Mumbai: Masala bonds have failed to whet the appetite of foreign investors, even months after the Reserve Bank of India (RBI) allowed Indian firms to raise rupee-denominated bonds in the overseas markets.

These bonds, termed Masala bonds in keeping with the bond market’s penchant for attaching trite descriptors to bonds issued in local currencies (eg: Chinese currency denominated bonds are called Dim Sum bonds; bonds issued in the Australian market are called Kangaroo bonds), were pitched hard to foreign investors but failed to take off. Even Prime Minister Narendra Modi’s efforts to make the case for these bonds during a visit to London in November did no good.

Bankers, however, haven’t given up and are now pinning their hopes on the budget to reheat the now cold conversations over Masala bond issues.

The expectation is that the 5% withholding tax imposed on overseas borrowings will be reduced in the case of Masala bonds. This, in turn, may help address issues related to the pricing of these bonds. As Mint reported in December, investors and issuers have found it tough to agree on the coupon rate for such issues. After pricing in key elements like the exchange rate risk (which is borne by investors in the case of Masala bonds) and the credit risk of the issuer, the coupon rate sought by the investors was higher than what companies were willing to pay.

What was adding to the cost of such borrowings was the 5% withholding tax imposed on all overseas borrowings. Bankers are expecting that this 5% withholding tax will at least be reduced in the upcoming budget, if not completely removed.

Still, they admit that the argument to remove the withholding tax on Masala bonds is not an easy one to make. At present, all external commercial borrowings (ECBs) are subject to the 5% withholding tax. This includes overseas loans and foreign currency bond issues. Removing the 5% withholding tax from just one single category of ECBs may skew the market.

“It’s not an easy argument to make. At best you can argue that it is being done to develop a new instrument," said a banker who spoke on condition of anonymity.

It’s possible that if the withholding tax is indeed cut or removed, we could see a handful of transactions go through. Companies such as HDFC Ltd and NTPC Ltd have already held discussions with foreign investors and the ground work for these Masala bond issues has been completed. The only reason the bond issues weren’t launched was because of the mismatch on pricing, which may reduce following the reduction of the withholding tax. Still, the Masala bond market will be restricted to only a few high quality borrowers and a rush of issues is unlikely.

Even if tax changes get this instrument, which one banker described as “stillborn", off the ground, there is a larger message in the lukewarm interest towards Masala bonds.

The message is that foreign investors still see substantial currency risk attached to investments in India. While relatively stable inflation and a manageable current account deficit have helped, these factors haven’t managed to dent the currency risk perception attached to India in a meaningful way.

Some of this may have to do with timing. After all, the Indian rupee has depreciated over 9% in the current fiscal year and is moving back towards all-time lows. Many in the market believe that the rupee is still overvalued and should fall further. While the Reserve Bank of India stays away from commenting on the level of the currency, RBI governor Raghuram Rajan in a speech on 13 February said that until inflation comes down, there will be a certain amount of currency depreciation, which is necessary to ensure competitiveness of the economy.

Investors will keep this in mind when they look to invest in any instrument, such as Masala bonds, where the currency risk is on their books.