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Mohammad Iftekhar Khan, Amit Banerji

The Journal of Developing Areas, Volume 48, Number 4, Fall 2014,

pp. 327-348 (Article)

Published by Tennessee State University College of Business

DOI: 10.1353/jda.2014.0071

For additional information about this article

http://muse.jhu.edu/journals/jda/summary/v048/48.4.khan.html

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 The Journal of Developing Areas
Volume 48 No. 4 Fall 2014

A STUDY OF DRIVERS, IMPACT, AND

PATTERN OF FOREIGN DIRECT INVESTMENT
IN INDIA
Mohammad Iftekhar Khan
Amit Banerji
Maulana Azad National Institute of Technology, India

ABSTRACT

Till 1991, there was excessive control of Government over economy with inward looking policies
leading to over protection of economy leading todeterioration of trade, economic growth and large
fiscal deficits financed by external borrowings. Foreign currency reserves plummeted to very low
levels. Since then India has seen a steady set of reforms in LPG mode with foreign investment playing
important role. In this study datahas been obtained from secondary sources, mainly government and
global bodies. Literature cited has been taken with reference to India or generic in nature and
problems identified. Policies needed for attracting FDI are not very different from those required for
domestic investors. Preferential for FDI may act as an extra incentive. Foreign Portfolio investment
is contingent upon returns expected from capital market and home country issues. Foreign direct
investment has slowly moved from manufacturing to service sector probably because of easy entry
and exit conditions as well as leveraging labour arbitrage. In this study we have reviewed papers on
determinants, patterns and impact of FDI and FII/FPI on Indian economy for the period 1991-2012
and attempted to find out interrelation between FDI and FII/FPIinflows.

JELClassifications:F 21, O 53, and F 62

Keywords: Foreign Investment, Globalization, FII, Pre Reforms period India
Corresponding Author’s Email Address: iftekhar2410@gmail.com

INTRODUCTION

In the period 2001-10, India had achieved higheconomic growth particularly, with an
average 8.5 - 9 percent GDP growth rates, rising domestic savings, investment levels and
the amount of foreign capital flowing into the country (Meena&Mathur 2012). India
suffered scarcity of financial resources and low level of capital formation during 1990,s
due to extensive Government controls over production, investment and trade. The policies
designed in pre reform period were inward looking with emphasis to protect domestic trade
and indigenous industries of the country and emphasis on import substitution. All these led
to slow economic growth (Bhagwati,1994). Rigid policies regarding foreign investment
and promotion of public sector adversely affected the efficiency of private sector due to
scarcity of capital. Restrictive investment policies followed till 1991,focused on financial
assistance in form of bilateral and multilateral loans in the form of aids, grants and external
commercial borrowing (Nagaraj, 2003).Foreign investments played a remarkable role in
India to supplement the low level of domestic investment. The FDI allowed in priority
sectors for the development of industries has drastically changed the scenario in last two
 328

decade. In the last quarter century, India has shown consistently high growth rate in almost
of all macroeconomic indicators including GDP.

PRE REFORM PERIOD IN INDIA

The fiscal deficit, which was moderate till early 1980s suddenly started rising up by late
1980s. As per data available from various studies it was over 8% of the GDP from 1985-
86 to 1989-90 mainly due to expenditures on subsidies, interest payments, salaries and
defence. The gap was managed by external borrowing. The condition became adverse and
in 1991, foreign exchange reserves came down to $1 billion barely sufficient for two weeks
imports at that time. The inflation rate peaked to 17% by August 1991 (Economic Survey
Issue, 1991).
Few steps were taken to liberalize economy in 1985 in form of deli censing some
industries but those unplanned and ad hoc measures resulted in macroeconomic
destabilisation of the economy leading to large fiscal deficit (Joshi & Little, 1994). During
1980s the main concentration in the five year plans were to liberalize imports by promoting
export oriented industries, reducing physical controls on production and relaxing
regulations for technology up gradation by FDI (Singh, S. 2012).

ECONOMIC REFORMS IN INDIA

Globalization can be defined in several ways; in context to India it also meant opening of
Indian economy to foreign investments, removing obstacles to entry along with facilities
to foreign enterprises like differential tax rates etc. Foreign collaboration and joint ventures
were also permitted as a part of globalisation in hitherto restricted sectors. A study done by
Goyal (2006) showed that LPG model to an extent can lead to rapid growth and poverty
reduction in developing countries (like India and China).
In India, LPG encompassed - market based adjustments of convertible currencies,
dismantling of industrial licensing, encouraging FDI, introduction of various Non Resident
Indian (NRI) schemes, private participation in public sector, repeal of Monopolistic and
Restrictive Trade Practice Act (MRTP Act 1969) and reduction of tariff. It improved global
position of India from eighth to fourth from 1991 to 2001 in terms of growth rate.
Globalization along with improving GDP of country has also led to selective sectoral
growth in country e.g., service sector has experienced exponential growth particular in
Information Technology and IT Enabled Service industry. Economic reforms to some
extent have been successful in controlling inflation and have boosted foreign trade and
enhanced foreign exchange reserves along with inflow of advanced technology and skilled
workforce (Datt&Sundharam 2012).
Singh and Srinivasan (2002) looked comprehensively into federal-provincial
relationship, economic reforms and globalization. It was noted that major contributing
factors in the growth of economy were globalization (integration with world), deregulation
and tax reforms which reinforced earlier studies. The study also looked into infrastructure
reforms, development of regulatory bodies, centre- state fiscal relationship and patterns of
change in regional inequalities. The Indian government at that time created certain
regulatory bodies of which it was found in study that market oriented institution (e.g.,
 329

Securities Exchange Board of India Telecom Regulatory Authority of India) were more
effective as compared to regulatory bodies for utilities mainly in power sector.

TYPES OF FOREIGN INVESTMENT IN INDIA

Since India is a developing country, capital scarcity along with issues like poor public
health systems, poverty, unemployment, low base of R&D, technology obsolescence and
global competition create pitfalls for development. FDI serves as an important source to
fulfil the gap between income and savings, in technology up gradation and efficient
exploitation of natural resources along with the development of basic infrastructure. It
improves balance of payment condition and helps the recipient firms to cope competition
in better ways (Daniel et al 2009).
Foreign investment comes in host country in through various route and many
forms. The two main routes are:
1. Foreign direct investment (FDI)
2. Foreign institutional investment (FIIs) also known as foreign portfolio investment
(FPI).
The three principal forms of FDI in India are joint ventures, acquisition of assets
in a country and Greenfield ventures. Portfolio investment occurs when individual
investors invest, mostly in stocks of companies in host country with profit motive (Bhalla
and Shiva 2010)

RESEARCH METHODOLOGY

Objective of present study is to analysis the pattern of inflow of FDI in India and its impact
on various sectors of economy in India since 1991 to 2010. To fulfil the objective, data
collection has been done from secondary sources from various Government bodies
(websites) like Department of industrial promotion (DIPP), Reserve bank of India( RBI),
Security Exchange Board of India (SEBI) and some from various issues of World
Investment Reports and Human Development Reports published by UNCTAD , IMF,
World Bank and United Nations. Research papers for literature review has been taken from
sources available within the institute i.e. limited access to Springer link, Taylor & Francis,
Science Direct, JSTOR and Goggle scholar etc. Literature review of FDI available from
these sources has been done and problem has been deduced and conclusions generated.
Study of FDI in India is incomplete without study of FPI and its drivers and impact, because
India hasawell developed capital market with depth, volume and well set rules and
regulation, reasonable enough, reasons for foreign capital inflow in capital market. Finally
at the end econometric analysis for FDI and FII/FPI is studied and conclusion drawn for
any interrelationship between them.

LITERATURE REVIEW (FDI

Singh (2012) studied pre and post reform economic situation of the Indian economy. An
interesting finding of the study is that in post reform period; there was deceleration in the
growth rate to the tune of 15% of the rate for a period of 5 years (1996 to 2002) due to slow
down of the reforms and fractured mandates of Coalition governments was partially
 330

responsible for it. Sahoo and Mathiyazhagam (2003) found positive correlation between
FDI visa-vies exports and GDP. But Hanson (2001) found weak evidence supporting FDI
having a positive spill over on host countries.
Sultana and Pardhasaradhi (2012) studied relationship and impact of FDI and FII
on the Indian stock market for the time period 2001-2011. They found significant positive
correlation between FDI and stock indices (BSE & NSE); while in case of FII moderate
correlation was observed. Singla (2011) studied the determinants of FDI inflow in India
(FY 1993 to 2011)with reference to stock market index, foreign exchange rate, index of
industrial production (IIP) foreign institutional net investment (FII) gross domestic product
(GDP) and foreign exchange reserves. It was found that exchange rate and foreign
exchange reserve do not have any significant effect on FDI inflow while inflow depends
on stock market, IIP and GDP. Chaturvedi (2011) studied country wise inflow in India with
reference to sector specificity inflow and ranked sectors on the basis of highest FDI inflow
and also studied correlation between FDI and economic development. The findings of
study were Mauritius is the leading investing country followed by Singapore. Service
sector received maximum amount of FDI followed by computer hardware and
telecommunication. Correlation between FDI and economic development was found to be
ca. 0.90. Saiyed (2012) examined the effect of FDI stock on economic growth of India in
the period 1990-91 to 2011-12 using regression technique. Positive correlation between
FDI and G.D.P growth was observed along with unidirectional causality between FDI and
output on an annual basis. Das & Das (2012) studied the difference in foreign direct
investment (FDI) trends in India during pre reform (1981-90) and post reform). They found
that inflow increased substantially in 1991-2000 as compared to pre reform period but in
period 2001-10 this trend deteriorated. Gharana (2012) examined the cause and effect of
FDI to GDP and exports to GDP for the period 1999 to 2008 and observed that in this short
period Granger cause was stronger from export led growth (i.e. Export to GDP) than vice
versa. Kinda (2012) found that crucial elements in attracting FDI are developed
infrastructure and developed HR, strengthened institutional capabilities and low inflation
& strong economic growth.
In study done by Agbloyer et al (2013) regarding Africa there were two main
findings (1)Existence of bi- Directional Causalities relationship between banking sector
development and increased FDI. (2) Existence of bi-directional causality between
improvements in financial sector and FDI. Jadhav (2012) found that FDI to BRICS
primarily was not because of resource seeking motive but to access their markets for the
products of investing organization. Vita &Kyaw (2009) studied impact of FDI & FPI flows
on economic growth of low, lower-middle & upper-middle income countries for the period
1985-2002. Findings were that in the case of upper-middle income countries, 1% increase
in FDI increases per capita real GDP growth by 0.004%, twice the magnitude of the impact
on lower-middle income countries in this group. For low income category countries impact
is negative.
Anwar & Nguyen (2010) reviewed the determinants regarding FDI in Vietnam. It
was observed that absorptive capacity (education, technological status) of the country play
an important role. The work done by Bayrakhtar (2013), focussed on the flow of FDI from
developed to developing countries (including India) and found that ‘ease of doing
business” plays a positive role. The parameters were- Starting an enterprise, construction
 331

permits, registration, tax structure & rate, trading across borders, contract enforcement and
winding up of a business.

DETERMINANTS OF FOREIGN DIRECT INVESTMENT (FDI)

Azhar and Marimuthu (2012) studied determinants and need of FDI in Indian economy.
India ranked second most favourable destination of FDI between 2009 & 2012. On host
country basis, Mauritius is the highest FDI investor in equity inflows with 42% of total
inflows followed by Singapore with 9.35% of the total inflows between 2000-2010 (high
FDI inflow from Mauritius is because of double taxation avoidance treaty of India with
Mauritius, which provides a tax haven to the foreign investor on account of zero capital
gains tax) (UNCTAD 2013).The main determinants of FDI in India as per table 1 are stable
policies in favour of foreign investment, favourable economic factors like interest loan
subsidies, removal of restrictions, tax exemptions, availability of cheap and skilled labour,
untapped markets and in spite of being a developing country infrastructure like roads,
information and communication networks is well developed.

TABLE 1. SOURCES OF FDI (2000-2011)

Country Amount of FDI

IN MILLIONS %with total FDI inflows
(US $)

Mauritius 51719.5 42.16

Singapore 11471.9 9.35
USA 9186.37 7.49
UK 6225.58 5.07
Netherlands 5254.89 4.28
Cyprus 4322.36 3.52
Japan 4300.29 3.51
Germany 2881.92 2.35
France 1851.48 1.51
UAE 1815.29 1.48
Other Countries 23657.3 19.38
SUB TOTAL FDI 122687 100
RBI;S Schemes 121.33
Grand total FDI 122808

Source: Department of Industrial Policy and Promotion (DIPP 2010)

PATTERN OF FOREIGN DIRECT INVESTMENT IN INDIA

Foreign technology collaboration and FDI are two important methods of foreign
technology induction in India. The total approvals recorded were 8080 between 2000 and
2010(Azhar and Marimuthu 2012). Among 8080 approvals 4580 proposals have been
 332

approved by RBI and 3500 by Secretariat for Industrial Assistance (SIA) and Foreign
Investment Promotion Board (FIPB).
TABLE 2. INVESTMENT PROPOSALS AND FOREIGN TECHNOLOGY
COLLABRATIONS

SECTORS NO. OF NO. OF TOTAL SECTORAL

APPROVALS APPROVALS PERCENTAGE
BY RBI BY SIA
&FIPB
Electrical equipments 811 450 1261 15.6
including software and
electronics
Industrial Machinery 623 249 872 10.8
Chemicals (0ther than 451 454 905 11.2
fertilizers)
Transport industries 400 356 756 9.4
including automobiles
Miscellaneous mechanical 267 177 444 5.5
and engineering

Metallurgical industries 217 161 378 4.7

Fuel (including power and 56 349 405 5
oil)
Drugs and pharmaceuticals 197 79 276 3.4
Hotel and tourism 42 246 288 3.6
Textiles 75 95 170 2.1
Food processing industry 93 73 166 2
Telecommunications 52 88 140 1.7
Industrial Instruments 91 30 121 1.5
Miscellaneous and other 1205 693 1898 23.5
industries
Total 4580 3500 8080 100

Source: Reserve Bank of India (2010) *(Foreign technology collaboration through RBI Automatic
routes from October 2004 is not included)

As evident from the table, a significant percentage of collaboration (FDI and technology)
has been in the high tech sectors. Kumar and Dhingra (2011) found that there is remarkable
change in the nature of FDI inflow from pre liberalization era. Manufacturing sector
received nearly 87% of total FDI in 1980 which reduced to 48% in 1997. The reasons for
this were liberalized policy of the government in service and infrastructure sector. Along
with this, several new sectors were opened for FDI by increasing sectoral limits. Limits of
FDI were raised from 49% to 74% in 2005 in most of the sectors. 100% FDI was permitted
in Automobile industry in the same period. Increased FDI inflow in power sector was due
to two reasons (1) high ROI (2) huge size of market (except in atomic energy).
During 1991-2010, the amount of actual FDI inflow increased 34 times; there was
sharp increase in FDI from 1991to 2000, but between 2000 and 2010 it came down to 8%.
Another major observation in this study was that percentage realisation of FDI was less
during early years of reform which is evident from gap between approved and actual. In
 333

2002 to 2004 and thereafter in 2006 the percentage of realization reached 100%, due to the
policy of automatic approval adopted by the government.

TABLE 3. APPROVED FDI IN PRE IBERALIZED PERIOD

YEAR AMOUNT IN RUPEES MILLION

1981 105.71
1982 628.06
1983 618.73
1984 1130.02
1985 1260.02
1986 1069.52
1987 1729
1988 2883.6
1989 3166.65
1990 1283.21
CAGR 1981-1990 29.46

Source: Economic Survey of India of Various Years

IMPACT OF FOREIGN DIRECT INVESTMENT (FDI)

Mathiyazhagam (2005) studied impact of FDI on different socio economic aspects with the
aid of panel co integration test. According to the study, till 1991 due to regulatory policy
framework, growth of FDI was insignificant in India. But soon after 1991 inflows increased
from US$ 143.6 million in 1991 to US$ 3108.9 million in 2003 which contributed to
average growth of 6% to GDP. The number of countries investing in India also increased
from 29 in 1991 to 106 in 2003. Even though the number of countries increased but the
major portion of invested FDI came from countries like Mauritius, which is the largest
investor. Sector wise analysis of FDI shows that 73% of total inflow was in Electrical
equipments, Telecommunication, Power & Fuels, Services, Chemicals, Drugs
&Pharmaceuticals sector. Core sectors like transportation sector had inflow of 12.75%
followed by electrical equipment along with IT and Electronics with 9.76% andService and
Telecommunication with 9.77 % and 9.76% respectively. To find the impact of FDI at
sectoral level long term relationship of FDI with gross output, exports andlabour
productivity in Indian economy from 1990-91 to 2000-2001 panel co integration test
technique was used.
The result of the study proved that FDI is positively co integrated with gross
output export and labour productivity in transportation and metallurgical sectors but
exhibited negative co integration in food processing and industrial machinery sectors.
Besides this test, fully modified OLS indicated an adverse impact on the exports in all
sectors due to FDI inflows. It was observed that inflow of FDI in totality did not have
positive impact on Indian economy at the sectoral level. Only minimal relation could be
directly attributed to FDI inflows between output- labour productivity and exports. The
probable reason, the study stated was due to low level of inflow both at macro and sectoral
level and the measures which can be taken to overcome this situation is to open and
encourage export oriented sectors to FDI.
 334

Economic growth in developing countries depends to a certain extent on sectoral

inflow of FDI. If the FDI inflow is towards manufacturing sector it applies positive effects
on growth, on the other hand if inflows are towardsservice sector or primary sector, it
causes adverse effect on economic growth (Ayut&Sayek 2007). From the beginning of
reforms, the aim of Indian Government was for FDI in advance technology sectors. This
led to skewed growth in export of engineering goods, IT &ITES sectors, which require
skilled and highly skilled workers.

TABLE 4. FDI INFLOW IN INDIA APPROVED V/S ACTUAL

Year Amount of FDI Amount of FDI Percentage

approved (rupees inflow inactual(rupees ofRealisation
million) million

1991(Aug-Dec) 5049 3534.8 70.01

1992 38178.9 6912 18.1
1993 88618 18619.6 21.01
1994 89552.2 31122.3 34.75
1995 308821.1 64853.6 21.01
1996 308860.5 87521.9 28.34
1997 503888.6 129897.6 25.78
1998 275895.7 132692.1 48.1
1999 251402.8 101667.1 40.44
2000 172369.7 123537.3 71.67
2001 209396.8 167777.5 80.12
2002 110581 181955.6 164.55
2003 54165.9 116171.7 214.47
2004 87412.5 172665.2 197.53
2005 78995.3 192990.9 244.31
2006 230036.1 503572.5 218.91

Source: Handbook of Industrial Policy& Statistics DIPP (2006)

INFERENCE (FDI)

FDI in India has played important role in providing capital, technology and
directly/indirectly (diffusion power) skill up gradation. In recent focus FDI has flowed
more towards service sector on ok of higher returns, availabilities of skilled manpower.
Reform especially related to FDI has a longer lasting impact on stock exchanges.
FDI per se has not increased exports but affects industrial product on and GDP positively.
In case of developing countries it is important that there be some amount of developed
physical infrastructure, availability of skilled HR, strong and independent institutions to
enforce rule of law, potential for high growth rate, stable & transparent tax laws, efficient
& transparent property transaction rules. In the presence of above, FDI is not greatly
affected by business cycles. Regarding India, the motive is FDI has been to tap the huge
consumer base also.
 335

Over the two decades 1991-2011 governments policies have played significant
role in influencing FDI. Automatic approvals of FDI and liberalization of FDI in service
sector has influenced positively the inflow.Study of FDI in India is incomplete without
study of FII/FPI and its drivers and impact because India has well developed capital market
with depth, volume and well set rules and regulation for reasonable reasons for foreign
capital inflow in capital market.

LITERATURE REVIEW ON FOREIGN PORTFOLIO INVESTMENT

(FPI)/FOREIGN INSTITUTIONAL INVESTMENT (FII)

Study done by Jain et.al (2012) examined the role of FII in sensitivity index (sensex) of
Indian stock market for period between 2001 -2010. Significant positive coefficient (Karl
Pearson) was found between BSE sensex and FII inflows. Stanley (2002) showed that FII
had a important role in building of Forex reserves of India which accelerated overall
economic growth. The report found that FIIs play a dominant role in short term market
movements. Hsin (2004) found that outflows from US play dominating role in transmitting
shocks to other markets. Dungreyet.,al (2004) also found that Australian markets are
effected by shocks that are common to all market and US markets play important role in
determining movements of Australian stock market. Clark and Benzo (1997) looked into
the beneficial aspects of FPI in stock markets and suggested base broadening hypothesis
i.e increase in investor base reduces risk premium due to risk sharing. Banaji (2002) was
of the views that for FII inflows, the important issue is the level of the free float i.e shares
that are publicly available rather than market capitalization.
Gordan and Gupta (2003) found that even though India receives approximately
1% of FII investment within the emerging market between March 1993 to October 2001,
portfolio flows is less volatile as compared to other emerging economies. Banaji (2000)
found that reforms in capital markets like high levels transparency, automation,
dematerialization, increased disclosure were introduced due to FII investment in markets ,
which also leads to further FII inflows. FII flows have been found to be both cause and
effects of capital market reforms. Aggarwalaet. al (2005) studied investment allocation of
US mutual funds, taking a sample of 114 US mutual funds’ investments in 1280 firms
access 30 emerging economies time period was late 1990’s to 2001 with the objective to
find out how country and firm level policies affect investment decisions. One broad
observation of the study was that countries having better accounting policies, strong legal
policies and good shareholder rights framework, stringent disclosures norms along with
fewer restrictions on foreign capital are able to attract American Depository Receipts
(ADR) and US mutual funds. Kumar (2001) found that FII investments were not affected
by short term changes of the market. It was also investigated that rise in NFI was preceded
by rise in sensex by one month. The time period of study was January 1993 to December
1993.
 336

According to Choeet.,al (2005) US (United States) investors do not prefer firm

with dominant insiders because of chances information asymmetry with to other
shareholders. (Li, S 2005) was of opinion that foreign investors prefer FDI investment
rather than indirect portfolio investment in the firms lacking good corporate governance.
Bansal and Pasricha (2009) found that entries of FIIs have affected both the volatility and
returns of Indian stock market but there is no significant change in average returns of
market.

FOREIGN INSTITUTIONAL INVESTMENT IN INDIA

Institutional investor is any investor or investment entity, which is registered in country

outside the country in which they are currently investing. It includes hedge funds, insurance
companies, pension funds, mutual funds, asset management companies among others.
Indian financial market was thrown open in September 1992 to FII. In India such fund has
to register with Securities and Exchange Board of India(SEBI). SEBI places limits and
ceiling limits on investment on sectors based on their evaluation. Major source of FII is in
form of Participatory Notes (P notes) also commonly known as offshore derivatives. Since
last decade they have contributed a lot in changing the face of the Indian markets. The
changes include both quantitative as well as qualitative aspects.

PATTERN OF FOREIGN INSTITUTIONAL INVESTMENT IN INDIA

Bohra and Dutt (2011) studied investment by FII in various group of shares in BSE and FII
behaviour in equity market of India for the period of 2000-2009. BSE Sensex and FI
investment had a close relationship during this period. With Sensex moving up FII
increased and vice versa. This correlates with another study byDhiman (2012). Demand
for portfolio investment is created by companies and route is decided by Government and
Regulatory bodies. FII being volatile in nature is considered as less reliable. Bombay Stock
Exchange (BSE) has classified equity scripts into A,B1, B2,S,T,TS &Z categories on the
basis of market capitalization, trading volume and numbers, track record, profits, dividend
policy, shareholding patterns and other basic quantitative aspects. As per their findings,
shares of some categories attracts FII to large extent while in some moderate amount and
in rest very less amount or almost nil. Group A shares have the facility for carrying forward
of open positions (called Badlain traditional commerce) to the next settlement cycle and
attract FII to largest extent. Companies of this group have good track record of incremental
growth, dividend and capital appreciation. Categories B1 and B2 Shares have higher
market capitalization and liquidity with high market capitalization. This group attracted
FIIs till 2007-08 but after the global crisis it decreased. S group represents BSE Indonext
segment. It has scripts from B1 and B2 group and companies listed on regional exchange
with capital between 30-300 million rupees. Trade is done through BOLT system (online
trading) under S group. This group was able to attract highest attention till 2007. T group
is trade to trade group having shares to be settled in delivery and squaring off bought &sold
position during the day is not permitted. In 2007 maximum FIIs were in T group shares. Z
group contains shares, which do not follow rules and regulation of stock exchange and are
suspended from trading. No correlation with total FII in India is found but some interest of
 337

foreign portfolio investment is found in this category’s group in the fixed income securities
(F group) while G group consists of government securities. FII has least interest in this
category due to fixed and low return in F group and strong regulation in G group securities.

TABLE 5. FII ACTIVITY BETWEEN 2000-2011

Year Gross purchase(($Mn) Gross sale(($Mn) Net Investment(($Mn) Cumulative Investment
($Mn)

2011 -357.83
61105.56 61377.08 -271.42
2010 29,361.83
76628.32 63301.71 13326.68
2009 17,458.14
62423.97 54081.47 8342.42
2008 -11974.30
72160.7 77459.73 -5298.74
2007 17,655.80
81487.79 74339.2 7148.63
2006 8,107.00
47562.49 43908.41 3654.02
2005 10,706.30
28602.14 23884.09 4718.19
2004 8669.80
18567.2 14670.68 3896.58
2003 6627.60
9441.2 6395.35 3045.9
2002 749.50
4647.91 4284.98 362.96
2001 2806.40
5176.12 3865.1 1312.82
2000 1532.60
7479.15 6842.16 637.008
Source: http://www.indiainfoline.com/MarketStatistics/FII-Activity/2011, retrieved on 18 July 2013

TABLE 6. FII INVESTMENT IN INDIA

Millions
FINANCIAL YEAR EQUITY DEBT TOTAL
1992-93 1.34 0 1.34
1993-94 512.65 0 512.65
1994-95 479.63 0 479.63
1995-96 694.2 0 694.2
1996-97 854.56 2.89 857.45
1997-98 526.7 69.105 595.805
1998-99 -71.72 -86.7 -158.42
1999-00 966.95 45.26 1012.21
2000-01 1020.67 -27.33 993.34
2001-02 807.22 69.04 876.26
2002-03 252.72 16.21 268.93
2003-04 3995.97 580.5 4576.47
2004-05 4412.27 175.86 4588.13
2005-06 4880.05 -733.38 4146.67
2006-07 2523.57 560.47 3084.04
2007-08 5340.38 1277.53 6617.91
2008-09 -4770.62 189.52 -4581.1
2009-10 11022.06 3243.77 14265.83
2010-11 11012.08 3631.73 14643.81
2011-12 4373.76 4998.79 9372.55
2012-13* 5932.2 1388.7 7320.9
TOTAL 54766.64 15401.965 70168.605
Source: http://www.sebi.gov.in/sebiweb/investment/statistics.jsp?s=fii, retrieved on 18 July 2013)
* The data presented above is compiled on the basis of reports submitted to SEBI by custodians and constitutes
trades conducted by FIIs on and up to the previous trading day(s) till November 30, 2012.
 338

Sen and Krishnamurti (2005) studied inter relationship between FII inflows and
domestic returns. They also tested the existence of base broadening hypothesis followed
by price pressure and feedback trading hypothesis. These methods confirmed high
correlation between returns and flow regarding market efficiency and FPI inflows. The
above study also found that increased foreign investor base ladto increased diversification
which led to reduced risk thus lowering risk premium
Prasanna (2008) examined contribution of FPI among selected companies
included in sensitivity index (sensex) of BSE and also examined relationship between FDI
and firm specific characteristics like ownership, structure, financial performance and stock
performance and found that FII is more in companies which have dispersed stock
ownership. FII invest in firms where promoter shareholding is not high. EPS and PE ratios
also influence investment decisions. It was observed that FII’s withdraw money when stock
market goes down. As per the study, financial market performance and widely distributed
ownership can be correlated with higher FPI. Findings of Li & Bon (2004) suggest that
foreign investors usually avoid investment in high cross corporate holdings. It was also
found that Japanese firms with low information asymmetry are preferred by FII. So it can
be said that promoters’ holdings and foreign investment are inversely related as FIIs prefer
to invest in corporates having lower family shareholding of promoters.
Pal (1998) founds that risk factors plays a very crucial role in determining both
domestic and foreign investment. It was found that FPI’s normally enter into secondary
market rather than primary markets and a lot of secondary transactions are on account of
FPIs. Role of FPIs has led to increased volatilities in secondary market.Another study done
by Bandopadhyay (2006) showed that portfolio investment improves balance of payment
position along with liquidity of host’s capital market. In the study done by Agarwal (1997)
it was observed that world stock market capitalization has a encouraging impact on FPI
inflows in India.

IMPACT OF FOREIGN INSTITUTIONAL INVESTMENT IN INDIA

Poshakwale and Thapa (2007) attempted to explain influence of Foreign Institutional

investment in short term and long turn relationship of Indian equity market with developed
equity markets of US and UK. The findings of study showed a strong relationship between
FPI inflows and movement of Indian stock market index (correlation coefficient of 0.9).
Average daily returns from Indian markets were higher as offered by US and UK markets.
The study also supported earlier findings that US and UK markets influence movements in
Indian stock market in short run as well as in long runs and also influence the flow of
foreign capital. The study found that Indian stock market returns is independent of the
returns in US and UK but FPI flows play a very important role to explain co- movements
of Indian equity market with markets of US and UK. This means that FPI flow to India
from USA and UK get affected by the capital market, sentiment of these two counties.
Pradhan et.,al (2010) attempted to test the casualty between FII and real economic
growth in India in the period 1993 to 2009. It was observed FII can cause real economic
growth of country. Applying vector autoregressive framework this paper studied the
dynamics of net inflow of cross border FPI and economic growth. Evidence of bi-
directional causality was observed running from net FPI flows and real economic growth.
Real economic growth of India both determines and gets influenced by volume of FPI in
 339

the country. As per this paper the reasons for FPI and FDI remain the same though the
tenure of foreign capital in India may differ with the nature of FI. The study focussed only
on macroeconomic parameters and no firm or micro level analysis was drive.
Saha (2009) in the study tried to find out the impact of participation of different
investor groups especially FII on performance of Indian stock market. The main factors
which have helped Indian stock market to gain momentum and to complete internationally
are-flexible exchange rate, stable debt and equity markets and industrial deregulation. This
again supports the reasoning of earlier studies.
According to Brenan and Henery (1997), FII have bi directional causation with
returns of other domestic financial markets such as –money market, capital market and
foreign exchange markets. FDI has impact on the host country in form of advance
technology, marketing skills, and organised management and in expansion of foreign trade.
While on the other hand FII increases liquidity of market along with increase in P/E ratio
which on other hand reduces cost of capital (World Bank, 1997).

INFERENCE (FPI/FII)

An important but less felt part of FPI is that FPI inflows have been both the cause and
effect of capital market reforms. FPI inflows are more influenced by indices movements
of USA and UK exchanges on comparative basis with Indian market movements. The
direct impact of FPI inflows also influences domestic money market and foreign exchange
markets.
In the Indian context it has observed that FPIs have invested where the ownership
in companies are widely dispersed and avoid high family promoter owned companies,
perhaps on perception of strategic information asymmetry. In India FPIs have been active
in secondary stock trading and have shown low interest in fixed income securities.
Preferential tax treatment (lower capital gain tax) to FPI has been a major incentive. The
choice of Mauritius and Singapore as home countries is on account of zero tax treaties with
these countries.
The role of FPI in increasing real economy growth is indirect form - enhancing
shareholder wealth, which leads to more focussed management effort in corporate finance,
making corporate competitive.

TIME SERIES ANALYSIS

An attempt has been made to undertake time series analysis between FDI and FPI inflow
between 2000 and 2012.
 340

TABLE 7. FI CATEGORIES

FY FDI IN INDIA (MILLION US$) FPI IN INDIA (MILLION US$)

2000-2001 4029 1897
2001-2002 6130 1505
2002-2003 5035 377
2003-2004 4322 10918
2004-2005 6051 8686
2005-2006 8961 9926
2006-2007 22826 3225
2007-2008 34835 20328
2008-2009 41874 -15017
2009-2010 37745 29048
2010-2011 32901 29422
2011-2012 41891 17365

Source: DIPB

FIGURE 1. FDI &FPI RECEIPT (FY 2001-2012)

50000

40000

30000
FDI IN INDIA IN
20000 MILLIONS

10000 FPI IN INDIA

0
1 2 3 4 5 6 7 8 9 10 11 12
-10000

-20000
 341

The upsurge in 2006 can be attributed to the adoption of automatic approval during 2003-
2004. 2006 onwards there was growth of FDI in telecom and real estate & construction
sectors (Kumar &Dhingra 2011). The inverse trend in the case of FPI can be attributed to
global economic recession and also stagnancy in economic reforms in the present
government (FPI flow is more perception driven compared to FDI).Following tests were
performed.

1. Unit root test using ADF confirmed that FPI and FDI series are (presence of unit root)
non stationary. FPI becomes difference stationary at first difference.FDI shows a linear
trend (R2 = 0.81), which is quite significant. However FDI also becomes difference
stationary at second difference.For VAR purpose, FDI was not made differenced
stationarity.

TABLE 2. ONE DIFFERENCED FPI SERIES (FY 2001-12)

D(-1)FPI
50000

40000

30000

20000

10000
D(-1)FPI
0
1 2 3 4 5 6 7 8 9 10 11
-10000

-20000

-30000

-40000

Stochastic trend never recovers from shock and forecast intervals grow over time,
making them unpredictable. The inference that can be drawn with first difference
Stationarity is that portfolio investors consider the Indian capital market and the economic
climate remunerative enough to stay invested for a longer run. This is quite expected since
FPI by their very nature are categorized as “hot money.” The movement is in line with
previous discussions as to the drivers of FPI. More alignment of business laws and laws
related to capital markets with that of developed markets can result in greater flow of FPI.
However its nature will remain volatile. The non stationarity of FDI can be explained by
two facts –
 342

 The upsurge from 2006 onwards on account of automatic approval and large FDI
inflows in select sectors. Loose monetary policies in USA and Japan also aided
FDI.
 FDI commitment being long term and permanent in nature, it takes longer time to
actually materialize (compared to FPI).

FIGURE 3. TWO DIFFERENCED FDI SERIES

14000

12000

10000
D(-2)FDI
8000

6000

4000

2000

0
1 2 3 4 5 6 7
-2000

-4000

2. Vector Auto regression (VAR) estimates was carried with following results. A lag
of 3 (three years) of FDI with first differenced FPI (after making FPI stationary), as per the
following VAR table (table 9) indicates that the reasons which impact FDI have a three
year lag effect on FPI. A plausible explanation is that quite often a FDI takes some time to
get implemented, maybe an average of approximately three years. Markets at the time of
any announcement related to FDI perhaps factor in the news but react after three years;
positively if FDI happens and negatively if it does not take place. This is supported by
Granger Causality tests between FDI and FPI (table 8), wherein, causality running from
FDI to FPI is stronger than that running in the opposite direction. Current year’s FDI can
be predicted correctly to a certain extent by its lagged value of one year (Gujarati 1995).

Caveat – the number of observations being less hence the results have the chance of being
mere statistical artefacts.
 343

TABLE 8. PAIR-WISE GRANGER CAUSALITY TESTS

Sample: 1 12
Lags: 3
Null Hypothesis: Observations F-statistic Prob
FPI does not Granger Cause FDI 9 2.52336 0.2965
FDI does not Granger Cause FPI 35.25750.0277
Lags: 2
Null Hypothesis: Observations F-statistic Prob
FPI does not Granger Cause FDI 10 6.75477 0.0379
FDI does not Granger Cause FPI 2.41911 0.1841

TABLE 9. VECTOR AUTO-REGRESSION ESTIMATES

Sample (adjusted): 4 11 (lag of 3)

Included observations: 8 after adjustments
Standard errors in ( ) & t-statistics in [ ]

D__1_FPI FDI

D__1_FPI(-1) -2.169366 0.466330

(0.38496) (0.33557)
[-5.63530] [ 1.38968]

D__1_FPI(-2) -2.653795 1.053970

(0.95830) (0.83534)
[-2.76929] [ 1.26173]

D__1_FPI(-3) -1.534047 1.195126

(1.23499) (1.07653)
[-1.24216] [ 1.11017]

FDI(-1) -0.682064 2.640239

(1.15093) (1.00326)
[-0.59262] [ 2.63167]

FDI(-2) -1.088657 -2.563839

(1.90365) (1.65940)
[-0.57188] [-1.54504]

FDI(-3) 2.467655 1.239105

(1.32587) (1.15575)
[ 1.86116] [ 1.07212]

C 12620.68 -5290.557
 344

(11560.7) (10077.4)
[ 1.09169] [-0.52499]

R-squared 0.981561 0.963761

Adj. R-squared 0.870924 0.746328
Sum sq. resids 67769171 51494417
S.E. equation 8232.203 7175.961
F-statistic 8.871967 4.432451
Log likelihood -75.16021 -74.06168
Akaike AIC 20.54005 20.26542
Schwarz SC 20.60956 20.33493
Mean dependent 805.8750 28385.50
S.D. dependent 22913.64 14247.67

Determinant resid covariance (dof adj.) 2.500000

Determinant resid covariance 0.039063
Log likelihood -9.732647
Akaike information criterion 5.933162
Schwarz criterion 6.072184

CONCLUSIONS

FDI and FPI have made significant contribution to economic development of country; both
of them have different drivers of inflow and impact. FPI inflow has made significant
contribution in the Indian capital markets. FPI has made the Indian capital markets more
integrated with the global capital markets particularly, US and UK. Their impact in terms
of disclosure corporate governance and respect for shareholders (non promoters) interest
has being significant.
FDI in India, has shown a continuous upward trend. As economic reforms
progressed in India, FDI started increasing. In the recent years, service sector has been the
bigger recipient of the FDI. Though weak, yet FPI gets influenced by FDI with lesser
intensity and uncertain lag. The divergence in the two forms of foreign investment in India
can be attributed to economic recession globally, particularly the impact felt by portfolio
investors. It is expected that FPI may become source of funds to compensate the growing
current account deficit (more than 5% of GDP). Clarity on future prospects of FDI norms
in certain sectors has likelihood of impeding FPI inflows in India on account of negative
sentiments and availability of better options. Broadly speaking on policy matters greater
FDI and also FPI will come if globalization of municipal laws) happens. This is because of
the familiarity of foreign investor with their laws/ regulators. Necessary reforms required
for investments from either domestic source or foreign source shall act as catalyst for FDI.
Reforms per se for FDI are not required currently. Rules & regulations required for “ease
of business” is sine qua non.
 345

Further liberalization and clarity on policy matters regarding FDI will increase its
inflow, which will with a certain lag period will increase FPI (more so when US$ and Yen
denominated debts are available at very low real interest rates presently). Thus Investment
issues and policy matters promoting FDI will increase the net inflow of Foreign Investment
(FI). Time series analysis between FDI AND FPI inflows was done between2000-2012.
Finally using VAR 3 years lag between FDI and FPI was obtained which indicates the
reasons which impact FDI have three year lag effect on FPI.

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