A PROJECT REPORT ON

VOLATILITY IN INDIAN STOCK MARKET

AND FOREIGN INSTITUTIONAL
INVESTOR

SUBMITTED BY
PRANJAL COHPDA

THIRD YEAR BACHELOR OF COMMERCE
(FINANCIAL MARKETS)
SEMESTER-V
2012-13


MODEL COLLEGE, DOMBIVALI
UNIVERSITY OF MUMBAI
OCTOBER-2012










SUBMITTED TO
THE UNIVERSITY OF MUMBAI
IN PRTIAL FULLFILLMENT FOR THE
AWARD OF
THE DEGREE OF BACHELOR OF
COMMERCE
FINANCIAL MARKETS
SEMESTER V


BY
PRANJAL CHOPDA

MODEL COLLEGE, DOMBIVALI
UNIVERSITY OF MUMBAI
OCTOBER 2012










DECLARATION


I, PRANJAL CHOPDA STUDENT OF
BACHELOR OF COMMERCE, FINANCIAL
MARKETS, SEMESTER V OF KERALEEYA
SAMJAM DOMBIVALIS MODEL COLLEGE,
HEREBY DECLARE THAT I HAVE
COMPLETED PROJECT REPORT ON
VOLATILITY IN INDIAN STOCK
MARKET AND FOREIGN
INSTITUTIONAL INVESTOR
FOR THE ACADEMIC YEAR 2012-13.


THE INFORMATION SUBMITTED IS TRUE
AND ORIGINAL TO THE BEST OF MY
KNOWLEDGE.


PRANJAL CHOPDA
BACHELOR OF COMMERCE
FINANCIAL MARKETS






TABLE OF CONTENTS

SR NO. TITLE PAGE NO.
1. CERTIFICATE
2. DECLARATION
3. ACKNOWLEDGEMENT
4. LIST OF ABBREVATIONS


















Chapter 1.

Volatility in Indian Stock
Markets and Foreign
Institutional Investors













CHAPTER 1.
AN INTRODUCTION
Indian financial market has seen an extraordinary volatility in the last few
years. Since year 2002, Indian market has grown from a much volatile
conditions to growth phenomena, from a SENSEX point of 5500 in
December 2003 to 13,787 in December 2006 and crossed the mark of
20,000 in the year 2007. Due to various reasons the stock market has also
experienced drastic decline to even less than 8,000 points in 2008. It is not
because of only the domestic market but also the international investors.
There are many other variables which contribute to the positive growth of the
stock market. FIIs investment is considered to be one of the biggest push
after the economic fundamentals. There is no doubt that the liberalization of
the FII flows into the Indian Capital Market since 1993 has had a
considerable impact on Indian stock market. The present paper is an attempt
to explore the FIIs investment behavior and its relationship with SENSEX
movement.

The Indian financial market has experienced tremendous growth in terms of
primary issues and trades on secondary market. The liberalization policies
initiated in India in the early 1990s brought about radical changes in the
behavior of stock market. Rising globalization, deregulation, and foreign
institutional investments made the Indian stock market more competitive and
efficient. The economic benefit from the developed economies particularly
from capital markets comes out as catalyst. With the rise of equity culture





throughout the world, India which has a long history of stock exchanges, has
witnessed a noticeable shift in the proportion of investors participation in
stock markets. The role of investors is very vital in the success of market
guided economic systems. As part of economic reforms, India opened its
stock market to foreign investors in September 1992 and has received
portfolio investment from foreigners in the form of foreign 2institutional
investment in equities and other markets including derivatives. It has
emerged as one of the most influential groups to play a critical role in the
overall performance of the stock market. The liberalization of FII flows into
the Indian capital market since 1993 has had a significant impact on market
practices. Many of the moves to modernize the equity markets in the past
decade may be attributed to pressure or behavioral changes from foreign
investors such as SEBIs amendment in 2006 about reducing the Validity
Period of Registration Certificate from five years to three years and increase
in the registration and renewal fees. The demat trading system introduced to
increase the confidence of FIIs and others. The demat form of trading could
able to avoid the problems of fake shares and fake transfers etc. The new
industrial policy of the government has initiated many measures to attract
foreign capital. The foreign Exchange Regulation Act has been replaced with
Foreign Exchange Management Act. This resulted in huge movements of





inflow and outflow of capital resources.

Section 2. Movement of Sensex and Volatility in the Stock Market
To recapitulate the events, the general election was held in four phases-the
dates of polls being 20
th
April, 26
th
April, 5
th
May and 10
th
May. The counting
started on 13
th
May and because of use of electronic voting machines, most
results were declared on that day. However, the exit polls conducted by the
media started to give an indication of a non-NDA government from the
second phase of polling. If one looks closely at the behavior of the Sensex
during this period, it shows that the downward movement of the Sensex
started around 23
rd
April, that is between the first and second phase of
polling and kept declining till the middle of May. The behavior of the foreign
portfolio investors matched the behavior of Sensex during this period. Net FII
investment in the Indian capital markets started fluctuating sharply from 23
April and from 30
th
April it turned negative. Net FII investment in the Indian
stock market continued to be negative till the middle of May. During this
period, the Sensex and net FII investment showed very high degree of





correlation. For the period 23rd April to 17th May, the correlation between
daily net FII equity investment and the Sensex was as high as 0.70. Fig u re
1 shows daily movements of Sensex and Net FII investment in India during
the months of April, May and June. A somewhat different trend is observed
from 18th May to the end of that month. The Sensex started a recovery from
18th May and the declining trend of net F II investment also reversed from
that day.

Indian financial market has seen an extraordinary volatility in the last few
years. Since year 2002, Indian market has grown from a much volatile
conditions to growth phenomena, from a SENSEX point of 5500 in
December 2003 to 13,787 in December 2006 and crossed the mark of
20,000 in the year 2007. Due to various reasons the stock market has also
experienced drastic decline to even less than 8,000 points in 2008. It is not
because of only the domestic market but also the international investors.
There are many other variables which contribute to the positive growth of the
stock market. FIIs investment is considered to be one of the biggest push
after the economic fundamentals. There is no doubt that the liberalization of
the FII flows into the Indian Capital Market since 1993 has had a
considerable impact on Indian stock market. The present paper is an attempt
to explore the FIIs investment behavior and its relationship with SENSEX
movement.









ABOUT THE REPORT


Title of the study
The present study is titled as A PROJECT REPORT ON Volatility in
Stock Markets in India and Foreign Institutional Investors. The study
made with special reference to commodity market-Energy segment.

Objectives of Study

To study in depth.
To know the changing scenario of Indian stock market after fii
investment.


Data And Methodology

For the purpose of the present study Secondary data were used. The data
is collected from Books & websites.


Limitations of the Study
The study has got all the limitations of using Secondary data and
Inferences were made based on that.










Chapter Layout

The Present study is arranged as follows.

Chapter 1 An Introduction

Chapter 2 Deals with the Theoretical view of INDIAN STOCK MARKET

Chapter 3 Deals with the IMPACT OF FIIs ON STOCK MARKET
INSTABILITY

Chapter 4 Deals with a.

Chapter 5 Summarizes the result of the Report.













CHAPTER 2.
- A THEORETICAL VIEW.

Diversifying globally i.e., holding a well diversified portfolio of securities
from around the globe in proportion to market capitalizations, irrespective
of investors country of residence, has long been advocated as means to
reduce overall portfolio risk and maximize risk-adjusted returns by the
traditional capital asset pricing model (CAPM). Foreign investment inflow
depends on returns in the stock market, rates of inflation (both home and
foreign), and exante risk. In terms of magnitude, the impact of stock
market returns and the ex-ante risk turned out to be the key determinants
of FII inflows. An investment will always carry the consideration of risk
factor in its risk-return behaviour. In an investment friendly environment
the bullish behaviour dominates the trends and at a given huge volume of
investments, foreign investors may play a role of market makers and book
their profits, i.e., they can buy financial assets when the prices are
declining thereby jacking-up the asset prices and sell when the asset
prices are increasing (Gordon & Gupta, 2003). Hence, there is a
possibility of bi-directional relationship between FII and the equity returns.
Although FII flows help supplement the domestic surplus resources and
augment domestic investments without rising the foreign debt of the
recipient countries, helps to maintain stabilized balance of payments
particularly current account segment. Entry of FII may also leads to
decrease the required rate of return for equity, and improve stock prices
of the host economies / nations. However, there are uncertainties about
the defencelessness of recipient countrys capital markets to such flows.
FII flows, often referred to as 'hot money' (i.e., short-term and overly
tentative), are extremely unstable in character compared to other forms





of capital flows. Foreign portfolio investors are regarded as 'fair weather
friends' who come in when there is money to be made and leave at the
first sign of impending trouble in the host country thereby destabilizing the
domestic economy of the recipient country. Often, they have been blamed
for exacerbating small economic problems in the host nation by making
large and concerted withdrawals at the slightest hint of economic
weakness. It is also alleged that as they make frequent marginal
adjustments to their portfolios on the basis of a change in their
perceptions of a country's solvency rather than variations in underlying
asset value, they tend to spread crisis even to countries with strong
fundamentals thereby causing 'contagion' in international financial
markets.
Several research studies on FII flows to emerging market economies
(EMEs) over the world have found that financial market infrastructure like
market size, market liquidity, trading cost, extent of informational
dissemination etc., legal mechanisms relating property rights,
harmonization of corporate governance, accounting, listing and other
rules with those followed in developed economies etc., are some of the
important determinants of foreign portfolio investments int o emerging
markets. The Securities and Exchange Board of India (SEBI) and
Reserve Bank of India (RBI) have initiated several measures such as
allowing overseas pension funds, mutual funds, investment trusts and
asset management companies, banks, institutional portfolio managers,
universal funds, endowments, easing the norms for registration of FIIs,
reducing procedural delays, lowering the fees of registration, mandating
strict disclosure norms, improved regulatory mechanisms etc. all these
are supported by strong fundamentals, have made India as one of the
attractive destinations for FIIs. The following table highlights the
registered FIIs in India during the period from 2006 to 2010.







From the above table it is clear that there is constant growth in the
number of registered FIIs in India. In the year 2006(January, 2006), the
number of registered FIIs were 833 only. The same number has been
increased to 1697 by the year 2010 (January 2010). The number has
been increased by more than 100 per cent. In spite of the global financial
crisis the number of registered FIIs has shown a significant increase.
Irrespective of the situation in Indian stock markets these FIIs has
earmarked their presence. But the investment made by FIIs has
experienced drastic decline in the recent past. This is mainly because of
the global economic meltdown. Though the number of registered FIIs
increased the net investments were not increased proportionately. The
important reasons for growth in number of registered FIIs are easing of
registration norms, lowering the registration fees, reducing the procedural
delays. The most important is strong economical foundation of Indian
economy. Though the entire globe affected with the global financial
meltdown, India could face the global financial meltdown effectively.
Compared to many other markets Indian markets are offering attractive
returns on the investments. The growth rates of Gross Domestic Product
(GDP) even during the financial crisis was attractive than many other
economies. This resulted in increased number of registered FIIs in the





last half decade. The following table (Table 2) provides a cross section of
data on the FIIs inflow and stock market movement from the year 2000 to
2011(31stMay). The FIIs and hedge funds had pulled out money mainly
due to higher interest rates in U.S. after Federal Reserve increased
7interest rates to 4.5% under their new governor. Similar changes took
place many times in the history since opening and few times in the study.



Additional indicators and data reflect that movements in the
SENSEX during the two years have clearly been driven by the
behaviour of foreign institutional investors (FIIs), who were responsible for
net equity purchases of as much as $6.6 and $8.5 billion respectively in
2003 and 2004. The Pearson correlation values indicate positive





correlation between the foreign institutional investments and the
movement of Sensex. (The value of Pearson correlation is 0.570894)



The above table (Table:3) shows the proportion of investment made
by the FIIs in Sensex scrips. It is observed that almost half of the
companies are equipped with FII investment to the tune of 10% to
20%. Nearly 25% of the companies (Sensex 30 scrips) are having the FII
investment between 30% and 40%. Another important thing is all
the thirty scrips are showing the presence of foreign institutional
investment. The pattern of change is also very minimal in respect of
these companies regard to FIIs are concerned. It can be understood that
the FIIs may enter and exit frequently form the other scrips but
not the Sensex scrips. The above table depicts the consistency of FIIs
over a period of time.


From the above table (Table:3) it can be understood that fifty percent of
the companies which are included in BSE SENSEX are having fifteen
to twenty percent of capital from the overseas. This indicates the level
of influence by the foreign institutional investment on those companies





particularly and on the stock market in general. Any withdrawal of
foreign institutional investment may result in huge volatility in the
market as well as share price movements. Similarly, any increase in
the shareholding pattern by the foreign institutional investors may
result huge rally in the market. The psychology of domestic investors
is also affected by the decisions of foreign institutional investors.
Being an agricultural based economy India has faced large number
of problems while establishing industries. After independence, to
establish core industries such as Iron & Steel, Cement, Electrical and
construction of Roads, buildings etc. it took decades. Indian economy
has experienced the problem of capital in many instances.
Particularly, to start large scale industries where capital requirement
was more . While planning to start the steel companies under
government control, due to shortage of resources it has taken the
aid of foreign countries. Likewise we have received aid from Russia,
Britain and Germany for establishing Bhiloy, Rourkela and Durgapur
steel plants. The foreign institutional investment was increased
during the years 2006 and 2007. Later on, due to global financial
crisis the investments by FIIs were reduced.











ADVANTAGES
OF FII IN INDAIN MARKET

Enhanced flows of equity capital
FIIs have a greater appetite for equity than debt in their asset
structure. The opening up the economy to FIIs has been in line with the
accepted preference for non-debt creating foreign inflows over foreign
debt. Enhanced flow of equity capital helps improve capital structures and
contributes towards building the investment gap.
Managing uncertainty and controlling risks.
FII inflows help in financial innovation and development of hedging
instruments. Also, it not only enhances competition in financial markets,
but also improves the alignment of asset prices to fundamentals.
Improving capital markets.
FIIs as professional bodies of asset managers and financial analysts
enhance competition and efficiency of financial markets.
Equity market development aids economic development.
By increasing the availability of riskier long term capital for projects,
and increasing firms incentives to provide more information about their
operations, FIIs can help in the process of economic development.
Improved corporate governance.
FIIs constitute professional bodies of asset managers and financial
analysts, who, by contributing to better understanding of firms operations,
improve corporate governance. Bad corporate governance makes equity
finance a costly option. Also, institutionalization increases dividend
payouts, and enhances productivity growth.








DISADVANTAGES
OF FII IN INDAIN MARKET
Problems of Inflation: Huge amounts of FII fund inflow into the
country creates a lot of demand for rupee, and the RBI pumps the amount
of Rupee in the market as a result of demand created.
Problems for small investor: The FIIs profit from investing in
emerging financial stock markets. If the cap on FII is high then they can
bring in huge amounts of funds in the countrys stock markets and thus
have great influence on the way the stock markets behaves, going up or
down. The FII buying pushes the stocks up and their selling shows the
stock market the downward path. This creates problems for the small
retail investor, whose fortunes get driven by the actions of the large FIIs.
Adverse impact on Exports: FII flows leading to appreciation of the
currency may lead to the exports industry becoming uncompetitive due to
the appreciation of the rupee.
Hot Money: Hot money refers to funds that are controlled by
investors who actively seek short-term returns. These investors scan the
market for short-term, high interest rate investment opportunities. Hot
money can have economic and financial repercussions on countries and
banks. When money is injected into a country, the exchange rate for the
country gaining the money strengthens, while the exchange rate for the
country losing the money weakens. If money is withdrawn on short notice,
the banking institution will experience a shortage of funds.












CHAPTER 2
Impact of FIIs on
Stock Market Instability
















Impact of FIIs on
Stock Market Instability
Investment of FIIs are motivated not only by the domestic and external
economic conditions but also by short run expectations shaped
primarily by what is known as market sentiment. The element of
speculation and high mobility in FII investment can increase the
volatility of stock return in emerging markets. In fact, a widely held
perception among academicians and practitioners about the emerging
equity markets is that price or return indices in these markets are frequently
subject to extended deviations from fundamental values with subsequent
reversals and that these swings are in large part due to the influence of
highly mobile foreign capital. Volatility is an unattractive feature that has
adverse implications for decisions pertaining to the effective allocation of
resources and therefore investment. Volatility makes investors averse to
holding stock due to increased uncertainty. Investors in turn demand
higher risk premium so as to ensure against increased uncertainty. A greater
risk premium implies higher cost of capital and consequently lowers
physical investment. In addition, great volatility may increase the option to
wait thereby delaying investment. Also weak regulatory system in
emerging market economies (EMEs) reduce the efficiency of market
signals and the processing of information, which further magnifies the
problem of volatility. But some researchers have the opposite
assumption of non-disestablishing hypothesis that says FIIs have no
adverse impact
Trading by FIIs happens on a continuous basis and therefore has a lasting
impact on the local stock market. There is, however, surprisingly little
empirical evidence on the impact of FIIs trading on the host countrys
stock return volatility, thereby making it imperative that this aspect of local
equity markets, which is important for both risk analysis and portfolio
construction, be examined. This chapter attempts to fill the gap. Beside
the introduction, this chapter is classified into two parts.
Part I presents the impact of foreign institutional investors on the
Indian stock market volatility.
Part II shows the structure of the volatility before and after
introduction of the foreign institutional investors in Indian stock market.





The scope of the study is limited to the India which has become an attraction
for FIIs in recent years, in fact the emerging markets of many developing
countries have been attracting large inflows of private capital in recent
years. The surge in capital flows occurred first in Latin America, then
South East Asia and is now clearly visible in South Asia. A significant feature
of these capital flows is the increasing importance of foreign portfolio
investment (FPI), whose buying and selling of stocks on a daily basis
determines the magnitude of such capital flows. A significant
improvement has also taken place in India relating to the flow of
foreign capital during the period of post economic reforms. The major
change in the capital flows particularly in Foreign Institutional Investors
(FIIs) investments has taken place following the changes in trade and
industrial policy. Over the past 15 years or so India has gradually
emerged an important destination of global investors investments in
emerging equity markets. In 2006, India had a share of about 0.55% of
global investment which is quite high in comparison to year 2001 in which
Indias share was only 0.12% . On the other hand some of the developed
countries have shown a downward trend.



The foreign financial inflows, beside other factors, helped the Indian stock
market to rise at a great height according to financial analysts. Sensex





crossed a new high. It crossed 20000- mark in December 2007, which
was 13786.91 in December 2006 and
9397.93 in December 2005. This historical movement is also due to the
other parameters of the economy, which are favorable for the investment.
The returns on investment are also much favorable. The profit
performance of the firms may explain the reasons for
high return on investment. There are other factors such as favorable
tax laws and relaxation on the caps of various kinds of investments.
The policy measures and economic factors are also the reasons for the
investors confidence.














Table 6.2 clearly indicates that both daily return and volatility during
1981-90, period of real sector reforms, were significantly higher than those
found pre-liberalization period (i.e.1961-80). Interestingly, return and volatility
increase further to 0.074 and 1.92 respectively. In era of first generation
reforms financial sector reforms (i.e. 1991-2000).It is appreciable to see
from the table that the second generation reforms have brought in
more cheers for the capital market as the risk (i.e. Standard Deviation of
return) decreased but the stock return went up in the period. Clearly
the volatility has declined in Indian stock market after year 2000.
Table 6.2 further reveals that the stock return has remained around
half (0.06%) after the arrival of FIIs as compared to that obtained (0.15%)
during 1986 to 1992 period. Simultaneously, the standard deviation which
measures the volatility has declined from 2.1598 percent during 1986-
92 to 1.59 percent during 1992-2007. Thus, both volatility and return
have declined after the opening up of domestic stock market for FIIs.
Time period 1994 to 2001 gave a serious set back to stock market
performance.


FII and FDI connection
The relationship between FII and FDI (Foreign Direct Investment) is
intertwined. In 1998 1999 a number of reforms were initiated, that were
designed specifically for attracting FDI. In India FDI is allowed through FIIs.
This is done through private equity, preferential allotment, joint ventures and
capital market operations. The only industries in which FDI isnt allowed are
arms, railways, coal, nuclear and mining. 100% financing by FDI is allowed
in infrastructural projects such as construction of the bridges and the tunnels.
In the financial sector, insurance and banking operations can have foreign
investors.








Differences between FII & FDI
FDI and FIIs are two important sources of foreign financial flows into a
country. FDI (Foreign Direct Investment) the acquisition abroad of physical
assets such as plant and equipment, with operating control residing in the
parent corporation. It is an investment made to acquire a lasting
management interest (usually 10 percent of voting stock) in an enterprise
operating in a country other than that of the investor, the investors purpose
being an effective voice in the management of the enterprise. It
includes equity capital, reinvestment of earnings, other long-term capital,
and short-term capital. Usually countries regulate such investments
through their periodic policies. In India such regulation is usually done
by the Finance Ministry at the Centre through the Foreign Investment
Promotion Board).
Types of Investments
FDI typically brings along with the financial investment, access to modern
technologies and export market. The impact of the FDI in India is far more
than that of FII largely because the former would generally involve setting
up of production base - factories, power plant, telecom networks, etc.
that enables direct generation of employment. There is also multiplier effect
on the back of the FDI because of further domestic investment in related
downstream and upstream projects and a host of other services. Korean
Steel maker Poscos USD 8 billion steel plant in Orissa would be the largest
FDI in India once it commences. Maruti Suzuki has been an exemplary case
in the India's experience. However, the issue is that it puts an impact
on local entrepreneur as he may not be able to always successfully
compete in the face of superior technology and financial power of the
foreign investor. Therefore, it is often regulated that Foreign Direct
Investments should ensure minimum level of local content, have export
commitment from the investor and ensure foreign technology transfer to
India.FII investments into a country are usually not associated with the direct
benefits in terms of creating real investments. However, they provide
large amounts of capital through the markets. The indirect benefits of
the market include alignment of local practices to international
standards in trading, risk management, new instruments and equities
research. These enable markets to become more deep, liquid, feeding in
more information into prices resulting in a better allocation of capital to





globally competitive sectors of the economy. Foreign Institutional
Investors Since, these portfolio flows can technically reverse at any
time, the need for adequate and appropriate economic regulations are
imperative.
Government Preference
FDI is preferred over FII investments since it is considered to be the most
beneficial form of foreign investment for the economy as a whole. Direct
investment targets a specific enterprise, with the aim of enhancing capacity
and productivity or changing its management control. Direct investment to
create or augment capacity ensures that the capital inflow translates
into additional production. In the case of FII investment that flows into
the secondary market, the effect is to increase capital availability in
general, rather than availability of capital to a particular enterprise.
Translating an FII inflow into additional production depends on
production decisions by someone other than the foreign investor
some local investor has to draw upon the additional capital made
available via FII inflows to augment production. In the case of FDI that
flows in for acquiring an existing asset, no addition to production capacity
takes place as a direct result of the FDI inflow. Just like in the case of FII
inflows, in this case too, addition to production capacity does not result from
the action of the foreign investor the domestic seller has to invest the
proceeds of the sale in a manner that augments capacity or
productivity for the foreign capital inflow to boost domestic production.
There is a widespread notion that FII inflows are hot money that it
comes and goes, creating volatility in the stock market and exchange
rates. While this might be true of individual funds, cumulatively, FII
inflows have only provided net inflows of capital
Stability
FDI tends to be much more stable than FII inflows. Moreover, FDI brings not
just capital but also better management and governance practices and,
often, technology transfer. The know-how thus transferred along with FDI
is often more crucial than the capital per se. No such benefit accrues
in the case of FII inflows, although the search by FIIs for credible investment
options has tended to improve accounting and governance practices
among listed Indian companies.





Types of FIIs
FII investments in India can be of the two types:
1. Normal FIIs: FII allocation of its total investment between equity and
non-equity instruments (including dated government securities and
treasury bills in the Indian capital market) should not exceed the ratio of
70:30. Equity related instruments would include fully convertible
debentures, convertible portion of partially convertible debentures and
tradable warrants.
2. 100% Debt FIIs: FII that can invest the entire corpus in dated
government securities including treasury bills, non-convertible
debentures/bonds issued by an Indian company subject to limits, if
any. A FII needs to submit a clear statement that it wishes to be
registered as FII/sub-account under 100% debt route.
Entities which can register as FIIs:
Entities who propose to invest their proprietary funds or on behalf of
"broad based" funds (fund having more than twenty investors with no
single investor holding more than 10 per cent of the shares or units of the
fund) or of foreign corporate and individuals and belong to any of the under
given categories can be registered for FII.
Pension Funds
Mutual Fund
Investment Trust
Insurance or reinsurance companies
Endowment Funds
University Funds
Foundations or Charitable Trusts
Charitable Societies who propose to in
on their own behalf, and
Asset Management Companies





Nominee Companies
Institutional Portfolio Managers
Trustees
Power of Attorney Holders
Banks
Foreign Government Agency
Foreign Central Bank
International or Multilateral Organization or an Agency there of


Trends in FIIs
In 1993, when investments in FII s were introduced, Pictet Umbrella
Trust Emerging Markets Fund, an institutional investor from
Switzerland, Indian market. While in 1994, no new registrations were
reported, between 1995 and 2003, an average of 51 new FIIs began
operations in the country each year. The graph below clearly indicates the
steep increase in number of FII to the number of registered FIIs at the end
of each calendar year). Currently, there are 1,695 registered FIIs and 5,264
registered sub accounts (As on 11th September, 2009).

Since 1993 when FIIs were first allowed to enter the India, there has
always been a preference towards investing in equity than debt. The
following graph shows the debt and equity FII flows from











FII investments through QIPs
QIPs are private placements or issuances of certain specified
securities by Indian listed companies to qualified institutional buyers in
accordance with the provisions of SEBI guidelines. Qualified Institutional
placements or QIPs were introduced in mid-2006.
Indian companies that are listed on stock exchanges having nationwide
terminals the BSE and NSE have been raising capital through the QIP
route. Quarterly Institutional buyers are preferred primarily because these





entities have a large risk appetite, possess the general expertise and
have the experience to make an informed decision.
In August 2008, SEBI liberalized the pricing conditions for QIPs by reducing
the period of reckoning to an average of two weeks stock price, prior
to the relevant date, against the earlier requirement of taking the higher of
the previous six months or 15 days average price. The pre-existing
slowdown in the markets led to attractive valuations for the investors.
Companies have taken advantage of this revision in pricing guidelines
.Unitech, raised Rs 1,621 cores in April 2009 at Rs 38.50 per share,
and again raised Rs. 2,760 crores in July 2009 at Rs 81 per share.
Other companies which successfully raised capital through QIPs were HDIL,
Shobha Developers, Network 18, Dewan Housing and Bajaj Hindustan. Most
of the companies which came out with QIPs were in the real-
estate/infrastructure sector. However, some companies like GMR
Infrastructure were not so successful and had to withdraw their issue
and GVK Power and Infrastructure had to scale down by nearly 60%
due to problems in the valuations. Domestic institutional investors,
especially life insurers kept away from the QIPs on valuation concerns.
However, FIIs which were net sellers had purchased Rs 9,500 crores in
the same period.
This led several FIIs to pick up the target stocks via QIP before the
July 6thBudget and offload the same after the budget session. As per
a CRISIL study, 10 out of 13 QIPs are currently quoting below the
offer price. Since most of QIPs were in the reality and infrastructure
sectors, one explanation is that FIIs came in expecting some quick gains
from significant sops to the infrastructure and housing sectors in the Budget.
It is also possible that the rush for QIPs was driven largely by short-term
considerations, where the FIIs hedged their bets by taking short positions
in the issuers stock even as they bought into the offers.

New sources of FII funds
The Securities and Exchange Board of India is in talks with the
Cayman Islands Monetary Authority (Cima), over allowing funds based
in the Caribbean into the country. Cayman Islands is one of the worlds
largest tax havens and a lot of global hedge funds are based out of Cayman





Islands Sebi has received numerous applications from Cayman-based funds
since June when Cima was admitted as a full member of the international
body of securities market regulators, the International Organization of
Securities Commissions (Iosco).
Iosco's constituents regulate more than ninety percent of the world's
securities markets. Funds from Cayman Islands were usually not favoured
by SEBI owning to lack of transparency and difficulty in establishing the
owner base. Consequently, these investments were viewed unfavorably
and any Cayman fund seeking to invest in India had to be carefully
examined.
Post Caymans admission to Iosco, Sebi is now determining which
grades of investment funds can be admitted expeditiously and which should
be examined more carefully. Presently, there are 19 registered foreign
institutional investors from Cayman Islands, taking the total to 19. The two
recent additions have been Fir Tree Capital Opportunity Master Fund and Fir
Tree Value Master Fund. The fund base of Cayman Islands is huge. There
are about 9870 funds based there. Indian markets can expect more inflow
from Cayman Island if SEBI agrees to let them come in.

Recommendations
-Sec Bond Markets:
Currently, the cap on FII investments in the bond market is USD 6 Billion. As
per the new budget, proposes to borrow Rs.4.5 lakh crore in 2009-10
to support its infrastructure and other developmental projects. This could
be opened up to the FIIs so that they can take part in Indias hitherto almost
closed debt market. The Indian debt markets are not fully developed and see
low volumes. The lifting of the cap on FIIs will increase the traded
volumes and it will also help in preventing the crowding out of investment
for private enterprises.

The suggestion by SEBI to permit dollar settlements for FIIs would
revolutionize the way in which they invest in the country. This will help
mitigate risks of currency fluctuations for FIIs, and help in improve the
volume and liquidity of the derivatives market. With dollar settlements,





many participants, who want to take exposure to Indian markets
through index buying, will be able to participate freely. This, in turn,
will give stability to Indian markets as there will be buying of underlying
stocks by the sellers of these contracts to FIIs.
At present, settlements in India are done in rupee denominations. As a
result, a number of FIIs, who intend to trade in Nifty futures, take the
Singapore route where CNX Nifty index futures are traded on SGX.
About 50 per cent of the total open interest (OI) build-up in Nifty futures
takes place on the SGX, which allows settlements in US dollar. This enables
different types of FIIs to operate there. Also, low transaction costs due to the
absence of securities transaction tax, stamp duty and P-note complications
have resulted in a gradual shift of FIIs into offshore markets.
Settlements in dollar would also help in reducing the volatility in
dollar-rupee conversion value caused due to FII flows. Each time a
settlement is done, a seller of futures contracts to an FII would buy an
equivalent amount of underlying stocks to hedge his/her exposure due to the
sale. This would increase the trading volume and liquidity of Indian markets,
once dollar settlement is allowed.
-notes etc.
To prevent the misuse of the participatory notes, there should be
stricter implementation of the regulations. Tough implementation of KYC
norms should be done. In the long run, the group is of the opinion
that registration procedures for FIIs should be made simpler after which
P-Notes should be done away with.

LIMITATIONS OF THE STUDY
As the time available is limited and the subject is very vast the study is
mainly focused on identifying whether there does exist a relationship
between FIIs and Indian Equity Stock Market.
The study is general.
It is mainly based on the data available in various websites;
The inferences made is purely from the past years performance;





There is no particular format for the study;
Sufficient time is not available to conduct an in-depth study





Conclusion
It is clear that the FIIs are influencing the Sensex movement to a greater
extent. Further it is evident that the Sensex has increased when there are
positive inflows of FIIs and there were decrease in Sensex when there
were negative FII inflows. It has been perceived in some quarters that
FII flows are major drivers of stock markets in India and hence a
sudden reversal of flows may harm the stability of its markets. The nature of
relationship between FII flows and Indian stock market returns can be
explained in terms of cumulative informational disadvantage of foreign
portfolio investors vis-a-vis domestic investors. The theory says that
domestic investors posses better knowledge about Indian financial
markets than foreign investors and this information asymmetry leads to
positive feedback trading by the foreign portfolio investors. There is no
doubt FIIs are influencing the movement of Sensex to a greater extent.













Why Do Companies Invest Overseas?
Compani es choose t o i nvest i n f or ei gn mar ket s f or a number
of r easons, of t en
t hes a me r e a s o n s f o r e x p a n d i n g t h e i r o p e r a t i o n s wi t h i n
t h e i r h o me c o u n t r y . Th e economist John Dunning has
identified four primary reasons for corporate foreigninvestments:
Market seeking -
Firms may go overseas to find new buyers for goods and services.Market-
seeking may happen when producers have saturated sales in their
homemarket, or when they believe investments overseas will bring higher
returns thanadditional investments at home. This is often the case with high
technology goods.
Resource seeking -
Put simply, a company may find it cheaper to produce its productin a foreign
subsidiary- for the purpose of selling it either at home or in foreignmarkets.
The foreign facility may be able to obtain superior or less costly access to
theinputs of production (land, labor, capital and natural resources) than at
home.
Strategic asset seeking -
Firms may seek to invest in other companies abroad to help bui l d
st r at egi c asset s, such as di st r i but i on net wor ks or new
t echnol ogy. Thi s
mayi nvol ve t he est abl i shment of par t ner shi ps
wi t h ot her exi st i ng f or ei gn f i r ms t hat specialize in certain aspects of
production.
Efficiency seeking -
Mul t i nat i onal compani es may
al so seek t o r eor gani ze t hei r overseas holdings in response
to broader economic changes. Fluctuations in exchangerates may
also change the profit calculations of a firm, leading the firm to shift
theallocation of its resources.
Introduction
Many developing countries, including India, restricted the flow of foreign
capital till the early 1990s and depended on external aid and official
development assistance. Later, most of the developing countries opened up
their economies by dismantling capital controls with a view to attracting
foreign capital, supplementing it with domestic capital to stimulate domestic
growth and output.






Since then, portfolio flows from foreign institutional investors (FII) have
emerged as a major source of capital for emerging market economies
(EMEs) such as Brazil, Russia, India, China and South Africa. Besides, the
surge in foreign portfolio flows since 1990s can be attributed to greater
integration among international financial markets, advancement in
information technology and growing interest in EMEs among FIIs such as
private equity funds and hedge funds so as to achieve international
diversification and reduce the risk in their portfolios.
Economic growth is a function of, among other things, capital formation. As
FII flows are a source of non-debt creating capital for the economy, many
EMEs have been competing with each other to attract such flows through
flexible investment norms/regulations or by offering fiscal sops. Further, FIIs
have been assured decent returns on their investments, enabling continuous
and sustainable investment flows.
FII flows into India registered substantial growth from a meagre US$4 million
in 199293 to over US$ 32 billion in 201011 (SEBI, 2011: 76). FII inflows
underwent a sea-saw movement in India during the last decade. They
registered spectacular growth especially since the middle of 2003 due to the
higher growth rate in Indian GDP, robust corporate performance and an
investment-friendly environment. Portfolio investment flows into India turned
negative (outflow of US$ 12 billion) during 200809 (ibid.) mainly due to the
heightened risk aversion of foreign investors, emanating from the global
financial meltdown.
Ever since foreign portfolio investors were allowed to invest in Indian
financial markets in September 1992, there have been extensive
deliberations on the impact of such flows. It is said that portfolio flows from
FIIs inject global liquidity into the capital markets, raise the price-to-earnings
ratios, thereby reducing the cost of capital. This, in turn, leads to further
issues of equity capital and stimulates investment growth in the host
economy, apart from bringing in best international corporate governance
practices. Yet, FIIs have been targets of criticism due to characteristics such
as return chasing behaviour, herd mentality, hot money flows, short-term
speculative gains and their influence on domestic policy-making.
Though numerous research studies have been conducted in respect of FII
flows into India, most of them have been confined to assessing the impact of
such flows on stock markets. Very few studies have focused on the overall





impact of FII flows on all segments of the Indian financial markets, viz., the
capital market, the foreign exchange market, the money market and other
macro-economic variables, such as inflation, money supply and Index of
Industrial Production (IIP). Given this background, it is all the more relevant
to undertake a causeand-effect study of FII flows into Indian financial
markets in a holistic manner, by considering various macro-economic
parameters, such as IIP, interest rates, inflation, exchange rates, apart from
the BSE Sensex, so as to enable policymakers to take informed decisions in
this regard. The present study examines the causes and effects of FII net
flows into Indian financial markets with the support of empirical data for the
period April 2003March 2011, i.e., a time span of eight years, covering the
period before, during and after the eruption of the global financial crisis.