Why the name “masala”?
The term "masala" is used to signify the Indian origin of these bonds. Just like how masala is a mix of various spices used in Indian cuisine, masala bonds represent a blend of:
- International financial markets with
- Indian financial assets
This name was chosen by IFC to:
- Reflect the Indian identity of these bonds
- While also hinting at the mix of investors and issuers involved
Types of masala bonds
Masala bonds are generally classified based on their maturity and interest payment structure. They can be either short-term or long-term, and offer either a fixed or floating interest rate.
Short-term masala bonds
- Have a maturity period of less than three years.
- Are suitable for investors seeking short-term exposure to Indian rupee-denominated assets.
- Often carry less risk but might offer lower returns compared to long-term bonds.
Long-term masala bonds
- Have a maturity period exceeding three years.
- Cater to investors with a longer investment horizon.
- Are generally used for extensive capital projects, offering potentially higher yields but with increased risk due to the longer duration.
Fixed-rate masala bonds
- Come with a predetermined interest rate, remaining constant over the bond's tenure.
- Are appealing to investors seeking predictable income and stability, as they provide protection against interest rate fluctuations.
Floating-rate masala bonds
- The interest rate on these bonds varies based on market conditions, usually pegged to a benchmark rate.
- Are ideal for investors looking to benefit from potential interest rate increases but come with the risk of fluctuating returns.
What are the key characteristics of masala bonds?
Masala bonds are unique financial instruments which connect the international capital markets with the Indian economy. They promote cross-border investment opportunities. Here are some their key characteristics:
Denomination in Indian Rupees (INR)
- Masala bonds are issued in Indian rupees.
- They are different from traditional bonds, which are typically denominated in the currency of the issuing country.
- This feature shields investors from currency exchange rate fluctuations.
Issued by Indian entities
- Masala bonds are issued by Indian entities, such as:
- Corporations
- Financial institutions, or
- Government-backed entities
Listed on foreign exchanges
- These bonds are listed on foreign exchanges, usually in financial centres like London or Singapore.
- For example,
- The first Masala bond issued by the IFC in November 2014 was listed on the London Stock Exchange (LSE)
- This listing allows international investors to access Indian markets indirectly.
Regulated by Indian authorities
- Despite being issued abroad, masala bonds are subject to regulations by Indian authorities.
- They are regulated by:
- The Reserve Bank of India (RBI)
- The Securities and Exchange Board of India (SEBI)
Some popular masala bond issues
Check out some of the popular masala bond issues:
Year
|
Issuing organisation
|
Amount raised
|
Purpose
|
November 2014
(maiden issue of masala bonds)
|
International Finance Corporation (IFC)
|
Rs. 10 billion
|
To support infrastructure projects in India
|
August 2015
(maiden issue of green masala bonds)
|
International Finance Corporation (IFC)
|
Rs. 3.15 billion
|
To finance private sector initiatives that address climate change in India
|
July 2016
|
HDFC
(first Indian company to issue masala bonds)
|
Rs. 30 billion
|
To diversify its funding sources and support its growth initiatives
|
August 2016
|
NTPC
(first Indian company to issue green masala bonds)
|
Rs. 20 billion
|
To finance green energy projects
|
How do masala bonds protect issuers from currency risk?
Masala Bonds transfer the currency risk from the Indian issuer to the foreign investor. These bonds are denominated in Indian rupees, so the issuer repays both interest and principal in INR. Despite being funded by foreign investors, any currency exchange fluctuation affects them, not the Indian company. This arrangement allows Indian firms to raise funds abroad without exposure to exchange rate volatility, making it an attractive alternative to conventional foreign currency bonds for issuers:
Component
|
Conventional Foreign Bond
|
Masala Bond
|
Denomination
|
Foreign currency
|
Indian rupees
|
Currency risk borne by
|
Issuer
|
Investor
|
Exchange rate fluctuation
|
Impacts Indian issuer
|
Impacts foreign investor
|
Example
|
USD bond by Indian firm
|
INR bond sold to global investor
|
Let us understand through a hypothetical example how masala bonds shield bond issuers:
The scenario
- An Indian company, ABC Ltd., wants to raise funds internationally to finance its expansion plans.
- Traditionally, if ABC Ltd. issued bonds in a foreign currency like the US dollar, they would face currency risk.
- If the value of the Indian rupee depreciates against the dollar, ABC Ltd. would have to pay back more rupees than they initially received.
- To avoid this risk, ABC Ltd. decided to issue masala bonds:
- Denominated in Indian rupees
- But sold to investors in foreign markets
- Say the company issued masala bonds worth Rs. 1 crore having:
- The maturity period of five years and
- Interest rate of 7%
The rupee depreciation
- Assume the rupee depreciates against the foreign currency (say US dollars) over the bond's duration.
- At maturity, the exchange rate is Rs. 80 per dollar, compared to Rs. 70 when the bonds were issued.
The hedge
- If ABC Ltd. had issued dollar-denominated bonds, they would have to convert more rupees to dollars to repay the bond.
- But since they issued masala bonds in rupees, they don't face this risk.
- They simply repay the bond in rupees, irrespective of the exchange rate fluctuations.
How can the money from Masala Bonds be used?
The funds raised through Masala bonds can be directed towards various purposes, with some restrictions:
Approved uses:
- Refinancing existing rupee loans and non-convertible debentures (debt instruments).
- Funding the development of integrated townships and affordable housing projects.
- Providing working capital for companies.
Restricted uses:
- Real estate activities beyond integrated townships and affordable housing projects, as mandated by the RBI (Reserve Bank of India).
- Activities prohibited under Foreign Direct Investment (FDI) guidelines.
- Investing in domestic capital markets or using the proceeds for domestic equity investments.
- Purchasing land.
- On-lending the funds to other entities for any of the prohibited purposes.
This clarifies the categories of approved and restricted uses upfront, making it easier to understand.
Advantages of masala bonds
Masala Bonds offer several benefits. They help Indian companies avoid currency exchange risk since the bonds are issued in Indian rupees. These bonds also attract a broader range of global investors, may offer lower borrowing costs than local loans, and let foreign investors invest in India without worrying about currency fluctuations.
- Reduced currency risk for issuer: By issuing debt in Indian rupees, Masala Bonds shift the currency exchange risk to investors. This is beneficial for Indian entities, as they avoid the risk of currency fluctuation affecting repayment amounts.
- Access to international markets: Masala Bonds provide Indian issuers access to foreign capital markets, broadening their funding sources. This diversification can be crucial, especially when domestic borrowing conditions are unfavourable or limited.
- Potentially lower borrowing costs: Issuing Masala Bonds can sometimes be cheaper than raising funds domestically, especially when there’s high demand for such bonds among international investors, leading to competitive interest rates.
- Exposure to the Indian economy for investors: For foreign investors, Masala Bonds offer a way to invest in Indian rupee-denominated assets, providing exposure to the Indian economy’s growth potential without direct currency risk.
- Strengthening the Rupee: As these bonds increase demand for the Indian rupee in international markets, they can help in strengthening the currency, reflecting positively on the Indian economy.
- Development of Indian capital markets: The success of Masala Bonds can bolster the international reputation and development of Indian capital markets, encouraging further international investment in other Indian financial instruments.
Disadvantages of masala bonds
The main disadvantages of Masala Bonds include the currency risk transferred to investors, potentially leading to limited interest from foreign investors, and higher interest rates due to this risk. Additionally, fluctuations in the Indian rupee can affect the bond’s attractiveness and returns.
Currency risk for investors: Investors bear the currency risk in Masala Bonds, as the bonds are denominated in Indian rupees. Fluctuations in the rupee’s value can impact returns, potentially deterring some international investors from buying these bonds.
Higher interest rates: To compensate for the added currency risk, Masala Bonds might offer higher interest rates compared to local currency bonds in the investors’ country. This can lead to increased borrowing costs for the issuing entity.
Market limitations: Since Masala Bonds are a niche product, their market is relatively limited compared to more established global bonds. This can restrict the issuer’s ability to raise large amounts of capital.
Regulatory and compliance challenges: Issuing Masala Bonds involves navigating various regulatory requirements and compliance with both Indian and international financial regulations, which can be complex and time-consuming.
Impact on Indian economy: The attractiveness of Masala Bonds is closely tied to the health of the Indian economy. Economic downturns or instability in India can reduce the demand for these bonds.
Limitations of Masala Bonds
While Masala bonds offer advantages, they also come with limitations:
- Reduced investor appeal: Periodic rate cuts by the RBI can make Masala bonds less attractive compared to other investment options, potentially deterring investors.
- Restricted use of funds: The RBI regulates where funds from Masala bonds can be invested, limiting their flexibility for borrowers.
- Emerging market risk: As Moody's points out, investors might be cautious about the inherent currency risk associated with emerging markets like India, impacting the sustainability of Masala bond financing.
- Limited Use of Funds: Masala Bond proceeds cannot be used for all purposes. Activities like land purchase, stock market investments, or real estate funding require government approvals.
- Not Retail Friendly: These bonds are generally suited for large investors like institutions, sovereign funds, and HNIs—not regular retail investors.
- Currency Risk for Investors: Issued in INR, the exchange rate risk lies with the investor. A fall in the rupee's value can reduce their returns.
- Conclusion: While Masala Bonds offer global access and fixed returns, understanding their limitations helps investors make well-informed decisions.
Conclusion
Masala bonds allow Indian entities to raise funds from foreign markets without assuming any currency risk. Since these bonds are denominated in Indian rupees, the currency risks are borne by foreign investors in exchange for potentially higher returns. In India, the International Finance Corporation (IFC) made the inaugural issue of masala bonds in November 2014. These bonds connect the international financial markets with the Indian economy and promote cross-border investment opportunities.
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