The credit rating agency expects Bangladesh’s gross foreign exchange reserves to remain below $30 billion for the next two to three years
Published : 30 May 2023, 08:42 PM
Moody's Investors Service has downgraded Bangladesh government’s long-term issuer and senior unsecured ratings to B1 from Ba3. saying the outlook is stable but gross foreign exchange reserves will remain below $30 billion for the next two to three years.
Together with institutional weaknesses uncovered during the ongoing global economic crisis, Bangladesh's persistently high external vulnerability and liquidity risks led Moody’s to downgrade the country’s ratings, the agency said in a statement on Tuesday, as the government is preparing to unveil its budget for FY24 later this week.
Concluding a review initiated about six months ago, the credit rating agency affirmed short term issuer ratings of the government at Not Prime.
Despite some easing, ongoing dollar scarcity and deterioration in foreign exchange reserves indicate continued pressures on Bangladesh's external position, exacerbating imports constraints and as a result energy shortages.
Meanwhile, the government has not yet fully reversed its import control measures and unconventional policies including a multiple exchange rate regime and interest rate caps, which are creating distortions.
Finally, Moody’s said, a very low level of fiscal revenues relative to the size of the economy constrains the government's policy choices and points to weakening debt affordability as higher interest payments result from the taka devaluation and short maturities for domestic debt.
Although Moody's expects external financing to help alleviate pressures on the external and fiscal metrics, external buffers will remain weaker than before the pandemic and higher debt levels will weaken fiscal strength, particularly as Moody's expects fiscal reforms will take years to materialise.
Concurrently, Bangladesh's local-currency and foreign-currency ceilings have been lowered to Ba2 and B1 from Ba1 and Ba3, respectively.
The local currency ceiling is placed 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 foreign currency 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.
‘WEAKER THAN BEFORE THE PANDEMIC’
In Moody's assessment, Bangladesh's external position will remain structurally weaker than before the pandemic.
It expects external financing will halt the deterioration of foreign exchange reserves, which will stabilise during the next fiscal year ending June 2024.
“However, reserves will not recover to pre-pandemic levels for the next 2-3 years.”
It said unfavourable terms of trade followed by a contraction in trade credit, as well as Bangladesh Bank's initial attempt to defend the taka, have eroded foreign exchange reserves by over $17 billion, or 40 percent, since their peak in August 2021.
Consequently, the import coverage ratio and Moody's external vulnerability indicator or EVI have weakened significantly, with gross foreign exchange reserves, excluding gold and SDRs, declining to $27 billion or around 3.7 months of goods and services imports as of April 2023 from $45 billion (around 7 months) in August 2021 – despite import restrictions and energy rationing.
EVI is the ratio of external debt payments and foreign currency deposits to foreign exchange reserves.
While the devaluation of the taka and import restrictions, along with resilient exports but tepid remittance flows, have turned the current account back into surplus, pressures on the current account remain due to still high energy commodity prices, Moody’s said .
It expects gross foreign exchange reserves to remain below $30 billion for the next two to three years, with net reserves likely lower, following Bangladesh Bank's commitment to the International Monetary Fund to start reporting reserves net of assets such as the Export Development Fund.
On a gross basis, Moody's assesses that the import coverage ratio will remain around 3 months of imports, while Bangladesh's EVI will significantly weaken to 90 in FY24 against about 30-40 percent pre-pandemic. Net reserves are currently at approximately $20 billion (or 2.7 months of import cover), implying an EVI of 115 percent.
FISCAL STRENGTH WILL WEAKEN
In Moody's assessment, persistently low revenue generation and rising interest payments will lead to weakening fiscal metrics, especially debt affordability.
The increase in the deficit, which added to higher debt levels, was driven by an inflated government subsidy bill due to higher energy, fertiliser and food costs despite significant price adjustments lately, while revenues fell due to the import restrictions.
Moody's expects the fiscal deficit to remain relatively wide, around 5.0-5.5 percent of GDP over the next few years, increasing the debt burden to almost 40 percent of GDP by end fiscal 2026 from below 30 percent in fiscal 2022.
Bangladesh's debt burden remains moderate compared to peers, and external debt payments will remain manageable due to the concessional nature of its external debt with long maturities. Nevertheless, interest payments will consume a widening share of the government's narrow revenue base, rising to a very high level of above 25 percent in fiscal 2023-25 from below 20 percent in fiscal 2019 before the pandemic.
While the IMF programme will spur some revenue mobilisation measures, Moody's expects improvements in revenue collection and tax administration will be slow, considering Bangladesh's poor track record of implementation as well as administrative and efficiency barriers.
Moody's expects the revenues to GDP ratio to improve modestly over the next 2-3 years, although it remains below 10 percent of GDP and still significantly below peers at the B1 rating level.
STABLE OUTLOOK
Moody’s said the stable outlook is based on Bangladesh's continued access to concessionary financing and support from international financial institutions.
It expects external financing to help alleviate pressures on the external and fiscal metrics.
Although the sovereign's financing options remain narrow due to the absence of international issuance, underdeveloped domestic capital markets, and limited foreign direct investment (FDI), concessional financing will support Bangladesh's funding plan over the next 2-3 years, enabling the stabilisation of foreign exchange reserves.
The IMF programme, approved in January 2023, will provide up to $3.3 billion to manage Bangladesh's immediate economic challenges, as well as $1.4 billion to mitigate climate change risks. The World Bank and Asian Development Bank have also pledged an additional $1 billion and $1.6 billion in support, respectively.
The stable outlook is also supported by Bangladesh's economic resilience.
Moody's expects growth to recover to 6 percent in fiscal 2025, supported by its globally competitive ready-made garment industry.
At the same time, this resilience is balanced by the country's low per capita income and constraints in infrastructure and human capital, low economic competitiveness, and high concentration in drivers of economic growth compared with peers.
Bangladesh's economy is also exposed to both sudden and gradual climate change risks that can create adverse economic and social costs.
FACTORS
Moody’s said a combination of factors will be required for Bangladesh to upgrade its ratings
They include significant progress in the government's fiscal reform implementation that would increase its revenue generation capacity, leading to an increase in debt affordability and fiscal space.
More rapid rebuilding of foreign exchange buffers to higher levels than Moody's expects will create an upward pressure in the ratings.
Material progress in diversifying the economy away from its reliance on the RMG sector, and developing key infrastructure that would raise longer-term economic competitiveness and FDI to sustain its economic growth.
Downward pressure on the ratings would result from a rising likelihood of a more severe deterioration of the external and liquidity position, including depreciation pressures that would worsen metrics beyond Moody's current expectations.
A severe weakening of the macroeconomic environment, including a material slowdown in growth and sustained high inflation, that would weigh on fiscal metrics , may also create downward pressure on the ratings.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Moody’s said Bangladesh's very highly negative (CIS-5) ESG Credit Impact Score reflects very high exposure to environmental and social risks, which weak governance is likely to prevent the sovereign from addressing.
The exposure to environmental risk is very highly negative (E-5), according to Moody’s. As a low-lying country with large coastal areas, Bangladesh is highly prone to rising sea levels, flooding, which disrupts economic activity and raises social costs. Low incomes and weak infrastructure quality compound the impact of weather-related events on the economy, and in turn, associated fiscal costs.
In addition, the magnitude and dispersion of seasonal monsoon rainfall also influence agricultural sector growth, generating some volatility and raising uncertainty about rural incomes and consumption.
Bangladesh is a net energy importer, however it is exposed to carbon transition risks because 90 percent of its energy mix comes from fossil fuels.
Bangladesh's exposure to social risks is very highly negative (S-5). Low incomes stem in part from physical and social infrastructure constraints to economic development that will take time to address.
That said, per capita incomes have grown strongly over the past decade and poverty rates have declined sharply, due to high and stable economic growth.
This has also delivered improvement in access to basic services, although Bangladesh's challenges related to improvements in educational opportunities and outcomes, health and safety, and labour force inclusion remain areas of social risk.
Bangladesh's weak institutions and governance profile constrain its rating, as captured by a highly negative governance issuer profile score (G-4). Challenges in control of corruption and rule of law weaken existing institutions, while the credibility of legal structures is also limited.
These governance challenges have in part contributed to asset quality issues in the banking sector. Besides, a deteriorating monetary policy framework undermines macroeconomic stability, while challenging fiscal prudence.