Strategy Note /

Bangladesh: Poor policy priced in

    Hasnain Malik
    Hasnain Malik

    Strategy & Head of Equity Research

    Tellimer Research
    20 January 2020
    Published byTellimer Research

    The Awami League is supreme in Bangladesh, but is using its power to enact poor policies, for example:

    • Fiscal: low tax collection and high fiscal deficits
    • Banking: crowding out, high state-owned bank NPLs, rate-cap proposals
    • FX rate: an over-valued and inflexible exchange rate
    • Regulation: ad hoc and discriminatory treatment of listed corporates, including:
      • SQUARE: delayed regulatory input cost pass-through
      • GRAM: back tax claims and operational interference
      • BRAC: SME interest rate cap proposal
      • BAT: formal sector cigarette tax hike 

    And garment exports suffered their sharpest decline for over a decade in Jul-Nov 2019.

    Yet, Bangladesh still appears to be gaining market share in EU and US garments, and remittance growth offset this garment export decline in Jul-Nov 2019.

    Also, corporate revenue growth is consistent with high nominal GDP growth in recent years.

    While we do not see a catalyst for better government policy, this is already priced in...equities are at their cheapest for a decade and among the cheapest in Asia.

    Therefore, we remain positive on Bangladesh despite the underperformance in the last 12 months

    * One-party state: Is the risk of kleptocracy now outweighing the benefit of political stability

    Bangladesh has been a one-party state for over a decade. The Awami League has used its political power, control of Parliament and external geopolitical support to:

    1. remove the constitutional role of the Army as a caretaker governor between elections (which the Army historically extended into full-blown military rule) and court-martial political opponents within the Army’s leadership; 
    2. sideline the Bangladesh National Party via anti-corruption investigations (a marginalisation which the BNP compounded by boycotting the 2014 election and unsuccessfully pursuing a protest strategy thereafter) and outlaw the Jamat-e-Islami (a BNP Parliamentary ally); 
    3. develop geopolitical and foreign investment dialogue beyond India (to include South Korea, Japan and, perhaps, most importantly, China); and 
    4. monopolise the tools of patronage.

    The Awami League has not used this political power to pursue more radical structural reform beyond that already underway before achieved supremacy (female empowerment, controlled population growth and ready-made garment export growth). While the expansion of power generation and the upgrade of road and bridge infrastructure is finally underway, there is little appetite to:

    1. adopt a more flexible currency regime; 
    2. remove tax collection deficiencies (eg VAT exemptions), privatisation;
    3. restructure state-owned enterprises; and 
    4. undertake a wholesale upgrade of education and skills (in order to enable a shift of exports towards higher value add). 

    Furthermore, recent policies have arguably bordered on kleptocracy: 

    1. the unwillingness to deal with long-running non-performing loans (c30% of loans) and low capital adequacy (below 10%) in the state-owned banks (c30% of loans in those banks), the crowding out of private-sector lending in favour of government lending in the banks, the attempt to interfere with free-market setting of bank lending rates;
    2. the maintenance of a rigid and expensive FX rate which favours those able to afford luxury imports and those motivated to shift excess wealth overseas as opposed to those whose labour cost is rendered less competitive;
    3. levying of ad hoc taxes on the providers of mass-market consumer staples (eg mobile telecom and cigarettes); and
    4. delays in timely price increases for regulated products (eg pharmaceuticals).

    Garment exports in decline recently; compensated, for now, by a pick-up in remittances

    All of the sins of poor economic policy can be washed away by high growth in garment exports (c15% of GDP) and remittances (c8% of GDP). These drivers keep growth high as well as the current account deficit and FX reserves comfortable.

    The first five months of the current fiscal year (July to November 2019) has seen the weakest garment export performance for at least the past decade (down c8%, we suspect driven mainly by Europe, although it is unclear whether this is because of demand weakness or, more concerning, market share loss).

    At the moment, the overall economic show remains on the road because remittances are up enough to compensate (up c20%, although whether this is due to an overall increase or greater use of official banking channels is unknown).

    Longer-term, with over 60% of remittances emanating from the GCC, a source which is very unlikely to grow sustainably at this rate (given pressures to localise labour and rein in fiscal deficits), we are concerned by the recent export data.

    Put simply, sustained weakness in garment exports will unravel the Bangladesh equity thesis.

    Corporate revenue growth is matching high nominal GDP growth

    Because quarterly year-on-year growth trends tend to be lumpy, we have found investors occasionally questioning whether much of the reported GDP growth is not accessible via the equity market or, indeed, whether GDP growth data is over-stated. Looking at growth rates of corporate revenue for some of the largest listed stocks and nominal GDP growth, over two to five years, does not support this concern in our view.

    Big corporates have kept pace with broader economy – nominal GDP and corporate revenue growth (yoy, %)

    Cheap equity valuation keeps us positive for now

    For the moment, we remain positive because equity valuation, in our view, more than reflects the poor policy environment and garment exports have, at times, grown in a lumpy fashion in the past.

    The MSCI Bangladesh IMI Index is near its one, three, five and ten-year trough trailing price/book multiple and it is among the cheapest indices in Asia (in trailing price/book or price/earnings versus five-year median). We highlight these different time frames because the constituents of this index have changed substantially over the past decade: c50% is currently made up by Square Pharma, BRAC Bank, Grameenphone, Beximco Pharma, and Olympic Industries (biscuits).

    This near trough valuation is despite a bounce in the last couple of trading days prompted by:

    1. local, rather than foreign, buying (as in other Frontier and small Emerging rallies recently, such as Pakistan, Kenya, and Nigeria); 
    2. speculation over a potential local government-led support fund (never a good or sustainable driver for equities except in countries with the deepest sovereign wealth pockets); and
    3. insider buying after very weak share price performance in the largest index constituent (SQUARE). 

    Furthermore, although Bangladesh no longer enjoys a current account surplus and FX reserves have not grown as much as they should have, given years of export and remittance growth, devaluation is not a pressing risk because:

    1. import cover is still c6 months;
    2. external debt is merely c10% of GDP;
    3. forecast current account deficit remains modest (c2% according to the IMF over 2020 and 2021); and 
    4. real effective exchange rate implies less than 10% over-valuation on the IMF estimate published in the September 2019 Article IV report (see page 7) – albeit Bruegel estimates imply a much bigger over-valuation.


    Source: Bloomberg