The future of Bahrain’s investment vehicle

Feature | 21 June 2017

Theodore Karasik and Andrew Vought look at the effect Bahrain’s domestic instability has had on the country’s sovereign wealth fund and its ability to stimulate the economy   

Bahrain’s political crisis has intensified this year. On 21 February, Bahraini lawmakers changed the constitution to allow civilians to be tried in military courts, empowering the country’s security forces on the six-year anniversary of the 2011 unrest, as tension continues to plague the archipelago kingdom.

Meanwhile a continued wave of bombings and clashes throughout the beginning of this year signals violent escalation of unresolved problems between the royal family and segments of the Shi'ite opposition. Should unrest exacerbate this year, Bahrain’s government and its sovereign wealth fund (SWF), Bahrain Mumtalakat Holding Company, or Mumtalakat, will experience deleterious consequences.

In February, Fitch affirmed Bahrain’s long-term foreign and local currency issuer default ratings (IDRs) at BB+ with a stable outlook, the country ceiling at BBB+, and the short-term foreign and local currency IDRs at B.i Unsecured foreign and local currency long-term bonds were also affirmed at BB+, while the senior unsecured local currency short-term bonds received a B rating.

A high GDP per capita and human development indicators, a developed financial sector, and external financing from wealthy neighbors and fellow Gulf Cooperation Council (GCC) members drove these ratings. Downside risks included double-digit fiscal deficits, high and rising debt, an oil-dependent budget, and the ongoing political crisis. Like most in the GCC, Bahrain is enacting subsidy reforms and austerity measures to adjust for weakness in the fossil fuel market, and is also emphasizing efforts to grow non-oil revenue.

Domestic giant

Founded in 2006, Mumtalakat is Bahrain’s state-controlled SWF tasked with managing the country’s non-oil and gas investments. The fund, although the smallest SWF in the GCC, is an important source of stability for the island kingdom. Its US$11.2bn in assets include stakes in 38 enterprises, many of which are among Bahrain’s largest employers. Bahrain, less oil-rich than other GCC members, has a national GDP of only US$24bn.

As a result Mumtalakat has an outsized presence in Bahrain’s domestic economy, requiring transparency and sound corporate governance for the enterprises in its portfolio. This accountability is critical for a nation experiencing unrest driven primarily by socioeconomic inequality. Jasim Husain, a Bahraini economist and former member of the largest Shi’ite political society, says “the big issue for many people is jobs, absence of discrimination and equal opportunity. These are very important things for the average Shi’ite”.ii

Mumtalakat’s mandate “is to play the role of a state entrepreneur, to make investments in related companies and infrastructure, and to help build the domestic economy – a role that Bahrain’s nascent private sector is unable to undertake”, says Ravi Shankar Chaturvedi, a research fellow at Tufts University.iii Although Mumtalakat is incorporated as a commercial entity, it receives no guarantee from the government on financial obligations. This means that “in effect, Mumtalakat’s ability to meet its financial obligations is solely dependent on its ability to fund such amounts from its operating revenues, cash flows and profits.”iv

Major portfolio holdings reveal Mumtalakat’s profound importance to the Bahraini economy. Alba is one of the world’s largest global aluminum producers. Of its 2,600 employees, 84% are Bahraini nationals. Batelco, a telecommunications provider and NBB, Bahrain’s first locally owned bank, both enjoy a dominant domestic presence. Mumtalakat has full ownership of Gulf Air, the country’s national airline, and Edamah, a property and real-estate holding company. Gulf Air is one of the largest employers in Bahrain and Edamah controls approximately 3.5 million square meters of Bahraini soil.

Testing conditions

Mumtalakat is comparable to the Singaporean state fund, Temasek. Singaporean policymakers were concerned that state-owned enterprises would become inefficient and limit national development because of government interference, so they created Temasek to “separate the regulatory and policy making function of the government from its role as a shareholder in commercial entities.” The spin-off was an immense success. Temasek companies like Singapore Airlines, Singtel, and port Singapore Authority are now globally-recognized powerhouses.v

The Bahrain Economic Development Board (BED) is a public agency which seeks to “shift from an economy built on oil wealth to a productive, globally competitive economy, shaped by the government and driven by a pioneering private sector.” Its “Economic Vision 2030” is guided by the principles of sustainability, competitiveness and fairness. Although BED is semi-private, Mumtalakat’s success is key to fulfilling its principles because of its stake in domestic enterprises. Unfortunately, the SWF has experienced revenue slack in several primary holdings, especially Gulf Air and Alba. In 2009, Gulf Air and Alba represented approximately 98% of Mumtalakat’s consolidated revenues. Alba has experienced operating losses due to the price of aluminum, which fell from high of US$3,000/ton in 2008 to US$1,500/ton last year. Gulf Air has been saddled by huge debts and has restructured or refinanced several times. It is “plagued by a discordant relationship between the management and the employee union.”vi

This situation led Mumtalakat to seek liquidity from public market debt issues and asset sales. In 2010, Mumtalakat issued US$750m in senior unsecured 5% notes on the London Stock Exchange. They also floated 10% of Alba stock on the Bahrain Bourse and London Alternative Investment Market. Mumtalakat’s involvement in public markets is limited by “its sovereign’s indiscipline… The fund’s transparency is of little good when its parent, the sovereign, is shrouded in a veil of corruption.”vii

The funds advisors are quick to discount political instability as an impediment to progress. Joseph Kirikian, head of the private equity Industrials and Services Group at Mumtalakat, asserted in 2016 that “geopolitics and instability in the region have always been interesting topics of discussion, but if you look at the recent US election, Brexit and the uncertainty surrounding the European Union we realise that instability is not something unique to the region. Although investors are generally more averse to the Gulf region, the potential returns far outweigh the associated risks… market penetration is very much achievable.”viii

Trade flows

In the first quarter of 2017, the value of Bahraini imports reachedUS$2.9bn and exports hit US$1.57bn. Agglomerated iron ores and concentrates were the top products exported, followed by aluminum wires and rectangular alloyed aluminum plates. Alba recently announced that it securedcommitments of around US$700mn from Export Credit Agency facilities to finance its Line 6 Expansion Project. Expected to begin in 2019, the expansion will boost annual production by 540,000 metric tonnes, bringing Alba’s total aluminum production capacity to 1,500,000 metric tonnes per year.

Aluminum is currently trading around US$1911.5/ton based on the London Metal Exchange 3 Month futures contract. At this price, added production would yield US$1.032bn in value per year. This project demonstrates that the impetus for export growth must come from inside the Kingdom. Annual credit growth slowedto 2.8% in 2016, down from 11% the year before. Deceleration is likely the result of the low oil price environment – outstanding business loans grew by only 0.1% last year, showing weak investor confidence. The central bank remains committed to a US dollar peg. As interest rates rise in the US, the cost of borrowing in Bahrain will increase despite austerity measures. Therefore, prudent SWF control (as in Mumtalakat’s 69.38% controlof Alba) will become even more critical to project stability and enhancing the viability of domestic exporters.

Today, with Mahmood Hashim al-Kooheji heading Mumtalakat, the Bahraini SWF is mainly focused on brokering secure deals that can lead to long-term growth in the non-oil sectors, chiefly education, healthcare, industry, and real estate. For example, last year Mumtalakat acquired an undisclosed equity stake in KOS Group, a Milano, Italy-based private healthcare company. In 2014, the Bahraini SWF acquired a minority stake in GEMS Education, a UAE-based international education company, which al-Kooheji recently stated will launch new schools in Bahrain and other Arab Gulf states. Currently, Bahrain Real Estate Investment (Edamah), which is one of Mumtalakat’s wholly-owned subsidiaries, has plans in place to sign a deal with Fairmont Hotels & Resorts to construct a luxurious resort in al-Jazayer with 215 rooms.ix

Breaking the cycle

The reemergence of civil unrest in Bahrain exacerbates Mumtalakat’s tenuous position. The government finances its deficit through a mixture of foreign and local debt. Fitch projects that foreign borrowing will reach nearly US$3.2bn this year and drop to US$2.2bn next year. Bahrain’s domestic situation is undoubtedly tense with scores of imprisoned activists, dismantled Shi’ite opposition societies and more Shi’ites resorting to militancy. Fitch cites “a severe deterioration of the domestic security situation” as a key factor that could lead to a negative rating, raising the cost of capital.x

Such deterioration would hamper Mumtalakat’s ability to access public markets and inculcate foreign investment. This could have vicious consequences because the government relies on its SWF to provide “jobs, absence of discrimination, and equal opportunity,” which are of primary concern for the average Shi’ite.xi Herein lies the perversity of Bahraini civil dissent. The government needs a profitable Mumtalakat to promote stability. Mumtalakat requires domestic stability to create profit. Unless Bahrain can alleviate rising tensions between state and citizenry, pernicious consequences will be self-reinforcing.

Theodore Karasik is the senior advisor at Gulf State Analytics (GSA), a Washington, DC-based geopolitical risk consultancy and Andrew Vought is a contributor to GSA













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