* Government sent requests for proposals to banks
* Last issued $750 mln sukuk in November 2011
* Fiscal gap of 3.7 pct/GDP forecast in 2012
By Rachna Uppal and Sudip Roy
DUBAI/LONDON, April 25 Bahrain, troubled by ongoing social unrest, is testing whether it could draw investors into a potential sovereign bond sale, although the issuance is unlikely to be imminent, government and banking sources said on Wednesday.
A year of clashes between mostly Shi'ite-led protesters and Sunni government security forces has been weighing on the small non-OPEC oil exporter, eroding capital parked in its mutual funds, while fiscal handouts have raised the country's vulnerability to a potential oil price drop.
"Bahrain sent out RFPs (requests for proposals) earlier this week. There are no mandates yet but they seem to be very serious about tapping the market," said a banker, who did not want to be identified.
A senior government source told Reuters that the issuance was not imminent despite the requests to banks, adding that the country was a regular issuer and the political situation in the kingdom would not negatively influence investor appetite.
"They tend to give out mandates and wait. There's no requirement to issue immediately," another banker said.
Last November, the island kingdom, drew $1.8 billion in demand for its $750 million, seven-year Islamic bond, or sukuk, its first sovereign issue since March 2010, pricing it at a yield of 6.273 percent. The order book mainly went to Middle East investors.
Bahrain had initially looked to sell a $1-billion conventional bond at the beginning of 2011 but was forced to postpone plans due to its worst turmoil since the 1990s, which it eventually suppressed with the help of martial law and Saudi troops.
But clashes between pro-democracy protesters and security forces has been going on on a daily basis for the past months.
Four policemen were wounded by an explosion in a village in western Bahrain on Tuesday that the government said was a "terrorist" act after weeks of protests against a Formula One Grand Prix held in the Gulf Arab state.
Another banking source said he believed Bahrain, a U.S. ally and home of the U.S. Navy's Fifth Fleet, wanted to issue a bond "as a PR stunt to show all is well."
Five-year Bahrain credit default swaps, which reflect how investors assess the risk that a country will not be able to pay back its obligations, have been easing gradually this year to around 372 basis points on Wednesday from a peak of 408 points at the end of January, according to Markit data.
"I think perhaps this is a question of getting money in the bank while markets are reasonably decent," said a London-based analyst, who declined to be named.
Yield on Bahrain's sukuk maturing in 2018 stood just below 5.0 percent bid on Wednesday, up from a low of 4.8 percent at the beginning of the month but well below this year's high of 5.7 percent in mid-January.
The turmoil prompted Bahrain, whose credit rating has been downgraded by up to three notches last year, to boost government spending by 22 percent from its original 2011 target to 3.1 billion dinars ($8.2 billion), though robust oil prices have been helping to ease budget strains.
For 2012, the government had forecast a deficit of 8.8 percent of GDP due to slightly lower spending, which at 3.1 billion dinars was still 14 percent higher than the original 2012 plan.
Bahrain, the regional financial centre, is rated 'Baa1' by Moody's and 'BBB' by Standard & Poor's and Fitch.
Bahrain needed an average oil price of $114 per barrel in 2011 to balance its budget, the highest in the Gulf, up from just $80 in 2008, the International Monetary Fund said on Tuesday. The Fund forecasts that the country's gross government debt will fall to 31.6 percent of GDP this year from an estimated eight-year peak of 36.4 percent in 2011.
Analysts polled by Reuters in March expected the kingdom to post a budget deficit of 3.7 percent of gross domestic product in 2012.