India: Corporate Bond Limits & Masala Bond Limits Delinked: Headroom Created For External Rupee Debt

In the current market scenario where corporate bond limits have exceeded the 95% mark, the RBI has issued a circular dated 22 September 2017 (the Circular) to remove Masala Bonds (or rupee denominated bonds issued overseas) from the purview of the corporate bond investment limit, creating headroom for corporate bond investment by Foreign Portfolio Investors (FPIs). This move comes in the wake of multiple demands from industry participants for increasing the foreign investment limit for corporate bonds after the issuance of the SEBI circular of 20 July 2017 (SEBI Circular) which put a halt on on-tap purchases of corporate bond limits by FPIs once the investment limit crossed 95% of the allotted limit. Post the 95% mark, the balance limits had to be purchased in an auction of the limits conducted periodically in accordance with the mechanism stipulated under the SEBI Circular. The SEBI Circular had also suspended the issuance of Masala Bonds until foreign holdings of rupee-denominated Indian corporate loans fell below 92% of the limit.

Masala bonds and corporate bonds issued to FPIs and Track III external commercial borrowings (ECB) are the only avenues for obtaining rupee borrowings from offshore lenders/investors under the present foreign exchange regime. On account of the unique nature of Masala Bonds, which are issued to foreign investors overseas but are denominated in INR, they were currently being reckoned both under the combined corporate debt limit of INR 244,323 crore for foreign investment in corporate debt (CCDL) and the ECB limit for raising Masala Bonds, which was pegged at INR 50 billion per annum for Indian corporates under the Master Direction - External Commercial Borrowings, Trade Credit, Borrowing and Lending in Foreign Currency by Authorised Dealers and Persons other than Authorised Dealers (ECB Regulations). This had the effect of Masala Bonds also being reckoned within the CCDL and consequently reducing the CCDL for FPI investments through the corporate bond route.

Key Takeaways of the Circular

• Dual Limits for Masala Bonds removed and harmonised with the ECB Regulations – The Circular specifies that currently the limit for investment by FPIs in corporate bonds is INR 244,323 crore, which includes issuance of Masala Bonds of INR 44,001 crore (including Masala Bond issuances that are in the pipeline). With effect from 3 October 2017, Masala Bonds will no longer form a part of the limit for FPI investments in corporate bonds. They will instead form a part of ECB and will be monitored accordingly.
• Headroom created for FPI investment: This releases limits of INR 44,000 crore which will be made available to FPI investors over the next two quarters in a phased manner with INR 27,000 crores being available during October-December and INR 17,001 crores in January-March, as demonstrated in the following table:

• Approval route for Masala Bonds to continue: It is important to note that the approval route introduced for all Masala Bond issuance vide the RBI circular issued on 07 June 2017 (June Circular) continues to apply and all eligible issuers proposing to issue Masala Bonds are required to approach the Foreign Exchange Department, RBI (please refer to our Newsflash dated 8 June 2017 for an analysis of the June Circular).
• Continued focus on infrastructure sector investments – The Circular also specifies that an amount of INR 9500 crore in each quarter (out of the overall corporate bond limits) would be earmarked specifically for investments by long term FPIs in the infrastructure sector. Long term FPIs would mean sovereign wealth funds, multilateral agencies, endowment funds, insurance funds, pension funds and foreign central banks. The definition of 'infrastructure sector' under the ECB regulations would be applicable for this purpose. For the infrastructure sector, the corporate bonds issued are not required to be listed even if they are issued to FPIs.

Comment

The revised limits are expected to result in higher FPI inflows and a likely compression in corporate bond spreads, given the above change. The removal of Masala Bonds from the corporate debt limits is being applied prospectively, with effect from 3 October 2017 but includes Masala Bond issuances which are in the pipeline (and currently under examination by the RBI). It remains to be seen whether the currently released limits under the Circular would be sufficient to address the demand for corporate bonds by Indian issuers through the FPI route. Certain additional measures had been put forth to the RBI for creating space for FPI investments, for instance, the current conversion rate being applied for reckoning the corporate bond limit, which would have created considerably larger headroom for FPI investments (than is being created on account of the removal of Masala Bonds from this limit). Another suggestion had been to simply increase the corporate bond limit, but it appears that the approach followed is to refrain from effecting further increases in the capped limit and to stick to a staggered release of limits. The Circular may also help to move forward pending proposals for Masala Bond issuances since these had been suspended due to lack of available limits and would now be covered under the ECB limits.

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