The island’s once vibrant economy was paralysed by violent pro-democracy protests which deterred foreign investment and crimped tourism. Where does it stand today?

The tiny Gulf monarchy saw economic growth of just 1.9 per cent when domestic unrest was at its peak, according to the Washington- based IMF, making it the slowest-growing country in the GCC.

Today, the kingdom is undergoing a steady rather than spectacular recovery. Bahrain is set to see 5.6 per cent economic growth in 2013, according to the country’s Economic Development Board (EDB), driven by a stronger oil sector, rebounding private sector and a brisk regional economy. The EDB estimated gross domestic product (GDP) grew 3.4 per cent in 2012.

The upturn has been aided by the largesse of wealthier Gulf states, which pledged $10bn in aid to Bahrain over 10 years following the unrest of 2011-12. This money is expected to start flowing in 2013 and 2014, further reviving the economy.

The UAE in February granted $2.5 billion to Manama to finance projects in housing, electricity, water, infrastructure and social services. In April, the Kuwait Fund for Arab Economic Development approved $1.3 billion in funding to finance a raft of development schemes in Bahrain.

“Though Bahrain’s 2011 political crisis weakened growth potential and damaged the country’s reputation as a business services hub, we believe a post- crisis status quo has been established,” Standard Poor’s said in late January as it upgraded the outlook for Bahrain’s BBB credit rating to stable from negative. It cited the inflow of Gulf funds and the high oil price as key factors in its decision.

Bahrain’s fiscal position remains challenged in comparison to the GCC’s wealthier oil exporters. Increased social spending has left Manama more reliant on high oil prices, and vulnerable to swings in the energy markets.

The Gulf state depends on output from the Abu Safa oil field, which it shares with neighbouring Saudi Arabia, for an estimated 70 per cent of its budget revenue. Output from the field fell in 2012, according to EDB, pinching economic growth.

The board expects Bahrain to receive its full share of 150,000 barrels per day for the remainder of 2013, along with higher output from an onshore Bahraini oil field. If oil prices slide below $100 a barrel for a prolonged period, however, state finances will face increased pressure.

The IMF echoed this view in a May report, which called on Bahrain to slash spending or risk unsustainable public debt. The fund predicted the country’s
debt burden could grow to 61 per cent of GDP by 2018 without stricter curbs on spending.

“There is therefore an urgent need for a gradual fiscal consolidation over the next three two-year budget cycles, of about 7.7 per cent of GDP,” the report said. This should contain government debt at 40 per cent of GDP over the medium term.

Bahrain said in November it planned to cut its budget spending by six per cent in 2013 in a bid to curb its deficit, with forecast expenditure of BD6.99 billion ($18.5 billion) to end-2014. Bahrain ramped up its initial 2012 expenditure plan by almost 19 per cent in September 2011, in order to pacify the uprising sweeping the kingdom.

As with other GCC states, economic diversification is vital if Bahrain is to generate jobs and lessen its dependency on oil. The economy is set to benefit this year from large-scale industrial investments, including a $4.8 billion oil refinery upgrade and the creation of a $2.2 billion production line at Aluminium Bahrain (Alba).

The government has also announced plans to tender five megawatts (MW) of renewable energy projects, in addition to $2.5 billion worth of infrastructure schemes, paving the way for fresh foreign investment and renewed private sector growth.

Banking and tourism

Bahrain’s status as a regional banking hub was thrown into doubt after the outbreak of tensions in 2011. The city’s financial centre became a flashpoint in the turmoil, prompting some banks to relocate their staff to Dubai. In particular, the exit of France’s Credit Agricole in late 2011 raised fears of a wider exodus, similar to that seen during the 1970s civil war in Lebanon.

Two years on, these fears have proved largely unfounded. Assets in Bahrain’s banking system stood at $195.3 billion in March, down about 12 per cent
from the end of 2010 or just before the uprising. While this reflects a decline, it is not substantial enough to suggest a widespread withdrawal of capital.

The total number of banks and financial institutions in Bahrain was 406 as of March, central bank data shows, matching that at the close of 2010.

The resilience of Manama’s banking industry is in part a reflection of Bahrain’s large pool of educated local talent, its low operating costs and its close proximity to Saudi Arabia, the Gulf’s wealthiest economy. Promises of financial support from the wider GCC have also helped to bolster investor confidence in the unrest- hit country.

Annual earnings results from several Bahraini banks are also encouraging.

Ahli United Bank, the kingdom’s largest lender by market value, saw its 2012 profit jump 8.1 per cent to $335.7 million. Gulf Finance House saw net profits for the year surge to $10.03 million, compared to $0.38 million in the previous 12-month period.

Bank lending to the private sector picked up in 2012, according to Bahrain’s Economic Development Board, setting the sector up for steady growth over the coming year.

The survival of Bahrain’s banking industry is vital. The sector employs more than 14,000 people, including around 9,400 nationals, and contributed about 17 per cent of the country’s $29 billion economy in 2011.

The challenge for Manama going forward will be in competing with Dubai and other regional financial hubs for foreign investment. Some form of political resolution will be vital if the kingdom’s efforts to attract and retain new business are to succeed.

Bahrain’s travel industry has not fared as well. Inbound tourism almost dried up in the wake of violent clashes between pro- democracy protesters and police in 2011, pushing state-backed carrier Gulf Air to the brink of bankruptcy.

Privately owned Bahrain Air said in February it was closing down, in part because of the impact of tensions on the travel sector. Data from the UN’s World Tourism Organisation shows tourist arrivals to Bahrain plummeted by 32.7 per cent in 2011, a steeper decline than that seen in Tunisia.

In step with the wider economy, however, the travel industry has showed signs of recovery. Passenger numbers at Bahrain International Airport rose by almost nine per cent in 2012 to 8.5 million, while arrivals on the Saudi causeway reached 6.4 million in the nine months to September.

Bahrain relies on Saudi Arabia for much of its tourism trade, and the kingdom’s wealthy tourists are vital in keeping its malls, hotels and restaurants afloat.

Hotel occupancy levels in Manama hit 51.7 per cent in April, a rise of 21.5 per cent on the previous year and the sharpest uptick in the Middle East. Revenue per available room, a benchmark of hotel health, jumped 18.5 per cent to $122.76 year-on-year, according to data from research consultancy STR Global.

Government support will be critical in harnessing this rebound, both by driving investment into the tourism sector and averting any further outbreaks of unrest.

The Gulf kingdom in November launched a huge 1,001-seat amphitheater in a bid to woo back tourists, ploughing $50 million into the cultural attraction.

Bahrain is also expanding the existing passenger terminal at its International Airport, boosting its capacity from nine million to 13.5 million passengers a year in a bid to grow its share of the lucrative regional aviation market.

Demographics

Bahrain’s population has grown steadily in recent years to reach an estimated 1.2 million people, according to the Washington-based IMF. Foreign workers comprise roughly 51 per cent of the population, predominately through the presence of blue-collar workers from South Asia, the Philippines and other Arab states.

This influx of expatriates attracted concern before the onset of the global financial crisis, with Bahrain leading calls for a five-year residency cap for unskilled workers in the GCC. The issue was shelved in the wake of the downturn and the subsequent ‘Arab Spring’ turmoil in the wider region.

Sectarian tensions in Bahrain bubbled to the fore in 2011, when the majority Shia population took to the streets to demand democratic reforms in the Sunni- ruled state. The uprising was fuelled by Shia complaints of unequal access to lucrative state jobs, housing and healthcare. The government denies such discrimination exists.

More than 30 people died during the clashes, according to the government, which led a brutal clampdown in 2011 aided by Saudi troops. Scattered protests have continued since then, amid failed attempts to reconcile the state and its Shia- dominated opposition. Fresh talks began in February in a bid to resolve the crisis.

With a restive population, Bahrain has ramped up spending on social housing and other development projects. More than BH114.8 million ($304 million)
of capital expenditure to end-2014 is earmarked for spending on housing, healthcare and education, in addition to grants from other Gulf countries. The government in 2011 also pledged to create 20,000 public sector jobs.

Geopolitics

Bahrain’s strategic importance is reflected in its close ties to the US and Saudi Arabia. It is seen as a gateway to Saudi, the GCC’s wealthiest economy, and the kingdom has a vested interest in its stability. Bahrain is also regarded as an ally in Washington’s standoff with Iran, given that Manama is the base for the US Fifth Fleet.

Bahrain’s domestic woes have tested its ties with the West. The government has faced pressure to engage in political and social reforms, and to renew dialogue with the Shia-dominated opposition. The largest opposition party, al-Wefaq, walked away from reconciliation talks in July 2011, saying they were not carried out fairly, and its engagement has since been patchy.

In the months since the uprising, the government has implemented a number of changes to the police and judiciary, including overhauling security practices and increasing powers for the elected parliament.

In May, moderate Crown Prince Salman al-Khalifa was appointed as Bahrain’s first deputy prime minister, seen by many as a sign the government is softening its stance on reform.

Opposition figures, however, say these measures still do not go far enough, as they fail to address the ruling family’s grip on power. It remains to be seen whether the latest round of talks will prove successful.

Political tension has also taken a toll on Bahrain’s economic reforms. Championed by Crown Prince Salman, these were once hailed as being among the region’s most progressive. The changes aimed to slash the Gulf state’s dependency on foreign labour by creating a skilled local workforce, to diversify the economy and to lessen Bahrain’s reliance on oil receipts.

As part of these plans, Bahrain scrapped its sponsorship scheme for foreign workers in favour of charging firms a set fee for every expatriate on heir payroll. This money is used to fund job training for locals, overseen by the government agency Tamkeen.

The process aimed to create a free labour market, where nationals had the skills and education to compete for both private and public-sector jobs.

Central bank data shows nearly 87,000 Bahrainis were employed by the private sector in the third quarter of 2011, accounting for 17.4 per cent of workers. Nationals hold 87 per cent of government roles, representing 37,141 jobs.

Bahrain’s private sector will be the engine of job creation as oil supplies dwindle. While the national unemployment rate is lower than that seen in other Gulf states, at around four per cent, the stakes for its disaffected youth are high.

It’s a source of comfort that Bahrain’s business fundamentals are still in play. The factors that made Manama a finance and trade hub – the quality of its workforce, low overhead costs and the access it provides to other regional markets – remain attractive to multinationals.

This reinforces the need for the country to reach a political settlement in order to attract investment and accelerate its economic growth.