November 10, 2017 / 10:53 AM / a year ago

Correction: Fitch Revises Bahrain's Outlook to Negative; Affirms IDR 'BB+'

(The following statement was released by the rating agency) HONG KONG, November 10 (Fitch) This announcement supersedes the rating action commentary published on 12 June 2017 by replacing the reference to Fitch's Supranational Rating Criteria, which were not used by the rating committee, with the Sovereign Rating Criteria dated 18 July 2016. The remaining contents of this announcement remain unchanged. Fitch Ratings has revised Bahrain's Outlook to Negative from Stable and affirmed the sovereign's Long Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at 'BB+'. The issue ratings on Bahrain's senior unsecured foreign and local currency long-term bonds have been affirmed at 'BB+'. The ratings on the sukuk trust certificates issued by CBB International Sukuk Company 5 have also been affirmed at 'BB+'. The Country Ceiling has been affirmed at 'BBB+' and the Short-Term Foreign- and Local-Currency IDRs at 'B'. The issue ratings on Bahrain's senior unsecured local-currency short-term bonds have been affirmed at 'B'. KEY RATING DRIVERS Bahrain's ratings are supported by high GDP per capita and human development indicators relative even to the 'BBB' median, a developed financial sector and the boost to external financing flexibility from strong GCC support. The strengths are balanced by double-digit fiscal deficits, high and rising debt, a highly oil-dependent government budget and domestic political tensions that hamper fiscal adjustment. The revision of the Outlook to Negative reflects the following key rating drivers: Beyond various near-term measures to rein in the fiscal deficit, the government has yet to identify a clear medium-term strategy to tackle high deficits and a rapidly growing government debt ratio. The lack of a medium-term fiscal framework, combined with the absence of the two-year budget for 2017 and 2018 six months into the budget period, creates increasing uncertainty around the outlook for debt and deficits. The government deficit widened to 16.2% of GDP in 2016 from 15.4% in 2015, with subsidy reforms not fully offsetting a decline in oil revenue, and interest costs undermining savings elsewhere on expenditure. Although Fitch expects the deficit to narrow to 10.2% of GDP by 2018, this will be insufficient to stabilise the debt trajectory. Under Fitch's baseline assumptions, which include a moderate rise in oil prices and implementation of fiscal measures already identified, debt will continue to rise, hitting 100% of GDP in 2026 (from 74% of GDP in 2016). Fitch's deficit numbers include estimated extra budgetary spending of 2.6% of GDP. In Fitch's view, the slow progress towards the new budget and a medium-term fiscal strategy reflects the difficulty of building consensus over the next wave of fiscal consolidation measures. Reining in the deficit further could call for deeper reforms to Bahrain's social and economic model, traditionally characterised by low taxation and generous benefits. In Fitch's view, the country's leadership is generally committed to reform, but this commitment is not yet shared by other stakeholders, and the government remains wary of social pressures. Bahrain's 'BB+' rating also reflects the following key rating drivers: Fitch expects hydrocarbon revenue to rise by around 28% and non-hydrocarbon revenue to rise by about 16% in 2017. Gradual increases in administered gas and fuel prices partly offset the negative effect of weak oil prices on hydrocarbon revenue in 2016 and will augment revenue increase this year. The government has already introduced higher fees for various government services and a fee on certain commodities ahead of GCC-wide implementation of an excise tax. The government is working to introduce a VAT in 2018 in line with agreement among GCC states, which could provide a fiscal boost in the region of 2% of GDP, according to IMF estimates. Fitch assumes that this implementation will be delayed from early 2018 into 2H18, given the magnitude of the technical challenges involved. Spending was flat in 2016, and Fitch expects it to grow at well below GDP growth in 2017-2018. Subsidy expenditure fell almost 8% in 2016 and a schedule of gradual increases to water and electricity tariffs holds out the promise of a further 4-5% decline per year in the subsidy bill in 2017 and 2018. Capital spending also fell by around 7% and will shrink further as the government's project pipeline is increasingly financed through the GCC Development Fund. The government's nominal wage bill was roughly constant in 2016, with significant government efforts to contain benefits and allowances to its employees offsetting the effect of a 1.5%-3% increase to base salaries. Fitch expects real GDP growth of 2.4% per year in 2017-2018. This reflects constant hydrocarbon volumes (after a slight fall in 2016) and a moderation of non-hydrocarbon growth to 3% from an estimated 3.7% in 2016. Spending on projects financed by the USD7.5 billion (20% of GDP) GCC Development Fund provides the most significant support to growth amid government retrenchment. Some USD3.1 billion of projects had been awarded to contractors at end-2016, up from USD1.1 billion at end-2015. Growth is also supported by state-owned enterprise projects (in oil, gas, and aluminium) and strong GCC demand for Bahrain real estate. Growth of credit to the private sector slowed to an estimated 2.5% in 2016 after 8.8% in 2015. Banks would be well-placed to extend more credit to the economy, given their sound profitability, high capitalisation and liquidity, and low non-performing loan levels. However, deposit growth has slowed and the high yields on government debt make some private sector lending unattractive. As a result, Fitch expects growth of credit to the private sector to stay muted at 2%-3% per year. The GCC Development Fund reflects the broader support that Bahrain enjoys from some GCC countries, particularly Saudi Arabia and Kuwait. This support is rooted in deep historical, cultural and familial ties as well as regional rivalries. Bahrain gets most of its oil from the Abu Sa'afa field shared with Saudi Arabia (it is entitled to 50% of production, but has sometimes received significantly more as a form of support). In Fitch's view, further material support from the GCC would be forthcoming in case of extreme political, financial, or fiscal instability, given Bahrain's small size and strategic importance. The expectation of such support has supported Bahrain's market access and US dollar peg despite low foreign exchange reserves, which had fallen to an estimated 1.2 months of current external payments at end-2016. Fitch expects Bahrain's recent severing of ties with Qatar to have a limited direct dampening effect on growth. Qataris make up slightly more than 1% of inbound arrivals to Bahrain, but loss of flights from Doha and heightened risk perceptions could deter some non-GCC visitors (currently more than a third of the total). Qatar had not been contributing to the GCC Development Fund, but some private real estate investment will likely be forgone. The ban on flights by Qatar Airways could provide an opportunity for state-owned Gulf Air to seize market share on regional routes and reduce reliance on government subsidies. Tensions continue between the government and the predominantly Shia opposition, resulting in sporadic and isolated incidents of violence and clashes with security forces. Courts have now banned the two main opposition groups, which boycotted the previous election and were charged with fomenting violence and terrorism. Fitch's baseline assumption is that Bahrain's security forces will continue to prevent the sort of escalation of domestic tensions that would materially affect economic growth. However, Fitch believes that the government's recently more hard-line stance increases the risk of instability, notwithstanding a tight security environment and strong regional support. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Bahrain a score equivalent to a rating of 'BB+' on the Long-Term Foreign Currency IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign Currency IDR by applying its QO, relative to rated peers, as follows: - External Finances: +1 notch, to reflect the boost to external financing flexibility from strong GCC support; - Public Finances: -1 notch, to reflect a rising debt trajectory and the rigidity of government revenue and expenditure. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year-centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The main factors that could lead to negative rating action are: - Failure to shrink the fiscal deficit and set out a clear path towards stabilising the government debt-to-GDP ratio; - Severe deterioration of the domestic security environment. The main factors that could lead to positive rating action are: - A narrowing of the budget deficit consistent with a decline of the government debt-to-GDP ratio in the medium term; - A broadly accepted political solution to domestic political tensions. KEY ASSUMPTIONS Fitch assumes that Brent crude will average USD52.5/bbl in 2017 and USD55/bbl in 2018. Fitch assumes no change to the rule of the royal family. Fitch assumes that regional conflicts will not directly impact Bahrain or its ability to trade. Fitch assumes no change to the peg of the Bahraini dinar to the US dollar. Contact: Primary Analyst Krisjanis Krustins Associate Director +852 2263 9831 Fitch (Hong Kong) Limited 19/f Man Yee Building 68 Des Voeux Road Central Hong Kong Secondary Analyst Toby Iles Director +852 2263 9832 Committee Chairperson Stephen Schwartz Senior Director +852 2263 9938 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email:; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: Additional information is available on Applicable Criteria Country Ceilings - Effective from 16 August 2016 to 21 July 2017 (pub. 16 Aug 2016) here Criteria for Rating Sukuk - Effective from 16 August 2016 to 14 August 2017 (pub. 16 Aug 2016) here Sovereign Rating Criteria - Effective from 18 July 2016 to 21 July 2017 (pub. 18 Jul 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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