596 07-May-2018, Mon
What are masala bonds?
Bonds are instruments of debt - usually used by corporates to raise money from investors. Masala bond is a term used to refer to a financial instrument through which Indian entities can raise money from overseas markets in the rupee, not foreign currency. In other words, they are rupee-denominated bonds issued to overseas buyers. This is how it is different from other instruments. Before Masala bonds, corporates have had to dependent on avenues such as External Commercial Borrowings (ECBs).
Let’s take an example.
Suppose an Indian entity issues masala bonds worth Rs 10 crores with a promise to pay Rs 11 crores the next year. Now the foreign investor will lend the dollar equivalent of Rs 10 crores. Now after a year, the Indian entity will return the dollar equivalent of Rs 11 crores.
How the name came?
a) IFC issued a Rs 1,000 crore bond to fund infrastructure projects in India. These bonds were listed on the London Stock Exchange (LSE).
b) IFC then named them Masala bonds to give a local flavour by calling to mind Indian culture and cuisine.
c) This kind of naming has been done before also. IFC’s Chinese yuan-denominated bonds are called Dim sum bonds, Japanese yen-denominated bonds are called Samurai.
d) Before the word masala, some names like Samosa, Ganga, and Peacock were also in line to be attached to these rupee-denominated bonds.
Why Masala Bond?
Masala bonds has a quite significance for the Indian economy. Indian Issuers face less risk in Masala bond as compared to bond markets. The currency risk is entirely borne by the foreign Investors. Masala Bonds are issued to foreign investors and settled in US dollars. Unlike external commercial borrowings (ECBs), where Indian companies raise money in foreign currency loans, the currency risk lies with the investor and not the issuer, Masala bonds are similar to external commercial borrowings (ECBs), in which Indian companies raise funds in foreign currency and are exposed to rupee-dollar fluctuations. If ECBs (ExternalCommercial Borrowings) help companies to take advantage of the lower interest rates in international markets, the cost of hedging the currency risk is significant, but If unhedged, adverse exchange rate movements bites the borrower. Inversely in the case of Masala bonds, the cost of borrowing can work out much low. Overseas investors will be eligible to hedge their exposure in rupee through permitted derivative products with banks in India to hedge the risks. It helps Indian companies to diversify their bond portfolio. Earlier, companies used to issue only corporate bonds. Masala bonds are an addition to their bond portfolio. It helps the Indian companies to reduce the cost. Bonds issued in Indian companies carries an interest rate of 7.5%-9.00%, whereas Masala Bonds are issued below 7.00% interest rate outside India. It also helps Indian companies to attract a large number of investors as these bonds are issued in the offshore market. An offshore investor earns better returns by investing in Masala bonds rather than by investing in his home country. If the rupee appreciates at the time of maturity, then an investor will benefit from his investment in Masala bonds.
Who can issue rupee denominated bonds?
a) Any corporate (registered as a company under the Companies Act) or body corporate created out of a specific act of the Parliament is eligible to issue Rupee denominated bonds overseas.
b) Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) coming under the regulatory jurisdiction of the SEBI are also eligible (September 2015 regulation).
c) These bonds will be issued for a minimum maturity period of 5-years.
d) Banks incorporated in India will not have access to these bonds.
How does Govt. and RBI view Masala Bonds?
a) The local currency bond markets can contribute to financial stability by reducing currency mismatches and extending the duration of debt.
b) It will also be a sign of early acceptance of the Indian currency in trading and settlement overseas, showing the confidence of investors and can lead to internationalization of the currency over the medium and long term.
c) Foreign investors prefer to hedge their risks overseas because there are limited products in the Indian market, especially for longer periods.
d) The other worry, if the overseas rupee bond market takes off, will be about the growth of the Indian corporate bond market and Indian banks as top companies shift to another market, impacting the growth here.
a) Masala bonds are a step to help internationalize the Indian rupee and also deepen the Indian financial system.
b) They are the first rupee bonds listed on the London Stock Exchange.
c) They can be issued for three or five or seven-year maturities.
d) The first Masala bonds were issued on 10 November 2014 under IFC’s $2 billion offshore rupee program.
e) They are different from External Commercial Borrowings (ECB) in a way that in ECB the currency risk lies with the Indian issuer while in case of masala bonds, the currency risk lies with the overseas investor.
f) Like ECB, masala bonds also provide cheaper funding as compared to domestic markets.
g) Though currency risk lies with the investor, but then also the overseas investor has many advantages like they have very few investment options in other countries due to weak economic conditions globally.
h) Coinciding with Prime Minister Narendra Modi’s visit to the UK last year, organisations such as HDFC, Yes Bank, and the Railways had announced they were going to raise funds through this route from the London market.