Decoding ‘Masala Bonds’

In a world where developed markets are struggling to keep their demand intact by keeping prime lending rates at bay, RBI decides to propagate this unique concept of Masala Bonds.

 

As the name suggests, it is expected to add some more flavor to the Indian growth story. However, the picture seemingly going blurred since its inception i.e. September, 2015; not a single company have raised through this alternative offshore funding route till recently when some PSUs from the power sector have announced to toe this route in order to raise around $1bn (a single company cannot raise more than Rs. 5000 crore through these Masala Bonds). China’s Development Bond had introduced Dim Sum Bonds back in the 2007; In China, PBoC issues Dim Sum Bonds, whereas in India, corporates issues Masala Bonds as per RBI guidelines. With this development, RBI is gradually trying to reform the foreign exchange segment of the Indian financial markets. Full Capital Account Convertibility (CAC) is still not allowed in India and this very measure takes the system an inch closer to that distant reality.

Masala Bonds offers some unique advantages to both lender and borrowers, but before we go there and discuss the benefits in detail, let us take a detour and try to understand the causal circumstances which brought this instrument into its reality.

 

Initially, the alternative route to get offshore funds is either through Equity (including Hybrid products) or Debts (including domestic and foreign i.e. ECB). In case of equity there are various issues like FDI restrictions, Tax implications like DDT and Capital Gain Tax. In Masala Bonds, this sector restriction provision has been waived off, the levy of DDT will not take place and going further the withholding tax rate has been brought down to 5% from earlier 20% to make it more attractive. And now if we compare it with the debt instruments, then considering the high interest rate regime at present, it becomes a little hard to raise fund domestically as one would prefer to tap the arbitrage opportunity to make project more feasible and profitable.

However, there lies a catch for the Corporates, to tap this arbitrage opportunity they have to issue ECBs (External Commercial Borrowings) and with the issuance of ECBs companies have to comply with the strict guidelines of RBI as companies can’t repatriate interest beyond the prescribed limit. The money coming through this will be subjected to capital investment or in capital projects, adhering to the ruling of “end use of foreign fund’ by RBI.

Masala Bonds have got some unique features which also satisfies the financial cravings of offshore investors. These bonds can be bought by retail investors along with institutions. The tenure for which these bonds can be issued is 3 yrs, 5yrs, 7 yrs and 10 yrs. These are INR denominated bonds but settlement takes place in USD (and in other currencies, as the case allows), so this way the forex risk gets transferred to the investor, which is the biggest gain for the issuer company (hedging cost in developed markets is lower than the domestic markets, which eventually neutralizes the risk bore by the lender). RBI has even allowed World Bank and other multilateral financial institutions to issue Masala Bonds and pour the proceeds to satisfy Indian infrastructure needs. IFC leads in raising funds for the first time by issuing Masala Bonds in 2015 (raised Rs. 11000 crores).

This instrument strengthens both the lender and the borrower. Corporations and Institutions see growth opportunity in India and to tap this opportunity they need fund and the best source to get this is overseas markets due to low interest rate regime. This instrument also provides opportunities in abundance to the investors sitting overseas as they could simply make profit through arbitrage. And looking at the present currency valuations scenario across the globe, INR has done fairly well amongst the developing nations. Appreciation of INR, which is down the line from here, will only benefit the investors as the settlement is likely to take place in other currency.

 

Regards

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AUTHOR: Ashish Andani
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