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Moody’s affirms Bangladesh’s Ba3 ratings, Maintains stable outlook

29 Mar 2022, Singapore.

Moody’s Investors Service (“Moody’s”) has today affirmed the Government of Bangladesh’s long-term issuer and senior unsecured ratings at Ba3 and maintained the stable outlook. The short-term issuer ratings are also affirmed at Not Prime. The drivers behind the rating affirmation include Moody’s expectation that the growth rebound following the pandemic will continue to anchor macroeconomic and external stability. Reliance on concessional borrowing also lowers debt refinancing risks. Nonetheless, weak revenue generation capacity continues to constrain improvements in debt affordability and limits Bangladesh’s fiscal flexibility at a time when deficits have increased. It also limits the government’s capacity to absorb inflationary pressures exacerbated by the energy and food price shock resulting from Russia’s invasion of Ukraine, and thereby contain social risks. The rating affirmation also considers increased vulnerability to future shocks as structural challenges have been exacerbated by the pandemic. The challenges include addressing infrastructure needs and low levels of human capital, both of which constrain greater foreign investment and limit prospects for economic diversification over the medium term. The stable outlook reflects broadly balanced risks at the Ba3 rating level, mainly related to the government’s slow implementation of key economic and fiscal reforms. Most significantly, more effective execution of fiscal reforms would expand Bangladesh’s revenue base and increase the government’s fiscal flexibility beyond Moody’s current expectations. Conversely, weaker implementation of measures to expand Bangladesh’s narrow revenue base would increasingly constrain the government’s fiscal flexibility. Bangladesh’ local-currency (LC) and foreign-currency (FC) ceilings are unchanged at Baa3 and Ba2, respectively. The LC ceiling is placed three notches above the sovereign rating, reflecting Bangladesh’s relatively small government footprint, but also weak predictability and reliability of government institutions; domestic political and geopolitical risks, and external imbalances are moderate. The FC ceiling is placed two notches below the LC ceiling, reflecting low capital account openness, weak policy effectiveness, but also a lower degree of external indebtedness. RATINGS RATIONALERATIONALE FOR THE AFFIRMATION OF THE Ba3 RATINGMACROECONOMIC STABILITY DRIVES THE RECOVERY FROM THE PANDEMIC, RESILIENCE TO RUSSIA-UKRAINE MILITARY CONFLICT Bangladesh’s macroeconomic stability during the pandemic illustrates the economy’s resilience. Following a low of 3.5% in fiscal 2020 (ending June 2020), GDP growth reached 5% in fiscal 2021, supported by ready-made garments (RMG) export growth (+11% in fiscal 2021) and a surge in remittance flows (+36%).Moody’s expects real GDP growth to reach 6% in fiscal 2022 and 6.5% in fiscal 2023, driven by exports and domestic demand. Moody’s expects the recovery will be slightly dented by a slowdown in export demand from Bangladesh’s key export markets (especially the EU) due to the Russia-Ukraine crisis. Nevertheless GDP growth is expected to return to pre-pandemic levels within the next two years. Higher commodity prices, exacerbated by the global spillover effects of Russia’s invasion of Ukraine, will lead to increased inflationary pressures. For fiscal 2022, Bangladesh Bank, the central bank, expects to maintain an expansionary stance, even though it projects inflation to be above its target rate of 5.3%, at 5.9%, after remaining relatively stable at 5.6% in fiscal 2021. Considering the surge in oil and food prices, Moody’s forecasts inflation to reach 6-7% over the next two years. Based on a historical track record of relatively stable inflation in Bangladesh, and adequate monetary policy management of potential pressures, Moody’s does not expect inflationary pressures to build up further and start jeopardizing macroeconomic stability. CONCESSIONAL FUNDING MITIGATES DEBT AFFORDABILITY AND LIQUIDITY RISKS, EVEN THOUGH FISCAL SPACE HAS DETERIORATED At less than 10% of GDP, Bangladesh’s general government revenue remains one of the lowest among sovereigns rated by Moody’s, significantly lower than the Ba-rated median of 25% of GDP. Meanwhile, increased spending under the government’s expansionary policy has led to wider deficits, surpassing the self-imposed 5% of GDP deficit limit for at least three years (fiscal 2021-23). Moody’s expects consolidation to pre-pandemic deficit levels by fiscal 2025 only.Low revenues and high domestic financing costs weigh on Bangladesh’s debt affordability. Interest payments hover around 20% of revenue. Though slightly lower than its peak during the pandemic, reliance on National Savings Certificates (NSCs) remains high at 29% of Bangladesh’s total general government debt stock. Although NSC reforms have been implemented Moody’s expects improvements in debt affordability to be slow.Nevertheless, the debt burden remains moderate, and Moody’s expects it to remain below 40% of GDP over the next few years, anchored by strong growth. Moreover, continued access to concessional funding (30% of Bangladesh’s general government debt and more than 70% of government external debt), even after pandemic-related support expires, is key to mitigating debt financing costs. Concessional financing also alleviates liquidity risks, although Moody’s expects gross borrowing requirements to rise as deficits have increased and debt maturities have shortened. Despite a recent increase in bilateral financing, Moody’s expects concessional financing to remain a material portion of Bangladesh’s government borrowings. In the medium term however, graduation from Least Developed Country (LDC) status suggests that Bangladesh will gradually lose its access to concessional funding, which could increase debt affordability and liquidity risks. VULNERABILITY TO FUTURE SHOCKS HAS RISEN DUE TO PANDEMIC’S IMPACT ON STRUCTURAL CONSTRAINTS Bangladesh will continue facing challenges related to institutions and governance, particularly in areas of legislative policy effectiveness, control of corruption, and weak credibility and effectiveness of its judiciary system. Such institutional weaknesses limit efficacy in enacting structural reforms that would improve the quality of infrastructure and human capital, thereby raising economic competitiveness and diversification, and attracting foreign investment – issues that are becoming more pressing as Bangladesh seeks to transition to a middle-income economy. Bangladesh’s export-driven growth model, which is reliant on a single commodity (RMG), faces challenges in moving up the value chain, while regional competition intensifies. While Bangladesh remains competitive in the RMG industry, due to low labour costs, vertical integration, technological investment and environmentally sustainable processes, it has been losing some market share to competitors such as Vietnam. The pandemic has also exacerbated weaknesses in the banking sector. Rescheduling and restructuring have delayed systemic reform. As of December 2021, about 25% of loans in the banking system were restructured or rescheduled. The NPL ratios have increased, and reported NPLs do not fully reflect the extent of problem assets, which Moody’s estimates to increase modestly after forbearance measures are rolled back. A weak banking sector constrains productivity, effective allocation of capital and GDP growth. Meanwhile, poverty, inequality, and unemployment have risen during the pandemic – exacerbating social risk at a time when inflationary pressures are also expected to rise. Unemployment levels increased to 5.3% in fiscal 2020 from 4.2% in fiscal 2019, according to International Labour Organization estimates, and the poverty rate (based on $1.9 per day) has risen to 12.9% in fiscal year 2020 from 11.9% in fiscal 2019, amounting to an additional 1.6 million people in poverty according to the IMF. The global energy and food price shock related to Russia’s invasion of Ukraine could lead to social discontent if the government is unable to contain inflationary pressures. Finally, schools have remained closed throughout the pandemic, and although some were able to provide online learning, this was not available to large segments of the population, pointing to lasting economic and social marks from missed education. RATIONALE FOR STABLE OUTLOOK The stable outlook reflects Moody’s expected progress on reforms, albeit very gradual, as pandemic pressures ease, which will help shore up macroeconomic stability. While the authorities have initiated a series of reforms to increase the tax base in recent years, implementation remains weak due to low capacity and poor governance, and has stalled during the pandemic. Moody’s expects government revenue to recover to around 9-10% of GDP largely due to the rebound in activity, still a very low level by international standards. External vulnerability risks remain low, and foreign exchange reserves have increased during the pandemic due to a surge in official remittance flows. This provides some protection against widening current account deficits as import prices rise. FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS FACTORS THAT COULD LEAD TO AN UPGRADE Upward pressure on the rating would result from a rising likelihood of (1) 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; and/or (2) 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. FACTORS THAT COULD LEAD TO A DOWNGRADE Downward pressure on the rating would result from a rising likelihood of (1) a severe weakening of the macroeconomic environment, including a slowdown in growth, sustained high inflation and depreciation pressures leading to a worsening of fiscal and external metrics; and/or (2) increased reliance on bilateral debt that would lead to a worsening of debt affordability and liquidity metrics without a commensurate improvement in infrastructure development; and/or (3) a weakening of the banking sector’s financial health after rolling back forbearance measures, particularly for state-owned banks, with rising contingent liability risks to the government. ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS Bangladesh’s very highly negative (CIS-5) ESG Credit Impact Score reflects very high exposure to environmental and social risks, further weakened by institutional challenges that present weaknesses in the control of corruption and rule of law, as well as challenges related to banking regulation and supervision. Bangladesh’s exposure to environmental risk is very highly negative (E-5). As a low-lying country with large coastal areas, Bangladesh is highly prone to 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, unreliability of seasonal monsoon rainfall also influence agricultural sector growth, generating some volatility and raising uncertainty about rural incomes and consumption. We assess Bangladesh’s exposure to social risks as 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, thanks 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 labor 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. Nevertheless, a relatively strong monetary policy framework and fiscal prudence contribute to ongoing macroeconomic stability. GDP per capita (PPP basis, US$): 5,287 (2020 Actual) (also known as Per Capita Income)Real GDP growth (% change): 3.4% (2020 Actual) (also known as GDP Growth)Inflation Rate (CPI, % change Dec/Dec): 6% (2020 Actual)Gen. Gov. Financial Balance/GDP: -4.8% (2020 Actual) (also known as Fiscal Balance)Current Account Balance/GDP: -1.5% (2020 Actual) (also known as External Balance)Economic resiliency: ba2Default history: No default events (on bonds or loans) have been recorded since 1983.On 24 March 2022, a rating committee was called to discuss the rating of the Bangladesh, Government of. The main points raised during the discussion were: The issuer’s economic fundamentals, including its economic strength, have not materially changed. The issuer’s institutions and governance strength, have not materially changed. The issuer’s governance and/or management, have not materially changed.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631.

 

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