At the end of 2010, the outlook for Bahrain was positive. The government had managed to get through parliamentary elections in October without major incident and had successfully tapped international capital markets. Oil prices were high and continuing to rise, and the country’s economy was recovering from the 2008-09 global financial crisis.

Bahrain has lost several significant tourism events as a result of the political turmoil

Bahrain was preparing to consolidate those gains in 2011 with further bond issues and a series of infrastructure projects that would ease some of its social tensions, while politically, it would assume the role of secretary-general of the GCC from April.

All that was quickly unwound when a youth-led protest movement mobilised on 14 February, inspired by uprisings elsewhere in the region. By 15 March, King Hamad bin Isa al-Khalifa had declared a state of emergency that lasted until 1 June.

Bahrain’s internal crisis

The anti-government demonstrations, which brought thousands of Bahrainis onto the streets, have been followed by a wave of recrimination by the authorities. According to opposition groups, up to 8,000 Shia workers have been sacked or suspended for taking part in the protests. Intimidation of doctors and nurses has been widely reported and human rights groups are alleging that prisoners have been tortured, although the government denies this.

The net result of the unrest has been a sharp reversal in the direction of Bahrain’s economy. Analysts have been hastily revising down their forecasts. The UK’s HSBC now expects gross domestic product growth to remain flat in 2011. The Washington-based IMF suggests a more optimistic 3.1 per cent increase, but this is down from earlier estimates of 4.5 per cent growth.

Meanwhile, credit default swaps rates for Bahrain rose sharply in the wake of the protests, convincing the central bank to put a bond issue on hold until rates fell again.

The GCC has agreed to give Manama $10bn over the next 10 years to revive its economy and address the social problems that brought demonstrators onto the street. A stimulus plan is expected before the summer, detailing a raft of projects, including an expansion of Bahrain International airport, a new oil refinery at Sitra and, perhaps most important politically, the construction of more social housing.

Bahrain faces two major challenges. First, it must create more jobs to alleviate the economic pressures that drew so many of its poor Shia community to protest.

Manama’s efforts so far have been laudable, creating the Labour Market Regulatory Authority which charges companies a fee for employing expatriates and uses the proceeds to train locals to take skilled jobs. It has also aggressively pursued economic diversification through industrialisation. But, clearly, more needs to be done.

Aluminium Bahrain, one of the world’s largest aluminium smelters, is planning further expansion and Manama hopes that through stimulating small-medium enterprises in its Bahrain Logistics Zone, it can create further jobs.

The second challenge is to restore stability to the country and reconcile the majority Shia population with their Sunni rulers. That will be more difficult following the recent security crackdown, which has acted to fan tensions.

Sectarian divide in Bahrain

Another election is promised, but the severity of the government response in recent months risks radicalising more Shias. The legitimacy of an election, when most opposition parties have either been banned or had leadership figures arrested, will also be called into question.

Although high oil prices have helped bolster Bahrain’s budget, the private sector has lost much of its first half economic activity and consumer confidence has taken a major knock. Banks say retail volumes are steadily returning, but Bahrain has lost several significant tourism events as a result of the political turmoil, particularly the Formula One Grand Prix. This may be rescheduled for later in the year, however, it is likely to be a more muted affair than usual.

Much will depend on how events play out over the rest of 2011. Diplomats and sources close to the government expect that now security has been restored, an economic stimulus package will follow, and then a degree of political engagement with opposition groups.

Yet, the kind of engagement they can expect from a government that now seems to be overseen by more hardline members of the Al-Khalifa family will be limited.

Bahrain’s future prosperity will require it to find a solution to its sectarian divide. The country does not have the resources to continue a campaign of repression. In the past, Manama has shown itself capable of coming up with one of the most forward-thinking and pragmatic development plans in the region with its Vision 2030 strategy. Getting that back on track will require more than a GCC-funded spending plan.