NBK ECONOMIC REPORT

Bahrain’s economic growth is set to hold steady in 2016, as a resilient non-oil economy helps weather some of the on-going weakness in the oil sector. We foresee growth in real GDP to hold at around 2.9 percent year-on-year (y/y) in 2016, before climbing to around 3.4 percent y/y in 2017 on stronger non-oil growth. Growth in real oil GDP is set to remain flat in 2016 and 2017 amid steady oil production levels. Real non-oil growth is expected to remain broadly stable at a relatively solid 3.6 percent y/y in 2016 before edging up towards 4 percent y/y on high levels of investment.

In the first quarter of 2016, real GDP growth recovered relative to 4Q15 and accelerated to 4.5 percent y/y. However, the acceleration was mostly attributed to a one-off jump in real oil GDP growth. Indeed, growth in real GDP slowed once again to 2.5 percent y/y in 2Q16, after real oil activity contracted by 1.7 percent y/y.

In contrast, growth in real non-oil activity climbed from 2.8 percent y/y to 3.6 percent y/y during the same period, helping shore up some of the weakness in oil activity. Non-oil GDP recorded its highest growth rate in a year in 2Q16, thanks to faster than expected utilization of GCC grants, which helped prop up investment. The GCC pledged $10 billion in investment over ten years which Bahrain has vowed to devote to infrastructure and housing developments.

Inflation in the consumer price index (CPI)rose for the most part of 1H16,after subsidy cuts in the food and housing components led the respective inflation rates higher(Chart 3). However, the initial impact of the subsidy cuts appears to have waned; CPI inflation peaked at 3.8 percent y/y in April and as of October, stood at 1.5 percent y/y on the back of a slowdown in inflation in the housing component and a decline in food prices.

Despite the ongoing ease in the overall inflation rate, we expect inflation to still edge up slightly and average around 2.5 percent in 2016,following the multi-month high readings recorded in 1H16.

Bahrain is forecast to see one of the largest budget deficits in the GCC region. With the breakeven oil price estimated at around $120 per barrel amid a weak oil price environment, the budget deficit is expected to expand to roughly 17 percent of GDP in 2016 before narrowing to around 14 percent of GDP in 2017.

Bahrain remains adamant about imposing fiscal reforms in line with the IMF’s recommendations to help shore up its public deficit. So far, it has agreed to cut government expenditures by 30 percent. Spending cuts have been concentrated on subsidies; public spending levels on infrastructure and development projects have remained broadly stable. In August 2015, the government lifted subsidies on meat products. In December 2015, the cabinet approved a new pricing system for diesel, kerosene and jet fuel to reduce subsidy costs and better reflect price increases in other GCC states. In 1H16, it approved the removal of subsidies on utilities.

However, engaging in further significant cuts in public spending remains a challenge, especially since the two politically sensitive areas of spending, namely subsidies and public wages, make up two-thirds of total government spending.

Given that the budget deficit is expected to remain high in spite of subsidy cuts, Bahrain will continue to turn to both domestic and international bond markets, to help finance its deficit. In 2015, Bahrain issued a total of $6 billion in bonds, $1.5 billion of which was in eurobonds. So far in 2016, the government of Bahrain has issued $3.4 billion in bonds, $2 billion of which was issued externally. Subsequently, the debt to GDP ratio is projected to remain at around a high of 60 percent of GDP in 2016.

Fiscal deficit and debt concerns have led to a bout of downgrades of the nation’s long-term credit rating. In June, Fitch, in line with the other two major rating agencies, downgraded Bahrain’s long-term credit rating to below investment grade status. The downgrades have no doubt made it more difficult for the government to negotiate better bond deals.

Banking sector

After remaining mostly steady in 2015, latest data reveal a slowdown in private sector claims growth (Chart 6). Growth slowed from 5.4 percent y/y in February to 3.3 percent y/y in March. We expect growth in this segment to have eased further in 2016 amid tighter liquidity conditions.

Total deposit growth has been weighed down by an ongoing decline in government deposits (Chart 7). Government deposits have continued to contract on lower oil revenues and high levels of government spending. According to the latest data, government deposits fell by 6.3 percent y/y in March. Growth in private sector deposits also remained weak during the same month, after it came in unchanged from February at 1.9 percent y/y.

Growth in the broad M2 money supply remains weak mainly on tepid growth in quasi-money supply. This, in turn, has continued to push interbank rates higher. In March2016, M2 money supply growth came in at a mere 2.0 percent y/y. Bahrain’s one-month and three-month interbank rates witnessed sharp increases in 2016. As of the end of November they were up 20 basis points (bps) and 27 bps year-to-date, respectively.

Bahrain stock market

In tandem with regional markets, the Bahrain All Share Indexhas been weighed down by depressed global oil prices. The weak oil price outlook continues to act as a damper on investor confidence and thereby market performance.