Masala in small doses please

RBI has released guidelines on the issue of ‘Masala’ bonds – bonds issued by Indian issuers to non-resident investors, denominated in Indian rupees. The idea that a country that has an internal savings deficit has to tap foreign savings is not news. Of course, one can sacrifice growth by limiting investment to the amount of savings available in the country. Sometimes, it may be worth it considering destabilisation caused by flow of foreign funds – in and out.

Further, Indian banks are perhaps still being cautious on lending and hence, it might make sense that India’s borrowers are being allowed to tap other sources. But, that assumes that corporations know what they are doing, that they are ready to invest and that they are only being stymied by lack of funds.

The good news, of course, is that this move might, at the margin, contribute to better corporate  governance. Other than that, I am not sure there is much to celebrate here.

Repeat after me:

(1) Borrowing in foreign currency and borrowing in domestic currency from foreigners are equivalent. In an external crisis, both of them may have similar adverse impacts

(2) Borrowing in domestic currency from domestic savers is not foolproof either. When there is excess domestic borrowing, flight of capital will follow, when domestic growth dries up. Ask China.

(3) Financial markets are not disciplining mechanisms except in academic papers. [Will be very happy to be contradicted here with evidence]. They are instruments of instability, for the most part. At least, as long as Western policy settings favour asset price bubbles and financial investors are disposed towards instant gratification, they are unlikely to be disciplining devices, on balance.

(4) There is no theoretical basis or empirical evidence to show that bond markets are important for economic growth, especially after accounting for growth costs of financial instability.

(5) State governments are allowed to borrow overseas. But, do they have the capability to stand up to and negotiate with Investment Bankers and overseas lenders? Local governments in America have been taken for many costly rides by these counterparties. So, should capacity building have preceded this decision or is it at least concurrent?

(6) With adequate and correct incentives, banks and specialised financial institutions can provide long-term funding. Do bond markets provide long-term funding?

In short, Masala can spice up food. It cannot substitute for food. Internal resources and domestic savings are the staple food. India’s limits, in comparison to other countries, for foreign lenders are still small. No shame here. Only safety. Keep it that way.


2 thoughts on “Masala in small doses please

  1. What about FX risk? In Masala bonds, FX risk is borne by investor, while in “normal” foreign currency bond, it’s borne by borrower. Doesn’t this make them different?


    1. The FX risk is transferred to the investor and the State from the borrower. That is why borrowings in Rupees from foreigners are shown as part of India’s External Debt. The money will be taken out in foreign currency at the time of redemption by the investor at the prevailing exchange rate. In that sense, he/she bears the exchange rate risk. But, the State has to find the Foreign Currency from its reserves to pay. The rupee is not convertible currency. Foreigners will not want to (not as yet) nor can they take and retain their proceeds in Rupees.


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