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The financial sector plays an important role in the economy of any nation. A well regulated and well-developed financial sector is vital to achieving the most basic need of efficient allocation of scarce resources. An article by EnnisKnupp estimates the world total investable market capitalization as on December 2005 as $93.7 trillion. It can be observed from Figure1 that the % of emerging market stocks is less than 2%. So there is a huge growth opportunity over the next few decades However according to Business Line dated September 9, 2006 an international survey of 175 fund managers, conducted by Standards & Poor's suggests that emerging market stocks now account for a high 16 per cent of all global equities. Figure 1: World Total Investable Capital Market
Total Investable Capital Market (December 31,2005)
Emerging Market Stocks
All Other Stocks Cash Equivalents Emerging Market Debt Non-US Bonds
17% 1% 6%
High Yield Bonds US Bonds
24% 21% 1%
Real Estate Private Capital US Stocks
Source: UBS Global Asset Management, Venture Economics, EnnisKnupp The far-reaching changes in the Indian economy since liberalization in the early 1990s have had a deep impact on the Indian financial sector. The financial sector has gone through a complex restructuring, capitalising on new opportunities as
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2 well as responding to new challenges. During the last decade, there has been a broadening and deepening of financial markets. Several new instruments and products have been introduced. Existing sectors have been opened to new private players. This has given a strong impetus to the development and modernization of the financial sector. New players have adopted international best practices and modern technology to offer a more sophisticated range of financial services to corporate and retail customers. This process has clearly improved the range of financial services and service providers available to Indian customers. The entry of new players has led to even existing players upgrading their product offerings and distribution channels. This is particularly evident in the non banking financial services sector, such brokerage industry, where innovative products combined with new delivery methods are allowing the sector to achieve very high growth rates. Over the past few years, the sector has also witnessed substantial progress in regulation and supervision. Financial intermediaries have gradually moved to internationally acceptable norms for income recognition, asset classification, and provisioning and capital adequacy. The past decade was an eventful one for the Indian capital markets. Reforms, particularly the establishment and empowerment of securities and Exchange Board of India (SEBI), marketdetermined prices and allocation of resources, screen-based nation-wide trading, dematerialisation and electronic transfer of securities, rolling settlement and derivatives trading have greatly improved both the regulatory framework and efficiency of trading and settlement. The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) are among the top five exchanges in the world with respect to the number of transactions. The portfolio flows have been one of the major forces that has changed the quantum and nature of international capital flows to India. Portfolio flows include the investment in ADRs/GDRs and offshore funds in addition to investment by Foreign Institutional Investors (FIIs). ALLIANCE BUSINESS SCHOOL
The FIIs are finding good company in domestic Mutual funds (MFs) in terms of inflow in to Indian equity market. The increased MF inflow in the recent past has been supported by the lot of money raised through IPO finding its way to the market.
1.1 Research Motivation
FII has a very short history in India. Prior to 1992, only non-resident Indians (NRIs) and overseas corporate bodies (OCBs) were allowed to undertake portfolio investment in India. All this changed from September 14th, 1992 when in line with the recommendations of the High Level Committee on Balance of Payments ,foreign institutional investors (FIIs) were allowed to invest in the Indian debt and equity markets. Repatriation of income was allowed, the ceilings of FII investments were progressively relaxed, and they have also been allowed in other segments of the market such as Futures and Options. The emergence of Foreign Institutional Investors (FIIs) as a force in India’s capital markets is an important part of the story of economic reforms initiated in 1991.FII inflows and outflows and conditions in the international markets are today constantly monitored for clues to the direction of FII flows into the country. A drying up of inflows is seen as pulling down the stock market and keen interest on the part of FIIs is seen as signalling a rise in stock prices. FII investment is viewed as compensating in some way for the relatively low levels of foreign direct investment (FDI) and as a welcome sign of international interest in the Indian economy. At the same time, there is unease over the impact of volatility in FII flows on the stock market and the Indian economy. In the first year of allowing FII participation in the Indian markets (1992-93), inflows though this route was a mere USD 4 million. This increased to a net
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4 inflow of USD 1.6 bn in the following year. In each of the subsequent years, the net inflows from FIIs have been positive (except for in 1998-99 when there were events such as the Pokhran nuclear detonation, the Kargil tensions etc). The net FII inflow in Indian equities was $8 billion in 2006. SENSEX, India’s benchmark index has been breaking all kinds of records and creating new historical highs and Indian GDP has also been growing at a very good pace. All these can be partially attributed to foreign investors .So this motivated me to carry out the study on Foreign Institutional Investors and their impact on the Indian stock market. This study therefore explores the relationship between the net foreign institutional investment flows and SENSEX, identifying the impact of net FII flows and SENSEX on each other, if any.
1.2 Research Objectives
1.2.1 Statement of the Problem
The stock market is influenced by many factors. Both institutional and individual investors have a critical role to play in the stock market. The volatility in the market is the result of buying and selling pressure on the stocks. The excessive buying pressure results in the bull market and the excessive selling pressure result in bear market. Under these circumstances it may be useful to study the impact of institutional investors on the market. This study basically aims at studying the influence of Foreign Institutional Investors on the Indian stock market.
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3 Scope of the study The rise in equity prices in emerging markets has happened on account of a surge in foreign inflows in recent years. But the scope of the study is limited to the impact of FII investments in equity market. ALLIANCE BUSINESS SCHOOL .5 1. FIIs are understood to play a vital role in Indian stock market.2 Objectives of the study The main objectives of the study is • • To study the impact of FII investments on stock market liquidity To investigate causality between SENSEX and net FII flow 1.2. India has turned out to be one of the favourite markets for the Foreign Institutional Investors (FIIs).2.
The importance of such studies has come to the fore in recent years owing to events like sudden ups and downs in the equity market. Literature Review Linkages between financial markets across geographical boundaries as well as the impact of one market on another have been the object of many studies. FII activity has become more important in the total activity level in the equity market and logically leading to an increase in their ability to swing the market either way.6 2. There have been several studies in the last few years relating to the movement of indices in Indian financial markets with the changes in foreign institutional investment FII. but their influence on the domestic markets is also growing. Only in the recent period of the past 5 years.” Parthapratim Pal (2005) in his detailed study on “Volatility in stock markets in India and FIIs” has concluded that not only are the FIIs major players in the domestic stock market in India. Some studies have suggested that the strengthening of Indian financial markets has been because of the influence of ALLIANCE BUSINESS SCHOOL . But despite the general upward trajectory of the BSE SENSEX there have been some months of correction and such corrections occurred in months with negative FII flows. “The influence of FIIs on the movement of the SENSEX became apparent after the 2004 general elections in India when the sudden reversal of (FII) investment. Pan (2006) certified the positive correlation between BSE SENSEX and FII inflows by analyzing the monthly trend of FIIs inflows and BSE SENSEX and inferred that “The upswings in the FII inflows from around May 2003 have also led to quantum jumps in the BSE SENSEX.
FIIs were net sellers at nearly Rs 9. that Indian equity market returns is an important (perhaps the most important) factor influencing FII inflow.7 FII flows triggered a panic reaction which resulted in very high volatility in the Indian stock market. evidence from causality tests suggests that FII flows to and from the Indian market tend to be caused by return in the domestic equity market and not the other way round. 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.” However a study by Ashok Banerjee & Sahadeb Sarkar (2006) has shown that the FIIs’ participation in the Indian stock market over a period of time has not led to a significant increase in the market volatility. They find. in particular. Chandrasekhar (2005) also suspect that the stock price spiral is largely because of surging FII inflows and is not based on the fundamental strength of the Indian economy or the Indian companies.” In a recent article published by the Market Bureau of the Financial Express. contrary to the general perception of FII activities having a strong demonstration effect and driving the domestic stock market in India. “The dependence of the Indian equity markets on the foreign investors is further proved by the fact that in the period between May 10. Bose and Coondoo (2002). 2006 and June 14.612. 2006. According to Mukherjee. “Movements in the SENSEX during these two years have clearly been driven by the behavior of FIIs.500 crore. the FIIs are perceived to be the drivers of the Indian equity market. when the SENSEX moved from a high of 12. but not influencing FII outflow.928.38 to a low of 8.44. ALLIANCE BUSINESS SCHOOL .
1 The Indian Capital Market . relationships and communication networks for originating and trading financial securities link the participants in the market. intermediaries and regulatory bodies. A financial market consists of investors or buyers of securities. Financial market does not refer to a physical location. which they lend to borrowers in the corporate and public sectors whose requirement of funds far exceeds their savings. Indian financial system consists of money market and capital market. Figure 2: Financial Market Financial Market Capital Market Money Market Financial Institutions Securities Market Secondary Primary Government Securities (Debt and Equity) Corporate Securities (Debt and Equity) Derivative Market ALLIANCE BUSINESS SCHOOL . Normally. borrowers or sellers of securities.An Overview The function of the financial market is to facilitate the transfer of funds from surplus sectors (lenders) to deficit sectors (borrowers).8 3. Formal trading rules. The Indian Capital Market 3. households have investible funds or savings.
The primary market deals with the issue of new instruments by the corporate sector such as equity shares. The organized market is dominated by commercial banks. General Insurance Corporation. But this market is shrinking. The inability of the poor to meet the "creditworthiness" requirements of the banking sector make them take recourse to the institutions that still remain outside the regulatory framework of banking. The secondary market mainly deals with the securities which are previously issued and enables participants who hold securities to adjust their holdings in ALLIANCE BUSINESS SCHOOL . The core of the money market is the inter-bank call money market whereby short-term money borrowing/lending is effected to manage temporary liquidity mismatches. generally less than one year. Life Insurance Corporation. Unit Trust of India. are dealt in this market. Normally. The other major participants are the Reserve Bank of India. In the unorganised market. various public sector industrial units (PSUs). cost (interest rates). Central and State governments. other primary dealers and mutual funds.9 Options Market Futures Market The money market has two components . The unorganised sector continues to provide finance for trade as well as personal consumption. statutory and other authorities such as state electricity boards and port trusts also issue bonds/debt instruments. The Reserve Bank of India occupies a strategic position of managing market liquidity through open market operations of government securities. availability of credit and other monetary management tools. preference shares and debt instruments. monetary assets of short-term nature. The unorganized sector of the money market comprises the indigenous bankers and the moneylenders. Discount and Finance House of India. access to its accommodation. there is no clear demarcation between short-term and long-term finance and even between the purposes of finance.the organised and the unorganised. The capital market consists of primary and secondary markets.
stock brokers (who are members of the stock exchanges). The secondary market has further two components.10 response to changes in their assessment of risk and return. Trades executed on the leading exchanges are cleared and settled by a clearing corporation which provides ovation and settlement guarantee. i. Participants also sell securities for cash to meet their liquidity needs. foreign institutional investors (FIIs) and individual investors. It is a telephone and computer linked network for dealers who do not meet physically. Capital Market Participants: There are several major players in the primary market. The Exchanges don’t provide facility for spot trades in a strict sense. All leading exchanges are regulated and controlled by Securities and exchange Board of India (SEBI). All the 23 stock exchanges in the country provide facilities for trading of equities. Over the counter markets are generally informal markets where trades are negotiated. and individual investors. These include the merchant bankers. mutual funds. foreign institutional investors (FIIs). Closest to spot market is the cash market where settlement takes place after some time. are settled together after a certain time (currently 2 working days). Exchange Traded Market: Exchange traded markets are those markets where trade takes place under certain organized exchange. namely Over-the-Counter (OTC) market and the Exchange-Traded Market. there are the stock exchanges.e. Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) are the major stock Exchanges in India. financial institutions. Most of the trades in government securities are in over the counter market. ALLIANCE BUSINESS SCHOOL . Trades taking place over a trading cycle. a day under rolling settlement. In the secondary market. financial institutions. Registrars and Transfer Agents. Over the Counter Market: OTC is different from the market place provided by the Over the Counter Exchange of India Limited. All the spot trades where securities are traded for immediate delivery and payment take place in OTC market. Nearly 100% of the trades settled by delivery are settled in demat form. the mutual funds.
reduced the risk of credit and also reduced the market. In place of Government Control. The basic objectives of the Board were identified as: • • • • to protect the interests of investors in securities.11 Custodians and Depositories are capital market intermediaries that provide important infrastructure services for both primary and secondary markets. Paradoxically this is a positive outcome of the Securities Scam of 1990-91. margining. to promote the development of Securities Market. SEBI has introduced the comprehensive regulatory measures. Since its inception SEBI has been working targeting the securities and is attending to the fulfillment of its objectives with commendable zeal and dexterity. 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. SEBI In 1988 the Securities and Exchange Board of India (SEBI) was established by the Government of India through an executive resolution. a statutory and autonomous regulatory board with defined responsibilities. The reform process was initiated with the establishment of Securities and Exchange Board of India (SEBI). establishment of clearing corporations etc. and independent powers have been set up. Market Regulation: The financial market in India was highly segmented until the initiation of reforms in 1992-93 on account of a variety of regulations and administered prices including barriers to entry. to cover both development & regulation of the market. prescribed ALLIANCE BUSINESS SCHOOL . The improvements in the securities markets like capitalization requirements. to regulate the securities market and for matters connected therewith or incidental thereto.
credit rating agencies. risk identification and risk management systems for Clearing houses of stock exchanges. In this context the introduction of derivatives trading through Indian Stock Exchanges permitted by SEBI in 2000 is a real landmark Bombay Stock Exchange Bombay Stock Exchange Limited is the oldest stock exchange in Asia with a rich heritage. insurance companies. the eligibility criteria. The Exchange ALLIANCE BUSINESS SCHOOL . mutual funds. The Exchange has a nation-wide reach with a presence in 417 cities and towns of India. 1956. primary dealers etc.12 registration norms. bankers to issue. merchant bankers. 1956. pursuant to the BSE (Corporatisation and Demutualisation) Scheme. which has made dealing in securities both safe and transparent to the end investor. and also to diversify the trading products. portfolio managers. registrars. Popularly known as "BSE". to transact through the Exchanges. surveillance system etc. the Exchange is now a demutualised and corporatised entity incorporated under the provisions of the Companies Act. it was established as "The Native Share & Stock Brokers Association" in 1875. Two broad approaches of SEBI is to integrate the securities market at the national level. underwriters and others. the code of obligations and the code of conduct for different intermediaries like. 2005 notified by the Securities and Exchange Board of India (SEBI). It has framed bye-laws. brokers and sub-brokers. is tracked worldwide. SENSEX. financial institutions. The systems and processes of the Exchange are designed to safeguard market integrity and enhance transparency in operations. It is the first stock exchange in the country to obtain permanent recognition in 1956 from the Government of India under the Securities Contracts (Regulation) Act.The Exchange's pivotal and preeminent role in the development of the Indian capital market is widely recognized and its index. Earlier an Association of Persons (AOP). so that there is an increase in number of traders including banks.
But it had varied effects across the countries. After the opening up of the borders for capital movement these investments have grown in leaps and bounds. Foreign investment provides a channel through which these countries can have access to foreign capital.13 provides an efficient and transparent market for trading in equity. But the foreign portfolio investment is a short-term investment mostly in the financial markets and it consists of Foreign Institutional Investment (FII).2 Foreign Investment Foreign Investment refers to investments made by residents of a country in financial assets and production process of another country. Foreign direct investment involves in the direct production activity and also of medium to long-term nature. debt instruments and derivatives 3. It can affect the factor productivity of the recipient country and can also affect the balance of payments. It can come in two forms: foreign direct investment (FDI) and foreign portfolio investment (FPI). In developing countries there was a great need of foreign capital. Figure 3 schematically shows how foreign portfolio investment can affect the economy through the stock markets. ALLIANCE BUSINESS SCHOOL . not only to increase their productivity of labor but also helps to build the foreign exchange reserves to meet the trade deficit.
Further . Parthapratim Pal. asset management companies. investment trusts. Source: Foreign Portfolio Investment. According to SEBI. nominee companies and incorporated/institutional portfolio managers or their power of attorney holders (providing discretionary and non-discretionary portfolio management services) can make investment in India.FIIs can also make investment in India on behalf of sub-accounts .14 Figure 3: Diagrammatic Representation of how Foreign Funds encourage Domestic Secondary and Primary Market.1 Foreign Institutional Investor Defined A Foreign Institutional Investor or FII is any institution established or incorporated outside India and intends to make investment in India in securities. Stock Market and Economic Development: A Case Study of India.which include foreign corporates or individuals and institutions established or ALLIANCE BUSINESS SCHOOL . 2006 3. FIIs including institutions like pension funds.2.
Overseas Corporate Bodies (OCBs) and Non-Resident Indians (NRI) to invest in the Indian capital market subject to some restrictions.Since then. One of the significant aspects of these reforms was the opening up of Indian capital market to global players. FII investment reduces the required rate of return for equity. through capital flows. In 1995.3 Benefits of FII Investments Reduced cost of equity capital FIIs operating in Indian capital market have eventually assumed a position so vital that its not practical to mention the stock prices without an elaborate discussion about their impact on the cost of equity capital. the Government of India in 1991 took up liberalization and economic reforms. 3. over and beyond the domestic savings. 3. regulations were issued regarding foreign exchange controls in the RBI permitting foreign transactions of FIIs.2. Imparting stability to India's Balance of Payments It becomes imperative for a developing economy like India to have a comprehensive expansion of domestic investment. and fosters investment by Indian firms in the country. the guidelines have been amended from time to time to keep liberalizing the foreign investment further. enhances stock prices. The excess of domestic investment over ALLIANCE BUSINESS SCHOOL .2 Evolution of FII With an intention of having an outward oriented economy that interacts with rest of the world apart from bringing about considerable growth. the Government of India permitted the FIIs. the Finance Ministry came up with guidelines on September 14.2. 1992. For the first time ever. Further the domestic asset management companies or portfolio managers can also register as FII and manage the sub account. the guidelines were suitably incorporated in the regulations and in 2000 when Foreign Exchange Management Act came into force.15 incorporated outside India and funds or portfolios established outside India whether incorporated or not. In consonance with this decision.
Portfolio flows in the equity markets. First. enhance competition in financial intermediation. when adverse macroeconomic news. Knowledge flows The activities of international institutional investors help strengthen Indian finance. unsettles many domestic investors. and international best practices and systems. FII participation in domestic capital markets often lead to vigorous advocacy of sound corporate governance practices. it may be easier for a globally diversified portfolio manager to be more dispassionate about India's prospects. with their vast experience with modern corporate governance practices. debt flows and official development assistance dominated these capital flows. as opposed to debt-creating flows. such as a bad monsoon. FIIs advocate modern ideas in market design. FIIs may act as a channel through which knowledge and ideas about valuation of a firm or an industry can more rapidly propagate into India. at the level of individual stocks and industries. For example. are less tolerant of malpractice by corporate managers and owners (dominant shareholder). promote innovation. Improvements to market efficiency A significant presence of FIIs in India can improve market efficiency through two channels. and lead to spillovers of human capital by exposing Indian participants to modern financial techniques.16 domestic savings result in a current account deficit and this deficit is financed by capital flows in the balance of payments. foreign ALLIANCE BUSINESS SCHOOL . Strengthening corporate governance Domestic institutional and individual investors accept ongoing practices of Indian corporates even when these do not measure up to the international benchmarks of best practices. FIIs. and engage in stabilising trades. improved efficiency and better shareholder value. development of sophisticated products such as financial derivatives. and FDI. Prior to 1991. Second. are important as safer and more sustainable mechanisms for funding the current account deficit.
2. • In line with the foreign exchange controls in force. sell or deal in Indian securities need to obtain a initial registration from the capital market regulator.17 investors were rapidly able to assess the potential of firms like Infosys. affiliates and subsidiary companies of a FII will be regarded as individual FIIs for the purpose of registration. 3. The initial registration issued by SEBI will be valid for a period of 5 years. • The FII can invest in securities traded on the primary and secondary markets including shares. unlisted. The nominee companies. debentures and warrants of companies. FII will have to file with SEBI an application addressing RBI to seek various permissions. • SEBI will grant the initial registration to FII after verifying the track record. professional competency. which are primarily export-oriented. financial soundness. 2000. SEBI. commercial papers and units of mutual funds. • The FIIs inclined to purchase.20 dated May 3. applying valuation principles that prevailed outside India for software services companies. derivatives traded on a recognized stock exchange. listed or to be listed on a recognized stock exchange as well as dated governments securities. The prospective FIIs shall hold a certificate of registration from the stock market regulatory organization in the country of their domicile. the registration needs to be renewed. experiences and other relevant criteria. SEBI acts as the nodal point in the entire process of FII registration. After expiry of 5 years.4 A Gist of the FII Guidelines and Regulations • Investment by FIIs is regulated under SEBI (FII) Regulations. 1995 and Regulation 5(2) of FEMA Notification No. Upon receipt of fees from the applicant and FEMA approval from Reserve Bank of India . SEBI grants the certificate of registration ALLIANCE BUSINESS SCHOOL .
ALLIANCE BUSINESS SCHOOL .18 • There are two categories of FII registered with SEBI 1. Once the aggregate limits or sectoral caps are reached. 2. The RBI grants investment till the aggregate ceiling limit when the link offices approach them on reaching the cut-off mark. Broad-based / Proprietary sub-accounts are allowed to individually invest upto 10% of the total issued capital. • All FIIs and their sub-accounts taken together cannot acquire more than 24% of the paid up capital of an Indian Company. • No individual FII/sub-account can acquire more than 10% of the paid up capital of an Indian company. who can invest only in debt instruments. FIIs with 100% debt funds. Indian Companies can raise the above mentioned 24% ceiling to the Sectoral Cap / Statutory Ceiling by passing a resolution by its Board of Directors followed by passing a Special Resolution to that effect by its General Body. Regular FIIs who can invest 70% of their total investments in equity and equity related instruments and 30% in non-equity instruments. RBI directs the banks not to purchase any shares on behalf of FII/NRI/PIO without its prior approval. • Investments by each sub-account in the category Foreign Corporates and foreign individuals should not exceed 5% of the issued capital • The investment ceilings of FII/NRI/PIO are monitored on a daily basis by the RBI and it has put in place a cut-off point that is 2 percentage less than the ceiling rate.
the FII acts as an exchange by executing and settling the trades. 2006 highest ever single month registrations by the FIIs since their entry into Indian market in 1993. The previous highest was 209 in 2005. This is the highest number of registrations by FIIs in a year till date. In 1993. In the beginning of calendar year 2006. The overseas investor deposits the funds in the European or the US operations of FII who purchase stocks on their behalf. 2006. Underlying securities in Participatory notes are Indian stocks.000 mark.5 FIIs Registered in India The number of Foreign Institutional Investors registered with the Securities and Exchange Board of India (Sebi) crossed the 1. In due course of these transactions. A ‘Participatory Note’ is a derivative instrument issued by FIIs registered in the country to foreign investors who like FIIs are not registered with SEBI but want an exposure to Indian equities. an institutional investor from Switzerland. 3. In a way it is an understanding between a foreign investor who is registered here and the other one who is not registered.19 • No permission from RBI is needed so long as the FIIs purchase and sell on recognized stock exchange.2. ALLIANCE BUSINESS SCHOOL . Pictet Umbrella Trust Emerging Markets’ Fund. The total number of FIIs having their offices in India has increased to 1.030 till December 28. As many as 217 new FIIs opened their offices in India during 2006. All non-stock exchange sales/purchases require RBI permission Of late. was the only FII to enter the Indian market. As many as 37 foreign entities registered with the market regulator till December 28. the figure was 813. FIIs have been investing in Participatory Notes (PNs) also.
35 each from Australia and Hong Kong. 34% France. The number of new registrations with the Sebi increased to 144 in 2004 and 209 in 2005. It can be observed from Figure 4 that out of 1. no new registrations were reported. 73.2. 176. 2% Netherland. 167 from the Great Britain. 35. 32. 3% Australia. 3% Singapore. 7% United Kingdom. 20. an average of 51 new FIIs opened their shops in the country each year.030 FIIs (till December 2006) from 42 different countries.20 While in 1994. 167. 5% Luxembourg. 29 from Ireland. 27. 3% Ireland. 3% Hong Kong. ALLIANCE BUSINESS SCHOOL . 27 from Netherlands. 29. 51 from Singapore. 2% Switzerland . 25 from Mauritius. as many as 388 FIIs are from the US. between 1995 and 2003. 338. 35. 3% Canada.6 Contribution by FIIs Positive tidings about the Indian economy combined with a fast-growing market have made India an attractive destination for foreign institutional investors (FIIs). 25. 16% 3. 32 from Canada. 2% Mauritius. Figure 4: Country wise breakdown of FIIs registered in India Country wise breakdown of FIIs Registered in India Others. 17% USA. 73 from Luxembourg. 51. 22. 22 from Switzerland and 20 from France.
1 10000 935. 34% originate from the US and 16% from the UK. 3. Of the new issuances in FY 2006 FIIs contributed over 75 % of new equity and equity-linked issuances. registered with SEBI as at December 31st.21 The diversity of FIIs has been increasing with over 1030 FIIs from over 30 countries.2 12000 224. The fact that FIIs have always been loyal to the Indian markets can be witnessed by their contribution in all the main rallies since the time the SENSEX touched 5000. Of these.9 13000 1017.Rs 1017.2 9000 420.30 crore.6 11000 550.3 6000 76.7 FII Inflows to India ALLIANCE BUSINESS SCHOOL .9 8000 543.com (20-12-2006) FIIs constituted approximately 11% of the total market and approximately 10% of the total market turnover in FY 2006.6 7000 298. It can be observed from Table 1 that between 5000 and 14000. Recently FIIs from Japan and continental Europe are increasing their India exposure. 2006. FIIs have pumped in money in the range of Rs 76. Evidently FIIs supplement domestic savings and augment domestic investment without increasing foreign debt.2 14000 433. Table 1: FIIs Contribution in major SENSEX rallies FIIs contribution(Rs core) Sensex's milestones FII contribution 5000 76.20 crore.2.2 Source: Moneycontrol.
09 billion from $4 million in 1992. reflecting the strong economic fundamentals of the country. Figure 5: Net FII flows to India ALLIANCE BUSINESS SCHOOL . except for 1998-99. FII net inflows into India have been positive. India is part of this surge.The decline during 1998-99 was due to the nuclear tests and East Asian Crisis but their effects were short lived. FII investment in emerging countries over a period of 10 years is shown in the Table 2 Table 2 :FII Investment in emerging markets(in USD Mn) India Indonesi Korea Phillippines Taiwan Thailand EM Asia a 2006 2579 832 -1741 2191 1117 856 441 86 1595 526 130 1837 -3168 3584 11212 12430 -2015 6875 11238 1197 3314 526 3933 488 355 319 -82 -53 86 -123 400 264 -406 2101 6252 24389 8140 13542 517 8161 5127 8261 749 -227 2194 1448 2976 119 -634 289 -149 -828 -65 679 1811 499 (Excluding Malaysia) 8431 40109 30411 32968 345 18216 17093 13112 5384 3403 13600 YTD 2005 10546 2004 8430 2003 6595 2002 751 2001 2802 2000 1593 1999 1724 1998 -148 1997 1569 1996 3036 (Source: Dalal Street Journal.22 The rise in equity prices in emerging markets has happened on account of a surge in foreign inflows in recent years. as well as confidence of the foreign investors in the growth and stability of the Indian market. Every year since FIIs were allowed to participate in the Indian market.June 26-July9. 2006 has been $49. 2006) It can be observed from Figure 5 that net FII inflows into India increased steadily through the decade of the 1990s to $8 billion in 2006 compared to a record inflow of $10.7 billion in 2005 The cumulative FII inflow till December 31.
The lasting interest implies the existence of a longterm relationship between the direct investor and the enterprise and a significant degree of influence by the investor in the management of the enterprise. and portfolio investment when the acquired stake is less than 10 per cent. While permitting foreign firms/high net worth individuals in February. towards specific objectives in terms of risk. especially small investors. FDI is that category of international investment that reflects the objective of obtaining a lasting interest by a resident entity in one economy in an enterprise resident in another economy. To allay fears ALLIANCE BUSINESS SCHOOL . and maturity of claims.23 Net FII flows to India 50000 40000 Crore(Rupees) 30000 20000 10000 0 -10000 19 92 19 93 93 19 94 94 19 9 5 95 19 96 96 19 97 97 19 9 8 98 19 99 99 20 00 00 20 01 01 20 02 02 20 03 03 20 0 4 04 20 05 05 -0 6 Net . According to EU law. Institutional investors on the other hand are specialized financial intermediaries managing savings collectively on behalf of investors. 2000 to invest through SEBI registered FII/domestic fund managers. returns. foreign investment is labeled direct investment when the investor buys more than 10 per cent of the investment target.2. it was noted that there was a clear distinction between portfolio investment and FDI. The basic presumption is that FIIs are not interested in management control. 3.8 FII versus FDI According to the International Monetary Fund’s Balance of Payments Manual 5.
have a lasting interest in their company and stay with it through thick or thin. it was noted that adequate safety nets were in force. and exit as soon as there is evidence that they will lose money by staying invested in a particular company. There is often a popular preference for FDI over FII on the assumption that FIIs are fair-weather friends. some commentators describe the Indian growth process as an organic one. who come when there is money to be made and leave at the first sign of impending trouble. for example. Finally. This entrepreneur class may prefer to have portfolio investors who share the project and business risk without interfering in the critical management decisions of the company. This preference has a close analogy with the choice between allowing a strategic investor to have management control in a public sector company and allowing a diversified mutual fund to hold a large part of the shares of such a company. if there is intent to encourage FDI. by contrast. Thus. there may be a preference for FII over FDI as far as this class is concerned. While there is some justified strength in this preference. Because of this strength. (ii) every transaction is settled through a custodian who is under obligation to report to SEBI and RBI for all transactions on a daily basis. some further arguments need to be taken into account while exercising the choice.24 of management control being exercised by portfolio investors. are ‘fair-weather’ friends. (i) transaction of business in securities on the stock exchanges are only through stock brokers who have been granted a certificate by SEBI. the strength of domestic home-grown entrepreneurship in India is widely acknowledged. 1997 (iv) monitoring of sectoral caps by RBI on a daily basis. In contrast with the Chinese experience. According to Shah and Patnaik (2004): “Net FDI flows into India have remained small. First. then this constitutes a case for easing restrictions upon FDI-style control oriented purchases by portfolio investors which is done through FII. relatively little FDI has come into ALLIANCE BUSINESS SCHOOL . all portfolio investors. whether domestic or foreign. Second. FDI. (iii) provisions of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations. either when compared with Indian GDP or when compared to global FDI flows.
liquid equity market. and induces smaller net FDI flows. for '05. FIIs formed nearly 70 per cent of foreign investment (FDI plus net portfolio equity flows) flow. ALLIANCE BUSINESS SCHOOL . where difficulties of indirect taxes and transportation infrastructure are less important. Fig. This may be associated with infirmities of Indian indirect taxes and transportation infrastructure. and the relative lack of correlation with the global business cycle. in China and Brazil the percentage was 26 per cent and 30 per cent. Given the size of the Indian economy. Brazil and Russia as FDI. respectively. a major chunk of foreign investment entered China. In addition. While in India.25 India in setting up factories which are 21 parts of global production chains. India’s share in global portfolio flows is higher than India’s share in global FDI flows. However. India is more important as a platform for services production as a part of global production chains. FDI and FII flows (net):1995-96 to 2004-05 Source: Economic Survey 2005-2006 India has one of the highest exposures to FII inflows among other emerging economies. and net portfolio flows are substantial when compared to Indian GDP. services production is less capital intensive. India has fared well in creating the institutional mechanisms of a modern. Indian equities have had low correlations with global risk factors. Unlike India. 6: Total Foreign Investment.
In fact. even with heavy FDI inflows. Brazil and Russia received nearly $15bn of FDI each in ‘05. on the other hand. according to data from the Global Development Finance report ‘06.7% for China. India’s FDI inflows as a percentage of GDP were barely 0. the capital and financial account of both these economies ended in the red in ‘05. however. while India’s current account deficit stood at $13bn. in Russia’s case. With FDI inflows stuck at the $5-6bn range. Russian corporations and banks invested nearly $66bn abroad during the year. while its FDI inflows were barely 2.4% of what was received by emerging economies. Not surprisingly. in Brazil and Russia. there were large commercial borrowings as well as heavy investments abroad by Russian companies. In comparison. received barely $6. which is higher than Brazil and Russia’s growth rate. while Russia received $77bn as private capital inflows. Nearly half of these inflows. forming a substantial portion of the capital inflows. Moreover. were portfolio investments considered volatile by RBI.26 India. it had a large capital account surplus amounting to $26bn. not only are the other three BRIC economies running a surplus in their current account. Recent developments ALLIANCE BUSINESS SCHOOL . the country has been unable to attract larger direct investments inspite of a GDP growth of 8%. Interestingly. India. attracted nearly 20% of the net portfolio investments flowing into developing countries.8% for Brazil and Russia and 2.5bn.8% compared to 1. This is primarily because of the prepayment of debt owed by them to the IMF and the Paris Club. on the other hand. and China received close to $53bn. During January-December ‘05.
This. matters are even more complicated. 2007 edition the government is examining the possibility of redefining foreign investments in companies by removing the distinction between FDI and FII investments. net FDI for 2006-07 would be around $9 billion. for instance.27 According to The Economic Times. are termed as FII. Once the changes are in place. January 12. irrespective of FDI or FII. Institutional investors have an edge over the private investors as they are equipped with the resources to analyze the relevant financial information which enables them to earn higher returns ALLIANCE BUSINESS SCHOOL . the Prime Minister’s Economic Advisory Council (EAC) has projected that for the first time in recent years FDI is likely to exceed FII. January 17. treating all foreign investments.9 Advantages to FIIs 1. as the same when it comes to investment limits and conditions could be seen as a more realistic approach. As reported in Financial Express. while funds from GE are bracketed as FDI. investments by GE Capital. 3. up from $4. According to the EAC.2. the policy would be more in tune with investments in developed countries where the distinctions between FDI and FII are fast disappearing. 2007. At present. despite the fact that GE Capital could be a subsidiary of GE. In such a situation.7 billion last year while FII or portfolio inflows are likely to be $7 billion. And in sectors which have a cap on investments.
monthly market capitalization of BSE. the large volumes of funds permit then them to hold welldiversified portfolios and thereby earn higher returns for less risk. 2. Further. The FIIs often exhibit herd mentality due to which a wrong move by one of the participants could adversely affect the remaining participants too.10 Disadvantages to FIIs 1. The data for the study consists of closing price of SENSEX reported by BSE on a daily basis.28 2. using secondary data only. Data and Methodology The study is empirical in nature.whose interests are different and conflicts with that of the institution. A large part of the FII funds are dealt by agents like domestic depository. monthly net FII flows and daily net FII ALLIANCE BUSINESS SCHOOL . 4. 3.2. designated banks .
β. the linear Granger causality tests were employed. For this purpose. and ε1. One of the objectives of the study was to investigate causality between SENSEX and net FII flow. γ are the parameters to be estimated. inflows minus outflows). Finally. The Economic Times. Moneycontrol . m1 . ε2 are standard random errors with zero mean and constant variance. m′ are the optimal lags chosen by Akaike’s (1969) information criterion.29 flows (i. i =1 j =1 ′ m1 ′ m2 Where ∆S t = S t − S t −1 is the first order forward difference in the daily closing prices of the BSE SENSEX and ∆Ft = Ft − Ft −1 is the first order forward difference in the net FII flows. The study spans for the period from January 2000 to December 2006. BSE. m2 . If the estimated lagged coefficient vector γ1 is statistically ALLIANCE BUSINESS SCHOOL . following Granger (1969). In order to test the significance of γ 1 and γ2. guidelines and enacted investment limit of FII’s from time to time in the capital market.During this period SEBI/RBI initiated various policy initiatives. α. myiris websites and several monthly publication of CMIE Economic Review. F-statistic was employed: ( SSER − SSEUR ) F= (df R − dfUR ) MSEUR The equations above provide a convenient framework for examining linear causality relationships. the orders ′ 2 m1 . The Granger causality tests involve the estimation of the following models: m1 m2 ∆S t = α 1 + ∑ β1i ∆S t −i + ∑ γ 1i ∆Ft − j + ε 1t i =1 j =1 ∆Ft = α 2 + ∑ β 2i ∆Ft −i + ∑ γ 2i ∆S t − j + ε 2t .e.The data source was SEBI.
implying that knowledge of past values of net FII flows improves the predictions of changes in SENSEX. 5. then no causality exists between net FII flows and changes in SENSEX. On the other hand. then it can be inferred that changes in SENSEX Granger cause changes in net FII flows with no feedback (i. Analysis and Interpretation ALLIANCE BUSINESS SCHOOL .e. then it can be inferred that net FII flows Granger cause changes in SENSEX with no feedback (i. while knowledge of past values of changes in net FII flows has no predictive power over changes in SENSEX. If both estimated lagged coefficient vectors γ1 and γ2 are statistically significant. a unidirectional causality exists from net FII flows to SENSEX). if the estimated lagged coefficient vector γ 1 is not statistically significant while the estimated lagged coefficient vector γ2 is statistically significant. if neither estimated lagged coefficient vectors γ1 and γ2 are statistically significant. implying that knowledge of past values of changes in SENSEX improves the predictions of changes in net FII flows. while knowledge of past values of changes in SENSEX has no predictive power over net FII flows. the bi-directional causality exists. implying that knowledge of past values of either variable is useful in the prediction of the other.30 significant while the estimated lagged coefficient vector γ2 is not statistically significant. Finally. a unidirectional causality exists from SENSEX to net FII flows).e.
Indian stock markets witnessed a great fall in the month of May 2006 and FII were net sellers in this month with net sales of US$ 1.45 ALLIANCE BUSINESS SCHOOL . This. with standard deviation Rs 332. leading to net inflows of US$ 10. prices of commodities like steel and aluminium went up. Calendar year 2004 ended with net FII inflows of US$9. The overall mean daily net FII flow was Rs 112.1 Descriptive Analysis The distribution of monthly net FII flows is shown in Figure 7. It can be seen from the graph that the year 2003 marked a turning point in FII investment in India.7 crore. FIIs started the year 2003 in a big way by investing Rs 888. In April 2003.31 5. The buoyant inflows continued in 2005. along with good macroeconomic fundamentals.7 billion during the year.8 crore. However after that the inflows became robust again leading to net inflows of $8 billion in the calendar year 2006. corporate India continued to report good operational results. after reversing direction briefly during the period May -June. increasing FII investment in June 2003 to Rs 2581. Meanwhile.1 crore in January itself. Figure 7: Distribution of Net FII flows (Monthly) 12000 10000 8000 6000 In Rs crore 4000 2000 0 -2000 -4000 -6000 -8000 -10000 Ja n0 1 A pr -0 1 Ju l-0 O 1 ct -0 Ja 1 n0 2 A pr -0 2 Ju l-0 O 2 ct -0 Ja 2 n0 3 A pr -0 3 Ju l-0 O 3 ct -0 Ja 3 n0 4 A pr -0 4 Ju l-0 O 4 ct -0 Ja 4 n0 5 A pr -0 5 Ju l-0 O 5 ct -0 Ja 5 n0 6 A pr -0 6 Ju l-0 O 6 ct -0 6 The distribution of daily net FII flows in the sample period is shown in Figure 8.6 billion. an all-time high since the liberalization. and the descriptive statistics of daily net FII flows is shown in table 1.2 billion. growing industrial and service sectors led FIIs to perceive great potential for investment in the Indian economy. In 2005. FII inflows became robust again.
0 0 .065 .0 .127 -2813.771 332. Also more than 80% of the daily net FII flows was within the range -Rs 750 crore – +Rs 1250 crore.0 . The Indian stock market entered a new ALLIANCE BUSINESS SCHOOL 0 . indicating high variability in daily net FII flows.0 .396 .2 Impact of FII investments on Stock Market Liquidity In recent times.8 3490.0 0 0 0 0 0 N t FI I flo e I n w Table 3: Descriptive Statistics of daily net FII flows N Mean Std.0 .0 .0 .8 N=1 9 . the boom in the Indian stock markets is frequently making headlines in the important newspapers.0 0 .0 . Error of Skewness Kurtosis Std.5 5. Deviation Skewness Std.445 1. with very few extreme values Figure 8: Distribution of daily net FII flows 10 00 80 0 60 0 40 0 20 0 S .0 0 .4 M a =1 2 e n 1 . Error of Kurtosis Minimum Maximum Valid Missing 1493 249 112.063 23.0 43 0 -2 5 7 -2 -1 -1 -7 -2 2 7 1 1 2 2 3 0 5 0 5 5 2 5 7 5 2 5 7 5 2 5 2 5 7 5 2 0 5 0 5 0 .32 crore.0 .0 . D v=3 2 5 td e 3 .
462.03 of 7 December 2006. A major factor that has been driving the SENSEX to new highs has been the increasing liquidity in the Indian stock market. in recent times. the number of FIIs registering with SEBI has gone up sharply from 637 in 2004 to 1057 as on 4 February 2007 resulting in sharp increase in inflows. Market capitalization refers to the value of the stock multiplied by the total number of shares outstanding. This pattern is examined by taking the proportion of FII investments in market capitalization. Infact. The Japanese investors also came to India in 2005 for the first time and have emerged as one of the biggest investors.33 bull phase in November 2004 . The market ended calendar 2006 on a strong note.786.91. Table4:Investment Behavior of FIIs and Market Capitalization Months Net Investment Cumulative Investment BSE Market Capitalization (Rs Cr) 2000 (Rs Cr) X (Rs Cr) Y ALLIANCE BUSINESS SCHOOL . with strong flows from FIIs.77 on 2 February 2007. The increased investment leads to the increased capital employed and vice versa in the short run. The stock market rally was ignited by FII inflows into the equity segment. The net inflows from FIIs during 2007 have been Rs 492. The BSE SENSEX touched a new intra-day record high of 14.403.77 and closed at an all-time closing peak of 14. Their optimism is based on the fact that the Indian economy has been growing at a faster rate and attracting more and more FIIs across the globe.972. less than 200 points off its all time closing high of 13.The BSE SENSEX crossed the 7700 mark in July 2005 and is fully gaining strength.1 crore as on 31 January 2007 and experts believe that this year could see the FII inflows surpassing 2006’s number. The relationship between FII investments and market capitalization indicates the degree of liquidity in the market. with the SENSEX settling at 13.
7 41544.2 61981 64562.8 35619 38330.3 53140.9 92287.2 142.3 11.4 58224.6 39395 42085.9 51378.5 42569.4 437.9 57737.2 69000.7 2346.4 2690.6 54751.5 53884.6 250.3 468.6 -56 -381.4 45816.8 57689.1 240.8 89110.7 40198.1 -952.3 57793.5 -415.4 601.6 -776.7 430.7 150.9 54600.3 722.9 1769.2 58651.3 41771.2 2711.9 41687.2 423.6 41616.6 715.7 66909.5 1819.4 59539.5 715.7 932.9 -1418 1346.5 3300.1 378.5 72851.5 -271.1 1972.5 2091.9 57356.3 1220.5 6161.7 57391 57782.8 52425.9 60760.1 3176.6 -576.4 55424.7 411.3 6797.3 391.9 4045.2 888.2 55001.3 82949.8 57622.8 79649.2 60329.7 927383 1029257 912842 755914 702777 793230 720884 766642 692757 653437 699229 692565 736631 716172 625553 567728 595938 553230 531576 523036 456263 481851 535724 532328 544397 596716 612224 625587 605065 637753 584042 605303 570273 563750 601289 628197 611472 619873 572197 572526 660982 734389 775996 905193 933087 1000494 1065853 1273361 1206854 ALLIANCE BUSINESS SCHOOL .34 January February March April May June July August September October November December 2001 January February March April May June July August September October November December 2002 January February March April May June July August September October November December 2003 January February March April May June July August September October November December 2004 January 151.9 47636 49608.2 58398.7 42348.3 3851.6 53863 54300.3 1966.9 57930.8 427.5 59918.6 1064.9 1046.4 41415.8 2581.5 484.1 333.
1 8376.8 160932 165578.7 186380.6 2892.6 175258.1 -3667.2 186524 193212.6 7587.9 128076.9 516.6 7934.2 -3246.1 9380.4 913.2 479.2 4646.267 3.1 121392.3 198073 206086.5 186860 188005.2 211798.3 7502.8 6688.6 107927.9 165923.1 5051.2 4643.8 136910.246 The following points are observed from the table ALLIANCE BUSINESS SCHOOL .35 February March April May June July August September October November December 2005 January February March April May June July August September October November December 2006 January February March April May June July August September October November December 2397.2 111388.8 457.9 105197.4 94685.3 2385.8 6683.6 3263.8 1196221 1201207 1255347 1023131 1047258 1135589 1216566 1309318 1337191 1539594 1685989 1661533 1730941 1698428 1635766 1783221 1850377 1987170 2123900 2254376 2065610 2323063 2489384 2616193 2695542 3022189 3255565 2842049 2721677 2712143 2993779 3185678 3370674 3577306 3624355 Correlation Rxy Coefficient of Determination (%) t-Test (calculated) t-.9 4038.3 143758.4 7638.3 6740.2 100289.9 -7354.7 155880.8 161884.1 144412.5 1145.2 -654.5 5604.8 114652.9 109003.7 8013.2 192648.05 (table value) 0.3 106110.1 -1140.8 -3693.1 147946.2 142618.7 128533.8 104680.7 9335 3677.1 215466.8 193734.965 93 13.8 521.1 5424.1 5328.6 178936.
9 crore The correlation between FIIs’ cumulative net investment and market capitalization on BSE was recorded 0.965 This highly correlated relation also gives the higher percentage of determination i. 93 % was observed on BSE. The higher percentage of determination explains any change that has been taken place in capital employed was because of the FIIs investment. The optimistic growth rate in the GDP 3. Hence. Implementation of further capital market reform along with liberalization of FII investment in India in different sectors. it says that the capital employed was influenced by FII investments in BSE. The reasons for such enormous enthusiasm of FIIs in the Indian capital market can be on account of the following .36 There has been steady growth in investment by FIIs in India over the years. The Indian capital market is well structured. The highest amount of FIIs’ net investment was Rs 9380.The calculated value of t is greater than the table value.e. The calendar year 2005 has received a historic net inflow from FIIs to the tune of Rs 47181.1 crore and was recorded in the month of November 2006. 2. 4. Japan find India a safe heaven for investment. This is also proved by the t-test . regulated and mature market. 1. The overseas investment companies’ mutual funds – the US. the UK and other European countries. ALLIANCE BUSINESS SCHOOL .
In performing the Granger regressions.66E-16 On the other hand. the restricted vector autoregressive model) yielded the following results: R Square .057299664 Sig.e.06 13096690. Regression of first order difference in SENSEX on its lagged values and on first order difference in daily net FII flows and its lagged values yielded the following results: R Square . regression of first order difference in SENSEX on its lagged values alone (i.23107 8062. as autocorrelations in daily net FII flows and SENSEX were significant up to twenty five lags.3 Granger Causality Test The Granger causality tests were performed to test the direction of causality between daily net FII flows and SENSEX.419053 F 3.109 Adjusted R Square . a lag structure of twenty five lags was chosen. 3.098 Sum of Regression Residual Total Squares 1897990.077 ALLIANCE BUSINESS SCHOOL .145 Adjusted R Square .37 5.792 11198700.86 df 77 1389 1466 Mean Square 24649.
7E-14 The F-test for significance of effect of first order difference in net FII on first order difference in SENSEX yielded: Δ adjusted . 9.036 Critical ΔF value 2.258462082 1. 4.3 df 77 1389 1466 Mean Square F 1297336.82287 Sig.65552 8248. the results of the Granger causality regressions indicate that variation in changes in net FII (and its lagged values) explained 2.021 ΔRsquare .449 ALLIANCE BUSINESS SCHOOL .1% of the variation in changes in SENSEX and it was statistically significant at 5% level of significance.38 Sum of Regression Residual Total Squares 1424565.3E-146 Adjusted R Square .431 11672125.386247673 Sig.329 16.52282605 78517.478 Sum of Regression Residual Total Squares 99894897. Regression of first order difference in net FII on its lagged values and on first order difference in SENSEX and its lagged values yielded the following results R Square .851891 F 3.43 13096690.R square .32 109061256 208956153.86 df 51 1415 1466 Mean Square 27932.503593694 Thus.
292864185 1.503593694 The results of the Granger causality regressions indicate that variation in changes in SENSEX (and its lagged values) explained 6.385 Sum of Regression Residual Total Squares 85006782.4% of the variation in changes in net FII. 3.2E-125 The F-test for significance of effect of first order difference in SENSEX on first order difference in daily net FII flows yielded: Δ adjusted . and this was statistically significant at 5% level of significance Thus it can be concluded that there was bi-directional Granger causality .05 123949371.3 df 51 1415 1466 Mean Square 1666799.0281038 Sig.648 87596. regression of first order difference in daily net FII flows on its lagged values alone yielded the following results: R Square .2 208956153. ALLIANCE BUSINESS SCHOOL .071 table ΔF value 7.064 ΔRsquare .407 Adjusted R Square .7288 F 19.39 On the other hand.R square .
The overall mean daily net FII flow was Rs 112. The higher percentage of determination explains any change that has been taken place in capital employed was because of the FIIs investment.4% of the variation in changes in net FII. • The results of the Granger causality regressions indicate that variation in changes in SENSEX (and its lagged values) explained 6. and this was statistically significant at 5% level of significance ALLIANCE BUSINESS SCHOOL . with very few extreme values • • The correlation between FIIs’ cumulative net investment and market capitalization on BSE was recorded 0. • The results of the Granger causality regressions indicate that variation in changes in net FII (and its lagged values) explained 2.1% of the variation in changes in SENSEX and it was statistically significant at 5% level of significance.40 6.e.965 This highly correlated relation also gave the higher percentage of determination i. Findings • • The FII investments in Indian equity market have shown a fluctuating trend year after year. 93 % was observed on BSE.8 crore and more than 80% of the daily net FII flows was within the range -Rs 750 crore – +Rs 1250 crore.
Hence there is a great need to understand the behavior of these flows to minimize the impact of this on the real economy. changes in daily net FII flows tend to cause changes in SENSEX. A number of studies in the past have observed that investments by FIIs and the movements of SENSEX are quite closely correlated in India and FIIs wield significant influence on the movement of SENSEX (Pan 2006). The worst-case scenario where foreign institutional investors suddenly remove their capital overnight from Indian capital markets is of course a serious threat. The results of the Granger causality tests indicate that there is bidirectional Granger causality from changes in daily net FII flows to changes in SENSEX in the short run. 2001” also observes that FIIs have a disproportionately high level of influence on the market sentiments and price trends. Conclusion After the initiation of economic reforms in the early 1990s. the movement of foreign capital flow has increased tremendously. and would undoubtedly have drastic consequences for Indian capital markets ALLIANCE BUSINESS SCHOOL . A note by National Stock Exchange “Indian Securities Markets: A review Vol IV. This increase in capital movement would be expected to have very significant impact on the domestic real economy.41 7. and vice versa. This is so because other market participants perceive the FIIs to be infallible in their assessment of the market and tend to follow the decisions taken by FIIs. that is. in the short run. This ‘herd instinct’ displayed by other market participants amplifies the importance of FIIs in the domestic stock market in India.
42 and the Indian economy as a whole. • FII investments in debt market has not been considered. . There is possibly a need to gear up macro-economic policies to target other form of foreign investments into the economy and reduce the over-reliance of the economy on portfolio flows. Scope for Further Research: The increasing role of foreign institutional investors in the capital market can be further analyzed and the effect of FIIs inflows can be extended to economic variables like exchange rate. Therefore. Limitations: • • The study is based on the secondary data only. Also understanding the determinants of FII will help in predicting the behavior. The study is restricted to the impact of FII flows on SENSEX only and its effect on S&P CNX Nifty and macro economic variables such as exchange rate has not been considered. which is very important for any emerging economy as it would have larger impact on the domestic financial markets in the short run and real impact in the long run. ALLIANCE BUSINESS SCHOOL . the priority should be to stabilize domestic markets so that any outflow from the country would not lead the economy in the situation of crises (like East Asian crises).
June). The ICFAI University Press. Portfolio Organiser. (2006. December). and Reddy. “FIIs Rocking the Indian Stock Market?” ICFAI Reader.K. June) Foreign Institutional Investors in the Indian Markets. “Foreign Institutional Investors Back in Action”. Portfolio Organiser. 25-33 Pal. P. “Foreign Portfolio Investment. The ICFAI University Press.S. B. (2006. 35-39 Gangadhar. The ICFAI University Press. “The Slowdown of FIIs”. “The Reality Behind the 13K Rally”.org/ideas/policy_library/data/01408 Pan. V.J.K. NCFM Handbook for NSDL Depository Operations Module Articles/Journals Kumar. G. (2006. V. October). (2004) Economic Environment of Business NSE.. December). (2006. S. (2006).policyinnovations. S. Stock Market and Economic Development: A Case Study of India” http://www. 21-23 Neeraja. I. and Puri. The ICFAI University Press.N. K. “Foreign Institutional Investment: bane or boon?” MEDC Banking & Finance Krishnan. 25-31 Sandilya. (2006. MEDC – Banking and Finance ALLIANCE BUSINESS SCHOOL . August). (2006. Portfolio Organiser. S. R.43 References Books Misra.
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