Statements by the Bahraini government to reduce its fiscal deficit and contain the rise in debt signal a renewed determination to improve its government finances, said a report released by Moody's Investors Service.

The presence of various challenges, including the limited scope for additional revenue generation and popular pressure to increasing current spending, will likely, however, dictate a gradual pace of improvement, the report added.

Moody's said that under its base scenario, Bahrain's fiscal deficit will widen and debt-to-GDP levels -- already above the Baa-rated median and higher than for any other Gulf Cooperation Council member country -- will continue to mount in 2014-15, adding to pressure on the sovereign's creditworthiness.

Moody's reached its conclusions in a just-released Credit Focus, titled, "Bahrain Indicates Will to Tackle Fiscal Challenges". Bahrain is rated Baa2 with a negative outlook.

The report said that the scope for generating additional government income is limited because of a narrow tax base and limitations to local oil production. Hydrocarbons accounted for 85.6 per cent of total income in 2013.

At the same time, the government is under pressure to further increase current spending to maintain public support, despite an abatement in social tensions, according to the report.

The 2014 budget envisages a 4.4 per cent increase in recurrent expenditures following a 14.0 per cent rise in 2013. Furthermore, Moody's expects reforming the country's subsidy system to proceed only gradually.

Moody's noted that the government's announcement in August is not the first time that the authorities have publicly expressed their concern over the country's fiscal challenges and they recognize that the country's public sector-powered growth model is unsustainable.

Bahrain's public finances have deteriorated since 2008, in large part driven by public unrest in 2011, and the weakening in the government balance sheet has been the key factor behind Moody's sovereign rating downgrades, from A2 in 2009 to Baa2 now.

In addition to government debt, Moody's noted contingent liabilities stemming from the wider public and private sectors.

However, the rating agency believes the risk that these will crystallize on the government's balance sheet has diminished recently. First, the government's investment fund, Mumtalakat (unrated), which experienced five consecutive years of losses from 2008 to 2012, turned a small profit in 2013.

Second, the size of Bahrain's retail banking sector has shrunk, from 2.5 times GDP in 2008 to about 2.3 times in 2013, and Moody's recently changed its outlook for the domestic banking system to stable from negative. - TradeArabia News Service