The Structural Deficit
Bahrain’s fiscal position is the most precarious in the Gulf Cooperation Council. Government debt exceeds 120 percent of GDP. Annual budget deficits have persisted for more than a decade. Domestic oil production is modest and declining. Sovereign wealth reserves are minimal relative to the scale of government liabilities. And the fiscal breakeven oil price — the price per barrel at which government revenue covers government expenditure — exceeds $90, the highest among GCC producers and well above recent market prices for sustained periods.
These are not temporary conditions. They are structural characteristics of an economy in which government expenditure has systematically exceeded government revenue for years, funded by a combination of debt issuance, drawdowns on limited reserves, and external financial support from wealthier Gulf neighbours. The question facing investors is not whether Bahrain has a fiscal problem — the data are unambiguous — but whether the political and geopolitical framework surrounding Bahrain is sufficient to prevent the fiscal problem from becoming a credit event.
The Debt Trajectory
Bahrain’s government debt has grown from approximately 30 percent of GDP in 2008 to over 120 percent by the mid-2020s. This trajectory reflects persistent primary deficits — the government spends more than it earns even before debt service costs — compounded by rising interest payments on the accumulating debt stock. The dynamic is self-reinforcing: larger deficits produce more debt, which produces higher interest costs, which produce larger deficits.
The debt composition matters for risk assessment. Bahrain has issued both domestic and international debt, with a significant share of international issuance denominated in US dollars. Dollar-denominated debt eliminates currency mismatch risk (since the Bahraini dinar is pegged to the dollar) but exposes the sovereign to international capital market sentiment. When global risk appetite declines or Gulf-specific concerns intensify, Bahrain’s access to international debt markets becomes more expensive — and potentially more constrained.
The maturity profile of Bahrain’s debt creates refinancing risk. Significant maturities in coming years require the kingdom to access debt markets repeatedly, rolling over maturing obligations while financing the ongoing deficit. Each refinancing is a test of market confidence; a failed or poorly received issuance would signal deteriorating creditworthiness and could trigger a loss of market access.
Bahrain’s credit default swap spreads — the market price for insuring against sovereign default — trade at levels significantly wider than those of Abu Dhabi, Saudi Arabia, or Qatar, reflecting the market’s assessment of relative credit risk. These spreads embed the market’s probability-weighted assessment of scenarios ranging from continued muddling through to fiscal crisis.
The GCC Support Package
The $10 billion GCC support package announced in 2018 — contributed by Saudi Arabia, the UAE, and Kuwait — was the most significant external financial intervention in Bahrain’s recent history. The package was designed to provide budget support, fund the Fiscal Balance Programme, and give Bahrain the fiscal space to implement reforms that would reduce the structural deficit over time.
The support package was not a one-time transfer. It was structured as a multi-year programme with disbursements linked to Bahrain’s progress on fiscal reform commitments. The conditionality — while less stringent than an IMF programme — represented an acknowledgment by the GCC contributors that unconditional transfers would merely delay adjustment without producing the structural changes needed for fiscal sustainability.
The package bought time. It stabilised Bahrain’s fiscal position during a period of particular vulnerability, prevented a potential debt crisis, and provided the political cover for reforms including VAT introduction and subsidy adjustments. But it did not resolve the underlying structural deficit. Bahrain emerged from the support programme with a more manageable near-term fiscal trajectory but without having achieved the fundamental rebalancing that would make external support unnecessary.
The implicit question behind the support package is whether the GCC contributors will provide additional support when needed — and under what conditions. The 2018 intervention established a precedent: Bahrain is too strategically important to fail. But precedents are not guarantees, and the terms of future support will reflect the fiscal and political conditions prevailing when the next request is made.
Saudi Arabia as Fiscal Backstop
Saudi Arabia is the primary fiscal backstop for Bahrain, both through its dominant contribution to the GCC support package and through the bilateral Abu Sa’fah revenue-sharing arrangement. Saudi Arabia’s willingness to sustain Bahrain financially reflects strategic calculations that extend beyond bilateral goodwill.
Bahrain hosts the US Fifth Fleet, making the kingdom’s stability a matter of American strategic interest — and by extension, a matter of Saudi interest in maintaining the US security relationship in the Gulf. Bahrain sits directly across the Gulf from Iran, and its stability is essential to the Saudi security perimeter. Bahrain’s Sunni monarchy governs a Shia-majority population, and its destabilisation could create a sectarian flashpoint with implications for Saudi Arabia’s own Eastern Province, where a significant Shia minority resides.
These strategic interests ensure that Saudi Arabia has strong incentives to prevent a Bahraini fiscal collapse. But the nature of the support — its scale, its conditions, and its duration — is a function of Saudi fiscal capacity and political will, both of which are subject to change. Saudi Arabia’s own Vision 2030 investment programme, combined with oil price uncertainty, creates competing demands on Saudi fiscal resources. A scenario in which Saudi Arabia must simultaneously fund its own transformation programme and provide expanded support to Bahrain would test the depth of Saudi commitment.
The power dynamic is unambiguous. A kingdom that depends on its neighbour’s fiscal support operates with constrained sovereignty. Bahrain’s economic and foreign policy choices are bounded by the need to maintain Saudi willingness to provide that support. This constraint is not typically visible in normal times — Bahrain and Saudi Arabia share most policy preferences on regional security, Iran, and domestic governance. But it would become binding in any scenario where Bahrain’s preferences diverged significantly from Saudi Arabia’s.
IMF Engagement and Reform Pressure
The International Monetary Fund has been a consistent voice urging Bahrain to accelerate fiscal consolidation. IMF Article IV consultations — the regular reviews of member country economic policies — have repeatedly recommended that Bahrain reduce subsidies, broaden the tax base, contain public sector wage growth, and develop non-oil revenue sources.
Bahrain has implemented some IMF-recommended reforms. The introduction of value-added tax in 2019, energy subsidy reductions, and measures to improve revenue administration reflect incremental progress on the fiscal adjustment agenda. However, the pace of reform has been insufficient to close the structural deficit, and the IMF’s assessment has consistently been that more ambitious measures are needed.
The difference between IMF recommendations and GCC conditionality is one of enforcement mechanism. The IMF can withhold technical assistance and programme support, and its public assessments influence market sentiment. But the IMF does not provide the scale of financial support that Bahrain requires. The GCC contributors provide the money; the IMF provides the analytical framework and the reform benchmarks. Bahrain must satisfy both — but when the two conflict, the GCC contributors’ conditions take precedence because they control the fiscal lifeline.
A scenario in which Bahrain required an IMF programme — a formal lending arrangement with strict conditionality — would signal a significant deterioration in the kingdom’s fiscal position and its relationship with GCC supporters. IMF programmes in the Gulf are politically sensitive; they imply a level of external oversight that is inconsistent with the sovereignty narrative that Gulf monarchies prefer. Bahrain’s leadership would resist an IMF programme unless all other options were exhausted.
The Politics of Austerity
Fiscal consolidation in Bahrain is not merely an economic challenge; it is a political risk management exercise. Bahrain’s population includes a Shia majority that has historically experienced political and economic marginalisation, and whose grievances erupted in the widespread protests of 2011. Austerity measures — subsidy cuts, public employment reductions, tax increases — disproportionately affect lower-income populations and can intensify existing social tensions.
The 2011 protests were not primarily about economic conditions — they reflected political demands for constitutional reform, representative governance, and an end to sectarian discrimination. But economic conditions provide the backdrop against which political grievances are expressed. A government that simultaneously reduces public services and faces accusations of sectarian bias creates a particularly volatile combination.
Bahrain’s government has managed this risk through a combination of targeted social transfers (providing support to lower-income households to offset subsidy reductions), security measures (maintaining a robust internal security apparatus), and external support (the Saudi security guarantee that was demonstrated in 2011). This approach has been effective at preventing a recurrence of large-scale unrest, but it imposes costs — the social transfers partially offset the fiscal savings from subsidy reduction, while the security apparatus requires its own funding.
The sustainability of this approach depends on the government’s ability to maintain a balance between fiscal adjustment and social stability. Too aggressive a pace of austerity risks social unrest; too cautious a pace risks fiscal crisis. The narrow path between these outcomes is the central challenge of Bahrain’s economic management — and it is a path that grows narrower as debt levels rise and the fiscal space for cushioning reforms diminishes.
The Oman Comparison
Oman’s fiscal trajectory before its reform programme offers an instructive comparison. Through the late 2010s, Oman faced many of the same challenges as Bahrain: persistent deficits, rising debt, limited sovereign wealth reserves relative to the scale of the problem, dependence on hydrocarbon revenue, and a high fiscal breakeven oil price.
Oman’s response — implemented following Sultan Haitham bin Tariq’s accession in 2020 — included a comprehensive reform programme featuring expenditure reduction, tax reform (including the GCC’s first personal income tax proposals), subsidy rationalisation, and a strategic focus on non-oil revenue development. The reforms produced measurable improvements in Oman’s fiscal position, supported by the post-2020 recovery in oil prices, and led to credit rating upgrades and improved market access.
The Omani experience suggests that fiscal reform in a Gulf monarchy is possible without triggering political instability — but it requires leadership commitment, a degree of social cohesion, and favourable external conditions (particularly oil prices) that provide the fiscal breathing room during transition. Bahrain shares some of Oman’s structural characteristics but faces the additional complexity of sectarian division that Oman’s more homogeneous society does not.
The key lesson from Oman is that markets reward reform credibility. Oman’s credit spreads tightened and its ratings improved not because the fiscal problems were fully resolved, but because the reform trajectory became credible. Bahrain’s path to improved credit market treatment runs through the same gate: demonstrating to creditors that the structural deficit is being addressed with sufficient urgency and commitment.
Credit Rating Trajectory
Bahrain’s sovereign credit ratings from the major agencies — currently in sub-investment-grade territory — reflect the fiscal fundamentals described above. The ratings incorporate the implicit GCC support that investors believe will prevent a default, but they also reflect the structural vulnerabilities that make the kingdom dependent on that support.
The rating trajectory depends on the interplay between reform progress and external support. Continued reform — expanding the tax base, controlling expenditure, developing non-oil revenue — combined with sustained GCC support could stabilise or gradually improve the ratings. Conversely, reform stagnation, reduced GCC support, or a sustained oil price decline could trigger further downgrades.
Credit rating agency assessments of Bahrain typically include a “support uplift” — additional notches above the standalone sovereign rating that reflect the expected probability of external support from GCC partners in a stress scenario. This uplift is the quantitative expression of the market’s belief that Saudi Arabia and the UAE will not allow Bahrain to default. If that belief weakened — due to a Saudi policy shift, a broader GCC fiscal strain, or a deterioration in the bilateral relationship — the support uplift would shrink, and Bahrain’s credit rating would decline toward its standalone level.
For bond investors, the practical implication is that Bahrain sovereign debt trades at a spread that embeds both the standalone fiscal risk and the probability-weighted GCC support expectation. Any event that changes either variable — worsening fiscal fundamentals or reduced support expectations — will move spreads. The current spread represents the market’s equilibrium assessment; investors must form their own view on whether that assessment is too optimistic, too pessimistic, or approximately correct.
The Investment Risk Premium
Bahrain’s fiscal vulnerability translates directly into an investment risk premium that affects all economic activity in the kingdom. Higher sovereign borrowing costs increase the government’s interest expense, crowding out productive spending. Higher risk perceptions deter foreign direct investment, as multinational companies factor sovereign risk into their location decisions. Higher insurance premiums for Bahrain-based operations reflect the combined fiscal, security, and geopolitical risks.
The risk premium is visible in multiple metrics. Bahrain’s sovereign bond yields trade at significant spreads to Abu Dhabi and Saudi Arabia. Bahrain-based companies pay higher borrowing costs than equivalent companies in more fiscally secure jurisdictions. Real estate yields in Bahrain incorporate a risk discount that reduces asset values relative to comparable properties in Abu Dhabi or Dubai.
For investors, the risk premium creates opportunity alongside risk. Bahrain’s asset prices are discounted relative to the broader Gulf because of the fiscal concerns described above. If those concerns prove manageable — if GCC support continues, reforms progress, and oil prices remain supportive — the risk premium represents excess return available to investors who correctly assessed the situation. If the concerns materialise in a fiscal crisis, the risk premium was insufficient to compensate for the losses incurred.
Implications for Vision 2030
Bahrain’s Economic Vision 2030 was designed to address the structural challenges that the fiscal data illuminate. The vision’s emphasis on economic diversification, private sector development, and non-oil revenue growth represents a strategic response to the fundamental unsustainability of a hydrocarbon-dependent fiscal model with declining production and rising debt.
The fiscal vulnerability constrains the vision’s execution in direct and measurable ways. Government capital expenditure on diversification projects competes with debt service costs and social spending for limited fiscal resources. The need to demonstrate fiscal responsibility to external supporters and credit markets limits the government’s ability to invest in long-term projects with uncertain returns. And the social and political constraints on austerity narrow the policy space within which reforms can be implemented.
The geopolitical dimension of Bahrain’s fiscal vulnerability is ultimately this: the kingdom’s economic future depends not only on the quality of its domestic policy choices but on the continued willingness of external actors — primarily Saudi Arabia — to provide the financial support that makes those choices possible. This dependence is the central vulnerability in Bahrain’s economic model, and no amount of domestic reform can fully eliminate it until the structural deficit is resolved.
The resolution of the structural deficit — achieving a fiscal position in which government revenue covers government expenditure without external support — is the single most important objective for Bahrain’s long-term economic sovereignty. Until that objective is achieved, Bahrain’s economic vision operates within boundaries set by its creditors, its supporters, and the oil prices it cannot control.