Capital flight threatens Bahrain, pressurises currency

Kingdom is the first Arab banking hub to be hit directly by the political instability sweeping across the Middle East
Capital flight threatens Bahrain, pressurises currency
(Getty Images)
By Reuters
Thu 17 Mar 2011 12:52 PM

Capital
flight from Bahrain is starting to pressure its currency and threaten its
position as a Gulf financial centre, though it looks likely to avoid a
full-blown currency crisis for now.

The small
non-OPEC oil producer, where nearly $10bn in mutual funds was parked last year,
is the first Arab banking hub to be hit directly by the political instability
sweeping across the Middle East and North Africa.

It is
struggling to contain its worst unrest since the 1990s after majority Shi'ite
protesters took to the streets, prompting Saudi Arabia to send in troops in an
effort to restore order. As many as six people were killed on Wednesday.

The central
bank's tight control over the foreign exchange market, and the possibility of
other Gulf countries providing financial support to prevent market turmoil from
spreading, mean Bahrain is unlikely for the foreseeable future to have to
abandon the dinar's peg against the US dollar.

"A
normal reaction to the ongoing downgrades by credit rating agencies would be
outflow of short-term capital from the country, but different from other
examples, possible financial helplines from other GCC (Gulf Cooperation Council)
countries are an alleviating factor," said Kubilay Ozturk, EMEA economist
at Deutsche Bank in London.

But bankers
said there had been substantial outflows of funds from Bahrain this week. On
Wednesday, banks in Manama's financial district closed down, the central bank
operated from an alternate location and the stock market stopped trading.

Bahrain,
home to a $66bn Islamic finance industry, has faced several downgrades by debt
rating agencies since protests started in February, and the cost of insuring
its sovereign debt has hit 20-month highs.

Fitch
Ratings on Tuesday slashed its sovereign credit rating of Bahrain, which has
postponed a $1bn government bond issue, by two notches to BBB, citing political
risks.

The scale of
capital outflows from the smallest Gulf economy of 1.2 million people is hard
to estimate because of a lack of timely data.

The
experience of Egypt is modestly encouraging for Bahrain; when commercial banks
reopened in Egypt in February after political unrest, the central bank was prepared
for an immediate outflow of $8-10bn from Egyptian pounds, but only about
$1.7bn was transferred out on the first day and about $1bn on each
of the next two days.

But
anecdotal evidence suggest substantial sums have already been moved out of
Bahrain, whose banks hold assets of about $200 billion.

One banking
source, speaking on condition of anonymity, estimated 15 to 20 percent of
deposits and investments of high-level Bahraini citizens in private banks had
been withdrawn over the past few days.

"A lot
of clients are pulling out their money, they're moving it to London, Europe,
wherever. It's not a question of taxes, but of access to their money,"
another banker from the region said.

"One
client pulled out $30 million in a matter of days. With banks closed, movements
are limited -- we will see the rush when they reopen."

While nearby
Qatar and the UAE could receive the fund flows, as they have
so far escaped political protests and have small local populations pampered by
petrodollars, some bankers said they would just be temporary stops for the
funds.

"In at
least two or three banks, the bulk of the clients have shifted their money
abroad," a banker said.

"Some
are moving it through the Emirates, then on to other centres. It makes the
transaction less remarkable, as moving a big chunk of money from Bahrain to,
say, London would raise eyebrows in this climate."

Should the
political crisis drag on, even long-term investors may start to consider
relocating their capital, seriously undermining Bahrain's status as a financial
hub where foreign claims on banks amount to 92 percent of gross domestic
product.

"The
type of money Bahrain was receiving is long-term money," said John Sfakianakis,
chief economist at Banque Saudi Fransi. "If uncertainty continues over
several months and people take out a lot of money, it will have a deep negative
impact."

The dinar
briefly weakened away from the 0.376 peg to the dollar on Wednesday, dropping
as far as 0.37716, but it soon bounced back as the central bank intervened to
supply dollars.

Although the
central bank had net foreign assets of just $4.7 billion at the end of October
2010, many analysts said its reserves would be enough to see off any threat to
the peg, especially because the peg system helps the central bank to influence
trade.

"We do
not expect pegs to be broken. It would create a bit of precedent in the region
and many central banks and authorities across the GCC have been priding
themselves on keeping the pegs unchanged," said Bartosz Pawlowski, head of
strategy for the region at BNP Paribas in London.

"In
order to have a pressure on the peg you need to have a really functioning
market. The risks as we stand are minimum."

If necessary,
Saudia Arabia might use its resources to defend Bahrain financially, just as it
is physically deploying its troops, analysts said.

"Bahrain
has foreign reserve resources to support the currency and at the very end of
the day even if there were pressures, Saudi Arabia and GCC would likely
alleviate pressure through further financial assistance," said Farouk
Soussa, Middle East chief economist at Citi in Dubai.

Bahrain,
which needs crude oil prices as high as $97 per barrel to be able to balance
its budget, is set to receive $10 billion from its wealthier Gulf neighbours to
upgrade housing and infrastructure over 10 years.

However, a
tumble by the Bahraini dinar in the forwards market on Wednesday suggested what
might happen to the currency if authorities did not maintain consistent
support. The forwards briefly implied dinar depreciation of about 0.9 percent
in one year's time, before they bounced back in response to the central bank
intervention.

 

 

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