What is Masala Bond? (Detailed Explanation with Example)

In the world of international finance, a flavorful blend of finance and culture has emerged in the form of Masala Bonds. These unique financial instruments have made a mark in the global marketplace since their introduction in 2014 by the International Finance Corporation (IFC). Designed to raise capital for Indian entities from foreign investors while exposing them to India’s thriving economy, Masala Bonds have become a significant player in international finance. In this article, we will explore the concept of Masala Bonds in detail, including their characteristics, benefits, usage, and a comparison with similar bonds like Dim Sum Bonds and Samurai Bonds. We will also uncover when the first Masala Bond was issued in India.

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What is Masala Bond?

Masala Bonds are rupee-denominated bonds issued by Indian entities outside of India. These bonds provide a unique avenue for Indian companies and organizations to raise capital from foreign investors in Indian currency (INR), rather than the local currency of the investor. An excellent example of Masala Bonds in action is when the Indian Railway Finance Corporation (IRFC) issued rupee-denominated bonds in the international market, raising funds for the development of rail infrastructure.

Introduced in 2014 by the IFC, the primary objectives of Masala Bonds are to fund infrastructure projects, promote internal growth through borrowings, and internationalize the Indian rupee. One key aspect to understand about Masala Bonds is that they allow Indian entities to secure funds in foreign currencies while minimizing currency risk for both issuers and investors on a global scale.

Example: Indian Railway Finance Corporation (IRFC) Masala Bond Issue

Imagine the Indian Railway Finance Corporation (IRFC), a government-owned entity responsible for financing railway infrastructure projects in India, is seeking to raise funds for the expansion and modernization of the country’s rail network. To achieve this, IRFC decides to issue Masala Bonds in the international market.

1. Issuance: IRFC decides to issue Masala Bonds with a total value of INR 1,000 crore (approximately USD 135 million at the exchange rate at the time) to attract foreign investors. These bonds will be denominated in Indian Rupees (INR), which is a unique feature of Masala Bonds.
2. Investor Participation: Foreign investors from countries that are members of the Financial Action Task Force (FATF) and whose securities market regulators are members of the International Organisation of Securities Commissions are eligible to invest in these bonds. Additionally, regional and multilateral financial institutions from countries where India is a member can also subscribe to these bonds.
3. Currency Risk: One crucial aspect to understand is that when foreign investors buy IRFC’s Masala Bonds, they are effectively lending money to IRFC in Indian Rupees. This means that the currency risk is borne by the investors themselves. If the Indian Rupee depreciates against their home currency during the investment period, the investors may face losses when converting their returns back to their original currency.
4. Usage of Proceeds: IRFC plans to use the proceeds from the Masala Bond issue for financing railway infrastructure projects, including the construction of new rail lines, upgrading existing infrastructure, and acquiring new rolling stock.
5. Maturity Period: As per the Reserve Bank of India (RBI) guidelines, the Masala Bonds issued by IRFC will have a maturity period of five years since the total value of the bonds exceeds USD 50 million equivalent in INR per financial year.
6. Impact on IRFC: By issuing Masala Bonds, IRFC diversifies its funding sources. Instead of relying solely on domestic financing options, it taps into the global capital market, potentially securing funds at competitive interest rates. Moreover, IRFC can raise significant amounts of capital through this bond issuance, allowing it to accelerate its railway infrastructure development plans.

What are the Benefits of Masala Bond?

Masala Bonds offer several advantages for both investors and borrowers:

For Investors:

1. Higher Interest Rates: Masala Bonds generally provide higher interest rates compared to other investment options, making them attractive to foreign investors seeking better returns on their investments.
2. Confidence in the Indian Economy: Investing in Masala Bonds helps build foreign investors’ confidence in the Indian economy, showcasing its potential for growth and stability.
3. Strengthening Foreign Investments: These bonds foster foreign investors’ confidence in the Indian currency (INR), encouraging more investments in the country.
4. Exempted Capital Gains: Capital gains arising from rupee-denominated Masala Bonds are exempt from taxation, further enhancing the attractiveness of these bonds.

For Borrowers:

1. No Currency Risk: Since Masala Bonds are issued in Indian currency (INR), borrowers are protected from currency fluctuations, as the currency risk is shifted to the investor.
2. Mobilizing Funds: Borrowers can mobilize substantial amounts of funds through Masala Bonds, which can be utilized for various purposes, such as infrastructure projects, refinancing loans, or providing working capital.
3. Portfolio Diversification: Issuing Masala Bonds helps Indian entities diversify their debt portfolio, reducing their reliance on domestic funding sources.

How are the Funds Raised from Masala Bonds Used?

The funds raised from Masala Bonds can be used for specific purposes, including:

1. Refinancing of Rupee Loans: Indian entities can use the proceeds to refinance existing rupee-denominated loans, potentially securing lower interest rates.
2. Development of Integrated Townships and Affordable Housing Projects: The funds can be channeled into initiatives aimed at urban development and affordable housing, contributing to India’s infrastructure growth.
3. Working Capital for Corporations: Businesses can use the funds as working capital to finance day-to-day operations and expansion.

However, it’s important to note that the Reserve Bank of India (RBI) has placed restrictions on the usage of proceeds from Masala Bonds. These funds cannot be used for real estate activities (except approved projects), activities prohibited by Foreign Direct Investment guidelines, investing in domestic capital markets, land purchase, or on-lending to other entities for restricted purposes.

Masala Bonds vs Dim Sum Bonds vs Samurai Bonds:

To better understand the concept of Masala Bonds, it’s helpful to compare them with similar bonds:

• Masala Bonds: These are issued by Indian entities in Indian Rupees (INR) and expose investors to currency risk while protecting borrowers from currency fluctuations.
• Dim Sum Bonds: Issued by Chinese entities in Chinese Renminbi (RMB), Dim Sum Bonds place the currency risk on investors while borrowers are shielded from currency fluctuations.
• Samurai Bonds: Issued by non-Japanese entities in Japanese Yen (JPY), Samurai Bonds shift the currency risk to borrowers, with investors protected from currency fluctuations.

These bonds collectively represent foreign-currency-denominated bonds that entities from one country issue to raise funds in the currency of another country, providing unique opportunities and challenges to both investors and borrowers.

When was the First Masala Bond Issued in India?

The first Masala Bond in India was issued by the World Bank-backed IFC in November 2014. This pioneering issuance raised Rs. 1,000 crore in bonds to fund infrastructure projects in India. Later, in August 2015, the IFC issued green Masala Bonds, raising Rs. 3.15 billion to support private sector investments addressing climate change issues in India.

In conclusion, Masala Bonds have added a distinct flavor to the world of international finance, offering Indian entities a way to access global capital markets while providing foreign investors with opportunities to invest in India’s economic growth. Understanding the intricacies and benefits of these bonds is essential for investors and borrowers alike as they continue to shape the landscape of international finance.