Masala bonds are rupee-denominated bonds issued outside of India. Masala bonds were first issued by the International Finance Corporation (IFC) in 2014. Masala Bonds have gained popularity in recent months. While International Finance Corporation pioneered the use of Masala Bonds to raise foreign capital, numerous Indian companies have since followed the suit. The Indian corporations that have raised capital via Masala Bonds are HDFC, Yes Bank, NTPC, and IRFC. A Masala bond is a Rupee bond repaid in dollars at the current exchange rate. The RBI permits reputable Indian companies to raise funds abroad via Masala Bonds; however, such bonds must have a minimum term of five years for bonds raised above 50 million USD equivalent in INR per financial year. The bonds are denominated in rupees, but interest and principal are repaid in dollars. The critical distinction here is that the issuer does not incur currency risk; instead, the investor does. This was once a significant issue for Indian corporations issuing dollar-denominated bonds. For instance, in 2008 and subsequently, in 2013, Indian rupee plunged precipitously against the US dollar. The INR’s decline against the dollar pushed several businesses closer to insolvency during such periods. To appreciate the significance of Masala Bonds, one must first grasp the adverse risk inherent in dollar-denominated bonds via a real-world example.
ORIGIN OF MASALA BONDS
1. Masala bond refers to a financial product that allows Indian firms to raise money in rupees, not foreign currency, from abroad markets.
2. These are bonds denominated in Indian rupees that have been issued in offshore capital markets.
3. The rupee-denominated bond is an attempt to insulate issuers from currency risk by passing it on to investors who purchase these bonds.
4. Interestingly, because the investor bears the currency risk, the RBI realizes a marginal saving if the rupee depreciates between the repayment of the bond coupon and maturity amount.
5. During fiscal 2015, the International Finance Corporation, a World Bank subsidiary, issued rupee-denominated loans in international markets (June 30, 2015).
6. It offered two bond issues: Maharaja Bonds to Indian investors and Masala Bonds to international investors. These Bonds were issued with the RBI’s express consent.
7. In September 2015, the Reserve Bank of India approved the foreign issuance of Rupee-denominated bonds by Indian firms. The following are the key features of the Masala Bonda
ELIGIBLE BORROWERS
1. Indian companies, Real Estate Investment Trusts, and Infrastructure Investment Trusts.
2. NBFCs and infrastructure holding companies can now access the Masala Bond Route to fund offshore ECBs.
A WIDER POOL OF INVESTORS
A resident of a country may subscribe to masala Bonds: 1. that is a member of the Financial Action Task Force (FATF) or a regional body modeled after the FATF; and 2. whose securities market regulator is a signatory to the International Organization of Securities Commissions (IOSCO) Multilateral MOU or the bilateral MOU with the Securities and Exchange Board of India (SEBI) for information sharing arrangements; and 3. It is not a country identified in the FATF’s public statement as having strategic anti-money laundering or counter-terrorism financing deficiencies that require countermeasures.
CEILING ON THE COST OF MASALA BONDS
Following “prevailing market conditions,” it should be comparable to the cost of raising cash domestically by the borrowing company.
MINIMUM MATURITY
These bonds will have a minimum maturity of three years for bonds raised up to 50 million USD equivalent in INR per financial year. The minimum average maturity length should be three years if the bonds are subscribed to/redeemed in tranches.
AMOUNT
By issuing these bonds via the automated method, any qualifying borrower may raise a maximum of INR 50 billion, or it’s equivalent in a financial year. This limit is in addition to the amount that an entity entitled to raise External Commercial Borrowings may raise via the automated route (ECB).
SECURITY
Charges on the immovable or moveable property, financial securities, corporate or personal guarantees are authorized with the prior approval of the approved dealer bank.
UNDERWRITING RESTRICTION
Where an Indian bank underwrites a Masala bond offering, it is not permitted to hold more than 5% of the issue size after six months, subject to applicable prudential standards. This is not claimed to apply to banks located outside of India.
FLEXIBILITY IN ISSUING UNLISTED SECURITIES
Depending on the host country’s legislation, bonds may be privately put or listed on exchanges.
CONVERSION RATE & HEDGING
The market’s prevailing exchange rate on the settlement date. Non-resident investors would hedge their exposure to rupee-denominated bonds in India via approved derivative instruments with AD Category – I banks. Investors can also gain access to the home market through backto-back branches/subsidiaries of Indian banks overseas or branches of international banks with an Indian presence abroad. The documentation states that bonds may be sold, transferred, or pledged subject to the aforementioned conditions. Following are the benefits of the Masala Bonds:
BENEFITS TO INVESTORS
• It helps build international investors’ confidence in the Indian economy.
• It allows for higher interest rates, which benefits investors.
• It strengthens the country’s foreign investment position by instilling investor trust in the Indian rupee.
• Capital gains on rupee denominations are largely taxfree.
• If the rupee appreciates in value at maturity, investors will get the best possible rate of return.
BENEFITS TO BORROWERS
• Masala bonds insulate the borrower from currency changes since they are devoid of currency risk.
• The borrower possesses the capacity to raise a substantial sum of money.
• Issuing these bonds supports the Indian organization in diversifying its portfolio.
• Investors need not worry about rupee depreciation because the bonds are denominated in Indian currency rather than foreign currency.
• It benefits borrowers by being issued outside India at a low-interest rate of less than 7%.
• Since these bonds are sold on the secondary market, they provide debtors with access to a large pool of investors.
BENEFITS TO ECONOMY
• Masala Bonds attempt to internationalize the Indian rupee and bolster the Indian financial and economic systems.
• The administration has also loosened the rules. While foreign portfolio investors can engage in India exclusively through rupeedenominated debt securities subject to a US$51 billion limitation, Masala Bonds are no longer included in this cap, as per a recent RBI statement.
• Businesses are protected from the risk of currency volatility.
• Foreign investment in rupee-denominated debt is increasing, indicating a growing worldwide interest in the instrument. For India, this was a positive step.
• Recent figures indicate an increase in rupee-denominated debt issuance and a significant drop in comparable foreign currency debt
• Liquid rupee-denominated debt markets facilitate financial stability.
• A robust bond market can create new opportunities for ordinary savers to invest in bonds, supporting the currency structure. A perfect example is the Dim Sum bond, which boosted Yuan use in worldwide trade and investment.
• With discussions taking place at home regarding the rupee’s full convertibility to other international currencies via a unified marketdetermined exchange rate, Masala bonds could help the rupee go worldwide. Let’s see the permitted and restricted end-use of Masala Bonds proceeds:
PERMITTED END-USE • Refinance of Rupee Loan and NCDs • Development of Integrated Townships / affordable housing projects • Working capital • General Corporate Purposes
RESTRICTED END-USE • Purchase of Land • Real estate activities except as indicated • Investment in Capital markets and using the proceeds for equity investment domestically • Activities prohibited under FDI guidelines. • On-lending to other entities for any of the above objectives
KEY CONSIDERATIONS FOR INVESTORS
Limitation of Access: Global INR Bonds are an essential investment vehicle for offshore investors who lack access to the domestic market via an FII / FPI license and hence are unable to take exposure to INR denominated credit risks. Settlement: Transactions are settled through Euroclear / Clearstream Risk: Global INR Bonds are best suited for investors with a view on the currency (USD – INR) and India’s credit. This product has become highly appealing as the current outlook for India’s growth story is bright. Arbitrage: Due to market dynamics, different markets may price the same credit differently, providing investors with an opportunity to participate in Global INR Bonds. Liquidity: Investors prefer liquidity in the secondary market to control their exposure depending on their perceptions of credit and foreign exchange rates; hence, the size of the offering will be a critical factor for investors. Liquidity will be aided by the fungibility of offshore INR bonds with onshore bonds.
TAXATION OF MASALA BOND PROCEEDS
Withholding Tax Rates: Nonresident investors’ interest income from Masala bonds is taxed at a maximum rate of 5%. Capital Gain Tax Rates: Capital gains resulting from rupee appreciation are taxfree. Beneficial rates under the relevant DTTAs with the investors’ respective jurisdictions may be applied.
REGULATORY EXEMPTIONS • Masala Bonds are classified as debt securities under section 2(30) of the 2013 Companies Act. As a result, the regulations governing the issuing of debt instruments will apply to Masala Bonds. • However, the MCA has clarified the applicability of Chapter III (Prospectus and Issue of Securities) of the Act with relation to the issuing of Masala Bonds in its General Circular No: 09/2016 dated 3rd August, 16. • As a result, Indian companies issuing Masala Bonds following the RBI’s policy on ECB Guidelines will be exempt from the following requirements: • Chapter III of the Act; and • Rules governing the issuance of secured debentures pursuant to Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014. • Foreign investors can now access the corporate debt limit for FPI investments. For Masala Bond issuances, the SEBI (FPI) Regulations, 2014 will no longer apply to an FPI, i.e., the FPI will not be subject to any reporting or compliance obligations. FPI investments in Masala Bonds will not be treated as such. • Depositories are expected to establish a process to ensure that the RBI receives data on foreign investments in Masala Bonds. • According to the SEBI Circular, the RBI would set the parameters for assessing foreign investment in Masala Bonds.
RELAXATIONS GIVEN THROUGH MCA CLARIFICATION.
• In general, the issue of Masala Bonds will not be subject to compliance with the following requirements: issuance of a private placement offer letter (PAS-4); • Compilation of an allottee list (PAS-5); • Filing of allocation return (PAS-3); • Including the required information in the prospectus; • There are numerous additional provisions of Chapter III of the Act; and provisions of Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014.
THE PROCESS UNDER COMPANIES LAW TO ISSUE MASALA BOND
- Regulation 29(1) of the SEBI LODR, 2015 – In the case of an equity-listed company, prior notification to the recognized stock exchange at least two working days in advance of the board meeting at which the proposal to issue bonds will be discussed.
- 2. Section 179(3) – Calling a meeting of the board of directors or a committee, as the case may be
- 3. Section 117 (3) – Within 30 days after passing the aforesaid resolution, file e-Form MGT-14 with the Registrar of Companies.
- 4. Regulation 30 of the SEBI LODR, 2015 – Within 30 minutes after the conclusion of a board meeting, notify the stock exchange of the outcome.
- 5. Section 71 and 180(1)(c) – Call an extra-ordinary general meeting: If the bonds are convertible into equity shares, approve a Special Resolution; and if the current and proposed borrowings exceed the sum of the paid-up capital and free reserves, pass a Special Resolution for the same.
- 6. Section 117 (3) – Within 30 days of enacting Special Resolution, file e-Form MGT-14 with the Registrar of Companies.
- 7. Section 77 – In the case of the issuance of secured bonds, file CHG-9 within 30 days after creating the charge.
CONCLUSION
So Masala bonds shift currency risk away from the issuer and the borrower. However, the question remains as to why investors should take on currency risk in the first place. There are two explanations for this. To begin, investors are tempted by the higher interest rates offered by Masala Bonds. In a world when alpha is scarce, even a few basis points of yield are welcomed. This takes us to the second currency risk. Investors rely on the INR remaining stable or appreciating relative to the dollar from present levels. This means that investors in Masala bonds benefit from a double whammy. They gain from the greater yields on Masala Bonds in comparison. Additionally, because these Bonds will be settled in dollars, the investor will receive a higher dollar value for the same rupees. However, why are foreign investors so certain of the INR’s stability or relative strength? Why are foreign investors so bullish on the Indian rupee? For an extended period, global investors favored the security of dollar-denominated investments over bonds denominated in emerging market currencies. However, a few critical factors have changed in the previous several years, making these investors more optimistic about the INR. Unlike other emerging markets such as Brazil, Russia, South Africa, and Indonesia, India is primarily a commodity importer rather than a commodity exporter. As a result, India may benefit from the dividends of low oil and commodities prices. Second, India’s GDP growth advantage over China is anticipated to attract more foreign portfolio investors (FPIs) than other Asian emerging countries. Finally, India has become a preferred FDI destination due to the more favorable business environment created by the present administration and the “Make in India” initiative. India already attracted more FDI than China in the last fiscal year. These factors have contributed to the INR’s strength and faith in the rupee’s stability. Unsurprisingly, demand for Masala Bonds has increased. Apart from greater returns, these Masala Bonds provide investors with the extra benefit of a strong rupee. This could spare Indian issuers the embarrassment of currency risk. Indian corporations are queuing up Masala Bonds worth roughly $1 billion in the following months in response to the BJP’s landslide victory in the Uttar Pradesh state elections. This may only be the beginning of Masala Bonds’ development and acceptance. Author is Finance and Forensic Accounting professional working with Education Industry in the capacity of Finance Officer. Views expressed are personal.