Definition of 'Foreign Institutional Investor - FII' 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. Investopedia explains 'Foreign Institutional Investor - FII' 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. The term foreign institutional investment denotes all those investors or investment companies that are not located within the territory of the country in which they are investing. These are actually the outsiders in the financial markets of the particular company. Foreign institutional investment is a common term in the financial sector of India. The type of institutions that are involved in the foreign institutional investment are as follows:
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Mutual Funds Hedge Funds Pension Funds Insurance Companies

The economies like India, which are growing very rapidly, are becoming hot favorite investment destinations for the foreign institutional investors. These markets have the potential to grow in the near future . This is the prime reason behind the growing interests of the foreign investors. The promise of rapid growth of the investable fund is tempting the investors and so they are coming in huge numbers to these countries. The money, which is coming through the foreign institutional investment is referred as 'hot money' because the money can be taken out from the market at anytime by these investors.

The foreign investment market was not so developed in the past. But once the globalization took the whole world in its grip, the diversified global market became united. Because of this the investment sector became very strong and at the same time allowed the foreigners to enter the national financial market. At the same time the developing countries understood the value of foreign investment and allowed the foreign direct investment and foreign institutional investment in their financial markets. Although the foreign direct investments are long term investments but the foreign institutional investments are unpredictable. The Securities and Exchange Board of India looks after the foriegn institutional investments in India. SEBI has imposed several rules and regulations on these investments. Some important facts about the foreign institutional investment:
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The number of registered foreign institutional investors on June 2007 has reached 1042 from 813 in 2006 US $6 billion has been invested in equities by these investors The total amount of these investments in the Indian financial market till June 2007 has been estimated at US $53.06 billion The foreign institutional investors are preferring the construction sector, banking sector and the IT companies for the investments Most active foreign institutional investors in India are HSBC, Merrill Lynch, Citigroup, CLSA Foreign Institutional Investment Changes to the SEBI (Foreign Institutional Investors) Regulations, 1995 In 1996-97, several changes have been made to the SEBI (Foreign Institutional Investors) Regulations, 1995 to diversify the foreign institutional investor base and to further facilitate inflow of foreign portfolio investment. The changes have also aimed at facilitating investment in debt securities through the FII route. The changes are as follows:

the eligible categories of FIIs have been expanded to include university funds, endowments, foundations, charitable trusts and charitable societies which have a track record of 5 years and which are registered with a statutory authority in their country of incorporation or establishment

subject to the overall limit of 24% on investments by all FIIs. NRIs and OCBs the 24% limit may be raised to 30% in the case of individual companies who have obtained shareholder approval for the same FIIs have been permitted to invest in unlisted securities FIIs have been allowed to invest their proprietary funds FIIs who obtain specific approval from SEBI have been permitted to invest 100% of their portfolios in debt securities. The foreign participation in financial services requires the approval of FIPB. At the end of 1996-97 there were no applications for FII registration pending with SEBI and RBI. In order to simplify the FII registration process. Further details are given in Part II of this Report. traded and settled overseas. Foreign financial services institutions have also been allowed to set up joint ventures in stock broking. each FII or sub-account of an FII has been permitted to invest upto 10% of the equity of any one company. Such investment may be in listed or to be listed corporate debt securities or in dated government securities.     The impact of these changes was felt as several endowment funds. proprietary funds and 100% debt funds of FIIs obtained registration. or only by the RBI depending the size of investment and the industry in which this investment is to be made. may also invest in Indian securities outside the FII route. whether registered as FII or not. the FIPB announced guidelines for foreign investment in the non-banking financial services sector. and is treated to be part of the overall limit on external commercial borrowing. Such investment requires case by case approval from the Foreign Investment Promotion Board (FIPB) and the RBI. . In 1996-97. asset management companies. Foreign Currency Convertible Bonds and Foreign Currency Bonds issued by Indian issuers which are listed. Foreign investment in Indian securities has also been made possible through the purchase of Global Depository Receipts. merchant banking and other financial services firms along with Indian partners. Foreign investors. SEBI and RBI set up a co-ordination committee.

are also eligible to be registered as FIIs:     Asset Management Companies Institutional Portfolio Managers Trustees Power of Attorney Holders Q1. following entities proposing to invest on behalf of broad based funds. What is a sub-account? . university fund. FII means an entity established or incorporated outside India which proposes to make investment in India. charitable fund.Highlights of New Rules     New norms to come into effect from tomorrow Unregulated pension fund. Q2. Who is a Foreign Institutional Investor (FII)? Ans. endowments etc to be treated as FIIs No dilution of know-your-customers norms for registration of FIIs to prevent money laundering FIIs to be registered on a permanent basis instead of earlier practice of renewing registration every three years Foreign Institutional Investor (FII) Foreign Institutional Investors (FII) include the following foreign based categories:           Pension Funds Mutual Funds Investment Trust Insurance or reinsurance companies Investment Trusts Banks Endowments University Funds Foundations Charitable Trusts or Charitable Societies Further.

Sub-account includes those foreign corporations. 2. Designated Bank means any bank in India which has been authorized by the Reserve Bank of India to act as a banker to FII. Broad Based Fund means 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. Provided further that if the fund has an institutional investor holding more than 10% of shares or units in the fund. 5. Following entities / funds are eligible to get registered as FII: 1. Q4. What is a Designated Bank? Ans. foreign individuals. then the institutional investor must itself be broad based fund. Who can get registered as FII? Ans. Q5. 3. Q3. funds or portfolios established or incorporated outside India on whose behalf investments are proposed to be made in India by a FII. What is a Broad Based Fund? Ans. FII REGISTRATION Q6. 4. Who is a Domestic Custodian? Ans. Provided that if the fund has institutional investor(s) it shall not be necessary for the fund to have twenty investors. Domestic Custodian means any entity registered with SEBI to carry on the activity of providing custodial services in respect of securities.Ans. Pension Funds Mutual Funds Insurance Companies Investment Trusts Banks . and institutions.

general reputation of fairness and integrity. 4. experience. Which form needs to be filled in when applying for FII registration? Ans. are also eligible to be registered as FIIs: 1. Q9. What are the parameters on which SEBI decides FII applicants‟ eligibility? Ans. 9. Asset Management Companies Institutional Portfolio Managers Trustees Power of Attorney Holders Q7. 1995. Article of Association or Article of Incorporation. Whether the applicant is a fit & proper person. How much is the fee for registration as FII? . Audited financial statement and annual report for the last one year (period covered should not be less than twelve months Q10. whether the applicant is registered with and regulated by an appropriate Foreign Regulatory Authority in the same capacity in which the application is filed with SEBI c. a. "Form A" as prescribed in SEBI (FII) Regulations. financial soundness. 3. 7. University Funds Endowments Foundations Charitable Trusts / Charitable Societies Further. professional competence. 8.6. Which documents need to be sent with "Form A"? Ans. Applicant‟s track record. b. 2. Q8. following entities proposing to invest on behalf of broad based funds. (The applicant should have been in existence for at least one year) b. Certified copy of relevant clauses (clauses permitting the stated activities) of Memorandum of Association. a.

seven days shall be counted from the days when all necessary information sought. Q11. reaches SEBI. SEBI seeks comments from the Reserve Bank of India (RBI). 7 working days would be counted from the day no objection is received from RBI.000 needs to be paid for renewal of FII registration. However. US $ 5. the registration needs to be renewed. in cases where the information furnished by the applicants is incomplete.000. Demand Draft in favour of "Securities and Exchange Board of India" payable at New York Q13. When is the registration fee payable? Ans. . Q17. Along with "Form A" and all the relevant documents. What is the validity period of FII registration? Ans. In such cases. Is there any renewal fee? Ans. What is the mode of payment? Ans. What is the registration process for FII? Ans.Ans. The FII registration is valid for 5 years. Q12. US $ 5. Same as initial registration. Q14. In cases where the applicant is bank and subsidiary of a bank. Q16. Q15. At the time of submitting the application for registration. How many days it takes to get registered as FII? Ans. Please contact us for registration. the applicants are required to fill in additional form (Annexure 1) while applying for renewal. After expiry of 5 years. Yes. What is the process of renewal? Ans. SEBI generally takes seven working days in granting FII registration.

The FII registration application should be sent to: Securities Division Mittal 224. Q19. When the application for renewal should be submitted Ans. Nariman 400 of First India Custodian Floor Point 021 Note: In case the applicant is a ‘Bank’ or "Subsidiary of a Bank" then the application form and relevant documents need to be submitted in duplicates. 100 % debt FIIs are debt dedicated FIIs which invest in debt securities only. Foreign Individuals . Proprietary fund of FII. Who can get registered as sub-account? Ans. c. Q20. under 100% debt route is similar to that of normal funds besides a clear statement by the applicant that it wishes to be registered as FII/sub-account under 100% debt route. Three months before expiry of the FII registration. Mumbai India and of Court Exchange Board FII & "B" Wing. What are 100 % debt FIIs/sub-accounts. and what is the process for their registration? Ans. a. Institution or funds or portfolios established outside India. The procedure for registration of FII/sub-account. whether incorporated or not. b. Where the application for FII registration should be sent? Ans.Q18. Foreign Corporates d. SUB-ACCOUNT REGISTRATION Q21.

Demand Draft in the name of "Securities and Exchange Board of India" payable at New York Q28. None Q25. Q24. US $ 1. Q23. When is the registration fee payable? Ans. The FII should apply on the behalf of the Sub-account. Same as initial registration. What is the validity period of sub-account registration? Ans. reaches SEBI. What is the mode of payment? Ans. . Q29. three days shall be counted from the days when all necessary information sought. What is the process of renewal of sub-account? Ans. What documents need to be sent with Annexure A? Ans. Which form needs to be filled when applying for sub-account registration? Ans. However.000 Q26. Q30. SEBI generally takes three working days in granting FII registration. How many days it takes to get a sub-account registered? Ans. Who need to apply for sub-account registration? Ans. Both the FII and the Sub-account are required to sign the Sub-account application form. The validity of sub-account registration is co-terminus with the FII registration under which it is registered.Q22. At the time of submitting the application. How much is the fee for sub-account registration? Ans. in cases where the information furnished by the applicants is incomplete. "Annexure B" to "Form A" (FII application form). Q27.

Is there renewal fee? Ans. Yes. the FII would be required to send a request for cancellation of its registration or registration of its Sub-account/s clearly mentioning the name and registration number of the entity. .000 Q32. POST-REGISTRATION PROCESSES Q33. What is the procedure for change of domestic custodian? Ans. the request should be accompanied with documents from home regulator and registrar of the company evidencing approval of name change. It should also mention the reasons for the name change and give an undertaking that there has been no change in beneficiary ownership. What is the procedure in case the FII/sub-account changes its name? Ans. Q35. Yes. If a registered FII/sub-account undergoes name change. The transferor FII should also submit a No-objection certificate.Q31. along with no-objection certificate from existing domestic custodian. Q36. The FII should ensure that it / Sub-account has nil cash / securities holdings. No. then the FII need to promptly inform SEBI about the change. The FII to whom the Sub-account is proposed to be transferred has to send a request along with a declaration that it is authorized to invest on behalf of the Subaccount. In case of name change of FII. What is the procedure for transferring a sub-account from one FII to another? Ans. Q34. The FII should send a request. and the original FII registration certificate issued by SEBI should be sent back for necessary amendment. for change in domestic custodian. Can OCBs / NRIs permitted to get registered as FII/sub-account? Ans. they are not permitted. Can FII/sub-account registration be cancelled on request? Ans. US $ 1.

And thus.Foreign Institutional Investments (FIIs) in India and the Related Laws In present era of globalization no country or economy has been left untouched from international trade and commerce. foreign direct investment pertains to international investment in which the investor obtains a lasting interest in an enterprise in another country. Basically foreign investment can be made through following routes: Foreign Direct Investment (FDI)  Foreign Portfolio Investment (FPI). these have grown in leaps and bounds.” Foreign investments provide a channel through which one can have access to foreign capital and after the opening up of the Indian economy. During the past few years. today most of the market entities are interested in attracting foreign capital as it not only helps in creating liquidity for the firms stock and the stock market but also leads to lowering of the cost of the capital for the firms and allows them to compete more effectively in the global market place. plants or equipments and thus  . More access to international capital markets and foreign investments has helped developing countries surmount their less developed capital markets. Foreign Investment It has been defined as “a transfer of funds or materials from one country (called capital exporting country) to another country (called host country) in return for a direct or indirect participation in the earnings of that enterprise. a flow of capital has been seen from the developed part of the world to the less developed economies which has led to decrease in the vulnerability of developing countries to financial crisis by reduction in their external debt burden from 39% of gross national income in 1995 to 26% in 2006 and increase in foreign exchange reserves to 92% of long term debt and 423% of more volatile short term debt in 200 Over the years same scenario has been witnessed in the Indian economy also. Mostly it takes the form of buying or constructing a factory in a foreign country or adding improvements to such a facility in form of property.  Private Equity investments-Foreign venture capital investor(FVCI) Firstly.

” Thus it was decided to open up the economy. Thirdly. On the other hand. That low point was the catalyst required to transform the economy through badly needed reforms to unshackle the economy. state monopolies broken.4 percent in 1985-86 and to 12. non resident Indian (NRI) and persons of Indian origin (PIO). One of its recommendation included developing an active . Controls started to be dismantled.2 bn which could barely finance 3 weeks‟ worth of imports. the committee on “the reforms of the financial system” under the chairmanship of Mr M. Narsimham Rao was made which sought for reforms in the financial sector. generally long term in nature. In return for an IMF bailout. a foreign portfolio investment is a shortterm to medium.0% of GDP in 1980-81 to 10. Consequently. the internal debt of the government accumulated rapidly. but the speed is often held hostage by coalition politics and vested interests. And India had to pledge its gold reserve with IMF to secure a loan of just US $457 mn. BACKGROUND In the late 1980s India suffered an acute financial crunch. The reforms process continues today and is accepted by all political parties. the economic policies were liberalized and private sector was given the freedom to participate in the Indian economy more effectively. At that time Indian foreign exchange stood at mere US $1. the economy was opened to trade and investment. Since these deficits had to be met by borrowings.term investment mostly in the financial markets and is commonly made through foreign Institutional Investors (FIIs). According to India Report. The Indian market was integrated with the world economy and international investors were invited to participate in India. a private equity investment is one made by foreign investors in Indian Venture Capital Undertakings (VCU) and Venture Capital Funds (VCF). the rupee devalued and economic reforms were forced upon India.private sector enterprise and competition were encouraged and globalization was slowly embraced. The gross fiscal deficit of the government rose from 9. duties and taxes progressively lowered. Astaire Research “A Balance of Payments crisis in 1991 pushed the country to near bankruptcy. gold was transferred to London as collateral. rising from 35% of GDP at the end of 1980-81 to 53% of GDP at the end of 1990-91.7% in 1990-91.

A domestic portfolio manager can also register as FII to manage the funds of the sub-accounts. India has developed a framework through which foreign investors participate in the Indian capital market. Some of the big American mutual funds are fidelity. listed non convertible debentures/bonds issued by Indian company and schemes of mutual funds but the sale should be only through recognized stock exchange. mostly in 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 the entity is originally incorporated. They are permitted to trade in securities in primary as well as secondary markets and can trade also in dated government securities. As a result of this. These also include domestic asset management companies or domestic portfolio managers who manage funds raised or collected or bought from outside India for the purpose of making investment in India on behalf of foreign corporate . FOREIGN INSTITUTIONAL INVESTORS The term „FII‟ is used to denote an investor. Merrill lynch.And thus this reform paved way for foreign investments which were at that time the need of the hour. Indian stock market witnessed metamorphic changes and a transition-from a “dull” to a highly “buoyant” stock market. listed equity shares. Basically FIIs have a huge financial strength and invest for the purpose of income and capital appreciation.government securities market and strengthening the open market operations as an instrument of monetary policy. From the early 1990s. vanguard. In December 2005. capital research etc. A foreign investor can either come into India as a FII or as a sub-account. the number of FII and sub-accounts stood at 823 and 2273 respectively. They are no interested in taking control of a company. Improved market surveillance system. According to Securities and Exchange Board of India (SEBI) it is “an institution that is a legal entity established or incorporated outside India proposing to make investments in India only in securities” These can invest their own funds or invest funds on behalf of their overseas clients registered with SEBI. trading mechanism and introduction of new financial instruments made it a center of attraction for the international investors. The client accounts are known as „sub-accounts‟.

Units of schemes floated by the Unit Trust of India and other domestic mutual funds.  And has also led to considerable amount of reforms in capital market and financial sector.70 (Equity Instruments): 30 (Debt Instruments) 100% Debt 100% investment has to be made in debt securities only Equity Investment route: In case of Equity route the FIIs can invest in the following instruments:  A. C. In the Indian context. Investments by FIIs A FII may invest through 2 routes:  Equity Investment 100% investments could be in equity related instruments or upto 30% could be invested in debt instruments i. access to cheap global credit.  It leads to higher asset prices in the Indian market. listed or to be listed on a recognized stock exchange in India. B.e.  It lowers cost of capital. Securities in the primary and secondary market including shares which are unlisted. who are not interested in participating directly in the Indian stock market.  It supplements domestic savings and investments.or foreign individuals. Why are FIIs required? FIIs contribute to the foreign exchange inflow as the funds from multilateral finance institutions and FDI are insufficient. Warrants 100% Debt route: In case of Debt Route the FIIs can invest in the following instruments: . foreign institutional investors (FIIs) and their sub-accounts mostly use these instruments for facilitating the participation of their overseas clients. whether listed or not.

Partly Convertible Debentures etc. investments trusts. mutual funds. a trustee or power of attorney holder incorporated or established outside India proposing to make proprietary investments or investments on behalf of a broad-based funds. endowments foundations. charitable societies. In 1996-97. For example in 1993. asset management companies. nominee companies and incorporated/institutional portfolio managers were permitted to invest directly in the Indian stock markets. Dated government securities D. They were allowed to invest in all the securities traded on the primary and the secondary market including the equity and other securities/instruments of companies listed/to be listed on stock exchanges in India. Treasury Bills E. only pension funds.A. LIBERALIZATION OF LAWS: Before 1992. When India opened investment into listed equities through the FII framework not all foreign investors were eligible to register with the Indian securities regulator (SEBI). foreign investors who sent orders to open outcry trading floor of the Bombay stock exchange found an array of problems including high transactions costs and low probability of order execution. Debentures (Non Convertible Debentures.) B. university funds. Bonds C. the group was expanded to include banks. Foreign investors faced many difficulties in accomplishing transactions in the Indian equity market. the settlement system which was based on physical paper share certificates found it difficult to handle the settlement volume of foreign investors. only Non-Resident Indians (NRIs) and Overseas Corporate Bodies were allowed to undertake portfolio investments in India. the Indian stock markets were opened up for direct participation by FIIs. No FII was permitted to own more than 5% of a firm and there were restrictions on ownership by all FIIs taken together. Presently the ceiling for overall investment for FIIs is 24% of the paid up capital of the Indian company. The limit is 20% of the paid up capital . the Ministry of Finance and SEBI led a strong reforms aiming at a fundamental transformation of the equity market. Thereafter. Other Debt Market Instruments It should be noted that foreign companies and individuals are not be eligible to invest through the 100% debt route. Thus from 1993 to 2003. Similarly. charitable trusts. Initially.

 Legally permitted to invest in securities outside country or its incorporation/establishment. the format of which is provided in the SEBI (FII) Regulations. Procedure for Registration: The Procedure for registration of FII has been given by SEBI regulations.“no person shall buy.  Permission under the provisions of the Foreign Exchange Management Act. and units of scheme floated by a Collective Investment Scheme.  Units of schemes floated by domestic mutual funds including Unit Trust of India. subject to the approval of the board and the general body of the company passing a special resolution to that effect. 1999 (FEMA) from the RBI. The Eligibility criteria for applicant seeking FII registration is as follows: Good track record. sell or otherwise deal in securities as a Foreign Institutional Investor unless he holds a certificate granted by the Board under these regulations”.in the case of public sector banks. It states.  The applicant must be a „fit and proper‟ person. The ceiling can be raised upto sectoral cap/statutory ceiling. Eligible Securities: A FII can make investments only in the following types of securities:  Securities in the primary and secondary markets including shares.  Government Securities . An application for grant of registration has to be made in Form A.  Local custodian and designated bank to route its transactions. whether listed on a recognized stock exchange or companies or companies listed on a recognized stock exchange. to. including the State Bank of India. debentures and warrants of unlisted. 1995.  Regulated by appropriate foreign regulatory authority in the same capacity/category where registration is sought from SEBI. professional competence and financial soundness.

these amendments are: 1. 5. 1995. Commercial paper. The cumulative debt investment limit for FII investments in Corporate Debt is US $15 billion. 4. . Following are some of important regulations by SEBI and RBI: 1.249 cr. The definition of “broad based fund” under the regulations was substantially widened allowing several more sub accounts and FIIs to register with SEBI. made on his own account and through his subaccounts. A Foreign Institutional Investor may invest only in the instruments mentioned earlier. Further. FIIs can now invest in interest rate futures that were launched at the National Stock Exchange (NSE) on 31st August. 2. 1000 crores of the government debt limits. The debt investment limit for FIIs in government debt is currently capped at $5 billion and cumulative investments under 2% of the outstanding stock and no single entity can be allocated more than Rs. 3. The total investments in equity and equity related instruments (including fully convertible debentures.accounts. The amount was increased from US $6 billion to USD 15 billion in March 2009. US $8 billion will be allocated to the FIIs and Sub-Accounts through an open bidding platform while the remaining amount is allocated on a „first come first served‟ basis subject to a ceiling of Rs. convertible portion of partially convertible debentures and tradable warrants) made by a FII in India. whether on his own account or on account of his sub.   Derivatives traded on a recognized stock exchange – like futures and options. 2009. should be at least 70% of the aggregate of all the investments of the FII in India. Security receipts FII Regulations: Investment by FIIs is regulated under SEBI (FII) Regulations. per registered entity. in 2008 amendments were made to attract more foreign investors to register with SEBI.

and the primary markets for India. the investment rose to Rs 5445 the next financial year when the economic changes were introduced and further today in 2010-11 it stands at Rs 133. foreign corporate etc. foreign individual. Registration once granted to foreign investors was made permanent without a need to apply for renewal from time to time thereby substantially reducing the administrative burden. were introduced. improve disclosure and thus FIIs have become the corner stone in the phenomenal rise of the Indian stock market. institutional investors including FIIs and their sub-accounts have been allowed to undertake short-selling.049. 2008. The changes have led to increase in liquidity. EFFECTS ON INDIAN ECONOMY The various reforms introduced by Indian government to encourage FIIs to invest in Indian market have been effective to such an extent that in November 2010 FIIs stood at 5426 whereas it stood at 1713 in early 1990s. sovereign wealth funds. Also the application fee for foreign investors applying for registration has recently been reduced by 50% for FIIs and sub accounts 5. YEAR 1992-93 1993-94 1994-95 Net Investments by FIIs (rs cr. Also the rigid criteria of requiring FIIs and sub-account to register as a 70:30 FII/ sub-account or 100% debt FII/sub-account has recently been done away with(as has been discussed above in the essay). reduce risk. 6. From the table below it becomes apparent that from just Rs 4 crores of net investment in 1992-93.2. Also. 3.) 4 5445 4777 .related equities trading has become the NSE and BSE in Bombay. It has led to shift of focus of foreign investors away from Indian securities traded at London or New York. lending and borrowing of Indian securities from February 1. Several new categories of registration viz. 4.

396. Fidelity. Macquarie.796 84. Temasek Holdings. among others to enter the Indian financial market. Goldman Sachs and Morgan Stanley. Citigroup.1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-2010 2010-2011 6721 7386 5908 -729 9765 9682 8273 2669 44000 41416 47. HSBC. Goldman Sachs. AIF Capital.60 71. Citigroup and India Equity Partners (IEP) have picked a combined . an institutional investor from Switzerland but today Indian growth story has attracted global majors like CLSA.269 133.952 -53.049 In 1993 the first and only FII to invest in India was Pictet Umbrella Trust Emerging Markets‟ Fund. Goldman Sachs and Macquarie have acquired a 20% stake each in PTC India Financial services Ltd. Crown Capital. Investment Corporation of Dubai. Merrill Lynch.602 36.

Managing uncertainty and controlling risks: FIIs promote financial innovation and development of hedging instruments. the FIIs can help in the process of economic development. they stabilize markets. But FII flows can be considered both as the cause and the effect of the capital market reforms. For example. Also an entity of Merrill Lynch has picked up 49% stake in seven residential projects of real estate major. FIIs in particular are known to have good information and low transaction costs. a variety of FIIs with a variety of risk-return preferences also help in dampening volatility. Not only it can help in supplementing the domestic savings for the purpose of development projects like building economic and social infrastructure but can also help in growth of rate of investment. B. The market reforms were initiated because of the presence of them and this in turn has led to increased flows. dematerialization and regulations on reporting and disclosure standards were initiated because of the presence of the FIIs. though good for Indian economy has led to a number of negative consequences. automation. but also improve the alignment of asset prices to fundamentals. Let us study the positive and the negative side of this rise of investments by FIIs one by one. of their portfolios in equity in 1998. By increasing the availability of riskier long term capital for projects. In addition. employment and income of the host country. FIIs not only enhance competition in financial markets. By aligning asset prices closer to fundamentals. it boosts the production. . A.stake of 10% in Bharti Infratel. These because of their interest in hedging risks. This boost. are known to have contributed to the development of zero-coupon bonds and index futures. and increasing firms‟ incentives to supply more information about them. pension funds in the United Kingdom and United States had 68 per cent and 64 per cent. DLF. respectively. Positive impact: It has been emphasized upon the fact that the capital market reforms like improved market transparency. Enhanced flows of equity capital: FIIs are well known for a greater appetite for equity than debt in their asset structure. C. Improving capital markets: FIIs as professional bodies of asset managers and financial analysts enhance competition and efficiency of financial markets.

If money is withdrawn on short notice. When money is injected into a country. B. and direct control via debt or relationship banking-the third model. Negative impact: If we see the market trends of past few recent years it is quite evident that Indian equity markets have become slaves of FIIs inflow and are dancing to their tune. the banking institution will experience a shortage of funds. and the RBI pumps the amount of Rupee in the market as a result of demand created. Information asymmetries and incomplete contracts between share-holders and management are at the root of the agency costs. high interest rate investment opportunities. which is known as corporate governance movement. Bad corporate governance makes equity finance a costly option.takeover or market control via equity. This situation leads to excess liquidity thereby leading to inflation where too much money chases too few goods. direct control via equity. . has institutional investors at its core. improve corporate governance. the exchange rate for the country gaining the money strengthens. Inflation: Huge amounts of FII fund inflow into the country creates a lot of demand for rupee. With boards often captured by managers or passive. And this dependence has to a great extent caused a lot of trouble for the Indian economy. Improved corporate governance: Good corporate governance is essential to overcome the principal-agent problem between share-holders and management. Potential capital outflows: “Hot money” refers to funds that are controlled by investors who actively seek short-term returns. leveraged control or market control via debt. while the exchange rate for the country losing the money weakens. Among the four models of corporate control . In this third model. ensuring the rights of shareholders is a problem that needs to be addressed efficiently in any economy. Some of the factors are: A.D. FIIs constitute professional bodies of asset managers and financial analysts. “Hot money” can have economic and financial repercussions on countries and banks. by contributing to better understanding of firms‟ operations. board representation is supplemented by direct contacts by institutional investors. These investors scan the market for short-term. Incentives for shareholders to monitor firms and enforce their legal rights are limited and individuals with small share-holdings often do not address the issue since others can free-ride on their endeavor. who.

Problem to small investors: The FIIs profit from investing in emerging financial stock markets. which enables large hedge funds to carry out their operations without disclosing their identity. which can lead to a great loss to the Indian economy. going up or down. Trading through participatory notes is easy because participatory notes are like contract notes transferable by endorsement and delivery. whose fortunes get driven by the actions of the large FIIs. will cause economic volatility in Indian exchange and generally these are blamed for the sudden fall in indices. participatory notes are popular because they provide a high degree of anonymity. Secondly. D. Issue related to participatory notes: When Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. The FII buying pushes the stocks up and their selling shows the stock market the downward path. some of the entities route their investment through participatory notes to take advantage of the tax laws of certain preferred countries. Thirdly. And India among the world inventors is believed to be a good investment destination inspite of all the political uncertainty and . Any entity investing in participatory notes is not required to register with SEBI (Securities and Exchange Board of India).C. E. Adverse impact on Exports: FII flows leading to appreciation of the currency may lead to the exports industry becoming uncompetitive due to the appreciation of the rupee. but they operate through sub accounts with FIIs and according to a number of studies it has been found that more than 50% of the funds are flowing through this anonymous route. whereas all FIIs have to compulsorily get registered. This creates problems for the small retail investor. Any dividends or capital gains collected from the underlying securities go back to the investors. The hedge funds borrow money cheaply from western markets and invest these funds into stocks in emerging economies. These unlike FIIs are not directly registered under SEBI. FIIs have contributed a lot in making Indian economy one of the fastest growing economy in the world today. Further. Foreign institutional investment can play a useful role in development by adding to the savings of low and middle income developing countries. acting through participatory notes. If the cap on FII is high then they can bring in huge amounts of funds in the country‟s stock markets and thus have great influence on the way the stock markets behaves. It is also feared that the hedge funds.

After the liberalization of financial policies India has been able to attract a lot of FII from rest of the world and which in turn has played its part very well by helping in development of Indian economy from what it was in early 1990s to a would be super power that it is today. And also attempts should be made to encourage small domestic investors to participate in the equity market. But still the harsh consequences of FIIs should not be ignored by the government and further reforms should be introduced in the economic sector to counter the tendency of the FIIs to destabilize the emerging equity market.infrastructural inefficiencies. .