In order to attract foreign currency into India from NRIs (Non Resident Indians), Reserve Bank of India (RBI) has come out with new propositions.

Earlier in December 2011, RBI has deregulated interest rates on Non Resident Ordinary (NRO) savings accounts and Non Resident External (NRE) term deposits.

A new initiative from RBI is on the anvil. It freed up interest rates on the Foreign Currency Non Resident (FCNR) Account.

Thus, the interest rate on all the NRO, NRE and FCNR accounts has increased.

Interest rates that NRIs earn on rupee deposits were freed in December. In the previous five years, inflows of NRI money averaged USD 2.9 billion.

The record inflows came amid sharp depreciation of the rupee from 44.5 to a dollar to 51.1

Among the different deposits options open to NRIs, only  foreign currency non-resident (FCNR) deposits - where NRIs can make deposits in a foreign currency - witnessed outflows of USD 431 million in 2011-12 against inflows of USD 1.33 billion in the previous year. The FCNR outflows were more than offset by a surge in inflows into non-resident (external) rupee accounts (NRE).

These accounts saw inflows of USD 7.5 billion during the 12-month period, from outflows of USD 280 million the previous year.

Of this, USD 4.5 billion came in during the last quarter of the fiscal, after interest rates on these deposits were freed. Some banks now offer rates as high as 9-10% on these accounts.

Non-resident ordinary (NRO) rupee accounts (where deposits cannot be repatriated) also saw substantial inflows of USD 3.9 billion during April-March.

The aggregate value of NRI deposits held by Indian banks stood at USD 57.9 billion by Mar. 31 2012, provisional RBI data show.

Non-resident external and non-resident (ordinary) accounts are two different types of rupee-denominated bank accounts permitted by the government for NRIs. While NRE funds are repatriable, NRO money can not be remitted abroad.

FCNR accounts, on the other hand, are denominated in foreign currency and the funds are fully repatriable.

In November 2011, the RBI raised maximum interest rates on NRE accounts for 1 year-plus to LIBOR/SWAP plus 275 basis points.

Many banks raised their interest rates on these accounts.   In December 2011, deposit rates on NRE accounts were deregulated.

Earlier this month, the RBI hiked the cap on FCNR interest rates, raising it to 200 basis points above the LIBOR/SWAP rate for 1-3 year deposits and 300 basis points for deposits with a 3-5 year tenor.

Take a quick review of the 3 types of terms deposit accounts featuring NRO, NRE and FCNRF.

Data from the RBI suggests that FCNR balances have always lagged behind balances in the NRE accounts. As of Feb 2012, while FCNR balance was at $15.54 billion, the same in NRE accounts was $29.94 billion.

Kotak Mahindra Bank’s Executive Vice President & Head - Branch Banking, Virat Diwanji, explains, "In current scenario, FCNR dollar deposits would suit more to an investor who is completely risk averse and looking at investing in India with an at least 3 year horizon. However NRE deposits at current attractive rates may prove to be a better option if one is willing to take the currency risk since the rate differential between a NRE deposit and FCNR is about 500 basis points for 3 year tenure and even higher for lower tenures."

Certified Financial Planner Gaurav Mashruwala says, "The NRE account allows an NRI to maintain a savings as well as term deposit account while FCNR is only a term deposit. Perhaps this, and the fact that NRE accounts are rupee accounts, makes it operationally convenient for investors to opt for the NRE term deposit. Another issue is that not many investors may be aware of the FCNR deposit since for the longest time, interest rates were barely around 1%."

Mashruwala adds, "If you are certain that you will repatriate the maturity proceeds, then it is best to invest in the FCNR as you protect yourself against currency risk. Conversely, if you are certain that your investment will remain in India, NRE would be a better choice."