Fitch Ratings has downgraded Bahrain’s long-term foreign currency issuer default rating (IDR) to ‘BBB’ from ‘A-‘, local currency IDR to ‘BBB+’ from ‘A’; and country ceiling to ‘BBB+’ from ‘A’.
The agency has simultaneously downgraded the short-term foreign currency IDR to ‘F3’ from ‘F1′. In addition, the agency has put the long-term IDRs on rating watch negative (RWN).
“The two-notch downgrade reflects further material escalation in political risk in recent days, following significant violent domestic protests, military intervention by Gulf nations and the imposition of a state of emergency by the Bahraini royal family,” said Purvi Harlalka, Director in Fitch’s Middle East and Africa Sovereign Ratings Group.
“The spectrum of possible political outcomes has widened and downside risks to political stability and sovereign creditworthiness have increased significantly.”
The RWN reflects that the political outlook is highly uncertain. Recent events have underscored both the near-term risks to stability and the deep divisions within Bahraini society.
Although Fitch recognises that more favourable outcomes are possible, it sees a significant risk that the involvement of troops from Saudi Arabia and the United Arab Emirates, and the declaration of martial law may harden the protestors’ (largely drawn from the Shia majority) opposition to the Sunni monarch and/or to lead to renewed and extended violence. The regional show of force, together with the $20billion aid package from the Gulf Co-operation Council (GCC) for Bahrain and Oman demonstrates that the regime enjoys broad support amongst its GCC neighbours.
However, it added, recent events may widen the divide between the ruling family and the opposition, and make it more difficult to achieve political reform and stability, with adverse implications for the economy.
The downgrade also reflects the risk that the political instability may harm Bahrain’s attractiveness as an international financial and business centre, which plays an important role in Bahrain’s economic model. Financial services make up 25% of Bahraini output.
The combination of these developments has also further weakened the outlook for an already deteriorating fiscal position – debt doubled to 33% of GDP in 2010 from 16.4% in 2008. While debt will remain below the forecast ‘A’ median even at these elevated levels and Bahrain has a demonstrated track record of fiscal prudence, Fitch believes that the worsening political climate is likely to result in greater populist spending demands on the budget. However, budgetary expansion is more affordable given increasing oil prices and rising oil production.
Nonetheless, low government debt, which has counter-balanced several structural weaknesses, including high dependence on a limited hydro-carbon endowment, and social and political tensions, was the main strength of Bahrain’s ‘A’ rating. However, the recent increase in debt has reduced the sovereign’s policy flexibility to deal with shocks that might materialise in an uncertain environment.
A further material worsening in the security situation and/or protracted delays in the political reform process would negatively affect prospects for growth and public and external finances, prompting a downgrade. By contrast, a smooth transition to a sustainable political outcome would alleviate the negative rating pressure.