The Emergence of Rupee Bond

The Emergence of Rupee Bond

Vighneswara Swamy

In his enthralling speech at the Wembley stadium in London, Prime Minister Modi said, “… after James Bond and Brooke Bond, we go to Rupee Bond.” And for the first time, the Indian railways have launched a rupee bond in the London stock exchange. Also, International Finance Corporation has launched an INR 170 crore ($25-million) Masala bond issue, betting on the growing interest in India among international investors, and will help Indian companies issue rupee bonds abroad. Masala bonds (as they are colloquially called) are Rupee bonds issued in foreign markets. There has been a greater momentum following the Reserve Bank of India's recent approval for Indian corporations to issue Masala bond. According to Jingdong Hua, the Vice President of IFC, investors have shown strong demand for global rupee bonds despite the volatility in emerging market currencies. The appetite for rupee bond among international investors is a welcome development. And now, the Rupee bond is on the rise in the international market.

Market making

RBI in 2014 had permitted the International Financial Corporation (IFC) and the Asian Development Bank (ADB), to issue Rupee bonds in the overseas market that was met with a robust demand for such Rupee bonds in the international markets. It was in April 2015 that the RBI allowed the companies to sell rupee bonds overseas and pushed for increased retail participation in the domestic government bond market as well. These measures announced as part of the monetary policy statement were aimed at liberalizing and deepening the financial markets. At the same time, the Indian government has shown determination to fundamentally upgrade infrastructure to increase foreign investment in India. The RBI’s move to allow the firms to sell rupee bonds overseas could open up another avenue for fund-raising without taking on the currency risk typically associated with borrowings abroad.

There has been an upsurge in the overseas borrowings by Indian companies to take advantage of the lower cost of capital in markets like the US and Europe. In 2014, Indian corporates have raised about $30.51 billion via External Commercial Borrowings (ECBs). The cost of hedging the currency risk involved in foreign currency borrowings takes away part of the advantage of lower borrowing costs. With the introduction of Rupee bond, the Indian corporates would now be able to raise ECBs through a rupee-denominated offshore bond with no end user restriction. According to the ECB norms, the currency risk in rupee bond lies with the lender or investor and hence the proposed framework provides for minimal control for these borrowings.

Framework

RBI has permitted Indian corporates to issue Rupee bonds with a minimum maturity of five years at overseas markets within the ceiling of foreign investment permitted in corporate debt of $51 billion.

Eligibility Definition: RBI has stated that any Indian corporate or body corporate, Real Estate Investment Trusts and Infrastructure Investment Trusts are permitted to issue Rupee Bonds. However, Banks, Non-banking Financial Companies (NBFCs), infrastructure or investment holding companies and companies in the service sector, that were otherwise not allowed to raise ECBs are not restricted from issuing Rupee Bonds. However, Indian corporates under investigation by any enforcement authority in India should seek prior RBI approval.

Amount of Issue: The maximum limit that can be raised through the Rupee Bonds under the automatic route has been limited to USD 750 million per annum. In the case of requirements for limits beyond USD 750 million, specific RBI approval is mandatory.

Maturity: Rupee Bonds will have a minimum maturity period of 5 years. The exercise of call and put options, if any, shall only be possible upon completion of the minimum maturity period. The Rupee Bond guidelines use the term "minimum maturity" as opposed to "minimum average maturity" used by the erstwhile ECB regime for foreign debt which implies bullet bonds rather than amortized bonds.

Location and Nature of Issue: The Rupee Bonds can be floated in any jurisdiction that is Financial Action Task Force (FATF) compliant. The issuance of these bonds could be in the form of vanilla fixed rate / floating rate bonds denominated in rupees and settled in a foreign currency (freely convertible) issued in an FATF-compliant financial centers can be issued. Rupee Bonds can be placed privately or listed on stock exchanges in accordance with the host country's regulations.

Conversion rate: As per the draft rules of RBI, for USD-INR conversion, the RBI reference rate on the date of issue will be applicable.

Coupon Rate: RBI stipulates that the coupon on the Rupee bonds should not be more than 500 basis points above the sovereign yield of the Government of India security of the corresponding maturity as per the FIMMDA yield curve prevailing on the date of issue.

Security: Creation of charge on immovable assets, movable assets, financial securities and the issue of corporate or personal guarantees in favor of the bond trustee, in order to secure the Rupee Bonds, is allowed with prior no-objection of the authorized dealer. However, issuance of guarantee or letter of comfort by banks, financial institutions, and NBFCs is not generally allowed for ECBs and may not be permissible for Rupee Bonds as well.

End-Use Restrictions: RBI has stipulated limited end-use restrictions. There are no restrictions on the end use of the proceeds for general corporate purposes, working capital, repayment of rupee debt raised from Indian banks.

Restrictions on Indian Banks: Banks incorporated in India are prohibited from accessing these bonds in any manner whatsoever. In case an Indian bank underwrites an issue of Rupee Bonds, it will not be able to hold more than 5 percent of the issue size after completion of 6 months of the issue subject to applicable prudential norms.

Hedging: An investor in the Rupee bonds is eligible to hedge both the foreign currency risk as well as credit risk through permitted derivative products in the domestic market. The investor can also access the domestic market through the branches of Indian banks abroad or branches of a foreign bank with Indian presence. Such hedging contracted with banks abroad on a back to back basis with AD category-I banks in India will be as per the procedure outlined

International Financial Institutions: RBI stipulates that if an International Financial Institution, of which India is a shareholding member, intends to deploy the entire proceeds of the issuance in India shall not require prior permission for the issuance of Rupee bonds overseas regardless of the amount of issuance. In case an International Financial Institution, of which India is a member, wants to retain the freedom to deploy the issue proceeds in any other member country shall require prior permission from the RBI / Government of India.

Advantages

The launch of Rupee bonds unlocks a new pool of investors for Indian companies to knock though the benefits may initially be mostly confined to large, high-rated corporates that have a proven track record in overseas bond markets.

The offshore rupee bond program offers some significant benefits for the Indian capital markets like:

1)      Imparts liquidity and depth of the offshore rupee market

2)      Helps mustering foreign investors to invest in rupee bonds

3)      Encourages other issuers to offshore markets

4)      Brings in an alternative source of funding for Indian companies

5)      Provides alternate hedging mechanisms for foreign investors

6)      Provision for offer and settlement in dollars to raise rupees from global investors.

Since the rupee bond would be raised in rupees and repayment would also be in the rupee, there is an inherent hedging because the exchange rate fluctuation risk doesn't exist. Permitting companies to issue rupee bonds will transfer any currency risk to the investor rather than the seller. However, there may be a broader set of investors who can invest directly.

The RBI’s move to allow Indian companies to issue Rupee Bonds overseas has the potential to give an unintended boost to the opaque offshore rupee derivatives market, which has been responsible for the currency volatility in the onshore market in the past. Further, since Rupee Bonds would transfer the exchange-rate risk over to the investor from the Indian company, the dollar/rupee non-deliverable forward market (NDF) volume would get an impetus.

Recent Issues

The first set of rupee-denominated global bonds was issued by the IFC in October 2013. The follow up was made by issuance of rupee bonds across different maturities ranging from three years to 10 years in November 2014 with the IFC issuing INR 1000 crore worth 10-year rupee bond listing on the London Stock Exchange. IFC will issue bonds whose principal amounts will be linked to the Indian rupee exchange rate. U.S. dollar proceeds from the bonds will be converted to rupees in the domestic spot exchange market and then invested in India. IFC will convert these bonds from dollars to rupees to finance private investment in India. If these bonds are lapped up by global investors, it would reflect their confidence in the Indian economy and its currency. It will also raise demand for similar products.

The new green bond issued by IFC will be the 12th Rupee Bond to be listed on the LSE is worth 31.5 billion rupees (approximately £31 million). The proceeds will be invested in suitable projects via Yes Bank. Previous issuers include the IFC, the European Bank for Reconstruction and Development and the Inter-American Development Bank. Together, these Rupee Bonds will have raised a combined total of around £1.9 billion to fund Indian infrastructure.

IFCs green Rupee Bond demonstrates the success of Indian Rupee as a new green bond currency and also supports India’s goals to strengthen this important asset class.

Tax Exemptions

The Central Board of Direct Taxes (CBDT), India's apex body on direct taxes, has stated that investors will not face any tax on capital gains on offshore rupee bonds. The capital gains, arising in the case of appreciation of rupee between the date of Issue and the date of redemption against the foreign currency in which the investment is made is exempt from capital gains tax. Nevertheless, in the case of non-resident investors, interest income would attract 5% withholding tax.

Boost to Infrastructure Sector

Rupee bonds will give a boost to infrastructure financing in India. Indian Railways is considering to float green bonds, a first of its kind by the public transporter to fund its clean energy projects to fund its clean energy and energy efficiency focused initiatives in railways.

Conclusion

Deepened, liquid domestic capital markets and access to local currency finance are vital for a booming private sector. The emergence of rupee bond is well-timed and indeed a statement of confidence in the Indian economy. In the immediate prospect, though issuers may not envisage a drop in the cost of raising overseas borrowings, however, the investor pool might widen. The launch of Rupee Bonds has the potential to promote foreign investment in Indian companies and can attract global investors in view of the limited restrictions on the pricing and end use.