What are FCNR(B) deposits?
A Foreign Currency Non-Resident (Bank) [FCNR(B)] deposit is a fixed deposit maintained in foreign currency by NRIs and PIOs. Both principal and interest are fully repatriable. These deposits are repayable by the bank in foreign currency. Therefore, the NRI investor earns interest without taking on the risk of Rupee depreciation.
Why are they attractive now?
Because the interest rates on such deposits have shot up by 3-4%. To shore up the Rupee and invite dollar inflows, the Reserve Bank of India (RBI) recently opened a special swap window for banks, where it will absorb all the currency hedging costs and exchange risks on to its own balance sheet. This applies to FCNR (B) deposits offered until September 30, 2026. This has allowed banks to jack up their interest rates to 6% to 7% on such deposits for fresh 3-to-5-year tenors. This compares with the 4% interest normally available on such deposits.
If the interest rate is 6-7% only, how come I am hearing about 12-20% returns on such products?
These are theoretical returns that assume that NRIs borrow in their home country to invest in these deposits. After RBI opened this window, some banks/intermediaries are said to be suggesting a structured product. Under this, NRI investors are encouraged to leverage their deposit by 5 to 10 times by borrowing from their home country at low rates. If this is invested in FCNR(B) deposits in India at 6-7%, the leverage magnifies the returns to 12-20%.
What is the problem with this? It does sound good.
On the face of it, this does look like a good scheme to make risk-free returns. After all, banks in India that accept FCNR (B) deposits are very sound and carry very little credit risk.
However, NRIs should be aware that the risks in this structure come from the leverage that they are taking on their own personal balance sheet. Following are the risks with this seemingly simple strategy.
- In most cases, the personal loans you take for this investment are pegged to floating interest rates or are short-tenor loans. If interest rates in your home country rise (rates are rising globally), you will be faced with spiraling borrowing costs that will eat into the returns from this deposit. Do note that the interest rate differential between India and developed markets is near its lowest level in the past 18 years.
- While the bank may offer a bundled ‘strategy’, the onus of repaying this loan is on you. This will eat up your ability to take more essential loans.
- Your home country may tax the full interest earned on leveraged capital. If there is no tax deduction for the interest paid on the borrowing, taxes could significantly reduce the net gains.
- If, due to an emergency, you are forced to prematurely close the FCNR(B) deposit, the applicable interest rate may be reduced due to penalties. But you will be forced to repay your personal loan at the contracted rate.
- While the interest earned on an FCNR(B) deposit is completely tax-free in India, it may be taxable in the depositor’s country of residence.
In the event that an NRI has to move back to India unexpectedly before the deposit matures, the interest earned could become taxable in India. In the case of leveraged deposits, this creates a much higher taxable gain. Furthermore, depending on the regulations of the foreign jurisdiction, some depositors may also be forced to prematurely close or unwind the overseas loan upon losing their non-resident status
Therefore, while simple math suggests that as long as the borrowing rate is lower than the deposit rate the investor will make money, in reality there are several factors that may work against this strategy:
Bottomline: The one-off hedging subsidy by RBI has created an opportunity for NRIs to earn attractive returns of 6-7% from a practically risk-free investment. It makes sense to grab this opportunity and invest in FCNR (B) deposits with sound banks in India, before the RBI swap window runs out. What doesn’t make sense, is to add on an unnecessary layer of risk and complexity to this simple investment, by taking leverage and trying to play rate arbitrage.
