Bahrain’s economic story over the past year is one of two parts: while the government has given much attention to the nation’s stubborn fiscal deficit and a challenging process of subsidy reduction, a longer-term focus has remained on the objective of economic diversification that the kingdom established in the early years of this century. Progress has been made regarding these concerns, in the face of the challenges presented by a precipitous decline in oil prices and regional unrest.
Despite the economy’s continued growth, the last year in which Bahrain enjoyed a fiscal surplus was 2008, which saw a surplus of 6.6% of GDP before rollover and 4.5% after. Since then a structural budget deficit has emerged on the balance sheet, the reduction of which has become a key priority for the government.
Fiscal consolidation is rendered a more challenging process when citizens have become accustomed to generous government support in areas such as home ownership, health care, education, energy costs and food prices.
The task is further complicated in Bahrain by a vocal National Assembly, half of which is made up of elected members, which has in the past shown a willingness to block spending cuts by government ministries and departments.
Parliamentary elections at the close of 2014 delayed publication of the two-year budget for 2015-16, but in May 2015 the government was able to present its fiscal plan. As expected, consolidation emerged as a key theme, though the deficit remains in place. The budget sees a significant increase in the deficit for 2015, from BD914m ($2.4bn) in 2014 to BD1.47bn ($3.9bn). The rise is largely the result of falling oil prices and their part in an anticipated year-on-year (y-o-y) drop in government revenue of 25% (with an oil price assumption of $60 per barrel in 2015). The picture for 2016 looks similar, according to the budget: an anticipated fiscal deficit of BD1.56bn ($4.1bn) as a result of depressed oil and gas income, despite modest rises in expected non-oil revenue.
Given Bahrain’s sensitivity to oil price movements, how closely the nation’s final accounts will reflect the budget’s projections is not yet known. In 2014, for example, the fiscal performance was more robust than anticipated – despite considerable oil price volatility in the second half of the year, the consolidated final accounts for 2014 show that government revenues rose 11% to reach BD3.09bn ($8.1bn), while expenditures declined by 11% to BD3.54bn ($9.3bn) to produce a budget deficit contraction of 62% to reach BD455m ($1.2bn), which was less than half the anticipated shortfall.
Bridging The Gap
Despite the potential for a better fiscal performance than the budget’s projections, Bahrain’s fiscal deficit is now deeply entrenched and has become a concern for the government. Boosting revenue and cutting spending have therefore been established as the twin objectives of the nation’s economic policy, but both tasks come with significant challenges.
On the revenue side, the low-tax environment that has helped establish Bahrain as a regional commercial centre leaves few options for policy adjustments that might boost government income. There are no taxes at all on corporate income, personal income, wealth or capital gains, death or inheritance, and according to the final accounts for 2014 published by the Ministry of Finance, taxation accounted for a modest 6.6% of total revenue for the year.
With tax largely off the agenda, the government is instead reassessing the fees charged on certain government services, for example through the imposition of a health care charge of BD72 ($190) per year on foreign residents’ visa fees. In October 2014 Bahrain raised the fees for all types of visit visas and their extensions, including one-week GCC residents’ visas and 72-hour visas.
More scope for fee increases lies in the large range of government services for both citizens and foreign workers, from driving licence renewals to contractor pre-qualifications.
On the spending side of the balance sheet, the government has more effective options to consider. Chief among these is the question of subsidies, which according to the current budget will account for 21.1% of total expenditure in 2015.
Reducing the level of government support on items such as meat, flour, gas, petrol, diesel, electricity and water has become a key government concern. As is the case for authorities across the MENA region, it is also an objective fraught with difficulties due to the public’s opposition to subsidy reduction.
In 2015 the government reassessed gas pricing, which it hopes to increase over a transition period until rates reflect the real cost of gas production or import. A reduction of the meat subsidy planned for August was delayed until September and then October, but will result in meat being sold at an open market rate in the future.
The biggest potential subsidy savings, however, are in utilities. According to the 2015-16 budget, subsidies directed to the Electricity and Water Authority will amount to BD325.5m ($857.5m) for electricity and BD315.7m ($831.7m) for water. These subsidies, the removal of which will affect both individuals and industry, are likely to be the most challenging to remove due to the political and economic impact of changes.
The timing of any adjustment of electricity and water subsidies, therefore, remains unclear. In mid-2015 the joint government-parliamentary committee formed to discuss the issue agreed that spending on electricity and water subsidies for citizens’ homes would remain in place for 2015 and 2016. This desire to protect citizens from the subsidy reduction programme has emerged as a key theme in all the government’s announcements on the subject. Instead, private businesses and expatriates are likely to face the first wave of subsidy cuts, leading to some concern that low-paid foreigners will be negatively affected while wealthier citizens continue to benefit from government largesse (see analysis).
Running with a budgetary shortfall since 2009 has had a deleterious effect on Bahrain’s macroeconomic position. According to Moody’s ratings agency, the persistent deficit resulted in general government debt rising to 48% of GDP by the close of 2014, up from 13% in 2008. The government’s attack on the fiscal deficit is a long-term project involving difficult fiscal consolidation and the implementation of a bold economic diversification strategy.
In the shorter term, the nation relies heavily on its oil revenue to pay recurrent expenditures such as manpower, services, consumables and debt servicing. In 2014 income from oil and gas activity accounted for 88.5% of total revenues, and this dependency on the resource at a time of depressed oil prices has become a key challenge.
The situation is made more acute by Bahrain’s relatively small foreign reserve cushion and the modest size of the nation’s sovereign wealth fund, Bahrain Mumtalakat Holding Company, which in 2015 was ranked 42nd in the world in terms of assets by the Sovereign Wealth Fund Institute. These challenges have been noted by major ratings organisations. In 2015 Moody’s downgraded Bahrain’s long-term government issuer rating from “Baa2” to “Baa3”. Similar downgrades were later released from Fitch and Standard & Poor’s.
Debt Market Appeal
Despite the sovereign downgrades seen in 2015, and the likelihood that oil prices will remain subdued over the medium term (Moody’s foresees only a very gradual recovery until 2019), investors appear to have confidence in Bahrain’s ability to manage its fiscal challenges. Since 2009 the country has successfully issued five international bonds, in doing so establishing a yield curve of 30 years.
Moreover, while yields on sovereign bonds have risen modestly as a result of the nation’s macroeconomic situation, they have remained stable since 2014, and are relatively low compared to those attained by other “Baa3”-rated sovereigns. International debt markets, therefore, remain a realistic route to funding, unlike other fiscally challenged countries in the region, such as Egypt.
As well as its ad hoc bond issuances, the government operates an extensive domestic debt programme, primarily made up of Treasury bills with tenors of three, six or 12 months, auctioned via a variable-rate process. The state also issues three types of sukuk (sharia-compliant bonds): long- and short-term ijara (leasing) sukuk and sukuk salam (sale of a specific commodity). Domestic banks have shown willingness to buy into government debt, viewing it as an easy route to yield, and traditionally issuances have been secured by institutions almost on an allocation basis and held to term, with no secondary market activity.
Recently, however, the Bahrain Bourse and the Central Bank of Bahrain (CBB) have established a new system by which individual investors can gain direct, beneficial access to primary government debt issuances. By July 2015 the bourse had already seen two successful subscription processes of government ijara sukuk under the new mechanism, as well as the successful offering of a BD150m ($395.2m) conventional government development bond (see Capital Markets chapter).
In July 2015 the government was granted considerably more manoeuvrability with regard to its debt programme when the National Assembly gave its approval to a royal decree first issued in November 2014 that increased the public debt ceiling from BD5bn ($13.2bn) to BD7bn ($18.4bn).
As well as investor support, Bahrain is the recipient of a more formal assistance framework established by regional allies, the existence of which explains much of the confidence that surrounds the nation’s ability to overcome its current economic challenges. As Bahrain grappled with civil unrest in 2011, the UAE, Kuwait, Saudi Arabia and Qatar joined forces to establish a $10bn financial development package for the country, to be paid over a 10-year period. This initiative has enabled Bahrain to cover its recurrent costs from government revenues, while relying on the GCC aid package to maintain the capital spending programme by which it aims to drive infrastructural improvement and economic growth. By 2014 the government said that it had spent $4.43bn of the GCC funds on the first phase of development projects.
Strategy & Institutions
Regional assistance has come to play an important part in the Bahraini economy, but the government has greater ambitions for the nation’s long-term economic future. The country’s development plan is mapped out in the Economic Vision 2030 document, which has the broad objective of creating a sustainable, competitive and fair economy capable of doubling household income by 2030.
Short-term development is governed by the National Development Strategy (NDS), a regularly updated action plan by which the broad ambitions of Vision 2030 are implemented through the establishment of specific milestones across the entire public and private economic landscape, including education and training, fiscal matters, health and societal concerns. Six economic areas have been prioritised for development, according to the NDS, all of which leverage Bahrain’s status as a business and commercial centre at the heart of the GCC: financial services; professional and industrial services; logistics; education and training; manufacturing (such as aluminium, food and beverage, chemicals and plastics); and ICT.
While all ministries and government bodies are charged with the implementation of the economic strategy, a number of key players are central to Bahrain’s development. The Economic Development Board (EDB) is a public agency mandated to attract inward investment and enhance the general investment climate, a role that makes it central to the development of Bahrain as a global brand synonymous with business friendliness.
Chaired by Sheikh Salman bin Hamad Al Khalifa, the crown prince, and including representatives of both the government and private sector, the organisation has spearheaded a range of crucial initiatives in the kingdom since its inception in 2000. These include labour market reform, the development of a new legal framework focused on targeted sectors, reform of education and health care, the establishment of Mumtalakat, the opening of Bahrain to international ratings and engagement with the private sector to provide much-needed social housing.
Tamkeen is the national labour fund, formed in 2006 and responsible for enhancing the work skills of Bahrainis through training programmes. Tamkeen’s principal focus is on private sector development, and much of its current activity revolves around enterprise creation and support for existing businesses (see Education chapter).
The Bahrain Development Bank (BDB) began operations in 1992 and is now the nation’s foremost development finance institution. It is tasked with diversifying the economic base, creating new employment opportunities and contributing to the overall socioeconomic development of the kingdom. Working with organisations such as Tamkeen to provide financial resources to businesses, the BDB has played an important role in the growth of small and medium-sized enterprises (SMEs), which are widely viewed as a crucial sector (see analysis).
As well as implementing the government’s public debt programme, the CBB is one of the best-regarded financial regulators in the region, its careful stewardship of banking, insurance and capital market activity largely responsible for Bahrain’s status as a commercial centre. It is also charged with the vital tasks of steering monetary policy and managing inflation.
For a small trading nation such as Bahrain, monetary policy is key to facilitating trade with global partners. Since the 1980s a high degree of rate stability has been maintained through a dollar peg, set at BD0.376:$1 and unchanged since. The dollar peg has also facilitated trade with regional partners that have similar ties to the US currency.
The primary objective of Bahrain’s monetary policy is to ensure appropriate liquidity in the banking sector. To this end the CBB provides a foreign exchange facility that is used to sell and buy Bahraini dinars against the dollar at the official exchange rate, while it aims to steer short-term interest rates in the money market by providing deposit and standing facilities to banks.
After maintaining key policy rates for most of 2015, the CBB raised the overnight lending rate from 0.25% to 0.5% in mid-December, following a raise in rates from the US Federal Reserve. The CBB’s Monetary Policy Committee has another important tool at its disposal in its ability to set the reserve requirement for all commercial banks in the kingdom, which currently stands at 5% of the value of non-bank deposits denominated in dinars.
Inflation has not been a significant concern for the CBB in recent years, and in May 2015 headline consumer price inflation stood at 2.4%, according to official data, rising from an earlier moderated level of 2.2% over the previous two months. May’s consumer price index showed a y-o-y gain of 7.7%, driven largely by the recovery of the real estate market, as well as price rises in water, electricity and gas.
Bahrain is setting about tackling its fiscal deficit and implementing its long-term strategy from an economic base that has already begun to expand from the traditional pillars of hydrocarbons and finance.
Oil, however, still plays a dominant role in the economy, accounting for 86.2% of government revenues and 20.4% of GDP in 2014, according to CBB data. Bahrain was the first country in the Gulf region to successfully produce oil after its discovery in 1932, and the onshore Bahrain Field is the GCC’s oldest source of crude.
Today, the kingdom’s most productive hydrocarbons resource is the offshore Abu Safa oilfield, the rights of which Bahrain shares with Saudi Arabia through Saudi Aramco, the state oil company. Production capacity of Abu Safa currently stands at some 150,000 barrels per day (bpd), although in early 2015 the average production rate amounted to a slightly lower 136,935 bpd due to seasonal maintenance work (see Energy chapter).
The financial sector is the second-largest contributor to GDP, accounting for 16.5% of the total in 2014. Bahrain emerged as a regional banking centre during the 1970s, as Lebanese institutions fleeing civil strife found refuge on the island. The growing reputation of the CBB and its muchlauded Rulebook – which forms the basis of a robust yet accommodating regulatory regime – resulted in a rapid deepening of the sector and made Bahrain a regional financial centre.
In 2015 Manama was home to 22 conventional retail banks, according to the central bank, some serving the domestic markets and others operating on a wholesale basis and reaching out to the Gulf and beyond for business.
Six Islamic retail banks and 18 wholesale operators, meanwhile, have helped to establish the kingdom as a leading player in the global sharia-compliant finance arena – a status that is considerably boosted by the presence in Manama of a number of standard-setting bodies, such as the Accounting and Auditing Organisation for Islamic Financial Institutions.
Insurance activity also plays a part in the financial mix, with 25 companies licensed by the CBB to operate in the country (seven of which are sharia-compliant) and 22 locally incorporated firms restricted to conducting business outside Bahrain.
The fruits of economic diversification efforts appear in the national accounts in the form of its manufacturing sector, which in 2014 accounted for 14.4% of GDP, making it the third-largest contributor.
Hopes for the sector are founded on Bahrain’s competitive edge in terms of location and a legal framework that allows for 100% foreign ownership of business and real estate, and the free movement of capital, profits and dividends. Much of Bahrain’s downstream manufacturing potential is generated by Aluminium Bahrain (Alba), one of the 10 largest aluminium smelters in the world, which in June 2015 announced that it would create a sixth production line to boost total production capacity to 1.45m tonnes per annum, making it the world’s largest single-site smelting facility.
A broader range of activity is being targeted by Bahrain International Investment Park (BIIP), a 247-ha complex created by the Ministry of Industry and Commerce (MoIC) near the new Khalifa Bin Salman Port in Hidd. Designed to attract export-oriented companies by providing quality facilities and nurturing clusters of activity, it has approved projects from a wide range of sectors, including food products, medical technology, household products, electronics devices, packaging materials and electrical switchgear manufacturing (see Industry chapter).
Other significant contributors include the transport and communications sector, which accounted for 7% of total GDP in 2014, and real estate and business activities, which made up 5.3%.
Trade & Investment
The expansion of manufacturing activity in Bahrain represents an important route to economic growth, and much of the capital that will power it is expected to come from beyond the nation’s borders.
The decision by Mondelez International ( previously Kraft Foods) to invest $90m in building a biscuit plant at BIIP, therefore, was one of the more important investment-related events of recent years, with the 2014 announcement coming as a vote of confidence in Bahrain after a challenging period since the unrest of 2011.
Inward flows of capital have remained resilient over recent years, even with the nation’s political challenges: despite a small y-o-y decline in 2014, foreign direct investment (FDI) was $957m, in excess of the levels seen in 2009-12.
Total inward FDI stock, meanwhile, stood at $18.8bn in 2014, a gain of 5.4% over the $17.8bn of 2013, and up 24% on the $15.2bn of 2010. Bahrain’s attractiveness as an FDI destination stems not only from the fact that the entire country is effectively a free zone, but also from its impressive trading links regionally and further afield.
Bahrain, unlike some free zones in the region, offers duty-free access to all GCC markets for commercial enterprises, as well as a free trade agreement with the US.
The nation’s physical link to Saudi Arabia makes the large neighbouring market an obvious trade destination, and in the first five months of 2015 it was the single largest recipient of Bahraini non-oil exports, accounting for BD250.6m ($660.2m) of the BD897.4m ($2.4bn) total.
The UAE is Bahrain’s second-largest export destination, accounting for BD153.7m ($404.9m) of total non-oil exports over the same period, followed by the US, at BD105.4m ($277.7m).
In terms of shipped goods, the leading non-oil exports were aluminium wires (BD88.8m, $233.9m), aluminium rods (BD74.6m, $196.5m) and iron ore (BD67m, $176.5m).
While Bahrain is a renowned centre for corporate activity, the government’s economic diversification efforts have thus far largely focused on the smaller end of the business spectrum. According to the MoIC, 97% of all companies in the kingdom fall into the micro or SME category, between them accounting for almost 30% of GDP. Over recent years a complex ecosystem of government, quasi-government and independent institutions has developed in the country, offering SMEs finance solutions, training, advisory services and infrastructural support.
An example of the interconnected nature of this effort is the online platform for SMEs recently inaugurated by the MoIC and launched in partnership with the International Finance Corporation, and with the assistance of the BDB and Bahrain Chamber of Commerce and Industry (see analysis).
Having successfully developed support for SMEs, the government and the private sector have more recently turned their attention to the start-up arena. The BDB has developed a range of incubators with specialised mandates, as well as a general-purpose incubator at Hidd that caters to over 150 different early-stage companies.
Private sector interest has emerged in the form of Tenmou, the first-of-its-kind angel investment company in Bahrain, which held the second MENA Angel Investors Summit in May 2015.
The rapid advancement of Bahrain’s start-up and SME arena, and more particularly the beginnings of private sector interest in it, bodes well for the long-term economic future.
“Bahrain holds many advantages geographically and culturally. Some bureaucratic procedures could be streamlined to make new development faster in a country where the ease of business is otherwise high,” Jalal Mohammed Jalal, managing director of Mohammed Jalal & Sons, told OBG.
While the nation remains a centre for corporate business thanks to its regulatory framework and a labour market that holds years of financial experience, the objective of creating a diverse, sustainable and inclusive economy necessitates a holistic approach to economic development. The success with which Bahrain has grown its manufacturing sector and nurtured its smaller businesses is therefore significant. In the shorter term, the nation’s fiscal outlook is inevitably tied to international oil prices. While the EDB foresees GDP growth of 3.3% in 2016, the likelihood of oil prices remaining weak means that the fiscal gap is not expected to close significantly, and the topic of subsidy cuts will remain at the forefront of economic debate as a result. Managing subsidy reductions without causing hardship to any segment of the population is thus likely to remain a central concern for government over the coming years.