In belt-tightening mode for the past five years, the Centre has substantially pruned its reliance on foreign currency debt. But India Inc continues to be on an overseas borrowing binge with its outstanding dues on ECBs (external commercial borrowings) at $181 billion by March 2015, compared to just $70 billion five years ago. With the bulk of these loans remaining un-hedged, in the event of a bout of rupee depreciation, they will strain corporate balance sheets and undermine foreign investor confidence in India. It is to address this problem that the RBI has recently issued guidelines for Indian companies to raise rupee-denominated overseas loans, known colourfully as masala bonds. It is good that the RBI has not only done away with many of the excessively restrictive conditions governing ECBs, but has also addressed the criticisms against its earlier draft guidelines. With these liberalised rules, masala bonds have the potential to emerge as a favoured route for borrowings by India’s top-rated companies, and may help the country address the funding gap in infrastructure without adding to its dollar outflows. The first few tranches of such bonds have recently been issued by IFC, to good global response.

There are three key sweeteners that may prompt corporate borrowers to consider rupee-denominated bonds in place of ECBs. One, these borrowings are open to all companies - including NBFCs and services, that are presently barred from accessing ECBs. Two, the bonds do not carry any end-use restrictions and can be deployed as working capital, unlike ECBs which are restricted for use only for project imports, infrastructure investments, etcetera. Three, masala bonds are not subject to any ceiling on their costs, leaving individual borrowers free to negotiate rates with their lenders. Indian companies have often complained that the RBI’s cost ceilings for ECBs (at 3.5 to 5 per cent over LIBOR) constrain most borrowers from accessing the overseas market. Global investors may be drawn to these bonds for higher yields, especially as the Indian economy is on a relatively strong footing compared to other developing economies. They may invest in Indian paper without registering as foreign portfolio investors or subjecting themselves to the investment limits in place for the domestic bond market.

But having said this, a rush to issue masala bonds has its pitfalls. Foreign lenders, who have a far lower cost of funds than Indian banks, may wean away the top-quality borrowers from domestic banks through competitive rates. Given that these bonds would carry both currency and credit risk for the lenders, it is unlikely that poorly rated companies will be able to raise big money through this route. Such a shift from domestic to overseas borrowings, would add to the outflow of capital from the economy, even if it is not in foreign exchange. But then, if the masala bonds subject Indian banks to a healthy dose of competition and force them to cut their lending rates, that will do the rest of India Inc a world of good.

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