Companies that don’t command a very good rating are finding it harder to tap the overseas investors for money after the Reserve Bank of India (RBI) capped the borrowing cost for masala bonds. In June, the RBI stipulated an interest rate cap for funds raised via masala bonds at 300 basis pointss over gilts of matching maturities making the product much like an external commercial borrowing (ECB). Also, while earlier companies could tap the market whenever they wished, they now need an approval from the RBI. That put paid to plans of not-so-highly rated companies, which had been using the masala bond route to tap overseas investors if they failed to borrow via ECBs, where the interest cost is capped at 300 basis points over the six-month LIBOR for a tenure of three years.
Investment bankers say that a couple of years back, the RBI rapped a couple of poorly-rated company on the knuckles for trying to circumvent the ECB guidelines. The modus operandi: First register an offshore special purpose vehicle (SPV), say in Singapore, which raises dollar funds in the offshore market. Since this is an offshore entity, there is no cap on the interest rate. This SPV then registers itself as a foreign portfolio investor (FPI) and uses the funds it has raised overseas to subscribe to non-convertible debentures (NCDs) floated in the domestic market by the onshore entity. No strict penalty was imposed because there was no straightforward violation of the law but the ECB guidelines were circumvented.
However, since FPI licences are not easy to come by, subsequently some companies floated masala bonds, which were earlier not subject to any pricing or approval restrictions. The SPV subscribed to the masala bonds using the funds it raised by issuing dollar bonds.
However, the new masala bond norms have made it difficult for poor quality issuers to mop money overseas since they are not able to offer high interest rates. When it first put out the masala bond guidelines in September 2015, the RBI said the all-in cost of such borrowings should be commensurate with prevailing market conditions and will be subject to review based on the experience gained. In June 2017, the central bank stipulated an all-cost ceiling of 300 basis over the prevailing yiled of government securities of matching maturities.
ECB guidelines require that for borrowings of three to five years, the all-in-cost ceiling be 300 basis points over six-month LIBOR or the applicable benchmark for the respective currency. For a tenure of over five years, the all-in-cost ceiling stands at 450 basis points per annum over six-month LIBOR or the applicable benchmark. Meanwhile, the Securities and Exchange Board of India recently halted further issuances of masala bonds till the investment limit by FPIs in corporate debt fell below 92% of the quota. Unless the RBI increases the quota for corporate debt, very few companies can raise funds via this route. As of now, almost all of the `2.44-lakh-crore limit stands utilised.