Knowledge Nugget: Why Masala Bonds and FEMA matter for your UPSC Exam

Vijayan is the chairperson of KIIFB and Isaac was its vice-chairperson in 2019, when the CPI(M) government issued a masala bond to raise funds for infrastructure development. Abraham is the chief executive officer of KIIFB, the state agency that mobilises funds for infrastructure projects beyond what is earmarked in the budgets.

Key takeaways:

1. A bond is an instrument to borrow money. A bond could be floated/issued by a country’s government or by a company to raise funds. Since government bonds (referred to as G-secs in India, Treasury in the US, and Gilts in the UK) come with the sovereign’s guarantee, they are considered one of the safest investments.

2. Masala Bonds are the rupee-denominated bonds issued to overseas buyers for raising money by the Indian corporates. The price of the bond is denominated in Indian currency. The International Finance Corporation (IFC), the investment arm of the World Bank, named them ‘masala’, literally meaning ‘blend of spices’, to reflect Indian culture.

3. Earlier, for raising money from abroad, Indian corporates relied on avenues such as external commercial borrowings (ECBs). The challenges with these arrangements were that the Indian company or issuer of an overseas bond offering runs the risk of currency fluctuations. A weakening of the rupee during the bond’s tenure can, for instance, significantly increase costs at redemption or repayment — normally at the end of five years.

4. By pricing or issuing bonds in rupees, the issuer gets rid of this risk which, instead, passes on to the investor. In issuance of Masala Bonds, investors pay USD amount equivalent to INR principal determined at the market exchange rate on the date of transactions undertaken for issue and servicing of the bonds.

5. The 2017 directive of the RBI stated that the “minimum original maturity period for Masala Bonds raised upto USD 50 million equivalent in INR per financial year should be 3 years and for bonds raised above USD 50 million equivalent in INR per financial year should be 5 years.”

6. The first Masala bond was issued by the International Finance Corporation in 2014 for the infrastructure projects. In 2019, Kerala became the first state to tap into the market for Masala Bonds to raise development funds. The KIIFB, a government entity established for mobilising funds for infrastructure projects, issued Masala Bonds, worth Rs 2,150 crore that were dual listed on the London Stock Exchange (LSE) and the Singapore Exchange Ltd in 2019.

7. In 2022, the ED registered a case related to Foreign Exchange Management Act (FEMA) violations in connection with KIIFB raising Rs 2,150 crore through masala bonds listed on the London Stock Exchange. The notices are a sequel to that probe.

8. Isaac said the masala bond funds were utilised for 339 projects in eight areas. Of this, Rs 466 crore was spent on the land acquisition component of various projects. The ED has interpreted this as land purchase. FEMA restrains the use of foreign currency for land acquisition to prevent speculation.

External Commercial Borrowings (ECB)

9. According to the RBI, “External Commercial Borrowings (ECB) refer to commercial loans in the form of bank loans, buyers’ credit, suppliers’ credit, securitized instruments (e.g. floating rate notes and fixed rate bonds, non-convertible, optionally convertible or partially convertible preference shares) availed of from non-resident lenders with a minimum average maturity of 3 years.”

10. ECB policy is applicable to the Foreign Currency Convertible Bonds (FCCBs) which are bonds issued by an Indian company expressed in foreign currency, and the principal and interest in respect of which is payable in foreign currency. They are also required to adhere to the provisions of FEMA.

BEYOND THE NUGGET: FEMA

1. FEMA came in 1999 as a successor to the Foreign Exchange Regulation Act or FERA of 1973, with changing economic conditions in a post-liberalisation India. It aims to boost external trade and payments and promote the development of the foreign exchange market in India.

2. FERA was designed for an era in India marked by a shortage of foreign exchange; it was aimed at conserving forex to ensure it was utilised only in the interest of the development of the country, as the preamble of the law stated.

3. Under FEMA, offences or violations were made a civil (rather than criminal) offence, and made transactions that are part of the current account, such as travelling abroad for tourism, education, etc., a matter of right — while putting in place restrictions on the capital account. Director and Assistant Director of Enforcement Directorate has the power to conduct investigations into any violations of FEMA.

Post Read Question

With reference to ‘IFC Masala Bonds’, sometimes seen in the news, which of the statements given below is/are correct? (UPSC CSE 2016)

1. The International Finance Corporation, which offers these bonds, is an arm of the World Bank.

2. They are the rupee-denominated bonds and are a source of debt financing for the public and private sector.

Select the correct answer using the code given below.

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

(Sources: ED notices to Kerala CM Pinarayi Vijayan, former minister Thomas Isaac over masala bond probe, Masala bonds in India’s new cash-and-curry push, rbi, As ED files case against BBC under Foreign Exchange Management Act, a look at why the law was brought in, )

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