As the name suggests, the Masala Bond is an Indian rupee bond that is issued abroad. Since the bond is denominated in rupees, there is no currency risk and the currency risk taken on by the person who buys the bond and not by the seller of the bond as is the normal case. Masala Bonds became popular product in between but then there have been issues of malpractices that were reported after which the regulations became tougher and companies are now less inclined towards these Masala Bonds. While the idea of raising foreign money via Masala Bonds was first employed by IFC, many Indian companies have followed suit. HDFC, Yes Bank, NTPC and IRFC are among the Indian companies that have raised money through the Masala Bonds route. Masala bonds are a signal of the rising acceptance of the rupee as a global currency and there are global investors that are willing to put their faith in rupee bonds. So what exactly is a Masala Bond and how does it operate.

Let us first look at what exactly is a Masala Bond in the Indian context. A Masala bond is a Rupee bond but is repaid in dollar terms based on the extant conversion rate. Reputed Indian companies are permitted by the RBI to raise money abroad through Masala Bonds but such bonds have to be for a minimum tenure of 5 years. The bonds are issued in rupee terms and the interest and principal repayment happens in dollar terms. The key difference here is that the issuer does not bear the currency risk in this case; but the risk is borne by the investor. This used to be a major problem for Indian companies issuing dollar denominated bonds in the past. For example in 2008 and later in 2013, the INR crashed sharply versus the US dollar. During such times, the depreciation of the INR versus the dollar actually pushed many companies closer to bankruptcy.

Let us understand why the depreciation in the INR versus the dollar actually hits the returns on the foreign currency bonds. That is because the foreign currency bond payments are denominated in dollars. To that extent, the local bond issuer is required to convert rupees into dollars and then pay the bonds. This opens the company to the vagaries of the rupee dollar movement. But first, to understand the relevance of Masala Bonds, one needs to understand the downside risk in dollar denominated bonds through a real example. Assume that Company ABC Ltd. issued dollar denominated bonds to the tune of $200 million at 5% interest rate. The exchange rate at that point of time was Rs.55/$. Thus, the company effectively brought in Rs.1100 crore to be deployed into the Indian business. When the bonds were redeemed 5 years later, the prevailing exchange rate was Rs.69/$. ABC Ltd. will therefore require Rs.1380 crore to repay the $200 million to its lenders. Therefore, apart from the interest that the company has already paid, it will have to shell out an additional Rs.280 crore due to rupee depreciation. Obviously, this is the kind of currency cost that most Indian companies cannot afford.