It’s too soon to feast on Masala bonds

HDFC's deal was nearly a year in the making and when it finally hit the market, investors showed up with gusto, allowing the housing mortgage lender to raise Rp30bn ($446m) after exercising a Rp10bn upsize option, thanks to a book that was 4.3x oversubscribed. Demand was such that the company even managed to price inside its recently sold domestic rupee bond.

Needless to say, the borrower deserves kudos for becoming the offshore rupee market's first mover from India, given the numerous other issuers that have also been mulling the sale of Masala debt over the past year.

HDFC took advantage of a good window, coming at a time when Indian bonds have rallied. In addition, it also took advantage of a moderation in pricing expectations among investors.

But behind the euphoria are plenty of unresolved issues that are key for the future of the asset class. And top of the list is the question of withholding tax.

According to Indian regulations, issuers have to shell out 5% withholding tax on their offshore fundraising. That was one of the big reasons behind the absence of issuance as borrowers were simply not willing to shell out that additional cost, especially as the economics in the onshore rupee debt market were more favourable.

Market participants have long been lobbying for a waiver of the tax in a bid to develop the asset class but to no avail. And with HDFC pulling the trigger on its Masala deal before the RBI provides any update on withholding tax, it will be harder for issuers that follow to seek a waiver.

Those in the industry reckon that the fact that HDFC has decided to absorb the withholding tax — in favour of broadening out its investor base — signals to the regulator that other borrowers could also do the same with minimum inconvenience. But that would be a foolhardy assumption to make as the tax significantly adds to an issuer’s fundraising costs.

That’s not to say the market is not open to new deals. Names like privately-owned Adani Transmission and state-owned groups including electricity generator NTPC, Power Finance Corp and Rural Electrification Corp have previously made public their interest in selling Masala debt.

And given the authorities’ ambitions to grow the offshore rupee market, some of the state-backed names will likely follow in HDFC’s footsteps. The question is at what cost?

In addition, while HDFC found solid interest in both the primary and secondary market, with its notes tightening in secondary, that doesn’t necessarily imply the availability of strong liquidity. Non-resident Indians are understood to have played a key role in primary demand, but given they earn their revenues in currencies other than Indian rupee, it is unlikely they can support an endless stream of issuance.

In addition, secondary market liquidity is also no guarantee given the relatively small pool of rupee available outside India.

Admittedly, liquidity can be shored up over time. But that is only possible with more issuance. And more deals will only come if the tax structure for offshore fundraising is relaxed enough to woo more issuers.

The reality is that future trades are like to be few and far between. HDFC may have served up a tasty appetiser, but Masala bonds are nowhere close to offering a feast.