NRE deposits are deposits made by NRIs in Indian Rupees. The interest earned is completely tax free. NRE deposit is akin to an investor converting foreign currency, most notably USD, into Indian Rupees (INR) and then making a Fixed deposit in INR. Such deposits help in creating demand for INR, thereby stemming the depreciation of INR, or an appreciation of INR vis a vis the foreign currency. 

For the investor, the returns need to be calculated after factoring in the change in exchange rate. For example, let us say the current USD/INR exchange rate is 80 (80 INR to 1 USD). A Non Resident converts USD10,000 into INR @Rs.80, which works out to Rs. 800,000. Assuming that the NRE deposit earns interest @5%, this amount grows to Rs.840,000. Meanwhile, in 1 year, the INR has depreciated to say 82. 

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