“We cannot rule out the possibility that Bahrain, with the most vulnerable fiscal outlook in the GCC, will have to consider introducing some form of taxation, whether a value-added tax or a corporation tax,” according to Standard Chartered latest Middle East Regional Focus.
“We foresee real GDP growth of 3% this year, which is likely to be the lowest in the GCC. We recently revised this down from our previous forecast of 4%,” StanChart in its report titled Challenges and Opportunities, said.
Social unrest has had economic costs, with the tourism sector hit particularly hard. The Formula 1 Grand Prix, originally scheduled for March 2011, is Bahrain’s biggest annual tourist event, and it is still unclear whether it will be held in the country at a later stage. Business conferences have also been affected, with several relocated to Dubai. The hotel occupancy rate in Manama, the capital, slumped to 33% in Q1, the lowest in the MENA region, with occupancy estimated at only around 5-10% at the peak of the crisis in March. Revenue per available room decreased 54% y/y, also the region’s worst performance. In March, the hit to the economy resulted in deflation of 2.1% y/y and 3.5% m/m. The housing sector pulled down the headline figure, with a steep 14.2% m/m price decline.
Bahrain also has a large banking sector, which contributes 25% to GDP. Banking assets are 10 times the size of GDP, and foreign assets account for 90% of the total assets of wholesale banks. In March alone, offshore banks’ assets fell 10% m/m to $135 billion, the lowest level since 2005. It could take time for the wholesale banking sector to rebuild these lost assets.
The volume of transactions on the Bahrain Bourse collapsed in Q1-2011, falling by 52% y/y. The country’s other markets have stabilised recently, with pressure on the currency easing and the interbank rate market normalising. While the Bahrain 5Y CDS – which traded at 265bps in early May – has come off its high of 350bps in March, it is still substantially higher than the 150-190bps band within which it traded in 2010.
Despite the impact of the recent unrest on the financial and hospitality sectors, the hydrocarbon sector has been resilient. Oil and gas production accounts for 13% of Bahrain’s economy, but this figure fails to fully capture the role of hydrocarbons. First, improved gas supply will facilitate the expansion of other industries that rely on gas as an energy source; downstream petrochemicals and manufacturing (16% of the economy) will benefit as well. Second, higher production and prices will boost oil revenues in the short to medium term, particularly in light of our oil-price forecast (we forecast Brent at 113/bbl on average in 2011). Although the oil sector is not the biggest driver of Bahrain’s GDP growth, it is the main source of government income, accounting for around 83% of total revenues and 65% of export receipts.
The government aims to improve oil exploration methods, allowing foreign companies to sign production-sharing agreements with its national oil company for the first time. Bahrain is targeting an increase in oil production in the Awali field from the current 32 thousand bbl/day (kbd) currently to 75kbd by 2015 and 112kbd by 2020 using enhanced oil recovery techniques.
The country’s natural gas capacity is also expected to expand from 500mn to 2bn cubic feet per day, drilling ever further, at depths of up to 20,000 feet on its onshore field. Continued support can be expected from Saudi Arabia, which provides the majority of the crude that Bahrain refines (Bahrain refines five times its own crude production levels). The growth in gas production is absolutely crucial for Bahrain if it wants to satisfy its rising domestic consumption, notably if it is to meet its ambitious downstream developments, which are essentially based on the principle of a cheap domestically produced feedstock.
The results of enhanced production capacity are already being felt. For the first time in a dozen years, oil and gas production are likely to increase in 2011, with the trend having started in Q4-2010. The rise in output should reach around 4.5% this year, just enough to cushion the adverse effects on other sectors of the economy.
The country will also benefit from higher fiscal spending, which received a significant boost from a $10 billion aid package (just under 50% of GDP) that will fund social spending and infrastructure projects. This should help to boost aggregate demand.
The 2011 budget has been reviewed following the announcement of new social spending. The original budget foresaw a budget deficit of around $1 billion. The total increase in spending following recently announced fiscal measures should be around 10%. However, despite the increase in fiscal spending, it is important to keep in mind that oil and gas represent three-quarters of budget revenue. Consequently, the surge in production and prices this year should result in a surplus of around 1.5%, despite the government’s projection of a deficit of 3.5%. The government has based its budget on an oil price of $ 80/bbl, while we forecast an average Brent crude oil price of $ 113/barrel in 2011.
The breakeven oil price for Bahrain’s budget has risen continuously to vulnerable levels in recent years (we estimate it at close to $100/bbl currently), and contrary to its neighbours, Bahrain has limited flexibility to reverse budget expenditure.
The government earlier announced that it would return to the international debt market with a planned $1 billion bond issuance, but this has been put on hold following the unrest and the constant rise in yield demanded by the markets. Should market conditions improve to satisfactory levels later in the year, the government could resurrect plans for the bond issuance.
“We are cautious on Bahrain from a credit perspective. Although the intrinsic fundamentals of the domestic banks were on an improving trajectory prior to the onset of the unrest earlier this year, the political standstill may have a knock-on effect on the real economy as, for example, some businesses move away from Bahrain. This could eventually filter through to the banking system, in our opinion.
“We are also concerned about Bahrain’s vulnerability through its banking system. At 1,000% of GDP, the banking system is by far the largest relative to the size of the economy among the GCC economies. If we exclude the wholesale/offshore banks and include only domestic/retail banks, the banking system still represents 300% of GDP, also the highest in the region. Recent figures from the Central Bank of Bahrain indicate that the wholesale banking system shrank by 10% between end-February and end-March 2011.
“Additionally, the breakeven oil price for the government budget, which was already very high, has increased further as the authorities have had to undertake additional spending. This means that the government will continue to run structural fiscal deficits. Given the current market outlook for Bahrain, we think it will be very difficult for the sovereign – or, for that matter, other Bahraini entities – to access international capital markets in the near term. Although the Bahrain sovereign (as well as corporate and bank) spreads are wider relative to where they were at the beginning of 2011, they are still relatively tight given the above-mentioned concerns. Local sponsorship for the Bahraini bonds has been very strong, causing spreads to trade tighter than where we see value,” the report added.