Analysis: London offers India the right growth masala

The world's leading financial hub will be India's mainstay over the next decade as it pumps in billions to create the base for a truly modern economy and the so-called 'Masala Bonds' hold the key.Over the next decade and more, London and the UK are expected to play an increasingly more importance role in India's growth story. Why Because of its status as the world's leading financial centre.By most estimates, India needs about $1 trillion over the next decade to build and rebuild India's creaking infrastructure and bring it up to global standards. Some of this will be in the form of FDI, ie, direct investments by foreign companies, but a large proportion will have to come from financial investors who will buy bonds and other papers floated by manufacturing, infrastructure, technology and financial services companies that are investing in these projects.For the purpose of this report, India Inc. will focus on rupee-denominated global paper, also known rather colourfully as “masala bonds”, a new instrument recently approved by the Reserve Bank of India.What is a masala bond Indian companies have traditionally raised foreign currency debt either via direct bank loans or through dollar or other foreign currency-denominated bonds, which they then convert into rupees and repatriate to India for investment in their projects.The obvious advantage is the lower cost of money in global markets compared to India. But there are huge risks as well. The primary threat is currency risk. This means the issuer of the bonds bears the risk of the Indian currency depreciating against the dollar or any other currency in which the paper had been denominated.For the uninitiated, an example will suffice. Company A issues 5-year bonds worth $1 million denominated in the US currency carrying a coupon rate of 5 per cent per annum when the exchange rate is Rs 65/dollar. That means it gets an investible corpus of Rs 6.5 crore. At the end of each year, Company A will, thus, have to pay $50,000 (or 5 per cent of the principal amount) and at the end of five years, it will have to pay back $1 million.On the face of it, it's liability over the five-year tenure of the bond will be $1.25 million or Rs 8.125 crore.But what if the rupee depreciates in value against the dollar by Re 1 every year to, say, Rs 70/dollar. The liability of Company A over the tenure of the loan would then rise to almost Rs 9 crore.Since actual ticket sizes of corporate bond issues are in multiples of hundred million dollars for individual companies and billions of dollars for the country as a whole, this could play havoc with the financial health of issuing companies while causing macro-economic disruption by setting of a current account deficit crisis.Rupee bonds, being denominated in Indian currency, transfers this risk from the issuing company to the investor.The World Bank's private sector investment arm, International Finance Corporation (IFC) issued the first rupee-denominated overseas bond in 2013. The name “masala bond” evokes the imagery of spices, for which India was best known in historical times, on the lines of the “dimsum bonds”, or remnimbi-denominated paper issued by Chinese companies since 2007. These are named after the popular Hong Kong dish of the same name.Why London scores over other global financial hubs Indian companies and their promoters have traditionally been most comfortable doing business and raising funds in London and the UK. Historical ties, family and community bonds and cultural affinities are only part of the story.There are other reasons as well and these are likely to gather speed in the years to come. London recently overtook New York as the world's most competitive financial centre, according to rankings released by Z/Yen Group. The city stood first on every parameter that went into the rankings - the best business environment, the most impressive infrastructure, the best human capital, the most developed financial structures and the best reputation.The victory of the Conservative Party, which is considered more business-friendly than the Labour Party and the Liberals, in last year's general elections boosted its reputation.British Prime Minister David Cameron's unflinching backing of India's economic ambitions his throwing the weight of his government behind the rupee bonds will only increase London's importance in India's growth matrix.“We want to become the Number 1 partner to finance the immense economic vision of Prime Minister Modi and make London the centre for off-shore rupee trading with the launch of one billion worth of bonds including the first government-backed rupee denominated bond,” he said during Narendra Modi's recent visit to the UK.This unconditional backing is important in more ways than one. A senior Finance Ministry bureaucrat speaking on condition of anonymity said: “The rupee is not fully convertible. Hence, the first lot of investors in masala bonds could find it difficult to offload their holdings in the secondary markets. The British government's support will boost sentiment and help make overseas rupee bonds more acceptable to foreign investors.”Though rupee bonds, with relatively small ticket sizes are becoming popular in Japan as well, experts said a centre like London will offer Indian issuers access to a much wider range of investors and help popularise this paper globally.A senior official at apex chamber of commerce, Confederation of Indian Industry (CII) said: “It will be better for Indian companies to test the waters for rupee-denominated bonds in one single hub like London, gain acceptance and then spread their wings to other centres such as New York, Singapore and Hong Kong.”“We are going to use the London market for fund raising even more and I'm happy to announce that we are set to launch a railway bond denominated in rupees in London. It is appropriate as the journey of Indian Railways started in the UK,” Modi told the same gathering before which Cameron had backed India's fund raising ambitions.The early birdsApart from the Indian Railways, large Indian private and public sector corporations such as HDFC, IIFCL, Power Finance Corporation Ltd and NTPC have planned overseas rupee bond issues out of London.A recent Standard Chartered Bank report estimated that global appetite for masala bonds will be about $3 billion-$5 billion a year in the initial years.As these bonds find a secondary market and holdings get dispersed among a wide and diversified pool of investors in other financial centres, the appetite will improve and more Indian companies, including those in the second and tiers of the corporate pecking order will begin to test the waters with offerings of their own.Thus, London is expected to occupy centre stage, providing ballast to the India growth story, in the years and decades to come.