Masala Bonds: Fuel in contributing funds to the Domestic Companies By CS Komal Jain & CS Karuna Jain (K K Jain & Co.)


Introduction and Origin:
 
Masala Bonds are the term is used to refer to rupee-denominated borrowings by Indian entities in overseas markets. International Finance Corporation (IFC) has named them as Masala bonds to give a local flavour, though it may seem odd to name a state debt instrument after food stuffs but to bring Indian culture and cuisine among international investors it was named so. The main objective behind issue of these bonds was to raise funds for infrastructural projects in India.
 
The idea of masala bonds was first floated by RBI in April 2015 following which the central bank issued guidelines for the same in September. Over the last four months, Indian Railway Finance Corp. (IRFC), Housing Development and Finance Corp., NTPC Ltd, Shriram Transport Finance and Dewan Housing Finance Ltd have all hawked masala bonds without success. Adani Transmission Ltd was the latest to market masala bonds overseas last month.
 
In order that an active market develops for masala bonds top Indian issuers need to access the market thereby enhancing the liquidity of the masala bond market and also giving international investors the opportunity to have exposure to the Indian Rupee.
 
Importance of Masala Bonds:
 
Masala bonds can be quite a significant for the Indian economy as 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 issuance of rupee-denominated offshore bonds, also known as ‘Masala’ bonds, by domestic firms will help larger issuers diversify their funding sources without taking on currency risks. These bonds have direct implications for the rupee, interest rates and the economy as a whole. Competition from overseas markets may nudge the government and regulators to hasten the development of our domestic bond markets, and as a result of which our rupee will prop up and this will tend the rupee to go global.
 
As such, the main incentive for Indian companies to issue Masala bonds is likely to be for the diversification of funding sources, as opposed to price. The major benefits lies with Non-bank financial institutions which currently rely heavily on domestic banks for funding, could now particularly benefit from the new market.


 
Terms and conditions of Issue:
 
Eligible borrowers to issue rupee denominated bonds:
 
Any company registered under the Companies Act or body corporate created out of a specific act of the Parliament is eligible to issue Rupee denominated bonds overseas. Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) coming under the regulatory jurisdiction of the SEBI are also eligible. In the latest regulation, banks are also allowed to issue such bonds to finance their tier I, tier II capital and infrastructure financing. Indian Corporates eligible to raise ECB are permitted to issue Rupee linked bonds overseas. For them, issue of Masala bond procedure is same as that of ECB guidelines.
 
Eligible investors:
 
Indian Residents are not eligible to invest in the rupee denominated bonds. Only residents of those countries where in these bonds are listed are to be included in the list of eligible investors.
 
Maturity period:
 
Masala bonds will be required to have a minimum maturity of three years, which was reduced from five years vide RBI guidelines in 2016 no call and put options can be exercised prior to the completion of the minimum maturity period. Amount and average maturity period of rupee denominated bonds should be as per the extant ECB guidelines.

Utilization of proceeds collected from issue:

The proceeds collected from the issue of Masala Bonds are to be utilized as per the guidelines issued for the ECB. The subscription, coupon payments and redemption may be settled in foreign currency.
The fund raised through rupee denominated bonds should not be used following activities:
  • Real estate activities other than for development of integrated township/affordable housing projects; 
  • Investing in capital markets and using the proceeds for equity investment domestically;
  • Activities prohibited as per the foreign direct investment guidelines; 
  • On-lending to other entities for any of the above objectives; and 
Maximum amount that can be raised through issue:
 
The maximum amount that any eligible borrower can raise through issuance of these bonds under automatic route is INR 50 billion or its equivalent during a financial year. The amount beyond this limit requires approval of RBI under approval route as mentioned in issue of External Commercial Borrowings (ECB) guidelines.
 
Procedure of Issuing Masala Bonds:
 
These shares can be issued on two ways basis: listed through overseas stock exchange or overseas unlisted private placement.
 
The issue of Masala bonds involves series of 
intermediaries viz. Settlement agent, Calculation Agent, underwriters etc for managing the whole issue procedure.
 
The steps involved are as under mentioned:

  • Obtain approval from the shareholders of the company by passing necessary special resolutions.
  • Obtain necessary Departmental approvals viz. RBI, SEBI and stock exchanges.
  • Obtain necessary approval from the overseas stock exchange wherein the bonds are to be issued.
  • Once the issue size, price and basis of issue is being determined, calculation agent is required to be appointed for setting reference FX rate.
  • Banker to an issue would collect the proceeds from the foreign investors in USD Subscription amount.
  • Settlement agents would then remit the proceeds to the issuers in the Indian currency.
  • And the final step is the issuer company will deliver the Masala bonds to the foreign investors.
  • At the time of maturity the final amount is being paid to the investors in USD via settlement agents.
Tax Aspects:
 
Union Budget has exempted Masala bonds from taxation for transfer among non-residents, while a low rate of 5 per cent will apply for investors till 2020 which is in the nature of a final tax, would be applicable in the same way as it is applicable for offshore dollar-denominated bonds. The lower TDS rate would be retrospectively effective from 01.04.2016. The tax treatment of such bonds is now at par with that of external commercial borrowings (ECBs) and domestic corporate bonds.

Further under section 194LC of Income Tax 1961 interest payable by the Indian companies to non residents by way of issue of long term Infrastructure bonds shall be taxed at rate of 5% at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by issue of a cheque or draft or by any other mode, whichever is earlier.
 
Representations are been made to allow exemption from capital gain arising to secondary holders between the dates of issue and redemption against the foreign currency in which the investment is made will be exempt from tax. And to allow exemption in respect of transfer of rupee denominated bonds from non-resident to non-resident for the purpose of increasing acceptability and transferability of such instrument in the foreign market.
 
Risk Factors involved holding of Masala bonds:

All investments offer a balance between risk and potential return. The reward is always associated with some or other sort of risks. Investors invest their funds on the basis of cost benefit analysis. Basically holding of Masala bonds involves broad components of cost which includes hedging cost, credit risk cost and withholding tax liability. The risks associated with Masala bonds are as under mentioned:  

Fluctuation in the rates of currency:

As Masala bonds are being dealt as currency derivatives, they are certainly exposed to currency exposure risk which is based on the volatile nature of Indian Rupees.  The value of underlying assets keeps on fluctuating, so to mitigate the same investors will choose to hedge their currency risk in the form of non deliverable forwards (NDF).

The risk that the proceeds from a bond will be reinvested at a lower rate than the bond originally provided for. Ultimate result of the same would be lower returns for the investors. Many a times instances are being noticed that Corporates invests the proceeds out of issue in unproductive manner, hence generating comparatively lower returns to the investors.   
 
Default risk:

The risk that the bond issuer will be unable to pay the contractual interest or principal in a timely manner. Credit ratings services such as Moody'sStandard & Poor's and Fitch give credit ratings to bond issues, which helps to give investors an idea of how likely it is that a payment default will occur. The Indian Corporates were granted “BBB” rating from Moody for Masala bonds.

Inflation risk:

The rate of inflation prevailing in the economy depends upon the stage of business cycle and the government monetary and fiscal policies. The risk that the rate of price increases in the economy deteriorates the returns associated with the bond. This has the greatest effect on fixed bonds, which have a set interest rate from inception. Rise in the rate of inflation has direct bearing upon the increase in the interest rates of such bonds.

Legal Enactments:
 
Pursuant to the circular issued vide Notification dated: 3rd August, 2016 by the Ministry of Corporate Affairs, Indian companies issuing Rupee denominated bonds overseas (Masala Bonds) under the Reserve Bank of India's (RBI) policy on external commercial borrowings will not be required to comply with the public issue and private placement disclosure and listing norms under Chapter III of the Companies Act, 2013 (Companies Act) as well as the provisions governing the issue of secured debentures under Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 (Debenture Rules). All other provisions of the Companies Act will continue to apply to Masala Bonds.
 
In order to further streamline the regime, Securities Exchange Board of India (SEBI) also released a Circular dated: 4th August 2016 clarifying that such foreign investment in Masala Bonds will not be treated as investments by Foreign Portfolio Investors (FPIs) and will not come under the purview of the SEBI (Foreign Portfolio Investors) Regulations, 2014, as amended. Foreign investments in Masala Bonds will be reckoned against the existing corporate debt limit set for investment by FPIs. 
 
Impact on the relationship between the two countries:
 
Due to issue of rupee denominated bonds on London Stock Exchange Indo-British economic ties has improved which has brought the two countries even more closer.  Britain’s exit from European Union has direct impact on the bilateral trade agreements which is said to be advantageous for domestic companies issuing bonds.  There has been rising demand for Indian assets and also the Masala bonds by international investors. Larger number of investors want access not just the pound or dollar-denominated Indian assets but also the rupee-denominated assets.
 
Statistical Facts and Findings:

According to Reserve Bank of India statistics Masala bonds accounted for 39% of the total external fund raising of $7.39 billion by Indian companies during Q4 of the financial year 2017. Housing finance and asset financing non-banking finance companies, which predominantly have rupee-denominated cash flows, have emerged as the leading borrowers. 
 
In 2017, there have been five masala bond listings in London, raising $ 135 million equivalent. In total, 39 such bonds have been listed on London Stock Exchange, raising equivalent to $ 5.4 billion. London Stock Exchange is increasingly becoming a hub for masala bond market as large institutions like Housing Development Finance Corp, India’s largest mortgage lender, too listed its bonds earlier. Further National Highways Authority of India (NHAI) has also raised Rs 3,000 crore by selling the rupee-denominated masala bonds which are now listed on London Stock Exchange.
 
Rating company ICRA said the recent increase in issuances of masala bonds in overseas markets is expected to be positive for Indian companies, especially for those who don’t have a natural hedge against the underlying foreign currency risks involved in external commercial borrowings (ECBs). Regulators have further approved masala bonds amounting to $4.59 billion in FY2017. Approvals surged to $2.9 billion in the fourth quarter from $0.8 billion in the preceding one so as to reinforce the view that the exchange platform is gaining popularity among Indian borrowers.

Corporate issue of Rupee denominated bonds:
 
Interest payment:
 
The interest payments (coupon payment) for the rupee denominated bonds should not be more than 500 basis points above the sovereign yield of the Government of India security of corresponding maturity. This means if the interest rate of a five-year G Sec is 7%, the interest rate for rupee denominated bond should not be above 12%.
For USD-INR conversion, the Reserve Bank's reference rate on date of issue will be applicable.
 
Regulation for international financial institutions where India is a member:
 
International Financial Institutions where India is a shareholding member need not require the prior permission of the RBI to issue rupee denominated bonds if they allocate the entire proceeds from the bond issuance in India.
 
In other cases, where an International Financial Institution (of which India is a member) wishes to retain the freedom to deploy the issue proceeds in any member country shall require prior permission from the Reserve Bank / Government of India.

Benefits of Listing Masala Bonds on the Overseas Stock Exchange

Overseas market provides a deep and liquid debt capital market for companies in the region to meet their financing needs. The demand for offshore bond issuances is fuelled by a broad community of asset managers and institutional investors seeking investment opportunities.
Success of any issue depends upon stable political environment, its conducive regulatory and tax framework (with streamlined prospectus requirements and less/no capital gains tax) makes a compelling argument for listing Masala bonds on the overseas Stock Exchanges.

Conclusion:
 
A vibrant bond market can open up new avenues for bond investments by foreign retail savers which will ultimately augment the Indian domestic companies to raise the funds in international markets.   The success of masala bonds would demonstrate overseas investors’ confidence on Indian currency. In other words, successful issue of these bonds by Indian corporate would imply faith on country’s macroeconomic fundamentals and the central bank’s role in currency management. In a way masala bond is a step to help internationalize the Indian rupee.
 
Summary:

Masala bond is a good idea to shield corporate balance sheets from exchange rate risks. The Rupee Bond Guidelines have increased the ability of Indian issuers to access the international debt capital markets and thereby have potentially opened up another avenue for Indian issuers to seek competitively priced funding from the international markets. Similarly, the Rupee Bonds Guidelines have allowed foreign fixed income investors the first real opportunity to have exposure to the Indian Rupee, which has been enjoying a lower volatility lately compared to other Asian currencies. Overall, the development of a Masala bond market would be positive for Indian firms, opening up potentially significant new sources of funding. Recently NHAI Masala Bond issue has attracted investors from across the spectrum with Asia contributing 60% of the subscription and the balance 40% coming from Europe.

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