1.

Introduction

Economies like India, which offer relatively higher growth than the
developed economies, have gain favour among investors as attractive investment
destinations for foreign institutional investors (FIIs). Investors are optimistic on
India and sentiments are favourable following government’s announcement of a
series of reform measures in recent months.

The developing countries are looking forward to steady flow of capital and
are undergoing the learning process of how to absorb them. As regard the
attendant risks, the central bank of the countries have to tackle them. There are
many ways the inflow can come into the country. Debt is a form of capital forms
which are raised from banks or from the markets. The non-debt creating
flows includes Foreign Direct Investment or Portfolio Investments.

Foreign investment has clearly been a major factor in stimulating

economic growth and development in recent times. According to a poll
conducted by Bank of America Merrill Lynch (BofA-ML) recently, in which 50
investors participated, India was the most favourite equity market for the global
investors for the year 2015 at 43 per cent, followed by China at 26 per cent. The
global investment bank is of the view that India remains to be in a structural bull
market.

India is poised to become the second biggest ecosystem option after the
US in the next two years on account of the on-going high growth rates. Several
technology based start-ups have received over US$ 2.3 billion in funding since
2010, while over 70 private equity (PE) and venture capital (VC) funds remain
active in the segment.

1
1.1 FOREIGN INSTITUTIONAL INVESTOR - Definition:

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

"Means an institution established or incorporated outside India which

proposes to make investment in India 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."

Foreign Investment refers to investments made by residents of a country

in financial assets and production process of another country. Entities covered by
the term ‘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 etc.(fund having more than 20 investors with no single
investor holding more than 10 per cent of the shares or units of the fund)”

FIIs can invest their own funds as well as invest on behalf of their
overseas clients registered as such with SEBI. These client accounts that the
FII manages are known as ‘sub-accounts’. The term is used most commonly
in India to refer to outside companies investing in the financial markets
of India. International institutional investors must register with Securities &
Exchange Board of India (SEBI) to participate in the market. One of the major
market regulations pertaining to FII involves placing limits on FII ownership in
Indian companies. They actually evaluate the shares and deposits in a portfolio.

2
1.2 OBJECTIVES:

 The basic objective is to know the Foreign Institutional Investments in

detail.

 To put forth the role played by Foreign Institutional Investments in

sensex.

 To know the guidelines for investment by Foreign Institutional

Investments

 To find out the impact of FII on Indian capital market.

 To determine the behavior and trend of FII’s on Indian stock market.

 To determine the factors that influence investment decision of FII’s.

1.3 RESEARCH METHODOLOGY

This project examines The Impact of Foreign Institutional Investors (FII)

on Indian capital market. The scope of the research comprises of information
derived from secondary data from Sensex, Nifty and FII investment was a
natural choice for inclusion in the study, as it is the most popular market
indicies and widely used by market participants for benchmarking. The study
period covered under this is for the years 2000-2015. 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 secondary data constitutes of daily net FII inflows
and the daily SENSEX and NIFTY from BSE and NSE websites
respectively. Findings are included which transmits the important points,

3
which were gathered from the study. Regression and correlation techniques
have been used for analysis purpose. The sample data consists of 2755
observations for FII, BSE Sensex and S&P CNX Nifty starting from Jan 2000 to
December 2015.

4
 2. NEED FOR FII IN DEVELOPING COUNTRIES

1. Infrastructure Renewal

To keep the Indian economy growing the infrastructure sector like power,
transport, mining & metallurgy, textiles, housing, retail, social welfare,
medical etc. has to be upgraded. After the Enron fiasco, it is difficult to
persuade anybody in the west to take interest in any of these sectors. Hence India
is left to its own devices to raise money and build this sector. Borrowing abroad
supplemented with Indian resources is the only way open to India. This upgrade
is needed prior or in step with the industrial and service exports sector growth. It
has to be placed on a higher priority. Only recently a suggestion to use a small
portion of India’s foreign reserves met with howl of protests. The protestors in
the Indian Parliament did not understand the proposal. Hence the government is
stuck to steam roller its proposal through the legislative process or succumb to
political pressure and do nothing. The latter is not acceptable.

If India finds its own $4 Billion a year for infrastructure then foreign
investors will kick in another similar portion. The resulting money will very
quickly rebuild the now cumbersome infrastructure.

2. Bridge the technological gap

Developing countries has a very low level of technology. Their

technology is not up to the standards and they lack in modern technology.
Developing countries possess a strong urge for industrialization to develop their
economies and to wriggle out of the low-level equilibrium trap in which they are
caught. This raises the necessity for importing technologies from advanced
countries. Such technology usually comes with foreign capital.

5
3. Optimum utilization of resources

A number of developing countries possess huge mineral resources

which are untapped and unexploited. Due to lack of technology these
countries are not able to use their resources to the fullest. As a result they
have to depend on the foreign investment with the help of which technology of
the country and that will ultimately lead to the optimum utilization of the
resources. India has very huge reserves of mineral resources and to optimize
their use or rather for extracting them efficiently and effectively modern
technology is required which is possible through foreign investment.

4. Balancing the balance of payment position

In the initial phase of economic development, the under developing

countries need much larger imports. As a result the balance of payment position
generally turns adverse. This creates gap between earnings and foreign
exchange. The foreign capital presents short run solution to the problem. So in
order to balance the Balance of Payment Foreign Investment is needed.

5. Develop the 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. Research firms in India
can provide the information to determine how, when and where to enter the
market. There are also companies which can guide the foreign firm through the
entry process from beginning to end performing the requisite research, assisting

6
with configuration of the project, helping develop Indian partners and financing,
finding the land or ready premises, and pushing through the paperwork required.

7
 3. REGULATORY FRAMEWORK FOR FII

The following entities, established or incorporated abroad, are eligible to

be registered as FIIs:

 Pension Funds.

 Mutual Funds. Investment Trusts.

 Asset Management Companies. Nominee Companies.

 Banks.

 Institutional Portfolio Managers. Trustees.

 Power of Attorney holders.

 University funds, endowments, foundations or charitable trusts or

charitable societies.

Besides the above, a domestic portfolio manager or domestic asset

management company is also eligible to be registered as an FII to manage the
funds of sub-accounts. The FIIs can also invest on behalf of sub-accounts. The
following entities are entitled to be registered as sub-accounts:

 An institution or fund or portfolio established or incorporated outside

India.

 A foreign corporate or a foreign individual.

 The general permission from the RBI will enable the FIIS to:

8
 Open foreign currency account(s) in a designated bank (there can be
more than one account in the same bank branch, in different
currencies, if so required by the FII for its operational purpose).

 Open a special non-resident rupee account in which all receipts from

the capital inflows, sale proceeds of shares, dividends and interest
credited.

 Transfer sums from the foreign currency accounts to the rupee

accounts and vice-versa, at the market rates of exchange.

 Make investment in securities in India out of the balances in the

rupee accounts.

 Transfer repatriable (after tax) proceeds from the rupee account to the
foreign currency accounts.

 Repatriate the capital, capital gains, dividends, income received by

the way of interest and any compensation received towards
sale/renouncement of rights offering of shares subject to the
designated branch of a bank/custodian being authorized to deduct
withholding tax on capital gains and arranging to pay such tax and
remitting the net proceeds at market rates of exchange.

 Register FII is holding without any further clearance under FERA.

 There would be no restrictions on the volume of investment-

minimum or maximum for the purpose of entry FIIs in the
primary/secondary markets and on the lock in period described for
the purpose of such investments made by FIIs. However, portfolio

9
 investment in primary and secondary markets will be subjected to
ceiling of

 24% of issued share capital for the total holding of all registered FIIs
in any one company. Conversions, out of the fully and partly
convertible debentures issued by the company will also be taken into
account for the purpose. The holding of a single FII in any company
would be subject to a ceiling of 5% of total issued share capital for
which purpose, holding of an FII group will be counted as holdings
of a single FII.

 The maximum holding of 24% for all non-residential portfolio

investments, including those of the registered. FIIs will also include
NRI corporate and non-corporate investments, but will not
include; direct foreign investment (which are permitted up to 51%
or 74% or even full in all priority sector) and investments by FIIs
through the following alternatives offshore single/regional funds,
global depository receipts and euro convertibles.

 Disinvestment will be allowed only through stock exchanges in India

including OTCEI. SEBI may permit sales other than through stock
exchanges, provided the sale prices are not significantly different
from the stock market quotations, where available.

 All secondary market operations would be only through the

recognized intermediaries on the Indian stock exchange including
OTCEI. FIIs would not be expected to take delivery of purchased and
give delivery of sold securities.

10
  FIIs can appoint a custodian, an agency approved by SEBI, as a
custodian of securities and for confirmation of transaction in
securities, settlement of purchase and sale and for information
reporting such a custodian shall establish separate accounts for
detailing on a daily basis the investment capital utilization and
securities held by each FII for which it is acting as custodian will
report to the RBI and SEBI semi-annually, as part of their disclosure
and reporting guidelines.

 RBI may at any time request by an order, a registered FII to submit

information regarding records of the utilization of the inward
remittances of investment capital and the statement of its securities
transactions. RBI and or SEBI may also any time conduct a direct
inspection of the records and accounting books of a registered FII.

 FIIs investing under this scheme will benefit from a concessional tax
regime of a flat tax rate of 20% on dividend and interest income and a
tax rate of 10% on long-term (one or more year) capital gains.

Entry options for Foreign Investors

A foreign company planning to set up business operations in India

has the following options.

1. Incorporated entity:

By incorporating a company under the companies Act, 1956 through Joint

venture; or wholly owned subsidiaries.

Foreign equity into such Indian companies can be up to 100% depending

11
on the requirements of the investor, subject to the equity caps in respect of the
area of activity under the foreign direct investment policy.

Unincorporated entity

A) As a foreign company through

 Liaison office/ representative office.

 Project office

 Branch office

Such offices can undertake activities permitted under the Foreign

Exchange Management

2. Incorporation of company:

For registration and incorporation, an application has to be filed with the

registrar of companies (ROC). Once a company has been duly registered and
incorporated as an Indian company, it is subject to Indian laws and regulations as
applicable to other domestic Indian companies.

3. Liaison office/ representative office:

The role of liaison office is limited to collecting information about

possible market opportunities and providing information about the company and
its products to prospective Indian customers. It can promote export/ import from/
to India and also facilitate technical/ financial collaboration between parent
companies and company in India. Liaison office cannot take any commercial
activity directly and indirectly and cannot, therefore, earn any income in India.
Approval for establishing a liaison office in India is granted by RBI, India.

12
4. Project office:

Foreign companies planning to execute specific projects in India can set

up temporary project/ site offices in India. RBI has now granted general
permission to foreign entities to establish project offices subject to specified
conditions. Such offices cannot undertake or carry on any activity other than the
activity relating and incidental to execution of the project. Project offices may
remit outside India the surplus of the project on its completion, general
permission for which has been granted by the RBI.

5. Branch office:

Foreign companies engaged in manufacturing and trading activities

abroad are allowed to set up branch offices in India for the following purposes:

 Export/ import of goods.

 Rendering professional or consultancy services.

 Carrying out research work, in which the parent company is engaged.

 Promoting technical or financial collaborations between Indian

companies and parent or overseas group company.

 Representing the parent company in India and acting as buying/

selling agents in India.

 Rendering services in information technology and development of

software in India.

 Rendering technical support to products supplied by the parent/ group

companies.

13
  Foreign airline/ shipping company

A branch office is not allowed to carry out manufacturing activities

on its own but is permitted to subcontract these to an Indian manufacturer.

Branch offices established with approval of RBI, may remit outside,

profit of the branch, net of applicable Indian taxes and subject to RBI
guidelines. Permission for setting up of branch officers is granted by the Reserve
Bank of India (RBI).

6. Branch office on “stand alone basis” in SEZ:

Such branch offices would be isolated and restricted to the special

economic zone (SEZ) Alone and no business activity/ transaction will be
allowed outside the SEZs in India, which include branches/ subsidiaries of its
parent offices in India.

No approval shall be necessary from RBI for a company to establish a

branch/unit in SEZs to undertake manufacturing and service activities subject to
specified conditions.

7. Investment in a firm or a propriety concern by NRIs:

A non-resident Indian or a person of India origin resident outside India

may invest by way of contribution to the capital of a firm or a proprietary
concern in India on non- repatriation basis provided:-

I) Amount is invested by inward remittance or out of NRE / FCNR / NRO

account maintained with AD.

14
 II) The firm or propriety concern is not engaged in ant agricultural/
plantation or real estate business i.e. dealing in land and immovable property
with a view to earning profit or earning income there from.

III)Amount invested shall not be eligible for repatriation outside India

NRIs/ PIO may invest in sole proprietorship concerns/ partnership firms with
repatriation benefits with the approval of government/ RBI.

8. Investment in a firm or a proprietary concern other than NRIs:

No person resident outside India other than NRIs/ PIO shall make any
investment by way of contribution to the capital of a firm or a proprietorship
concern or any associations of persons in India. The RBI may, on an application
made on it, permit a person resident outside India to make such investment
subject to such terms and conditions as may be considered necessary.

15
 Reasons to invest in India

Some of the major reasons to invest in India:

 It is one of the largest economies in the world, fourth largest

economies in terms of purchasing power parity.

 Strategic location- access to the vast domestic and south Asian

market.

 Large and rapidly growing consumer markets up to 300 million

people constitute the market for branded consumer goods- estimated
to be growing at 8% per annum.

 Demand for several consumer products is growing at over 12% p.a.

 Skilled manpower and professional managers are available at

competitive cost

 One of the largest manufacturing sectors in the world, spanning

almost all areas of manufacturing activities.

 One of the largest pools of scientists, engineers, technicians and

managers in the world.

 Rich base of mineral and agricultural resources.

 Developed banking system- commercial banking network is over

63000 branches supported by a number of national and state level
financial institutions.

 Well developed R&D infrastructure and technical and marketing

16
 services.

 Well balanced package of fiscal incentives.

 English is widely spoken and understood.

 Foreign brand names are freely used.

 No income tax on profits derived from export of goods.

 Complete exemption from customs duty on industrial inputs and

corporate tax Holiday for five years for 100% export oriented units
and Export Processing Zones.

A corporation must also decide where in India to set up. India has 28
unique states, each with their own problems and benefits.

The most popular hubs for investment in India are Mumbai,

Maharashtra, Bangalore, Karnataka and New Delhi. Thus benefits make India a
competitor for foreign investment.

17
 REVIEW OF LITERATURE

Shrikanth, Maram and Kishore Braj (2012) ‘Net FII Flows into India: A
Cause and Effect Study’ ASCI Journal of management, Vol.41(2),pp.107-12.

In their paper investigated a cause and effect relationship between FII

and Indian capital market. They observed that FIIs carried the institutional
flavor in terms of market expertise and fund management by way of pooling
small savings from retail investors. The main objective of FIIs is maximizing
returns and minimizing risk while keeping liquidity of the investments intact.
They concluded that net FII inflows had a positive impact on the Indian stock
market and foreign exchange reserves.

Loomba, Jatinder. (2012) ‘Do FIIs Impact Volatility of Indian Stock

Market?’ International Journal of Marketing, Financial Services &
Management Research Vol.1 Issue 7.

He attempted to testify the behavior of FII trading and its effect on

Indian stock market. He observed that in the course of capital market
liberalization, foreign capital has become increasingly significant source of
finance and institutional investors are growing their influence in developing
markets. He concluded that the Indian stock markets have come in age where
there were significant developments in the last 15 years make the markets at par
with the developed markets.

18
Bohra, N. Singh and Dutt, Akash.(2011) ‘Foreign Institutional Investment
in Indian Capital Market: A Study of Last One Decade’ International
Research Journal of Finance and Economics, Retrieved 24 Jan. 2012
<http://www.eurojournals.com/finance.htm>

They studied the behavioral pattern of FII in India and figure out the
reasons for indifferent responses of BSE Sensex due to FII inflows. They found
the correlation between FII investment and turnover of different individual
groups at BSE sensex. They concluded that there is a positive correlation
between FII investment and stock market but in year 2005 and 2008, it was also
observed that positive or negative movement of FII’s investment leads to a
major shift in the sentiments of domestic or related investors in market.

Shukla, K. Rajeev et al (2011) ‘FII Equity Investment and Indian Capital

Market: - An Empirical Investigation.’ Pacific business review
international.

He investigated the impact of foreign institutional investors on Indian

stock indices. He revealed that India, after United States hosts the largest
number of listed companies and Global investors now enthusiastically seek
India as their preferred destination for investment. Many Indians working in
foreign countries now divert their savings to stocks. They concluded that FIIs
have significant impact on the share prices of the Midcap & Small-cap
companies but small and a periodic shift in their behavior leads to market
volatility.

19
Kaur, Manjinder. & Dhillon, S.Sharanjit (2010) ‘Determinants of Foreign
Institutional Investor’s Investment in India’ Eurasian Journal of Business
and Economics 2010, 3 (6), 57-70.

They focused on the determinants of Foreign Institutional investment in

India. Market capitalization and stock market turnover of India have significant
positive influence only in short-run but Stock market risk has negative
influence on FIIs inflows to India. Among macroeconomic determinants,
economic growth of India has positive impact on FIIs investment in both long
run and short run but all other macroeconomic factors have significant influence
only in long run like inflation.

They concluded that host country stock market returns (returns on

Sensex) have positive and significant impact whereas home country returns
(returns on S&P 500 Index) have negative but insignificant influence on FIIs
investment inflows in long-run as well as in short-run.

Saha, Malayendu. (2009) ‘Stock Market in India and Foreign

Institutional Investments: An Appraisal’ Journal of Business and
Economic Issues, Vol.1 No.1.

He investigated the participation of foreign institutional investors and the

other financial institutions in India and the performance of the Indian stock
markets and she concluded that Indian stock market is regarded at par with
the developed markets Moreover, it had a very unique economic model and is
based on strong economic growth with huge liquidity and it is not depended on
the US economy for its GDP growth.

20
Singh, Sumanjeet. (2009) ‘Foreign capital flows into India:
Compositions, regulations, issues and policy options’ Journal of
Economics and International Finance Vol. 1(1), pp. 014-029.

He revealed that the size of net capital inflows to India increased from US
$ 7.1 billion in 1990-91 to US $ 108.0 billion in 2007-08. India has one of the
highest net capital inflows among the EMEs of Asia. Capital inflows,
however, not an unmitigated blessing, the main danger posed by large and
volatile capital inflows is that they may destabilize macroeconomic
management. He concluded that the intensified pressures due to large and
volatile capital flow in India in the recent period in an atmosphere of global
uncertainties

Prasanna, P.K. (2008) ‘Foreign Institutional Investor: Investment

preference in India’ JOAAG, Vol. 3, No. 2, pp 40-51.

He discussed role of FII in Indian Capital market and examined the

contribution o f foreign institutional i n v e s t m e n t particularly among
companies included in sensitivity index (Sensex) of Bombay Stock Exchange.
She found that Higher Sensex indices and high price earnings ratio are the
country level factors attracting more foreign investment i n India and the
foreign investment is more in the companies with higher volume of publically
held shares. The promoter’s holdings and the foreign investments are
inversely related.

21
 Major Determinants of FII Flows

The unpredictability of autonomous FII flows, in both scale and direction,

has developed a substantial research effort to identify their major
determinants. An extensive literature based generally on three approaches –
aggregate econometric analysis, survey appraisal of foreign investors opinion,
and econometric study at the industrial level – has failed to arrive at the
consensus. This can be partly attributed to the lack of reliable data, particularly
at the sectoral level, and to the fact that the most empirical work has analyzed
FII determinants by pooling of countries that may be structurally diverse. The
subject is mainly concerned with examining the factors influencing the
destination of the investment, host country determinants, rather than industry
specific factors.

1. Market size:

Econometric studies comparing a cross section of countries indicate a well

established correlation between FII and the size of market (proxied by the
size of GDP) as well as some of its characteristics (e.g. average income
levels and growth rates.) some studies found GDP growth rate to be a
significant explanatory variable, while GDP was not, probably indicating that
where the current size of national income is very small, increments may have
less relevance to FII decisions than growth performance, as an indicator of
market potential.

2. Liberalized trade policy:

Whilst across to specific markets – judged by their size and growth- is

important, domestic market factors are predictability much less relevant in

22
export oriented foreign firms. A range of surveys suggests a widespread
perception that ‘open’ economies encourage more foreign investment. One
indicator of openness is the relative size of the export sector.

3. Labour costs and productivity:

Empirical research has also found relative labour costs to be statistically

significant, particularly for foreign investment in labour intensive industries and
for export oriented subsidiaries. In India labour market rigidities and relatively
high wages in the formal sector have bee reported as deterring any significant
inflows into the export sector in particular. The decision to invest in china has
been heavily influenced by the prevailing low wage rate.

4. Political scenario:

The ranking of the political risk among FII determinants remains

somewhat unclear. Where the host country possesses abundant natural
resources, no further incentive may be required, as is seen in politically
unstable countries such as Nigeria and Angola, where high returns in the
extractive industries seem to be compensated for political instability. in general
,so long as the foreign company is confident of being able to operate profitably
without undue risk to its capital and personnel, it will continue to invest. Large
mining companies, for example, overcome some of the political risks by
investing in their own infrastructure maintenance and their own security forces.
Moreover, these companies are limited neither by small local markets nor by
exchange rate risks since they tend to sell almost exclusively on the
international, market at hard currency prices.

23
5. Infrastructure:

Infrastructure covers many dimensions, ranging from roads, ports,

railways and telecommunication systems to institutional development (e.g.
accounting, legal services, etc.) studies in china reveal the extent of transport
facilities and the proximity to major ports as having a positive significant
effect on the location of FII within the country. Poor infrastructure can be seen,
as both, an obstacle and an opportunity for foreign investment. For the majority
of the low income countries, it is often cited as one of the major
constraints. But foreign investors also point potential for attracting significant
FII if host country government permits more substantial foreign participation in
the infrastructure sector.

6. Incentives and operating conditions:

Most of the empirical evidence supports the notion that specific incentives
such as lower taxes have no major impact on FII particularly when they are seen
as compensation for continuing comparative disadvantages. On the other hand,
removing restrictions and providing good business operating conditions are
generally believed to have a positive effect. Further incentives such as granting
of equal treatment to foreign investors in relation to local counterparts and the
opening up of markets (e.g. air transport, retailing, banking,) have been reported
as important factors in encouraging FII flows in India.

7. Dis-investment policy:

Though privatization has attracted some foreign investment flows in

recent years, progress is still slow in majority of low income countries, partly
because the divestment of the state assets is a highly political issue. In India for

24
example, organized labour has fiercely resisted privatization or other moves,
which threaten existing jobs workers rights. A number of structural problems are
constraining the process of privatization. Financial markets in most low income
countries are slow to become competitive; they are characterized by the
inefficiencies, lack of debt and transparency and the absence of regulatory
procedures. They continue to be dominated by government activity and are often
protected from competition. Existing stock markets are thin and illiquid and
securitized debt is virtually non-existent. An underdeveloped financial sector of
this type inhibits privatization and discourages foreign investors.

Benefits of FII:

Host countries derive several benefits from FII:

1. Additional equity capital from whose profits yield tax revenues.

2. Transfer of patent technologies.

3. Access to scarce managerial skills.

4. Creation of new jobs.

5. Access to overseas market networks and marketing expertise.

6. Reduce flight of domestic capital abroad.

7. Long commitment to successful completion of FII projects.

8. A catalyst for associated lending, for specific projects, thus increasing

the availability of external funding.

25
 9. Free flow of capital is conducive to both the total world welfare and to
the welfare of each individual.

10. Since returns on foreign investments are linked to the profits earned
by the firm, it is more flexible as compared to the foreign loans which are
guided by rigid interest and amortization requirements.

11. Being subject to business calculation of private profit, it is likely

to be employed more productively as compared to public financial aid.

Potential for investment in India

1. Expansion of various transport facilities:

a) Roads:

The Government is focusing on expansion and modernization of roads

and has opened this up for private sector participation. 48 new road projects
worth US$ 12 billion are under construction. Development and up gradation of
roads will require an investment of US$ 24 billion till 2008. Private sector
participation in road projects will grow significantly.

b) Railways:

The railway sector will need an investment of US$ 22 billion for new
coaches, tracks, and communications and safety equipment over the next ten
years.

c) Airways:

Up gradation and modernization of airports will require US$ 33 billion

investment in the next ten years.

26
d) Waterways:

There is potential for investment in the expansion and modernization of

ports. The government has taken up a US$22 billion 'Sagarmala' project to
develop the Port and Shipping sector under Public-Private Partnership. 100
percent FDI is permitted for construction and maintenance of ports. The
government is offering incentives to investors.

2. Better power facilities:

The Ministry of Power has formulated a blueprint to provide reliable,

affordable and quality power to all users by 2012. This calls for investment of
US$ 73 billion in the next five years. The gap between demand and
production of power is around 10000 MW. Opportunities are there for
investment in power generation and distribution and development of non-
conventional energy sources.

3. Urban projects need investments:

There is potential for investment in urban infrastructure projects. Water

supply and sanitation projects alone offer scope for annual investment of US$
5.71 billion.

4. Exploration of mineral reserves:

India has an estimated 85 billion tones of mineral reserves remaining to

be exploited. Potential areas for exploration ventures include gold, diamonds,
copper, lead zinc, cobalt silver, tin etc. There is also scope for setting up
manufacturing units for value added products.

27
5. Develop Telecom IT sector:

The telecom market, which is one of the world's largest and fastest
growing, has an investment potential of US$ 20-25 billion over the next five
years. The telecom market turnover is expected to increase from US$ 8.6
billion in 2003 to US$ 13 billion by

2007. Mobile telephony has started growing at the rate of 10-12 million
subscribers per year. The IT industry and IT-enabled services, which are rapidly
growing offer opportunities for FDI.

6. Service sector opportunities:

India has emerged as an important venue for the services sector including
financial accounting, call centers, and business process outsourcing. There is
considerable potential for growth in these areas.

7. For R & D and healthcare sector development:

Biotechnology and Bioinformatics, which are in the government's priority

list for development, offer scope for FDI. There are over 50 R&D labs in the
public sector to support growth in these areas. The Healthcare industry is
expected to increase in size from its current US$ 17.2 billion to US$ 40 billion
by 2012.

8. Positive future of automobile industry:

The Indian auto industry with a turnover US $ 12 billion and the auto
parts industry with a turnover of 3 billion dollars offer scope for FDI. The
government is encouraging the establishment of world-class integrated textile
complexes and processing units. FDI is welcome.

28
9. Agricultural sector:

While India has abundant supply of food, the food processing industry is
relatively nascent and offers opportunities for FDI. Only 2 percent of fruits and
vegetables and 15 percent of milk are processed at present. There is a rapidly
increasing demand for processed food caused by rising urbanization and income
levels. To meet this demand, the investment required is about US$28 billion.
Food processing has been declared as a priority sector.

10. Promotion of exports:

The Government has recently established Special Economic Zones with

the purpose of promoting exports and attracting FDI. These SEZs do not
have duty on imports of inputs and they enjoy simplified fiscal and foreign
exchange procedures and allow 100% FDI.

11. Development of Tourism industry:

The travel and tourism industry which has grown to a size of US$ 32
billion offers scope for investment in budget hotels and tourism infrastructure.

29
 POSITIVE ATTITUDE TOWARDS FIIs

Positive tidings about the Indian economy combined with a fast-growing

market have made India an attractive destination for Foreign Institutional Investors
(FIIs).

The Foreign Institutional Investors' (FIIs) net investment in the Indian stock
markets in calendar year 2015 crossed US$ 89.5 billion in the 2015 calendar, the
highest ever by the foreign funds in a single year after FIIs were allowed to make
portfolio investments in the country's stock markets in the early 90s.

FII’s net investments in Indian equities and debt have touched record highs in
the past financial year, backed by expectations of an economic recovery, falling
interest rates and improving earnings outlook. FIIs have invested a net of US$ 89.5
billion in 2014-15— expected to be their highest investment in any fiscal year. Of
this, a huge amount—US$ 57.2 billion—was invested in debt and it is their record
investment in the asset class, while equities absorbed US$ 32.3 billion.

India continues to be a preferred market for foreign investors. India-focused

offshore equity funds contributed US$ 0.5 billion, whereas India-focused ETFs
added a much higher US$ 1.2 billion of the total net inflows of about US$ 1.7
billion into the India-focused offshore funds and ETFs during the quarter ended
June 2015.

India companies signed merger and acquisition (M&A) deals worth US$
31.16 billion in January-November 2015. The total M&A transaction value for the
month of November 2015 was US$ 2.97 billion involving a total of 47 transactions.
In Private Equity, a total of 91 deals worth disclosed value of US$ 1.43 billion were
reported in November 2015.

Major Investments

30
 Singapore-based investment firm, Temasek Holding, has acquired 73 per cent
stake in Hyderabad-based Care Hospitals, India's fifth largest private
healthcare network, for Rs 1,800 crore (US$ 268.7 million).

 Macquarie Infrastructure and Real Assets (MIRA), the realty investment arm
of Australian Macquarie Group Ltd, plans to invest in real estate projects in
India and is in talks with Tata Housing Development Co. to jointly set up an
investment platform to invest in luxury residential projects.

 KKR India, the Indian arm of global private equity firm KKR & Co. L.P., has
planned to raise its second alternative investment fund (AIF) of Rs 1,500
crore (US$ 226.4 million) which will offer credit solutions to Indian
companies.

 Global private equity major Warburg Pincus plans to invest Rs 1,800 crore
(US$ 283 million) in Piramal Realty, which will help the real estate company
to expand its portfolio and to acquire land parcels in and around Mumbai.

 Sequoia Capital, one of the leading venture capital firms, will invest Rs 125
crore (US$ 20 million) in Bengaluru-based MedGenome, a genomics-based
diagnostics and research firm specialising in DNA sequencing and data
analytics.

 Viacom, one of the leading American global mass media companies, has
acquired 50 per cent stake in Prism TV for Rs 940 crore (US$ 153 million).
Prism TV owns and operates regional entertainment channels under the
‘Colors’ umbrella.

 Global funds such as Macquarie Infrastructure and Real Assets (MIRA), I

Squared Capital, Brookfield Asset Management Inc. are investing in Indian
road construction and power projects as a result of government’s efforts to
improve infrastructure and ease the operating environment for such projects.
31
 Japanese conglomerate SoftBank has led a group of investors to pump Rs
630 crore (US$ 100 million) in Gurgaon-based OYO Rooms, which helps
local hotels and select set of vendors to spruce up room amenities.

 Acumen, a not-for-profit global venture fund, has invested US$ 1.8 million in
Sahayog Dairy, an integrated company that sources milk from 272 centres
across five districts adjoining Harda district in Madhya Pradesh.

 Global infrastructure investment manager I Squared Capital, has decided to

invest US$ 150 million in Amplus Energy Solutions Private Ltd, which sets
up distributed solar power generation projects in India.

 Zomato, a restaurant search and discovery platform, has raised US$ 60

million from Singapore government-owned investment company Temasek,
along with existing investor Vy Capital, in order to explore new business
verticals.

32
Government Initiatives

Government of India has accepted the recommendation of A.P. Shah

Committee to not impose minimum alternate tax (MAT) on overseas portfolio
investors retrospectively for the years prior to April 01, 2015, thereby providing
significant relief to foreign portfolio investors (FPIs).

The RBI has also allowed a number of foreign investors to invest, on

repatriation basis, in non-convertible/redeemable preference shares or debentures
issued by Indian companies listed on established stock exchanges in India. The
investment should be within the overall limit of US$ 51 billion allocated for
corporate debt. Long-term investors registered with SEBI will also be deemed as
eligible investors. The Government of India is also planning to relax some of the
safe harbour rules set for offshore fund managers, in order to allow private equity
investors to shift their base to India without attracting a tax on capital.

The People’s Bank of China (PBoC) has invested US$ 500 million in Indian
bonds for the first time since the Indian government eased restrictions on foreign
investors.

Road Ahead

India is being viewed as a potential opportunity by investors, with the

economy having the capacity to grow tremendously. Buoyed by strong support
from the government, FII investments have been strong and are expected to
continue to improve going forward. "FIIs are flocking towards Indian bonds as the
confidence level of central bank and the government is at one of the highest levels
and benign commodity prices have added confidence," said Rahul Goswami, Chief
Investment Officer for fixed income at ICICI Pru Mutual fund. "India is among the
few markets where interest rates are expected to drop with fair visibility, which
would attract flow from FIIs" said Arvind Sethi, MD & CEO, TATA Asset
Management. 33
 A PricewaterhouseCoopers India report based on a survey of 40 PE firm
partners has projected that the country has the potential to get PE funding of US$
40 billion by 2025. Future PE investments would be driven by India’s consumption
story, realistic valuations, competitive businesses, growing private
entrepreneurship, among other factors, as per the report.

"The FII participation has been very consistent as far as India is concerned
and we see the trend continuing. We have been overweight India in the context of
Asia and emerging markets since November 2013 and that stance very much
continues," said Mr Bharat Iyer, MD, Global Research, JP Morgan India.

FIIs AS PORTFOLIO INVESTMENTS

Introduction

Portfolio investment flows from industrial countries have become

increasingly important for developing countries in recent years. The Indian
situation has been no different. In the year 2000-01 portfolio investments in India
accounted for over 37% of total foreign investment in the country and 47% of
the current account deficit. The corresponding figures in the previous year were
59% and 64% respectively. A significant part of these portfolio flows to India
comes in the form of Foreign Institutional Investors’ (FIIs’) investments, mostly in
equities. Ever since the opening of the Indian equity markets to foreigners, FII
investments have steadily grown from about Rs. 2600 crores in 1993 to over Rs.11,
000 crores in the first half of 2001 alone. Their share in total portfolio flows to
India grew from 47% in 1993-94 to over 70% in 1999-2001.

While it is generally held that portfolio flows benefit the economies of

recipient countries, policy-makers worldwide have been more than a little uneasy
about such investments. 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
34
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. They have also been
held responsible for spreading financial crises – causing ‘contagion’ in
international financial markets.

International capital flows and capital controls have emerged as an

important policy issues in the Indian context as well. Some authors have argued
that FII flows have, in fact, had no significant benefits for the economy at large.
While these concerns are all well-placed, comparatively less attention has been paid
so far to analyze the FII flows data and understanding their key features. A proper
understanding of the nature and determinants of these flows, however, is essential
for a meaningful debate about their effects as well as predicting the chances of their
sudden reversals.

Zoom in view of International Portfolio Flows

International portfolio flows are, as opposed to foreign direct investment,

liquid in nature and are motivated by international portfolio diversification
benefits for individual and institutional investors in industrial countries. They are
usually undertaken by institutional investors like pension funds and mutual funds.
Such flows are, therefore, 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 offer. While the Mexican crisis of 1994, the
subsequent ‘Tequila effect’, and the widespread ‘Asian crisis’ have had temporary
dampening effects on international portfolio flows, they have failed to counter the
long-term momentum of these flows. Indeed, several researchers have found
evidence of persistent ‘home bias’ in the portfolios of investors in industrial
countries in the 90’s. This ‘home bias’ –has the tendency to hold
disproportionate amounts of stock from
35
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 which 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.

In recent years, international portfolio flows to developing countries have received

the attention of scholars in the areas of finance and international economics
alike. Portfolio Investment. While papers in the finance tradition have focused on
the nature and determinants of portfolio flows from the perspective of the
diversifying investors, those from the international macroeconomics perspective
have focused on the recipient country’s situation and appropriate policy response to
such flows. For the present purposes, we shall focus only on papers that address the
issue of portfolio flows exclusively.

Previous research has also attempted to identify the factors behind this capital
flows. 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 question is particularly important for policy makers in order to
get a better understanding of the reliability and stability of such flows. 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. 36

As for the motivation of US equity investment in foreign markets, recent

research suggest that US portfolio managers investing abroad seem to be chasing
returns in foreign markets rather than simply diversifying to reduce overall portfolio
risk. The findings include the well-documented ‘home bias’ in OECD investments,
high turnover in foreign market investments and that, in general, the patterns of
foreign equity investment were far from what an international portfolio
diversification model would recommend. The share of investments going to
emerging markets has been roughly proportional to the share of these markets in
global market capitalization but the volatility of US transactions were even
higher in emerging markets than in other OECD countries. Furthermore there
was no relation between the volume of US transactions in these markets and their
stock market volatility.

The Mexican and Asian crises and the widespread outcry against
international portfolio investors in both cases have prompted analyses of short-term
movements in international portfolio investment flows. The question of ‘feedback
trading’ has received international capital flows in general (comprising both FDI
and portfolio flows) considerable attention. This refers to investors’ reaction to
recent changes in equity prices. If a gain in equity values tends to bring in more
portfolio inflows, it is an instance of ‘positive feedback trading’ while a decline in
flows following a rise in equity values is termed ‘negative feedback trading’.
Between 1989 and 1996 unexpected equity flows from abroad raised stock prices in
Mexico with at the rate of 13 percentage points for every 1% rise in the flows.

There has been, however, no evidence of ‘feedback trading’ among foreign

investors in Mexico. In the period leading to the Asian crisis, on the other hand,
Korea witnessed positive feedback trading and significant ‘herding’ among foreign
investors. Nevertheless, contrary to the belief in some segments, these tendencies
actually diminished markedly in the crisis period and there has been no
evidence of any ‘destabilizing role’ of foreign equity investors in the Korean
crisis. While FII flows to the Asian Crisis countries dropped sharply in 1997 and
1998 from their pre-crisis levels, it is37generally held that the flows reacted to the
crisis (possibly exacerbating it) rather than causing it.
38
 More recent studies find that the effect of ‘regional factors’ as determinants
of portfolio flows have been increasing in importance over time. In other words
portfolio flows to different countries in a region tend to be highly correlated. Also
the flows are more persistent than returns in the domestic markets. Feedback
trading or return-chasing behavior is also more pronounced. The flows appear to
affect contemporaneous and future stock returns positively, particularly in the case
of emerging markets. Finally stock prices seem to behave on the assumption of
persistent portfolio inflows.

It is commonly argued that local investors possess greater knowledge about a

Country’s financial markets than foreign investors and that this asymmetry lies at
the heart of the observed ‘home bias’ among investors in industrialized countries. A
key implication of recent theoretical work in this area12 is that in the
presence of such information asymmetry, portfolio flows to a country would be
related to returns in both recipient and source countries. In the absence of such
asymmetry, only the recipient country’s returns should affect these flows.

FIIs Investment in Indian Capital Market and Sensex

A capital market is a market where both government and companies raise

long-term funds to trade securities on the bond and the stock market. It consists of
both the primary market where new issues are distributed among investors, and the
secondary markets where already existent securities are traded. In the capital
market, mortgages, bonds, equities and other such investment funds are traded. The
capital market also facilitates the procedure whereby investors with excessfunds
can channel them to investors in deficit. The capital market provides both overnight
and long-term funds and uses financial instruments with long maturity periods. The
capital market acts as brake on channeling saving to low yielding enterprises and
impels enterprises to focus on performance. It continuously monitors the
performance through movement of share
39 prices in the market and the threats of
takeover. This improves efficiency of resource utilization and there by increases the
return on investment. As a result, savers and investors are not constrained by their
individual abilities, but facilitate by the economies capability to invest and save,
which inevitably enhances savings and investment in the economy.

Table 1: FII Investment in Indian Capital Market (Rs in Crore)

FIIs Change in FIIs %

Year
Investment Investment Change

2000-01 9933 -189 -1.86722

2001-02 8763 -1170 -11.7789
2002-03 2689 -6074 -69.3142
2003-04 45764 43075 1601.897
2004-05 45880 116 0.253474
2005-06 41467 -4413 -9.61857
2006-07 30841 -10626 -25.6252
2007-08 66179 35338 114.5812
2008-09 -45811 -111990 -169.223
2009-10 142658 188469 -411.406
2010-11 146438 3780 2.649694
2011-12 93725 -52713 -35.9968

Source: Various Issues of SEBI Handbook

40

Figure 1: Year Wise FIIs Investment

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. 5126 crores in 1993-94 to Rs.146438 crores in 2010-11 with
relative ups and downs during the period as per the above table. During the period of 19 years there has been increase
in eight 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 1993-94 to 2011-12. 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 5126 i.e. 99.76% of 1992-93 during 1993-94
because government had opened door for investment in India. Thereafter, the FII inflows witnessed a dip of 6.44%.
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 30.05 %. 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

41
year1998-99, an outflow nearly of Rs. 17699 crores was witnessed for the first time. This was primarily due to the
economic sanctions imposed on India by Japan, 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
1.86 % in 2000-01, 11.78 % in 2001-02 and 69.31 % 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. However, 2008-09 saw the highest FII outflow in any financial year
since inception. This could be attributed to the global financial meltdown and the home bias of FIIs in the crisis.
The gross purchases of debt and equity by FIIs declined by 35.2 per cent to Rs.6, 14, 576 crore in 2008-09 from Rs.
9, 48, 018 crore in 2007-08. The combined gross sales by FIIs also declined by 25.1 per cent to Rs.6, 60, 386 crore
from Rs.8, 81, 839 crore during the same period. The total net outflow of FII was Rs.45, 811 crore in 2008-09 as
against a net inflow of Rs.66, 179 crore in
2007-08. This was the highest net outflow for any financial year so far. FIIs made a record investment in the Indian
equity market in 2009, surpassing the 2007 inflows.
The total net inflow of FII was Rs.1, 42, 658 crore as against an outflow of FII was Rs.45, 811 crore in 2008-09.
This was the highest net inflow for any financial year so far. FIIs made a record investment in the Indian equity
market in
2010-11, surpassing the 2009-10 inflows. The total net investment of FII was Rs 1, 46, 438 crore as compared
to of Rs.1, 42, 658 crore in 2009-10. This was the highest net FII investments into Indian securities market in any
financial year so far. Cumulative investment by FIIs at acquisition cost, which was US$ 89,335 million at the end
of March, 2010, increased to US$ 1, 21, 561 million at the end of March, 2011. The total net inflow of FII
was ` 93,725 crore in
2011-12 compared to 1, 46, 438 crore in 2010-11 decreased by 36%. The cumulative investment by FIIs at acquisition
cost, which was USD 121.6 billion at the end of March 2011, increased to USD 140.5 billion at the end of March
2012.
No. of registered foreign institutional investors increases from the year to year when they are allowed to invest in
Indian capital market Year wise registration of FIIs is given by the following table 2.

Table 2: Year Wise Registration of FIIs Registered with SEBI

No. of FIIs
Year Trend %
Registered
2000-01 527 4.15
2001-02 490 -7.02
2002-03 502 2.44
2003-04 540 7.56
2004-05 685 26.85
2005-06 882 28.75
2006-07 997 13.03
2007-08 1319 32.29

42
From the table and figure 2 it is revealed that India is the important destination for foreign investment therefore the
number of FIIs is going on increasing year to year. The number of FIIs in 1992-93 was only 18 which are increased
to
1765 in 2011-12; maximum number of FIIs registered 322 in 2007-08 subsequently 316 in 2008-09. No. of
FIIs registration was decreased in 1998-99 due to Asian financial crises in 1997 and subsequently in 2001-02 due to
early 2000s recession in USA. Major increase in the trend of registration of FIIs in 1993-94 and 1993-94 i.e. 777.77
% and 94.93 %.
Country wise domination of FIIs registered with SEBI in Indian Capital market is as follows:-
Table 3: Country Wise Domination of FIIs Registered with SEBI
Name of the No. of
Country FIIs
USA 576
UK 259
Luxemburg 113
Mauritius 101
Canada 75
Hong Kong 71
Singapore 80
Australia 63
Ireland 63
Netherland 32
South Korea 23
Taiwan 21
Denmark 21
Switzerland 24
France 26
Malaysia 20
Sweden 11
Cayman Island 16
Channel Island 11
Norway 10
Austria 11
UAE 15
Germany 17
Others* 94
Total 1753

Source: Compiled from FII Index (sebi.org.in)

43
From the above mentioned table and Pie - chart 3 it is revealed that number of FIIs from USA is about

33% therefore any economic destabilization in USA causes heavy turmoil in Indian Stock Market. After
USA numbers of FIIs are from Europe is about 27% (U.K., Luxemburg, Ireland and Netherland) which also
causes the volatility in the Indian stock market and after Europe numbers of FIIs from Asia is about 15%
(Mauritius, Hong Kong and Singapore) also causes the volatility in the Indian stock market.

DETERMINANTS OF FII FLOW IN INDIA

Risk: Whenever risk in home market increases, the foreign investors would start to pull out their money
to their home country thereby creating a deficiency of funds in domestic market, so to attract the foreign
investment domestic interest rate would increase thereby to ensure that the above equality is restored.

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 8.5% interest rate actually gives a real return of
just 1% if the inflation is 7.5%. If the inflation increases further, the real return would decline more.

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. 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.

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 averser, thus they would react more vigorously to bad
news than to good news.

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.
44
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.

Currency Fluctuation: 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. We’ll 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.

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.

The 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 observed sharp

45
Depreciation of the rupee. While this depreciation may be good for India’s 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 Government’s 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), there’s no way to figure out
how the other variable will behave. So basically, one can compute the correlation coefficient
between the Sensex and FII flows.

DATA ANALYSIS AND INTERPRETATION

BSE Sensex and FIIs

In running the regression analysis, daily BSE Sensex has been taken as the dependent variable and
the daily FII investment is considered as the independent variable. To test the above-mentioned
hypothesis, linear regression model fitted with the econometric technique of ordinary least square
(OLS) has been done. Regression equation looking at relationship between BSE Sensex and FII flows
is as follows:

Y(BSE Sensex) = α + β (FII) + €

Y (BSE Sensex) is dependent variable, FII

Table 4: Model Summary

46
 Change Statistics
R Adjusted R Std. Error of
Model R R Square F Sig. F
Square Square the Estimate df1 df2
Change Change Change
a
1 .138 .019 .019 5775.387 .019 57.135 1 2923 .000
a.
Predictors: (Constant), FII

Table 5: Coefficientsa
a.
Dependent Variable: BSE

Unstandardized Standardized
Model Coefficients Coefficients T Sig.
B Std. Error Beta
(Constant) 9688.501 109.117 88.790 .000
1
FII 1.197 .158 .138 7.559 .000

Interpretation

From the above table, it is found that the correlation between Daily net FII investment and Daily BSE
Sensex is
0.138 which shows a very low degree of relationship between Daily FII investment and Daily BSE Sensex.
The positive correlation between the two reveals the fact that the daily FII investment is an important
factor in enhancing the Daily BSE Sensex of Bombay stock exchange consequently have a positive impact on
Indian capital market. But the extent of the enhancement in BSE Sensex by FII flows can be examined by
running the regression analysis. It can be observed from the above table that all explanatory variables, taken
together establish a relationship nearly 1.9 % because the coefficient of determination r2 is 0.019 of the total
variables in the daily BSE Sensex of Bombay stock exchange.
This means that whatever changes have taken place, in the daily BSE Sensex, the FII investments is
responsible up to 1.9 % only. This implies that there are many other macro economic factors have
indirectly affected the daily BSE Sensex of Bombay stock exchange. The regression equation Y (BSE
Sensex) = α + β (FII) + € shows that for every unit change in β (that is FII) there is 1.197 unit change
in Y (that is BSE Sensex). The value of α (Alpha) is
9688.501 which show that the other factors are more responsible for this relationship. The t value is 7.559 and
significant value is 0.000 which is less than 0.05, therefore the alternative hypothesis is accepted and null
hypothesis is rejected. So we can say that there is significant impact of foreign institutional investment (FII) on
BSE Sensex.
CNX Nifty and FIIs

In running the regression analysis, daily CNX Nifty has been taken as the dependent variable and the daily
FII investment is considered as the independent variable. To test the above-mentioned hypothesis, linear
regression model fitted with the econometric technique of ordinary least square (OLS) has been done.
Regression equation looking at relationship between CNX Nifty of NSE and FII flows is as follows:
Y(CNX Nifty) = α + β (FII) + €

Y (CNX Nifty) is dependent variable, FII investment is independent variable, α is the intercept and €
is white-noice (Random shock)
Table 6: Model Summary

Change Statistics
R Adjusted R Std. Error of
Model R R Square F Sig. F
Square Square the Estimate df1 df2
Change Change Change
a
1 .139 .019 .019 1690.319 .019 57.673 1 2923 .000
a.
Predictors: (Constant), FII

Table 7: Coefficientsa

47
 Unstandardized Standardized
Model Coefficients Coefficients T Sig.
B Std. Error Beta
(Constant) 2927.416 31.936 91.665 .000
1
FII .352 .046 .139 7.594 .000
a.
Dependent Variable: NSE

Interpretation

From the above table, it is found that the correlation between daily FII investment and daily CNX Nifty
is
0.139 which shows a very low degree of relationship between daily FII investment and daily CNX Nifty. The
positive correlation between the two reveals the fact that the daily FII investment is an important factor in
enhancing the daily CNX Nifty of National stock exchange consequently have a positive impact on Indian
capital market. But the extent of the enhancement in daily CNX Nifty by daily FII flows can be examined by
running the regression analysis.
It can be observed from the above table that all explanatory variables, taken together establish a
relationship nearly 1.9 % because the coefficient of determination r2 is 0.019 of the total variables in the
daily CNX Nifty of NSE.
This means that whatever changes have taken place, in the daily CNX Nifty of NSE, the FII investments is
responsible up to 1.9 % only. This implies that there are many other macro economic factors have indirectly
affected the daily CNX Nifty of NSE. The regression equation Y (CNX Nifty) = α + β (FII) + € shows that for
every unit change inβ (that is FII) there is
0.352 unit change in Y (that is CNX Nifty). The value of α (Alpha) is 2927.416 which show that the other
factors are more responsible for this relationship. The t value is 7.594 and significant value is 0.000 which is
less than 0.05, therefore the alternative hypothesis is accepted and null hypothesis is rejected. So we can say
that there is significant impact of foreign institutional investment (FII) on CNX Nifty.

FINDINGS OF THE STUDY

Daily BSE Sensex and daily CNX Nifty has very low degree of positive correlation with daily FII’s
investment. This implies that there are many other macro economic factors have indirectly affected the daily
BSE Sensex and daily CNX Nifty but their influence on the stock prices cannot be completely ignored. Hence
both indices move in direction of FII’s investment.
Largest number of FII is from USA ultimately the foreign investment from USA is maximum.

Economic growth i.e. IIP and GDP, inflation and interest rate are the basic parameters used by FII’s to invest
in any countries. FII’s investments also guide to economic growth of country since they bring the much
needed capital.
FII’s helped in the improvement of market efficiency. Since investment of FII’s increasing therefore SEBI have
to improve market trading efficiency in order to sustain FII’s investment.

48
49
50
Swot Analysis

Foreign Institutional Investments

Strengths Weakness

1) Provides the most important 1) Focuses more on developing

resource i.e. is finance. countries.

2) Contributes to the economic

growth of the country.
2) Hampering the progress due to
3) Balances the balance ofanytime withdrawal.
payment position.
Opportunities Threats
3) Provides only short term
opportunities.

1) Better infrastructure. 1) Anytime withdrawal of

investments.
4) Provides more returns than in
domestic countries.
2) Exploitation of resources to the
5) Develops relationship between
maximum. 2) Investments made in Foreign
two countries.
countries poses threat to the Indian
3) Better technology available.
companies.

3) Increased returns.

51
Swot Analysis

Strengths:

1 Provides most important resource i.e. finance:

To start any business and to make the idea to be actually

implemented it needs finance. The FIIs brings the inflow of money into the
country. Many projects that require funding is done with the help of FIIs.
Today in this world, the Finance is the only resource, which has the capability
to be easily transferred from one place to another, and hence providing as a
base for business opportunities .Free flow of capital is conducive to both the
total world welfare and to the welfare of each individual.

2 Contributes to the economic growth of the country:

When FIIs enters the domestic country they bring in the money and acts
as the facilitator of the business development. As money comes into the
country, it provides various benefits to the leading sectors and ultimately
results into the development of various sectors.

For e.g. in India I.T sector is the most booming sector and has shown the
signs of improvement thus attracting the FIIs.

3 Balances the balance of payments:

In the initial phase of economic development, the under developing

countries need much larger imports. As a result, the balance of payment
position generally turns adverse. This creates gap between earnings and foreign
exchange. The foreign capital presents short run solution to the problem. So in

52
order to balance the Balance of Payment Foreign Investment is needed.

4 Provides more returns than in domestic countries:

FIIs provide more returns to the investors as compared to the domestic

country. This is one of the most important strength of FIIs. The main reason is
that the countries in which th Foreign Institutional Investors invest their
money, provides more opportunities and many benefits. So investors invest in
foreign countries rather than in the domestic countries.

5 Develops relationship between two countries:

Due to FIIs the investors from different countries come into picture and
various people also come into the contact with each other. This develops a
sense of relationship between different people and develops a nice intra-
cultural atmosphere.

Weaknesses

1 Focuses more on developing countries:

The main weakness of foreign institutional investments is that they

provide opportunities to only the developing and developed countries. The
Foreign institutional investors focuses on the developing countries rather than
on the underdeveloped countries and because of this the under developed
countries remain underdeveloped. So this drawback of the FIIs should be
improved upon by making their investments in the under developed countries.

2 Hampering the progress due to anytime withdrawal:

53
 The FIIs do not provide any guarantee i.e. the Foreign institutional
investors can anytime withdraw their money when they want to so this makes
the nature of the FIIs unpredictable and ultimately hampering the progress of
the economy of that country. The very good example of this is the mass
withdrawal of the FIIs in the far eastern countries like Malaysia, Indonesia etc
in 1996-97.

3 Provides only the short term opportunities:

FIIs provide only the short term opportunities i.e. they do not provide
the long term opportunities as they are very much supple in nature and there by
limiting its scope to short term opportunities. As far as the market seems to
be good the FIIs are attracted and after that they are not predictable. So FIIs
are bound to provide only the short term opportunities.

Opportunities:

1 Better infrastructure:

Better infrastructure is available only when there is adequate finance

available and this comes with the help of FIIs. Infrastructure covers many
dimensions, ranging from roads, ports, railways and telecommunication
systems to institutional development (e.g. accounting, legal services, etc.)
studies in china reveal the extent of transport facilities and the proximity to
major ports as having a positive significant effect on the location of FII within
the country. Poor infrastructure can be developed with the help of the foreign
investment. Foreign investors also point potential for attracting significant FII
if host country government permits more substantial foreign participation in the
infrastructure sector.

54
2 Exploitation of resources to the maximum:

The major resources i.e. manpower, material and machines can be

utilized to its fullest so as to get the maximum benefit out of it. Through FIIs,
the reserves or the resources that are untapped because of the lack of funds
can be exploited. Potential areas for exploration ventures include gold,
diamonds, copper, lead zinc, cobalt silver, tin etc. There is also scope for
setting up manufacturing units for value added products.

3 Better technology available:

Technology is the main aspect on which the growth of the country is

determined. Developing countries has a very low level of technology. Their
technology is not up to the standards and they lack in modern technology.
Developing countries possess a strong urge for industrialization to develop
their economies and to wriggle out of the low-level equilibrium trap in which
they are caught. This raises the necessity for importing technologies from
advanced countries. Such technology usually comes with foreign capital.

Threats:

1 Anytime withdrawal of investments:

The FIIs are more flexible in nature i.e. unlike FDI they are not
guaranteed. Foreign Institutional Investors can withdraw at any time they want.
Foreign Direct Investment is for a fixed period and the investments could not
be withdrawn until a specified period. The recent example was the net outflows
of the money from the stock market that affected the whole economy and its
consequences are very much appalling resulting into posing threats to the
economy.

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2 Investments made in Foreign Companies poses threat to Indian
companies:

Many MNCs have their set up in India and these MNCs provide a stiff
competition to the domestic industries. The Foreign Institutional Investors
invest their money in these MNCs and they are equipped with the latest
technology to provide products at cheaper rates. Moreover, the Indian
labourers are opposing the use of modern technology as the company
downsizes the number of workers that substitutes the modern technology.

3 Increased returns results in outflow of money:

Increased returns can pose a threat to the domestic country as the money
flows out of the country and this may affect the economy of the domestic
country. The returns that the Foreign Institutional Investors are getting are very
much high and this returns they take to their home country and this leads to the
outflow of money from domestic country to the foreign country.

56
 Conclusion:

Foreign Institutional Investments are very much needed for India.

They are necessary for the continuous development of our country. The
economy of our country has shown a better performance and has led to the
economic growth due to the FIIs. Though there are threats from the Foreign
Institutional Investments we should be positive and see the future of our
country. In last 50 years, India has developed a strong and
professionally competent technical, marketing and business manpower in
Livestock production and Information Technology.

This is an added advantage over many developing countries of

Asia and Africa. Availability of competent and comparatively low-cost
manpower in India is a great asset which is attracting foreign investors. As a
result of stagnancy or in some cases reduction in agricultural production,
demand for several inputs like machinery and equipment, feeds,
pharmaceuticals etc. has reduced in some countries of America and Europe.

It is therefore not surprising that these business enterprises have focused

their attention to emerging Asian markets, particularly India and China. India
is in a better position as it has a strong technical manpower base and large
number of English speaking population.

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India’s Future

The future of the India is bright and moreover due to FIIs the economy
will gain a swing in the future in short run as well as long run. India is a
pool of various resources, their effective utilization is possible only with the
investments and in large sum. The prosperity of India will soon be visible in the
near future. By evolving the strategy to improve the competitive position in
these areas, overall level of competitiveness can be raised thereby enhancing the
export potential of the country.

Thus, India could take a proactive initiative in seeking an international

discipline on investment incentives with a built in exception based on the level
of industrialization. Soon India will be leading country.

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Recommendations

Foreign investment is a valuable non-debt creating, external

resource supplement inadequate savings and has a major role in transforming
technology, improving managerial skills and facilitating market development.
In our economic system, capital is the fuel that generates profits.

India must extend a hospitable environment for foreign investors by

providing essential guarantees for investors for

1) Enter and exit.

2) Operate on equal terms alongside local operators.

3) Repatriate their investments when needed

India has a pool of human resource and this can attract the Foreign
Institutional Investors to invest their money into our country there by
increasing the output with the help of tapping the human resource.

The ready availability of the required infrastructure in the form of

serviceable roads, ports, telecommunications, airports and water and power
facilities is a pre-requisite for attracting large volume of foreign investments.

Continued export and careful management of India’s imports will also be

crucial in maintaining India’s ability to maintain and continue to build
international equity and debt Institutional Investors confidence.

An environment should be created in India whereby investors would be

confident in remitting funds into India, instead of just obtaining approval and
waiting for the time to invest.

59
 Though Foreign Investments poses threats, the strengths should also be
considered and the opportunities that Foreign Institutional Investments provide.
If India has to attract huge amounts of Foreign Investments, it needs to first
overcome the barriers that exist. There should be no room for Bureaucracy, Red
Tapism and a laid back attitude. Approvals should be easily forth coming.

Both the FIIs and FDI should be invited to the fullest and given
importance so that it will create a win-win situation on the part of both the
parties. Both the parties will be benefited from Foreign Investments i.e. India
will get capital and the investors will get returns to maximum.

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 Annexure

Art
icle:

FII inflows cross $4 bn mark Friday, April 07, 2006 (Economic Times)

The impressive returns given by Indian equities have received yet

another stamp of approval and this time by the prime drivers of the Bull Run, the
Foreign Institutional Investors (FIIs) themselves. The net FII inflows in Indian
equities have crossed the $4 billion mark in the current calendar year (CY06). As

57
on April 4, FII inflows stood at $4.03 billion.

Interestingly, experts opine that the Indian markets have become a

global force and the coming days will only further cement India’s place in the
global arena. This will, in turn, attract more and more FIIs to the country, too.
Uday Kotak, managing director, Kotak Mahindra Bank, said, “I expect that in
the next five years, if nothing goes wrong, India will be the second largest
capital market in the world after the US.

A section of market participants is also of the view that while on one hand,
Indian equities look a bit overvalued, on the other hand, they have been able to
outpace most of the other global and emerging markets in the recent past.
This will only lead to an increase in the inflows to the equity markets. However,

58
it seems that the dependence of the markets on foreign inflows is dipping at
a time w

59