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Fitch Downgrades Bangladesh’s Long-Term Foreign-Currency Rating to ‘B+’

Fitch Ratings has downgraded Bangladesh's Long-Term Foreign-Currency Issuer Default Rating from 'BB-' to 'B+', maintaining a Stable Outlook. The complete list of rating actions is provided at the end of this commentary.

Key Rating Drivers:

Downgrade Reflects Weakening External Buffers: The downgrade to ‘B+’ is due to Bangladesh’s sustained weakening of external buffers, despite recent policy reforms. These vulnerabilities could make the country more susceptible to external shocks. Measures taken since early 2022 have failed to stop the decline in foreign exchange reserves and alleviate domestic dollar shortages. The adoption of a crawling peg exchange rate aims to enhance flexibility, but its effectiveness in correcting market distortions and rebuilding reserves remains uncertain.

Stable Outlook: The Stable Outlook is supported by Bangladesh’s favorable external creditor composition, IMF-programme reforms enhancing macroeconomic stability and addressing banking sector weaknesses, moderate government debt, and promising medium-term growth prospects.

Weak External Buffers: Foreign exchange (FX) reserves have significantly decreased due to continued FX interventions, capital outflows, and reliance on informal remittance channels. Reserves have dropped by 15% since January 2024, standing at USD18.4 billion. Reforms are expected to stabilize reserves, but the implementation of the new FX regime and its alignment with the parallel market rate remains uncertain. The Bangladesh Bank considers the crawling peg a temporary measure before adopting a fully flexible market-based exchange rate, a shift complicated by persistent high inflation (9.8% in April 2024).

FX Rationing: Domestic US dollar scarcity has led to import restrictions, managed by authorities. Lower imports and sustained export growth have resulted in a current account surplus estimated at 1.4% of GDP for the fiscal year ending June 30, 2024 (FY24). Increased FX flexibility should alleviate US dollar shortages, potentially increasing imports in the coming years, while formal remittance channels may see a boost due to better alignment between official and parallel market exchange rates.

High Inflation: High inflation is expected to persist due to domestic supply shortages, import restrictions, and a weaker exchange rate. Inflation averaged 9.7% in FY24, exceeding the central bank’s target of 7.5%, despite a 200 basis point hike in the policy rate. The removal of interest rate caps for banks and non-bank financial institutions (NBFIs) may improve monetary policy transmission.

Long-Term Foreign-Currency IDR Factors:

Low Government Revenues: Bangladesh’s low general government revenue-to-GDP ratio remains a fiscal weakness. At 8.2% of GDP, it is significantly below the ‘B’ median of 19.5%. Revenue continues to underperform due to tax exemptions, weak tax administration, and challenges in implementing tax reforms. Several tax reforms are planned under the IMF programme, with measures such as tax hikes on tobacco and land registration already implemented, posing an upside risk to revenue forecasts.

Favorable Debt Composition: Bangladesh’s medium-term external debt is primarily owed to bilateral or multilateral partners, ensuring ongoing debt service capacity despite US dollar shortages. Projected external debt service is low compared to peers, averaging about 9.2% of current external receipts over 2024-2025, against a ‘B’ median of 20%. The IMF programme, agreed in January 2023, supports continued access to multilateral and bilateral financing, contingent on meeting programme targets.

Favorable Growth Prospects: The medium-term growth outlook is positive, driven by the established ready-made garment sector, demographic advantages, and stable remittance inflows. However, near-term growth is expected to moderate to 5.3% in FY24 due to the US dollar shortage and high inflation impacting investment and consumption.

Government Debt Below Peers: Gross government debt is expected to increase gradually to about 40% of GDP over the medium term, from about 36% in FY23, still below the current ‘B’ median of 55%. Fiscal risks include budget underperformance due to revenue shortfalls, high borrowing costs, banking sector forbearance measures, and potential contingent liabilities from state-owned enterprises.

Weak Banking Sector: Banking sector metrics, including asset quality, capitalisation, and governance, are weak, particularly in public-sector banks. The non-performing loan ratio was 9% at end-December 2023, with state-owned banks at about 21%. These ratios could rise once forbearance measures are withdrawn. The banking sector could pose a contingent liability if credit stress intensifies. Removing lending rate caps on banks and NBFIs is a significant step towards improving profitability.

Weak Structural Metrics: Bangladesh ranks in the 21st percentile on the World Bank’s composite governance score, below the ‘B’ median of 33rd percentile. Foreign direct investment is hindered by infrastructure gaps, though upcoming government projects may increase investment. The Awami League’s strong political position following the January 2024 general election supports the implementation of its agenda focused on poverty reduction, infrastructure development, climate resilience, and achieving upper middle-income status by 2030.

ESG – Governance: Bangladesh has an ESG Relevance Score of ‘5’ for Political Stability and Rights, as well as for Rule of Law, Institutional and Regulatory Quality, and Control of Corruption. These scores reflect the high weight of the World Bank Governance Indicators (WBGIs) in Fitch’s Sovereign Rating Model. Bangladesh’s low WBGI ranking in the 21st percentile indicates weak political participation, institutional capacity, rule of law, and high corruption levels.

Rating Sensitivities:

Negative Rating Action/Downgrade:

  • External Finances: Increased external vulnerability due to a significant decline in FX reserves or other liquidity buffers.
  • Public Finances: Higher fiscal deficits or financing stress driven by increased interest/revenue ratios or failure to significantly increase government revenue.

Positive Rating Action/Upgrade:

  • External Finances: Reduced external vulnerabilities through credible exchange-rate policies supporting sustained FX reserves build-up.
  • Public Finances: Structural increase in fiscal revenue collection aiding fiscal consolidation and improving the interest/revenue ratio.
  • Structural: Significant improvements in institutional capacity and measures addressing economic vulnerabilities, such as enhanced bank asset quality and capitalisation.

Sovereign Rating Model (SRM) and Qualitative Overlay (QO): Fitch’s proprietary SRM assigns Bangladesh a score equivalent to a ‘BB-‘ rating on the Long-Term Foreign-Currency IDR scale. Fitch’s sovereign rating committee adjusted this to ‘B+’ due to institutional capacity weaknesses, including macroeconomic policy framework vulnerabilities and banking sector issues.

Country Ceiling: The Country Ceiling for Bangladesh has been downgraded to ‘B+’ from ‘BB-‘, reflecting no material constraints against capital or exchange controls that would impede the private sector from converting local currency into foreign currency to service debt payments.

ESG Considerations: Bangladesh has ESG Relevance Scores of ‘5’ for Political Stability and Rights, Rule of Law, Institutional and Regulatory Quality, and Control of Corruption, indicating these factors are highly relevant to the rating. Bangladesh also has an ESG Relevance Score of ‘4’ for Human Rights and Political Freedoms, and ‘4’ [+] for Creditor Rights.

The highest level of ESG credit relevance is ‘3’, meaning ESG issues are credit-neutral or minimally impact the entity’s credit profile. Fitch’s ESG Relevance Scores do not directly influence the rating process but reflect the relevance and materiality of ESG factors in the rating decision.

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