Dhaka, Bangladesh (BBN) - Moody's Ratings (Moody's) has downgraded the Government of Bangladesh's long-term issuer and senior unsecured ratings to B2 from B1 and affirmed short-term issuer ratings at Not Prime. The outlook has been changed to negative from stable.
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, says Moody’s in its latest report released from Singapore on Monday.
Ongoing political uncertainty and weakening growth lead Bangladesh to rely increasingly on short-term domestic debt to finance its deficit, raising liquidity risks.
Additionally, higher risks to asset quality amplify structurally weak capital and liquidity in the banking system, increasing contingent liability risks for the sovereign.
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.
The negative outlook reflects downside risks to Bangladesh's growth outlook beyond our 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.
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.
Bangladesh's local-currency (LC) and foreign-currency (FC) ceilings have been lowered to Ba3 and B2 from Ba2 and B1, respectively.
The LC 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 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 THE DOWNGRADE TO B2
Political risk has increased following the recent social unrest that led to the resignation of former Prime Minister Sheikh Hasina and the subsequent introduction of an interim government led by Nobel laureate Muhammad Yunus.
While economic activity has largely normalized 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.
Together with the impact on agricultural production from recent floods, we have lowered our growth projections to 4.5% from 6.3% for FY2025 (from 01-July 2024 to 30-June 2025) and to 5.8% from 6.0% for FY2026.
Execution risk for reforms under the current IMF program 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. 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 FY2025, up from 20% in FY2023.
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 mobilization reform is expected to remain challenging in a weakening growth environment.
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,” it noted.
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.
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. We now expect 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 (EVI) — 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. Heightened political risk and payment delays to energy suppliers will continue to exert pressure on the reserve buffers.
RATIONALE FOR THE NEGATIVE OUTLOOK
The negative outlook reflects downside risks to Bangladesh's growth outlook beyond our current expectations, which could further strain the country's already weak fiscal position, exacerbate external vulnerabilities and government liquidity.
The risk of further deterioration in law and order, fueled by challenging social conditions and on-going political uncertainty, cloud the outlook for the ready-made garments sector and exports. There are further downside risks to our growth forecasts as the full economic impact of social unrest and supply disruptions remains uncertain.
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, the 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 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 neighboring 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.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Bangladesh's ESG Credit Impact Score of CIS-5 reflects very high exposure to environmental and social risks, and weak governance which, together with low financial capacity, constraint the sovereign's ability to adjust to environmental and social risks.
“We assess Bangladesh's E issuer profile score at E-5 given 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,” it added.
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. As a net energy importer, exposure and risks related to carbon transition are not present.
“We assess Bangladesh's S issuer profile score at S-5 given 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,” it continued.
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 G issuer profile score at 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.
BBN/SSR/AD