Reader question: Foreign currency transaction fees on India-issued cards

A few days back, Reader Ravikiran left a question on the blog.

I have a euro trip coming up and Wanted to check with you reg the foreign transactions. How do you end up spending foreign currency? Credit cards, travelers cheques etc. Which one has the best value and benefits?

If its credit cards, which one in India has the least foreign currency markup? Would love to know your thoughts.

It's been quite a while since I saw, let alone used, travellers cheques, and I'm not really sure how many people use it any more. To me, it seemed like a great idea initially, but then I realised it was more of a pain - carrying pieces of paper to exchange for further pieces of paper! Of course, there's the security aspect of it (requiring identification to encash TCs) but we've all heard enough horror stories about them, haven't we?

Personally speaking, I normally use a mix of credit cards and cash when I travel overseas. This, even more so when there are promotions running. I recently travelled overseas to Kazakhstan and Dubai, and Citibank PM card had a promotion for 2x Premier Miles on all international spends, which I was able to make good use of. 

Having said all of that, and to be absolutely honest, credit cards aren't really the optimal way to spend overseas. Here's why.

Who's involved

As with any transaction, there are multiple parties involved. They are:

• the customer (you)
• the merchant (establishment where you swipe your card)
• the merchant's bank (who collects funds on behalf of the merchant via the credit card network agency)
• the credit card network agency (Visa, MasterCard, etc)
• your bank (who issued your credit card, and pays funds on your behalf to the merchant's bank).

For normal credit card transactions (ie, where Dynamic Currency Conversion is not applied), the ones that determine the charges are the last 3 above - merchant's bank, credit card network agency and your bank. And like Shylock, each one demands their own pound of flesh.

What exchange rate is applied

Banks do not settle transactions amongst themselves immediately when you swipe your card (RTGS or Real Time Gross Settlement), or indeed even on the same day. With the number of credit card transactions that are going around every day, that kind of settlement would be a nightmare. Instead, they fix a time period at the end of which each day's transactions are settled, usually on a net basis. So for example, all transactions on Monday, 14 July 2014, could be agreed by 2 banks to be settled on T+2, ie on 16 July 2014 (2 days from Monday). So the exchange rate that gets applied on the transaction you incurred on Monday, will actually be Wednesday's rate, and that's what hits your credit card statements. And because your bank needs to buy foreign exchange to pay off the bank that supported the purchase, the exchange rate will generally always be against you.

This can be made worse (or in rare cases, better), if the merchant does not immediately (by end of day) post the transaction to the credit card network agency.

What are the charges

The merchant's bank is providing a collection service to the merchant, for which they will earn an income (read, cost to you!). Similarly, your bank is rendering you the service of buying foreign exchange and paying it overseas (ultimately reaching the merchant's bank), and so there's a cost involved for that as well. All of this is usually covered by the foreign transaction fees, for which your bank normally charge between 3% and 4% of the converted value (ie, the INR value).

This is the fee for the transaction, as well as the service of conversion from foreign currency to home currency (INR for us folks). You can see some samples here, here and here, which serve to illustrate the going rate of about 3.5%, though this list is by no means conclusive or complete. In addition, the credit card network agency will normally charge around 1%. So, that's a total of 4.5% already. The problem is, you will never know how much each of the intermediaries charge you, since all of that is driven by algorithm and computed against each transaction. 

Remember, there will always be charges for cash withdrawals at cash machines (ATMs), bordering on the exorbitant, when you make cash withdrawals overseas on credit cards. This cash advance fee can be as high as even 4-5%, and is in addition to the foreign transaction fees, so you should avoid making cash withdrawals overseas, if you can.

Conclusion on credit card charges

To summarise, you should expect about 4.5% on the charges, plus about 1-1.5% on the exchange rate difference, to be added to your original expectation of the INR value of the swipe abroad, based on the spot exchange rate on that date.

A word on Dynamic Currency Conversion

This is the relatively new-fangled thing where, when shopping abroad, establishments ask you if you want to charge the amount in the foreign currency (currency of the country you're swiping your card in), or your home currency (INR). If you selected home currency, you'd be able to see what the purchase would cost, in INR terms, and that gives you a pretty perfect idea of how much you're paying for the purchase, in INR. You'd also be making a big mistake!

Image courtesy: BusinessInsider.com

Dynamic Currency Conversion, or DCC, was introduced to help improve transparency in foreign currency usage of credit cards. Unfortunately, the way the mechanics are designed, the exchange rate at which the currency is converted to home currency, is set by the merchant, and not the bank or the credit card network agency. Because of this, merchants tend to set highly unfavourable (or favourable to them, depending on your POV) exchange rates, and end up making a further margin on the swipe.

Finally, even if you selected "home currency" for the purchase, there's a foreign transaction fee that will continue to be levied by your issuer. You can think of this as a cost of the "privilege" of letting you use an Indian credit card abroad.

So my advice to you would be, if you're offered DCC, do reject it. It is, after all, an offer you can refuse!

Coming back to the original question

Cash, cards or TCs? TCs are ruled out for me. Cash is OK as long as it isn't large amounts. I mean, I don't fancy myself carrying something in the order of US$ 1,000 for a five-day overseas trip. And that's just for the hotel. Plus meals, transport, shopping, duty free purchases, and you get the idea. Put simply, it is unsafe, and the risk of loss is quite high.

So in my case, I do make all almost my spends on credit cards. Admittedly, virtually all India-issued cards carry a foreign currency transaction fee, so there's really no getting away from that. But the what softens the hit is the reward points / miles you earn (hopefully you're using a card that does give you those!), which can minimise the impact of the fees. For instance, the Citi PM card generally earns 4 PMs per Rs 100 of spend, and each PM is valued at Rs 0.50. So for every Rs 100 of spend, you claw back Rs 2, or 2%. That brings the overall charge of 4.5% potentially down to 2.5%. I say "potentially" because you have to actually use those PMs in order to make use of the saving. I think the net 2.5% cost is worth the benefit of not having to constantly worry about where my cash is, and count it eighteen times a day!

I also do carry some cash for petty expenses like transport, a bottle of water or a Coke, but for a 10-day trip, I'd probably take no more than $200 with me.

This last set of views on credit card over cash, is set in my personal context. I don't intend to be prescriptive, so I've given you an example of how I would address the situation. Your own circumstances and compulsions may differ, so as they say in the points and miles game, YMMV !

What are the alternatives

If you still do not want to use a credit card overseas, you could use a prepaid foreign exchange card. Most private banks offer these (Citibank and ING Vysya certainly do, as I've seen), pre-loaded up to your choice of amount, and issued specific to the country you're travelling to. Purchases on these cards will be treated as local purchases, and there are no foreign exchange fees. However, keep in mind that you've got to fill up enough funds up front to cover your future purchases, so you're potentially losing out on interest that you could've otherwise earned (of course, that will matter much only for very high amounts and/or very long travel periods).

The other option would be to pick up a credit card with lower fees. Most credit cards from Canara Bank come at 3% or lower of foreign currency transaction fees. I'm also informed (unverified) that Regalia and Diners Club cards from HDFC Bank charge 2%.

I'm happy to answer any follow-on questions that readers may have. Simply leave a comment below.

Happy spending!