Question

Our cities need to be transformed into economically vibrant and environmentally sustainable habitats. In this context, Innovative finance instruments like masala bonds are crucial for the development of cities in India. Comment

Answer 1

Approach

• Start with a basic definition of Masala Bonds.
• Then proceed to introduce its features.
• In the next section briefly outline the problems faced by cities w.r.t finance.
• Then explain how masala bonds can be the right solution for the problems mentioned.
• Conclude by mentioning how this intervention is critical for the success of government schemes in this sector.

Background
Masala bond is a term used to refer to a financial instrument through which Indian entities can raise money from overseas markets in the rupee, and not foreign currency. These are Indian rupee-denominated bonds issued in offshore capital markets.
Currency risk is borne by the investor and hence, during repayment of bond coupon and maturity amount, if rupee depreciates, the savings thus made will be realized by the RBI.

Problems faced by cities

• Infrastructure is crumbling in majority of Indian cities and its revamp is imperative
• Shortage of funds is the major issue stalling urban governance.
• Taxing properties or monetising assets are not enough to meet the huge capital requirements
• Even though State Finance Commissions recommend devolution of funds to the local level, it is rarely followed in spirit.
• State governments might also place additional caps in their investments in cities to remain within the state fiscal deficits as prescribed by the FRBM Act.
• The key areas of concern for urban administration are infrastructure, technology-based interventions etc. These are capital intensive and require sustained, long-term funding which most cities are unable to meet.

Masala Bonds

• Masala bonds can raise money to meet the long term capital expenditure requirements of cities. This can be used to fund capital intensive infrastructure projects.
• These instruments can be used to sidestep the fiscal deficit caps placed on states. This gives more flexibility in project financing for urban administration.
• The fact that the risk of currency volatility is borne by the investor, makes this instrument even more desirable.
• Masala Bonds can also be used to attract foreign investments in key sectors thereby revitalising the economy and improving competitiveness in the markets.

Pune, Indore etc have issued Masala bonds to meet its development needs and fund new projects and other cities should follow suit.
City administration does not have enough fiscal legroom to manoeuvre. Even in such a condition they have to attract funds to meet their development objectives. Masala bond creates a perfect investment vehicle that balances risks and opportunities.