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Swap window for FCNR-dollar deposits! Festival bonanza for NRIs?

The NRIs are poised to take advantage of the swap window which will fetch them handsome returns on deposits


Even before the commencement of festival season, the Reserve Bank of India (RBI) has showered a bonanza on non-resident Indians (NRIs) and it appears to be a “festival sale offer”, in the form of abnormally high interest rates on foreign currency non-resident deposits (FCNR), offered by commercial banks that will last till 30 November 2013.

The RBI has been trying to attract foreign exchange into the country with a view of bringing down the current account deficit (CAD), one of the main reasons for the recent depreciation of the rupee which had fallen by almost 20% against US dollar during the year.
 

When India attained independence, the value of the rupee was on par with the US dollar. However, due to a variety of reasons, the Indian rupee depreciated year after year, touching a record low of Rs68.85 to a US dollar. In other words, it has depreciated at an average of one rupee every year since Independence.


The Indian rupee plummeted to a new low on 28 August 2013 on rising concerns of flight of capital invested in India by foreign institutional investors (FIIs) due to the imminent tapering of quantitative easing (QE) by the Federal Reserve Bank of US (US Fed). Though this fall has stopped temporarily and rupee has stabilised around Rs62 per dollar, the government has been frantically trying to boost inward remittances from NRIs with a view to shore up the forex reserves.


Inward remittances from NRIs

The inward remittances from NRIs form a good part of the forex reserves and these remittances have been growing at a good pace as show in the following graph.
 


Attracting NRI deposits through FCNR deposits
 

Though the foreign exchange position of our country is not that precarious even as remittances from NRIs are growing year after year, RBI appears to be keen to ensure that the forex reserves are not depleted further even when the anticipated outflow of foreign exchange from the country takes place when the US Fed tapers down the pumping of money into the market under its quantitative easing program.
 

To attract NRI remittances, the RBI has provided additional incentives to NRIs to invest in India under the FCNR deposit scheme by raising interest rates. However, to protect the banks in India from possible exchange rate loss, the RBI offered banks the facility of swapping the US dollar funds received from NRIs at a fixed swap rate of 3.50 %, permitting the banks at the same time to accept these deposits up to a tenure of five years at a rate linked to LIBOR (London Inter-Bank Offered Rate) as under:
 

Maturity Period

Interest rate

>1 and <3 years

LIBOR*/Swap plus 200 basis points

>3 and <5 years

LIBOR*/Swap plus 400 basis points

 

FCNR deposit rates currently offered by commercial banks in India
 

Based on the ceiling imposed by RBI, banks are offering higher interest rates to the NRIs on FCNR deposits and are fixed on the first working day of every month valid till the end of the month. The current rates of interest offered on FCNR deposits in India in six foreign currencies with effect from 1st October, 2013 are as under:
 

FCNR Deposit rates (in %) w.e.f. 01-10-2013 offered by Bank of India through their branches in India

MATURITY USD GBP EURO JPY CAN$ AUS$
1 YR TO LESS THAN 2 YRS 2.63 2.87 2.47 2.41 3.49 4.52
2 YRS TO LESS THAN 3 YRS 2.48 2.83 2.57 2.26 3.47 4.79
3 YRS TO LESS THAN 4 YRS 4.77 5.12 4.77 4.29 5.73 7.08
4 YRS TO LESS THAN 5 YRS 5.16 5.44 5.00 4.34 6.01 7.39
5 YRS (Maximum) 5.53 5.71 5.24 4.41 6.24 7.61

Note: These are the rates of deposits offered at present by most of the commercial banks in India, though there are minor variation in these rates from bank to bank which can be ascertained by visiting their websites and they are subject to change from time to time without notice.


If you compare these rates with what is offered on US dollar deposits by banks in the US, it is certainly a bonanza for NRIs, as currently U.S banks offer very low interest rates ranging from 0.25% to 0.50 % per annum on Certificate of Deposits of one to five years (one year Libor is around 0.62 % per annum during last week).

 

Obviously, these high rates of interest offered to NRIs cannot last long and the RBI has already indicated that the swap facility offered to banks will be available only till 30 November 2013, and could be closed earlier with prior notice. Also, Dr SS Tarapore, former deputy governor of the RBI, has written in a local media that the swap facility offered by RBI on FCNR deposits to banks “exposes RBI to losses of an estimated Rs60,000 crore which would be self-immolation”. If this estimate is right, RBI may not continue with this facility for long and may even reduce the interest rates permitted on FCNR deposits if and when the intended purpose of attracting forex inflows into the country is achieved.
 

What are the pros and cons of investing in FCNR deposits with banks in India?
 

Apart from the higher interest rates offered on these deposits, the NRIs enjoy the following benefits from investing in FCNR deposits with authorized banks in India.
 

1. The interest earned on these deposits in India is totally exempt from Indian Income-tax. The tax free status of these deposits is the most important reason for NRIs to invest here.
 

2. The deposit amount and the interest earned on these deposits are freely repatriable to the country of residence of the depositor without any restrictions.
 

3. There is no exchange risk to the depositor in these FCNR deposits. The principal and the interest are transferred back on the due dates in the currency of deposit without any exchange loss.
 

4. These deposits can be held in joint names with the close relation of the depositor living abroad. With a view to facilitate smooth banking operations for NRIs in India, RBI has since allowed the NRIs to open FCNR accounts jointly with their resident close relative (close relative as defined in Companies Act) on former or survivor basis. The resident close relative shall be eligible to operate the account as a Power of Attorney holder in accordance with the extant instructions during the life time of the NRI/PIO account holder
 

But following precautions must be taken by NRIs while investing in FCNR deposits in India:
 

1. Though the interest earned on FCNR deposits at present is tax-free in India, it may be taxable in the country where the NRIs live and they should, therefore, consult their tax advisor in the country of their residence to be clear about the tax implications of investing in India. There are certain double taxation avoidance treaties between India and many countries of the world, which may mitigate the tax burden to some extent, but this can best be ascertained from the tax advisor before investing in India
 

2. NRIs/Persons of Indian Origin (PIOs) residing in the US should be aware of the implications of the new law recently enacted called the Foreign Accounts Tax Compliance Act (FATCA). From 1 July 2014, this law will require all financial institutions around the world to report directly to the US Internal Revenue Service (IRS) all the assets and incomes of any US citizen with $50,000 on their books. The law applies to banks and financial institutions, even if their home countries have secrecy laws. Those that do not comply could face significant fines or be locked out of doing business with American clients. Unlike many other countries, Americans are taxed not only as residents of the US but also as citizens, wherever they live. It appears to be an attempt by US government to recover an estimated $100 billion a year in unpaid taxes on US citizens' assets invested overseas.
 

3. These FCNR deposits are accepted for fixed periods ranging from one to five years and any withdrawal before their maturity date will result in penalties for early withdrawal which may vary from bank to bank. It is, therefore, advisable to ascertain from the bank concerned the full details of such penalties before making the deposit.
 

4. The rules of investment in India by NRIs are framed by the RBI under the Foreign Exchange Management Act and with regard to tax by Government of India under Indian Income Tax Act and they are, therefore, subject to change from time to time. NRIs are advised to consult their financial advisor for clarity in these matters.

5. The chances of commercial banks in India going bust are remote, if past experience is any indication. However, there is no guarantee that banks will not fail. Whenever any commercial bank is teetering on the brink, the RBI normally arranges to merge such a weak bank with a strong one, so that the depositors generally do not lose money.
However, shareholders may not get back their full investment. The same can not be said of co-operative banks.
 

6. Besides, in India each depositor in a bank, which is authorised and approved by RBI, is insured up to a maximum of one lakh rupees, for both principal and interest amount. This amount at the present exchange rate is equivalent of approximately $1,600, which is so low it is best to consider deposit insurance as non-existent while investing in banks in India.
 

(The author is a banking analyst and is a regular contributor on banking and finance. He writes for Moneylife under the pen-name ‘Gurpur’.)

 

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