20 Oct 2016 17:13 IST

Masala bonds add flavour to FDI policy

This instrument has found more takers now than ever before

With a view to boost the ease of doing business in India and further promote ‘Make in India’ and ‘Start-up India’ initiatives, the Government introduced significant reforms in its Foreign Direct Investment (FDI) policy in November 2015.

These reforms were primarily aimed at attracting more foreign investments through further easing, rationalising and simplifying the process of foreign investments in the country. Since then, India Inc. has witnessed a spurt of foreign equity investment across sectors. Infusion of funds via the traditional equity route has always been available and the most commonly used option for a variety of reasons. It gives investors voting rights and as such, there are no restrictions on the usage of funds raised via this route.

However, while a flipside of equity is that there is no fixed return for equity shareholders, it is the dividend distribution tax which acts as the final pain point. On the other hand, debt options which, typically involve a fixed interest payment and additionally lend potential tax break have always been an attractive but difficult route, especially given the regulatory restrictions around them. The decision of debt vs. equity has never been easy and has continued to intrigue corporates for some time now.

Overseas borrowing

On the debt front, overseas borrowings have always been attractive for Indian Inc. on account of lower interest rates abroad. Typically, such borrowing would always be in foreign currency — in the form of foreign loans, bonds, and debentures.

As a result, though the Indian borrower enjoys the advantage of lower interest rates, the high cost of hedging the risk associated with exchange rate fluctuations cannot be overlooked. And often, currency risk brings the cost of foreign borrowings at par with local borrowings.

Thus, in line with the overall liberalisation and to provide an impetus to India Inc’s borrowing capacity, this aspect of currency risk became the genesis of a financial instrument called the Rupee Denominated Bond, now popularly known as the ‘Masala Bond’.

Adding the masala

In 2015, the RBI introduced a framework for issuance of such bonds. These are Indian rupee denominated bonds through which Indian entities can raise money from overseas markets in Indian rupees, as against foreign currencies. These bonds aim to safeguard issuers from currency risks by transferring the risk to the investors buying into these bonds, which can be placed privately or listed on exchanges.

Interestingly, issue of bonds in the borrower’s local currency is not a new phenomenon. China’s dim sum bonds, Japan’s samurai bonds are similar in nature.

What’s in it for investors?

Masala bonds are a way for investors to participate in India’s growth story and yield higher interest income as compared to interest offered by overseas bonds in the US and Europe. However, at the same time, the currency risk continues to be borne by them.

Regulatory Requirements

Issue of masala bonds is subsumed under the RBI’s External Commercial Borrowings (ECB) policy. Such bonds can be issued to any investor in FATF (Financial Action Task Force) compliant finance centres. Currently, masala bonds can be issued up to ₹50 billion under the automatic route, beyond which it requires RBI’s approval.

The bonds have a minimum maturity of three years. While the RBI requires that the all-in-cost of rupee denominated bonds be commensurate with prevailing market conditions, no guidance has been issued as to the computation of the comparable.

Earlier, there were several restrictions on the end-use of ECBs. But with the passage of time, the ECB route has been opened up for borrowings for several purposes. In line with the ECB policy, masala bonds can be raised for all purposes except for a specified negative list of uses like dealing in real estate sector, investing in capital markets and domestic equity investment. Corporates can issue masala bonds for meeting their fixed as well as working capital requirements, raising project finance, and other similar requirements.


In 2015, the Central Board of Direct Taxes (CBDT) issued a press release, clarifying that a withholding tax of 5 per cent would be applicable on interest paid by Indian corporates on masala bonds. This would be a final tax payable on such interest. This is in line with the present withholding tax regime for interest on off-shore dollar denominated bonds. Complete clarity, by way of amendment in the Income Tax Act, is awaited.

Tax at the rate of 10 per cent (40 per cent if period of holding is less than 24 months) would be payable on the sale of masala bonds. The success of these bonds would demonstrate investors’ confidence in Indian currency, and their willingness to participate in India’s success story.

Recently, in what can be termed as a first for India, Canada’s British Columbia became the first foreign government issuer of masala bonds, raising ₹5 billion over the London Stock Exchange. The proceeds of the bond issue were invested into HDFC’s masala bonds. Canadian Finance Minister Michael de Jong said, “The masala bond issuance offers British Columbia a means to become well-positioned to profile our confidence in the outlook for India, and to participate in the internationalisation of the rupee and India’s economy.”

Increasingly, masala bonds have now found more takers than ever before. Recently, HDFC became the first member of India Inc to raise ₹3,000 crores by issue of Masala bonds in offshore markets. Adani Transmission has also followed suit, and has approximately raised ₹500 crores.

(Neelu Jalan is the Director, M&A Tax, and Vishal Yeole is a manager, M&A, Tax PwC India)

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