The draft framework, released on June 9, is aimed at expanding the scope of issuance of Masala bonds to permit Indian corporates to issue them.
Under the framework, the RBI has laid out the criteria under which corporates and international financial institutions are permitted to issue without prior permission. They also indicate the maximum coupon for corporate issuers of Masala bonds, and the rules largely align with existing ones governing external commercial borrowings (see table).
“There is a lot of demand for onshore rupee bonds — the Foreign Portfolio Investor [FPI] quotas are filling up quickly — so this will create an avenue, particularly for investors that cannot access the domestic market, to gain exposure to Indian debt linked to the rupee,” said Kenneth Akintewe, senior investment manager at Aberdeen Asset Management.
But FPIs who are already active in the domestic market, such as Akintewe himself, find little reason to look at offshore rupee bonds.
“We have invested in the domestic market for many years in the government and corporate space,” said Akintewe. “Given the domestic market has participation by large domestic institutions like the asset liability management companies, the quality of the market will be much better in terms of liquidity and volatility characteristics.”
The offshore rupee market has until now been limited to only a handful of international institutions.
International Finance Corp (IFC) brought the first London-listed rupee issue last November, a Rp10bn ($162.5m) 10 year bond, adding to its three, five and seven year offshore rupee bonds.
The European Bank for Reconstruction and Development (EBRD) and German development bank KfW have also tapped the market.
Pricing concerns
While the lack of deals so far means that the bonds are tightly held, there are worries about how much liquidity would ever be available in an offshore rupee bond market.
“For me, the concern would be liquidity,” said one Hong Kong based syndicate banker. “Even for the offshore renminbi market, which has loads more deposits than the rupee globally, CNH bonds are still suffering from illiquidity issues and investors have a hard time exiting when things go wrong.”
In addition to weak liquidity, with the market supported only by global investors it would also be more susceptible to huge swings of volatility. Adding those two factors up means issuers looking to print Masala bonds would have to pay extra compared to onshore.
“At the moment it’s still too early to tell what sort of pricing we could potentially get from Masala bonds," said Neeraj Seth, head of Asian credit at BlackRock. "But I would expect volatility to be high and there would be a premium, not a discount, to onshore rupee bonds."
India’s weakening currency does not help either. The rupee has lost 1.08% against the dollar since the start of the year and, with the dollar widely expected to go from strength to strength thanks to an improving US economy, issuers will have to factor in the currency risk for investors when it comes to pricing Masala bonds.
“I don’t see a lot of Indian companies rushing to do offshore rupee bonds unless foreign investors are willing to take the currency risk,” said Deep Mukherjee, senior director of corporate ratings at India Ratings & Research.
To cover the costs of hedging, he estimated that at least 7%-8% of forward cover would need to be added to entice investors.
As a result, interest from the corporate sector is likely to be very low, given that BBB- rated corporates are able to issue five year bonds onshore at around 8.5%-9%.
Chicken and egg
Mukherjee added that another impediment to Masala bonds, or Indian bonds in general, was the country’s low sovereign rating — a point echoed by the syndicate banker. India is rated Baa3/BBB/BBB-.
“A lot of the foreign [investors'] mandates don’t allow them to buy low rated issues. And since India’s rating is so low, most of the corporates are naturally lower rated,” the syndicate banker said. “It then becomes a chicken and egg situation, where investors don’t buy low grade issues and the lack of liquidity forces the low grade issuers out.”
For the usage of Masala bonds to expand beyond the few top tier corporates, India will first have to improve its credit rating, market participants agreed.
India Ratings’ Mukherjee also suggested that Masala bonds should also be allowed to be printed in tenors of one year, as opposed to the minimum five year requirement under external commercial borrowing rules. Such a move would align the Masala bond market more with the onshore segment, which is predominantly short dated debt ranging from 12-18 months.
Rays of hope
Still, the RBI’s efforts are not considered completely futile. One India based head of DCM for a bulge bracket firm said the fact that the offshore rupee market was limited to higher rated names should be no surprise since that was in line with the RBI’s goals.
“I don’t get the pessimistic view many others in the market are saying about Masala bonds, because if you’ve been following the RBI closely the past few months, what they’re trying to tackle is to push the large corporates into the bond market and reduce their reliance of banks for funding,” an India based head of DCM said.
“That’s their number one concern right now, and the Masala bond market allows them to do this because it provides the large corporates another avenue for fundraising.”