Bahrain’s Sovereign Ratings Downgraded; Outlook Revised to Stable

(MENAFN- Capital Intelligence Ltd) Rating Action

Capital Intelligence Ratings (CI Ratings or CI) today announced that it has lowered Bahrain’s Long-Term Foreign Currency Rating (LT FCR) and Long-Term Local Currency Rating (LT LCR) to ‘B+’ from ‘BB-’. At the same time, CI Ratings has affirmed the sovereign’s Short-Term Foreign Currency Rating (ST FCR) and Short-Term Local Currency Rating (ST LCR) at ‘B’. The Outlook for all ratings has been revised to Stable from Negative.

Rating Rationale

The ratings downgrade reflects the persistent weaknesses in the public finances, including high budget deficits and rising debt levels, which have in turn contributed to a heavy interest burden and large financing needs. The ratings also take into account Bahrain’s external vulnerabilities, with large external financing requirements and modest foreign reserves. Bahrain’s credit metrics remain heavily influenced by developments in the oil market, with the commodity accounting for around 17.7% of GDP, 58% of fiscal revenues, and 42% of exports in 2020.

Despite increasing hydrocarbon prices and recovering economic performance, fiscal strength remains weak, aggravated by low non-oil revenues and high current spending as a result of Covid-19. The government has partially resumed the implementation of its fiscal balance programme in a bid to eliminate the budget deficit and place public debt on a more sustainable trajectory by 2024. The budget draft for 2021 and 2022 includes limited fiscal consolidation measures, such as reducing transfers to the Electricity and Water Authority by reforming their tariffs to cover costs, reducing cash subsidies, and decreasing the budgets of ministries through a centralised procurement structure. The government also intends to double the VAT rate to 10% from 5% from January 2022 onwards, subject to parliamentary approval. The implementation of these measures should help reduce the budget deficit, but in CI’s view they are insufficient to balance the budget and reduce government debt by 2024. Indeed, given our baseline oil price assumption of USD65 per barrel in 2021 (well below the fiscal breakeven price of around USD90 per barrel), we expect the budget deficit to average a still high 7% of GDP in 2021-22.

Central government debt continues to increase and is expected to reach an unsustainable 132.3% of GDP in 2022. About 70% of the debt stock is classified as external, most of which is denominated in USD. The debt stock includes the financial obligations of the recently liquidated National Oil and Gas Authority (estimated at 10.7% of GDP in 2021), as well as the outstanding zero-interest loans from the GCC development fund, estimated at USD6.3bn as at end-2020.

Government interest expense is very high at an estimated 29.4% of revenues in 2021, rendering the public finances vulnerable to changes in risk perceptions and higher interest rates and reducing fiscal flexibility.

Refinancing risks remain significant, with gross government financing needs estimated at an average 18.2% of GDP in 2021-22, compared to 27.2% in 2020. The government mostly relies on GCC financial assistance and the international markets to meet its needs, but has also increased its borrowing from the central bank – a potentially risky strategy, particularly given the fixed exchange rate.

Crucially, GCC support serves as both a direct source of fiscal financing and as a key element in the preservation of investor confidence and capital market access. The government issued USD2bn in long-term euro notes and sukuk in January 2021 (bought mainly by investors from Saudi Arabia), and is expected to tap the capital markets for a second time in the last quarter of 2021.

Bahrain’s external strength remains low, with the current account deficit expected to narrow to 4.5% of GDP in 2021, from 9.6% in 2020. Increasing hydrocarbon exports are expected to be partially offset by the lagged recovery of tourism receipts due to the pandemic. Official foreign reserves are expected to remain under pressure, standing at a modest USD3.8bn in June 2021 and covering less than two months of imports. Net foreign exchange reserves are expected to be negative, with the country accumulating significant foreign currency liabilities against these assets. Bahrain’s external financing needs – excluding the liabilities of the banking sector – remain large at an estimated 62% of GDP in 2021; this is also considered a constraining factor for the ratings.

Bahrain’s ratings are supported by the country’s relatively high GDP per capita and reasonably diversified economy, particularly compared to its regional oil exporting peers.

Rating Outlook

The Outlook for the ratings is Stable, indicating that the ratings will remain unchanged in the next 12 months. The Stable Outlook reflects CI’s assumption that sufficient financial support from the GCC member states is likely to be forthcoming in order to partially cover the government’s financing needs. It also takes into account government efforts to implement modest fiscal consolidation measures to reduce the budget deficit, as well as higher oil revenues.

Rating Outlook: Upside Scenario

Although unlikely at present, the Outlook could be revised to Positive if the government successfully implements broad based fiscal reforms, reining in its budget deficit and placing public debt on a declining trajectory, and/or oil prices increase above the forecast levels, reaching a fiscal breakeven price of USD90/barrel.

Rating Outlook: Downside Scenario

The Outlook could be revised to Negative in the next 12 months if the government fails to rein in the large budget deficit and stem the increase in debt, and/or refinancing risks increase, with the government unable to fully access capital markets or secure additional financial assistance from the GCC. An unexpected decline in hydrocarbon prices would also trigger an outlook revision.

Contact

Primary Analyst: Dina Ennab, Sovereign Analyst; E-mail: dina.ennab@ciratings.com
Secondary Analyst: Yesenn El-Radhi, Senior Sovereign Analyst
Committee Chairperson: Morris Helal, Senior Credit Analyst

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