IMF Executive Board Concludes 2016 Article IV Consultation with Bahrain
The decline in oil prices adversely affected Bahrain’s fiscal and external balances. GDP growth slowed to an estimated 3.2 per cent in 2015 from 4.5 percent in 2014. Fiscal and external buffers are limited and vulnerabilities rose. Consumer and investor sentiment weakened. Bank deposit growth slowed and excess liquidity fell. However, the banking sector remains well-capitalized and liquid.
In recent months, authorities have implemented significant fiscal adjustment measures, including reforms of energy prices. Gasoline prices have been raised by nearly 60 percent, while prices of diesel, kerosene, natural gas, and electricity and water tariffs are being adjusted gradually over the medium term. Tobacco and alcohol taxes have been increased.
In 2016 and 2017, growth is expected to slow further on account of the fiscal adjustment and weaker investor sentiment. Inflation is expected to rise modestly in 2016 with the increase in energy prices, and ease over the medium term with weak economic activity containing the pass-through to wages. Despite the implementation of fiscal measures, lower oil prices imply that the fiscal deficit is projected to reach 19.5 percent of GDP in 2016 and remain high over the medium term. The current account deficit is projected to reach over 8 percent of GDP in 2016 and narrow gradually. Financial outflows are expected to continue.
Executive Board Assessment2
Executive Directors noted that the large decline in oil prices since mid-2014 has adversely affected the economy. Growth has slowed and, notwithstanding the positive impact that could be expected from the recent uptick in oil prices, fiscal and external vulnerabilities have increased significantly. Directors welcomed the substantial fiscal measures the authorities have implemented, including on energy price reform, to safeguard macroeconomic stability. Nonetheless, additional efforts are needed to further reduce the fiscal deficit, while continued reforms to diversify the economy should strengthen the country’s growth prospects.
Directors agreed that additional sizable and frontloaded fiscal adjustment is needed to put debt on a downward trajectory over the medium term and rebuild fiscal space over time. They recommended measures to contain current expenditure, including the wage bill, while protecting capital spending; efforts to raise nonoil revenue, including adoption of a VAT; and further reductions in energy subsidies by replacing them with targeted transfers. Directors acknowledged that some measures could be politically challenging to implement, and underscored the need for strong communication to strengthen public awareness and support. Directors encouraged the authorities to enhance the fiscal framework to support consolidation, and recommended adoption of an annual budget within a medium-term framework. They also suggested formulating a fiscal contingency plan, as well as a strong debt management strategy.
Directors agreed that the exchange rate peg remains appropriate for Bahrain, noting that it has delivered monetary policy credibility and low inflation. Strong fiscal adjustment and structural reforms will be important to support the peg and stabilize international reserves by improving external balances and raising competitiveness.
Directors noted that Bahraini banks have strong liquidity and capital buffers. They commended the central bank’s efforts to strengthen the regulation and supervision of the financial sector to promote financial development and stability. Given the challenging economic environment, they encouraged the authorities to further enhance supervision, including for Islamic banks and cross-border activities, and have a contingency plan for liquidity support. Directors also recommended phasing in reforms to strengthen the macroprudential framework and toolkit to mitigate risks.
They stressed the importance of addressing data gaps for both banks and nonbanks.
Directors underscored the need to address impediments to private investment to achieve diversified and sustainable growth. They commended recent initiatives to improve the business climate, and called for additional measures to reduce the cost of doing business and equip national workers with skills for private sector employment. They also welcomed planned infrastructure investments, which will support long-term growth.