Masala bonds will be crucial in India's post-Covid development

Masala bonds enable Indian companies to borrow money from overseas without taking on any currency risk. After the Covid-19 crisis, they will play an important role in building the Indian economy.

The development of Masala bonds has been an important part of the Indian economy since their inception in 2014, but the bonds have still not reached their full potential. The huge capital demands of India's infrastructure needs in the coming years can only be met if Masala bonds play a role. The objective of the bonds is to invigorate internal growth, contain current account deficit and, in turn, fund commercial infrastructure projects.   

The effect of the COVID-19 pandemic on businesses' borrowing capacities is undeniable. The year 2020 was uneven with regard to foreign borrowings by Indian entities. With many policy enhancements on their way in the light of the Union Budget 2021 and India aiming to become a $ 5 trillion economy by 2024, more foreign borrowing by Indian companies is likely in the years ahead.

Masala bonds are Indian rupee-denominated bonds issued in the overseas capital market. It is a financial instrument through which Indian entities can raise money from overseas markets in the Indian rupee and not foreign currency, unlike traditional bonds. They form part of External Commercial Borrowing (ECB) in India, which is a way by which Indian entities can borrow money from the overseas market for commercial purposes.

Masala bonds allow an Indian company to diversify its funding sources and reduce its borrowing costs by taking advantage of low interest rate in the overseas market as compared to India. They also allow an Indian company to tap into global liquidity without incurring currency risk. Since these are rupee-denominated and are ultimately settled in a foreign currency, the currency risk falls on the overseas investor.

The Reserve Bank of India (RBI), India's central bank, regulates ECBs by setting limits and restrictions on how much money can be raised, the interest rate charged and the end-use of such funds. In 2019 it revised the framework for ECBs and Masala bonds (the ECB Framework) with the aim of further easing the regulatory constraints.

As a general rule, all ECBs can be raised under the automatic route, that is the ECB Framework does not set out any requirement for prior approval of the RBI for issuances of Masala bonds. However, if any requirements set out under the ECB Framework are not met, prior approval from the RBI will be required before the bond can be issued. 

The ECB Framework allows a range of companies to issue Masala bonds, including all companies eligible to receive foreign direct investment (FDI), including port trusts, units in special economic zones (SEZs), Small Industries Development Bank of India (SIDBI) and EXIM Bank of India.

The lender or subscriber of Masala bonds should be a resident of a country that is compliant with the Financial Action Task Force (FATF) or International Organization of Securities Commissions (IOSCO, or a country that is a signatory to bilateral Memorandum of Understanding with the Securities Exchange Board of India for information sharing arrangements. Multilateral and regional financial institutions where India is a member country will also be considered as recognised lenders. Individuals as lenders can only be permitted if they are foreign equity holders or for subscription to bonds or debentures listed abroad.

According to the ECB Framework, Masala bond proceeds can be used for any purpose including working capital, general corporate purposes, on-lending by Non-Banking Financial Company (NBFC), or the repayment of rupee loans, provided that the borrowing meets certain Minimum Average Maturity Period (MAMP). They cannot be used for investment in capital markets or equity investment, or for real estate activities that include the purchase or sale of land, except where this involves the development of townships or affordable housing projects.

The Minimum Average Maturity Period (MAPP) for ECB is generally three years, with any call and put options to be exercised only after the completion of MAMP. However, certain specific categories of ECBs for which the ECB Framework provides different MAMP.

Masala bonds have to be structured as plain vanilla rupee-denominated bonds issued overseas, which either can be placed privately or listed on exchanges as per the host country's rules and regulations.   

$750 million a year under the automatic route can be borrowed by the Indian entity without any prior approval of the RBI. Prior approval of the RBI is needed for borrowing beyond that.

Under the ECB Framework there is a pricing restriction for Masala bonds: the all-in costs of an issuance must be 450 basis points over the prevailing yield of the benchmark government bond of the corresponding maturity.

Investors can hedge their exposure in rupees through permitted derivative products with banks in India which are licensed by the RBI to buy and sell foreign exchange for specified purposes.  

Co-written by Ishan Zahoor