Singapore July 25 2023: On July 25, 2023, S&P Global Ratings revised its long-term rating outlook on Bangladesh to negative from stable.
At the same time, S&P Global Ratings affirmed our ‘BB-‘ long-term and ‘B’ short-term sovereign credit ratings on Bangladesh.
Outlook
S&P Global Ratings revised the long-term rating outlook on Bangladesh to negative from stable to reflect the risk that its external liquidity position could deteriorate further over the next 12 months. They also affirmed our ‘BB-‘ long-term and ‘B’ short-term sovereign credit ratings on Bangladesh.
Downside scenario
S&P Global Ratings may lower the ratings on Bangladesh if net external debt or liquidity metrics worsen further, such that narrow net external debt surpasses 100% of current account receipts, or gross external financing needs exceed 100% of current account receipts plus usable reserves, on a sustained basis.
Lower generation of current account receipts than we expect, a higher overall current account deficit than we forecast, or a failure to materially boost foreign exchange reserves would indicate downward pressure on the rating.
S&P Global Ratings could also downgrade Bangladesh if we observe a material and sustained rise in commercial banks’ ownership of government debt as a proportion of the sector’s total assets, signifying a limited ability for banks to lend more to the government without crowding out private sector borrowing.
Upside scenario
S&P Global Ratings may revise the outlook to stable if Bangladesh materially improves its external position, which would likely be indicated by a substantial increase in foreign exchange reserves combined with a modest current account deficit, and healthy growth in current account receipts.
Rationale
S&P Global Ratings revised the outlook to negative from stable to reflect sustained pressure on Bangladesh’s external position, marked in particular by a continued decline in foreign exchange reserves. Bangladesh’s external financial assets have fallen markedly over the past year, despite the introduction of a sweeping IMF reform and funding program, alongside a substantially lower current account deficit.
In January 2023, Bangladesh agreed to a 42-month Extended Credit Facility and Extended Funding Facility (ECF/EFF), as well as a Resilience and Sustainability Facility with the IMF. Total funding under the three facilities will amount to US$4.7 billion over the course of 42 months from the date of the agreement. The ECF/EFF programs will emphasize reforms to rebuild Bangladesh’s diminished external buffers, and to strengthen the management of its public finances.
S&P Global Ratings view the programs as an important anchor for stabilizing Bangladesh’s external position, which has deteriorated over the past 18 months and continues to experience net financial outflows.
The agency ratings on Bangladesh reflect the country’s modest per capita income and limited fiscal flexibility owing to a combination of low revenue-generation capacity and high interest burden. Evolving administrative and institutional settings represent additional rating constraints.
S&P Global Ratings weigh these factors against consistently high economic growth and an external position that’s supported by substantive engagement with bilateral and multilateral development partners, large remittances from overseas Bangladeshi workers, and a globally competitive garment sector. Despite this structural support, Bangladesh has witnessed a material decline in the strength of its external balance sheet and liquidity position.
Institutional and economic profile: Growth slowing as economy experiences necessary rebalancing
Bangladesh’s economy is likely to expand at 6.0%-6.4% over the next three years, reflecting a slight moderation compared with the growth trend of its long-term average real GDP.
The downshift in headline growth reflects necessary rebalancing following a period of overheating. Faster economic growth in fiscals 2021 and 2022 (ended June 30) was accompanied by a weakening of Bangladesh’s external position, and we anticipate relatively slower domestic demand conditions as part of the economy’s stabilization.
Bangladesh’s highly concentrated political landscape may constrain the effectiveness of institutions and limits checks and balances on the government.
Bangladesh’s economy is moderating following two years of fast growth. As higher inflation, interest rates, and policies aimed at managing imports continue to bite, domestic demand growth will likely remain modest in comparison to the long-term trend. We estimate that Bangladesh’s economic growth slowed to 5.5% in fiscal 2023, versus 7.1% the previous year, as the aforementioned challenges cooled domestic consumption and investment activity.
Soft external demand conditions are likely to persist for at least the remainder of 2023, with a gradual recovery set to take shape from 2024. Against a weaker external backdrop, domestic demand conditions in Bangladesh are also likely to remain subdued as a weaker Bangladeshi taka (BDT) and elevated commodity prices undermine purchasing power.
Modest per capita income, which we estimate at less than US$2,700 for fiscal 2024, remains one of Bangladesh’s main rating constraints. This level of per capita income limits the fiscal and monetary flexibility needed to respond to exogenous shocks.
Bangladesh’s 10-year weighted average real per capita GDP growth of about 5.1% helps to mitigate these weaknesses. The economy’s long-term trend growth rate is much stronger than sovereigns at a similar level of income, which is supportive of our credit ratings on Bangladesh.
S&P Global Ratings expect Bangladesh’s strong trend growth performance to remain largely intact, even as the pace of expansion slows somewhat relative to Bangladesh’s post-pandemic recovery period.
Bangladesh’s garment industry remains highly competitive in a global context, with low unit labor costs and ample supply of labor. Demographics continue to favor Bangladesh, and the government is working on strengthening access to key external markets ahead of its expected graduation from least developed country (LDC) status in 2026.
That said, Bangladesh’s electricity generation infrastructure has been increasingly challenged by adverse weather events and higher energy input costs over the past 12 months, and this has reportedly hit the garment manufacturing sector in some cases. Improvements to the related infrastructure will be important, in our view, in order to support continued rapid economic growth over the next three to four years.
Bangladesh’s highly concentrated domestic political conditions may undermine the predictability of future policy responses. The confrontational stance between the ruling Awami League and opposition Bangladesh Nationalist Party (BNP) reflects the deep division between the historically prominent political parties. Bangladesh’s foreign direct investment has remained persistently low, given the country’s evolving institutional settings, infrastructure deficiencies, high levels of perceived corruption, and uneven business environment.
The political landscape in Bangladesh remains polarized, with considerable power centered with the ruling Awami League. The opposition’s representation in parliament remains extremely small, limiting checks and balances on the government. Bangladesh will hold parliamentary elections in January 2024, though it is currently unclear whether the BNP will participate.
Flexibility and performance profile: Bangladesh’s external profile remains under pressure despite IMF program, lower import bill
Bangladesh’s external profile remains under pressure despite the introduction of the landmark IMF funding facilities, and a notable decline in imports over recent quarters.
Foreign exchange reserves continue to decline, suggesting ongoing financial account outflows even as the goods trade balance improves. A reversal of this trend will be necessary to stabilize Bangladesh’s external liquidity metrics over the next twelve months.
Bangladesh’s interest burden is considerable, in part due to the government’s very low revenue generation. However, the country relies entirely on multilateral and official lending for its foreign currency borrowing, which partially mitigates risks to its debt profile.
Bangladesh’s external profile remains under pressure despite a narrowing of its current account deficit. Falling foreign exchange reserves reflect continued net balance of payments outflows, suggesting elevated demand for dollars relative to the taka, which is facing sustained depreciatory pressure. We have also adjusted our calculation of Bangladesh’s usable foreign exchange reserves materially lower, primarily to account for central bank lending to quasi-fiscal programs which may impair the liquidity of allocated funds, as well as reserve related liabilities, and reserves deposited in domestic banks.
External trade flows are beginning to show signs of stabilization, and we anticipate that Bangladesh’s current account deficit is unlikely to revert to the unsustainable levels witnessed in fiscal 2022.
After falling by 14.5% in fiscal 2022, secondary income transfers (a close proxy for remittances) rose by about 1% in the 11 months through May 2023, versus the same period in the previous fiscal year. Meanwhile, goods exports grew by 6.8%, compared with a 14.1% decline in the value of imported goods. Readymade garment exports rose by about 10.7% during the first 11 months of fiscal 2023, despite variable external demand conditions and occasional domestic electricity shortages.
These developments have helped to reduce Bangladesh’s current account deficit to around 1% of GDP in the outgoing fiscal year, versus a multi-year high of 4.3% in fiscal 2022. Bangladesh Bank’s limitations on the issuance of new letters of credit to fund external transactions have also capped import payments.
The trajectory of Bangladesh’s current account dynamics will be critical to the stabilization of its broader external metrics. We foresee a roughly stable current account deficit averaging slightly less than 1% of GDP through fiscal 2026. This is driven by our expectations of roughly flat energy commodity prices over that period, combined with moderated domestic demand driven by the weaker taka, tighter monetary conditions, and continued administrative measures by the central bank.
Nevertheless, Bangladesh’s external buffers have deteriorated, meaning that its external liquidity position is now more sensitive to fluctuations in its current account, with a higher degree of vulnerability should the trade deficit begin to rise again, or if remittances fall short of our forecasts. A rapid recovery in import demand, or a loosening of policies aimed at curbing the generation of LCs, could also drive a higher current account deficit.
Bangladesh’s falling foreign exchange reserves, and the recent depreciation of the taka have contributed to a weaker external liquidity ratio, with its gross external financing needs averaging slightly less than 97% of current account receipts plus usable foreign exchange reserves over the next three years.
Bangladesh’s external profile draws substantial donor support, ensuring that the bulk of public external debt is low-cost borrowing with long maturities. This support is underpinned by the country’s structured funding programs agreed with the IMF earlier this year.
S&P Global Ratings anticipate that the EFF will provide some support for Bangladesh’s fiscal and external settings over the long run. Key provisions of the reform program include increasing exchange rate flexibility, boosting the government’s fiscal space by mobilizing revenue and rationalizing subsidies, and arresting the decline in foreign exchange reserves.
S&P Global Ratings estimate Bangladesh’s fiscal deficit will be roughly stable over the next few years, following a shortfall of 4.6% of GDP in fiscal 2022. However, we forecast Bangladesh’s change in net general government debt will be slightly higher, owing to continued depreciation in the taka, and the government’s material exposure to foreign currency-denominated debt, which we project at more than 40% of its outstanding debt stock.
Despite higher pandemic spending and continued efforts to boost capital expenditure over recent years, many basic social and infrastructure needs in Bangladesh remain unmet, implying a higher potential expenditure burden in the future.
Bangladesh’s net general government debt remains moderate, and we estimate that it will average 33.9% of GDP through fiscal 2026.
The government continues to fund itself partially through the issuance of costly national savings certificates (NSCs), with interest rates well above the market rate. While we expect the government to eventually shift toward less costly borrowing over the long term, this transition is likely to take a while, because it will require the broader development of Bangladesh’s debt capital markets. Bangladesh Bank has also extensively increased its purchases of government debt over the past year, with a surge in government debt held by the central bank of just over BDT1 trillion.
The costly nature of NSC funding, in addition to the relatively high domestic cost of capital, contributes to Bangladesh’s elevated interest burden. We forecast the government’s interest payments will account for greater than 20% of revenue through at least 2026.
The government may also rely more heavily on banks for local currency funding. Should the resident banking sector’s claims on the government continue to rise as a share of the banking sector’s overall balance sheet, this could crowd out private-sector borrowing or limit the availability of additional funds to the government, in our view.
Bangladesh’s narrow revenue base constrains the government’s flexibility to provide fiscal support to the economy during periods of stress, and to fund important social and capital expenditure requirements.
S&P Global Ratings estimate that general government revenue rose slightly to 8.8% of GDP in fiscal 2023, from 8.5%, though revenue generation remains critically low as a share of the economy. We forecast a gradual improvement in the government’s revenue generation efforts over the next three years, aided by the IMF program, though we do not expect it to surpass 10% of GDP during that period.
Some measures introduced during the pandemic will act as a continued drag on the government’s fiscal accounts over the longer term. These measures include a higher taxable income threshold for individuals, and sequential reductions in the tax rates for both unlisted and listed companies. These steps have curtailed upside for the government’s weak revenue generation framework.
The sovereign faces limited risk of contingent liabilities from the banking sector. The sector is relatively small with assets less than 100% of GDP. We classify Bangladesh’s banking sector in group ‘9’ under our Banking Industry Credit Risk Assessment (with ‘1’ being the highest assessment and ’10’ being the lowest).
State-owned commercial banks (SOCBs) have notable risks relative to private-sector banks. SOCBs account for less than 30% of total banking sector assets, and their nonperforming loans ratio is considerably higher than that of peer commercial banks.
S&P Global Ratings view Bangladesh’s monetary assessment as a neutral factor to the rating. The central bank’s limited independence, multiple mandates, and underdeveloped capital markets hamper monetary flexibility. We consider Bangladesh’s exchange rate regime as a crawl-like arrangement, though the trading mechanism was further liberalized in June 2022.
Since then, the central bank has gradually loosened trading conditions for the currency, which has depreciated by approximately 13.7% over the past 12 months. We anticipate further progress in establishing a more market-guided mechanism for the taka, including the eventual unification of the exchange rates for various types of traders, under the structural benchmarks introduced as part of the IMF program.
More flexibility should help to restore competitiveness relative to key trading partners, and to manage demand for imports. At the same time, depreciation in the currency is adding to domestic inflation pressures, and will make external debt servicing costs more expensive.
Bangladesh’s central bank is fighting rising inflationary pressures, even as price pressures in the global economy begin to cool. Inflation fell slightly to 9.7% year on year in June 2023, versus 9.9% in May, but well above the 7.6% rate observed in June 2022. Since 2015, inflation has generally remained below 6% annually, it may take some time to return inflation to that level as the impact of the depreciation of the taka continues to work its way through the economy.
