Bahrain 'A' ratings affirmed on continued reforms; outlook stable

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Standard & Poor's Ratings Services today said it had affirmed its 'A' long-term and 'A-1' short-term sovereign credit ratings on the Kingdom of Bahrain. The outlook is stable.

"The ratings on Bahrain reflect the government's net financial asset position and strong international alliances," Standard & Poor's credit analyst Remy Salters said. "These factors provide a counterbalance to high geopolitical risks (relative to the majority of other rated sovereigns), the Bahraini economy's vulnerability to external shocks, and the secular decline of its hydrocarbon resources."

Net of deposits, minority stakes in quoted companies, and other financial assets, we estimate the general government's net asset position at 25% of GDP in 2008. This is sharply down from estimates of around 65% a year ago, owing to the inclusion of only the most liquid assets, as well as past opacity on the composition of asset holdings. Nevertheless, it still compares well with a median net debt position of 22% of GDP for Bahrain's 'A' rated sovereign peers. Oil revenues were conservatively budgeted on the basis of a $40 oil price in 2008, and we expect there to be a general government surplus (including extra-budgetary expenditures) of 5% of GDP. According to our forecast, however, fiscal surpluses will decline to 2.2% of GDP in 2009 and an average of 0.7% in 2010-2011.

A well developed and closely regulated financial system mitigates Bahrain's vulnerability to shifts in the real estate and stock markets. Some institutions have been affected by deleveraging in developed markets, but the main impact is likely to be felt via a slowdown in the important financial sector and wider economic activity. We assume per capita GDP growth of just above 3% over the next two years, but there are significant downside risks, particularly if financial services are more severely impacted and petroleum prices continue weakening.

Structural reforms continue, with a recent focus on the labor market, as well as the rationalization of public asset management. On the fiscal side, the ratio of expenditure to GDP has been declining in recent years. Further economic diversification remains a key structural need, particularly given the challenge of boosting private sector employment growth for Bahrainis as large cohorts enter the labor market in coming years.

The stable outlook balances the fiscal and external asset positions (notwithstanding significant issues surrounding data) against political risks, diminishing oil resources, and the challenge of carrying through structural reforms needed for economic diversification, in particular in education and the labor market. Success in improving human capital to underpin sustainable growth, addressing long-term energy needs, and reducing the pace of current expenditure growth could have a positive effect on the ratings. Conversely, the ratings would come under pressure if there was a sustained deterioration in fiscal or economic performance, or if reforms were to be postponed.

"The global financial crisis will pressure economic performance, via financial sector activity and a likely real estate correction, but we expect that the impact on systemic risk will be contained," Mr. Salters said.