NDA (II) 2016 General Ability Test · Question 123 of 150

Correct — C, three years. Masala bonds are rupee-denominated bonds issued outside India, and the Reserve Bank governs them under its external commercial borrowing framework. The RBI's circular of 13 April 2016 — RBI/2015-16/372, A.P. (DIR Series) Circular No. 60, on the issuance of rupee denominated bonds overseas — states that it had been decided to reduce the minimum maturity period for such bonds to three years, in order to align it with the maturity requirement for foreign investment in corporate bonds through the foreign portfolio investment route. That circular was five months old when this paper was set in September 2016, so three years is the rule the question is testing.

• (a)Five years — The strongest distractor, because it was the correct answer until a few months before this exam and became correct again afterwards for larger issues. The original framework of 29 September 2015 set a minimum maturity of five years; the April 2016 circular cut it to three; and from 7 June 2017 the RBI made the requirement tiered, at three years for issues up to the equivalent of USD 50 million in a financial year and five years above that. A candidate revising from a pre-April-2016 note would have marked this option.
• (b)Four years — Four years has never been a prescribed minimum maturity for these bonds at any stage of the framework. It is filler placed between the two figures that have actually been used.
• (d)Two years — Also never prescribed. Two years would fall below the three-year residual maturity that the foreign portfolio investment route required for corporate debt, and alignment with that requirement was the stated reason for choosing three.

A masala bond is a bond issued offshore but denominated in Indian rupees, so the borrower repays in rupees and the overseas investor, not the Indian issuer, carries the exchange-rate risk. That is the whole point of the instrument, and the contrast with a conventional foreign-currency external commercial borrowing, where a fall in the rupee raises the Indian borrower's repayment burden. The International Finance Corporation, the private-sector arm of the World Bank Group, issued the first such bonds in November 2014; HDFC became the first Indian company to issue them in July 2016 and NTPC followed the next month with the first corporate green masala bond.

Questions built on a regulatory number are the ones most likely to go stale, so anchor this one firmly to its date. As of the September 2016 exam the answer was three years, flat. The rule today is not that: since the RBI's circular of 7 June 2017 the minimum original maturity has been three years for bonds raising up to the equivalent of USD 50 million in a financial year and five years for anything larger, and that tiered rule is what the current external commercial borrowing Master Direction carries. So this item is still worth learning for the concept and the history, but the bare number should not be memorised as current. The other elements of the 2015 framework are worth carrying too — investors had to come from jurisdictions compliant with the Financial Action Task Force, and the proceeds could not be used for real estate other than affordable housing and integrated townships, for buying land, or for investing in domestic equity.

• Masala bonds are denominated in rupees but issued overseas, so the currency risk sits with the foreign investor rather than the Indian issuer.
• The RBI's original framework of 29 September 2015 set a five-year minimum maturity; the circular of 13 April 2016 reduced it to three years.
• From 7 June 2017 the requirement became tiered — three years up to the equivalent of USD 50 million per financial year and five years above that.
• The IFC issued the first masala bonds in November 2014; HDFC was the first Indian company to issue them, in July 2016.

• Carrying forward the pre-2016 five-year figure, or today's tiered rule, into a 2016 question.
• Assuming the Indian issuer bears the currency risk; in a rupee-denominated bond it does not.
• Confusing masala bonds with ordinary foreign-currency convertible bonds or with sovereign borrowing.

Economy items in the GAT are usually pinned to an instrument that was in the news that year, so learn what the instrument is and who bears which risk, and treat any regulatory number as attached to a date.

• practice — not a real PYQ

  In a masala bond, the exchange-rate risk is borne by

  • (a)the Indian issuer
  • (b)the overseas investor
  • (c)the Reserve Bank of India
  • (d)the Government of India

  Answer(b) the overseas investor — the bond is denominated in rupees, so the issuer repays in rupees and any depreciation is the investor's loss.

• practice — not a real PYQ

  The first masala bonds were issued in November 2014 by

  • (a)the Reserve Bank of India
  • (b)HDFC
  • (c)the International Finance Corporation
  • (d)NTPC

  Answer(c) the International Finance Corporation — the World Bank Group's private-sector arm; HDFC was the first Indian company to issue them, in July 2016.