A Closer Look


€‹A lower rating and cancelled bond sale have big implications for private equity and tax reforms.

Standard & Poor’s lowered the Kingdom of Bahrain’s rating to BB/B, which is a non-investment grade. This raised the cost of access to global capital markets. Plans for a 750 million-dollar bond sale by the Bahraini government were cancelled after the announcement, raising questions about future financing and budget obligations. Rating downgrades generally increase borrowing costs, and this could be at the heart of the decision.

Earlier on, as a measure against already tightening budgets, fuel prices were increased significantly, a tricky move in the Gulf and one that will increase the cost of living in Bahrain. The sharp decline in oil prices has made many oil producing countries struggle to make ends meet, and spending and subsidies have been cut in the United Arab Emirates and Saudi Arabia. The barrel price Bahrain needs to balance the budget is about $125, which is over three times the $40 price as of March 2016, so the government is looking for ways to boost non-oil revenues.

Despite this dire-sounding downgrade, most investors saw it coming although they may not have anticipated its magnitude. Being somewhat restricted from the regular avenues for financing on the capital markets can open other opportunities for venture capitalists and private equity, and those groups are giving Bahrain another hard look now. When access to cheap money on capital markets disappears, other lenders can take their chances in financing projects in Bahrain. Furthermore, the country is already home to many private equity firms, and can take a stance to further enhance its role as financial roundabout in the region. A role that is most visibly played for Saudi Arabia, and for which Bahrain acts as financial hub in many respects. The lower rating is not likely to affect this situation.

Mutual support among GCC governments during this period of low prices is underlined by a $919 million dollar investment by the United Arab Emirates to expand the Manama airport. The project involves construction of a new passenger terminal to accommodate the anticipated growth of the number of passengers and air traffic. For the construction industry and its subsidiaries, this investment will create hundreds of job opportunities, and indicates investors’ trust in the economy of the small Gulf state.

The sharp decrease of oil prices worldwide is forcing governments to shift gears, and economic diversification is more than a buzzword. Fortunately for Bahrain, petroleum exports account for a modest 11% of the GDP, but 70% of the government revenues. Diversification must therefore begin with the collection of revenue, rather than in the economy itself. A larger trend in the Gulf region indicates a willingness to introduce VAT to control spending, increase tax revenues and balance the budget in tougher years. The plans for Gulf-wide implementation of VAT have been on the agenda for some years already, but indications are that it might be realized as soon as 2017. The Saudi Arabian Minister of Finance, Mr. Ibrahim Alassaf, mentioned a percentage of 5% was considered, starting in 2018, but that it is coordinated with other countries in the region. This follows a draft agreement that was signed in May 2015, stating the implementation of pan-GCC VAT which would offset the loss of customs revenues arising out of the removal of internal customs duties. The discussion on VAT in the Gulf states has been going on for years, but current oil prices present the strongest incentive to move in this direction.

For Bahrain, having one of the most diversified economies in the Gulf, strong tax reforms can actually be helpful in balancing the budget in a smart way. After all, diversifying tax revenue seems easier than diversifying the entire economy. Regardless of this, what will happen to Bahrain, as the more vulnerable state in the Gulf, can be a signal for what is happening to the other ones—for example when it comes to ratings.