. The government also plans to decrease expenditure through a centralized procurement structure, and to balance the revenues and expenditures of the Electricity and Water Authority, which would reduce government transfers. The plan also includes the reform of subsidy programs. Currently, multiple entities grant subsidies, and the government intends to consolidate disbursement and more strictly monitor eligibility of recipients.

Government interest payments are an increasing expenditure item, now comprising almost 17% of total expenditures, up from about 6.5% in 2014. Though the financial support package, concessional in nature, should help control the growth of interest costs, we believe it will remain a large component of expenditure.

Disbursements for the support package from Kuwait, Saudi Arabia, and the United Arab Emirates, announced in October 2018, began in 2018. We expect disbursements will continue over the length of the government's 2019-2022 budgetary consolidation program. The support package consists of concessional debt, the disbursement of which we do not believe are tied to strict conditions. The support funds are on top of the US$7.5 billion announced in 2011 for infrastructure investment(US$10 billion before the withdrawal of Qatar).

In our view, a high level of debt constrains the government's fiscal flexibility. We estimate that the gross debt stock will increase toward 96% of GDP by 2022, which includes the US$10 billion in fiscal support from other GCC sovereigns.

Our forecasts include an additional 1% of GDP over the budget deficit in annual government debt accumulation, in relation to the government's historical off-budget spending on defense and the Royal Court. We estimate debt on a net basis will average 74% of GDP over 2019-2022.

In our view, monetary policy flexibility is limited because the Bahraini dinar is pegged to the U.S. dollar. In addition, we consider the Central Bank of Bahrain (CBB) has limited credibility regarding its ability to maintain its exchange rate arrangements, given its low and volatile level of gross international reserves.

Bahrain's gross international reserves are low, covering less than one month's current account payments and about 40% of the monetary base, according to our estimates. Gross international reserves were about US$2.6 billion as of April 2019. We estimate reserve levels at US$2 billion at the end of 2019. They have been volatile, in the absence of a substantial and sustained net inflow of foreign currency. Nevertheless, GCC financial support should support reserves, while the CBB receives daily foreign currency inflows from the sale of oil (through the national oil companies). We forecast year-end reserves will be broadly flat over the next few years.

We expect a modest narrowing in Bahrain's current account deficit this year compared with a deficit of 5.9% in 2018, which was partially caused by increased outward remittances. However, we assume a decline in oil prices over the forecast period, which should keep current account deficits at about 4% on average over 2019-2022. Increased exports of aluminum from the expansion of Aluminium Bahrain should support exports. Although we expect Bahrain will remain in a net external creditor position over the forecast period, we expect that the coverage of external liabilities by liquid external assets (narrow net external debt) will fall slightly. Gross external financing needs remain high due to Bahrain's large banking sector.

For our banking sector contingent liability assessment, we refer only to the resident retail banks because, in our view, the cost of the wholesale banks' potential financial distress would not be fully borne by the government, given the high share of foreign ownership. This is not the case, however, in our external risk analysis, where the international investment position contains both resident retail and resident wholesale banks. Despite Bahrain's large financial sector (domestic retail banks) with gross assets estimated at about 235% of GDP and a large number of companies majority-owned by the government, we consider the government's contingent liabilities to be limited. Our Banking Industry Country Risk Assessment for Bahrain is '7' (on a scale of 1-10, with '1' being the lowest risk and '10' the highest).