Economic challenges due to fall in oil prices

Bahrain is facing economic challenges arising from the drop in oil prices and weak global economic indicators. The general consensus is that this negative environment is likely to continue over the medium term.  

In this difficult environment the government has started using fiscal policy in an effort to bridge the budgetary gap by reducing subsidies and increasing taxes. This is likely to give rise to inflationary pressures as individuals and organizations come to terms with their increased costs.  

Bahrain maintains a fixed exchange rate against the US dollar. When a small country such as Bahrain ties its exchange rate to a larger country’s currency, it limits its options in terms of its monetary policy. Increase in the US dollar interest rates will tend to reflect in an increase local interest rates in the Bahraini economy due to this peg. Increased interest rates could lead to a decline in investment appetite in the economy. 

In order to counteract this, it is essential for the Central Bank to manage its monetary policy. The goal of monetary policy is to drive the economy, through changes in the money supply of the country, to an output level with positive economic growth, full employment and stable prices. 

The continuing use of an expansionary monetary policy by maintaining low interest rates would have a big effect on the economy as it will have an of lowering yields on bonds and creating cheaper borrowing for banks. This, in turn, boosts banks’ capacity to lend to individuals and businesses, thus lowering unemployment rates and allowing the economy to increase economic growth.

The Central Bank can also consider quantitative easing, whereby it purchases government securities or assets from banks in order to increase the supply of money in the economy thus driving down the interest rates making the cost of investment for businesses cheaper. 

Recently, the rate of 63 percent of government debt is estimated to increase further in 2016. With the aid of expansionary monetary policy, low nominal interest rates as well as low inflation will help reduce the debt to GDP ratio.  

Therefore Bahrain would need to balance its fiscal pressures with an expansionary monetary policy to maintain its goals for a stable economy and to a higher level of GDP.