Israel's New Ally, Bahrain, Is Desperate for an Economic Reboot

The island's oil-dependent economy, balanced on a sectarian tightrope, has been overwhelmed by COVID-19, but Israeli fintech could provide relief

Israel Fisher
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General view of Bahrain's financial district in Manama, Bahrain, June 20, 2019.
General view of Bahrain's financial district in Manama, Bahrain, June 20, 2019.Credit: Hamad I Mohammed/Reuters

Almost one year ago, Bahrain’s Finance Ministry was full of optimism. Finance Minister Sheikh Salman bin Khalifa Al Khalifa announced that the country was meeting its goal for reducing the fiscal deficit and that its budget would be in balance by 2022.

“We’ve had very good execution so far,” Sheikh Salman told Reuters, when asked if Bahrain would meet its target. “We’ve been very disciplined with regards to executing the fiscal balance plan and ensuring that we’re executing with regards to the targets.”

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But the joy was short-lived: Within a few months, the coronavirus was ripping truth the economy, making mincemeat of all the treasury’s efforts.

Like the other countries of the Persian Gulf, the tiny island nation relies on oil and gas revenues, and the collapse of prices starting in 2014 has left it reeling. In 2007, just before the global economic crisis erupted, Bahrain’s economy had grown more than 8%. It’s never succeeded in repeating that feat. In 2018, gross domestic product expanded 2% and in 2019 by just 1.9%.

Two years ago, Bahrain unveiled a wide-ranging economic program to reduce its swelling debt, which had by then reached 93% of GDP. In June 2019, when it looked like the country might not be able to repay its debt, it was forced to turn to its wealthier neighbors – the United Arab Emirates, Saudi Arabia and Kuwait – for $10 billion in aid.

But Bahrain isn’t as free to impose austerity policies as many other countries because its Sunni Muslim rulers risk angering its majority-Shi’ite population, which has been a source of political instability since the days of the Arab Spring in 2011.

Bahrain is contending with several fundamental problems. The first is its failure since the drop in energy prices to find a substitute engine for economic growth as the UAE and Saudi Arabia have done to one degree or another. Bahrain doesn’t have a lot of time: Its oil and gas reserves are dissipating quickly and will run out entirely within 10 to 15 years.

To help balance its budget, Bahrain imposed a 5% value-added tax and cut subsidies on water and electricity. But to make itself more attractive to overseas investors, the government refused to raise the personal or corporate income tax rate. The economic program also sought to encourage tourism.

Then came COVID-19, and that upset everything. The authorities are struggling to contain the pandemic, and the number of confirmed cases per capita in the country of 1.5 million people rose nearly to the high level of neighboring Qatar. It undertook massive the coronavirus testing, causing public spending to balloon at a time when the government was desperate to cut it.

According to figures released in August by the Finance and National Economy Ministry, state revenue plunged 29% in the first half of the year to 910 million dinars ($2.4 billion). Oil revenue fell 35%, and a deathly silence fell over the tourism industry. The budget deficit swelled to 797 million dinars, nearly double the level of a year earlier.

A day after the figures were released, the international credit rating agency Fitch lowered Bahrain’s rating to B+ from BB-, citing the combined impact of lower oil prices and the coronavirus pandemic. The government had succeeded in bringing down its deficit to just 4.6% of GDP in 2019, but Fitch forecast it would rise to 15.5% in 2020.

Another rating agency, Moody’s, estimated that public debt had already reached 100% of GDP and that Bahrain was spending one-fifth of its GDP on interest payments alone. Standard & Poor’s said it expected the economy to contract by 5% this year and then stage only a modest, 3.5%, recovery in 2021, assuming the coronavirus is contained.

Because of the tense political situation, Bahrain’s rulers can’t allow a prolonged period of economic distress like that. Its been trying hard these days to market itself as a destination for tourism and foreign corporate offices. It’s gotten some help from AIRINC, a global human resources consultant, that ranked Manama, the country’s capital, number 1 in the world in its Financial Attractiveness Index, which measures prevailing pay relative to taxes and cost of living (Tel Aviv ranked 81st). However, in terms of quality of life and social assets, it ranked only 68th (versus Tel Aviv’s 66th).

To lure foreign companies, Bahrain offers a 0% corporate tax rate and, in contrast to the other countries in the region, allows them to hold 100% of corporations established there. Bahrain this year rose to 43rd place in the World Bank’s Doing Business rankings, up 19 notches from 2019 thanks to reforms it undertook, most notably in banking and digital services.

Late in the game relative to other Gulf nations, Bahrain is trying to reinvent itself by, among other things, branding itself as a regional financial technology capital. Indeed, the joint statement issued Friday by the United States, Bahrain and Israel expressed hope that “opening direct dialogue and ties between these two dynamic societies and advanced economies will continue the positive transformation of the Middle East.”

The country’s aggressive move into the financial technology space could serve as an opportunity for Israeli companies, after Israel and Bahrain announced the normalization of ties Friday, although it will face stiff competition for Israeli tech’s attention from the UAE.

Last year, Bahrain established a hub for financial technology companies called FinTech Bay, which provides office space and holds events featuring industry leaders. FinTech Bay’s CEO, Khalid Saad, told Reuters that the initiative would be a “great contributor” to Bahrain, but said it was too early to quantify that contribution.

Nevertheless, Manama is not yet a challenge to Tel Aviv in the financial technology arena. Today it ranks a very low 153rd among world financial technology research and development centers, compared with 18th for Tel Aviv this year (after finishing 6th in 2019).

Despite that Bahrain still holds great hope for the sector and announced in January a tie-up between FinTech Bay and Standard Chartered Bank, which will enable resident startups to get up help from the giant British lender.

In any case, its benefits are unlikely to materialize soon, Nasser Saidi, a Dubai-based economist, told Reuters after the hub opened.

“It takes a minimum of four to five years, so if you’re going to get any revenue it’s not going to be immediate, so you still have to face the adjustment to a large fiscal deficit and a large budget deficit,” he said, adding, “How much more are you going to get from fintech? Are you going to add 1% or 2% of GDP? I don’t think so, it’s not a big employment generator.”

The next step after financial technology, under Bahrain’s Economic Vision 2030 program, is to transform itself into an e-commerce center for the region. Last week announced new laws to encourage the industry.

Meanwhile, Bahrain has won support from some big multinationals. Last year, Amazon said it was setting up a cloud-computing service center in Bahrain, making it the first tech giant to establish a foothold in the country.