(Practice Question: What do you understand by the term ‘masala bonds’? How is the issue of ‘masala bonds’ advantageous to the Indian economy? – 150 words.)

(Why in news: Recently, the government announced measures aimed at checking the rupee’s slide and lowering the current account deficit. One of these is removal of some restrictions on what are known as “masala bonds”, such as doing away with the withholding tax on these bonds.)

What are ‘masala bonds’:

Masala bonds are essentially bonds issued by Indian companies, denominated in rupees, to overseas investors to attract funds for projects, especially in infrastructure.

A brief history:

The International Finance Corporation, the private arm of the World Bank, set the ball rolling on rupee bonds in 2013 (after the currency came under attack) by issuing successive tranches of such bonds. After 2016, many Indian companies such as HDFC, NHAI, REC, IIFCL and NTPC hit the international market with rupee bonds, which became popular as “masala bonds” as foreign investors started buying into these bonds, attracted by the prospect of high growth compared to many other countries.

Advantages of ‘masala bonds’:

Indian corporates have for long borrowed in international credit markets — in the form of loans and bonds, and in various foreign currencies. This always came with the risk of the company having to pay more while repaying its debt, or while servicing the interest on such borrowings if the rupee weakened. By issuing bonds in rupees in the overseas markets, the risk is transferred to investors who sign up for that, taking into account the growth prospects of the country and the issuing company as well as the strength of the rupee. From the issuer’s perspective, it means cheaper borrowings compared to raising funds in India besides diversifying its sources of fund-raising.

The capital raised by many Indian companies through the masala bonds, and which flowed back into the country, helped boost the Indian currency. The broader, long-term aim of countries that issue such local-currency bonds abroad — these are counted as part of the country’s foreign debt — is to gain global acceptance for their currencies and find a wider set of investors, besides ensuring liquidity for their debt offerings in international markets.

Steps taken by the government to make ‘masala bonds’ attractive:

By knocking off the withholding tax of 5% on masala bond offerings in FY19, the government and the RBI hope to make these bonds a little more attractive to foreign investors who could then buy into rupee bonds of Indian firms — and the inflows that result could help check the slide of the rupee and also reduce the current account deficit over time.

Source: The Indian Express