In a move that has caught the attention of non-resident Indians (NRIs), the Reserve Bank of India (RBI) has opened a lucrative window for parking their hard-earned dollars. The recent announcement of a special swap facility has sparked interest, offering NRIs an opportunity to boost their savings with attractive interest rates on Foreign Currency Non-Resident (FCNR) deposits.
This development is particularly intriguing as it presents a unique scenario where banks can offer higher rates without bearing the burden of hedging costs against rupee fluctuations. As a result, NRIs are now presented with an enticing proposition: the chance to earn significantly higher returns on their deposits compared to what is typically available in their host countries.
The FCNR Deposit Advantage
Let's delve into the specifics. Major Indian banks, including HDFC Bank, ICICI Bank, Axis Bank, and Bank of Baroda, are now offering peak rates of 6% on FCNR deposits with tenures ranging from three to five years. This is a substantial increase, with some banks raising their rates by up to 300 basis points.
The beauty of this arrangement lies in the fact that banks can convert these dollar deposits into rupees and lend them to Indian borrowers, earning a higher interest rate than they pay out to NRIs. However, the traditional risk for banks has been the potential weakening of the rupee before the deposit matures. To mitigate this risk, banks typically engage in hedging, which comes at a cost.
J.P. Joy, EVP and country head for retail liability and fee products at Federal Bank, highlights that the hedging cost can be significant, ranging from 2.90% to 3% annually. This means that, previously, if a bank offered a 6.5% interest rate on fixed deposits to resident customers, the FCNR rates for NRIs would be reduced to approximately 3.5% after accounting for hedging expenses.
However, the RBI's recent intervention has changed the game. By absorbing the hedging cost, the central bank has effectively removed the currency risk for banks. As Uttam Tibrewal, deputy CEO of AU Small Finance Bank, notes, this regulatory measure has optimized hedging economics, enabling banks to offer substantially higher rates to NRI customers.
Currency Considerations
It's important to note that the current swap facility is specifically for dollar deposits. Consequently, rates on FCNR deposits in other currencies, such as the British pound sterling, Australian dollar, Euro, Canadian dollar, and Singapore dollar, have not experienced a similar increase.
Should NRIs Jump Onboard?
The higher rates on FCNR deposits have made them an attractive option for NRIs, especially when compared to the rates offered on equivalent term deposits in their host countries. For instance, in the US, certificates of deposit (CDs) are the equivalent of fixed deposits in India. The current annual percentage yield (APY) for three to five years on CDs at the five biggest US banks ranges from a mere 0.03% to 2%, while similar-sized banks in India offer rates of 5.75% to 6%.
Smaller US banks and credit unions provide slightly better rates, around 4.2% on three to five-year deposits. However, even in this case, FCNR rates in comparable Indian banks are still roughly 300 basis points higher, at around 7%.
Himanshu Pandya, a Sebi-registered Investment Advisor, emphasizes the significance of this yield gap, which has widened from a previous range of 25-50 basis points to the current 200-300 basis points.
FCNR deposits are accessible, with most banks requiring a minimum deposit of $500-$1000. However, the higher rates of 5.7-7.1% are only available for three to five-year terms, and these deposits come with a one-year lock-in period.
In the event of a premature withdrawal after the mandatory one-year lock-in, the deposit will earn interest at the applicable rate for the completed tenure. For example, if a depositor withdraws in the second year of a four-year deposit, they will receive interest for the two-year tenure, which is at a lower rate. Some banks also impose a penalty for premature withdrawal, typically around 1% of the eligible interest rate for the deposit period.
Investment experts like Pandya and Animesh Hardia, senior vice president of Quantitative Research at 1 Finance, advise NRIs with a three to five-year timeline to consider booking these deposits. However, Hardia cautions that NRIs should compare the after-tax rate in their country of residence rather than solely focusing on the headline rate.
Deepak Shenoy, CEO of Capital Mind MF, emphasizes that even a 100 bps differential is significant for debt products. He believes FCNR deposits are an excellent option for US-resident NRIs or Overseas Citizens of India (OCIs) who want to park their money for three years as part of their long-term debt allocation in USD terms.
The Leverage Game
While the higher rates on FCNR deposits are undoubtedly attractive, it's important to approach the leverage aspect with caution. The potential to borrow several times your own money to magnify the spread is an enticing prospect, but it's a game primarily suited for ultra-high net-worth individuals (UHNIs).
As Rahul Agarwal, a Sebi-registered investment advisor and founder of Advent Financial, explains, the deposit pays a fixed rate, but the overseas loan funding is usually on a floating rate. This means that even a small increase in global borrowing costs can significantly erode returns, especially when the investor is leveraged multiple times over.
Additionally, the input costs associated with the loan can eat into the spread. Agarwal highlights the fee for obtaining a guarantee from Indian banks in the form of a standby letter of credit (SBLC), which is given to the overseas bank to secure the loan. This fee alone can be 0.50-1% a year, and there are additional processing and documentation charges. Given these nuances and potential risks, Agarwal advises against leveraging for his clients.
It's worth noting that personal loan interest rates were significantly lower in 2013, ranging from 1-1.5%, compared to the current rates of 4-5%. This makes the current swap facility less attractive for leverage purposes than it was in 2013.
A Word of Caution
For most NRIs, the prudent approach is to use their disposable savings to make a deposit for three to five years and leave the leverage to those who are better equipped to manage the associated risks. While the opportunity to earn higher returns is tempting, it's essential to carefully consider one's financial goals, timeline, and risk tolerance before making any investment decisions.
In conclusion, the RBI's move to open this window for NRIs is an intriguing development, offering a unique opportunity to boost savings. However, as with any investment, it's crucial to approach it with a clear understanding of the risks and rewards, and to seek professional advice when needed.
