With FCNR rates regulated by RBI and volatile foreign currency market, a lot of banks have introduced and are marketing products for NRIs to generate more return on FCNR deposits. While there are catchy names used for the plans by various banks, like RupeeMax (HDFC Bank), Rupee Advantage Plan (Kotak), FCNB Premium Account (SBI), Smart Rupee Deposit Scheme (Union Bank), etc., the nature of investment is the same i.e. FCNR deposit with Forward Cover. It offers better returns than FCNR deposits, but whether NRIs should rush to invest in them?
FCNR Deposit Accounts: NRI/PIO can open and invest in Foreign Currency Non-Resident (FCNR) Deposit Account in India. As the name suggests, only deposit account (No saving or current account) can be opened. The tenure of FCNR deposits are from 1 year to 5 years. As the minimum duration of FCNR FD is 1 year, no interest is payable for premature withdrawal before 1 year.
RBI has allowed FCNR deposits to be maintained in any freely convertible foreign exchange. Currently, SBI offers FCNR deposits in USD, EURO, GBP, CAN$, JPY, AUD, CHF, DKK, NZD and SEK. Most of all banks offer FCNR deposits in at least original 6 foreign currencies i.e. USD, EURO, GBP, CAN$, JPY and AUD.
The interest rates on FCNR deposits are regulated by RBI and are the same across all banks. Interest on FCNR deposits are also tax free in India and are fully repatriable.
The biggest advantage is that there is no currency risk i.e. you invest in USD, you receive USD on maturity. The disadvantage is that its interest is regulated and is lower; e.g. interest on FCNR deposit in USD for 1-2 years is 2.70% only.
To address the disadvantage of lower interest on FCNR deposits and looking at volatile Rupee, the banks came up with forward cover to increase the yield on the FCNR deposits.
NRI/PIO will enter into a forward contract with the bank wherein investor will exchange foreign currency at a predetermined exchange rate on future date. The amount of foreign currency and date of forward exchange will coincide with the FCNR deposit to give investor a better return.
The forward contract locks in the Rupee Return on the deposit and future movements in currency markets cannot affect returns. While the forward contract protects the depositor from unfavorable movements in the exchange rate, investor won’t be able to take advantage of any favorable movements. For that, he will need to break the forward contract at a fee/penalty.
Combining FCNR deposits with Forward cover could increase the return (yield) from 2.70% to 8-9%.
Looks promising, Right?…….. Not so much because of following 5 reasons.
5 Reasons why FCNR deposit with forward cover may not be advisable:
- By entering the forward contract, your investment is subject to the currency risk as the money will be credited in the NRE account in Indian Rupees. And, it defeats the very purpose and benefit of having deposit in Foreign Currency.
- Currently, the interest rates on NRE deposits are equal to or better than the total return of FCNR deposits with forward cover.
- If the foreign exchange rate turns favorable, you are still stuck with the forward rate. Otherwise, you have to pay fees or penalty to get out of the forward contract.
- NRE deposits can be made also for more than 5 years whereas FCNR deposits are for maximum of 5 years.
- Interest on NRE deposits is exempt from income tax in India. While interest on FCNR deposits are exempt from income tax in India, taxation of gain due to entering forward contract is debatable. That’s why, while comparing taxation between FCNR and Rupee Max (FCNR with forward contract), HDFC bank stated “tax exempt in entire deposit” and “-” respectively. Please check out my blog providing detailed analysis on taxation of such investment at “Are FCNR deposits with Forward Cover Completely Tax free for NRIs in India?
What to do?
This could be a great product for both investors and banks BEFORE December 16, 2011 when NRE interest rate was regulated giving return of 3.25%. However, it lost its value thereafter. Unfortunately, most of the banks introduced and/or marketing heavily such products only after December 16, 2011 (at a wrong time).
If you are ready to take the currency risk, please invest in NRE FD instead of FCNR deposits with forward cover. It will be easy, less paperwork, less worry (no monitoring of forex whether favorable or not), no complicated taxation and more rewarding (higher interest and no fees to get out of the contract).
However, if the return on FCNR deposits with forward cover is at least 1% higher than the return on NRE deposits, it may be explored by certain HNI investors. For others, it is simply not worth it as they still can get 9%+ return on NRE deposits (even after RBI reducing repo rate to 7.25% on May 3, 2013).