Keeping pace with the sentiment of the investors and making India more attractive for foreign investments/ funds, the regulators have recently introduced a new framework under the External Commercial Borrowing (‘ECB’) regime, called the Rupee Denominated Bonds issued overseas and more popularly known as ‘masala bonds’.

The Reserve Bank of India (‘RBI’) first introduced the regulations for issuance of the rupee denominated bonds overseas in September 29, 2015 and thereafter issued the master directions for ‘External Commercial Borrowings, Trade Credit, Borrowing and Lending in Foreign Currency by Authorised Dealers and Persons other than Authorized Dealers’ which incorporated the framework on masala bonds.

Masala bonds are debt instruments, which can be issued by Indian resident entities in FATF (Financial Action Task Force) member countries and can be placed either privately or listed on exchanges, depending on the regulations of the country in which these bonds are being issued. These bonds, whilebeing part of the overall ECB framework, have been made accessible to a much larger market and in terms of eligible borrowers, any corporate or body corporate is permitted to issue masala bonds, unlike ECBs where only certain categories of borrowers were permitted to borrow. Even the category of investors has broadened and residents ofsuch countries, where the bonds are issued and which countries fulfil the criteria set forth by RBI (which includes countries being members of the Financial Action Task Force and whose securities market regulator is a signatory to the International Organisation of Securities Commission’s Multilateral Memorandum of Understanding or has a bilateral MoU with SEBI), are permitted to invest.

Since the masala bonds are issued in Indian rupees, the foreign currency risk shifts to the investors who are subscribing to or purchasing such bonds. Further, RBI has, in an attempt to keep the terms of masala bonds consistent with corporate bonds and attract investors, recently reduced the minimum maturity period to 3 (three) years (from the earlier 5 years) for these bonds. This also comes with the condition that there cannot be put and/or call options till such period.

Unlike the limited end uses under the ECB route (which were pre-dominantly meant for the benefit of the infrastructure sector), the proceeds from issuance of masala bonds can be used for any purpose, with some limited restrictions. These restrictions include not using the proceeds for real estate activities (other than development of integrated townships/ affordable housing projects), investing in capital markets and equity investments, activities prohibited under the foreign direct investment (‘FDI’) regulations and purchase of land. There is a good case for the real estate development/ construction sector to seek clarification/ guidance from RBI to allow issuance of masala bonds if the conditionalities of FDI regulations are fulfilled. Furthermore, the proceeds from masala bond issuance cannot be used for purchase of land; this uncalled for restriction may also hamper the prospects of Indian companies who may not necessarily be engaged in real estate activities, but may require the funding for acquiring land for other uses (like having their own corporate offices or manufacturing units etc.).

While the good news is that the masala bond regulations do not prescribe for any specific limit on interest and in-fact it states that the all-in cost ceiling will be commensurate with prevailing market conditions, without defining such conditions any further, the test of “market conditions” is yet to be seen. Also, there seems to be some ambiguity on the withholding tax on the interest payments; so a lower tax of 5% (as indicated in a government press release) is certainly attractive, but the lack of clarity on the same has made the investors wary.

As is the case with most new investment structures and regulations (and in this case a new instrument all together), the investors and issuers still seem to be developing their taste for masala bonds and hopefully with this market developing, we may see some successful issuances of masala bonds in the near future.