www.ifc.org/ThoughtLeadership Note 30 | January 2017 MASALA BOND PROGRAM – NURTURING A LOCAL CURRENCY BOND MARKET The financing needs of emerging markets are enormous. Sectors such as infrastructure, small business, and housing are vital to a nation’s sustainable development and require substantial financing support. Since these sectors primarily generate revenues in local currency, foreign currency financing may incur a mismatch that can expose emerging market borrowers to exchange rate risk in times of high volatility. Local currency bond issuance is a significant potential option that avoids such risks and can support private sector investment in productive sectors of emerging markets. Of the $590 billion in infrastructure bonds that companies issued The first offshore bond program of $1 billion was launched in in five large non-Japan Asia countries since 1990, 88 percent were October 2013. IFC would issue Indian rupee bonds in the offshore in local currency, with a sharp rise in the local currency financing market for various maturities and bring the proceeds onshore for share since 2001, according to recent Deutsche Bank research. investment in the country. From 2013 to 2014, IFC issued seven This trend toward local currency financing reflects the substantial tranches of offshore rupee-denominated bonds, settled in US economic potential that improved credit quality has brought to dollars and pegged to the rupee foreign exchange rate, for emerging market economies. maturities ranging from three to seven years. Though these bonds were settled in dollars offshore, the dollar return is determined by Yet global investors interested in high-quality emerging market the change in the rupee-dollar exchange rate just as if they were assets available in the onshore bond market still face issues that rupee bonds. This enables international investors to assume the undermine their overall attractiveness. These include the limited exchange rate risk. capacity of local bond markets, cumbersome registration processes, foreign exchange administrative procedures, and Rapid delivery of the program—later named the Masala Bond possible capital controls. As a result, the development of offshore Program—was achieved with high liquidity, despite the local currency bond markets may provide an alternative method complexity of the bond issuance and turbulence in foreign for resolving currency and maturity mismatches, and may also exchange markets. The program was subsequently extended to a help diversify the overall currency market in emerging second phase with longer maturities. economies. IFC issued four tranches of 3-year bonds, one tranche of 5-year bonds, and one tranche of 7-year bonds, for a total of Rs 62 billion, The Masala Bond Program or $1 billion equivalent, in Phase I of the program, which extended from November 2013 to April 2014. In March 2016 IFC The Indian rupee fell to a record low against the US dollar in 2013 issued Rs 10 billion, 10-year bonds in November 2014 and Rs 2 due to capital flight spurred by a severe current account deficit billion, 15-year bonds in Phase II, through a $2 billion offshore and the tapering of quantitative easing by the US Federal Reserve. rupee program. The 15-year tranche of issuance marked the In response, IFC and the Indian government discussed how to longest-dated bonds in the offshore rupee market at the time. IFC support capital market development in rupees, both onshore and also issued the first Green Masala bond (with proceeds earmarked offshore. They decided that IFC would launch rupee bond for specific climate or environmental sustainability purposes), the programs in both the onshore and offshore markets in order to proceeds of which were deployed in a YES Bank green bond. In provide rupee financing sources for IFC projects in India as well March 2016, IFC issued an Rs 300 million Masala Uridashi bond as help develop Indian markets by creating an AAA yield curve. which was sold to Japanese retail investors subscribed in yen, and Following the successful launch of the Masala bond, Bangladesh, the payments were settled in yen. Pakistan, and Sri Lanka have consulted IFC about offshore bond programs. IFC’s first Rwanda franc offshore bond was launched All issuances attracted a diverse investor base. The 3, 5, and 7- in 2015. year maturity issuances all received robust interest from global investors and were oversubscribed. The yields of IFC-issued Meanwhile, observing the strong market reaction, in September Masala bonds were approximately 100 to 190 basis points below 2015 the Reserve Bank of India released new guidelines yields of Indian government bonds for corresponding maturities. permitting Indian entities to issue in the offshore rupee market, for which both state-owned firms and private firms have Asset managers were the main source of funds (74 percent) for expressed an appetite. In July 2016, HDFC Bank, a leading each issuance of IFC Masala Bonds at maturity shorter than 10 housing finance company in India, completed a successful initial years. Private banks stepped in and acted as the second largest corporate Masala bond issuance and Adani Transmission investors in the market for the 10-year maturity issuance. Region- announced a private placement with Credit Suisse —both below wise, US investors dominated investment in the 3 and 5-year their onshore borrowing costs. National Thermal Power issuances. European entities were the biggest investors for Corporation issued a green Masala bond in August 2016 and issuances with maturities longer than 5-years. Indiabulls became the first high-yield Masala bond issuer. The bond proceeds have been converted from dollars to rupees to Many additional issuers are now signaling interest, including finance private firms in India. Specifically, the proceeds of the 10- Power Finance Corp. and Rural Electrification and Indian year Masala bonds were invested in Axis Bank, the leading Railway Finance Corporation, among other private firms. The infrastructure financing institution of India, to support its initial estimates of the rupee offshore bond market were between financing of infrastructure projects. Proceeds of the green Masala $2 billion and $5 billion equivalent by some market bonds have since been deployed in the first green onshore rupee counterparties. Approximately $3.6 billion has been issued to bonds executed by clients such as YES Bank and Punjab National date. Bank Housing Finance. In the medium to long term, a well-established offshore rupee Program Strengths market could incentivize regulators to streamline listing and Overall, the Masala Bond Program succeeded in several respects. disclosure requirements and procedures, eventually leading to a It had a demonstration impact that prompted additional issuances well-developed and liquid domestic bond market that benefits and created an offshore rupee bond market. It also tested both issuers and investors. international markets for potential internationalization of the rupee. For Indian entities, the lack of currency risk with such As a further commitment to support India’s capital market issuances brings greater access to a large global investor base development and finance projects in infrastructure, IFC launched looking for high-quality, rupee denominated assets, which in turn four inaugural tranches of onshore bonds under the Maharaja allows for a larger potential program size to be executed in Bond Program in September 2014 for Rs 6 billion ($100 million offshore markets. And dollar-settled rupee bonds enable global equivalent) with tenors ranging from five to 20 years. To match investors to benefit from India’s strong economic fundamentals the nature of loans to infrastructure projects, the bonds were while avoiding the cumbersome onshore investment route that structured with characteristics of long tenor, amortizing, and the results from foreign portfolio investment quota limits, potential for staged disbursements, as IFC is allowed to repeatedly sophisticated registration procedures, and currency convertibility reissue bonds from the same investors up to a preset amount. This issues. innovative transaction structure greatly eases the process of Program Impact raising funds in the markets to meet infrastructure funding needs. By pioneering the offshore rupee market through the Masala bond, IFC succeeded in setting a pricing benchmark for the market through strategically issuing 3, 5, 7, 10 and 15-year bonds. This paved the way for potential Indian corporate issuers to achieve a more diversified funding source without exposure to exchange rate risk. This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. Non Convertible Debentures (NCDs) Funded by the IFC Masala Bonds (percentage by sector) 3% 7% 3% 5% Microfinance Bank Infrastructure Finance Company 51% MAS Debt and Asset Recovery (DARP) 31% Housing Note: Non-convertible debentures are long-term unsecured bonds that cannot be converted to company equity or stock. They usually have higher interest rates than convertible debentures. investors entering the newly established rupee offshore bond Key Risk and Mitigants market. Start-up Risk for Launching New Product: Taking advantage of its international AAA rating, IFC was able to launch the rupee Liquidity Risk: IFC’s considerable issuance volume of 3, 5, and 7- offshore bond market by offering low credit risk products that year bonds has allowed trading among a sufficient number of attract institutional investors, including pension funds. buyers and sellers to create a liquid market for those bonds. Investors tend to hold the 10 and 15-year bonds and the Masala In addition, IFC’s experience developing offshore local currency Uridashi bonds to maturity, which renders liquidity in those bonds bond markets substantially strengthened the necessary market a minor concern for the market. institutions, further contributing to the success of the program. Foreign Exchange Rate Risk: Though they had to bear the foreign Conclusion exchange rate risk, foreign investors’ concerns about exchange rate stability were alleviated by the strong economic fundamentals The Masala Bond program created an offshore rupee-market yield of India, which had enjoyed a 7.8 percent average annual growth curve stretching from three to 15 years that has deepened India’s rate over a decade. In addition, the approaching Indian general capital market and made it more resilient, and has paved the way election of April 2014 lifted expectations for Indian economic for international investors and domestic entrepreneurs to benefit growth among both international and domestic investors. That from India’s strong economic fundamentals. The international helped restore and boost the appetite for the early tranches of demand for high-quality emerging market assets remains strong— Masala bonds among international investors between late 2013 notwithstanding global financial uncertainties—and will continue and early 2014. Capturing that window of opportunity, the IFC- to support private sector development in emerging market nations through well-functioning onshore and offshore local currency issued Masala bonds received strong interest from global bond markets. investors despite the severe capital outflows due to rupee depreciation at that time. Lin Shi, Strategy Analyst, Office of the Chief Economist – Thought Leadership (lshi1@ifc.org). Credit Risk: Concerns about credit risk were mitigated by IFC’s international AAA rating, which provided comfort to global This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group.