The phenomenal success of rupee denominated bonds issued overseas is leading to full convertibility of the rupee, though at a slower pace
What do Chinese Dim-sum, Japanese Samurai and Indian Masala have it in common, except that they are Asian?
Well, these three are brand names of debt instruments, raising finance from global capital market.
The Masala bond was launched for the first time in October 2013, by the International Finance Corporation (IFC), to fund infrastructure projects in India. IFC, a venture capital subsidiary of the World Bank, named it Masala to add an Indian flavour. The Dim-sum bonds—named after a traditional Chinese dish—was issued in 2011. It hiked Chinese yuan's prospects in the global investment market. Likewise, the yen-denominated bonds were named Samurai, after the revered Japanese warrior class.
Of late, the Reserve Bank of India (RBI) has permitted commercial banks to raise Masala bonds, so far restricted to corporates.
Offshore rupee financing has undergone a major change with this innovative concept. Gaining international acceptance is a significant step towards full convertibility of the rupee. And it has full backing of RBI. In a couple of years, Masala bonds business is expected to touch $5 billion annually. The success of these offshore bonds proved the confidence global investors have in the Indian rupee.
Masala bonds can be traded in London Stock Exchange, not in India.
Masala bonds are not simply cashing on the sentiments of Indians settled abroad. The rupee-denominated bonds guarantee attractive returns for everyone who wants to park money in India. The investors are exempted from paying withholding tax—Tax Deducted at Source (TDS) on deposits by non-residents—on accrued interests. The investors also have additional benefit of tax exception on capital gains due to rupee appreciation.
Investors in developed countries turn to India as there are only limited options for investment due to low interest rates, though they offer better stability and liquidity. India being fast growing economy, investors are willing to take calculated risks for good returns.
Then, what about the special benefits the issuer gets for borrowing from abroad?
Quite often, the Indian rupee works on shaky markets, subjected to heavy fluctuations. However, the bonds are insulated from rupee depreciation, a prime concern of borrowers. Protection from exchange rate risks or the impact of falling rupee is a major benefit for the entity.
Imagine that an Indian entity issues a Masala bond for Rs1,000 crore. After a year the financiers have to shell out an equivalent of Rs1,100 crore, in US dollars. Due to the limited convertibility of Indian rupee, the settlements are always done in US dollars. However, the variation in exchange rate is not taken into account. The investor alone bears the currency risk. So the issuer raised money in foreign currency without worrying about currency risk involved otherwise.
At one time, corporates counted on External Commercial Borrowings (ECB) to raise money from forex markets. When Indian currency depreciates—and mostly it does—the burden of currency risk fell entirely on the issuer. An Indian entity that earns mostly in rupee, found this resourcing to be an unworkable idea.
Too much is bad
Indian Railways Finance Corporation, NTPC, HDFC and Adani Transmission are among the corporates that have successfully used Masala bonds. Though the bonds have proved beneficial for the economy, financial experts recommend only moderate use of Masala bonds. Relying too much on them can prompt downgrading by rating agencies, putting the Indian money at risk.
Investors beware! Watch credit ratings of the entity carefully before taking a plunge. The borrowings are subject to central bank regulations.