A Study of FII's in India

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A STUDY ON FIIS IN INDIA


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ABSTRACT

Since Indian stock market is vast and attract investors as a hotspot of investment .The Indian market is

steadily growing and had allured domestic investors community and foreign investors group in the past.

The major part of investment in Indian market is attributed to institutional investors among whom

foreign investors are of primary importance. One eminent concern in the matter is whether these

foreign investors (FII) direct the Indian stock market .This paper examines whether market movement

can be explained by these investors and their impact on the stock markets. FII, because of its short-term

nature, can have bidirectional causation with the returns of other domestic financial markets such as

money markets, stock markets, and foreign exchange markets. Hence, understanding the determinants

of FII is very important for any emerging economy as FII exerts a larger impact on the domestic financial

markets in the short run and a real impact in the long run. The present paper is an attempt to find out

determinants of foreign institutional investment in India, a country that opened its economy to foreign

capital following a foreign exchange crisis. The objective of the study is to find out whether there exist

relationship between FII and Indian stock market.

The Foreign Institutional Investors (FIIs) have emerged as important players in the Indian equity market

in the recent past. This study makes an attempt to develop an understanding of the dynamics of the

trading behavior and the factors influencing FIIs and returns in the Indian equity market by analyzing

daily and monthly data. The study concludes that FIIs follow positive feedback trading on a daily basis,

while they follow negative feedback trading on a monthly basis. But the main determinant remains

lagged stock returns. The study concludes that FIIs inflows in India are determined by stock market

characteristics, macroeconomic factors and international factors.

INTRODUCTION

With rapid changes in the economy because of liberal economic policies and fast pace changes due toglobalization, Indian market has become a focus point for foreign investors. Organizations tend to target

for large volume of trade in this era of globalization. Trade flows are indeed one of the most visible

aspects of globalization. International investment is a powerful source in propelling the world toward

closure economic integration. FII refers to the investment made by resident of one country in the

financial capital and asset of another country. It facilitates and persuades large productivity and help in

shaping up balance of payments. FII flows in India have continuously grown in importance.

NEED

Since the beginning of liberalization FII flows to India have steadily grown in importance. Foreign capitalflows 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. 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. India is considered as a good investment option by world

investors in spite of political differences and lack of infrastructure facility etc. Indian market presents

vast potential and alluring and encouraging foreign investors continuously. The FII flows were close to

$15bn in the last three months of 2009. However the SEBI statistics reveal that the FIIs are seen as the


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net sellers in the Indian markets, they sold securities worth Rs 7236.8 crores since 2008. On January 21

2008, BSE Sensex saw the largest ever fall in record, BSE shack by 2000 points intra-day. In this regard

everyones query is whether the FII positions have caused Indian markets as we see most often vie

versa. 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. The present study also focuses on theirinvestment pattern in the Indian stock market. It examines the factors expected to affect the investment

decisions of FIIs. The Foreign Institutional Investors (FIIs) have emerged as important players in the

Indian equity market in the recent past. This paper makes an attempt to understand whether there

exists a relationship between FII and Equity Market returns in India.

Foreign Institutional Investors:

FOREIGN INSTITUTIONAL INVESTOR:The term Foreign Institutional Investor is defined by SEBI as under:

Means an institution established or incorporated outsideIndia which proposes to make investment inIndia in securities. Provided that a domestic asset management company or domestic portfolio manager

who manages funds raised or collected or brought from outside India for investment in India on behalf

of a sub-account, shall be deemed to be a Foreign Institutional Investor.

FII is defined as an institution organized outside of India for the purpose of making investments into the

Indian securities market under the regulations prescribed by SEBI.

FII include Overseas pension funds, mutual funds, investment trust, asset management company,

nominee company, bank, institutional portfolio manager, university funds, endowments, foundations,

charitable trusts, charitable societies, a trustee or power of attorney holder incorporated or established

outside India proposing to make proprietary investments or investments on behalf of a broad-based

fund.

Why FIIS Required?

FIIs contribute to the foreign exchange inflow as the funds from multilateral finance institutions and FDI

(Foreign direct investment) are insufficient. Following are the some advantages of FIIs.

1. It lowers cost of capital, access to cheap global credit.

2. It supplements domestic savings and investments.

3. It leads to higher asset prices in the Indian market.

4.

And has also led to considerable amount of reforms in capital market and financial sector.

Investments by FIIS:

There are generally two ways to invest for FIIs.

1. Equity Investment:


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100% investments could be in equity related instruments or up to 30% could be invested in debt

instruments i.e.70 (Equity Instruments): 30 (Debt Instruments)

100% DEBT

100% investment has to be made in debt securities only

2. Equity Investment Route:

In case of Equity route the FIIs can invest in the following instruments:

A. Securities in the primary and secondary market including shares which are unlisted, listed or to be

listed on a recognized stock exchange in India.

B. Units of schemes floated by the Unit Trust of India and other domestic mutual funds, whether listed

or not.

C. Warrants

100% DEBT ROUTE: In case of Debt Route the FIIs can invest in the following instruments:

A. Debentures (Non-Convertible Debentures, Partly Convertible Debentures etc.)

B. Bonds

C. Dated government securities

D. Treasury Bills

E. Other Debt Market Instruments

It should be noted that foreign companies and individuals are not be eligible to invest through the 100%

debt route.

The Eligibility Criteria for Applicant Seeking FII Registration is as Follows:

Regulated by appropriate foreign regulatory authority in the same capacity/category where

registration is sought from SEBI.

Permission under the provisions of the Foreign Exchange Management Act, 1999 (FEMA) from

the RBI.

Legally permitted to invest in securities outside country or its incorporation/establishment.

The applicant must be a fit and proper person.

Local custodian and designated bank to route its transactions.

Eligible Securities:

Securities in the primary and secondary markets including shares, debentures and warrants of

unlisted, to- be listed companies or companies listed on a recognized stock exchange.


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Units of schemes floated by domestic mutual funds including Unit Trust of India, whether listed

on a recognized stock exchange or not, and units of scheme floated by a Collective Investment

Scheme.

Government Securities

Derivatives traded on a recognized stock exchangelike futures and options. FIIs can now invest

in interest rate futures that were launched at the National Stock Exchange (NSE) on 31st August,2009.

Commercial paper

Security receipts

Regulation Relating to FII Operation:

Investment by FIIs is regulated under SEBI (FII) Regulations, 1995 and Regulation 5(2) of FEMA

Notification No.20 dated May 3, 2000. SEBI acts as the nodal point in the entire process of FII

registration.

FIIs are required to apply to SEBI in a common application form in duplicate. A copy of the

application form is sent by SEBI to RBI along with their No Objection so as to enable RBI to

grant necessary permission under FEMA.

RBI approval under FEMA enables a FII to buy/sell securities on stock exchanges and open

foreign currency and Indian Rupee accounts with a designated bank branch.

FIIs are required to allocate their investment between equity and debt instruments in the ratio

of 70:30. However, it is also possible for an FII to declare itself a 100% debt FII in which case it

can make its entire investment in debt instruments.

All FIIs and their sub-accounts taken together cannot acquire more than 24% of the paid up

capital of an Indian Company. Indian Companies can raise the above mentioned 24% ceiling to

the Sartorial Cap / Statutory Ceiling as applicable by passing a resolution by its Board ofDirectors followed by passing a Special Resolution to that effect by its General Body.

The definition of broad based fund under the regulations was substantially widened allowing

several more sub accounts and FIIs to register with SEBI.

Several new categories of registration viz. sovereign wealth funds, foreign individual, foreign

corporate etc. were introduced.

Registration once granted to foreign investors was made permanent without a need to apply for

renewal from time to time thereby substantially reducing the administrative burden.

Also the application fee for foreign investors applying for registration has recently been reduced

by 50% for FIIs and sub accounts. Also, institutional investors including FIIs and their sub-

accounts have been allowed to undertake short-selling, lending and borrowing of Indian

securities from February 1, 2008.

Entry Options for FII:

Incorporated Entity, by incorporating a company under the Companies Act, 1956 through

Joint Ventures; or


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Wholly Owned Subsidiaries

Foreign equity in such Indian companies can be up to 100% depending on the requirements of the

investor, subject to equity caps in respect of the area of activities under the Foreign Direct Investment

(FDI) policy.

Important Terms to Know About FIIs:

Sub-account:

Sub-account includes those foreign corporations, foreign individuals, and institutions, funds or portfolios

established or incorporated outside India on whose behalf investments are proposed to be made in

India by a FII.

Designated Bank:

Designated Bank means any bank in India which has been authorized by the Reserve Bank of India to act

as a banker to FII.

Domestic Custodian:

Domestic Custodian means any entity registered with SEBI to carry on the activity of providing custodial

services in respect of securities.

Broad Based Fund:

Broad Based Fund means a fund established or incorporated outside India, which has at least twenty

investors with no single individual investor holding more than 10% shares or units of the fund.

Acts and Rules:

FII registration and investment are mainly governed by SEBI (FII) Regulations, 1995.

ELIGIBILITY FOR REGISTRATION AS FII: Following entities / funds are eligible to get registered as FII:

1. Pension Funds

2. Mutual Funds

3. Insurance Companies

4. Investment Trusts

5. Banks


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6. University Fund s

7. Endowments

8. Foundations

9. Charitable Trusts / Charitable Societies

Further, following entities proposing to invest on behalf of broad based funds are also eligible to be

registered as FIIs:

1. Asset Management Companies

2. Institutional Portfolio Managers

3. Trustees

4. Power of Attorney Holders

Investment Opportunities for FIIs:

The following financial instruments are available for FII investments:

a) Securities in primary and secondary markets including shares, debentures and warrants of companies,

unlisted, listed or to be listed on a recognized stock exchange in India;

b) Units of mutual funds;

c) Dated Government Securities;

d) Derivatives traded on a recognized stock exchange;

e) Commercial papers.

f) Investment limits on equity investments

g) FII, on its own behalf, shall not invest in equity more than 10% of total issued capital of an Indian

company.

h) Investment on behalf of each sub-account shall not exceed 10% of total issued capital of an India

company.

i) For the sub-account registered under Foreign Companies/ Individual category, the investment limit isfixed at 5% of issued capital.

These limits are within overall limit of 24% / 49 % / or the sectorial caps a prescribed by Government of

India / Reserve Bank of India.

Investment Limits on Debt Investments:


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For FII investments in Government debt, currently following limits are applicable.

For corporate debt the investment limit is fixed at US $500 million.

Brief Profiles of Important Institutions:

Reserve Bank of India:

Indias Central Bank - the RBI - was established on 1 April 1935 and was nationalized on 1 January 1949.

Some of its main objectives are regulating the issue of bank notes, managing Indias foreign exchange

reserves, operating Indias currency and credit system with a view to securing monetary stability and

developing Indias financial structure in line with national socio-economic objectives and policies.

Securities and Exchange Board of India:

In 1988 the Securities and Exchange Board of India (SEBI) was established by the Government of Indiathrough an executive resolution, and was subsequently upgraded as a fully autonomous body (a

statutory Board) in the year 1992 with the passing of the Securities and Exchange Board of India Act

(SEBI Act) on 30th January 1992.

The basic objectives of the Board were identified as:

To protect the interests of investors in securities;

To promote the development of Securities Market;

To regulate the securities market and

For matters connected therewith or incidental thereto.

Another significant event is the approval of trading in stock indices (like S&P CNX Nifty & Sensex) in2000. A market Index is a convenient and effective product because of the following reasons:

It acts as a barometer for market behavior;

It is used to benchmark portfolio performance;

It is used in derivative instruments like index futures and index options;

It can be used for passive fund management as in case of Index Funds.

Bombay Stocks Exchange:

Of the 22 stock exchanges in the country, Mumbais (earlier known as Bombay), Bombay Stock Exchangeis the largest, with over 6,000 stocks listed. The BSE accounts for over two thirds of the total trading

volume in the country. Established in 1875, the exchange is also the oldest in Asia. Among the twenty-

two Stock Exchanges recognized by the Government of India under the Securities Contracts (Regulation)

Act, 1956, it was the first one to be recognized and it is the only one that had the privilege of getting

permanent recognition Ab-initio. 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


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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.

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.

National Stock Exchange of India:

The National Stock Exchange of India Limited has genesis in the report of the High Powered Study Group

on Establishment of New Stock Exchanges, which recommended promotion of a National Stock

Exchange by financial institutions (FIs) to provide access to investors from all across the country on an

equal footing. Based on the recommendations, NSE was promoted by leading Financial Institutions atthe behest of the Government of India and was incorporated in November 1992 as a tax-paying

company unlike other stock exchanges in the country.

On its recognition as a stock exchange under the Securities Contracts (Regulation) Act, 1956 in April

1993, NSE commenced operations in the Wholesale Debt Market (WDM) segment in June 1994. The

Capital Market (Equities) segment commenced operations in November 1994 and operations in

Derivatives segment commenced in June 2000.

S&P CNX Nifty:

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.

DATA ANALYSIS & INTERPRETATION

FII and Indian stock market

Foreign Institutional Investors is used to denote an investor, it is mostly of the form of a institution or

entity which invests money in the financial markets of a country. The term FII is most commonly used inIndia to refer to companies that are established or incorporated outside India, and is investing in the

financial markets of India. These investors must register with the Securities & Exchange Board of India

(SEBI) to take part in the market. 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.


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But as with many of the other aspects of globalization, 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, labor standards and economic stability. India opened its stock

market to foreign investors in September 1992, and in 1993, received portfolio investment from

foreigners in the form of foreign institutional investment in equities. This has become one of the mainchannels of FII in India for foreigners.

Initially, there were many terms and conditions which restricted many FIIs to invest in India. But in the

course of time, in order to attract more investors, the major source (almost 50%) of money the FIIs

invest is from the issue of Participatory Notes (P-Notes) or what are sometimes called Offshore

Derivatives. They are instruments used by foreign investors that are not registered with the SEBI

(Securities & Exchange Board of India) to invest in Indian stock markets. For example, Indian-based

brokerages buy India-based securities and then issue Participatory Notes to foreign investors. Any

dividends or capital gains collected from the underlying securities go back to the investors. That is why

they are also called Offshore Derivative Instruments.

According to analysts, the upward revision of economic growth from 5.8 per cent to 6.1 per cent, better-

than-expected performance of companies in the quarter ended- June 30, the proposed new direct taxes

code that might lead to savings in the tax payers money, and the trade policy with an ambitious target

of US$ 200 billion exports for 2010-11 have all revived the confidence of FIIs investing in India. FIIs have

made net investments of US$ 10 billion in the first six months (April to September) of 2009-10. A major

portion of these investments have come through the primary market, than through buying via

secondary markets. FII inflows into Indian equities have been steady ever since the markets were

opened up to FIIs in 1993. With the exception of FY99 and FY09, net flows have been positive. FIIs own a

dominant 16% of Indian equities (worth US$147bn) and account for 10-15% of the equity volumes.

(Source: CLSA Asia-Pacific Markets) Although FIIs pulled out US$ 9.77 billion of the Indian equity markets

during FY09, they have been quick to return in FY10 and within just the first four months they havenearly made up for the exit, reinvesting US$ 8.50 billion or 87% of the amount that they had pulled out

in FY09. (Source: CLSA Asia-Pacific Markets).

Govt. of India has put investment limits on FIIs. 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. Positive correlations have often beenheld 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;


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3) The base-broadening theory; and

4) The positive feedback strategy view.

The omitted variables view is the classic case of spurious correlationthat 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.

The base-broadening argument contends that once foreigners begin to invest in a country, the financial

markets in that country are now no longer moved by national economic factors alone but rather begin

to be affected by foreign market movements as well. As the market itself is now affected by more

factors than before, its exposure to domestic shocks decline.

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 positiverelationship in the contemporaneous monthly data. In the present context, both directions of causation

are equally plausible.

General Foreign Institutional Investors (FIIs)

Including pension funds, mutual funds, investment trusts, university funds, endowments, foundations or

charitable trusts or charitable societies, etc. are permitted to invest in all securities i.e. equity

shares/debentures/ / Rights renunciations / warrants of Indian companies listed as well as unlisted,

dated Government securities, Treasury Bills and units of domestic mutual funds schemes in the primary

and secondary markets.

The holding of a single FII or the concerned FII group in any company would also be subject to a ceiling

of 10% of total paid up equity capital. Indian companies however, would be permitted to raise the

ceiling limit of 24% to 30% provided it has been approved by the Board of Directors of the company and

a Special Resolution is passed to that effect by the General Body. The ceiling of 24% or 30% as the case

may be, applicable for investment by FLLS will not include investment made by NRIs under the Portfolio

Investment Scheme.

India, the second fastest growing economy after China, has recently seen positive foreign institutional

investor (FII) inflows driven by the sound fundamentals and growth opportunities. According to analysts,

the upward revision of economic growth from 5.8 per cent to 6.1 per cent, better-than-expectedperformance of companies in the quarter ended-June 30, the proposed new direct taxes code that might

lead to savings in the tax payers money, and the trade policy with an ambitious target of US$ 200 billion

exports for 2010-11 have all revived the confidence of FIIs investing in India.

FIIs have made net investments of US$ 10 billion in the first six months (April to September) of 2009-10.

A major portion of these investments have come through the primary market, than through buying via

secondary markets. FII inflows into Indian equities have been steady ever since the markets were


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opened up to FIIs in 1993. With the exception of Financial Year 1999 and Financial Year 2009, net flows

have been positive.

FIIs own a dominant 16% of Indian equities (worth US$147bn) and account for 10-15% of the equity

volumes. Although FIIs pulled out US$ 9.77 billion of the Indian equity markets during Financial Year

2009, they have been quick to return in Financial Year 2010 and within just the first four months they

have nearly made up for the exit, reinvesting US$ 8.50 billion or 87% of the amount that they had pulled

out in Financial Year 2009.

India is well placed to attract FII flows over the long term. With FIIs holding 16 per cent of equity of

Indias biggest 500 companies and as growth in the Indian economy accelerates, FII sentiment is

expected to remain positive towards India.

Securities Exchange Board of India (SEBI) Announces the New Regulators for Foreign Institutional

Investors (FIIs)

Market regulator Security Exchange Board of India (SEBI) recently announced new rules for foreigninvestments through financial instruments such as participatory notes, asking FIIs to wind up P-Notes

for investing in derivatives within 18 months.

Security Exchange Board of India (SEBI) also imposing cu rbs on P-Notes for investing in the spot market

In derivatives, foreign institutional investors (FII) and their sub-accounts cant issue fresh P-Notes and

will have to wind up their current position in 18 months.

In spot markets, Foreign Institutional Investors will not be issued P-Notes more than 40 per cent of

their assets under custody. The reference date for calculating such assets will be September 30.


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That Foreign Institutional Investors (FII) who has issued P-Notes of more than 40 per cent of their

assets could issue such instruments only if they cancel, redeem, or close their existing P-Notes. Those

FIIs who have issued P-Notes less 40 per cent of their assets under custody can issue additional

instruments at the rate of 5 per cent of their assets.

FIIs to be registered on a permanent basis instead of earlier practice of renewing registration every

year.

FII Trends in India

Yearly Trend of FII flow

FIIs were allowed to invest in capital market securities since September 1992. However, these have

invested from January, 1993 only. The net inflow has risen from Rs.2608.13 crores in 1993 to

Rs.141627.1 crores in 2010 with relative ups and downs during the period as per the above table .during


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the period of 18 years there has been increase in in nine years while decline in the rest years It may be

concluded that there are significant variations in the yearly inflow of FIIs into the Indian capital market

during 1993-2010. During the initial year 1992-93, the FII flows started in September 1992, which

amounted to Rs. 13 crores because at this moment government was framing policy guidelines for FIIs.

However, within a year, the FIIs rose to 39338 i.e. 46% of 1992-93 during 1993-94 because government

had opened door for investment in India.

Thereafter, the FII inflows witnessed a dip of 6.45%. However, the year 1995-1996 witnessed a

turnaround, gliding up the contribution by FII to enormous amount of Rs. 6942 crores. Investments

made by FIIs during 1996-1997 rose a little i.e. 23.52% of that of the preceding year. This period was ripe

enough for FII Investments as that time the Indian economy posted strong fundamentals, stable

exchange rate expectations and offered investment incentives and congenial climate for investment of

these funds in India. During 1997-98, FII inflows posted a fall of 30.51%. This slack in investments by FIIs

was primarily because of the S-East Asian Crisis and the months of volatility experienced during

November 1997 and February 1998. The net investment flows by FIIs have always been positive from

the year of their entry. However, only in the year 1998-99, an outflow nearly of Rs. 17699 crores was

witnessed for the first time. This was primarily due to the economic sanctions imposed on India byJapan, US and other industrialized economies. These economic sanctions were the result of the testing

of series of nuclear bombs by India in May 1998.FII investment posted a year-on-year decline of 1.8 % in

2000-01, 11.87 % in 2001-02 and 69.29 % in 2002-03. Investments by FII posted a fall of 80 % in 2002-03

as compared with investments in the period of 1999-00. Investments by FIIs rebounded from depressed

levels from the year 2003-04 and witnessed an unprecedented surge. FIIs flows were recycled to India

following readjustment of global portfolios of institutional investors, triggered by robust growth in

Indian economy and attractive valuations in the Indian equity market as compared with other emerging

market economies in Asia. The slowdown in 2004-05 was on account of global uncertainties caused by

hardening of crude oil prices and the upturn in the interest rate cycle. The resumption in the net FII

inflows to India from August 2004 continued till end 2004-05. The inflows of FIIs during the year 2004-05

was Rs. 45881 crore. During 2006-07 the foreign institutional investors continued to invest large funds in

Indian securities market. Strong FII flows had been a key characteristic of the period prior to December

2007.

Sectoral investment by FIIs in India


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It can be seen from the diagram above that the major proportion of FII investments is into consumer

goods and then followed by investments in the IT and the banking sector. It can be observed from the

table below that India is one of the preferred investment destinations for FIIs over the years. The total

number of FIIs in India has almost grown 99 times since the beginning they were allowed to enter theIndian equity markets.

SEBI Registered FIIs in India


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Source: SEBI reports

Trends of FII and Sensex

From the above chart it is evident that FIIs and sensex move in the same direction that is there exists apositive correlation between the BSE Sensex and FII fund flows. It can be observed that FIIs have

significant influence on the sentiments and price trends in the Indian equity market as other market

participants tend to follow their moves as they perceive the FIIs to be intelligent investors with deep

assessment of the markets. Such herd mentality amplifies the role of the FIIs in the Indian stock

market.

FII Purchases, Sales v/s Sensex


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It can be seen from the above graph that with the advent of Sub- Crime crisis in US and its spillover

effects, soon after the Sensex touched its record high of 1,20,000 points, the market soon tumbled with

increase in FIIs sellings and a decrease in FII purchases thereby resulting in a decline in net FIIs. In FY 07-08, the net FII inflow in India amounted to $20.3 billion (at fund cost) and as compared to this they

pulled out $11.1 billion (more than half of which they brought in 2007), of which $8.3 billion occurred

over the 1st 6.5 months of FY 08-09. The pullout resulted in the fall of stock prices, as a result the sensex

fell from its closing peak of 20,873 on Jan 8, 2008 to less than 10,000 by Oct 17, 2008. FII holdings in

PSUs is increasing because Overseas investors are increasingly reposing their faith and money in PSUs,

with as many as nine public sector firms including Coal India, Power Grid Corp and NTPC, recording an

increase in FII holdings over recent months. The trend of increased FII holdings in PSUs can be attributed

to the strong balance sheet and long-term prospects of these entities. Also, most of the PSUs come out a

lower price band for their initial stake sales than private sector companies and their operations are

based on sound business practices, so the chances of facing corporate governance issues are very less.

Its 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.

Determinants of FII Flow in India:

1.

Risk- Whenever risk in home market increases, the foreign investors would start to pull out oftheir home country thereby creating a deficiency of funds in domestic market, hence so as to

attract investment domestic interest rate would increase thereby to ensure that the above

equality is restored.

2. Inflation- At the time of high inflation, the real return on fixed income securities like bonds and

fixed deposits declines. Thus a bond which gives say around 7.5% interest rate actually gives a

real return of just 1% if the inflation is 6.5%. If the inflation increases further, the real return

would decline more.


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3. Interest rates- For the business, cost of borrowing rises this has a negative result on their profit

margins. As a result they might even delay any investment activity which may be funded by

borrowing to some later period when the interest rates are lower so as to reduce their

investment costs. As it can be seen from the above table, over the past year RBI has increased

the repo rate reverse repo rate, CRR and SLR. This has led to an increase in the Prime Lending

Rate (PLR) and hence the general interest rate in the economy.4. Good news /bad news- If say there is some bad news in the nation, which affects that is

decreases the asset price, which in turn decreases the return and hence FII would withdraw

from the market. However on the other hand, if there is good news, asset prices would increase;

thereby increasing return and hence FII would be attracted. But the sensitivity with which

investors withdraw is greater than with which they invest i.e. they would be more cautious

while investing than at the time of withdrawing. This is primarily due to their basic nature of

being risk averse, thus they would react more vigorously to bad news than to good news.

5.

Equity Returns- The results show that, the equity return in India (RBSE) is the main driving force

for foreign institutional investment, which is significant at all levels. That is increase in the

returns in US stock market adversely affects the portfolio investment flowing to India.

Predictable risk in foreign market (SDSRF) adversely affects FII flow to India and is highly

significant in the model.

6. GDP of India- Both have more or less direct relationship. The reason is change in capital

account. When interest rates were high India was attracting lot of investments so the credit

balance was high for that period. It kept on increasing form 2003-04 to 2007-08 and interest

rates also kept on increasing from 2003-04 to 2007-08.besides there are various other factors

like rules and regulation , taxation , govt. policies etc.

Impact of FII on economic indicators in India- FII flow affects the economy of country.

Balance of payment- A net positive swing in invisibles (due to increase in software exports and

remittances sent by Indians working abroad) and increase in investments (both FDI and FII), has been

improving the Balance of Payment (BOP) of the Indian economy and increasing the demand of rupee in

the international currency market. In view of this the RBI had been following a policy of buying dollars

(by selling rupee) in the international market, thereby avoiding an appreciation of rupee viz-a-viz the

dollar.

Fluctuating Rupee- FIIs convert Dollars to Rupees to invest in Indian Markets- FII money comes in India

at high Dollar rates. FII money would go out when Dollar dips to low values. Thereby the new

nomenclature for this FII dollars let be SMART MONEY which finds more money. Well now see some

major points on Sensex from 2003 with peaks of dollar as that could trigger money push into India

ideally-

Jan-May 2003- USD/INR roughly 47-48. Sensex moved from 3000 to 6000 and dollar dipped till 43 by

May. Market corrected to 4200 after that.

July-Sept 2005- USD/INR 46 Sensex again moved from 5k to 12k and dollar dipped to 44 - 43.5. Market

corrected to 8800 after that.


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July-Sept 2006- USD /INR 46 -47 Sensex moved from 9k to 21k and dollar dipped to 39. Market

corrected to 13k. Maybe this is confusing but from the data it seems FII dollars starts entering into India

when Dollar is quoting at a price of 45-47 or tops out and this money creates the next Bull Run.

This withdrawal by the FIIs lead to a sharp depreciation of the rupee. Between January 1 and October

16, 2008, the RBI reference rate for the rupee fell by nearly 25 per cent, in relative to dollar, from Rs

39.20 to the dollar to Rs 48.86. This was despite the sale of dollars by the RBI, which was reflected in a

decline of $25.8 billion in its foreign currency assets between the end of March 2008 and October 3,

2008. The result has been the observed sharp depreciation of the rupee. While this depreciation may be

good for Indias exports that are adversely affected by the slowdown in global markets, it is not so good

for those who have accumulated foreign exchange payment commitments. Nor does it assist the

Governments effort to rein in inflation.

Stock Market- Mathematicians and Statisticians use a measure known as the correlation coefficient,

which is used to depict a relationship between two variables mathematically. This coefficient ranges

from minus 1 to plus 1. So, if we consider two variables, and the coefficient is -1, it means that when one

moves up, the other moves down in the same proportion. When it is 1, it means when one moves up or

down, the other also moves in the same manner, and when it is zero, it means there is no correlation. So

when one moves up (or down), theres no way to figure out how the other variable will behave.

Influence of FII on Indian Market:

Portfolio investments brought in by FIIs have been the most dynamic source of capital to emerging

markets in 1990s. At the same time there is unease over the volatility in foreign institutional investment

flows and its impact on the stock market and the Indian economy.

Apart from the impact they create on the market, their holdings will influence firm performance. For

instance, when foreign institutional investors reduced their holdings in Dr.Reddys Lab by 7% to less than

18%, the company dropped from a high of around US$30 to the current level of below US$15. This 50%

drop is apparently because of concerns about shrinking profit margins and financial performance.

Some major impact of FII on stock market:

They increased depth and breadth of the market.

They played major role in expanding securities business.

Their policy on focusing on fundamentals of share had caused efficient pricing of share.

These impacts made the Indian stock market more attractive to FII & also domestic investors. The

impact of FII is so high that whenever FII tend to withdraw the money from market, the domestic

investors fearful and they also withdraw from market.


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CONCLUSION:

In this study I tried to find out the impact of FDIs and FIIs on Indian Stock Market .the important result of

this study is that the foreign investment is determined by stock market return. But foreign investment is

not a major factor for the stock market boom in India the FII are increasingly dominant in the stock

market. The domestic investors and domestic companies remain not so dominant. There is therefore the

fear of sudden outflows of the foreign capital and this may be a trigger a third stock market scam as

most regulatory changes are being made only as a follow up of an adverse event.

A Study of FII's in India

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