Executives should closely monitor the outlook for the Bahraini dinar in the coming months. The country’s foreign exchange reserves are under significant pressure, and the authorities need financial assistance from allies to maintain the dinar’s peg to the US dollar. While Bahrain isn’t a significant country in many multinational firms’ MENA portfolio, the developments around its currency have implications for the rest of the Gulf Cooperation Council (GCC) countries.
Pressure on Bahrain’s economy is increasing
With GDP just above US$30 billion, Bahrain has the smallest economy in the GCC. Oil rents make up only 2.6% of GDP (vs. 22.5% in Saudi Arabia) and the crude petroleum and gas industry overall makes up only 12.5% of GDP. However, the country has still suffered from the oil price collapse: Bahrain’s economy is highly reliant on visitors and investors from Saudi Arabia and other GCC countries, and the country needs financial support from the its wealthier Gulf allies to maintain its very strong currency and current account surplus.
Bahrain’s current account has turned from a surplus of 7.3% of GDP in 2013 to a deficit of 4.7% of GDP in 2016. As can be seen from the chart below, this has strained the country’s foreign exchange reserves, and the country has been receiving intermittent support from other GCC countries to prop up the reserves.
A breaking of the peg is low likelihood but has region-wide implications
Saudi Arabia and the UAE are likely to continue supporting Bahrain’s reserves, due its potential negative implications for the rest of the region. However, they’ve asked for tighter fiscal control in return. Its relatively less stable political dynamics have also prevented the Bahraini government from cutting expenditures as easily as the likes of Saudi Arabia. The government has registered deficits since 2009; however, the deficit dipped from 5% of GDP in 2014 to 17.7% of GDP in 2016.
Thus, the maintenance of the peg in Bahrain will entail cutting government expenditures further in 2018. The country had already planned to keep its 2018 budget tight, but further contractions in spending are possible. MNCs selling directly to the Bahraini government can expect less demand in 2018. However, the majority of infrastructure projects should continue as they are mostly funded by the GCC Development Fund.
Meanwhile, the low likelihood scenario where the Bahraini dinar is re-pegged at a weaker rate – or allowed to float – has implications for the other GCC countries. This will not necessarily cause other GCC pegs to break. However, it will increase risk premiums for other GCC currencies in international financial markets, intensifying depreciation pressure. This will increase the cost of maintaining pegs in the other countries, adding pressure on their foreign exchange reserves. If this scenario materializes, MNCs should:
- Prepare contingency plans for a similar scenario in Oman
- Manage corporate expectations and prevent falling confidence regarding Saudi Arabia and the UAE
- Prepare for weaker local business confidence in the next few months across the GCC
- Reduce expectations for an upside to government spending plans in Saudi Arabia and the UAE, and Kuwait, as they’ll have to maintain tighter budgets and limit pressure on reserves
- If the pressures on non-Bahraini currencies continue to increase in the following months, expect governments to implement some measures to limit imports to manage the rising pressure on reserves
For more detailed scenario analysis, signpost identification, and contingency planning, FSG clients can contact their client services director and access the client portal.