INTERNATIONAL. Standard & Poor's Ratings Services said today that it affirmed its long-term foreign and local currency sovereign credit ratings on the Kingdom of Bahrain at 'BBB'.
We also raised the short-term foreign and local currency sovereign credit ratings to 'A-2' from 'A-3'. The outlook remains negative.
At the same time, we affirmed the long-term ratings on the Central Bank of Bahrain and raised the short-term ratings to 'A-2' from 'A-3'.
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 the fiscal dependency on sustained high oil prices.
More than a year after major unrest in Bahrain, stability has not returned. 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, such as the November 2011 report of the Bahrain Independent Commission of Inquiry (BICI) on the events of March 2011.
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.
Aside from tourism, most sectors are showing moderate rates of growth, albeit posting lower-than-historical averages. The outflow from Bahrain's international financial sector also appears to be stabilizing, at least for banks. Increased hydrocarbon production, as well as public spending, generated real GDP growth of 2.2% in 2011 and we expect growth to rise to 3.2% in 2012.
Given Bahrain's high population growth, however, we estimate GDP per capita dropped by 1.7% in 2011 and foresee average income stagnating in the medium term, exacerbating 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, the central government deficit amounted only to 0.4% of GDP in 2011, with a significantly wider deficit of 4.6% 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 37.1% of GDP in 2012 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. However, this will be offset in part by Gulf Cooperation Council (GCC) development funds, which we expect to begin flowing before the end of the year.
We estimate that general government debt will rise to 42% of GDP in 2012, from 24% in 2009, reducing the government's net asset position to 6.9% of GDP in 2012 from 25% in 2009. Despite a relatively large financial sector, 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. That said, we believe Bahrain's competitive advantage lies largely in it being a gateway to Saudi Arabia.
The change in the short-term foreign and local currency ratings to 'A-2' from 'A-3' reflects the revision of our criteria regarding the link between long-term and short-term sovereign credit ratings.
According to these criteria, the short-term rating on a sovereign government is derived directly and solely from the long-term rating. As a result, the change in the foreign and local currency short-term ratings does not reflect our view of an improvement in Bahrain's short-term creditworthiness.
The negative outlook reflects our opinion that we could lower the ratings if political turmoil further weakens economic prospects and threatens external and fiscal performance. We could also lower the ratings if oil prices remain below $100/barrel for a sustained period, if difficulties arise in securing GCC development funds, or if other government expenditures arise that worsen the fiscal profile.
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. Lastly, fiscal reforms that would improve the structural deficit could lead us to revise the outlook to stable.