Moody's Investors Service has downgraded Bahrain's local and foreign currency government bond ratings to A3 from A2. The outlook on these ratings is now stable. The move was motivated, among others, by a gradual but significant rise in the breakeven oil price in the Bahraini budget over recent years. This, together with a relatively modest level of official financial assets, has led to a divergence between the government's fiscal flexibility and that of rating peers, it said. As a result, reduced fiscal flexibility makes it more challenging potentially to meet contingent liabilities arising from Bahrain's financial sector, which is relatively large compared with the government's resources, Moody's said. Moody's has a negative outlook on Bahrain's banking system. “Bahrain's credit fundamentals, while robust and still within the A category, have diverged in some respects from those of rating peers. Published fiscal data imply that the oil price necessary to balance the budget has gradually risen over time. Additionally, Bahrain's cushion of official financial assets is thinner than that of other investment-grade commodity exporters. This exposes the country's public finances to a degree of risk that, in Moody's opinion, is better reflected by an A3 rating,” said Tristan Cooper, Moody's head analyst for Middle East Sovereigns. Published fiscal accounts indicate that the oil price necessary to balance the budget in Bahrain has risen in recent years from levels which Moody's estimates to be approximately $30 per barrel in 2004 to almost $80 per barrel in 2009 (for the benchmark Brent crude). This trend is largely due to upward pressure on current expenditure, which has restricted the government's room for maneuver. Although capital expenditure can be cut in some years to offset revenue shortfalls (as it was in 2009), Moody's notes that such reductions cannot usually be sustained without damaging growth prospects. “While acknowledging Bahrain's high level of GDP per capita and its good progress toward economic diversification, Moody's believes that the government's ability to generate revenues from the non-oil sector is hampered by its narrow tax base,” Cooper added. The government's ability to widen its tax net, which remains heavily dominated by oil receipts, is constrained by the absence of personal income tax and VAT. These would be difficult to introduce given the tax-free status of neighboring Gulf countries. Moody's also has some concerns about the performance of Bahrain's financial sector, which is large in relation to the government's resources. In August, Moody's reiterated its negative outlook on Bahrain's banking system, reflecting the ongoing weaknesses in the domestic and regional real-estate sectors, to which banks maintain significant exposure. Moody's has downgraded the ratings of a number of banks in Bahrain over the past two years. The rating agency recognizes that riskier wholesale banks present only a limited contingent liability for the government given the restrictions on their interaction with residents. However, the retail banking sector is also extensive, with assets worth approximately three times GDP. Bahrain's ratings are supported by the country's relatively robust economic strength, positive net international investment position and effective regulatory environment. Bahrain's strong international alliances are also credit positive, it said.
