Will the butterfly effect of US rating downgrade reach our shores?

The Fitch Ratings logo is seen at their offices at Canary Wharf financial district in London, Britain.

  • The US rating downgrade could lead to a further increase in US Treasury yields.
  • This could result in capital losses for Bangladesh’s foreign exchange reserves invested in US treasury bonds.
  • The downgrade could also put additional strain on foreign investment inflows, intensifying stress on the country’s capital account.
  • The Bangladesh Bank has said its investments in the US treasury are for the short term, so there is no chance of capital loss.
  • However, some analysts believe the downgrade could still have a negative impact on Bangladesh’s economy.
  • They say it could lead to a decrease in foreign investment, an increase in the cost of borrowing, and a depreciation of the taka.
  • The downgrade comes at a time when Bangladesh’s economy is already facing some challenges, such as rising inflation and a current account deficit.

The rating downgrade of the US could potentially lead to a further increase in US Treasury yields, resulting in capital losses for Bangladesh’s foreign exchange reserves invested in US treasury bonds.

This situation may also put additional strain on foreign investment inflows, intensifying stress on the country’s capital account, analysts suggest.

On Tuesday, rating agency Fitch downgraded the US government’s top credit rating to AA+ from AAA, a move that the White House and the US Treasury strongly criticised as arbitrary.

Analysts say the downgrade might leave an impact on Bangladesh as the US is the biggest source of foreign investment for the country.

The credit rating downgrade implies an increased risk of rising treasury yields and a decrease in bond prices, which may cause capital losses for countries that have invested their foreign exchange reserves in US treasuries, said Zahid Hussain, former lead economist of the World Bank’s Dhaka office.

Bond prices and bond yields are inversely related. As the price of a bond rises, the yield decreases, and vice versa, due to the fixed coupon rate of the bond, causing fluctuations in secondary market prices to align with prevailing market rates.

Zahid Hussain mentioned that Bangladesh’s foreign exchange reserves are divided into two forms: liquidity and investment. A significant portion of the investment tranches is invested in US treasury bonds. If the interest rate of these bonds increases due to the rating downgrade, their prices will decline. In such a scenario, Bangladesh could face capital losses if it needs to liquidate the investments before maturity.

However, the economist noted that there is no risk if the investment is for the short term.

Now the question is whether the Bangladesh Bank is in a good position with dollar liquidity to meet the substantial demand for fuel imports from the government, he said, adding that there is also a risk for rising trade financing costs due to the US rating downgrade.

Interest rate hikes have already made short-term external financing for imports costlier. The rating downgrade may further increase the Secured Overnight Financing Rate (SOFR) cost, Zahid Hussain maintained.

SOFR, the average rate at which institutions can borrow US dollars overnight, is now above 5.3% which was less than 2% a year back.

Zahid Hussain said two regional US banks collapsed due to loss from bond portfolios after an increase in bond rates. So, if the bond rate increases further after the US rating, that could land US banks into a crisis, which will increase external financing costs for Bangladesh.

Banking stocks on global markets experienced a huge shock after Silicon Valley Bank and Signature Bank collapsed under the weight of heavy losses on their bond portfolios and a massive run on deposits this year.

Despite the assurances from President Joe Biden that the banking system is safe, US banks lost about $90 billion in stock market value in a single day as investors feared additional bank failures.

Bangladesh Bank data show that 80% of the total forex reserves are held in the US dollar, of which a major portion remained invested in the US treasury as of May this year.

When contacted, a senior executive of the Bangladesh Bank told TBS that investments in the US treasury are for short term mostly for 30 days and 60 days, and the central bank reviews the investment every two weeks. As a result, there is no chance of capital loss from US treasury investment, he added.

He said the US rating downgrade will make the dollar weaker, making other currencies like Euro, and yuan stronger which could ease the dollar crisis.

Among other reserve currency components, Euro accounted for 6.49%, the second highest share in forex reserve, according to Bangladesh Bank’s data.

The Bangladesh Bank in its annual report for last year mentioned, “BB put its best efforts to ensure optimum return on foreign exchange reserve investments through diversifying the foreign asset portfolio into bonds (issued by sovereign, supranational and highly rated foreign commercial banks), US Government Treasury Bills and Notes, and short-term deposits with globally reputed foreign commercial banks. BB is also active in the New York Fed’s Repo process which yields fair returns at a very low risk.”

Dr Saleh Uddin Ahmed, former governor of Bangladesh Bank, told TBS that the rating downgrade may put further pressure on Bangladesh’s forex market if the rating really impacts the US market.

If treasury yield increases, fresh investment from the US will reduce. The rise in treasury yield could lead to an outflow of reinvested earnings of foreign companies operating in Bangladesh, he said.

He also said foreign inflow will be challenging which will ultimately put pressure on the country’s financial account which is already in negative territory.

The country’s financial account which is used for international payments turned to a negative $2.5 billion in July-May of last fiscal year, down from a surplus of $13.37 billion in the same period of the previous fiscal year, according to Bangladesh Bank data.

Saleh Uddin said there is also a risk of capital loss if US treasury yield increases. In this case, the Bangladesh Bank should avoid liquidating investment in the US treasury before maturity.

However, Dr Ahsan H Mansur, executive director of the Policy Research Institute (PRI), sees no impact of the US rating on Bangladesh.

He said the US market is very strong, they will never default and the rating downgrade may have political grounds.

The US rating will not have much impact on foreign investment inflow, rather a rate hike by the Federal Reserve Bank will have a negative impact on foreign investment in Bangladesh, he added.

Data from the Bangladesh Bank reveal that total net equity capital investment decreased by 10% to $1 billion last year, mainly due to the decline in net investment from the US and China. The growth in net equity capital investment was 35% in 2021.

However, net foreign direct investment increased by 20% to $3.4 billion in 2022, driven by a 61% growth in reinvested earnings.

Intra-company loans, another component of net foreign direct investment, also saw a decline of 129.6% last year as foreign companies retrieved their loans to invest in other markets.

Selim RF Hussain, managing director of Brac Bank, told TBS that the US rating will not have any impact on external borrowing of commercial banks as Bangladesh’s borrowing amount is insignificant compared to other countries.

However, an increase in bond yields in the US market will cause a reduction in foreign investment in Bangladesh, he said.

The rating downgrade of the US came at a time when Bangladeshi banks have already been facing difficulties in external borrowing after Moody’s and S&P lowered their respective ratings for Bangladesh.

S&P Global Ratings lowered the long-term rating outlook for Bangladesh to negative from stable when Moody’s Investors Service Moody’s downgraded Bangladesh’s rating for the first time, placing it at B1 from the Ba3 category in their latest reports.

Commercial banks’ external borrowing turned to negative $2.4 billion in July-May of last fiscal year which was a surplus of $1.5 billion in the same period of the previous year, central bank data shows.

On the other hand, the Asian stock markets already felt the shock of the US rating as Hong Kong, Tokyo, Australia, Korea, and other Asian markets fell by up to 2% following the downgrade by Fitch. Stocks of tech firms that depend on the US and Western markets for business were impacted the most, according to media reports.

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