The Myth of India’s 9% Interest Savings Accounts

The United Arab Emirates has a substantial Indian expatriate population, with estimates ranging from 30% – 60% of the local population. Wikipedia cites that the labour force of the UAE are 99% foreign workers, and a substantial number of the workforce in Dubai and Abu Dhabi is compromised of Indian nationals.

In 2005, an estimated $7 Billion USD was remitted from the UAE to India, with more than $4 Billion of that being sent to the Kerala region alone.

Speaking to my Indian friends here I was initially quite shocked to hear that banks in the country offer Fixed Deposit rates of 9%+ with minimum deposit terms of only 1 year.
For example, take a look at the NRE Deposit rates offered by Standard Chartered Bank in India:
SC India Term Deposit
source

Now, to give this some relativity, the average return of the US S&P500 for the past 10 years was around 9.15%* this account offers almost the same rate of return without putting your capital at the mercy of the markets.

To understand what is going on here, we need to understand the difference between Nominal Interest Rates and Real Interest Rates.

Example

Imagine it is the 2nd may 2013, and our friend Sampat has USD$185,800 to invest or deposit somewhere.

Sampat decides to take up the offer of a Fixed Deposit at a 9% per year rate of nominal interest and transfers his USD$185,800 into INR₹10,000,000

One year later (today), Sampat looks in his account and can see that his INR₹10,000,000 has now become INR₹10,900,000
Sampat is very happy to have made INR₹900,000 on his capital.

Sampat decides he wants to take his money out of India now and use it to buy an apartment in Dubai.
He remembers that he deposited USD$185,800 and that his money has grown at 9%.
He quickly does the maths here:
$185,800 * 9% = $16,722
$185,800 + $16,722 = $202,522

Sampat transfers the money from his INR₹ account back to his USD account and is anticipating USD$202,522 – the bullshit Correspondent Bank Fees

But when the transfer goes though, he notices he only has USD$181,098.

Not only has his $185,800 deposit not gained any interest, it has in fact lost money and returned $4,702 LESS than he initially deposited.

Sampat would have been better off had he driven out to the desert and buried his $185,800 in the ground, then come back a year later and dug it up.
But his account grew at 9%.

So what has gone wrong here?!
2nd May 2013 INR₹10,000,000 = USD$185,800
2nd May 2014 INR₹10,900,000 = USD$181,098
Source – XE.com

Nominal Interest Rates vs Real Interest Rates

The headline rate of any savings account or investment product is, unless stated, the Nominal Interest Rate.
That is to say, the rate at which your capital will appreciate over the given time.

What we need to take into account is the impact of inflation.
Inflation is the enemy of interest.

Inflation is the reason that your rent goes up each year, or the reason you get a pay-rise each year.
Both of these are examples of when you either pay more for something (increased rent) or sell something for more money (your work for a higher salary)

Let’s imagine that you want to buy a milkshake that costs $100 and you live in a country that is experiencing 3% inflation per year.
To buy the same milkshake next year, you can expect to pay $103.

Today you know that you want to buy the same milkshake next year, so you place $100 into an investment that pays 3% per year.
Next year you take out the $103 in your investment ($100 +$3 interest) and buy the milkshake.

Here, your Nominal Rate of Interest is 3%
Your account grew by 3% and your $100 turned into $103.

But your Real Rate of Interest is 0%
Your Purchasing Power grew by 0% as the amount in your account could buy you the same stuff last 12 months ago as it can now.

As you can see, the Real Rate of Interest can be worked out using the following:

Nominal Rate of Interest – Inflation = Real Rate of Interest.

To work out the Real Rate of Interest on the 9% fixed deposit that Sampat took out, we need to know the Inflation rate in India in order to complete the missing data point in the equation.

As of March 2014, the rate of inflation in India is given as 8.31%
For the previous 12 months the inflation rate we between 8.03% and 11.16% and was above 9% for 8 of the 12 months.
If we consider the impact of the compounding growth rate here, the average rate of inflation can be approximated at around 9.8% for the year.

  • May 2013: 9.31%
  • June 2013: 9.87%
  • July 2013: 9.64%
  • August 2013: 9.52%
  • September 2013: 9.84%
  • October 2013: 10.17%
  • November 2013: 11.16%
  • December 2013: 9.87%
  • January 2014: 8.79%
  • February 2014: 8.03%
  • March 2014: 8.31%
  • April 2013: 8.31%*estimated

CAGR 9.8172%**

Now, we know the Fixed Deposit account paid Sampat a return of 9%.
The Inflation rate was 9.82%

Nominal Rate of Interest – Inflation = Real Rate of Interest.
9% – 9.82% = -0.82%

The Real Rate of Interest is -0.82%.

This, combined with the weakening of the INR₹ against the USD come together to mean that in our scenario Sampat realizes a return of -2.53% on his $185,800 over the 12 month period.

*source
**source

The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Links to external sites are for information only and do not constitute endorsement. Always obtain independent professional advice for your own particular situation.

12 Comments

  1. sid

    27th October 2014 4:29 pm, Reply

    Very interesting blog. 🙂
    Just a quick question on this particular post – while what you say is accurate when you need to repatriate the funds out of India. Can you briefly explain how it works if the funds are never repatriated and intended to be spent in India? Thanks!

  2. RK

    29th November 2015 3:35 am, Reply

    You do realise that in the short term, forex doesn’t reflect inflation right? If you want to enjoy short term higher interest rates, you can still do so at minimal currency risk which does not come from inflation (Your sample consists of when the Indian rupee and the economy were under stress from external factors).

    • Dan Clarke

      9th December 2015 1:01 pm, Reply

      Regardless of the cause of the forex risks, it’s still a risk – no?
      Would you care to elaborate more on your feedback?

  3. jai

    21st December 2015 9:57 am, Reply

    You should compare apple to apple.

    In 2005 1 USD = 45 INR and in 2015 1 USD = 66 INR
    100 INR invested in 2005 @ 9%(compounded quarterly) for 10 year will give you 243.50 INR.
    243.50 INR.= 3.69 USD
    2.22 USD ( 100 INR) nvested in 2005 @ 0.5% in a US saving account (compounded quarterly) for 10 year will give you 2.33.
    Even depositing in FCNR and considering 4% interest will generate only 3.3 USD.
    If i do not want to invest in market and keep money safe in bank than returns from Indian banks are better even considering high inflation.

  4. Akhilesh Reddy

    15th August 2016 5:03 pm, Reply

    what if USD to INR rate decreated..

    lets say in march 2009 it was 50.52–i invested $1000(50520INR) in india as fixed deposit at 9% for 1 year
    >>march 2010 it was 45.46 i get $1000(45460INR)>>45460+4091.4(9%)=49551.4

    (50520+(4546.8)9%=55066.8)

    this might also happen/..

  5. Sam

    9th September 2016 5:20 am, Reply

    Let’s forget nri here. If indian in india deposit 100000 at 9 percent interest should get 109000 by end of year. So u say the bank won’t give him 109k but will reduce interest minus inflation rate and that amount will be the real amount he will get with his principal 100k. Am I right

  6. Naran

    26th September 2016 10:06 pm, Reply

    Dan is talking about inflation when he should be about exchange rate. What you get is interest rate adjusted for exchange rate gain or loss. If rupee gets stronger or foreign exchange gets weaker you will make more then 9% and loose all your gain if rupee looses value by 9% over the term of the deposit. Elementary Mr Watson. If there is no movement in exchange rate then 9% is real growth and if Rupee looses value then it is reduced and can even be nagative.

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