Sunday, 19 February 2017

Short notes about Masala Bonds | Banking

Masala Bonds

When any entity wants to raise money or we can say want to borrow money, it can issue bonds worth that value. So, now when an Indian company wants to borrow money from a foreign company, there are many methods like FDI, ECB, etc. and one of them is issuing bonds. All methods of borrowing have their own advantages and disadvantages. In the same way are Masala bonds which are named by the International Finance Corporation (IFC), the investment arm of the World Bank. We will read later that how the word masala attached with these bonds.

Now what are these Masala Bonds?

Masala bonds are the rupee-denominated bonds which can be issued by the Indian entities to raise money from overseas markets. By rupee-denominated bonds, it meansthat the money borrowed will be in Indian rupees and not any foreign currency. Let’s take an example: Suppose an Indian entity issues masala bonds worth Rs 10 crores with a promise to pay Rs 11 crores the next year. Now the foreign investor will lend the dollar equivalent of Rs 10 crores. Now after a year, the Indian entity will return the dollar equivalent of Rs 11 crores.
Now what is the advantage of using these new masala bonds over the initial methods?
The advantage is that that of the currency risk. Since the Indian entity will return the dollar equivalent of Rs 11 crores, this means that if in a year if there is any fluctuation in the currencies whether large or small, the risk lies with the overseas investor and not the Indian entity.

How the name came?

  • IFC issued a Rs 1,000 crore bond to fund infrastructure projects in India. These bonds were listed on the London Stock Exchange (LSE).
  • IFC then named them Masala bonds to give a local flavour by calling to mind Indian culture and cuisine.
  • This kind of naming has been done before also. IFC’s Chinese yuan-denominated bonds are called Dim sum bonds, Japanese yen-denominated bonds are called Samurai.
  • Before the word masala, some names like Samosa, Ganga, and Peacock were also in line to be attached to these rupee-denominated bonds.

The Reserve Bank of India has issued certain guidelines allowing the Indian entities to issue masala bonds:

  • Any corporate or body corporate as well as Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) can issue such off-shore rupee denominated bonds.
  • Banks incorporated in India will not have access to these bonds.
  • Indian banks, however, can act as arranger and underwriter.
  • The minimum maturity period is 3 years.
  • Companies can raise under the automatic route (i.e., without prior approval) an amount equivalent to USD 50 billion (till April 2016 it was USD 750 million) per annum.
  • Cases beyond this limit would require prior approval of the Reserve Bank.

Some facts:

  • Masala bonds are a step to help internationalize the Indian rupee and also deepen the Indian financial system.
  • They are the first rupee bonds listed on the London Stock Exchange.
  • They can be issued for three or five or seven-year maturities.
  • The first Masala bonds were issued on 10 November 2014 under IFC’s $2 billion offshore rupee program.
  • They are different from External Commercial Borrowings (ECB) in a way that in ECB the currency risk lies with the Indian issuer while in case of masala bonds, the currency risk lies with the overseas investor.
  • Like ECB, masala bonds also provide cheaper funding as compared to domestic markets.
  • Though currency risk lies with the investor, but then also the overseas investor has many advantages like they have very few investment options in other countries due to weak economic conditions globally.
  • Coinciding with Prime Minister Narendra Modi’s visit to the UK last year, organisations such as HDFC, Yes Bank, and the Railways had announced they were going to raise funds through this route from the London market.