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Term Paper on FII & FDI

Term Paper on FII & FDI

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A TERM PAPER ON FDI AND FII IN INDIA

SUBMITTED TO: DR. SAMPADA KAPSE SUBMITTED BY:
LEENA KANJANI (08080) SULABH MAHETA (08084) ANITA PARYANI (08096) AMIN PATTANI (08100) MEHUL RAKHOLIYA (08101) KRISHNA VYAS (08118)

INTRODUCTION

Foreign investment refers to investments made by the residents of a country in the financial assets and production processes of another country. The effect of foreign investment, however, varies from country to country. It can affect the factor productivity of the recipient country and can also affect the balance of payments. Foreign investment provides a channel through which countries can gain access to foreign capital. It can come in two forms: FDI and foreign institutional investment (FII). Foreign direct investment involves in direct production activities and is also of a medium- to long-term nature. But foreign institutional investment is a short-term investment, mostly in the financial markets. FII, given its short-term nature, can have bidirectional causation with the returns of other domestic financial markets such as money markets, stock markets, and foreign exchange markets. Hence, understanding the determinants of FII is very important for any emerging economy as FII exerts a larger impact on the domestic financial markets in the short run and a real impact in the long run. India, being a capital scarce country, has taken many measures to attract foreign investment since the beginning of reforms in 1991. India is the second largest country in the world, with a population of over 1 billion people. As a developing country, India’s economy is characterized by wage rates that are significantly lower than those in most developed countries. These two traits combine to make India a natural destination for FDI and foreign institutional investment (FII). Until recently, however, India has attracted only a small share of global FDI and FII primarily due to government restrictions on foreign involvement in the economy. But beginning in 1991 and accelerating rapidly since 2000, India has liberalized its investment regulations and actively encouraged new foreign investment, a sharp reversal from decades of discouraging economic integration with the global economy. The world is increasingly becoming interdependent. Goods and services followed by the financial transaction are moving across the borders. In fact, the world has become a borderless world. With the globalization of the various markets, international financial flows have so far been in excess for the goods and services among the trading countries of the world. Of the different types of financial inflows, the FDI and foreign institutional investment (FII)) has played an important role in the process of development of many economies. Further many developing countries consider FDI and FII as an important element in their development strategy among the various forms of foreign assistance.

The FDI and FII flows are usually preferred over the other form of external finance, because they are not debt creating, nonvolatile in nature and their returns depend upon the projects financed by the investor. The FDI and FII would also facilitate international trade and transfer of knowledge, skills and technology. The FDI and FII is the process by which the resident of one country (the source country) acquire the ownership of assets for the purpose of controlling the production, distribution and other productive activities of a firm in another country(the host country). According to the international monetary fund (IMF), FDI and FII is defined as “an investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of investor”. The government of India (GOI) has also recognized the key role of the FDI and FII in its process of economic development, not only as an addition to its own domestic capital but also as an important source of technology and other global trade practices. In order to attract the required amount of FDI and FII it has bought about a number of changes in its economic policies and has put in its practice a liberal and more transparent FDI and FII policy with a view to attract more FDI and FII inflows into its economy. These changes have heralded the liberalization era of the FDI and FII policy regime into India and have brought about a structural breakthrough in the volume of FDI and FII inflows in the economy. In this context, this report is going to analyze the trends and patterns of FDI and FII flows into India during the post liberalization period that is 2006 to 2009 year.

OBJECTIVES
➢ Examines the trends and patterns in the FDI across different sectors and from

different countries in India during 2000 to 2009.

➢ Influence of FII on movement of Indian stock exchange during period that is

September 2006 to September 2009. ➢ To understand the FII & FDI policy in India.

METHODOLOGY
In order to accomplish this project successfully we will take following steps.

Data collection:

Secondary Data: Internet, newspapers, journals and books, other reports and projects, literatures FDI: The study is limited to a sample of top 10 investing countries e.g. Mauritius, Singapore, USA etc. and top 10 sectors e.g. service sector, computer hardware and software, telecommunications etc. which had attracted larger inflow of FDI from different countries. FII:

Correlation: We have used the Correlation tool to determine whether two ranges of data move together — that is, how the Sensex, Bankex, IT, Power and Capital Goods are related to the FII which may be positive relation, negative relation or no relation. We will use this model for understanding the relationship between FII and stock indices returns. FII is taken as independent variable. Stock indices are taken as dependent variable

Hypothesis Test: If the hypothesis holds good then we can infer that FIIs have significant impact on the Indian capital market. This will help the investors to decide on their investments in stocks and shares. If the hypothesis is rejected, or in other words if the null hypothesis is accepted, then FIIs will have no significant impact on the Indian bourses.

FDI
In this section we are going to discuss or describe the main business of the report i.e. analysis of secondary data. It includes data in an organized form, discussion on its significance and analyzing the results. For this we had divided this section in further two subsections i.e. the first subsection fulfill the requirement of first objective which is pertaining to FDI. The

objective for FDI is to examine the trends and patterns in the FDI across different sectors and from different countries in India during 2000 to 2009. Objective 1: Examine the trends and patterns in the FDI across different sectors and from different countries in India during 2000 to 2009.

I. About foreign direct investment.
Is the process whereby residents of one country (the source country) acquire ownership of assets for the purpose of controlling the production, distribution, and other activities of a firm in another country (the host country). The international monetary fund’s balance of payment manual defines FDI as an investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor. The investors’ purpose being to have an effective voice in the management of the enterprise’. The united nations 1999 world investment report defines FDI as ‘an investment involving a long term relationship and reflecting a lasting interest and control of a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor ( FDI enterprise, affiliate enterprise or foreign affiliate).

II. Foreign direct investment: Indian scenario
FDI is permitted as under the following forms of investments – · Through financial collaborations. · Through joint ventures and technical collaborations. · Through capital markets via Euro issues. · Through private placements or preferential allotments.

Forbidden Territories: • • • • Arms and ammunition Atomic Energy Coal and lignite Rail Transport

Mining of metals like iron, manganese, chrome, gypsum, sulfur, gold, diamonds, copper, zinc.

Foreign Investment through GDRs (Euro Issues) – Indian companies are allowed to raise equity capital in the international market through the issue of Global Depository Receipt (GDRs). GDR investments are treated as FDI and are designated in dollars and are not subject to any ceilings on investment. An applicant company seeking Government's approval in this regard should have consistent track record for good performance (financial or otherwise) for a minimum period of 3 years. This condition would be relaxed for infrastructure projects such as power generation, telecommunication, petroleum exploration and refining, ports, airports and roads. 1. Clearance from FIPB – There is no restriction on the number of Euro-issue to be floated by a company or a group of companies in the financial year. A company engaged in the manufacture of items covered under Annex-III of the New Industrial Policy whose direct foreign investment after a proposed Euro issue is likely to exceed 51% or which is implementing a project not contained in Annex-III, would need to obtain prior FIPB clearance before seeking final approval from Ministry of Finance. 2. Use of GDRs – The proceeds of the GDRs can be used for financing capital goods imports, capital expenditure including domestic purchase/installation of plant, equipment and building and investment in software development, prepayment or scheduled repayment of earlier external borrowings, and equity investment in JV/WOSs in India.

I. Foreign direct investments in India are approved through two routes –
1. Automatic approval by RBI – The Reserve Bank of India accords automatic approval within a period of two weeks (subject to compliance of norms) to all proposals and permits foreign equity up to 24%; 50%; 51%; 74% and 100% is allowed depending on the category of industries and the sectoral caps applicable. The lists are comprehensive and cover most industries of interest to foreign

companies. Investments in high priority industries or for trading companies primarily engaged in exporting are given almost automatic approval by the RBI. 2. The FIPB Route – Processing of non-automatic approval cases – FIPB stands for Foreign Investment Promotion Board which approves all other cases where the parameters of automatic approval are not met. Normal processing time is 4 to 6 weeks. Its approach is liberal for all sectors and all types of proposals, and rejections are few. It is not necessary for foreign investors to have a local partner, even when the foreign investor wishes to hold less than the entire equity of the company. The portion of the equity not proposed to be held by the foreign investor can be offered to the public.

iii.
S.No. 1. 2. 3. 4.

Analysis of sector specific policy for FDI
Sector/Activity Hotel & Tourism NBFC Insurance Telecommunication cellular, value added services 49% FDI cap/Equity 100% 49% 26% Entry/Route Automatic Automatic Automatic Automatic

ISPs paging

with

gateways,

radio74% 100%

Above

49%

need

Govt. licence

Electronic Mail & Voice Mail 5. Trading companies primarily export activities bulk imports, cash and carry wholesale trading 6. Power(other than atomic reactor power plants) 7. 8. Drugs & Pharmaceuticals

51%

Automatic

100%

Automatic

100% 100%

Automatic Automatic Automatic

Roads, Highways, Ports and 100% Harbors and 100% 100% 100%

9.

Pollution Management Call Centers BPO

Control

Automatic

10 11. 12.

Automatic Automatic

For NRI's and OCB's i. 34 High Priority Industry Groups ii. Export Trading 100% Automatic

Companies iii. Hotels Projects iv. Hospitals, Diagnostic Centers v. Shipping and

Tourism-related

vi. Deep Sea Fishing vii. Oil Exploration viii.Power ix. Housing and Real Estate Development x. Highways, Bridges and Ports xi. Sick Units xii. Industries Requiring Compulsory Licensing xiii.Industries Reserved Small Sector 13. Airports Greenfield projects Existing projects 14 15. 16. 17. Assets reconstruction company Cigars and cigarettes Courier services Investing infrastructure telecom sector) companies (other 100% 100% 49% 100% 100% in 49% than Automatic Beyond 74% FIPB FIPB FIPB FIPB FIPB for Scale Industrial

iii.

Analysis of FDI inflow in India
From April 2000 to August 2009 (Amount US$ in Millions)

S.No

Financial Year

Total FDI Inflows

%

Growth

Over

Previous Year 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10( Up to August 2009) 4,029 6,130 5,035 4,322 6,051 8,961 22,826 34,362 35,168 16,232 ---(+) 52 (-) 18 (-) 14 (+) 40 (+) 48 (+) 146 (+) 51 (+) 02 ----

iv.

Analysis of share of top ten investing countries FDI equity in flows
From April 2000 to August 2009 (Amount in Millions)

S.No

Country

Amount Of FDI Inflows

%

As

To FDI

Total

Inflow 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Mauritius Singapore U.S.A. U.K. Netherlands Japan Cyprus Germany France U.A.E. 19,18,633.61 3,80,142.56 3,32,935.60 2,40,974.98 1,78,047.76 1,50,129.05 1,32,448.04 1,12,242.06 61,686.39 50,915.59 44.01 8.72 7.64 5.53 4.08 3.44 3.04 2.57 1.42 1.17

Mauritius
Mauritius invested Rs.19,18,633 million in India Up to the August 2009, equal to 44.01 percent of total FDI inflows. Many companies based outside of India utilize Mauritian holding companies to take advantage of the India- Mauritius Double Taxation Avoidance Agreement (DTAA). The DTAA allows foreign firms to bypass Indian capital gains taxes, and may allow some India-based firms to avoid paying certain taxes through a process known as “round tripping.” The extent of round tripping by Indian companies through Mauritius is unknown. However, the Indian government is concerned enough about this problem to have asked the government of Mauritius to set up a joint monitoring mechanism to study these investment flows. The potential loss of tax revenue is of particular concern to the Indian government. These are the sectors which attracting more FDI from Mauritius Electrical equipment Gypsum and cement products Telecommunications Services sector that includes both non- financial and financial Fuels.

Singapore
Singapore continues to be the single largest investor in India amongst the Singapore with FDI inflows into Rs. 3,80,142 crores up to August 2009.

Sector-wise distribution of FDI inflows received from Singapore the highest inflows have been in the services sector (financial and non financial), which accounts for about 30% of FDI inflows from Singapore. Petroleum and natural gas occupies the second place followed by computer software and hardware, mining and construction.

U.S.A.
The United States is the third largest source of FDI in India (7.64 % of the total), valued at 732335 crore in cumulative inflows up to August 2009. According to the Indian government, the top sectors attracting FDI from the United States to India are fuel, telecommunications, electrical equipment, food processing, and services. According to the available M&A data, the two top sectors attracting FDI inflows from the United States are computer systems design and programming and manufacturing

U.K.
The United Kingdom is the fourth largest source of FDI in India (5.53 % of the total), valued at 2,40,974 crores in cumulative inflows up to August 2009. Over 17 UK companies under the aegis of the Nuclear Industry Association of UK have tied up with Ficci to identify joint venture and FDI possibilities in the civil nuclear energy sector. UK companies and policy makers the focus sectors for joint ventures, partnerships, and trade are non-conventional energy, IT, precision engineering, medical equipment, infrastructure equipment, and creative industries.

Netherlands
FDI from Netherlands to India has increased at a very fast pace over the last few years. Netherlands ranks fifth among all the countries that make investments in India. The total flow of FDI from Netherlands to India came to Rs. 1, 78,047 crores between 1991 and 2002. The total percentage of FDI from Netherlands to India stood at 4.08% out of the total foreign direct investment in the country up to August 2009.

Following Various industries attracting FDI from Netherlands to India are: • • Food processing industries Telecommunications that includes services of cellular mobile, basic telephone, and radio paging

• • •

Horticulture Electrical equipment that includes computer software and electronics Service sector that includes non- financial and financial services

iii.

Analysis of sectors attracting highest FDI equity inflows
From April 2000 to August 2009 (Amount in Millions)

S.No

Country

Amount Inflows

Of

FDI %

As

To FDI

Total

Inflow 1. Service Sector (Financial & Non Financial) 2. 3. 4. 5. 6. 7. 8. 9. 10. Computer Software & Hardware Telecommunication Housing & Real Estate Construction Activities Automobile Industry Power Metallurgical Industries Petroleum & Natural Gas Chemical 4,13,419.03 3,68,899.62 3,25,021.36 2,65,492.96 1,90,172.22 1,79,849.92 1,25,785.57 1,11,957.00 1,01,680.18 9.48 8.46 7.46 6.09 4.36 4.13 2.89 2.57 2.33 9,65,210.77 22.14

The sectors receiving the largest shares of total FDI inflows up to August 2009 were the service sector and computer software and hardware sector, each accounting for 122.14 and 9.48 percent respectively. These were followed by the telecommunications, real estate, construction and automobile sectors. The top sectors attracting FDI into India via M&A activity were manufacturing; information; and professional, scientific, and technical services. These sectors correspond closely with the sectors identified by the Indian government as attracting the largest shares of FDI inflows overall. The ASSOCHAM has revealed that FDI in Chemicals sector (other than fertilizers) registered maximum growth of 227 per cent during April 2008 – March 2009 as compared to 11.71 per cent during the last fiscal. The sector attracted USD 749 million FDI in FY ‘09 as compared to USD 229 million in FY ’08, During the year 2009 government had raised the FDI limit in telecom sector from 49 per cent to 74 per, which has contributed to the robust growth of FDI. The telecom sector registered a growth of 103 per cent during fiscal 2008-09 as compared to previous fiscal. The sector attracted USD 2558 million FDI in FY ‘09 as compared to the USD 1261 million in FY ’08, acquired 9.37 per cent share in total FDI inflow.

India automobile sector has been able to record 70 per cent growth in foreign investment. The FDI inflow in automobile sector has increased from USD 675 million to 1,152 million in FY ’09 over FY ’08. The other sectors which registered growth in highest FDI inflow during April – March 2009 were housing & real estate (28.55 per cent), computer software & hardware (18.94 per cent), construction activities including road & highways (16.35 per cent) and power (1.86 per cent).

FII
Objective 2: Influence of FII on movement of Indian stock exchange during the post liberalization period that is September 2006 to September 2009. I. Introduction to FII

Since 1990-91, the Government of India embarked on liberalization and economic reforms with a view of bringing about rapid and substantial economic growth and move towards globalization of the economy. As a part of the reforms process, the Government under its New Industrial Policy revamped its foreign investment policy recognizing the growing importance of foreign direct investment as an instrument of technology transfer, augmentation of foreign exchange reserves and globalization of the Indian economy. Simultaneously, the Government, for the first time, permitted portfolio investments from abroad by foreign institutional investors in the Indian capital market. The entry of FIIs seems to be a follow up of the recommendation of the Narsimhan Committee Report on Financial System. While recommending their entry, the Committee, however did not elaborate on the objectives of the suggested policy. The committee only suggested that the capital market should be gradually opened up to foreign portfolio investments. From September 14, 1992 with suitable restrictions, FIIs were permitted to invest in all the securities traded on the primary and secondary markets, including shares, debentures and warrants issued by companies which were listed or were to be listed on the Stock Exchanges in India. While presenting the Budget for 1992-93, the then Finance Minister Dr. Manmohan Singh had announced a proposal to allow reputed foreign investors, such as Pension Funds etc., to invest in Indian capital market.

II. Market design in India for foreign institutional investors
Foreign Institutional Investors means an institution established or incorporated outside India which proposes to make investment in India in securities. A Working Group for Streamlining of the Procedures relating to FIIs, constituted in April, 2003, inter alia, recommended streamlining of SEBI registration procedure, and suggested that dual approval process of SEBI and RBI be changed to a single approval process of SEBI. This recommendation was implemented in December 2003. Currently, entities eligible to invest under the FII route are as follows:
i)

As FII: Overseas pension funds, mutual funds, investment trust, asset management company, nominee company, bank, institutional portfolio manager, university funds, endowments, foundations, charitable trusts, charitable societies, a trustee or power of attorney holder incorporated or established outside India proposing to

make proprietary investments or with no single investor holding more than 10 per cent of the shares or units of the fund.
ii)

As Sub-accounts: The sub account is generally the underlying fund on whose behalf the FII invests. The following entities are eligible to be registered as subaccounts, viz. partnership firms, private company, public company, pension fund, investment trust, and individuals.

FIIs registered with SEBI fall under the following categories: a) Regular FIIs- those who are required to invest not less than 70 % of their investment in equity-related instruments and 30 % in non-equity instruments. b) 100 % debt-fund FIIs- those who are permitted to invest only in debt instruments. The Government guidelines for FII of 1992 allowed, inter-alia, entities such as asset management companies, nominee companies and incorporated/institutional portfolio managers or their power of attorney holders (providing discretionary and non-discretionary portfolio management services) to be registered as FIIs. While the guidelines did not have a specific provision regarding clients, in the application form the details of clients on whose behalf investments were being made were sought. While granting registration to the FII, permission was also granted for making investments in the names of such clients. Asset management companies/portfolio managers are basically in the business of managing funds and investing them on behalf of their funds/clients. Hence, the intention of the guidelines was to allow these categories of investors to invest funds in India on behalf of their 'clients'. These 'clients' later came to be known as sub-accounts. The broad strategy consisted of having a wide variety of clients, including individuals, intermediated through institutional investors, who would be registered as FIIs in India. FIIs are eligible to purchase shares and convertible debentures issued by Indian companies under the Portfolio Investment Scheme.

iii.

Prohibitions on Investments:

FIIs are not permitted to invest in equity issued by an Asset Reconstruction Company. They are also not allowed to invest in any company which is engaged or proposes to engage in the following activities:

1) Business of chit fund 2) Nidhi Company 3) Agricultural or plantation activities 4) Real estate business or construction of farm houses (real estate business does not include development of townships, construction of residential/commercial premises, roads or bridges). 5) Trading in Transferable Development Rights (TDRs).

iv.

Trends of Foreign Institutional Investments in India.

Portfolio investments in India include investments in American Depository Receipts (ADRs)/ Global Depository Receipts (GDRs), Foreign Institutional Investments and investments in offshore funds. Before 1992, only Non-Resident Indians (NRIs) and Overseas Corporate Bodies were allowed to undertake portfolio investments in India. Thereafter, the Indian stock markets were opened up for direct participation by FIIs. They were allowed to invest in all the securities traded on the primary and the secondary market including the equity and other securities/instruments of companies listed/to be listed on stock exchanges in India. It can be observed from the table below that India is one of the preferred investment destinations for FIIs over the years. As of March 2009, there were 1609 FIIs registered with SEBI.

SEBI Registered FIIs in India Year 1992-93 1993-94 1994-95 1995-96 1996-97 End of March 0 3 156 353 439

1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

496 450 506 527 490 502 540 685 882 996 1279 1609

v.
Year

FII trend in India
Gross Purchases Gross Sales (b) (a) (Rs.crore) (Rs.crore) Net Investment % increase (a-b) (Rs.crore)

1992-93

17

4

3

-

1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

5593 7631 9694 15554 18695 16115 56856 74051 49920 47061 144858 16953 346978 520508 896686 548876

466 2835 2752 6979 12737 17699 46734 64116 41165 44373 99094 171072 305512 489667 844504 594608

5127 4796 6942 8575 5958 1584 10122 9935 8755 2688 45764 45881 41466 30841 52182 -45732

39338.46 -6.45 44.75 23.52 -30.52 126.59 739.02 -1.85 -11.88 69.30 1602.53 0.26 -9.62 -25.62 69.20 187.64

There may be many other factors on which a stock index may depend i.e. Government policies, budgets, bullion market, inflation, economic and political condition of the country, FDI, Re./Dollar exchange rate etc. But for my study I have selected only one independent variable i.e. FII and dependent variable is indices of nifty.

vi.

Co – relation with Indices
Indices Sensex Bankex Power IT Capital Goods Co-relation with FII 0.80 0.18 0.33 0.13 0.44

From the above table we can say that FII has a positive impact on all the indices which means that if FIIs come in India then it is goods for the Indian economy. FIIs have more co-relation with Sensex so we can say that they are mostly invest in big and reputed companies which are included in Sensex. Power and Capital Goods sector have more co-relation with FII investment which shows more interest of FIIs in those sectors.

vii.

Hypothesis Test
VAR00003 VAR00003 Pearson Correlation Sig. (2-tailed) N VAR00004 Pearson Correlation Sig. (2-tailed) N 35 .801** .000 35 36 1 VAR00004 .801** .000 35 1

**. Correlation is significant at the 0.01 level (2-tailed).

Here the correlation 0.8 which shows that both have positive relation if FII increase then Sensex will also increase. But if we compare the significance with the degree of freedom then null hypothesis is accepted because (0.00<0.01) so it shows that FIIs will have no significant impact on the Sensex.

CONCLUSION Objective 1:
A large number of changes that were introduced in the country’s regulatory economic policies heralded the liberalization era of the FDI policy regime in India and brought about a structural breakthrough in the volume of the FDI inflows into the economy maintained a fluctuating and unsteady trend during the study period. It might be of interest to note that more than 50% of the total FDI inflows received by India during the period from 2000 - 2009 came from Mauritius, Singapore and the USA. The main reason for higher levels of investment from Mauritius was that the fact that India entered into a double taxation avoidance agreement (DTAA) with Mauritius were protected from taxation in India. Among the different sectors, the service sector had received the larger proportion followed by computer software and hardware sector and telecommunication sector.

Objective 2:
According to findings and results, we have concluded that FII did have significant impact on Sensex but there is less co-relation with Bankex and IT. One of the reasons for high degree of any linear relation can also be due to the sample data. The data was taken on monthly basis. The data on daily basis can give more positive results (may be). Also FII is not the only factor affecting the stock indices. There are other major factors that influence the bourses in the stock market.

Bibliography Sites
http://dipp.nic.in www.bseindia.com www.financeexpress.com www.tradechakra.com www.madaan.com www.indianembassy.com www.sebi.gov.in

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