FIIs and their influence on Indian Capital Markets (1) Foreign Institutional Investor [FII] is used to denote an investor

- mostly of the form of an institution or entity, which invests money in the financial markets of a country different from the one where in the institution or entity was originally incorporated. Institutional investors include hedge funds, insurance companies, pension funds and mutual funds. The term is used most commonly in India to refer to outside companies investing in the financial markets of India. International institutional investors must register with the Securities and Exchange Board of India to participate in the market. One of the major market regulations pertaining to FIIs involves placing limits on FII ownership in Indian companies. (2)The growth of institutional investors in the market -advantages & problems almost always purchase stocks on the basis of fundamentals. This means that it is essential to have information to evaluate, research becomes important companies become more transparent and more disclosures. reduction in information asymmetries that plagued the Indian markets for quite a while. reform of securities trading and transaction systems, nurturing of securities brokers, and liquid markets. If we see the numbers of FII flows, It is increasing every year :

On the flip side there are always some dangers if certain limits are exceeded. Increased volatility The foreign capital is freely available and unpredictable too therefore they (FIIs) are always on the look out for profits. Flls frequently move investments, and those swings can be expected to bring severe price fluctuations resulting in increased volatility. Here we analyze the comparative trend of sensex and FII, how it affected the market, Here the grey curve shows sensex indices and black curve shows the FII cash flow, Here we can see how FII cash inflows increases the market indices and cash outflows decreases the Indian stock market indices.The simple economics of demand and suplu works here too.

This is the way FII is supplementing volatility in Indian market. This is what has happened in immediate recent past. Secondly, increased investment from overseas results in shift of control of domestic firms to foreign hands. This has showed us how the Indian market has been influenced by global markets like U.S., Europe and other asian markets. This was exactly the same as happened in current scenario, U.S. and other market meltdown directly impacted on Indian market. The FII are taking out the money and the impact is for all of us to see. As per the current guidelines of the RBI,FII can invest upto 24% in a company but if they want further investment they need special approval from the company's board and in any case cannot go beyond the foreign investment cap for the sector, set by the government. Even for sectors like insurance, where the government is considering raising the foreign investment cap to 49% as against 26% at present, there is ambiguity about whether FII investment should be allowed in it. FII can invest in all the securities traded in the primary and secondary markets. These include shares, debentures, warrants, and the schemes floated by domestic Mutual Funds. (3)GENERAL POINTS ABOUT FII: An application for registration has to be made in Form A, the format of which is provided in the SEBI(FII) Regulations, 1995 and submitted with required documents in duplicate addressed to SEBI as well as to Reserve Bank of India (RBI) As per Regulation 6 of SEBI (FII) Regulations,1995, Foreign Institutional Investors are required to fulfill the following conditions to qualify for grant of registration. The applicant is required to have the permission under the provisions of the Foreign Exchange Management Act, 1999 from the Reserve Bank of India. For granting registration to the FII, SEBI shall take into account the track record of the FII, its professional competence, financial soundness, experience and such other criteria that may be considered by SEBI to be relevant. SEBI and RBI initial registration is valid for five years. Both are renewable for another five years.

A registered FII would be expected not to engage in any short selling of securities and to take delivery of purchased and give delivery of sold securities.In other words only cash transactions will be permitted. Applicant must be legally permitted to invest in securities outside their country of origin or its in-corporation / establishment. Reserve Bank of India may at any time request by an order a registered FII to submit information regarding the records of utilization of the inward remittances of investment capital and the statement of securities transactions FII can transfer sums from the foreign currency accounts to the rupee account and vice-versa, at the market rate of exchange.

International institutional investors must register with the Securities & Exchange Board of India (SEBI) to participate in the market. One of the major market regulations pertaining to FIIs involves placing limits on FII ownership in Indian companies. They actually evaluate the shares and deposits in a portfolio. The major source (almost 50%) of money the FIIs invest is from the issue of Participatory Notes (P-Notes) or what are sometimes called Offshore Derivatives. As on September 5,2008 there were over 1484 FIIs and 38 foreign brokers registered with Securities & Exchange Board of India (SEBI). We are also examining whether market movement can be explained by these investors. We often hear that whenever there is a rise in market, it is explained that it is due to foreign investors' money and a decline in market is termed as withdrawl of money by FIIs. Usually, the mode of operations of FIIs is borrowings from countries where interest is low (like Japan) and invest in booming markets like India. But the sub-prime crisis and other economic conditions had caused a liquidity crunch for these institutions. They were forced to withdraw money from Indian market to repay loans they had taken. These withdrawals had caused panic in market, and even domestic Players were seen offloading their portfolios. The FII's increased role had changed the face of Indian stock market. It brought, both, quantitative and qualitataive change. It had also increased the market depth and breadth. The emphasis on fundamentals caused efficient pricing of shares. Since there is no obligation on FIIs to disclose their investments, those figures are not available. Many qualitative tests like regression tests had proved that there is direct relation between market movements and fund flows of FIIs. In this, we will analyze the investments in different months and years, and tries to find the impact of FIIs in stock market. History of FII After 1991, due to our liberalization process, there was large flow of foreign funds from abroad. Current investments by FII is Rs. 2,55,464.40 Crores as compared to Rs. 2,83,468.40 Crores by the end of 31 December 2007. That implies that they had withdrawn almost 9% of money they had deposited till December 2007. The amount was much in the months of 2008 as compared to corresponding months of 2007, and that is a reason for the volatility of the stock

market. In 2008, the net buying is only Rs. 5,603 Crores compared to Rs. 36,869 Crores in 2007.From all this, we can see how FII's influence market. India opened its stock market to foreign investors in September 1992, and in 1993, received portfolio investment from foreigners in the form of foreign institutional investment in equities. This has become one of the main channels of FII in India for foreigners. Initially, there were many terms and conditions which restricted many FIIs to invest in India. But in the course of time, in order to attract more investors, SEBI has simplified many terms such as: The ceiling for overall investments of FIIs was increased 24% of the paid up capital of Indian company. Allowed foreign individuals and hedge funds to directly register as FIIs. Investment in government securities was increased to US $ 5 Billion. Simplified registration norms. P-Notes (Participatory Notes) are instruments used by foreign investors that are not registered with the SEBI (Securities & Exchange Board of India) to invest in Indian stock markets. For example, Indian-based brokerages buy India-based securities and then issue Participatory Notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors. That is why they are also called Offshore Derivative Instruments. Trading through Participatory Notes is easy because participatory notes are like contract notes transferable by endorsement and delivery. Secondly, some of the entities route their investment through Participatory Notes to take advantage of the tax laws of certain preferred countries. Thirdly, Participatory Notes are popular because they provide a high degree of anonymity, which enables large hedge funds to carry out their operations without disclosing their identity. The first question that we need to ask is the necessity of FIIs as an instrument for investment into India. This is not a common place of markets; if, for example, a nonresident of the US or of England chooses to invest in an American or an English or a German stock, he does not have to hold his investment indirectly through an FII, but can hold it directly in his own name. . FIIs serve no economic purpose but they provide a bureaucratic layer between a foreign investor and the regulator. It is a good example of obscuring the true character of foreign investment in India through a non-transparent and expensive setup. The P-Note is an additional twist in this indirect investment as it enables those who wish to invest in the Indian market to do so without disclosing their identity. (4)(i) Influence of FIIs on Indian Stock Market The current investments of FIIs is Rs. 2,55,464.40 Crores. This is almost 9% of the total market capitialisation. The major impacts are: -

They increased depth and breadth of the market. They played major role in expanding securities business. Their policy on focusing on fundamentals of the shares had caused efficient pricing of shares. These impacts made the Indian stock market more attractive to FIIs and also domestic investors, which involves the other major player MF (Mutual Funds). The impact of FIIs is so high that whenever FIIs tend to withdraw the money from market, the domestic investors become fearful and they also withdraw from market. Just to show the impact, we analyze below the 10 biggest falls of stock market: Day (Points Loss in Gross Purchases (Rs. Gross Sales (Rs. Net Investments (Rs. Sensex) Crores) Crores) Crores) 21/01/2008 (1408) 3062.00 1060.30 2001.80 22/01/2008 (875) 2813.30 1618.20 1195.10 18/05/2006 (856) 761.80 527.40 234.40 17/12/2007 (826) 670.00 869.00 -199.00 18/10/2007 (717) 1107.00 1372.50 -265.50 18/01/2008 (687) 1077.20 1348.40 -271.20 21/11/2007 (678) 640.70 791.80 -151.10 16/08/2007 (643) 989.50 750.30 239.20 02/08/2007 (617) 534.50 542.00 -7.50 01/08/2007 (615) 809.40 956.90 -147.50 Note:Table made in the order of loss of sensex points. Major Intra Day Collapses in BSE Sensex From above table, we can see that the major falls are accompanied by the withdrawal of investments by FIIs. Take the case on January 18, 2008, the Sensex lost almost 687 points. Here, the net sales by FIIs was Rs. 1348.40 Crores. This is a major contributor to the fall on that day. But contrary to that day, take the case on January 21, 2008, the Sensex lost 1408 points and the gross sales was Rs. 1060.30 Crores and the purchases were Rs. 3062.00 Crores. So this can be concluded that after the fall of market, FIIs had invested again into the market. From this, we can see the effect of FIIs. % Change Year Gross Purchases Gross Sales Net Investment 2003 2004 2005 2006 2007 94410.5 185671.5 286020.5 475622.5 814877 63951.8 146706.4 238839.4 439082.8 743390.7 30458.7 38965.1 47181.2 36539.7 71486.5 0 27.92765 54.90221 19.96474 134.6998

2008 (10/08/08)

560480.9

589650

-29169

-195.766

From the graph above,we analyze the net investments' graph from 2003 to 2008. From this, we can see that there is a constant increase in net investments till 2005 and there was small decrease in investments in the year 2006. But there was a steep increase in the year 2007-08. This was the best period in Indian stock market where stock prices were at peak and the market was in good mood. When we take the investments in 2008, the net investments is negative. And we know the market is volatile in this year. So we find that there is direct relation between net investments and movement of stock market. FIIs Gross Purchases & Sales from 2003-08

Now this graph represents the relation between gross purchases and gross sales. We can see from the graph that gross purchases are increasing from 2003 to 2007 and gross sales are lower than gross purchases. So we conclude that this caused the market to reach the magical figure of 21,000 in Sensex. But when we look at the year of 2008, the involvement of FIIs is reduced, and we can also find in this year the gross sales is higher than gross purchases. This analysis also indicates the impact of FIIs in markets. FII's Percentage Change in Investment (Here we are taking 2003 as the base year and calculating the percentage change for

remaining years.)

In this graph, we took the base year as 2003 and the trends of the investments by FIIs are plotted. We can see from the graph that till 2007, the investment is more than that of 2003, and the most interesting thing is that when we look at 2008, the percentage change in investments is much lower than 2003, even going to the negative side. This finding also leads to our conclusion that the FII's impact on stock market is high. (5) Conclusion From all the above discussions and data analysis, we conclude that FII has a major impact in Indian stock market. Particularly, the fall on October 17, 2007, in which just a speculation about governments plan to control P-Notes had caused the biggest fall in Indian stock market, even market had to be closed for one hour without trading. The impact is that even the domestic players and MFs also follow a close look on FIIs. So if FIIs are confident about Indian markets, there is a general perception that market is on the rise. We had also found that the major (almost 50%) of FIIs' investments are from P-Notes. So it implies that major forces behind the FII investments are anonymous. This has a negative impact on stock market. Because money launders use this facility to pump money to Indian market and their sudden withdrawal causes volatility in markets.

From the above graphs , we can see that the major falls in stock market is accompanied by the withdrawal of money by FIIs. So there is a direct relation between the FII's money flow and the movement of sensex. The biggest fall in stock markets occurred in 2007 and 2008. This means the volatility of market is more during this period.There was an increase in registration of FIIs and the investments reached almost Rs. 283468.40 Crores by the end of 2007. The present situation is that the investments have reduced by 9% to 255464.40 Crores as on September 5,2008. So this reduction is also one cause of volatailty. In 2008, the net buying was only Rs. 5603 Crores compared to Rs. 36,869 Crores in 2007. Hence we have seen that FIIs also influence the markets in a major way.