Sunday 30, July 2017 by Georgina Enzer

Moody's downgrades Bahrain to B1, maintains negative outlook

Moody’s Investors Service has today downgraded the Government of Bahrain's long-term issuer rating to B1 from Ba2 and maintained the negative outlook.

The main driver for the rating downgrade is Moody's view that the credit profile of the Bahraini government will continue to weaken materially in the coming years, predominantly because despite some fiscal reform efforts there is a lack of a clear and comprehensive consolidation strategy. In particular, the rating agency expects Bahrain's government debt burden and debt affordability to deteriorate significantly over the coming two to three years.

The negative outlook reflects continued downside risks to the rating, which manifest themselves in heightened government and external liquidity risks. Furthermore, although Bahrain has benefited from the support of neighbouring countries during times of stress in the past, such support at this juncture lacks clarity, both in its form and timeliness.

Moody's has today also lowered Bahrain's long-term foreign-currency bond ceiling to Ba2 from Baa3 and long-term foreign-currency deposit ceiling to B2 from Ba3. The short-term foreign-currency bond ceiling was lowered to Not Prime from Prime-3, whereas the short-term foreign-currency deposit ceiling remains unchanged at Not Prime. Bahrain's long-term local currency country risk ceilings were lowered to Ba1 from Baa2.

In addition, the long-term foreign-currency bond ceiling for Bahrain - Off Shore Banking Center was lowered to Baa1 from A3 while the foreign-currency deposit ceiling remains at Baa1. The short-term foreign-currency bond and deposit ceilings for Bahrain - Off Shore Banking Center remain unchanged at Prime-2.

RATINGS RATIONALE

RATIONALE FOR THE DOWNGRADE TO B1

The rating downgrade to B1 reflects Moody's view that the credit profile of the Bahraini government will continue to weaken materially in the coming years. In particular, the rating agency expects Bahrain's government debt burden and debt affordability to weaken further significantly over the coming two to three years. In Moody's view, the

B1 rating better captures this anticipated weakening of the government balance sheet, than the previous rating of Ba2.

The government has taken initial steps towards fiscal consolidation, including some subsidy reforms for fuel and utility tariffs, the streamlining of government entities, increasing taxes, and targeting a cost recovery in the provision of government services. In Moody's view, the most prominent revenue measure is the introduction of a value-added tax from 2018, but a clear and comprehensive fiscal consolidation strategy is lacking and is unlikely to be introduced going forward, as the country manages growing domestic political and social tensions that render difficult the introduction of unpopular fiscal measures.

In the absence of more aggressive measures, Moody's expects that Bahrain will continue to post large fiscal deficits over the coming years.

Following deficits of 18% of GDP on average in 2015 and 2016, Moody's expects fiscal deficits to stay in double-digits in 2017 and 2018, and narrow only gradually over the following years.

The government's debt-to-GDP ratio rose to more than 73% by the end of

2016 from around 62% in 2015. Under its baseline scenario, the rating agency expects Bahrain's government debt-to-GDP ratio to cross 100% by 2020. Bahrain has no sizable and liquid sovereign wealth fund assets it can draw on, and therefore has to rely fully on debt funding to finance its large fiscal deficits. Moody's believes that sharply rising debt levels in conjunction with projected increases in Bahrain's funding costs will lead to a further deterioration in the country's debt affordability metrics and complicate the return to more sustainable government debt levels. According to Moody's estimates, Bahrain's interest payments this year may consume as much as 21% of budgetary revenue, up from only about 13% in 2015.

Peer comparison among similar-rated sovereigns shows that Bahrain's key fiscal credit metrics will worsen beyond the B-rated median by the end of 2018. According to Moody's projections Bahrain's debt burden and debt affordability indicators will weaken to about twice the median levels for B-rated peers by next year.

These sizable credit challenges are mitigated by only limited sources of credit strength. Bahrain's high per capita income, estimated by the IMF at $50,700 in purchasing power parity terms in 2016, is significantly higher than the B-rated median of $6,800, and could provide some buffer if the government were to embark on more ambitious fiscal consolidation measures.

While Moody's sees support for Bahrain's economic strength from the fact that the economy is fairly diversified, with non-oil sectors contributing close to 80% of nominal GDP on average since 2010, the government shows no indication that it will use this economic base to materially diversify its revenue base to reduce its reliance on oil-related income which will continue to suffer from weak oil prices in the coming years. Non-oil economic performance will be supported by access to funding under the Gulf Development Fund. While these funds are not part of the Bahraini government's budget, they will support the government in reducing investment expenditure without unduly harming growth.

Bahrain's net asset international investment position, which stood at 74.5% of GDP in 2016, provides some form of external buffer. However, Moody's expects it to decline significantly because external liabilities will increase at a much faster rate than the country's assets. More importantly, foreign exchange reserves at the Central Bank of Bahrain are low and very volatile, covering only around one month of goods and services imports. Following a pause in the dissemination of this data in 2015, the time series disclosed by the central bank more recently shows a material decline in foreign exchange reserves over the last two years, averaging only around $2.5 billion in the first quarter of 2017.

RATIONALE FOR THE NEGATIVE OUTLOOK

The negative outlook reflects continued downside risks to the B1 rating, which manifest themselves in heightened government and external liquidity risks. Given the expected large fiscal deficits and sizable amortization payments falling due over the coming years, Bahrain's government gross financing needs will reach more than 30% of GDP over the next two years.

The further deterioration in the government's balance sheet, combined with continued external debt issuance from other countries in the region expected in 2017-2018, will lower the supply of external funding. In addition, in light of rising global interest rates the cost of funding will go up.

Moody's expects that the combination of these two factors heightens the risk that finance is obtainable only at much less affordable rates for Bahrain, or potentially reduced amounts. While Moody's would expect support from neighbouring countries in times of crisis -- predominantly from Saudi Arabia -- there is no clarity about the form and timeliness of this support in the event that external funding dries up.

WHAT COULD MOVE THE RATING UP/DOWN

Given the negative rating outlook, any upward movement in the rating in the foreseeable future is highly unlikely. However, Moody's would consider moving the outlook back to stable if a clear and credible fiscal and economic policy response were to emerge, offering the prospect of containing the deterioration in the fiscal balance and government balance sheet. In particular, a stabilization of government debt levels below 90% of GDP, and strengthening of Bahrain's fiscal and external buffers would be credit-positive. A clear, sizable and timely support from one of its financially stronger neighbours could also contribute to stabilizing the outlook.

Signs of an emerging fiscal or balance-of-payments crisis would exert downward pressure on the rating. In particular, any signs of funding stress or loss of market access would trigger a further rating downgrade.

A deterioration in the domestic or regional political environment would also be highly credit negative.

  • GDP per capita (PPP basis, US$): 50,704 (2016 Actual) (also known as Per Capita Income)
  • Real GDP growth (% change): 3% (2016 Actual) (also known as GDP Growth)
  • Inflation Rate (CPI, % change Dec/Dec): 2.8% (2016 Actual)
  • Gen. Gov. Financial Balance/GDP: -17.6% (2016 Actual) (also known as Fiscal Balance)
  • Current Account Balance/GDP: -4.6% (2016 Actual) (also known as External
  • Balance)
  • External debt/GDP: 175.1% (2016 Estimate)
  • Level of economic development: High level of economic resilience
  • Default history: No default events (on bonds or loans) have been recorded since 1983.

 

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