January 25, 2012 / 1:35 PM / 8 years ago

TEXT-S&P affirms 'BBB/A-3' ratings on Bahrain; outlook negative

(The following statement was released by the rating agency)

Jan 25 -

— In our view, the dynamics of Bahrain’s internal political conflict remain unchanged, with entrenched polarization indicating prolonged tensions.

— Although most sectors have not suffered materially from the unrest, we see growth coming only from the hydrocarbon sector and government spending, and we expect GDP per capita growth will remain stagnant for now.

— We are therefore affirming our long- and short-term sovereign credit ratings on the Kingdom of Bahrain at ‘BBB/A-3’.

— The outlook remains negative, indicating the likelihood of a downgrade if renewed political tensions, slower growth, or lower oil prices weaken Bahrain’s fiscal or external performances.

Standard & Poor’s Ratings Services today affirmed its long- and short-term local and foreign currency sovereign credit ratings on the Kingdom of Bahrain at ‘BBB/A-3’. The outlook remains negative.

At the same time, we also affirmed the ‘BBB/A-3’ ratings on the Central Bank of Bahrain.

The transfer and convertibility (T&C) assessment on Bahrain is ‘BBB’.

The ratings on Bahrain are supported by the country’s net external and fiscal asset positions, which are underpinned by the renewed development of hydrocarbon resources. The ratings are constrained by our view of severe domestic political tensions, high geopolitical risks, stagnating real GDP per capita, and its fiscal dependency on sustained high oil prices.

Nearly a year after major unrest in Bahrain, tensions still remain. Violent street protests with occasional fatalities occur regularly and there is entrenched polarization between the two sectarian communities, which both also appear internally divided. The authorities have made efforts to defuse tensions, notably with the November 2011 report of the Bahrain Independent Commission of Inquiry (BICI) on the events of March 2011, as well as the King’s announcement of constitutional reforms on Jan. 15, 2012. In our view, however, these measures have failed to revive a broader political process that includes opposition representatives. As such, we believe challenges to government legitimacy will persist and the potential for unrest remains acute. In our view, this could continue to undermine Bahrain’s international image as a business-friendly location. Finally, geopolitical competition between Bahrain’s large neighbors Iran and Saudi-Arabia is a further complicating factor to restoring a balanced social contract.

So far, the immediate damage to the real economy from the unrest has been limited. Business activity has remained largely unaffected except for the comparatively small tourism sector (less than 5% of GDP). The outflow from Bahrain’s international financial sector also appears to be stabilizing, at least for banks. We estimate increased hydrocarbon production, as well as public spending, generated real GDP growth of 2.2% in 2011. In addition, a generous 10-year development package from the GCC starting in 2012 (equivalent to 4.1% of GDP annually) should lift growth to 3.5% in 2012 and 4.1% in 2013. Given Bahrain’s high population growth, however, we expect GDP per capita will drop by 1.7% in 2011 and a further 0.5% in 2012. We note that the stagnation of average incomes over the past decade has exacerbated political tensions.

The unrest has weakened Bahrain’s fiscal position, with the budget-balancing oil price rising to $120/barrel. Given an average oil price of $111/barrel in 2011 and increased oil output, we estimate the general government deficit at 0.8% of GDP in 2011, with a wider deficit of 3.1% of GDP forecast for 2012. Oil and gas-related revenues account for 88% of total revenues, making the budget precariously sensitive to declines in price or volume. The hydrocarbon-related increase in government revenues masks the full extent of Bahrain’s expansionary fiscal policy, where general government expenditures have climbed to 37.3% of GDP in 2011 from 34.5% in 2010. Moreover, spending has mainly been in the form of transfers and subsidies that have buffeted temporary consumption. As such, we view the structural features of the budget as having deteriorated even if many transfers were designed as one-off payments.

We estimate that general government debt will rise to 35% in 2012, from 24% of GDP in 2009, reducing the government’s net asset position from 25% of GDP in 2009 to 4.8% by 2014. Despite a relatively large financial sector contributing nearly 25% to GDP, we consider sovereign contingent liabilities to be limited. The financial system appears relatively well regulated, with manageable asset quality risks from the real estate overhang. Dollarization and the currency peg to the U.S. limit monetary flexibility, but persistent current account surpluses have maintained a net external asset position. The political unrest has raised cross-border funding costs for domestic institutions, but there is no sign of any systemic stress. Some factors, such as poor credit conditions in Dubai, have helped prevent assets draining away from Bahrain. That said, we believe Bahrain’s competitive advantage lies largely in it being a gateway to Saudi Arabia.

Our local currency rating is equalized with the foreign currency rating because monetary policy options, which underpin a sovereign’s greater flexibility in its own currency, are constrained by Bahrain’s pegged exchange rate regime and relatively less developed domestic bond markets. Our T&C assessment is equalized with the sovereign foreign currency rating to reflect our opinion that the likelihood of the sovereign restricting access to foreign exchange needed by Bahrain-based non-sovereign issuers for debt service is similar to the likelihood of the sovereign defaulting on its foreign currency obligations. This reflects our view of the difficult political environment, the somewhat gray line between the public and private sectors, and the modest capital controls that exist at present.

The negative outlook reflects our view that we could lower the ratings if political turmoil weakens economic prospects and threatens external and fiscal performance. We could also lower the ratings if oil prices decline and remain low for a sustained period or if difficulties arise in implementing the GCC development funds. In addition, our view of Bahrain’s creditworthiness could weaken if public spending fails to stimulate economic growth.

The ratings could stabilize at the current level if a credible political process emerges and a renewed social contract appears likely. In addition, if the boost in public investment improves Bahrain’s growth prospects, this would also support the current ratings.

RELATED CRITERIA AND RESEARCH

— Rating On Bahrain Removed From Watch Negative And Affirmed At ‘BBB’; Outlook Negative Due To Latent Political Tensions, July 20, 2011

— Sovereign Government Rating Methodology And Assumptions, June 30, 2011

— Use Of CreditWatch And Outlooks, Sept. 14, 2009

— Methodology: Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009

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