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Dissertation Submitted in partial fulfillment of the requirements for the award of the Degree
MASTER OF BUSINESS ADMINISTRATION OF BANGALORE UNIVERSTY BY USHA RANI.R Register no 05JJCM6057 Under the Guidance of Dr. Justin Nelson Michael (Faculty Guide)
KRISTU JAYANTI COLLEGE OF MANAGEMENT & TECHNOLOGY Bangalore – 560077 2007
CERTIFICATE FROM GUIDE AND HEAD OF THE INSTITUTION Certified that this dissertation entitled “Foreign Institutional Investments in Indian Markets”, submitted in partial fulfillment for the award of MBA Degree of Bangalore University was carried out by Ms.Usha rani.R under the guidance of Prof.Dr.JustinNelson Michael This has not been submitted to any other University or Institution for the award of any degree /diploma/certificate.
DEAN MBA DEPARTMENT
STUDENT’S DECLARATION 2
I hereby declare that this dissertation titled Foreign Intuitional Investments in Indian Markets submitted by me to the department of management, Bangalore University in partial fulfillment of the requirements of MBA programme is a bonafide work carried by me under the guidance of Prof . .Dr.Justin Nelson Michael. This has not been submitted earlier to any other university or institution for the award of any degree, diploma/ certificate or published any time before.
Foreign institutional investors in Indian market is the topic which I have been selected because I want to do some thing new and interesting FII’s seem to have been following a hedging strategy with simultaneous Investments in cash and derivatives market. Foreign investment – both portfolio and direct varieties – can supplement domestic savings and augment domestic investment without increasing the foreign debt of the country. Such investment constitutes non-debt creating financing instruments for the current account deficits in the external balance of payments. Capital inflows into the equity market give higher stock prices, lower cost of equity capital, and encourage investment by Indian firms. Foreign institutional investors (FII’s) were net sellers from November 1997 through January 1998. The outflow, prompted by the economic and currency crisis in Asia and some volatility in the Indian rupee, was modest compared to the roughly dols 9 billion which has been invested in India by FII’s since 1992. Foreign institutional investors (FII’s) were net sellers from November 1997 through January 1998. The outflow, prompted by the economic and currency crisis in Asia and some volatility in the Indian rupee, was modest compared to the roughly dols 9 billion which has been invested in India by FII’s since 1992. Every year since FII’s were allowed to participate in the Indian market, FII net inflows into India have been positive, except for 1998-99. This reflects the strong economic fundamentals of the country, as well as the confidence of the foreign investors in the growth with stability of the Indian market. The year 2003 marked a watershed in FII investment in India. FII’s started the year 2003 in a big way by investing Rs. 985 crore in January itself.
First and foremost, I praise and thank God Almighty from the depth of my heart, which has been the source of strength in the completion of this Dissertation Work. I would also like to express my gratitude to all my respondents for having cooperated with me and having provided me with all the relevant information. There was also a lot of help and encouragement that I had received from them in order to complete this Project. It is my profound concern to thank the Principal, Rev. Fr. Josekutty P. D, Kristu Jayanti College who paved the path for offering me this opportunity and avenues of infinite possibilities of knowledge. And I am deeply indebted to Dr. JUSTIN NELSON MICHAEL, Kristu Jayanti College, for his guidance, assistance and for giving all the formal support to conduct this stud and for completing this Project Work. I am also thankful to my sisters and friends for their encouragement and support, Finally, I would like to express my sincere gratitude to all those who spent their valuable time for providing the necessary data for this Organizational Study. USHA RANI.R
Chapter 1 Introduction 1.1 Background of the study 1.2 In flows from foreign Institutional Investors 1.3 FII’s Growth in India Chapter 2 Research Design 2.1 2.2 2.3 2.4 2.5 Statement of the problem Literature Review Scope of the study Objective of the study Methodology 21-23 1-20
2.6 Plan of Analysis 2.7 Limitation of the study Chapter 3 Industry Profile Chapter 4 Data Analysis and Interpretation Chapter 5 Findings, Suggestions, conclusion 41-57 58-60 24-40
LIST OF TABLES/GRAPHS Table No. Title Page No.
The table shows the* Net investment at US $ mn. at monthly exchange rate FII’s shareholding in the year
t test results Shareholding Pattern in Nifty Companies as
46-47 48-49 49-50 51
5 6. 7 8
Value of FII’s Investment Cap and Gap Analysis of FIIs Investment Gap in Market Value Trading Strategy of FII’s
FII Net Investments in different years Gap Available for investments
Gap Analysis of FII’s Investment at Market Value
1 INTRODUCTION 1.1 Background of the study Foreign investment refers to investments in the financial assets and production processes of another country. After the opening up of the borders for capital movement, these investments have grown in leaps and bounds. 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. In developing countries there has been a great need for foreign capital, not only to increase the productivity of labor but also because foreign capital helps to build up the foreign exchange reserves needed to meet trade deficits. Foreign investment provides a channel through which developing countries can gain access to foreign capital. It can come in two forms: Foreign Direct Investment (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.
The present study examines the foreign institutional investment in India, a country that opened its economy to foreign capital following a foreign exchange crisis.India, being a capital scarce country, has taken many measures to attract foreign investment since the beginning of reforms in 1991 upto the end of January 2003. India succeeded in attracting a total foreign investment of around U.S.$48 billion out of which U.S.$12 billion was in the form of FII. These figures show the importance of FII in the overall foreign investment program. India is in the process of liberalizing its capital account, and this has a significant impact on foreign investment and particularly on FII, which affects short-term stability in the financial markets. Hence, there is a need to determine the push and pull factors behind any change in the FII, so that policies can be framed to influence the variables that attract foreign investment. Also, FII has been the subject of intense discussion, as it is held to be responsible for having intensified the currency crises of the 1990’s in East Asia and elsewhere in the world. Foreign Institutional investors are the primary source of investment in India. In September 1992 the Government of India announced the opening of the country’s stock market to direct participation by FII’s through guiding for FII. In November 1995 the regulations had been notified largely based on the earlier guidance. The regulation require FII to register with SEBI and to obtain approval from the RBI of India under the FII Act,1973 to enable them to buy and sell securities to open foreign currency and rupee bank accounts and to remit and repatriate funds.
One category of institutional investors eligible for registration as FII who proposed to invest on their own behalf includes Pension Funds, Mutual Funds, Investment Trusts, Insurance Companies, Charitable Societies. The other 10
categories of FII’s who proposed to invest their proprietary funds on or behalf of broad based funds which are registered with SEBI as of accounts of FII’s include asset management companies, investment advisor, nominee companies, institutional portfolio managers, trustees and power of attorney holders. FII may invest in India through two routes. One is Equity investment route and 100%debit.Under the equity investment route 100% investment could be in the equity related instruments or upto 30% could be invested in debit instrument. A FII or a sub-account can hold up to 10% of paid up equity capital of any company. The total investment by FII and sub-accounts in any Indian Company cannot exceed 40% of its total paid up capital. FII have to pay tax at the rate of 10% on long term capital gains at 30% on short term capital gains and at the rate of 20% on interest income. The amount invested in FII is fully convertible. For this purpose FII are required to seek permission from the RBI under the Foreign Exchange Regulation Act 1973. The FII which are active participants in the Indian securities have been allowed to lend stocks through and approved intermediary. 1.2 In flows from foreign Institutional Investors Inflows from Foreign Institutional Investors (FII) into India have been strong. FII’s poured in Rs7.49 bn, taking their net investment close to the billion dollar mark (US$971.9mn). Foreign funds were net buyers of only US$316.7mn in the Indian equities. Their net investment was US$1.35bn. FII’s were net sellers of US$63.7mn. Year-to-date, their net inflows stand at US$2.58bn.
Overall fund flows into the emerging markets too have been good. Emerging markets equity funds saw net inflows to the tune of US$1.1bn, according to the Emerging Portfolio Funds Research (EPFR). With the latest round of inflows, emerging market equity funds have attracted a net of about US $4.9bn. Within the emerging market space, investors particularly took a liking to Latin America, brining in about US $260mn during the week under review, totaling 1.03% of assets under management. "Investors responded to evidence that demand for the region’s commodities will continue to underpin prices, In flows into the geographically-diversified Global Emerging Markets (GEM) equity funds were only 0.24% of assets under management. Asian funds (ex- Japan) saw the largest inflows, pulling in a net of US $472.7mn. GEM equity funds have seen net inflows of over US $2bn. However, this is much lower than US $11.45bn these funds pulled in during the same period. Japanese funds had net outflows for the fifth time in six weeks amid nagging concerns about the strength of the world’s No.2 economy. Global equity funds, dedicated largely towards the developed markets, attracted US $2bn of inflows during the week and have now recorded net inflows of around US $20bn so far in 2007. In 2006, these funds had witnessed net inflows of US $29.6bn. "These funds benefited from their heavy exposure to Europe. Equity markets in France, Germany, Italy, Spain and the UK remain at or around six-year highs thanks to a better than expected earnings outlook and a surge in mergers and acquisitions activity," . But investors in US equity funds domiciled outside of the US were not impressed since they were responsible for the redemptions, removing US $390mn from these funds. Still, the US $153.9mn of outflows from all US equity funds was better than the stronger outflows of recent weeks," according to EPFR.
Foreign Institutional Investors FII’s including pension funds, mutual funds, investment trusts, university funds, endowments, foundations or charitable trusts or charitable societies, etc. are permitted to invest in all securities, i.e. equity shares/ debentures/ PCDs /FCDs /Rights renunciations /warrants of Indian companies (other than Banking Companies) listed as well as unlisted, dated Government securities, Treasury bills and units of domestic mutual fund schemes in the primary and secondary markets. Investments by FIIs will be subject to a ceiling of 24% of the total paid up equity capital of the company. The ceiling would apply to all holdings taken together including conversions out of the fully and partly convertible debentures issued by the company. The holding of a single FII or each SEBI approved sub-account of an FII or the concerned FII group in any company would also be subject to a ceiling of 10% of the total issued and paid up capital of the company. Indian companies, however, would be permitted to raise the normal ceiling limit of 24% to 40% of the issued and paid up capital of the company provided it has been approved by the Board of Directors of the company and a Special Resolution is passed to that effect by the General Body. The ceiling of 24% or 40%, as the case may be, applicable for investment by FII’s will not include investments made by NRI’s / OCB’s under the Portfolio Investment Scheme. It will also not include direct foreign investment by an FII as a foreign collaborator and investment by FII’s through off-shore funds, Global Depository Receipts and Euro-Convertible Bonds. FII’s are required to register themselves with Securities and Exchange Board of India (SEBI) before they invest in the Indian capital market. Application for registration should be made by FII’s to SEBI in the prescribed form in duplicate.
The application will be forwarded by SEBI to Reserve Bank. Reserve Bank will grant permission under FERA 1973 to the bank branch designated by the applicant FII to buy/sell equity shares/ debentures/ warrants/dated Government securities/Treasury Bills /units of domestic mutual funds. Reserve Bank's permission will be initially valid for five years and will be operative only after obtaining registration from SEBI. This permission can be renewed for a further period of five years on request. Reserve Bank's permission would enable the FII’s to buy/sell the securities and remit the income/dividend/sale proceeds after payment of applicable taxes through the designated bank branch. Reserve Bank's permission will also cover investment in shares/debentures of Indian companies in primary market i.e. new issues provided the company has reserved certain quota out of its public issue in favor of FII’s. The designated bank branch is required to submit to Reserve Bank a statement in form LEC(FII) on daily basis in respect of purchases/ sales of shares/ debentures made for the purpose of monitoring by Reserve Bank the overall ceiling of 24% or 40%, as the case may be, referred to in sub-paragraph . In order to facilitate making of investments in India and repatriation of income/sale proceeds of such investments, Reserve Bank will permit the designated bank to open a foreign currency denominated account and a special Non-resident Rupee account in the name of FII. The designated bank branch will also be permitted (a) to transfer funds from foreign currency account to rupee account and vice versa, (b) to make investments out of the balance in the rupee account, (c) to credit sale proceeds of shares and other investments as also dividend/interest earned on the investments to the rupee account and (d) to transfer the repatriable proceeds (net of taxes) from the rupee account to the foreign currency account. Reserve Bank vide its Notification No.F.E.R.A.212/99-RB dated 18th October 1999 has 14
granted general permission to mutual funds in India to issue units or similar instruments to FII’s under the schemes approved by Securities and Exchange Board of India and to send such units/instruments out of India to their global custodians, as also to repurchase units/instruments from FII’s Foreign institutional investors (FIIs) are back in the Indian stock markets. In April 2007, the net inflow of FII investment in equities has touched $1.56 billion as against a net outflow of $ 243.90 million in March 2007. The companies have good order positions. And with India emerging as a manufacturing hub after China, the growth story is likely to continue. Though inflation and rising interest rates are casting a shadow over high growth rate, investors think that performance of the Indian companies won't be affected due to strong domestic and international demand. In 2007, the net investment of FII’s in stocks has reached $3.05 billion as against $ 3.57 billion in the same period of the last year. Foreign investors have turned positive (buyers) in April 2007 after becoming net sellers in March. In February also FII’s were aggressive buyers and increased their exposures by $1.62 billion (Rs.7240crore). But the 30-share sensitive index of Bombay Stock Exchange (BSE) fell 1,153 points to close at 12,938 on February 28 as against the close of 14,091 on last trading day of January 2007. However FII’s become net sellers, but the Sensex improved marginally by 134 points. Though FII’s are the major players, domestic investors also play important roles in the equity market. Unless FIIs turn big sellers or buyers, market is not hugely influenced by them. When FII’s were net sellers of $370.90 million, Sensex fell by 541 points to close at 12,938.
When FIIs were net sellers by $99 million, the Sensex improved by 222 points to close at 13,160 points. On March 6, 2007, when FIIs were net sellers by 128.70 points, Sensex improved by 282 points to close at 12,697 points. But as FII’s net investment so far in the Indian capital market is $52.14 billion and will play an important role in the market. In April 2007, the Sensex has improved by 836 points on the back of strong FIIs' inflow. FII inflows cross US$ 3 bn mark It's raining dollars in the Indian stock market with the overseas investment on the local bourses crossing three-billion dollars mark since the beginning. Foreign Institutional Investors have put in a net of US$3.05 billion in the Indian stocks so far in 2007, while taking their total net investment in the country so far to over US$52 billion. However, the net FII inflows in the first four months of 2007 are over a billion dollars. More than half of the net investment by FII’s in the month of April 2007 alone after the overseas investors returned to the bourses with positive sentiments as Sensex regained its once-lost 14,000 level. The bourses had witnessed a herd-like flight of FIIs after a sharp fall in February but with the corporate earnings results meeting or beating expectations, the sentiments have improved considerably, said a broker. According to the data available with the market regulator SEBI, FIIs purchased stocks worth close to (about 1.56 billion dollars). However, the net FII investment for January-April period is estimated to remain around three-billion dollar level, as against about 3.3 billion dollars in the same period of 2006.FII’s had purchased stocks worth a net of about eight billion dollars in entire 2006, as against a record high of 10.7 billion dollars in 2005. After playing second fiddle to foreign institutional investors for over a decade, 16 Rs 46,400 crore and sold stocks worth about Rs 39,500 crore in April 2007, taking their net investment to about Rs 6,900 crore
domestic mutual funds are with a combined equity asset of about $23-24 billion now, mutual funds are regularly playing counter-balance to FII’s. According to market players and fund managers signs of rising to a position of strength from where they could call the shots in the Indian market boosted by huge inflows in a slew of new equity fund offers in the first half of the current year, the MF’s had provided a much-needed cushion to the marker in May and June when FIIs were selling heavily. As a result, while the net fund infusion by FIIs between May 11 and October 13,2005 stands at about Rs 3,000 crore, during the same period the MFs had put in more than double that amount SEBI data showed. This welcome change, according to fund managers, was possible mainly because of increasing retail participation. 1.3 FII’s Growth in India Mutual funds have also been net buyers though they are conservatively cautious on the markets. The problem is that since FII’s have been buying for a series of Six months it is a time for them to sell off and are they going to again dump the stocks. There may be bouts of profits booking in the markets but these are good signs and are important for markets to consolidate before moving ahead. International capital flows and capital controls have emerged as an important policy issues in the Indian context as well. The danger of Mexico-style ‘abrupt and sudden outflows ’ inherent with FII flows and their destabilizing effects on equity and foreign exchange markets have been stressed. Some argues that FII flows have no significant benefits for the economy at large. A proper understanding of the nature and determinants of these flows, however, is essential for a meaningful debate about their effects as well as predicting the chances of their sudden reversals.
FII’s' demand for quick gains Also, the national interest may not always coincide with the FIIs' demand for quick gains,conflict situations can emerge. The country must learn to deal with such conflicts without affecting its interests. Institutions are becoming larger and in many cases dwarf sovereign governments. Their ability to arm-twist central banks and finance ministries is well known. Hence, while encouraging foreign fund flows in the stock market, the policy-makers must be prepared for the worst. As of December 2006 993 FIIs were registered with the Securities and Exchange Board of India. Positive tidings about the Indian economy combined with a fast-growing market have made India an attractive destination for foreign institutional investors (FIIs). The number of foreign institutional investors (FIIs) registered with the Securities and Exchange Board of India (SEBI) has now increased to 1,030. In the beginning of 2006, the figure was 813. As many as 217 new FIIs opened their offices in India during 2006. This is the highest number of registrations by FIIs in a year till date. The previous highest was 209 in 2005. The net investments made by the institutions during 2006 was US$ 9,185.90 million against US$ 9,521.80 million in 2005 India opened its stock market to foreign investors in September 1992 and since then has received portfolio investment from foreigners in the form of foreign institutional Investment in equities. This has become one of the main channels of FII in India. In order to trade in the Indian equity market, foreign corporations need to register with the Securities and Exchange Board of India (SEBI) as foreign institutional investors. India allows only authorized foreign investors to invest in pension funds, investment trusts, asset management companies, university funds, endowments, foundations, charitable interests and charitable societies that have a track record 18
of five years and which are registered with a statutory authority in their own country of incorporation or settlement. It is possible for foreigners to trade in Indian securities without registering as an FII but such cases require approval from the Reserve Bank of India (RBI) or the Foreign Investment Promotion Board (FIPB).Foreign institutional investors generally concentrate on the secondary market. The total amount of foreign institutional investment in India has accumulated to the formidable sum of over U.S.$12 billion as of January 2003..
1.4 Some investment highlights:
Billionaire investor George Soros-owned fund Dace croft and New Yorkbased investment firm Blue Ridge are picking 21 per cent equity stake in Anil Dhirubhai Ambani Group's Reliance Asset Reconstruction Company (Reliance ARC). A clutch of financial investors including Government of Singapore Investment Corporation (GIC) and the New York-based hedge fund Galleon Partners have picked up around 20 per cent stake in Edelweiss Capital for around US$ 90 million. US-based Private equity major Blackstone Group is close to investing nearly $60-65 In India, all of us are used to the notion of `FII' as being the channel through which foreign investors access the Indian market.
But looking forward, the future easing of capital controls in India will some day involve eliminating the concept of the FII, and opening up the equity spot and derivatives markets to anyone in the world. The FII is a piece of State-induced canalisation, and it will surely (someday) go the way of canalisation to favour the State Trading Corporation or import license holders. It is, hence, of interest to all of us to ponder what lies beyond. .
The Indian firm will treat the orders coming from the U.S. brokerage firm as one big customer, except for the purpose of a `large trader reporting system' (which isn't yet in place in India) where the names of large positions are required. The article says: Regulatory authorities in some countries have responded by banning omnibus accounts, but this leads to at least two problems.
First, it becomes less efficient for global brokers and their customers to enter those markets, and in some cases legally impossible. Second, some market participants will resort to trading "look-alike" contracts with their broker on an over-the-counter basis. The broker then offsets these contracts by establishing an identical position on the exchange. This arrangement does allow these customers to trade these markets, but it provides the regulators with even less information on the ultimate customer. In any case, many institutional investors do not like the lack of price transparency of over-the-counter contracts, so they avoid these markets. This deprives new exchanges of liquidity. In India, these "look-alike" contracts go by the name of Participatory Notes. It is found fascinating that in the same issue of Futures Industry magazine, there was an article on developments in Taiwan which is a country which is in the midst of this FII Ombinus Accounts transition. Taiwan is like India in having a very big direct retail participation in the securities markets. Roughly 10% of their population trades - in an Indian setting, that would translate to 100 million direct market participants. Taiwan is trying to move towards one thing is right: to merger between the spot stock exchange and the futures exchange. Right from the L. C. Gupta report onwards, India has been clearheaded on this, requiring no silly separation between the spot and the derivative. But the other frontiers which Taiwan is moving on are a jump ahead of us. They are removing their QFII system, and 20
shifting to omnibus accounts. They are worrying about offering a range of traded products which are interesting to global market participants - such as gold futures and a dollar denominated Taiwanese stock market index - so as to make Taiwan a trading centre for market participants from all over the world. They are increasing the size of position limits. Taiwan is one of the unhappy countries which has taxation of financial transactions - a bad idea in public finance if there ever was one. They seem to be headed to drop the tax rate from 2.5 basis points to basis point. Finally, you might find this article on Mexico interesting; they already have omnibus accounts. The year 2007 was one more unusual year in India's stock markets. It began with the Sensex still at a high and above the 6000 mark. It witnessed a decline to a low in mid-May of around 4500, delivered ultimately with the market's single day loss of close to 565 points. It then registered a recovery that turned into a bull run, which took the Sense to 6679 on the first trading day in the New Year. And then it witnessed an abrupt end to the bull run, signalled by a 316point intra-day decline in the Sensex FII Investment in future republic offerings Securities and Exchange Board of India’s latest guidelines on participation of qualified the FII Investment in future republic offerings under the new norms, QIBs will now have to bring in at least 10% margin while submitting bids in public offers through the book building route. So far, while institutional investors — like FIIs, banks and mutual funds — were not required to deposit any money while submitting bids for a public issue through book-build route, retail investors had to deposit the entire bid amount with the application. That’s not all. Sebi has also drafted norms for allotment of shares in QIB category, which is normally 50% of the offer size. So far, allotments to QIBs were the discretion of the issuer. Under the new guidelines, allotment of shares to
QIB’s shall be on a proportionate basis. A senior merchant banker said this would make it difficult to market shares through the book-build route to FIIs based outside India. He said many of the large FIIs registered with Sebi mostly operate from Singapore, Hong Kong, London, New York and Los Angeles. "These large international players would not change the norms that they were following so far to invest in India A source said FIIs do not invest in a country unless they are sure of an investment. "Even when they operate in secondary market, they buy the shares and then move in the fund just before the pay-in time." With the new system restricting issue managers from committing shares to an FII, sources said, many large institutional investors are not likely to apply at all. "Besides, FIIs are not interested in buying shares in small lots as it tends to increase cost of operation. In the new system, the number of shares allotted to an FII would be restricted to few hundreds which they might not be interested in taking at all." After playing second fiddle to foreign institutional investors for over a decade, domestic mutual funds are now showing signs of rising to a position of strength from where they could call the shots in the Indian market. With a combined equity asset of about $23-24 billion now, mutual funds are regularly playing counter-balance to FIIs, market players and fund managers said. Boosted by huge inflows in a slew of new equity fund offers in the first half of the current year, the MFs had provided a much-needed cushion to the marker in May and June when FIIs were selling heavily. As a result, while the net fund infusion by FIIs between May 11 and October 13 stands at about Rs 3,000 crore, during the same period the MFs had put in more than double that amount, Sebi data showed. This welcome change, according to fund managers, was possible mainly because of increasing retail participation.
Over the last several months, whether markets were in a bullish phase or bearish, we have always seen positive gross inflows into equity funds," said head of equity at a fund house. This also counters the general notion that retail investors have not participated in the current rally. Portfolio investment flows from industrial countries have become increasingly important for developing countries in recent years. The Indian situation has been no different. In the year 2000-01 portfolio investments in India accounted for over 37% of total foreign investment in the country and 47% of the current t account deficit. The corresponding figures in the previous year were 59% and 64% respectively. A significant part of these portfolio flows to India comes in the form of Foreign Institutional Investors ’ (FIIs ’ ) investments, mostly in equities. Ever since the opening of the Indian equity markets to foreigners, FII investments have steadily grown from about Rs. 2600 crores in 1993 to over Rs.11,000 crores in the first half of 2001 alone. Their share in total portfolio flows to India grew from 47% in 1993-94 to over 70% in 1999-2000 1 . The nature of the foreign investor ’ s decision-making process, that lies at the heart of the portfolio flows, is briefly outlined While it is generally held that portfolio flows benefit the economies of recipient countries 2 , policy-makers worldwide have been more than a little uneasy about such investments. Portfolio flows – often referred to as “ hot money ” – are notoriously volatile compared to other forms of capital flows. Investors are known to pu ll back portfolio investments at the slightest hint of trouble in the host country often leading to disastrous consequences to its economy. They have been blamed for exacerbating small economic problems in a country by making large and concerted withdrawals at the first sign of economic weakness.
They have also been held responsible for spreading financial crises – causing ‘contagion’ in international financial markets Prominent economists have, for these reasons, expressed doubts about the wisdom of the IMF view of promoting free capital mobility among countries. International capital flows and capital controls have emerged as an important policy issues in the Indian context as well. The danger of Mexico-style ‘abrupt and sudden outflows’ inherent with FII flows and their destabilizing effects on equity and foreign exchange markets have been stressed. Some authors have argued that FII flows have, in fact, had no significant benefits for the economy at large. While these concerns are all well-placed, comparatively less attention has been paid so far to analyzing the FII flows data and understanding their key features. A proper understanding of the nature and determinants of these flows, however, is essential for a meaningful debate about their effects as well as predicting the chances of their sudden reversals. In an attempt to address this lacuna, this paper undertakes an empirical analysis of FII investment flows to India. The objective at present is to gain a better understanding of the nature and determinants of FII flows. Towards this end we first take a look at the FII investment flows data to bring out the key features of these flows. 1.5 Relationship between FII flows and the stock market returns in India The relationship between FII flows and the stock market returns in India with a close look at the issue of causality.The impact of other factors identified in the portfolio flows literature on the FII flows to India. In all of these investigations we make a distinction between the pre-Asian crisis period and the post -Asian crisis period to check if there was a regime shift in the relationships owing to the Asian crisis.
The section sketches a brief review of the recent literature in the area. It provides an over view of the nature and sources of portfolio flows in India pointing out their main characteristics. It probes into the possible determinants of FII flows to India.. India opened its stock markets to foreign investors in September 1992 and has, since 1993, received considerable amount of portfolio investment from foreigners in the form of Foreign Institutional Investor ’ s (FII) investment in equities. This has become one of the main channels of international portfolio investment in India for foreigners . In order to trade in Indian equity markets, foreign corporations need to register with the SEBI as Foreign Institutional Investors (FII) . SEBI ’ s 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. The trickle of FII flows to India that began in January 1993 has gradually expanded to an average monthly inflow of close to Rs. 1900 crores during the first six months of 2001. By June 2001, over 500 FIIs were registered with SEBI. The total amount of FII investment in India had accumulated to a formidable sum of over Rs. 50,000 crores during this time . In terms of market capitalization too, the share of FIIs has steadily climbed to about 9% of the total market capitalization of BSE (which, in turn, accounts for over 90% of the total market capitalization in India). The sources of these FII flows are varied. The FIIs registered with SEBI come from as many as 28 countries (including money management companies operating in India on behalf of foreign investors). US-based institutions accounted for slightly over 41%, those from the UK constitute about 20% with other Western European countries hosting another 17% of the FIIs . It is, however, instructive to bear in mind
The national affiliations do not necessarily mean that the actual investor funds come from these particular countries. Given the significant financial flows among the industrial countries, national affiliations are very rough indicators of the ‘home’ of the FII investments. In particular institutions operating from Luxembourg, Cayman Islands or Channel Islands, or even those based at Singapore or Hong Kong are likely to be investing funds largely on behalf of residents in other countries. Nevertheless, the regional breakdown of the FIIs does provide an idea of the relative importance of different regions of the world in the FII flows. In 2004-05 portfolio investments in India accounted for about 62% of total Foreign investment in the country and at about 1.29% of GDP well exceeded the current account deficit (0.95% of GDP). Foreign Institutional Investors’ (FIIs’) investments accounted for about 97.5% of this. Ever since the opening of the Indian equity markets to foreigners, FII investments have steadily grown from about Rs. 2,600 crores in 1993 to Over Rs.48, 000 crores in 2005. At the end of June 2006, the cumulative FII flows to India accounted for a little over 9% of the Bombay Stock Exchange market capitalization. While it is generally held that portfolio flows benefit the economies of recipient Countries, policy-makers worldwide have been more than a little uneasy about such Investments. Often referred to as “hot money”, they are known to stampede out at the slightest hint of trouble in the host country leaving an economic wreck in their wake, like Mexico in 1994. They have been blamed for exacerbating small economic problems in a Country by making large and concerted withdrawals at the first sign of economic weakness. They have also been held responsible for spreading financial crises – causing ‘Contagion’ in international financial markets. International capital flows and capital controls have emerged as important policy Issues in the Indian context as well. The danger of abrupt reversals and 26
their destabilizing Consequences on equity and foreign exchange markets are always a concern Nevertheless, in recent years, the government has been making strong efforts to increase FII flows in India from being healthy for the economy, FII inflows have actually imposed certain burdens on the Indian economy. Understanding the determinants and effects of FII flows and devising appropriate Regulation therefore constitute an important part of economic policy making in India entities covered by the term ‘FII’ include “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 investments on behalf of abroad-based fund (i.e., fund having more than 20 investors with no single investor Holding more than 10 per cent of the shares or units of the fund. FIIs can invest their own funds as well as invest on behalf of their overseas clients registered as such with SEBI. These client accounts that the FII manages are known as ‘sub-accounts’. A domestic portfolio manager can also register itself as an FII to manage the funds of sub-accounts. A few large FIIs (less than 3% of all registered ones, according to GOI (2005)), issue derivative instrument s called ‘participatory notes’ that are registered and traded overseas, backed by the FIIs’ holdings of Indian securities. This arrangement has raised some concerns in regulatory circles since it makes it difficult to trace the ultimate beneficiary in the funds and may be used to bring in “unclean” funds (funds generated Out of illegal activities) into the Indian markets.
As of mid-July 2006, there were 932 FIIs registered with SEBI, of which 115 Were registered in the first half of 2006 itself. US-based funds accounted for 39% of all registered FIIs, followed by UK-based ones (16%), Luxembourg (7%) and Singapore (5%). In terms of net cumulative investment, US based funds accounted for 29% at the end of October 2005 (GOI (2005)) Though initially restricted to investing only in listed company stocks, FIIs are now allowed to invest in equity, bonds and derivative instruments in India subject to limits of foreign ownership for various sectors as well as ceilings on total investment per FII. Regular FII’s follow what has come to be known as the “70:30 rule”, i.e. they must invest no less than 70% of their funds in equity-related instruments and may invest the remainder in debt-related instruments. There are also some FIIs that are registered as “100 per cent debt-fund FIIs” that are permitted to invest exclusively in debt instruments. Although equity holdings of FIIs have received maximum attention from the press, researchers and policymakers alike, the debt holdings of FIIs are not wholly insignificant. As of July 21, 2006, the regular FIIs held USD 224.25 million (about Rs. 1,009 crores) in government securities/Treasury Bills and USD 82.02 million (about Rs. 369 crores) in corporate debt. At the end of June 2006, the open interest of FIIs in stock and index futures and options exceeded Rs 22,000 crores.
2.1 Introduction Foreign companies/Individuals are permitted to invest in equity shares traded in Indian Stock markets if they are registered as a Foreign Institutional Investor (FII) or if they have a sub account in India. Investment in Indian securities is also possible through the purchase of Global Depository Receipts (GDR), American Depository Receipts (ADR), Foreign Currency Convertible Bonds and Foreign Currency Bonds issued by Indian issuers, which are listed, traded and settled overseas and mainly denominated in US dollars. FII investments in Indian capital market is more than US $ 11,000 million. Indian Stock market with a market capitalization of over US $ 165,000 million has been a major attraction for investors all over the world 2.2 Statement of The problem A hectic flow of FII in Indian market witnessed a terrific bounce of sensex from a level market of 7500-8000 to 14000. A genuine research is very much required to study the pattern and impact of Foreign Institutional Investment. 2.3 Reviewing the Literature A survey of the literature shows that existing studies do not account for volatility which can be expected in most of the monthly financial time series Data yet given the increase in financial market integration, both domestically and in foreign financial markets, accounting for volatility is unavoidable. Further, the existing studies either do not incorporate risk in foreign and domestic markets or make use of realized risk, an approach that does not always yield robust results.
This is because standard deviation/variance (realized risk variable) increases in 482 Investments, either domestic or foreign, depend heavily on risk
factors. Hence, while studying the behavior of FII, it is important to consider the relationship between unexpected risk and FII is obscure. Therefore, while examining the impact of risk on FII, one needs to separate the unobserved component from the realized risk. Another possible determinant of FII is the operation of foreign factors such as Returns in the source country’s financial markets and other real factors in the source Economy. So far, however, studies have found that both return in the source country stock market and the inflation rate have not exerted any impact on FII. The world stock market capitalization had a favorable impact on the FII in India. Since investment in stock markets is sentiment driven, and is affected more or less by everything, the crucial task is to identify a few critical determinants. . 2.4 Scope Of The Study It covers the foreign investments made in Indian capital market from 2002-2006. 2.5 Objectives of The Study 1. To understand the overall stock market in India. 2. To study the structure of FII in India 3. To understand the impact of FII on Indian stock market.
2.6 Research Methodology This study is based on Secondary data which will be collected from books, Internet, Reports, newspapers and the method of study reveals the data gathered for analysis of data & presenting in a proper form. The collection of data is done throughSecondary data analysis: These are interpretations of primary data which include encyclopedias, textbooks, handbooks, magazines & newspaper articles.
2.7 Operational Definition Of Concepts FII- . Means an entity established or incorporated outside India which proposes to make investment in India. FIPB- Foreign investment promotion is regulatory govt. agency which is been established to promote FDI, FII in various sectors. PLAN OF ANALYSIS The data would be collected through secondary sources. This data is analyzed implementing by using statistical tools, ratios, Tables etc.
2.7 Limitations of the study The data collected is not available in updated form; it is one of drawbacks of this study. The information collected is extracted from secondary data analysis through internet & the information is already in historical format.
Stock Market Foreign Institutional Investors have put in a net of 3.05 billion dollars (over Rs 13,500 crore) in the Indian stocks so far in 2007, while taking their total net investment in the country so far to over 52 billion dollars. However, the net FII inflows in the first four months of 2007 is over a billion dollars, less than the figure invested in the same period of the previous year. More than half of the net investment by FII’s this year came in the month of April alone after the overseas investors returned to the bourses with positive sentiments as Sensex regained its once-lost 14,000 level. The bourses had witnessed a herd-like flight of FII’s after a sharp fall in February this year, but with the corporate earnings results meeting or beating expectations, the sentiments have improved considerably, said a broker. According to the data available with the market regulator SEBI, FIIs purchased stocks worth close to Rs 46,400 crore and sold stocks worth about Rs 39,500 crore in April 2007, taking their net investment to about Rs 6,900 crore (about 1.56 billion dollars). However, the net FII investment for January-April period is estimated to remain around three-billion dollar level, as against about 3.3 billion dollars in the same period of 2006, said another broker. FII’s had purchased stocks worth a net of about eight billion dollars in entire 2006, as against a record high of 10.7 billion dollars in 2005. A sharp plunge of about 30 per cent in the May-June period and another major fall in December were the major drivers for the decline in FII inflows last year. However, if the prevailing positive trend continues on the FII front, the total overseas investment on the domestic bourses could rise to as high as 12 billion dollars, while beating the record set in 2005, the broker added.
Besides, the depreciating dollar against the Indian rupee could also propel the net FII inflows in terms of the US currency. A lot would depend on how the market reacts to further corporate earnings results going forward, the analysts believe. If the benchmark Sensex manages to regain the 14,000 level decisively by keeping above this mark for a couple of weeks, the sentiments could get a significant boost and herald a prolonged uptrend on the bourses. the Sensex plunged by more than 320 points while ending a five-day upward rally primarily driven by strong corporate results.
Foreign Institutional Investors have put in a net of 3.05 billion dollars (over Rs 13,500 crore) in the Indian stocks so far in 2007, while taking their total net investment in the country so far to over 52 billion dollars. However, the net FII inflows in the first four months of 2007 is over a billion dollars, less than the figure invested in the same period of the previous year. More than half of the net investment by FII’s came in the month of April 2007 alone after the overseas investors returned to the bourses with positive sentiments as Sensex regained its once-lost 14,000 level. More than half of the net investment by FII’s this year came in the month of April alone after the overseas investors returned to the bourses with positive sentiments as Sensex regained its once-lost 14,000 level. Considering the tremendous growth in India and huge FII flows coming into Asia and more importantly China and India - India seems to be the hottest destination. Equity booming, financial services & political environment more open leads to positive outlook the government and the regulatory authorities have tried hard to bring more transparency and clarity in the market processes and environment. The growth fundamentals of the country are pretty strong and India is on target to achieve 8% growth.
The FII’s have shown immense interest in our markets showcasing the belief in our markets even though the Indian market is considered a bit overvalued compared to its peers. So everything looks promising with a bit of cautiousness coming from the coalition government wherein the Left does create problems at times Growth seems to be taking more roots and spreading across various sectors. Persistence of this growth may lead to long-term benefits in terms of Income and Wealth. economy growing at 7-8%, significant jump in credit off-take increase in investments
FII putting in more USD 10 billion this year The markets have seen exceptionally high liquidity driven growth over the last year The way the markets have sustained the high growth rates defying expectations The political stability and conformance to liberalization and market economy principals across the politics spectrum The main reason for being a little more optimistic is that while there have been set backs in the reform process, there have been a few positive signals off late. Currently Indian equities are fairly valued, but, should the reform process get back on track, there is potential for higher growth. FII Inflows have been growing at an amazing rate. The Indian markets still are trading lower than other emerging market PEs. Growth is not speculative but fundamental in nature The Indian stock market has delivered very high returns in the past 2 years and right now the BSE-Sensex remains at an all-time high. The market seems to be over-heated and some of the valuations are not sustainable. The upswing in Sensex has been mainly on account of cheap foreign money (they do not have an option as the long term yield curve is flat) coming into India The market may undergo a sharp correction from these levels as the fickle-minded foreign money moves out.
The trigger for that would be slowdown of economic growth due to rising current account deficit, higher inflation, lower than expected growth in corporate earnings and global recession. Also, the quality of earnings seems suspect for a large no. of the mid-cap companies. the BSE Bombay stock exchange as an indicator, clearly there is too much money running after too few stocks, this has resulted in the average PE changing from 12-13(2004) to about 15 (2005) in a years time. Given that India is part of the "emerging markets" and an overall bullish sentiment of institutional funds like CALPERS this upward trend is likely to continue. view is as regards to investment in the sectors and not in the stock markets. Regarding investment in the stock market, within the last one year my view has changed from being optimistic to slightly cautious. Corporate disclosures have improved significantly over the past five years. There has also been market structure improvement over the last 6-7 years. Investing in Indian equities always appealed to bottom-up investors, now with increased focus on improving demographics and potential increased capital investments over the next 15-20 years, India has become a more appealing topdown investment story. The Indian market has become too expensive and it has become extremely difficult to identify undervalued investment ideas the investment climate and market sentiment in India is very positive. The economy is on a consistently growing trend. India Inc has been performing well and over and above expectations. There has been a strong rebound in the investment/infrastructure spending in the country, besides India being a preferred destination for outsourcing. Given the growth in corporate profits and credit off take, the rally in the stock markets and hardening interest rates seem justified
Over the last few years, research has brought to light a few important features of FII flows to India. The key question has been the relationship between FII flows and returns in the Indian markets . Clearly FII equity investments and the stock market performance in India have been very closely interlinked. Also both variables experience a sharp break around April of 2003 after which they ramp up steeply. The association is unmistakable – the correlation of monthly net FII equity inflows and monthly Sensex returns is 0.61 since April 2003 and 0.33 in the overall sample. FII flows are routinely depicted as a major driver of Indian stock market return in the financial press. However, research seems to suggest they are more of an effect than a cause of stock market performance. Analyzing daily flow data during 1999.Tthe post-Asian crisis period, stock market performance has been the sole driver of FII flows, though monthly data in the pre-Asian crisis period may suggest some reverse causality. This return-chasing behavior has been confirmed using daily data during 1999-2002 in the sales of Indian securities by FIIs are affected by returns but not purchases. Analyze monthly data over the period 1993-2000 to conclude that FII flows are negatively related to lagged stock market returns, suggesting negative feedback trading. There are, however, issues about the appropriateness of using monthly data The largest single-month pull-out of FII funds happened in May 2006 when the FIIs withdrew over $1.7 billion (Rs. 8247 crores) followed by May 2004 ($ 719 million, Rs. 3250 crores). These were also the months with the fourth largest and the largest single month percent decline in the Sensex respectively (15.8% and 18.8% respectively) in the post reforms era.
Government policy regarding FII flows In policy circles in India, FII flows are believed to have a positive impact on the country’s development ; so much so that encouraging FII flows – while reducing the financial sector’s vulnerability to speculative capital flows – constitute an objective of the National Common Minimum Programme. Accordingly, an expert group was set up in 2004 (in addition to a committee in 2002 which reported in 2004) to suggest ways to accomplish this goal. The group submitted its report in November 2005 (GOI 2005). Its 6 rationale for encouraging FII flows is that such flows can increase domestic investment without increasing foreign debt. They can raise stock prices, lower cost of equity and stimulate investment by Indian firms and lead to improvements in securities market design and corporate governance. FII inflows into India . Net FII inflows into India increased steadily through the decade of the 1990s to reach an annual peak of US$10.25 billion in 2004-05 (Table 1). Cumulatively, FII investments as onOctober 31, 2005 have been US$ 39.27 billion.1. Every year since FIIs were allowed to participate in the Indian market, FII net inflows into India have been positive, except for 1998-99. This reflects the strong economic fundamentals of the country, as well as the confidence of the foreign investors in the growthwith stability of the Indian market. The year 2003 marked a watershed in FII investment inIndia. FIIs started the year 2003 in a big way by investing Rs. 985 crore in January itself.Meanwhile, corporate India continued to report good operational results.
This, along with good macroeconomic fundamentals, growing industrial and service sectors led FIIs to perceive great RBI data generally shows that investment by FIIs has been smaller, when compared with SEBI data. This discrepancy in the statistical system needs to be corrected. One possible explanation may involve differences in the treatment of reinvestment of profit earned. potential for investment in the Indian economy. The year 2004 was one more unusual year in India's stock markets. It began with the Sensex still at a high and above the 6000 mark. It witnessed a decline to a low in mid-May of around 4500, delivered ultimately with the market's single day loss of close to 565 points. It then registered a recovery that turned into a bull run, which took the Sense to 6679 on the first trading day in the New Year. And then it witnessed an abrupt end to end bull run, signaled by a 316point intra-day decline in the Sensex on January This volatility has been visible in the medium and long terms as well. From a low of 2924 on April 5, 2003, the Sensex had risen to 6194 on January 14, 2004, only to fall to 4505 on May 17, before rising to close at a peak of 6679 on January 3, 2005. These wild fluctuations have meant that for those who bought into the market at the right time and exited at the appropriate moment, the average return earned through capital gains were higher in 2003 than 2004, despite the extended bull run in the latter year. There are two messages that this experience sends out. The first is that, if market expectations can turn so whimsically, the signals or rumours on which they are based must lack any substance since any "fundamentals" on which they could be anchored have not shifted so violently. The second is that there must be some unusually strong force that is determining movements in the market which alone can explain the wild swings it is witnessing.
The combination of these two factors is indeed a disconcerting phenomenon, since if some force has the ability to lead the market and the others can be taken along without much resistance, the market is in essence being subjected to manipulation, even if not always consciously. Not surprisingly, recent market developments have once more focussed attention on the volatility that has come to characterise India's stock markets. 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. These figures compare with a peak level of net purchases of $3.1 billion as far back as 1996 and net investments by FIIs of just $753 million in 2002. In sum, the sudden FII interest in Indian markets in the last two years account for the two bouts of medium-term buoyancy that the Sensex recently displayed. At one level this influence of the FIIs is puzzling. The cumulative stock of FII investment, totalling $30.3 billion at the end of 2004, amounted to just 8 per cent of the $383.6 billion total market capitalisation on the Bombay Stock Exchange. However, FII transactions were significant at the margin. Purchases by FIIs of $31.17 billion between April and December 2004 amounted to around 38.4 per cent of the cumulative turnover of $83.13 billion in the market during that period, whereas sales by FIIs amounted to 29.8 per cent of turnover.. A recent analysis by Parthaprathim Pal estimated that at the end of June 2004 FIIs controlled on average 21.6 per cent of shares in the Sensex companies. Further, if we consider only free-floating shares, or shares normally available for trading because they are not held by promoters, government or strategic shareholders, the average FII holding rises to more than 36 per cent. In a third of Sensex companies, FII holding of free-floating shares exceeded 40 per cent of the total.
In 2004-05 portfolio investments in India accounted for about 62% of total foreign investment in the country and at about 1.29% of GDP well exceeded the current account deficit (0.95% of GDP). Foreign Institutional Investors’ (FIIs’) investments accounted for about 97.5% of this. Ever since the opening of the Indian equity markets to foreigners, FII investments have steadily grown from about Rs. 2,600 crores in 1993 to over Rs.48,000 crores in 2005. At the end of June 2006, the cumulative FII flows to India accounted for a little over 9% of the Bombay Stock Exchange market capitalization. while it is generally held that portfolio flows benefit the economies of recipient countries, policy-makers worldwide have been more than a little uneasy about such investments. Often referred to as “hot money”, they are known to stampede out at the slightest hint of trouble in the host country leaving an economic wreck in their wake, like Mexico in 1994. They have been blamed for exacerbating small economic problems in a country by making large and concerted withdrawals at the first sign of economic weakness. They have also been held responsible for spreading financial crises – causing contagion’ in international financial markets. International capital flows and capital controls have emerged as important policy issues in the Indian context as well. The danger of abrupt reversals and their destabilizing consequences on equity and foreign exchange markets are always a concern Foreign investment – both portfolio and direct varieties – can supplement domestic savings and augment domestic investment without increasing the foreign debt of the country. Such investment constitutes non-debt creating financing instruments for the current account deficits in the external balance of payments. Capital inflows into the equity market give higher stock prices, lower cost of equity capital, and encourage investment by Indian firms.
Foreign investors often help spur domestic reforms aimed at improving the market design of the securities markets, and help strengthen corporate governance These benefits do require concomitant policy effort in terms of improving financial regulation and corporate governance. The Reserve Bank of India (RBI) has said 77% of the net annual foreign capital inflow into the country was for 2005-06 . This is the first time the central bank has defined volatility in foreign capital flows with respect to India. According to the RBI definition, volatile foreign capital inflows comprise portfolio investment and short-term trade credit. This means RBI categorizes the entire inflow of FII funds into the stock markets as volatile. Short-term trade credit is defined as the credit extended to importers by suppliers of goods and services from abroad. According to the RBI definition, the share of such inflows in the net total foreign capital inflows has been 76.3% in 2003-04 . The volatile component of the flow had eased to 40.9% in 2004-05 but picked up momentum thereafter, as stock markets have gathered steam. In the current year, for instance, net FII inflow has been $2.39 billion, according to Sebi data. However, despite it being clubbed as volatile, the government has comfort room, as the total is less than 40% of total foreign exchange reserves of the country, at present. Compared to this, inflow of FDI has been much less. The definition by the central bank is in reply to a question in the Parliament about the share of volatile capital, as defined by RBI, in total foreign capital inflow into India.
Further, according to estimates, the finance ministry and RBI had to spend Rs 4,166.18 crore, about 0.2% of total fiscal deficit, to sterilise the impact of the flow of foreign exchange into the country in 2005-06 . The sum was Rs 3,701.26 crore in 2004-05 . In recent years, the country's stock of foreign exchange has shot up largely through the surge in FII investment. The two instruments used to mop up excess flow of dollars are the market stabilisation scheme (MSS) and the liquidity adjustment facility (LAF). While interest payments on MSS are borne by the government, â€œsuch payments on account of LAF affect the government only indirectly through lower net disposable income of RBI,â€ the reply said.
3.2 Maximum FII flows in India International The classical capital asset pricing model (CAPM) predicts that, to maximize risk adjusted returns, investors should hold a diversified market portfolio of risky assets, irrespective of their country of residence. In practice, however, the proportion of foreign assets in investors’ portfolios tends to be very small, and there is a ‘home bias.’ There is evidence of the home bias decreasing over the years. The share of foreign stocks in the equity portfolio of US investors, for example, increased from an estimated 2 per cent in the late 1980s to about 10 per cent at the end of 1997, but is still far short of the 52 per cent of world stock market capitalization accounted for by non-US stocks. A part of the home bias is because of barriers to international investment. The international CAPM predicts that individuals should hold equities from around the world in proportion to market capitalizations. This is predicated on the assumption that there are no barriers to international investment. In practice, such barriers do exist, but they are falling overtime, including in India. 44
Empirically, the dominant explanation for international portfolio flows is in terms of stock returns in dollar terms examine estimates of aggregate international portfolio flows on a quarterly basis and find evidence of positive, contemporaneous correlation between inflows and returns. International investors may have a ‘cumulative informational disadvantage’ relative to local investors. In response to some new information, local investors may trade in stocks that results in a price change, and this price change in turn may lead to international portfolio flows. There is some evidence that the impact of international portfolio flows on stock prices depends on whether such flows are ‘expected’ or ‘unexpected’ and the composition of such investment. For Mexico during the late 1980s through the crisis of 1993. evidence of unexpected inflows of 1 per cent of market capitalization driving prices up by as much as 13 per cent.’ unexpected’, not the ‘expected’, inflows correlated with contemporaneous returns. One of the worries stemming from the informational asymmetries between foreign investors and domestic investors is the problem of herding and overshooting. A positive feedback strategy leads to buys (sells) when prices are rising (falling) and can lead to prices spiraling up (down) and overshooting the equilibrium, a one-basis-point shock to international portfolio flows generates an additional 1.5 basis point of additional inflow over the subsequent 45 days. The data on daily cross-border flows for 44 countries from August 1, 1994 to December31, 1998 , the Asian crisis, and the Russian and long term capital They find evidence that “All crisis episodes are clearly associated with a strong attenuation of inflows in general, and of emerging market inflows in particular.
It appears that foreign investors held fast during the Mexican crisis, slightly withdrew some resources in the midst of the Asian crisis, and were hardly fazed by the Brazilian crisis. Interestingly, the LTCMfailure appears as the only shock that is associated with strong foreign equity selling. Russia’s devaluation by itself seems to have left little imprint on flows. By contrast, during theintracrisis periods, the inflows came rapidly, at an annual rate of approximately 50 basis points of market capitalization.” This argument suggests that the gains. The Tequila crisis began with Mexico’s sudden devaluation in December 1994 and continued through the spring of 1995, the Asian crisis begins with the Thai devaluation in July 1997 and continued through the spring of 1998,and the Russian/LTCM crisis occurred in late summer/fall of 1998 with Russia devaluing in August 1998 andLTCM failing i financial globalization may be smaller as compared with those predicted by the ICAPM. This suggests that for India to fully capture these benefits, progress is needed on issues of corporate governance and the risks of expropriation by the offer of rationale in favor of capital controls. FII net inflows in India Using a monthly data-set for the period May 1993 to December 1999, the FII net inflows were not only correlated with the return in Indian equity market but was more likely the effect than the cause of the Indian equity market return. FIIs did not appear to be at an informational disadvantage compared to domestic investors in the Indian markets. Furthermore, the Asian crisis marked a regime shift. In the post-Asian crisis period, the return in the Indian equity market turned out to be the sole driver of the FII inflow, while for the pre-Asian crisis period, other covariates reflecting return in other competing markets were also correlated with FII net inflow. explored the relationship of daily FII flows to the
Indian equity market for the period January, 1999 to May, 2002 with two types of variables. The first type included variables reflecting daily market return and its volatility (representing risk) in domestic and international equity markets, based on the BSE Sensex, S&P 500 and the MSCI WI, as well as measures of comovement of returns in these markets (the relevant betas). The second type of variables, on the other hand, were essentially macroeconomic like daily return son the Rupee-Dollar exchange rate, short-term interest rate and index of industrial production(IIP); variables that are likely to affect foreign investors' expectation about returns in the Indian equity market. They distinguished among three kinds of daily FII flows, namely, FII flows into the country or FII purchases, FII flows out of the country or FII sales, and the net FII inflows into the country or FII net, and related these to the above mentioned variables along with their past history over different time frames, like a week or fortnight. While, the dependence of net FII flows on daily return in the domestic equity market at a lag, to be more specific) is suggestive of foreign investors' return-chasing behavior, the recent history of market return and its volatility in international and domestic stock markets have some significant effect as well. However, while FII sale (and FII net inflow) is significantly affected by the performance of the Indian equity market, FII purchase is not responsive to this market performance. . Global factor is the London Inter-bank Offered Rate (LIBOR), which inversely related to FII inflows. Among domestic factors, lagged stock market returns, rating downgrades and rupee depreciation affected FII flows adversely.
Policy implications that emerge from the studies are that a move towards a more liberalized regime, in emerging market economies like India, should be accompanied by further improvements in the regulatory system of the financial sector. To fully reap the benefits of capital market integration, in India, the prime focus should be on improving investor confidence in the equity market so as to strengthen the domestic investor base of the market, which in turn could act as a built-in cushion against possible destabilizing effects of sudden reversal of foreign inflows.“ Findings of several studies on FII flows emerging equity markets over the world have shown the importance of financial market infrastructure such as the market size, market liquidity, trading costs, information dissemination, and legal mechanisms relating to property rights, etc. in attracting foreign portfolio investments into the emerging markets.”
FII’S IN INDIAN MARKET
4.1 Foreign Institutional Investment Overseas pension funds, mutual funds, investment trust, asset management companies, nominee companies, banks, institutional portfolio managers, 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 investments on behalf of a broadbased fund (that is, fund having more than 20 investors with no single investor holding more than 10 per cent of the shares or units of the fund). The primary market deals with the Initial public offerings (IPO) or sales of shares by companies to the public for the first time. The recent IPO’s that took place in BSE can be viewed. Once the IPO’s are completed all further transactions of the sold shares take place in the secondary market, more commonly known as stock markets or as bourses (jargon in finance). The major stock exchanges in India are the BSE and the NSE..The National Stock Exchange or NSE was incorporated in November 1992 as a tax-paying company unlike other stock exchanges in the country. The NSE’s index is known as S&P CNX Nifty which is a 50 stock index which covers almost 25 sectors of the economy. Bombay Stock Exchange Limited is the oldest stock exchange in Asia. The Exchange has a nation-wide reach with a presence in 417 cities and towns of India. The BSE’s index is the SENSEX which is a 30 stock index. The SENSEX is an acronym for Sensitive index of the BSE. FII flows do have a great impact even on the common man. The large inflows are often cited by politicians and media as proof that India is a success story and that global investors are flocking in their hordes.
It should be kept in mind that the so-called `global investor' can be very fickle. He goes where he perceives profits. If the tide turns, he would be the first to flee with the profits. A sharp reversal of fund flows could result in economic and financial instability. India was relatively immune to the Asian crisis in the mid-1990s as its integration into the global financial market was not so strong. It may not be so lucky the next time around. India also needs to focus on long-term flows in the form of foreign direct investment to sustain the economic reform process As sub-accounts: A sub-account is generally the underlying fund on whose behalf the FII invests. The following entities are eligible to be registered as sub-accounts: Partnership firms, private companies, public companies, pension funds, investment trusts, and individuals. Domestic entity: A domestic portfolio manager or a domestic asset management company shall also be eligible to be registered as an FII to manage the funds of sub-accounts. FIIs can register with SEBI under the following categories: Regular FIIs – those required to invest not less than 70 per cent of their investments in equity-related instruments and up to 30 per cent in non-equity instruments. .
Table 4.1 Trends in FII investment
Gross purchases (Rs. Mn.)
Gross Sales (Rs. Mn.) 4,663 28,348 27,517 69,794 127,372 176,994 467,335 641,164 411,650 443,710 990,940
Net Investment (Rs. Mn.) 51,262 47,963 69,420 85,745 59,575 -15,844 101,219 99,340 87,552 26,889 457,645
Net investment * (US $ mn.) 1,634 1,528 2,036 2,432 1,649 -386 2,339 2,160 1,846 562 9,949
Cumulative Net Invetment* (US $ mn.) 1,638 3,167 5,202 7,634 9,284 8,898 11,237 13,396 15,242 15,804 25,754
1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-2000 2000-01 2001-02 2002-03 2003-04
55,925 76,310 96,935 155,539 186,947 161,150 568,555 740,506 499,200 470,601 1,448,575
Source : secondary data Interpretation It can be observed from the above table that the portfolio investment inflows have always been on the increase. But the years 2001-02 and 2002-03 saw some reversal in the trend. From a net inflow of US $ 2.1 billion in 2000-01, such inflows declined to US $ 1.8 billion in 2001-02, and further dropped to US $ 0.562 billion in 2002-03.
The decline is because of the lower portfolio inflows, The decline witnessed a sharp reversal in the year 2003-04. FIIs have made a net investment of US $ 9969 million during this year registering a growth of 1670% over the previous year, creating a record in the history of FII investment in India. Gross purchases in this year registered a growth rate of 208% compared to the year before in rupee terms. This trend continued in April 2004, only to suffer reversal again during May and June 2004, when the net investment became negative.
Graph 4.1 Trends in FII Investments
Trends in FII investments
1600000 1400000 FII Investments 1200000 1000000 800000 600000 400000 200000 0 -200000 years
Table 4.2 FII’s shareholding as of September 30, 2004 FIIs shareholding as a per cent Number of companies of total outstanding shares 0-1 1-5 5-10 10-15 15-20 20-25 25-30 30-35 35-40 40-45 45-50 50-55 55-60 60-65 Source: Secondary data Interpretation Average total traded value for all Nifty stocks is approximately 77 per cent of the traded value of all stocks on the NSE. Nifty stocks represent about 61 per cent of the total market capitalization as on August 31, 2004. 234 74 51 46 32 20 6 0 2 1 1 1 0 1
Graph 4.2 FIIs shareholding as of September
FII's share holdings in 2004
45000 40000 30000 25000 20000 15000 10000 5000 0 Months 0 No of companies 35000 Shareholdings 200 150 100 50 250
Table 4.3 t test results N Nifty Companies Non-Nifty Companies # p < 0.05 50 419 Mean 16.9278 4.1476 Standard deviation 12.8318 6.6009 t value 6.934#
Source: Secondary data Interpretation Analysis was done to see if Nifty and non Nifty companies differe in their FII investments. Thus we can conclude t test the calculated value is significant at 5% level of significance
Ho : there is no significance difference between Nifty and non Nifty companies in their FII investments H1: There is significance difference between Nifty and non Nifty companies in their FII investments There fore Null hypothesis is rejected
Table 4.4 Shareholding Pattern in Nifty Companies as of September 2004 Companies FIIs Shareholding (in mn.) Total outstanding FIIs Shareholding shares (in mn.) NIFTY 3,227 Non-NIFTY 1,508 Total 4,735 Source: Secondary data Interpretation The table above shows that the FIIs investment is certainly more concentrated in the Nifty companies than in Non-Nifty companies. The FIIs shareholding is around 13.85 per cent in Nifty companies as against 4.30 per cent in the Non-Nifty companies. This analysis is not complete, though the shareholding of the FIIs as a per cent of the total outstanding shares of the company makes it comparable with similar figures for other companies, it does not indicate the amount of FIIs investment in each of these companies in relation to others. 23,285 35,060 58,345 as a % of total outstanding shares 13.85 4.30 8.12
This is because a mere comparison of the number of shares held by FIIs is meaningless as the market price per share varies across companies and it 56
takes different quantum of money to acquire the same number of shares in different companies. Hence, this analysis is further extended to include the monetary value of the FIIs investment as of September 30, 2004.
Graph 4.4 Shareholding Pattern in Nifty Companies as of September 2004
FII share holdings
60000 50000 40000 30000 20000 10000 0 companies total outing shares 50000-60000 40000-50000 30000-40000 20000-30000 10000-20000 0-10000
Table 4.5 Value of FIIs Investment Category FIIs Shareholding (Rs. mn.) Nifty Non-Nifty Total 1,328,556 231,520 1,560,076 FIIs Shareholding as a percentage of the total value 85.16 14.84 100
Source: secondary Interpretation The shareholding of FIIs is analyzed in terms of the market value of their investment as of September 30, 2004, about 85 per cent of the total value of their investment is held in Nifty companies and only about 15 per cent is in Non-Nifty companies. A separate analysis of the Nifty and Non-Nifty companies bears evidence to this fact. The investment is about 14 and 12 per cent respectively. 50 per cent of the total market value of the FIIs investment is only in 6 companies namely Infosys Technologies (13.87%), Reliance Industries (12.44%), ICICI Bank (7.51), HDFC (7.05), ONGC (5.25%) and Satyam (4.88). The total value of the FIIs investment in these companies is around Rs.677,516 million .
Graph 4.5 Value of FIIs Investment
V a lu e o f F II In v e s tm e n t
1600000 1400000 1200000 1000000 F I I 's sh a r e h o l d8i0 0g0 0 0 n 600000 400000 200000 0 c a te g o r y
Table 4.6 Cap and Gap Analysis of FIIs Investment Source: secondary data Category Total outstanding shares Permissible Investment for FIIs (Cap) FIIs shareholding Gap Available for Investment All Companies Nifty Non-Nifty 58,345 23,285 35,060 17,123 7.937 9,186 4,734 3,227 1,508 12,389 4,711 7,678
1 4 0 0 0 0 0 -1 6 0 0 0 0 0 1 2 0 0 0 0 0 -1 4 0 0 0 0 0 1 0 0 0 0 0 0 -1 2 0 0 0 0 0 8 0 0 0 0 0 -1 0 0 0 0 0 0 6 0 0 0 0 0 -8 0 0 0 0 0 4 0 0 0 0 0 -6 0 0 0 0 0 2 0 0 0 0 0 -4 0 0 0 0 0 0 -2 0 0 0 0 0
Interpretation The percentage of the investment gap in case of Nifty companies is around 59 and it is 84 for the Non-Nifty companies. The total gap in respect of all the companies works out to 72 per cent. FIIs investments in Nifty companies is higher than in Non-Nifty companies, both in terms of number of shares held by them and the market value of these shares. FIIs investment cap is not uniformly the same figure for all the companies Graph 4.6 Cap and Gap Analysis of FIIs Investment
Cap & gap analysis of FII
70000 total outing shares 60000 50000 40000 30000 20000 10000 0 cap/Gap available for investment
Table 4.7 Gap in Market Value Category Gap Available for Gap in Market Value# (Rs. in mn.) 2,711,522 1,338,886 1,372,637 Investment All Companies Nifty Non-Nifty Source: secondary data (in mn.number of shares) 12,389 4,711 7,678
Interpretation The above table shows the number of shares available for further investment by FIIs is less in Nifty companies than Non-Nifty companies, in terms 60
of value the difference is not very wide as the average market price per share of the Nifty category, is very much higher than that of the Non-Nifty category. The top 5 companies where the gap is at the maximum in Nifty category of companies are Bharti Televentures, Reliance Industries, ONGC, Hindustan Lever and Wipro. In the Non-Nifty companies the top 5 companies are Mphais BFL, Neyveli Lignite, LIC Housing Finance, Tata Teleservices(Maharastra) and Himachal Futuristic.
Graph 4.7 Gap in Market Value
Gap analysis of FII's at market value
6000000 5000000 4000000 3000000 2000000 1000000 0 gap in market value
Table 4.8 Trading Strategy of FIIs
Gross Purchases (Rs. Crores)
Gross Sales (Rs. Crores)
Ratio of Gross Sales/Gross Purchases(per cent) 81 84 67 61 121 95 92 77 81
January 2004 February 2004 March 2004 April 2004 May 2004 June 2004 July 2004 August 2004 September 2004
16830.20 14952.10 17238.20 19691.50 15531.60 10633.50 11096.20 12594.80 12385.10
13653.50 12555.00 11633.90 12053.30 18778.10 10116.80 10182.80 9702.30 9999.80
Source: secondary Interpretation This Table Shows the Trading strategy of FII from January 2004 o September 2004 through gross purchases & gross SalesGraph
Graph4.8Trading strategy of FII’s
Trading Strategy of FII's
160000 140000 120000 100000 80000 60000 40000 20000 0
TABLE 4.9 FII Net Investments in different years Year 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Jan 138 340 -375 370 184 3872 378 1088 2483 1324 Feb 1613 424 628 384 2727 1574 2024 433 3183 7484 Mar 1089 484 472 204 1360 2265 484 283 8812 7888
2006 Source: secondary data Interpretation
The above table shows the FII net Investments and compared that to monthly performance of the S&P Nifty 50 index there is lot of difference in each month
Graph 4.9 FII Net Investments
FII net investments in each year
20000 18000 16000 14000 12000 10000 8000 6000 4000 2000 0 -2000
Table 4.10 Gap Available for investments Category Total outstandi ng Shares All Companies 58,345 Permissible Investment for FIIs (Cap) 17,123 4,734 12,389 FIIs shareholding Gap Available for Investment
Source: secondary data
Interpretation The above table shows the percentage of the investment gap in case of NIFTY companies is around 59 and is 84 for the Non-NIFTY companies. The total gap in respect of all the companies works out to 72 per cent. where it is brought out that the FIIs investments in NIFTY companies is higher than in NonNIFTY companies
Graph 4.10 Gap Available for investments
Gap available for investment
7 6 5 4 3 2 1 0 10000 20000 30000 40000 50000 60000 70000 Table 4.9 FIIs shareholding Investment for Table 4.9 Permissible Investment for Table 4.9 Total outstanding Shares Table 4.9 Category Table 4.9 Gap Available for Investment
Table 4.11 Gap Analysis of FII’s Investment at Market Value
Gap Available for Investment (in mn.number of shares)
(Rs. in mn.)
Source: Secondary data Interpretation In the above table number of shares available for further investment by FII’s is less in NIFTY companies
Graph 4.11 Gap Analysis of FIIs Investment at Market Value 67
gap in market value
All Companies NIFTY Non-NIFTY
India opened its stock markets to foreign investors in September 1992 It as received considerable amount of portfolio investment from foreigners in the form of Foreign Institutional Investor’s (FII) investment in equities FII’s have been permitted to purchase shares/convertible debentures of an Indian company through offer / private placement.
Eligibility to obtain an FII license a fund must be "broad-based" -that is, it must have at least twenty individual investors with no single investor holding more than 10 percent of the funds outstanding shares. FII’s are also permitted to trade in all exchange traded derivative contracts subject to certain limits. FII’s are not permitted to invest in Print Media Sector through FDI or PIS routes. Investment by FII requires prior approval of Government of India. FII’s have been permitted to purchase shares/convertible debentures of an Indian company through offer / private placement. It is clarified that a FII may invest in a particular issue of an Indian company .
5.2 SUGGESTIONS 69
A foreign investor that meets certain eligibility criteria must obtain approval as an FII from both SEBI and the Reserve Bank of India, and must renew its license every five years. If the FII’s investments could concentrate in a large number of companies the market value will raise FII must be increased in india
The foreign institutional investments in India after the initiation of economic reforms in the early 1990s, the movement of foreign capital flow increased very substantially. This increase in capital movement could have a very significant impact on the domestic real economy. There is great need to monitor the behavior of these flows so as to minimize possible adverse impacts on the real economy. For this purpose, we need to be aware of the determinants of foreign capital, rather than what influences this capital to cross borders. The present study examines the determinants of foreign institutional investments in India. Foreign institutional investors (FII’s) were net sellers from November 1997 through January 1998. The outflow, prompted by the economic and currency crisis in Asia and some volatility in the Indian rupee, was modest compared to the roughly dols 9 billion which has been invested in India by FII’s since 1992. Foreign institutional investors (FII’s) were net sellers from November 1997 through January 1998. The outflow, prompted by the economic and currency crisis in Asia and some volatility in the Indian rupee, was modest compared to the roughly dolls 9 billion which has been invested in India by FII’s since 1992. Every year since FII’s were allowed to participate in the Indian market, FII net inflows into India have been positive, except for 1998-99. This reflects the strong economic fundamentals of the country, as well as the confidence of the foreign investors in the growth with stability of the Indian market. The year 2003 marked a watershed in FII investment in India. FII’s started the year 2003 in a big way by investing Rs. 985 crore in January itself.
REFERENCES Agarwal, R. N. 1997. “Foreign Portfolio Investment in Some Developing Countries Chakrabarti Agarwal, R. N. 1997. “Foreign Portfolio Investment in Some Developing Countries
, Rajesh. 2001. “FII Flows to India, Journals Trivedi, Pushpa, and Abhilash Nair. 2003. “Determinants of FII Investment Inflow to India.” Icfai pushpa Trivedi and Abihilash Nair
Web sites www.business Line .com www.google.com www.economic times.com www.indiatines.com
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