The Flavoursome Financial Instrument

Masala, or rupee denominated, bonds are an exciting new financial instrument that transfers the currency risks from the issuer to the investors. Its success will depend on the investors’ confidence in the Indian growth story.

Prime Minister Modi, on his visit to the UK, announced that the Indian Railways would issue bonds in the London stock exchange and raise funds. Though an Indian company raising funds in foreign markets is not new, this time it was slightly different. Traditionally overseas issuance of bonds has been in foreign currencies: pounds and dollars. However, this time, the bond issued by the Indian Railways will be denominated in rupees.

Rupee denominated bonds were first issued by the International Finance Corporation, the private corporate lending arm of the World Bank group, in 2013 and were given the innovative name of ‘Masala Bonds’. It was only in 2015 that an Indian entity, the railways, issued a rupee denominated bond in overseas market. Since then, HDFC issued the first corporate masala bond in London to raise about $750 million. Many others have followed suit: IIFCL, a state-backed funder of infrastructure projects, Power Finance Corporation Ltd, which arranges finance for the electrical power sector, power producer NTPC, etc.

The concept of Masala bonds is not entirely new. The Chinese have been issuing bonds denominated in their local currencies in overseas markets called Dim sum bonds. There are also the Japanese Samurai bonds, US Yankee bonds and the British Bulldog bonds.

Masala Bonds are rupee denominated bonds issued in foreign markets.

Masala Bonds are rupee denominated bonds issued in foreign markets.

The advantage with the Masala bonds is that the risk of currency fluctuations is solely with the investors and not the issuer. Usually, in a bond denominated in a foreign currency, the issuer bears the risk of currency fluctuations – if the rupee were to depreciate significantly during the period, the issuer loses out. To counter this, the issuer will have to hedge against this risk, which adds to the borrowing costs. With the Masala bonds, the risk has been transferred to the investor, who is taking a bet on the Indian story.

Further, the issuer gets access to the larger and more liquid overseas markets. The cost of borrowing is also significantly lower in the foreign markets, roughly by about 200 basis points, than in India. An Indian company usually pays about about half a percentage point higher than the government bonds, which translates into roughly 8.25 for a five year bond and 8.2% for the 10 year bond. In the UK, the issuer will be willing to pay upto 7.5 or even 7.8% for the bond. This is a good alternative for companies who struggle to raise funds in India as Indian commercial banks are reluctant to lend to sectors with heavy debt and facing weak demand.

Investors are exempt from many taxes for investing in the 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. Also, capital gains from rupee appreciation are exempted from tax. The masala bonds will offer an opportunity to those foreign investors who are not registered in India to take exposure to Indian debt. It will diversify the investor base for Indian corporations and, most importantly, its success will internationalise Indian currency.

Though this is an exciting new venture, it is unlikely to see immediate big results. There are still concerns in the overseas markets about the liquidity for offshore bonds raised by Indian companies. In a report by Standard Chartered, ―analysts cited investor worries over pricing and a lack of liquidity in offshore rupee paper as factors likely to limit the market‘s growth in the short term. The bank said the global Masala market was likely to be worth between $3bn and $5bn over the financial year ending in March 2017.

Anupam Manur is a Policy Analyst at the Takshashila Institution and tweets @anupammanur 

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