Bahrain. Summary. Moody s B1 / S&P BB- / Fitch BB+ 1 Economy: Industry 37%, Services 62% Economic Indicators

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1 Bahrain Summary Moody s B1 / S&P BB- / Fitch BB+ 1 Economy: Industry 37%, Services 62% The Kingdom of Bahrain is a small island nation nestled between Saudi Arabia and Qatar, two of the richest countries in the region. With a GDP per capita of US$25,759, it is considered a High Income Non OECD country by the World Bank. Because it has few oil reserves, Bahrain has diversified its economy to be less oil-dependent than others in the region with sizable financial and manufacturing sectors, and the Government is fostering the fintech industry to support its position as a regional financial hub. Bahrain was the hardest hit among Gulf Cooperation Council (GCC) countries during the Arab Spring of 2011, although in times of crisis, Bahrain has reliably depended on GCC support for short-term stability. Its major vulnerability is its large fiscal deficit, which heavily subsidizes a welfare state and is an unsustainable burden for the government. This risk is exacerbated by low oil production as a major revenue source, making Bahrain particularly vulnerable to prolonged periods of low oil prices, as the recent oil shock demonstrates. Economic Indicators F 2018F Population (Millions) GDP per Capita (USD) 26,178 26,331 24,054 24,153 25,166 25,759 Nominal GDP (USD Billions) Real GDP (%) Year-End CPI (%) Fiscal Balance (% of GDP) Interest (% of Revenues) FC Debt/Public Debt (%) Government Debt (% of GDP) Government Debt (% of Revenue) Current Account (% of GDP) FDI (% of GDP) External Debt (% of GDP) Foreign Reserves/External Debt (%) Foreign Reserves (Mo. of imports) Foreign Reserves (% of GDP) As of November 2017 Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Source: Lazard, Bahrain 2015 Bond Prospectus, Citibank, Haver Analytics, IMF 471

2 Lazard Emerging Markets Debt Rating History Below is a history of the country s foreign and local currency ratings by the major agencies dating back to We have also included a chart of the country s hard currency external debt spread and the JP Morgan EMBI Global Diversified Index spread for comparison. Rating History Hard Currency Local Currency A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B Moody s S&P Fitch Moody s S&P Fitch As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: Bloomberg, Fitch, Moody s, Standard and Poor s Bond Spreads Bahrain 2012 EMBIGD 2017 As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: JP Morgan 472

3 Bahrain Strengths Relatively Well-Diversified Economy Relative to its regional neighbors, Bahrain has a more diversified economy and is less dependent on the hydrocarbon sector, at only 18.7% of 2017 GDP. The country also has a large financial and banking sector (16.9% of GDP) and manufacturing sector (14.7% of GDP). 2 Bahrain is a regional financial hub, and the financial sector is not only the largest sector of the non-oil economy but also the largest employer. 3 Bahrain is also home to one of the largest aluminum smelters in the world, government-owned Alba Aluminum, which produces more than 900,000 tons per year. 4 As part of Bahrain s economic program, Vision 2030, the government is seeking to further diversify the economy from its oil-driven base. The government has implemented measures to encourage entrepreneurship and the flourishing of the fintech industry in an effort to become a financial hub. 5 Bahrain s Economic Development Board targets growing the following sectors: information technology, business services, healthcare, financial services, tourism, high-tech manufacturing, and education. 6 Pro-Business Environment Bahrain is a major regional financial center for the Middle East and North Africa region (MENA), with more than 400 banks and financial institutions operating on the small island. The size of the financial system totaled US$186.5 billion as of May Wholesale assets total 320% of 2016 GDP, while retail assets total 258% of GDP. 7 While Bahrain s diversification strategy is fairly similar to that of other regional centers, such as Dubai or Qatar, Bahrain competes by offering a relatively lower-cost alternative with a skilled labor force. For instance, in the financial sector, about 66% of employees are local citizens in contrast to the UAE, where expatriates account for a large majority of the labor force. The appointment in March 2013 of Crown Prince Salman bin Hamad Al-Khalifa as first deputy prime minister is also a positive for the business environment, as he is seen as business friendly and has mandated improvements to facilitate the business and investment environment. 8 This positive business environment is reflected in Bahrain s relatively high ranking relative to regional peers in the World Bank s 2018 Ease of Doing Business at 66 out of 190 countries. 9 Political and Economic Support from Saudi Arabia Bahrain has very close relationships with other GCC countries and in particular with Saudi Arabia, the most powerful of the GCC members, who provides economic and political support when needed. For instance, during the Arab Spring of 2011, Saudi Arabia led a collective military force to help suppress Shiite protests in Bahrain that threatened the Sunni monarchy and in turn would destabilize the region. Saudi Arabia has stated firmly that it will not permit, under any circumstances, a Shiite takeover of Bahrain, and strongly backs the Bahrain ruling family, therefore providing a stabilizing force in the event of a political disturbance. In 2017, Bahrain was also part of the Saudi-led coalition that initiated the blockade against Qatar, thus reinforcing its alliance. On the economic front, Saudi Arabia is Bahrain s key trade partner, and both countries are connected via a highway as Bahrain is a popular weekend destination for Saudis. Since the unrest, Saudi Arabia is reported to have donated more than US$500 million to help Bahrain s economy. 10 Overall, GCC countries have pledged more than US$7.5 billion of aid over 10 years (of which US$6.7 billion worth of contracts are already identified as of June 2017) 11, which will help ensure Bahrain s status as a convenient and safe business center for the region

4 Lazard Emerging Markets Debt Investment-Led Growth Economic growth in the non-oil sector will be strengthened on the back of stronger financial sector performance and the start of a series of GCC-funded infrastructure projects in the housing, water, and power sectors, etc., worth more than US$5.2 billion from the US$7.5 billion committed by GCC countries. 13 It is estimated that Bahrain plans to invest US$22 billion in infrastructure projects in the next few years, which, along with the private sector projects already underway, should provide a boost to the economy. 14 The oil shock, however, has led to a slowdown in capital investments, although infrastructure projects are currently an important driver of economic growth. 15 Weaknesses Domestic Political Unrest Bahrain has historically been exposed to domestic political unrest due to friction between the 30% minority (but ruling) Sunni population in a country where 70% of the population are Shiite. 16 This has created tension as Shiites perceive themselves as lower class citizens who do not share proportionally Bahrain s political power and economic wealth that tends to be concentrated within Sunnis. 17 As a result of this tension, Bahrain was the hardest-hit country among GCCs during the Arab Spring unrest of 2011 that created not only political disturbance, but also undermined the economy. Fiscal Dependence on Oil Despite its diversified economic base, fiscal revenues depend heavily on oil production. Most government revenues come from a single source, the Abu Saafa offshore oil field that Bahrain ceded to Saudi Arabia in return for 50% of oil production of 209,413 bpd as of The oil and gas industry accounted for 86% of government revenue in 2014 but it has decreased to 77% by 2017, 19 although this high dependency is expected to continue at least in the short term. 20 Therefore, oil prices remain of decisive importance in the stability of public finances, which makes Bahrain very vulnerable to a prolonged period of low oil prices. In addition, Bahrain does not have a sizable sovereign wealth fund (SWF) like Kuwait, UAE, or Saudi Arabia. The Bahrain Mumtalakat Holding Company has estimated assets of more than US$10. billion 21 that are invested mostly in the local economy, in sharp contrast to the SWFs of Kuwait or UAE, which are not only much larger in size but also invest globally. 22 Continued Budget Deficit A major vulnerability of Bahrain is its continued fiscal deficit. It is the only GCC country with a deficit that rose after the 2011 social unrest as the government decided to increase wages and subsidies to the population. Bahrain had a fiscal deficit of 3.6% in 2014, but this is estimated to more than tripled; to around 12% GDP in 2018 and 2019 as a result of high recurrent spending and lower revenues from the oil shock. Bahrain s breakeven oil price has increased from US$100/barrel in 2010 before the Arab Spring, to an estimated US$135/ barrel in although the IMF estimates that it will be lower at US$95.2 in Despite the lower breakeven price, it remains the highest in the region, highlighting the fiscal pressure Bahrain currently faces, particularly in light of low oil prices. 474

5 Bahrain Difficulty of Fiscal Reforms A major weakness of government finances is its overreliance on oil revenue alongside large structural and recurring expenditures in the form of welfare and subsidies for the population. But political instability and the potential for the resurgence of protests has derailed the government s attempt to reduce subsidies and implement economic reforms. For instance, in December 2013 the government announced plans to reduce subsidies in diesel fuel to reduce a heavy financial burden on government finances, but this plan was subsequently postponed due to strong opposition. 25 While the government is aware of the need to reform its finances and reallocate money to spend on development, it also has the challenging task of balancing the risks of having more dissent and protests as it cuts back the welfare system that the population expects. For example, while the government was able to reintroduce the measures to gradually eliminate subsidies to gas and diesel, 26 it subsequently had to postpone a plan to remove meat subsidies due to political opposition. 27 However, citizens and the business community are now more accepting of the need to reduce subsidies, and Bahrain has successfully reduced popular subsidies such as for meat in 2015 and for oil in Despite this challenge, the government has implemented changes to subsidies that will result in savings of US$854 million in 2017 which is expected to double from 2021 onwards. 29 Relatively High Debt Level and Non-Investment Grade Status A continued budget deficit for the past few years, especially since the social unrest of 2011, has significantly increased the government debt level from roughly 30% of GDP in 2010 to almost 100% of GDP by 2018, according to the IMF. 30 The IMF considers debt stabilization and correcting the fiscal imbalances to be Bahrain s most immediate policy challenge. 31 As a result of its weaker fundamentals, all three rating agencies downgraded Bahrain to noninvestment grade status in Low Oil Reserves Because it is a small island, Bahrain has the lowest oil and gas reserves among GCC countries, estimated at only 210 million barrels of oil, which will only cover about 15 years of exports. 32 However, limited onshore oil supply may be offset by a planned increase in production from 48,353 bpd to 100,000 bpd. 33 The Abu Saafa and other fields shared with Saudi Arabia produce an estimated additional 200,000 bpd. This is the country s main source of government revenue. Gas reserves are also low by regional standards, having only 3.25 billion cubic feet of gas reserves, and all production is consumed domestically

6 Lazard Emerging Markets Debt Country Background Size 760 KM 2 (188th) Capital Manama Population 1.4 Million Religion Muslim 70.3%, Christian 14.5%, Hindu 9.8%, Buddhist 2.5%, Jewish 0.6%, Other 2.9% Median Age 32.3 Years Literacy Rate 95.7% Independence 15 August 1971 Political System Constitutional Monarchy Government Leadership King Hamad Bin Isa Al-Khalifa; Prime Minister Khalifa Bin Salman AlKhalifa Legislative Branch Bicameral National Assembly Elections November 2018 Economy Agriculture 0.3%, Industry 37.3%, Services 62.3% Labor Force Agriculture 1.0%, Industry 32.0%, Services 67.0% Merchandise Exports Petroleum and Petroleum Products, Aluminum, Textiles Export Partners Saudi Arabia 18.3%, UAE 17.5%, United States 11.1%, Japan 8.7%, Qatar 4.8%, China 4.2% Currency Bahrain Dinars (BHD) As of November 2017 Source: CIA 476

7 Bahrain Country Timeline 1971 Bahrain declares independence and signs a new treaty of friendship with Britain. Sheikh Isa becomes the first Emir, and the Council of State becomes a cabinet Following claims by prime minister Sheikh Khalifah Bin-Salman Al Khalifah that the National Assembly is impeding the work of the government, the Emir dissolves the assembly and rules by decree As part of the Gulf Cooperation Council (GCC) Peninsula Shield Force, Bahrain participates in the coalition "Operation Desert Storm" against Iraq (the Gulf War) 1996 The government says it has uncovered a coup plot by an Iranian-backed group, Hezbollah- Bahrain. Bahrain recalls its ambassador to Iran and downgrades its representation to charge d'affaires level Bahrain turns itself into a constitutional monarchy and allows women to stand for office in a package of reforms Bahrain and US sign free trade pact; Saudi Arabia condemns the move, saying it hinders regional economic integration Thousands of protesters gather in Manama, inspired by popular revolts that toppled rulers in Tunisia and Egypt. A security crackdown results in the death of several protestors. Saudi troops are called in following further unrest. Authorities declare martial law and clamp down hard on pro-democracy activists. Protests continue, despite ban on demonstrations. Focal point of demonstrations the Pearl monument is demolished. Source: BBC 477

8 Lazard Emerging Markets Debt Notes 1 As of December Kingdom of Bahrain Bond Prospectus Narrative Report on Bahrain, Tax Justice Network, Financial Secrecy Index, accessed on 30 November 2015, 4 Kingdom of Bahrain Bond Prospectus accessed 30 October Kingdom of Bahrain Bond Prospectus Kingdom of Bahrain Bond Prospectus HRH Premier order easy procedures for investor, businessmen, Bahrain News Agency, 25 November 2015, accessed on 30 November 2015, 9 Economy Rankings, Doing Business, 2018, accessed on 1 November 2017, org/rankings. 10 Katzman, Kenneth, Bahrain: Reform, Security and US Policy Congressional Research Service, 3 October Kingdom of Bahrain Bond Prospectus, Bahrain fights unrests, competition to remain business hub, Reuters, 16 June 2014, accessed on 8 November 2014, 13 Kingdom of Bahrain Bond Prospectus, Bahrain investing $22 billion in infrastructure, Saudi Gazette, accessed on 4 December 2014, saudigazette.com.sa/index.cfm?method=home.regcon&contentid= accessed 16 November Erlich, Resse, Bahrain s monarchy stokes divisions between Sunni and Shiite, Global Post, 13 December 2012, accessed on 4 December 2014, 17 Katzman, Kenneth, Bahrain: Reform, Security and US Policy, Congressional Research Service, 16 July Kingdom of Bahrain Bond Prospectus, Kingdom of Bahrain Bond Prospectus, Kingdom of Bahrain Bond Prospectus mln-for-new-deals-ceo.html 22 accessed 16 November Kingdom of Bahrain Bond Prospectus, November MENA Regional Outlook October 2017, mreo1017 accessed 31 October Bahrain will lift diesel prices to cut subsidy burden, Arab News, 24 December 2013, accessed on 4 December 2014, 26 Kingdom of Bahrain Bond Prospectus, November Bahrain postpones plan to remove meat subsidies, Reuters, 2 September 2015, article/2015/09/02/bahrain-subsidies-idusl5n1180xf accessed 30 November accessed 16 November Kingdom of Bahrain Bond Prospectus World Economic Outlook, International Monetary Fund, October IMF Executive Board Concludes 2014 Article IV Consultation with Bahrain, International Monetary Fund, IMF Press Release No. 14/289, 18 June 2014, 32 Katzman, Kenneth, Bahrain: Reform, Security and US Policy, Congressional Research Service, 24 March accessed 16 November Bahrain, U.S. Energy Information Administration, August 2013, accessed on 4 December 2014,

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