The encounter was typical of the new political mood fostered in Bahrain by Emir Sheikh Hamad bin Isa al-Khalifa, since he assumed power in March 1999. He has been seeking to create a more inclusive political regime, in which sensitive issues that people had been afraid of discussing openly would become an integral part of official political discourse.

The broad framework of the reform programme was laid out in the national charter that was overwhelmingly approved in the referendum 12 months ago. The emir is expected to use the first anniversary of the vote as an occasion to provide more detail on the new constitutional arrangements, and set a date for municipal elections some time in the next six months, and for parliamentary elections in 2003 or 2004.

'The emir has said he wants to be the first to introduce democracy in this part of the world, because the Bahraini people are ready for it,' says a Western diplomat in Manama. 'That is a realistic aspiration because Bahraini society is relatively sophisticated, and was a leader in democratic politics in the old days.'

Over the past year, Bahrainis have been exploring the new political space that has been opened up, in preparation for getting involved in the new institutions. 'The infrastructure is being built for a new civil society,' says Adnan Bseisu, a member of the economic development board and head of financial consultancy MECON. 'Throughout the year there has been an environment of freedom of expression that makes it easier to implement the ideas of the emir.'

Bseisu says one of the most encouraging signs of this has been the stream of registrations of new societies - particularly professional associations and women's groups. 'This shows there is growing civic awareness of what strategies are needed to create an atmosphere of liberalisation.' He says the upcoming municipal elections will provide a means for preparing people for the wider parliamentary elections that will follow.

The proposed new parliament will have an appointed upper chamber and a freely elected lower house. The charter states that the lower house will have 'legislative attributes'. That is taken to indicate that the parliament will have an active role in framing legislation. It is understood that the appointment of the government will rest with the emir, but ministers are expected to be accountable to parliament. The new system is said to be loosely modelled on that of Jordan, and this has led to suggestions that the constitution may be amended to denote Bahrain as a kingdom.

In common with Jordan, Bahrain does have an important demographic element in its political make-up that has periodically threatened to provoke instability. In Bahrain, the challenge for the country's Sunni rulers has been to deal with the grievances of the Shias, generally reckoned to make up some 60 per cent of the 400,000-strong indigenous population. The emir's reforms are aimed at strengthening the links between the two communities, and elevating particular concerns of the Shias - unemployment above all - into questions of common national purpose.

'From the emir down everyone recognises that unemployment is the key issue,' says the diplomat. The government puts the total number of unemployed at 15,800, equivalent to some 8 per cent of the total workforce. Hopes of reducing the number of unemployed, and absorbing the steady stream of new entrants to the labour market, are pinned on maintaining robust rates of growth, and changing the structure of employment so that there are more opportunities for Bahrainis. 'Unemployment is a fundamental problem for any free enterprise system,' says Bseisu. 'It can be solved not through politicisation, but solely on an economic basis, getting new projects and investment under way.'

Real gross domestic product (GDP) growth has been running at more than 4 per cent a year since 1998. The most recent official figure for growth is for 2000, at 5.3 per cent. The government had been expecting growth of some 6 per cent in 2001, but the actual figure is likely to be lower because of the fall in oil prices in the second half of the year and the losses incurred in the tourism and aviation sectors. These effects are expected to persist into 2002, but there is sufficient new activity in the Bahraini economy to suggest that a real growth rate of over 4 per cent can be achieved in 2002.

Bahrain is now only a marginal player in the oil market, but the oil and gas sector still plays an important role in the economy. In 2000, high oil prices meant that oil and gas accounted for some 28 per cent of GDP. Oil revenues also provide the bedrock of the government's accounts, making up 55 per cent of total budgeted revenues in 2001.

The government is keen to reduce its dependence on the oil sector, given the volatility of the oil market and the capital-intensive nature of most oil and gas projects. Major industrial projects are already an essential feature of the Bahraini economy, and account for a large part of the new investment drive that is now moving into gear.

The largest of these new schemes is the expansion of the Aluminium Bahrain (Alba) smelter. This will cost some $1,700 million, including $400 million for the associated power plant. Four international companies have been invited to bid in early March for the contract to build a fifth potline at the complex, raising capacity by almost 50 per cent to 750,000 tonnes a year. The smelter at present employs 2,500 people, of whom 90 per cent are Bahrainis. It also provides raw materials for dozens of downstream industries in Bahrain. The extra output at Alba will provide a basis for existing downstream companies to expand, and for new ventures to emerge. Alba sells 65 per cent of its output to regional consumers, and that bias is set to continue after the expansion even if a large part of the extra output finds its way onto the international export market.

The $660 million expansion of the Sitra refinery of Bahrain Petroleum Company (Bapco) and the new power plants being built at Hidd and Riffa will also create significant numbers of new jobs, although nothing on the scale of Alba. The government will be keen to ensure that these projects and other infrastructure schemes such as the Hidd port expansion and the planned road link with Qatar create ample opportunities for local contractors.

However, the mood among Bahraini construction firms is not universally positive. 'For this decade there is just too much work out there for us to handle, and international contractors will have to be brought in on the big projects,' says one contractor. 'Local firms could end up being priced out of the market.'

Costs for local firms have been inflated by a government clampdown on the use of imported labour, and there are concerns about the additional cost of having to pay the minimum wage to Bahraini workers. This has already had an effect in the textile industry. The minimum wage for garment industry workers has gone up by 50 per cent to BD 120 ($318) a month. The government has just taken steps to offset this extra cost by abolishing duties on garment exports to the US, which accounts for virtually all the output of the 21 garment companies operating in Bahrain. These factories employ 11,000 people, of whom 35 per cent are Bahrainis.

Tourism is now being presented as one of the most promising sectors for new investment and employment. There is no shortage of new project ideas in the sector, ranging from creating a beach paradise on the Hawar islands to the construction of a Formula 1 grand prix circuit. However, contractors say there is still a lot to be done before most of these projects can be confirmed as viable propositions. The Hawar islands project requires huge quantities of rock to be put in place, which contractors say may end up pushing costs too high. Efforts to get tourism projects off the ground in the south of the main island of Bahrain have yet to make progress. Contractors also say that smaller developments have been affected by losses local business people have suffered on their investments overseas.

Despite the difficulties being encountered by some specific sectors of the economy, analysts say the general mood is upbeat. 'There is a buzz about the place at the moment,' says the diplomat. The optimism about Bahrain's economic prospects is matched by enthusiasm about the prospects for a political evolution that is about to enter a new phase.

Additional reporting by Andy Critchlow