It is common for Non-resident Indians (NRIs) to borrow in their country of residence to invest in India. They borrow to pay off loans in India, purchase real estate or even invest in stocks or mutual funds.
Why do it?
The borrowing rates may be lower in their country of residence. Say, you can borrow locally at 4% p.a. instead of at 8% p.a. in India. Everything else being the same, a low-cost loan is far better than a high-cost loan. In an earlier post, we wrote about the things to watch out for if you are borrowing abroad to replace a loan in India.
In my limited experience, I see this trend more often in the investors based in UAE/Middle East. Not so much with investors who are based in Europe and the US. A couple of reasons could be:
- These countries may also not have as many investment options available compared to the US and Europe.
- If the investors in the Middle East don’t have plans / possibility of settling there, they would want to make investments in their home country.
What Is the Biggest Risk with Such Investments?
Potential rupee depreciation. The low-cost loan is in a foreign currency and must be repaid in the same currency (and not in INR).
I reproduce the 5-year chart for UAE Dirhams/INR exchange rate (AED/INR). As you can see, the AED has appreciated by ~25% in the past five years. In the past year, it has appreciated 6.44% vis-à-vis INR. So, if you took a 1-year personal loan at 5% in UAE 12 months back and had to repay the bullet repayment in 12 months, the effective cost of loan in INR terms is ~11% p.a.
NRIs Are Smart
NRI borrowers do not just use local currency loans to invest in India. Many times, they use the funds to close a high-cost loan in India. Say, your home loan outstanding is Rs 25 lacs, you can borrow in Rs 25 lacs equivalent in Dirhams and use the proceeds to square off the home loan in India. Your home loan may be costing you 8% p.a. but the personal loan abroad may cost you only 5% p.a.
Further, if you are using your local cash flows to repay the loan, then you don’t really have much of a problem. Because you do not rely on converting Rupee to foreign currency for loan repayments. Hence, you can be indifferent to Rupee depreciation, at least from the point of view of loan repayment. That is Smart.
When Is Rupee Depreciation a Problem?
The rupee depreciation is a problem if you rely on the income/gains from those investments in India to pay off the loan. At the time of borrowing abroad, things look rosy. The stock markets have been shooting through the roof. You want to make a killing too. However, if you were to just put what you have, you won’t make much. 20% of Rs 2 lacs is 40,000. By taking leverage through a low-cost loan and investing in Indian markets, you can magnify your gains. 20% of Rs 20 lacs is Rs 4 lacs.
You borrow at 4% and believe that your investments would return 20%. If your call goes as expected, you can easily repay the loan.
You run two risks with this approach. Your investments may not perform as expected, making the loan repayment difficult. And this is true for every leveraged investment. Leverage is a double-edged sword. You borrowed and invested Rs 25 lacs (equivalent). The investment falls to 20 lacs. If you were to close the loan on that day, you would have to pay Rs 5 lacs from your own pocket (a loss of Rs 5 lacs for you). Further, if INR were to depreciate against the local currency, that is a double whammy.
Borrowing abroad to square off a loan or make an investment is a fine idea. I do not see anything wrong with this approach. However, you must not use such loans for speculation or making quick money. Compared to buy-and-hold investments made with your own money, making short term investments on leverage carries a much higher risk and you need very fine trading skills and investment discipline to pull it off.
If you stay abroad, rupee depreciation affects all your investments in India. If INR depreciates, the value of your asset reduces in foreign currency (local currency). If, for any reason, you had to sell your Indian asset and remit the money abroad, you will get less in local currency (AED/USD/Euro). And there is a financial planning lesson for NRI investors. All of us have home-country bias i.e., we are more comfortable investing in India than any other geography. NRIs are no different. However, if you are staying abroad and plan to stay there for a long time, do not bet your entire fortune on Indian markets/economy and rupee-denominated assets. Diversify.