A sales tax introduced this year means government coffers will gain with every glass of wine sold and shisha pipe smoked but that’s not enough to plug a large gap in the island kingdom’s finances and wean it off aid from richer neighbours. Saudi Arabia, along with Kuwait and the United Arab Emirates, came to the rescue of Bahrain last year when a prolonged period of lower oil prices pushed its public debt to nearly 93% of annual economic output.
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The price of Bahrain’s 2028 dollar bonds has risen by one-third from a record low last June when the country looked in danger of default but that upward trajectory could go into reverse if Manama does not tackle its spending overruns.
With an overall deficit last year equivalent to 11.7% of annual economic output, an estimate by the International Monetary Fund (IMF) said Bahrain would need to introduce a raft of new taxes and spending cuts to eliminate its budget deficit by 2022, a target set as part of its bailout.
However, the country’s Sunni Muslim royal rulers are wary of austerity measures roiling sectarian tensions among their Shia majority populace and of taxes, fees and spending cuts dampening growth. Instead, the government has set its sights on trying to grow the local economy to boost revenues and balance the books.
Investments in the fintech sector, a major oil and gas find and the development of Bahrain as a hub for foreign companies wanting to tap into the larger Saudi market are initiatives touted by the government as potential sources of revenue.
They are not, however, seen as enough to close the gap by 2022. The IMF said it expected the Bahraini economy to grow approximately 1.8% this year, the same pace as last year, and that additional reform efforts were needed.
“We still think there will be deficits at the end of the period,” said Trevor Cullinan, sovereign credit analyst at Standard & Poor’s, which, like the other main rating agencies, has a junk rating on Bahrain’s debt.
Bahrain’s Ministry of Finance and National Economy said the country’s fiscal programme was on track to deliver a balanced budget in 2022.
“This is a comprehensive and credible plan, which, through a combination of spending reductions and revenue measures, is already delivering significant progress,” the ministry said in a statement
A recovering oil price, along with new excise taxes and cuts in subsidies for water and power consumption have helped shrink Bahrain’s deficit from a record 18.4% of GDP in 2015.
As part of the bailout from its Gulf allies, Bahrain agreed to introduce a 5% value added tax, as well as additional subsidy cuts and a voluntary retirement plan for state workers.
The government has ruled out taxing income or company profits, partly to continue attracting business to a region where such taxes are non-existent.
The plunge in the oil price has forced all Gulf countries, including Saudi Arabia, to rethink generous welfare programmes and push economic diversification harder.
Bahrain, which does not have the vast oil wealth of its neighbours, discovered a large oil and gas field off its west coast last year and is in talks with US oil companies about developing it. The discovery could be an important source of revenue but its benefits are unlikely to materialise soon as converting the estimates to reserves is a costly and lengthy process.
“It takes a minimum of four to five years, so if you’re going to get any revenue it’s not going to be immediate, so you still have to face the adjustment to a large fiscal deficit and a large budget deficit,” said Nasser Saidi, a Dubai-based economist.
In the meantime, Bahrain has been trying to market itself as a financial technology hub for the Middle East and North Africa. Last year, it inaugurated Bahrain FinTech Bay, a state-backed platform, offering technology companies office space, networking events and a mobile app for collaborations.
FinTech Bay CEO Khalid Saad said the initiative would be a “great contributor” to Bahrain but added that it was too early to quantify that contribution.
Saad said the hub had attracted 36 firms — 60% of them international — to work on technologies such as digital currency and blockchain-based payments.
S&P has not factored in any contribution from the fintech initiative in its estimates for Bahraini economic growth.
“How much more are you going to get from fintech? Are you going to add 1 or 2% of GDP? I don’t think so. It’s not a big employment generator,” said Saidi.
Amazon Web Services, the world’s biggest cloud computing provider, is opening a regional data centre in Bahrain this year. The company has declined to say how many people it would employ but Zubin Chagpar, the head of public sector for Amazon Web Services in the Middle East said the government’s willingness to focus on digital transformation was a key factor in Amazon’s decision to locate there.
“Bahrain is very particular in saying [it wants] to leverage technology to redefine our economy,” Chagpar said.
Leveraging its proximity to Saudi Arabia has been part of Bahrain’s economic toolkit since a bridge connecting it to Saudi Arabia’s Eastern province, where oil giant Aramco has its headquarters, opened in 1986.
Some 1.1 million people entered Bahrain via the bridge in January, many attracted by the country’s more relaxed rules on drinking and socialising. Unlike Saudi Arabia and neighbouring Kuwait, where alcohol is prohibited, alcoholic drinks are sold in Bahrain.
Some international companies, which want to sell into the Saudi market, also base themselves in Bahrain, where the operating costs are cheaper. US manufacturer Mueller Industries and Mondelez, the world’s No 2 confectioner, recently expanded their presence in Bahrain.
Bahrain’s prime position as a “stepping stone” to Saudi Arabia could wane, given the fast pace of change in the conservative country as it moves to relax social restrictions and build entertainment and tourism industries.
Saudi Arabia is also developing its own manufacturing sector.
“It used to make sense four or five years ago, it doesn’t make sense now that Saudi Arabia has opened up,” said Saidi.
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