Masala bonds

The Reserve Bank of India (RBI) has announced different measures to boost investor participation and market liquidity in both the corporate bond and currency markets. Many of the measures are taken from the Khan Committee to develop the corporate bond market
Measures announced are :

• RBI will allow commercial banks to issue rupee bonds in overseas markets — known as Masala bonds, both for their capital requirement and for financing infrastructure and affordable housing.
• The aggregate limit of partial credit enhancement (PCE) provided by banks will be enhanced. The aggregate PCE that will be provided by the financial system for a given bond issue will be increased from the present level of 20% to 50% of the bond issue size, subject to the PCE provided by any single bank not exceeding 20% of the bond issue size and the extant exposure limits.
• Brokers in corporate bond repos will be permitted and the platform for repo in corporate bonds will be authorized.
• It has also been decided to seek suitable legal amendments to enable it to accept corporate bonds under the Liquidity adjustment Facility (LAF).
• In order to ease access to the foreign exchange market for hedging in over the counter (OTC) and exchange-traded currency derivatives, the RBI has allowed entities exposed to exchange rate risk, both resident and non-resident, to undertake hedge transactions with simplified procedures, up to a limit of $30 million at any given time.
• Banks can also allow the customer an open position limit of up to $5 million. This is intended to improve liquidity and depth in the foreign exchange market and the limit will be revised from time to time.
• A working group will be formed to review the guidelines for hedging of price risk by residents in the overseas markets.
• To enhance participation in the corporate bond market, the RBI has decided that brokers authorized as market makers will be allowed to participate in the corporate bond repo market. This measure is expected to meet their funding and securities requirement arising out of market making activities. Currently, banks, primary dealers, mutual funds, insurance companies are only allowed. In addition, foreign portfolio investors have been allowed to transact in corporate bonds directly without involving brokers.
• With an aim to reduce risk in banking sector, RBI has also proposed to limit exposure of a bank to a business group to up to 25% of its capital, down from the existing 55%.

Analysis
How does issuing bonds in rupees help an Indian issuer

• An Indian company or issuer of an overseas bond offering runs a risk on account of currency fluctuation. A weakening of the rupee during the tenure of the bond can, for instance, add significantly to costs at the time of redemption or repayment. By pricing or issuing bonds in rupees, the issuer gets rid of this risk which, instead, passes on to the investor.
• Borrowing overseas can be relatively cheap compared to India, with average costs at least 200 basis points lower. It also offers the promise of a new and diversified set of investors for Indian companies, and more liquidity in exchanges such as London, apart from bank funding and the corporate bond market in India.

Benefit to foreign investors:

• By looking into current situation of India, there is possibility of stable exchange. If currency rate remain stable foreign investors definitely earn more money by investing in bonds than normal investment which revolve around LIBOR (London Interbank Offered Rate or Libor).
• With India’s GDP or national income rising, and projected to grow at a reasonably fast clip over the next few years, many overseas investors would like to buy into such bonds to join the party — and to earn higher returns compared to the US and Europe where interest rates are still low.

Concerns and benefits to India:

• Indian companies have very less risk coverage in abroad due to lack of assets. So if they raise rupee dominated bonds they can park their assets in India. This will help companies to easily raise money. But this will also lead to rise in overall foreign borrowing of India.
• It will also be a sign of early acceptance of the Indian currency in trading and settlement overseas. In other words, this will be an attempt at testing the internationalization of the currency over the medium- and long term, and of the confidence of investors.
• A potential worry for the RBI could be the currency rate setting as issuance grows. Foreign investors may prefer to hedge their rupee investments in the Non Deliverable Forward Market abroad, over which the Indian central bank has no control. Foreign investors prefer to hedge their risks overseas because there are limited products in the Indian market, especially for longer periods.
• The other worry, if the overseas rupee bond market takes off, will be about the growth of the Indian corporate bond market and Indian banks as top companies shift to another market, impacting growth here.

By: Vishal