Sunday, June 23, 2013

Near term prospects for Bahrain goverment debt yields

Originally written on 20th May 2013

Bahrain faces a steep challenge relative to its other oil rich neighbors in the GCC over the medium terms in putting its fiscal health on a more sustainable path. In a nutshell concerns over Bahrain’s fiscal health have their provenance in two sources
1.  Generous state subsidies (including those on fuel, electricity, water, selected food items)
2. High dependence on Bahrain’s limited hydrocarbon production to support fiscal spending and generous subsidies

The political unrest which began in early 2011 and continues to this day-albeit having stabilized progressively-have put further pressure on state coffers to increase spending in order to both simulate a stagnant private sector, as well as, create employment on urgent basis. Secondly, subsidies tend to be sticky with steps to control / cutting back remaining highly unpopular with the constituencies, reform in that direction though urgently needed will be extremely challenging politically given the already stressed relationship between the government and a large majority of its countrymen.

Bahrain’s current break-even oil price at $115 is already above the market price and perhaps the highest among all oil exporters in the world.(breakeven price is the price of oil, keeping export volumes constant, would be required to fully fund budgeted state expenditure without resorting to borrowing or liquidation of past reserves). To me that would imply that the country will continue to run fiscal deficits persistently since my subjective judgment is for that expenditure on other hand will be extremely difficult to cut back and near term oil prices have probabilistically more downside risk rather than upside.

Given the small size of the economy and flagging private sector growth, a incrementally rising debt to GDP ratio will not be quite appeasing for both existing investors as well as prospective investors in Govt. of Bahrain paper. I consider the prospect for credit premium on Bahraini debt and CDS to increase over the next 2-3 year horizon from current levels than to decrease. Once the exigency to control ballooning government debt becomes a consensus opinion, a downward revision in Bahraini dinar-USD exchange rate (devaluation of the BHD) cannot be ruled out either.

On the positive side, Bahrain remain geo-politically important to contain Iran’s influence in the Arabian peninsula and has historically shared very strong relationship with regions big boy Saudi Arabia. A GCC bailout or soft financial assistance (as the current $10bn 10 assistance) is also a quite likely scenario in case of sudden distress. That would make investing in short term Bahrain government debt (after the yields have spiked in tune with new information) a attractive proposition in future if the country goes through a financial panic in coming years.

Key economic statistics of Bahrain

1.  GDP  2012 – 2.7% p.a.  (Historically, from 2000 until 2012, Bahrain GDP Annual Growth Rate averaged 4.61 Percent)

2.  Current account to GDP – 15.4%

3.  Government Debt to GDP – 31.6% (Historically, from 2000-2012, Bahrain Government Debt To GDP averaged 19.84 Percent)

4.  Yield on Bahrain (2020) government USD bond – 4.12% p.a. (USD 10yr T-Bond 1.95%)

5.  5 years CDS spread –c.2.05% p.a.


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