Masala Bonds

Masala Bonds are rupee denominated bonds issued in overseas markets by Indian entities. The capital raised through masala bonds is in Indian Rupees, unlike any other external commercial borrowings, where the currency is normally dollar, euro, yen, etc. The aim of issuing masala bonds is to fuel internal growth via borrowings, fund infrastructure projects in India and internationalise the Indian currency.

The term “Masala”, meaning spices, was used by the International Finance Corporation (IFC) to represent the culture and cuisine of India on foreign platforms.

The advantage of issuing masala bonds is that the issuer is safeguarded against the risk of rupee depreciation in comparison to other instruments that are denominated in foreign currencies. This is normally a major concern for Indian issuers while raising money in the overseas markets. If the value of the rupee falls at the time of the bond redemption, the issuer has to pay more rupees to repay the dollars. In 2007, most Indian companies which had raised funds overseas via the Foreign Currency Convertible Bonds (FCCBs) faced great difficulty as the rupee had depreciated very sharply during the global financial crisis.

Masala bond investors are offered a higher coupon rate to compensate for the risk of currency depreciation, enabling them to earn a higher yield.

Eligible Borrowers

The eligible borrowers for masala bonds are as follows:-

Form of Borrowing

The framework for the issuance of rupee-denominated overseas bonds permits eligible resident entities to issue only plain-vanilla rupee-denominated bonds in Financial Action Task Force (FATF) compliant financial centres. These bonds may be issued through private placement or listed on overseas exchanges, in accordance with the regulations of the host country.

Maturity Period

The minimum original maturity period for masala bonds is 3 years for issuances up to USD 50 million equivalent in INR per financial year. For Masala Bonds raised above USD 50 million or its equivalent in INR per financial year, the minimum original maturity period is 5 years. The put and call option (also known as a callable bond), if any, cannot be exercised before the completion of the minimum maturity period.

All-in-cost ceiling

The all-in-cost ceiling for such rupee denominated bonds overseas is 300 basis points over the prevailing yield of the Government of India securities of corresponding maturity.

Exchange Rate for Conversion

The exchange rate for converting foreign currency into Indian Rupees shall be the prevailing market rate on the date of settlement for transactions related to the issuance and servicing of the bonds.

End Use

The proceeds raised from masala bonds can be used for all purposes except for the following:-

Hedging

Overseas investors are allowed to hedge their rupee exposure using eligible derivative products offered by Authorised Dealer (AD) Category I banks in India. Investors may also access the domestic market through overseas branches or subsidiaries of Indian banks, as well as through branches of foreign banks with a presence in India on a back-to-back basis.

Masala bonds are denominated in Indian rupees, even though they are issued in overseas markets. The principal and returns of these bonds are in accordance with the value of the Indian Rupee rather than a foreign currency. The foreign investor pays the foreign currency equivalent of the rupee amount at the time of issuance and receives the foreign currency equivalent of the due rupee payments at the time of coupon payment and redemption. Therefore, any depreciation in the Indian rupee directly affects the returns of foreign investors. The issuer does not have to pay more rupees to repay the dollars if the rupee weakens, unlike foreign currency denominated borrowings. Masala bonds shield bond issuers from currency risk by transferring the exchange rate risk or currency risk to foreign investors.

For Investors

For Issuers

In July 2016, Housing Development Finance Corporation (HDFC) became the first Indian company to issue Masala Bonds on the London Stock Exchange for an aggregate amount of Rs 3,000 crores. Here is the analysis:-

Aftermath, National Highways Authority of India, Indian Renewable Energy Development Agency, National Thermal Power Corporation (NTPC) and India’s largest corporates, state-owned companies and government agencies have listed masala bonds on the London Stock Exchange to fund infrastructure projects.

The capital gains arising from these rupee denominated bonds are exempt from income tax. The profits arising on rupee appreciation between the purchase date and the redemption date of the masala bond of an Indian company held by the non-resident assessee against foreign currency in which the investment is made are not included in the calculation of capital gain tax. This treatment of tax on bonds provides relief to the non-resident investor from currency fluctuations, encouraging foreign capital inflow into India. However, according to Section 194LD, 5% TDS is deducted on the payment of interest on rupee denominated bonds of an Indian Company to a Foreign Institutional Investor or a Qualified Foreign Investor.