Fitch Affirms Bangladesh at 'BB-'; Outlook Stable

Fitch Ratings has affirmed Bangladesh's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'BB-'. The Outlooks on the Long-Term IDRs are Stable. The Country Ceiling has been affirmed at 'BB-' and the Short-Term Foreign- and Local-Currency IDRs at 'B'.

KEY RATING DRIVERS

Bangladesh's ratings balance strong foreign-currency earnings and high and stable real GDP growth against weak structural indicators, significant political risk and weak banking-sector health.

Bangladesh's external finances are supported by comfortable and gradually rising foreign-exchange reserves, amounting to USD32.1bn in December 2016 (7.9 months of current external payments, compared with 4.4 months for peers in the 'BB' category). Remittances have started to decline in mid-2016, however, especially inflows from the Middle East, leading to an 11% drop in 2016 to USD13.6bn. Bangladeshi ready-made garment exports continued to be strong, accounting for 81% of total exports and earning the country USD26.1bn in the first 11 months of 2016 (USD24.6bn in 2015). In 2017, this sector may feel the pinch of further real effective exchange rate appreciation, although Bangladeshi labour costs are still relatively low.

Bangladesh's real GDP growth is high at a five-year average of 6.5% compared with the 'BB' category median of 3.5%. Growth has been remarkably stable over the years despite both political turmoil and natural disasters. In the financial year ended 30 June 2016 (FY16), GDP growth was 7.1%, supported by increased purchasing power from public-sector wage hikes and monetary policy loosening. Fitch expects GDP growth to decline to 6.6% in FY17 and 6.4% in FY18, in part due to lower consumer spending resulting from falling remittances. Inflation is relatively high compared with peers, averaging 5.4% in the first half of FY17, but below the authorities' target of 5.8% set for FY17.

Political and safety risks remain substantial in Bangladesh. Security incidents or political turmoil could inflict long-term economic harm if it deters foreign investors and buyers of Bangladeshi goods, especially ready-made garments, from doing business in Bangladesh. Calm has returned after political violence erupting in 2014 and 2015, but continued strong political polarisation could again lead to widespread violence and blockades, especially nearer to parliamentary elections, which are to be held no later than January 2019.

The risk that the sovereign will need to provide considerable additional support to the banking sector is substantial, although the small size of private credit, at just 36.5% of GDP, would moderate the impact. The sector's health and governance standards are generally weak, particularly in public-sector banks. The official non-performing loan ratio is high at 10.3% in 3Q16, while the capital adequacy ratio (CAR) is low at 10.3%, down from 10.6% in 1Q16. The CAR for the six state-owned commercial banks was just 5.6%.

Bangladesh's general government debt was 32.4% of GDP in FY16, which compares well with the 'BB' median of 51.4%. However, the government's revenue intake of 9.9% of GDP is the second-lowest of all sovereigns rated by Fitch after Nigeria, implying limited fiscal space to boost badly needed infrastructure development. Implementation of the new VAT has been postponed to July 2017. The new VAT has the potential to significantly boost revenues, but the impact will depend on the details, such as the final tax rate and whether the rate will be uniform for all products.

Bangladesh scores poorly on a broad range of structural indicators, such as the World Bank's governance indicator (22nd percentile versus the 'BB' median of 50th percentile). GDP per capita of USD1,443 is well below the 'BB' peer category median of USD5,325, although major improvements have taken place over the past decade on a number of social metrics. The difficult business environment is illustrated by the country's position of 176th out of 190 countries in the World Bank's Ease of Doing Business report, while a large infrastructure deficit also hampers investment. However, the government seems focused on making progress on some big ongoing infrastructure projects, including the Padma Multipurpose Bridge.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Bangladesh a score equivalent to a rating of 'BB' on the Long-Term Foreign-Currency IDR scale.

Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR by applying its QO, relative to rated peers, as follows:

Structural Features: -1 notch, to reflect political risk arising from a polarised political environment and domestic security concerns, as well as weak banking-sector health and governance.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES

The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are well-balanced.

The main factors that individually, or collectively, could trigger positive rating action are:

• An improvement in governance, which would strengthen the business climate and could improve banking-sector health
• A reduction in political risk or domestic security concerns

The main factors that individually, or collectively, could trigger negative rating action are:

• Protracted substantial economic disruption from materialising political risk or a deterioration in the security situation
• A significant rise in the government debt-to-GDP ratio, for example due to substantial government support for the banking sector

KEY ASSUMPTIONS

The global economy performs broadly in line with forecasts in Fitch's latest Global Economic Outlook.