Fitch Affirms Bahrain at 'BBB'

Outlook Stable

Fitch Ratings-London-23 July 2012: Fitch Ratings has affirmed Bahrain's Long-term foreign currency Issuer Default Rating (IDR) at 'BBB' and its local currency IDR at 'BBB+'. The Outlook is Stable. The agency has simultaneously affirmed Bahrain's Country Ceiling at 'BBB+' and Short-term foreign currency IDR at 'F3'.

The affirmation reflects the stabilisation of the political crisis that peaked in February and March of 2011. Fitch resolved the 'BBB'/Rating Watch Negative in August 2011 by returning the Outlook to Stable as the agency considered the worsening of Bahrain's political climate was adequately reflected in its 'BBB' rating. Economic performance has also been robust in the face of the political unrest, benefitting from high oil prices and production levels and an increase in government spending.

A number of industries, particularly the services sector, saw output decline in H111, although indicators point to a recovering economy in 2012, with Fitch projecting GDP growth of 3.5% for 2012, following 2.2% growth in 2011. Government spending and the USD10bn funding package, to be provided by Bahrain's Gulf Co-operation Council (GCC) neighbours over the next decade, will play an increasingly important role in driving economic growth. In particular, GCC money will help fund projects without straining public finances, and Saudi private investments will provide further material support to the economy.

While Fitch acknowledges that this financial support from Saudi Arabia will enable key developmental initiatives to proceed and reduce Bahrain's financing requirements, in Fitch's opinion, Saudi Arabia's increasing involvement is also likely to constrain the willingness of the authorities to engage in dialogue and introduce reforms that would eventually lead to a genuine solution to Bahrain's political crisis.

The absence of deep-rooted reforms since the start of the crisis has placed Bahrain in a stalemate position that could fuel radicalisation within Bahrain's different factions if sustained, raising the likelihood of further unrest and imposing additional economic and fiscal costs on the sovereign. Continual allegations of political repression would also further damage Bahrain's image as a business friendly destination, with potential negative spill-overs to key industries such as the banking sector, which thus far has remained relatively unaffected.

Specifically, retail banks saw deposits in 2011 increase by 4%, while wholesale banks continue to deleverage in the aftermath of the 2008 global financial crisis and a tighter global funding environment. Islamic banks - representing 12% of the sector - continue to underperform, largely due to their exposure to the real estate market correction in Bahrain and the region.

Bahrain's public finances were supported by a 34% increase in oil and gas revenues in 2011, with the general government deficit declining to around 2% of GDP (including off-budget items) despite a 30% rise in current spending. At 36% of GDP, general government debt is in line with the 'BBB' median for 2011. However, with Fitch forecasting gross debt at close to 50% of GDP by 2014, and net debt rising even faster, Bahrain's public finances are set to deteriorate relative to the 'BBB' category, limiting future financing flexibility in the case of external shocks including through a prolonged period of lower oil prices.

The triggers that would likely prompt a rating action are as follows:

- A substantial worsening in the security situation would put renewed downward pressure on the rating.

- Conversely, genuine political reform leading to concrete steps towards a political resolution would have positive consequences for the rating.

- Failure to stabilise and ultimately reduce the debt-to-GDP ratio, which on Fitch projections will exceed the peer median in the medium term, will result in renewed downward pressure on the rating.

As a net external creditor to the tune of almost 70% of GDP in 2011, Bahrain's external position continues to be one of its main credit strengths. The current account has been in surplus for almost a decade, reaching 12.5% of GDP in 2011. Bahrain's rating is also supported by its high level of GDP per capita relative to 'BBB' peers and relatively attractive business environment.

For all of Fitch's Eurozone Crisis commentary go to http://www.fitchratings.com/web_content/pages/grs/eurozone

Contact:
Primary Analyst
Maria Malas-Mroueh
Director
+44 20 3530 1081
Fitch Ratings Limited
30 North Colonnade
London, E14 5GN

Secondary Analyst
Charles Seville
Director
+44 20 3530 1048

Committee Chairperson
Richard Fox
Senior Director
+44 20 3530 1444