Getting the right mix for masala bonds

Masala bonds, the rupee-denominated overseas bonds issued by Indian borrowers, have been gaining traction in recent times.

It is, therefore, right that the RBI has made further changes to the guidelines governing these instruments in order to plug existing loopholes and to make them more attractive.

Masala bonds are superior to external commercial borrowings (ECBs) because the bonds are denominated in rupees, though the settlement takes place in dollars. The buyer of the bonds assumes the exchange rate risk. In return, he enjoys the high returns, much above similar instruments available overseas.

The term was first used by IFC, which named its rupee-denominated bonds as ‘Masala Bonds’ in 2014. Earlier, only multilateral institutions were issuing these bonds.

In September 2015, the RBI allowed Indian corporates to issue rupee-denominated bonds overseas as well. Since then many Indian companies such as NTPC, Axis Bank and HDFC have successfully raised funds through these bonds.

There are three changes that have been made in the masala bonds issuance rules in the current policy. One, it has been stated that for issuances of up to $50 million or ₹325 crore, minimum maturity period should be three years. In case of issues that are over $50 million in size, minimum maturity period should be five years.

In the initial set of guidelines issued in September 2015, the minimum maturity for all issues was set at five years. It was brought down to three years in April 2016.

The recent change will ensure that larger issuances have longer lock-in periods and will thus attract long-term investors and not short-term traders. This will help protect India’s external balance against volatility caused by fund flows.

The second change in the masala bond guidelines is setting the cost ceiling for these issuances 300 basis points above the yield of Government of India securities of corresponding maturity. The HDFC masala bond issue in 2017 was made at 7.35 per cent. It is, therefore, obvious that corporates with sound fundamentals are able to raise funds at competitive rates.

In the original guidelines issued in 2015, no limit for cost had been set with the rules stating that ‘the cost should be commensurate with prevailing market conditions’.

Setting a limit is a good step as it will ensure that only corporates with good credit rating which can raise funds relatively easily tap this market. Else, India could have a redux of the Indian GDR fiasco of the 1990s when corporates with dubious credentials had raised funds overseas.

The third tweak done to the rules is to specify that entities or persons associated with the issuer do not subscribe to the issue. This is another step to prevent round-tripping of funds through this route. The RBI had issued a long set of rules in April 2016 to prevent money laundering through this route.

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