2. What are Offshore Rupee Bonds? Giving examples, discuss their benefits with regards to mobilisation of resources for domestic sector. Also, comment on their role in internationalisation of Indian Rupee.

Approach:

The definition should clearly explain the meaning of all the three terms –‘Offshore’, ‘Rupee’ and ‘bonds’. Giving examples of IFC (Masala bonds), or Railway finance corp. bonds, benefits such as alternate and cheaper source of finance, increasing foreign investor base, hedging, etc. can be provided. Internationalisation through greater offshore trading should be mentioned. The role of retaining investor confidence must be emphasised.

Answer: Offshore Rupee Bonds (ORBs) are debt instruments offered in capital markets outside India and are denominated in Indian rupees (meaning that the principal amount is linked to exchange rate of rupee). They are offered and settled in dollars to raise Indian rupees from international investors. The issuer converts bond proceeds from dollars into rupees in the domestic (Indian) market and uses them to finance its requirements in India. As such, the currency risk in these bonds resides with the investor. The investor base in these bonds is much wider than the FIIs, which invest in the Indian markets.

ORBs have been issued in past by the International Finance Corporation (IFC) with a maturity upto seven years. The latest issue is called ‘Masala Bonds’ which have a maturity of 10 years and are the first ORBs to be listed on London Stock Exchange. They are named so because masala is a globally recognised term that invokes culture and cuisine of India. Similar bonds are proposed to be offered by Indian Railway Finance Corporation and Asian Development bank. Reserve Bank of India has also allowed Indian corporates to issue ORBs. There are several benefits of ORBs, such as –

♤ Bringing liquidity and depth to offshore rupee market

♤ Crowding in foreign investors to invest in rupee bonds and fund domestic investment

♤ Paving the way for an alternative source of funding for Indian Companies

♤ As currency risk is borne by the investor, the cost of borrowing as compared to External Commercial Borrowings (ECBs) comes down for the investor as there is no need for hedging.

♤ The cost of borrowing has also been lesser than government bonds in domestic markets.

It has been estimated that domestic corporates are likely to raise $30 billion in ECBs this fiscal year, while their Offshore Bond issues are likely to be $6 billion. In the next fiscal year, the bond issuances are likely to be $12 billion, but the quantum of ECBs will remain stagnant at $30 billion. However, the cost of funds for Indian companies will significantly depend on their ratings, which will be lesser than AAA rated Masala bond.

Internationalisation of the currency has two essential features:

♤ A state where exporters from other countries (such as Oil companies in Saudi Arabia) agree to take payments in rupees, and

♤ Where currency risks in international borrowings are borne by lenders rather than borrowers in India.

At the heart of internationalisation lies stability and confidence in the currency which makes it acceptable for cross-border transactions. Internationalisation is desired because countries that can borrow in their own currency are less susceptible to international crises. Please note that internationalisation is different from capital account convertibility, which means that domestic and foreign assets can be freely exchanged.

ORBs are a significant step towards internationalisation of rupee - they are international borrowings with currency risk at lenders' side. The Masala bonds were well received by foreign investors, notwithstanding the fact that rupee is still not fully convertible. ORBs are launch pad to sell strength of rupee to overseas investors as listing on foreign bourses will provide visibility and set benchmarks for yields in future issuances. Views on rupee will now be partially formed offshore, albeit in a very small way as ORBs will be subject to caps on external commercial borrowings. They could also increase demands for similar products as liquidity of these bonds rises. This also shows

the confidence of international investors in Indian economy and rupee. This will require the government and the central bank to impart stability and confidence in the rupee internationally. Critical elements such as fiscal policy, current account balances and inflation have to be benchmarked to best standards to retain investor confidence in rupee. Putting these elements on a firm footing will be essential requirement for rupee internationalisation.