Bahrain's downgrade by the credit agency Moody's yesterday served as a reminder for all Gulf states that the rampant spending of recent years can come at a price. At its most basic level, that could translate to higher borrowing costs for Bahrain as it boosts its infrastructure and broadens its international investment portfolio.
However, that may not necessarily deter investors from future debt issuances, analysts say. "Dar al Arkan came to market at a difficult time with a rare sub-investment grade [rated] sukuk," said Khalid Howladar, a vice president at Moody's, referring to a recent bond sale by a Saudi property developer. "They paid a high coupon but it's not the rating that decides whether it's successful. In theory a lower rating just means the borrower has to pay a little more but as an investor - as long as you reward me for risk - I'm willing to take it."
Moody's Investors Service lowered Bahrain's ratings to "A3" from "A2" yesterday, citing concerns about rising government spending and a relatively small cushion of oil savings to tide it over through deficits. But economists said yesterday the country remained on a relatively strong fiscal footing. The downgrade, they said, was a means of drawing distinctions between Bahrain and its more oil-rich neighbours.
"The fiscal situation is not something that's alarming," Giyas Gokkent, the chief economist of the National Bank of Abu Dhabi, told Bloomberg, citing low public debt as a portion of GDP. Bahrain's government debt amounts to about 30 per cent of its GDP. Those low debt levels, though, come at a time when Bahrain continues to spend on major development projects even without a large backstop of oil savings.
That, Moody's said, distinguished the country from its neighbours. While Saudi Arabia, Kuwait and Abu Dhabi are all pursuing ambitious development and spending plans of their own in spite of the financial crisis, they hold hundreds of billions of dollars of oil savings and sit on some of the world's largest oil reserves. Bahrain, by contrast, has neither large oil reserves or a big pool of savings to draw on in case of government budget deficits.
The country's largest sovereign wealth fund is the Mumtalakat Holding Company, which controlled about US$12.7 billion (Dh46.64bn) of assets at the end of last year, according to its financial statements. To bring its rating back up, Bahrain may have to rethink how it spends, saves and budgets. Yet Moody's said yesterday there was little room for the country to raise revenues to substitute for the relative dearth of oil savings.
The country's ability to raise revenues was "constrained by the absence of personal income tax and [value-added tax]". Such taxes would be hard to introduce because Bahrain is competing for business with Gulf countries that do not levy them, Moody's said. The agency also pointed to concerns about Bahrain's banking system, a key fixture of the island country's economy that has come under significant stress because of banks' exposure to property projects.
Foreign investors fled the property sector across the Gulf during the financial crisis, leading to sharp declines in prices. Several Bahraini investment companies have also fallen on hard times, including Gulf Finance House, the Islamic investment bank that recently announced its seventh straight quarterly loss and is in the middle of a wholesale restructuring of its business. "Moody's believes that, over the longer term, Bahrain's banking sector will increasingly face competition as other regional financial centres develop," the agency said, adding that although banks were "only a limited contingent liability for the government", they had assets worth about three times the country's GDP.