Impact of Exchange Rates on NRI Account Deposits

For most NRIs, investing in India is not only a financial decision, but it is also emotional. However, there is one factor that many individuals overlook, i.e., currency exchange rates. Here is the truth: exchange rate movements can subtract or add 15-20% to your investment returns over three years. This is more than the interest you earn on your account deposits. Yet 80% of NRIs do not understand the impact of exchange rates on their deposits and make the currency conversion decision at the wrong time.

Further, to help you out, in this blog, you will get to know the impact of exchange rates on NRI account deposits, and when the timing actually matters, additionally, about the specific strategies you can implement in this situation. So read on and get all the information. 

Understanding Exchange Rates

Currency exchange rates, in simple words, represent the value of the currency of one country in terms of the currency of another country. It dictates how much one currency you can exchange for another and is fundamental to global finance, international trade, and tourism. 

For instance, 1 USD = INR 80, and later it becomes INR 85. Here, against the dollar, the value of the rupee has depreciated. Depending on the direction, this situation can either reduce or boost your returns. Additionally, the rate you see online and on the app is not the exchange rate that your banks provide you. 

Further, let's know about the three types of exchange rates:

• Market Rate (Mid-Market Rate): It is the true rate that is generally mentioned on the financial website or Google. It is the central point between what sellers and buyers are willing to trade. 
• Buying Rate of the Bank: It is the rate you receive from the bank on the sale of your foreign currency. Compared to the market rate, it is always lower. 
• Selling Rate of the Bank: It is the rate the bank charges you when you purchase foreign currency from them. It is generally always higher than the market exchange rate. 

This was all about the currency exchange rates. Moving ahead, let's know the impact of currency conversion on NRIs and their bank accounts. 

Impact of Currency Movements on NRE, NRO & FCNR Accounts

Depending on the NRI bank account type, the impact of the currency exchange rate varies. Confused, let's understand this in detail.

NRE Account Deposits: Maximum Currency Exposure

In your NRE account, when you deposit your foreign currency at the prevailing exchange rate, it immediately gets converted to INR. This states your exposure to currency risk. Confused? Let's understand this with an example.

For instance, when USD/INR = 82.00, you deposited $10,000. Now:

• • Your deposit = INR 8,20,000
  • At 7% interest after one year = INR 8,77,400
  • When you convert back, the USD/INR moves to 85.00= $10,322
  • In USD terms, net gain = 3.22% (despite earning 7% interest in INR)

If USD/INR moved to 78.00:

• • • Converting Back = $11,249
    • In USD terms, net gain = 12.49%

Here, the same INR 7% interest rate based on currency movement provides you with completely different USD returns. 

NRO Account Deposits: Different Tax Treatment, Similar Exposure

NRO accounts, for currency exposure, work similarly to NRE accounts. However, these accounts have some additional tax complications. 

Here, the key difference is that, on the earned interest, 30.90% TDS is charged unless you are eligible to claim the DTAA benefits. Additionally, you can only repatriate up to $1 million per financial year.

FCNR Deposits: Zero Currency Risk

FCNR (Foreign Currency Non-Resident) deposits are maintained in foreign currency. Considering this, your principal and interest remain in the original deposited currency. This further eliminates the risk of exchange rate risk.

• Trade-Off: Generally, FCNR rates are 1-2% lower than the NRE rates. However, in this, you avoid currency volatility.
• When it is Sensible: It is sensible when you are sure that in the future, you need this money in the same foreign currency. 

So, this is how currency exchange rates affect NRE, NRO, and FCNR accounts. Moving on, let's look at the hidden costs and bank charges. 

Hidden Cost & Bank Charges

The hidden cost of currency conversion is that, without realizing it, many NRIs lose their money. Through multiple layers of changes, many banks earn significant profits from currency conversion. 

Bank Spreads and Markups

Bank spread can be defined as the difference between the buying and selling rates of the bank. Generally, it ranges between 0.25% to 2% of the transaction amount. Further, let's see the cost breakdown for converting $25,000:

• Market exchange rate (USD/INR @88.10) = $25,000, i.e., INR 22,02,500
• Bank exchange rate (with 1% spread) = The exchange rate offered by the bank is ~87.22 = INR 21,80,500
• Hidden prices from spread = INR 22,000 ($250)
• Service and wire charges = INR 500 to INR 1500 + GST additional
• Total cost of conversion = INR 22,500 to INR 23,500

Comparison of Banks

The table below showcases the comparison of different Indian banks according to their currency conversion rates:

From the above table, it is clear that ICICI Bank generally offers the best combination of flexibility and rates for large-amount conversions. 

Service Charges and Additional Fees

The service charges and additional fees include:

• Wire transfer charges: INR 500 to INR 1,500 per transaction
• SWIFT charges: INR 500 to INR 1,000
• Documentation charges: INR 200 to INR 500 for forms and certificates
• Correspondent bank charges: $15-50 (it is deducted from your transferred amount)

This was all about the hidden costs and bank charges involved in the exchange rate. Moving ahead, let's explore smart strategies NRIs can implement to increase the value of their NRE. 

Smart Strategies to Maximize Your NRE Conversion Value

There are several strategies through which NRIs can minimize the impact of exchange rate fluctuations. These are as follows:

Currency Options: Insurance Against Bad Moves

In this, you pay a premium for a minimum guarantee exchange rate while having upside potential. For instance, if you deposit $50,000, you may need to pay at least $25,000 to get a minimum conversion rate of 87.50. In this scenario, if the rate decreases to 86.00, you still receive 87.50. However, if the rate increases to 90.00, you can exchange at higher rates. 

Further, it generally makes sense in uncertain economic periods when you have large deposits.

Forward Contracts: Locking in Today's Rate

It is an agreement to exchange the currency on a future date at a fixed rate. It works like this: if you agree to convert $50,000 at an exchange rate of 88.5. In this, three months from now, no matter where the market moves, you will have to exchange that currency on that fixed rate.

Further, the minimum amount should be $25,000. Additionally, the exchange rate cost is between 0.10% and 0.25%. The option is available at ICICI, HDFC, Axis Bank, and Standard Chartered. 

Natural Hedging Through Asset Allocation

Under this option, instead of converting your every asset to INR, it advises maintaining it in foreign currency. Confused? Let's understand this with a practical approach:

• For Indian expenses, keep 60% in INR deposits.
• For lifestyle and emergencies, keep 40% in AED/ USD investments.
• Based on needs, rebalance annually.

Systematic Investment Plans (SIPs) for Currency

Instead of lump sums, create fixed monthly amounts. For instance, instead of converting the whole $60,000 at once, convert $5,000 for 12 months. Further, using the SIP, you get the following benefits:

• Reduce risk timing
• Averages out the volatility of the exchange rate
• In financial planning, it creates discipline

However, while using SIP, you can miss out on essential moves that are favorable for you. 

So, this is how using the strategies as mentioned above can reduce the impact of exchange rates on NRI account deposits. Moving further, let's know the tax implications for NRIs. 

Tax Implications for NRIs

Tax implications are the most vital information that most NRIs overlook until it is time to file taxes. Considering this, let's examine the currency gains for tax purposes.

• For NRE Accounts: Generally, currency gains/on repatriation are not taxable in India. It is because the principal amount is from foreign income. 
• For NRO Accounts: Depending on the nature of the transaction and the conversion time, you may need to pay capital gains tax on currency gains. The currency gains taxed are charged on two bases, i.e., short-term capital gain and long-term capital gain. Short-term capital gain tax occurs when the amount is held for less than 36 months. Whereas, long-term capital gain tax occurs when the amount is held for more than 36 months. 

Here, the tax is imposed as per the INR value at the time of deposit vs withdrawal. Confused, let's understand this with an example.

For instance, when USD/INR was 75.00, in your NRO FD, you deposited $100,000. After three years, when USD/INR = 83.00, you withdraw the amount. Here:

• INR withdrawal including interest = INR 96,05,000
• Currency Gain = INR 8,00,000 (83-75 = INR 8 per dollar * $100,000)
• Potential Tax Liability= *20% on currency gain = INR 1,06,000
• Currency gains on NRO accounts:
  • Short-term = Added to gross income and taxed as per your tax slab rate.
  • Long-term = With indexation, taxed at 20%.

Further, through DTAA benefits you can avoid paying tax on the same income twice. Additionally, there are other benefits as well that DTAA offers to NRI individuals, such as:

• Through this, you can claim foreign tax credits
• On interest, you can reduce the TDS rates
• On currency gains, you can avoid double taxation.

However, before claiming the DTAA benefits, first check whether your resident country has signed this agreement with India or not. Also, while claiming the DTAA benefits, you need to submit the following documents:

• Form 10F filed with your Indian bank 
• Tax residency certificate (TRC)
• Proper documentation of paid foreign tax

So, this was all about the tax implications that NRIs face during the currency exchange in India. 

Final Thoughts

Lastly, you may think of currency exchange rates as a technical topic; however, the impact of it on NRI investment is very real. Considering this, whether you are investing for income, repatriation, or long-term growth, monitoring the currency exchange trades assists you in making the right decision.

Further, if you are reviewing or planning your NRI portfolio, taking guidance from financial experts like Savetaxs can help you maximize your income returns while handling currency exposure. Additionally, we can also assist you with your tax obligations.