Photo: Mint
Photo: Mint

Pricing emerges as first hurdle for masala bonds

50bps gap between the price quotes of issuers and investors, and Fed meet on 16 Dec keeping bond buyers away

Masala bonds, or rupee bonds issued by Indian firms in the overseas markets, are facing their first hurdle with sellers and potential investors failing to agree on the pricing of such bonds.

In September, Reserve Bank of India (RBI) allowed firms to sell rupee-denominated bonds overseas to allow firms to diversify their funding sources without having to bear the currency risk.

Since these bonds are issued and settled in rupees, the currency risk is borne by the investor. The bonds have received much attention, including from Prime Minister Narendra Modi, who pitched these bonds to investors during a recent visit to London.

But investors are approaching such issues with caution.

Two issuers, India’s largest mortgage lender Housing Development Finance Corp. Ltd and the nation’s largest power producer NTPC Ltd, have been on the road to secure investors for such bonds since last month but are yet to launch their respective issues. HDFC began talking to investors early November while NTPC concluded its marketing a week ago.

Both the firms are still to agree on a coupon rate, which the companies and the investors are comfortable with, said two bankers involved with the marketing of these issues. They declined to be identified as negotiations are confidential.

With the gap between what investors are asking and what issuers want to pay as wide as 50 basis points (bps), arrangers are finding it difficult to build a consensus and strike a deal, said the bankers cited above.

One basis point is one-hundredth of a percentage point.

“The feedback from the investors has been good, but it is still too premature to comment on pricing," said Keki Mistry, vice-chairman and chief executive of HDFC. “Investors are still trying to assess how to build in the currency risk."

NTPC did not respond to an emailed questionnaire sent by Mint on Friday.

Issuers want to borrow at least 10-15 bps cheaper than what they pay in the domestic bond market.

For HDFC, that could mean a coupon of about 8.20% as the mortgage company recently borrowed 500 crore through a three-year bond sale at 8.35%.

For NTPC, this would mean borrowing at a coupon rate of below 8%.

For the first issuance, companies may be willing to forego some of this benefit in order to get access to a new pool of investors. Still, companies would not want the borrowing cost to be substantially about the domestic borrowing rates.

Bankers, however, said investors are unwilling to buy the bonds at these levels as they feel it does not compensate adequately for the exchange rate risk in addition to the country and credit risk of the company.

India is rated BBB- by global ratings agencies—a notch above junk rating.

“The most important aspect of acceptability into the international fixed-income market is the liquidity. Even for long-only investors who take a view for three and five years, at the end of the day, India is still classified within the basket of emerging markets and any kind of global shock does impact the view on what to do with that portfolio. So, they would not like to put money in an asset which is difficult to exit or more expensive to exit in such times," said Ajay Marwaha, director and head of investment and investment advisory at Sun Global, a UK-based hedge fund.

Moreover, for the borrowers themselves, cost of marketing and listing a rupee bond overseas and the withholding tax of 5% will add at least another 40 bps to the overall cost of borrowing, explained the bankers cited above.

“It defeats the purpose of borrowing cheaply from overseas," said the first banker cited above.

He added that the timing of the bond issues is also working against the firms as the US Federal Reserve’s rate-setting meet, which will conclude 16 December, is also keeping bond buyers on the sidelines. “There is nothing wrong with the product. But December is a time for consolidation, and given that the Fed meeting is due, investors are not willing to put money now," said the first banker.

These factors, together with the fact that this is a new product, which has no established benchmarks, is delaying the closure of these deals.

“On an average, a regular issuer can close a deal within couple of days to a week. A new issuer could take considerable time, which could be up to one month," said the second banker cited above.

Masala bonds have drawn a lot of attention after Prime Minister Narendra Modi announced that Indian Railways would borrow through these bonds. Others like HDFC and NTPC were also quick to announce their intention to raise funds through such bonds soon after.

While HDFC and NTPC have concluded road shows for the bonds, Indian Railway Finance Corp. is putting in place a plan to sell Masala bonds it is unlikely to launch them at least until January, said a third banker familiar with the plans, requesting anonymity.

Ratings agencies have also listed pricing as one of the issues that companies may face in raising funds through masala bonds.

“Uncertainty about liquidity, availability of the existing option to invest in onshore rupee bonds and currency risk could subdue investor demand. Masala bond issuances have potential to reach $5 billion over the next two-to-three years if they overcome these challenges," said Standard & Poor’s in a note on 25 November.

Under the automatic route, companies can raise as much as $750 million per annum through Masala bonds, RBI said in September. Cases beyond this limit will require prior approval, the central bank said.

The minimum maturity of such borrowings is five years.