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Bahrain On The Brink

Zawaya: Political disruptions have hurt the $23Bn Bahraini economy and raised questions about its competitiveness against its peers, who were taking away business even before the unrest. Can Bahrain fully recover from this crisis?

Executive Summary
Decades of carefully crafted image as a model, free economy in the Middle East lay in tatters, as the Bahraini government squashed opposition and imposed emergency rule. What started as a protest for job creation, equality and justice, has become a revolutionary struggle for the Shia opposition.

The disruptions have hurt the $23-billion Bahraini economy and raised questions about its competitiveness with its peers who were taking away business even before the unrest. Can Bahrain recover fully from this catastrophe?

Finding A Way Back For Bahrain.

Bahrain has always done well in the Heritage Foundation's annual Index of Economic Freedom. In its 2011 edition, published on January 12 ‑ just two days before Tunisian strong man Zine El Abidine Ben Ali fled his country as the first victim of the Arab Spring - Heritage Foundation ranked Bahrain as the 10th freest economy in the world, with improvements in investment freedom and labour freedom.

Countries that score well demonstrate a commitment to individual empowerment, non-discrimination and the promotion of competition. Their economies tend to perform better, and their populations tend to enjoy more prosperity, better health and more positive measures on a variety of quality-of-life indices. A score of 80 or higher merits the designation of "free economy." Those who score in the 70s are considered "mostly free," said Heritage in its note. Bahrain's score was 77, and was seen as the freest economies in the Middle East North Africa region.

This year's survey may paint a different picture of the country. Bahrain, the most vulnerable of the Gulf economies, has caught the Arab Spring fever, and it has taken an emergency rule of law and the military might of Saudi-led Gulf forces to bring its temperature down.

Bahrain, a nation of half a million indigenous people, has a 70% Shia population, but is ruled by a Sunni dynasty. In the past, the Shia majority has rioted and complained of discrimination and lack of job opportunities, but this time it was further emboldened by Arab Spring protests.

Repeated calls of dialogue from both, including the Bahraini prime minister Sheikh Khalifa Bin Salman Al Khalifa came to nought and soon escalated into a violent crackdown and the arrival of Saud-led Gulf forces.

The protests and the unrest, the shooting and jailing of Shia protestors against their Sunni rulers have been quashed for now, but a pall of uncertainty hangs over Bahrain.

While the emergency rule is expected to be lifted by June 1, the Gulf forces will remain in place according to the authorities to ensure that it serves as deterrence to "foreign forces", in other words, Iran.

Most of the opposition leaders are now in jail, apart from journalists, bloggers and others seen sympathetic to the protestors.

The political upheavals have already had economic ramifications. According to Ernst & Young, occupancy rates in hotels in Bahrain for the month of March 2011 stood at just 10%, a fall of 50% compared to the same period last year.

Tourism accounts for 5% of Bahrain's GDP and 10% of employment, and the absence of leisure and business tourists suggests that Bahrain has not been open for business on account of the troubles.

The tourism and business conference sectors (with knock-on effects in hotels and restaurants) have been hit hard, with the cancellation of the Formula 1 Grand Prix having a major impact. Retail trade has also been adversely affected, and the banking sector, which had recovered well from the global financial crisis, is set to suffer tangentially, says the Institute of International Finance (IIF).

The International Monetary Fund (IMF) expects the Bahraini economy to slow to 3.1% in 2011, with the IIF expecting a slightly lower 2.9% growth.

"Other key sectors, such as oil and gas and manufacturing, are unlikely to be impacted significantly. As a result, we think that more than 2.0% will be shaved off growth in Bahrain this year, with considerable downside risk if the situation goes unresolved for an extended period," say the IIF.

Citibank, which opened a wealth management service centre in Manama on May 9, is even more pessimistic, suggesting that Bahraini GDP growth may shrink to 1% this year.

The bank expects growth to return in 2012 as funds from GCC neighbours help accelerate planned housing works and other projects, largely designed to restore social stability to the Kingdom, including $10-billion from the Gulf Development Plan.

"Long-term, however, the violent unrest may take its toll on Bahrain's ambitions of fostering a regional financial centre," says Citibank.

Searching For A USP
It's the last point - coming from an influential international bank - which should strike terror in the hearts of Bahraini authorities. The unrest has brought to the fore a problem Bahrain has been struggling with for years: namely its unique selling point.

Bahrain was long regarded as the calm, peaceful stable banking hub of the region, but that reputation has slowly eroded as other centres emerged and slowly chipped away at Manama's market share. Dubai's rise over the past fifteen years, Abu Dhabi and Doha's financial muscles and Saudi Arabia's own financial reforms has meant that Bahrain is no longer an obvious regional base for foreign financial institutions.

"Medium-term growth prospects have become more uncertain due to the increase in political risk and the likely damage to Bahrain's reputation as a relatively liberal regional financial centre - particularly at a time when competition for international business from other Gulf states is increasing," says Capital Intelligence.

Higher political risk perceptions, if they persist, will make it harder to generate the private sector growth required to absorb the expanding Bahraini workforce over the coming years, says the bank.

The International Labour Organization has also blamed the government of unfair dismissals of more than 300 employees of Gulf Air, Alba Aluminium Company, the Khalifa Sea Port and many trade union leaders, which could further exacerbated employment issue for Shias.

However, its banking sector and regulatory authorities continue to offer hope as base for a revival. According to Central Bank of Bahrain's quarterly data, 409 financial institutions in the country by the end of the first quarter of 2011, and 30 new mutual funds.

In March however, foreign assets in the country's offshore banking sector fell 10%, hitting their lowest levels since 2005. Anecdotal evidence suggests that much of the funds were transferred to Dubai and other regional centres. While this could have been a temporary measure, there is a chance that those funds may never come back on account of increased political risk.

This increased political risk in an already volatile region is a gauge foreign investors will watch closely. Not surprisingly, all the ratings agencies have downgraded Bahrain's sovereign rating.

"The downgrade also takes into account the weakening of fiscal flexibility over the past few years, which has reduced the authorities' capacity to cope with external shocks and will be harder to restore in the current climate," says Capital Intelligence, as it lowered Bahrain's long-term foreign and local currency ratings from A to BBB+.

The IIF notes that the high oil prices will provide some fiscal relief, although spending will be higher than originally budgeted due to increased allocations to social benefits and low-cost housing, this will be more than offset by a sharp increase in oil revenue.

"We therefore expect the budget to remain in surplus at around 1% of GDP. However, Bahrain's fiscal vulnerability has increased, as the breakeven oil price that balances the budget has now moved above $100 per barrel," says the IIF. The tripling of oil production at the onshore Awali oil field over the next seven years will help to alleviate budget pressures, even though not all the extra revenue will accrue to the government.

High oil prices will also keep the current account in large surplus this year and next. The trade surplus is forecast to reach a record $5.5 billion in 2011, which will easily offset a larger deficit in services, income and transfers due to a sharp drop in tourism and travel receipts.

"As a result, we expect the current account surplus to widen to about 11% of GDP this year and to remain in double digits in 2012. This will help counterbalance any capital flight this year and underpin the exchange rate," says the IIF.

Maneouvering Room
Unlike Saudi Arabia, which unleashed $130-billlion to pacify its citizens, Bahrain can not afford the same luxury. According to data available in Bahrain Economic Development Board's (EDB) latest quarterly report, Bahrain has the highest breakeven oil price at $85, a barrel, making it especially vulnerable to oil price fluctuations.

While we can expect Saudi Arabia and other Gulf states to extend more aid in addition to the $10-billion already promised to Manama, it could send a signal that Bahrain is completely dependent on Saudi Arabia and its Gulf counterparts, rather than a competitive neighbour.

"Bahrain's cushion of official financial assets is thinner than that of other investment-grade commodity exporters," said Tristan Cooper, head analyst for Middle East Sovereigns. "This exposes the country's public finances to a degree of risk that, in Moody's opinion, is better reflected by an A3 rating," Cooper said.

While Bahrain's EDB's Q1 quarter suggests a 5.2% growth in 2011 and 5.7% in 2012, with sterling growth in hotels and restaurant (5% in 2011), transport and communication (9.5%), these figure look like a distant dream.

Going forward, Bahrain faces a mountain of problems. Its political reforms and parliamentary processes are in tatters, so decision-making will remain with the Bahrain King.

The Economist Intelligence Unit expects Bahrain to maintain an open attitude towards foreign investment, allowing 100% foreign ownership of firms in the country.

But, "its position as a regional financial centre will weaken in the forecast period, relative to Dubai and Qatar. It will seek to invest in infrastructure such as ports in an attempt to remain competitive with its GCC peers," says the EIU adding that real GDP growth over the next five years will hover around 3.8%, compared to the 5.8% witnessed in the preceding five years.

There may be relative calm on the streets of Manama, but it is primarily due to the jailing of the key opposition leaders.

While prime minister Sheikh Salman is on a charm offensive visiting the U.K. to get the government's point across to dismayed allies, the pressure is on Manama to show some signs of change.

"The only way forward is for the government and opposition to engage in a dialogue, and you can't have a real dialogue when parts of the peaceful opposition are in jail," chided U.S. President Barack Obama in a direct reference to Bahrain in his speech on the Middle East on May 19.


Bahrain's long-term prosperity hinges on two key issues - its political ability to navigate the country away from the brink of disaster and open some form of dialogue or reconciliation with at least some members of the opposition. This seems difficult given the pressure from its Gulf neighbours to retain the status quo.

Secondly, Bahrain's economic competitiveness is under severe threat from its neighbours. Given Saudi influence in Bahrain, it may be worthwhile to consider some kind of an economic pact with the Kingdom to further strengthen and formalise ties with the Saudi economy. A model similar to the Hong Kong-China nexus, where Manama, like Hong Kong, serves as a free-wheeling capitalist world-facing centre in contrast to the more conservative and formal commercial capital of Riyadh, could be considered.

A bold move, no doubt. But this is hardly the time for half-hearted measures.

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