Financial services, industrial manufacturing and a business-friendly environment have traditionally marked out the island Kingdom from other GCC states. Lacking the hydrocarbons of its neighbours, Bahrain has spent years diversifying its economy to meet future challenges.
As civil war raged in Beirut in the late 1970s and early 1980s, regional and international banks seeking a stable political environment relocated their offices and staff to Bahrain. This made it one of the first GCC states to move its economy beyond a traditional reliance on hydrocarbons exports. In recent decades the Dubai economic model may have grabbed headlines, but Bahrain has always been a good base from which to build a business targeting regional opportunities. Financial services now account for 25% of GDP, according to the Central Informatics Organisation (CIO).
OPENING UP: Over the past decade Bahrain has continued to open its economy to private sector investment – not only in financial services but in utilities and manufacturing as well. The country has focused on building capacity in aluminium smelting, oil refining and petrochemicals production, industries which rely on a steady supply of hydrocarbons. Guided by the Economic Development Board (EDB), Economic Vision 2030 outlines the country’s strategy, which aims to create a competitive, sustainable and diversified economy providing employment opportunities for nationals.
Given the political unrest that began in February 2011, concerns have mounted among policymakers and investors over how much impact the demonstrations and protests might have on the economy. While political reforms are under way to resolve the worst unrest since the 1990s – albeit at a slower pace than the opposition would like – the government will pursue a twin-pronged strategy of growth and tighter fiscal discipline to reduce the budget deficit.
NEW SPENDING: The need to make wide-ranging infrastructure upgrades to improve the economy in areas such as housing, health care and education will be used by the government to provide public works contracts for local private firms. The infrastructure improvements are important for putting the economy on a stronger footing with its regional competitors but the wider aim of the spending drive is to increase the level of private sector activity in the economy and to meet the social and economic aspirations of the people. New growth funds will be set up by the Ministry of Finance together with the National Bank of Bahrain, including a BD100m ($264m) Food Fund targeting investment in food processing and aquaculture, and a BD100m ($264m) Aluminium Fund to support the development of the downstream aluminium sector. More support for small and medium-sized enterprises (SMEs) is also to be included in the proposal for the 2012-13 budget.
A fiscal adjustment programme aimed at redirecting but not eliminating government subsidies for electricity, water, food, fuel and sewage should also help reduce the budget deficit, predicted to decrease slightly from 10.1% of GDP in 2011 to 8.8% of GDP in 2012. Nevertheless the Kingdom is backed by strong financial support from the rest of the GCC, which has committed $10bn to Bahrain over the next 10 years, with a first tranche of BD377m ($995.35m) that is expected to be received over the course of 2012.
GROWTH: “For 2011 we are estimating 2.2% GDP growth,” Yousif Humood, the assistant undersecretary for economic affairs at the Ministry of Finance, told OBG. “The recovery of the banking sector after the global financial crisis, high oil prices and increased aluminium exports are the main sectors which have helped us to achieve this 2% growth despite the unrest. After the political protests of 2011, we are trying to return to a more normal cycle of growth over 2013-14 and we are introducing more fiscal discipline. For 2012 we are forecasting GDP growth of some 4%.”
According to the EDB annual review for 2010, between 2000 and 2009 real GDP increased by 70%, at an average annual rate of 6%. At the height of the global financial crisis in 2008-09, Bahrain avoided recession, recording real GDP growth of 6.3% in 2008 and 3.1% in 2009 thanks to a government stimulus package and strong output from the manufacturing sector.
The latest data from the CIO puts 2010 GDP at current prices at BD8.3bn ($21.9bn). This rose to BD9.7bn ($25.61bn) in 2011 and is predicted to reach BD10bn ($26.4bn) in 2012. Over 2003-09 nominal GDP more than doubled from $9.7bn to $19.6bn, according to IMF data. In 2011 the nominal GDP growth rate was 17.8%, up from a rate of 12% in 2010.
ECONOMIC CONTRIBUTORS: Financial services remains a key contributor to the economy, accounting for 24.7% of overall real GDP in 2011, according to the EDB. Next in line is manufacturing, which comprised 16.7% of GDP, followed by heavy industries such as mining and quarrying, which contributed 13.1%. Of mining and quarrying’s contribution, the crude petroleum and natural gas quarrying subsegment provided the overwhelming majority. Transport and communications is a developing sector, accounting for 9.8% of GDP, an 11% rise over 2010. Unsurprisingly the construction, real estate, hotels and restaurants sectors have all suffered from the political unrest, recording shrinkages of 3.8%, 5% and 13.2%, respectively, compared to 2010.
Developing the non-oil sector has been a government priority for decades and much of the growth in this segment has come down to creating a business-friendly environment. The last year has been challenging for the government as it balances internal security requirements with the need to allow people to travel freely to conduct business. Despite current events Bahrain still ranks 38th out of 183 economies in the World Bank’s “Ease of Doing Business” survey for 2012, down from 33rd the year before. This places it above Oman and Kuwait, but below the UAE, Qatar and Saudi Arabia. The survey measures protection offered to investors, the availability of credit, business registration and the enforcement of contracts, among other factors. Bahrain’s more liberal atmosphere remains attractive to international firms, which can base themselves in the Kingdom and build a business or target regional opportunities. In addition, the Kingdom has no personal or corporate taxes apart from in the hydrocarbons sector.
FINANCIAL SERVICES: Accounting for a quarter of GDP and employing 14,342 people, 66% of whom are Bahraini, the banking system looks set to continue to remain an integral part of the economy. The sector has not emerged unscathed from the political crisis, however. According to Central Bank of Bahrain (CBB) data, the consolidated balance sheet of the banking system dropped 11.2% from $222bn in 2010 to $197bn by fourth-quarter 2011. While the balance sheets of retail and Islamic banks remained stable, wholesale banks saw a drop of 17.3% from $156bn to $129bn over the same period. This led a number of institutions to relocate elsewhere in the region. The CBB has noted this is not indicative of a mass exodus, however.
“As it stands now the actual number of banks and financial institutions remains unchanged at more than 400 licences,” Abdul Rahman Mohammed Al Baker, executive director of financial institutions supervision at the CBB, told OBG. “The fundamentals are still there.”
The current number of CBB licences has in fact increased from 406 at end-2010 to 415 by the end of 2011, with nine new licences still under review by year’s end. “We have seen 15% average growth in the financial sector over the past 10 years. Insurance premiums stood at BD210m ($554.44m) in 2010 and there have been 177 insurance business licences submitted so far,” said Al Baker. “This sector has deep roots dating back to the 1970s and we have learnt and developed over the years. Our in-depth knowledge, gained over decades of experience, puts us in a good position to survive the current stress-testing.”
The financial services sector is set to expand further in the near future, Al Baker said. Investment banking is well established, but widening the scope of the capital markets is under way. International asset managers, stockbrokers, mutual funds and real estate investment trusts have all expressed interest in new licences as well as self-regulatory organisations. Future activity in financial services is expected to come from project finance opportunities arising from the government’s infrastructure spending drive. Some $20bn is already being spent in the oil and gas sector. New housing schemes, road networks, an estimated $5bn-6bn causeway to Qatar and a liquid natural gas (LNG) terminal will all drive demand for long-tenor loan financing. The Ministry of Transport is also looking at a jointly funded Saudi-Bahrain rail project to run parallel to the King Fahd Causeway and the restructuring of national carrier Gulf Air. Various sources of financing to be tapped include commercial loans, conventional bonds and sharia-compliant bonds. Over the long term the fundamentals of the financial services sector remain sound. Project finance is set to increase in line with a new infrastructure drive while capital markets expansion is under way.
BUDGET: The government has increased public spending in response to the recent political unrest, raising the budget deficit to 8.6% of GDP in 2011. According to calculations from the EDB’s Economic Planning and Development Department (EPD), the deficit for 2012 is forecast to come in at BD727m ($1.92bn), or around 7.1% of projected 2012 GDP. The Ministry of Finance recorded an original expenditure budget for 2011-12 of BD6.2bn ($16.37bn). Over the course of 2011 the government added an estimated BD325m ($858m) to the budget (5.2% of the combined 2011-12 budget). The additional spending came from a wage increase decree in August 2011, according to an EDB report. Civilian, military and retirement wages received an extra “living improvement raise” of around BD50-60 ($132-158) per month for employees below a certain threshold. This increase was designed to raise civil servants’ minimum wage to BD402 ($1061) per month and of those in retirement to BD275 ($726) per month.
In a country which does not levy corporate tax or income tax on individuals the state still remains heavily reliant on oil and gas for revenue. According to the Ministry of Finance’s 2011-12 budget, net oil revenue, after subtracting oil and gas product subsidies and payments to the Future Generation Fund, is projected to reach BD2bn ($5.28bn) in 2012 or 87.6% of the government’s total income for that year. In 2011 net oil revenue reached BD1.9bn ($5.02bn) or 87.3% of overall income. Bahrain’s budget is still vulnerable to oil price shocks and would need to see continuing high oil prices around an average of $115 per barrel to balance its budget going forward, according to the EPD. The IMF puts the figure slightly lower, at about $114.
According to the EDB’s 2010 annual review, for much of the last decade (up to 2008) the Kingdom enjoyed budget surpluses, with the government’s debt-to-GDP ratio dropping to 15% due to high oil prices. As prices fell below $35 a barrel in early 2009 and public sector spending rose to compensate for a lack of private investment, budget deficits appeared. From a surplus of 4.9% of GDP in 2008, the government recorded deficits of about 6.1% of nominal GDP in 2009 and around 5.6% of nominal GDP in 2010.
SPENDING: Most of the spending under the 2011-12 budget of BD6.2bn ($16.37bn) focused on social infrastructure schemes such as a $500m affordable housing project and a programme for disbursing $2660 to every Bahraini family. According to Humood, similar social initiatives are also planned for the infrastructure, housing, health care and education sectors in 2012 and 2013. “Housing is problem number one,” Humood told OBG. Total housing demand among nationals is projected to grow from 124,065 units in 2010 to 173,069 in 2020 and 225,131 in 2030, according to the EDB’s third-quarter 2011 report. The Kingdom has a current housing deficit of 40,000 units. Total housing demand (including non-nationals) is set to rise to 263,536 units by 2020 and 346,711 by 2030, with the government aiming to build around 77,000 units for Bahrainis by then to help meet this demand.
The cost implications for the Ministry of Finance are sobering. According to the EDB, the average price tag of building a social housing unit is BD43,000 ($113,529) excluding the value of the land and associated infrastructure, which it is assumed would be covered by the government anyway. The total cost to the government is BD3.9bn ($10.3bn) over the next nine years and BD2.6bn ($6.86bn) between 2020 and 2030. The annual cost is BD437m ($1.15bn) up to 2020.
“Growth and [tackling] low unemployment are our main policy goals,” said Humood. “The budget deficit is important but over 2013-14 we will be able to rely on GCC support and try to minimise our debt by introducing more fiscal discipline by redirecting, though not eliminating, subsidies on electricity, water, food, fuel and sewage.” A 10-year, $10bn stimulus package, known as the Gulf Development Programme, is important to the government’s ability to provide essential public services while trying to balance its books. The package is being offered by Bahrain’s fellow GCC states. In addition, oil and gas revenues from the government’s upstream exploration programme will provide more cushioning so long as oil prices remain high.
FISCAL DISCIPLINE: The government recognises its subsidy system is unsustainable in its current form and is seeking ways of adapting it to projected future demand for fuel and food as a result of economic growth. The July 2011 National Dialogue concluded with several recommendations: further economic diversification, now under way; encouraging more private sector involvement; and cutting expenditure in key areas. The dialogue suggested the government examine redirecting subsidies and levying direct and indirect taxes. Resolving the issue of the high growth in expatriate workers was also recommended. A committee within the Cabinet of Ministers is focusing on all these issues.
One area attracting great interest from government is redirecting current energy subsidies. “There are many energy efficiency initiatives now being looked at by the Ministry of Finance,” Humood told OBG. “The World Bank is giving us assistance on this. It is carrying out a master plan to look at current building codes, electricity use and so on. KPMG is carrying out a study on smart meters for the Electricity & Water Authority to work out how to manage consumption during peak usage periods.” Other areas in which the government is seeking savings is the current structure for fees and charges. “On a macro level we need to start seeing greater efficiency in the economy,” said Humood. “Fees and charges is an area where we can start to be more efficient on a micro level.” Sewage treatment was previously free of charge but some are now looking at fees for corporates, although not for households. While there was previously a 1% charge for property registration, now it is 3%. Other areas where charges are low or non-existent include fees for traffic parking and vehicle registration.
DEBT, BONDS & RATINGS: In 2011 the Cabinet of Ministers agreed to increase Bahrain’s debt ceiling from $6.6bn to $9.2bn by issuing conventional development bonds and sharia-compliant bonds for infrastructure projects. At the end of 2010 total public and external debt stood at $7.4bn, or 35% of GDP according to EDB data. Although the debt-to-GDP ratio is low by international standards, the country’s debt insurance costs have risen. Bahrain credit default swaps (CDS) were at 372 basis points in early March 2011, according to Reuters. Before the political disturbances CDS were trading in the range of 175-200 basis points. In July 2011 Standard & Poor’s put a negative outlook on the Kingdom’s BBB long-term rating. “Some debts are now maturing over 2012-13,” Humood told OBG. “Our total debt is currently at 40% of GDP. As these debts mature we may borrow for repayment in the future and roll over. In the medium term we think it can be managed.”
INFLATION: Consumer price inflation (CPI) in Bahrain remains low. The average inflation rate has never risen above 3.5% over the last 10 years, according to IMF data. It fell from 2% in 2010 to -0.4% in 2011 but is projected to rise to 1.8% in 2012 and to 2.5% by 2016.
The government’s current review of its system of generous subsidies for nationals on fuel, electricity, food and water may start to have an impact on the rate of inflation over the coming years. Although much of the redirection of subsidies is expected to affect corporations rather than households (with, for example, possible fees for companies for sewage treatment being considered), there is increasing pressure to identify where savings might be made to ensure the viability of the government’s spending plans.
TRADE: Between 2003 and 2009 the Kingdom’s exports rose by 56% from $6.6bn to $11.9bn (2009 projection), according to IMF data. In 2010 Bahrain had a trade-to-GDP ratio of 140%, according to data from the EDB. The country continues to export more than it imports, although imports rose over the same period from $5.3bn to $9.5bn. Both exports and imports suffered a decline due to the global financial crisis of 2008-09 with exports falling 31.4% from BD6.5bn ($17.16bn) in 2008 to BD4.4bn ($11.62bn) by 2009.
Over the same period imports dropped 32.5% from BD5.3bn ($14bn) to BD3.6bn ($9.5bn), according to CBB statistics from December 2011. By 2010 exports had bounced back to BD5.1bn ($13.47bn) and imports had risen to BD4.2bn ($11.1bn). The current account balance stood at BD289.5m ($764.33m) in 2010.
A member of the World Trade Organisation (WTO) since January 1995, Bahrain’s leading export destinations are its regional neighbours. Saudi Arabia comes in top, accounting for 25.5% of total exports. The second is Qatar (with 13.6%), then India (8.8%), the UAE (8.1%) and finally the EU (7.9%) according to WTO data. In terms of imports, the Kingdom receives most from the EU (19.2%), followed by Brazil (18%), China (11.6%), Japan (7.4%) and the US (7.1%). A US-Bahrain Free Trade Agreement (FTA) has been in force since 2006. Exports to the US market totalled $420m in 2010. Fertilisers, textiles, aluminium and organic chemicals were the leading export categories according to the Office of the US Trade Representative. The Kingdom also has FTAs with the Norway, Iceland, Liechtenstein and Switzerland trade bloc, and, through its GCC membership, with Singapore and the Pan-Arab Free Trade Area.
In terms of main commodities exported, fuels and mining products accounted for 80.2% of total exports with manufacturing contributing 9.1%. On the import side manufacturing commodities were the most sought after imports, accounting for 63%, while 10% of total imports were agricultural products.
OIL & ALUMINIUM EXPORTS: Oil and aluminium are substantial contributors to the economy. According to the EDB’s third quarter 2011 report, both commodities contributed BD2.5bn ($6.6bn) to nominal GDP in 2010, or 31% of total. Half of the Kingdom’s foreign currency earnings come from the trade of these two commodities. These primary export industries are crucial to the country’s balance of trade.
The EDB’s data shows that between 2001 and 2010 oil and aluminium maintained a steady share of about 30% of nominal GDP. Despite a fall in the Bahrain Field’s oil output over the last decade, declining from 14m to 12m barrels per year in the period between 2003 and 2010, oil’s share of GDP actually remained steady from 24.3% in 2001 to 24.8% in 2010 due to high oil prices. In addition, the declining production trend has recently been reversed by the new Tatweer Petroleum joint venture (see Energy chapter).
Despite a large trade-to-GDP ratio of 140%, the EDB argues this ratio is exaggerated due to oil, which made up half of all trade in 2010. Much of Bahrain’s oil revenues comes from importing Saudi crude, refining it at the Bahrain Petroleum Company refinery and then re-exporting it back to Saudi as refined product for a profit. The EDB argues that to calculate oil’s actual contribution to the current account the value of intermediate imported goods used in the production of refined products (in this case imported Saudi crude) should be deducted from total oil exports. In 2010 the Kingdom imported BD2bn ($5.28bn) of oil and almost all of it was used in the production of refined products valued at BD3.8bn ($10.03bn) which was exported back to Saudi Arabia. So the actual current account contribution from oil was BD1.8bn ($4.75bn).
Oil exports currently play an important role in helping to maintain Bahrain’s trade balance, which is still vulnerable to oil price shocks. As the EDB stated in a report, “The current account is particularly important to Bahrain, as we trade heavily and maintain a currency peg to the US dollar. In order to maintain the exchange rate while importing goods, Bahrain must earn at least as much foreign currency as it spends to avoid a strain in the reserves.” Boosting its manufacturing sector and exports market remain among the top economic priorities for the Kingdom’s government.
DIVERSIFICATION & FDI: While the financial services sector has been a success story for Bahrain in terms of direct contribution to GDP and employment, there is a recognition among policymakers that economic diversification needs to be pushed across all sectors. The non-oil sector still needs to increase its contribution to the Kingdom’s trade balance. Out of total exports of BD6.72bn ($17.74bn) in 2010, according to the CIO, non-oil exports accounted for around 20% at BD1.3bn ($3.43bn), with the bulk coming from manufacturing.
The EDB, which, amongst a number of roles, seeks to attract foreign direct investment (FDI) into Bahrain, identifies high-tech light manufacturing, food processing, aerospace manufacturing, professional services and financial services as key targets for foreign participation in the Kingdom. “This year much of our focus has been on how we can add to the value chain, so to speak, in the downstream aluminium sector,” Vivian Jamal, director of business development at the EDB, told OBG. “We continue to encourage investment in financial services – which has proved successful – but education, health care, aviation and food processing are all areas we are now focusing on in 2012.”
FDI into the Kingdom has ebbed and flowed over the last 12 years. From $364m in 2000 inward investment jumped to a high of $2.9bn in 2006. However, the global financial crisis hit the Kingdom hard – FDI inflows fell by 85.6% from $1.79bn in 2008 to $257m by 2009. As the European debt crisis preoccupied the world economy, the Kingdom managed FDI inflows of $156m in 2010. “Despite the political crisis over 2011 we have redoubled our efforts, bringing in an estimated $780.9m,” said Jamal. “The retail and tourism sectors have been hard hit, as people know. Geographically, we are now focusing particularly on markets in Asia such as Japan, South Korea, India, China and Singapore.” The EDB’s strategy is to ensure it retains existing investors while at the same time maintaining a trade balance by boosting investment in manufacturing and not being dependent on any one sector of the economy.
Given these priorities the government is establishing new growth funds. A BD100m ($264m) Food Fund has been set up with seed funding from the Ministry of Finance. It is being led by the private sector under the National Bank of Bahrain and will invest in and promote food processing industries.
A second BD100m ($264m) Aluminium Fund is being set up under a similar model by the Ministry of Finance, which will also be private sector-led and focused on developing the downstream aluminium sector. In other manufacturing and services sectors several firms invested in the Kingdom in 2011, including German chemicals giant BASF, international law firm DLA Piper, US-based oil service company Enerflex, UK-based Swinton Technology ME and German pipeline maker RMA.
SMES & EMPLOYMENT: One of the most dynamic areas of activity is the government’s support for SMEs, which is closely tied to the policy of fostering an entrepreneurial spirit among Bahraini citizens.
Tamkeen (meaning “empowerment”) was set up in August 2006 as part of Economic Vision 2030. Its role is to act as an incubator and support system for new SMEs and private sector enterprises in the Kingdom. Tamkeen works closely with other government agencies such as the Labour Market Regulatory Authority (LMRA) and the Ministry of Labour on issues like employment policy. As of December 2011, Tamkeen had provided private sector businesses with up to BD166m ($438.27m) in funding to support their business plans and to take on new workers. The agency will also assist firms taking part in international trade fairs and exhibitions. Over 2012 Tamkeen will launch 20 training initiatives that are aimed at developing and improving skills among the Bahraini population.
The agency plays a dual role in offering training courses to students and employees as well as assisting domestic and foreign businesses in finding skilled Bahrainis to fill specific roles. Tamkeen either provides direct funding to businesses wanting to develop their own apprenticeship schemes for local staff or offers to provide the training itself. Funding for Tamkeen comes from 50% of the existing corporate labour fees collected by the LMRA. The Kingdom’s unemployment rate fell from 3.8% in January 2012 to 3.7% in February 2012, according to figures from the Ministry of Labour.
Tamkeen works closely with its strategic partner, Bahrain Development Bank (BDB), to finance viable new business opportunities in Bahrain. Through its guaranteed and subsidised loans, Tamkeen enables entrepreneurs to acquire the necessary capital to start their business at a low financing cost.
The total support that has been extended to greenfield businesses through the Tamkeen-BDB finance scheme exceeds $46m. BDB is a state-controlled bank that is 87% owned by the Ministry of Finance with the Pension Fund and the Social Insurance Organisation retaining a joint 13% share. During 2011 it financed 2687 enterprises with BD73.4m ($193.8m).
Through public-private partnerships with more than eight banks, Tamkeen has successfully extended its support to SMEs through its “Finance Scheme”. The scheme enabled more than 3000 enterprises to access low-cost capital through the private banking system by subsidising the interest rate and guaranteeing the loan amount. Tamkeen has also partnered with banks that specialise in microfinancing as part of its efforts to close the financing gap faced by individuals and microenterprises. The project should help achieve long-term economic goals. “For the country to decrease relative poverty and create additional employment opportunities, the government must encourage families and individuals to generate their own incomes through home-based businesses,” Fatima Al Balooshi, minister of human rights and social development, told OBG.
OUTLOOK: Despite the political upheaval of the past year, many of the challenges facing Bahrain’s economy remain the same as before. Further diversification as outlined under Economic Vision 2030 is under way, aiming to boost non-oil exports. On the fiscal side the government is seeking a return to budget surpluses with tighter discipline and a study of the subsidy structure. Energy saving projects aimed at reducing consumption and demand are also much in favour in the Ministry of Finance and across government departments. All of this, however, is being offset with social development. Making savings across sectors on a macro and micro level is important as the government pursues its two-year spending drive, which is aimed at upgrading infrastructure in terms of sanitation, energy and transport, as well as reducing the housing deficit. Employment for nationals is a key issue and the array of initiatives in place to support employment is testimony to the seriousness it is being treated with by the Kingdom’s government.
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