Raising concern about the health of the banking sector, Fitch, the global rating agency, said the reported default loan is likely understated because of an extensive loan moratorium during the pandemic.
The rating agency fears that default loans will increase significantly after the ongoing loan moratorium facility is lifted, putting the banking industry under stress.
The Bangladesh Bank extended the moratorium to 31 December this year in response to a request from businesspeople.
"The health of Bangladesh's banking sector and its governance standards remain weak, especially among public-sector banks," said Fitch in its evaluation report for the 2021 released on 8 November.
"The system's gross non-performing loan (NPL) ratio rose modestly to 8.2% by June 2021 from 7.7% at end-2020, but the reported figure is likely understated because of an extensive loan moratorium," the report said.
"State-owned commercial banks' NPL ratio of 20.6% is substantially higher than private-sector banks' 5.4%, but we expect both to rise significantly when repayment relief is withdrawn next year, provided it is not extended again."
Banks' capitalisation is thin relative to prevailing risks in the market, with the system's capital ratio at 11.6% as of June 2021, and state-owned banks' at 6.8%, the report also said, adding, "We believe the banking sector could be a source of contingent liability for the sovereign if credit stress intensifies."
In the Fitch evaluation, Bangladesh continued its stable outlook with strong economic growth despite the pandemic.
The rebound of economic activities thanks to pandemic containment measures and improvement of consumption helped the country contain its stable outlook, said the evaluation report.
Bangladesh continued its same stable rating since 2014.
The latest Fitch evaluation report said Bangladesh's economic growth slowed significantly to 3.5% in FY20 owing to the Covid-19 impact.
Growth recovered to 5.5% in FY21 as pandemic containment measures were eased and consumer spending improved.
"We expect economic growth to accelerate to 7.0% in FY22 and 7.2% in FY23, almost double the 'BB' median's 3.7% average for 2022-2023."
The global evolution of the pandemic may create risks to our growth forecast. Daily infections have been declining since August and supply disruptions that caused delays early in the vaccination programme have eased, but vaccination rates are low, as about 18% of Bangladesh's population has been fully vaccinated as of 3 November 2021, the report said.
Bangladesh's foreign-exchange (FX) reserves increased to about $46 billion by end-September 2021, from $43 billion at end-2020, owing to the higher remittances, increased external borrowings primarily for Covid-19 relief and a pick-up in exports.
"We estimate FX reserve coverage of current external payments to remain healthy at about 9.2 months by end-2021, above the 6.6-month forecast for the 'BB' median."
Recent media reports suggest that according to the IMF, the actual level of international reserve assets could be lower due to the potential investment of reserves in non-liquid assets.
The Business Standard ran a report on 24 October titled "Forex reserves overstated by $7.2bn: IMF."
The report was done based on a draft report of IMF on safeguards assessment of the Bangladesh Bank for 2021.
However, the Bangladesh Bank did not give any explanation over IMF's claim of overstatement of $7.2 billion reserve.
Referring to that IMF report, Fitch in its evaluation report said the government could also be considering the use of a portion of international reserves to finance infrastructure projects. Bangladesh's international reserve buffers are currently adequate, but the lack of transparency in reserve management could create uncertainty and hurt the credibility of the existing policy framework.
"We believe the Bangladesh Bank will maintain its policy stance for a stable and competitive exchange rate through FX intervention. FX reserves could come under pressure if the authorities were to intervene aggressively to support the exchange rate in the event of an external or confidence shock."
The pandemic has raised risks to the fiscal outlook. Revenues in FY21 exceeded the authorities' estimates and the budget deficit is likely to be lower than their current expectations.
"We estimate the FY21 budget deficit at 5.8% of GDP, slightly above the 5.7% forecast for 'BB' rated peers."
"The authorities forecast a budget deficit of about 6.2% of GDP in FY22. We expect spending on Covid-19 relief measures to continue until FY22 and withdrawn from FY23. Risks to our forecasts remain if economic recovery is weaker than the authorities' expectations or due to the extension of support measures. Fiscal risks from contingent liabilities have increased due to the economic fallout of the pandemic on state-owned enterprises and forbearance measures still in place for the banking sector," said Fitch in its evaluation report.
According to Fitch, Bangladesh's low government revenue-to-GDP ratio remains a key weakness in the sovereign's credit profile. The official revenue-to-GDP ratio in FY20 was 9.8%, a fraction of the "BB" median of around 28%.
Introduction of a new VAT law from July 2019 has not been effective in raising the revenue ratio so far.
"We estimate government debt to GDP at about 38.8% in FY20, below the 'BB' median of 58.3%, but the debt-to-revenue ratio of about 396% in FY20 was far above the 'BB' median of 232%. A high proportion, almost 50%, of external debt is concessional, thus mitigating refinancing risks and reining in debt-servicing costs," the report said.
Bangladesh's structural indicators remain a weakness relative to its peers. In addition to weaker governance indicators, foreign direct investment remains constrained by large infrastructure gaps, although the government's focus on building large infrastructure projects in the next few years could bode well for investment, according to the report.
The security situation in Bangladesh has improved in recent years and is now less of a concern to foreign visitors, although the risk of a recurrence of security incidents and political turmoil remains, Fitch noted.