India's rupee bonds lacking spice

India wants foreign investors to fund infrastructure projects via so-called masala bonds but key ingredients are still missing.
Narendra Modi speaks at Wembley
Narendra Modi speaks at Wembley

When Indian Prime Minister Narendra Modi made his first state visit to the UK last November, he referenced fictional spy James Bond to illustrate his attempt to push for greater usage of the rupee currency aboard.

His address at Wembley Stadium in London delighted the crowd of 60,000 and led to high expectations for prompt offerings of so-called masala bonds – rupee-denominated notes sold to offshore investors.

“Bond reminds me of James Bond. Bond also reminds me of Brooke Bond tea. James Bond provides entertainment and Brooke Bond invigorates us,” Modi said at the time.

“But now we need to go beyond entertainment or refreshment. We need development. That’s why after James Bond and Brooke Bond, we go to rupee bond,” he continued.

His lively performance, aimed at raising India’s international profile, went down well with the crowd of expatriates and British Indians. But since then progress to develop the masala bond market has been slow.

There have only been two issuers to date. The International Finance Corporation, a private sector arm of the World Bank, kick-started the masala bond market with a $1 billion issue in October 2013 followed by the European Bank for Reconstruction and Development, a London-headquartered development bank, with a $50 million offering in January 2015.

The Indian government itself has yet to launch its maiden sovereign offshore rupee bond to stimulate investor interest and establish a benchmark – a well-trodden path in the development of other local currency markets.

For example, the first renminbi-denominated offshore bond – so-called dim sum bonds – was issued by China Development Bank in 2007, as part of a longer-term effort by Beijing to reduce its financial dependence on the US and promote greater use of the Chinese currency for investment purposes.

Tax is another hindrance. A 5% withholding tax on masala bonds means raising funds offshore is more expensive than in the onshore market, creating a disincentive for cost-conscious borrowers looking to tap international markets. 

“Issuers are looking to pay what they can get in the local market and they are willing to borrow offshore only if they can get a pricing benefit.” Avinash Thakur, head of the debt origination group in Asia Pacific at Barclays, told FinanceAsia.

“They are willing to pay up a little bit for investor diversification but they will not pay a lot,” he said.


On the demand side, too, liquidity is a problem. Unlike China, which can tap renminbi funds in Hong Kong and Singapore, investors outside India cannot easily access large rupee holdings.

Rupee-denominated bonds’ higher interest rates may make them more attractive to overseas investors. Rupee sovereign bonds, Asia’s best performer for two years in a row, are still the top pick for some global investors. According to Bloomberg data, rupee debt returned 8.1% last year and 16.5% in 2014, as plunging oil prices improved India’s public finances.

“For offshore investors to buy rupee bonds, they are either looking to diversify their dollar/euro holdings to take a currency view or [get] the attractive yield on rupee bonds on a currency unhedged basis,” said Avinash of Barclays.

Benchmark 10-year Indian bonds currently yield 7.5%, higher than the 2.8% yield on Chinese sovereign bonds.

The Reserve Bank of India (RBI) is expected to cut interest rates by another 25 basis points this year to 6.5%, according to the median estimate of economists. Raghuram Rajan, governor of the RBI, cut the repurchase-agreement rate by 50 basis points to 6.75% last September. 

After inflation receded from its 2013 double-digit peak to last year’s lows, economists expect the central bank to further reduce borrowing costs. 

Raghuram Rajan


Rajan had first floated the possibility of masala bonds in April 2015 and in September the regulator issued detailed guidelines. The move to open the offshore rupee market shows that India is trying to find ways to attract foreign capital to fund its infrastructure projects and reduce the country’s over-reliance on bank loans.

At least five blue-chip Indian companies have been actively looking to raise capital in offshore rupees since late last year, but are struggling to come to terms with investors who are demanding higher yields.

“For investors, the main issue is liquidity,” Rishi Jalan, vice president at Citi, told FinanceAsia. “The absence of domestic investor participation is a drain on the liquidity in the masala bond market,” he added.

Currently, onshore investors cannot participate in the offshore market, and issuers are unwilling to pay offshore investors a premium of 50 basis points above onshore rates. These are the key road blocks to pricing the first masala debt from India Inc.

In an attempt to break the gridlock, Dewan Housing Finance Corporation (DHFC), a deposit-taking housing finance company, mandated Barclays, Credit Suisse, Standard Chartered Bank and UBS in early March for an offshore bond denominated in rupees, according to two people familiar with the company.

If successful, DHFC’s offshore debt could pave the way for more issuance. Standard Chartered Bank said the global masala market was likely to be worth between $3 billion and $5 billion over the financial year ending in March 2017.

The Canadian state of British Columbia is also keen to raise money by issuing masala bonds, with plans to raise $150 million for investment in India, state Minister of Finance Michael De Jong said during his visit to the country in December last year.

Geeta Chugh, a senior director at Standards & Poor’s, said finance companies were more likely to be first to issue masala bonds as they lack access to overseas debt markets.

Before DHFC’s attempt to issue the first corporate masala bond, Indian housing finance group HDFC and the Indian Railway Finance Corp met with investors in December and January, respectively. Both failed to strike deals as there was too much of a gap between compensation investors wanted for liquidity and currency risks and what borrowers wanted to pay.

What few masala bond offerings there have been so far have come from supranational issuers such as the International Finance Corp, the financing arm of the World Bank, and European Bank for Reconstruction and Development. 

The IFC raised 2 billion rupees ($30 million) in March through the sale of 15-year masala bonds – the longest tenure in the market to date, setting a pricing benchmark for other potential issuers and extending the masala yield curve.

“IFC has created an offshore rupee-market yield curve that stretches from three to fifteen years, deepening the market and making it more resilient,” Jingdong Hua, vice-president and treasurer at IFC, said in a press release. 

However, it is clear India’s masala finance project has yet to live up to the early hype and more work is needed if is to avoid being Bond villain. 

“Lack of liquidity and the associated high/prohibitive hedging costs are surely concerns,” Vijay Chander, an executive director at Asia Securities Industry & Financial Markets Association, an industry group, told FinanceAsia. “It would have helped if the government had scrapped the 5% withholding tax on masala bonds – something that has not happened.” 

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