The Daily Update - Bahrain

Bahrain has seen its Moody’s long-term foreign issuer rating plummet by 6 credit notches from Baa1 in 2013 to B1 (negative outlook) currently. The rating agency expects the ‘government debt burden and debt affordability metrics to deteriorate significantly over the coming two to three years.’ Bahrain has been one of the GCC sovereigns most negatively impacted by the fall in the oil price as not only does it have one of the highest fiscal breakeven oil prices (~$100 per barrel for 2017-2018) but it has weaker financial buffers.

Given the Bahraini dinar is pegged to the US dollar the burden of external balance adjustment has fallen on fiscal policy. However, subsidy and expenditure reduction in the face of lower government revenues has been limited. Thus, Bahrain has continued to run double digit fiscal deficits, eating into its buffers and rapidly pushing up government debt levels. The IMF forecasts that the fiscal deficit will be at 12.2 percent of GDP in 2017, down from 17.8 percent last year, and advocates that Bahrain should do more to address this. Moreover, since 2015 Bahrain has run a current account deficit which reached 4.6% of GDP in 2016.  Debt issuance has been a key way to finance the deficits: Moody’s forecast that general government debt to GDP will reach 84.3% in 2017, up from 73.3% in 2016; it is forecast to continue rising to 91.7% in 2018. The deterioration has been rapid as in 2014 general government debt was 44.4% of GDP. Increased foreign debt issuance has also increased Bahrain’s external vulnerability.

Using IMF data, the Central Bank of Bahrain’s gross official reserves of USD 2.5bn amounted to only 1.4 months of import cover. This is a considerable drop from closer to USD 6bn of reserves in 2014. Its sovereign wealth fund, Mumtalakat Holding Company, has assets estimated at ~20% of GDP at the end of 2015 but set against this Bahrain’s net international investment position (the difference between the market value of a country’s foreign assets and liabilities relative to GDP - Moody’s data) has fallen from 79.2% in 2015 to an estimated 20.4% for 2017. Fortunately, Bahrain has enjoyed a high level of support from Saudi Arabia through the GCC Development Fund and also revenues from the shared Abu Sa’afa oil field. Saudi Arabia also provided military support at the Government of Bahrain’s behest during the civil unrest of the 2011 Arab Spring. Thus, it seems likely that Bahrain would continue receive further support from the GCC in the event of any difficulties.

S&P and Fitch rate Bahrain BB- and BB+ (foreign currency long term) respectively but have a negative outlook: both outline the importance of taking corrective action to address the fiscal deficit. Fitch notes that ‘Failure to shrink the fiscal deficit and set out a clear path towards stabilising the government debt-to–GDP ratio’ along with ‘severe deterioration of the domestic security environment’ are the main factors that could lead to a negative rating action. For S&P, ‘The negative outlook reflects our view that Bahrain's net external asset position could weaken to a level that we could consider insufficient to mitigate the effects of oil price volatility on Bahrain, or that foreign exchange reserves could drop further below already low levels.’

For us, the rapid deterioration in Bahrain’s fundamentals and accompanying move from investment grade to sub-investment grade has made it ineligible as an investment. Even where we have scope to hold sub-investment grade issues it currently fails to screen attractively. For example, on our models the Bahrain 6% 2044 issue is trading close to fair value using a BB- rating.