The Bahraini dinar (BHD) is the official currency of the Kingdom of Bahrain. It is divided into 1000 fils and is pegged to the United States dollar at a rate of BHD 0.376 = USD 1. The dinar was introduced in 1965, replacing the Gulf rupee at par. Since then, the BHD has been one of the highest valued currency units in the world.

History of the Bahraini Dinar

Origins and Introduction

The origins of the Bahraini currency can be traced back to the early 20th century when the Indian rupee was the main currency used in the Gulf states including Bahrain. After India’s independence in 1947, the Gulf rupee was established by the Reserve Bank of India to replace the rupee. The Gulf rupee was pegged to the British pound at a rate of 13 rupees = 1 pound.

In 1959, the Reserve Bank of India devalued the Gulf rupee, triggering the introduction of distinct national currencies by Qatar and Dubai. On October 5, 1965, the Bahrain Currency Board introduced the Bahraini dinar to replace the Gulf rupee as the official currency of Bahrain. The dinar was equivalent to 10 rupees and initially pegged to the British pound at BD 0.3750 = GBP 1.

Breaking the Sterling Peg

The dinar remained pegged to the British pound until the UK devalued the pound on November 18, 1967. This caused the dinar’s value to fall in lockstep. To avoid further depreciation, the government of Bahrain decided to delink the dinar from the pound and peg it to the International Monetary Fund’s special drawing rights (SDR) basket of currencies.

In 1971, the BHD was briefly pegged to the U.S. dollar at BD 0.3780 = USD 1. However, when the dollar was devalued in 1973, the peg shifted once again to a trade-weighted basket of currencies.

Adopting the USD Peg

By 1980, most trade from Bahrain was being conducted in U.S. dollars, outweighing the basket of currencies. Thus, the government repegged the BHD to the USD at a new fixed exchange rate of BD 0.376 = USD 1. This peg has remained unchanged for over 40 years, making the Bahraini dinar one of the most stable currencies in the world.

Coins and Banknotes

Coins

The Bahrain Monetary Agency (now called the Central Bank of Bahrain) issued the first coins denominated in 5, 10, 25, 50 and 100 fils in 1965. The original coins bore the name of the previous currency – Gulf rupees.

In 1970, new coins were introduced bearing the name Bahraini dinars, with the same denominations of 5 to 100 fils. Additional 500 fils coins were also minted from 1977 to 1980. In 1992, a new coin series was launched, including 5, 10, 25, 50, and 100 fils. A 1⁄4 dinar coin was introduced in 1998.

The current standard circulating coins in Bahrain are the 5, 10, 25, 50, 100 and 500 fils. The coins have distinct shapes, sizes and metal compositions making them easy to identify. The lower denominations are generally minted from aluminium while the 100 and 500 fils coins contain copper, nickel and zinc.

Banknotes

The Bahrain Monetary Agency printed the first series of Bahraini dinar banknotes in 1967 in denominations of 1⁄4, 1⁄2, 1, 5 and 10 dinars. The Central Bank of Bahrain took over the issuance of banknotes in 1973. It has since released modified note designs over the years, with the latest series launched in 2017.

The current banknotes in circulation are the 1⁄2, 1, 5, 10 and 20 dinar notes with predominantly purple, green and brown hues. The front of the notes features illustrations of the Bahrain World Trade Centre, King Faisal bin Salman Al Khalifa, and the national bird – the bulbul. The reverse displays images showcasing Islamic motifs and Bahraini heritage sites.

Advanced security features such as holographic strips, anti-copy designs, watermarks, microprinting and tactile marks have been incorporated to deter counterfeiting. The higher value 10 and 20 dinar notes also have Braille identification marks for the visually impaired.

Monetary Policy and Regulation

Central Bank of Bahrain

The Central Bank of Bahrain (CBB) is the sole independent government entity responsible for maintaining monetary and financial stability in the Kingdom of Bahrain. It was established in 2006, taking over the functions of the Bahrain Monetary Agency that had operated since 1973.

The CBB exercises a number of regulatory and supervisory powers over monetary policy, the banking sector, and the financial services industry in Bahrain. Its primary objectives are to foster economic growth, issue legal tender, oversee payment systems, set interest rates, manage gold and currency reserves, and promote price stability in the Kingdom.

Currency Peg

The most essential function of the Central Bank of Bahrain is to maintain the currency peg of 0.376 Bahraini dinars per 1 U.S. dollar. This fixed exchange rate policy has been in place since 1980 to provide stability and confidence in the Bahraini dinar.

Over the years, the CBB has successfully defended the peg through foreign exchange interventions, adjusting interest rates, and implementing prudent reserve management. It holds substantial U.S. dollar assets to maintain the BD’s 1:1 convertibility with the dollar.

Financial Regulation

The Central Bank of Bahrain regulates the entire banking and financial services sector. Its regulatory framework and supervisory policies align with international best practices to ensure robust institutions, consumer protection, and systematic stability. The CBB oversees 4 main areas:

  • Conventional retail and wholesale banks
  • Islamic banks
  • Specialized institutions like money changers, brokers, leasing firms
  • The insurance sector

By developing the regulatory regime and fostering innovation, the CBB aims to establish Bahrain as a major international financial center.

Benefits of the Bahraini Dinar

Stability

The Bahraini dinar’s fixed peg to the U.S. dollar provides unmatched stability compared to most currencies. Being pegged to the world’s reserve currency insulates it from volatile currency fluctuations driven by macroeconomic forces. The BHD is far less susceptible to depreciation and instability.

Purchasing Power

While the dinar’s value is nominally among the highest globally, its actual purchasing power is equivalent to the U.S. dollar. Goods and services in Bahrain are priced in line with dollar rates. However, the higher face value gives the perception of greater worth.

Convertibility and Transferability

The legal 1:1 convertibility between BHD and USD enables easy conversion between the currencies. The dinar is highly transferable with no restrictions on exchanging or transferring funds freely in and out of Bahrain.

No Transaction Costs

The fixed exchange rate eliminates foreign exchange conversion fees and hedging costs associated with transactions in other currencies. It provides transaction cost savings for both citizens as well as entities dealing with Bahrain.

Trust and Confidence

The Bahraini dinar garners significant public trust and confidence domestically as well as in the Gulf region due to its stability. The currency is well regarded globally by central banks, investors, and institutions.

Challenges Facing the Bahraini Dinar

While the BHD provides major advantages, the currency also faces some structural challenges.

Dollar Dependency

The rigid peg to the dollar implies that monetary policy in Bahrain cannot be independent. Interest rates and money supply have to mirror the stance of the U.S. Federal Reserve to maintain the peg. This dependence makes the BHD vulnerable to dollar volatility.

Inflation Constraints

The currency board arrangement restricts the ability to contain imported inflation. As a net importer, inflationary pressures from abroad directly transmit to Bahraini prices. Responding with policy adjustments is difficult without threatening the peg.

Loss of Competitiveness

Occasional mismatches between U.S. and Bahraini economic conditions can lead to loss of external competitiveness. During periods of diverging growth, the BHD may become over or undervalued impacting the Kingdom’s trade balance.

Financial Sector Risk

Bahrain’s fixed exchange rate reduces FX risk but introduces interest rate risk. Sudden rate hikes by the Fed can destabilize local banks and institutions saddled with dollar-denominated liabilities. This causes systemic risk.

Reserve Requirements

To robustly back the currency peg, the CBB must continually maintain adequate foreign exchange reserves. This necessitates prudent reserve management and restrictions on capital outflows from Bahrain.

Outlook for the Bahraini Dinar

Prospects for Continued Stability

The currency board regime has served Bahrain exceptionally well over the past 40+ years. Despite the challenges, the institutional framework and reserves provide stability. The currency peg seems poised to persist given its benefits.

Financial Sector Deepening

Bahrain aims to build its role as a leading financial services hub in the Middle East. With the CBB fostering fintech innovation, digital banking, and regulatory reforms, the BHD will bolster growth in the banking and insurance sectors.

New Trade Partnerships

Expanding trade ties with China, India, Africa and neighbors via the GCC and other pacts will accelerate growth and offset over-reliance on dollar or oil prices. This will strengthen and diversify the Bahraini economy over the long-term.

Managed Liberalization

While a free float is unlikely soon, incremental relaxation of certain foreign exchange controls may occur. This can enhance flexibility without disrupting the peg. Gradual liberalization prepares the economy for more alternative scenarios.

Conclusion

In summary, the consistent four-decade dollar peg has served the BHD remarkably well by engendering stability. Although not without its challenges, the future of the dinar looks reasonably assured in the medium-term given its entrenched status. Sustaining reserves and prudent monetary policies will be key going forward. With apt financial reforms, the BHD can propel Bahrain’s ambitions to become a banking and fintech leader regionally and globally.