Indian currency CD Vs. HB PP - risk/reward perspectives

[pfan]

I have been thinking of switching to HB PP for good reasons. Have been following this forum for a while and also reading more about HB PP as well. Recently I came across another option which seems too attractive to ignore. Would like to hear from experienced people on this thread about different perspectives from risk/reward point of view.

I have also listed pros and cons as I understand of two options.

Option 1: Indian currency CD , interest 9.25%, 10 year term
Pros :Attractive interest, compound effect, India growth story, minimal Tx cost, Money fully repatriable upon maturity,
Cons : currency risk, credit/default/safety risk is minimal since this bank in India are pretty much Govt owned.

More on currency risk : I calculated hypothetical situation of Indian currency devaluating 50% in next 10 years. Even in this case, return on dollar investment CD comes out to be 6.6% annually. Not too bad considering here interest rate is less than 1% currently. (currently 1 US Dollar is ~50 Rupees)

Options 2 : Obviously putting this money into HB PP
Pros : no need to mention
Cons : Risk is bit more involved due to investment and not being CD nature.Returns also varies as economy/mkt tend to perform over years.

I am leaning toward going for option 1 - Indian currency desisgnated CD for this money due to mentione benefitts. Not sure though if I have overlooked other risk factors here. Major one i see is currency risk but that too in worst case comes out much ahead of Dollar investment counterpart.

Would like to hear from experienced people on this from risk/reward perspectives what sound better investment.

Appreciate inputs/perspectives.

Regards,
pfan

[moda0306]

I don't know if Option 1 qualifies as a "carry trade," but I've been intrigued by these for a while. You take a relatively stable country that for some reason is offering great interest rates... seems hard to pass up as a VP option.  Not sure how one goes about getting into that, though.

[craigr]

You should only buy currencies of the countries where you live. You are introducing a lot of currency risk into your portfolio. This sounds like a better variable portfolio idea for money you can afford to lose. Emerging market debt is especially dangerous.

[craigr]

Also read this:

https://web.archive.org/web/20160324133 ... your-cash/

But especially read the comments about chasing yield with your cash.

If you are looking for safety of your cash, why put it into Indian CDs?

My personal opinion is that before anyone puts a lot of money into emerging markets they should first get a plane ticket and go to many of those places and see how they operate. If they are comfortable with the level of corruption and lack of transparency that's fine. But I've been to over 20 countries in my life and I'd be extremely careful about putting non-speculative money in any emerging market. Not saying they aren't nice people and places. But when the chips are down it's the foreign owners of investments that will get skinned first.

[pfan]

Agreed about currency risk and country dynamics. I am from Indian origin so for me it is easy to get into this CD and feel comfortable about how it operates in India.

For most part, it is CD , so does not need any active monitoring except one year a check.

Craig, you point of chasing return. I agree it is chasing higher yield to get relatively safer return. But isn't that the whole point of investment. Trying to maximize your Risk/Reward profile  ? If currency risk is deemed not affecting this negatively even in worst case, I am not sure what other hidden risk it carries ?

Main attractive point is getting compound return at 9.25% for 10 years, that too for a CD and not really any stock investment ! It sounds too good to be true but don't know what else can go wrong here.

Regards,
pfan

[MediumTex]

Main attractive point is getting compound return at 9.25% for 10 years, that too for a CD and not really any stock investment ! It sounds too good to be true but don't know what else can go wrong here.

But isn't that 9.25% return in a currency that could easily lose more value than that annually in relation to the dollar over the period of the CD?  I took a look at Indian inflation figures and inflation looks to have been higher than 9% in 20 of the last 22 months.  In such an environment, is a 9.25% return really all that impressive?

I also assume that Indian banks can fail just like U.S. banks can, right?  Is there an Indian FDIC?  Is it reliable?

In general, doesn't the Indian government have a lot of corruption?  What's the strategy in trusting your money to a foreign bank controlled by a corrupt government?

What about Indian taxes?  I assume India is going to want you to pay taxes on interest earned on funds in an Indian bank, right?

[craigr]

Agreed about currency risk and country dynamics. I am from Indian origin so for me it is easy to get into this CD and feel comfortable about how it operates in India.

Now if you think you are going back to India and would like to have an account there then that is a different matter. Then yes it may make sense to operate a CD there if you are comfortable with the situation. But as a US investor I would see no purpose to holding Indian Rupee (or any other currency) for cash. However in your case it may make sense, especially if you thought you would want to hedge against your dollar exposure here.

Craig, you point of chasing return. I agree it is chasing higher yield to get relatively safer return. But isn't that the whole point of investment. Trying to maximize your Risk/Reward profile  ? If currency risk is deemed not affecting this negatively even in worst case, I am not sure what other hidden risk it carries ?

I think it is better to chase risk on asset classes that profit the most from it (stocks, etc.). Chasing risk with cash goes against why you even hold cash. Most cash is held because people think they want some emergency funds, etc. at close hand and stable. So that is the *last* place I'd want to speculate.

I would in this case encourage someone to make a larger variable portfolio and play their hunches but leave the core alone.

Main attractive point is getting compound return at 9.25% for 10 years, that too for a CD and not really any stock investment ! It sounds too good to be true but don't know what else can go wrong here.

I agree it sounds too good to be true. That's the problem! Plus, how do you know the US dollar couldn't go up +10% a year against the Rupee and leave you negative? Not to mention the tax considerations going across multiple jurisdictions.

Also I am not trying to pick on India, etc. I am just very careful about how and where I think investors should take risks. Problem with many emerging markets is that they are notorious for doing things that really hurt foreign investors in times of trouble. This can be anything from capital controls, extra taxes, devaluing currencies, or simply not paying them back. When you are not part of the political constituency in a country it is often more politically expedient to not do what you promised in order to save votes back home. These things have even happened in developed countries.

Here's an example of this kind of political risk in Ecuador 2008:

http://online.wsj.com/article/SB122911515875502569.html

Ecuador's President Rafael Correa said his nation is defaulting on its foreign debt, in a hardball move prompted as much by leftist ideology as economic distress.

President Rafael Correa said Ecuador would skip a $30.6 million payment to bondholders due on Monday, calling foreign creditors 'real monsters.'

Mr. Correa said Ecuador will skip a $30.6 million payment to bondholders due Monday, asserting that there are irregularities in how the debt had been contracted by an earlier administration. Mr. Correa, an economist who is close to Venezuelan president Hugo Chávez, lashed out at foreign creditors as "real monsters."

Then in 2011 they went out and issued new debt it seems. Now why would anyone buy that debt and not expect to get ripped off again even if it did have a high yield?

So you know I am saying that I'd be very careful and understand the risks. I am not expecting India to do anything of this sort, but at the same time if they did do it what could a foreign investor really do about it?  



P.S. I hope to make it to India this year. It is on my short list of places I've not seen yet.

[craigr]

And just to illustrate that I'm not just picking on emerging markets, here is what the Swiss did last year to the venerable Franc - a currency that many buy for inflation protection:

http://www.guardian.co.uk/business/2011 ... franc-euro

The Swiss National Bank in effect devalued the franc, pledging to buy "unlimited quantities" of foreign currencies to force down its value. The SNB warned that it would no longer allow one Swiss franc to be worth more than €0.83 – equivalent to SFr1.20 to the euro – having watched the two currencies move closer to parity as Switzerland became a "safe haven" from the ravages of the eurozone crisis.

The move stunned currency traders, and sent the Swiss franc tumbling against other currencies. Jeremy Cook, chief economist at currency brokers World First, said it was "intervention on a grand scale", and the start of a "new battle in the currency wars".

Countries will always move first to protect their own citizens. They are not going to care what happens to foreign holders of their currency. Currency risk is very much a real problem. Caveat emptor!

[pfan]

For MT questions,

This is offered on Special account called Non Resident Indians (NRE) account in India. By law, this a/c does not pay any taxes in India to Indian Govt. It needs to be reported to US for taxation though like regular income.

In order to lose value of interest earned and any principal, Indian currency value has to devalaute by that much amount each year compounded then only original principal is lost.

Eg: If you invest $1000 in this CD at current exchange rate of ~50 Rupee/dollar. At the end of 10 year, principal + interest == (1000*50) + 9.25 compound interest == 121,111.24 Rupees. Assuming Rupee depreciates max 250% from here in next 10 years than only it loses all interest and break even. So rupee value after 10 years with 250% depreciation = 121 Rupee/dollar. ROI here is 121,111/121 == ~$1000

so all interest is lost in this currency depreciation. Now looking at past 20 years of data, it is almost impossible for this to happen, unless world falls down in some kind of catastrophy.

So my point is even at some improbable 50% deprecation for all practical matter, this is still way ahead in terms of investment. ROI is 121,111/75 == $1614. This is roughly equal to ~6.6% return on my US dollar investment for relatively safer investment - CD

There is no double taxes paid in India, only in US as regular income tax.

NRI accounts have been there for a long periods of time..without any issue of corruption or safety. Indian govt backed banks run this. So unless India as a country defaults, don't see much credit/default risk here. As a country, it is one of the very strong growth story after China. It is expected to be third most big economy after China/US from 20-30 years from now. Only non resident indians can open up this account though, so not available to general world population.

Craig's points,

You should definitely visit India. I am pretty sure you would love the culture, dynamics, rhythm and liveliness in environment. This seems good investment regardless one goes back to India or not, in Dollar terms. To me it seems particularly suited well to hold for your cash component, once your emergency  6 month cash is handy here. We are not taking any more risk than opening a CD and losing a principal even in worst cases ..

My only argument going against is , taking it one step further : I am sure there may be more currencies in world who may be offering more interest due to their country's inherent inflation. If i apply all this logic to that country, wouldn't i do better as an investor holding that country's CD , if there is such one ? I don't know if this is not applicable here since India as a country is much more stable economy/GDP is doing much better than most of emerging mkt ones ?

thoughts ?

[craigr]

My only argument going against is , taking it one step further : I am sure there may be more currencies in world who may be offering more interest due to their country's inherent inflation. If i apply all this logic to that country, wouldn't i do better as an investor holding that country's CD , if there is such one ? I don't know if this is not applicable here since India as a country is much more stable economy/GDP is doing much better than most of emerging mkt ones ?

My advice is to make this part of your variable portfolio and keep your cash in T-Bills for safety. Investing in high yield foreign CDs has bitten a ton of people in the past. I remember reading about investing in Mexican high yield CDs years ago. Maybe it worked fine up until the Mexican government devalued the peso and wiped out investors.

I just skimmed this paper, but it may provide background:

http://www.wider.unu.edu/publications/w ... /WP132.pdf

Again not saying this will happen in India. But honestly I've heard about a ton of sure thing investments over the years that have blown up. I never trust sure things and I definitely never trust high yield CDs promising to pay historical stock market return rates but claim to offer bank CD safety. That kind of thing just doesn't exist. Sorry.

[stone]

pfan, I think it is all to easy to not fully appreciate just how significant currency risk is. You seem to think that a one off 50% depreciation is a worst case scenario. History shows that 99% depreciations are normal. Like you I have a hunch that emerging market currencies will do very well indeed over the coming decades in relation to developed country currencies. That is simply an unwinding of the truely spectacular shift in relative value that happened in the 1980-2000 period in favour of the USD versus the emerging market currencies.

Clive keeps posting on here saying that gold must fall because it has increased in price  7x since 2000. The reason why I doubt he is right is because I just think that that apparent rise is due to USD and GBP slipping back down towards a more realistic value relative to the total returns of the Indian rupee, Brazilian Real etc etc. There is a big difference between having a hunch and seeing something as a sure thing. Perhaps India will instead pan out like Iceland. Iceland cash savings accounts paid out fantastically up until 2008. Perhaps India will do worse than Iceland. Iceland had a one off 90% depreciation or something like that. Currencies can and do suffer consecutive, compounding, massive depreciations spread over decades. Many emerging market currencies did that versus the USD in the 1980-2000 period. Personally I'm thinking that the 25% gold in the PP will guard against devaluation of the GBP (I'm UK based). I attribute the bulk of the "gains" in gold in GBP terms to the GBP sinking versus emerging market currencies (once interest is taken into account).

I guess the reason why you are wanting the Indian CD rather than a diversified emerging market currency holding is for your personal tax reasons as an Indian citizen? Brazilian, Malaysian etc currency are all doing much the same thing as Indian currency. Might it be worth considering having an entirely Indian PP? Perhaps have both an Indian PP and a US PP if you live in the USA but might think about moving to India.

[stone]

Craigr, I do think that there is a significant difference between current emerging market currencies such as the Indian Rupee, Brazilian Real, Malaysian etc and the 20th century emerging market currencies that were pegged to the USD. The current crop are free floating (not including Balerus, China and a few pegged currencies). That perhaps protects them from events such as the Mexican Peso crisis, the Argentinian crisis and the 1997 South East Asian crisis. I think the reason why the currencies stopped being pegged to the USD is that they saw how George Soros was able to exploit the peg to pillage South East Asia in 1997. George Soros did the same thing to the UK GBP when it was pegged to the Deutschmark in 1992.

That said, I totally agree about your general point that currencies shift around relative to each other by a LOT.

[stone]

I just listened to the Rick Ferri interview on Craigr's podcast. The MASSIVE mistake Rick Ferri made was to look at the gold price in terms of Indian Rupees etc rather than comparing the total return of holding gold versus the total return of holding emerging market currencies. If you had bought  Brazilian STT and compounded them that is what gold needs to be compared against to see if it is over-valued now. This year the Brazilian PP lagged Brazilian cash. Those currencies have had strongly above inflation interest rates for much of the last decade. I think Warren Buffet bought a lot of Brazilian Real at the end of the 90's.

One thing though is that in global panics, emerging market currencies plunge before bouncing back up. Perhaps a variable portfolio idea might be your Indian CD (or a diversified emerging market currency holding) rebalanced against US LTT or Japanese Yen. I'm still thinking just a straight Indian PP might be better.

[craigr]

Craigr, I do think that there is a significant difference between current emerging market currencies such as the Indian Rupee, Brazilian Real, Malaysian etc and the 20th century emerging market currencies that were pegged to the USD. The current crop are free floating (not including Balerus, China and a few pegged currencies). That perhaps protects them from events such as the Mexican Peso crisis, the Argentinian crisis and the 1997 South East Asian crisis. I think the reason why the currencies stopped being pegged to the USD is that they saw how George Soros was able to exploit the peg to pillage South East Asia in 1997. George Soros did the same thing to the UK GBP when it was pegged to the Deutschmark in 1992.

Well I just can't agree with you. Many of these countries have fundamental problems with corruption. It's just my feeling on these things and I'm not passing judgment one way or another. It's just the way things are in many places on this planet. When I was last in Brazil in 2004 it was corrupt from the lowest cop all the way up. Lots of poverty. Very sad. It's hard to have a long term stable growth when you can't trust the government to protect private property.

Re: It's Different This Time!

No it's not. Here is Brazil imposing a tax on foreign investments in 2010:

http://www.bloomberg.com/news/2010-10-1 ... efire.html

And now they apparently have scrapped it, but it hasn't gotten a lot of coverage.

All I am saying is that someone paying you high interest is doing so because there IS risk there. I would only put money in other currencies as a speculation. Currency speculation has no business being part of the Permanent Portfolio. Governments are always going to look out for their own interests first and foremost. They don't care about foreign currency holders. Just accept this as an immutable law of the universe and you'll be a lot happier.

[stone]

Craigr, I totally agree that mingling foreign currency into a PP would be a mistake. The tax on interest also makes it less attractive even for a variable portfolio hunch. But pfan says that because he is a non-resident Indian citizen he won't be paying such taxes. Don't you think for an Indian, an Indian PP might be sensible? The developed world does have problems of our own. The employee stock options/share buyback system makes our stocks very slippery for average joe investors. I agree we make a much better job of things than the BRIC countries but perhaps the direction of travel might be towards them improving and us getting worse. I'm not saying that is certain, I'm just saying it might be true.
 

[craigr]

Don't you think for an Indian, an Indian PP might be sensible?

Absolutely. If that is his situation then that is what he should do. But this needs to be a decision made because it actually fully applies. I wouldn't do it because of an enticingly high interest rate on the cash. That would be a tremendous mistake.

The developed world does have problems of our own. The employee stock options/share buyback system makes our stocks very slippery for average joe investors. I agree we make a much better job of things than the BRIC countries but perhaps the direction of travel might be towards them improving and us getting worse. I'm not saying that is certain, I'm just saying it might be true.

All possible. But believe me when I say that the problems the US has in terms of corruption are nowhere near what they are in many other places. I'm just being realistic.

Any country scoring less than 4.0 on this chart I'd be very careful about putting lots of my money in outside of pure speculation. Just my opinion:

http://cpi.transparency.org/cpi2011/results/

[stone]

It is interesting to see how well Japan comes out on that chart. The Olympus debacle made it seem as though Japanese Institutional investors expected weird cover ups to take place. It is apparently standard for Japanese construction firms to pay protection money to gansters.

Corruption is something that pans out differently in each country. In the UK police turn a blind eye to criminals inorder to massage the crime stats. Officials "silver plate" regulations in order to create more work so that they can justify employing more underlings and elevate themselves. Tony Blair promptly got £20M when he retired -much of it was from key players in the 2008 crisis. Lansdowne Partners rewarded him hansomely as soon as he retired. They had massive short positions in Northern Rock bank in 2008:
http://www.telegraph.co.uk/news/politic ... risis.html

[craigr]

Corruption is everywhere. But let's just say when I'm traveling around the UK I don't carry money in my shoe in case I got shaken down by a Bobby. 

[stone]

Craigr, I always think the relationship between Nigeria and the UK is a perfect illustration of global skullduggery in its various forms. If a UK buisness person goes to Nigeria apparently the classic ruse is for thugs to look out for someone at the airport holding a board with the visitor's name on it, copy the name and intercept the visitor, whisk them off and rob them. The UK is full of Nigerians who get jobs in the post office to intercept mail and conduct identity theft. Our email is flooded with Nigerian fraudulent spam etc etc. BUT the vast net flow of loot is FROM Nigeria to the UK. Nigerian's put their savings in our stock market etc and buying property in prime locations in London. The more corrupt Nigeria is the more Nigerians try and put their money in the UK not Nigeria. That depresses their currency in relation to ours. It means that we get oil, timber, coco etc from them and they get electronic account statements from us. Basically we get real stuff for nothing real in return. It all depends on having a kleptocratic elite in Nigeria who syphon off all of the country's earnings and stuff them into UK and Swiss assets. We support and nurture that elite. Who is ripping off who?

[stone]

pfan, this link might be worth considering as a doubting voice about India:
http://www.project-syndicate.org/commen ... 12/English
Why India is Riskier than China
Stephen S. Roach
"But the real problem is that, in contrast to China, Indian authorities have far less policy leeway. For starters, the rupee is in near free-fall. That means that the Reserve Bank of India – which has hiked its benchmark policy rate 13 times since the start of 2010 to deal with a still-serious inflation problem – can ill afford to ease monetary policy. Moreover, an outsize consolidated government budget deficit of around 9% of GDP limits India’s fiscal-policy discretion."