What are Masala Bonds?

The international bond market presents a compelling opportunity for various entities seeking to raise funds for specific foreign projects. Firstly, the international bond market provides access to a potentially vast and diverse investor base, expanding the pool of potential funding sources. This broader reach can enhance the likelihood of securing financing for projects that may have a limited investor base in domestic markets. Additionally, tapping into the international bond market can help finance foreign ventures more efficiently by reducing the cost of financing. This can be particularly advantageous for organizations with global ambitions, as it enables them to access funds at potentially lower interest rates compared to domestic borrowing options. Innovative instruments constantly emerge to cater to such diverse needs of investors and issuers in the ever-evolving world of finance. One such spicy addition to the bond market that has gained significant traction in recent years is the Masala Bond. This article aims to provide a comprehensive overview of what is masala bond, exploring their origin, characteristics, benefits and their impact on the financial landscape.

The Origin Story

In 2013, the global financial markets experienced a significant event known as the “Taper Tantrum.” This occurrence was triggered by the U.S. Federal Reserve’s announcement of scaling back its bond-buying program (QE), causing a massive flight of investors from emerging markets. India, being one of the affected countries, witnessed a considerable outflow of foreign capital, resulting in rupee instability and pressure on its foreign exchange reserves. In addition to this, Indian corporations faced a massive hurdle when raising foreign capital through ECB route which imposed strict regulations and numerous restrictions. In order to tackle this challenging situation, India introduced a pioneering financial instrument known as “Masala Bonds,” effectively addressing two objectives and playing a vital role in drawing capital back to its domestic market.

Meaning of Masala Bonds

Overseas Rupee-denominated bonds, commonly referred to as “Masala Bonds,” are debt instruments issued by Indian entities in foreign markets with the objective of raising capital. Masala bonds are constructed on a principle, whereby they are denominated in Indian Rupees but settled in US$. For example, if a bond has a coupon of 10%, on the day of coupon payment the 10% of INR Notional is calculated and converted into US$ and paid to the investor. The same method is used for principal repayment. This arrangement allows foreign investors to invest in the Indian market taking a constructive view on INR currency while earning interest rate from the bond. The notion of foreign bonds enjoys significant popularity within the realm of the global bond market. Some examples of foreign bonds are:

Why the name Masala?

Masala Bonds are named to reflect their Indian origin, adding a cultural touch to the financial instrument. “Masala” stands for a blend of spices in Hindi, symbolizing the mixture of opportunities and flavors they bring to the investment landscape. These bonds allow Indian entities to raise funds in rupees from international markets without exposing themselves to the risk of currency fluctuation. By evoking the richness and variety of Indian spices, the name “Masala” captures the essence of these bonds’ unique characteristics in the global financial market, combining the local economic spirit with international investment appeal.

How Do Masala Bonds Protect Issuers from Currency Risk?

Masala Bonds provide a significant advantage to issuers by mitigating the currency exchange risk associated with international borrowing. Unlike traditional foreign currency-denominated bonds, where the issuer must bear the risk of currency fluctuations, Masala Bonds are denominated in Indian Rupees but settled in foreign currency (usually US Dollars). This arrangement means that while investors accept the currency risk, the bond issuers are not liable for losses arising from rupee depreciation. Consequently, Indian companies can raise funds internationally without worrying about the exchange rates between the rupee and other currencies, making it a financially prudent option for securing overseas capital.

Key Features of Masala Bonds

Masala bonds have several unique characteristics that set them apart from other types of bonds:

• The issuance of the bonds is exclusively limited to residents of countries that hold membership in the Financial Action Task Force (FATF). This ensures compliance with international standards for combating money laundering and terrorism financing.
• They can either be privately placed or can be listed on exchanges
• The security market regulator of the country where the investor resides must be a member of the International Organisation of Securities Commission (IOSCO). This ensures investor protection and regulatory oversight.
• Financial institutions, where India is a member country, can also subscribe to masala bonds, expanding the investor base.
• The minimum maturity period for bonds issued up to 50 million US dollars per financial year is required to be 3 years. And bonds raised above 50 million must have a minimum maturity period of 5 years.
• The proceeds can be used for creating affordable housing projects in India, increasing the working capital of corporates, refinancing of NCDs and rupee loans.
• The proceeds can’t be used for purchasing land, funding other corporates or investing in capital markets.

Benefits of Masala Bonds

Masala bonds offer several benefits for both issuers and investors. Here are the key benefits of Masala bonds:

• Borrowers can obtain funds at lower interest rates compared to prevailing rates in India, as interest rates in well-developed markets are generally lower.
• Currency risk is borne by investors, relieving the issuers from worries about rupee depreciation.
• Masala bonds attract a diverse investor base, increasing liquidity.
• Offshore investors have the potential to earn higher returns compared to their own country’s interest rates, as Indian entities offer bonds with rates higher than LIBOR.
• Any capital gains resulting from the appreciation of the rupee are exempt from taxation.
• Documentation requirements are reduced as registration as a Foreign Portfolio Investor (FPI) in India is not necessary.
• With India’s GDP and national income on the rise, institutional investors have the opportunity to make profits.
• Masala bonds increase the confidence of offshore investors and contribute to the internationalization of the Indian rupee.
• Development of the domestic bond market is accelerated due to competition with overseas markets, providing new opportunities for investors.
• Masala bonds provide a pathway for international investors, who lack access to the Indian market through conventional means, to explore investment opportunities.

Major Milestones: Masala Bond Examples

Conclusion

Masala bonds are a unique and innovative way for Indian companies to raise capital from international markets. The cumulative issuance of Masala bonds reached approximately $20 billion in 2021. While they have some limitations, they offer many benefits for both issuers and investors. As the Indian economy continues to grow, it’s likely that we will see more and more companies turning to masala bonds as a way to finance their growth. To know more such delicious content on bonds log on to IndiaBonds.

FAQs

Q: What are (QE) Quantitative easing and taper tantrum?

A: Quantitative easing (QE) is a monetary policy tool used by central banks to stimulate the economy. It involves the central bank purchasing government securities or other financial assets from commercial banks and other financial institutions. This injection of money into the economy aims to increase lending, boost economic activity and encourage investment.

Taper tantrums, on the other hand, refer to market reactions characterized by sudden and volatile price movements following hints or announcements by central banks about reducing or tapering their quantitative easing programs. These reactions occur because market participants become concerned that the withdrawal of the central bank’s support could lead to higher interest rates, reduced liquidity, and potential disruptions in financial markets.

Q: What is a maharaja bond?

A: A maharaja bond is an onshore rupee-denominated debt instrument issued by IFC in 2014. This was followed by the issuance of masala bonds. Listed in the NSE, the issue raised 600 crores from both domestic and foreign investors to support the country’s domestic capital markets.

Q: Masala Bonds Definition

A: Masala bonds are a type of debt instrument issued by Indian entities in the international market but denominated in Indian rupees (INR), as opposed to the local currency of the foreign market. They are named “masala” to reflect the Indian origin and cultural identity of the bond.

Disclaimer: Investments in debt securities/ municipal debt securities/ securitised debt instruments are subject to risks including delay and/ or default in payment. Read all the offer related documents carefully.