Masala Bonds

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What are 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 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.

Features of Masala Bonds 

Eligible Borrowers

The eligible borrowers for masala bonds are as follows:-

• Any corporate or body corporate is eligible to issue masala bonds.
• REITs and INVITs, as per the SEBI regulatory framework, are also eligible.
• Indian banks are also eligible to issue Masala Bonds in the form of:
  • Perpetual Debt Instruments that qualify for inclusion as Additional Tier-1 capital.
  • Debt Capital Instruments that qualify for inclusion as Tier-2 capital.
  • Long term Rupee Denominated Bonds overseas for financing infrastructure and affordable housing.

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 call and put option, 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:-

• Real estate activities other than the development of integrated townships or affordable housing projects;
• Investment in the capital market and use the proceeds for domestic equity investment;
• Activities prohibited under the guidelines of foreign direct investment;
• On-lending to other entities for any of the above purposes; and
• Purchase of land

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.

How do Masala Bonds protect issuers from currency risk

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.

Advantages of Masala Bonds

For Investors

• Masala bonds provide portfolio diversification to its investors through exposure to rupee-denominated instruments without investing directly in Indian markets.
• These bonds offer an opportunity to invest in Asia’s fastest growing market.
• The capital gains arising from rupee-denominated bonds are exempt from tax.

For Issuers

• The issuer is shielded against the risk of currency fluctuation associated with borrowing in foreign currency, thus no hedging costs.
• Enables issuers to access a wider and more diverse investor base by issuing bonds in offshore markets, thus increasing market appetite.
• The cost of borrowing is low in Western economies.

Disadvantages of Masala Bonds

• Exchange Rate Risk: The main disadvantage for a foreign investor is the currency risk. The fluctuations in the exchange rate against their domestic local currency during the masala bond tenure can affect the returns for foreign investors.
• Liquidity Risk: Masala bonds may have lower liquidity compared to bonds issued in global bond markets, making it difficult to buy or sell bonds.

FAQ

Q: Why Rupee Denominated Bond are known as Masala Bonds?

A: Masala Bonds are derived from the word ‘masala’, meaning spices. The word ‘masala’ was used by the International Finance Corporation (IFC) to reflect the culture and cuisine of India on foreign platforms.

Q: What is the maturity period of masala bonds?

A: The minimum original maturity period for masala bonds is 3 years for issuances up to USD 50 million (or its equivalent in INR) in a financial year. For issuances exceeding USD 50 million (or its equivalent in INR) in a financial year, the minimum original maturity period is 5 years.

Q: Where can the proceeds from a Masala Bond be used?

A: The proceeds from the Masala Bond can be used for all purposes under the RBI’s External Commercial Borrowing (ECB) guidelines. However, there are certain restrictions on their end use. The funds cannot be utilised for real estate activities other than the development of integrated townships or affordable housing projects, nor can they be used for investment in the capital market or for domestic equity investment. Additionally, the proceeds cannot be deployed for activities prohibited under the FDI guidelines, on-lending to other entities for any of these restricted purposes, or for the purchase of land.

Q: What is the currency risk of Masala Bonds?

A: Currency risk refers to the possibility of gains or losses arising from fluctuations in exchange rates between two currencies. In the case of Masala bonds, since the bonds are Indian rupee denominated but issued overseas, changes in the rupee’s value against the foreign currency can affect returns for an investor. This currency risk is borne by the investor, while the issuer remains shielded from foreign exchange fluctuations.

Q: Which Indian company was the first to issue Masala bonds?

A: Housing Development Finance Corp (HDFC) became the first Indian company to issue Masala Bonds on the London Stock Exchange for an aggregate amount of Rs 3,000 crores in July 2016.

Q: Who can invest in Masala Bonds?

A: Masala bonds can be invested in by foreign investors, subject to applicable regulatory guidelines.