Bahrain Business Forecast Report Q2 2008

Growth Diversifying But Oil Remains Key

Like many of its regional peers, Bahrain is enjoying the current oil price boom while at the same time trying to diversify its economy away from the hydrocarbons industry in anticipation of future price falls. The need is particularly pressing in Bahrain in light of its relatively small oil reserves, but its diversification efforts are also more advanced - non-oil sectors already account for more than 8 % of real GDP.

On the political front, we see little threat to the al-Khalifa family's rule, although ongoing unrest from several quarters does pose some threat to stability going forward. On one hand, Bahrain's Shi'a communities continue to protest against their lack of political representation and their perceived economic marginalisation. Although the ruling family, and Crown Prince Sheikh Salman bin Hamad al-Khalifa in particular, have argued for further economic reform in order to spread the fruits of Bahrain's growth, the government remains reluctant to allow greater Shi'a representation in the armed forces. At the same time, the Kingdom has witnessed a wave of protests by foreign labourers over pay and conditions; more specifically, the erosion of the real value of wages by inflation within Bahrain and the depreciation of the dinar against Asian currencies.

Despite this unrest, Bahrain's economic outlook looks fairly positive. With oil output expected to remain stable over the next few years, real GDP growth will be driven entirely by the non-oil sector, and by construction, banking and tourism in particular. However, that is not to say that oil will not remain a key driver of economic trends: taxes on oil production and foreign oil sales will continue to account for the bulk of government revenues, with high global energy prices making 2008 a bumper year for the budget surplus. High oil prices are also a major source of Bahrain's surging money supply, which is contributing to inflation. Consumer price inflation (CPI) reached 4.1% year-on-year (y-o-y) at the end of 2007, on the back of sharp house price rises and increased food prices. The government is attempting to limit the effect on consumers through food subsidies and an emergency grant package for low-income families, but we expect inflation to remain at 4.0% y-o-y by the end of 2008.

Inflation does pose some threat to Bahrain's business environment: combined with labour shortages and high global commodity prices, it is driving up costs in the construction sector, which could threaten some planned infrastructure projects. Nevertheless, the Kingdom remains an attractive place to do business, as illustrated by its success in building a regional financial services hub, particularly for the Islamic finance industry. Physical infrastructure is robust, corruption is less of a concern than in many Arab states and the creation of a Gulf Co-operation Council (GCC) common market should boost regional trade flows.