Moody's downgrades Bahrain's sovereign ratings to A3

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RATINGS RATIONALE

Today's rating action was motivated by the following factors:

1.) A gradual but significant rise in the breakeven oil price in the Bahraini budget over recent years. This, together with a relatively modest level of official financial assets, has led to a divergence between the government's fiscal flexibility and that of rating peers.

Moody's has a negative outlook on Bahrain's banking system.

Published fiscal data imply that the oil price necessary to balance the budget has gradually risen over time. Additionally, Bahrain's cushion of official financial assets is thinner than that of other investment-grade commodity exporters. This exposes the country's public finances to a degree of risk that, in Moody's opinion, is better reflected by an A3 rating," explains Tristan Cooper, Moody's Head Analyst for Middle East Sovereigns.

Published fiscal accounts indicate that the oil price necessary to balance the budget in Bahrain has risen in recent years from levels which Moody's estimates to be approximately $30 per barrel in 2004 to almost $80 per barrel in 2009 (for the benchmark Brent crude). This trend is largely due to upward pressure on current expenditure, which has restricted the government's room for manoeuvre. Although capital expenditure can be cut in some years to offset revenue shortfalls (as it was in 2009), Moody's notes that such reductions cannot usually be sustained without damaging growth prospects.

"While acknowledging Bahrain's high level of GDP per capita and its good progress toward economic diversification, Moody's believes that the government's ability to generate revenues from the non-oil sector is hampered by its narrow tax base," adds Mr Cooper. The government's ability to widen its tax net, which remains heavily dominated by oil receipts, is constrained by the absence of personal income tax and VAT.

Moody's also has some concerns about the performance of Bahrain's financial sector, which is large in relation to the government's resources. In August, Moody's reiterated its negative outlook on Bahrain's banking system, reflecting the ongoing weaknesses in the domestic and regional real-estate sectors, to which banks maintain significant exposure. Moody's has downgraded the ratings of a number of banks in Bahrain over the past two years.

The rating agency recognises that riskier wholesale banks present only a limited contingent liability for the government given the restrictions on their interaction with residents. However, the retail banking sector is also extensive, with assets worth approximately three times GDP. Moody's believes that, over the longer term, Bahrain's banking sector will increasingly face competition as other regional financial centres develop.

Bahrain's ratings are supported by the country's relatively robust economic strength, positive net international investment position and effective regulatory environment. Bahrain's strong international alliances are also a credit positive, particularly those with Saudi Arabia and the US, which would be expected to potentially assist the Bahraini government in case of difficulty. However, Moody's notes Bahrain's domestic political tensions, which could rise in the run-up to parliamentary elections scheduled in October, as well as elevated regional geopolitical risk.

In addition to downgrading Bahrain's government bond ratings to A3 from A2, Moody's has also implemented the following rating actions today:

Bahrain's long-term country ceiling for foreign currency bonds was downgraded to A1 from Aa3; the long-term country ceiling for foreign currency bank deposits was downgraded to A3 from A2; the short-term country ceiling for foreign currency bank deposits was affirmed at P-1 (the primary rationale being the still comfortable level of liquidity in the retail banking system); the local currency ceilings were downgraded to Aa3 from Aa2. The outlook on Bahrain's sovereign ratings is now stable.

The principal methodology used in rating Bahrain was Moody's Sovereign Bond rating methodology published in September 2009. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found on Moody's website.

REGULATORY DISCLOSURES

Information source used to prepare the credit rating is the following:
public information.

Moody's Investors Service considers the quality of information available on the issuer satisfactory for the purposes of maintaining a credit rating.

This issuer did not participate in the credit rating process. The Rating Committee was not provided, for purposes of the rating, access to the books, records and other relevant internal documents of the rated entity or related third party.

Moody's Investors Service adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from reliable sources; however, Moody's Investors Service does not and cannot in every instance independently verify, audit or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

-Ends-

DIFC - Dubai
Tristan Cooper
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Middle East Ltd.
Telephone: +971-44-01-9536

Singapore
Thomas J. Byrne
Senior Vice President - Regional Credit Officer Sovereign Risk Group Moody's Investors Service Singapore Pte. Ltd.
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