Should NRIs invest in FCNR Deposits?
I am an NRI and i have been approached by a few banks about their respective products on FCNR deposits with forward cover. Some of them are RupeeMax (HDFC Bank), Rupee Advantage Plan (Kotak), Premium Rupee Plan (YES Bank), etc. Their illustrations show a tax free interest rate of 12-14% per annum (5 year lock in) in YEN. I have been trying to get my head around it but i still havent been able to see if its really a good product or like they say “a wolf in sheep’s skin”. Also, they all mention that it is tax free, though i do have my doubts and i didnt find any mention of “deposits with forward cover” under non-taxable income. Since, NRE deposits/FCNR Deposits are tax free, they are claiming that this product too is tax free, which again is a grey area to me. Could you clarify on this or write a seperate post on this subject?
Here’s the deal:
FCNR deposits: I’ve written about this, and that you can even get leverage from certain banks, if you’re willing to lock in your funds for three years: https://content.capitalmind.in/2013/09/the-low-risk-nri-mega-return-through-leveraged-fcnr-deposits/
The 12-14% per annum is a leveraged return. If you put $15K and borrow $85K at (say) 3% for three years, you will after three years make a return of 15%, assuming an FCNR deposit of 5% at an Indian bank.
It’s a decent product. The interest rate is guaranteed by the bank and they take on a dollar swap with the RBI (for three years or more) which basically ensures you’ll get your principal back - the RBI isn’t likely to default. The interest has to be paid by the bank, and presumably they have the ability to do at least that, so their default risk is low (not as low as the RBI, but you get the picture)
Tax Free: These products’ returns are not taxed in India. But they could be taxed in the area you are in - for instance, if you live in the US, you will be have to pay US taxes on the returns.
**What could go wrong: **Many many things, but they’re all unlikely at this point.
a) At an exchange rate of Rs. 100 to a dollar, bank costs go through the roof.
Let’s say you put $100,000 in an FCNR deposit at 5% compounded annually. This means you must get back $115,000 after three years. The bank swaps the 100K to the RBI at $1=Rs. 61, gets Rs. 61 lakh and will have to return to the RBI Rs. 67.63 lakh after three years to get back $100K. That’s fine for the principal.
But if the exchange rate goes to Rs. 100, the interest of $15,000 will have to be bought from the market, and costs Rs. 15 lakh. So along with the RBI, the bank has to pay Rs. 15 lakh (interest cost) plus Rs. 67.63 lakh (principal cost), taking the repayment cost to Rs. 83 lakh. This translates to a cost to 11% per year for the bank.
(Note: thanks to alert reader Rajan for noticing this)
This is where it could get difficult if banks can’t pay back. But this is not a huge risk, given the assumption is that exchange rate in rupees goes down 66% in three years and the cost to banks only goes to 11%.
b) If US interest rates increase, NRIs cannot exit easily. If the rupee appreciates, they can’t use the opportunity.
Given the early withdrawal penalties on such products, the NRI can’t get out of it easily. What if rates in the US cross 5% in the interim? Of course they don’t look like it, but things can move really fast.
Another opportunity cost is if the rupee goes back to Rs. 40, these products might not earn as well in terms of dollars as they would have in rupees.
Here the risk isn’t a loss of capital but a loss of opportunity. Both these scenarios are unlikely but it’s a risk nevertheless.
My choice: I’d invest, if I had the money to spare for three years, with no better opportunities. In fact if I could leverage it I would, but not 10x (maybe enough to get a double digit return, which works at 5x). However, retirement money and such would do better in the longer term invested in good quality stocks abroad than in such schemes.
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