Model Answer

In an increasingly globalised financial system, emerging economies like India require diversified and stable sources of external capital. Traditionally, India has relied heavily on External Commercial Borrowings (ECBs) and foreign currency loans, which expose borrowers to exchange rate volatility. To address this challenge and strengthen India’s global financial integration, Masala Bonds were introduced as an innovative debt instrument that enables Indian entities to raise funds abroad while mitigating currency risk. What are Masala Bonds? Masala Bonds are rupee-denominated bonds issued overseas by Indian entities, where the principal and interest are payable in Indian rupees. Unlike conventional foreign currency bonds or ECBs, the currency risk is borne by the foreign investor and not the Indian issuer. The concept was first operationalised in 2014 when the International Finance Corporation (IFC) issued the world’s first Masala Bond worth ₹1,000 crore. Subsequently, in 2015, the Reserve Bank of India (RBI) formally permitted Indian entities to issue rupee-denominated bonds overseas under its external debt framework. Objectives of Masala Bonds

1. Reducing Exchange Rate Risk for Indian Borrowers A major objective is to shield Indian issuers from forex volatility. Since repayment is in INR, depreciation of the rupee does not inflate debt servicing costs, unlike in dollar- or euro-denominated borrowings.
2. Diversification of External Financing Sources Masala Bonds provide an alternative to ECBs and domestic bond markets, enabling Indian corporates, NBFCs, and infrastructure entities to tap into a global investor base.
3. Promotion of Infrastructure Financing Given India’s large infrastructure financing gap, Masala Bonds were envisioned as a stable long-term funding source for sectors such as transport, energy, and urban development.
4. Deepening Offshore Rupee Markets By creating demand for rupee-based instruments abroad, Masala Bonds contribute to the development of offshore INR markets.
5. Internationalisation of the Indian Rupee Wider global acceptance and usage of INR-denominated financial instruments strengthens confidence in the Indian rupee and supports its gradual internationalisation. Key Features of Masala Bonds

• Rupee-Denominated Instrument: Though issued and subscribed overseas, pricing and repayment are in INR.
• Currency Risk with Investor: Foreign investors bear exchange rate fluctuations.
• Eligible Issuers: Indian corporates, NBFCs, REITs, InvITs, and infrastructure entities.
• Listing Platforms: Bonds can be listed on international exchanges such as London and Singapore.
• End-use Restrictions: Prohibited for capital market investments, land purchases, real estate (except affordable housing), and FDI-restricted sectors.
• Maturity Norms: Initially set at 5 years, later relaxed to 3 years to improve attractiveness.
• Tax Incentives: Concessional 5% withholding tax on interest and exemption of capital gains from rupee appreciation. Benefits of Masala Bonds for India

1. Macroeconomic Stability By transferring currency risk to investors, Masala Bonds reduce India’s vulnerability to external shocks and sudden capital flow reversals.
2. Lower Cost of Borrowing For credible issuers, Masala Bonds can offer competitive interest rates compared to domestic debt, especially during periods of stable macro fundamental.
3. Infrastructure and Development Financing Long-term rupee funding is well-suited for infrastructure projects with long gestation periods, aligning repayment obligations with revenue streams.
4. Investor Diversification Access to pension funds, sovereign wealth funds, and global institutional investors broadens India’s funding base.
5. Strengthening India’s Financial Reputation Successful issuance signals macroeconomic confidence, regulatory credibility, and financial maturity to global markets. Challenges and Concerns

• Higher Coupon Rates due to currency risk premiums demanded by foreign investors.
• Limited Investor Appetite during periods of rupee volatility or global uncertainty.
• Regulatory and Compliance Issues, as seen in recent enforcement actions related to RBI and FEMA norms.
• Lower Market Depth compared to established global bond markets. Masala Bonds represent a strategic innovation in India’s external financing architecture by aligning global capital inflows with domestic currency stability. While challenges remain in terms of investor appetite and regulatory compliance, their role in reducing forex risk, supporting infrastructure development, and promoting rupee internationalisation makes them an important instrument in India’s long-term economic strategy. With prudent governance and macroeconomic discipline, Masala Bonds can significantly contribute to India’s sustainable growth ambitions.