Standard & Poor’s Ratings Services has revised its foreign currency outlook on the Kingdom of Bahrain to positive from stable. At the same time, the ‘A-/A-2’ foreign currency and ‘A/A-1’ local currency sovereign credit ratings on Bahrain were affirmed.

“The revision reflects the improved prospects for the fiscal position, transparency, and structural reforms,” says Standard & Poor’s credit analyst Ala’a Al-Yousuf. “The local currency outlook remains stable. The long-term foreign and local currency ratings are likely to be equalised, and thereafter move in tandem, ahead of Bahrain’s membership of the Gulf single currency in 2010.”

The ratings on Bahrain are supported by monetary stability and a well-developed financial system. In particular, the fixed exchange rate regime underpins price stability, while the payments regime significantly reduces transfer and convertibility risk.

On the fiscal side, central government gross debt is expected to stand at 37% of GDP at year-end 2003. Taking into account an estimate of the government’s financial assets and the portfolios of the two pension funds, Standard & Poor’s expects the general government to be in a net asset position of about 60% of GDP by year-end 2003, remaining broadly in this position until 2006.

The central government budget this year is likely to record a deficit of about 1.5% of GDP (including extra-budgetary capital spending), compared with a budgeted deficit of 10.0%, largely as a result of higher-than-budgeted oil prices. Standard & Poor’s expects the budget to show a deficit of 3.2% of GDP in 2004, followed by surpluses of 0.5%-1.0% in 2005 and 2006, as oil production is slated to increase from mid-2004.

While oil revenues are very conservatively budgeted by the authorities, the ratings remain constrained by Bahrain’s increasing dependency on this source of revenues, accounting for more than 70% of the total. Although the government’s oil revenues are expected to increase, they will also become more vulnerable to event or market risks.

The opacity of public finances also weighs on the ratings. The government acknowledges the existence, but not the size, of extra-budgetary transactions. These include additional spending on defence and security, additional foreign grant receipts, and investment income from an undisclosed portfolio. In addition, the financial statements of public enterprises are not disclosed. The newly established National Assembly and Audit Bureau should gradually enhance the transparency and comprehensiveness of public accounts.
Finally, Bahrain aspires to becoming a constitutional monarchy, but the new system has yet to mature, and some setbacks cannot be excluded. An expected change of prime minister would be the first ever, and would test the robustness of the new system. Externally, Bahrain’s defence alliance with the US remains strong, but geopolitical event risks exist.

“The long-term foreign currency rating on Bahrain could be raised if the government strengthens the structure of the budget, improves fiscal transparency, and makes progress on structural reforms,” Al-Yousuf adds. “Conversely, both the foreign and local currency ratings could come under pressure if the expansion in oil production does not materialize as expected, if there is a sustained deterioration of the budget balance, or if there are setbacks to the domestic political reform process.”