What are masala bonds?

Masala bonds are rupee-denominated bonds issued outside India by Indian entities to raise funds from international markets. They are named after the Hindi word for spices and represent India's distinctive approach to global fundraising.

Those wondering 'what is a masala bond?' should know that the term reflects the Indian flavour these bonds bring to international debt markets.

Since their 2014 introduction, masala bonds have gained traction among Indian corporates, financial institutions, and public sector undertakings seeking to diversify funding beyond domestic markets. Let's discuss the masala bonds meaning in detail.

What is a masala bond?

The simple masala bond definition is that it is a debt instrument denominated in Indian Rupees (₹) but issued and traded in overseas capital markets. It encompasses securities that allow Indian entities to borrow from international investors while keeping the currency risk with the investors rather than the issuers.

Masala bonds were first introduced by the International Finance Corporation (IFC) in November 2014, which raised ₹1,000 crores to fund infrastructure projects in India. These bonds established a new pathway for Indian companies to access global capital.

In 2015, the Reserve Bank of India (RBI) formalised the framework for what are masala bonds, enabling more Indian entities to tap into this funding avenue while maintaining regulatory oversight.

Features of masala bonds

The distinctive characteristics of masala bonds include:

• Denomination in ₹: Both principal and interest payments are made in Indian Rupees, transferring currency risk to investors
• Eligible issuers: Indian corporates, Non-Banking Financial Companies (NBFCs), and Public Sector Undertakings (PSUs) can issue these bonds
• International listing: These bonds are listed on global exchanges like the London Stock Exchange (LSE) and Singapore Exchange (SGX)
• Maturity requirements: Minimum original maturity period of 3 years with no specified maximum limit
• Conversion restrictions: Can be secured or unsecured, but cannot include equity conversion options
• Size requirements: For bonds up to USD 50 million equivalent in INR per financial year, the minimum maturity period is 3 years, with no prescribed maximum
• Investor eligibility: Foreign portfolio investors, Non-Resident Indians (NRIs), foreign central banks, and international organisations can invest
• Taxation: Interest income is taxed at 5% for non-resident investors, subject to certain conditions

Usage of proceeds from these bonds

The funds raised through masala bonds support various corporate objectives, though with certain restrictions. Indian companies can utilise these proceeds for business expansion, infrastructure development, working capital requirements, and general corporate purposes.

The masala bonds' meaning extends to their role in financing long-term projects that contribute to India's economic growth.

However, RBI regulations prohibit using these funds for:

• Real estate activities (except for affordable housing and integrated township development)
• Land purchases
• Capital market investments
• On-lending to other entities

These restrictions ensure that capital flows into productive sectors of the economy rather than speculative ventures.

Types of masala bonds

Masala bonds come in various forms to suit different requirements:

• Plain vanilla masala bonds: Standard bonds with fixed interest rates and maturity periods, commonly issued by established corporates.
• Green masala bonds: Specifically designed to fund environmentally friendly projects, particularly in renewable energy, sustainable transportation, and water management sectors
• High-yield masala bonds: Issued by lower-rated entities offering higher interest rates to compensate investors for the additional risk
• Structured masala bonds: Customised bonds with special features like step-up/step-down coupon rates or call/put options
• Perpetual masala bonds: Bonds with no fixed maturity date, typically issued by financial institutions to strengthen their capital base
• Municipal masala bonds: Issued by local government bodies to fund urban infrastructure projects
• Asset-backed masala bonds: Secured by specific assets, providing additional security to investors

Each type serves specific financing needs while adhering to the fundamental principle of rupee (₹) denomination.

Benefits of masala bonds

Now that you know the masala bond meaning, here are some of its advantages:

For Issuers

• Diversification of funding sources: Reduces dependency on domestic markets, broadening the investor base
• Currency risk mitigation: Masala bonds eliminate foreign exchange fluctuation risks as repayments are in rupees (₹)
• Global market access: Establishes presence in international capital markets, enhancing corporate visibility
• Competitive pricing: Often achieves better pricing compared to domestic markets due to wider investor participation
• Flexible structuring: Allows customisation in terms of tenure, coupon rates, and other features

For Investors

• Exposure to the Indian growth story: Provides direct access to one of the world's fastest-growing economies
• Attractive yields: Masala bonds generally offer higher returns compared to bonds from developed markets
• Portfolio diversification: Adds an alternative asset class to investment portfolios
• Liquidity: International listing ensures trading opportunities on global exchanges

Limitations of masala bonds

Despite their advantages, masala bonds face challenges. The primary limitation is currency risk, deterring investors during rupee volatility. The nascent market means limited liquidity compared to dollar-denominated securities.

Regulatory restrictions on end-use and minimum maturity constrain issuer flexibility. Issuance costs, including legal fees and listing expenses, can be substantial, especially for smaller entities. Investor familiarity with Indian market dynamics is limited, requiring extensive marketing for successful issuances.

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