Project report on “ANALYTICAL STUDY OF IMPACT OF FOREIGN

INSTITUTIONAL INVESTORS (FIIS) ON EXCHANGE RATE AND VALUE OF

INDIAN NATIONAL RUPEE (INR) IN TERMS OF VOLATILITY”
Uploaded by Jayantkumar Kumbhare on Oct 31, 2011

Chapter No.2

Introduction
2.1:
Introduction of Topic
In this project we will try to understand the concept of the Foreign Instit
utionalInvestment (FII) and their role and effect on the exchange rate of Indian R
upee means thefluctuation in FII investment affects the value of exchange rate or
not.In order to understand the role and effect of the FII on Indian Rupee
we need toknow in brief about the Foreign Institutional Investment and
Exchange Rate of Indian National Rupee.
2.2: FII (Foreign Institutional Investors)
Foreign institutional investor means an entity established or incorporated outside
India for the purpose of making investments into the Indian securities m
arket under theregulations prescribed by SEBI. Positive tidings about the
Indian economy combinedw i t h a f a s t -
growing market have made India an attractive destination f
o r f o r e i g n institutional investors.‘F I I ’ i n c l u de “ Ov er s ea s pe ns i o n f u n d
s , m u t ua l f u n ds , i nv es tm e nt tr us t, a s s et ma n a g em en t co m pa ny , n
o mi ne e co m p a n y , b a n k , i ns t i t u ti o n a l po r t f o l i o m a n a g er , u ni v er s i t
y f u n d s , e nd o w me n ts , f o un da t i o n s , c h a r i ta bl e tr u s t s , c ha r i t a b l e s
o ci et i es , a trustee or power of attorney holder incorporated or established outs
ide India proposing tomake proprietary investments or investments on beh
alf of a broad-
based fund. FIIs caninvest their own funds as well as invest on behalf of
their overseas clients registered assuch with SEBI. These client accounts that
the FII manages are known as ‘sub-
accounts’.A domestic portfolio manager can also register itself as an FII t
o manage the funds of sub-
accounts.F o r e i g n In s ti t u ti o na l I nv es to r s (F I Is ) a r e en t i t i es es t a bl i s h
e d o r i n co r po r a t e d outside India and make proposals for investments i
n India. These investment proposals by the FIIs are made on behalf of su
b accounts, which may include foreign corporate,individuals, and funds
etc. In order to act as a banker to the FIIs, the RBI has designated banks t
hat are authorized to deal with them. The biggest source through which FIIs invest
is the issuance of participatory Notes (P-
N o t es ) , w hi c h a r e a l s o kn o w n a s o f f s ho r e Derivatives.F o r ei g n I nv es t
m e n t r ef er s t o i nv es t m e nts ma d e b y r es i de n ts o f a c o un tr y i n fina
ncial assets and production process of another country. After the openin
g up of the
 borders for capital movement these investments have grown in leaps an
d bounds. But ith a d v a r i e d ef f e c ts a cr o s s t h e co u ntr i es . It c a n a f f e
c t t he f a c to r pr o d u c ti v i t y o f t h er e c i p i e n t co u n tr y a n d ca n a l s o a f
f e c t th e ba l a n c e o f pa y m e n ts [ B O P] . I n d ev el o pi n g countries there was
a great need of foreign capital, not only to increase their productivityof labour,
but also helps to build the foreign exchange reserves to meet the trade
deficit.Foreign investment provides a channel through which these countries can
have access toforeign capital. It can come in two forms: Foreign Direct In
vestment (FDI) and ForeignPortfolio Investment (FPI).Foreign Direct Invest
ment [FDI] involves in the direct production activity anda l s o o f m e di u
m to long-
t er m na t u r e. B ut t h e F o r ei g n Po r t f o l i o I nv es t m e n t[ F P I] i s a s h o r t -
term investment mostly in the financial markets and it con
s i s t s o f F o r e i g n I n s t i t u ti o na l I nv e s t m en t (F I I). T he F I I , g i v e n i ts s
h o r t - t er m na t ur e, mi g ht ha v e bi -
directional causation with the returns of other domestic financial marke
ts like moneym a r k e t , s t o c k m a r k e t , f o r e i g n e x c h a n g e m a r
k e t e t c . H e n c e , u n d e r s t a n d i n g t h e determinants of FII is very i
mportant for any emerging economy as it would have larger impact on the
domestic financial markets in the short run and real impact in the long run.The pr
esent study examines the determinants of foreign portfolio investment in the Indi
anc o nt ex t a s t h e c o un tr y a f ter ex p e r i e n ci n g t he f o r ei g n ex ch a ng e
c r i s i s o p e ne d u p t h e economy for foreign capital.India, being a capital sca
rce country, has taken lot of measures to attract foreigninvestment since t
he beginning of reforms in 1991. Till the end of January 2003 it couldattract a tota
l foreign investment of around US$ 48 billions out of which US$ 23 billionsi s i n t
he form of FPI. FII consists of around US$ 12 billions in the
total foreigninvestments. This shows the importance of FII
i n t h e o v e r a l l f o r e i g n i n v e s t m e n t programme. As India is in the
process of liberalizing the capital account, it would havesignificant impa
ct on the foreign investment and particularly on the FII, as this wouldaffe
ct short-
term stability in the financial markets. Hence, there is a need to determine the pu
sh and pull factors behind any change in the FII, so that we can frame ou
r policies toinfluence the variables which drive-
in foreign investment. Also FII has been subject of intense discussion, as
it is held responsible for intensifying currency crisis in 1990’selsewhere.T
he present study would examine the determinants of FII in Indian context. Herew
e make an attempt to analyze the effect of return, risk and inflation, which are tra
ced to be major determinants in the literature on FII. The proposed relation (discu
ssed in detaillater) is that inflation and risk in domestic country and retur
n in foreign country woulda d v er s el y a f f e c t t he F I I f l o w i ng t o do m es
t i c co u n tr y , w h er e a s i nf l a t i o n a nd r i s k i nforeign country and return in
domestic country would have favorable affect on the same.In the next section we
would briefly discuss the existing studies. In section 3, we discussthe theoretical
model. Section 4 briefly discusses the trends in FII in India. Database andmethodol
ogy adopted in this study are discussed in Section 5. In section 6, we discuss thees
timated results and conclusions are drawn accordingly in the last section