Negative Yields Globally Provide a Window of Opportunity for Blue chip Masala Bonds

The uncertainty in global markets and the resultant flight to safety has resulted in USD11.7trn worth of negative yielding sovereign debt, leading to highly rated entities in India capitalising on this opportunity by tapping the masala bond market, says India Ratings & Research. Ind-Ra believes the cost (including withholding tax) economics for most entities lower down the credit curve and credit risk aversion in an uncertain time may keep overall issuer interest muted. The issuances at the higher end, will allow issuers to diversify their investor base and also provide investors a reasonable yield with the expectation of a relatively stable currency.

The global economy has been going through a rough patch since the 2008 global financial crisis. The incipient recovery however is now turning fragile due to Brexit - a geopolitical conundrum. This has however opened up opportunities for the global fixed income investors; the secular rally has now increasingly entering into an unchartered negative yield territory. Fitch estimates that the total sovereign debt trading at a negative yield stood at USD11.7trn as of 27 June 2016, up by USD1.3trn from the end of May. Fitch has highlighted the widespread adoption of unconventional monetary policies, including large-scale bond-buying programs and negative deposit rates, to have driven the large increases in negative-yielding debt seen this year. However, an increasing amount of long-term negative-yielding debt underscores the challenges faced by large bond investors, namely insurance companies that need to match their long-term liabilities with similar maturity assets.

This opens up opportunities for Indian corporates to tap a new spectrum of investors residing abroad. The Reserve Bank of India (RBI) introduced masala bonds in 2015. Ind-Ra highlighted in its report 'Ind-Ra: Indian Masala Bond Market May Take Time to Kickoff' in October 2015, that RBI's efforts to operationalise the issuance of Indian rupee denominated off-shore bonds by Indian corporates will help to broaden the investor base without dollarisation of the corporates balance sheets, but may take time for lower rated corporates to reap the benefits.

The RBI in April 2016, enabled issuers to issue short term bonds by reducing the minimum tenure to three years compared to the initially allowed five years. This enables issuers to issue short term bonds to develop investor confidence, which may push up appetite for higher tenure issuances in the future, as investors are cautious about credit quality, coupled with higher duration. The RBI also fixed the ceiling for the borrowing limits by an entity in a financial year under the automatic route to INR50bn, with a provision of prior approval for higher issuances. Moreover the relatively stable Indian currency, on the back of the stable macroeconomic conditions has also led to higher investor appetite.

India's largest housing finance company Housing Development Finance Corporation Limited (HDFC) is the first Indian entity to issue masala bonds and the issue received an encouraging response from investors. HDFC issued its 37 month maturity masala bonds, at a fixed semi-annual coupon of 7.87%, and the bond has been issued at a price of 99.24% of the par value and will be redeemed at par, this translates into 8.33% annualised return for the investor. The bond will be listed in the London Stock Exchange. Cost economics at present show that it is almost similar to domestic borrowing rates, since HDFC issued a three year domestic bond at a coupon of 8.38% subsequently.

The masala bond gained considerable interest in the primary markets, notwithstanding weak appetite for domestic corporate bonds by Foreign Portfolio Investors (FPI). The utilisation limit of FPI in corporate bonds has been hovering at around 66% (of the limit INR2.44trn), which has come down from 76% in October 2015. Masala Bond will also be an easier mode of investments by foreign investors not registered as FPIs in India. However for FPI's registered in India, the yield differential is unattractive for investments in the issuer's domestic bond or masala bond. In view of India's sovereign rating, Ind-Ra continues to expect the market for masala bonds to take some more time to develop. In this round of masala bond issuances we may see PSUs and quasi-sovereigns coming into the market to diversify. The feeble recovery in the global economy is likely to keep investor appetite muted for issuers with relatively lesser credence.

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