Currency Risk in GIFT City Funds: Complete Guide for NRIs

For global investment and cross-border wealth management, among NRIs, high-net-worth individuals, and investors, GIFT City has emerged as a major gateway. It provides them access to international markets, foreign-currency investments, and tax efficiency. However, many investors focus completely on the potential returns from the investment and overlook a vital factor, i.e., currency risk in GIFT City funds. It significantly alters their investment gains because fluctuations between the Indian Rupee and the foreign currency you earn can either increase your returns or silently decrease them.

As more NRIs are investing in GIFT City, it is important to understand the currency risk to make an informed decision. To help you out with this blog provides you with complete information on currency risk in GIFT City funds for NRIs. So read on and gather all the information.

What is Currency Risk and Why Does it Matter for NRIs?

Currency risk, also known as exchange rate risk, means the potential for financial loss occurs when the value of one currency changes against another. In simple words, currency risk can be defined as the impact of exchange rate movements on your investment returns.

It is one of the primary risks associated with GIFT city funds. Since NRIs invest in funds in several currencies in GIFT city, any change in the exchange rate impacts the value of their investment and returns.

Confused? For instance, you are an NRI who has invested in an FD in US dollars. During the investment period, the value of the dollar falls against the Indian rupee. In this situation, when converting your returns to your local currency, you may face a loss.

This was all about currency risk and why it matters for NRIs. Moving ahead, in the next section, let's understand the double currency risk framework in GIFT city funds.

Understanding the Double Currency Risk Framework

The double currency risk in GIFT City funds includes two key things when the exchange rate impacts your investment. The first is when you enter and exit the investment, and in some cases, at the asset level. Here is how it works:

• At entry, if you are investing in GIFT City funds from India, you convert Indian rupees to foreign currency for investment. The exchange rate at this point determines how many dollars your rupees purchase.
• During the investment, the fund positions your capital into underlying assets. Depending on whether the funds are invested in global bonds, equities, real estate, or other instruments, they may be denominated in several currencies.
• At the time of exit, being an NRI, you convert your dollar-denominated returns back into rupees or into another currency. At this point, the exchange rate determines how much you actually earn in your home currency.
• If the value of the rupee is more than the foreign currency between your entry and exit points, your returns will be lower, even if, in dollar terms, the fund itself performed well in dollars. In contrast, if the value of the rupee is lower, in terms of investment, your effective return may increase.

Further, for NRIs who already hold dollars, the initial currency conversion risk may not impact them. However, they can still face risk when exiting or if the fund invests in assets denominated in different currencies.

So, this is how the double currency risk framework works. Moving further, let's know how in GIFT City investments' currency exposure differs.

How Currency Exposure Differs in GIFT City Investments?

The GIFT City consists of two types of funds, i.e., inbound and outbound funds. For managing currency risk, it is vital to understand the difference between these two funds.

Inbound Funds

Inbound funds collect your foreign currency and invest in the Indian market. For instance, the Sundaram India Mid Cap Fund and the Tata India Dynamic Equity Fund. In these investments, your money flow is USD → Indian equities → USD returns. Inbound funds may invest in Indian debts, equities, or India-focused alternative assets.

For an NRI, investing in an inbound fund, the fund is denominated in foreign currency, and the assets are priced in rupees. The currency movements impact your dollar returns directly. In the inbound funds, there is a hidden currency risk. Considering this, you are exposed to INR even though you invest and redeem your investment in foreign currency.

Confused? Let's understand this with a few examples.

• Scenario 1: The value of Indian stocks rise 20%, and the rupee depreciates 5%.
  • Your INR 8,05,000 investments turn to INR 10,02,000 investments. At the same time INR 8 rate, you get back $12,000. Simple 20% USD return.
• Scenario 2: The value of Indian stocks rise 20%, and the rupee appreciates 5%.
  • Your INR 8,05,000 investment becomes INR 10,02,000. The INR/USD is now INR 80.75. Considering this, you get $12,632, and your USD returns rise to 26.3%

Outbound Funds

The outbound funds collect your capital and invest it in global markets outside India. Common examples of it include Edelweiss Greater China Equity Fund and the DSP Global Equity Fund. In these funds, the flow of your money is USD → Global Equities → USD returns. Compared to inbound funds, these funds work differently. These funds invest your dollars directly into dollar-denominated assets.

For instance, the DSP Global Equity Fund holds stocks like Microsoft, Amazon, and Meta. These companies report their earnings in USD. Additionally, on US exchanges, the stock prices of these are quoted in USD. So, when you invest in $10,000, the fund purchases global stocks worth $10,000. If these stocks rise by 15%, your investment is $11,500. Here, the currency does not enter the equation at all. It is a true currency alignment as it matches your asset currency.

This was all about inbound funds and outbound funds. If you are earning in USD and want Indian market exposure, inbound funds are a good option. However, if you want global investment diversification, you should invest in outbound funds.

Now, moving ahead, let's know how global market risk impacts GIFT City funds.

How Global Market Risk Affects GIFT City Funds?

Currency risk does not work alone; it interacts with global market risk. The combination of the two results in amplified gains or losses in ways that are more difficult to predict than either risk on its own.

Global market risk can be stated as the possibility that the value of the underlying assets falls due to wider economic conditions. It includes central bank rate decisions, recession fears, commodity price shocks, geopolitical events, and equity market corrections.

Considering this, here is how global market risk impacts GIFT City funds:

• Decrease the value of the underlying assets in their local currency.
• Impact currency movements that calculate the loss when converted back to rupees or dollars.

For instance, a GIFT City fund invests in the technology stocks of the US. Suddenly, the US market drops by 20%, and the fund value in dollars decreases. On the other hand, if the global market increases, while the value of the rupee decreases, Indian investors with outbound funds can see their returns increase significantly. During rising markets, this positive impact from changes in currency helped increase profits for investors invested in dollar-denominated foreign funds.

Further, when looking at the performance of the GIFT City fund, it is vital to check if the returns are stated in the base currency of the fund (generally USD) or in your home currency. The difference can lead to very different assessments of how well the fund will work for you.

Moving further, let's know how to overcome currency risk in GIFT City funds.

How to Overcome Currency Risk in GIFT City Funds?

Once you understand the structure, you can easily manage the currency risk in the GIFT City funds. Here is what you can do:

• Know Your Underlying Exposure: Do not assume that USD denominations mean USD assets. Considering this, know what the fund actually purchases.
• Match Currency to Financial Goals: If spending in USD, favor USD-asset funds. In contrast, if spending in INR, invest in rupee exposure funds.
• Without Currency Adjustment, Don't Chase Returns: After depreciation, Indian funds showing 15% returns in dollar terms may only offer only 10%.
• Use the Flexibility of GIFT City: Unlike regular investments available for NRIs, GIFT City helps you select your currency exposure. Considering this, take advantage of it.

Moreover, a well-structured approach includes professional guidance, diversification, and long-term financial planning. While investing in GIFT City funds, focus on aligning them with your financial goals, residency considerations, risk tolerance, and time horizon.

Final Thoughts

Lastly, currency risk in GIFT City funds is real, layered, and often underestimated. It not only happens because of one exchange rate movement. It also gets impacted during investment entry, during the holding period, and at exit. For NRIs, the currency risk heavily depends on the direction of the fund flows, i.e., inbound or outbound. Considering this, it is vital to understand the currency exposure of the fund you are considering, check whether any hedging is in place, and at what price.

Furthermore, if you need any assistance with investment planning in India, connect with Savetaxs. We have a team of financial experts who help you in choosing the right investment plan as per your financial goals, risk appetite, and time horizon.