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Adviser MONEY MAKING MC
15 July 2016
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| Masala Bonds(The
Total Investment & Insurance Solutions)
Indian curry
is quite a hit in the West. On a similar note, can global investors be tempted
to try out Masala bonds? That is something the Indian Railway Finance Corp,
which approved the raising of $1 billion through the issue of Masala bonds and
other companies such as Indian Rail Finance Corp and NTPC are trying out now.
However, it is Housing Development Finance Corp Ltd (HDFC) that is launching
first sale of so-called masala bonds by an Indian entity this week, seeking to
raise at least Rs2,000 crore with an option to retain oversubscription of up to
Rs1,000 crore. The advent of much talked about masala bonds market is a
positive precursor for corporates as it has opened up potentially significant
new sources of funding over External Commercial Borrowings (ECB). This will
also integrate financial markets in India further with the rest of the world.
We can certainly envisage several innovative applications of the RDB option by
companies going forward. The Total Investment & Insurance Solutions
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The term “Masala
Bonds” is used to refer to rupee-denominated borrowings by Indian entities in
overseas markets. The International Finance Corp (IFC), the investment arm of
the World Bank, issued a Rs1,000 crore bond in November 2014. The purpose of
issue was to fund infrastructure projects in India. IFC named them ‘masala’
bonds to reflect the Indian flavor. The term masala bonds have been used ever
since.
The Total Investment & Insurance Solutions
Before
masala bonds, corporates raised finance from international market through
external commercial borrowings or ECBs. However, since funds raised through
ECBs are denominated in foreign currency, the same attracts risk of forex
fluctuation. A year is a long time in forex markets where currencies fluctuate
sharply. So, imagine the risk an issuer of bond has to face, especially of one
with largely rupee earnings, where issue and repayment are years apart. This is
how masala bond is different from other instruments as the risk of currency
lies with the investor and not the issuer.
China has
been ahead. In October 2015, when President Xi Jinping was in London, the
People’s Bank of China issued Yuan denominated bonds, dubbed “dimsum bonds” in
Hong Kong to raise funds at a little over 3%. A key difference between these two
countries is that unlike China, the Indian government has never borrowed abroad
on its own — preferring to push its state owned units, instead. And Reserve
Bank of India (RBI), unlike the Chinese central bank, cannot issue debt with no
legal sanction for it. The Total Investment & Insurance Solutions
Market Scenario
The need for
a healthy corporate debt market in India has been emphasized repeatedly. A
well-developed corporate debt market will not only support the banking system
in meeting the long term funding requirements of the corporate but will also be
a reliable source of finance in situations when the equity market is unstable.
In the recent years, the Indian corporate bond market has experienced
development both in number and volume; however, when compared with the Indian
government bond market, it still has a long way to go.
The
corporate bond market in India is dominated by non-banking finance companies
(NBFCs) as issue of unsecured bonds by non-banking non-financial Companies
(NBNFCs), until recently, were covered under the ambit of deposits. The same
has been discussed at length below. So, the issue of corporate bonds in India
by NBNFC is quite small as compared to that of other developed countries and
the same can be viewed in the figure below: The Total Investment
& Insurance Solutions
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Corporate Bonds(The
Total Investment & Insurance Solutions)
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Looking at
the global trends, bank financing seems to be an uncommon phenomenon as
compared to that of bond financing, but the current situation in India follows
a totally contrary path. The reason for hindering growth of corporate debt
market against that of PSU’s debt market can also be attributed to the high fiscal
deficit of Indian economy.The Total Investment & Insurance
Solutions
Spate of action
The
regulators have now started taking steps to streamline the regulatory regime
surrounding the Indian bond market. The motive of regulators behind such push
is to transform the Indian bond market into a much more vibrant trading field
for debt instruments from the elementary market that it was about a decade ago,
but there is still a long way to go. Lately, there have been a number of
changes, which is likely to cause a positive impact.
Until
recently, the Companies (Acceptance of Deposits) Rules, 2014 barred the
corporates from issuing unsecured debt instruments. However, the Ministry of
Corporate Affairs (‘MCA’) vide notification issue on 29 June 2016 issued the
Companies (Acceptance of Deposits) Amendment Rules, 2016 (‘Amendment Rules)
thereby providing relaxation with respect to issuance of corporate bonds by
excluding listed unsecured non-convertible debentures (NCDs) from the
definition of deposits. Earlier, corporates, other than financial entities,
were allowed to issue either secured bonds or bonds compulsorily convertible
into equity within a period of five years from the date of issuance, anything
apart from the said were treated as deposits. However, RBI allowed NBFCs to
issue unsecured NCDs with a maturity of more than one year and minimum
subscription amount being Rs1 crore per investor.The Total Investment
& Insurance Solutions
Enabling Provisions by RBI
The RBI, on
29 September 2015, vide circular RBI/2015-16/193 has issued guidelines allowing Indian
companies, Real Estate Investment Trusts (REITs) and Infrastructure Investment
Trusts (InvITs) to issue rupee-denominated bond overseas. The Total Investment
& Insurance Solutions
As per the
guidelines, the issue size by an eligible borrower has been restricted to $750
million under automatic route. The regulator also mentioned a minimum maturity
period of five years. However, RBI, on 13 April 2016, vide circular RBI/2015-16/372 had reduced the tenure of such bonds to three
years and allowed borrowing up to Rs5,000 crore under the automatic route.
According to the RBI, the masala bonds can only be issued in a country and subscribed
by a resident of a country that is a member of Financial Action Task Force
(FATF) or a member of an FATF-style regional body. The country should have
strategic anti-money laundering or combating the financing of terrorism
deficiencies to which countermeasures apply. The Total Investment
& Insurance Solutions
Reason to invest in masala bonds
The
following are the reason to invest in masala bonds:
• The Ministry of Finance has
slashed the withholding tax on interest income of masala bonds to 5% from 20%,
making it lucrative for investors. Also, capital gains from rupee appreciation
are exempted from tax.
• On a global scale, there is
abundant liquidity because of lower interest rates in developed markets, but
there remain very few investment options due to weak conditions of the global
financial market. India, along with China amongst others, is that rare
fast-growing large economy, so investing in masala bonds is one of the rare
ways for investors to take advantage of this. The Total Investment
& Insurance Solutions
Reason to issue masala bonds
The
following are the reason to issue masala bonds:
• It helps the Indian companies
to diversify their bond portfolio as previously they one issued corporate
bonds. Masala bonds are an addition to their bond portfolio.
• It helps the Indian companies
to tap a large number of investors as these bonds are issued in the offshore
market.
• Masala bonds will help in
building up foreign investors’ confidence in Indian economy and currency which
will strengthen the foreign investments in the country. The Total Investment
& Insurance Solutions
Cost of funds
Borrowing
from overseas is at low cost however hedging is made mandatory in the country
and the cost of hedging is very high. The reduction in minimum tenure from five
years to three years could have possibly been an indicator to reduce the cost
of hedging, thus reducing the cost of issuance for Indian issuers. While, the
cost of external commercial borrowings is around LIBOR + 150 bps but the
hedging cost is as high as 6%-7%, which does not incentivize the borrowers to
avail funds from overseas. Here, the investor has been allowed to hedge their
exposure in Rupee through permitted derivative products with AD Category - I
banks in India.
Indian
Companies desirous of playing safe and not having the natural hedge advantage
like that of Reliance Industries Limited, who service the debt obligations in
US dollars with the export proceeds in the same US dollars, would ebb from
issue of ECBs and plumb towards masala bonds should the cost of such borrowings
turnout up to be lower than that of Indian banks as well as under the ECB route
with forex risk added to it.
Consequent
upon issue of masala bond to offshore markets, the Indian corporates will
reduce their interest cost burden on the raised debt amount. Also, the funds
raised can be used for infrastructural development in the country ultimately
leading to the development of the nation at a global level. For this, RBI must
be lauded for coming up with yet another avenue for raising international
finance for Indian corporates.The Total Investment & Insurance
Solutions
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