While the budget largely evaded the economy's main challenges, they came to the fore earlier in the week as international credit rating agency Moody's Investors Services, or Moody's, on Tuesday (May 30) downgraded the government of Bangladesh's long term issuer and senior unsecured ratings by one notch from Ba3 to B1 and affirmed short term issuer ratings at Not Prime.

Earlier Moody's had placed Bangladesh's long-term issuer and senior unsecured ratings at Ba3 on review for downgrade. The rating action concluded the review initiated last December. The rating outlook, Moody's said, remains stable.

In March, Moody's had downgraded its outlook for Bangladesh's banking sector (independent of the sovereign) from stable to negative.

A sovereign credit rating is an independent assessment of the creditworthiness of a country or sovereign entity and how risky investing in it might be. At Ba3, Bangladesh had the lowest rating Moody's offers for 'speculative' grade bonds. B1 is the highest credit rating from Moody's for what are still considered 'non-investment grade' bonds.

B1 signifies that the issuer is relatively risky, with a 'higher than average' chance of default.

In its rationale for the downgrade, Moody's said that Bangladesh's heightened external vulnerability and liquidity risks are persistent, and that, together with institutional weaknesses uncovered during the ongoing crisis, the sovereign's credit profile is consistent with a B1 rating.

Despite some easing, ongoing dollar scarcity and deterioration in foreign exchange reserves indicate continued pressures on Bangladesh's external position, exacerbating imports constraints and as a result energy shortages.

Meanwhile, the government has not yet fully reversed its import control measures and unconventional policies including a multiple exchange rate regime and interest rate caps, which are creating distortions.

Finally, a very low level of fiscal revenues relative to the size of the economy constrain the government's policy choices and point to weakening debt affordability as higher interest payments result from the taka devaluation and short maturities for domestic debt.

Although Moody's expects external financing to help alleviate pressures on the external and fiscal metrics, external buffers will remain weaker than before the pandemic and higher debt levels will weaken fiscal strength, particularly as Moody's expects fiscal reforms will take years to materialise.

Concurrently, Bangladesh's local-currency (LC) and foreign-currency (FC) ceilings have been lowered to Ba2 and B1 from Ba1 and Ba3, respectively.

The LC ceiling is placed two notches above the sovereign rating, reflecting weak predictability and reliability of government institutions and high external imbalances, which raise risks for the garment export sector's contributions to government revenue; balanced by a relatively small government footprint.

The FC ceiling is placed two notches below the LC ceiling, reflecting low capital account openness, weak policy effectiveness, and some degree of unpredictability surrounding capital flow management, but taking also into account a low external indebtedness.