It has been a couple of months since the Reserve Bank of India, India's central bank, permitted residents to remit up to $25,000 every year for any purpose.

However, the excitement surrounding this development refuses to abate. In this article, let us take a look at fixed deposits denominated in foreign currencies as an investment option.

First, let's visit the argument for investing in a fixed deposit. There are primarily two reasons:

• Safety of capital (not to say that deposit taking companies always return the money, but if you have done your home work well, this is the norm).
• Stability of income (same conditions apply here).

Because of these two reasons, fixed deposits appeal to the risk averse investor. It also appeals to individuals who have spare amounts awaiting deployment (short-term FDs ensure that money is not sitting idle).

But what happens if you decide to invest in a FD not in India (in Indian rupees), but, say, in Singapore (in another currency)?

The risk element associated with this product increases. The risk here stems from the possibility that the currency you are invested in might appreciate (you will gain as on conversion you will get more local currency per unit of the foreign currency you invested in) or depreciate (conversely, you will lose) vis-à-vis your local currency.

In other words there is greater uncertainty about both the capital being protected and the interest income remaining stable.

And then there is question of the possibility of interest rates (US dollar-linked) going up. The answer is apparent from the following statement, which is part of a speech delivered by the vice chairman of the Federal Reserve on the April 8, 2004: . . . we also have to recognize that maintaining the current level of the funds rate for too long will eventually result in an unwelcome increase in inflationary pressures. In other words, don't bank on the interest rates remaining low for too long.

Not a very attractive proposition for the typical FD investor to consider going global. But the option of a foreign currency deposit will appeal to some.

Take for example; your son/daughter is going to London to pursue higher studies. Your expenses in this case will be denominated in pound sterling, while your income is probably in Indian rupees.

Since the rupee has been consistently losing value vis-à-vis the pound sterling, there is a possibility the expenditure may actually exceed expectations (if depreciation continues, or happens at a faster rate, every time you send a pound sterling draft to your son/daughter you will have to shell out more rupees for every pound sterling).

In such an instance a pound-based fixed deposit can be of great use. Since you save and spend in pound sterling, currency risk is eliminated.

Another reason to consider a foreign currency deposit is to diversify the risk of being invested in only one currency (for most of us that is the Indian rupee).

And to counter the possibility of rising interest rates, we recommend that you invest in short term FDs.

Attempts to get information on the global FD products launched by the banks were unsuccessful. However, the returns offered are far less than what you will get by making a deposit in any local bank/institution (for example, a three month US$ denominated FD is likely to return you only 1 per cent p.a). But the same is worth considering if you have a foreign currency denominated liability or upcoming expenditure.

Need assistance? At Personalfn and Equitymaster we are taking initiatives to ensure that you are ahead of the curve when it comes to benefiting from this opportunity. We request you to fill a brief questionnaire. This way we can keep you posted on new investment opportunities that we will make available to our customers in the next few weeks and other regulatory developments that are taking place.

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