Understanding Masala Bonds: A Comprehensive Guide For Investors
Consider this scenario: An Indian infrastructure development company requires funds for expansion. The decision-makers, after carrying out capital analysis, concluded that raising debt capital is in the best interest of the company. The CFO informed the board that the company's existing debt cost is close to 7.5% per annum, and they should be happy to raise additional capital at around the same rate. The CEO wanted to raise funds from overseas investors but was vary of the currency rate volatility.
One of the senior finance managers forwarded the proposal to raise funds through ‘Masala Bonds.’ The chairman of the board and an industry stalwart thought it was another jargon. However, the rest of the board wanted to know everything about this bond category and how it could help the company and the investors.
Origin Of Masala Bonds
The concept of ‘masala’ bonds was introduced in 2014 by the International Finance Corporation (IFC). By using these debt instruments, entities based in India can raise capital from foreign markets while minimising currency risk. These are Indian rupee-denominated bonds settled in US dollars. It is a novel way for international investors to pour money into a comparatively safe debt instrument without currency rate fluctuations.
For Indian entities who wish to raise debt finance and do not want to dilute control (such as in equity capital), this can be an excellent source of capital.
What Are Masala Bonds?
Masala bonds are issued by Indian entities in international markets. Being Indian rupee-denominated bonds means these are priced in INR, but investors pay and receive settlements in U.S. dollars.
The settlement process involves converting the rupee amount into U.S. dollars based on the market exchange rate two days before the transaction date (T-2), according to the RBI reference rate. Due to this mechanism, investors are protected from currency fluctuation during the transaction period. On the other hand, issuers are exposed to international markets without bearing currency risk.
However, masala bonds are not the only country-specific debt instruments. Various other countries have introduced similar bonds, which will be discussed in the next section.
Types Of Foreign Bonds
Bond Type | Country | Description |
Yankee Bond | US | U.S. dollar-denominated bonds issued by foreign entities in the USA. These bonds allow international issuers to access capital from U.S. investors under familiar conditions. |
Samurai Bonds | Japan | Yen-denominated bonds issued by non-Japanese entities in the Japanese market. This enables issuers to diversify their funding sources by tapping into the Japanese financial market. |
Maple Bonds | Canada | Canadian dollar-denominated bonds issued by foreign entities in Canada. Maple Bonds are attractive for issuers seeking to exploit the Canadian investment landscape. |
Kangaroo Bonds | Australia | Australian dollar-denominated bonds issued by foreign entities in Australia. These bonds offer issuers access to one of the Asia-Pacific region's most stable and developed capital markets. |
Baklava Bonds | Turkey | Turkish Lira-denominated bonds issued by non-Turkish issuers in Turkey. Baklava Bonds allow issuers to leverage the growing Turkish economy and its investment potential. |
Matador Bonds | Spain | Euro-denominated bonds issued by foreign entities in Spain. Often chosen by issuers looking to penetrate European markets without the complexities of managing multiple currency exposures. |
Table 1.0: Country Specific Debt Instruments
Hence, foreign bond markets are full of examples of country-specific bonds based on which the Masala bonds have been popularised.
Benefits Of Masala Bonds
Masala bonds offer a wide range of advantages to the issuer entity as well as to the investors. Here is a list of benefits both the parties can receive by exploring this alternative:
Benefit | For Issuing Entity (Indian) | For Investors (Foreign) |
Allows diversification beyond corporate bonds and ECBs, accessing international capital markets. | It provides new investment avenues in the Indian market and is attractive in low-yield environments. It is an excellent tool to enhance bond investment strategies. | |
Cost Reduction | As the interest rate is lower than that of Indian bonds, Indian entities enjoy a lower cost of capital. | Higher yields compared to similar instruments in home countries, with yields between 5% and 7%. (For instance, the US government's 10-year bond yield was close to 4.55%1).
|
Expansion | The issuing entity taps into a broader range of international investors, increasing funding opportunities. | An investor expands the existing portfolio by including international debt instruments. |
Investor Confidence | As foreign investors become part of the Indian entity, it enhances confidence in the Indian economy and its corporate sector, strengthening foreign investment inflows. | Since India is one of the world's fastest-growing and largest markets, investors gain from the country’s economic stability and growth prospects, enhancing return potential. |
Rupee Internationalisation | Supports efforts to internationalise the Indian Rupee, enhancing its global presence. | Participates in the growth and broader acceptance of the Rupee internationally.
|
Higher Returns | Issuers get access to international financing due to the innovative bond structure. | Masala bonds offer attractive interest rates, which can be better than risk-free average returns in the investor’s native country. |
Tax Advantages | There can be lower taxes or exemptions on international financing. | Investors typically enjoy tax exemptions on income from these bonds, depending on local regulations in the investor's country. |
Table 2.0: Benefits of Masala Bonds
Risks Associated With Masala Bonds
Even though masala bonds are a safe investment option, there are a few risks the investor should be concerned with:
Category of Risk | Description |
Currency Risk in Bonds | Due to their rupee denomination, Masala Bonds expose investors to INR/USD exchange rate fluctuations, potentially affecting returns if the rupee depreciates against the dollar. |
Credit Risk in Bonds | Investors face the risk of issuer default. The creditworthiness of the issuing entity is crucial, as a default could lead to financial losses. |
Liquidity Risk in Bonds | Masala Bonds may face challenges in terms of liquidity, which can affect the ability to buy or sell large quantities without significant price changes. |
Table 3.0: Risks of Investing in Masala Bonds
Regulatory Framework
Since Masala Bonds include raising funds from international investors, there are numerous regulators involved in the framework:
- Guidelines by the Securities and Exchange Board of India (SEBI)
- Guidelines by the Reserve Bank of India (foreign exchange)
- Issuance in FATF-compliant financial centers only.
- The minimum maturity of bonds must be 3 years.
- Interest rates for Masala Bonds are capped at 300 basis points above the prevailing yield of Government of India securities of similar maturity
Notable Masala Bond Issuances
Here are some of the most notable masala bond issuances in India:
| Issuer | Year | Issue Size |
| IFC | First Issue 2014 | INR 1000 Crore |
| HDFC | 2016 | INR 3000 Crore |
| NTPC | 2016 | INR 2000 Crore |
| KIIFB | 2019 | INR 2150 Crore |
| ADB | 2021 | INR 300 Crore |
Table 4.0: Major Issuers of Masala Bonds in India
Conclusion
Masala bonds are strategic tools for Indian entities to raise funds from international investors. They enhance India’s financial inclusion in the global market, support infrastructural development, and promote the internationalisation of the rupee, reinforcing India's economic position globally.
For the investors, Masala Bonds offers international investors a valuable opportunity to diversify their portfolios by investing in Indian securities while earning potentially higher returns.
Frequently Asked Questions
1. Who can issue Masala Bonds?
Indian corporates, non-banking financial companies (NBFCs), and Real Estate Investment Trusts (REITs) are eligible to issue Masala Bonds.
2. What is the typical maturity period for Masala Bonds?
The typical maturity period for Masala Bonds is three years, but it can be extended depending on the issuance size and regulations.
3. Can Masala Bonds be traded in secondary markets?
Yes, Masala Bonds can be traded in secondary markets, making them accessible to a broader range of investors.
References
1. Trading Economics <https://tradingeconomics.com/united-states/government-bond-yield>
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