Fitch Ratings-Hong Kong-February 28: Fitch Ratings has affirmed Bahrain's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BB-' with a Stable Outlook.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
Bahrain's ratings are supported by strong financial backing from richer neighbours in the GCC, a large and developed financial sector and high GDP per capita and human development indicators relative even to the 'BBB' median. Weak public finances, high fiscal dependence on oil revenue and political constraints on enacting reforms all weigh on the ratings.
The government's Fiscal Balance Plan (FBP) announced in October 2018 and supported by USD10 billion funding from Saudi Arabia, Kuwait and the UAE present a credible opportunity for Bahrain to stabilise its public finances. The FBP, which aims to eliminate the fiscal deficit by 2022 and put government debt on a downward trajectory, is Bahrain's clearest medium-term plan in recent years, but there are still significant risks to implementation, in Fitch's view.
The USD10 billion Gulf support package of long-term interest-free loans to be disbursed in 2018-2022 is significant in the context of Bahrain's annual financing needs and will help contain interest costs for the government, which had risen sharply. The announcement of the package led to a compression of bond yields and we expect Bahrain will again be able to access external markets as a result. The assumption of Gulf support has generally underpinned Bahrain's market access and US dollar peg despite extremely low foreign exchange reserves, which dipped below one month of current external payments in 2018.
The first instalment, of USD2.3 billion, was disbursed in October-November, around the time of Bahrain's maturing USD750 million sukuk (there is no published schedule of future disbursements). In 2019-2022 Bahrain faces USD5.3 billion of maturing external debt. Under our forecasts, Bahrain will need the equivalent of USD2.3 billion on average per year of new financing in 2019 and 2020 to cover the budget deficit, with banks in a position to provide a portion of that and roll over holdings of short-term domestic debt.
Gulf backing was already captured in our ratings for Bahrain. There is no public information about conditionality for the support, but Fitch believes that Gulf backing will ultimately materialise even if implementation of the FBP stalls, given the country's small size and strategic importance. The package builds on existing channels of support, which are rooted in deep historical, cultural and familial ties as well as regional rivalries. The USD7.5 billion (close to 20% of GDP) GCC Development Fund provided in the wake of the Arab Spring unrest in 2011 has supported economic growth. Bahrain gets most of its oil from the Abu Sa'afa field shared with Saudi Arabia (it is entitled to 50% of production, but has sometimes received significantly more as a form of support). Gulf corporates and institutions invest heavily in Bahrain, including in government bonds.
A significant reduction in the budget deficit to 7.6% of GDP in 2018 from 12.3% of GDP in 2017, according to preliminary data (including more than 2% of GDP of estimated extra-budgetary spending), largely reflected higher oil prices (up by 33% yoy) accounting for approximately 75% of the deficit reduction. The remainder derived largely from the further cuts in gas subsidies (which shows up in stronger gas revenue), savings on wages (0.5% of GDP) and transfers and subsidies (0.5% of GDP) and on capital spending. These savings more than offset an 0.8% of GDP increase in interest expenditure.
In 2019-2020, despite lower average oil prices, we forecast smaller budget deficits (6.1% and 5.3% of GDP, respectively, again including more than 2% of GDP extra-budgetary spending), because of new measures taken under the FBP and interest cost savings. The FBP is targeting net savings of at least BHD800 million (5.4% of forecast 2019 GDP) in addition to existing policies. New measures include the introduction of 5% VAT; a voluntary retirement scheme (VRS); further subsidy reform; and greater control of operational spending.
VAT was introduced at the start of 2019 with a headline rate of 5%, as in Saudi Arabia and the UAE, and the government hopes to collect BHD150 million in 2019, rising to BHD300 million in 2020 (1.9% of GDP). A VRS under the FBP has attracted 8,711 applicants (out of 48,000 civil servants) and the first batch left their positions at end-January. The government estimates that headcount reduction could save BHD166 million in 2019 (11% of the 2018 wage bill), with further savings in 2020-22. However, there is uncertainty about the cost and financing (not yet disclosed) of the cash compensation associated with the VRS, which Fitch believes could amount to 5%-7% of GDP but is not included in our fiscal forecasts. The government plans for this to be funded off-budget, but has not yet clarified the source of these funds.
Key risks to the implementation of the FBP, in Fitch's view, include the sustainability of the cut to the workforce and the squeeze on operational spending; whether the ambitious savings on subsidies can indeed be made; and to what extent economic growth can weather the storm of fiscal adjustment. There has been parliamentary pushback against sharper fiscal adjustment in recent years. However, the outgoing parliament approved VAT and the new parliament following the November 2018 election approved the government's overarching four-year action plan in January.
Fitch expects government debt/GDP to stabilise at just over 95% in 2019-2020 and to decline gradually to 2022. Government debt/GDP continued to rise in 2018, to 93% from 88% in 2017. The 2018 government debt figure includes BHD952 million (6.6% of GDP) of liabilities to the central bank and USD2.2 billion (6% of GDP) from the first instalment of the Gulf support package. Without these two items government debt/GDP was 80.4% at end-2018. The government could attempt to monetise state assets, notably parts of Mumtalakat Holding Company. Mumtalakat has a portfolio of assets with a balance sheet value of around 40% of GDP. A large oil discovery in 2018 may bring further fiscal respite when developed in around five years.
For 2019-2020 we forecast average real GDP growth of 2.6%, down from an average of 3.6% in 2013-2018). We assume the hydrocarbons sector to remain flat and for non-oil growth averaging just above 3%, supported by project activity related to state-owned companies (in oil, gas, and aluminium), GCC Development Fund awards and other private sector investment.
Political fault lines, both domestic and regional, will continue to be a source of tension in Bahrain. Lack of reconciliation between the government and the predominantly Shia opposition presents a degree of political risk. Fitch's baseline assumption is that Bahrain's security forces will continue to prevent the sort of escalation of domestic tensions that would materially affect economic stability.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Bahrain a score equivalent to a rating of 'BB' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
- External Finances: +1 notch, to reflect the boost to external financing flexibility from strong GCC support, which more than outweighs the very low level of foreign reserves
- Public Finances: -1 notch, to reflect low revenue mobilisation, expenditure rigidities, the high fiscal breakeven oil price (forecast at USD91/b in 2019) and the high level of government debt.
- Structural Features: -1 notch, to reflect the political and social constraints on fiscal policy, which have prevented the government from cutting expenditure more rapidly and make it harder to use GDP per capita for generating more substantial diversified revenue.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The main factors that could lead to positive rating action are:
- Confidence in a narrowing of the budget deficit consistent with placing government debt-to-GDP on a firm downward path.
- A broadly accepted political solution to domestic political tensions.
The main factors that could lead to negative rating action are:
-Further significant deterioration of debt dynamics, combined with increased financing constraints.
- Severe deterioration of the domestic security environment.
- Brent crude will average USD65/bbl in 2019 and USD62.5/bbl in 2020.
- No change to the rule of the royal family.
- Regional conflicts will not directly impact Bahrain or its ability to trade.
- No change to the peg of the Bahraini dinar to the US dollar.
The full list of rating actions is as follows:
Long-Term Foreign-Currency IDR affirmed at 'BB-'; Outlook Stable
Long-Term Local-Currency IDR affirmed at 'BB-'; Outlook Stable
Short-Term Foreign-Currency IDR affirmed at 'B'
Short-Term Local-Currency IDR affirmed at 'B'
Country Ceiling affirmed at 'BBB-'
Issue ratings on long-term senior unsecured foreign-currency bonds affirmed at 'BB-'
Issue ratings on long-term senior unsecured local-currency bonds affirmed at 'BB-'
Issue ratings on short-term senior unsecured local-currency bonds affirmed at 'B'
Issue ratings on the sukuk trust certificates issued by CBB International Sukuk Company 5 and 6 and 7 affirmed at 'BB-'
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Country Ceilings Criteria (pub. 19 Jul 2018)
Sovereign Rating Criteria (pub. 19 Jul 2018)
Sukuk Rating Criteria (pub. 25 Jul 2018)
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