Bahrain may not be able to count on unconditional support from its fellow Gulf Cooperation Council (GCC) members moving forward as the country’s fundamentals continue to deteriorate, according to Bank of America Merrill Lynch (BofAML).
The island kingdom is rated junk by three major credit ratings agencies having been hit hard by the fall in oil prices but has so far borrowed successfully in international markets due to investor belief that it can guarantee support from neighbours including Saudi Arabia.
In a report by MENA economist Jean-Michel Saliba, BofAML said Bahrain’s fundamentals had “deteriorated faster than expected” with a material drop in foreign exchange reserves due to dollarisation, financial outflows and twin imbalances and unanchored government debt dynamics.
“We expect GCC support to Bahrain to eventually move to being conditional and explicit, from unconditional and implicit,” the bank said.
“Key risks would be market access being compromised in the coming period, dollarisation and capital outflows picking up, as we expect the situation to get worse before getting better.”
The bank noted that Bahrain had attempted to issue international bonds without explicit GCC support and only raised $1bn from regional accounts.
“This source of finance is unlikely to last for long, and, as such, market access appears compromised,” it added.
Looking further forward, BofAML said Bahrain’s largest oil discovery in decades last month, with a potential 80 billion barrels or more of tight oil, could improve the county’s fiscal dynamics in the medium term but it may have difficulty financing development costs for the project.
Saudi Arabia is expected to continue to prioritise sustaining the Bahraini regime and supporting its US dollar peg to prevent wider implications in the region, according to the report.
However, direct support may not be forthcoming until Bahrain’s foreign reserves run out or it is priced out of the market, which should be clarified by the end of the first half of the year.
The bank cautioned that any debt restructuring could damage Bahrain’s US dollar peg unless broad GCC financial support is provided until the country can return to the market with a consolidation programme.
“Alternatively, explicit GCC support coupled with a credible front-loaded fiscal consolidation could lower Bahrain’s funding costs and lengthen the timeline to achieve fiscal reforms. This should be eventually the preferred support mechanism from the GCC, in our view,” the bank said.
“The more likely scenario near-term would be some support from the GCC to kick the can down the road further if Bahrain fully loses market access, and without credible reform efforts from Bahraini authorities.”
Ratings agency Moody’s expects Bahrain government debt to reach 100 per cent of gross domestic product by 2019. Rival agency S&P estimated debt to GDP reached 81 per cent last year.