Masala Bonds - All You Need to Know

During his visit to the UK last week, Prime Minister Narendra Modi spoke about the Indian Railways issuing bonds and listing them on the London Stock Exchange.

What are Bonds?

Bonds are debt instruments which allow the companies or govt. to raise funds only by incurring debt and lender is guaranteed of a fixed repayment (Principle and Interest).

What are instrument available with Company to raise funds?

1. Issue Bonds – Companies will have to pay the fixed amount when the bond matures.
2. Issue Shares – Companies would like to raise money but don’t want it as a debt so the company will issue shares.

How the bonds are more secure than the shares?

In case of liquidation of the company, the bond holders get their claim before the share holders.

Masala Bond is nothing but a bond in Indian rupee denominated bonds issued in offshore capital markets.

Introduction of Masala Bonds

The bonds listed on the London Stock Exchange (LSE) is termed as Masala Bonds. These bonds are offered and settled in US dollar to hike Indian Rupee in International market. These bonds help to raise Indian rupees from International investors for infrastructural development in India. International Financial Corporation (IFC) converts bond from dollars into rupees and uses the rupees to finance private sector investment in India. The term Masala bond was coined by IFC and it recognized globally.

'Masala' refers to spices and it evokes the culture and cuisines of India. These bonds can be issued by Indian corporates only. No bank is allowed to issue Masala bonds Some of the corporates like HDFC, Indian Railway Finance Corporation and NTPC are willing to raise funds abroad.

The major component of Masala Bond is its hedging costs. The rupee-dollar equation plays an important role and the stability of this equation gives assurance and confidence to invest. IFC issues Masala bond in the offshore market. The price of a bond is denominated in Indian currency and not in the US dollars, but it is paid in dollars after maturing.

Why Masala Bond?

Masala bonds have a quite significant 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 (External Commercial 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 bite 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 riskes. 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.

Facts Rules of Masala Bonds –

As per RBI guidelines, not only corporates but also Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) are eligible to issue these bonds.
These bonds can be privately placed or listed on exchanges as per host country regulations.
These bonds will be issued for a minimum maturity period of 5-years.

What’s new in the Masala Bonds?

Basically, overseas rupee bonds are known as Masala bonds.

Indian firms have earlier raised money abroad through bonds and other forms of borrowings, but always in foreign currency, mainly via ECBs (External commercial borrowings).
However, the first overseas rupee bonds were issued in 2013 by the International Finance Corporation, the World Bank’s private sector investment arm.
To raise funds for capital expenditure, the Indian Railway Finance Corporation will be issuing bonds denominated in rupees.

What are the risks faced by Indian companies associated with foreign currency overseas bond?

An Indian company issuing an overseas bond (i.e. in other currencies especially dollar) runs into a risk on account of currency fluctuation.
If rupee weakens during the period of the bond, then it adds significantly to costs at the time of repayment, normally at the end of 5 years.

How Masala Bonds will benefit Indian companies?

If the issuer, issues bonds in rupees, then he gets rid of this risk (currency fluctuation) which passes on to the investor.
This bond brings a new and diversified set of investors for Indian companies and more liquidity in foreign exchanges, apart from bank-funding and the corporate bond market in India.

Does Masala bond offer something to the foreign investors?

The investor who purchases a bond issued by an Indian entity is betting on India, in a hope that the currency and inflation would be stable enough to ensure good returns after hedging for foreign exchange risks.
With India’s GDP or national income rising and projected to grow at a reasonably fast clip over the next few years, many overseas investors would like to buy into such bonds to join the party and to earn higher returns compared to the US and Europe where interest rates are still low.

How does Govt. and RBI view Masala Bonds?

The local currency bond markets can contribute to financial stability by reducing currency mismatches and extending the duration of debt.
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.
Foreign investors prefer to hedge their risks overseas because there are limited products in the Indian market, especially for longer periods.
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.

Was such an approach adopted by any emerging economies in past?

China’s People’s Bank of China has previously issued yuan denominated bonds (Dim Sum Bonds) to raise funds at a little over 3%.
Japan had also floated yen denominated bonds called as ‘Samurai’

Let’s take into account the differences between India and China!

Unlike China, the Indian govt. has never borrowed abroad on its own, preferring to push its state owned firms, instead.
RBI, unlike the Chinese central bank, cannot issue debt with no legal sanction for it.

But these have been borrowings in dollar or other currencies. The Railways bond, on the other hand, will be denominated in rupees.

==>> Must read about Gold Bond schemes