US dollar strength spoils the gravy for Indian masala bonds

Moneycontrol BureauThe Reserve Bank of India's (RBI) decision to allow corporates to raise funds from overseas through rupee-denominated bonds has found interest but major deals are yet to be struck. The Economic Times today reported that Power Finance Corporation (PFC) on Friday cancelled its plans to issue USD 250 million through the so-called "masala bonds" after investors failed to offer an agreeable price. Recently, HDFC, which had announced it would raise USD 750 million through the route, put its plan on hold.Launched in September this year, masala or rupee-denominated bonds are instruments that can be used by Indian corporates to raise money from abroad. Being rupee-denominated, the bonds transfer exchange rate risk from the issuer to the buyer, unlike traditional foreign currency-denominated bonds such as ECBs or FCCBs. Since the foreign investor takes on the currency risk, naturally she would charger a higher coupon, compared to traditional bonds that are issued in her local currency.The central bank issued guidelines for these bonds in September this year, capping maximum issuance size at USD 750 million. In order to sweeten the deal, the government had also cut withholding tax on gains from the bonds from 20 percent to 5 percent.But investors have not been ready to bite.A Mint piece suggests pricing has been a bone of contention for issuers and investors. This is understandable given the fact that the US dollar has lately strengthened in anticipation of the first Federal Reserve rate hike in nine years. A weak rupee would eat into the returns that investors would get. Also, in light of expected currency volatility, hedging costs tend to rise for emerging market currencies.Accordingly, dealmakers have not been able to arrive at a coupon that would be agreeable to both. The Mint report suggests that while Indian companies have been looking for a price slightly below borrowing costs in their home markets, investors have not been willing to agree to the same.In fact, the gap in issuance prices is as high as 50 basis points (bps), bankers told the newspaper. However, once the Fed meeting is out of the way, and if the rupee exhibits a sense of stability, the rupee bonds could be off to a better start.