Can you give me a source for this? Not that I hold Mohan Guruswamy in high esteem for his politics, but this statement is too off-handed for someone who knows even basic economics to have made.
Let me approach this in parts:
>They hold almost $122 billion as NRE and FCNR accounts fetching them 7.5-8.5% interest. Most of this money is borrowed from US and European banks for 2.5-4% interest and deposited in Indian banks to fetch them a neat annual profit. Banks like Citibank lend from their domestic funds to these NRI's and PIO's and hold the money in their NRI and FCNR accounts with their "customers " skimming the spread.
Clearly, the author does not understand the concept of carry in FX. FX rates are expected to drift year after year, and the reason for this drift is the difference in interest rates. This follows the No Arbitrage Principle. To put it simply, the No-Arbitrage principle says that you cannot make more than the risk-free interest rate (let's say Sovereign Bond Yield), without taking on risk. And most importantly, you cannot make money without bringing money. All financial instruments are priced basis this.
Now let me show you how this is a flawed observation. Let's go with the case of NRE deposits - which are denominated in INR
1. Citibank lends at 2.5% p.a.. However, this is for US Dollars, and not Indian Rupees. Let's say I have borrowed 100k USD like this.
2. I send this money to India, converting it to Indian rupees @ 60INR/USD, and deposit it in a NRE FD yielding 7.5% p.a..
Now my assets/liabilities are :
-100k USD @ 2.5% p.a.
6mn INR @ 7.5% p.a.
Expected value after one year (assume continuous compounding)
Let's look at the net value of our portfolio. Remember Interest Rate Parity - which says that the expected spot rate after an year (forward rate), is a function of current spot rate and interest rate differential. Using this USD/INR is expected to be at 63.08
Converting 6.47mn at 63.08 (I've calculated with exact decimals - if you're trying to replicate, keep this in mind) - which works out to 102.53k USD
Which means, at the end of this round trip, I ended up making no money. Now your argument would be that 63.08 is the expected rate, and that it doesn't have to be so. Let's assume for a moment that this is what drives the rationale of the investor (truth is, if they wanted to bet on FX rates, they needn't go through all this borrowing depositing process, they just need to buy/sell a USD/INR Future on the CME) - even in this case, they would want the value of their asset to go up, which is when they make a profit, and for the value of their asset to go up, rupee should strengthen (correlate with economy) and USD/INR after an year should be less than 63.08
The next thing you'll tell me, is that this FX risk and USD/INR fundae is not valid for FCNR deposits, where it is denominated in USD itself. Have you ever happened to check the prevailing FCNR rates? Here is ICICI bank's page. The 7.5% is not for FCNR deposits, it is for rupee denominated deposits.
And before you counter me again, that these are marginally higher than US deposit rates - let me explain that to you as well - the yield(interest) on a security is priced in such a way that it incorporates a risk premia for the expected losses. If you're looking at something completely risk free, the closest you can get is a sovereign bond.
Deposit rate = Sovereign Rate + Risk Premia
And how do you arrive at Risk Premia? You equate the returns from 100$ invested in a sovereign bond, to the returns you should expect from this investment minus the expected losses, each multiplied by their respective probabilities.
The reason that Indian Banks have a higher risk premia is due to our regulations and capital requirements (US has been 80% BASEL 3 since 2015, and 100% since 2017, we on the other hand begin next year)