In April 2003 the Bahraini Government broke Batelco’s monopoly in telecommunications by awarding a mobile phone operating license to MTC-Vodafone, a joint venture between MTC of Kuwait and the United Kingdom’s Vodafone. MTC-Vodafone begins operations early next year. By the time that happens, the Bahraini Government will have awarded licenses in just about every other sector of the telecommunications industry, from Internet services to fixed lined telephony.

Do not underestimate the significance of this move. Bahrain is the first Gulf country to open its telecommunications sector to foreign competition. Even the UAE, by many measures the most liberal country in the region, has categorically refused to allow foreign (or for that matter domestic) competition in the communications sector.

Why is this so important? Because over the past three decades, the telecoms industry has emerged as the definitive bellwether of economic liberalization. Time and again in country after country, it has proved to be the catalyst for sweeping changes in the business climate. Bahrain’s telecoms revolution epitomizes the changes that are transforming Bahrain’s business architecture. The reality on the ground is that the cold winds of competition are sweeping away the bad habits of the past. It is coming down to fundamentals: service, ability to cut costs, a good product.

Is this change good news for the Bahraini economy? Or will local companies be forced out of business by a wave of leaner, larger global competitors? The early indicators are promising. The Bahraini economy is booming, profits of established local companies are soaring, and a new spirit of entrepreneurship is gripping the country, with business start-ups appearing every day.

But there are underlying risks that must not be ignored. The current boom is underpinned by three factors that cannot be sustained indefinitely: high public spending, high oil prices and low interest rates. The question is can this boom be sustained once one or more of these stimulants dries up?

GDP growth rates on this scale are not uncommon in the Gulf—wild fluctuations in oil prices and output among major oil producing nations such as Kuwait and Saudi Arabia make them a fact of life. Bahrain stands out because its strong recent performance is not a function of oil markets. Rather, it is based on solid, domestic fundamentals.

It is believed by some experts that Bahrain is one of the most diversified economies in the region. In terms of its vulnerability to oil price shocks, it is pretty well protected. GDP growth volatility is one of the lowest in the region. You don’t get the big swings that you get in some of the Gulf States.

A large increase in public spending is underpinning the current upswing. The government has taken a strategic decision to boost investment spending in the short term in a bid to build the infrastructure and cash-generating industries needed to support the country in the medium and long term.

Crucially, this public investment spending is translating into real profits for Bahraini companies. The benchmark Bahrain Stock Exchange (BSE) index has risen some 10% this year, closing at 2,054 points on 11 September 2003. That’s a healthy gain, but it masks the full extent of the country’s stockmarket success; which should be more like 20-30% across the board.

Bahrain’s economy has performed well in recent years due to relatively high world oil prices, increasing volumes of non-associated natural gas, and robust growth in non-hydrocarbon sectors. In real terms, GDP expanded on average by an estimated five per cent annually in 2000-02, while the non-hydrocarbon sectors grew by a slightly faster 5.2% per year over the same period. "Growth has outpaced population growth, thereby raising per capita incomes.

Despite significant progress diversifying the economy away from oil and gas, hydrocarbons remain the mainstay of the economy. Oil and gas account for around 20% of GDP, 68% of merchandise export receipts, and more than 60% of budget revenue. Moreover, government services, which are financed largely by oil proceeds, account for 21% of non-hydrocarbon GDP.

The growth of non-oil sectors has not translated into higher budgetary revenues due to the absence of a developed tax system. This is unlikely to change much going forward due to official concerns that broadening the tax base would erode Bahrain’s competitive position in the region. Public finances, external accounts, and much of the real economy are therefore vulnerable to fluctuations in oil prices.

One of Bahrain’s most pressing weaknesses is unemployment. The precise level of unemployment is not clear, but it is estimated at well in excess of 10%. The unemployment situation in some sectors of society is an issue. If you look at the demographics, around 40% of the population is below 15 years of age. They have got to find jobs for these people, but they are going to enter a situation where there is already high unemployment. And if you look at some of the industries they are investing in, such as aluminum, these are capital-intensive but labor-light.

What is being seen is a growth in entrepreneurs. People are thinking ‘we can get in here’. They can spot an angle; spot a niche that hasn’t been developed. We are seeing it even with large established family firms. They are looking for anything a bit different that their competitors are not doing in the market; spotting an extra service that could be provided.

There are a lot of small companies just starting up. That is very nice to see—someone putting their own capital at risk, and working hard to make something a success. They cross industry sectors. Small industrial is one area, but also the service sector.

In particular, Bahrain is witnessing a surge in niche downstream activity relating to its large industrial sectors, such as aluminum. Entrepreneurs are spotting opportunities to add another link to the value chain. People have built up the expertise, working for these large companies over a number of years. Now they are looking to leverage that expertise as entrepreneurs.

It’s a similar story in financial services. In particular, Bahrain is emerging as a global center for innovation in Islamic finance. The government is taking a lead, through the Bahrain Monetary Agency by helping to establish the world’s first Islamic money market. This is presenting a number of opportunities in the private sector. We are continuing to see the increase in Islamic banking; that is encouraging a number of budding entrepreneurs.

Bahrain’s domestic banking sector enjoyed a strong first half of 2003. A host of factors contributed to the sector’s impressive performance, including low interest rates and strong domestic economic growth.

"Margins for banks improved quite a bit," says Shahid Hameed, head of asset management at SICO. Commercial banks have benefited because spreads have increased substantially. Lending rates have not decreased as much as cost of funding. Also, with interest rates lowering, loan demand increases. At the same time, asset quality improves. So you have three factors: margins have increased; demand has increased and asset quality has improved.

Bahrain-based Ahli United Bank (AUB) reported 2003 first-half net profit up 51% on the same period last year, to $49.4 million. This strong result has been achieved through the over performance of AUB’s retail, corporate and Treasury activities. It has been assisted by a continuing favorable interest rate environment as well as by successful proprietary transactions.

National Bank of Bahrain saw net income rise 14% to BD 13.2 million for the first six months of 2003. Profit at Bank of Bahrain and Kuwait rose 16% to BD 11.9 million. However, some of the country’s offshore investment banks continued to suffer the fallout from the bursting of the U.S. securities bubble in 2000. In early September, ratings agency Moody’s Investors Service withdrew its rating of Bahrain International Bank and BMB Investment Bank after they failed to file financial results. Both banks have been in default for around a year; they defaulted on their loans after recording heavy losses on U.S. and European investment portfolios.

There was better news for the country’s larger investment banks. The recovery in the U.S. and European markets saw half year operating income at Arab Banking Corp. increase to $157 million for the first half of the year, 16% higher than the $135 million generated in the first half of 2002. Investcorp also claimed to have performed well during the period, although changes in the bank’s financial reporting structure make direct, year-on-year comparisons difficult.

Perhaps the most impressive of Bahrain’s slew of mega-projects currently being undertaken is the billion-dollar Bahrain Financial Harbor (BFH). Futuristic in appearance and pragmatic in application, BFH is far more than a glamorous real estate project. In the worlds of Prime Minister Sheikh Khalifa bin Salman Al Khalifa, BFH aims to create a "harmonized and sophisticated climate for a futuristic financial environment that will be based on the latest and most modern finance-related infrastructure".

As a financial city, BFH will be the first of its kind in the Middle East. With a site area of 202,272 square meters totally reclaimed from the sea, BFH will be located at Manama’s Old Harbor and will expand eastward, westward and into the sea. BFH will comprise a community of financial institutions, investment companies and corporations; will house institutions operating in capital and retail banking markets, asset management and insurance; and will also provide residential accommodation and leisure facilities.

While the Bahrain Government has taken a keen interest in the Harbor, it only has a minority share in the project. As a private sector initiative, the major shareholders are Qatar Islamic Bank, Dubai Islamic Bank, Shamil Bank of Bahrain and Gulf Finance House, who have agreed in principle to finance between $150 million and $200 million of the development at this stage.

On a grander scale, BFH represents an unprecedented opportunity for Bahrain’s thriving financial services sector to flourish. The development will add a new cohesion and professionalism to the sector—the largest contributor to Bahrain’s GDP. BFH will offer Bahrain a platform to build on its dominant regional position in finance and banking.

In this regard, the country’s skilled, indigenous pool of financial talent could prove critical. One of Bahrain’s key defining factors is that it has a national workforce with decades of experience in financial services. It doesn’t need to import financial service professionals from abroad. That makes a huge difference. If the financial companies want to hire staff, there are plenty of Bahrainis who have worked in that sector.

Internationally, new trading opportunities are opening up all the time for Bahraini exporters. The biggest story on this is the proposed Free Trade Agreement with the United States. The signing of the agreement led to remarkable export performance for Jordan. It will certainly help Bahrain in manufacturing. One thing that is unclear is how that is going to work with GCC customs union.