Masala bonds less palatable after rate cut

Mumbai: The 75-basis-point emergency interest rate cut by the Reserve Bank of India late in March has taken the shine off Masala Bonds — an offshore rupee-denominated debt instrument — for foreign investors.

While the lower coupon rate on these bonds after the monetary easing does not make the cut at many overseas funds, the spectre of higher taxes could dash the appetite for this product.

Masala bonds are issued by Indian entities on a foreign platform such as London Stock Exchange (LSE). The bonds were originally introduced in 2014 to help India stem the weakening of the rupee.

These rupee-denominated bonds carry interest rate up to 5 per cent over and above State Bank of India’s base rate. After the rate cut by RBI in March, SBI’s base rate has fallen from 8.45 per cent to 8.15 per cent. This means the highest rate that masala bonds can offer has fallen to 13.15 per cent from 13.45 per cent.

Market participants say while bigger and well known names such HDFC or NHAI manage to find investors at single digit coupon rates, lesser known companies find it difficult to get investors unless they fork out double digit coupon rates.

“Any further tax burden on masala bonds will likely drive overseas investors away from this product especially when risk-off sentiment and flows to emerging markets resumes globally,” said Ajay Manglunia, head of fixed income at JM Financial. “A volatile exchange rate and lack of appetite by FPIs in emerging markets has already dampened interest for masala bonds that see little or no new issuances now a days.”

Effectively, until mid-March, several deals were happening at around 13.4 per cent interest rates. This is because foreign investors were willing to sacrifice the additional returns as the threshold for availing of a lower tax slab was 13.45 per cent (8.45 per cent + 5 per cent).

If a foreign investor received less than 13.45 per cent returns from masala bonds, the fund was eligible for concessional tax slab of 5 per cent. In case the returns crossed the threshold, the tax slab applicable for FPIs goes up to as much as 15-40 per cent based on the country from which the FPI hails.

“Giving rupee loans to Indian corporates will become less attractive because of the fall in the SBI base rate by almost 90 basis points in the last 4-5 months,” said Rajesh Gandhi, partner, Deloitte India. “This is especially because the concessional TDS rate of 5 per cent is pegged to the SBI base rate plus 500 basis points and most foreign lenders were very close to that limit when the rate was higher.”

“The FPI is facing the double whammy on their returns on rupee denominated bonds, firstly interest rate is decreasing as an offshoot of recession and secondly, the dollar is appreciating,” said Amit Singhania, partner, Shardul Amarchand Mangaldas.