Will Fiscal Balance Program bring budgetary harmony back to Bahrain?

While Bahrain has a more diversified economy than many of its Gulf neighbours, at least in real economic terms, in fiscal terms more than 80% of state revenue still comes from oil. And with Bahrain’s breakeven point one of the highest in the region, estimated at more than $100 per barrel, far above the current market price, state revenue is down markedly, impacting on government spending and future plans.

Even so, there are positive signs for the economy, with a new $10bn fiscal aid package in place, as well as a fiscal programme announced in late 2018 that aims to balance spending and decrease the public debt.

Economic growth

For the third quarter of 2018, real economic growth in Bahrain was 1.6%, according to the latest Economic Quarterly issued by the Bahrain Economic Development Board (EDB), underpinned by expansion in the construction and manufacturing sectors. The country’s non-oil economy grew by 2.4% year on year, with new project infrastructure spending increasing by 16.3% year on year during the quarter. 

“Headline growth in 2018 is now likely to fall significantly below the 2017 figure – to the neighbourhood of 2%,” the EDB report found. “This is to a large extent due to a larger-than-expected contraction in the oil sector but also reflects more subdued non-oil momentum.” Growth is set to rise slightly to 2.3% in 2019, it predicts, but this is down from overall growth of 3.8% in 2017.

Lower oil prices have had a strong impact. According to ratings agency Moody’s, bank deposit inflows accounted for about 4% of Bahrain’s gross domestic product (GDP) in the three years to 2017, with the government relying on international capital markets and lending from other governments as the fiscal deficit came in at 9% of GDP. “While we now expect some fiscal consolidation as the government implements some measures agreed as part of a Gulf Co-operation Council support package, the deficit will remain wider than bank deposit inflows,” Moody’s said in a January 2019 report. 

Meanwhile, the International Monetary Fund (IMF) noted in July 2018 that the decline in global oil prices since 2014, along with the absence of buffers in Bahrain, had led to the country's public debt increasing to 89% of GDP, with large fiscal and external current deficits persisting. 

Spending cuts

Bahrain is well aware of the financial concerns and is targeting a sharp reduction in spending as a ratio to GDP. Bahrain’s Fiscal Balance Programme (FBP), released in October 2018, targets the elimination of the country's fiscal deficit by 2022, while reducing existing pubic debt.

Key to this will be reducing state expenditure, largely through a voluntary retirement scheme for public sector employees and the cutting of subsidies. The introduction of a 5% value-added tax (VAT), approved in late 2018 and in place since January 1, 2019, as well as increases in domestic natural gas prices, should also boost revenue. Another key goal of the FBP is to double non-oil revenue as a share of budgetary expenditure, with Fitch Ratings predicting that non-oil revenue will rise from 15% of GDP in 2017 to 25% in 2020.

“The economy has been doing quite well in recent years. Growth has been stronger than elsewhere in the Gulf,” says Toby Iles, director in the Middle East and Africa sovereigns team at Fitch Ratings. “The big question this year and in 2020 is fiscal consolidation, and what impact that has on the economy.” 

While Bahrain has been pushing through measures to cut public spending in recent years, Mr Iles says that rising costs related to higher debt eroded many of those gains. “What we have now is a much better-thought-out programme,” he says. “We’ve had some immediate actions. The VAT law passed, and on January 1 came into effect. We’ve had the first phase of the voluntary retirement scheme, with about 8700 civil servants signing up and the first cohort leaving their jobs at the end of January.”

Though he is doubtful the FBP will manage to fully reduce the deficit, Mr Iles says it could still have a strong impact in the next two years. “Just the VAT, voluntary retirement and controls on operational government spending could make a sizeable dent on that deficit. Even if it's not fully executed it stands a very good chance of at least stabilising the debt-to-GDP ratio,” he says.

In the aftermath of the announcement, Moody’s forecast the narrowing of Bahrain’s fiscal deficit from 9.1% in 2018 to about 4.5% of GDP in 2019 alone. 

Support package

In August 2018, Moody’s downgraded Bahrain's sovereign rating to B2 from B1, and maintained a 'negative' outlook, due to the further rise in external and government liquidity risks constraining access to market financing. This followed a similar move by Fitch in March 2018. The country also shelved an international bond issue in March 2018, worth $1bn, after finding the pricing demands of potential investors too high due to mounting debt.

However, in early October Bahrain’s gulf neighbours Saudi Arabia, Kuwait and the United Arab Emirates agreed on a $10bn support package for the country, which is likely to restore external market access and stabilise public finances. Moody’s subsequently stabilised its outlook “on the basis that government and external liquidity risks, while remaining elevated, have materially reduced”.

The financial package to Bahrain will come in the form of a long-term, interest-free loan, disbursed over the period between 2018 and 2022. 

“The funding is incredibly useful for Bahrain, because it is basically interest free,” says Fitch’s Mr Iles. “What was really killing Bahrain's progress in the past year or so was the interest costs, which were just spiralling out of control. This gives them breathing space to enact some of the changes. It will also improve market sentiment. The risk is that it is not like a transparent IMF deal whereby you have conditionality, timelines and targets,” he adds. "It’s much more opaque. There's an element of not knowing exactly what's always happening and when the next instalment will come, for example.”

Despite the cash injection, Fitch predicts that Bahrain will need the equivalent of about $3bn of new financing every year between 2018 and 2020 just to cover its budget deficit, with $7bn and $8.5bn a year needed to roll over existing debt, mostly short-term instruments held by domestic banks.

“Although Bahrain's bailout package has reduced near-term liquidity pressures, oil prices at [2017] levels would likely imply larger borrowing needs than assumed in the arrangement, potentially raising government liquidity risks again,” Moody’s wrote in its January 2019 sovereign outlook report.

Spend to earn

Bahrain has been investing heavily in recent years in upgrading some of its existing industrial operations. In January 2019, Aluminium Bahrain (Alba), one of the Middle East’s largest aluminium smelters, closed two loan facilities related to its Line 6 Expansion Project, which is expected to boost Alba’s yearly production by 540,000 tonnes, up from about 1 million tonnes today. State-run Bahrain Petroleum Company is also currently engaged in an expensive modernisation drive, including the expansion of Sitra oil refinery, which will raise production from 267,000 barrels a day to 360,000 barrels, and which could ultimately cost more than $5bn.

“The fact that Bahrain was highly indebted at a time when oil prices were going down was the side effect of the development of industrial projects, which had a very positive effect on the economy,” says Jean-Christophe Durand, CEO of National Bank of Bahrain, pointing to the fact that Bahrain's economy has been growing faster than its neighbours. “Of course, everything is a balance,” he says, adding that 2018 already saw a substantial reduction in the deficit, though that needs to be accelerated to meet the 2022 targets.

Meanwhile, in April 2018 Bahrain announced that it had discovered significant oil and gas reserves in the offshore Khaleej Al Bahrain Basin, predicted to be one of the largest finds in the country’s history. Estimates place the find at about 80 billion barrels of oil, as well as deep gas reserves in the region of 290 million cubic metres to 580 million cubic metres, though it will take years for the reserves to come online.

Bahrain is also looking to new technologies, notably fintech and cloud-based services, as a way to grow its economy in new directions. In 2018, Bahrain Fintech Bay, currently the largest fintech incubator in the Middle East and north Africa region, launched. Meanwhile, the cloud computing arm of e-commerce giant Amazon, AWS, will shortly open a data centre in Bahrain, its first in the region, which is expected to bring in thousands of jobs.

“A vote of confidence from such a globally successful company demonstrates its confidence in Bahrain’s business environment,” says David Parker, executive director of financial services at the EDB. “We worked very closely with AWS to build this environment, including designing one of the most modern cloud regulatory systems in the world. It isn’t just about one data centre, it is about the ecosystem that its opening will enable.”

Despite Bahrain’s economy remaining heavily tied to the fluctuations in global oil prices, there are positive signs of a more balanced economic landscape.