Bahrain

Notwithstanding the recent improvement in the overall fiscal accounts, the underlying fiscal position has remained weak. After declining during the first half of the 1990s, the non-oil fiscal deficit deteriorated significantly during the second half, particularly between 1998 and 2002, when it increased by about 60 percent in nominal terms (or from 15 percent to about 21 percent of GDP), reflecting higher current expenditures across the board—Bahrain’s wage bill at more than 13 percent of GDP is among the highest in the GCC area. This deterioration took place even though non-oil revenues, in particular fees and charges, increased significantly as the authorities adopted cost recovery measures for government-provided services, such as electricity, water, and sewerage. Moreover, budget policy has usually presented a “stop-and-go” approach. When oil prices fell, capital expenditures have been cut, while current spending, in particular the wage bill, have remained practically untouched.
Bahrain’s well-capitalized and supervised financial sector has been quite profitable, with a sound asset quality. The Bahrain Monetary Agency (BMA) maintains a strict segregation between the domestic and the offshore financial systems. ⁴ Aside from conventional banking, the BMA’s recent efforts to develop a comprehensive regulatory and operational framework for Islamic banking has supported the government’s ongoing efforts to establish Bahrain as a leading Islamic financial center. The BMA adheres to Basel Core Principles for Effective Banking. Stable and credible monetary and exchange rate policies have also helped maintain a sound financial system.
The BMA is in charge of enforcing monetary policy, which is basically directed at short-term regulation of domestic liquidity by using indirect instruments. It also uses open market operations to manage domestic liquidity by discounting treasury bills and government development bonds, as well as by carrying out foreign exchange swap operations with commercial banks. Monetary policy is framed within a currency board type of arrangement, which maintains foreign exchange coverage of 100 percent of the currency in circulation. The authorities have recently adopted a new law and several regulations to combat money laundering and the financing of terrorism.
Although economic growth has remained buoyant through much of the last decade, unemployment pressures among nationals have started to mount, since the vibrant sectors in the economy (offshore banking, trade, and tourism) continue to depend largely on expatriate workers for employment. To deal with this problem, the Bahraini authorities have adopted an active policy of training and education, flexible employment quotas, and incentives for firms to employ Bahraini nationals. ⁵ Moreover, they have established recruitment centers to help employers find qualified and suitable local candidates. These measures have had some success in gradually reducing the share of expatriate workers in the workforce, but a rapidly growing national labor force has hindered further improvement.
Structural reforms have advanced gradually in Bahrain. These reforms have aimed at improving the general functioning of public administration and promoting the role of the private sector. The authorities have completed the public expenditure reviews for education and health and contracted out the management of two small public enterprises (Appendix III). Progress in privatization has been limited, in part due to the possibility of worsening unemployment among nationals in the short run. The authorities have also simplified administrative procedures and business licensing, and reformed the investment laws to make Bahrain more attractive to foreign direct investment (barriers for non-GCC foreign companies to own real estate have been eased as well). ⁶ In addition, import tariffs on selected consumer products are in line with the adoption of the GCC common external tariff in January 2003.

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