Non-oil growth sustains Bahrain’s momentum

Published in MEED, 28 June 2017

There seems little that Bahrain can do to rescue itself from its position as one of the laggards among the GCC states.

Its economy is easily the smallest of the six GCC countries and its credit rating is ranked in the “junk” category by all three main credit ratings agencies, along with a negative outlook from the US’ Moody’s Investors Service and Standard & Poor’s to boot.

The country has little in the way of hydrocarbons to exploit and, with oil prices remaining relatively low, it is a long way from being able to balance its budget. The Washington-based IMF estimates Bahrain’s breakeven oil price will be about $101 a barrel this year, which is very nearly double the current market rate of about $50 a barrel; few analysts expect prices to rise significantly anytime soon.

With limited savings and only small sovereign wealth fund assets, the government has turned to the debt markets to make up the difference. Since 2010, there has been a steady stream of international debt issuances from Manama, often at much higher yields than for other Gulf sovereigns.

That at least has forced the government into a degree of transparency. The Central Bank of Bahrain stopped publishing monthly data on its foreign exchange reserves in June 2015 and since then the only source of official information on this has come from government bond prospectuses.

According to Steffen Dyck, senior credit officer at Moody’s, these have shown that reserves dropped from $5bn to $2.5bn in a short period of time. “Bahrain has the highest level of external debt outstanding of all the GCC countries,” says Dyck. “The vulnerability from that perspective is quite high.”

According to the IMF, the country’s fiscal deficit stood at almost 18 per cent last year and public debt reached 82 per cent of GDP. With little prospect of a turnaround in revenues, the debt figure is likely to continue to rise in the years ahead. Slightly higher oil prices this year will provide a modicum of relief to the Ministry of Finance, but the deficit is expected to still be 12.6 per cent this year and to stay at that level over the medium term.

“A substantial increase in debt is projected,” says Padamja Khandelwal, who led the IMF team to Bahrain for the fund’s annual Article IV review of the economy in March.

 The government has taken some measures to address the difficulties it is facing, but there is still much more it could, and perhaps should, do. To date, its spending cuts and revenue-raising efforts have been more modest than those of other GCC governments. There has been a gradual phasing out of subsidies on meat, water, electricity and fuel, for example, and an increase in charges for some government services, but most outside observers have urged Manama to go much further.

“Bahrain, like other GCC countries, was hit hard by the drop in oil prices,” said Jihad Azour, director of the IMF”s Middle East and Central Asia department, at a press conference in Washington on 21 April. “Bahrain did the needed fiscal consideration. They still need to do more. They need to pursue fiscal consolidation.”

The problem is that any sustained fiscal adjustments, whether they involve spending cuts, revenue-raising measures or both, are likely to dampen the economy’s growth rate. The IMF estimates the economy expanded by 2.9 per cent last year, but the figure is expected to fall to 2.3 per cent this year and 1.6 per cent in 2018.

Last year’s growth rate was buoyed by a 3.5 per cent expansion in the non-oil economy, the second-highest in the GCC after Qatar. That relatively strong performance highlights the fact that Bahrain does at least have a reasonably well-diversified economy compared with most others in the region – the finance and construction sectors grew by more than 5 per cent last year, according to government officials.

However, Bahrain itself can only take part of the credit for this; some must also go to the richer GCC countries that have provided the funding for a lot of its recent infrastructure schemes. Bahrain’s Economic Development Board says the value of active projects paid for by the GCC Development Fund doubled from $1.6bn in the first quarter of 2016 to $3.2bn in February 2017.

Some other reforms have been introduced recently that could help the non-oil sector further. In April, for example, Bahrain introduced an Investment Limited Partnership Law, which allows investors to establish limited partnerships anywhere in the country, rather than just in free zones. The hope is that this will provide a boost to the financial sector, including real estate funds, private equity and venture capital funds, as well as captive insurance.

The IMF says the non-oil sector will continue to outpace the wider economy, with growth forecast at 2.9 per cent this year and 2 per cent in 2018, again helped by GCC-backed projects as well as spending cuts and new revenue streams.

While the fund has been urging the government to do more, the options are, for the most part, fairly unpalatable. The introduction of value-added tax is due in early 2018, although it may yet be delayed. That should be relatively easy to push through as it is being done on a GCC-wide basis and so will not put Bahrain at a disadvantage to other economies in the region. But other possible measures will be more difficult.

The IMF has suggested Manama consider reducing the high public sector wage bill by “streamlining” allowances, freezing wages and cutting the number of civil servants. Any of those measures could provoke protests in what is an already volatile atmosphere, with violent clashes between unyielding security forces and pro-democracy opposition groups a regular occurrence.

And while the richer GCC countries will probably be willing to provide more help in the future, any further aid is likely to come with strings attached. “There is an overwhelming consensus that, if push comes to shove, the other Gulf economies would come forward with financial support,” says Jason Tuvey, Middle East economist at the UK’s Capital Economics. “That said, rather than simply provide a blank cheque, it looks like financing would be conditional on further fiscal consolidation.”