Bangladesh has significant leeway to raise external commercial borrowings: Citi

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FE Report Bangladesh has promising growth prospects with significant scope to boost investment and export capacity, the latter given its comparative advantage from low labor costs, but the country needs to address significant infrastructure bottlenecks. "It has a decent track record of prudent macro policy management, reversing the external imbalances it temporarily faced in FY2011-1H FY2012 (Jul-Dec 2011) through corrective policies, with international reserves and BDT now on an upward/appreciation path," a Citi research on Bangladesh said. It said Bangladesh benefits from significant access to concessional funding - external debt ratios have remained consistently low (and declining), well below median-BB peers, while government debt ratios are in line with median BB ratios but low by South Asian standards. BD has also made some recent inroads on structural reforms, most notably the new VAT law passed in Nov 2012. "After three years of stable ratings of Ba3 and BB- from Moody's and S&P, respectively, the government plans to issue inaugural sovereign bonds this year. However, it will probably need to seek further waivers on external commercial borrowing limits with the IMF, alongside other preparatory work, so we don't think the issuance is imminent - delay risk is high," the Citi said. The government is also considering lifting the 1-yr holding period restriction on foreign purchases of BDT-denominated Treasury bonds - a major stumbling block for foreign participation. While liquidity remains very poor, after-tax yields of 10.6% on 5yr BDT Treasury bonds for a current account surplus country with a gradually appreciating currency and a track record of macro stability look attractive if the oneyear lock-up is lifted. Vulnerabilities from a concentrated economic structure, very low revenue base and state sector institutional weaknesses BD has the lowest per capita income among countries we cover and has a very narrow manufacturing/export base which is highly concentrated in garments (with exports to the EU also being very high). It also has very low revenue- and tax-to-GDP ratios that, along with still sizeable subsidy spending pressures (though government is capping these now), limit the fiscal space for much-needed social and infrastructure spending. Significant institutional weaknesses surrounding governance and business climate issues are also sources of risk, with these deficiencies undermining private investment and the management of state-owned enterprises and state-owned commercial banks. Next General Elections, to be held by January 2014, a key event to watch BD's political environment can be characterized by the deep rivalries of the two major political factions and their leaders - Awami League and Bangladesh Nationalist Party (BNP). "We could see increased political noise in the run-up to the polls, with the constitutional amendment to abolish the caretaker government arrangement having triggered a threat by the opposition to boycott the polls," the Citi mentioned. Bangladesh (Ba3/BB-) has demonstrated a stable growth pattern over the last decade Averaging about 6.2%, even amidst periodic natural disasters, political noise and external shocks. Stability comes from its domestic-driven economic structure (export to GDP ratio of 21% in FY2011/12 [fiscal year is Jul- Jun] is comparable to Indonesia and the Philippines, but higher than South Asian peers like India and Sri Lanka at ?16-17% of GDP), ability to lean on remittances to offset inadequate domestic employment opportunities (at 11% of GDP, Bangladesh has the highest remittance to GDP ratio among the Asian economies we cover, trumping Philippines and Sri Lanka; About 65% of the country's remittances in FY 2011/12 came from the Middle East) and insulation from global capital flows (partly due to capital account regulations). Bangladesh has the lowest per capita income in our country coverage (US$763 in FY2011/12) - the only one in our coverage classified as "lower income" by World Bank lending classification - and thus, qualifies for deeply concessional lending terms from official creditors. Boosting investment rates and export capacity are critical to raising growth While private consumption has been the dominant source of growth, accounting for 75% of GDP and contributing over half of real GDP growth in the last decade, much-needed investment and associated productivity improvements that could boost exports (to offset high import dependence) are the critical growth drivers that could accelerate Bangladesh's convergence towards (lower) "middle income status". Relative to some in Asia, Bangladesh's investment rates remain at relatively low levels at ?25% of GDP (see Fig 2) despite its gross infrastructure deficiencies, with net FDI being particularly low (averaging ?0.9% of GDP in the last 5 years), likely due to weak business climate and infrastructure. Bangladesh's measure of trade openness at ?60% of GDP also remains far lower than East Asian (or median BB) peers, though slightly higher than in South Asia. Inaugural sovereign bond issue - A matter of time, but not so imminent Pressing infrastructure requirements, lack of domestic financial market depth and need to diversify out of official loans are motivating factors. There are some concerns that wanting to obtain financing flexibility in the budget ahead of upcoming elections may also be a motivating factor to the bond issuance. "We also believe the government increasingly feels it is ready - it now has a track record of almost three years of stable ratings of Ba3/BB- from Moody's/S&P (inaugural ratings given on April 2010) and has seen renewed macro stability that would mean it was issuing a bond from a position of relative strength." "Based on media reports, we would expect the size to be in the $500mn - $1bn range, which seem very manageable given relatively low external debt ratios (?19% of GDP and ?55% of CA receipts as of FY2011/12E, well below double-B median ratios of 37% of GDP and 84% of CA receipts". One potential hitch is the breach of the non-concessional external debt ceiling, which was one of the factors that caused a brief delay in the second tranche disbursal during the IMF's first review of the ECF. In Jan 2013, the government secured $1.5bn of non-concessional loans from Russia (US$500mn for nuclear power feasibility study and another $1bn on defense-related purchases) that caused the breach - the IMF has given the government a waiver and set a new limit on new non-concessional debt maturing in one year at a cumulative US$3.75bn as of end 2013 (this includes $0.9bn of borrowings up to 2012 and another $1.35bn of loans and guarantees for power projects) but does not yet incorporate sovereign bond issuance. While IMF is not opposed (and seems rather supportive based on our January meetings) of Bangladesh's plans to diversify funding and issue bonds, the government has yet not provided IMF details on its sovereign bond plans. Given that the IMF program review is done every 6 months, the next soonest time sovereign bond plans can be incorporated in the plan without breaching the IMF program's external debt ceiling requirement may be around Aug-Sep. This could be a delaying factor for the much awaited deal. Nonetheless, if the government waits too long, the upcoming elections would also complicate the timetable. Local markets - Attractive if not for the 1-yr lock-up; could the lock-up restriction be lifted? Bangladesh' domestic debt market is dominated by central government issuance of Treasury bills and bonds to meet its funding requirements. Despite appreciating bias of BDT over the last year and relatively high yield (vis-à-vis the rest of Asia), there is zero foreign participation due to two major impediments: First, one-year lock-up is a deterrent. Unlike India or Sri Lanka, there are no quotas or restrictions for foreign institutional investors (FIIs) to invest in BDT treasury bonds (FIIs are required to open a Non-Resident Foreign Currency Account before purchasing) but FIIs are required to hold these bonds for 1-year, whether purchased in the primary or secondary markets. This is made more problematic by the fact that foreigners are not allowed to invest in BDT BB and Treasury bills (this is similar to Vietnam). "However, we believe BB has proposed to MoF to waive this 1-yr lock up restriction, but we have no clear timetable for such a move yet," the Citi said. Second, market liquidity is very poor with average trading volume of only US$0.5-US$1.0mn across all tenors - trading volume for the longer tenor bonds being extremely limited. The size of the market is very small - outstanding BDT Treasury bonds are ?$8.6bn (7% of GDP), even smaller than the VND Treasury bond market and only 40% the size of the LKR Treasury bond market. If not for the lock-up, after-tax yields on the 5yr Treasury bond look attractive Tax treatment looks fairly benign as far as we can tell, with interest paid to nonresidents subject to a 10% WHT unless the rate is reduced under a tax treaty, and there is no capital gains tax. With recent policy and liquidity easing, the Treasury bond/bill curve has been steepening as Treasury bond yields have edged slightly higher. On an after-tax basis, the net yields on 5yr of 10.6% are about 63bps tighter than Sri Lanka 5yr but without the analogous FX pressures/ external imbalances.