The introduction of a goods and services tax, coupled with cost-cutting measures and a proposed multibillion-dollar loan, is expected to help Bahrain improve its fiscal position and reduce national debt.
On October 8 the Shura Council, the upper house of Parliament, ratified a bill authorising the introduction of a 5% value-added tax (VAT) to come into effect on January 1 next year.
The decision will see Bahrain follow other economies in the region, such as Saudi Arabia and the UAE, which introduced their own VAT at the beginning of this year.
The government had initially intended to introduce VAT at the start of 2018, in line with a GCC-wide decision to apply a goods and services levy in all member states; however, implementation was deferred due to concerns over a lack of technical readiness in adopting the changes.
Oman, Kuwait and Qatar also delayed their respective launches of the tax due to the need for greater preparation and technical groundwork, according to a statement from the IMF issued in February.
Reforms aim to eliminate government debt by 2022
The planned launch of VAT, which the government estimates will generate $2.1bn annually, is part of a wider programme aimed at reducing the state deficit and balancing the budget within five years.
In early October the authorities released the Fiscal Balance Programme 2018-22. The reforms include streamlining cash subsidies, creating a central procurement unit, setting up six different taskforces to advise the government on reducing operational expenditures and incentives for public servants to take early retirement in order to reduce state employee levels.
The programme is expected to save some BD800m ($2.1bn) annually once fully implemented, with the aim of eliminating the fiscal deficit by 2022, down from 13.2% last year. It should also help efforts to reduce overall national debt, which the government places at 87% of GDP.
Meanwhile, the announcement of the fiscal reforms was coupled with news that regional partners Saudi Arabia, Kuwait and the UAE agreed to provide Bahrain with $10bn to support funding requirements in the short to medium term.
According to international media, the proposed funding will take the form of a long-term, interest-free loan, to be dispersed gradually.
VAT Implementation could affect short-term consumer spending
While the introduction of VAT should help boost government revenues, the experiences of other neighbouring countries suggest the levy could lead to some fluctuations in spending and place pressure on household budgets in the short term.
Leading up to their introduction of VAT in January, both Saudi Arabia and the UAE saw a rise in discretionary spending at the end of 2017, followed by a dip in spending once VAT took effect at the start of 2018, with consumer spending levels rebounding in recent months.
Furthermore, while the tax is expected to feed into inflation by adding to costs along the production, retail and service provision chain, experience elsewhere in the region has suggested the impact may be limited after some initial pricing pressure.
According to a report issued by ratings agency Moody’s in mid-September, the inflationary impact of the VAT on the UAE economy was modest, and the levy helped bolster efforts to broaden the base of the economy and improve state revenue flows.
In Saudi Arabia, while inflation picked up earlier in the year following the introduction of VAT, peaking at 3%, the consumer price index has since eased back, dropping to 2.2% as of the end of August.
Despite the expectation of market fluctuations, Fawzi Kanoo, acting CEO of the mixed-activity company YBA Kanoo, says the tax would benefit Bahrain in the long term.
“In the end it will be good for the country and will help the government continue to construct and maintain the infrastructure that all businesses depend on,” he told OBG.
Implementation of technical measures poses challenge
There are concerns that the kingdom may struggle to align its bureaucratic and technical processes in time to ensure a smooth launch of the levy on January 1.
Both Saudi Arabia and the UAE announced details of their respective VAT programmes well in advance of their introduction, the former in July and the latter at the beginning of August last year.
By comparison, Bahrain has a far shorter timeframe to educate the public on the implications of VAT, clarify its exceptions and allow businesses to train personnel on the regulations governing the new levy.