Indian government agencies and corporates are looking to revive their funding plans to issue offshore rupee-denominated bonds, also known as masala bonds, after the Reserve Bank of India last week removed the ban on foreign investment.
Indian Renewable Energy Development Agency (IREDA), a state-run power producer, launched a Reg S, five-year green bond issue early on Thursday that could raise as much as $300 million. And at least three other issuers, including Power Finance Corp., India Railway Finance Corp., Rural Electrification Corp., and Shriram Transport Finance are meeting this week with investors in Hong Kong, Singapore, and London, aiming to raise from $150 million to $500 million each, well-placed debt bankers told FinanceAsia.
As one of them put it, foreign investors are keen to buy Indian corporate debt due to expectations of further cuts in interest rates.
The country’s central bank cut its benchmark rate to a six-and-a-half year low of 6% in August in response to slowing economic growth and weak consumer inflation. Bond prices move inversely to interest rates.
“Foreign investors in masala bonds or domestic bonds generally take a view on the interest rate cycle before investing,” Rishi Jalan, a vice-president in Citi’s Asia debt capital markets team told FinanceAsia. “In the masala market, there is little credit differential since most of them are either triple A rated or are quasi-sovereign."
“The latest policy by the RBI to carve out masala bonds from the [Foreign Portfolio Investor] investment limit, Jalan added, "frees up a lot of dry power, which currently translates into $6.5 to $7 billion of new issuance,”
Effective October 3, masala bonds will be removed from the quota system, which currently allows foreign investors to buy Rs2.44 trillion ($51 billion) of rupee debt. This limit has been fully taken up following massive foreign capital inflows after elections in 2014 delivered a market-friendly majority government under Prime Minister Narendra Modi.
There are still some conditions though. The RBI in June imposed a price ceiling on offshore rupee bonds and required the minimum tenor of a masala bond to be at least five years for deals over $50 million. Issuers can only sell offshore bonds that are a maximum of 300 basis points above the government curve, to bring masala bond rules in line with those on external commercial borrowings in other currencies.
So far this year, India has attracted $23.7 billion of investments in debt securities and another $6 billion in equities, helping the rupee to appreciate 5%, making it one of the best-performing currencies in the region.
“A swift policy response and prudent macro picture underpin further liberalisation for foreign investors,” Ajay Manglunia, head of fixed-income at Edelweiss Finance told FinanceAsia, adding that the country’s external debts remain in a comfortable level.
According to RBI’s official data, external commercial borrowings stood at $124.5 billion, accounting for about 26% of the overall $471.9 billion of total external debt in March.
Lingering tax hurdle
Even so, issuing rupee debt offshore can be more expensive for Indian corporates than in the local market because of a 5% withholding tax on international transactions. That’s stopping the market from truly taking off more than 14 months after Housing Development Finance Corp issued the first of its kind, a Rs30 billion three-year note yielding 8.33%.
“The attraction for overseas investors has gradually built up since the HDFC deal last year,” one of the bankers told FinanceAsia. “We expect more government agencies will tap the market in the final quarter of the year.”
“The 5% withholding tax will remain an issue but the pricing gap has narrowed,” the banker added.
IREDA, for example, initially marketed its five-year masala bond at an annualised yield of 7.3%, or about 30bp higher than its onshore bond over the same maturity, in part because the issuer has embedded the 5% withholding tax.
“The development of this funding source is important, given the Modi administration’s push to promote the rupee as a reserve currency and asset class among international investment community,” said a Singapore-based emerging markets-focused fund manager. “It is a fast-growing large economy that no foreign investors can ignore.”
