The Economic and Environmental Impact of Large Financial Developments in an Oil-Dependent Economy: The Case of Bahrain

The Economic and Environmental Impact of Large Financial Developments in an Oil-Dependent Economy: The Case of Bahrain

Hanan Naser (American University of Bahrain, Bahrain)
DOI: 10.4018/978-1-7998-1196-1.ch013

Abstract

This study examines the economic and environmental impact of large financial developments in Bahrain from year 2006 to 2016. To do so, the relationship between energy consumption, oil prices, market shares, dividend yields, and economic growth has been investigated using Vector Error Correction Model (VECM). The key findings are summarized as follow: (1) Long run relationship exists between the suggested variables. (2) Both energy and financial markets are significant in the long run relationship, and positively affect the economic growth of Bahrain. (3) According to the estimated ECM term, the model is stable in the short run. (4) Decline in oil price has negative significant drawback on the economic growth of Bahrain. Accordingly, it is recommended that policy makers in Bahrain focuses on implement strong strategies that aim at encouraging investments in non-oil sectors without impeding energy sector or economic growth in order to move towards sustainability.
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Introduction

Since the discovery of oil in 1930s, the six Gulf Cooperation Council (GCC) countries including: Kingdom of Bahrain, Kingdom of Saudi Arabia, Kuwait, Oman, Qatar and the United Arab Emirates, have witnessed a considerable high rates of economic growth. Such growth did not only have the means to build the foundations of basic infrastructure, but also to improve the standards of living, levels of education, life expectancy and lower rates of poverty. Although many economists attribute this growth to several factors, oil revenues played the key role as its benefits covered the entire Arab world and not only the GCC countries due to the appearance of alternative forms of energy (such as wind, water, and solar power). Nevertheless this, the importance of oil exceeds economic aspects and affects social life in general. Thus, the prevailing view among economists is that there is a strong relationship between the growth rate of a country and oil-price changes. Precisely what form this relationship takes, and how it might be modified, and other such questions are issues of outstanding value. Accordingly, the subject of oil price-economic growth relationship has become an interesting subject for many researchers. It has been proved that various transmission channels exist through which oil prices may have an impact on economic activity (Balke, Brown, and Yücel (2002)(Brown & Yücel, 2002), (Lescaroux & Mignon, 2008) or (Lardic & Mignon, 2006) among others). These consequences are expected to be different in oil importing and in oil exporting. Whereas an oil price increase should be considered good news in oil exporting countries and bad news in oil importing countries, the reverse should be expected when the oil price decreases.

On the other hand, although the financial developments are considered as an important factor for sustainable growth, the financial system in the GCC was tightly regulated and protected from foreign competition by keeping relatively high levels of government controls over the banking and financial system. While those financial and regulatory policies were aimed at providing stability to the financial system, they had their negative effects on the financial system’s competitiveness and efficiency.

Looking at the case of oil exporting countries like the GCC, where both oil prices and investments are matter, it has been noticed that there is an adverse impact of the hikes of oil prices on investments as the firms’ costs are consequently increase. In addition, changes in oil prices do not only affect the supply and demand, but also influence inflation, foreign exchange and stock markets.

As in most GCC countries, Bahrain's economic growth has been strongly influenced by the fluctuations in oil and gas prices in international markets. This reveals Bahrain's economic dependence on its oil sector even though it is considered as the least oil dependent compared to its regional peers. Bahraini growth rates have generally followed a similar path to Saudi growth rates but have been less volatile because of huge gaps in oil and gas production and reserve between the two countries. Precisely, Bahrain’s oil and natural gas production and sales create about 85% of the Bahraini government revenues. Oil is about 70% of government revenues and about 60% of export revenues.

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