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Fitch revises Bahrain’s outlook to negative; affirms at ‘BBB’

Fitch Ratings has revised the Outlooks on Bahrain’s Long-term foreign and local currency Issuer Default Ratings (IDR) to Negative from Stable and affirmed the IDRs at ‘BBB’ and ‘BBB+’, respectively. The issue ratings on Bahrain’s senior unsecured foreign and local currency bonds have also been affirmed at ‘BBB’ and ‘BBB+’, respectively. The agency has simultaneously affirmed Bahrain’s Country Ceiling at ‘BBB+’ and Short-term foreign currency IDR at ‘F3’.

Key rating drivers

The revision of the Outlook to Negative reflects the following key factors and their relative weights:

High

The fall in oil prices has exacerbated the already challenging fiscal situation. Fitch estimates Bahrain’s fiscal breakeven oil price to be around USD130/bl, compared with a forecast for Brent to average USD83/bl in 2015. Fiscal flexibility is constrained by the very low share of non-oil revenue of just 14% of total revenues. Wages and subsidies together account for 70% of total budget spending.

The 2015 budget has been delayed until at least March due to November’s elections. Fitch has few details on the fiscal strategy that will be adopted or specific measures that may be proposed. Fitch’s forecasts assume a cut back in capital spending, some moderation in current spending growth, and incremental measures to raise non-oil revenue and reduce subsidies by better targeting. However, these measures are unlikely to make major inroads in the deficit, which is forecast to increase by 2ppts to 7.7% of GDP in 2015 on a general government basis, including estimated extra-budgetary spending. (The state budget deficit is forecast to rise from an estimated 3.7% of GDP in 2014 to 6.2% in 2015).

Government debt has continued to rise, to reach a forecast 47.2% of GDP at the end of 2014 and 52% in 2015. The ratio has moved further ahead of the ‘BBB’ median of 39.2%. Moreover, Fitch’s forecasts show the ratio continuing to rise in the medium term, even assuming some fiscal adjustment measures in the delayed 2015 budget.

Medium

Talks between the government and opposition aimed at reaching a political compromise ahead of the November elections came to nothing and the opposition boycotted the elections, which went ahead without major incident. There are no plans for further talks and the political stalemate continues. Fitch does not expect a comprehensive political solution to be achieved in the near term.

The affirmation also reflects the following factors:

Financing flexibility is good. The government has domestic bank deposits of an estimated 14.4% of GDP. These were drawn down during the last oil price fall in 2009 and were also used in 2014. Fitch assumes further drawdown during the forecast period. The domestic capital market is quite deep: a single two-year development bond issued in September financed the whole of this year’s estimated budget deficit of 5.6% of GDP. Bahrain has also become a regular eurobond issuer, most recently raising USD1.25bn at 30-year maturity in August.

Growth has accelerated this year, with both hydrocarbon and non-hydrocarbon activity surprising to the upside. Oil sector growth averaged 6% in 9M14, while non-oil growth rose to 5.2% in Q314. The latter is largely due to the increased activity triggered by GCC-funded infrastructure projects, particularly in housing. Of the USD4.4bn of projects approved to date (out of a total USD10bn promised over 10 years), work has now commenced on 28% of them. This is a substantial increase from six months ago when virtually no projects had commenced. GCC funded projects are off budget and will not be affected by any fiscal consolidation effort. Fitch’s forecasts of 4.3% overall GDP growth this year and next are higher than six months ago.

Bahrain’s external position is stronger than its ‘BBB’ rated peers. It registered a current account surplus of an estimated 6.7% of GDP in 2014 (quarterly balance of payments data are not published) and although this will decline next year, Fitch still expects a figure in excess of 4% of GDP. Although gross oil exports are over 50% of current external receipts (CXR), Bahrain also imports oil from Saudi Arabia to refine exported products. Net oil exports are only 25% of CXR. Bahrain is also a net external creditor at 150% of GDP, well above the ‘BBB’ median.

GDP per capita and broader human development and business environment indicators exceed the ‘BBB’ median. The strong regulatory framework and local skill base, combined with low costs, are key supports to the financial sector.

Bahraini banks have generally reported sound profitability during 2014. Capitalisation remains solid and asset quality improved overall. The smaller Islamic banks have continued to merge. The sector is in the process of preparing for the implementation of Basel III regulations, and the Central Bank is overseeing measures aimed at improving corporate governance and oversight.

Rating sensitivities

The rating Outlook is Negative. The main factors that individually, or collectively, could lead to a downgrade include:

– Difficulty in reining in fiscal deficits, resulting in a continuing rise in the government debt burden.

– Sustained oil price weakness that would exacerbate an already challenging medium term debt trajectory

– Severe deterioration of the domestic security situation.

The main factors that, individually or collectively, could lead to a stabilisation of the rating Outlook include:

– Significant fiscal measures which reduce the budget deficit and are consistent with the stabilisation of the debt-to-GDP ratio in the medium term.

– A broadly accepted political solution that eases political unrest.

– A recovery in oil prices that improves public finances.

KEY ASSUMPTIONS

Fitch forecasts that Brent crude will average USD83/bl in 2015 and USD90/bl in 2016. Production levels are assumed to increase marginally to reflect capacity upgrades.

Fitch assumes that Bahrain will continue to benefit from savings through the implementation of GCC development projects financed by Kuwait, Saudi Arabia, and the UAE. Agreement on commitments from Qatar is at a less advanced stage.

Fitch assumes there will be no challenge to the rule of the royal family or the current succession.

Fitch assumes no material deterioration in the internal security situation but also does not expect a comprehensive political solution to be achieved in the near term.

Bahrain is in a volatile region and its rating factors in existing tensions and conflicts which are assumed to continue. Fitch assumes that regional geopolitical conflicts will not impact directly on Bahrain or on its ability to trade.

Contact:

Primary Analyst
Richard Fox
Senior Director
+44 20 3530 1444
Fitch Ratings Limited
30 North Colonnade
London E14 5GN
Secondary Analyst

Paul Gamble
Director
+44 20 3530 1623