A touch of spice
India is allowing domestic firms to raise rupee-denominated debt abroad for the first time, but companies may need to improve their balance sheets before they can take full advantage.
India has opened the door for companies to sell rupee bonds overseas in an attempt to attract new investors and lower the country’s cost of capital.
Shrugging off its conservative image, the Reserve Bank of India relaxed rules to allow corporate borrowers to issue so-called Masala bonds in late September in a move seen as a measured step towards full currency convertibility.
At least a dozen Indian companies, both state owned and private, plan to enter the market as early as the end of October or November, market sources say.
“The Masala bond market is likely to be opened by investment grade or quasi-sovereign issuers. It will be good to have these as initial issuers as, in the beginning, not many investors will have the appetite to take credit risk along with liquidity and currency risks,” said Rakesh Garg, managing director of global finance for India at Barclays.
“With appropriate FX management, investors can get very good US dollar returns. For long-term investors, the rupee is unlikely to depreciate higher than the interest differential and, hence, will generate positive return.”
So far, the only Masala bond issuers have been two supranationals, the International Finance Corporation and the Asian Development Bank.
IFC has issued around Rs106bn (US$1.6bn) of Masala bonds in tenors from three to 10 years, building a benchmark yield curve.
IFC, the private-sector financing arm of the World Bank, wants to encourage emerging-market companies to borrow in their own currencies and is ready to support other issuers to encourage the Masala market to take off.
“We are happy to offer credit enhancement to companies to access the global market,” said Keshav Gaur, director, treasury client solutions, IFC.
“IFC can also be an anchor investor for a rated or unrated Masala bond offering as long as the end project meets our investment criteria.”
Testing the waters
Initial offerings are likely to be of moderate sizes to allow both issuers and investors to see how the market develops. However, “if the rupee is appreciating and Indian economy is doing well, people will pile into these offerings,” Garg said.
As investors will bear the currency risk of Masala bonds, rules are more liberal than those governing external commercial borrowing (ECB), he points out.
However, Masala bonds fall under the ECB framework applicable to applies to all offshore borrowings of Indian companies, meaning they will face limits to the total amounts they can borrow.
Issuers will be able to raise up to US$750m through Masala bonds under the automatic route (and beyond the usual ECB limits). For further Masala offerings, prior approval from the RBI will be required.
The RBI has allowed Indian lenders to access the new market as arrangers or underwriters of Masala bonds. They, however, are not allowed to be issuers.
Indian banks will also be able to keep up to 5% only of an offering after six months of the issuance. They must also comply with the usual issuer-exposure rules.
However, Masala issuers will enjoy more freedom in the use of proceeds and will be free from any pricing caps – a climb-down from the June draft proposal of a cap of 500bp over Indian government bonds.
Under existing ECB rules, the price cap on dollar borrowings of three to five years is 350bp over six-month Libor, while that on borrowings of more than five years is 500bp over Libor. In late September, the RBI proposed a 50bp cut to the 350bp price cap, but a similar hike to the 550bp ceiling over Libor for long-term borrowings.
Market players say freeing up the cap for Masala bonds will give more flexibility in price discovery and will widen the range of issuers able to target offshore investors.
Some even expect the Masala market to encourage new issuers to come to the capital markets and invigorate India’s shallow domestic corporate bonds segment.
Under the new RBI rules, Masala bonds must have a minimum tenor of five years. There are no end-use restrictions, except for a few limitations. For instance, issuers are not allowed to use the proceeds for real-estate purchases other than the development of integrated townships and/or affordable housing projects.
Proceeds cannot be used to invest in capital markets, including equity. Also, activities prohibited under the foreign direct investment guidelines cannot be funded with proceeds from Masala bonds. The negative list also applies where proceeds are on-lent to a third party.
Issuers are now waiting for some clarity on taxation. Offerings of Masala bonds will be subject to 5% withholding tax, but it is not clear if capital gains and potential currency gains will also be taxed in India.
On the demand side, bankers reckon the appeal of higher returns and a general belief that the rupee will not depreciate markedly over time will make Masala bonds attractive to foreign investors.
“With appropriate FX (foreign exchange) management, investors can get very good US dollar returns. Especially, for long-term investors (five years and beyond), the rupee is unlikely to depreciate higher than the interest differential and, hence, will generate positive return,” said Samir Lodha, director at QuantArt Market, a Mumbai-based forex advisory firm. “Even with some depreciation, Indian rupee offers great carry to investors.”
Lodha says “it will make more sense for investors with long-term views on India to invest in the Masala bonds. In the short term, the rupee may see a spike, but it will bounce back in the long term”.
He sees the odds for sharper depreciation of the rupee in the long term as low because India does not face inflationary pressures, its current account and fiscal deficits are contained, economic growth is sustainably high and political stability supports reforms.
Masala bonds will be denominated in rupees, but the principal and interest will be paid in foreign currency, mostly US dollars, meaning, investors will end up with the currency risk.
So far in 2015, the rupee has depreciated around 2% against the US dollar and was hovering around Rs64.76 in mid-October after a volatile year.
India Ratings and Research, the local arm of Fitch, expects the rupee to be in the Rs64.50-66.25 range against the US dollar before the end of the Indian financial year on March 31 2016.
Foreign investors have been optimistic towards the rupee even in times of uncertainty. In November 2013, when the currency was down 15% against the dollar year to date, 27 investors bought the debut Rs10bn three-year Masala bonds of IFC.
Priced at 7.75% and inside the Indian government benchmark bond curve, the bonds were a safe credit bet coming from an issuer globally rated Triple A, in spite of the currency risk.
Lately, the pro-reform Modi government has further enhanced investor confidence. The government, which came to power in June 2014, has already pleased investors with the unveiling of a host of regulatory measures.
On the macro front, India’s economy is looking up and is likely to be the best performer in the Asian region this year. Analysts expect Indian GDP growth to touch 7.6% in FY16 from 7.3% last year.
Strained balance sheets
With the new regulations in place and investor appetite whetted, the ball is now in the court of Indian issuers. The government wants companies to raise long-term money through Masala bonds, but there may be some resistance.
“Not many investors have a 10-year appetite, but, if they do, they’ll get a lot of opportunities to come out of the investment or appropriately hedge their risk during the period to get at least 4.5%–5.0% dollar returns,” Lodha said.
Nevertheless, he cautions that Indian companies should repair their balance sheets, failing which the new market will remain the preserve of only a select few high-grade issuers.
However, India Inc is highly leveraged, though the top 500 Indian companies are slowly addressing the problem, according to India Ratings. The rating agency says the median leverage (net debt/Ebitda) for these companies has fallen to 4.33x in the current financial year from 4.65x a year ago, the first recorded annual decrease since 2010.
On the other hand, high interest rates and weak earnings have dragged the median interest coverage (Ebitda/interest expense) to 1.56x in the first quarter of the current financial year from 1.64x in FY2015 and 1.84x in FY2014.
On average, two-thirds of corporate Ebitda goes towards servicing interest, the weakest coverage ratio in over a decade, according to Deep N Mukherjee, senior director for corporate ratings at India Ratings.