Bahrain will probably need its Gulf neighbours to pledge more money to defend the dinar's dollar peg and roll over its foreign debt, Capital Economics said in a note on October 21.
The London-based consultancy expects that support to come, "not least because the rest of the Gulf will want to avoid question marks over their own pegs", but said Manama would be asked to tighten fiscal policy aggressively in return.
Bahrain has the weakest balance sheet in the Gulf and is among the most exposed to the closure of the Strait of Hormuz, one of the chokepoints the Iran war has shut. It relies entirely on the waterway for the two-thirds of its exports that go outside the Gulf, and China's imports from Bahrain fell 99% y/y in September, the note said.
Bahrain's five-year credit default swap premia have climbed to close to 350bp, above their peaks in March, shortly after the war broke out, and in August, and near their highest since the early stages of the pandemic. They are far above those of the other Gulf states and higher even than Egypt's.
International reserves at the Central Bank of Bahrain stood at $3.1bn in August, close to their May low and down from $6.7bn in March. That covers less than two months of pre-war imports, and only half of it is in liquid foreign currency, Capital Economics said.
Manama has other buffers. Its sovereign wealth fund holds about $18bn, though much of it is illiquid, and it has an AED20bn ($5.4bn) currency swap line with the UAE, signed in April. Minister of Sustainable Development Noor bint Ali Alkhulaif, who sits on the central bank's board, said last week that the line had not been tapped.
"Bahrain's ability to maintain its dollar peg will come under increasing strain the longer that energy flows remain disrupted," the note said. "Either domestic demand needs to fall to reduce imports, or the dinar will eventually need to be devalued."
The thin buffer also raises questions over whether the government can refinance maturing external debt. The IMF estimates public debt rose to more than 140% of GDP last year, most of it owed abroad. On the face of it, Capital Economics said, Bahrain looks at high risk of devaluation and sovereign default.
Its neighbours have stepped in before, Saudi Arabia with a bailout in 2018 and the UAE with the swap in April. Capital Economics expects them to do so again: Saudi Arabia or the UAE could see support as a way to bolster their standing as they vie for regional leadership, and as a cheap way to head off wider doubts about Gulf dollar pegs.
The price would be austerity, as in 2018, which would weigh on the recovery of Bahrain's non-hydrocarbon economy. As with Egypt, Gulf lenders may also ask for stakes in Bahraini assets, the note said.
Tourism is showing signs of life: card spending in Bahrain on cards issued abroad, presumably by business and leisure travellers, was up 23% y/y in August. The central bank has had little room to cushion the economy: it raised its overnight deposit rate by 25bp to 4.50% on September 17 to keep step with the US Federal Reserve.