In the past few weeks, we’ve seen China devaluing its currency, US Federal Reserve not increasing its rates and a steady depreciation of INR against USD. As a fall out and knee jerk reaction to such events, there has been a sharp increase in NRI remittances to India to benefit from a weaker rupee (news article).
In my view, remittances and investing in India should never be a factor of rupee volatility and there should instead be a PROCESS of systematic investing regardless of which way exchange rates are moving, which effectively means that one should never time the exchange rates.
Let us look today at the concept of exchange risk in NRI investments & how families can manage it in a better way.
Historical exchange rate trend & futility of predicting the future
I’ve tried to get the exchange rate value for the past 15 years (source: www.investing.com) and plotted the values on a chart and it looks as follows:
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If you see, the exchange rates were primarily range bound in the 40-50 range for a long period between 2001-2012 & from there, it really picked up pace. So, in the space of 3 years between 2012 and 2015, we’ve seen an almost 47% depreciation in rupee that is nothing short of dramatic.
Now, we can call it a short term thing or a longer term event where we say that the exchange rate will not move south again. And we have all sorts of forecasts. The problem with forecasts is that it is based on the information available as on date, and does not & cannot take into account the black swan events of future.
So, if you google and see forecasts by made way back in 2012 when the rates started its northward trip, nobody at that time could actually predict that it can go to 65 levels where we are standing now. Again, forecasts as of today say that 2-3 years, exchange rate will move to 75 levels but I leave it up to you to decide whether to believe on those or not.
First of all, we need to understand the context in which these forecasts are made. If you are a business owner and you import/export your goods or purchase raw material from overseas, short term exchange rate movements matter a lot & such businesses can protect themselves by intelligently hedging their exposure in the currency futures market and so on.
However, here you are not a business owner having short term business liabilities. You are an “investor” having long term FINANCIAL GOALS. Let us understand with the help of an example:
Suppose you’re a US tax resident and are planning to relocate to India in say next 10 years. You have a financial goal of funding your child’s education around the same time. You’ve been building a corpus in India via NRE fixed deposits which gives around 8% tax free interest in India (of course, interest shall get taxed in US, but let us ignore it for this example).
Also suppose that you’ve put $ 1,00,000 today into NRE deposits at an exchange rate of Rs. 65. Since the account is a rupee account, funds along with interest total to Rs. 1.40 CR after 10 years.
Note that if at that point your son decides to study in India since you’ve relocated to India, then there is no issue at all. The funds are already in the rupee account and there is no exchange rate impact.
However, issue will come when your son wants to study abroad. And if at that time, the exchange rate is at say 75, when you remit the funds back to US, the dollar worth of money will be $ 1,87,107. So, against your original outlay of $ 1,00,000, your investment will yield an annualised return of just 6.47% and not 8%.
Now, an even worse situation: Assuming that the exchange rate then is 85, return will drop to 5.14%!!
Consider a reverse situation. Instead of depreciating, if the rupee strengthens and becomes 55, return will be 9.82%!
So, for NRI/PIOs, apart from taxation aspects of their India investments in country of residence, exchange rate plays a big role in how their final portfolio returns and goal funding works out. The very fact that exchange rates depend on macro economic factors which is beyond an investor’s control, in my opinion one should not time investments by predicting the future exchange rates which in my view is a complete waste of time. Instead, one should craft an asset allocation strategy considering one’s own financial goals and exchange risk involved at the time of repatriation.
First things first: Does the family plan to have rupee liabilities in the long term?
Firstly and most importantly, the couple needs to first envision their their long term financial goals and future plans. That means, if the family is geographically mobile presently due to career opportunities but will look to settle down in India on retirement, they’ll definitely want to build a long term portfolio comprising of rupee denominated assets (as the expenses in retirement will be in INR) which will mean investment in Indian mutual funds, NRE deposits, real estate etc.
However, if a family is not sure of returning back to India and settling here presently, then India is just another market which needs to be evaluated dispassionately w.r.t. returns and risk involved and there is no real need to go overboard with allocating a very large portion of investments in India, because considering the exchange rate risk, your investments returns can actually dilute. Having said that, a simple comparison of government bond yields of developed markets vs India shows the wide difference between what one can earn in US vs India. Then, we have all the hype about the India’s long term growth story.
While these factors keep bringing investors into India, my view is slightly different. The proportion of India investments should not be guided by the stories of how India will give better returns but a result of a careful asset allocation whereby investment is first spread between various asset classes & then even within equity, it is spread across various markets (like Asian and European markets), and not just India. This will ensure that though in the short term, one may look like a fool not getting higher returns that Indian markets offer, but over long term the investment portfolio balances the country specific risks and gives a sound and balanced return.
Segregate your money requirements w.r.t. currency:
Once you are clear on the financial goals, you can segregate your funds according to currency in which your liability will arise. So, for example, you are sure of retiring in India. Hence, your investments can be denominated in rupee funds. For your son’s education or foreign holidays abroad, it has to be in USD as the liability will arise in USD and you need to protect it against exchange rate risk.
Select the right investment avenues for the investments:
Once you’ve segregated your money requirements w.r.t. currency, you can take a call to align your liability with the currency. So, your foreign currency liabilies may remain invested in that currency and rupee liabilities may be invested in India. Another option, if the family wants most of its investments in India is to divide into foreign currency and rupee denominated accounts.
A table given below shows the present position of accounts allowed by RBI to be opened by NRI/PIOs t remit their foreign exchange earnings and the denomination & indicative interest rates:
Different types of bank accounts for NRI/PIO & currency denomination
| Type of account | Currency | Exchange risk? | Interest rate | Tax Impact |
| Non Resident External (NRE) | INR | Yes | 8% | NIL (tax free) |
| Foreign Currency Non Resident (FCNR) | USD, GBP, EUR, JPY | No | Between 1.5-2.5% | Taxable |
| Resident Foreign Currency Fixed Deposit (RFC) | USD, GBP, EUR, JPY | No | Between 1-2% | Taxable |
Note: Interest rates and currencies are indicative and taken from ICICI Bank website. NRO account is not considered in the table as the funds from that account are anyways not repatriable outside India.
If you wish to know further on NRE, FCNR and RFC accounts, you can head over to RBI website on FAQs on these e accounts (link).
A final note
While I was researching on this topic, I found suggestions to do a natural hedge in terms of investing in Indian export oriented mutual funds schemes or IT and pharma stocks which are given to gain due to rupee depreciation but I found it to be baseless. Also, “experts” advise playing in currency futures, which again in my view is risky and dangerous for small investors. These measures may give some benefit in short term but over the long term, I feel that the right way NRI/PIO families can manage this risk is by a proper and well thought goal based multi currency asset allocation.
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