Country Report (sample)

OVERVIEW

The Economist Intelligence Unit expects tensions between the ruling Sunni minority and the less affluent elements of Bahraini society, mostly made up of the Shia majority, to continue in 2005-06. The opposition coalition that boycotted the 2002 parliamentary election, the first in three decades, seems determined to pursue its demand that the king, Hamad bin Isa al-Khalifa, repeal constitutional changes that give the appointed Consultative Council voting rights equal to those of the elected Chamber of Deputies. The coalition argues that the present parliamentary arrangement in effect gives the king a built-in majority. The king may be prepared to make some concessions, but he is unlikely to back down on this core issue. The outcome of the current impasse is therefore difficult to call, as considerable flexibility will be required to ensure the survival of the political process. The government will continue to push to diversify the economy away from its dependence on oil.

Key changes from last month

Political outlook

Our political outlook is unchanged.

Economic policy outlook

A further upward revision to our oil price forecast has improved the outlook for Bahrain's fiscal account. The fiscal surplus is expected to rise to 8.6% of GDP in 2005, before contracting to 7% of GDP in 2006.

Economic forecast

The outlook for the current account has improved following an upward revision to our oil price forecast. In 2005 the current-account surplus is projected to widen, to the equivalent of 10.3% of GDP. In 2006 the surplus will narrow to 9.3% of GDP.

Outlook for 2005-06

The Economist Intelligence Unit expects tensions between the ruling Sunni minority and the less affluent elements of Bahraini society, mostly made up of the Shia majority, to continue in 2005-06. The opposition coalition that boycotted the 2002 parliamentary election, the first in three decades, seems determined to pursue its demand that the king, Hamad bin Isa al-Khalifa, repeal constitutional changes that give the appointed Consultative Council in the parliament voting rights equal to those of the elected Chamber of Deputies. The coalition argues that the present parliamentary arrangement in effect gives the king a built-in majority. The king may be prepared to make some concessions, but he is unlikely to back down on this core issue. The outcome of the current impasse is therefore difficult to call, as considerable flexibility will be required to ensure the survival of the political process. The government will continue to push to diversify the economy away from its dependence on oil.

The political scene

The king has ratified a new law controlling the activities of political societies, which took to the streets in protest. The law has caused internal differences within the opposition, however. The government also took other measures to restrict political activity, such as banning the use of religious establishments for political purposes, closing down a political association and censuring an opposition seminar held in London.

Economic policy

Parliament has finally approved the 2005-06 budget, forcing an upward revision to both revenue and expenditure assumptions. Outturn figures for the 2004 fiscal year (calendar year) have been released and show a significant discrepancy from the budget assumptions for that period. The Labour ministry has announced proposals for unemployment benefit, and the government has established a minimum wage for public-sector workers.

The domestic economy

GDP growth fell in 2004, although growth in the financial services sector shows a degree of success in economic diversification. Interest rates were raised, resulting in slower money supply growth. Aluminium Bahrain announced plans for a sixth potline and the cabinet approved the proposal for an industrial zone at Hidd. Offshore banking assets rose to record highs.

Foreign trade and payments

Parliament approved an free-trade agreement with the US, and trade with Japan reached new highs. Stocks of foreign reserves also registered record highs.

Official name

Kingdom of Bahrain (known as the State of Bahrain until February 14th 2002)

Form of state

Constitutional monarchy

Legal system

Based on a newly amended constitution published in 2002. The previous constitution was drawn up in 1973

Legislature

Bahrain has a bicameral legislature, the National Assembly (al-Majlis al-Watani), consisting of 40 elected members who sit in the Chamber of Deputies, and a Consultative Council of the same size appointed by the king; the first legislative session was held in December 2002; an unelected 30-member body, the Shura (Consultative) Council, which had no legislative powers, was formed in 1992 and dissolved in 2002

National elections

Municipal, May 2002; legislative, October 2002. Next legislative elections in October 2006

Head of state

Hamad bin Isa al-Khalifa succeeded to the throne in March 1999 following the death of Sheikh Isa, Bahrain’s ruler since 1961; he changed his constitutional status to king from emir in February 2002; Salman bin Hamad al-Khalifa, King Hamad’s son, is the crown prince

Executive

Cabinet, headed by the prime minister, appointed by the king (most recent reshuffle, January 2005)

Main political parties

Political parties are not permitted, but political societies have been sanctioned formally since late 2001

The government

Prime minister: Khalifa bin Salman al-Khalifa

Key ministers

Deputy prime minister & Islamic affairs: Abdullah bin Khaled al-Khalifa

Deputy prime minister & foreign affairs: Mohammed bin Mubarak al-Khalifa

Communications: Ali bin Khalifa bin Salman al-Khalifa

Defence: Khalifa bin Ahmed al-Khalifa

Education: Majid bin Ali al-Nuaimi

Electricity & water: Abdullah bin Salman al-Khalifa

Finance: Ahmed bin Mohammed al-Khalifa

Health: Nada Hafadh

Information & minister of state for foreign affairs: Mohammed Abdel Ghaffar Abdullah

Industry & commerce: Hassan bin Abdullah Fakhro

Interior: Rashid bin Abdullah bin Ahmed al-Khalifa

Justice: Mohammed al-Sitri

Labour: Majid bin Mohsen al-Alawi

Municipalities & agriculture: Ali Saleh al-Saleh

Oil: Isa bin Ali al-Khalifa

Public works & housing: Fahmi Ali al-Jowder

Prime minister’s court: Khalid bin Abdullah al-Khalifa

Social affairs: Fatima Mohammed al-Beloushi

Minister of state for cabinet affairs: Abdel-Hussain bin Ali Mirza

Minister of state for Shura Council & Chamber of Deputies affairs: Abdel-Aziz Mohammed al-Fadil

Head of the Royal Court

Ali bin Isa bin Salman al-Khalifa

Central bank governor

Rashid al-Maraj

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Long-standing tensions between the ruling Sunni minority and the less wealthy elements of Bahraini society, mostly made up of the majority Shia population, will persist throughout the forecast period. The October 2002 parliamentary election, Bahrain’s first in three decades, failed to achieve the difficult task of eliciting widespread endorsement of a political system that, despite some liberalisation, is still dominated by the ruling Al Khalifa family. The Economist Intelligence Unit does not expect a return to the levels of civil unrest witnessed in the mid-1990s, although political tension appears to be rising (recently there have been public demonstrations over perceived inequities in the constitution), and sporadic incidents of violence stemming from such protests could occur. Furthermore, the newly enacted Political Societies Law may cause splits in the opposition, which, while weakening it, may also radicalise it. Given that the next legislative elections are scheduled for October 2006, the coming year is likely see increased activism, particularly if relations between the government and opposition activists remain deadlocked.

The coalition of opposition groups that boycotted the 2002 election, by far the largest of which is the main Shia association, the al-Wefaq National Islamic Society, has followed through on its promise to stimulate extra-parliamentary debate on matters of concern to its would-be constituents, an approach that has met with some success. However, the coalition has made little ground on its main demand: that the king, Hamad bin Isa al-Khalifa, repeal constitutional amendments made in February 2002, specifically his decision to give the Consultative Council of the new National Assembly (parliament) legislative powers equal to those of the Chamber of Deputies, the elected house. The opposition argues that, since the king appoints the Consultative Council, he has in effect a built-in majority. Indeed, although the Chamber of Deputies has begun to scrutinise government policy more closely, it is unlikely to present any serious challenge to the overall direction of the government’s agenda, particularly since the elected house is more sympathetic to the ruling elite than would have been the case in the absence of a boycott.

The king would probably be prepared to make some concessions to guarantee the participation of the opposition coalition in the next parliamentary poll in 2006, but he is highly unlikely to meet its core demand that the elected chamber be given pre-eminence in the legislature, as such a move would threaten the dominance of the ruling family. Considerable flexibility and political imagination will therefore be required to overcome the current impasse. Should this be lacking, there is a risk that differences between opposition activists and the more conservative elements of the monarchy could provide the spark for wider unrest.

A separate potential threat to domestic stability comes from attacks by militant Islamists. The bombing in Doha, the Qatari capital, in March and the accompanying al-Qaida statement, which urged its followers to attack “crusaders” in Qatar, Bahrain, the UAE and Oman, suggest that Bahrain remains a potential target.

Bahrain’s foreign policy has been dominated by the need to maintain strong relations with the region’s larger and wealthier powers, namely Kuwait, the UAE and Saudi Arabia, who are its main financial backers. However, Bahrain’s increasingly close ties with the US appear to have begun to irritate Saudi Arabia, the pre-eminent power in the region and the dominant force within the Gulf Co-operation Council (GCC). Bahrain has long hosted the US Fifth Fleet, but the US sought to strengthen military ties in October 2001 when it designated Bahrain a “major non-NATO ally”. Ties have also been strengthened in the economic sphere, with the rapid conclusion in 2004 of a bilateral free-trade agreement, recently ratified by the Bahraini parliament and due to be signed into law in the US imminently. Saudi Arabia has objected to the accord, arguing that it contravenes Bahrain’s commitments under GCC trade agreements, and Saudi disapproval may have contributed to an apparent decision by Riyadh to reduce its financial support for Bahrain in the form of crude oil transfers. However, the considerable political capital to be gained by maintaining strategic relations with the US makes it unlikely that Bahrain will back down on the US accord at this late stage. This presents an outside risk of relations with Saudi Arabia deteriorating further, although with the Saudi administration having already exhausted much of its economic leverage over Bahrain and given Saudi Arabia’s ultimate interest in maintaining stability in the island kingdom, the threat of any additional economic measures being deployed is limited.

Bahrain’s economic outlook appears less robust after Saudi Arabia’s recent decision to reduce the oil-related support it offers the island kingdom, although high oil prices will mask the impact in the short term. Transfers of crude oil from Saudi Arabia to Bahrain fell by about 50,000 barrels/day (b/d) in the third quarter of 2004, and in the absence of any indication otherwise it would appear that this additional source of support has dried up. The transfer does not appear to have shown up in Bahraini current-account data, and will therefore have no impact on our current-account forecasts. (It is presumably captured in capital-account data, although it is not obvious where.) The reduction (amounting to more than 20% of oil receipts, local output included) would have had a more significant impact on Bahrain’s fiscal position had oil prices not remained so high, and is therefore not expected to restrain government consumption significantly over the forecast period. Besides this, Bahrain has not received any additional revenue from the doubling of capacity, to 300,000 b/d, at the Abu Saafa oilfield, which it shares with Saudi Arabia but which is administered by the Saudi oil monopoly, Aramco. (Since the mid-1990s Bahrain had received all of the revenue from the field.) It is over a year since the expansion at Abu Saafa came on stream and it is fairly safe to assume that Bahrain cannot expect any increases in oil transfers from Saudi Arabia in the near future.

Whatever the outcome, Bahrain will remain vulnerable to the volatile global oil market. The government recognises that Bahrain’s continued prosperity rests on its ability to diversify its economy and provide a welcoming environment for foreign investment, particularly in light of the dynamic approach to attracting service industries adopted by Dubai, Bahrain’s main competitor. In order to achieve this, the government has begun to look to private-sector investment, as exemplified by ongoing preparations to liberalise the electricity sector.

Bahrainisation—the policy of replacing foreign workers with local ones—has failed to stem the growth in unemployment, the main economic and social policy problem. Consequently, the government is contemplating radical changes to labour laws to stimulate the employment of locals, including the levying of fees on employers who hire foreign workers.

The king’s drive to improve living standards among the Shia population—reinforced by political tensions between the extra-parliamentary opposition and the regime—will ensure spending continues to expand relatively robustly. In line with the upward revision to our oil price forecast, we have raised our projection for oil revenue growth, which, combined with additional income from expansion in other sectors—notably the extension of the state-owned Aluminium Bahrain (Alba) and the port development at Hidd—will exceed the rise in spending. As a result, we now expect Bahrain to register a fiscal surplus of BD403m (US$1,072m), or 8.6% of GDP, in 2005. In 2006 revenue will continue to expand, despite the projected fall in the average annual price of the benchmark dated Brent Blend. Growth in spending will accelerate in the run-up to parliamentary elections. As a result, the fiscal surplus will narrow to BD349m, or 7% of GDP.

The Bahrain Monetary Agency (BMA, the central bank) will maintain the Bahraini dinar’s peg to the US dollar. The peg requires Bahraini interest rates to track those in the US, albeit with a positive differential. Although we expect US three-month interest rates to rise to an average of 3.5% in 2005, up from 1.5% in 2004, they will remain well below the ten-year average. Domestic monetary conditions will therefore remain stimulatory. In 2006 US rates are projected to increase again, causing monetary conditions in Bahrain to tighten once more. However, at an average of 4.8%, US rates—and therefore Bahraini rates—will remain well below the trend level of the 1990s.

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After several years of strong expansion, the global economy is likely to be characterised by a gradual deceleration in output and demand growth over the forecast period. However a pick-up in demand growth in two major economies—the US and Japan—in the second quarter has led to an upward revision to our outlook for world GDP growth in 2005, which (on a purchasing power parity basis) is now projected to reach 4.3%. However, this is still a more modest pace of economic expansion than that recorded in recent years and this gradual deceleration is expected to continue into 2006, with world GDP growth projected to slow further, to 4.1%.

Despite the slowdown in global growth, energy demand remains strong, forcing a further upward revision to our oil price forecast in 2005-06. Brent Blend is now projected to average a record US$55.5/barrel in 2005, declining to US$53.5/b in 2006. The average of US$54/b over the two-year period is more than US$29/b higher than the average over the previous ten years. The sustained high prices are a result of strengthening global demand and concerns over supply as sociopolitical and security concerns in key oil-producing regions persist.

The government will attempt to alleviate concerns over social stability through increased public expenditure, a move facilitated by sustained high oil prices. Economic growth will be further boosted by an expansion to Alba, the country’s largest industrial concern, which will raise domestic production and lift exports. Growth will be underpinned by continued high levels of construction activity, as work on large-scale projects such as the Bahrain Financial Harbour (BFH) continues. The government is also expected to press ahead with the liberalisation of utilities, which should promote more rapid inflows of foreign investment—in mid-2004 the authorities awarded the contract for the establishment of Bahrain’s first independent power project, a facility that is due to come on stream by mid-2006; a US$1.3bn integrated petrochemicals, power and water complex is also planned by Kuwait Finance House. Consequently, real GDP growth is forecast to rise to 5.9% in 2005, up from 5.3% in 2004.

A rise in interest rates will curb borrowing for investment and private consumption in 2006. However, this will be offset by an increase in government spending in the run-up to parliamentary elections due late in the year. Investment and consumption will once more be underpinned by the development of large-scale projects such as the BFH and the major upgrade and expansion of the refinery of the state-owned Bahrain Petroleum Company—both of which are due to come on stream in 2007. Services exports will be supported as a major port development at Hidd opens. Overall, real GDP growth is expected to ease marginally but remain strong at 5.6%.

We estimate that inflation accelerated to 4.9% in 2004, as a strong rise in government spending stimulated domestic demand. The weakening of the average exchange rate of the US dollar against the euro will also have brought some inflationary pressure, as the Bahraini dinar’s peg to the US dollar will have raised the cost of imports from Europe. However, helped by the recent strengthening of the US dollar, inflation is expected to fall to an average of 2.1% in 2005. A further relatively strong expansion of domestic demand and a retreat in the value of the US dollar against the euro in 2006 will be offset by the continued decline in average prices for international non-oil commodities. Inflation will ease to 1.9%, helped by a rise in interest rates.

The BMA will maintain the Bahraini dinar’s peg to the US dollar, in place since 1981, at the rate of BD0.376:US$1. At the end of 2004 foreign reserves stood at US$1.9bn. Although providing only 3.3 months of import cover, reserves are largely in line with historical levels. It is highly likely that Bahrain would be able to rely on support from its wealthier neighbours in the event of a crisis.

Oil receipts are projected to rise in 2005, in line with a further upward revision to our oil price forecast. Non-oil exports will al