Masala Bonds – issued overseas in rupees, to stay in tax soup. Is it affecting money raised?

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Updated: May 6, 2016 7:53:06 AM

Despite the demand from Indian industry, the government has no plans right now to remove a 5% withholding tax on income from offshore rupee bonds.

Bankruptcy codeIndian corporates can raise a maximum of Rs 5,000 crore in a year through the bonds under the automatic route. (Photo: PTI)

Despite the demand from Indian industry, the government has no plans right now to remove a 5% withholding tax on income from offshore rupee bonds. “The withholding tax will stay,” a senior finance ministry official told FE, on condition of anonymity.

Corporates, especially those in the infrastructure and energy sectors, including some top PSUs, are keen to issue overseas rupee bonds, popularly known as masala bonds, as these instruments involve a shifting of the currency risk to the investors.

Even though the Reserve Bank of India (RBI) notified the rules for issuance of masala bonds in September last year, several corporates including NTPC, HDFC and Power Finance Corporation chose not to proceed with their planned bond issues due to concerns over the tax burden and liquidity.

Investors are largely reluctant to subscribe to these bonds in overseas markets as they will have bear the tax burden. Also, they feel the current liquidity conditions might not allow them to exit these bonds easily.

The 5% withholding tax effectively reduces the investors’ returns, say, to about 7.6% on a coupon rate of 8%. In addition, foreign investors are understood to have demanded an “illiquidity premium”, citing possible difficulty in offloading their holding due to a lack of buyers. Combined, these two costs would mean the Indian firms would have to offer an interest rate of over 8.5%, which make no sense for them as they could raise money at a lower rate than that in the domestic market.

To make such bonds liquid, analysts say foreign investors should be allowed to offload their holding in the domestic market while domestic institutional investors should be allowed to buy/sell such bonds.

As there were no takers for the bonds, which was aimed at helping corporates in shifting the currency risk associated with foreign borrowings to foreign investors, the RBI tried to address part of the problem last month by reducing the tenure for such bonds to three years from five. The reduction in tenure might reduce hedging cost for investors.

Indian corporates can raise a maximum of  Rs 5,000 crore in a year through the bonds under the automatic route. These are to be issued and repaid in rupees.

Power minister Piyush Goyal had recently said in London that state-owned blue-chip companies including NTPC, Neyveli Lignite Corporation, PFC, Power Trading Corporation and Rural Electrification Corporation would gauge investor appetite for raising $1 billion in the city through masala bonds.

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