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By
NITHYASHREE .T.
Reg. No. 03VWCM6067
(2003-2005)
I further declare that this project has not been submitted earlier in any other
university or institution for the award of any degree or diploma.
DATE:
Date:
Place: Bangalore
Prof.R.Narayanaswamy
Faculty
Alliance Business Academy
ACKNOWLEDGEMENT
The satiation and euphonies that accompany the success completion of a task would be
incomplete without a mention of people who made it possible. So, with immense gratitude, I
acknowledge all those, whose guidance and encouragement served as a beacon light and crowned
my effort with success.
I am indebted to Dr. Mihir Das, Faculty of Alliance Business Academy for his help in
analysing, interpreting the data and for the stimulating discussion which has greatly
added to the study.
Lastly, I would like to thank all those who have directly or indirectly helped me complete
the project successfully.
NITHYASHREE.T.
RESEARCH ABSTRACT
Since the beginning of liberalization FII flows to India have steadily grown in
importance. In this paper we analyze these flows and their relationship with Indian equity
market. Foreign capital flows have come to be acknowledged as one of
the important sources of funds for economies that would like to grow
at a rate higher than what their domestic savings can support. Foreign
capital flows have particularly become prominent after the advent of
globalization that has led to widespread implementation of
liberalization
programmes and financial reforms in various countries across the
globe in 1990s. This resulted in the integration of global financial
markets. As a result, capital started flowing freely across national
borders seeking out the highest rate of return.
Foreign portfolio inflows through FIIs, in India, are important from the policy
perspective, especially when the country has emerged as one of the most attractive
investment destinations in Asia. This paper reveals if the FIIs influence the Indian Equity
Market.
CHAPTER 1
THEORETICAL BACKGROUND
Introduction
When people think about globalization, they often first think of the increasing volume
of trade in goods and services. Trade flows are indeed one of the most visible aspects
of globalization. But many analysts argue that international investment is a much
more powerful force in propelling the world toward closer economic integration.
Investment, often alters entire methods of production through transfers of know-how,
technology and management techniques, and thereby initiates much more significant
change than the simple trading of goods.
Over the past ten years, foreign investment has grown at a significantly more rapid
pace than either international trade or world economic production generally. From
1980 to 1998, international capital flows, a key indication of investment across
borders, grew by almost 25% annually, compared to the 5% growth rate of
international trade. This investment has been a powerful catalyst for economic
growth.
But as with many of the other aspects of globalisation, foreign investment is raising
many new questions about economic, cultural and political relationships around the
world. Flows of investment and the rules that govern or fail to govern it can have
profound impacts upon such diverse issues as economic development, environmental
protection, labour standards and economic stability.
Commercial loans: These primarily take the form of loans by banks to foreign
businesses or governments.
Official flows: This category refers generally to the forms of development assistance
given by developed countries to developing ones.
Foreign Direct Investment (FDI): This category refers to international investment in
which the investor obtains a lasting interest in an enterprise in another country. FDI is
calculated to include all kinds of capital contributions, such as the purchases of
stocks, as well as the reinvestment of earnings by a wholly owned company
incorporated abroad (subsidiary), and the lending of funds to a foreign subsidiary or
branch. The reinvestment of earnings and transfer of assets between a parent company
and its subsidiary often constitutes a significant part of FDI calculations. An investor's
earnings on FDI take the form of profits such as dividends, retained earnings,
management fees and royalty payments.
Until the 1980s, commercial loans from banks were the largest source of foreign
investment in developing countries. However, since that time, the levels of lending
through commercial loans have remained relatively constant, while the levels of
global FDI and FPI have increased dramatically. Over the period 1991 - 1998, FDI
and FPI comprised 90% of the total capital flows to developing countries.
Similarly, when viewed against the tremendous and growing volume of FDI and FPI,
the funds provided in the past by governments through official development
assistance, or lending by commercial banks the World Bank or IMF, are diminishing
in importance with each passing year. When one talks about the recent phenomenon
of globalization therefore, one is referring in large part to the effects of FDI and FPI,
and these two instruments will therefore be the primary focus of this issue brief.
Calculating Investment:
Calculations of FDI and FPI are typically measured as either a "flow," referring to the
amount of investment made in one year, or as "stock," measuring the total
accumulated investment at the end of that year.
One of the most important distinctions between Portfolio and Direct investment to
have emerged from this young era of globalisation is that portfolio investment can be
much more volatile. Changes in the investment conditions in a country or region can
lead to dramatic swings in portfolio investment. For a country on the rise, FPI can
bring about rapid development, helping an emerging economy move quickly to take
advantage of economic opportunity, creating many new jobs and significant wealth.
However, when a country's economic situation takes a downturn, sometimes just by
failing to meet the expectations of international investors, the large flow of money
into a country can turn into a stampede away from it.
By contrast, because FDI implies a controlling stake in a business, and often connotes
ownership of physical assets such as a equipment, buildings and real estate, FDI is
more difficult to pull out or sell off. Consequently, direct investors may be more
committed to managing their international investments, and less likely to pull out at
the first sign of trouble.
This volatility has effects beyond the specific industries in which foreign investments
have been made. Because capital flows can also affect the exchange rate of a nation's
currency, a quick withdrawal of investment can lead to rapid decline in the purchasing
power of a currency, rapidly rising prices (inflation) and then panic buying to avoid
still higher prices. In short, such quick withdrawals can produce widespread economic
crisis. This was partly the case in the Asian Economic Crisis that began in 1997.
Although the economic turmoil began as a result of some broader shifts in
international economic policy and some serious problems within the banking and
financial sectors of the affected East Asian nations, the capital flight which ensued --
some compared it to the great financial panics which took place in the United States
during the 19th century -- significantly exacerbated the crisis.
Why Do Companies Invest Overseas?
Companies choose to invest in foreign markets for a number of reasons, often the
same reasons for expanding their operations within their home country. The
economist John Dunning has identified four primary reasons for corporate foreign
investments:
Market seeking - Firms may go overseas to find new buyers for goods and services.
Market-seeking may happen when producers have saturated sales in their home
market, or when they believe investments overseas will bring higher returns than
additional investments at home. This is often the case with high technology goods.
Resource seeking - Put simply, a company may find it cheaper to produce its product
in a foreign subsidiary- for the purpose of selling it either at home or in foreign
markets. The foreign facility may be able to obtain superior or less costly access to the
inputs of production (land, labor, capital and natural resources) than at home.
Strategic asset seeking - Firms may seek to invest in other companies abroad to help
build strategic assets, such as distribution networks or new technology. This may
involve the establishment of partnerships with other existing foreign firms that
specialize in certain aspects of production.
As stated earlier in this brief, international investment levels have exploded in recent
decades. These increases in the flows of foreign investment have themselves marked a
new and distinct phenomenon in the era of globalisation. Several factors have helped
drive this growth:
1) Technology. Telecommunications and transportation advances have simply made
it easier to do business across large distances. As former President Clinton once
pointed out, in the 1960s, transatlantic telephone lines could only accommodate 80
simultaneous calls between Europe and the United States. Today, satellites and other
telecommunications infrastructure can handle one million calls at one time.
Fax machines, email and the drop in the cost of air travel have also contributed
significantly to the growth of FDI. As you can imagine, a business owner might think
twice about trying to run an affiliate in a foreign country if communication with that
office were not both easy and cheap. Changes in practices tend to be driven by
changes in capabilities, and these new methods to communicate have unquestionably
helped drive much of the subsequent desire to promote economic integration.
2) The lure of higher profits. Many countries in East Asia had built their
phenomenal growth on a foundation based on greater integration into the international
economy, particularly emphasizing export-led growth. Investors from around the
world realized that access to East Asian markets and their trading partners might help
them attain much higher returns on their investments than they could obtain at home.
3) Financial liberalization. Prior many countries imposed strict limits on the rights
of companies and individuals to invest overseas, to purchase foreign securities, or
even to hold foreign currencies. Many of these restrictions were put in place following
the Great Depression of the 1930's, which had produced volatile movements of
capital, triggering financial panics in some cases. Financial liberalization has been the
most direct, and probably the single biggest, factor accounting for the growth of
international investment flows over the past several decades.
Now that you understand the basic economic reasons why companies choose to invest
in foreign markets, and what forms that investment may take, it is important to
understand the other factors that influence where and why companies decide to invest
overseas. These other factors relate not only to the overall economic outlook for a
country, but also to economic policy decisions taken by foreign governments, aspects
that can be very political and controversial.
The policy frameworks relating to FDI and FPI are relatively similar, although there
are a few differences.
In addition to these general economic indicators, portfolio investors also look at the
economic policy environment as well, and especially at factors such as:
SURVEY OF LITERATURE:
Balance of Payments is a statistical record of ALL of a country's int'l transactions
with the rest of the world, over a certain time period (quarter or year), using double-
entry bookkeeping. (private transactions and government transactions).
1. CURRENT ACCOUNT
Exports (X) / Imports (M) of: a) Merchandise, b) Services, c) Factor income and d)
Unilateral (one way) government transfers.
Balance on Current Account (CA) = X + M + Net Transfer
2. CAPITAL ACCOUNT
Record of the Sales of Indian Assets (Stocks, bonds, real estate, businesses) to
foreigners, X of assets, resulting in a capital inflow, or a Credit (cash inflow); and the
Purchases of Foreign assets by Indians, M of assets, capital outflow, Debit (cash
outflow).
Specifically:
b. Portfolio Investment:
Purchases/sales of stocks, bonds, notes, mutual funds, money market securities,
options, etc., in foreign capital markets not involving controlling interest.
International portfolio investments have increased significantly recently due to a)
relaxation/deregulation of capital controls (increased capital mobility) and b) a desire
for International portfolio diversification (most security returns have a low correlation
among countries, resulting in risk reduction).
3. OTHER ACCOUNTS
FII flows and contemporaneous stock returns are strongly correlated in India. The
correlation coefficients between different measures of FII flows and market returns on
the Bombay Stock Exchange during different sample periods.
Positive correlations have often been held as evidence of FII actions determining
Indian equity market returns. However, correlation itself does not imply causality.
A positive relationship between portfolio inflows and stock returns is consistent with
at least four distinct theories:
1) the “omitted variables” hypothesis;
2) the “downward sloping demand curve” view;
3) the “base-broadening” theory; and
4) the “positive feedback strategy” view.
The “omitted variables” view is the classic case of spurious correlation – that the
correlated variables, in fact, have no causal relationship between them but are both
affected by one or more other variables missed out in the analysis.
The “downward sloping demand curve” view contends that foreign investment creates
a buying pressure for stocks in the emerging market in question and causes stock
prices to rise much in the same way as suddenly higher demand for a commodity
would cause its price to rise.
Finally the ‘positive feedback view’ asserts that if investors ‘chase’ returns in the
immediate past (like the previous day or week) then aggregating their fund flows over
the month can lead to a positive relationship in the contemporaneous monthly data.
In the present context, both directions of causation are equally plausible.
The positive relationship between market return and FII flows, however, serves only
as a first-pass in understanding the nature of such flows and their implications for the
Indian markets. Since the FII flows essentially serve to diversify the portfolio of
foreign investors, it is only normal to expect that several factors – both domestic as
well as external to India – are likely to affect them along with the expected stock
returns in India. The declining world interest rates have been among the important
“push” factors for international portfolio flows in the early 90’s. The “usual suspects”
in the literature include:
US and world equity returns, changes in interest rates, stock market volatility, some
measure of the country risk and the exchange rate. Other factors that may affect FII
flows Country risk measures, that incorporate political and other risks in addition to
the usual economic and financial variables, may be expected to have an impact on
portfolio flows to India though they are likely to matter more in the case of FDI flows.
CHAPTER 2
DESIGN OF THE STUDY
REFERENCE PERIOD
The study period covered under this is for the financial year : 1st April 2004 to 31st
March 2005.
RESEARCH DESIGN:
TYPE OF RESEARCH:
SOURCES OF DATA
The main source of obtaining necessary data for the study was Secondary Data. This
study is empirical in nature and hence secondary data is used to conduct the research.
The data was collected from the Internet by exploring the Secondary sources available
on websites.
Secondary Data: The secondary data constitutes of daily FII flows data which was
collected from Money Control and Equity Master, the daily returns of SENSEX and
NIFTY from BSE and NSE websites respectively. The trends in FII flows from the
RBI website and information on FII from SEBI.
PLAN OF ANALYSIS
The data gathered from various sources were primarily studied and necessary data
was sorted out sequentially keeping in mind the procedure of the study. The analysis
has been made by, correlating the FII purchases, sales and net investment with equity
market returns to identify whether a relation exists between them. Findings are
included which transmits the important points, which were gathered from the study.
METHODOLOGY
HYPOTHESIS
Null Hypothesis (Ho): There is no influence of FIIs on the Stock indexes.
Alternative Hypothesis (Ha): There is an influence of FIIs on Stock indexes.
If we reject the Ho, then we accept the Ha, setting the significance level to 5% and
1% at Degree of Freedom = n-2.
Gold standard-When a country is said to be on the Gold Standard, the value of its
currency and the quantity of its currency in circulation is tied the nation's reserve of
gold. Such a system tends to restrict the country's monetary supply.
Debt/equity ratio-The debt/equity ratio measures the extent to which a firm's capital
is provided by lenders (through debt instruments such as fixed-return bonds) or
owners (through variable-return stocks). A greater reliance on financing through debt
can mean greater profitability for shareholders, but also greater risk in the event things
go sour.
Interest rates-Interest rates have a powerful effect on the volume of a nation's money
supply. By raising interest rates, i.e., making the cost of borrowing money more
expensive, governments or banks can decrease the money supply. A decrease in the
money supply tends to be counter-inflationary, which makes a currency more valuable
compared to other currencies.
Most Favored Nation Treatment-The phrase "most favored nation" refers to the
obligation of the country receiving the investment to give that investment the same
treatment as it gives to investments from its "most favored" trading partner.
• All the goods, services, factor income and current transfers an economy
receives from or provides to the rest of the world
• Capital transfers and changes in an economy's external financial claims and
liabilities
Portfolio investment – covers the acquisition and disposal of equity and debt
securities that cannot be classified under direct investment or reserve asset
transactions. These securities are tradable in organised financial markets.
FDI Flows and Stocks – Through direct investment flows the investors builds up a
direct investment stock (position), making part of the investor’s balance sheet. The
FDI stock (position) normally differs from accumulated flows because of revaluation
(changes in prices or exchange rates) and other adjustments like rescheduling or
cancellation of loans, debt forgiveness or debt-equity swaps with different values.
Host Economy – is the country that receives FDI or FPI from the foreign investor(s).
CHAPTER 4
INDUSTRY PROFILE
Success in India
Success in India will depend on the correct estimation of the country's potential;
underestimation of its complexity or overestimation of its possibilities can lead to
failure. While calculating, due consideration should be given to the factor of the
inherent difficulties and uncertainties of functioning in the Indian system. Entering
India's marketplace requires a well-designed plan backed by serious thought and
careful research. For those who take the time and look to India as an opportunity for
long-term growth, not short-term profit- the trip will be well worth the effort.
Market potential
India is the fifth largest economy in the world (ranking above France, Italy, the United
Kingdom, and Russia) and has the third largest GDP in the entire continent of Asia. It
is also the second largest among emerging nations. (These indicators are based on
purchasing power parity). India is also one of the few markets in the world, which
offers high prospects for growth and earning potential in practically all areas of
business. Despite the practically unlimited possibilities in India for overseas
businesses, the world's most populous democracy has, until fairly recently, failed to
get the kind of enthusiastic attention generated by other emerging economies such as
China.
The rapid economic growth of the last few years has put heavy stress on India's
infrastructure facilities. The projections of further expansion in key areas could snap
the already strained lines of transportation unless massive programs of expansion and
modernization are put in place. Problems include power demand shortfall, port traffic
capacity mismatch, poor road conditions (only half of the country's roads are
surfaced) and low telephone penetration.
Indian Bureaucracy
Although the Indian government is well aware of the need for reform and is pushing
ahead in this area, business still has to deal with an inefficient and sometimes still
slow-moving bureaucracy.
Diverse Market
The Indian market is widely diverse. The country has 17 official languages, 6 major
religions, and ethnic diversity as wide as all of Europe. Thus, tastes and preferences
differ greatly among sections of consumers. Therefore, it is advisable to develop a
good understanding of the Indian market and overall economy before taking the
plunge.
International portfolio flows are largely determined by the performance of the stock
markets of the host countries relative to world markets. With the opening of stock
markets in various emerging economies to foreign investors, investors in industrial
countries have increasingly sought to realize the potential for portfolio diversification
that these markets present.
It is likely that for quite a few years to come, FII flows would increase with global
integration. The main question is whether capital flew in to these countries primarily
as a result of changes in global (largely US) factors or in response to events and
indicators in the recipient countries like its credit rating and domestic stock market
return. The answer is mixed – both global and country-specific factors seem to matter,
with the latter being particularly important in the case of Asian countries and for debt
flows rather than equity flows.
From a net foreign investment inflow of US $ 5.3 billion in 1997-98, such inflows
declined to US $ 2.4 billion in 1998-99. This is because of the lower portfolio
inflows, as a result of which the net investment has dropped. The changes in the
investment conditions in a country or region can lead to dramatic swings in portfolio
investment. For a country on the rise, in other words for developing countries, FPI can
bring about rapid development, helping an emerging economy move quickly to take
advantage of economic opportunity, creating many new jobs and significant wealth.
However, when a country's economic situation takes a downturn, sometimes just by
failing to meet the expectations of international investors, the large flow of money
into a country can turn into a stampede away from it.
CHART: FOREIGN INVESTMENT FLOWS
12000
10000
8000
6000
4000
2000
0
1990-91 1991-92 1992- 1993- 1994-95 1995-96 1996-97 1997-98 1998- 1999- 2000- 2001- 2002- 2003-
93 94 99 00 01 02 03 04
FPI FDI Y EA R
The committee would also suggest that the capital markets should be gradually
opened up to foreign portfolio investments and simultaneously efforts should be
initiated to improve the depth of the market by facilitating the issue of new types of
equities and innovative debt instruments.’ (Narasimham committee report)
Prior to 1992, only non-resident Indians (NRIs) and Overseas corporate bodies
(OCBs) were allowed to undertake portfolio investment in India. Only on September
14, 1992 the Government of India issued guidelines on FII investments in India which
was followed by a notification by Securities and Exchange Board of India (SEBI)
three years later in November 1995.
FOREIGN INSTITUTIONAL INVESTMENT IN INDIA: MILESTONES
All these are indications for the country's continuous efforts to mobilize more foreign
investment through portfolio investment by FIIs. The FII portfolio flows have also
been on the rise since September 1992. Their investments have always been net
positive, but for 1998-99, when their sales were more than their purchase
ACTS AND RULES
FII registration and investment are mainly governed by SEBI (FII) Regulations,
1995.
TAXATION
The taxation norms available to a FII is shown in the table below.
Nature of Income Tax Rate
Long-term capital gains 10%
Short-term capital gains 30%
Dividend Income Nil
Interest Income 20%
Long term capital gain: Capital gain on sale of securities held for a period of more
than one year.
Short term capital gain: Capital gain on sale of securities held for a period of less than
one year.
The first concern of a central bank is the maintenance of a soundly based commercial
banking structure. While this concern has grown to comprehend the operations of all
financial institutions, including the several groups of non-bank financial
intermediaries, the commercial banks remain the core of the banking system. A
central bank must also cooperate closely with the national government. Indeed, most
governments and central banks have become intimately associated in the formulation
of policy.
They are often responsible for formulating and implementing monetary and credit
policies, usually in cooperation with the government. they have been established
specifically to lead or regulate the banking system.
Since its inception SEBI has been working targetting the securities and is attending to
the fulfillment of its objectives with commendable zeal and dexterity. The
improvements in the securities markets like capitalization requirements, margining,
establishment of clearing corporations etc. reduced the risk of credit and also reduced
the market.
Two broad approaches of SEBI is to integrate the securities market at the national
level, and also to diversify the trading products, so that there is an increase in number
of traders including banks, financial institutions, insurance companies, mutual funds,
primary dealers etc. to transact through the Exchanges. In this context the introduction
of derivatives trading through Indian Stock Exchanges permitted by SEBI in 2000 AD
is a real landmark.
Approximately 70,000 deals are executed on a daily basis, giving it one of the highest
per hour rates of trading in the world. There are around 3,500 companies in the
country which are listed and have a serious trading volume. The market capitalization
of the BSE is Rs.5 trillion. The BSE `Sensex' is a widely used market index for the
BSE.
The main aims and objectives of the BSE is to provide a market place for the purchase
and sale of security evidencing the ownership of business property or of a public or
business debt. It aims to promote, develop and maintain a well-regulated market for
dealing in securities and to safeguard the interest of members and the investing public
having dealings on the Exchange. It helps industrial development of the country
through efficient resource mobilization. To establish and promote honourable and just
practices in securities transactions
BSE Sensex
The BSE Sensex is a value-weighted index composed of 30 companies with the base
April 1979 = 100. It has grown by more than four times from January 1990 till date.
The set of companies in the index is essentially fixed. These companies account for
around one-fifth of the market capitalization of the BSE.
• The average total traded value for the last six months of all Nifty stocks is
approximately 58% of the traded value of all stocks on the NSE
• Nifty stocks represent about 60% of the total market capitalization as on
March 31, 2005.
• Impact cost of the S&P CNX Nifty for a portfolio size of Rs.5 million is
0.07%
• S&P CNX Nifty is professionally maintained and is ideal for derivatives
trading
CHAPTER 4
ANALYSIS AND INTERPRETATION
Portfolio flows – often referred to as “hot money” – are notoriously volatile compared
to other forms of capital flows. Investors are known to pull back portfolio investments
at the slightest hint of trouble in the host country often leading to disastrous
consequences to its economy. They have been blamed for exacerbating small
economic problems in a country by making large and concerted withdrawals at the
first sign of economic weakness.
Year FII PURCHASE FII SALES FII NET FII NET CUM FII NET
in crores in crores in crores US$ million US$ million
1993-94 5593 466 5126 1634 1638
1994-95 7631 2835 4796 1528 3167
1995-96 9694 2752 6942 2036 5202
1996-97 15554 6979 8575 2432 7634
1997-98 18695 12737 5958 1649 9284
1998-99 16115 17699 -1584 -386 8898
1999-00 56856 46734 10122 2339 11237
2000-01 74051 64116 9934 2160 13396
2001-02 49920 41165 8755 1846 15242
2002-03 47060 44371 2689 562 15804
2003-04 144858 99094 45765 9949 25754
Source: Reserve Bank of India Annual Report 2004
INFERENCE: The investments by FIIs have been registering a steady growth since
the opening of the Indian capital markets in September 1992. Their investments have
always been net positive, but for 1998-99, when their sales were more than their
purchases.
It can be observed from the above table that the portfolio investment inflows have
always been on the increase. But the years 2001-02 and 2002-03 saw some reversal in
the trend. From a net inflow of US $ 2.1 billion in 2000-01, such inflows declined to
US $ 1.8 billion in 2001-02, and further dropped to US $ 0.562 billion in 2002-03.
The decline is because of the lower portfolio inflows, as a result of which the net
investment has dropped in these years. However, this decline witnessed a sharp
reversal in the year 2003-04. FIIs have made a net investment of Rs. 45,764 crores
during this year registering a growth of 1602% over the previous year, creating a
record in the history of FII investment in India. Gross purchases in this year amounted
to Rs.144,857 crores, a growth rate of 208% compared to the year before. This trend
continued in April 2004, only to suffer reversal again during May and June 2004,
when the net investment became negative. Fortunately, the year from July 2004 has
been seeing a net positive portfolio flows by FIIs. As of September 2004, the net FII
portfolio investment stands at US $ 27,637 million. If it is so, then increasing the FII
investment cap per se will not be helpful. The country has to work on specific
measures to encourage more FII investments. The analysis of data indicates that there
has been substantial divestment by the FIIs during the year 1998-99. The maximum
outflow was during the months of May and June 1998 (almost US$430 millions).
INFERENCE: The sources of these FII flows are varied. The FIIs registered with
SEBI come from as many as 28 countries. US-based institutions accounted for
slightly over 41%, those from the UK constitute about 20% with other Western
European countries hosting another 17% of the FIIs). It is, however, instructive to
bear in mind that these national affiliations do not necessarily mean that the actual
investor funds come from these particular countries. Given the significant financial
flows among the industrial countries, national affiliations are very rough indicators of
the ‘home’ of the FII investments. In particular institutions operating from
Luxembourg, Cayman Islands or Channel Islands, or even those based at Singapore or
Hong Kong are likely to be investing funds largely on behalf of residents in other
countries. Nevertheless, the regional breakdown of the FIIs does provide an idea of
the relative importance of different regions of the world in the FII flows.
160000 144858
GROSS PURCHASE (in Rs crores)
140000
120000
100000
74051
80000
56856
60000 49920 47060
40000
15554 18695 16115
20000 5593 7631 9694
0
1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04
YEAR
INFERENCE: On observation of the above chart of trends in yearly Gross
Purchases, the Gross Purchases of FIIs in India registered a record of Rs.144,857
crores in the year 2003-04, a growth rate of 208% compared to the previous year
2002-03. This trend continued in April 2004, only to suffer reversal again during May
and June 2004, when the net investment became negative.
99094
100000
GROSS SALES (in Rs. crores)
80000
64116
60000
46734 44371
41165
40000
17699
20000 12737
6979
466 2835 2752
0
1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04
YEAR
INFERENCE
In the above chart we can see that during the year 2003-04 FIIs Gross Sales amounted
an increase Rs.99094 crores when compared to Rs. 44371 crores. The FIIs Gross
Sales shows an upward trend with reference to the base year of 1993-94 when the
Gross Sales where only Rs. 466 crores.
CHART: TRENDS IN YEARLY NET INVESTMENT
12000
(in US$ million)
10000
8000
6000
NET INVESTMENT
4000
2000
0
1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04
-2000
YEAR
If one looks at the trend of portfolio equity investment in the Indian stock market
since 2002-03, it shows that there has been a very sharp increase in the net FII
investment in India since April 2003. For the financial year 2003-04, FIIs have
invested more than Rs 44,000 crore of portfolio capital in the Indian stock market. To
put this figure into perspective, for the period 1992-93 to 2002-03, the maximum
annual net investment by FIIs in India was in the year 1999-2000 and for that year,
total net FII investment in India was Rs 9,765 crores. This rising trend of portfolio
investment continued in 2004 also. In fact, in March 2004, a record Rs 8.800 crores of
net foreign portfolio investment came into the Indian equity market. This trend
continued till the end of April and more than Rs 4,200 crores of portfolio investment
was made in the Indian stock market in that month. However, for the month of May,
FIIs turned net sellers in the Indian equity markets. Between 30th April 2004 and 31st
May 2004, net FII investment was negative. During this period, FIIs withdrew more
than Rs 3,500 crores from the Indian equity market. In June, net FII investment turned
positive, however, net FII investment for the month of June was only Rs 516 crores
which is much lower than the average
The analysis of data indicates that there has been substantial divestment by the FIIs
during the year 1998-99. The maximum outflow was during the months of May and
June 1998 (almost US$430 millions).
A major factor which led to continuous outflow of funds during the middle and end of
the year 1998 was the worsening outlook on the emerging markets. Credit worthiness
of almost all the South-east Asian nations was severely damaged by the crises which
started in July 1997. As a result, the FIIs were facing heavy redemption pressures
from the Emerging Markets Funds. The stock markets in all these countries fell
continuously from March 1998 till about September 1998. The integration of the
Indian capital markets with the international markets thus spilled over to Indian
markets as well. However, the net outflow from the Indian markets was much lower
than the other Asian countries. A further indication of the integration of the Indian
markets can be seen from the upsurge in the valuations and funds inflows during the
first quarter of 1999, when all the other Asian countries have also seen rising trend in
stocks indices.
The sluggishness in investment in the emerging markets was exacerbated by the fact
that throughout 1998-99, US and European markets showed historically high
valuations, and the expectations of further rise because of the strong economic
indicators there which led to reduced allocations elsewhere.
We are interested in testing a hypothesis about the influence of FII in Equity Stock
Market by correlating Gross Purchases, Gross Sales and Net Investment with Nifty
and Sensex. T-test is conducted at 1% and 5% significance. Statistical significance is
way to measure the likelihood that chance explains the results.
FORMULATING A HYPOTHESIS:
Null Hypothesis (Ho): there is no influence of FIIs on the Stock indexes.
Alternative Hypothesis (Ha): there is an influence of FIIs on Stock indexes.
If we reject the Ho, then we accept the Ha. Setting the significance level to 5% and
1%, the null hypothesis would be rejected only when the maximum number of months
show positive correlation.
T-Statistic:
Using T-test is calculated using the following formula:
r
t=
(1 − r ) 2
n−2
When,
-the calculated t>t(0.05,0.01) for (n-2) d.f., variable is significant at 5% level.
-if t<t(0.05) the data are consistent with the hypothesis of an uncorrelated
Conclusion: At the 1% level of stat sig we find that there is an influence of FIIs on
Stock Market Indexes of India.
FII flows and contemporaneous stock returns are strongly correlated in India. The
correlation coefficients between different measures of FII flows and market returns on
the Bombay Stock Exchange during different sample periods are shown in Table
above. While the correlations are quite high throughout the sample period, they
exhibit a significant rise since the beginning of the 1999-00. The calculations show
that there exists a relationship between FIIs and Nifty since 6 out of 12 months show
positive correlation in the case of Gross Purchass and 8 out of 12 months indicate a
positive correlation in the case of Net FII Investment and Nifty.
TABLE : CORRELATION OF FII WITH SENSEX
The behaviour of the foreign portfolio investors matched the behaviour of Sensex
during this period. Net FII investment in the Indian capital markets started fluctuating
sharply during April and it turned negative. Net FII investment in the Indian stock
market was positive from May to July. During this period, the Sensex and net FII
investment showed very high degree of correlation. For the month of June showed a
correlation as high as 0.60. The months of September, October, November and
December shows a declining trend, the FII investment reversed from that day. On the
whole, there exists a relationship between FIIs and Sensex since 7 out of 12 months
show positive correlation in the case of Gross Purchases and 8 out of 12 months
indicate a positive correlation in the case of Net FII Investment and Sensex.
Similarly, in the case of FII and Sensex we have R2 = .46, indicating that variation in
FII explains about 46% of the variation in Sensex. 54% of the variation in Sensex is
unexplained by FII, explainable by other factors, omitted variables, random variation,
etc. We shouldn't put too much emphasis on R2, t-stat are more important. However,
R2, or some other measure of goodness of fit is expected in reported empirical results.
Comparing the t-stat to the critical value at the 1% level (one-tailed test) at degree of
Freedom, D.F. = N –2;
-the calculated t>t(0.05,0.01) for (n-2) d.f., variable is significant at 5% level.
-if t<t(0.05) the data are consistent with the hypothesis of an uncorrelated
We accept the Null Hypothesis since the maximum number of months show that FII
and Nifty are uncorrelated.
Comparing the t-stat to the critical value at the 1% level (one-tailed test) at degree of
Freedom, D.F. = N –2;
-the calculated t>t(0.05,0.01) for (n-2) d.f., variable is significant at 5% level.
-if t<t(0.05) the data are consistent with the hypothesis of an uncorrelated
We accept the Null Hypothesis since the maximum number of months show that FII
-Nifty and FII-Sensex are uncorrelated.
F-STATISTIC:
If we reject the Ho, then we accept the Ha. Setting the significance level to 1%, the
null hypothesis would be rejected only when the entire year of 2004-05 shows
positive correlation.
Formula For F Test
f =
( n − 2) r 2
(1 − r )
2
The positive relationship between market return and FII flows, however, serves only
as a first-pass in understanding the nature of such flows and their implications for the
Indian markets. Since the FII flows essentially serve to diversify the portfolio of
foreign investors, it is only normal to expect that several factors – both domestic as
well as external to India – are likely to affect them along with the expected stock
returns in India.
CHAPTER 5
SUMMARY OF FINDINGS, RECOMMENDATIONS AND CONCLUSION
FINDINGS:
It is an accepted fact now that FIIs have significant influence on the movements of
the stock market indexes in India. If one looks at the total FII trade in equity in
India and its relationship with the stock market major indexes like Sensex and
Nifty, it shows a steadily growing influence of FIIs in the domestic stock market.
FIIs and the movements of Sensex are quite closely correlated in India and FIIs
wield significant influence on the movement of Sensex. NSE also observes that in
the Indian stock markets FIIs have a disproportionately high level of influence on
the market sentiments and price trends. This is so because other market
participants perceive the FIIs to be infallible in their assessment of the market and
tend to follow the decisions taken by FIIs. This ‘herd instinct’ displayed by other
market participants amplifies the importance of FIIs in the domestic stock market
in India.
Results of this study show that not only the FIIs are the major players in the
domestic stock market in India, but their influence on the domestic markets is also
growing. Data on trading activity of FIIs and domestic stock market turnover
suggest that FII’s are becoming more important at the margin as an increasingly
higher share of stock market turnover is accounted for by FII trading. Moreover,
the findings of this study also indicate that Foreign Institutional Investors have
emerged as the most dominant investor group in the domestic stock market in
India. Particularly, in the companies that constitute the Bombay Stock Market
Sensitivity Index (Sensex) and NSE Nifty, their level of control is very high.
Dominant position of FIIs in the Sensex companies, it is not surprising that FIIs
are in a position to influence the movement of Sensex and Nifty in a significant
way.
Since FIIs are dominating the Indian Market, individual investors are forced to
accept the dictates of major FIIs and hence join the group by entering the Mutual
Fund group. Many Mutual Funds floated specific funds for the sectors favoured
by the FIIs. An implication of MFs gaining strength in the Indian stock market
could be that unlike individual investors, whose monies they manage, MFs can
create market trends whereas the small individual investors can only follow the
trends. The situation becomes quite difficult if the funds gain a vested interest in
certain sectors by floating sector specific funds. One can even venture to say that
the behaviour of MFs in India has turned the very logic that mutual funds invest
wisely on the basis of well-researched strategies and individual investors do not
have the time and resources to study and monitor corporate performance, upside
down. Thus, the entry of FIIs has not resulted in greater depth in Indian stock
market; instead it led to focussing on only a few sectors. Ultimately to provide a
level playing field, even the domestic investors had to be offered lower rates of
capital gains tax.
While it can be expected that foreign affiliated mutual funds would follow the
investment pattern of FIIs, it is important to note that many domestic ones also
followed FIIs. The sectors favoured by FIIs account for a substantial portion of the
net assets under control of many Mutual Funds. The Mutual funds are gaining
prominence in the Indian Stock market and that the share of foreign affiliated MFs
is growing, a number of Indian funds are following the investment strategies of
the foreign ones.
On the other hand if FII investments constitute a large share of the equity capital
of a financial entity, an FII pullout, even if driven by development outside the
country can have significant implications for the financial health of what is an
important institution in the financial sector of this country.
Similarly, if any set of developments encourages an unusually high outflow of FII
capital from the market, it can impact adversely on the value of the rupee and set
of speculation in the currency that can in special circumstances result in a
currency crisis. There are now too many instances of such effects worldwide for it
be dismissed on the ground that India's reserves are adequate to manage the
situation.
The ‘home bias’ portfolios of investors in industrial countries – the tendency to hold
disproportionate amounts of stock from the ‘home’ country – suggests substantial
potential for further portfolio flows as global market integration increases over time.
It is important to note that global financial integration, however, can have two distinct
and in some ways conflicting effects on this ‘home bias’. As more and more countries
– particularly the emerging markets – open up their markets for foreign investment,
investors in developed countries will have a greater opportunity to hold foreign assets.
However, these flows themselves, along with greater trade flows will tend to cause
different national markets to increasingly become parts of a more unified ‘global’
market, reducing their diversification benefits. Which of these two effects will
dominate is, of course, an empirical issue, but given the extent of the ‘home bias’ it is
likely that for quite a few years to come, FII flows would increase with global
integration.
RECOMMENDATIONS:
Some of the steps that can be taken to help influence the choices made by foreign
institutional investors include:
The Government should cut its fiscal deficits, which would result in strengthening
the economy as a whole.
The ability of governments to prevent or reduce financial crises also has a great
impact on the growth of capital flows. Steps to address these crises include
strengthening banking supervision, requiring more transparency in international
financial transactions and ensuring adequate supervision and regulation of financial
markets.
An attempt should be made to bring down the inflation level to attract more
foreign institutional investments into India.
The fact is that developing country like India has its own compulsions arising out
of the very state of their social, political and economic development. To attract
portfolio investments and retain their confidence, the host countries have to follow
stable macro-economic policies,
The provision for clear procedures must be followed in the event of disputes
between investors and host governments, to ensure that rules are adhered to and that
arbitration may be established by mutual consent.
There has been a significant shift in the character of global capital flows to the
developing countries in recent years in that the predominance of private account
capital transfer and especially portfolio investments (FPI) increased considerably. In
order to attract portfolio investments which prefer liquidity, it has been advocated to
develop stock markets.
The general perception about the foreign portfolio investments is that, not only do
they expand the demand base of the stock market, but they can also stabilise the
market through investor diversification.
Obstacles to investment prevent countries from making optimal use of their own and
other countries' resources. Countless billions of dollars of potential wealth - for
investors in the form of profits, for workers in the form of wages, and for consumers
in the form of lower prices - are lost every year due to barriers to trade and
investment. Certain policy decisions of potential target countries of investment
receive close scrutiny from international investors. Consequently, a number of
international agreements have been written to specifically address those concerns.
CONCLUSION
This paper provides a preliminary analysis of FII flows to India and their influence on
the prices of stocks in the Indian stock market. A more detailed study using daily data
of equity returns for a longer period or, better still, disaggregated data showing the
transactions of individual FIIs at the stock level can help address questions regarding
the extent of herding or return-chasing behavior among FIIs which now account for a
significant part of the capital account balance in our balance of payments. The extent
to which FII participation in Indian markets has helped lower cost of capital to Indian
industries is also an important issue to investigate.
Broader and more long-term issues involving foreign portfolio investment in India
and their economy-wide implications have not been addressed in this paper. Such
issues would invariably require an estimation of the societal costs of the volatility and
uncertainty associated with FII flows. A detailed understanding of the nature and
determinants of FII flows to India would help us address such questions in a more
informed manner and allow us to better evaluate the risks and benefits of foreign
portfolio investment in India.