A term which has recently gained momentum in the financial market is termed as Masala Bonds. They are the bonds issued outside India but denominated in Indian Rupees, rather than the local currency of that country. They are named after the Masala Spice, a mix of spices used in India. Unlike dollar bonds where the borrower takes the currency risk, masala bond investors have to bear the risk. The first Masala Bond was issued by the World Bank backed International Finance Corporation in November, 2014 when it raised Rupees 1000 crore bond to fund infrastructure projects in India. Later in August 2015 International Finance Corporation for the first time issued green masala bonds and raised Rupees 3.15 billion to be used for private sector investments that address climate change in India.

About Masala Bonds

“Masala Bond is a kind of financial instrument through which Indian entities can raise money from overseas Markets in rupee and not in foreign currency. Indian rupee denominated bonds issued in offshore Capital markets.”

Masala Bond is a kind of financial instrument through which Indian entities can raise money from overseas markets in the rupee and not foreign currency. These are Indian rupee denominated bonds issued in offshore capital markets. The rupee denominated bond is an attempt to shield issuers from currency risk and instead transfer the risk to investors buying these bonds. In a way Masala Bonds is a step to help internationalize the Indian rupee. Investors in these bonds however will have a clear understanding and view on the Indian rupee risks. Therefore, stable Indian currency would be key to the success of these bonds.

The currency risk in the Masala Bonds lies in the hands of investors thus the investor demands a currency risk premium on the coupon and hence borrowing cost for Indian corporates through this route would be slightly higher. However, it may still be cheaper if one considers the currency risk. Though raised in Indian currency, these bonds will be considered as part of foreign borrowing by Indian corporate and hence would have to follow the RBI norms in this regard. Under the automatic route, companies can raise as much as Rupees 50 billion per annum through Masala bonds.

Pricing of Masala Bonds

There are two critical factors for the success of such bond : (a) coupon rate and (b) liquidity of Indian currency.  India is rated BBB- by global ratings agencies—a notch above junk rating. Sovereign rating will influence pricing of these bonds.  HDFC, for example, had recently borrowed in the domestic market through a three-year bond at 8.35%. HDFC expects to fix a coupon rate at least 10 basis points lower than the domestic rate for the masala bonds. It was observed that Indian banks were borrowing US dollar-denominated loan at under 4% in later half of 2015. If HDFC were able to issue masala bonds at 8.25%, it would imply a currency risk premium of above 4% per annum. Overseas investors are yet to decide their preferred coupon rate for the Indian masala bonds. Generally, given the view on Indian currency, investors are expecting a higher coupon from the issuers, which may make these bonds costly for Indian borrowers. This is the main reason holding back issue of masala bonds. If US Fed increases interest rate, that would make Indian masala bonds less attractive.

Allowing Indian firms to raise rupee-denominated loan from overseas market is a step towards full convertibility of Indian currency and the Indian central bank is supportive of this experiment. Despite initial glitches on pricing, masala bonds have potential to raise $5 billion in next two years. British government is wooing masala bond issuers and would like to position London as the global hub for offshore rupee financing. 

The success of masala bonds would demonstrate overseas investors’ confidence on Indian currency. In other words, successful issue of these bonds by Indian corporate would imply faith on country’s macroeconomic fundamentals and the central bank’s role in currency management.

Regulatory Regime for Masala Bonds

The Reserve Bank of India (RBI) has paved the way by permitting the issuance of rupee – denominated bonds as part of its Fourth bi-monthly Policy statement for the year 2015-16 on September 29, 2015. While the RBI pronounced on the issue from the perspective of foreign exchange regulation, particularly that governing external commercial borrowings (ECBs), several other issues remained, including whether the issuance of masala bonds were to comply with the provisions of company law as well as securities regulation. These issues have been clarified by the respective regulators more recently.

On August 3, 2016, the Ministry of Corporate Affairs (MCA) issued a Circular, which stated that Chapter III of the Companies Act, 2013, which deals with prospectus and allotment of securities, and rule 18 of the Companies (Share Capital and Debentures) Rules, 2014, which deals with debentures, would not apply to the issue of rupee denominated bonds made exclusively to persons resident outside India in accordance with the applicable legal regime Separately, on August 4, 2016, the Securities and Exchange Board of India (SEBI) issued a Circular, which laid down the corporate debt limit for all foreign investments in bonds issued by Indian companies, and also clarified that investments in rupee-denominated bonds shall not be treated as foreign portfolio investments (FPI), and hence will not fall within the regime that apply to them.

Why needed/Importance

It was not due to a whim or loyalty to one’s country that led to such a colourful christening for the local currency bonds. Masala bonds, if they take off is quite a significant advantage for the Indian economy. They are issued to foreign investors and settled in US dollars. Hence the currency risk lies with the investor and not the issuer, unlike external commercial borrowings (ECBs), where Indian companies raise money in foreign currency loans. While ECBs help companies take advantage of the lower interest rates in international markets, the cost of hedging the currency risk can be significant. If unhedged, adverse exchange rate movements can come back to bite the borrower. But in the case of Masala bonds, the cost of borrowing can work out much lower.

Masala bonds can have implications for the rupee, interest rates and the economy as a whole.

Advantages & Disadvantages

Competition from overseas markets may nudge the government and regulators to hasten the development of our domestic bond markets. A vibrant bond market can open up new avenues for bond investments by retail savers. If Masala bonds are eagerly lapped up by overseas investors, this can help prop up the rupee. The rising demand for Dim-sum bonds in 2011, for instance, promoted the use of the yuan in global trade and investment. Dim-sum bonds also provided investment avenues for yuan-holders outside of China. With talks of a full rupee convertibility back home, Masala bonds can help the rupee go global.

But these bonds can have bad after-effects too if companies decide to binge on them. As of December 2014, corporate overseas borrowings stood at $171 billion. The recent turmoil in the rupee is already prompting caution on existing foreign loan exposure. Some reports estimate that Indian corporates, are likely to issue about $6 billion worth of Masala bonds this fiscal. With our economy still on shaky ground, too much reliance on external debt (even in rupees) can weigh heavily on our rating by global agencies.

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Acquisory News Chronicle - August 2016