Masala bonds

RBI has allowed banks to issue masala bonds which are rupee-denominated bonds issued in offshore capital markets - would ultimately deepen the market for additional tier (AT1) and tier II bond issuance. This measure will help banks in accessing new AT1 and tier 2 capital, given the limited size of the domestic investor pool relative to the scale of the capital needed. Fitch estimates a capital shortfall of $90 billion over next several years as basel III regulatory requirements build from the financial year 2017 to 2019.

In November 2014, the rupee- denominated bond was listed by International Finance Corporation in London to support infrastructure development in India. The Rs 10 billion 10-year Masala bond is the longest-dated paper in the offshore rupee markets. RBI has not resorted to the use of this name in their guidelines. Masala bonds, like any other off-shore bonds, are intended for those foreign investors who want to take exposure to Indian assets, yet constrained from doing it directly in the Indian market or prefer to do so from their offshore locations.

The settlement of the bonds will be in US dollars but since they are pegged to the rupee, investors will directly take the currency risk or exchange rate risks. Settlement is done in US dollars because of the limited convertibility of rupee. Offshore bonds have its own set of advantages and disadvantages for both the issuer and the investor as well as for the economy. Competition from offshore markets may induce improvements in domestic bonds markets such as strengthening of domestic market infrastructure, improving investor protection and removing tax distortions that hinder domestic market development etc.

Against these benefits come the risks associated with financial openness and sudden shifts in capital flows, and the risk that offshore markets may draw liquidity away from the domestic market, according to Arthapedia. The proceeds can be used for all purposes except for the following: I. Real estate activities other than for development of integrated township / affordable housing projects; ii. Investing in capital market and using the proceeds for equity investment domestically; iii. Activities prohibited as per the foreign direct investment (FDI) guidelines; iv. On-lending to other entities for any of the above objectives; and v.Purchase of land, adds Arthapedia.