Masala Bonds: An Innovative Financial Instrument

Prof. Ashok Banerjee Download Article

Ashok Banerjee is a senior Professor in the Finance and Control group at IIM Calcutta. He takes several advanced courses in Finance like Corporate Financial Reporting, Corporate Finance, Corporate Restructuring, Quantitative Applications in Finance and Trading Strategies. He is also the faculty in-charge of the Financial Research and Trading Laboratory at IIM Calcutta.

Indian corporate sector borrowed around USD 20 billion in the first nine months of 2015 through external commercial borrowing (ECB) route and none through foreign currency commercial bond (FCCB) route. These borrowings have maturity anywhere between three and ten years.  The major risk that a borrower availing ECB faces is currency risk and Indian banks have, of late, refused to bail out many Indian corporate by way of refinancing. A couple of year ago (2013) a study by CRISIL had put the outstanding foreign currency loan of Indian corporates at over USD200 billion. What was more alarming was about half of such foreign currency exposure was unhedged.

Corporates typically make use of currency swaps and similar financial instruments to manage currency risk.  With the Indian rupee depreciating, the currency risk looms large and this may trigger possible default. In the past Indian firms were able to roll over their foreign borrowings owing to the willingness of the lenders to do so triggered mainly by easy liquidity conditions in the US. However, with the tapering of quantitative easing by the US Fed, such option may no longer be available.  With the devaluation of Chinese currency (Yuan) and fall in Indian currency, the burden of foreign currency borrowing is felt even more now.

Indian firms (mostly financial institutions) have issued US dollar-denominated foreign currency bonds in to the tune of about US$3 billion in the last six months of 2015 (Table) amd a much lower number (102 million Yuan) in Chinese Yuan. One can easily notice that the main motivation for issuing such bonds is very low coupons. But as mntioned earlier, the impact of falling rupee may overwhelm lower coupn rates.

Table: Issue of US Dollar Bonds.

Issuer Name Cpn Issue Date Maturity Amt ($ Million)
IDBI Bank Ltd/DIFC Dubai 4.25 30/11/2015 30/11/2020 350
Videocon Industries Ltd 4.30 30/12/2015 31/12/2020 97.2
ICICI Bank Ltd/Dubai 3.13 12/08/2015 12/08/2020 500
Adani Ports & Special Economic Zone Ltd 3.50 29/07/2015 29/07/2020 650
Reliance Industries Ltd 2.51 26/08/2015 15/01/2026 225
Prakash Industries Ltd 5.35 30/09/2015 01/10/2020 17.85
Adani Ports & Special Economic Zone Ltd 3.50 29/07/2015 29/07/2020 650
Export-Import Bank Of India/London 2.13 06/11/2015 06/11/2020 42.8
ICICI Bank UK PLC 1.45 28/09/2015 28/03/2017 50
ICICI Bank UK PLC 1.10 30/12/2015 29/06/2016 12
Axis Bank Ltd/Dubai 1.63 29/12/2015 29/12/2017 9
ICICI Bank Ltd/Dubai 1.56 04/12/2015 04/12/2018 100
Axis Bank/Hong Kong 0.00 27/07/2015 27/01/2016 20
ICICI Bank UK PLC 1.10 16/12/2015 16/06/2016 10
ICICI Bank UK PLC 1.05 22/12/2015 27/06/2016 10
ICICI Bank UK PLC 1.77 29/09/2015 29/09/2018 5
ICICI Bank UK PLC 1.42 19/11/2015 19/11/2018 5
ICICI Bank Ltd/Hong Kong 0.85 24/09/2015 24/03/2016 20
ICICI Bank UK PLC 1.77 29/09/2015 29/09/2018 5
ICICI Bank UK PLC 0.98 04/09/2015 06/09/2016 10
Total       2788.85

Source: Bloomberg

Therefore, Indian corporate sector was looking for an option to raise money in foreign currency without necessarily bothering about currency risk. Enter Masala Bond!


Masala bond is a term used to refer to a financial instrument through which Indian entities can raise money from overseas markets in the rupee, not foreign currency. These are Indian rupee denominated bonds issued in offshore capital markets.  The rupee denominated bond is an attempt to shield issuers from currency risk and instead transfer the risk to investors buying these bonds.  Interestingly currency risk is borne by the investor and hence, during repayment of bond coupon and maturity amount, if rupee depreciates, RBI will realize marginal saving.  Experts believe that Indian currency is still a bit overvalued. In a way masala bond is a step to help internationalize the Indian rupee.  Investors in these bonds will have a clear understanding and view on the Indian rupee risks. Therefore, a stable Indian currency would be key to the success of these bonds. It is believed that as the investors in a masala bond will bear the currency risk, they would demand a currency risk premium on the coupon and hence borrowing cost for Indian corporates through this route would be slightly higher. It may still be cheaper if one considers the currency risk. Though raised in Indian currency, these bonds will be considered as part of foreign borrowing by Indian corporate and hence would have to follow the RBI norms in this regard. Under the automatic route, companies can raise as much as $750 million per annum through Masala bonds.

Issue of Masala Bonds

The International Finance Corporation (IFC), an arm of the World Bank, issued the first masala bonds in October 2013 as part of its $2 billion dollar offshore rupee programme. However, no Indian corporate has yet issued any masala bond.

Two prospective issuers, India’s largest mortgage lender Housing Development Finance Corp. Ltd (HDFC) and the nation’s largest power producer NTPC Ltd, have been on the road to secure investors for such bonds since last month but are yet to launch their respective issues. HDFC began talking to investors early November while NTPC concluded it’s marketing a week ago.  HDFC initially wanted to raise USD 750 million. However, following its meeting with the investors, HDFC has decided to raise about USD 300 million in the first tranche with a maturity of five years.  NTPC has not yet announced the date and size of its issue.

Pricing of Masala Bonds

The critical factors for the success of such bond are two: (a) coupon rate and (b) liquidity of Indian currency.  India is rated BBB- by global ratings agencies—a notch above junk rating. Sovereign rating will influence pricing of these bonds.  HDFC, for example, had recently borrowed in the domestic market through a three-year bond at 8.35%. HDFC expects to fix a coupon rate at least 10 basis points lower than the domestic rate for the masala bonds. It was observed (see Table) that Indian banks were borrowing US dollar-denominated loan at under 4% in later half of 2015. If HDFC were able to issue masala bonds at 8.25%, it would imply a currency risk premium of above 4% per annum. Overseas investors are yet to decide their preferred coupon rate for the Indian masala bonds. Generally, given the view on Indian currency, investors are expecting a higher coupon from the issuers, which may make these bonds costly for Indian borrowers. This is the main reason holding back issue of masala bonds. If US Fed increases interest rate, that would make Indian masala bonds less attractive.

Allowing Indian firms to raise rupee-denominated loan from overseas market is a step towards full convertibility of Indian currency and the Indian central bank is supportive of this experiment. Despite initial glitches on pricing, masala bonds have potential to raise $5 billion in next two years. British government is wooing masala bond issuers and would like to position London as the global hub for offshore rupee financing.  The success of masala bonds would demonstrate overseas investors’ confidence on Indian currency. In other words, successful issue of these bonds by Indian corporate would imply faith on country’s macroeconomic fundamentals and the central bank’s role in currency management.