All you wanted to know about Masala Bonds

Indian curry is quite a hit in the West. So can global investors be tempted to try out Masala bonds? That’s something the Indian Railway Finance Corporation, which recently approved the raising of $1 billion through the issue of Masala bonds and other firms such as NTPC, are trying out now.

The term is used to refer to rupee-denominated borrowings by Indian entities in overseas markets. The International Finance Corporation (IFC), the investment arm of the World Bank, last November, issued a ₹1,000 crore bond to fund infrastructure projects in India. These bonds were listed on the London Stock Exchange (LSE). IFC then named them Masala bonds to give a local flavour by calling to mind Indian culture and cuisine. While it may seem odd to name a staid debt instrument after food stuffs, it has been done in the past. Chinese bonds, named Dim-sum bonds after a popular dish in Hong Kong, have been around for while. So have Japanese bonds named Samurai after the country’s warrior class.

It was not due to a whim or loyalty to one’s country that led to such a colourful christening for the local currency bonds. Masala bonds, if they take off, can be quite a significant plus for the Indian economy. They are issued to foreign investors and settled in US dollars. Hence the currency risk lies with the investor and not the issuer, unlike external commercial borrowings (ECBs), where Indian companies raise money in foreign currency loans. While ECBs help companies take advantage of the lower interest rates in international markets, the cost of hedging the currency risk can be significant. If unhedged, adverse exchange rate movements can come back to bite the borrower. But in the case of Masala bonds, the cost of borrowing can work out much lower. The RBI in its April policy said that it would issue guidelines for allowing corporates to issue rupee bonds in overseas markets.

Masala bonds can have implications for the rupee, interest rates and the economy as a whole. Let us consider the advantages first. Competition from overseas markets may nudge the government and regulators to hasten the development of our domestic bond markets. A vibrant bond market can open up new avenues for bond investments by retail savers. If Masala bonds are eagerly lapped up by overseas investors, this can help prop up the rupee. The rising demand for Dim-sum bonds in 2011, for instance, promoted the use of the yuan in global trade and investment. Dim-sum bonds also provided investment avenues for yuan-holders outside of China. With talks of a full rupee convertibility back home, Masala bonds can help the rupee go global.

But these bonds can have bad after-effects too if companies decide to binge on them. As of December 2014, corporate overseas borrowings stood at $171 billion. The recent turmoil in the rupee is already prompting caution on existing foreign loan exposure. Some reports estimate that Indian corporates, are likely to issue about $6 billion worth of Masala bonds this fiscal. With our economy still on shaky ground, too much reliance on external debt (even in rupees) can weigh heavily on our rating by global agencies.

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.

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