Thoughts from a Renaissance Man How Vulnerable Is the Bangladeshi

Thoughts from a Renaissance man Economics & Strategy

21 June 2018

Charles Robertson +44 (207) 005-7835 [email protected]

Mobile +44 7747 118 756 @RenCapMan

Vikram Lopez +44 (207) 005-7974 [email protected] Thoughts from a Renaissance man How vulnerable is the Bangladeshi taka? Four overvalued South Asian currencies in 2015 have now become two, putting growing pressure on Bangladesh. We expect depreciation of the Bangladeshi taka (BDT) to pick up from 4% and approach 10% annually.

One-fifth of South Asia’s textile exports have got much more competitive vs Bangladesh

First Sri Lanka, starting in 2015, and then Pakistan, in the past six months, have removed most of their overvaluation that we identified in our real effective exchange eate (REER) model in recent years. Together they account for 20% of all South Asian textile exports (vs 50% from Bangladesh), and after 15-20% currency deprecation between them, there is pressure on the BDT to follow suit. The current 4% annualised deprecation in the BDT is probably not enough, especially given two additional factors. First, a possible hike in the minimum wage before elections (expected in 4Q18) threatens further damage to Bangladesh’s regional competitiveness. Second, we see a high risk that US profit repatriation from the EU to the US will strengthen the dollar significantly against the euro. Given that 55.5% of Bangladesh’s exports went to the EU in FY2017, the BDT needs to be depreciating against the euro, not appreciating by 5%, as it has done in the past two months.

When Bangladesh’s CA goes into deficit, FX depreciation picks up to 10% or more

Looking back over the past 20 years, we can see two periods where after years of only very modest depreciation (2002-2004, 2007- 2010, 2013-2016), BDT depreciation has accelerated to over 10% in a single year. Both the 2005-2006 and 2011 sell-offs appear linked to the current account (CA) slipping into a small 0-1% of GDP deficit range in 2004 and 2011; we saw similar in 2017. One IMF exchange rate model reckons that while a 5% of GDP CA deficit is normal, they adjust this for Bangladesh, arguing that -1% of GDP in Bangladesh is “normal”, presumably because the currency has indeed adjusted when the deficit has reached this level.

We think a 10% annualised depreciation is more likely than a bigger 19% move as in 2011-2012

The question for investors is whether a sell-off over the coming year will peak at an 11% move as it did in 2005-2006, or does it risk becoming more extreme? A 9% move in the year to November 2011 accelerated sharply in the subsequent two months and peaked at 19% (before rallying back over the following year, to end up just 10% weaker than two years previously).

The argument in favour of the bigger move is that the BDT has never been as expensive in today’s money as it was in 2017. Also the IMF forecasts the CA deficit will reach 2.0% of GDP in 2018 and 2.3% of GDP in 2019, with the latter figure being the biggest deficit since 1990. However, we see a few significant differences from 2011. First, inflation is around 6% while back then it was 12%, driven higher by a poor harvest which sucked in imports too. Second, gross foreign exchange reserves are equivalent to around eight months of import cover now, against just under three months in 2011. Third, key export markets such as Europe looked in deep trouble in 2011, while in 2018 there is a modest recovery under way in Europe. This does not look like 2011.

EUR/$, minimum wage hikes, elections, oil and the INR are all variables to watch

We expect nominal BDT depreciation to be 10% over a 12-month period, which would still leave the BDT about 15-20% overvalued in REER terms, implying more deprecation in subsequent years. The 4% pace of depreciation may only pick up after 4Q18 elections are out of the way. A stronger dollar and big wage hikes will demand more depreciation and earlier. Falling oil prices might help slow the rate of required depreciation. The Indian rupee (INR) rate vs the dollar and local food production are two other important variables.

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Renaissance Capital 21 June 2018

Thoughts from a Renaissance man

There is an excellent overview of the Bangladeshi economy and market outlook from Dan Salter, All aboard published on 6 April 2016 – so there is no need to repeat his cool work here. There is further good macro work from the IMF in its last Article IV from June 2017.

What we will add is this key table from Electric Power to the People, published on 30 April 2018. It shows in the first column that electricity consumption, at an average 305 kWh per capita, scrapes over the 300 kWh threshold that allows industrialisation. However, adult literacy at 61% is too low to allow manufacturing to rise above 20% of GDP on a sustainable basis1, although as we pointed out last year, this conceals big regional variations within the country (the more highly literate coastal areas probably do meet the 70% literacy threshold for industrialisation). Lastly, it shows that Bangladesh’s strong growth record might well be explained by its excellent investment/GDP ratio, which at 31% is well above the 25% key threshold Dan Salter has written about previously.

In brief, when adult literacy reaches 70% – perhaps in 2024, assuming a 1-ppt improvement each year – Bangladesh will be on the path to fast sustained growth and much higher per-capita GDP, via industrialisation, high value added services or both.

Figure 1: Key electricity, literacy, investment and manufacturing metrics kWh per Adult Investment to Manufacturing, kWh per Adult Investment to Manufacturing, capita literacy GDP value added % of GDP, capita literacy GDP value added % of GDP, (2015) (2015) (2017) (2016) (2015) (2015) (2017) (2016) Armenia 1,842 100 21 10 Mozambique 498 59 44 10 Jordan 1,835 98 20 18 Zimbabwe 492 87 20 10 Egypt 1,644 76 15 17 Pakistan 465 56 16 13 Namibia 1,562 91 23 12 Papua New Guinea 425 63 na 2*** Tajikistan 1,532 100 21 11* Cambodia 321 78 22 17 Vietnam 1,465 95 27 16 Ghana 316 77 14 6 Tunisia 1,409 81 22 17 Bangladesh 305 61 31 18 Moldova 1,298 99 22 14 Angola 302 71 26 na Colombia 1,188 95 23 13 Sudan 274 59 13 na Iraq 1,180 80 na 2 Cameroon 253 75 26 13** Jamaica 1,030 88 20 9 Ivory Coast 245 43 21 14 Gabon 981 83 32 3** Senegal 217 56 26 14*** Morocco 868 72 34 18 Rep of Congo 180 79 24 8 India 789 72 32 17 Kenya 164 78 17 10 Indonesia 786 95 33 21 Nigeria 139 60 13 9 Zambia 711 85 42 8 Tanzania 92 80 28 6 Philippines 667 97 25 20 Ethiopia 82 49 39 4 Laos 636 80 na 9 Uganda 73 74 25 9 Sri Lanka 558 93 na 17 Rwanda 55 71 23 6 *2013. **2015. ***2014. Source: EIA, IE, UN, IMF

Also worth adding are our thoughts on political risk in the country, given forthcoming elections due in 4Q18. Based on 223 countries with Bangladesh’s income level and its political system type of “open anocracy” (democracy, with elements of autocracy), we see a 12% annual chance of a significant regime shift, including a 4.5% chance of a shift to full Gulf/China-style autocracy, a 1.8% chance of a shift towards Egyptian-style closed anocracy, a 0.9% chance of state failure (Somalia, Afghanistan – but we discount even this 0.9% risk though) and a 4.9% chance of a shift to democracy. The base 88% chance is no change in any given year, but the risks are slightly on the side of a shift towards autocracy/failure. This matters because reduced foreign aid was a factor that undermined the BDT in 2011 and foreign aid could be at risk if the political regime changed away from the type that donors tend to favour.

1See Thoughts from a Renaissance Man: Literacy, development and industrialisation, 27 July 2017

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Thoughts from a Renaissance man

Figure 2: Percentage chance of these "open anocracies" seeing a regime shift at various per-capita GDP levels (constant 2011 PPP $) To closed To full Data Key countries and their To autocracy To democracy To occupation To failure anocracy democracy points per-capita GDP ($ '000) in 2014 0 4.8% 2.4% 9.5% 0.0% 0.0% 1.2% 84 1,000 2.6% 3.9% 5.2% 0.0% 0.0% 2.6% 153 Mozambique 1, Zimbabwe 2 2,000 4.5% 1.8% 4.9% 0.0% 0.0% 0.9% 223 Tanzania 2, Bangladesh 3, Ivory Coast 3 4,000 0.5% 2.2% 8.6% 0.0% 0.0% 0.5% 186 8,000 1.7% 0.9% 8.6% 0.9% 0.0% 0.0% 116 Ukraine 10, Venezuela 14 15,000 0.0% 0.0% 10.0% 0.0% 0.0% 0.0% 20 Turkey 19, Malaysia 23, Russia 24 25,000 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0

Source: Polity IV, Penn, Renaissance Capital

Exchange rates – pressure on the BDT

For the past few years, we have been showing that South Asia was a region of overvalued currencies. EM investors have loved the India story (it is ready to industrialise, as Figure 1 above shows) and Frontier investors loved Pakistan when it was preparing to transition to EM. Portfolio flows have kept South Asian currencies strong. Oil prices were low, which helped them too. But overvalued currencies on our REER model don’t last forever unless there is a fundamental change in an economy’s structure.

Change began with Sri Lanka and a 5% devaluation in September 2015, followed by a steady 5% annualised depreciation ever since (slightly accelerating in recent weeks). From a peak overvaluation of about 26% in early 2015, the LKR became the least overvalued south Asian currency by 2017. It is about 10% overvalued now.

Figure 3: FX rates, our REER model estimate of ‘fair’ value (average 1995-2018 rate in today’s money), etc. Data as of 20 June 2018 FX rate FX rate if Long-term IMF IMF Standard Yvonne's* 1-year implied by REER Date of RenCap Current FX average 2017E 2018E deviations avg local long-term falls to REER YE18 rate vs $ divided by C/A C/A away from REER currency average previous low forecast current rate (% GDP) (% GDP) historical average estimate yields, % REER lows Kenya 101 157 298 Jul-95 1.56 -6.4 -6.2 1.0 124 107.5 10.7 Vietnam 22,864 28,796 36,655 Jan-04 1.26 4.1 3.0 1.0 2.3 Bangladesh 84.1 104 128 Dec-06 1.24 -1.2 -2.0 1.0 4.2 Kuwait 0.30 0.37 0.45 Jun-95 1.22 2.0 5.8 2.0 1.9 Lebanon 1,512 1,772 3,161 Dec-92 1.17 -25.0 -25.8 1.0 7.2 Estonia 0.86 1.00 1.64 Jan-95 1.15 3.2 2.0 1.0 na Jordan 0.71 0.82 1.01 Sep-95 1.15 -8.7 -8.5 1.0 7.3 Lithuania 0.86 0.99 1.92 Apr-95 1.15 1.0 -0.1 0.0 0.0 Oman 0.39 0.42 0.49 Nov-07 1.10 -11.5 -6.2 1.0 3.2 Sri Lanka 160 175 220 Feb-04 1.09 -2.9 -2.7 0.0 9.5 Mauritius 35.1 37.9 44.0 Dec-06 1.08 -6.0 -7.4 1.0 3.8 Argentina* 27.8 30.0 65.4 Mar-02 1.08 -4.8 -5.1 0.0 34.4 Nigeria 361 385 867 Apr-95 1.07 2.5 0.5 0.0 313 356 13.0 Romania 4.03 4.20 8.84 Feb-97 1.04 -3.5 -3.7 0.0 3.0 Bahrain 0.38 0.39 0.47 Jun-11 1.02 -3.9 -3.2 0.0 4.2 Croatia 6.37 6.42 7.17 May-00 1.01 3.7 3.0 0.0 0.0 Ivory Coast 580 575 668 Aug-97 0.99 -1.2 -1.5 0.0 561 5.6 Slovenia 0.86 0.85 0.92 Aug-97 0.98 6.5 5.7 0.0 -0.4 Morocco 9.55 9.09 9.68 Aug-12 0.95 -3.8 -3.6 -1.0 2.3 Serbia 102 96.3 163 Feb-01 0.94 -4.6 -4.5 0.0 na Senegal 580 527 581 Nov-00 0.91 -9.4 -7.9 -2.0 561 5.5 Kazakhstan 341 280 364 Jan-16 0.82 -2.9 -1.4 -1.0 335 8.5 Tunisia 2.61 1.89 2.49 Nov-17 0.73 -10.1 -9.2 -2.0 6.0 *Argentina's inflation data were unreliable for 2007-2015 – we have constructed an REER series using 'shadow' inflation data Armenia 483 556 867 Mar-95 1.15 -2.6 -2.8 0.0 6.6 Saudi Arabia 3.75 4.15 5.05 Mar-08 1.11 2.7 5.4 1.0 2.5 Georgia 2.46 2.63 4.40 Apr-95 1.07 -9.3 -10.5 0.0 2.65 7.3 Azerbaijan 1.69 1.60 2.62 Jan-95 0.95 3.5 5.6 0.0 8.2 Ukraine 26.5 20.9 40.0 Feb-15 0.79 -3.7 -3.7 -1.0 16.4 Iran 42,440 30,116 68,105 Jun-95 0.71 4.3 7.0 0.0 na Belarus 2.00 1.33 2.32 Oct-11 0.67 -1.8 -2.5 -1.0 3.8

*Yvonne Mhango, our SSA economist. Note: Govt bonds/bills except: Morocco, Kenya, Senegal, Tunisia, Mauritius, Ivory Coast, Georgia, Azerbaijan, Belarus, Saudi Arabia (auction yields); Oman, Bahrain, Jordan (interbank rates); Argentina (deposit rate); Kazakhstan (12M NDF implied yield). Source: IMF, Bruegel, Bloomberg, Renaissance Capital

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Pakistan came next, ahead of the July 2018 elections. It had devalued by 2% just a week ahead of Sri Lanka in 2015, but only began to take its overvalued currency seriously when it was 24% stronger than its long-term fair value in mid-2017. At the time, it was one of the most overvalued currencies in emerging markets, with the biggest CA deficit. A 5% devaluation in December 2017, a 4% move in March 2018 and another move in June 2018, means its overvaluation has shrunk to about 3%.

Figure 4: FX rates, our REER model estimate of "fair" value (average 1995-2018 rate in today’s money), etc. Long-term IMF IMF Standard Current FX rate implied FX rate if Date of Yvonne's avg RenCap 1-year local average 2017E 2018E deviations away FX rate vs by long-term REER falls to REER REER YE18 currency divided by C/A (% C/A (% from historical $ average REER previous lows low estimate Forecast yields current rate GDP) GDP) average China 6.47 8.10 10.9 Apr-95 1.25 1.4 1.2 1.0 3.3 India 68.1 79.9 106 Feb-96 1.17 -2.0 -2.3 1.0 6.4 Czech Republic 22.3 25.9 39.3 Jan-95 1.16 1.1 0.3 0.0 0.8 Thailand 32.8 36.5 52.8 Jan-98 1.11 10.8 9.3 1.0 1.5 UAE 3.67 4.05 4.58 Nov-07 1.10 4.7 5.3 1.0 3.2 Qatar 3.65 3.99 5.01 Dec-03 1.09 1.3 2.5 0.0 3.0 Philippines 53.5 57.1 78.9 Feb-04 1.07 -0.4 -0.5 0.0 4.3 Korea 1,105 1,158 1,790 Jan-98 1.05 5.1 5.5 0.0 1.8 Indonesia 13,932 14,596 37,894 Jun-98 1.05 -1.7 -1.9 0.0 6.4 Pakistan 122 125 144 Sep-01 1.03 -4.1 -4.8 0.0 7.1 Russia 63.5 64.3 125 Jan-99 1.01 2.6 4.5 0.0 61.5 6.9 Chile 640 646 797 Jun-03 1.01 -1.5 -1.8 0.0 2.7 Hungary 279 278 372 Apr-95 0.99 3.6 2.5 0.0 0.4 Poland 3.72 3.61 4.38 Nov-97 0.97 0.0 -0.9 0.0 1.4 Taiwan 30.1 29.2 34.3 Nov-09 0.97 13.8 13.6 0.0 1.1 Peru 3.28 3.14 3.50 Jul-07 0.96 -1.3 -0.7 0.0 2.7 Greece 0.86 0.82 0.95 Sep-00 0.95 -0.8 -0.8 0.0 1.0 Malaysia 4.01 3.78 5.73 Dec-98 0.94 3.0 2.4 0.0 3.4 Brazil 3.73 3.27 6.28 Oct-02 0.88 -0.5 -1.6 0.0 7.7 South Africa 13.6 11.7 17.5 Dec-01 0.86 -2.3 -2.9 -1.0 11.3 8.0 Egypt 17.9 15.0 22.9 Dec-03 0.84 -6.5 -4.4 0.0 14 17.6 18.3 Mexico 20.4 15.1 24.6 Mar-95 0.74 -1.6 -1.9 -1.0 8.1 Turkey 4.74 3.50 5.16 Oct-01 0.74 -5.5 -5.4 -1.0 18.4 Colombia 2,914 1,794 3,016 Nov-17 0.62 -3.4 -2.6 -2.0 4.8

Source: IMF, Bruegel, Bloomberg, Renaissance Capital

Below we show the REER of the four currencies together. We do not expect each REER average to be the same over time – each country has its own special characteristics. But what is obvious is that on this model, Bangladesh is looking like a significant outlier from the other three. Its distance from its own average REER of 24% is wider than India’s 17% overvaluation.

Figure 5: How South Asian currencies have moved in 1995-2018 – with average REER rate as dashed line

Real Effective Exchange Rate index (2007=100) India Pakistan Bangladesh Sri Lanka 70 80 Weak 90 100 110 120 130 140 150 Strong 160 170 Jul-95 Jul-96 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Source: Bruegel, Renaissance Capital

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Pakistan is developmentally decades behind Sri Lanka – on education, electricity or investment – and we think this explains the relatively controlled depreciation of the LKR compared with the jerky currency shifts approved by Pakistan’s Ministry of Finance and the State Bank of Pakistan (SBP). Curiously, Bangladesh seems to be trying to follow the Sri Lanka model.

We had been arguing that South Asia could stay overvalued for as long as India did, because each sector of the smaller economies competes with similar in India. But once one country moved, a competitive advantage would occur. Sri Lanka accounts for 9% of South Asia’s clothes exports (and clothes account for 46% of Sri Lanka’s exports), and 7% of food and live animal exports (22% of Sri Lanka’s exports), so two-thirds of its exports received a benefit from the LKR depreciation, presumably at the expense of the other three.

Figure 6: What share of South Asia ’s (India, Pakistan, Bangladesh, Sri Lanka) exports come from each country Bangladesh India Pakistan Sri Lanka Total all products 11% 80% 6% 3% Food and live animals 3% 78% 11% 7% Beverages and tobacco 7% 83% 1% 9% Crude materials, inedible, except fuels 5% 87% 5% 3% Mineral fuels, lubricants and related materials 0% 99% 1% 1% Animal and vegetable oils, fats and waxes 2% 85% 5% 9% Chemicals and related products, n.e.s. 1% 97% 2% 0% Manufactured goods (ex-textiles) 1% 95% 2% 2% Textile yarn and related products 7% 62% 30% 1% Machinery and transport equipment 1% 97% 1% 1% Misc. manufactured articles (ex apparel, footwear) 2% 92% 4% 2% Articles of apparel & clothing accessories 51% 32% 9% 9% Footwear 20% 74% 3% 3% Other commodities and transactions, n.e.s. 1% 99% 0% 0% Note: Bold represents where countries’ competition with each other is likely to matter. Source: UNCTAD

Pakistan also accounts for 9% of South Asia’s clothes exports (this is 25% of Pakistan’s exports) and 11% of its food and live animal exports (18% of Pakistan’s exports), as well as 30% of South Asia’s textile yarn and related products (37% of Pakistan’s exports). So 80% of Pakistan’s exports that compete directly with the other three have received a significant competitiveness boost.

With nearly one-fifth ($9bn) of South Asian clothes exports now 15-20% cheaper than two years ago, it makes sense that Bangladesh should be getting a little concerned. It accounts for 51% ($29bn) of all South Asian clothes exports (more than India, which is 32% or $18bn), and these account for 84% of all its exports.

Bangladesh is now roughly 6-7% overvalued vs India, about 13% overvalued vs Sri Lanka and about 20% overvalued compared with Pakistan. We estimate the minimum wage of a textile worker is around $60, far below China’s $200-300, but more than three times that of Ethiopia. The government worker has a minimum wage of $181, above Russia’s $174 (developmentally 80-90 years ahead of Bangladesh) and Vietnam at $148. That looks too high.

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Figure 7: Minimum wages from Eurostat on the left (Ireland to Bulgaria) and a variety of sources on the right (Lebanon to Ethiopia) – in dollars at June 2018 exchange rates

Minimum wage based on 19 June 2018 exchange rates - Eurostat (lhs) and many other sources (rhs) via Renaissance Capital, note data on right-hand side may be mix of gross or net wages (not so reliable) 1,803 1,862 1,821 2,000 1,729 1,729

1,800 1,617 Blue = EM 1,600 Green = FM

1,209 * = avg mix of min wages

1,400 991 973

1,200 577 863 563 1,000 789 554 781 446 551 800 344 534 496 491 329 471 462 425 267 310

600 148 332 267 301 291 141 262 137 130 196 183 181 174 124

400 103 102 94 83 77 71 67 63 50 45 200 19 - UK US SA* Malta Spain Latvia Brazil Egypt Serbia Ireland France Poland Croatia Greece Estonia Jordan Russia Ghana* Mexico Nigeria Tunisia Belgium Czechia Bulgaria Belarus Ukraine Portugal Slovakia Hungary Slovenia Georgia Romania Ethiopia* Vietnam* Lithuania Germany Pakistan Lebanon Morocco* Argentina Indonesia Colombia Turkey (g) Azerbaijan Ivory Coast Netherlands Bangl (govt) Kazakhstan China (Heil.) Kenya (unsk) Banglad. (text) China (Shenzhen)

Source: Eurostat, Bloomberg, Google searches, Wikipedia

Bangladesh has a track record of hiking the minimum wage near elections, and the garment unions want it hiked to $1922. Unless the BDT depreciates significantly, this would further threaten the competitiveness of Bangladeshi exports.

We see nascent signs of overheating in Bangladesh too. Credit growth is high, at 15% in real terms in February 2018, which is similar to Pakistan and beaten only by Argentina and Vietnam in EM or FM. This will have contributed to the CA moving into deficit.

Is this 2011 all over again?

What investors might fear is a repeat of the rapid depreciation of 2011, which culminated in a 10% sell off in just 6 weeks, from BDT77/$ to BDT84/$. Credit growth had been high then too, and the CA had slipped into deficit. The harvest (as now) had also been poor, and was lifting inflation. Foreign aid had fallen (and politics means this this could face threats again) and in 2011 this left the government dependent on financing from the banks and the central bank itself.

We think there are some key differences. Reserves provided just four months of import cover in 2010, which fell below three months in 2011. Today, the number is around eight months. Inflation is around 6% while in 2011 it was in double digits. Bangladesh had just experienced a retail-led equity boom that had imploded, and this is quite different now. There is not such an obvious trigger for a sharp depreciation today (but December 2011 was a surprise too).

2 http://www.industriall-union.org/bangladesh-garment-workers-call-for-increased-minimum-wage

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Figure 8: BDT vs other key currencies

BDT % YoY vs $, EUR, INR BDT vs $ BDT vs EUR BDT vs INR 1.30 1.25 Depreciation 1.20 1.15 1.10 1.05 1.00 0.95 0.90 Appreciation 0.85 0.80 Jul-01 Jul-06 Jul-11 Jul-16 Oct-02 Apr-05 Oct-07 Apr-10 Oct-12 Apr-15 Oct-17 Jan-04 Jun-04 Jan-09 Jun-09 Jan-14 Jun-14 Feb-01 Mar-03 Feb-06 Mar-08 Feb-11 Mar-13 Feb-16 Mar-18 Dec-01 Aug-03 Nov-04 Sep-05 Dec-06 Aug-08 Nov-09 Sep-10 Dec-11 Aug-13 Nov-14 Sep-15 Dec-16 May-02 May-07 May-12 May-17 Source: Bloomberg, Renaissance Capital

However, we do think the BDT needs to depreciate by 15-20% in real terms. It has depreciated since the peak overvaluation in mid-2017, but it is still more than 20% overvalued relative to its own history, and this has been true in only 12% of months since January 1995.

Has Bangladesh structurally changed, so that a stronger currency is justified? In 1995, there were more primary exports (one-fifth were food, animals and yarn), but 63% back then were textile exports and today this ratio is 84%. That is a limited change compared with China, which used to be an agricultural and textile exporter but now makes iPhones, ships and cars. We think China can afford a currency that looks overvalued in REER terms. We do not think Bangladesh can, especially if large minimum wage hikes are granted. As in Turkey after its 2016 minimum wage hike, currency depreciation will be needed to restore competitiveness.

Figure 9: The structure of Bangladeshi exports, 1995, 2000, 2005, 2010 and 2016 1995 2000 2005 2010 2016 Food and live animals 9% 7% 6% 4% 3% Beverages and tobacco 0% 0% 0% 0% 0% Crude materials, inedible, except fuels 3% 1% 2% 2% 1% Mineral fuels, lubricants and related materials 0% 0% 0% 1% 0% Animal and vegetable oils, fats and waxes 0% 0% 0% 0% 0% Chemicals and related products, n.e.s. 3% 1% 2% 1% 1% Manufactured goods (ex-textiles) 7% 4% 3% 2% 1% Textile yarn and related products 10% 7% 7% 7% 5% Machinery and transport equipment 1% 1% 1% 1% 1% Misc. manufactured articles (ex apparel, footwear) 2% 1% 1% 1% 1% Articles of apparel & clothing accessories 63% 76% 77% 80% 84% Footwear 1% 1% 1% 1% 2% Other commodities and transactions, n.e.s. 1% 0% 0% 0% 0% 100% 100% 100% 100% 100%

Source: UNCTAD

Meanwhile, on the import side, a crude petroleum/petroleum product bill in the range of $17-19bn in 2007-2010, soared to $38-39bn in 2011-2013, before falling back to $21bn in 2015-2016 – and rose back to $32bn in the 12 months to February 2018. OPEC success

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Thoughts from a Renaissance man in partly reversing the 2H17/1H18 oil price rise would take some pressure off Bangladesh3.

To conclude, we think Bangladesh needs to raise the pace of currency depreciation. The current pace implies BDT87/$ in December 2018, BDT95/$ by end-2019, and BDT100 by end-2020, but our estimate of BDT ‘fair value’ is BDT104/$ today.

Sri Lanka was able to make progress with only a 5% annual depreciation, but this was on top of a 5% one-off depreciation at the beginning. Moreover, it had first-mover advantage, and is still depreciating its currency. Bangladesh will not claw back the loss of competitiveness if it depreciates at the same pace as Sri Lanka. Second, we suspect the authorities would ideally want to wait until the 4Q18 elections before increasing the pace, but by waiting they might also have to make a one-off devaluation as well. Third, a stronger dollar against the euro is a problem, given that 56% of exports go to the EU. Fourth, any hike to minimum wages will increase medium-term pressure for currency depreciation. Given our expectations, we think BDT depreciation needs to pick up to an annualised rate of 10% and stay there for at least two years.

We think Bangladesh may be able to avoid that faster depreciation if the dollar weakens substantially. Any significant fall in the oil price would also help. Leaning against a big wage hike would also help justify a more modest pace of BDT deprecation.

3 Note there is some offset to the oil bill via higher remittances from workers in the Gulf when oil prices are high.

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Bangladesh

Figure 10: Key data Figure 11: Performance, $ (31 Dec 12 = 100) Figure 12: Economic outlook Local Currency BDT IMF Forecasts 2016 2017 2018 2019 S&P / Moody's Rating BB-/Ba3 MSCI Bangladesh ($) MSCI Frontier ($)NGDP_RPCHReal GDP (% YoY) 7.2 7.1 7.0 7.0 170 Weight in MSCI FM (%) 2.8% NGDPDPCGDP/Capita, $ 1,459 1,602 1,734 1,878 MSCI Index MXBD 150 LP Population, mn 161.5 163.2 164.9 166.6 2018 P/E 16.2 PCPIEPCHCPI (year-end, %YoY) 5.7 5.9 6.0 6.0 130 2018 EPS Growth 13.4% BCA_NGDPDC/A balance (% of GDP) 0.6 -1.2 -2.0 -2.3 Trailing P/B 4.3 110 GGXCNL_NGDPGovt. bal. (% of GDP) -3.4 -3.3 -4.1 -4.6 Beta to EM 0.1 Bloomberg consensus 90 MSCI Full MktCap, $bn 12.1 Real GDP (%YoY) 7.2 7.1 6.9 6.8 MSCI FF MktCap, $bn 3.4 70 CPI (year-end, %YoY) 5.7 5.9 na na No. of Companies 5 C/A balance (% of GDP) 0.6 -1.2 -1.5 -1.6 50 3M ADTV ($mn) 4.6 Key policy rate (year-end) 6.00 6.00 na na Local Index DSEX 30 FX MktCap ($bn) 37.9 BDT vs $ 79 83 na na Jul-13 Jul-14 Jul-15 Jul-16 Jul-17

No. of Companies 247 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 BDT vs EUR 83 99 na na 3M ADTV ($mn) 53.6 Note: EPS growth excludes -ve to +ve earnings changes

Figure 13: 3MADTV, $mn Figure 14: Valuations vs EM, 12M Fwd P/E (x) Figure 15: MSCI sector weights MSCI Bangladesh ($mn) MSCI Bangladesh Frontier Bangladesh local index ($mn) 200.0 20 Healthcare 9% 150.0 15 16% Financials 100.0 10 58% 5 50.0 17% Telecoms

0 0.0 Materials Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18

Figure 16: Population, '000 Figure 17: Export destinations, total: $31.3bn Figure 18: Currency and Real effective exchange rate Export, 2017 ($bn) BDT vs $ 0-19 20-64 65+ Export, 2017 (% of total), RHS BDT vs EUR 140,000 5.0 14% 120 80 Bangladesh REER (Dec 07 =100), RHS 120,000 12% Weaker 4.0 100 10% 100 100,000 3.0 8% 120 80,000 2.0 6% 80 60,000 4% 140 1.0 2% 60 40,000 160 0.0 0% 20,000 Stronger US UK 40 180 Italy Spain China 0 Japan France Poland Canada Belgium Denmark Germany Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 Netherlands

Source for all tables and charts: IMF, Bloomberg, MSCI

9 Renaissance Capital 21 June 2018

Frontier Thoughts from a Renaissance man

Bangladesh Figure 19: Index and key stock data (by free float market cap), May 2018 data Market Float 3M US$ performance (%) 12MF Trail 12MF 12MF # of MSCI cap Mcap ADTV P/E P/B RoE DY Analyst Weight Ticker Name Sector ($mn) ($mn) ($mn) 1M 3M 12M (x) (x) (%) (%) recs. (%) MXBD MSCI Bangladesh 12,119 3,405 4.6 -7.1 -6.3 4.4 15.6 4.3 30.1 2.7 10 2.8% SQUARE BD Square Pharma Healthcare 2,518 1,763 1.0 -7.0 -9.4 5.4 15.1 4.3 23.9 2.0 3 52% BRAC BD BRAC Bank Financials 977 586 1.6 -11.7 3.7 23.5 13.8 2.9 19.6 1.3 4 17% GRAM BD Grameenphone Telecoms 6,843 547 1.1 -9.3 -12.0 23.2 16.6 13.1 100.9 6.2 2 16% LHBLBD BD LHBL Materials 760 304 0.6 -11.2 -9.8 -18.1 na 4.4 na na na 9% RENATA BD Renata Healthcare 1,021 204 0.1 -1.5 -4.0 23.0 21.7 6.7 23.8 na 1 6% BXPHAR BD Beximco PharmaceFinancials 480 460 0.4 -6.1 -6.6 -11.9 14.5 1.6 10.8 2.0 2 na TITASGAS BD Titas Gas Transm Energy 446 446 0.1 -7.3 -10.5 -25.8 na 0.6 na na na na BATBC BD Brit Amer Tobacc Cons. Staples 2,413 416 0.0 -1.2 -7.5 23.5 17.8 7.9 39.5 3.4 2 na OLYMPI BD Olympic Inds Ltd Cons. Staples 573 408 0.1 -9.0 -8.2 -14.0 19.8 9.0 35.7 2.9 2 na ISLAMI BD Islami Bank Bang Financials 431 284 0.3 -13.2 -29.8 -31.3 11.4 0.7 6.1 3.5 1 na CITYBA BD City Bank Ltd Financials 374 271 0.6 -2.4 -7.5 5.8 9.1 1.3 12.6 na 1 na POWERGRI BD Power Grid Co Of Utilities 251 251 0.0 -7.0 -9.3 -16.5 na 0.5 na na na na BEXIMC BD Beximco Export Industrials 278 235 2.3 -8.5 10.2 -12.8 na 3.9 na na na na NBL BD Natl Bank Ltd Financials 312 235 0.3 -6.6 -10.6 -0.7 na 0.6 na na na na IDLC BD Idlc Finance Financials 303 218 0.2 -2.8 -6.4 -6.4 na 2.0 na na 1 na EBL BD Eastern Bank Ltd Financials 314 215 0.1 -9.1 -14.7 8.8 8.0 1.2 13.9 5.6 2 na PUBALI BD Pubali Bank Ltd Financials 278 198 0.0 -0.6 -13.6 -2.8 na 0.9 na na na na ALARAB BD Al-Arafah Islami Financials 300 185 0.8 -2.0 3.3 44.4 na 1.3 na na na na SUMITPOW BD Summit Power LtdUtilities 453 180 0.2 -5.1 -1.6 -11.2 na 1.3 na na na na RUPALI BD Rupali Bank Ltd Financials 171 171 0.2 -11.7 -11.5 80.9 na 1.0 na na na na ICB BD Invest Corp Bang Financials 981 167 0.1 -5.2 -11.5 -30.2 na 2.1 na na na na IFIC BD Intl Finance Inv Financials 202 164 0.2 -6.8 -11.4 -12.9 na 0.8 na na na na SEB BD Southeast Bank Financials 188 153 0.1 -9.9 -12.5 -5.3 na 0.6 na na na na PB BD Prime Bank Ltd Financials 240 150 0.1 -10.3 -9.0 -11.7 8.0 0.8 9.6 3.9 1 na BSRM BD Bsrm Steels Ltd Materials 291 150 0.1 -6.8 -0.3 -24.3 na 2.1 na na na na BKASIA BD Bank Asia Ltd Financials 215 149 0.0 -12.0 -16.1 14.4 na 0.8 na na na na ACI BD Aci Ltd Industrials 198 147 0.3 -11.9 -16.8 -29.7 na 1.6 na na 1 na IFAD BD Ifad Autos Ltd Cons. Disc. 291 147 0.9 -4.7 -5.6 13.5 15.4 27.7 21.2 na 1 na SJIB BD Shahjalal Islami Financials 232 146 0.1 -10.3 -15.6 58.5 na 1.4 na na na na UCB BD United CommerciaFinancials 224 145 0.2 -12.9 -14.9 -1.2 7.9 0.7 8.5 na 1 na EXIM BD Exim Bank Financials 198 138 0.3 -19.0 -19.9 11.6 na 0.6 na na na na ACMELAB BD Acme LaboratoresHealthcare 242 137 0.1 -7.0 -13.8 -18.9 10.9 1.2 9.9 na 1 na BASR BD Bangladesh Steel Materials 271 134 0.6 -0.6 13.1 -14.5 na 2.2 na na na na PADMAO BD Padma Oil Co Ltd Energy 270 134 0.1 -1.4 -1.1 -8.6 na 2.1 na na na na DOREENPW BD Doreen Power GenUtilities 125 125 0.5 -8.4 -5.2 -22.9 na 3.7 na na na na BBSCABL BD Bbs Cables Ltd Telecoms 124 124 0.7 -6.3 -16.3 735.7 na na na na na na LBF BD Lankabangla Fina Financials 159 124 0.7 -13.0 -20.6 -22.7 na 1.1 na na na na ONEB BD One Bank Ltd Financials 159 123 0.2 -15.9 -13.9 -11.4 na 1.0 na na na na MTBL BD Mutual Trust Bnk Financials 207 122 0.1 4.9 2.6 43.8 na 1.7 na na na na DELTAL BD Delta Life Insur Financials 151 120 0.2 -5.3 0.5 6.0 na 11.0 na na na na NCCB BD Ncc Bank Ltd Financials 164 120 0.1 -5.2 -6.4 24.9 na 0.8 na na na na MERBNK BD Mercantile Bank Financials 172 116 0.6 -8.0 -17.5 3.8 na 0.8 na na na na SOCIN BD Social Islami Financials 153 114 0.2 -11.9 -21.8 -23.7 na 1.0 na na na na ABBANK BD Ab Bank Ltd Real Estate 113 108 0.2 -22.5 -27.9 -28.4 na 0.4 na na na na MJL BD Mjl Bangladesh Materials 358 102 0.2 -1.7 -9.3 -18.2 na 3.0 na na na na UTTARA BD Uttara Bank Ltd Financials 113 99 0.2 -15.9 -19.2 -1.2 na 0.7 na na na na NATLIF BD Natl Life Insura Real Estate 165 98 0.0 -2.3 -2.1 -5.8 na 14.7 na na na na MPL BD Meghna PetroleumEnergy 238 98 0.0 -0.3 -3.5 -8.7 na 1.8 na na na na JMOIL BD Jamuna Oil Co Energy 240 96 0.1 -2.1 -4.2 -13.9 na 1.1 na na na na DBHF BD Delta Brac Financials 191 93 0.1 -3.0 -1.6 11.3 na 3.4 na na na na DKBK BD Dhaka Bank Financials 141 93 0.3 -1.4 -7.6 -7.7 na 0.7 na na na na LINDEBD BD Linde Bangladesh Materials 223 89 0.1 -2.4 -0.8 -9.3 na 5.1 na na na na TRBK BD Trust Bank Ltd Financials 222 89 0.1 -14.3 -18.0 29.4 na 1.4 na na na na DUBA BD Dutch Bangla Ban Financials 280 85 0.1 -5.1 -1.6 12.2 na 1.2 na na na na Source: MSCI, Bloomberg

10 Renaissance Capital 21 June 2018

Thoughts from a Renaissance man

Bangladesh 739 BGD 513 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Figure 20: Bangladesh key economic indicators, May 2018 data Ratings (M/S&P/F) Ba3/BB-/BB- EODB Rank: 177 (176) - Weak Corruption Rank: 143 (145) - Weak RenCap Legal score: 7 (8) - Weak Year 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E Activity Real GDP (% YoY) 6.5 5.5 5.3 6.0 6.5 6.3 6.0 6.3 6.8 7.2 7.1 7.0 7.0 NGDP_RPCH Investment (% GDP) 26.2 26.2 26.2 26.9 27.9 28.3 28.5 28.7 29.3 30.1 31.1 32.0 32.5 NID_NGDP Unemployment rate year-end (%) na na na na na na na na na na na na na LUR Nominal GDP (lcl bn) 5,892 6,669 7,513 8,567 9,855 11,271 12,713 14,297 16,243 18,543 21,086 23,939 27,192 NGDP Nominal GDP ($bn) 86 97 109 122 131 142 161 184 208 236 261 286 313 NGDPD Population (mn) 146 148 150 151 153 155 157 158 160 162 163 165 167 LP GDP per capita ($) 585 656 728 808 857 916 1,030 1,163 1,303 1,459 1,602 1,734 1,878 NGDPDPC Stock of bank credit (lcl, bn) 1,892 2,284 2,712 3,473 4,114 4,790 5,189 6,125 6,978 8,131 9,689 11,530 13,490 Lending/GDP (%) 32.1 34.2 36.1 40.5 41.7 42.5 40.8 42.8 43.0 43.8 46.0 48.2 49.6 Gross domestic saving (% of GDP) 27.8 28.2 29.0 29.1 29.4 30.2 29.8 29.1 30.3 30.6 29.8 29.9 30.1 NGSD_NGDP Prices CPI (average % YoY) 9.1 8.9 4.9 9.4 11.5 6.2 7.5 7.0 6.2 5.7 5.7 6.0 6.0 PCPIPCH CPI (year-end, % YoY) 11.6 6.7 7.7 11.6 7.6 7.1 7.3 6.1 5.9 5.7 5.9 6.0 6.0 PCPIEPCH Fiscal balance (% of GDP) Consolidated government balance -2.2 -4.0 -3.2 -2.7 -3.6 -3.0 -3.4 -3.1 -4.0 -3.4 -3.3 -4.1 -4.6 GGXCNL_NGDP Primary government balance -0.6 -1.9 -1.0 -0.8 -1.9 -1.1 -1.4 -1.0 -1.9 -1.5 -1.6 -2.4 -2.7 GGXONLB_NGDP Total public debt (% of GDP) 41.9 40.6 39.5 35.5 36.6 36.2 35.8 35.3 32.4 32.1 32.4 32.7 33.4 GGXWDG_NGDP External indicators Exports ($bn) 11 12.2 13.6 14.4 16.5 23.1 22.3 25.9 28.4 29.9 30.1 31.3 na na TXG_FOB_USD Imports ($bn) 16 18.5 23.8 21.8 27.8 36.1 34.2 37.5 41.6 39.4 41.2 47.8 na na TMG_CIF_USD Trade balance ($bn) -6.2 -10.2 -7.4 -11.3 -13.0 -11.9 -11.6 -13.2 -9.5 -11.0 -16.4 na na Trade balance (% of GDP) -7.3 -10.5 -6.8 -9.2 -10.0 -8.4 -7.2 -7.2 -4.6 -4.7 -6.3 na na Current account balance ($bn) 0.6 1.2 2.7 0.5 -1.3 1.0 1.9 2.1 3.6 1.4 -3.2 -5.8 -7.2 BCA Current account balance (% of GDP) 0.7 1.2 2.4 0.4 -1.0 0.7 1.2 1.2 1.7 0.6 -1.2 -2.0 -2.3 BCA_NGDPD Net FDI ($bn) 0.7 1.1 0.7 0.9 1.1 1.3 1.6 1.6 2.2 2.3 na na na Net FDI (% of GDP) 0.8 1.1 0.6 0.7 0.9 0.9 1.0 0.8 1.1 1.0 na na na C/A balance plus FDI (% of GDP) 1.5 2.3 3.1 1.2 -0.2 1.6 2.2 2.0 2.8 1.6 na na na Exports (% YoY, value) 13 12 6 15 40 -4 16 10 5 1 4 na na Imports (% YoY, value) 15 29 -8 27 30 -6 10 11 -5 4 16 na na FX reserves (ex gold, US$bn) 5.2 5.7 10.2 10.6 8.5 12.0 17.6 21.8 27.0 31.8 32.8 na na Import cover (months of imports) 3.4 2.9 5.6 4.6 2.8 4.2 5.6 6.3 8.2 9.3 8.3 na na External Debt Gross external debt YE ($bn) 22 24 27 23 22 26 32 35 38 41 47 na na Gross external debt YE (% of GDP) 25 25 25 19 17 18 20 19 18 18 18 na na Gross external debt YE (% of exports) 177 177 186 140 97 117 123 122 128 137 149 na na Short-term external debt YE ($bn) 2 3 3 0 0 2 4 3 7 8 0 na na Short-term external debt YE (% of GDP) 3 3 3 0 0 1 2 2 3 3 0 na na Short-term external debt YE (% of exports) 19 22 23 1 0 8 14 12 22 26 0 na na Short-term external debt to reserves (%) 44 54 32 2 0 14 21 16 25 25 0 na na Total debt service ($bn) 1 1 1 1 2 2 2 2 2 na na na na Total debt service (% of GDP) 1 1 1 1 1 1 1 1 1 na na na na Total debt service (% of exports) 8 7 7 7 7 7 7 7 6 na na na na Total debt service to reserves (%) 19 17 10 11 19 14 11 9 6 na na na na Currency and monetary policy IMF forecasts Key policy rate (% YE) na 8.8 4.5 5.5 7.3 7.8 7.3 7.3 7.3 6.8 6.8 6.8 na Broad money growth (%YoY) 14.7 17.9 20.7 21.7 19.1 19.0 15.6 13.3 13.1 13.8 10.7 na na FM2_XDC Exchange rate (€) annual average 94.4 101.1 96.2 93.1 104.7 102.3 104.7 103.2 86.6 87.1 91.2 103.8 109.0 Exchange rate ($) annual average 68.8 68.7 69.0 70.2 75.2 79.5 78.8 77.7 78.0 78.7 80.7 83.8 86.9 Credit rating history Latest Moody's - - - Ba3 Ba3 Ba3 Ba3 Ba3 Ba3 Ba3 Ba3 Ba3 na Standard & Poor's - - - BB- BB- BB- BB- BB- BB- BB- BB- BB- na Fitch ------BB- BB- BB- BB- BB- na Note: 2018-19E exchange rate forecasts are the IMF implied exchange rates from April 2018 World Economic Outlook Source: IMF, World Bank, UNCTAD, Bloomberg

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