Of late, a term called ‘Masala Bonds’ has gained momentum in the global financial market. Bonds are instruments of debt used by corporates to raise money from investors. Masala Bonds are the bonds issued outside India, but denominated in Indian rupees, instead of the local currency of a respective country. They are named ‘Masala Bonds’ after the masala spice, a mix of spices used in India. While in dollar bonds, the borrower bears the currency risk, in Masala Bond, investors have to bear the risk.
The World Bank-backed International Finance Corporation (IFC) issued the first Masala Bond in November 2014, when it raised INR 1,000 crore bond to fund infrastructure projects in India. Later, in August 2015, for the first time, IFC issued green masala bonds and raised INR 3.15 billion to be used for private sector investments that address climate change issues in India.
What is ‘Masala Bond’?
Masala Bond is a type of financial instrument which enables Indian entities to raise money from overseas markets in rupee and not in foreign currency.These are bonds denominated in Indian rupees issued in offshore capital markets. This is how it is different from other instruments. Before the emergence of Masala Bonds, corporates had to depend on other avenues such as External Commercial Borrowings (ECBs).
Masala bonds attempt to protect issuers from currency risk and instead shifts the risk to investors, who buy these bonds. Masala bonds help globalize the Indian rupee. These bonds are listed on the London Stock Exchange (LSE). Investors in these bonds are fully aware of the Indian rupee risks. Therefore, stable Indian currency would be paramount to the success of these bonds.
The investors bear the currency risk in Masala Bonds and thus they demand a premium on the currency risk coupon, which leads to comparatively higher borrowing costs for Indian corporates through this route. However, it may still be economical if one considers the currency risk. The Masala Bonds, though raised in Indian currency, will still be considered by Indian corporate as a part of foreign borrowing and hence it should conform to the RBI norms in this regard. Under the automatic route, companies can annually raise as much as INR 50 billion through Masala bonds.
Origin of Masala Bonds
IFC christened the bonds as Masala Bonds to give a local flavor looking at the Indian culture and cuisine. Indian spices have been popular globally since ancient times. It named the bonds as ‘masala bonds’ to reflect the Indian angle to it. While it may seem a tad weird to name a formal debt instrument after food stuffs, this is not the first time it has been done so. Chinese bonds were named as ‘Dim-sum’ bonds after a popular dish in Hong Kong. Similarly, Japanese bonds are named ‘Samurai’ after the country’s warrior class.
Significance of Masala Bonds
The birth and growth of Masala Bonds and the weird name for it is not due to a craze or loyalty to one’s country. Masala bonds can provide quite a significant advantage to the Indian economy (Refer Table-1). They are issued to foreign investors and settled in US dollars. The buyer will earn a higher yield (coupon rate) to compensate for the risk of currency depreciation. Unlike ECBs – where Indian companies raise money in foreign currency loans – the currency risk with Masala Bonds lies with the investor and not the issuer. While ECBs aid organizations availing the benefits of lower interest rates in global markets, the cost of hedging the currency risk can be significant. If not hedged, adverse exchange rate movements can return to pester the borrower. But in the case of Masala Bonds, the cost of borrowing can work out to be much lower. Masala Bonds can not only have implications for the rupee, but also for interest rates and the entire economy.
Competition from overseas markets may impel the government and regulatory authorities to expedite the development of domestic bond markets. A dynamic bond market can create new avenues for bond investments by retail savers. If Masala Bonds are eagerly lapped up by overseas investors, this can help perk up the rupee. The soaring demand for Dim-sum bonds in 2011 encouraged the use of the yuan in international 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.
These Masala Bonds can cause bad repercussions, too, if companies decide to have too much of them. When the economy is unstable, too much dependence on external debt (even in rupees) can weigh heavily on rating by global agencies.
What makes Masala Bonds an attractive investment is that it offers an opportunity to diversify funding sources and uncorrelated funding options, which are a key priority for most Non-Banking Finance Companies (NBFCs). NBFCs do not have much material access to global markets for sourcing money and Masala Bonds offers the access and the ability to tap a deep investor base in the global markets.
A Few Key Facts About Masala Bonds
- The primary purpose of Masala bonds is to help globalize the Indian rupee and also boost the Indian financial system.
- Through the issue of bonds in rupees, an Indian company is safeguarded against the risk of currency fluctuations, usually associated with borrowing in foreign currency. In addition to aiding diversify funding sources, it also reduces the cost of borrowing compared to domestic markets.
- The first Masala Bonds were issued by the IFC, a wing of the World Bank, in 2014. Similar offerings from other countries have also been named after the food or culture of that country like "Dim Sum" bonds for Chinese offshore bonds or "Samurai" bonds for Japanese offshore bonds.
- As Masala Bonds are denominated in rupees, foreign investors will bear the currency risk. So, a stable exchange rate would be the key for the success of these bonds.
- Masala Bonds are the first rupee bonds to be listed on the London Stock Exchange.
- According to RBI norms, an Indian company is permitted to raise a maximum of $750 million per annum through Masala Bonds with a minimum maturity of 5 years.
Masala Bonds – A New Funding Source for Indian Companies
According to the IFC, the Masala Bonds (also known as offshore rupee bonds) can provide a novel source of funding for Indian companies, who would benefit in the longer run from comparative pricing landscape. In March 2016, IFC issued Masala Bonds worth USD$30 million with a 15-year tenure, which was the longest-dated offshore rupee bond.
Since its inception, only HDFC and NTPC have successfully listed its Masala Bonds worth INR 4,500 crore (~ $677 million) and INR 2,000 crore (~ $300 million) respectively on the London Stock Exchange (LSE). HDFC’s Masala Bonds are traded on LSE, while NTPC’s bonds are traded on both LSE and Singapore Stock Exchange (SGX).
Earlier no Indian company had introduced the Masala Bonds and were quite reluctant to tap this route due to several factors such as lack of full knowledge about the market and its cost. There is just a small gap – a difference of between 40 and 80 basis points – between the interest rates of offshore and onshore bonds. Indian companies are more cautious about funding costs and want to go for economical ones, which is the domestic market. In the longer run, companies issuing offshore bonds will benefit more from comparative pricing landscape.
Among primary emerging economies, India is the ‘bright spot’ and is likely to be the next emerging market continental economy that can form (along with China) the emerging market anchor of a future Special Drawing Rights (SDR). In 2016, IFC issued bonds worth about INR 110 billion (INR 11,000 crore) and the proceeds were invested in 11 different private sector development projects in India. Earlier, IFC had issued Masala Bonds with maturities of three, five, seven and 10 years.
With the launch of the Masala Bond program, India has started its SDR journey. The Masala Bond program is a green shot and India is creating a viable Indian rupee asset.
Created by the IMF in 1969, SDR is a global reserve asset to supplement the official reserves of its member countries. Today, the value of SDR depends on a basket of five major currencies, viz., the US Dollar, the Euro, the Japanese Yen, the Chinese Renminbi, and the British Pound Sterling.
Advantages of Masala Bonds
The advantages of issuance of Masala Bonds are umpteen, as there can be acceleration in fixed income market. Moreover, once the Masala Bond lures investors in the offshore market, it will also play a critical role in reviving the Indian currency.
Competition from foreign markets may compel the government and regulators to expedite the development of our domestic bond markets. A dynamic bond market can create new opportunities for bond investments by retail savers. If Masala Bonds are eagerly embraced by foreign investors, it can aid shore up the Indian rupee. For instance, the increasing demand for Dim-sum bonds in 2011 encouraged the use of the yuan in international trade and investment. Dim-sum bonds also provided investment opportunities for yuan-holders outside of China. With talks of a full rupee convertibility in India, Masala Bonds can help the rupee go international.
Borrowing Overseas in Indian Rupees
Companies issuing Masala Bonds can forget worries about rupee depreciation, which is generally a huge worry while raising money in overseas markets. If the rupee weakens when the bonds come up for redemption, the borrower (company) will need to pay more rupees to repay the dollars. This is a big advantage because a few Indian companies that raised money overseas in 2007 by issuing Foreign Currency Convertible Bonds ended up in a crisis because of the sharp depreciation in rupee in the wake of the global financial crisis.
An organization that uses Masala Bonds vis-à-vis the conventional sources of funding reaps many benefits, including benefits of competitive interest rates. The interest rates for Masala Bonds are usually lower than the bank financing rates. Though they may be a tad expensive than domestic bond rates, as the markets deepen, there is a lead curve that starts getting established in the market, and as institutional investors in the international markets start appreciating the credit, one will see encouraging yields and rising attractiveness. There is an increase in liquidity, and as more people access the markets internationally, the yield curves will start reflecting that and a broader credit spectrum will be seen.
Disadvantage of Masala Bonds
Masala Bonds can have bad effects, too, if companies decide to have too much of them. The corporate overseas borrowings as of December 2014 was $171 billion. Moreover, a few reports indicate that Indian corporates are likely to issue about $6 billion worth of Masala Bonds in the fiscal year 2016-17. The turmoil in the rupee is compelling caution on current foreign loan exposure. With our economy still struggling to establish itself on a stable ground, too much dependence on external debt (even in rupees) can take a heavy toll on our rating by global agencies.
Regulatory Regime for Masala Bonds
On September 29, 2015, the Reserve Bank of India (RBI) paved the way for rupee-denominated bonds by allowing its issuance as part of its fourth bi-monthly policy statement for the year 2015-16. RBI issued guidelines allowing Indian companies, NBFCs and infrastructure investment trusts and real investment trusts to issue rupee-denominated bond overseas. While the RBI announced the issue from the foreign exchange regulation angle, especially governing ECBs, several other issues remained unanswered, including whether the issuance of Masala Bonds had to comply with the provisions of company law and securities regulation. These issues were later clarified by the respective regulators.
On August 3, 2016, the Ministry of Corporate Affairs (MCA) issued a circular that 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 Masala Bonds made exclusively to persons resident outside India as per the applicable legal regime. On August 4, 2016, the Securities and Exchange Board of India (SEBI) issued a circular that fixed 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 considered as foreign portfolio investments (FPI), and hence it will not fall within the regime applicable to them.
Tax Benefits for Masala Bonds
In the Union Budget 2017-18, Masala Bonds got a tax benefit boost when the Union Budget exempted them from taxation for transfer among non-residents to increase acceptability and transferability of such instrument in the foreign market. However, a nominal rate of 5% will apply for investors until June 30, 2020. The decision to impose lower tax deducted at source (TDS) of 5% (from the earlier 20%) for Masala Bonds would be with retrospective effect from April 1, 2016. The decision to continue with lower TDS rate for Masala Bonds was taken in the wake of several demands from various stakeholders.
The Union Budget also proposed to extend the benefit of Section 194LC to rupee-denominated bonds issued outside India before July 1, 2020. This amendment will also take come into force retrospectively from April 1, 2016 and will apply in relation to the assessment year 2016-17 and subsequent years.
To provide relief regarding gains from appreciation of rupee against a foreign currency at the time of redemption of Masala Bonds to secondary holders, the government has decided to amend the Income Tax Act. The amendment would be made accordingly to ensure that the said appreciation of rupee is ignored for the purposes of computation of full value of consideration. Another proposal is to provide that any transfer of rupee denominated bond of an Indian company issued outside India, by a non-resident to another non-resident would not be regarded as transfer. In this regard, the amendments would take effect from April 1, 2018 and will, accordingly, apply in relation to the assessment year 2018-19 and subsequent years.
Green Masala Bonds
In May 2016, Indian state firms such as NTPC Ltd, Neyveli Lignite Corp., Ltd., Power Finance Corp., Ltd., (PFC), Rural Electrification Corp., Ltd. (REC), and PTC India Ltd., planned to issue masala bonds to raise $1 billion. Energy Efficient Services Ltd., a joint venture of NTPC, PFC, REC and Power Grid Corp., of India Ltd., also planned to explore options to issue green masala bonds. India has set a target to achieve 175 gigawatt (GW) of renewable power generation capacity by the year 2022, which requires an investment of $160 billion. 100 GW is the solar power target and 60 GW is expected to come from wind power generation. The tenure of these bonds is expected to be between five and seven years and would be in smaller denominations ranging from $150-250 million.
In July 2016, National Thermal Power Corporation (NTPC), India’s largest power company, authorized HSBC, Axis Bank, Mitsubishi UFJ Financial Group (MUFG), and Standard Chartered Bank as joint lead managers and joint book-runners for offering of green Masala Bonds. This was the first corporate Masala Bond offering that committed the proceeds to green projects.
HDFC too raised INR 3,000 crores through rupee-denominated bonds in July 2016, which were over-subscribed by 4.3 times. In August 2016, NTPC raised INR 2,000 crores by introducing green Masala Bonds on the LSE.
Market Scenario of Masala Bonds
Masala Bonds are in its incipient stages and has the potential to be a game-changer for the Indian economy. Not prohibited by Indian regulators, financial institutions such as Inter-American Development Bank (IDB), IFC, and European Bank for Reconstruction & Development (EBRD) have issued rupee bonds outside India for more than 10 years. A report by LSE indicates that, at present, there are more than 30 offshore Indian rupee bonds listed on its index, raising approximately $3.5 billion. However, the latest issues by HDFC bring the total of Masala Bonds to 33, with aggregate amount being $3.86 billion.
Indian & International Issuers of Masala Bonds
- In July 2016, HDFC Bank, the first Indian company to issue Masala Bonds, issued Masala Bonds worth INR 3,000 crores ($450 million).
- In August 2016, NTPC issued the first corporate Green Masala Bonds worth INR 2,000 crores ($300 million).
- In September 2016, HDFC issued Masala Bonds worth INR 500 crores, the entire amount being subscribed by The Province of British Columbia, also raised by issue of masala bonds.
- In September 2016, HDFC issued Masala Bonds worth INR 1,000 crores.
- In November 2014, IFC issued INR 1,000 crores ($150 million) worth Masala Bonds to fund infrastructure projects in India.
- In April 2015, IFC issued Masala Bonds worth INR 1,800 crores ($ 270 million) to support private sector investment in India.
- In August 2015, IFC issued Masala Bonds worth INR 315 crores ($47.25 million) to be used for private sector investments that address climate change concerns in India.
The European Bank for Reconstruction and Development (EBRD), the Inter-American Development Bank (IDB), and The Province of British Columbia are the other issuers of Masala Bonds.
China has been ahead in the issue of such overseas bonds. In 2007, the China Development Bank issued overseas the ‘Dim Sum Bonds’, denominated in the Chinese Renminbi (RMB). According to a report dated July 2016 by Citibank, currently there are approximately 110 Dim Sum Bond issues trading in the market, with a par value of RMB 183.10 billion ($27.61 billion) and a market value of RMB 185.22 billion ($27.92 billion) — the average coupon is 4.10%, the yield-to-maturity (YTM) is 4.05% and the average life is 3.34 years, with over 75% bonds being of the investment grade. Since China has been delivering rapid growth in its gross domestic product (GDP) for the past years, Dim Sum Bonds have become very attractive and popular, with the stock exchanges of Luxembourg, London and Hong Kong being the home of trade for these bonds.
In March 2017, HDFC raised its largest tranche of $504 million (INR 3,300 crores) in the overseas market through such bonds. HDFC issued the bonds at a coupon rate of 7.35% payable half-yearly. The bonds are unrated and would be listed on the LSE. Since September 2015, when the RBI first allowed Indian firms to raise money through Masala Bonds, 14 Masala Bond issues have been listed on the LSE with an aggregate outstanding value of just below INR 13,000 crores.
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