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The New Bond Thing: Sub Sovereign Masala Bonds?

posted by Mitu Gulati

Bored on my flight into Kerala, India’s southern most state, a few weeks ago, I picked up a newspaper lying on the empty seat next to me.  Most of the news was either about the Indian elections and how the nationalist BJP party had swept to power or about or India’s prospects in the cricket World Cup.  What caught my eye though was a little piece in the back section with a photo of luminaries from Kerala’s Marxist party at the London stock exchange. Kerala, for those who don’t know, has a long tradition of cycling between electing the supposedly anti-market Marxists and their pro-market Congress opponents. But here, I was seeing the Kerala Marxist party leaders at the London Stock Exchange.  My first thought was: This is a gag. Turned out not to be though.  The occasion was a five-year rupee denominated bond issued by Kerala, with a Canadian pension fund as its anchor investor (For more, see here).

The celebration at the London exchange was for Kerala having issued the first ever sub sovereign “masala” bond issue on the LSE.  Masala bonds are rupee-denominated bonds issued overseas (like Dim Sum, Samurai and Yankee bonds) and there are almost fifty of these masalas out there.  This though was the first one ever issued by an Indian state on the international market. I was intrigued for multiple reasons.

First, this was the first international sovereign bond of any variety from post-independence India that I had ever seen.  India has long had an enormous capacity to borrow on the international markets.  But its sovereign entities, state and federal, have staunchly refused tap this capacity until now.   

Second, I’ve long been fascinated by the question of why some countries borrow internationally at both the national and state (or sub sovereign) level (e.g., Spain), and others do their international borrowing only at the national level and effectively constrain the states to borrow from domestic markets (e.g., U.S.).  Here, we appear to have a new third category:  tapping the international market at the state level and not doing so at the national level. 

Third, I had had the vague impression that the Indian constitution barred the states from tapping the overseas markets (the language of the constitution, best I can tell, is not crystal clear on the matter).  And yet here it was: a bond issued by a wholly owned corporation of the state of Kerala (the Kerala Infrastructure Investment Fund Board or KIIFB), fully backed by a state guarantee with a rating from Fitch of BB.

What appears to have happened, best as I’ve been able to piece together, is that the Indian Central Bank decided in early 2019 that state government enterprises, if they were eligible for foreign direct investment as per the Central Bank’s rules, could also borrow overseas. And given that Kerala was allowed to put a state guarantee on the KIIFB bond issue, this essentially means that the Reserve Bank of India has opened a potential avenue for all the Indian states to tap the international markets.  Rumour is that a number of other Indian states are in line to follow the Kerala masala bond model.

Is this a good thing?  I’m not the biggest fan of state guarantees of corporate debt (here and here); it caused significant problems for Greece.  But, Kerala’s borrowing is tiny compared to the gargantuan size of the Greek debt stock.  Plus, there appear to be other controls in place to protect against abuses.  Specifically, the “Guarantee Act” in Kerala stipulates that guarantees may not exceed 5% of the GSDP or Gross State Domestic Product. 

And then there is the context, that is different from most sovereign borrowing – especially of the irresponsible kind.  Many countries borrow pro cyclically.  The better they are doing economically, the more they borrow (Why? Because they can). And this gets them into big trouble when hit bad economic times and actually need to borrow, because they don’t have much borrowing capacity left. The Kerala context looks to be different; that is, counter cyclical.  Kerala is borrowing as part of its anti-recession package. A decline in migrant labor to the middle east, stagnation in the prices of commercial crops, and a horrific monsoon season last year, have combined to a desperate need to raise capital. And that’s what Kerala appears to have done.  (Disclosure: Fifteen years ago, I co authored an article with the current Kerala finance minister, Thomas Isaac on worker cooperatives; Isaac used to be a development economics professor).   

To wrap up, here are a few questions I’m eager to find out more about.

First, will the international sub sovereign market grow on the back of this Kerala masala bond?  As noted at the start, I’ve long been puzzled by why, for example, more sub sovereigns do not tap the international markets.  Take the US states such as California, for example.  If they went on the international markets, I suspect that there would be enormous demand.  Part of the answer here has to do with exemptions from taxes for local purchasers, creating a structural preference in favour of local borrowing.  But why was the choice made to set up this structure?  Would it not be good to have sub sovereigns subject to the disciplining effects – at least to a small extent – of the international markets?.

Second, is the interest rate on these Kerala masala bonds too high? The flavour of the discussion in a number of local Indian press articles seems to suggest that many think that the rate Kerala is paying lenders is too high. And the yield on the masala bonds, 9.723%, looks pretty steep.  But is it?  It is not clear to me.  The first issue is that this rate is for payments in rupees. To compare the Kerala rate to other sovereign borrowing rates (which are almost all in dollar terms), one has to adjust for expected rupee versus dollar inflation. And that will yield a significantly lower number than 9.723, I suspect, given India’s bouts with inflation in the past.  Also, there is the question of what Kerala’s cost of borrowing similar amounts in the local market would have been (assuming that was even possible).  My understanding from press reports is that that cost would have been over 10% (here). The second issue is making the adjustment for the governing law and other legal provisions in this bond.  One cannot get a good sense of what the rate on a bond should be, unless one controls for its key legal characteristics.  The governing law is one of these characteristics. And we know that borrowing rate should be lower if the governing law is foreign (English or New York), rather than local (see here).

Third, what about those dedicated revenue streams that have been promised creditors? The bonds appear to have dedicated revenue streams, including from a motor vehicle tax.  I’m curious about the legal terms surrounding this promise of access to dedicated revenue streams. Can creditors meaningfully exercise legal remedies to seize these revenue streams in the event of a default by Kerala?  I’m assuming not.  But it would be interesting to see the legal terms and figure out what the governing law and related provisions are.

Last but not least:  Why the name “masala” bonds?  Who came up with that? Someone on the London exchange? The name sucks. I hope we can get a better name in place soon.


The name "masala bond" comes from IFC, which was the first issuer and continues to be active. Masala bonds are a type of bond denominated in local currency, but payable in USD (based on a published FX rate). Masala bonds were not the first of this type, however. Sovereign issuers in other countries (e.g. Brazil, Uruguay) w non-convertible currency have issued these local-currency international bonds, targeted at international investors wanting local currency risk (and yields) with international settlement (e.g. Euroclear). While governed under international law, that may not be so important to investors.

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