how should new NRIs factor in inflation at India while making NRE/NRO deposits?

POSTED BY anon smith ON July 19, 2012 11:14 pm COMMENTS (10)

Here’s the scenario for a typical NRI:

1. US bank accounts give a 3.5% interest. This is again taxable and you typically get 60% of the interest in hand so effectively it’s a 2.1% increase of your income (Please correct me if I’m wrong).

2. Indian banks offer 9% interest.
if using an NRO account: Factor it with taxes 30% TDS and 10% after DTAA (total 40%) or
if using an NRE account: Factor it with 40% combined state/federal tax and effectively,
either way it’s 60%(9%) which is 5.4% return.

Current inflation rates in US and India are roughly 1.7% and 10%.

On returning to India (after say 10-15 years), we can get a 70%(9%) or 6.3% interest on FDs (assuming the tax brackets remain the same) and we also transfer all our money into Indian banks.

Consider this plan which maintains a small savings account in the US which grows slowly and always slightly more than sufficient for expenses while everything else goes into an NRE account in India (which I guess has an added advantage of repatriability incase there are surprise expenses in the US). You are effectively growing your money by 5.4% and later by 6.3% after returning instead of letting it grow slowly by having more than what is needed in an american savings bank.

Can somebody point out all flaws in the above plan? I haven’t factored in inflation, I don’t see what role it has to play here although the *only* goal is to maximize what you have on returning to india.

10 replies on this article “how should new NRIs factor in inflation at India while making NRE/NRO deposits?”

  1. Dear Anon, you are always welcome. Please feel free to discuss as & when you feel so.

    Thanks

    Ashal

  2. anon smith says:

    I meant 0.3% not 0.03% in the previous post…sorry for the typo.

  3. anon smith says:

    @ashal thanks again for the suggestion on MFs. I am still reading about them. Most of my queries until now were related to long term investments. I plan to post new questions later based on my familiarity for MFs (which is almost nil until now) for short term investments during my stay in the US.

    @banyanFA thanks a lot for the tip. I am still reading a lot about other investment plans. I understand relying on pure FDs to live is a bad bad idea when there are other chances to get greater returns using MFs and other extensions like what you were talking about.

    @PK Indeed I am slowly beginning to accept that there’s no easy and legal escape to a 40% cut while in the US. They’re going to apply to MF’s as well but I assume they are going to give huge returns compared to FDs in the short term (I believe we can simulate this growth cumulatively every year for the long term if we remain conservative in our spending).

    From my (extremely primitive) knowledge of MFs, does anyone think this is too good to be true? (obviously it looks to be so)

    Assume I start investing in MFs in the US and have a really diverse (and thus safe?) portfolio and stock trading happens on a daily basis. *IF* it is reasonable to expect a *net* 0.03% profit every week (after possible profits and losses over the week’s trading),
    at the end of the year, we get a 16.5% profit (from (1.003)^51), which after tax cuts brings it down to 9.9% which is still pretty big.

    The above story is strongly based on the assumption of 0.03% profit per week. I have never traded before so I don’t know if this is feasible. Does anyone know from experience about the typical gains/losses per week from MFs or stock trading in the US?

    I’m planning to create a new post/question regarding MFs after I get to learn more about them.

    1. Dear Anon, I’m sorry to say but your whole thinking proces is going in wrong direction. For long Term you are planning for Debt investment whereas for short term you are thinking of Eq. (of course via MFs). Actually it should be opposite.

      What the thing is – If you start investing in MFs from now onwards & keep on investing & do not redeeming till your return to India which is 10-15 years away, you ‘ll save a lot of amount on US tax itself. Should I add any more?

      Thanks

      Ashal

      1. anon smith says:

        Thank you ashal for the advice. Like I said, I’m still reading up about MFs and their expected returns. Will be back later with hopefully a much better portfolio. I guess I read in some websites that FDs were the best long term investments so I was naturally getting biased towards them when setting up my plan.

  4. BanyanFA says:

    Anan,
    You have a very valid point – the answer to your query actually depends upon the options which you have. End of the day you would want max out of your money. If you intend to return to India, then it would be better to invest into NRE Deposits. (5.4 is more than double 2.1).

    What I have got most of my NRI clients is routing the NRE FD interest into Equity Mutual Fund SIPs for a 10 year tenure. This would ensure that after 10 years, it would give a blasting return (FD + Interest + Capital Gain on Mutual Funds). The gains on MF would be classed as Capital Gains and if I understand US taxation, Long Term CG are taxed less than normal taxation and hence they won’t bite that much out of the income. You can avoid this tax till the time you really need funds to fund your requirements such as Retirement, etc.

    By the way – if you are not planning to return, then one of the risks which you need to factor in is the Forex fluctuations and if the gains from the portfolio would be material enough to offset the FX fluctuations.

    Regards
    BanyanFA

  5. PK says:

    @Anon Smith,

    I dont think the housing reason doesn’t apply for cars. Its better to buy it as and when required.

    @Ashal,
    Actually its a good idea to invest in MF. But my worry is that the 40% tax applies to it as well. If not its definitely a must have option in the portfolio.

    PK

  6. Dear Anon, why are you not thinking for investing in MFs, any Idea?

    Thanks

    Ashal

  7. anon smith says:

    dear PK,
    Thanks a lot for the answer. That’s exactly what I’ve expected for houses and planning to invest soon.

    Do you expect the same reasoning to apply to luxury cars i.e buying them upfront? I heard they are depreciation assets and also almost all of them are from big international brands which set the same price in every country which in turn is governed by it’s relatively stable market value in the US.

  8. PK says:

    Anon Smith,

    It actually depends on where you want to finally settle. If you surely want to be back in India after 10-15 yrs… it is better to create some assets in India starting now instead of holding the money for 15 yrs and then buying. That is due to the inflation. Its better to take some loan from Indian bank and buy a house/flat and keep paying the EMIs from US.

    However, we cant talk about lot of things like what exchange rate would be 10-15 yrs down the line and things like that. But I personally feel its better to create assets in India if you want to be back in India after 10-15 yrs. Otherwise your money might lose value due to inflation in India. Flat rates in India are increasing at 10-12% a year and your money in india will be increasing at 5%. so after 15 yrs the flat rates would be some 3-4 crores and you wont get much with your savings.

    PK

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