FII Overview

An institution that is a legal entity established or incorporated outside india proposing to make investments in india only in securities. An investor or investment fund that is from or registered in a country outside of the one in which it is currently investing. Institutional investors include hedge funds, insurance companies, pension funds and mutual funds.
INVESTMENT IN INDIAN MARKET

India is believed to be a good investment despite political uncertainty, bureaucratic hassles, shortages of power and infrastructure deficiencies. India presents a vast potential for overseas investment and is actively encouraging the entrance of foreign players into the market. No company, of any size, aspiring to be a global player can, for long ignore this country, which is expected to become one of the top three emerging economies.
SUCCESS IN INDIA

Success in India will depend on the correct estimation of the country's potential; underestimation of its complexity or overestimation of its possibilities can lead to failure. While calculating, due consideration should be given to the factor of the inherent difficulties and uncertainties of functioning in the Indian system. Entering India's marketplace requires a well-designed plan backed by serious thought and careful research. For those who take the time and look to India as an opportunity for long-term growth, not short-term profit- the trip will be well worth the effort.

MARKET POTENTIAL

India is the fifth largest economy in the world (ranking above France, Italy, the United Kingdom, and Russia) and has the third largest GDP in the entire continent of Asia. It is also the second largest among emerging nations. (These indicators are based on purchasing power parity). India is also one of the few markets in the world, which offers high prospects for growth and earning potential in practically all areas of business. Despite the practically unlimited possibilities in India for overseas businesses, the world's most populous democracy has, until fairly recently, failed to get the kind of enthusiastic attention generated by other emerging economies such as China.
LACK OF ENTHISIASM AMONG INVESTORS

The reason being, after independence from Britain 50 years ago, India developed a highly protected, semi-socialist autarkic economy. Structural and bureaucratic impediments were vigorously fostered, along with a distrust of foreign business. Even as today the climate in India has seen a sea change, smashing barriers and actively seeking foreign investment, many companies still see it as a difficult market. India is rightfully quoted to be an incomparable country and is both frustrating and challenging at the same time. Foreign investors should be prepared to take India as it is with all of its difficulties, contradictions and challenges. Developing a basic understanding or potential of the Indian market

Envisaging and developing a Market Entry Strategy and implementing these strategies when actually entering the market are three basic steps to make a successful entry into India. The Indian middle class is large and growing; wages are low; many workers are well educated and speak English; investors are optimistic and local stocks are up; despite political turmoil, the country presses on with economic reforms. But there is still cause for worries- Infrastructure hassles. The rapid economic growth of the last few years has put heavy stress on India's infrastructure facilities. The projections of further expansion in key areas could snap the already strained lines of transportation unless massive programs of expansion and modernization are put in place. Problems include power demand shortfall, port traffic capacity mismatch, poor road conditions (only half of the country's roads are surfaced) and low telephone penetration.

INDIAN BUREAUCRACY

Although the Indian government is well aware of the need for reform and is pushing ahead in this area, business still has to deal with an inefficient and sometimes still slow-moving bureaucracy.

Diverse Market

The Indian market is widely diverse. The country has 17 official languages, 6 major religions, and ethnic diversity as wide as all of Europe. Thus, tastes and preferences differ greatly among sections

of consumers. Therefore, it is advisable to develop a good understanding of the Indian market and overall economy before taking the plunge.

INTERNATIONAL PORTFOLIO FLOWS:

International portfolio flows, as opposed to foreign direct investment (FDI) flows, refer to capital flows made by individuals or investors seeking to create an internationally diversified portfolio rather than to acquire management control over foreign companies. Diversifying internationally has long been known as a way to reduce the overall portfolio risk and even earn higher returns. Investors in developed countries can effectively enhance their portfolio performance by adding foreign stocks particularly those from emerging market countries where stock markets have relatively low correlations with those in developed countries. International portfolio flows are largely determined by the performance of the stock markets of the host countries relative to world markets. With the opening of stock markets in various emerging economies to foreign investors, investors in industrial countries have increasingly sought to realize the potential for portfolio diversification that these markets present. It is likely that for quite a few years to come, FII flows would increase with global integration. The main question is whether capital flew in to these countries primarily as a result of changes in global (largely US) factors or in response to events and indicators in the recipient countries like its credit rating and domestic stock

market return. The answer is mixed both global and countryspecific factors seem to matter, with the latter being particularly important in the case of Asian countries and for debt flows rather than equity flows.

FOREIGN INSTITUTIONAL INVESTMENT IN INDIA:

MILESTONES

India embarked on a programme of economic reforms in the early 1990s to tie over its balance of payment crisis and also as a step towards globalisation. An important milestone in the history of Indian economic reforms happened on September 14, 1992, when the FIIs (Foreign Institutional Investors) were allowed to invest in all the securities traded on the primary and secondary markets, including shares, debentures and warrants issued by companies which were listed or were to be listed the stock exchanges in India and in the schemes floated by domestic mutual funds. Initially, the holding of a single FII and of all FIIs, NRIs (NonResident Indians) and OCBs (Overseas Corporate Bodies) in any company were subject to a limit of 5% and 24% of the company's total issued capital respectively. ( In order to broad base the FII investment and to ensure that such an investment would not become a camouflage for

individual investment in the nature of FDI (Foreign Direct Investment), a condition was laid down that the funds invested by FIIs had to have at least 50 participants with no one holding more than 5%. Ever since this day, the regulations on FII investment have gone through enormous changes and have become more liberal over time. ( From November 1996, FIIs were allowed to make 100% investment in debt securities subject to specific approval from SEBI as a separate category of FIIs or sub-accounts as 100% debt funds. Such investments were, of course, subjected to the fund-specific ceiling prescribed by SEBI and had to be within an overall ceiling of US $ 1.5 billion. The investments were, however, restricted to the debt instruments of companies listed or to be listed on the stock exchanges. In 1997, the aggregate limit on investment by all FIIs was allowed to be raised from 24% to 30% by the Board of Directors of individual companies by passing a resolution in their meeting and by a special resolution to that effect in the company's General Body meeting. ( From the year 1998, the FII investments were also allowed in the dated government securities, treasury bills and money market instruments. ( In 2000, the foreign corporates and high net worth individuals were also allowed to invest as sub-accounts of SEBIregistered FIIs. FIIs were also permitted to seek SEBI registration in respect of sub-accounts. This was made more liberal to include the domestic portfolio managers or domestic asset management companies.

 ( 40% became the ceiling on aggregate FII portfolio investment in March 2000. ( This was subsequently raised to 49% on March 8, 2001 and to the specific sectoral cap in September 2001. ( As a move towards further liberalization a committee was set up on March 13, 2002 to identify the sectors in which FIIs portfolio investments will not be subject to the sectoral limits for FDI. ( Later, on December 27, 2002 the committee was reconstituted and came out with recommendations in June 2004. The committee had proposed that, 'In general, FII investment ceilings, if any, may be reckoned over and above prescribed FDI sectoral caps. The 24 per cent limit on FII investment imposed in 1992 when allowing FII inflows was exclusive of the FDI limit. The suggested measure will be in conformity with this original stipulation.' The committee also has recommended that the special procedure for raising FII investments beyond 24 per cent up to the FDI limit in a company may be dispensed with by amending the relevant regulations. ( Meanwhile, the increase in investment ceiling for FIIs in debt funds from US $ 1 billion to US $ 1.75 billion has been notified in 2004. The SEBI also has reduced the turnaround time for processing of FII applications for registrations from 13 working days to 7 working days except in the case of banks and subsidiaries. All these are indications for the country's continuous efforts to mobilize more foreign investment through portfolio investment by FIIs. The FII portfolio flows have also been on the rise since

September 1992. Their investments have always been net positive, but for 1998-99, when their sales were more than their purchase

ACTS AND RULES

FII registration and investment are mainly governed by SEBI (FII) Regulations, 1995. ELIGIBILITY FOR REGISTRATION AS FII: Following entities / funds are eligible to get registered as FII: 1. Pension Funds 2. Mutual Funds 3. Insurance Companies 4. Investment Trusts 5. Banks 6. University Fund s 7. Endowments 8. Foundations 9. Charitable Trusts / Charitable Societies Further, following entities proposing to invest on behalf of broad based funds(a fund established or incorporated outside India, which has at least twenty investors with no single individual investor

holding more than 10% shares or units of the fund) , are also eligible to be registered as FIIs: 1. Asset Management Companies 2. Institutional Portfolio Managers 3. Trustees 4. Power of Attorney Holders

INVESTMENT OPPORTUNITIES FOR FIIs

The following financial instruments are available for FII investments a) Securities in primary and secondary markets including shares, debentures and warrants of companies, unlisted, listed or to be listed on a recognized stock exchange in India; b) Units of mutual funds; c) Dated Government Securities; d) Derivatives traded on a recognized stock exchange; e) Commercial papers. Investment limits on equity investments a) FII, on its own behalf, shall not invest in equity more than 10% of total issued capital of an Indian company. b) Investment on behalf of each sub-account shall not exceed 10% of total issued capital of an India company.

c) For the sub-account registered under Foreign Companies/Individual category, the investment limit is fixed at 5% of issued capital. These limits are within overall limit of 24% / 49 % / or the sectoral caps a prescribed by Government of India / Reserve Bank of India.

Investment limits on debt investments The FII investments in debt securities are governed by the policy if the Government of India. Currently following limits are in effect: or FII investments in Government debt, currently following limits are applicable:

For corporate debt the investment limit is fixed at US $ 500 million.

TAXATION

The taxation norms available to a FII is shown in the table below. Nature of Income Long-term capital gains Short-term capital gains Dividend Income Interest Income Tax Rate 10% 30% Nil 20%

Long term capital gain: Capital gain on sale of securities held for a period of more than one year. Short term capital gain: Capital gain on sale of securities held for a period of less than one year.
BRIEF PROFILE OF IMPORTANT INSTITUTIONS:

A brief profile of important institutions included in the study is given below.

RESERVE BANK OF INDIA

India's Central Bank - the RBI - was established on 1 April 1935 and was nationalized on 1 January 1949. Some of its main objectives are regulating the issue of bank notes, managing India's foreign exchange reserves, operating India's currency and credit system with a view to securing monetary stability and developing India's financial structure in line with national socio-economic objectives and policies. The RBI acts as a banker to Central/State governments, commercial banks, state cooperative banks and some financial institutions. It formulates and administers monetary policy with a view to promoting stability of prices while encouraging higher production through appropriate deployment of credit. The RBI plays an important role in maintaining the exchange value of the Rupee and acts as an agent of the government in respect of India's membership of IMF. The RBI also performs a variety of developmental and promotional functions.

The first concern of a central bank is the maintenance of a soundly based commercial banking structure. While this concern has grown to comprehend the operations of all financial institutions, including the several groups of non-bank financial intermediaries, the commercial banks remain the core of the banking system. A central bank must also cooperate closely with the national government. Indeed, most governments and central banks have become intimately associated in the formulation of policy. They are often responsible for formulating and implementing monetary and credit policies, usually in cooperation with the government. they have been established specifically to lead or regulate the banking system.
SECURITUIES AND EXCHANGE BOARD OF INDIA

In 1988 the Securities and Exchange Board of India (SEBI) was established by the Government of India through an executive resolution, and was subsequently upgraded as a fully autonomous body (a statutory Board) in the year 1992 with the passing of the Securities and Exchange Board of India Act (SEBI Act) on 30th January 1992. In place of Government Control, a statutory and autonomous regulatory board with defined responsibilities, to cover both development & regulation of the market, and independent powers has been set up.

The basic objectives of the Board were identified as: To protect the interests of investors in securities;

To promote the development of Securities Market; To regulate the securities market and For matters connected therewith or incidental thereto. Since its inception SEBI has been working targeting the securities and is attending to the fulfillment of its objectives with commendable zeal and dexterity. The improvements in the securities markets like capitalization requirements, margining, establishment of clearing corporations etc. reduced the risk of credit and also reduced the market. SEBI has introduced the comprehensive regulatory measures, prescribed registration norms, the eligibility criteria, the code of obligations and the code of conduct for different intermediaries like, bankers to issue, merchant bankers, brokers and sub-brokers, registrars, portfolio managers, credit rating agencies, underwriters and others. It has framed bye-laws, risk identification and risk management systems for Clearing houses of stock exchanges, surveillance system etc. which has made dealing in securities both safe and transparent to the end investor. Another significant event is the approval of trading in stock indices (like S&P CNX Nifty & Sensex) in 2000. A market Index is a convenient and effective product because of the following reasons: It acts as a barometer for market behavior; It is used to benchmark portfolio performance; It is used in derivative instruments like index futures and index options;

It can be used for passive fund management as in case of Index Funds. Two broad approaches of SEBI is to integrate the securities market at the national level, and also to diversify the trading products, so that there is an increase in number of traders including banks, financial institutions, insurance companies, mutual funds, primary dealers etc. to transact through the Exchanges. In this context the introduction of derivatives trading through Indian Stock Exchanges permitted by SEBI in 2000 AD is a real landmark.

BOMBAY STOCK EXCHANGE:

Of the 22 stock exchanges in the country, Mumbai's (earlier known as Bombay), Bombay Stock Exchange is the largest, with over 6,000 stocks listed. The BSE accounts for over two thirds of the total trading volume in the country. Established in 1875, the exchange is also the oldest in Asia. Among the twenty-two Stock Exchanges recognized by the Government of India under the Securities Contracts (Regulation) Act, 1956, it was the first one to be recognized and it is the only one that had the privilege of getting permanent recognition ab-initio. Approximately 70,000 deals are executed on a daily basis, giving it one of the highest per hour rates of trading in the world. There are around 3,500 companies in the country which are listed and have a serious trading volume. The market capitalization of the BSE is Rs.5 trillion. The BSE `Sensex' is a widely used market index for the BSE.

The main aims and objectives of the BSE are to provide a market place for the purchase and sale of security evidencing the ownership of business property or of a public or business debt. It aims to promote, develop and maintain a well-regulated market for dealing in securities and to safeguard the interest of members and the investing public having dealings on the Exchange. It helps industrial development of the country through efficient resource mobilization. To establish and promote honorable and just practices in securities transactions
BSE Sensex

The BSE Sensex is a value-weighted index composed of 30 companies with the base April 1979 = 100. It has grown by more than four times from January 1990 till date. The set of companies in the index is essentially fixed. These companies account for around one-fifth of the market capitalization of the BSE.

NATIONAL STOCK EXCHANGE OF INDIA

The National Stock Exchange of India Limited has genesis in the report of the High Powered Study Group on Establishment of New Stock Exchanges, which recommended promotion of a National Stock Exchange by financial institutions (FIs) to provide access to investors from all across the country on an equal footing. Based on the recommendations, NSE was promoted by leading Financial Institutions at the behest of the Government of India and was

incorporated in November 1992 as a tax-paying company unlike other stock exchanges in the country. On its recognition as a stock exchange under the Securities Contracts (Regulation) Act, 1956 in April 1993, NSE commenced operations in the Wholesale Debt Market (WDM) segment in June 1994. The Capital Market (Equities) segment commenced operations in November 1994 and operations in Derivatives segment commenced in June 2000.

S&P CNX Nifty S&P CNX Nifty is a well-diversified 50 stock index accounting for 23 sectors of the economy. It is used for a variety of purposes such as benchmarking fund portfolios, index based derivatives and index funds. S&P CNX Nifty is owned and managed by India Index Services and Products Ltd. (IISL), which is a joint venture between NSE and CRISIL. IISL is India's first specialized company focused upon the index as a core product. IISL have a consulting and licensing agreement with Standard & Poor's (S&P), who are world leaders in index services. The average total traded value for the last six months of all Nifty stocks is approximately 58% of the traded value of all stocks on the NSE Nifty stocks represent about 60% of the total market capitalization as on March 31, 2005.

Impact cost of the S&P CNX Nifty for a portfolio size of Rs.5 million is 0.07% S&P CNX Nifty is professionally maintained and is ideal for derivatives trading.

FOREIGN INVESTMENT FLOWS IN INDIA:

One of the most important distinctions between Portfolio and Direct investment to have emerged from this young era of globalisation is that portfolio investment can be much more volatile.
TABLE: Foreign Investment Flows in India

Year

A. DirectB. Portfolio Investment Investment Total (A + B) (US (US $ million) (US $ million) million) $

1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97

97 129 315 586 1314 2144 2821

6 4 244 3567 3824 2748 3312

103 133 559 4153 5138 4892 6133

1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04

3557 2462 2155 4029 6131 4660 4675

1828 61 3026 2760 2021 979 11377

5385 2523 5181 6789 8152 5639 16052

From a net foreign investment inflow of US $ 5.3 billion in 1997-98, such inflows declined to US $ 2.4 billion in 1998-99. This is because of the lower portfolio inflows, as a result of which the net investment has dropped. The changes in the investment conditions in a country or region can lead to dramatic swings in portfolio investment. For a country on the rise, in other words for developing countries, FPI can bring about rapid development, helping an emerging economy move quickly to take advantage of economic opportunity, creating many new jobs and significant wealth. However, when a country's economic situation takes a downturn, sometimes just by failing to meet the expectations of international investors, the large flow of money into a country can turn into a stampede away from it.

CHART: FOREIGN INVESTMENT FLOWS

12000

10000

FOREIGN INVESTMENT INFLOWS

8000

6000

4000

2000

0 1990-91 FPI 1991-92 FDI 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04

YEAR

FOREIGN PORTFOLIO FLOWS TO INDIA

Foreign portfolio investments have been allowed in India on the basis of the recommendations of the Narasimham committee which stated: The committee would also suggest that the capital markets should be gradually opened up to foreign portfolio investments and simultaneously efforts should be initiated to improve the depth of the market by facilitating the issue of new types of equities and innovative debt instruments. (Narasimham committee report)

Prior to 1992, only non-resident Indians (NRIs) and Overseas corporate bodies (OCBs) were allowed to undertake portfolio investment in India. Only on September 14, 1992 the Government of India issued guidelines on FII investments in India which was followed by a notification by Securities and Exchange Board of India (SEBI) three years later in November 1995.
TRENDS IN FII INVESTMENT IN INDIA
TABLE: Trends in FII investment

FII PURCHAS FII Year E SALES

FII NET

CUM FII NET NET US$ million

FII

in crores 199394 5593 199495 7631 199596 9694 199697 15554 199798 18695

US$ in crores in crores million

466

5126

1634

1638

2835

4796

1528

3167

2752

6942

2036

5202

6979

8575

2432

7634

12737

5958

1649

9284

199899 16115 199900 56856 200001 74051 200102 49920 200203 47060 200304 144858

17699

-1584

-386

8898

46734

10122

2339

11237

64116

9934

2160

13396

41165

8755

1846

15242

44371

2689

562

15804

99094

45765

9949

25754

Source: Reserve Bank of India Annual Report 2004

INFERENCE: The investments by FIIs have been registering a steady growth since the opening of the Indian capital markets in September 1992. Their investments have always been net positive, but for 1998-99, when their sales were more than their purchases. 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, as a result of which the net investment has dropped in these years. However, this decline witnessed a sharp reversal in the year 2003-04. FIIs have made a net investment of Rs. 45,764 crores during this year registering a growth of 1602% over the previous year, creating a record in the history of FII investment in India. Gross purchases in this year amounted to Rs.144,857 crores, a growth rate of 208% compared to the year before. This trend continued in April 2004, only to suffer reversal again during May and June 2004, when the net investment became negative. Fortunately, the year from July 2004 has been seeing a net positive portfolio flows by FIIs. As of September 2004, the net FII portfolio investment stands at US $ 27,637 million. If it is so, then increasing the FII investment cap per se will not be helpful. The country has to work on specific measures to encourage more FII investments. The analysis of data indicates that there has been substantial divestment by the FIIs during the year 1998-99. The maximum outflow was during the months of May and June 1998 (almost US$430 millions).
TABLE: Monthly Trends of FIIs for the Year 1998-99

Month

Purchases (Rs mn)

Sales (Rs mn) 11756 13284

Net (Rs mn) -335 -5031

Net (US$ mn) -8.4 -124.3

Apr-98 May-98

11422 8253

Jun-98 Jul-98 Aug-98 Sep-98 Oct-98 Nov-98 Dec-98 Jan-99 Feb-99 Mar-99

8023 13098 7932 14381 10737 10391 11089 16355 16477 25207

16072 12154 11783 12458 16470 9845 8789 11894 13084 23973

-8049 944 -3851 1923 -5733 546 2300 4462 3393 1233

-190.5 22.2 -90.1 45.2 -135.4 12.9 104.8 104.8 79.8 29

A major factor which led to continuous outflow of funds during the middle and end of the year 1998 was the worsening outlook on the emerging markets. Credit worthiness of almost all the South-east Asian nations was severely damaged by the crises which started in July 1997. As a result, the FIIs were facing heavy redemption pressures from the Emerging Markets Funds. The stock markets in all these countries fell continuously from March 1998 till about September 1998. The integration of the Indian capital markets with the international markets thus spilled over to Indian markets as well. However, the net outflow from the Indian markets was much lower than the other Asian countries. A further indication of the integration of the Indian markets can be seen from the upsurge in the

valuations and funds inflows during the first quarter of 1999, when all the other Asian countries have also seen rising trend in stocks indices. The sluggishness in investment in the emerging markets was exacerbated by the fact that hroughout 1998-99, US and European markets showed historically high valuations, and the expectations of further rise because of the strong economic indicators there which led to reduced allocations elsewhere.
CHART : GROWTH OF FII INVESTMENTS IN INDIA

INFERENCE: 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).
TABLE: CORRELATION OF FII WITH NIFTY

MONTH APRIL MAY JUNE JULY AUGUST

GROSS PURCHASES -0.308891015 -0.203839618 0.40719847 0.231397721 -0.296292834

NET GROSS SALES INVESTMENT -0.486299015 -0.226174846 0.013881057 -0.008199745 -0.009987101 -0.122510317 0.127555673 0.556762421 0.352195939 -0.288696993

SEPTEMB ER 0.631541276 OCTOBER -0.107835133 NOVEMBE R 0.103856902 DECEMBE R -0.689594568 JANUARY -0.02034654 FEBRUAR Y 0.124176605 MARCH 0.419911809

0.478957403 -0.303940405

0.377141924 0.118451125

0.232269601

-0.020576251

-0.692805116 -0.57330261

-0.496878284 0.64885866

-0.056354197 -0.255570154

0.233709555 0.483718703

FII flows and contemporaneous stock returns are strongly correlated in India. The correlation coefficients between different measures of FII flows and market returns on the Bombay Stock Exchange during different sample periods are shown in Table above. While the correlations are quite high throughout the sample period, they exhibit a significant rise since the beginning of the 1999-00. The calculations show that there exists a relationship between FIIs and Nifty since 6 out of 12 months show positive correlation in the case of Gross Purchass and 8 out of 12 months indicate a positive correlation in the case of Net FII Investment and Nifty.
TABLE : CORRELATION OF FII WITH SENSEX

MONTH APRIL MAY JUNE JULY AUGUST

GROSS PURCHASES -0.267580403 -0.184653959 0.405635894 0.291205286 -0.315900375

GROSS SALES

NET INVESTMENT

-0.509025858 -0.076211493 -0.224809346 0.1484205 -0.004710378 0.575995013 0.045396684 0.353391901

-0.033391574 -0.301709231

SEPTEMBE R 0.661834837 OCTOBER -0.067640059

0.506184274

0.389776394

-0.311421901 0.18995454

NOVEMBER 0.083505749 DECEMBER -0.666663184 JANUARY 0.02201209

0.244942636

-0.057919794

-0.688620778 -0.46494095 -0.551509386 0.679227006 -0.170243004 0.149373722 -0.250893125 0.479619465

FEBRUARY 0.00689661 MARCH 0.417854257

The behaviour of the foreign portfolio investors matched the behaviour of Sensex during this period. Net FII investment in the Indian capital markets started fluctuating sharply during April and it turned negative. Net FII investment in the Indian stock market was positive from May to July. During this period, the Sensex and net FII investment showed very high degree of correlation. For the month of June showed a correlation as high as 0.60. The months of September, October, November and December shows a declining trend, the FII investment reversed from that day. On the whole, there exists a relationship between FIIs and Sensex since 7 out of 12 months show positive correlation in the case of Gross Purchases and 8 out of 12 months indicate a positive correlation in the case of Net FII Investment and Sensex.

TABLE: COEFFECIENT OF DETERMINATION OF FII WITH NIFTY

MONTH APRIL MAY JUNE JULY AUGUST SEPTEMBER OCTOBER NOVEMBER DECEMBER JANUARY FEBRUARY MARCH

GROSS PURCHASES 0.095413659 0.04155059 0.165810594 0.053544905 0.087789444 0.398844383 0.011628416 0.010786256 0.475540669 0.000413982 0.015419829 0.176325927

GROSS SALES 0.236486732 0.051155061 0.000192684 6.72358E-05 9.97422E-05 0.229400194 0.09237977 0.053949168 0.479978929 0.328675883 0.003175796 0.065316104

NET INVESTMENT 0.015009 0.01627 0.309984 0.124042 0.083346 0.142236 0.014031 0.000423 0.246888 0.421018 0.05462 0.233984

Coefficient of Determination (R2), ranges from 0 - 1, is always part of the standard regression output, the important measure of goodness of fit. R2 = correlation coefficient (r) squared, since the range of r is from -1 to +1, squaring r forces R2 to fall between 0 and 1. R2 in the above table gives the percentage (%) of the total variation in Nifty that is explained by the regression equation, or explained by FIIs. During the month of January the total variation in Nifty explained by FII amounted to 42% and the remaining 58% is explained by other factors which influence Nifty. TABLE : COEFFECIENT OF DETERMINATION OF FII WITH SENSEX

MONTH

GROSS

GROSS

NET

PURCHASES APRIL MAY JUNE JULY AUGUST 0.071599272 0.034097085 0.164540479 0.084800519 0.099793047

SALES

INVESTMENT

0.259107325 0.005808 0.050539242 0.022029 2.21877E-05 0.33177 0.002060859 0.124886 0.001114997 0.091028 0.256222519 0.151926 0.0969836 0.036083

SEPTEMBER 0.438025352 OCTOBER 0.004575178

NOVEMBER 0.00697321 DECEMBER 0.444439801 JANUARY 0.000484532

0.059996895 0.003355 0.474198576 0.21617 0.304162603 0.461349 0.028982681 0.022313 0.06294736 0.230035

FEBRUARY 4.75632E-05 MARCH 0.17460218

Similarly, in the case of FII and Sensex we have R2 = .46, indicating that variation in FII explains about 46% of the variation in Sensex. 54% of the variation in Sensex is unexplained by FII, explainable by other factors, omitted variables, random variation, etc. We shouldn't put too much emphasis on R2, t-stat are more important. However, R2, or some other measure of goodness of fit is expected in reported empirical results.