Bahrain Mirror (Moody's): Moody's Investors Service has today downgraded the Government of Bahrain's long-term issuer ratings to Ba2 from Ba1 and assigned a negative outlook. Today's rating action concludes the review for downgrade which Moody's initiated on 4 March 2016.

The main driver for the rating downgrade is Moody's view that the credit profile of the Bahraini government will continue to weaken materially in the coming years, despite its fiscal consolidation efforts. In particular, the rating agency expects Bahrain's government debt burden and debt affordability to deteriorate significantly over the coming two to three years.

The negative outlook reflects increased downside risks to the rating, which manifest themselves in heightened government liquidity and external liquidity risks. Furthermore, although Bahrain has benefited from the support of neighbouring countries during times of stress in the past, such support at this juncture lacks clarity, both in its form and timeliness.

Moody's has today also lowered Bahrain's long-term foreign-currency bond ceiling to Baa3 from Baa2 and long-term foreign-currency deposit ceiling to Ba3 from Ba2. The short-term foreign-currency bond ceiling remains at Prime-3, whereas the short-term foreign-currency deposit ceiling remains at Not-Prime. Bahrain's long-term local currency country risk ceilings were lowered to Baa2 from Baa1.

In addition, the foreign-currency bond ceilings for Bahrain - Off Shore Banking Center remain at A3/Prime-2 and the foreign-currency deposit ceiling remains at Baa1/Prime-2.

(Moody's ratings for Bahrain were not solicited by the government of Bahrain. Moody's considers a rated entity or its agent(s) to be participating when it maintains an overall relationship with Moody's. On this basis, the government of Bahrain is considered to be a non-participating entity. The government of Bahrain does not provide Moody's with information for the purposes of its ratings process.)

RATINGS RATIONALE

RATIONALE FOR THE DOWNGRADE TO Ba2

The rating downgrade to Ba2 reflects Moody's view that the credit profile of the Bahraini government will weaken materially in the coming years, despite its consolidation efforts. In particular, the rating agency expects Bahrain's government debt burden and debt affordability to weaken significantly over the coming two to three years.

The government has taken initial steps towards fiscal consolidation, including some subsidy reforms for fuel and utility tariffs, the streamlining of government entities, increased sin taxes, and targeting a cost recovery in the provision of government services. In Moody's view, the most prominent revenue measure is the introduction of a value-added tax from 2018.

However, in the absence of more aggressive measures, Moody's expects that Bahrain will continue to post large fiscal deficits over the coming years. Following an already wide deficit in 2015, estimated at 13.1% of GDP, Moody's expects the fiscal deficit to widen to 16% in 2016 and narrow only gradually over the following years.

Under its baseline scenario, the rating agency expects Bahrain's government debt-to-GDP ratio to approach 100% by 2019, a sharp increase from an estimated 59% of GDP at the end of 2015. Bahrain has no sizable and liquid sovereign wealth fund assets it can draw on, and therefore has to rely fully on debt funding to finance its large fiscal deficits. Moody's believes that sharply rising debt levels in conjunction with projected increases in Bahrain's funding costs will lead to a further deterioration in the country's debt affordability metrics and complicate the return to more sustainable government debt levels. According to Moody's estimates, Bahrain's interest payments this year may consume as much as 27% of budgetary revenue, up from 16% in 2015.

Peer comparisons show that Bahrain's key fiscal credit metrics will worsen beyond the Ba-rated median: for example, Bahrain's fiscal deterioration is more pronounced than it is for Azerbaijan (Ba1 negative), Russia (Ba1 negative) and Kazakhstan (Baa3 negative), three other oil exporters for which Moody's recently announced rating actions.

However, these sizable challenges are set against the background of some important sources of credit strength. Bahrain's high per capita incomes, estimated by the IMF at $50,100 in purchasing power parity terms in 2015, are significantly higher than the Ba-rated median of $15,000, and provide some economic buffer. Furthermore, Moody's sees support for Bahrain's economic strength from the fact that the economy is fairly diversified, with non-oil sectors contributing close to 80% of nominal GDP on average since 2010. Non-oil economic performance will be supported by access to funding of a total $10 billion under the Gulf Development Fund. While these funds are not part of the Bahraini government's budget, they will support the government in reducing investment expenditure without unduly harming growth.

Finally, Bahrain's net asset international investment position, which stood at 78% of GDP in 2014, provides some form of external buffer. However, Moody's expects it to decline significantly because external liabilities will increase at a much faster rate than the country's assets.

RATIONALE FOR THE NEGATIVE OUTLOOK

The negative outlook reflects increased downside risks to the rating, which manifest themselves in heightened government liquidity and external liquidity risks.

The further deterioration in the government's balance sheet, combined with increased external debt issuance from other countries in the region, will lower the supply of external funding, thereby heightening the risk that finance is obtainable only at much less affordable rates for Bahrain, or potentially reduced amounts. While Moody's would expect support from neighbouring countries in times of crisis -- predominantly from Saudi Arabia -- there is no clarity about the form and timeliness of this support in the event that external funding dried up.

WHAT COULD MOVE THE RATING UP/DOWN

Given the negative rating outlook, any upward movement in the rating in the foreseeable future is highly unlikely. However, Moody's would consider moving the outlook back to stable if a clear and credible fiscal and economic policy response were to emerge, offering the prospect of containing the deterioration in the fiscal balance and government balance sheet. In particular, a stabilization of government debt levels below 90% of GDP, and strengthening of Bahrain's fiscal and external buffers would be credit-positive. A clear, sizable and timely support from one of its financially stronger neighbours could also contribute to stabilizing the outlook.

Signs of an emerging fiscal or balance-of-payments crisis would exert downward pressure on the rating. In particular, any signs of funding stress or loss of market access would trigger a further rating downgrade. A deterioration in the domestic or regional political environment would also be highly credit negative.

Prompted by the factors described above, the publication of this credit rating action occurs on a date that deviates from the previously scheduled release date in the sovereign release calendar, published on www.moodys.com.

GDP per capita (PPP basis, US$): 50,094 (2015 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 2.9% (2015 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 0.7% (2015 Actual)

Gen. Gov. Financial Balance/GDP: -13.1% (2015 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -2.1% (2015 Actual) (also known as External Balance)

External debt/GDP: 152.7% (2015 Estimate)

Level of economic development: High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 10 May 2016, a rating committee was called to discuss the rating of the Bahrain, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/framework, have decreased. The issuer's fiscal or financial strength, including its debt profile, has decreased. The issuer's susceptibility to event risks has increased.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2015. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.