Will masala bonds whet the appetite?


There had not been too many occasions in the past when Prime Minister Narendra Modi hawked a financial instrument to raise money overseas. Modi has done so during his recent UK visit by announcing that India’s railway network would soon issue masala bonds in London to raise funds for its expansion.

Apart from the Indian Railway Finance Corp., the financing arm of the railways, India’s oldest mortgage lender, Housing Development Finance Corp. Ltd (HDFC); the nation’s largest energy conglomerate, NTPC Ltd; and India Infrastructure Finance Co. Ltd are readying to float this rupee-denominated and dollar-settled debt instruments soon. HDFC’s board has approved its plan to raise the rupee equivalent of $750 million through masala bonds, and if it goes ahead, we may see HDFC hitting the market in the first half of December. Investment bankers have already held informal roadshows in some parts of the Far East for NTPC’s masala bonds.

International Finance Corp., or IFC, the private investment arm of the World Bank, was the first to issue masala bonds, listed on the London Stock Exchange. IFC had issued a 10-year, Rs.1,000 crore bond in November 2014 to support infrastructure development in India. The bonds were issued under IFC’s $2 billion offshore rupee programme.

The AAA-rated IFC bonds allowed money managers to invest in India’s growth and earn a 6.3% yield, far higher than what US Treasury Bills offer. Worldwide, the IFC bonds are priced below comparable maturity government yields because they are AAA-rated, while most sovereign ratings are lower. Will Indian corporations—capped by a country rating of minus BBB, the lowest investment grade—be able to raise money at such a fine rate? How much more are they willing to offer to raise money overseas?

Masala bonds are floated overseas and since they are issued in rupees, the currency risk is borne by the investors. Unless they earn a handsome yield that can neutralize the currency risk, why will they subscribe to such bonds?

Typically, an AAA-rated Indian company raises money in the domestic market paying around half a percentage point more than the government paper. This means the cost of five-year money is around 8.25% and that of 10-year, around 8.2%. Such companies will probably be ready to offer around 7.9% or so after factoring in the legal cost, expenses for holding roadshows overseas and the 5% withholding tax, which all overseas issues are subject to. Will foreign investors be willing to pick up Indian papers at this rate?

If investors want to hedge against the currency risk, they will have to spend and, to that extent, their return on investment will be lower. If they don’t do so, a depreciating rupee can erode the return even as they will earn more if the rupee appreciates. By buying masala bonds, the overseas investors will take a bet on the Indian economy. Many say that with inflation under control and interest rates moving southwards, the rupee will remain stable and India represents a far more exciting growth story than many other emerging markets. Hence, one would not need to spice up the masala bonds; it will sell well. My limited interaction with overseas investors says it may not be a cakewalk for Indian companies.

The dim sum bonds—denominated in Chinese yuan and issued in Hong Kong—were attractive to foreign investors until recently as this debt market instrument gave them an exposure to yuan-denominated assets which otherwise they could not do as China’s capital controls did not allow them to invest in domestic Chinese debt. China is now opening up the domestic market, allowing offshore lenders to issue panda bonds, yuan-denominated debt sold locally.

Dim sum bonds succeeded because they did not have to compete with panda bonds and China’s country rating is higher than that of India’s. The masala bonds will compete with the rupee bonds that are issued for foreign investors in India and listed on local stock exchanges. In September 2014, IFC had sold maharaja bonds, to raise $100 million—the first instalment of its $2.5 billion onshore bond programme spread over the next five years—to raise infrastructure finance for India.

However, this was not the first such issue by a foreign investor. In March 2004, the Asian Development Bank had issued a 10-year, Rs.500 crore bond.

The masala bonds will offer an opportunity to those foreign investors who are not registered in India to take exposure to Indian debt. It will diversify the investor base for Indian corporations and, most importantly, its success will internationalize Indian currency. However, it may end up competing with products such as maharaja bonds. Between two markets—overseas and domestic—investors may find the domestic market more liquid.

We will need to see whether the interest for masala bonds is sustained, or after a few signature deals the investors develop cold feet once the novelty factor wears off as had happened with peso bonds in the Philippines. It could also emerge as a seasonal product like dim sum bonds, hot when the view on the currency and economy is positive and cold when it is not.

Postscript: My last week’s column—Bad loans of Indian banks: Is the worst over?—had an error in data collation. Though there is no change in the trend, while computing the year-on-year data (September 2015 on September 2014) got interchanged with the quarter-on-quarter data (September 2015 on June 2015). In absolute terms, the state-owned banks’ gross non-performing assets (NPAs) rose 26.09% to Rs.3.04 trillion in the September quarter from Rs.2.41 trillion in the year earlier. The rise for the private banks has been 33.14%. Overall, gross NPAs of listed banks in the September quarter rose 26.76% to Rs.3.37 trillion from Rs.2.66 trillion in the year earlier. Sorry.

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