S&P Global Ratings has affirmed its ‘BB/B’ long- and short-term foreign and local currency sovereign credit ratings on the Kingdom of Bahrain.
‘We also affirmed our ‘BB/B’ long- and short-term foreign and local currency issuer credit ratings on the Central Bank of Bahrain, in line with our ratings on the sovereign’, the global credit ratings agency said in a statement.
Below is the full text of S&P’s statement, where it justifies its credit ratings of the Kingdom:
‘Our ratings on Bahrain are supported by the country’s strong net external asset position and our assumption that Bahrain could receive additional support from Saudi Arabia, or from other Gulf Cooperation Council (GCC; Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, United Arab Emirates) neighbours, in the event of further significant deterioration in its fiscal position or domestic political instability.
The ratings are constrained by our view of Bahrain’s continued fiscal dependency on oil revenues and its unresolved domestic political tensions, which hamper economic policy effectiveness. The ratings are also limited by stagnating real GDP per capita growth.
The government has continued to implement numerous consolidation measures, which so far equate to about 7% of estimated 2016 GDP over the period through 2021, by which time the government aims to run a balanced budget.
Measures include introducing price increases on fuel, removing subsidies on utilities, accelerating fee increases on tobacco and alcohol, and cost cutting at ministries. Furthermore, discussions on a second wave of consolidation measures are currently underway, although the time line for implementation is not fully clear.
Bahrain’s fiscal vulnerability to oil price fluctuations has increased from 2009, when, in response to the global economic slowdown and civil unrest, government expenditures started to rise (reaching 30% of GDP in 2012 from 23% in 2008), particularly owing to recurrent items such as public-sector wages and subsidies.
In 2015, recurrent expenditures accounted for 88% of total expenditures, up from 81% in 2009. Also, wages and salaries accounted for 40% of total expenditures, with subsidies representing another 27%. On the revenue side, Bahrain generated 78% of total revenues from the oil and gas industry.
Despite the government implementing a number of consolidation measures, our estimate of the government’s fiscal deficit has widened. We had previously assumed that Saudi Arabia would provide financial support to Bahrain, starting from the first half of 2016. But the support has yet to be provided.
However, our February 2016 rating action already incorporated a significant weakening in our assessment of Bahrain’s fiscal position and this further worsening is not sufficient to change our view of Bahrain’s creditworthiness.
Wider fiscal deficit assumptions cause us to expect a higher annual increase in debt than in our previous review, and we now expect Bahrain’s debt burden will reach nearly 72% of GDP in 2016 and maintain its ascent toward 90% of GDP by 2019.
We note that stock-flow discrepancies between fiscal performance and the annual change in government debt over the past five years average approximately 3% of GDP. Net of liquid government assets (belonging to the social security system and government-owned investment holding company Bahrain Mumtalakat), we expect this figure will stand at 36% of GDP in 2016 and about 60% by 2019.
We continue to assume that Bahrain could receive support from Saudi Arabia or from other GCC neighbours if its financial position or domestic political landscape significantly deteriorates. Regional support for Bahrain currently comes from the GCC Development Fund.
Disbursements from this fund, with approximately $10bn committed over a 10-year period, have been slow, with less than $1bn disbursed since 2011.
However, we expect that up to $1bn (3.2% of Bahrain’s GDP) will be disbursed in 2016, based on an acceleration of disbursements so far in 2016, compensating for expected government capital expenditure cuts and supporting economic growth. These funds are intended to promote private-sector activity and improve Bahrain’s infrastructure. They are not directly credited to the budget.
Bahrain’s economic performance showed resilience in 2015, supported by growth in the manufacturing, construction, and transportation sectors. We expect economic growth will average about 3% over 2016-2019. Our projection mainly reflects Bahrain’s relatively diversified economy, with oil accounting for approximately 20% of GDP in 2015.
We also factor in Bahrain’s proximity to the large market of Saudi Arabia, its strong regulatory oversight of the financial sector, a relatively well-educated workforce, and its relatively low-cost environment. These factors continue to provide incentives for investment and facilitate growth of the non-oil economy.
Bahrain’s population growth has continued at a higher pace than we previously expected (4%-5% per year) and is consistently above the pace of real GDP growth. We also note that the Bahraini dinar’s real effective exchange rate has appreciated by 16% since early 2014.
In our view, this represents a deterioration in international competitiveness of the country’s modest tradables sector, which could dampen non-oil GDP growth, absent any offsetting factors such as improved efficiency or technological capacity.
Both international investment position and balance of payments data have undergone substantial revision by the statistical authorities and now exclude wholesale banking institutions registered abroad and foreign branches of Bahrain’s wholesale institutions.
Current account data has been restated to more accurately reflect non-oil trade data and indicates a much smaller current account deficit in 2015 than we had anticipated, largely due to a lower deficit on the income account. However, we note the presence of large negative errors and omissions in 2015, which could indicate an under-reported current account deficit.
We continue to project current account deficits averaging 1% of GDP over our 2016-2019 forecast horizon. Currently, the net data show an outflow of foreign direct investment of about 6% of GDP. We note, however, that this data is preliminary.
The restated data continues to show that Bahrain’s public and banking sectors’ liquid external assets exceed external debt. Bahrain’s net external asset position supports the ratings.
Our measure of external liquidity has improved due to the removal of short-term external debt related to the wholesale banks registered abroad. The latter measure remains high, however, reflecting the operations of locally registered wholesale banking operations and accounting for the high proportion of short-term external debt at about 2.5x current account receipts in 2016.
Despite Bahrain’s large financial sector, with gross assets estimated at 255% of GDP and a high number of majority-government-owned companies, we consider the government’s contingent liabilities to be limited.
On average, banks display high regulatory capital positions, and our Banking Industry Country Risk Assessment for Bahrain is ‘7’ (on a scale of 1-10, with ‘1’ being the lowest risk and ’10’ the highest). In our view, the cost of the banks’ potential distress would not be fully borne by the government due to the high share of foreign ownership of the wholesale banks.
However, we view the Bahraini government as a potential source of support for some wholesale institutions not covered by parent entities or home countries, but still important from a systemic or reputational standpoint.
We expect that competition will continue to strain profitability at Bahraini retail banks, encouraging further consolidation. Although the size of the overall banking system has declined by about 25% since its peak in 2008, driven by offshore banks’ balance-sheet downsizing, we assume that outflows, in terms of both external funding and the physical presence of international banks, will be contained.
Bahrain’s retail banks carry a large credit exposure to the real estate and construction sector (about one-fifth of total lending). In our view, this sector remains in a correction phase, which has contributed to the buildup of a large percentage of problem assets over the past few years.
We do not expect that the Central Bank of Bahrain would act as a lender of last resort for offshore banks. We believe that financial support from the rest of the GCC region would be available if foreign reserves became constrained, so as to maintain Bahrain’s exchange rate peg.
We anticipate that Bahrain’s political tensions will continue, with the potential for security incidents to occur. We consider that any heightened disruption relating to this could hamper the implementation of consolidation measures, as they could stoke unrest. Bahrain still faces occasional street protests, entrenched polarisation between the Shia and Sunni communities, and internal communal divisions.
The stable outlook reflects our expectation that Bahrain’s modest economic growth will offset ongoing fiscal and external pressures over the next 12 months. If Bahrain materially outperforms our fiscal and external forecasts, we could consider raising the ratings.
Conversely, if these constraints intensify, we could consider a negative rating action. We could also consider lowering the ratings if social unrest increases, given the possibility that this could derail fiscal consolidation efforts’.
