FCNR swap deal: What it means for NRIs

Recently the Reserve Bank of India (RBI) announced several measures to stabilize
the Indian rupee against the US dollar. Among them was a swap deal on FCNR deposits
where the RBI has opened a window to the banks to swap fresh FCNR dollar funds,
mobilised for a minimum term of three years at a fixed rate of 3.5% per annum for the
tenor of the deposit. The swap window will be open until November 30, 2013.

What does this mean and will it impact Non Resident Indians investing in FCNR (B)
deposits? We find out.
What is an FCNR account?
An FCNR account is a term deposit account that can be maintained by NRIs and PIOs in
foreign currency. This account can be a good option for Non Resident Indians (NRIs)
looking to invest in India without worrying about currency risks.
The funds in an FCNR account must necessarily come from your overseas funds. FCNR
deposits can be maintained in 'permitted currency' which means any a foreign currency
which is freely convertible and includes US dollar, Pound Sterling (GBP), Euro, Japanese
Yen, Australian dollar, Canadian dollar, Danish Krone, Swiss Frank and Swedish Krona
among others.
What are the features of FCNR accounts? 
You can open an FCNR account for a minimum term of 1 year and maximum term of 5
years. The interest rates vary between terms and from currency to currency. Rates may
also vary between banks. For instance, the rate for a 1 year FCNR deposit in US
dollar would be in the range of 3-4% while the same for a deposit in Australian dollar
would be 6-7%.
This interest is tax free in India. However, you may be subject to tax in the country of
your residence for such interest.

Balances in FCNR can be freely repatriated outside India. You can also use the balance in
FCNR account for making local payments in India.

How do banks manage FCNR funds?

Banks raise FCNR funds in various foreign currencies. They then sell the foreign
currency in exchange for Indian rupees at the prevailing exchange rate and use the
Indian rupees for domestic lending. When the FCNR deposit becomes due for maturity,
banks would need foreign currency to pay the depositor. Waiting until the date of
maturity to purchase foreign currency would leave the bank open to exchange rate risk.
In order to protect this risk, banks hedge their FCNR commitments by entering into
forward contracts. To explain with an example, if an FCNR deposit was opened today for
a term of 1 year, the bank would enter into a forward contract to buy the foreign currency
after a year at a fixed exchange rate. Currently the forward rate is at a premium of
around 7% per annum. That means, if the exchange rate today is Rs 65 per dollar, banks
would enter into a forward contract to buy the dollar at Rs 69.55 per dollar. This way, the
bank hedges any uncertainty arising out of exchange rate risk.
What is the FCNR swap deal?
The swap deal was introduced as a means to encourage banks to attract more US dollars
into India. The RBI has promised banks a forward rate at a premium of 3.5% per annum
for all fresh 3-year FCNR deposits raised between now and November 30, 2013. So
instead of hedging at the rate of 7% per annum, banks are getting this swap deal at 3.5%
per annum. This acts as an incentive for banks to raise fresh FCNR funds as it lowers the
cost of hedging.

This swap deal is open until November 30, 2013 and only for deposits opened in US
dollar for a period of over 3 years.

Will this benefit NRIs?

NRIs are likely to be swarmed with offers from banks to open FCNR deposits. For an
NRI, the FCNR deposit itself can be an attractive proposition because the interest rates
on US dollar deposits are in the range of 3-4% per annum as compared with rates as low
as 1% in the US. Further, this interest is tax free in India and there is no currency risk.

The swap deal may not necessarily impact NRIs directly unless banks decide to share
their gains and increase the interest rates on these deposits.

However, according to reports, what is happening is that foreign banks are rushing to
lend funds to NRIs who can invest the money into FCNR deposits. For instance, an NRI
would invest $100 of his own funds and borrow $400 from the US branch of his bank.
The interest rate on the loan would be say 1%. The NRI would then open an FCNR
account in the Indian branch of the bank and earn interest of 4%. At the end of year 1, he
would make a total interest of 4% on his own funds of $100 and a net interest of 3% on
the borrowed funds of $400. That makes a total interest of $16 or 16% of the original
investment. For banks too, this is a win-win as their loan gets covered by the FCNR
deposit and they get access to funds at a lower cost.
 Who is an NRI?
An Indian Citizen who stays abroad for employment/carrying on a business or vocation outside India,
or stays abroad under circumstances indicating an intention for an uncertain duration of stay abroad is
a non-resident. Non-resident foreign citizens of Indian Origin are treated on par with non- resident
Indian citizen (NRIs).

Person can have Indian origin, if,

 He/she, at any time, held an Indian passport, or

 Parents or any of his grandparents hold Indian citizenship.
An NRI can make the following investments in India.

 Maintain bank accounts in India.

 Invest in securities/shares, and deposits with Indian firms/companies.
 Invest in immovable properties in India.
You must be familiar with terms like NRE account, NRO account, SBI NRI account, NRE account,
NRO account, SBI NRI account, ICICI NRI Account, HDFC NRI Account. Yet, it is likely that you are
still confused on how to invest money in India. This article explains the type of bank accounts
available for NRIs.

Types of Non-Resident Bank Accounts

 Ordinary Non-Resident Accounts in Rupees [NRO]
 Non-Resident (External) Accounts in Rupees [NR(E)]
 Foreign Currency (Non-Resident) Account (Bank) Scheme [FCNR(B)]
 Non-Resident Non-Repatriable Rupee Account [NR(NR)]
Ordinary Non-Resident Accounts in Rupees [NRO]:
As the name suggests, it's an Ordinary Non-Resident Accounts in Rupees, also known as NRO
account. The existing accounts of any Indian National can be designated as Ordinary Non-Resident
Accounts, upon your NRI status, or these accounts can also be opened with initial deposits paid into
any bank or post office (saving a/c) authorized to open Non-Resident accounts. NRO account can be
of any type: saving, current or Fixed Deposit. Interest payable on NRO accounts is the same as on
resident accounts. They vary from bank to bank as they have been freed from RBI regulation. You
can also have a joint account with residents in India. NRO accounts may be re-designated as resident
accounts when the account holder becomes a resident in India. 
Disadvantages of NRO:

 Interest earned on balances in NRO Accounts is not exempted from Indian Income tax.
Instead income tax is deducted at source (TDS) i.e. at the time of payment of interest by the bank.
 Balance held in NRO account can neither be repatriated. No remittance in foreign currency is
allowed without prior approval of Reserve Bank as well. So overall, the money stays 'as is' in India.
NRE Accounts NON-RESIDENT (EXTERNAL) ACCOUNTS:
The rates of interest on term deposit kept under NR(E) are generally higher than the rates of interest
on NRO deposits. The following highlights some of the key features of NRE accounts.

 No income Tax.
 No joint account with an Indian residence.
 Non-Resident account holders can grant a power of attorney or such other authority to any
residents in India for operating their NR(E) Accounts in India. Such authority is however, restricted
to withdrawals for local payments. The attorney holder cannot repatriate funds held in accounts
outside India under any circumstances or make payment of gifts on behalf of the account holder.
The rates of interest payable on NR(E) accounts are subject to change from time to time as per
directions issued from Reserve Bank of India.
An eligible Non-Resident Indian can open an account with any RBI approved authorized bank.

Tips
 The NRO account can't be converted into NRE. Also funds can't be transferred from NRO to
NRE account without a special permission from RBI and proof of all existing funds required, which
is a complex procedure than opening a new NRE account.
 The entire credit balance (inclusive of interest earned thereon) can be repatriated outside
India at any time without any reference to Reserve Bank of India.
 Once you go back to India for good and become an Indian resident, NRE account can be
converted into your normal Resident Rupee Account.
Disadvantages of NR(E) Accounts
 NR(E) Accounts are opened in Indian rupees, and all foreign exchange remittances received
for credit of that account are first converted to Indian rupees at the buying rates by the banks. The
bank will permit any withdrawal in foreign currency, by converting Indian rupees in the account to
foreign currency at the selling rate. All balances in the account are held in Indian rupees and are
thus exposed to exchange fluctuation risk.
FOREIGN CURRENCY (NON-RESIDENT) ACCOUNTS -FCNR Account:
The deposit under FCNR (Banks) scheme is held in foreign currency. The interest and the repayment
of the deposit is also made in the same foreign currency in which the account is maintained. The
depositor may at his own will, obtain repayment in Indian rupees, converted at the buying rate on the
date of repayment.

Deposits under this scheme are held for the following period: 6 months and above, but less than 1 yr-
1 yr and above but less than 2 yrs-2 yrs and above but less than 3 yrs-3 yrs only. Premature
withdrawal is allowed, but there will be a penalty.

Non-Resident Account holders can grant power of attorney (for a specimen click here) or such other
authority to residents in India for operating their FCNR(B) accounts in India. Interest rates are subject
to the RBI guidelines.

FCNR Accounts can be maintained in U.S. Dollar, Pound Sterling, Japanese Yen and Deutshe Mark.

NON-RESIDENT, NON-REPATRIABLE RUPEE DEPOSIT SCHEME-NRNR: - Discontinued

from April 1st 2002 by RBI
Accounts under the Non-Resident (Non-Repatriable) Rupee Deposit Scheme may be opened in
Indian rupees, out of the funds in freely convertible foreign exchange transferred, for the purpose of
India in an approved manner, from the country of residence of the prospective non-resident account
holder, or from any other country. Transfer of funds from the existing NRE/ FCNR Accounts of the
non-resident account holder may also open accounts. No penal interest is charged in case of
premature withdrawal of existing NRE/ FCNR deposits for the purpose of making investment under
the Scheme.

From 01.04.2002 Non Resident Indians are not permitted to open or renew NRNR deposits, as the
scheme will cease to exist after 31.03.02. Premature closure of existing NRNR deposits for
reinvestment in NRE/FCNR accounts is not permitted.