Why FCNR Deposits at 6-7.1% Rates Are a Game-Changer for NRIs
The Reserve Bank of India (RBI) has recently unveiled a special swap facility that has transformed the landscape of foreign currency non-resident (FCNR) deposits for non-resident Indians (NRIs). This move has made parking dollars in India more rewarding than ever before, and it's a game-changer for those looking to maximize their savings. But what does this mean for NRIs, and is it the right move for everyone?
The Allure of FCNR Deposits
The current rates on FCNR deposits are a steal, offering 5.7-7.1% interest for 3-5 year terms. This is a significant jump from the rates offered on equivalent term deposits in other countries, such as the US. For instance, the current annual percentage yield (APY) for three to five years on CDs at the five biggest US banks range from 0.03% to 2%, while similar-sized banks in India offer 5.75% to 6%. Smaller US banks and credit unions offer about 4.2% on three-to-five-year deposits, but even against these, FCNR rates in similar-sized Indian banks sit roughly 300 basis points higher, at around 7%.
What makes this particularly fascinating is that FCNR deposits are accessible to even those with smaller dispensable amounts, starting at $500-$1000 across different banks. However, the higher rates of 5.7-7.1% are only available for 3-5 year terms, and come with a 1-year lock-in period. This means that NRIs need to be prepared to commit their funds for a longer period of time.
The Risks of Leverage
Much of the excitement around this scheme is about leverage – borrowing several times your own money to magnify the spread. Take an NRI who puts in $100,000 of his own and borrows another $900,000 to build a $1 million deposit. At an FCNR rate of 7%, the deposit earns $70,000 a year. If he borrowed the $900,000 at 5%, his interest cost is $45,000. That leaves him $25,000, earned on his own capital of just $100,000 – a return of about 25%. The return will change depending on how much he borrows and at what rate. Brokerage estimates peg such structures at dollar returns of 17-27% a year.
However, in my opinion, this is a game for the ultra-high net-worth individuals (UHNIs) and carries nuances. Leverage typically comes through private banking relationships, so in that case HNI-UHNIs matter a lot more. The deposit pays a fixed rate, but the overseas loan funding is usually on a floating rate, so even a small rise in global borrowing costs can significantly erode returns because the investor is leveraged multiple times over. Moreover, the input costs of a loan eat into the spread. Getting a guarantee from the Indian banks in the form of a standby letter of credit (SBLC) that is given to the overseas bank to secure the loan, alone comes at a fee of 0.50-1% a year. Other processing and documentation charges are extra.
The Right Move for Most NRIs
For most NRIs, the right way to use this window is to use their disposable savings to make a deposit for three to five years and leave the leverage to those equipped for its risks. This is a more prudent approach, as it allows NRIs to take advantage of the higher rates without exposing themselves to unnecessary risks. In my opinion, this is the best way to maximize the benefits of the FCNR deposit scheme.
The Bottom Line
The RBI's special swap facility has opened up a world of opportunity for NRIs, offering rates that are simply too good to pass up. However, it's important to remember that this is not a one-size-fits-all solution. NRIs need to carefully consider their financial goals and risk tolerance before making a decision. For most, the best approach is to use their disposable savings to make a deposit for three to five years and leave the leverage to those equipped for its risks.
In my opinion, this is a game-changer for NRIs, offering a unique opportunity to maximize their savings. But it's important to approach it with caution and a clear understanding of the risks involved.
