Fitch Ratings-Hong Kong/London-June 28: The financial support for Bahrain being prepared by the GCC will ease near-term external financing pressures, but a more durable improvement in Bahrain's financial position will depend both on the scale and nature of GCC support and on Bahrain's ability to implement fiscal reform, Fitch Rating says. We expected further material support from the GCC, given Bahrain's small size and strategic importance. Bahrain's 'BB-'/Stable sovereign rating already incorporates significant uplift to reflect existing and expected GCC support.
On Tuesday, Saudi Arabia, Kuwait and the UAE said that they were finalising "an integrated program that will soon be announced to enable the kingdom of Bahrain to support its economic reforms and fiscal stability". Bahrain's finance minister confirmed this, and the central bank reaffirmed its commitment to its US dollar peg.
We think support is likely to include dollar deposits at the Central Bank of Bahrain (CBB) to improve Bahrain's weak foreign exchange position ahead of a USD750 million sukuk maturing in November. GCC countries have boosted central bank reserves in a range of countries in recent years, including Egypt, Yemen, Jordan and Ethiopia. We estimate that the CBB's reserves cover less than one month of current external payments (CXP), despite rising in April to USD2.1 billion from USD1.4 billion in March following a USD1 billion sukuk issue. Reserves have been sliding following the oil shock at end-2014, when they totalled USD6.2 billion. An influx of USD3 billion-USD3.5 billion would put reserves back to around two months of CXP (their average in 2000-2015), although coverage would likely worsen again without fundamental fiscal improvements, in Fitch's view.
Additional options for support could include Saudi Arabia allowing Bahrain a larger share of production from the offshore Abu Safa'a oil field. Bahrain currently receives half of the output (150,000 b/d), but has received more in the past, including 100% of output in some years. An extra 75,000 b/d (taking its allocation to 75%) in 2018-19 would imply extra revenue of at least USD1.5 billion in 2018 and 2019 (assuming Brent crude prices of USD70/b and USD65/b), potentially cutting the budget deficit and bringing public debt/GDP below 75%. Bahrain hopes to significantly boost its own oil production following a large oil discovery in April, but this will take at least five years.
Another conduit could be a top-up of the GCC Development Fund, inaugurated in 2011. Bahrain's USD7.5 billion allocation has enabled it to reduce capital spending in the budget and has supported robust GDP growth. An enlargement may bolster medium term growth, but would not create as much additional fiscal space as capex is a smaller component of the budget.
A boost to FX reserves and other financial support would bolster Bahrain's sovereign credit metrics, at least temporarily. The full impact will depend on the exact nature of GCC support, but without a stronger fiscal reform programme, Bahrain's public finances would likely come under renewed pressure at some point. While GCC support does not typically come with explicit conditionality, we believe that Bahrain's partners will push for fiscal reform measures to contain the need for further support. This could involve introducing VAT in a certain timeframe, for example.
Some subsidy reforms and spending restraint notwithstanding, Fitch's view that the government had yet to identify a clear medium-term strategy to tackle high deficits was reflected in our two-notch downgrade to 'BB-' in March. We forecast that government debt/GDP will edge down in 2018 to 80%, given higher oil prices, but then rise to 89% in 2020 and continue rising thereafter, as oil prices drop back (we forecast USD57.5/b in 2020, while Bahrain's fiscal breakeven price is still close to USD100/b). Debt maturities also pick up from 2020, averaging around USD1.5 billion annually in 2020-2023.
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