Source - Times of India, May 11, 2012 | 8:28 PM IST
The rupee has been in slide mode for some time now and in order to arrest that fall, the Reserve Bank of India (RBI) has been taking several steps to attract dollars into the country. One slew of changes were introduced in December 2011 when the central bank deregulated interest rates on Non Resident Ordinary (NRO) savings accounts and Non Resident External (NRE) term deposits. As a next step, earlier this month, the RBI also freed up interest rates on the Foreign Currency Non Resident (FCNR) Account. The result: a significant spike in interest rates on all these accounts.
For NRIs, this is great news. They now have a choice of 3 attractively priced term deposit accounts in India: NRO, NRE and FCNR. The table gives you a snapshot of the features of the 3 types of term deposit accounts.
Data from the RBI suggests that FCNR balances have always lagged behind balances in the NRE accounts. As of Feb 2012, while FCNR balance was at $15.54 billion, the same in NRE accounts was $29.94 billion. Certified Financial Planner Gaurav Mashruwala says, "The NRE account allows an NRI to maintain a savings as well as term deposit account while FCNR is only a term deposit. Perhaps this, and the fact that NRE accounts are rupee accounts, makes it operationally convenient for investors to opt for the NRE term deposit. Another issue is that not many investors may be aware of the FCNR deposit since for the longest time, interest rates were barely around 1%."
But today, given the volatile relationship between the rupee and the dollar, FCNR deposits, with deregulated interest rates, might provide a currency hedge to investors.
How to choose: Over the years, the RBI has made repatriation fairly liberal. While you can freely repatriate NRE and FCNR balances, NRO account balances are repatriable up to USD 1 million per financial year. So this feature may not be an important consideration for most. What would be important though are tax and currency risk.
Check tax impact
Interest on the NRO account is taxable and for NRIs, tax is deducted at source at 30%. In case of a Double Taxation Avoidance Agreement (DTAA) between India and other countries, this TDS rate would be lower. For instance, the DTAA between India and the US lays down a TDS rate of 15% on interest from deposits in India. These deposits may also be taxed in the country of your residence. The US, for instance, taxes global income of its residents and citizens. However, if tax has been deducted at source in India, the investor will get a credit in the US for taxes paid in India.
Interest on the NRE account and FCNR account are tax free in India. However, countries like the US, which levy tax on global income of its residents and citizens will tax this income. So while interest on NRE and FCNR accounts maybe tax free in India, a US resident or citizen would have to add this interest to his total income in the US tax return and pay taxes thereon.
For NRIs in tax free zones like the Gulf region, the NRE and FCNR option would work best. For residents of the US, the choice would depend on the tax slab applicable in the US.
Assess currency risk
Currently, the rupee-dollar relationship is extremely volatile. In such times, currency risk is an important consideration while making investments in India.
Let us consider an example to understand this. You invested $ 20,000 in a rupee deposit when the rupee was at 53. Let us say that at maturity, after 1 year, the rupee touches 55. Here are your gains:
Principal: $20,000 or Rs 10,60,000 Interest @8%: Rs 84,800 Maturity: Rs 11,44,800 or $ 20815 Gain in dollars: $ 815 or 4%
Thus, if the rupee slips to 55 at the end of one year, your 8% interest rate would translate into a net 4% gain after currency adjustment. If the rupee were to slip further, say to 56, your net gains would further drop to 2%. Instead, had you invested in a dollar deposit, your gains would have been 4% irrespective of currency movement.
Conversely though, if the rupee appreciates, say to 51, then your net gains from the rupee deposit would be 12%.
The outlook for the rupee remains uncertain as it is reeling under the impact of a widening capital account deficit, a slowing economy, fears about policy reforms and uncertainty about taxation of foreign investors. In such a scenario, the choice of deposit would depend on the risk profile of the investor.
Virat Diwanji, Executive Vice President & Head - Branch Banking, Kotak Mahindra Bank advices, "In current scenario, FCNR dollar deposits would suit more to an investor who is completely risk averse and looking at investing in India with an at least 3 year horizon. However NRE deposits at current attractive rates may prove to be a better option if one is willing to take the currency risk since the rate differential between a NRE deposit and FCNR is about 500 basis points for 3 year tenure and even higher for lower tenures."
Mashruwala adds, "If you are certain that you will repatriate the maturity proceeds, then it is best to invest in the FCNR as you protect yourself against currency risk. Conversely, if you are certain that your investment will remain in India, NRE would be a better choice."