People#s Republic of Bangladesh #BB-/B# Ratings Outlook Stable

Stocks and Financial Services Press Releases Friday May 19, 2017 17:53
S&P Global Ratings--19 May--S&P Global Ratings

On May 19, 2017, S&P Global Ratings affirmed its 'BB-' long-term and 'B' short-term sovereign credit ratings on the People's Republic of Bangladesh. The outlook remains stable. The transfer and convertibility (T&C) assessment remains 'BB-'.

RATIONALE

The ratings on Bangladesh reflect the country's low economic development and limited fiscal flexibility owing to a combination of constrained revenue-generation capacity and the high spending to improve its basic infrastructure and government services. The country's volatile political setting combined with administrative and institutional weaknesses represent additional rating constraints. We weigh these factors against a relatively modest external debt burden, reflecting support from substantial donor engagement, and large remittances from the Bangladeshi diaspora.

Low economic development, as represented by per capita GDP of US$1,500 for 2017, is one of Bangladesh's main rating constraints. This income level offers a weak and narrow revenue base, in turn limiting the fiscal and monetary flexibility needed to respond to exogenous shocks. Nevertheless, Bangladesh's real per capita GDP growth of about 5.3% is healthy and in line with peers' at this income level. Despite numerous structural impediments to growth, in particular the shortage of electricity, the economy has a record of steady growth. Should these impediments be addressed, we believe Bangladesh's growth trajectory would be stronger than peers'. That said, the high dividend payouts in comparison to foreign direct investments suggest little earnings are retained due to the difficult business operating environment.

Bangladesh's fractious domestic political conditions distract from stable policymaking. In the past, widespread strikes and blockades had often caused substantial economic disruption. Domestic security concerns stemming from extremist activities had also heightened over the past year. In addition, the confrontational stance between the incumbent Awami League and opposition Bangladesh Nationalist Party harbors the potential for conflict. Given a weak institutional setting and infrastructure deficiencies, Bangladesh's foreign direct investment have remained persistently low. That said, large-scale strikes disruptive to economic activities have subsided since early 2015.

On the fiscal front, Bangladesh tends to run moderate deficits. We forecast the change in general government debt will average 2.8% of GDP annually over fiscal 2017-2020 (end June 30). However, many basic social and infrastructure needs remain unmet, implying the need for higher outlays ahead. Although the government's debt burden is low, with net general government debt at our projection of 22% of GDP as of the end of fiscal 2017, its high interest expense at 17.4% of revenues limits fiscal flexibility. The government's increasing use of a costlier national savings certificates scheme rather than commercial borrowings infers that its debt-servicing ratio will not necessarily fall even if there is fiscal consolidation. In addition, over 40% of the total government debt is denominated in foreign currency. Nevertheless, the availability of official concessional funding tempers the negative effect of high foreign currency exposure.

We see moderate risk of contingent liabilities from financial institutions, in particular the state-owned commercial banks (SOCB) sector. Although the private sector banks are in adequate shape, significant risks reside in the SOCBs. SOCBs account for 28% of total banking sector assets and nonperforming loans had reached 25% of its total loans as of end 2016. Although the government has begun to recapitalize some of the SOCBs, we expect the sector to remain below prudential norms and will continue to require budgetary support.

Bangladesh's narrow revenue base limits the government's flexibility to mitigate the effect of economic downturns or other shocks. It has only 2 million registered taxpayers (out of a population of 155 million). General government revenue was 10% of GDP in fiscal 2016, among the lowest of rated sovereigns globally. Numerous initiatives are underway to expand the tax base, most notably the plan to reform the complicated Value Added Tax (VAT) system. The government has set a target to standardize the VAT rate at 15% by July 2017. However, the plan has been repeatedly delayed over the past years since it was first passed into law in 2012.

We view Bangladesh's monetary assessment as a neutral rating factor. The central bank's limited independence, multiple mandates, and underdeveloped capital markets hamper monetary flexibility. After the cyber heist of US$100 million in foreign reserves from Bangladesh Bank last year, the Ministry of Finance has since asserted more control over the central bank.

Bangladesh's exchange regime is classified by the IMF as "stabilized arrangement," which is akin to a managed float. The Bangladeshi Taka exchange rate has remained fairly stable in the past two to three years. However, Bangladesh's real effective exchange rate has been rising, reflecting the currency depreciation of its trading partners. Should this persist, it could strain the competiveness of its export garment sector.

The central bank has made progress in managing inflationary expectations. In the past two years, inflationary pressure subsided with reduced government borrowing from the banking sector. Inflation has stayed in the single digits

since 2011.

Bangladesh's low external borrowings support the ratings. Large remittance inflows and an internationally competitive garment export sector resulted in current account surpluses for most years. But we expect modest current account deficits over the forecast period given that remittances have contracted of late due to the oil price slump taking its toll on the Gulf States, the largest hosts of the Bangladeshi diaspora. We envisage remittance inflows to remain subdued over the next one to two years, but a drastic collapse is not within our base-case scenario.

We expect Bangladesh's gross external financing needs to average 77% of current account receipts plus usable reserves over 2017-2020. The country's significant reserve accumulation improved the narrow net external debt position, and we project it to be about 7.6% of current account receipts by end 2017. But we expect reserve accumulation to stagnate due to lower remittance flows. Nonetheless, we believe external balance and liquidity will remain key credit-supporting factors.

Bangladesh's external profile draws substantial donor support, ensuring that the bulk of public external debt is low-cost borrowing with long maturity. Additionally, donors and multilateral lenders condition policy formulation and provide direct budgetary support.

OUTLOOK

The stable outlook reflects our expectation that Bangladesh's steady growth path and strong donor support will continue raising average income and sustaining the country's external profile over the next 12 months. These factors are balanced against lingering governance and fiscal weaknesses, and infrastructure deficiencies.

We may raise the ratings if measures aimed at expanding the revenue base and boosting collection efficiency materially improve Bangladesh's fiscal performance. We may also upgrade Bangladesh if the government significantly reduces energy, infrastructure, and administrative bottlenecks, and boosts investment, leading to a durable increase in trend growth for real per capita GDP. In addition, we may raise the ratings if Bangladesh's monetary flexibility strengthens, as seen in well-controlled inflation over a sustained period and deeper capital markets with market-based tools.

Conversely, we may downgrade the sovereign if fiscal slippages result in rising public debt and external donor support declines materially.

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