Look beyond returns on your NRI deposit

India's rupee woes seem to have worked in favour of non-resident Indians (NRIs). Last week, the Reserve Bank of India increased the cap on foreign currency non-resident (FCNR) and non-resident external (NRE) interest rates. Taking the cue, several banks such as SBI, PNB, Union Bank of India and Federal Bank have increased the interest rates offered on FCNR and NRE deposits.

FCNR deposits are foreign currency denominated. Investors can transfer funds in dollars, pounds, euros, yen and even Canadian and Australian dollars. The deposit will be held in the same currency. NRE deposits, on the other hand, are rupee-denominated, i.e. though funds may be transferred in foreign currency, the bank will convert these to rupees.

After the increase, SBI is offering a return of 2.32 (2.19 previously) per cent for a one-year FCNR deposit, going up to 2.35 (2.30 formerly) per cent for up to five years. For NRE deposits, the rates are slightly higher, starting with 3.82 (3.69 formerly) per cent for one year to 3.64 (3.52 previously) per cent for five years. Besides these, another option NRIs can consider are the non-resident ordinary (NRO) deposits, also rupee-denominated. These offer the highest rates, comparable to those offered on resident term deposits, from seven per cent for seven-90 days to 9.25 for one-10 years.

However, interest rates alone should not guide your investment decision. Minimum investment for an FCNR deposit starts at $1,000 for HDFC Bank. That works out to Rs 52,000 at the current exchange rate of $1 = Rs 52. It is almost half for NRE and NRO accounts at Rs 25,000. Along with this, one must consider aspects like repatriability, taxation and even any underlying currency conversion risk.

Currency conversion risk: “The choice for the deposits should depend on one's view on the rupee movement," says K V S Manian, group head, retail liabilities and branch banking, Kotak Mahindra Bank.

For instance, say you have $1,000. If you opt for the NRE deposit, then you would be investing (after converting) Rs 52,000. Your view is that the rupee will strengthen on maturity a year from now. If you are proved correct and, say, the rupee has appreciated to Rs 45 against the dollar, the principal amount will be converted into dollars according to the rate prevalent at the time of maturity. Then, you get around $1,115. This means a double gain; appreciation of principal plus interest income. However, this sword cuts both ways. In a reverse situation, it could mean an erosion of your capital. FCNR deposits would protect investors against any such risks due to currency fluctuations.

Repatriation: This is a limitation for NRO deposits, as only the interest earned thereon can be repatriated to your account abroad. Reason: NRO deposits use the funds from NRO accounts. The funds in these accounts even include your local income, if any (like rental income from Indian properties and so on). Therefore, they cannot be repatriated fully.

However, in case of FCNR and NRE deposits, the principal as well as interest can be repatriated fully, since the funds are sourced entirely from your earnings abroad.

Taxation: The interest earned on NRO deposits is taxed at a flat 30.9 per cent (tax rate of 30 per cent plus education cess of three per cent on tax amount). However, for NRE and FCNR deposits, the interest earned is completely exempt from tax. Despite the tax liability, the NRO accounts work best in terms of returns, says a senior official in charge of NRI banking at a public sector bank. For example, say you have $1,000 to put in a deposit with SBI. In case of FCNR deposits, you would earn about $23.2 (Rs 1,206 at an exchange rate of Rs 52) over a year. For an NRE deposit, the amount will be first converted to rupees. It would be Rs 52,000, earning Rs 1,986 in a year. Similarly, for a NRO deposit, the interest earned would be Rs 4,810. After tax, this would mean an income of Rs 3,323.