Does Bangladesh deserve a higher sovereign rating?
In Fiscal Year (FY) 2014-15, global sovereign rating agencies Moody's, Standard & Poor's and Fitch assigned Bangladesh a 'stable' sovereign credit outlook. While certainly commendable, Bangladesh's rating is still well below many emerging economies. A higher sovereign rating lowers the interest rate companies and sovereign governments have to pay to access international credit markets. This is particularly relevant now that Bangladesh has opened up foreign commercial borrowing. It is also used as a gauge by foreign investors when deciding to invest in various manufacturing sectors. This article uses Moody's rating methodology to highlight that Bangladesh deserves a higher sovereign rating from international rating agencies.
Moody's rating methodology is based on four broad categories - economic strength, fiscal strength, institutional strength and susceptibility to event risk. Each of these categories is based on multiple sub-factors. For instance, fiscal strength is determined by the level and cost of overall government debt. Economic strength is based on the level and volatility of GDP growth as well as scale of the economy's wealth. Susceptibility to event risk depends on political risk, government's liquidity risk, banking sector risk and external vulnerability risk. Scores to these sub-factors are aggregated to give individual rankings to the four broad categories listed above. Rankings to the broad categories are then aggregated and assigned a formal credit rating. Bangladesh achieved a 'Ba3' rating from Moody's last year.
Fiscal strength: Bangladesh's below-par rating in fiscal dimension reflects low revenue base compared to peer countries. This creates challenges for the country's debt burden (ratio of government debt to government revenue) and debt affordability (ratio of government interest payment to government revenue). We all know that improving tax collection has been a major challenge in Bangladesh. In this regard, completion of the VAT automation process by the end of this year will show (rating agencies) progress in a key fiscal dimension. Reduction of interest rates on National Savings Schemes (NSS) by 2 percent last year should also not be overlooked (albeit rate of return on NSS is still considered relatively high). The slump in international oil prices has created fiscal space through reduction in energy subsidy. Overall, assuming continued political stability, improved economic activity will generate higher revenue in the near term. These developments suggest fiscal strength warrants a more positive outlook.
Institutional effectiveness: A low score in this category reflects widely-known challenges to public institutional credibility and good governance. Fiscal policy echoes these concerns more, especially given below-par quality of fiscal expenditure. On the other hand, monetary policy has been generally laudable. The central bank brought down inflation from 11 percent in 2011 to 6 percent and ensured both price and nominal exchange rate stability in recent years. This success notwithstanding, improving institutional effectiveness and policy credibility is a longer term concern. For instance, further improvements in monetary policy effectiveness will depend on bond market development. So at least for the coming year, Bangladesh's existing ranking in this category is justified.
Economic Strength: Moody's based its previous score in this category on a projected 6.1 percent growth in FY 15, substantially lower than the actual 6.5 percent. With political turmoil significantly reduced, analysts are now relatively bullish on Bangladesh's growth rate for FY 16 and are projecting economic expansion above 6.5 percent. Additionally, volatility of growth rate is substantially lower than peer countries. Concerns have also been raised about Bangladesh's investment scenario. While credit flow to the real economy has improved in recent months, sustained periods of 15-16 percent private sector credit growth requires substantial improvement in infrastructure. In this regard, Bangladesh Economic Zones Authority (BEZA) is starting development work of 10 economic zones. According to recent press reports, the next budget plans to create a separate 'capital budget' for big public investment projects. Consistent with the need for additional capital to fund mega projects, Bangladesh joined the Asian Infrastructure Investment Bank. Finally, the central bank's continued the 'Selective Easing' initiative to ensure affordable credit to productive sectors – with strong emphasis on small and medium enterprises - is also worth mentioning. These initiatives suggest that medium-term infrastructure and investment outlook is certainly credit-positive and warrants a higher ranking in economic strength.
Susceptibility to event risk: The main factor which lowered ranking in this category last year was political volatility. But since the first quarter of 2015, political condition has been relatively stable. Confrontational politics and frequent strikes have more or less dissipated and signs are that this year will be free of such turmoil. Two other factors in this category – government liquidity risk and external vulnerability - are also in strong shape. With banks sitting on excess liquidity, raising funds through sale of debt-securities is certainly not a challenge for the government if the need arises. Low-cost and limited foreign liability backed by record-high international reserves means our vulnerability to an external debt-related crisis is minimal. Additionally, the central bank's recent appointment of 'observers' to public banks shows that authorities are taking tangible steps to improve asset quality in the financial sector. Based on these arguments, Bangladesh's ranking in 'Susceptibility to Event Risk' deserves an improved ranking as well.
Given an outlook of improving private sector credit, higher GDP growth with restrained inflation, gradual initiatives to address infrastructural bottlenecks, political stability and stronger external condition, we can argue that Bangladesh deserves a higher sovereign rating. It should be mentioned that the methodologies of international credit rating agencies largely focus on similar economic indicators. So the arguments raised in this column can be extended to ratings assigned by all agencies.
The writer currently works as a macroeconomic analyst for an organisation in Washington D.C. He is a Fellow for the Asian Center for Development in Dhaka.