Sep 08 2011
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Lost political decade?
Bahrain can't hope to radically improve its economy, if the government remains hostile to the opposition and a majority of the population feels excluded from the political, social and economic progress of the country. In that sense, no amount of economic aid or Formula One events can gloss over the fundamental issues facing the country.
In many ways, Bahrain is the odd one out in the GCC bloc. The smallest state in the Gulf with the smallest economy and geographic area, Bahrain is also weak on natural resources, unlike its other fellow GCC members. Its Sunni rulers also find themselves in the minority and in the tough position of running a Shia-dominated population - other Gulf states don't have that acute problem.
And these issues appear to be undoing much of Bahrain's economic progress of the past few decades.
"We believe the medium-term political outlook remains delicate, complex and concerning, with deep sectarian divisions which, if not addressed, seemingly point at best to another cycle of mild reform and continued repression," says Bank of America Merrill Lynch (BAML) in a note.
The government's political crackdown earlier in the year with the help of Gulf states have soured the uneasy relationship between King Hamad's regime and the Shias which make up 70% of the population. Thirty-three people died during the protests and while the opposition has been quashed for now, it does not appear to be the end of the revolt against the Saudi-backed rulers.
Al-Wefaq is also boycotting parliamentary elections expected to be held on September 24, on the 18 seats left vacant when its parliamentarians resigned.
While western outcry over the political difficulties in Bahrain remain muted, the United Nations High Commissioner For Human Rights says conditions in the country "remains tense and unpredictable."
"We continue to receive reports of the repression of small protests and understand that at least 264 cases involving protestors remain pending before the courts, many of whom may be tried in the Court of National Safety, which is effectively a military court," says Rupwert Colville.
According to the UN watchdog, 124 of these political cases have received verdicts, including two death sentences, 16 acquitted and seven partially acquitted.
Bahrain's GDP, which had grown 4.5% last year is expected to slow down considerably this year, although oil production and aluminium production are set to offset the losses suffered by tourism, financials, services and the retail sector.
The government's Central Informatics Organisation (CIO) reported that the economy grew 1% in the second quarter and 0.8% year-on-year; meanwhile the number of new companies setting up in the Kingdom rose by 30% compared to last year, according to reports. The economy had declined 1.4% in the first quarter, notes the CIO.
Ratings agency Moody's says that the political situation is likely to have damaged economic growth significantly, especially in service sectors such as tourism, trade and financial services, although IMF maintains an adequate GDP growth forecast of 3.1% in 2011 and 5.1.% in 2012. In May, Bahrain's sovereign credit rating was cut by Moody's to Baa1 (from A3) with a Negative outlook due to continued political unrest.
Higher oil and manufacturing revenues helped to offset the decline in Bahrain's services sector in the second quarter of this year, says Capital Economics, a research house. "What's more, although the country's GDP grew by only 0.8% y/y in Q2 (down from 1.8% y/y in Q1), it has performed better than anticipated. Accordingly, we now expect Bahrain's output to grow by 2% in 2011 - our previous forecast was 0%."
The country's M3 money supply growth slowed to 1.6 percent year-on-year at the end of June, the lowest increase in 27 months, after a 5.9 percent rise in May, the Gulf country's central bank data showed.
The government has also revised upwards public sector wages to appease Bahraini citizens. Last month the cabinet approved an $862 million budget to cover pay rises.
These initiatives will take their toll on the country's fragile finances. Bank of America Merrill Lynch (BAML), estimates that the 2011 and 2012 budgets breakeven at US$112/bbl and US$108/bbl respectively (up from the US$99/bbl it had estimated for the January 2011 version of the budgets).
"The rapid increase in expenditures leaves the government highly exposed to volatile oil prices, we think. On a cash basis, the 2010 fiscal balance was -5.3% of GDP and, on our house forecasts for oil prices (US$108/bbl in 2011 and US$114/bbl in 2012), the 2011 fiscal balances should be around -1.3% and 1.6% of GDP respectively. This nevertheless assumes a full spending of the appropriations (capital expenditures may have been impacted by the unrest, while delay in the adoption of the budget would result in flat-lining 2010 expenditure).
"Structural fiscal rigidities remain difficult to address in this tense environment. On the expenditure side, the wage and pension bill represent 50-60% of current expenditure, subsidies another 25%, while there is no appetite currently to implement VAT or corporate taxes to increase non-oil revenues."
The FI organisers' decision to return to Bahrain in 2012, after cancelling this year's event in Manama, should come as a great relief to the country's rulers. The unrest in the country had cost the economy around $2-billion or nearly 10% of GDP, apart from damage to its reputation as a modern and progressive Middle East economy.
Bahrain should also benefit from the $20-billion Gulf Development Plan that was set up by GCC states to aid Manama and Muscat, but it's not clear how it would be utilised.
BAML says that increased hydrocarbon production should cushion the impact of the unrest on the non-oil economy, particularly the hard-hit tourism, services and retail trade sectors. Gas production was 1%yoy higher in Q111 while crude oil production was up 0.2%yoy, as output expansion in the onshore Awali oil field offset output decline in the Abu-Sa'afa field jointly owned with Saudi Arabia.
While refined oil production contracted, Q211 results from ALBA showed aluminum production remained at full capacity. After Q111 capital outflows, the wholesale banking sector seems to be stabilizing, with liabilities to corporates increasing by US$2.1bn in particular in May.
EFG-Hermes reports that the value of project awards in Bahrain fell 24.1% quarter-on-quarter in the second quarter, "following political developments and instability in 1Q2011. The sharp increase in 1Q project awards took us by surprise, and likely occurred before the onset of protests."
"A total 68.3% of planned projects were cancelled or put on hold. We expect most project activity going forward to be linked to government activity (i.e., hydrocarbon and infrastructure investments."
EFG expects delays in project implementation and awards to continue into 2H2011. The government is looking to push ahead projects as well as devise a new investment programme to revitalise the economy. "We believe that any activity linked with the latter is unlikely to occur in 2011."
The real estate sector has also been hit hard by the downturn. Bahrain's market has struggled with its residential and commercial sectors having suffered continued year-on-year negative growth in both rental and sales values since their peak in 2008, notes property consultant Knight Frank.
The average rental rate is now BD1,200 per month (US$3,183) which is a drop of -25%, down from BD1,600 per month (US$4,243) in the second half of 2010, although gated communities such as Amwaj Islands and Riffa Views are commanding a premium.
International banks Credit Agricole and BNP Paribas are expected to move completely or partially out of the country, and the situation could get worse given the wider global downturn which has compelled many banks to lay off workers and downsize their operations. There is a danger that Bahrain's vulnerable state could push many global financial institutions to move out as part of a wider cost-cutting measure. That would be a significant below given that 400 financial institutions are present in the country, employing 14,000 people, including a little over 9,000 Bahrainis.
But the Central Bank of Bahrain governor believes disruption in the financial services sector is overdone.
"As far as we can see, the banking sector has not been hurt so far and there has certainly been no flight of capital in spite of what some international news agencies have said," the governor was quoted in the CBB's quarterly review in June.
"In the first quarter of 2011, deposits were down about 1.5% from the previous quarter but were still up 8% year-on-year. By and large, first quarter results from banks have been better than expected. The profitability of banks will face difficulties because the flow of business has been less but there are no problems and the banks are adequately capitalised."
Although he did admit that the political troubles had impacted the retail sector, particularly the hotel and restaurant industries, likely had an impact on the banking sector. But the return of law and order would see a gradual pick up in the retail sector though this may take time to come through, he said in a speech quoted by the CBB Review.
Reconciliation is not an easy process, especially when Saudi Arabia, its most influential ally, is worried about a spillover of Shia dissent on its own domestic front. And yet Bahrain is in danger of losing its competitive edge due to the political standoff that is making the small state even weaker.
With global economic outlook darkening, there is a danger that Bahrain may be overlooked as investors flee to safer havens and less risky enterprises. That would no doubt hurt Manama's economy and undo much of the stellar work it had done over the past few decades.
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