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Bahrain last week announced its plans to raise the VAT rate to 10 per cent, from 5 per cent from January 2022, which analysts believe is a right move in its fiscal reform efforts. Image Credit: Istockphoto

Dubai: Bahrain last week announced its plans to raise the VAT rate to 10 per cent, from 5 per cent from January 2022, which analysts believe is a right move in its fiscal reform efforts.

“A reboot of Bahrain’s Fiscal Balance Programme (FBP), including a rise in the VAT rate, could improve the trajectory of the country’s public finances,” said Fitch Ratings.

“We believe that progress with other fiscal measures would be necessary, in addition to the VAT increase, to bring the budget deficit to balance, based on our current oil price assumptions.”

Fitch estimate that such a VAT hike could raise an additional 1.5 per cent to 2 per cent of GDP in revenue.

Credit rating agency Moody’s said the VAT increase marks a renewal of the fiscal reform momentum that is a prerequisite for Bahrain to secure continued financial support from fellow Gulf Cooperation Council (GCC) neighbours.

According to Moody’s the additional VAT receipts will only partly address the significant challenge the government faces in reducing, its debt burden, which amounted to over 130 per cent of GDP (including central bank lending) at the end of 2020.

“Bahrain’s plans to double the value added tax to 10 per cent from 1 January 2022 are credit positive. Aside from adding up to another 1.8 per cent of GDP to government revenue, the implementation would mark a renewal of the fiscal reform momentum, which we see as the pre-requisite to the augmentation of the GCC financial support package that is about to run out in early 2023,” Said Alex Perjessy, VP-Senior Analyst at Moody’s

Elusive fiscal balance

Bahrain launched its Fiscal Balance Programme (FBP) at end-2018, targeting a balanced budget in 2022, a target Fitch now expect to be reached further out.

The initial FBP projected government debt/GDP without the FBP would rise to 106 per cent of GDP, but would decline to 82 per cent in 2022 with the reforms. It assumed an average oil price of $60/barrel (bbl). Initial steps at the start of 2019 included the introduction of VAT and a voluntary retirement scheme.

However, the Covid-19 pandemic blew the FBP off course, disrupting activity and pushing down oil prices.

Fitch expects general government debt/GDP to stand at around 125 per cent of GDP in 2021 (including borrowing from the central bank worth around 14 per cent of GDP that the government does not include in its own debt number). We project the debt ratio to rise further in 2022-2023.

The 2021-2022 budget included some reforms, such as reducing electricity and water subsidies and trimming operating expenses like administration and procurement costs. Spending in H1 2021 has been restrained, falling by 4 per cent year on year. The rebound in oil prices has meanwhile helped to lift budget revenue by 23 per cent year on year in H1 2021.

Fitch’s latest forecasts, which do not assume any VAT hike, see the budget deficit falling to 7.9 per cent of GDP in 2021, from 16.8 per cent in 2020.

“This implies government debt/GDP would continue to rise. We estimate that Bahrain’s fiscal break-even oil price remains over $90/bbl,” Fitch said.

GCC support

The original FBP paved the way for a commitment from Bahrain’s Gulf partners (Saudi Arabia, Kuwait and the UAE) to provide $10 billion in support loans over 2019-2023. Fitch believes a VAT increase would help to ensure ongoing support from the current financial package, while a broader reboot of the FBP would facilitate further Gulf GCC support beyond 2023.

Fitch believes that Bahrain, which faces a substantial amortisation schedule, will require further GCC support over the medium term, as external liquidity remains very tight and debt and debt-service metrics are weak.