Masala Bonds: Can it spice up Indian bond market?
Saurabh Dugar 14 July 2016
Indian curry is quite a hit in the West. On a similar note, can global investors be tempted to try out Masala bonds? That is something the Indian Railway Finance Corp, which approved the raising of $1 billion through the issue of Masala bonds and other companies such as Indian Rail Finance Corp and NTPC are trying out now. However, it is Housing Development Finance Corp Ltd (HDFC) that is launching first sale of so-called masala bonds by an Indian entity this week, seeking to raise at least Rs2,000 crore with an option to retain oversubscription of up to Rs1,000 crore. The advent of much talked about masala bonds market is a positive precursor for corporates as it has opened up potentially significant new sources of funding over External Commercial Borrowings (ECB). This will also integrate financial markets in India further with the rest of the world. We can certainly envisage several innovative applications of the RDB option by companies going forward.
The term “Masala Bonds” is used to refer to rupee-denominated borrowings by Indian entities in overseas markets. The International Finance Corp (IFC), the investment arm of the World Bank, issued a Rs1,000 crore bond in November 2014. The purpose of issue was to fund infrastructure projects in India. IFC named them ‘masala’ bonds to reflect the Indian flavor. The term masala bonds have been used ever since. 
Before masala bonds, corporates raised finance from international market through external commercial borrowings or ECBs. However, since funds raised through ECBs are denominated in foreign currency, the same attracts risk of forex fluctuation. A year is a long time in forex markets where currencies fluctuate sharply. So, imagine the risk an issuer of bond has to face, especially of one with largely rupee earnings, where issue and repayment are years apart. This is how masala bond is different from other instruments as the risk of currency lies with the investor and not the issuer. 
China has been ahead. In October 2015, when President Xi Jinping was in London, the People’s Bank of China issued Yuan denominated bonds, dubbed “dimsum bonds” in Hong Kong to raise funds at a little over 3%. A key difference between these two countries is that unlike China, the Indian government has never borrowed abroad on its own — preferring to push its state owned units, instead. And Reserve Bank of India (RBI), unlike the Chinese central bank, cannot issue debt with no legal sanction for it.
Market Scenario
The need for a healthy corporate debt market in India has been emphasized repeatedly. A well-developed corporate debt market will not only support the banking system in meeting the long term funding requirements of the corporate but will also be a reliable source of finance in situations when the equity market is unstable. In the recent years, the Indian corporate bond market has experienced development both in number and volume; however, when compared with the Indian government bond market, it still has a long way to go. 
The corporate bond market in India is dominated by non-banking finance companies (NBFCs) as issue of unsecured bonds by non-banking non-financial Companies (NBNFCs), until recently, were covered under the ambit of deposits. The same has been discussed at length below. So, the issue of corporate bonds in India by NBNFC is quite small as compared to that of other developed countries and the same can be viewed in the figure below:
Looking at the global trends, bank financing seems to be an uncommon phenomenon as compared to that of bond financing, but the current situation in India follows a totally contrary path. The reason for hindering growth of corporate debt market against that of PSU’s debt market can also be attributed to the high fiscal deficit of Indian economy. 
Spate of action
The regulators have now started taking steps to streamline the regulatory regime surrounding the Indian bond market. The motive of regulators behind such push is to transform the Indian bond market into a much more vibrant trading field for debt instruments from the elementary market that it was about a decade ago, but there is still a long way to go. Lately, there have been a number of changes, which is likely to cause a positive impact. 
Until recently, the Companies (Acceptance of Deposits) Rules, 2014 barred the corporates from issuing unsecured debt instruments. However, the Ministry of Corporate Affairs (‘MCA’) vide notification issue on 29 June 2016 issued the Companies (Acceptance of Deposits) Amendment Rules, 2016 (‘Amendment Rules) thereby providing relaxation with respect to issuance of corporate bonds by excluding listed unsecured non-convertible debentures (NCDs) from the definition of deposits. Earlier, corporates, other than financial entities, were allowed to issue either secured bonds or bonds compulsorily convertible into equity within a period of five years from the date of issuance, anything apart from the said were treated as deposits. However, RBI allowed NBFCs to issue unsecured NCDs with a maturity of more than one year and minimum subscription amount being Rs1 crore per investor. 
Enabling Provisions by RBI
The RBI, on 29 September 2015, vide circular RBI/2015-16/193 has issued guidelines allowing Indian companies, Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) to issue rupee-denominated bond overseas. 
As per the guidelines, the issue size by an eligible borrower has been restricted to $750 million under automatic route. The regulator also mentioned a minimum maturity period of five years. However, RBI, on 13 April 2016, vide circular RBI/2015-16/372 had reduced the tenure of such bonds to three years and allowed borrowing up to Rs5,000 crore under the automatic route. According to the RBI, the masala bonds can only be issued in a country and subscribed by a resident of a country that is a member of Financial Action Task Force (FATF) or a member of an FATF-style regional body. The country should have strategic anti-money laundering or combating the financing of terrorism deficiencies to which countermeasures apply.
Reason to invest in masala bonds
The following are the reason to invest in masala bonds:
The Ministry of Finance has slashed the withholding tax on interest income of masala bonds to 5% from 20%, making it lucrative for investors. Also, capital gains from rupee appreciation are exempted from tax. 
On a global scale, there is abundant liquidity because of lower interest rates in developed markets, but there remain very few investment options due to weak conditions of the global financial market. India, along with China amongst others, is that rare fast-growing large economy, so investing in masala bonds is one of the rare ways for investors to take advantage of this.
Reason to issue masala bonds
The following are the reason to issue masala bonds:
It helps the Indian companies to diversify their bond portfolio as previously they one issued corporate bonds. Masala bonds are an addition to their bond portfolio.
It helps the Indian companies to tap a large number of investors as these bonds are issued in the offshore market.
Masala bonds will help in building up foreign investors’ confidence in Indian economy and currency which will strengthen the foreign investments in the country.
Cost of funds
Borrowing from overseas is at low cost however hedging is made mandatory in the country and the cost of hedging is very high. The reduction in minimum tenure from five years to three years could have possibly been an indicator to reduce the cost of hedging, thus reducing the cost of issuance for Indian issuers. While, the cost of external commercial borrowings is around LIBOR + 150 bps but the hedging cost is as high as 6%-7%, which does not incentivize the borrowers to avail funds from overseas. Here, the investor has been allowed to hedge their exposure in Rupee through permitted derivative products with AD Category - I banks in India. 
Indian Companies desirous of playing safe and not having the natural hedge advantage like that of Reliance Industries Limited, who service the debt obligations in US dollars with the export proceeds in the same US dollars, would ebb from issue of ECBs and plumb towards masala bonds should the cost of such borrowings turnout up to be lower than that of Indian banks as well as under the ECB route with forex risk added to it. 
Consequent upon issue of masala bond to offshore markets, the Indian corporates will reduce their interest cost burden on the raised debt amount. Also, the funds raised can be used for infrastructural development in the country ultimately leading to the development of the nation at a global level. For this, RBI must be lauded for coming up with yet another avenue for raising international finance for Indian corporates.
(Saurabh Dugar works with Vinod Kothari Consultants Pvt Ltd)


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