Understanding the implications of Fitch downgrading Bangladesh's sovereign rating outlook

Recently, Fitch's Ratings revised the outlook for Bangladesh's sovereign rating from stable to negative due to a decrease in reserves and a tightening of dollar liquidity, which has heightened the nation's susceptibility to economic shocks. 

Despite Bangladesh receiving a $4.7 billion bailout from the International Monetary Fund in January, this action by Fitch comes following a similar downgrade by S&P Global Ratings. In addition, Bangladesh's credit rating was downgraded by Moody's Investors Service in May. 

The three major credit rating agencies collectively are often referred to as the "Big Three '' credit rating agencies, as they are the top three sovereign credit ratings companies in the world. By now, the Big Three rating companies have downgraded Bangladesh's sovereign credit ratings, and this is not a good sign for the economy during such a tumultuous period of instability and economic downturn. 

This change means that Fitch Ratings is becoming more worried about the country's financial stability. It suggests that there might be some problems on the horizon that could make it harder for the country to pay back its loans. 

In practical terms, this change in outlook could lead to higher interest rates for Bangladesh when it tries to borrow money from other countries or institutions. It might also make foreign investors more cautious about investing in Bangladesh – this could have implications for the country's economy.

Fitch's Ratings has evaluated the revised Outlook on Bangladesh's Long-Term Foreign-Currency Issuer Default Rating (IDR) to Negative from Stable, mostly due to a number of factors, including but not limited to the economy's vulnerability to shocks, foreign-exchange reserve challenges, low revenue collection, weak banking sector governance, weak structural indicators, weak rights for participation in the political process and institutional capacity, uneven application of the rule of law and a high level of corruption.

One of the main focal points is the increased vulnerability to shocks for the Bangladesh economy. As has been seen in the last few months, none of the stabilisation monetary strategies seemingly achieved the intended result for the country's economy. 

As the exchange rate spirals upward, the taka loses its stability as a currency. And Fitch predicts that the currency is likely to depreciate even more. 

So, this has two-fold implications - firstly, the currency will see decreasing purchasing power; and secondly, it is going to be a more unstable currency. 

"What the rating companies are essentially saying is that there is a higher chance of currency volatility for Bangladesh. And when that happens, the domestic market is going to face the inevitable challenge of higher inflation," said Dr Javed Hossain, a teacher of Economics at North South University. 

"Since we are a major importer nation, the exchange rate volatility has already strapped our market with commodity shortages, leading to higher inflation. And now, more currency volatility will exacerbate the problem even more," he added. 

Another major rationale for the rating is the unresolved domestic US-dollar liquidity strains. 

Since last year, the country has been facing an acute dollar crisis that has seemingly given rise to a plethora of economic restraints, and it is highly unlikely that this is going to be a short phase of downturn. This is matched by low tax collections, low per capita income, a weak banking sector and poor governance indicators. 

Now, for avid observers of the banking sector or financial sector, it is not a new concern. The structural management crisis has been impacting the banking sector for years now, and the lack of investor confidence has left the banks dry. This is not a fleeting issue, this has transfixed the sector onto one single point - the liquidity crisis for both the US dollar and taka. 

Fitch forecasts that foreign exchange reserves will stay under pressure, driven by rising imports and foreign-currency (FX) intervention by the central bank. Most importantly, they estimate that foreign reserves fell by 19%, and their take is that end-2023 FX reserve coverage of current external payments will be at 3.0 months. This is a highly concerning issue for the economy. Not only Fitch, but also Moody's and S&P have also expressed similar concerns. 

Perhaps the bigger challenge is that, amid a still-managed exchange rate, elevated oil prices and a further relaxation of import restrictions, the current account deficit will only increase through to 2025. 

They expect reserve coverage of current external payments at about 2.6 months over 2024-2025, as the IMF's June-end FX reserve target was not met. Such low coverage is indicative of a bigger economic crisis for Bangladesh, which looms over the embattled economy of the country. 

However, Fitch has a positive outlook for external loan sourcing as they argue that the country will likely continue to receive foreign loans. An IMF programme, agreed in January 2023, they believe, should support the external position – although this depends on meeting programme targets. And Dr Javed Hossain is also of the same opinion. 

"If a country can fulfil most of the conditions, the development organisations will overlook one or two shortcomings. So, the development organisations are likely to provide loans." 

But he also had a word of caution, "If the reserves continue to decrease, and sovereign credit ratings continue to downgrade, then they may have second thoughts about giving loans. After all, these are the indicators of creditworthiness of the country." 

Another glaring concern is that the gross general government revenue/GDP is far below the 'BB' median by Fitch. The IMF requires Bangladesh to improve its revenue/GDP ratio and projects a ratio of 8.8% in the financial year ending June 2023 (FY23) and 10.3% in FY26. 

However, this is challenged by large tax exemptions, evasion and weak tax administration, and these issues are also persistent. Economists have cautioned against these factors, and yet, the government and the tax authorities have not been quite successful in remediation. 

The IMF's June-end revenue target was not met. The budget deficit is likely to widen this fiscal year, mostly due to the increased fiscal expansion by the government, since it is, after all, the election year. 

Perhaps the most concerning of the issues is the weak governance of the banking sector. It is not a surprise that the banking sector has been teetering for years now, and recent banking scandals have drained the little confidence left in the sector. 

Banks are facing a liquidity crisis and low rate of deposit amounts – indicative of a sector running low on investors' and depositors' confidence. Fitch regards the health of the banking sector and its governance standards as weak, especially among public-sector banks. 

Official data reveals a high system gross non-performing loan (NPL) ratio of 8.8% at the end of March 2023. The NPL ratio of state-owned commercial banks, at about 20.0%, is much higher than the 6.0% of private-sector banks and could rise further once forbearance measures are withdrawn. 

Bank capitalisation is thin relative to prevailing market risks and they believe the banking sector could be a source of contingent liability for the sovereign if credit stress intensifies. But, the solution is not easy, and the recent government policies regarding the banking sector will encourage more, not less, scandals. 

Perhaps another important issue is the lack of foreign direct investments. Foreign direct investment is hampered by large infrastructure gaps, and the credit ratings will discourage potential investors. 

Dr Javed Hossain said, "For the private investors, this is not a good indicator. They will ask themselves, 'Is this the right place to invest?' And they greatly rely on the rating agencies for their analysis. So the private investors will be discouraged greatly by the recent downgrades, which will, in turn, reduce FDI. And for the country running dry of US dollars, this is really bad news."

Bangladesh has an ESG Relevance Score of '5' for both Political Stability and Rights and the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGIs) have in our proprietary Sovereign Rating Model. 

Bangladesh has a low WBGI ranking in the 23rd percentile, reflecting weak rights for participation in the political process and institutional capacity, uneven application of the rule of law and a high level of corruption. 

And before the election, major reforms are highly unlikely. At such a time, the economic outlook is already looking gloomy. On top of that, when all three of the major rating companies have downgraded the sovereign credit ratings, it is a warning sign that the country's financial situation might be getting a bit shaky, and it is something that government officials and policymakers will need to address to ensure economic stability in the future.

Shadique Mahbub Islam. Sketch: TBS