Bahrain: Year in Review 2019

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Despite ongoing fiscal challenges, Bahrain’s economy proved resilient throughout 2019, with the World Bank projecting growth of 1.8%. While expansion of the non-oil economy is expected to slow from 2.5% to 2.2%, the oil sector is due to move back into the black (0.2%), reversing the 1.2% contraction recorded the previous year.

By most estimates, inflation has remained low and stable, and was on track to settle at 1.4% for the year, according to IMF projections from October, due in part to the exchange rate peg to the US dollar.

This comes despite the introduction of a 5% value-added tax (VAT) in January 2019, which some observers feared would drive up prices. Indeed, the World Bank forecast in October that inflation could tick up to 3.3% by year’s end; however, the latest figures from the Central Informatics Organisation showed a rate of 1.9% as of November.

Foreign direct investment (FDI), meanwhile, was up 1% year-on-year at $262.6m in the second quarter of 2019. Kuwait accounted for the largest share of FDI inflows, with $119.8m, followed by India ($57.8m) and Saudi Arabia ($54.3m).

See also: The Report – Bahrain 2019

Fiscal adjustment progress

After a period of challenging fiscal conditions for Bahrain, in 2018 Kuwait, the UAE and Saudi Arabia collectively pledged $10bn to shore up the country’s finances and help it achieve a balanced budget by 2022.

The funds were accompanied by a comprehensive reform programme, which largely came into effect in 2019 through the Fiscal Balance Programme (FBP).

The programme includes the introduction of VAT, targeted spending cuts and a voluntary retirement scheme that has reduced the public sector workforce by 18% to date.

While these adjustments are broadly seen as steps in the right fiscal direction – most notably by global credit ratings agency Standard & Poor’s (S&P), which upgraded Bahrain’s outlook from stable to positive in November – estimates vary as to their ultimate impact on the deficit.

The IMF projects the budget shortfall will grow moderately from 4.3% of GDP in 2019 to 4.4% in 2020. The World Bank, for its part, published a deficit projection as high as 7.7% for 2020, though this represents an improvement from its projection for 2019. S&P was in the middle of the pack, expecting the fiscal deficit to continue to decline, from 5.7% to 5.1%.

VAT implementation

On January 1, 2019 Bahrain become the third GCC country – after the UAE and Saudi Arabia – to introduce VAT, which S&P estimates could raise government revenue by 1.5% of GDP per year.

The deadline for compliance with the 5% VAT was staggered. The first stage mandated that businesses with annual supplies in excess of BD5m ($13.3m) register for VAT by December 20, 2018. In the second stage businesses with more than BD500,000 ($1.3m) worth of annual supplies were required to register before June 20, 2019.

The deadline for the third stage was extended by a week, to December 26, 2019, allowing smaller businesses with annual supplies above BD37,500 ($99,700) more time to register. It will not be applied to either the health or education sectors.

While the introduction of VAT is a notable departure from prior practice in the region, it appears to have been broadly accepted by the business community. Some 90% of executives surveyed in Oxford Business Group’s latest Bahrain CEO Survey, published in August, described the country’s tax environment as competitive or very competitive at the global level.

Moreover, Bahrain ranks as the easiest jurisdiction in the world to pay taxes, according to the “Paying Taxes 2020” report published by the World Bank and consultancy PwC in December 2019.

Construction powers non-oil growth

In addition to boosting government revenue, the FBP targets a reduction in spending, which has had to be balanced against government commitments to prioritise public expenditure on infrastructure, given the significance of the construction sector to GDP.

It was the fastest-growing non-oil sector in 2018, expanding by 5.6%. A similar performance is expected for 2019, given the number of major projects that have finished or are nearing conclusion.

In November King Hamad bin Isa Al Khalifa inaugurated the Aluminium Bahrain (Alba) Line 6 expansion project, making it the largest smelter in the world outside of China. Aluminium is the largest manufacturing segment in terms of both value and output, and Alba accounts for 12% of GDP. This is expected to increase to 16% once the project reaches maximum capacity.

Another important project due to come on-line is Bahrain Airport’s new $1.1bn terminal, the inauguration of which is now scheduled for March 2020. One of the largest projects to date in Bahrain, work on the terminal began in February 2019, supported by funding from Gulf partners, including the Abu Dhabi Fund for Development.

Other notable projects include the $6bn modernisation of the Sitra Refinery, which began in March 2019 and is due for completion in 2022, and construction of the $4bn King Hamad Causeway, set to commence in 2021.

Given the robust project pipeline, the construction sector is set to remain a driving force behind non-oil growth over the medium term, helping to push non-oil revenue to 5.4% of GDP in 2019 and 5.7% in 2020, as per the latest IMF estimates. While an improvement, this would fall short of the FBP’s targets of 6.2% and 6.6%, respectively.

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