Why in news?
Recently, the Enforcement Directorate (ED) has issued show-cause notices to Kerala Chief Minister, and others regarding alleged irregularities under the Foreign Exchange Management Act (FEMA) concerning the Kerala Infrastructure Investment Fund Board (KIIFB) Masala Bond issuance.
Key Features of Masala Bonds:
- Rupee-Denominated: These bonds are issued in Indian Rupees, meaning that interest payments and principal repayment are made in INR.
- Issued Overseas: Masala bonds are issued by Indian entities in international financial markets.
- Currency Risk Borne by Investor: A significant feature is that the currency risk (fluctuations in the exchange rate between INR and foreign currencies) is borne by the investor, not the issuer. This is a major advantage for Indian companies, as they can raise funds without being exposed to exchange rate volatility.
- Internationalizing the Rupee: They aim to promote the use and familiarity of the Indian Rupee in international markets.
- Eligibility: Investors typically need to be residents of countries that are members of the Financial Action Task Force (FATF) and whose securities market regulator is a member of the International Organisation of Securities Commission.
- Maturity Period: The minimum maturity period for bonds raised up to USD 50 million equivalent in INR per financial year is generally 3 years, and for those raised above USD 50 million, it's typically 5 years.
Benefits of Masala Bonds:
For Issuers (Indian Entities):
- Access to Global Capital: Allows Indian companies to tap into a larger pool of international funds.
- Reduced Currency Risk: Eliminates the exchange rate risk for the issuer, as repayments are in INR.
- Potentially Lower Cost of Funds: Can offer a cheaper way to raise capital compared to domestic borrowing, especially when global interest rates are low.
- Enhanced Global Reputation: Improves the international visibility and credibility of Indian companies.
For Investors:
- Investment Route: Opens up investment opportunities in the Indian market for global investors who may not have direct access.
- Higher Yields: Can offer potentially higher returns compared to bonds denominated in major developed market currencies, compensating for the currency risk.
- Diversification: Provides diversification benefits from shallow domestic bond markets.
- Less Documentation: In some cases, less regulatory documentation is required compared to registering as a Foreign Portfolio Investor (FPI) in India.
Limitations and Risks:
- Currency Risk for Investors: Investors bear the risk of the INR depreciating against their home currency, which can reduce their returns.
- Regulatory Changes: Periodic policy changes by the Reserve Bank of India (RBI) can affect the attractiveness of Masala bonds.
- Limited Use of Funds: There can be restrictions on how the funds raised can be utilized.
- Sustainability Concerns: As with any emerging market investment, there can be concerns about the long-term sustainability of financing via Masala bonds, with investors potentially being cautious about currency risks.
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