And when concerns emerged in the late 1960s about the ability of its ageing oil field to maintain output, it was the first country in the region to embark seriously on a programme of economic diversification.

Its industrialisation programme led to the creation of the region’s largest aluminium industry. This was followed in the mid 1970s, by the emergence of Bahrain as the region’s financial services and banking hub.

More recently however, Bahrain status as the region’s business hub has been challenged by the stellar economic development of its neighbours such as the UAE and Qatar. This has led to plans for a radical overhaul of the kingdom’s hydrocarbons sector.

Although members of the ruling Al-Khalifa clan have been head of state since they invaded from Qatar in 1743, an agreement was signed with the UK shortly afterwards, effectively making the islands a British protectorate until 1971.

Tensions have arisen numerous times in the past between the ruling Sunni Muslims and disaffected members of the kingdom’s majority Shia population.

Bahrain’s central bank is considered to be one of the region’s most progressive regulators, and has helped develop the country’s reputation as an international finance centre. This capitalised on its position as one of the first Gulf states to begin diversifying away from oil and into financial services prompted by the collapse in prices in the 1970s and the Lebanese Civil war of around the same time that destroyed Beirut’s position as the region’s banking hub.

By hosting Formula One racing events Bahrain is also hoping to improve its reputation as a tourist destination.

The small cluster of islands which constitutes Bahrain is linked to Saudi Arabia by causeway, and there are also plans for a new causeway to link the country with Qatar.

The country is also home to the US Navy’s Fifth Fleet.

Table: Bahrain at a glance

Government

Bahrain is a constitutional monarchy and members of the Sunni Muslim royal family hold the most significant political posts, although elections to the 40 member Council of Representatives (sometimes translated as Chamber of Deputies) in 2007 put 17 Shia MPs onto the main legislative body. The next elections are scheduled for 2010.

The elections are part of King Hamad’s political reform programme, which included allowing women to vote, and freeing political prisoners in line with the National Action Charter, a reform package that 98.4 per cent of the population voted in favour of in a referendum in 2002.

The other main legislative branch is the Consultative Council, which is made of 40 members all appointed by the king and has the power to veto legislation.

The introduction of democratic elections is considered to have increased the influence of religious clerics who have significant sway over the votes of their congregations.

Government officials

• Head of State: H.M. Sheikh Hamad bin Isa al-Khalifa

• Crown Prince: H.H. Sheikh Salman bin Hamad al-Khalifa

• Prime Minister: H.H. Sheikh Khalifa bin Salman al-Khalifa

• Deputy Prime Minister: H.E. Sheikh Mohammed bin Mubarak al-Khalifa

• Deputy Prime Minister: H.E. Jawad al-Arrayed

• Deputy Prime Minister: H.E. Sheikh Ali bin Khalifa al-Khalifa

• Minister of the Primer’s Court: H.E. Sheikh Khalid bin Abdulla al-Khalifa

• Minister of Defence: H.E. Dr. Sheikh Mohammed bin Abdulla al-Khalifa

• Minister of Shura and Representatives of Council Affairs: H.E. Abdul-Aziz bin Mohammed al-Fadhel

• Minister of Foreign Affairs: H.E. Sheikh Khalid bin Ahmed bin Mohammed al-Khalifa

• Minister of Interior: H.E. Lt. General Sheikh Rashid bin Abdullah al-Khalifa

• Minister of Industry and Commerce: H.E. Dr. Hassan bin Abdulla Fakhroo

• Minister of Works: H.E. Fahmi bin Ali al-Jowdar

• Minister of Housing: H.E. Sheikh’ebrahim bin Khalifa al-Khalifa

• Minister of Finance: H.E. Sheikh Ahmed Bin Mihd Alkhalifa

• Minister of Education: H.E. Majed bin Ali al-Nuaimi

• Minister of Labour: H.E. Dr. Majeed bin Muhsen al-Alawi

• Minister of Oil and Gas Affairs: H.E. Dr. Abdul-Hussain bin Ali Mirza

• Minister of Social Development: H.E. Dr. Fatima Mohammed Albalooshi

• Minister for Cabinet Affairs: H.E. Sheikh Ahmed bin Ateyatalla al-Khalifa

• Minister of Justice and Islamic Affairs: H.E. Sheikh Khalid bin Ali al-Khalifa

• Minister of State: H.E. Mansoor bin Hassan bin Rajab

• Minister of State for Foreign Affairs: H.E. Nezar bin Sadeq Albaharna

• Minister of Culture and Information: H.E. Sheikha Mai Bint Mohammed al-Khalifa

• Minister of Health: H.E. Dr. Faisal bin Yaqoob al-Hamer

• Minister of Municipalities Affairs and Agriculture: H.E. Dr. Juma’a bin Ahmed Al-Kaabi

Economy

Spurred on by its limited oil and natural gas reserves, expected to last for only another 10 to 15 years, Bahrain had first mover advantage among the Gulf states when it began liberalising its economy. It is now one of the region’s most diversified economies, and in 2006 the United Nations Economic and Social Commission for Western Asia described Bahrain as the fastest growing economy in the Arab world.

Despite this, Bahrain remains particularly vulnerable to the oil price fluctuations because its budgets are calculated using much higher estimates of oil prices than its regional peers. Oil revenue makes up almost three quarters of government income, although only a quarter of GDP.

The financial sector is the second biggest contributor to GDP after oil, contributing 20 per cent to GDP, followed by manufacturing, which contributed 13 per cent to GDP. These two sectors will continue to be the backbone to growth in the Bahraini economy. Crude petroleum and natural gas contribute 25 per cent to total GDP.

In 2005 Bahrain was the first Gulf state to sign a free trade agreement with the US, and has begun a privatisation process of government assets including utilities, banks and telecoms.

Bahrain has the lowest inflation rate of all the GCC states, forecasted at about 2.5 per cent for 2007. Unemployment among the young and continuing to reduce dependence on oil remain a key challenge for Bahrain’s future. The Bahrain Financial Harbour, a $1.5 bn waterfront development, aims to address this with the creation of 2,500 jobs.

Table: Economic indicators

($ million, unless stated)

Sectors

Oil & Gas

In 2005 the government announced an overhaul of its economy that put hydrocarbons at the heart of the agenda for the first time in decades. Key to reforms of the sector was the creation of the National Oil & Gas Authority (Noga), a holding company that unifies control of the kingdom’s natural resources with one body rather than three government departments.

The government is also encouraging foreign investment in the upstream oil sector with the licensing of four offshore exploration blocks.

Banking

Bahrain’s regulatory environment, low start-up costs and lack of any limitations on foreign ownership have made it a destination for banks looking to establish themselves in the region. The replacement of the Bahrain Monetary Agency with the Central Bank of Bahrain to further promote and regulate the financial services industry has played a significant role in opening up the market to international banks. Reform of bank licensing has also promoted Bahrain as destination for banks looking to enter the Middle Eastern markets and led to over 370 financial firms being licensed in Bahrain.

Foreign assets also account for 85.2 per cent of total banking assets, indicating how successful Bahrain has been at attracting foreign institutions.

Insurance

The country is more proactive than its GCC peers at regulating and developing its traditional insurance and Takaful (Islamic insurance) market, because of this a number of global insurance firms have sought licences in Bahrain, and although premiums only make up 3 per cent of GDP, this is still high compared to the rest of the region. The number of insurance policies issued is growing at over 10 per cent a year.

Bahrain has ambitions to become an insurance hub for the region, which given the low penetration of insurance in the GCC and the growing need for both individual and large scale project insurance.

Manufacturing

Manufacturing contributed 13 per cent of the kingdom’s GDP in 2005 compared to 10.6 per cent the previous year. Aluminium Bahrain (Alba) is currently the largest aluminium smelter in the Middle East and has plans to expand production and is considering floating on the Bahrain Stock Exchange.

Saudi’s Qayam Al-Arab Company is investing SR350 million to manufacture computers and software in Bahrain, for supply across the region.

Construction and Real Estate

The government has one of the region’s most liberal attitudes toward foreign property ownership, this coupled with increasing foreign investment, excess liquidity, and demand for housing has been a boon to the sector over the last few years. Judging by the growth in construction permits issued by the government and the number of high profile projects underway the sector will continue to exhibit strong growth for some years to come. Demand for cement is pushing up construction costs, leading two local banks to invest in developing Falcon Cement Company, Bahrain’s first cement factory.

Other key projects underway include the Bahrain Bay Development, a $1.5bn mixed use development off the coast of Manama, and the $1bn Amwaj Islands residential project.

Transport

Bahrain International Airport is the hub for Gulf Air, which formally was owned by a regional governmental consortium including Abu Dhabi, Oman, and Qatar. Over the last decade all these owners have gradually withdrawn from the airline leaving the government of Bahrain 100 per cent owners. Since its peak in the 80s when Bahrain served as a regional transport hub for its stakeholders, its fortunes have now turned as it struggles to compete with newer rivals like Emirates, Etihad and Qatar Airways.

Infrastructure

Infrastructure development is a key part of the government’s attempts to diversify the economy and create more employment opportunities.

The Bahrain Financial Harbour forms a key part of this, along with the $1bn Science and Technology Park, financed by Kuwait Finance House. The park is intended to be a host for technology companies to grow niche markets and promote scientific innovation.

The government plans to invest $1bn to develop a 1,200 MW power station to meet the 5 per cent growth a year in power demand. There is also a need to upgrade the existing water systems to replace the ageing national power grid.

Construction on the Reef Island project, a $1bn government-backed project to provide exclusive residential property on reclaimed land, is currently under construction, due for completion in 2009.

Other projects underway in Bahrain, including the $450mn Seef District development, are intended to help Bahrain reach the Economic Development Board’s target of doubling tourism’s contribution to GDP by 2014. For 2007 tourism accounted for about 7.6 per cent of GDP and was one of the largest employment sectors.

Telecoms

Domestically the government is looking to sell licences for two more fixed-line wireless services while Batelco, Bahrain’s largest mobile phone operator, is looking to acquire licences to operate in Kuwait, Lebanon and Oman.