RBI Masala bonds Pdf Download – IAS Mains Exam

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RBI Masala bonds Pdf Download - IAS Mains Exam

Banks to issue Masala bonds, RBI opens currency markets (GS Paper 3)

Introduction –Download Monthly Policy Review 2016 Pdf – PRSIndia.Org

The Reserve Bank of India (RBI) has announced a raft of measures to boost investor participation and market liquidity in both the corporate bond and currency markets.

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The central bank will allow commercial banks to issue rupee bonds in overseas markets — known as Masala bonds, both for their capital requirement and for financing infrastructure and affordable housing.

Accepting many of the recommendations of the Khan Committee to develop the corporate bond market, it has been decided to –

  1. Enhance the aggregate limit of partial credit enhancement (PCE) provided by banks,
  2. Permit brokers in corporate bond repos,
  3. Authorise the platform for repo in corporate bonds and
  4. Encourage credit supply for large borrowers through market mechanism.
  5. Decided by the regulator that the aggregate PCE that will be provided by the financial system for a given bond issue will be increased from the present level of 20 per cent to 50 per cent of the bond issue size, subject to the PCE provided by any single bank not exceeding 20 per cent of the bond issue size and the extant exposure limits.

Hedge transactions –UPSC Civil Services Mains 2016 Detailed Application Form released

  • In order to ease access to the foreign exchange market for hedging in over the counter (OTC) and exchange-traded currency derivatives, the RBI has allowed entities exposed to exchange rate risk, both resident and non-resident, to undertake hedge transactions with simplified procedures, up to a limit of $30 million at any given time.
  • Banks can also allow the customer an open position limit of up to $5 million. Since exposure of Indian entities to commodity price risks has been accentuated by the growing integration of the Indian economy and increasing volumes of cross border trade, a working group will be formed to review the guidelines for hedging of price risk by residents in the overseas markets.
  • To enhance participation in the corporate bond market, the RBI has decided that brokers authorised as market makers will be allowed to participate in the corporate bond repo market. Currently, banks, primary dealers, mutual funds, insurance companies are only allowed. In addition, foreign portfolio investors have been allowed to transact in corporate bonds directly without involving brokers.
  • With an aim to reduce risk in banking sector, RBI has proposed to limit exposure of a bank to a business group to up to 25 per cent of its capital, down from the existing 55 per cent.

About Masala Bonds

  • The term is used to refer to rupee-denominated borrowings by Indian entities in overseas markets. The International Finance Corporation (IFC), the investment arm of the World Bank, last November, issued a ₹1,000 crore bond to fund infrastructure projects in India.
  • These bonds were listed on the London Stock Exchange (LSE). IFC then named them Masala bonds to give a local flavour by calling to mind Indian culture and cuisine.

Importance of MB

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  1. They are issued to foreign investors and settled in US dollars. Hence the currency risk lies with the investor and not the issuer.
  2. The cost of borrowing can work out much lower. The RBI said that it would issue guidelines for allowing corporates to issue rupee bonds in overseas markets.
  3. Competition from overseas markets may nudge the government and regulators to hasten the development of our domestic bond markets.
  4. Vibrant bond market can open up new avenues for bond investments by retail savers.
  5. With talks of full rupee convertibility back home, Masala bonds can help the rupee go global.
  6. Companies issuing masala bonds do not have to worry about rupee depreciation

Why should investors look at masala bonds?

  • The Finance Ministry has cut the withholding tax (a tax deducted at source on residents outside the country) on interest income of such bonds to 5 per cent from 20 per cent, making it attractive for investors. Also, capital gains from rupee appreciation are exempted from tax.
  • Globally, there is ample liquidity thanks to lower interest rates in developed markets, but there are very few investment options due to weak economic conditions globally. India is that rare fast-growing large economy, and masala bonds are one way for investors to take advantage of this.
  • By the way, these bonds are bought by retail investors as well as big institutions overseas.

What do masala bonds mean to the issuer?

  • An important consideration for issuers is the access to cheaper funding than what’s available in the domestic markets; according to ratings firm S&P.
  • For corporates, who would be the main issuers, masala bonds will be one other key source of funding apart from banks and local debt markets.
  • Another ratings firm India Ratings and Research says such bonds would lower the cost of capital over a period of time – the cost remains one of the highest in Asia.
  • This also makes sense given that Indian banks are reluctant to lend to sectors facing weak demand and heavy debt.

Is there anything investors need to worry about?

  • Investors would need to keenly watch the credibility of the issuer. For example, it would easy for an HDFC or NTPC to easy to raise the bond when compared to a smaller firm.
  • Higher the credit rating of a firm, the better would be the appetite for their issues. Since the currency risk is on the investors, they will like the rupee to be stable.
  • S&P says the initial excitement over masala bonds will give way to the ultimate realisation that because currency and economic growth are external factors, investors will subject issuers to a lot more scrutiny.

Masala bonds are a good idea to shield corporate balance sheets from exchange rate risks. But they are best used in moderation.