Indian expats: Earn more from deposits made in non-resident bank accounts till end of October

Dubai: Non-resident Indians (NRIs) can now earn more from their deposits in certain non-resident Indian bank accounts. This was after the Indian central bank removed the cap on how much interest rates can be raised for NRI bank deposits. But what does this mean for NRIs and how will it boost NRI savings?

The Reserve Bank of India (RBI) recently removed the cap on interest rates on foreign currency non-resident bank (FCNR) and non-resident external (NRE) account deposits for the period from the July 7 to October 31, and this was followed by banks raising rates on NRI deposits at several banks.

Difference between FCNR and NRE bank accounts

FCNR is an account that allows NRIs to park their foreign income in Indian banks in the currency of their resident country and earn interest on it. FCNR deposits can be made in currencies such as the US dollar, British pound, euro, yen, Australian dollar, Singapore dollar and Canadian dollar, among others.

On the other hand, an NRE account is a bank account opened in India in the name of an NRI, to park his foreign earnings. In an NRE deposit, the currency deposited from overseas is converted to the rupee.

Indian residents can also open and maintain these deposits as joint holders with an NRI relative, but as the money has to come from outside India, Indian joint account holders can’t make deposits. The money from both types of deposits is repatriable or transferrable.

Indian Rupee
Non-resident Indians (NRIs) can now earn more from their deposits in certain non-resident Indian bank accounts.

What does the recent rule change mean for NRIs?

As per RBI guidelines, banks can offer up to 2.5 per cent and 3.5 per cent for FCNR deposits with maturity of one year to less than a year, and three years and up to five years, respectively.

For NRE deposits, interest rates cannot be higher than the rates being offered by the banks on comparable term deposits in the country.

The RBI has removed these guidelines till October 31, but this will apply only on the new deposits booked during the allowed period. The benefit of this is proposed to be passed on to the NRI customers by means of better interest rates.

What does it mean for NRIs to invest in FDs?

What it means for NRIs looking to invest in FDs during the four-month window is that the agreed-upon rates locked on new deposits will be for the entire tenure. Also, interest earned from these deposits is exempt from tax in India.

It is an excellent move to attract more foreign exchange in India by offering higher interest rates on FCNR

– Dixit Jain

“It is an excellent move to attract more foreign exchange in India by offering higher interest rates on FCNR which can be placed in US dollar or some other foreign currencies,” said Dixit Jain, Managing Director at The Tax Experts DMCC, a Dubai-based tax advisory firm.

“The move come amid massive pressure on the Indian rupee against the US dollar and falling forex reserves in the country.”

NextGen FDI, fdi, foreign direct investment
The central bank’s recent move is aimed at attracting US dollars into the country to stem the Indian rupee’s current steep devaluation.

Beware of higher premature withdrawal rates

However, keep in mind that these deposits also carry a penalty of 0.25 per cent to 1.0 per cent on premature withdrawal and no interest is paid if deposits are withdrawn before one year.

Experts additionally recommend potential investors to calculate the returns on NRE deposits after factoring in the conversion loss and change in the exchange rate.

This is why depositors are asked to also choose a strong scheduled commercial bank to park their funds, while also adding that they be mindful about the fact that the deposit insurance covers accounts for only up to Rs500,000 (Dh22,954), which comes to approximately $6,300 or £5,300, which is low.

Illustration on how to factor conversion loss and change in the exchange rate

Let’s say the exchange rate of the Indian rupee against the US dollar is currently 80. An NRI converts $10,000 (Dh36,700) into Indian rupee at the above-mentioned rate of Rs80, which equates to Rs800,000.

If the NRE deposit you’re considering to invest in earns interest rate at 5 per cent, this amount grows to Rs840,000 (Dh38,564). Furthermore, let’s also consider the rupee devaluates to 82 after a year. At the depreciated rate, Rs840,000 is now equal to $10,244, instead of $10,500 at Rs80 conversion rate.

In other words, the NRI investor earns a return of 2.44 per cent in dollar terms. This is advantageous to the depositor if, during the period when the NRE deposit was made, the interest rate on a 1-year US dollar deposit rate is more than 2.44 per cent.

How did investing in FDs work until now?

Most banks in India have only offered fixed rate FDs up until now, and most advisors have recommended ‘laddering’ to their customers in order to derive the benefit of high interest rates and liquidity. But what does this ‘laddering’ mean?

For instance, an investor with Rs500,000 (Dh22,959), would keep Rs100,000 (Dh4,591) in a three-month FD, another Rs100,000 in a six-month FD, and another Rs100,000 in a one-year FD. The remaining amount of Rs200,000 (Dh9,183) would be kept in a longer tenure two or three-year FD.

“While the smaller amount FDs would be useful for sudden liquidity requirements, the larger amount deposits would be useful for earning higher interest rates. Usually, when interest rates move upwards, banks immediately hike loan rates. However, the same is not the case for fixed deposits as banks take time in offering higher rates,” said India-based banking analyst Shanu Thomas.

Stock Reserve Bank of India RBI
Reserve Bank of India RBI building in Mumbai, India
Image Credit: Bloomberg

Key takeaways

The central bank’s recent move is aimed at attracting US dollars into the country to stem the Indian rupee’s current steep devaluation. Keep in mind that the RBI has removed these guidelines only till October 31. So NRI investors are to take advantage of this policy until then, experts strictly advise.

“For debt investors seeking capital building over a predetermined time period, fixed deposits (FDs) have consistantly been a good option,” said Thomas.

“The above central bank move is expected to not only limit the Indian currency’s current devaluation but also see overseas customers depositing more in the coming months, given that there has been an uptick in recent weeks.”

Although along with fixed rates of return, bank FDs have flexible terms that vary from 7 days to 10 years, potential investors are warned against the bank imposing a penalty rate on early liquidity that is deducted from the interest pay out.

“Premature withdrawals from fixed deposits can transpire in an emergency, so it’s essential to be aware of the bank’s penalty fees and the specific time period for which they apply in order to avoid paying them,” said Thomas.

In other words, penalty rates arise if an investor withdraws the fixed deposit account before it has reached maturity but in the case of tax-saving FDs one cannot make premature withdrawals as these are the deposits that come with a lock-in tenure.

These rates and charges vary from bank to bank, so be mindful when approaching banks to find the best FD rates.