The US-based global credit rating agency Moody's Investors Service yesterday downgraded Bangladesh's sovereign rating by one notch to B1 from Ba3.

This is the first time the country's rating has been downgraded since the agency started rating the nation in 2010.

Bangladesh's long-term rating remained unchanged at Ba3 from 2010 to 2022, according to a report issued by the agency yesterday.

Moody's rating scale, which ranges from a maximum Aaa to a minimum C, consists of 21 notches.

Economists say that the downgrade will take a heavy toll on the economy as it taints the country's image abroad.

They think it is "one of the worst incidents" in the recent history of Bangladesh's economy.

The downgrading means local businesses will have to pay more to take loans from foreign sources, said the economists, adding that foreign investors would also feel discouraged about investing in Bangladesh as this would increase the country's credit risk.

Moody's assessment is that Bangladesh's heightened external vulnerability and liquidity risks are persistent, and that, together with institutional weaknesses uncovered during the ongoing crisis.

"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," it said.

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, said the report.

Moody's expects gross foreign exchange reserves to remain below $30 billion for the next two to three years, with net reserves likely lower, following the Bangladesh Bank's commitment to the International Monetary Fund to start reporting net reserves excluding the Export Development Fund (EDF).

The country's forex reserves stood at $30.96 billion on April 30, down from $42.29 billion a year ago.

In Moody's assessment, persistently low revenue generation and rising interest payments will lead to weakening fiscal metrics, especially debt affordability.

Ahsan H Mansur, executive director of the Policy Research Institute of Bangladesh, says that the sovereign rating downgrade should be considered as one of the worst incidents for Bangladesh's economy in recent history.

"It will raise questions among foreigners about the strength of our economy. We have earlier requested both the central bank and the government to take time-befitting policy measures to address the ongoing foreign exchange crisis. But they did not attach importance to the suggestions," he said.

The downgrade will definitely hit the foreign direct investment and the businesses will have to pay higher interest rates for loans from abroad, said Mansur, also a former IMF official.

If the government does not take immediate steps to address the macroeconomic challenges, the rating agency may downgrade the rating further, he said.

Zahid Hussain, a former lead economist at the World Bank's Dhaka office, said that the current pressure on the country's foreign exchange market may deepen due to the Moody's downgrading.

The deficit in the country's financial account, which is now mainly responsible for the current foreign exchange crisis, may widen in the coming months as it will be tough for the private sector to manage funds from foreign sources, he observed.

A financial account is a component of a country's balance of payments (BoP) that covers claims or liabilities to non-residents concerning financial assets. Its components include foreign direct investment, medium and long-term loans, trade credit, net aid flows, portfolio investment, and reserve assets.

Between July and March of 2022-23, Bangladesh's financial account registered a deficit of $2.21 billion in contrast to a surplus of $11.92 billion a year ago, according to Bangladesh Bank data. The deficit was $1.97 billion in July-February.

Historically, the financial account of Bangladesh has seen a surplus almost every year.

Syed Mahbubur Rahman, managing director of Mutual Trust Bank, says that the cost of doing business will go up.

Banks may have to increase charges for settling letters of credit (LCs), commonly known as import payments, due to the downgrade, he said.

It will be tougher for local banks to negotiate with global lenders regarding commissions and charges to settle foreign exchange transactions, the MD added.