Masala bonds, not spicy enough

By: and | Published: July 17, 2015 12:21 AM

RBI may consider revising the all-in cost ceilings and the minimum average maturity requirements

RBI has been trying to change the manner in which offshore investors perceive India and has brought forth substantial changes in its policies and regulations.

Recently, RBI kept the promise that it had made in the Bi-monthly Monetary Statement, 2015-16, and invited comments from the public on the draft framework for the issue of rupee-linked bonds, or masala bonds (i.e. rupee-linked bonds issued in overseas capital markets but settled in dollars), by Indian corporates and international financial institutions. Indian corporates had been bullish on the Statement and initial reports suggest such bonds could form a substantial chunk of total foreign currency borrowings that will be availed by Indian corporates in the financial year 2015-16.

Following the success of the issue of masala bonds by the International Finance Corporation (IFC) last year, RBI has now permitted Indian corporates to issue them. But the draft framework has received mixed reactions from the markets. While the issue of such rupee-linked bonds would shift the exchange rate risk onto offshore investors, the draft framework has sought to link the issuance to existing guidelines on external commercial borrowings (ECBs).

Under the current ECB regulatory framework, certain ‘eligible’ borrowers are permitted to borrow from recognised offshore lenders without taking the prior approval of RBI under the automatic route, subject to compliance with three major conditions. These are (1) the facility being availed for specific permitted end-uses; (2) maintenance of a minimum average maturity based on the total amount of the facility; and (3) maintenance of an all-in cost (i.e. the total cost of the facility which includes interests, fees payable in foreign currency) based on the average maturity period of the facility. Those not eligible under the automatic route require prior approval of RBI.

The draft framework proposed by RBI is not as bare as it looks. The central back has tried to lay down certain basic principles for the issuance of rupee-linked bonds, but by making the ECB regime applicable to such issuances, a wide variety of existing ECB restrictions such as end-use, all-in cost, average maturity and the eligibility to borrow/issue have also consequently sought to be made applicable to the issuance of bonds.

The Committee to Review the Framework of Access to Domestic and Overseas Capital Markets had recently provided certain recommendations on the existing ECB framework. It had observed that the numerous restrictions on borrowers, lenders, amount, end-uses, maturity, all-in cost, etc, in the extant ECB framework may have outlived their utility.
For example, in connection with end-use of an ECB, the Committee had observed that the current end-use restrictions have been imposed and relaxed at the same time in an arbitrary manner and are not serving any purpose. Interestingly, the Committee has echoed the views, as provided in the report on the Macroeconomic Framework and Financial Sector Development headed the RBI governor and published way back in 2007. The Committee as well as the 2007 Report had suggested that the end-use restrictions should not be applicable for ECBs. Even though a blanket removal of the end-use restrictions for ECBs may not be currently viable, RBI may in the meantime consider permitting rupee-linked bonds in those sectors in which FDI is permitted. Needless to add, a negative list should be prescribed for end-uses of rupee-linked bonds as the Committee had also noted.

In connection with the all-in cost ceilings and maturity of a loan, the rationale of excluding ‘unreliable borrowers’ from accessing foreign bond market or excessive preventing short-term exposures is well taken. But given that the issuers of such bonds are likely to be some of the better credit-rated corporates, RBI may consider revising the all-in cost ceilings and the minimum average maturity requirements to ensure that offshore investors are given enough incentive to invest in these bonds and Indian corporates are not discouraged from exploring foreign capital markets for their short-term requirements. The parties to the transaction (investor and issuer) should have the flexibility to decide upon cost of a facility and its maturity, and enough headroom should be given to them to decide on this based on their commercial terms.

Also, the attractiveness of the rupee-linked bonds may be examined in light of existing debt instruments such as non-convertible rupee bonds that may be issued by Indian corporates to foreign portfolio investors and NRIs. The current framework applicable to the issue of rupee non-convertible debentures provides greater flexibility to offshore investors and very few restrictions are placed on issue of these instruments vis-a-vis end-use, all-in cost and maturity.

While overhauling the current ECB framework may take substantial time and involve a lot of deliberations on a policy level as well as require greater regulatory-level decision-making, RBI may, while finalising the guidelines, consider having a specific carve out from the ECB restrictions towards rupee-linked bonds. Keeping in mind that many Indian corporates such as the Indian Railway Finance Corporation and the National Thermal Power Corporation have already shown interest in issuing these masala bonds, this may turn out to be a good opportunity for RBI to bring back the offshore investors’ confidence in the Indian market by permitting greater flexibility for these bonds. Having a no-restriction regime may currently be too aggressive but this calibrated move by RBI towards capital convertibility could give a much-needed impetus to the Indian economy.

Wadia is partner and Dutta is senior associate at J Sagar Associates

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