Fitch Ratings has downgraded Bangladesh's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'B+' from 'BB-', citing sustained weakening of the country's external buffers.

The outlook is stable, says its report, reflecting recent policy reforms aimed at improving macroeconomic stability and addressing banking sector weaknesses.

The downgrade highlights concerns about Bangladesh's ability to sufficiently reverse the decline in foreign exchange reserves and resolve domestic dollar tightness, despite policy actions taken since early 2022.

The recent shift to a crawling peg is intended to increase exchange-rate flexibility, but its effectiveness in addressing lingering FX market distortions and supporting significant reserves build-up remains to be seen, says the report of Fitch rating.

Fitch notes that Bangladesh's external refinancing risks are mitigated by a favorable external creditor composition, moderate government debt, and favorable medium-term growth prospects.

However, the country remains vulnerable to external shocks due to the persistent weakening of its external buffers.

Fitch points out that Bangladesh's foreign exchange reserves have plummeted by 15% since January to USD 18.4 billion due to continued interventions, capital outflows, and informal remittance channels.

It predicts stabilization with recent reforms, but uncertainty remains about the new forex regime's implementation and the official rate's alignment with the parallel market.

Fitch believes the central bank's crawling peg is intended as a temporary measure before transitioning to a fully flexible market-based exchange rate.

However, persistent high inflation of 9.8% in April may complicate further moves towards increased exchange rate flexibility, it says.

The agency noted that import restrictions in Bangladesh have been effectively implemented due to the domestic scarcity of US dollars, as authorities manage the allocation of foreign exchange.

This, coupled with sustained export growth, led to a current account surplus estimated at 1.4% of GDP in the fiscal year ending June 30, 2024.

Increased foreign exchange flexibility is expected to alleviate dollar shortages, potentially boosting imports in the coming years, says the agency.

However, the impact on the current account is predicted to be moderate, as remittances through formal channels should also increase with better alignment between official and parallel market exchange rates.

Bangladesh's long-standing fiscal weakness, its low general government revenue/GDP ratio of 8.2%, significantly lags behind the 19.5% 'B' median, noted Fitch.

Revenue continues to fall short of budget targets due to tax exemptions, weak tax administration, and challenges in implementing reforms.

However, planned tax reforms under the IMF program and measures like tax hikes on tobacco and land registration offer potential for improved revenue collection, it says.

The agency says Bangladesh's medium-term external debt, owed to bilateral or multilateral partners, is expected to remain sustainable with continued financing and low projected debt service relative to peers.

The ongoing IMF program also supports continued access to financing, contingent on meeting program targets, it points out.