Fitch rating downgrades Bangladesh to 'B+', outlook stable

The global credit rating agency Fitch downgraded Bangladesh's rating on Monday as it felt that a sustained weakening of external buffers has left the country more vulnerable to external shocks.

In the latest assessment, Fitch Ratings has lowered Bangladesh's Long-Term Foreign-Currency Issuer Default Rating to "B+" from "BB-", keeping the outlook stable.

Explaining the ground of the latest rating, the Fitch report says 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.

"We project reserves to stabilise on recent reforms. Uncertainty remains around the implementation of the new FX regime, and to what extent the official rate will be permitted to align with the parallel market rate," it said.

The 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 persistently high inflation (9.8% in April 2024).

This is the second rating agency to downgrade the country's rating after Moody's in May last year did the same, placing Bangladesh at "B1" from the previous "Ba3" category on the similar ground of heightening external vulnerability and liquidity risks amid deterioration in forex reserve.

"The downgraded rating means the access to foreign finance will be costlier for the country as the risk premium for trade financing will go up," said Dr Zahid Hussain, former lead economist of the World Bank's Dhaka Office.

He said the short-term foreign loans against imports are decided based on country rating by foreign lenders.

"Another thing is that the fee charged for LC confirmation may rise since a risk premium is charged on this as well. The other issue will be a lot of people will lose interest in financing because of this not prime status; as it is rather risky. In that case, access to finance will be constricted. So, the immediate impact I think will be on trade financing as the interest goes up, confirmation fees go up and access becomes stricter," he said.

The Stable Outlook reflects the 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, according to the Fitch report.

Domestic US dollar scarcity has resulted in effective import restrictions, as authorities manage the 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 ending 30 June 2024 (FY24), the report said.

"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," it said.

Removal of interest rate caps for banks and non-bank financial institutions (NBFIs), could bode well for monetary policy transmission, the American rating agency said.

Inflation in FY24 averaged 9.7%, far above the central bank's target of 7.5%, despite a 200 basis points hike in the policy rate, it pointed out.

"We expect high inflation to persist due to domestic supply shortages, import restrictions and a weaker exchange rate."

Bangladesh's low general government revenue/GDP ratio is a long-standing fiscal weakness. Revenues continue to underperform budget targets owing to prevailing tax exemptions, weak tax administration and challenges in implementing tax reforms, it noted, referring to several tax reforms planned under the IMF programme and some measures to increase revenue collection.

Favourable debt composition

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%.

"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, it said.

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.