Will Bahrain Emerge Stronger From Cheap Oil Era?

In the Gulf region, it was Bahrain that felt the strongest heat from the Arab Spring in 2011.

Protests and subsequent unrest and uncertainty dented Bahrain’s business friendliness causing some international investors to look at island kingdom with scepticism. However, Bahrain has managed to the stage a comeback since then, thanks largely to increased government spending.

“Over the first three quarters of 2014, headline growth was 4.6 per cent while non-oil growth was 4.3 per cent,” said Jarmo Kotilaine, chief economist at the Bahrain Economic Development Board (EDB).

“The big surprise was the oil sector which expanded by six per cent. We expected it to be more or less flat but they actually posted some positive growth.”

Growth in Bahrain’s construction sector also rose from 3.6 per cent in Q2 last year to 12.3 per cent in Q3, figures from the EDB revealed. Though the Q4 growth figures are yet to be made public, Kotilaine was conservative, in his projections for the economy in 2014.

“Given the global economic growth rate, we made some relatively cautious assumptions for Q4. our current projection for 2014 as a whole is headline growth of 4.2 per cent, which I think is a little bit cautious because during Q3 2014 there have been significant pick up in infrastructure activity, involving long term projects,” he said.

Although the government has helped prop up the economy, Kotilaine emphasised that economic growth in 2014 should be attributed to rising private sector activity in Bahrain’s infrastructure projects.

“It is due to a number of things. The government contribution has been quite minimal for last few quarters,” he said, drawing from the methodology that the EDB uses to calculate growth.

“What had been happening in the last few years was that there were a number of significant infrastructure projects in the planning stages – some of them were funded by the GCC development fund… some were private sector while some are government projects…in 2014, we began to see a significant acceleration in their implementation.”

THE SPENDING DILEMMA

Even as Bahrain hobbles out of the Arab Spring, ongoing oil price volatility is proving to be its next big challenge.

Lower revenues, a high break-even price for oil and the continued need for social spending could risk a ballooning budget deficit for the state. Such a pallid view has also led to ratings agency Standard & Poor (S&P) lowering Bahrain’s outlook to negative.

“We estimate that 2015 government revenues will reduce by some 30 per cent from 2014 levels, using an average annual oil price assumption of $55 per barrel,” said Benjamin Young, an analyst at S&P.

“We lowered Bahrain’s ratings because we think this will lead to a significant widening of the fiscal deficit and a commensurate increase in government indebtedness. We also expect weaker external performance. These factors will materially detract from Bahrain’s growth performance.”

But the proverbial light at the end of the tunnel for Bahrain is its economic diversity. Oil contributes just 20 per cent to the country’s overall GDP, far less than peers like Kuwait where nearly 90 per cent of public finance comes from oil revenues.

“Bahraini authorities have, for a long time, adopted a business-friendly policy setting, aimed at developing other sectors of the economy, most notably by bolstering its physical transportation facilities and developing the financial services sector,” said Young.

“The country has maintained a well-regarded regulatory environment and its businesses attracted significant numbers of skilled migrants. So we do think that Bahrain has a relatively well- diversified economy. We think that this diversification will help support economic growth while oil prices are low.”

But the danger of overspending, much of which is politically necessary, is hard to overlook when rating the country’s fiscal position in the face of low oil prices. “While Bahrain’s economic base may be diversified, its fiscal revenues are not,” added Young.

With political tensions simmering within the country, the government could also find it challenging to raise revenues by either hiking taxes or slashing expenditure, he said.

“In our estimates, we include a significant cut to capital expenditure, but even including this, we expect that the fiscal deficit will widen to the region of eight per cent of GDP, from an average deficit of less than one per cent of GDP over the past four years.”

MERGE OR WITHER

Bahrain is especially banking on its robust financial services sector to help buoy the economy.

With new infrastructure projects slated to begin over the next few years, lending among banks is also expected to pick up following a lull, according to Bahrain Central Bank governor Rashid Al Maraj.

Banks in the island kingdom have also seen rebounding economic activity.

“Overall activity is almost back to 2010 levels and that is a good thing for Bahrain considering the winds the country has been facing,” said Hassan Jarrar, CEO of Standard Chartered Bahrain.

“We have seen an uptick in the increase in assets, which translates into loans…it [2014] has been a positive year for us combined with a knock on wind and a clean portfolio. Our non-performing loans have been very good. We are well below the industry average of Bahrain.”

But such optimism is also overshadowed by worries of oil price volatility. Al Maraj said that he was concerned banks’ profitability could be affected if low oil prices sustain over a longer period.

“There will be an effect on banks not because of the oil price slide but because of economic activity. If there is going to be sustained low levels of oil price, then it is going to change the dynamics.”

Jarrar too admitted that banks might face a rough patch if clients fall on hard times, but ruled out any long-term impact.

“As a bank, we don’t remain static. We are pro-active in analysing the portfolio that we have and we do that on a daily basis. The bank does not always have the same risk appetite…If [oil prices] go down to 40, will it affect the way we operate? It is like any other economic indicator, you can’t just sit still.”

However, the central bank governor also said that lenders in the country are now in a far better position to withstand economic turbulence.

“Banks are on much better footing. They are well prepared for any kind of negative downturn since they have cleaned up their portfolio and become more conservative in their approach to lending. So this gives me comfort that it is not going to be as severe this time.”

Bahrain has also been encouraging consolidation in its banking sector. Al Maraj said the country will continue to see mergers, with at least one such deal on the table.

“Smaller banks will face a challenge to operate in the market, find the right resources and acquire the right people. We will guide them [by encouraging consolidation] to a safe future.”