Despite a lot of initial excitement, the Masala bond market, or offshore rupee bond market, has had a quiet start to life. Only a handful of foreign institutions have sold Masala debt since the market was born at the end of 2014 with Indian names glaringly absent.
Compared to the incredible vibrancy of the Dim Sum market for offshore RMB bonds soon after its launch, the Masala bond market is in danger of disappointing its many supporters.
But if Piyush Goyal is to be believed, this could all be about to change. Meeting investors at the London Stock Exchange in April, India’s union minister of state for power, coal and new and renewable energy said investors could expect to see $1bn of Masala bonds hitting the market over the next three months with issuers such as NTPC, Neyveli Lignite Corporation, Power Finance Corporation, Power Trading Corporation and Rural Electrification Corporation likely to test market appetite.
Meanwhile, Indian Railway Finance Corp (IRFC) has mandated six banks for its first foray into rupee-denominated offshore debt. The bond will have a tenor of five years and has a target size of Rp20bn ($300m). However, the timing of the trade depends on market conditions, according to the issuer.
That final caveat is keeping the champagne corks firmly in their bottles. This is by no means the first time an Indian issuer has flirted with the idea of selling offshore rupee debt. Adani Transmission and Dewan Housing Finance Corp have both expressed interest in selling Masala bonds. Neither has made it to pricing though and, regrettably, IRFC might not either.
WITHHOLDING TAX
The factors that have prevented deals coming to market have not been addressed. The Indian government imposes a 5% withholding tax on foreign investors and this, as well as India’s lack of standing in global capital markets, has led to a yawning chasm between issuer and investor price expectations.
“The issue of withholding tax is still a challenge, as is the fact that offshore investors expect Indian issuers to pay up a significant premium over the yields they offer domestically, especially for new issuers with a triple-B rating,” says Monish Mahurkar, director for treasury market operations at International Finance Corporation in Washington DC.
There are two big attractions in the Masala bond market for Indian corporations: they gain access to the global investor base; and avoid currency risk by funding in their own currency.
However, for blue chip state-owned enterprises, the pricing they achieve in the domestic market is typically very sharp. This has led many of the top quality issuers to baulk at the yields international investors expect. “These high quality, blue chip quasi-sovereigns are used to achieving sharp pricing domestically so there is some difficulty in meeting investors’ yield expectations,” says Mahurkar.
The Reserve Bank of India is doing what it can to ease the process of price discovery, reducing the minimum maturity for Masala bonds from five years to three years. “The Reserve Bank of India’s decision to shorten the minimum tenor for Masala bonds is a clear signal that they want to see the market grow,” says Mahurkar.
“It will help with price discovery because the premium that issuers will have to pay up is easier to swallow with a three year tenor. The same is true of investors: compromising on yield is easier with a shorter term.”
IRFC’s deal though, has a five year tenor and will therefore have all the old problems. However, despite the elephant of price discovery remaining in the room, there is a growing acceptance among Indian issuers that accessing the foreign investor base in their own currency is an opportunity worth paying for, at least in the short term.
“Issuers are beginning to realise that this is a strategic market that potentially offers a completely new group of investors for rupee financing,” says Mahurkar. “There is a growing sense that it might be worth paying up at first. As they build a presence in the market that will allow them to tighten pricing towards their domestic levels.”
If an issuer steps up and takes the initial hit to bridge the pricing gap, market participants believe that the Masala bond market could take off quickly and make up for lost time.
“Once you have an issuer willing to concede the premium investors are demanding, they will get the ball rolling and other issuers will follow suit,” says Sameer Rehman, director, fixed income origination and syndication at TD Securities in London.
“There is pent-up demand for rupee assets. The Indian rupee is very much a restricted access market and when the government increases quotas, they are filled very quickly. The fact that the IFC developed a liquid curve over a wide range of maturities in such a short time speaks to the strength of demand for rupee exposure.”
SMOOTHING TRANSITION
As an emerging market currency play, the Indian rupee has been a solid investment. Despite a rocky start to 2016, the rupee has performed well relative to other emerging market currencies.
In fact, the rupee has scarcely deviated from the Rp64-Rp67/$ range since the IFC entered the market in 2014. The IFC priced the market’s first deal in November 2014 raising Rp10bn via 6.4% notes.
A stable, if still low oil price allowed the currency to gain back much of its earlier losses. “Part of the reason the currency has outperformed its EM counterparts is that it is not as strongly correlated with commodity prices,” says Rehman.
While the IFC has had remarkable success in developing a functional Masala bond curve in order to attract offshore investment to India, its triple-A credit rating means that the investor base is interested primarily in exposure to the currency. Getting investors to make the leap into Indian credit exposure is the next step.
According to Mahurkar, the IFC’s investor base is not too dissimilar from the prospective investors in Masala bonds from Indian issuers, despite the disparity in credit quality.
“Broadly, the investors for IFC paper and potential Indian issuers are fairly similar: global institutional investors looking for diversity and yield,” he says. “IFC paper gives exposure to long-term rupee investment. For Indian issuers, it is a large subset of those investors looking to add credit exposure.”
The IFC is attempting to smooth investors’ transition from pure currency risk to additional credit risk by offering credit enhancement to boost single-B or double-B issuers to triple-B status and allow them to access the markets without paying a prohibitively high yield. This allows investors to gain exposure to interesting Indian credits with the backing of the IFC. The IFC is also able to provide anchor investments to support new issuers. “IFC would be interested in providing credit enhancements or anchor investments to support some of these new issuers,” says Mahurkar.
SECOND TIER CREDITS
Although the London Stock Exchange, the largest centre for Masala bonds in the world, has publicly supported the market’s transition to domestic credit, its focus has been primarily on the top level of blue chip Indian corporations as the likeliest source of a maiden Masala bond.
Intuitively, it makes sense: the biggest obstacle to attracting investment is the uncertainty of Indian credit so, to minimise that, it seems only natural to look to the top level of Indian credits — the blue chip quasi-sovereigns like IRFC and Dewan Housing Finance Corporation.
But there is another, perhaps more fruitful, section of potential Masala issuers. Corporations in the second tier, below the triple-B rated state owned enterprises, do not have the same efficient and cheap access to domestic capital markets.
Without a well established domestic curve of tight funding, second tier companies may be more willing to meet the yield expectations of international investors.
“The next tier down from the top-notch quasi-sovereigns may actually be more likely to access the Masala bond market,” says Mahurkar. “They don’t have the same level of access to the capital markets in India and so may be prepared to pay up in order to diversify their funding sources. Obviously investors have to be happy with a greater degree of credit risk but price discovery might be an easier process.”
Infrastructure financing in particular is tipped for growth. Many Indian banks, whose balance sheets are hampered by legacy non-performing asset problems, are ill-equipped to provide the capital to infrastructure projects.
As a result, the companies behind the projects, while unlikely candidates for the maiden Masala issues, will be looking to the offshore rupee market for support. “Once the market gets going, I expect infrastructure financing to be an area of growth, says Mahurkar. “These companies may well turn to the Masala market.”
“Solar power is a particular area [of infrastructure financing] which could interest the international investor and would be an excellent sector for green Masala issuances as well,” says Mahurkar. IFC has paved the way here, introducing green funding to the Masala market with a Rp3.15bn five year note sold in August 2015.
Green bonds are sufficiently well established that adding a green component to a Masala bond issue is more likely to expand the investor base than reduce it. “The EM SRI investor base is still modest but issuers like IFC are helping to grow the market,” says Rehman.
While the main dish of a triple-B rated state-owned issuer may be on hold, investors will be hoping that borrowers further down the credit curve and in sectors such as infrastructure will bring out some appetisers to get the Masala bond market off the back burner.