Bahrain’s main vulnerability arises via its banking system. The banking system is by far the largest relative to the size of the economy among the GCC economies, 300% of GDP for retail banks and an additional 700% of GDP for wholesale banks. Although retail banks have remained relatively stable, the wholesale banking system contracted by 14% between end-2010 and June 2011. Also, although retail banks‟ fundamentals were on an improving trajectory prior to the onset of the unrest earlier this year, the political situation is likely to have a knock-on effect on the real economy as, for example, some businesses move away from Bahrain. Given these concerns, we see little value in Bahraini bonds (sovereign, quasi sovereign and banks), despite the seemingly attractive spreads.
The report jointly produced by economists Philippe Dauba-Pantanacce and Victor Lohle in Standard Chartered Middle East Focus titled ‘oil will save the day’ shed a light on the economic growth, forecast and on ground realities and challenges being faced by the financial capital of the Middle East.
The report in its chapter ‘Bahrain – Diversification strategies at stake’ said that after the unrest early this year that led to the most serious destabilisation in years, the authorities opened a National Dialogue (ND) that ended prematurely with the departure of the main opposition party. The ND ended with recommendations to devolve more power of scrutiny to parliament but no fundamental change in the balance of power between the elected chamber and the state-appointed upper house. There has been no agreement on the crucial demands for changes to electoral districts.
This year, StanChart expect real GDP growth to be capped at 1.6%, as a result of feeble non-oil economy real growth in Q1 (1.8% y/y), which was even weaker in Q2 (0.8%). Growth is essentially driven by higher oil production and prices and an increase in public demand through a record expansion of fiscal spending. Quarter-on-quarter growth nevertheless showed a slight rebound from Q1 to Q2, at 1% against -1.4% in Q1, suggesting that the economy is rebounding. The poor H1 economic performance was directly linked to the destabilisation experienced. Year-on-year figures show that during Q1, the number of tourist arrivals declined by 36%, while output in the hospitality sector slumped by 29.3% followed by a 30.3% fall in Q2. Strikes affected the output of crude oil and refined products. Refinery output fell 11% y/y in Q1. A fall in vehicle demand translated into a 23% decline in imported vehicles while the number of new commercial licences fell 37%.
In July the central bank published revised figures for 2010 which confirmed the worrying trend of increased fiscal fragility. Despite increasing the current account surplus, as well as most of the macroeconomic indicators, the revision also showed a much higher fiscal deficit than previously thought (at -5.3%), proving that the fiscal breakeven point has risen drastically in recent years, and 2011 will aggravate this. We think that the oil price at which the country can balance its budget is now around $100/bbl.
In May, the parliament approved a $14.4billion budget over two years, representing a 44% increase in government spending. The government’s commitments in terms of social housing, subsidies and cash handouts ($2,660 to each family), as well as current expenditure will most likely push the fiscal deficit to close to 6% this year.
The hit taken in the non-oil economy has been reflected in a fall in the CPI. In June, the index fell 2.1% y/y, the fifth consecutive month of deflation, something unseen in 25 years. Mirroring the absence of domestic demand, transport costs kept falling while housing costs, in May alone, declined by 14% y/y. A slow return to normal economic activity and some inflationary pressure during Ramadan should see the index retrace its course, and we expect inflation for the year to average 1%.
“We are cautious on Bahrain from a credit perspective. The breakeven oil price for the government budget, which was already very high, has increased further as a result of additional government expenditure, contributing to continued structural fiscal deficits. Bahraini issuers (both sovereign and corporate) will find it difficult to tap international capital markets in the current environment,” the economists added.