In the heyday of the global bull run, as the Gulf embraced new financial services, technology and real estate at a frenetic pace, many viewed Bahrain as a nicely diversifying economy, yet dull compared to the dazzle of Dubai.
But as the financial crisis hit GCC markets, Bahrain may have quivered, but a full-blown debt crisis erupted in the emirate.
Strong financial regulation coming into the crisis and public spending this year have helped to compensate for the collapse in private economic activity in Bahrain. The government over the past year has completed a new $137 million Sheikh Khalifa bin Salman Port – designed to rival Dubai as the premier cargo port in the Gulf – expanded the Bahrain International Airport and spent heavily on other infrastructure projects.
This decision to prime the fiscal pump was always controversial. “When oil prices went down to $40 per barrel, there was a lot of speculation that it might go down even further,” Sheikh Ahmed bin Mohammed Al Khalifa, Bahrain’s finance minister, tells Emerging Markets. “We had the choice to cut spending or continue with spending to make investments in the economy, which we did and it worked out well for us.”
Bahrain weathered low oil prices – which traditionally make 75% of government revenues – and banking weakness, the biggest single contributor to its output, partly thanks to government spending. In addition, its reputation as a well-managed economic hub and low-cost base has averted the economic crash facing the region as foreign investors keep the faith, says Jarmo Kotilaine, chief economist at NCB Capital in Manama.
Khalifa’s dedication to reform has boosted market confidence at a crucial time. Active fiscal policy and increasingly efficient and transparent decision-making have helped to attract private investors and diversify the economy,” says Kotilaine.
But government spending this year comes at a price: the fiscal deficit is projected to rise to 8.7% this year compared with a 4.9% surplus in 2008. However, Khalifa pledges medium-term fiscal sustainability, arguing that investment-led spending can be easily adjusted, depending on the oil price. “Infrastructure spending is a variable, and we can slow this down if oil prices drop below $70 per barrel,” he says.
Thanks to Bahrain’s deep local capital markets – partly down to Khalifa’s reforms as central bank governor between 2001 and 2005 – a faithful band of domestic buyers is snapping up government debt.
In recent years, a cluster of new insurance firms, banks, Islamic finance outfits and investment houses have sprung up in Bahrain. But massive financial market turbulence globally and domestically, and large losses incurred by local banks could have caused the kingdom to buckle under the strain.
But, Bahrain’s relatively diversified economy, privatization efforts and governance reforms in recent years have helped to insulate the kingdom from the worst of the crisis. Khalifa says he will push ahead to develop new growth areas for the economy and to develop new sectors such as Islamic financial services and the telecoms industry.