IMF Executive Board Concludes 2012 Article IV Consultation with BahrainPublic Information Notice (PIN) No. 12/39
April 24, 2012
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On March 28, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Bahrain.1
Disruptions caused by protest activity during the first half of 2011 have weighed on growth which is expected to reach about 2 percent for the year as a whole, brought down by weaknesses in the financial and tourism sectors. The macroeconomic impact of the unrest has been cushioned by the largely unaffected oil and aluminum sectors—the former contributing over 85 percent of fiscal and external receipts. Credit growth remains very slow. Inflation turned negative during 2011, largely due to falling real estate rents. Profitability of listed companies has recovered, but smaller banks and companies reported increasing NPLs on SME credits, and in early December, the Central Bank of Bahrain urged five of the smaller Islamic retail institutions to merge.
The impact on financial markets has been more limited, but capital outflows increased significantly resulting in a decline in official reserves. There was a modest shift into foreign currency deposits in March 2011, but this has now been reversed, and overall deposits at retail banks continue to rise. Currency forward premia show no signs of pressure on the exchange rate. Reserves have fallen since the start of the year, despite an improved current account, standing about $4.2 billion at end-2011—but still well above seven months of import cover. The slightly strengthened current account reflects higher oil receipts and subdued imports as economic activity slowed. The private sector has continued to build up assets overseas, with the overall net international investment position increasing to $19.6 billion in Q3 2011 (from $17.0 billion at end 2010).
The deepening crisis in the Euro Area has contributed to further deleveraging of the wholesale banking sector in Bahrain but broader economic impacts have been limited so far. Wholesale bank balance sheets declined by 15 percent through the first 11 months of 2011 implying a cumulative 37 percent decline from their peak in July 2008. The principal impact on the domestic economy has been the associated loss of employment in the financial sector, as contagion to the conventional retail banks appears to have been contained. The combination of downgrades by the credit ratings agencies during 2011Q1–Q2, increases in CDS spreads due to both local and global risks, and reduced term funding due to liquidity constraints in Europe have restricted the availability of project financing and reduced options for banks and corporates seeking to rollover maturing debt. Nevertheless market access was maintained, and a $750 million sovereign sukuk was issued in November at a yield of just over 6 percent.
The fiscal stance has been expansionary, with the break-even oil price reaching $114 a barrel in 2011—the highest level in the GCC—compared to just $80 in 2008. Expenditure commitments were increased permanently through wages and associated allowances—a 15 percent salary increase for all civil servants in August—and transfer increases as well as via one-off cash transfers. The impact on the 2011 budget has been offset by a sharp increase in oil revenues reflecting high global oil prices and a reduction in capital spending to a level commensurate with execution capacity, but still above historical norms.
Executive Board Assessment
Executive Directors noted that high oil prices along with fiscal and monetary easing has helped limit the impact of the crisis in the euro area and domestic unrest on economic activity. In light of the continued risks posed by the external and internal challenges, policies should be geared to restoring confidence in the economy, including by finding a lasting resolution to the social unrest, promoting growth, and securing a sustainable fiscal position.
Directors considered that the current accommodative stance of monetary policy is warranted. They agreed that the exchange rate peg to the U.S. dollar has played an important role in anchoring expectations, and continues to be appropriate in the run up to a GCC common currency.
Directors emphasized the importance of strengthening the fiscal framework to tackle rising imbalances and stabilize the debt-to-GDP ratio. They agreed that the 2013–14 budget offers the opportunity to lay the foundations for fiscal adjustment over the medium term. This could include the adoption of value-added and corporate income taxes, enhancing the efficiency of spending including through better targeted subsidies and transfers, and a reform of the pension system.
Directors took note of the resilience of Bahrain’s financial institutions. The deleveraging of wholesale banks has been orderly and retail banks have been able to absorb higher NPLs and have seen continued deposit growth. Given the complexity of the financial system, Directors encouraged the central bank to continue monitoring risks carefully and ensure the effectiveness of the regulatory framework, especially for cross-border issues.
Directors considered that further measures to diversify the economy, improve the investment climate, and strengthen the labor market are essential for sustained growth and employment. Better focused vocational programs and greater support for SMEs will help absorb the growing contingent of labor market entrants, as would further regional integration.
Directors welcomed the improvements in the coverage and quality of Bahrain’s statistics. Further efforts to improve the timeliness and periodicity of fiscal data will be consistent with the authorities’ intention to subscribe to the Fund’s Special Data Dissemination Standard.