Middle East under pressure

5 min
Manfred Stamer
Manfred Stamer Senior Economist for Emerging Europe and the Middle East

Bahrain: A large and credible support package is needed

Concerns on the rise again

At the end of June, Bahrain returned into the spotlight as yields on its government bonds and credit default swaps surged within a few days, putting pressure on the peg of the Bahraini dinar (BHD) to the USD. Previously, the smallest GCC country had come under scrutiny in November 2017 on reports that it had asked Saudi Arabia and the UAE for financial support in order to replenish its foreign exchange (FX) reserves and avert a currency devaluation. The latest sell-off had no specific new trigger. It appeared to reflect investor concerns over Bahrain’s precarious public finances and external debt sustainability while there was still no credible support commitment from the richer GCC countries.

Against the backdrop of falling oil prices, the fiscal deficit surged to around -18% of GDP in 2015-2016. With the gradual recovery in oil prices, the shortfall moderated to -15% in 2017 and is forecast at a still large -11% in 2018 as Bahrain has the highest fiscal breakeven oil price in the region, estimated at 95 USD/bbl (see Chart 1). External debt sustainability is threatened as FX reserves fell again at the start of the year and were estimated at just USD2.4bn in April. This is equivalent to just one month of import cover (see Chart 2). In other terms it is even more critical: it covers only a meagre 10% of the external debt payments falling due in the next 12 months, much below an adequate ratio of 100%.  Adding Bahrain’s assets held in  its SWF – which amount to USD11bn (the smallest in the GCC) – to the FX reserves, that ratio remains modest at just over 50%.

 

 

Chart 1  Fiscal breakeven oil price forecasts 2018 (USD/bbl)    

Sources: IMF, Allianz Research forecasts

Support to come?

In the meantime, Saudi Arabia, the UAE and Kuwait have delivered a firmer statement that they will provide a financial support program. Details have to be disclosed yet, but any aid is likely to be conditional on strict fiscal consolidation. Ultimately, we expect a policy package to come as the neighbors will want to avoid a currency devaluation in Bahrain which could spill over to the region. We expect the program to include the introduction of a 5% VAT, which was already planned but postponed at the start of this year, in 2019.

Impact on growth

Bahrain posted healthy growth of +3.9% in 2017 – the highest rate in the GCC region – despite the fiscal woes. This was thanks to a strong +4.9% expansion in the non-oil sector, which accounts for 80% of GDP, hereby offsetting the effect of a
-0.4% decline in the oil sector. In 2018, we expect the oil sector to grow again since oil prices are higher and the impact of OPEC-agreed oil production cuts at the end of 2016 is fading. On the other hand, fiscal consolidation measures will slow down the non-oil sector in 2018-2019. As a result, we forecast GDP growth to decelerate to +2.4% in 2018 and +2% in 2019.

 

Chart 2  Bahrain - FX reserves and import cover

 

Sources: IMF, Allianz Research calculations and estimates