Increase in value added tax (VAT), commitment of financial support by the UAE, Saudi Arabia and Kuwait and a strong recovery in the economy backed by higher oil prices are expected to support Bahrain’s fiscal strength. Image Credit: Supplied

Dubai: Proposed increase in value added tax (VAT), commitment of financial support by the UAE, Saudi Arabia and Kuwait and a strong recovery in the economy backed by higher oil prices are expected to support Bahrain’s fiscal balancing programme (FBP) in the face of high government debts.

The authorities have approved an increase in the VAT rate from 5 per cent to 10 per cent, effective January 2022, to boost state revenue. Government debt, however, will remain above 100 per cent of GDP.

We expect a solid economic recovery. The surge in global; energy prices combined with gradual fiscal consolidation will narrow the twin [fiscal and current account] deficits.

- Garbis Iradian, Chief Economist Middle East North Africa (Mena) of the Institute of International Finance

GCC support

The ministers of finance of Saudi Arabia, Kuwait, and the UAE met with Bahrain’s finance minister on October 19 to discuss Bahrain’s progress in improving its finances.

Following the meeting the GCC neighbours reiterated their support for Bahrain’s plans to balance its budget, a move expected to help their neighbor.The three Gulf states extended a $10 billion aid package to Bahrain in 2018 to help it avoid a credit crunch.

Debt burden

The fiscal balance programme - a set of reforms aimed at balancing the budget - was linked to the pledged $10 billion.

Bahrain’s public debt climbed to 133 per cent of gross domestic product (GDP) last year from 102 per cent in 2019, according to the International Monetary Fund. S&P forecasts Bahrain’s budget deficit, which was 16.8 per cent of GDP last year, to average 5 per cent between 2021 and 2024, excluding the impact of a possible hike in value-added tax.

“Stronger fiscal consolidation is needed to put the debt on a firm downward path and reduce the need for central bank lending and support the pegged exchange rate. The financial system remains well capitalized and liquid. However, vulnerabilities related to non-performing loans, and low profitability may emerge,” said Iradian.

Credit strength

Rating agencies said the support from GCC neighbours and a commitment to increase VAT are right moves in fiscal reforms.

“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. According to rating agency Moody’s the additional VAT receipts will only partly address the significant challenge the government faces in reducing, its debt burden.

Getting Fiscal Balancing Programme back on track
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.

Last month Bahrain said that due to the coronavirus crisis last year, it had postponed the target year for a
balanced budget to 2024.

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.
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.