Moody's Investors Service said they have placed Bahrain's A3 government bond ratings on review for possible downgrade.

Today's rating action was motivated by Moody's concern that the ongoing political turmoil in Bahrain has sharpened fiscal and broader economic downside risks.

The review will focus on the degree to which political risk has structurally increased and how significantly the credit fundamentals of Bahrain are threatened relative to rating peers.

Moody's has also placed under review for possible downgrade the following sovereign ratings of Bahrain: (1) the A1/P-1 country ceilings for foreign currency bonds, the A3/P-1 country ceilings for foreign currency bank deposits; (2) the Aa3 country ceilings for local currency bonds and bank deposits; and (3) the Aa3/P-1 ceilings for the bonds and deposits of Bahrain's wholesale banks.

Moody's expects to conclude the ratings review within three months. Barring an extreme outcome to the political unrest, Moody's expects Bahrain's ratings to remain within investment grade.

Moody's decision to place Bahrain's ratings on review for downgrade was triggered by the large anti-government protests in the country in recent weeks.

Moody's believes that efforts by the authorities to appease discontent are likely to lead to further increases in government expenditure. However, even before the recent turmoil, Moody's had already expressed its concerns about the loosening direction of the country's public finances, as reflected in the downgrade of Bahrain's government bond ratings to A3 from A2 in August 2010. The primary driver of this downgrade was the gradual rise in the breakeven oil price of Bahrain's budget.

The government's expansionary budget for 2011 and 2012, which was published in January this year (before the recent outbreak of unrest), requires a breakeven oil price of between $97 and $100 per barrel - a high level compared with other oil exporters rated by Moody's. Unlike other oil exporters in the region, Bahrain is not known to have a significant sovereign wealth fund of offshore financial assets that could potentially be liquidated to support the budget or broader economy in a crisis. Moreover, Bahrain's hydrocarbon reserves are relatively limited.

Moody's also remains concerned about the large size of Bahrain's banking system relative to the government's resources. Total bank assets amount to around 11 times GDP, with assets of retail banks alone amounting to over three times GDP. The potential liabilities stemming from the banking sector in a systemic crisis could therefore present a significant challenge to the authorities, notwithstanding mitigating factors.

Moody's recognises that the wholesale banks have limited ties to the domestic economy and that some are owned by regional governments that have previously stepped in to support these institutions. The rating agency also notes that banks in Bahrain tend to have high levels of capital adequacy and liquidity which would limit the extent of support needed should their condition significantly deteriorate. The foreign operations of retail banks would also be likely to receive support from the respective governments of the countries in which they operate.

Moody's is keen to stress the positive factors that support Bahrain's sovereign ratings. These include a substantially positive net international investment position (as per the latest data for the end of 2009), a current account surplus, a typically dynamic non-oil sector and a high (albeit volatile) level of GDP per capita. Furthermore, Bahrain has strong international relations that should ensure external financial support, if needed. Moody's would expect Saudi Arabia to be especially supportive in case of need.

Moody's last rating action affecting Bahrain was implemented on August 23, 2010, when the government's bond ratings were downgraded to A3 from A2.-TradeArabia News Service