CI lowers Bahrain sovereign ratings

Capital Intelligence (CI), the international credit rating agency, has downgraded Bahrain’s Long-term Foreign and Local Currency ratings to ‘BBB+’ from ‘A’ and lowered its Short-term Foreign and Local Currency ratings to ‘A2’ from ‘A1’. The outlook is ‘negative’.
The downgrade reflects the recent increase in political risk, which may have adverse consequences for economic growth and public finances in the short-term and beyond. It also takes into account the weakening of fiscal flexibility over the past few years, which has reduced the authorities’ capacity to cope with external shocks and will be harder to restore in the current climate.
Bahrain’s ratings are supported by the authorities’ track record of prudent macroeconomic management, moderate – albeit increasing– government debt and the country’s small net external creditor position.
The rating agency added that the civil unrest of the past two months “has clearly exposed the fault lines – sectarian and economic – that run through Bahraini society. While the violence has abated following the imposition of a state of emergency and tightening of internal security, the underlying problems are unchanged and the risk of a low level insurgency will remain until a durable political settlement is achieved.”
Prospects for such a settlement in the near future are not high. The divide between the government and opposition on key issues – such as the extent of political liberalisation, the power of the monarchy, and policies for addressing economic inequality and job discrimination – appears currently unbridgeable.
Depending on the extent of any further unrest, real economic growth is likely to be low or negative this year. Key sectors of the economy, such as the financial industry, which accounts for more than 20% of GDP, and tourism are likely to be hit hard.
CI notes that Bahrain’s external finances were in good shape prior to the political crisis, supported by high oil prices and a small net external creditor position, and there have been no signs so far of excessive stress. CI recognises that capital outflows have increased but would expect any risks to financial system stability to be contained, in the near term at least, by banks’ holdings of liquid foreign assets, which in aggregate exceed their short-term foreign obligations.
On the fiscal side, high oil prices should make expenditure pressures arising from the unrest more affordable in the near term, although the state budget is expected to remain in deficit. CI is concerned, however, that the government may find it difficult to reverse temporary spending increases and that higher spending levels will make the budget more vulnerable to potentially volatile oil prices.
The threat to government finances from a sharp fall in oil prices has been a longstanding constraint on Bahrain’s ratings. This credit weakness has become more of a concern over the past few years with the growth of public expenditure and the lack of progress on broadening the non-oil revenue base. This signifies, in effect, that the budget has become increasingly reliant on the oil price rising. The oil price required to balance the 2011 and 2012 state budgets agreed last year (before the turmoil and additional spending measures) was estimated to be around USD 100 a barrel; the break-even price was closer to USD 70 a barrel in 2008 and was less than USD 40 a barrel as recently as 2005.
The government of Bahrain lacks the fiscal reserves of most other Gulf States, and with a less flexible balance sheet, its room to use fiscal policy to counter economic shocks or to ease public discontent is more limited.
CI notes that Bahrain is expected to receive substantial financial support from the Gulf Cooperation Council (GCC) following its decision in March to provide the government with up to USD 10 bln (equivalent to 45% of 2010 GDP) over 10 years to support economic development.