BACKGROUND

BACKGROUND

INTRODUCTION
Investment is the commitment of money or capital to purchase financial instruments or other
assets in order to gain profitable returns in the form of interest, income, or appreciation of the
value of the instrument. Investment is related to saving or deferring consumption.
The economies like India, which are growing very rapidly, are becoming hot favorite
investment destinations for the foreign institutional investors. These markets have the
potential to grow in the near future. This is the prime reason behind the growing interests of
the foreign investors. The promise of rapid growth of the investable fund is tempting the
investors and so they are coming in huge numbers to these countries. The money, which is
coming through the foreign institutional investment, is referred as 'hot money' because the
money can be taken out from the market at anytime by these investors.

FII AND INDIAN ECONOMY

Positive tidings about the Indian economy combined with a fast-growing market have made
India an attractive destination for foreign institutional investors (FIIs). The foreign
Institutional Investors' (FIIs) net investment in the Indian stock markets in calendar year 2005
crossed US$ 10 billion, the highest ever by the foreign funds in a single year after FIIs were
allowed to make portfolio investments in the country's stock markets in the early 1990s. As
per the Securities Exchange Board of India (SEBI) figures, FIIs made net purchases of US$
587.3 million on December 16, 2005, taking the total net investments in the 2005 calendar to

US$ 10.11 billion. India's popularity among investors can be gauged from the fact that the
number of FIIs registered with SEBI has increased from none in 1992-93 to 528 in 2000-01 to
803 in 2005-06. In 2005 alone, 145 new FIIs registered themselves, taking the total registered
FIIs to 803 (as on October 31, 2005) from 685 in 2004-05.
A number of these investors are Japanese and European funds aiming to cash in on the rising equity
markets in India. In addition, there was increased registration by non-traditional countries like Denmark,
Italy, Belgium, Canada and Sweden. The Japanese have, in fact, been increasing their foothold in India.
Mizuho Corporate Bank's decision to successfully expand base in the country has managed to convince
almost 60-65 major Japanese corporate to set up manufacturing or marketing base in India. This list of
corporate includes big names in auto sectors such as Honda, Toyota and Yamaha, as well as those in
home appliances, pharmaceuticals, and communications.

FOREIGN INSTITUTIONAL INVESTMENT IN INDIA

The increase in the volume of foreign institutional investment (FII) inflows in recent years has
led to concerns regarding the volatility of these flows, threat of capital flight, its impact on the
stock markets and influence of changes in regulatory regimes. The determinants and
destinations of these flows and how are they influencing economic development in the country
have also been debated. This paper examines the role of various factors relating to individual
firm-level characteristics and macroeconomic-level conditions influencing FII investment.
The regulatory environment of the host country has an important impact on FII inflows. As the

pace of foreign investment began to accelerate, regulatory policies have changed to keep up
with changed domestic scenarios.
NEED OF FII
Foreign Institution investment or FII is becoming a boon for the developing countries. The
term represents the possession of assets by any foreign company. The assets may be any
company, factory, mines and many more.
In the recent years the Foreign Institution investment has grown manifold. The prime reason
behind this is the globalization. The diversified global market has emerged as a lucrative
option for investment. In such a situation, inflow of foreign funds is quite natural.
In the past the Foreign Institution investment was limited to the highly industrialized
countries and the developing countries were not preferred by the foreign giants. But at present,
the trend has changed totally and the developing economies are preferred highly for foreign
direct investment. There are several reasons for this. These are:
Availability of raw material

Ready market

Availability of cheap labor

Legal facilities in such countries

Cheap production Cost

On the other hand, the developing countries are also getting some facilities from foreign
direct investment. Foreign aid proves to be of great use for the infrastructural development of
the developing countries. These initiatives are also providing ample scope of employment,
which is the major problem in all developing nations.

MEANING
1. FII denotes all those investors or investment companies that are not located within the
territory of the country in which they are investing.
2. SEBIs definition of FIIs presently includes foreign pension funds, mutual funds,
charitable/endowment/university funds etc. as well as asset management companies and
other money managers operating on their behalf.

INSTITUTIONS INVOLVED
The types of institutions that are involved in the foreign institutional investment are as
follows:
Mutual Funds

Pension Funds

Hedge Funds

FEATURES
1. It is generally short-term investment
2. Investment in financial assets
3. Aim is to increase capital availability
4. FII results in only capital inflows
5. FII flows into the secondary market

Insurance
Companies

6. Entry and exist is relatively easy

7. FII is eligible for capital gain
8. Tends to be speculative
9. No direct impact on employment of labour and wages
10.Fleeting interest in mgt.

PROS OF FII INVESTMENTS

(i)

Enhanced flow of equity capital

(ii)

Improving capital markets

(iii) Better corporate governance

(iv) Foreign investors confidence attracts FDI.
(v)

Enhanced flows of equity capital

(vi) FIIs have a greater appetite for equity than debt in their asset
structure. It improves capital structures.
(vii) Managing uncertainty and controlling risks.
(viii) FII inflows help in financial innovation and development of hedging
instruments.
(ix) Improving capital markets.
(x)

FIIs as professional bodies of asset managers and financial analysts

enhance competition and efficiency of financial markets.

(xi) Equity market development aids economic development.

(xii) 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.
(xiii) Improved corporate governance.
(xiv) FIIs constitute professional bodies, improve corporate governance.

CONS OF FII
(i)

fear of loss of management control

(ii)

The FIIs may leave any time and create problems.

(iii) Problems of Inflation

(iv) Problems for small investor
(v)

Adverse impact on Exports

(vi) Black Money

PARTICIPATORY NOTES AS INSTRUMENT OF FII

International access to the Indian capital market is limited to FIIs registered

with SEBI. The other investors, interested in investing in India, can pen
their account with any registered FII and the FII gets them registered with
SEBI as its sub-account. There are some investors who do not want to
disclose heir identity or who do not want to get registered with SEBI. Such
investors invest in Indian stocks through P.Notes. More than 50 per cent of
all FII inflows into the domestic markets are estimated to be through PNotes. Participatory Notes are instruments issued by FIIs (not their subaccounts1) registered in India to overseas investors who wish to invest in
the Indian stock markets without registering themselves with SEBI.
Suppose an overseas investor, not registered in India, is interested in
buying the shares in Indian stock market, the investors deposits the money
with the FII, the FII purchases the shares on its own account and issues the
PN to the investor. The details of the investor are not revealed at all in the
Indian market or to the SEBI unless specifically asked by SEBI. The FII
continues to hold the share in its own name. Any dividends or capital gains
collected from the share go back to the investor. The foreign investors
prefer P Notes route for the following reasons:
(i) Some investors do not want to reveal their identities. P Notes serve this
purpose.

(ii) They can invest in Indian shares without any formalities like registration
with SEBI, submitting various reports etc.
(iii) Savings in cost of investing as no office etc is to be maintained
(iv) No Currency conversion.
FIIs are not allowed to issue P-Notes to Indian nationals, persons of Indian
origin or overseas corporate bodies (which are majority owned or
controlled by NRIs). This is done to ensure that the P-Note route is not used
for money laundering purposes. FIIs are required to report to the SEBI on a
monthly basis if they issue, renew, cancel, or redeem P-Notes. The SEBI
also seeks some quarterly reports about investing in P-Notes.
P notes are not preferred by SEBI for the following reasons: 1 Further Issuance
of P Notes by sub accounts has been banned by SEBI on 24th Oct. 2007.
(i)There is no way of knowing who owns the underlying securities. (It is
suspected that terror organizations may be using this route to make
money. It is also suspected that Indian holding unaccounted money abroad
may be using this route to make money)
(ii) Large funds acting through P-Notes cause volatility in exchanges.
(iii) P-Notes reflect hot money coming only for short-term fast profits. Its
investors do not have much holding capacity. (Enquiries have revealed that
most of the investors borrow money on short term for the purpose of

buying the P. Notes.) FII investment is generally a long term investment.

But investments by
P-Notes are generally a short term investment with easy entry and exit
options. Investors can borrow money cheaply in the West and invest in
emerging market equities for bigger returns.
Participatory Notes are slap on the face of every citizen who is an investor.
To invest in shares one has to fill up many forms and provide proof of
residence, PAN number, and so on. But for PN investors, the system is
totally silent, even on basic information.
FOREIGN INSTITUTIONAL INVESTORS GUIDELINES
FIIs can individually purchase up to 10% and collectively up to 24% of the paid-up
share capital of an Indian company
This limit of 24% can be increased to sectoral cap/ statutory limit applicable to the
Indian company by passing a board resolution/shareholder resolution
FIIs can purchase shares through open offers/private placement/stock exchange
Shares purchased by FII through stock exchange cannot be sold through a private
arrangement
Proprietary funds, foreign individuals and foreign corporate can register as a subaccount and invest through the FII. Separate limits of 10% / 5% is available for the subaccounts

 FIIs can raise money through participatory notes or offshore derivative instruments for
investment in the underlying Indian securities
FIIs in addition to investment under the FII route can invest under FDI route

FOREIGN

INSTITUTION

INVESTMENT

VS.

FOREIGN

INVESTMENT

INSTITUTIONS
1. FDI stands for Foreign Direct Investment, a component of a country's national financial
accounts.
2. Foreign Institution investment is investment of foreign assets into domestic structures,
equipment, and organizations.
3. It does not include foreign investment into the stock markets.
4. FDI is thought to be more useful to a country than investments in the equity of its
companies because equity investments are potentially "hot money" which can leave at
the first sign of trouble, whereas FDI is durable and generally useful whether things go
well or badly.

FDI
It is long-term investment
Investment in physical assets

Aim is to increase enterprise

capacity or productivity or change
management control

Leads to technology transfer,

access to markets and management
inputs
FDI flows into the primary market
Entry and exit is relatively difficult
FDI is eligible for profits of the
company
Does not tend be speculative
Direct impact on employment of
labour and wages
Abiding interest in mgt.

Aim is to increase capital availability

FII results in only capital inflows

It is generally short-term investment

Investment in financial assets

FII flows into the secondary market

Entry and exist is relatively easy
FII is eligible for capital gain
Tends to be speculative
No direct impact on employment of
labour and wages
Fleeting interest in mgt.

FII

REGULATORY FRAMEWORK OF FII

On 14th Sept, 1992, India allowed Foreign Investment Institutions (FIIs) to
invest in all the securities issued by the companies which were listed on
Stock Exchanges in India. Later on, the FIIs were also allowed to invest in
government securities. The FIIs investments are subject to some limits.
The current scenario is explained in the following paragraphs:
(i) FIIs registered with SEBI are eligible to invest.
(ii) The FIIs can invest either on their on behalf or on behalf of their clients
(know as sub accounts) these sub accounts have to be registered with
SEBI.

(iii) Minimum 70 % of the funds have to be invested in equity

(iv)The FIIs are permitted to trade in exchange traded derivatives subject
to certain limits
(v) The FIIs can protect their foreign exchange risk through forward
contracts
(vi) The total holding of each SEBI registered FII / SEBI registered sub
account shall not exceed 10 % of paid capital of an Indian company
(vii) Total holdings of all SEBI registered FIIs and sub accounts put together
shall not exceed 24 % of paid up capital of an Indian company. This limit
can be raised by the company to the sector limit fixed by the government (
for example, the GOI has fixed the limit of 74% for private banks ) or to the
statutory limits ( for example, the law does not permit foreign investment
in public sector insurance companies exceeding 26%).
(viii) Every transaction is to be reported to SEBI and RBI on daily basis.

FACTS ABOUT FII

Some important facts about the foreign institutional investment:
The number of registered foreign institutional investors on June 2007 has reached 1042
from 813 in 2006
US $6 billion has been invested in equities by these investors

 The total amount of these investments in the Indian financial market till June 2007 has
been estimated at US $53.06 billion
The foreign institutional investors are preferring the construction sector, banking sector
and the IT companies for the investments
Most active foreign institutional investors in India are HSBC, Merrill Lynch, Citigroup,
CLSA

FII Inflows Vs Sensex