Masala bonds can be a game-changer for the rupee

Union budget 2022 and global minimum tax
As the model rules for legislation to implement the two-pillar solution are not ready, Union Budget 2022 may not have proposals on the global minimum tax.

Ever since Indian economy was liberalised in 1990s, foreign investors have become an important source of its capital needs. Indian companies raised debt from overseas markets, and borrowings were denominated in dollars or other currencies. This has exposed them to exchange rate risks. The solution to this may be masala bonds, Indian rupee-denominated bonds issued in the overseas market. Any corporate body or Indian bank is eligible to issue rupee-denominated bonds to attract funds for projects. But Indian corporates seem to be hesitant to explore this option.

In the coming years, masala bonds will play a major role in funding the capital requirements of Indian corporates, especially those in the infrastructure sector. In India, masala bonds were introduced by the International Finance Corporation (IFC) in 2014. The primary objective of the masala bond was to fund infrastructure projects and internationalise the Indian Rupee. The IFC issued Rs 1000 crore worth bonds to fund infrastructure projects in India and mobilising international capital markets to support infrastructure development in the country. IFC named them masala bonds to give a local flavour.

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Masala bonds were listed on the London Stock Exchange (LSE). Both the government and Indian companies can issue masala bonds outside India to raise money in Indian currency. Thus, if the rupee rate falls, foreign investors take the exchange rate risk, and the foreign investor will bear the losses, not the issuing Indian entity.

Investors outside India who would like to invest in Indian assets can subscribe to these bonds. However, the bonds subscribed by a resident of such country must be a member of the financial action task force and whose securities market regulator is a member of the International Organisation of Securities Commissions. It can also be subscribed by multilateral and regional financial institutions where India is a member country.

As per Reserve Bank of India (RBI) norms, maturity period is three years for the bonds raised up to the rupee equivalent of $50 million in a financial year. The maturity period is five years for bond issues above $50 million. Conversion of these bonds happens at the market rate on the date of settlement of transactions undertaken for the issue and servicing of interest.

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RBI mandates that the money raised through such bonds cannot be used for investment in capital markets, equity investment, or real estate activities other than developing integrated townships or affordable housing projects. However, masala bond proceeds can be used for any purpose, including working capital, general corporate purposes, on-lending by non-banking finance company (NBFC), or the repayment of rupee loans, provided that the borrowing meets certain minimum average maturity period (MAMP).

Interest income from rupee-denominated bonds is ordinarily subject to a 5% withholding tax. But the Indian government exempted the interest earned on these bonds from the withholding tax. Further capital gains received by the investor on maturity due to the appreciation of the rupee are exempted from capital gains tax. Investments in RDBs by institutional investors will not be considered foreign portfolio investments.

Benefits of masala bonds

Masala bonds have various benefits. The economy, investors, and borrowers benefit from issuing these bonds. Masala bonds have opened up an investment route for global investors who have no access to the domestic market through the Foreign Institutional Investors or Foreign Portfolio Investment route. It will help internationalise the rupee by making it familiar to international investors. It boosts the domestic bond markets in competition with the overseas markets. Since Indian rupees are internationalised through masala bonds, it strengthens the domestic financial system and economy.

Further, the bond market can open new avenues for bond investments by retail savers to support the rupee structure. A Liquid rupee-denominated debt markets kindle financial stability. Masala bonds can help the Rupee go global.

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Investors in Masala bonds get the benefit of higher comparative yields. Additionally, since these bonds are settled in dollars, the investor receives more dollars for the same amount of rupees. It offers higher interest rates and benefits to the investor. It helps strengthen foreign investments in the country as it facilitates the foreign investors’ confidence in Indian currency. If the rupee appreciates at the time of maturity, it benefits the investor.

It benefits the borrower as there is no currency risk. It saves the borrower from currency fluctuations. Borrowers need not worry about rupee depreciation as the issuance of these bonds is in Indian currency. The borrower can mobilise a considerable amount of funds. It helps the Indian entity issuing these bonds to diversify its portfolio. As these bonds are issued in the offshore market, it allows borrowers to tap many investors.

Masala bonds are significant for the Indian economy. They can have implications for the rupee, interest rates, and the economy as a whole. Competition from overseas markets may push the government and regulators to accelerate the development of our domestic bond market. A vibrant bond market can open up new avenues for bond investments by retail savers.

HDFC, NTPC, The Indian Railway Finance Corporation, Yes Bank, and Indiabulls Housing Finance raised funds through masala bonds. In the last few years, global investors have been positive towards Indian rupee. The GDP growth of India appeal to more foreign portfolio investor flows compared to other Asian emerging markets.

Moreover, Make in India initiative has made India a favoured FDI destination compared with other emerging markets. All these factors contributed to the strength of the rupee and created confidence in the minds of foreign investors. If overseas investors enthusiastically slurp up masala bonds, the rupee will benefit vis-à-vis other major currencies. Masala bonds can further help the standing of the rupee among other global currencies.

(Dr Naliniprava Tripathy is Professor of Finance at IIM Shillong.)

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Naliniprava Tripathy is an Indian economist based in Shillong. She teaches finance at IIM Shillong.