The first question that arises is if there is anything common in Dim Sum, Samurai, Kangaroo, Maple, Yankee or Bull Dog? To answer this: All the above are international bonds.
The international bonds are given such distinct names to evoke an association with their home country.
Just like how Dim Sum bonds are Chinese variant, Samurai are Japanese, Kangaroo are Australian, Maple are Canadian, Yankee is USA and Bull Dog is UK. India also wanted to be a part of these bonds and hence, came up with its own variant i.e. Masala Bonds.
The word Masala means spices and since India has always been famous for its spices globally, this term was used to evoke the culture and cuisine of India.
What is Masala Bond?
Before we understand masala bonds, lets understand the concept of International Bonds. International bonds are debt investment instruments issued in a country by a non-domestic entity, in the currency of that non-domestic country. e.g.- A company which is based in China, issues a bond in the UK market in Chinese Yuan.
On similar lines, masala bonds are rupee denominated bonds i.e. denominated in Indian rupee but settled in foreign currency and are issued to overseas investors by Indian entities. The entire transaction including buying of bonds, payment of interest and repayment at the time of maturity is in Indian rupees.
Features:
Some of the unique features are as follows:
- Rupee currency risk is borne by bond investors instead of bond issuers. This means that an investor of masala bond will be affected by the appreciation or depreciation of the rupee.
- The minimum maturity period for Masala Bonds raised up to Rupee equivalent of USD 50 million in a financial year is 3 years and for bonds raised above USD 50 million in 5 years
- The interest income is taxable at 5% up to 30th June, 2020 (except for interest received between 17th Sept,18 to 31st Mar,19 as the same was exempt by CBDT)
- It can be subscribed by an investor from the Financial Action Task Force compliant jurisdiction outside India
- They are issued by Indian entities looking to raise money overseas
Why Foreign investor are attracted to Masala Bonds?
The principal reason is the higher rate of interest provided on these bonds as compared standard rate prevailing in the market where the investor is residing. The coupon rate is higher to compensate for the risk associated with currency depreciation. To understand this better, let’s take the following example:
For a like-to-like comparison, selected bonds mature within one month of each other. As can be seen in the table above, the NTPC masala bond due 2021 yields 8.39% if held to maturity. This is 4.77% higher than the yield on NTPC’s USD denominated bond due 2021. This explains why foreign investors are drawn towards local currency bonds like masala bond.
Beneficial to Issuer & Economy
Not only does it is benefit the investors, issuer of masala bond is benefited due to no currency risk i.e. the issuers do not have to worry about rupee depreciation which is usually the biggest worry while raising money in overseas market. It also helps them widen their bond portfolio.
It also benefits the Indian economy as helps to internationalize the Indian Rupee and give value to the Indian Financial system and economy and flow in the Foreign Investment in rupee- denominated debt shows an increasing international interest in the instruments which leads to development of India.
However, excess of masala bonds can lead to bad after effects. As too much reliance on external debt/overseas borrowing can have a negative impact on the sovereign ratings by global agencies.
Limitations
Just like the two sides of a coin, a masala bond has its own limitations. Money raised by issuing masala bonds cannot be used for the following:
- Real estate activities other than the development of affordable housing projects
- Investing in the capital market
- Activities that are prohibited as per the Foreign Direct Investment Guidelines
- On- lending to other entities for the above purposes
- Purchase of land
Some Recent Issues of Masala Bonds
The most recent issue of Masala bonds which lead to major controversy was done by the Kerala Infrastructure Investment Fund Board (“KIIFB”), a state-owned organization. The funds were required for financing the infrastructure needs of Kerala. KIIFB became the first State Government body from India to issue Masala bonds. In its debut Masala bonds issue (via private placement), it raised INR 2,150 Crore.
Conclusion
In the end just like how the right quantity of masala is required to make the food delicious, a little less or little more of masala can ruin the food taste.Similarly, the right quantity of masala bonds in an issuers balance sheet is required to benefit from diversification of bond portfolio. The after effects of too much masala bonds is detrimental both for the issuer and the economy.