After eight months since September last year, Fitch Ratings has again downgraded Bangladesh's long-term credit rating due mainly to a weakening of the country's external buffers.
In its latest review released on Monday, Fitch has downgraded Bangladesh's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'B+' from 'BB-', which reflects a sustained weakening of Bangladesh's external buffers.
Fitch Ratings said that despite recent policy reforms, it could be challenging to reverse this weakening sufficiently. This leaves the country more vulnerable to external shocks.
Policy actions taken since early 2022 have been insufficient to stop the decline in foreign exchange reserves and address the domestic shortage of US dollars. The recent shift to a crawling peg exchange rate system aims to increase exchange rate flexibility, according to the American credit rating agency.
However, it remains unclear whether this will fully address lingering distortions in the foreign exchange market and support a significant build-up of reserves, said Fitch.
"The outlook is stable," the New York-based global rating agency said.
The stable outlook reflects factors that mitigate external refinancing risks. These factors include a favourable composition of external creditors, International Monetary Fund (IMF) programme reforms to improve macroeconomic stability and address weaknesses in the banking sector, moderate government debt levels and favourable medium-term growth prospects.
About the weak external buffers, Fitch Ratings noted that foreign exchange reserves have fallen substantially due to continued interventions by the authorities, capital outflows and the persistent use of informal channels for remittances. Reserves have dropped by 15 per cent from January 2024, reaching $18.4 billion.
The agency expects reserves to stabilise following recent reforms. However, uncertainty remains around the implementation of the new foreign exchange regime and the extent to which the official exchange rate will be allowed to align with the parallel market rate.
Regarding forex rationing, the report said a scarcity of US dollars domestically has resulted in effective import restrictions, as authorities manage the allocation of foreign currency. Lower imports caused by these measures, combined with sustained export growth, led to a current account surplus of 1.4 per cent of GDP in the fiscal year ended 30 June 2024 (FY24), according to Fitch Ratings' estimates.
Greater foreign exchange flexibility should ease US dollar shortages, which could lead to an increase in imports over the next few years. The impact on the current account is expected to be modest, as remittances through formal channels should also accelerate with a better alignment between the official and parallel market exchange rates.
The rating agency expects high inflation to persist as a result of domestic supply shortages, import restrictions and a weaker exchange rate.
Inflation in FY24 averaged 9.7 per cent, far exceeding the central bank's target of 7.5 per cent, despite a 200 basis point hike in the policy rate. The removal of interest rate caps for banks and non-bank financial institutions (NBFIs) could bode well for the transmission of monetary policy, it said.
Govt revenue low
Bangladesh's low general government revenue/GDP ratio is a long-standing fiscal weakness, according to Fitch.
It said, at 8.2 per cent of GDP, this is significantly lower than the 19.5 per cent median for countries with a 'B' rating. Revenues continue to underperform budget targets due to prevailing tax exemptions, weak tax administration, and challenges in implementing tax reforms.
The IMF programme includes plans for several tax reforms, and some measures to increase revenue collection, such as tax hikes on tobacco and land registration, have already been implemented.
These measures could lead to higher revenue than currently forecast.
Debt composition still favourable
Fitch says Bangladesh's medium-term external debt is owed to bilateral or multilateral partners and financing from these sources is likely to continue, supporting ongoing debt service capacity despite US dollar shortages.
Projected external debt service is low compared to similar economies, averaging around 9.2 per cent of current external receipts over 2024-2025, compared to a median of 20 per cent for countries with a 'B' rating.
The ongoing IMF programme, agreed upon in January 2023, also supports continued access to multilateral and bilateral financing, as long as Bangladesh meets programme targets.
The rating agency expects gross government debt to gradually rise to around 40 per cent of GDP over the medium term, up from about 36 per cent in FY23. This remains well below the current 'B' median of 55 per cent.
Growth prospects look good
On the growth front, the agency said the medium-term growth outlook remains favourable, supported by a well-established ready-made garment sector, a demographic dividend and stable remittance inflows.
In the near term, however, Fitch Ratings expects growth to moderate to 5.3 per cent in FY24 due to the US dollar shortage, which is likely to dampen investment and high inflation, which is likely to reduce consumption.
The rating agency expects gross government debt to gradually rise to around 40 per cent of GDP over the medium term, up from about 36 per cent in FY23. This remains well below the current 'B' median of 55 per cent.
Risk factors
Fitch noted several factors pose risks to the fiscal position, including budget underperformance due to a shortfall in revenue, high borrowing costs, extension of forbearance measures in the banking sector, potential contingent liabilities arising from weaknesses in the banking sector and debt of state-owned enterprises.
On the banking sector, it said that banking sector credit metrics - asset quality, capitalisation and governance standards are weak, particularly for public-sector banks.
As of end-December 2023, the non-performing loan ratio for the entire sector was 9 per cent, while that of state-owned banks was a much higher 21 per cent.
These ratios, according to the rating agency, could deteriorate once forbearance measures are withdrawn. The sector could become a source of contingent liability for the government if credit stress intensifies.
The recent removal of lending rate caps on banks and NBFIs, following the removal of the floor on deposit rates, is a positive step towards improving banking sector profitability, Fitch noted.
On the structural metrics, the credit rating agency said Bangladesh ranks at the 21st percentile on the World Bank's composite governance score, compared to the 33rd percentile median for countries with a 'B' rating.
Foreign direct investment (FDI) is hampered by significant infrastructure gaps, although some planned government projects could attract higher investment over time.
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