Bonds are instruments of debt, usually issued by corporates to raise money from investors. Typically, corporates had to rely on avenues such as External Commercial Borrowing (ECBs) for raising money which was faced with currency risk i.e., they have to be raised and repaid in dollar terms. Due to sharp currency fluctuation in the Forex markets and span of ECB being anywhere from 1 to 10 years, there is a lot of inherent risk involved for the issuer. To solve this problem and transferring the risk to the investor, Reserve Bank of India came up with Masala Bonds.
Masala Bonds are rupee denominated overseas bonds. By issuing these bonds in rupees an Indian company is shielded against the risk of currency fluctuation, typically associated with borrowing in foreign currency. An issuer can issue masala bonds worth a maximum $750 million a year and the bonds must have a minimum maturity of 3 years. (reduced to 3 years from 5 years in April 2016).
Benefits of Masala Bonds
- Diversification of bond portfolio for Indian companies.
- Lower interest payouts as Masala Bonds issued outside India is below the interest rate of 7%.
- As these bonds would be issued outside India, it will help Indian companies to tap a large number of investors which will further build their confidence in India.
- Better returns for offshore investors then their home countries. For example, if an investor based out of US where the bond yields are around 2 %, will be able to generate more returns with Masala Bonds with yields ranging from 5-7%
- Also, since these are rupee denominated bonds, an appreciation of rupee at the time of maturity will be beneficial.
Downside of owning a Masala Bond
Since it is a rupee denominated bond, the risk will be borne by the investor. The issuer does not carry any risk by issuing this bond in the foreign market.
Housing Development Finance Corp (HDFC) has raised Rs. 3000 crores by issuing masala bonds. The bond bears a fixed semi-annual coupon of 7.875 percent 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 annualised yield to the investors is 8.33 percent per annum. These bonds are traded in London Stock Exchange, not in India.
Masala bonds will open up an access to cheaper funding than what’s available in the domestic markets, since the Indian banks are reluctant to lend to sectors facing weak demand and heavy debt as a result investors would need to keenly watch the credibility of the issuer. Since, the currency risk is on the investors they would like rupee to be stable, as this initial excitement will give way to the ultimate realisation that currency and economic growth are external factors.