Masala Bond requires additional masala for lenders to get excited

Masala bond is an additional way of borrowing for Indian entities from foreign markets. The distinctive feature of these bonds is that the bonds are Indian Rupee denominated and so the exchange rate risk is carried by the lender and not the borrower. This particular feature was instrumental in allowing for various relaxations available to borrowers with respect to use of funds raised through masala bond.

The Indian borrowers see this as an opportunity to borrow money in foreign markets at the prevalent market rates. For them, the bonds have the potential to reduce the cost of borrowing as well as provide the flexibility to use the money. The driving force for the lenders to buy these bonds is the ‘India story’.

However, the lenders have a different perspective. Irrespective of ‘India story’, India carries a higher risk and they seek risk adjusted return. Secondly, the lenders have to hedge the exchange rate risk as Indian currency is showing only a downward trend for quite some time. Further, the secondary market for Rupee denominated bonds yet to develop. Form lenders’ perspective there are quite a number of risks and the return on the masala bonds should take care of this. These and related parameters are likely to enhance the cost of borrowing for Indian entities than their expectation.

Another fundamental issue faced by lenders pertains to the option to invest through FPI route. For both, the Masala Bond as well as FPI route the lender carries the exchange rate risk. Further, FPI route may provide withholding tax advantage in case the investment is through countries whose DTAA with India provides this advantage. Further, they have the opportunity to tap the higher domestic interest rates and also provides the much needed liquidity in India. 

Masala bonds are likely to be used by investors unable to use the FPI route and are sold on Indian story. However, to attractive them, some level of balance to be reached w.r.t. the rate of interest. A middle ground between the foreign market interest rates and the Indian domestic rates have to be found.

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