Masala bonds are rupee-denominated bonds or debt instruments issued by Indian corporates to raise money from foreign investors for different projects. Earlier, corporates relied heavily on platforms such as external commercial borrowings or ECBs for overseas credit but faced acute currency risk, wherein the funds have to be raised as well as repaid in dollar terms. And in cases, where an entity raising money or issuing bonds has largely rupee earnings, the risk amounts to be huge if the bond issuance and repayment are years apart as currency fluctuates sharply.
How masala bonds work?
Say for instance the Indian entity issues masala bonds worth Rs. 10 billion with a promise to repay Rs. 11 billion in a year. And as the Indian currency has limited convertibility, overseas investors will extend dollar equivalent of Rs. 10 billion which after a year has to be paid back by the Indian corporate with interest to the investor as dollar equivalent of Rs. 11 billion. Notably, herein the currency risk lies with the investor.
Why these bonds are referred as 'masala bonds'?
The 'masala' tag was given to such rupee-denominated bonds by IFC to provide an Indian side to it. IFC or International Finance Corporation, the investment arm of the World Bank, issued a Rs. 1,000 crore bond to fund infrastructure activities in India for the first time in 2013. Similar names are given to bonds issued in other currencies, for instance- Japanese yen-denominated bonds are named Samurai whereas Chinese yuan-denominated bonds issued by IFC are named Dim sum bonds.
Later, companies including the likes of NHAI, HDFC, IIFCL, NTPC and REC issued masala bonds.
Recent relaxations introduced by the government on masala bonds
To curb rupee's further free fall and rein in ballooning current account deficit, Arun Jaitley who recently took over finance minister duties after undergoing kidney transplant surgery said that it has been decided to withdraw the withholding tax on such bonds issued till March 2019. At present the withholding tax stands at 5%.
Also, restrictions with regard to marketing and underwriting of masala bonds on Indian banks will be removed.
It is worth mentioning that so far in this fiscal year no masala bond has been issued.
How masala bonds can boost the weakening Indian currency?
In a scenario when the rupee is stable, offshore investors subscribe to these rupee-denominated masala bonds for substantial returns. But as in the current situation that lends high volatility to rupee, investors shy away from taking fresh positions or step up their investments in rupee-denominated assets.
Nonetheless, funds raised by Indian corporates by issuing such rupee-denominated bonds flow back into the country, which thus provides strength to the currency.