Masala Bonds Just Lost Their Spice

(Bloomberg Gadfly) -- There was a flicker of anticipation last year when an Indian borrower issued the first masala bond, a local-currency note sold outside the country. Gadfly expressed the hope that, once a thorny tax issue was sorted, the securities would go on to become the Indian version of dim sum debt, which has played a large role in internationalizing the Chinese yuan.

But the Reserve Bank of India, now under a different boss, has poured cold water into the curry.

In guidelines issued late Wednesday, the central bank imposed a ceiling on the extra yield (300 basis points over similar maturity government notes) that an Indian borrower can offer investors in London or Singapore. It also barred issuers from raising more than $50 million for less than five years.

Worst of all, it said that investors couldn't be related to borrowers.

India imposes similar curbs on foreign-currency borrowing, but extending them to offshore rupee bonds makes little sense. Money owed to foreigners is far less likely to trigger a financial crisis when the liabilities are in local currency than when the debt to be serviced -- think Indonesia in 1998 -- is in dollars.

The most puzzling showstopper, however, is the requirement that investors be unrelated to issuers. In February, Lianting Tu and Anurag Joshi of Bloomberg News chronicled the innovative structure of a $475 million, five-year bond issue. ReNew Power Ventures Private Ltd., a Goldman Sachs Group Inc.-backed solar power producer, was hamstrung by the RBI guideline that the all-in-cost of such dollar financing should be no more than 300 basis points over six-month Libor. According to the reporters' calculations, the cost of ReNew Power's 6 percent borrowing, excluding transaction expenses, worked out to a little over 400 basis points.

To get over the hump, Neerg Energy Ltd., a Mauritius-incorporated special purpose vehicle, raised the financing, and invested in ReNew, which in turn offered rupee-denominated masala bonds -- which had no pricing restrictions -- to Neerg.

There's nothing dodgy here. Having an additional transaction merely allows credit and currency risk to be unbundled. Investors know all too well that their exposure is to an Indian company, which might get into difficulty servicing its masala debt to the special purpose vehicle, which may then stop paying the dollar notes.

But now the RBI has decided that deals like ReNew's, which showed an encouraging way forward for high-yield Indian issuers, shouldn't be allowed. Under the accounting standard it has chosen, the regulator will probably rule that a company like Neerg, whose sole purpose is to invest in ReNew, is related to the latter and hence not permitted to invest in its masala bonds.

It's time RBI started fighting some real fires. After all, it's also the regulator for banks, which are saddled with $180 billion in bad loans, leaving them with little enthusiasm and even less capital to make new corporate advances. The nascent domestic bond market, meanwhile, is the private borough of large, well-known companies. Out of the $23 billion that Indian issuers have raised since January last year, barely $1 billion has gone to firms offering double-digit yields.

It appears the RBI wants the same large banks and public-sector borrowers to dominate the offshore rupee bond market as well. That's a shame. Deep overseas markets have a craving for yield; and small, fast-growing Indian companies can afford to whip them up without taking on currency risk. A regulator that doesn't believe in letting consenting adults decide the quantum of spice in their masala will never be able to stoke an appetite among investors.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

1. The Neerg innovation followed the RBI's November clampdown on companies raising expensive dollar funds. That time, the trigger was Greenko Group Plc which had used a related offshore entity Greenko Dutch BV to sell dollar debt. In turn, the Dutch company bought the wind power producer's rupee notes. The latter aren't masala bonds because they were sold in India.  

To contact the author of this story: Andy Mukherjee in Singapore at amukherjee@bloomberg.net.

To contact the editor responsible for this story: Katrina Nicholas at knicholas2@bloomberg.net.