Fitch Ratings has downgraded Bangladesh's Long-Term Foreign-Currency Issuer Default Rating to 'B+' from 'BB-'.
The Outlook is Stable. A full list of rating actions is at the end of this rating action commentary.
Key Rating Drivers
Ratings Downgraded, Outlook Stable: The downgrade to 'B+' reflects sustained weakening of Bangladesh's external buffers, which could prove challenging to sufficiently reverse despite recent policy reforms, leaving the country more vulnerable to external shocks. Policy actions since early 2022 have been insufficient to stem the fall in foreign exchange reserves and resolve domestic dollar tightness. The recent shift to a crawling peg aims to increase exchange-rate flexibility. Whether this will fully address lingering FX market distortions and support significant reserves build-up remains unclear.
The Stable Outlook reflects mitigation of external refinancing risks by a favourable external creditor composition, IMF-programme reforms to improve macroeconomic stability and address banking sector weaknesses, moderate government debt and favourable medium-term growth prospects.
Weak External Buffers: FX reserves are down substantially due to continued FX interventions, capital outflows and persistent use of informal channels for remittances. Reserves have fallen by 15% from January 2024 levels to USD18.4 billion. We project reserves to stabilise on recent reforms. Uncertainty remains around implementation of the new FX regime, and to what extent the official rate will be permitted to align with the parallel market rate.
Bangladesh Bank says the crawling peg is an interim arrangement before moving to a fully flexible market-based exchange rate. Further moves to increase exchange rate flexibility may be complicated by persistent high inflation (9.8% in April 2024).
FX Rationing: Domestic US dollar scarcity has resulted in effective import restrictions, as authorities manage allocation of FX. Lower imports from such measures and sustained export growth drove the current account surplus to a Fitch-estimated 1.4% of GDP in the fiscal year ended 30 June 2024 (FY24). Greater FX flexibility should ease US dollar shortages, which could drive up imports in the next few years. The impact on the current account should be modest, as remittances through formal channels should also accelerate with better alignment between the official and parallel market exchange rates.
High Inflation: We expect high inflation to persist due to domestic supply shortages, import restrictions and a weaker exchange rate. Inflation in FY24 averaged 9.7%, far above the central bank's target of 7.5%, despite a 200bp hike in the policy rate. Removal of interest rate caps for banks and non-bank financial institutions (NBFIs), could bode well for monetary policy transmission.
The Long-Term Foreign-Currency IDR also reflects the following factors:
Low Government Revenues: Bangladesh's low general government revenue/GDP ratio is a long-standing fiscal weakness. At 8.2% of GDP, this is far lower than the 19.5% 'B' median. Revenues continue to underperform budget targets owing to prevailing tax exemptions, weak tax administration and challenges in implementing tax reforms. Several tax reforms are planned under the IMF programme and some measures to increase revenue collection, including tax hikes on tobacco and land registration, have been implemented. These measures pose an upside risk to our revenue forecasts.
Favourable Debt Composition: Bangladesh's medium-term external debt is owed either to bilateral or multilateral partners, and financing from these sources is likely to continue, supporting ongoing debt service capacity, notwithstanding US dollar shortages. Projected external debt service is low relative to peers, averaging about 9.2% of current external receipts over 2024-2025, against a 'B' median of 20%. The ongoing IMF programme agreed in January 2023 also supports continued access to multilateral and bilateral financing, subject to meeting programme targets.
Favourable Growth Prospects: The medium-term growth outlook is favourable, supported by a well-established ready-made garment sector, demographic dividend and stable remittance inflows. In the near term, however, we expect growth to moderate to 5.3% in FY24 due to the US dollar shortage that is likely to weigh on investment and the high inflation reducing consumption.
Government Debt Below Peers: We expect gross government debt to increase gradually to about 40% of GDP over the medium term, from about 36% in FY23, but still well below the current 'B' median of 55%. Budget underperformance owing to a revenue shortfall, high borrowing costs, extension of forbearance measures to the banking sector and potential contingent liabilities owing to weaknesses in the banking sector and debt of state-owned enterprises, are risks to the fiscal position.
Weak Banking Sector: Banking sector credit metrics - asset quality, capitalisation and governance standards - are weak, especially those of public-sector banks. The sector's non-performing loan ratio was 9% at end-December 2023, while that of state-owned banks was about 21%. These ratios could rise once forbearance measures are withdrawn. The sector could be a source of contingent liability for the sovereign if credit stress intensifies. The removal of lending rate caps on banks and NBFIs, after removal of the floor on deposit rates, is a significant step towards improving banking sector profitability.
Weak Structural Metrics: Bangladesh is at the 21st percentile on World Bank's composite governance score, against the 33rd percentile for the 'B' median. FDI is hampered by large infrastructure gaps, although some government projects in the pipeline could lead to higher investment over time. The Awami League, which won the general election in January 2024, is in a strong political position to implement its policy agenda that is focused on lowering poverty, developing infrastructure, strengthening resilience to climate risks and reaching upper middle-income status by 2030.
ESG - Governance: Bangladesh has an ESG Relevance Score of '5' for both Political Stability and Rights, as well as the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGIs) have in our proprietary Sovereign Rating Model. Bangladesh has a low WBGI ranking in the 21st percentile, reflecting weak rights for participation in the political process and institutional capacity, uneven application of the rule of law and a high level of corruption.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
External Finances: Increased external vulnerability, for example, due to a marked decline in FX reserves or other liquidity buffers.
Public Finances: Higher fiscal deficits or financing stress that is driven, for example, by a further increase in the interest/revenue ratio or an inability to significantly increase the government's revenue over the medium term.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
External Finances: A reduction in external vulnerabilities, for example, due to greater confidence in a credible exchange-rate policy supporting a sustained build-up of FX reserves or other liquidity buffers.
Public Finances: A structural increase in fiscal revenue collection that supports fiscal consolidation and improves the interest/revenue ratio.
Structural: A significant improvement in institutional capacity and implementation of measures to address economic vulnerabilities, including weaknesses in the banking sector, evident, for instance, in better bank asset quality and capitalisation.
Sovereign Rating Model (SRM) and Qualitative Overlay (QO)
Fitch's proprietary SRM assigns Bangladesh a score equivalent to a rating of 'BB-' on the Long-Term Foreign-Currency IDR scale.
Fitch's sovereign rating committee adjusted the output from the adopted SRM score to arrive at the Long-Term Foreign-Currency IDR by applying its QO, relative to SRM data and output, as follows:
Structural: -1 notch to reflect weaknesses in institutional capacity, including the macroeconomic policy framework and broader vulnerabilities in the banking sector in terms of governance, data quality, asset quality and capitalisation.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
Country Ceiling
The Country Ceiling for Bangladesh has been downgraded to 'B+' from 'BB-', in line with the LT FC IDR. This reflects no material constraints and incentives, relative to the IDR, against capital or exchange controls being imposed that would prevent or significantly impede the private sector from converting local currency into foreign currency and transferring the proceeds to non-resident creditors to service debt payments.
Fitch's Country Ceiling Model produced a starting point uplift of 0 notches above the IDR. Fitch's rating committee did not apply a qualitative adjustment to the model result.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Bangladesh has an ESG Relevance Score of '5' for Political Stability and Rights, as WBGIs have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As Bangladesh has a percentile rank below 50 for the respective governance indicator, this has a negative impact on the credit profile.
Bangladesh has an ESG Relevance Score of '5' for Rule of Law, Institutional & Regulatory Quality and Control of Corruption, as WBGIs have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As Bangladesh has a percentile rank below 50 for the respective governance indicator, this has a negative impact on the credit profile.
Bangladesh has an ESG Relevance Score of '4' for Human Rights and Political Freedoms, as the Voice and Accountability pillar of the WBGIs is relevant to the rating and a rating driver. As Bangladesh has a percentile rank below 50 for the respective governance indicator, this has a negative impact on the credit profile.
Bangladesh has an ESG Relevance Score of '4' [+] for Creditor Rights, as willingness to service and repay debt is relevant to the rating and is a rating driver for Bangladesh, as for all sovereigns. As Bangladesh has 20-plus year record without a restructuring of public debt - as captured in our SRM variable - this has a positive impact on the credit profile.
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visitwww.fitchratings.com/topics/esg/products#esg-relevance-scores
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