NRIs have long favored NRE Deposits as a means to save their excess funds. On paper, it seems like they offer certain features that seem to make them attractive for NRIs. But let’s dig a little deeper to see if NRE accounts are actually beneficial to US-based NRIs.
As of March 2020, most NRE 1-year deposits were offering around 6.5%. One gets an interest rate around 1.8-2% from a one year CD at certain banks. Many NRIs view this higher rate offered by the Indian NRE deposits to be attractive.
But the fact is, the 6.5% offered is in INR, and the higher rate only compensates for the higher inflation in INR. For instance, the interest rate in Argentina is 40% and in Uzbekistan, it is 16%. This does not mean that the Argentinian bank deposit is an attractive investment opportunity.
The higher inflation erodes the value of INR and this leads to its depreciation against a currency with lower inflation such as the US dollar.
The Rupee has been continuously depreciating, and it has depreciated by an average of 4.5% annually in the last decade, which in this case aptly is more or less the differential in interest rates offered in USD & INR.
Let us take an example to understand this scenario better. Say you want to invest $ 10,000 in a bank deposit today.
Option 1- US Bank CD rate at 2%
Value of your savings at the end of the year- $10,200
Option 2- India NRE FD rate at 6.5%
In this case, you will first need to convert your 10,000 USD into INR, where you will incur a cost of 1-2%. Assuming the current interbank exchange rate to 74, one can expect to receive about 730,000 INR after transaction charges. This will be worth 777,450 INR by the end of the year, based on the 6.5% interest rate. Let us assume that the Rupee would depreciate at 4.5%, the average depreciation rate over the last decade. Therefore, the Rupee would be trading at 77.33 at the end of the year and the value of your savings would be worth $10,053.
Of course, we don’t have a clue about what the actual Rupee exchange rate is going to be at the end of the year. Rupee could depreciate more than 4.5% or less than that. But when we invest in a bank deposit, we are looking for stability and not speculate on the exchange rate.
In the case of a savings account, the point we made in the case of deposit accounts only gets more weight as the interest rate differential between INR & USD is in the 1-2% range. One gets anywhere between 3-4% in INR and about 1.8% in USD in the case of savings accounts.
The Myth that NRE Interest is tax-free
In many NRE promotional material, it would be prominently mentioned that the NRE interest is tax-free in India. Yes, indeed, one doesn’t have to pay tax in India, but you will have to pay the taxes in the US. So, there is isn’t really any tax benefit in investing in NRE deposits.
Other factors to Consider
As mentioned earlier, one needs to incur forex transaction charges every time you convert your USD to INR. If you need to repatriate this money back to the US for some reason, you will incur another leg of forex charges, causing a double whammy. This could add up to a total of 2-4%.
Insurance coverage is a critical factor to consider before depositing money with Banks. In India, your deposit is insured to the extent of 500,000 INR (~$6,700), but the same for a deposit in a US bank is $250,000. For most practical purposes, a limit of $250,000 would be good enough for most investors.
Then there is the ease of opening an account. As a US-based NRI, it will be a straight forward process to open a deposit or savings account. Many companies nowadays offer an utterly seamless account opening experience. The same cannot be said about the process of opening an NRE account.
Of course, there would be times when investing in NRE deposits would have turned out to be more beneficial, and this depends on how the Rupee moves with respect to the Dollar. This is suitable for people who are willing to speculate on the USD/INR rate. But for the average person who is looking to save, it may not be an appropriate strategy.
NRIs should take into account all these above factors before choosing to save in an NRE deposit and understand the reason behind why Indian banks offer a high-interest rate on NRE deposits. There is no such thing as a free lunch so much so in financial services.