Multilateral FIs allowed investing in ‘masala bonds’

• The Reserve Bank of India (RBI) has permitted multilateral and regional financial institutions to invest in rupee-denominated bonds.
• This decision aims to provide more choices of investors to Indian entities issuing rupee-denominated bonds abroad.
• With this, agencies like the Asian Development Bank and the BRICS led New Development Bank can also invest in these bonds.

About Masala bonds

• The term is used to refer to rupee-denominated borrowings by Indian entities in overseas markets.
• The International Finance Corporation (IFC), the investment arm of the World Bank, last year , issued a ?1,000 crore bond to fund infrastructure projects in India.
• These bonds were listed on the London Stock Exchange (LSE).
• IFC then named them Masala bonds to give a local flavour by calling to mind Indian culture and cuisine.

Analysis:

• Masala bonds are issued to foreign investors and settled in US dollars. Hence the currency risk lies with the investor and not the issuer, unlike external commercial borrowings (ECBs), where Indian companies raise money in foreign currency loans.
• While ECBs help companies take advantage of the lower interest rates in international markets, the cost of hedging the currency risk can be significant. If unhedged, adverse exchange rate movements can come back to bite the borrower. But in the case of Masala bonds, the cost of borrowing can work out much lower.
• Masala bonds can have implications for the rupee, interest rates and the economy as a whole. Competition from overseas markets may nudge the government and regulators to hasten the development of our domestic bond markets.
• A vibrant bond market can open up new avenues for bond investments by retail savers. If Masala bonds are eagerly lapped up by overseas investors, this can help prop up the rupee.
• The rising demand for Dim-sum bonds in 2011, for instance, promoted the use of the yuan in global trade and investment. Dim-sum bonds also provided investment avenues for yuan-holders outside of China. With talks of a full rupee convertibility back home, Masala bonds can help the rupee go global.
• But these bonds can have bad after-effects too if companies decide to binge on them. As of December 2014, corporate overseas borrowings stood at $171 billion.
• The recent turmoil in the rupee is already prompting caution on existing foreign loan exposure.
• With our economy still on shaky ground, too much reliance on external debt (even in rupees) can weigh heavily on our rating by global agencies.
• Masala bonds are a good idea to shield corporate balance sheets from exchange rate risks. But they are best used in moderation. The after-effects of too much masala are not pleasant.

By: Vishal