Jargon buster. Masala bonds

The local currency-denominated bonds of both China and India have a culinary moniker. The Chinese yuan-enominated bonds are known as Dim Sum bonds, while the Indian rupee-denominated bonds are known as Masala bonds.

The Masala bonds were launched with two objectives — one, to help Indian companies access low-risk borrowings from abroad, and two, to help internationalise the rupee and take a step further on the road to full convertibility of the currency. The bonds, offered to overseas investors, are set in rupee terms but are settled in foreign currency, usually the US dollar. Thus, the currency risk is borne by the investors. If the rupee weakens, the investors lose and if the rupee gains, they benefit.

Despite the foreign currency risk, the masala bonds should find takers. That’s because the interest rate on these bonds would be attractive compared with the low single-digit rates offered in many of the big global economies. The government cutting the withholding tax on interest on such bonds to 5 per cent from 20 per cent is another carrot. Capital gains from rupee appreciation are also exempt from tax.

India is among the relatively bright spots in a weak global economy, and money from quantitative easing measures in geographies such as Japan and Europe can find a home in Masala bonds.

Shielding against risks The Masala bond should help Indian companies by providing access to cheaper funds, compared with the cost of borrowing within the country. These bonds also shield the issuer from currency fluctuation risk, which in the past came to bite many Indian companies that had borrowed in foreign currency through the external commercial borrowing (ECB) route. That said, it is possible that for the currency risk, the foreign investor would ask for a higher return from the Indian company.

The International Finance Corporation, an affiliate of the World Bank, has floated Masala bonds in the past to fund Indian infrastructure projects.

Success hinges on credibility The RBI has permitted Indian companies to issue such bonds within the policy framework relating to external commercial borrowings (ECBs). A seller can issue masala bonds worth a maximum $750 million a year and the bonds must have a minimum maturity of five years.

Organisations such as HDFC, NTPC and Indian Railways have reportedly planned to enter the ring. The success of a Masala bond issue will primarily depend on the credibility and financial strength of the issuing Indian company and, of course, the interest rate offered. A relatively stable Indian rupee will also provide comfort to foreign investors. Ambiguities regarding taxation on the Masala bonds also need to be sorted out.

The writer is a student of SRM University. He is an intern with Business Line

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