Masala Bonds

What recalls you by the word- Masala?

When I hear this word, me being an Indian remember of the Indian Spices.
Indian spices have been popular all over the world since ancient times. And this is how
the bonds were named masala bonds, to reflect the Indian angle to it. Because they
are rupee-denominated bonds issued to overseas buyers.
Bonds are instruments of debt - usually used by corporates to raise money from
investors. Masala bond is a term used to refer to a financial instrument through which
Indian entities can raise money from overseas markets in the rupee, not foreign
currency.
In other words, they are rupee-denominated bonds issued to overseas buyers. This
is how it is different from other instruments. Before Masala bonds, corporates have had
to dependent on avenues such as External Commercial Borrowings (ECBs).

Indian corporate sector borrowed around USD 20 billion in the first nine months of 2015
through external commercial borrowing (ECB) route and none through foreign currency
commercial bond (FCCB) route. These borrowings have maturity anywhere between
three and ten years. The major risk that a borrower availing ECB faces is currency risk
and Indian banks have, of late, refused to bail out many Indian corporate by way of
refinancing. A couple of year ago (2013) a study by CRISIL had put the outstanding
foreign currency loan of Indian corporates at over USD200 billion. What was more
alarming was about half of such foreign currency exposure was unhedged.
Corporates typically make use of currency swaps and similar financial instruments to
manage currency risk. With the Indian rupee depreciating, the currency risk looms large
and this may trigger possible default. In the past Indian firms were able to roll over their
foreign borrowings owing to the willingness of the lenders to do so trigger mainly by
easy liquidity conditions in the US. However, with the tapering of quantitative easing by
the US Fed, such option may no longer be available. With the devaluation of Chinese
currency (Yuan) and fall in Indian currency, the burden of foreign currency borrowing is
felt even more now.
Indian firms (mostly financial institutions) have issued US dollar-denominated foreign
currency bonds in to the tune of about US$3 billion in the last six months of 2015 (Table)
and a much lower number (102 million Yuan) in Chinese Yuan. One can easily notice

that the main motivation for issuing such bonds is very low coupons. But as mentioned
earlier, the impact of falling rupee may overwhelm lower coupon rates.
Therefore, Indian corporate sector was looking for an option to raise money in foreign
currency without necessarily bothering about currency risk. Enter Masala Bond!

What has been the regulator's stance on this?

RBI has issued guidelines allowing Indian companies, non-banking finance companies
and infrastructure investment trusts and real investment trusts to issue rupeedenominated bond overseas.

Important Facts about Masala Bonds

Masala bonds are a step to help internationalize the Indian rupee and also
strengthen the Indian financial system.

By issuing bonds in rupees, an Indian entity is shielded against the risk of

currency fluctuation, typically associated with borrowing in foreign currency. Besides
helping diversify funding sources, the cost of borrowing could also turn out to be
lower than domestic markets.

The first masala bonds were issued by the International Finance Corporation
(IFC), an arm of the World Bank, in the year 2013. Similar offerings from other
countries have also been after the food or culture of that country like "dim sum" label
for Chinese offshore issues or "Samurai" bonds for Japanese offshore issues.

As masala bonds are denominated in rupees, foreign investors will be taking the
currency risk. So the key for the success of these bonds will be a stable exchange
rate.

Masala bonds are the first rupee bonds listed on the London Stock
Exchange.

According to RBI's norms, an Indian entity is allowed to raise a maximum of $750

million per year through masala bonds with a minimum maturity of five years.

Issue of Masala Bonds

The International Finance Corporation (IFC), an arm of the World Bank, issued
the first masala bonds in October 2013 as part of its $2 billion dollar offshore
rupee programme. However, no Indian corporate has yet issued any masala
bond.

Two prospective issuers, Indias largest mortgage lender Housing Development

Finance Corp. Ltd (HDFC) and the nations largest power producer NTPC Ltd,
have been on the road to secure investors for such bonds since last month but
are yet to launch their respective issues. HDFC began talking to investors early
November while NTPC concluded its marketing a week ago. HDFC initially
wanted to raise USD 750 million. However, following its meeting with the
investors, HDFC has decided to raise about USD 300 million in the first tranche
with a maturity of five years. NTPC has not yet announced the date and size of
its issue.

Why should investors look at masala bonds?

The Finance Ministry has cut the withholding tax (a tax deducted at source on residents
outside the country) on interest income of such bonds to 5 per cent from 20 per cent,
making it attractive for investors.
What is in it for the buyer of the bond?
The buyer will earn a higher yield to compensate for the risk of depreciation.
Whats the tenor and the coupon rate on the HDFC masala bond?
The bond bears a fixed semi-annual coupon of 7.875% per annum and has a tenor of 3
years and 1 month. The bonds have been issued at a price of 99.24% of the par value
and will be redeemed at par. The all in annualized yield to the investors is 8.33 percent
per annum.
Will the bonds be traded?
Yes, but on the London Stock Exchange, not in India.

Bottom line
Masala bonds are a good idea to shield corporate balance sheets from exchange rate
risks. But they are best used in moderation. The after-effects of too much masala are
not pleasant.