Fiscal improvements to lag economic recovery in Bangladesh: Fitch

Bangladesh's latest budget indicates that public finances in the fiscal year ending in June 2023 (FY23) will remain weaker than in the past, even as the country's economic recovery gathers pace, says Fitch Ratings.

However, Bangladesh has a record of posting deficits below those targeted in the budget, adds the New York-based credit rating agency in a report published on its website.

The budget targets a deficit of 5.5% of GDP in FY23, up from a revised estimate of 5.1% in FY22. This remains higher than the norm prior to the outbreak of the Covid-19 pandemic – the deficit averaged 3.5% of GDP in FY15-FY19. In contrast, the authorities expect the economy to expand by 7.5% in FY23, above the average of the same five-year period.

Fitch says that the deficit could undershoot the government's target, as has often occurred in the past. The authorities originally projected a deficit of 6.2% of GDP in FY22, but expenditure fell below budgeted levels and growth, at 7.25% according to provisional estimates, was above Fitch's expectations. However, the agency's forecast for economic growth in FY23, at 6.4%, is lower than the government's, and it expects the budget deficit to slightly exceed the government's target.

Government revenue/GDP is low, at just 9.8% in FY22, compared with a 'BB' category sovereign median of 27.3%. This represents a key credit weakness. Measures in the budget risk amplifying the problem, with the authorities cutting corporate tax rates without offsetting measures; for example, to 27.5% from 30.0% for non-listed companies and to 22.5% from 25.0% for one-person companies. Value added tax (VAT) exemptions have also been extended or introduced for certain goods categories. Offsetting this, VAT rates for other categories were increased and the budget proposes the removal of a provision that exempts those with no permanent establishment in Bangladesh from submitting income tax returns. A tax amnesty may also provide a one-off lift to tax revenue in FY23, although the medium-term impact is uncertain.

A failure to return the budget deficit to pre-pandemic levels in the next two to three years is unlikely to pressure Bangladesh's rating, which Fitch affirmed at 'BB-' with a Stable Outlook in November 2021.

Fitch estimates government debt/GDP at around 38% at FYE21, compared with a 'BB' median of 55%, indicating that Bangladesh has fiscal headroom at its current rating level. Even so, a lack of fiscal consolidation while economic growth is strong could increase the sovereign's vulnerability to economic shocks.

The risk of shocks has been highlighted by the pandemic and surging global fuel and food costs stemming from the Russia-Ukraine war. The latter effects have been relatively muted in Bangladesh so far, and the government's move to raise the allocation for subsidies, including those on fuel, gas, electricity and fertiliser, to 1.9% of GDP in FY23, from 1.7% in FY22, should further cushion the near-term impact. The authorities also increased funding for physical infrastructure under the annual development programme. If implemented effectively, this could alleviate supply-side bottlenecks and ease inflation in the longer run, adds the report.

Bangladesh's external metrics are a source of rating strength. The budget retains a 15% preferential tax rate for textiles, a sector that drives export growth. US imports of apparel from Bangladesh rose by 65% yoy in 4M22 to USD3.3 billion.

However, official foreign-exchange reserves fell to USD42.2 billion by end-May 2022, from USD46.2 billion at end-2021. This reflected rapid growth in goods imports, a slight decline in inward remittances and central bank intervention to slow the taka's depreciation, among other factors.

A continued drop in reserves – for example, in the context of weaker global growth hitting garment exports – would over time increase the risk of negative rating action on Bangladesh, according to Fitch.