Although it managed to avoid some of the worst ravages of the global financial crisis, Bahrain’s economic growth has slowed sharply in the past two years. Real gross domestic product (GDP) growth fell to 6 per cent in 2008, down from 8 per cent in 2007. Growth slowed even more sharply in 2009, with GDP at 3.2 per cent for the year.

Despite these figures, Bahrain has performed better throughout the downturn than many of its neighbours in the Gulf.  

“Bahrain’s economy didn’t witness the over-heating seen elsewhere in the GCC in 2007 and 2008,” says Philippe Dauba-Pantanacce, senior economist for the Middle East and North Africa (Mena) region at Standard Chartered. “So growth has been less severely curtailed by the downturn.”

In common with the rest of the GCC, and despite the region’s oldest and most robust diversification programme, the Bahraini economy remains dangerously dependent on a smaller number of key sectors, particularly on its financial and hydrocarbon sectors, which account for 21 and 11 per cent of the country’s GDP. Both sectors have suffered as a result of the downturn.  

Banking losses

Bahrain’s banking sector assets, (including retail and wholesale banks), decreased by 12.1 per cent from $252.4bn at the end of 2008 to $221.8bn at the end of 2009.

Offshore, or wholesale banking, was particularly badly hit, reflecting the downturn in property development in the region.

“Bahrain’s banking sector serves the financing needs of projects in Saudi Arabia,” says Dauba-Pantanacce. “And the biggest blow
to its sector was the defaults linked to two Saudi conglomerates.”

The trouble for Saudi Arabia’s Ahmed Hamad al-Gosaibi & Brothers Company first began in Bahrain in May 2009 when the firm’s wholly owned bank, The International Bank Corporation (TIBC), defaulted on loans amounting to an estimated $2.2bn. It was subsequently downgraded by credit rating agencies, before its ratings were withdrawn altogether.

At the beginning of June, it emerged that another Bahrain-based institution Awal Bank – owned by Saudi Arabia’s Saad Group – had neglected creditors and was also seeking to restructure its obligations.

In July 2009, the Central Bank of Bahrain (CBB) took control of both banks and appointed law firms to run their operations.

Fortunately, the spread of further debt defaults in the kingdom’s banking sector was limited because the losses mainly related to internationally-sourced finance, although Gulf Finance House (GFH), one of Bahrain’s biggest Islamic banks, also was hit by a major default in 2009. The bank then narrowly escaped a further default in February 2010 on a $300m loan by striking a last-minute deal to roll over one third of the debt by six months.

The investment house posted a loss of $728m in 2009 after its revenues from financing real estate projects fell close to zero and it cleaned its books of bad debts.

Several other Bahraini banks and investment companies announced losses for 2009, including Ithmaar Bank, an Islamic lender, that saw losses of $235m for the financial year. But while other GCC financial institutions have been less open in admitting they are facing difficulties, Dauba-Pantanacce says Bahrain has been noticeably more forthcoming.

Better transparency

“I think Bahrain deserves some praise for the high levels of transparency throughout the crisis,” says Dauba-Pantanacce. “Furthermore, they have used best international practices in handling problems when they did arise.
For example, GFH has conducted a very successful restructuring.”

The CBB’s conservative regulation and deft handling of the crisis has arguably played the most pivotal role in mitigating the impacts of the downturn. 

Furthermore, the safeguards put in place by the CBB ensured the kingdom’s financial sector has avoided the worst effects of the liquidity crunch. The 75-80 per cent loan-to-deposit ratio requirement ensured that banks were able to weather the squeeze in liquidity, and it introduced various measures such as lowering the rate of compulsory reserve requirements from 7 per cent to 5 per cent, boosting the ability of retail banks to give loans.  

Bahrain’s three-month interbank rates currently stand at 1.29 per cent, compared to the UAE’s 2.28 per cent, where interbank lending is much tighter. These interbank rates are indictors of the overall health and liquidity in the system. The higher the rate, the less liquidity in the banking sector. 

Bahrain’s banking sector has also suffered because of Dubai’s debt woes, in particular the ongoing uncertainty surrounding the restructuring of state-owned Dubai World.

Although direct exposure to Dubai’s debt is limited, Bahrain’s ability to access debt markets to finance projects became tougher, when in November 2009, the Dubai conglomerate announced it was seeking a six-month standstill on repaying debts worth $26bn. Only a few bond issuances took place as investors are still reluctant to tap international debt markets.

“Unlike the rest of the GCC, Bahrain relies heavily on accessing debt markets, both from a corporate and sovereign perspective,” says Dauba-Pantanacce. “Bahrain has the most fragile fiscal position of all the GCC states, and as a result, they constantly have to issue sovereign bonds to try and plug any fiscal deficits.”

The current high borrowing cost is also another deterrent to issuing sovereign debt.

“The premium costs international debt issuers demand in the region will be dependent on how it perceives risk and that, of course, is linked to Dubai’s problems,” he adds. 

Diversification efforts

Dubai’s problems have helped to highlight Bahrain’s strengths as a financial hub in the region. As the oldest financial centre in the Gulf, it has carved out a niche in asset management, insurance and Islamic finance. With 27 Islamic banks, Bahrain continues to lead the region in Shariah-compliant financing. 

The strength of Bahrain’s financial sector is impressive, having grown at an average annual rate of 12 per cent in the past 10 years and accounting for one third of GDP growth in the past five years,

But as a central pillar of the economy, Bahrain’s high dependence on its financial sector also reinforces the need for diversification.

In 2009, petroleum production and refining accounted for more than 60 per cent of Bahrain’s export receipts, more than 70 per cent of government revenues, and 11 per cent of GDP.

I think Bahrain deserves some praise for the high levels of transparency throughout the crisis

Philippe Dauba-Pantanacce, Standard Chartered

In October 2008, Bahrain’s Economic Development Board (EDB), a government body responsible for formulating and overseeing the economic development strategy in Bahrain, launched the Economic Vision 2030.

Intended to serve as a blueprint for future development, it is being translated into a tangible and coordinated national strategy across ministries and government agencies to transform the kingdom’s hydrocarbon-dependent economy to a diversified and globally competitive one.

Key among the initiatives is strengthening the private sector, building a knowledge-based economy and ensuring appropriate skills-building to match the changing needs. “We recognise that in the coming years, oil production revenue will have to be supplemented by other revenue sources,” says Kamal Ahmed, chief operating officer of Bahrain Economic Development Board. 

“That is an issue that we and all GCC countries have under review. But, we are confident that the steps we are taking as part of Vision 2030 will lead to an increasingly diverse economy in the kingdom.”

Bahrain hopes the planned diversification programme will create new jobs, given that unemployment is a long-standing problem the kingdom has been trying to address.

Bahrain’s steps to tackle its unemployment problem has brought down its jobless rate from 16 per cent in 2002 to 3.8 per cent in March.

One of the major initiatives has been the establishment of the Unemployment Insurance System, which permits unemployed citizens registered with the Labour Ministry to receive financial assistance for six months, depending on their experience and qualification.

Under the scheme, the ministry assists nationals in searching for new jobs and in some cases, allow jobseekers to join state-funded training programmes. The project has helped more than 13,000 nationals get jobs and has been pivotal in reducing Bahrain’s unemployment rate.

In 2009, Bahrain initiated plans to end the sponsorship system for expatriate workers and increase the costs of employing cheap foreign labour to help reduce Bahraini unemployment. The government has also introduced an undisclosed levy on employers for each foreigner employed in order to encourage them to hire nationals. 

Training nationals

The government realises it needs to train nationals to job market requirements, especially in the private sector. 

“We realise the education of the Bahraini workforce is integral to building a sustainable economy, which is why Tamkeen is investing in training for local Bahrainis,” says Ahmed. 

Tamkeen is a state-backed independent authority, which formulates strategic and operational plans to improve employment of nationals. To date, it has invested $185m in more than 30 projects targeting more than 19,000 Bahrainis and 5,700 small and medium enterprises.

We recognise that oil production revenue will have to be supplemented by other revenue sources

Kamal Ahmed, Economic Development Board

Going forward, an increased focus on education and training will be essential for ensuring Bahrain is able to keep its diversification plans on track. The global downturn has put a brake on many of these plans, but growth has started to slowly pick up.

Economic growth in the fourth quarter of 2009 was 5.4 per cent higher than the fourth quarter of 2008.

During the period of strong economic growth between 2003-08, Bahrain reduced total public debt from 37 per cent of GDP to less than 15 per cent. By 2009, public debt was at a manageable level, allowing the government to increase spending to overcome the effects of the global financial crisis.

Today, Bahrain’s debt to GDP ratio is 27 per cent, allowing more room for the government to adjust fiscal policy to help the economy weather the crisis.

Standard Chartered is currently forecasting real GDP growth in Bahrain of 3 per cent in 2010 and 4 per cent in 2011. Given that more than 60 per cent of Bahrain’s export earnings come from oil, the current rise in prices will have a direct positive effect on the government’s plan to push ahead with diversification efforts.