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Bahrain resisted reform, has finally succumbed. Why?

Bahrain has been knee-deep in a troubling financial situation for months now.

The IMF even warned, “Bahrain needs a comprehensive package of reforms to reduce its fiscal deficits over the medium term.” But, the doom and gloom did not end there.

“Despite planned fiscal consolidation measures, fiscal and external deficits are projected to continue over the medium term, due to the large and growing interest bill,” IMF’s Executive Board said in a recent report. “Public debt is expected to increase further over the medium term and reserves are projected to remain low.”

Bahrain’s GCC neighbors have shown a willingness to provide aid to the economically ailing country, but their efforts have been held off by a building sense of anxiety regarding Bahrain’s efforts to reform its economy.

“Saudi Arabia, Kuwait, and the United Arab Emirates are waiting for Bahrain to submit its proposal for economic reforms before giving any money to the cash-strapped nation,” three people familiar with the issue told Bloomberg.

Now, following news from regional media outlets, it seems Bahrain has finally decided to take action. Tax experts are foreseeing the implementation of 5% VAT in the near future, perhaps by 2019.

Bahrain turns to VAT for a hand

David Stevens, VAT implementation leader at firm Ernst & Young (EY), expects Bahrain, Qatar, and Oman to adopt VAT in early 2019. At this current moment in time, no firm dates have been decided on. He expects Kuwait to most likely be the last to implement the tax, possibly later in 2019.

“We hope all four will make public announcements as to their intended start dates after Eid Al Adha, so businesses can act with some certainty in their time consuming and essential readiness preparations,” Stevens said.

Bahrain’s latest move is in accordance with the GCC Unified VAT Agreement signed by all 6 Gulf states.

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Bahrain is slow on diversification efforts

Reuters reports that Bahrain’s GDP, adjusted for inflation, shrank 1.2% from a year earlier in the first quarter of 2018 as oil production sagged, data from the official statistics agency revealed in July.

The oil sector of the economy shrank 14.7% from a year ago, while the non-oil sector expanded by 1.9%.

Unlike the UAE, which has shrunk the percentage of oil and gas related GDP revenue to 30% (according to Index Mundi), Bahrain still has a ways to go. 86% of the island nation’s GDP is comprised of fossil fuel-related revenue.

VAT could be the first step on the long road of economic diversification of the country, as it gets its finances in order.

READ: Can Bahrain be saved from a “terminal decline”?

VAT will cause inflation 

Like Saudi and the UAE, Bahrain is also expected to exhibit a rise in inflation, at least in the short-term.

Stevens of EY told Gulf Daily News Bahrain will experience a “one-off 2-3% spike in inflation (rise in consumer prices) as a result of value-added tax (VAT) early next year.”

“From what we have observed in markets like Saudi Arabia and the UAE, there is likely to be a pull forward of some discretionary spending ahead of the VAT commencement date that will then see a decline in such spending after the tax is introduced,” he explained.

Saudi has indeed suffered from a short-term bout of inflation. According to a report by business site Mubasher Info, the Saudi Arabian Monetary Authority (SAMA) forecast earlier this month that inflation would rise in the year’s third quarter, as a result of economic reforms.

After the immediate onset of VAT in January, official data by Saudi revealed that inflation spiked to 3%, similar to Bahrain’s forecasted rate.

A survey by comparison site YallaCompare noted a 2% increase in inflation in the UAE in Q2 2018, quarter-on-quarter.

Bahrain residents might catch a break, however. Stevens that Bahrain may decide not to “apply VAT to basic food items, education, and healthcare, as well as medicines, medical equipment, international transport and exports of goods and services.”

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