Moody's downgrades Bangladesh's ratings to B2, changes outlook to negative for first time

Moody's has lowered Bangladesh's long-term ratings to B2 from B1, marking the country's second consecutive downgrade in less than two years, while affirming its short-term ratings at "Not Prime".

The rating agency also revised its outlook to "negative" from "stable" for the first time in 14 years since Bangladesh began receiving ratings from Moody's in 2010.

The downgrade and shift to a negative outlook could raise borrowing costs for both the government and private sector, making access to international funds more expensive amid high inflation.

The international rating agency has also revised Bangladesh's GDP growth forecast, lowering it to 4.5% from 6.3% for the current fiscal year and to 5.8% from 6% for the next.

Moody's said the downgrade reflects heightened political risks and lower growth, which increases government liquidity risks, external vulnerabilities and banking sector risks, following the recent political and social unrest that led to a change in government.

It said the ongoing political uncertainty and weakening growth lead Bangladesh to rely increasingly on short-term domestic debt to finance its deficit, raising liquidity risks.

"Also, higher risks to asset quality amplify structurally weak capital and liquidity in the banking system, increasing contingent liability risks for the sovereign."  

Moody's found that despite improving remittance flows and loan disbursements from development partners, external vulnerability risk remains weaker due to a sustained decline in the reserve buffer over the past years.

"With elevated social risks, the absence of a clear election roadmap, the deterioration of law and order, and the nascent reemergence of community-based tensions also raises political risk," Moody's said.

The negative outlook reflects downside risks to Bangladesh's growth outlook beyond Moody's current expectations, which could further strain the country's already weak fiscal position and exacerbate external vulnerabilities.

These risks stem from weaker domestic demand and supply disruptions due to recent protests and disruptions to law and order that cloud the export outlook and lower prospects for the ready-made garments sector, added the rating agency.  

"While the interim government remains committed to a broad reform agenda, its capacity to execute remains uncertain. Furthermore, the political capital to push through challenging reforms could diminish if the interim government cannot swiftly deliver outcomes, including taming inflation and addressing high unemployment," said Moody's.

Bangladesh's local-currency (LC) and foreign-currency (FC) ceilings have been lowered to Ba3 and B2 from Ba2 and B1, respectively.

The rating has placed LC ceiling two notches above the sovereign rating, reflecting weak predictability and reliability of government institutions and high external imbalances, which raise risks for the garment export sector's contributions to government revenue, balanced by a relatively small government footprint.

The FC ceiling is placed two notches below the LC ceiling, reflecting low capital account openness, weak policy effectiveness, and some degree of unpredictability surrounding capital flow management, but taking also into account a low external indebtedness.

Rationale for downgrade to B2

In its rationale for the downgrade, Moody's said political risk has increased following the recent social unrest that led to the resignation of Sheikh Hasina and the subsequent introduction of an interim government.

While economic activity has largely normalised under the interim government, political uncertainty punctuated by occasional lapses in law and order weakens domestic demand and weighs on activity in the ready-made garment sector.

The rating agency also said execution risk for reforms under the current IMF programme has increased, while the lack of a clear election roadmap introduces uncertainty around the longer-term commitment to reform.

Furthermore, political capital to push through challenging reforms could diminish if the interim government cannot swiftly meet social demands, including taming inflation and addressing high unemployment.

"Political uncertainty and weakening growth increase risks related to government liquidity, banking sector and external vulnerabilities," it said. Given the liquidity constraints in recent years, the government has increasingly relied on short-term borrowing through treasury bills, which will account for more than 40% of the total gross financing needs for FY25, up from 20% in FY23.

With ongoing monetary tightening, the yields on treasury bills increased rapidly to around 12% at the end of October 2024, up from approximately 11.5% in April 2024 and 9.8% in October 2023. Higher yields rapidly translate in an overall higher cost of debt given the shortening debt maturity.

Furthermore, with fiscal revenues at a very low level relative to the size of the economy, debt affordability will likely weaken further, especially as revenue mobilisation reform is expected to remain challenging in a weakening growth environment.

Moody's also said vulnerabilities in the banking sector have also increased, given the expectation for higher problem loans due to the political and economic disruptions, which raises contingent liability risks for the sovereign.

"We expect a material portion of loans to politically connected borrowers under the Sheikh Hasina regime will default through the year, adding to existing structural weaknesses in the banking system. This is likely to increase the fiscal cost of banking sector reform, which the government is currently reviewing with the IMF," said Moody's.

Despite the narrowing of Bangladesh's current account deficit, supported by robust remittance flows and import restrictions, pressures on the country's external position persist due to a sustained decline in its reserve buffer, says the ratings.

The foreign-exchange reserves stood at $19.8 billion as of October 2024, about 3.2 months of import cover, down from $21.7 billion in June 2024.

Moody's now expects reserves to reach approximately $20 billion by the end of 2024 and only improve in 2025 with disbursements from the IMF and other development partners.

"Consequently, our external vulnerability indicator - the ratio of external debt payments and foreign currency deposits to foreign exchange reserves - has weakened to 91% at the end of 2024 from 63% from at the end of 2023, albeit remaining at moderate levels," it said, adding that heightened political risk and payment delays to energy suppliers will continue to exert pressure on the reserve buffers.

Rationale for negative outlook

There are further downside risks to the growth forecasts as the full economic impact of social unrest and supply disruptions remains uncertain, said Moody's, warning that inflation will remain elevated, prompting Bangladesh Bank to maintain a tight monetary policy stance, which will likely weigh on consumption.

Given that inflationary pressures are largely driven by supply-side factors, such as supply chain disruptions and high domestic food prices, Moody's expects monetary policy effectiveness to be limited. This is further compounded by the structurally weak policy transmission mechanism in Bangladesh.

"While our baseline assumes gradual recovery in the ready-made garment sector and that its competitiveness will underpin the country's medium-to-long-term growth prospects, it may face greater challenges as buyers look to divert garment orders to neighbouring countries in light of the political uncertainty and Bangladesh's graduation from UN's LDC (least developed countries) status in 2026, which will gradually reduce access to concessional financing and preferential export market access," it added.