BAHRAIN. On June 12, 2015, Standard & Poor’s Ratings Services affirmed its long- and short-term foreign and local currency sovereign credit ratings on the Kingdom of Bahrain at ‘BBB-/A-3’. We also affirmed our long- and short-term foreign and local currency credit ratings on the Central Bank of Bahrain at ‘BBB-/A-3’.
The outlooks on both Bahrain and its central bank remain negative.
We expect that Bahrain’s fiscal metrics will be adversely affected over 2015-2018 by a pronounced reduction in revenues relating to the fall in oil prices. At our last review, we lowered our ratings on Bahrain by one notch to ‘BBB-/A-3’ from ‘BBB/A-2′ to reflect this deterioration, along with uncertainties over the authorities’ response to these challenges.
Since then, there have been some policy developments that, in our opinion, should help to alleviate these fiscal pressures, mainly in the form of prospective consolidation measures that the government will phase in over the remainder of 2015 and into2016.
However, we understand that these measures will not be included in the formal budget, which in draft form envisages a fiscal deficit of approximately 12.8% of GDP (versus 3.6% of GDP in 2014). Instead, these consolidation efforts will be extra-Parliamentary and therefore in addition to the budget.
However, we see uncertainties over the scope and implementation time-line of consolidation measures. Carrying out measures that both reduce and re-direct social expenditures that were initially designed to placate Bahrain’s polarized society is politically sensitive and could face delays.
Over 2014, Bahrain derived approximately 65% of its fiscal revenues from crude oil receipts, which are part of the 84% of total revenues derived from the oiland gas industry.
Bahrain’s fiscal break-even oil price, estimated at nearly $123 per barrel (/bbl) of oil in 2014, was the highest of all members of the Gulf Cooperation Council (GCC; Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, andUnited Arab Emirates).
This compares with an average of $52/bbl between 2000 and 2010. We view this as an erosion of the longer-term sustainability of the government’s fiscal position. Recurrent expenditures increased to 90% of total expenditures in 2014 from 81% in 2009, and wages and salaries account for 42% of total expenditures, with subsidies representing another 30%.
Recurrent expenditures total 87% of total expenditures in the draft 2015 budget, indicating that there is little formal consolidation planned. These increasingly burdensome social expenditures underpin Bahrain’s marked vulnerability to oil prices.
However, we understand that debate among the key stakeholders in Bahrain, including the Ministry of Finance, the central bank, and the Shura Council is increasingly focused on countering this continued fiscal deterioration and mounting debt burden.
Tabled consolidation measures have an estimated value ofjust under Bahrain dinar (BHD) 400 million per year, or just more than 3% of GDP.
Key among these measures are plans to reduce subsidies to expatriates and corporates over periods of three and four years, respectively, and to reallocate transfers to poorer sections of society. We think these proposals indicate that there will be a policy response to clear fiscal challenges.
At the same time, however, we expect that this response will generate objections, particularly since the topic of subsidies is sensitive given the delicate political environment.
Our fiscal projections show Bahrain’s general government deficit widening to 9.5% of GDP in 2015 compared with a surplus that averaged 1% of GDP over 2007-2013. The government’s debt burden has doubled since 2009, reaching some 43% of GDP at the end of 2014.
We estimate that the government will be in a net debt position of almost 20% of GDP by the end of 2015, from 10% of GDP in 2014 and a net asset position of 12% of GDP in 2010.
Furthermore, the drop in oil prices has affected our analysis of Bahrain’s external accounts. We now expect the current account will fall into a slight deficit in 2015, given that approximately 80% of exports are linked to oil. Bahrain’s services balance is related to the profitability of the financial sector.
It could deteriorate slightly due to weaker economic activity in the region and subdued loan growth in Bahrain. We project that corresponding outflows from the financial account will decline as a result, albeit with a potential time-lag, as prices feed through the financial system.
We continue to believe that Bahrain’s external stock position could be overstated as a result of a historical statistical discrepancy relating to the size of the financial system, much of which has limited bearing on the domestic economy. While the exact external asset exposures of the wholesale banks (80% of the total system) are uncertain, we believe the majority is to head offices, other banks, and securities. We treat these assets as liquid, in line with an international financial sector. They also account for the very high stock of short-term external debt of 5x current account receipts.
In both our fiscal and external assessments of Bahrain’s creditworthiness, we continue to assume that regional financial support will be forthcoming when needed. However, beyond 2015, the terms and timing of such support remain less certain, in our opinion. Moreover, we believe that increasing this dependency could reinforce policy complacency, with the potential to undermine Bahrain’s credit quality.
We continue to believe that disbursements from the GCC Development Fund, with approximately $10 billion in funding committed over a 10-year period, will offset expected (but not budgeted) government capital expenditure cuts and will act as a key growth contributor.
We think that real GDP growth will slow over 2015 as regional demand decreases, but that growth will remain positive at about 2% over 2015-2018. We understand that real economic activity over 2015 thus far has been more buoyant than expected–anecdotal evidence suggests this relates to increasing employment in construction projects related to GCC funding (particularly the airport expansion) but also in the private sector (expanding the aluminum smelter).
Although we do not believe that any further funding has been disbursed since our last review, we expect the Development Fund will disburse a further $750 million (2.1% of GDP) in 2015. These funds are intended to promote private-sector activity (albeit with little local bankfinancing) and improve Bahrain’s infrastructure. Other projects under way include housing, new roads, and schools.
Bahrain’s economic performance has shown resilience to shocks, and real GDP growth averaged more than 4.5% between 2007 and 2013. Bahrain’s proximity to the large market of Saudi Arabia, its strong regulatory oversight, a relatively well-educated workforce, and its low-cost environment still provideincentives for investment and create potential for the future growth of the non-oil economy, representing approximately 75% of total GDP.
Moreover, measures to ease restrictions on foreign participation in the labor force have improved flexibility for employers. Regulations that afford flexibility to foreign investors when managing their relationships with local businesses (which by law hold majority stakes in all businesses) are also signs of a relatively business-friendly policy setting.
However, we believe the already high level of competition in financial services–locally and regionally, particularly from Dubai–will limit the scope for growth at Bahrain’s offshore and retail banks. As a result of this and the reduced confidence caused by lower oil prices, we think the need to bring foreign talent into the workforcewill slacken.
While these factors limit upside growth potential, we expect that slower rates of immigration, which are a key determinant of population growth, could feed through into higher GDP per capita growth figures.
Despite Bahrain’s large financial sector and high number of majority-government-owned companies, we consider its contingent liabilities tobe limited. On average, banks display high regulatory capital positions and our Banking Industry Country Risk Assessment is 6 (on a scale of 1-10, with ‘1’ being the lowest risk and ’10’ the highest).
We expect that competition will continue to strain profitability at Bahraini retail banks, encouraging further consolidation. Although the size of the overall banking system has declined by about 25% since its peak in 2008, driven by offshore banks’ balance-sheet downsizing, in our base-case scenario we assume that outflows, in terms of both external funding and the physical presence of international banks, will be contained.
Bahrain’s retail banks carry a large credit exposureto the real estate and construction sector (about one-fifth of total lending on Sept. 30, 2014).
In our view, the real estate and construction sector remains in a correction phase, which has contributed to the build-up of a large percentage of problem assets (nonperforming loans and restructured loans; see “Banking Industry Country Risk Assessment: Bahrain,” published June19, 2014).
We do not expect that the Central Bank of Bahrain would act as a lender of last resort for offshore banks. However, we view the Bahraini government as a potential source of support for wholesale institutions not covered by parent entities or home countries, but still important from a systemic or reputational standpoint.
Consequently, we include all wholesale banks’ external liabilities in our assessment of Bahrain’s external financing needs.
The outlook on Bahrain remains negative to account for our view of Bahrain’s weakening fiscal profile and ongoing uncertainties around the extent and implementation of a sustainable response from the government. We could lower the ratings over the next year if our fiscal deficit assumptions are materially exceeded, or if measures to combat falling government revenues or structurally improve Bahrain’s public finances are not put in place. We could also lower the ratings if economic growth is substantially lower than our current projections.
We could revise the outlook to stable if the Bahraini government embarked on a feasible path to fiscal sustainability or if oil prices outstripped our current assumptions, thereby reducing fiscal deficits and limiting increases in government indebtedness.
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