FACTBOX-Key political risks to watch in Bahrain

MANAMA Wed Oct 20, 2010 7:31pm IST

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MANAMA Oct 20 (Reuters) - Bahrain holds on Saturday a parliamentary vote that the Shi'ite Muslim majority doubt will win it greater representation in the country's decision-making, long dominated by the Sunni elite.

The government, led by the Sunni Muslim Al Khalifa dynasty, is tightly controlling the elections by making changes to voting districts that prevent the Shi'ite opposition from gaining a majority, fuelling Shi'ite suspicions that the decade-old country's reform process only served to co-opt them.

The United States and top oil producer Saudi Arabia see Bahrain, home to the U.S. Navy's Fifth Fleet, as a Sunni bulwark against neighbouring Shi'ite regional power Iran.

Bahrain's off-shore investment houses have been hit hard by a regional property crash and political influence on banking supervision could prevent foreign investors from assessing the full extent of the damage.

SHI'ITE UNREST

The Al Khalifa family rules over 1.3 million people, around half of whom are expatriates. The majority of Bahrainis are Shi'ites who complain of discrimination in government jobs, housing and health care, an accusation the government denies.

Shi'ites also want their government to stop granting Sunnis from outside Bahrain citizenship and jobs in the armed forces and national security services to try and change the demographic balance.

These issues lie at at the heart of deep-seated Shi'ite discontent, expressed in on-an-off unrest since the mid 1990s.

The Gulf Arab state's largest Shi'ite political group Wefaq, holding 17 out of 40 seats in the current assembly, is competing with Sunni Islamist groups and secular group Waad for parliament seats in a country whose stability is important for Washington.

Bahrain is a small oil producer that in the long-term needs to phase out subsidies and introduce taxes to reduce its fiscal deficit and stem infrastructure investments.

It will be hard for the government to push through economic reforms without granting more political participation in return.

The introduction of a new constitution and parliamentary elections a decade ago helped quell the Shi'ite unrest, but tensions have risen again in recent years as Shi'ites have been disappointed with the assembly's limited clout.

Regular night-time clashes between young protesters burning tyres and security forces have been limited to some Shi'ite villages, below the radar of the bankers working in Manama's commercial districts.

The protests have not had any impact on foreign investments or money inflows, but an anti-Shi'ite security crackdown ahead of the polls could make it harder for moderate groups such as Wefaq, the biggest Shi'ite bloc in parliament, to take part in future dialogue with the government.

During the crackdown some 23 men, including some Shi'ite clerics, were arrested and accused of plotting to overturn the political system in a coup, partly through instigating protests.

The government also said last month that it had arrested two people who it said had planned a series of car bombings. This would have been an escalation of violence, but details provided by the government were sketchy and could not be verified.

What to watch out for:

-A spread of street protests away from Shi'ite villages into the capital Manama and its commercial districts.

-The use of more sophisticated weapons than the fire bombs sometimes hurled at police cars.

-Any comment by Wefaq that would suggest the group is considering boycotting future elections.

IRAN CONFLICT

Gulf Arab states fear the rising regional influence of Shi'ite power Iran and share the suspicion of their Western allies that Tehran is seeking a nuclear weapons capability. Iran says it wants nuclear power only for electricity generation.

Observers say Iran's influence in the country is limited as Bahraini Shi'ites look to clerics in the more moderate centres of their faith in Iraq, such as Kerbala and Najaf.

The United States and Israel, Iran's main foes, do not rule out military action if diplomacy fails to end the nuclear row. The U.S. Navy large base in Manama would make Bahrain an obvious target for any Iranian retaliation.

Bahrain has very close political and commercial ties with its neighbour Saudi Arabia, a Sunni Arab power that is particularly wary of Iran.

The naval base in Manama allows Saudi Arabia to enjoy U.S. military protection of its oil installations and the Gulf waterways, on which its oil exports depend, without any controversial presence of Western troops on its ground.

What to watch for:

-Lack of progress in talks between Iran and the West.

-Any sign for a military strike against Iran.

ENERGY SUPPLY

Bahrain, like its Gulf Arab neighbours, has seen a rapid increase in natural gas consumption as its economy has grown with a petrodollar-fuelled boom in the region.

It consumed 1.3 billion cubic feet of gas per day in 2007 and expects consumption to rise to 2 billion cubic feet per day in about 10 years.

The country needs to close some of that gap through imports, but regional politics have burdened its talks with gas exporters, threatening its economic growth.

Aluminium Bahrain [ALNUB.UL] (Alba) plans to launch an initial public offering later this year and has had to postpone an expansion of its production capacity, partially due to the lack of energy.

Bahrain has held talks with neighbouring Qatar, the world's largest exporter of liquefied natural gas (LNG), but the recent reappearance of diplomatic tension between the two countries after settling a border dispute make any deal very unlikely.

Bahrain is also in talks with Iran to import 1 billion cubic feet of natural gas per day, but progress has been slow.

What to watch for:

-Lack of progress on talks with Iran over gas imports. They were halted for much of 2009 after an Iranian official made comments that appeared to question the country's sovereignty.

BANKING SYSTEM

Bahrain has established itself as a regional banking hub catering to the Gulf's oil wealth. Its banks hold assets of about $211 billion.

But its investment houses failed to build up sustainable revenue streams during the region's oil and property boom that collapsed in 2008 as they relied on fees raised on real estate and private equity projects, a market that has since collapsed.

Gulf Finance House GFHB.BH (GFH), a poster child for the sector during the boom years, has struggled to repay its debt as it could not sell its illiquid assets or find new income.

The Central Bank of Bahrain (CBB) was seen as a solid regulator in the region alongside the Saudi Arabian Monetary Agency (SAMA).

But bankers say the true extent of damage done to the sector is hidden from investors as the CBB is above all concerned with protecting the reputation of Bahrain as a banking hub and could shy away from sending companies into default.

They question in particular is whether the current valuations of investment houses' real estate portfolios reflect the property crash in 2008.

Some investment houses such as GFH have also partnered with Bahrain's ruling family in real estate projects on Bahrain's north coast, making conflicts of interest and political influence on banking supervision very likely, bankers say.

What to watch for:

-Any defaults of Bahraini investment houses.

-Whether or not the larger institutions such as GFH and Arcapita are able to find new revenue streams over the coming quarters.

* For political risks to watch in other countries, please click on [ID:nEMEARISK]

(Reporting by Frederik Richter; Editing by Samia Nakhoul)

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