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Masala Bonds- The Slow but Steady Spicy Option

By: Mahafrin Sidhwa

“Masala bonds” is a term given to financial instruments issued by an Indian entity in Indian rupees and not foreign currency. Given the penchant for masalas in India, the rupee denominated bonds overseas are called ‘masala’ bonds! Simply put, if a body corporate in India issues a masala bond worth Rs. 1000/- with the current exchange rate at Rs. 50 to a dollar, the buyer in the international market will pay the dollar equivalent of Rs. 1000/- i.e.$ 20$ and buy the bond. If the rupee depreciates from Rs. 50 to Rs. 75 at the time of repayment of the principal, the investor will suffer a loss.

The International Financial Corporation was the first to issue such rupee denominated bonds. Fullerton India Credit Company and Indiabulls Housing Finance have raised funds via Rupee Denominated Bonds recently. International equivalents are the Chinese Dim sum bonds (bonds issued outside of China but denominated in Chinese renminbi), Uridashi bond (a secondary offering of bonds outside Japan) and the Baklava bond ( a bond denominated in Turkish Lira and issued by an entity in the Turkish market and named after the delicious Turkish baklava).

The Reserve Bank of India (RBI) has come out with the guidelines for issue of rupee denominated bonds overseas under the existing External Commercial Borrowings (ECB) policy framework.[1]

Eligibility criteria: Any corporate entity incorporated under Indian company law (or by way of a specific act of Parliament) in India is eligible to issue rupee denominated bonds overseas. This includes Indian banks as well as real estate investment trusts and infrastructure investment trusts registered with the Securities and Exchange Board of India (SEBI). Other entities such as limited liability partnerships and partnership firms are not eligible to issue these bonds.

These bonds can only be issued in a country and subscribed by a resident of a country, that is a member of the Financial Action Task Force (FATF) or similar regional body; and whose securities market regulator is a signatory to the International Organization of Securities Commission’s Multilateral Memorandum of Understanding or a signatory to bilateral Memorandum of Understanding with the SEBI for information sharing arrangements.

Maturity period, Amount and other requirements: The minimum maturity period for rupee denominated bonds is 3 years to align it with the maturity prescription regarding foreign investment in corporate bonds through the Foreign Portfolio Investment (FPI) route. In case the subscription to the bonds/ redemption of the bonds is in tranches, minimum average maturity period should be 3 years. So the bonds cannot have an optionality clause for prepayment before completing 3 years. The bonds can either be placed privately or listed on exchanges as per host country regulations.

The maximum amount that any eligible borrower can raise through issuance of these bonds under automatic route is INR 50 billion or its equivalent during a financial year. This limit is over and above the amount permitted to be raised under the automatic route by an entity under the ECB route.

End-use requirements: The proceeds raised by an Indian entity through the masala bonds route can be used for all purposes excluding the following:

  1. Real estate activities (other than for development of integrated township / affordable housing projects);

  2. Investing in capital market and using the proceeds for equity investment domestically;

  3. Activities prohibited as per the Foreign Direct Investment (FDI) guidelines;

  4. On-lending to other entities for any of the above objectives; and

  5. Purchase of land.

Other compliances:  Masala bonds have to be issued subject to prevailing FDI sectoral caps and conditions set out by the sector-specific regulator. Reporting compliances with the RBI essential to track the actual inflows / outflows from and into India have to be adhered to.

Why go the masala route?

Masala bonds are low-priced bonds as the interest rates are comparatively lower which proves advantageous compared to other debt instruments. An investor will benefit from his investment in masala bonds if the rupee appreciates at the time of maturity. Non-resident investors will thus be eligible to hedge their exposure in rupee denominated bonds through permitted derivative products with banks in India. It is a good instrument for investors to access the domestic market through branches / subsidiaries of Indian banks outside India or branches of foreign banks with Indian presence outside India having back-to-back/reciprocal arrangements.

Real estate investment trusts and infrastructure investment trusts may benefit from use of masala bonds as it helps them tap the international markets to finance the ever-growing capital requirements for public-private partnership projects. There are news reports that entities in this space are considering masala bonds given the easy (and cheaper) access to capital that will unlock value in their infrastructure projects.

It is also possible to convert the bond into equity subject to specific parameters under the FDI policy framework being met. There is also a tax advantage as withholding tax in interest on such bonds is 5 % (as against 20% for other bonds). The investors also have an additional benefit of tax exception on capital gains due to rupee appreciation.

The key risk for the investor arises in case the value of the rupee falls. The investor has to be cautious while considering the credit rating assigned to the bond as also the value of the Rupee at the time of issue although, they could hedge the risk in other markets. With the impact of demonetization looming large over the Indian economy as well as the stability of the rupee, we are poised for interesting times as we enter the new year.


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