Economic diversification in Bahrain

The Kingdom of Bahrain has long been dependent on its oil revenues to fund its budget and its public services. This is why the Bahraini government started intensifying efforts to diversify away from oil and gas back in the early 2010s, but this resulted in only a minimal increase in non-oil revenues. From 2014–2015, on the heels of a significant decline in oil prices, Bahrain’s oil-dependent economy started facing fiscal difficulties that hindered the balancing of its annual budgets and increased its debt-to-GDP ratio.

The year 2016 onwards, the government implemented several reforms to adjust these fiscal imbalances. In particular, the economy appears to struggle to align non-oil government revenues with the economic growth of non-oil business relative to GDP. In other words, the diversification sought by government has indeed increased the contribution of non-oil business to GDP, but the non-oil revenues from that diversification have not increased at a similar rate.

The situation was clearly not sustainable, so the Bahraini government took measures to respond to this discrepancy and put in motion the much-needed fiscal adjustment. In October 2018, Bahrain—backed by $10 billion in promised funding from Saudi Arabia, Kuwait, and the UAE—publicly announced an ambitious package of reforms known as the Fiscal Balance programme (FBP). The FBP’s principal target is to eliminate the budget deficit by 2022. The FBP includes measures to: (a) cut public expenditure; (b) introduce a voluntary retirement scheme for government employees; (c) reduce cash subsidies; and (d) simplify government procedures and increase non-oil revenues.

The government recognised how fundamental these measures are to attract investment and better manage its budget deficit, as is to adopt the latest technologies to streamline administrative procedures and enhance the business climate. But it first had to increase its non-oil revenues and did so by following the example of the UAE and Saudi Arabia: it introduced a five per cent VAT on the sale and purchase of goods and services.

This was first mentioned at the time the FBP was announced, in Law No. 48/2018 (VAT Law), which came into effect on 1 January 2019 and was followed by the executive regulations issued by Minister of Finance Decree No. 12/2018. The five per cent VAT applies to the sale and purchase of all goods and services unless the transaction is expressly exempt from it or subject to VAT at a different rate under the VAT Law. The provision of financial services is a clear example of a transaction that is exempt.

According to the latest figures, in 2019 the Bahraini government collected approximately $663 million in revenues from applying the VAT, which proved crucial in cutting the government deficit. The Bahraini Minister of Finance broke this down further in a statement released in October 2019, in which he shed light on a series of fiscal indicators relating to the FBP’s targets.

Among other things, he reported that Bahrain, in the first six months of 2019, had: (a) reduced its budget deficit by 37.8 per cent; (b) increased its non-oil revenues by 47 per cent; (c) cut governmental administrative costs by 14 per cent; and (d) seen 18 per cent of government employees accept voluntary retirement packages.

After revising upwards its budget deficit forecasts for 2019 and 2020, and following the successful Aramco IPO, the Bahraini government is considering transferring some of its stakes in state-owned oil and gas companies to a sovereign fund that can sell these stakes to private sector investors.

Available data and reports suggest that the Bahraini government might not meet its target of balancing the budget by 2022. This was underlined by the International Monetary Fund (IMF) in the report it issued following Art. IV consultation with the Bahraini government: the IMF recommends additional measures to ensure that Bahrain can balance its budget in the target time frame. These include: (a) introducing direct taxes; (b) reducing VAT exemptions; and (c) phasing out untargeted subsidies.

Bahrain reduced its deficit-to-GDP ratio from 15 per cent in 2015 to 4.7 per cent in 2019 and is thus making good strides towards completing its FBP reform plan. However, signs still indicate that a balanced budget by 2022 might be a little too optimistic, unless the government introduces additional measures to those proposed by the IMF.

PHOTO CREDIT: Asia-Pacific Images Studio /iStock

Denis Francis Partner at McKinsey in Cologne and Hesham Elmais Associate Principal at MkKinsey in Dubai, paint a picture of impending structural shifts that will demand changes in how corporate banks in the region operate

Corporate banking plays a major role in the Middle East banking sector, accounting for nearly 75 per cent of total banking assets and contributing some 60 per cent of total revenues. The sector is also riding a wave of healthy returns as national economic diversification efforts create a wealth of new investment opportunities.

Corporate banks in the region are generating average returns on equity of over 12 per cent, far outstripping their European counterparts, which average just seven per cent, according to McKinsey Panorama Global Banking Pools. But impending structural shifts may threaten this comfortable position. To navigate them, Middle East corporate banks must significantly transform the way they operate, and potentially at a much faster pace than their global peers.

As is often the case, major structural changes will likely present exciting opportunities as well. The drive by several governments in the region to diversify their economies away from oil is one such change. For example, the Saudi Arabian Monetary Authority recently created a regulatory ‘sandbox’ to help transform the Kingdom into an ‘intelligent financial centre’. The sandbox aims to attract local and international financial technology companies to provide innovative financial services to Saudi markets, opening the Kingdom to a whole new type of investor.

But structural changes also bring challenges, which are exacerbated by the fact that many banks in the region have only limited capabilities—especially in transaction banking—and outdated infrastructures, which make it harder to adapt. Many are also behind in terms of automation and digitisation— which makes serving smaller customers increasingly difficult at a time when regulators are pushing for a higher share of lending to the segment.

Established banks are also under threat from the evolution of their customer base. ‘Internationalisation’ and the increasing sophistication of domestic corporates is translating into a demand for a wider range of products, and to expectations for more strategic advice from their financial partners. The April 2019 tapping of public markets by Saudi Aramco (raising roughly $12 billion in bonds) indicates that banking clients can—and will—find alternative sources of funding.

Meanwhile, the ongoing wave of banking consolidation is creating a new bracket of GCC ‘wholesale banks’. This may increase competition for the traditional client base of large corporates and state-owned enterprises, and further reduce lending and cross-sell margins. These new wholesale banks are joining international banks in offering treasury and transaction banking offerings and could potentially dominate these highly profitable businesses. To remain relevant, corporate banks need to change their business models to effectively serve all customer segments, including medium and small corporates.

Retail banks in the region have already made bold and aggressive moves in digitisation and analytics; some have been effective enough to serve as global examples of successful digital transformations. To succeed, we believe Middle East corporate banks need to be as ambitious as their retail counterparts in pursuing holistic transformations.

They need to be, because radical transformation is required. Corporate banks in the region must be able to offer their customers more sophisticated advice on their daily business operations and meet their increasingly complex banking product and service needs.

To do so, they need to step up in two key areas: first, by developing analytics capabilities at scale to achieve a new level of customer understanding and targeting; second, by applying digitisation at scale to deliver an almost seamless integration of banking services into corporate clients’ daily business routines.

These efforts will require significant operating model changes, and the development of a whole new set of capabilities. Complicating the challenge, banks need to make these transformations in a difficult context characterised by uneven data quality and availability; scarcity of local top-level digital and analytics talent (for example, agile coaches, UX designers); and a lack of well-developed fintech ecosystems.

Consider that European banks with similar challenges have their pick of willing fintechs they can partner with to create new digital solutions for clients (for example, RBS’s partnership with Taulia to offer dynamic discounting and ING with Kabbage for SME loans). By comparison, the Middle East fintech ecosystem is still nascent.

Transformations of the kind that Middle East corporate banks must make can be multi-year journeys and require stamina. There are initial signs that the region’s corporate banks are ready to commit significant time and manpower to the challenge. The rewards for those that make this commitment now will be significant.

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Director, Gulf Region, Jersey Finance

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