Bahrain Business Forecast Report Q1 2008

Positive Economic Outlook, But Employment An Issue Economic diversification is a major theme in Bahrain, as it is throughout the Middle East. However, the issue is more pressing in Bahrain, in light of its relatively small oil reserves and declining oil production. Diversification into new industries - with the emphasis on the services sector - is essential, not just to ensure economic growth, but also to provide new job opportunities. Meanwhile, Bahrain is enjoying rising inflows from abroad, thanks to large, petrodollar-funded portfolio investments.

New rules, raising the cost of work permits, have been put in place to encourage the employment of Bahraini nationals over foreign workers. The move is part of a government drive to reduce unemployment levels among Bahraini citizens and diffuse any social unrest. Foreign nationals dominate the local job market and unemployment has the potential to become a major political issue, not least because it disproportionately affects the Shi'a population, which largely supports the parliamentary opposition. However, given Bahrain's dependence on foreign labour, we believe that the increased fees could have an inflationary impact at a time when Bahrain is already experiencing rising inflation levels.

We are forecasting a slight decline in GDP growth to 5.4% in 2008, on the back of slowing oil production. However, moving forward, it is the non-oil sector that will be the key driver of the Bahraini economy, led by key sectors such as financial services, telecommunications and real estate. Bahrain is establishing itself as a regional banking hub, with the sector strengthened by several recent mergers, acquisitions and share offerings. We see this loosening of Bahrain's oil dependence as a positive step and one that should reduce the volatility of GDP growth during our forecast period; we anticipate steady growth of 4.5-5% per annum over the next five years.

We retain our positive view on Bahrain's business environment, with the Kingdom providing an attractive investment climate for international businesses. The government is receptive to foreign investment and indeed, Bahrain already enjoys high levels of foreign direct investment (FDI). A number of foreign banks have announced plans to establish operations in the Kingdom, aided by the lack of capital restrictions on non-Bahraini firms and the ongoing liberalisation of the insurance market. As the non-oil sector - which is driven primarily by private sector companies - grows in importance, so the government's influence over the economy is waning.