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Masala Bonds – Quick Facts, Positive Side & Apprehensions
ECB vs Masala Bonds
ECBs refer to commercial loans in the form of bank loans, securitized instruments, buyers’ credit, suppliers’ credit availed of from non-resident lenders with a minimum average maturity of 3 years. Borrowers can raise ECB from internationally recognized sources, such as (a) international banks, (b) international capital markets, (c) multilateral financial institutions (such as IFC, ADB, CDC, etc.) / regional financial institutions and Government owned development financial institutions, (d) export credit agencies, (e) suppliers of equipments, (f) foreign collaborators and (g) foreign equity holders [other than erstwhile Overseas Corporate Bodies (OCBs). The maximum amount of ECB which can be raised by a corporate other than those in the hotel, hospital and software sectors, and corporate in miscellaneous services sector is USD 750 million or its equivalent during a financial year. Though there is the advantage of lower interest rates when companies raise funds through ECB, cost of hedging against currency risk may be high. In case of masala bonds since the currency risk is borne by the investor cost of borrowing is lower for the issuer company compared to ECB. All in cost ceilings do not apply to masala bonds unlike ECB.
Quick facts on Masala Bonds
- Issued in overseas financial markets
- Issued in Indian Rupees
- Redeemed in Indian Rupees
- Investors pay and receive in equivalent US Dollars or other foreign currency according to prevailing exchange rates at the time of issue or redemption
- Foreign exchange risk is borne by the investor and not by the issuer
- Minimum maturity of 5 years
- Maximum issue size is USD 750 million per year per company
- Pricing of these bonds will depend on credit risk of the borrowers, security features of the bond, Indian and Global interest rates and the country risk. It is important to note that country risk rating for India is BBB- (S&P 2014) which is lowest investment grad
The positive side of Masala Bonds
These bonds offer an excellent avenue for foreign investors interested in Indian assets and are not able access it directly. Competition from foreign bond markets will make domestic bond market to perform better. These bonds give morediversified sources of funds for Indian companies.Exchange rate risk is borne by the investor and not by the issuer company. International investors can expect at least around 2% extra return on these bonds when compared to similar other bonds provided currency risk does not reduce the return. Another significant advantage is that if these issues of masala bonds become successful, Indian Rupee will become globally visible.
This will be the first step towards Indian Rupee becoming a truly international currency and its full convertibility. Moreover these bonds give an opportunity for those international investors who are not able to invest directly in Indian bond markets due to legal restrictions on registrations. Indian companies can benefit by way of a lower cost of capital by the issue of these bonds. The cost of capital for Indian companies is comparatively higher.
Apprehensions about masala bonds
There are limitations with respect to pricing of these bonds, maturity, volume, end use and yield too. The yield has to be 500 basis points above similar maturity sovereign bonds of similar maturity. Only those blue chip Indian companies will be able to issue masala bonds as per the RBI guidelines. These companies already have access to multiple cheap funding sources. Another drawback is that banks incorporated in India cannot issue these bonds. This is a significant limitation in the light of Indian banks trying to meet Basel III capital adequacy norms.
There is a withholding tax of 5%. Considering other expenses incurred by the investors with respect to subscribing to these bonds, hedging cost against currency risk which is borne by the investors and the withholding tax, it may turn out that the extra return anticipated by the investors may not realise. Only in case of yield compensating for the currency exchange risk investors will have continued interest in these instruments. These bonds may negatively affect the domestic bond market and compete with them.
Another restriction regarding the issue of these bonds is that if an Indian bank underwrites the issue it can’t hold more than 5% of the issue size after completion of six months of the issue
Entities in the process of issuing masala bonds: There is a list of companies who have already announced their intention of tapping this new source of funds. Indian Railway Finance Corporation, NTPC, HDFC and Indian Infrastructure Finance Company are some among them. Interestingly British Columbia, the 15th largest metropolitan region in Canada has announced that they will issue rupee denominated bonds of US$150 million in the first quarter of 2016. British Columbia is a AAA rated jurisdiction. No foreign Governments has issued masala bonds till now. They will list this issue in the London Stock Exchange.
Indian corporate has to wait and see how this new source of funding evolves and the international investor reaction to it in the long run.
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