asheesh complete project
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CHAPTER: 1
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 and they
are highly volatile in nature net FII flow in 1995-96 was $2009 million, $20,328 million in 2007-
08, -$15,017 million in 2008-09 and $23,611 million up to January 2010.1 The nature of the
foreign investors decision-making process that lies at the heart of the portfolio flows.
International portfolio flows, as opposed to foreign direct investment (FDI) flows, refer to capital
flows made by individuals or investors seeking to create an internationally diversified portfolio
rather than to acquire management control over foreign companies. Diversifying internationally
has long been known as a way to reduce the overall portfolio risk and even earn higher returns.
Investors in developed countries can effectively enhance their portfolio performance by adding
foreign stocks particularly those from emerging market countries where stock markets have
relatively low correlations with those in developed countries. The portfolio investors problem
may be thought of as deciding upon appropriate country weights in the portfolio so as to
maximize portfolio returns subject to a risk constraint, or in the absence of a pre-specified risk
1 Foreign Investment Flow in India, RBI Bulletin, January (2010), pp. 1827-1832.
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level, to reach the optimum portfolio since the variability of the portfolio return depends on the
correlation matrix of the country level returns, emerging markets with their lower correlation
with developed markets help to reduce the overall risk of the investor. Thus, emerging markets
like India are naturally attractive to international portfolio investors as investment destinations.
Beginning in the mid-80s several of these markets that were previously closed to foreign
investors, began to liberalize making portfolio investments possible and portfolio investments
poured into them in the 90s till the Asian crisis. 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 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. The danger of
Mexico-style abrupt and sudden outflows inherent with FII flows and their destabilizing effects
on equity and foreign exchange markets have been stressed.
FOREIGN INSTITUTIONAL INVESTMENT IN INDIA: AN OVERVIEW
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FII flows to India formally began in September 1992 under the foreign portfolio investment
(FPI) scheme, when the Guidelines for Foreign Institutional Investment were issued by the
Government of India. In November 1995, the Securities and Exchange Board of India (SEBI)2
enforced the Securities and Exchange Board of India (Foreign Institutional Investors)
Regulations, 1995 (henceforth, referred to as SEBI FII Regulations) to regulate matters relating
to FII investment flows. At present, investment by FIIs is jointly regulated by this and
Regulation 5(2) of the Foreign Exchange Management Act(FEMA), 1999. The SEBI regulations
require FIIs to register with the SEBI and also obtain approval from the Reserve Bank of India
(RBI) under the FEMA for securities trading, operating foreign currency and rupee bank
accounts and remitting and repatriating funds. In the entire process of FII registration and
regulation, the SEBI acts as the nodal authority and once SEBI registration has been obtained, an
FII does not require any further permission for trading securities or for transferring funds into or
Out of India. The SEBI FII Regulations and RBI policies are amended and modified from time to
time in response to the gradual maturing of the Indian financial market and changes taking place
in the global economic scenario. Such modification, needless to mention, is required to be done
to ensure quantitative as well as qualitative improvements in the portfolio flows through the FII
route, as India has to compete with other Asian nations and other emerging markets of the world
for global capital inflows. In India, FII investment (in shares and debentures) started in January
1993. After that number of FII registered with SEBI and investment in India both has increased.
[FIGURE: 1.1]
2Empowered by the Securities and Exchange Board of India Act, 1992.
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SOURCES: SEBI web site .www.sebi.gov.in
The sources of these FII flows are varied. The FIIs registered with SEBI come from as many as
28 countries (including money management companies operating in India on behalf of foreign
investors). US-based institutions accounted for slightly over 41%, those from the UK constitute
about 20% with other Western European countries hosting another 17% of the FIIs (see Figure
1.1). It is, however, instructive to bear in mind that these national affiliations do not necessarily
mean that the actual investor funds come from these particular countries. Given the significant
financial flows among the industrial countries, national affiliations are very rough indicators of
the home of the FII investments. In particular institutions operating from Luxembourg, Cayman
Islands or Channel Islands, or even those based at Singapore or Hong Kong are likely to be
investing funds largely on behalf of residents in other countries. Nevertheless, the regional
breakdown of the FIIs does provide an idea of the relative importance of different regions of the
world in the FII flows.
HISTOGRAM AND DESCRIPTIVE STATISTICS OF FII FLOW
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FIGURE: 1.2 (Values are in Rs.) Crore
SOURCES: SEBI web site .www.sebi.gov.in
FII flow which started in the year of 1992-93 was not able to bring huge amount of money in the
initial years up to 2003 FII flows were less than 10,000 crore But in the year of 2003-04 there
was huge surge in FII flow in the year it touched the level of 44,000 crore in 2007-08 went to
62,583.56 crore but in 2008-09 due to bad economic condition FII flow became negative and it
touched the level of -43,337.75 crore.
FII regulations by the SEBI were first introduced on November 14, 1995 in the form of the SEBI
FII Regulations. Over the years, the SEBI and the RBI together, through a variety of measures,
are trying to improve the scope, coverage and quality of FII investment. These measures include
(a) widening the array of instruments in which FIIs are allowed to trade, (b) expanding the list of
the types of funds that can be registered as FIIs in India and the entities on behalf of whom they
can invest, (c) raising the caps for FII investment in different sectors and companies, (d) easing
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the norms for FII registration, reducing procedural delays, lowering fees, etc., and (e) mandating
stricter disclosure norms, etc. A summary of the major regulatory changes relating to FIIs along
with their reference dates is as follows:
Chronology of important regulations related to FIIs3
Nov-95 SEBI empowered by the Securities and Exchange Board of India Act, 1992
institutionalized the FII regulations, known as the Securities and Exchange Board of India
(Foreign Institutional Investors) Regulations, November 14, 1995, allowing Pension Funds,
Mutual Funds or Investment Trusts, incorporated outside India; any Asset Management
Company or Nominee Company, Bank or Institutional Portfolio Manager, established or
incorporated outside India and proposing to make investments in India on behalf of broad based
funds any Trustee or Power of Attorney holder, incorporated or established outside India, and
proposing to make investments in India on behalf of broad based funds to apply for FII status to
carry out trading in equities and debentures listed on the Indian stock exchanges.
Oct-96 University fund, endowments, foundations or charitable trusts or charitable societies
were considered eligible for being registered as FIIs; FIIs were allowed to invest in unlisted
companies; Equity share investment on own account and on behalf of subaccounts increases to
10 from 5 per cent, of total capital issue of a company. Custodians asked to become members of
the clearing houses/ clearing corporations of the stock exchange(s) and participate in the clearing
and settlement process through the clearing house/clearing corporation for all securities.
Feb-97 Proprietary funds were included as eligible FIIs (for FII and subaccount).
3www.sebi.gov.in; www.rbi.org.in & www.finmin.nic.in
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Nov-97 SEBI allowed institutional investors, FIIs, stock brokers, stock exchanges etc. to make
use of the facility of warehousing of trades.
Apr-98 The gilts market was opened up to FII investment. Investments in Treasury bills and
dated Government Securities were allowed within the overall approved debt ceilings. Stock
lending permitted through an approved intermediary in accordance with stock lending scheme
Jun-98 FIIs allowed to invest in unlisted companies through the 100 per cent debt route FIIs
asked to tender their securities directly in response to an open offer made in terms of the SEBI
(Substantial Acquisition of Shares and Takeovers) Regulations, 1997; FIIs allowed to buy and
sell derivative (index futures) contracts traded on a stock exchange; FIIs permitted to trade in
derivatives without requiring to take or give delivery; Transactions among FIIs with respect to
Indian stocks would no longer require the post facto confirmation from RBI; Process of approval
of sub-accounts of registered FIIs simplified. Trigger point limit for investments in Indian
companies by FIIs/ NRIs/OCBs under the portfolio scheme was raised by 2 percentage points;
ADs were to be permitted to provide forward cover to FIIs in respect of their fresh investments
in India, in equity, effective June 12, 1998. ADs were to be allowed to extend forward cover
facility to FIIs to cover the appreciation in the market value of their existing investments in
India.
16-Apr-99 In respect of investments in the secondary market, FIIs were allowed to participate in
open offers in accordance with take-over codes; in case of an open offer by a company to buy-
back its securities, the FIIs may sell the securities held by it to such company in accordance with
the SEBI (Buy-Back of securities) Regulations, 1998.
29-Feb-00 A domestic portfolio manager or domestic asset management company were made
eligible to be registered as a foreign institutional investor to manage the funds of sub-accounts,
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provided the applicant is an approved asset management company or a registered portfolio
manager and that the approval or registration is valid and no disciplinary proceeding is pending
before the Board against such applicant. In case of foreign corporate or individuals, investing in
equity, each of such sub-account (substituted forall sub accounts together) shall not invest more
than 5% of the total issued capital, within the aggregate limit of 24%, of the company in which
such investment is made. Non-resident Indians (NRIs) and overseas corporate bodies (OCBs)
registered with RBI shall not be eligible to invest as sub-account or as foreign institutional
investor.
24-Apr-00 Indian companies (other than banking companies) including those which have
already enhanced the aggregate ceiling from the normal level of 24% to 30% were permitted to
enhance the aggregate ceiling on FII investment up to 40% of the issued and paid-up capital.
20-Sep-01 In consultation with the Government, RBI permitted Indian companies to increase the
FII investment limit up to the sectoral cap/statutory ceiling, as applicable.
27-Feb-02 FIIs permitted to trade in all exchange traded derivative contracts; FII portfolio
investments will not be subject to the sectoral limits applicable for FDI except in specified
sectors.
02-Dec-04 Limit for investment by FIIs in Corporate Debt will be US $1.75 billion applicable to
FII investment in dated Government securities and T-bills only, both under 100% debt route and
general 70:30 route.
21-Jul-2008 All FIIs have to submit their monthly report to their custodians.
13-Mar-09 The Government of India reviewed the External Commercial Borrowing policy and
increased the cumulative debt investment limit by USD 9 billion (from USD 6 billion to USD 15
billion) for FII investments in Corporate Debt.
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SIGNIFICANCE OF FOREIGN INSTITUTIONAL INVESTORS
A survey of literature on portfolio investments revealed the importance of such investments for a
developing economy like Indias. Foremost, FII investments are non-debt creating flows, also a
reason why Indian policy makers sought to liberalize such flows in the wake of the BoP crisis in
1990-91. Theoretically, FII investments bring in global liquidity into the equity markets and raise
the price-earnings ratio and thereby reduce the cost of capital domestically. FII inflows help
supplement domestic savings and smoothen inter-temporal consumption. Studies indicate a
positive relationship between portfolio flows and the growth performance of an economy, though
such specific studies for India were not found. India, in the recent past few years seems to have
received a disproportionately large part of its foreign investment flows via the FII investments in
the equity markets and FII inflows had significantly contributed to the sharp increase in the
foreign exchange reserves of the economy. Without immediately implicating any significant
withdrawal of funds out of India of crisis precipitating proportions, it needs to be noted that
outflows of FII capital from the market could adversely impact the value of the Indian currency,
as FII inflows form the most significant part of foreign inflows into the economy. There are
likely to be repercussions on the growth momentum of the Indian economy if FII inflows
significantly slow down. This is because a large extent of buoyancy in consumption was possible
due to the positive wealth effects of a booming stock market and a decline in the interest rates
due to a large overhang of rupee liquidity in the system. Therefore, if FII inflows were to slow
down, it will reduce the wealth generated by the stock market, the Indian currency will
depreciate and RBI will have to draw down on the foreign exchange reserves or hike interest
rates to prevent wild swings in the exchange rate.
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CHAPTER: 2
LITERATURE REVIEW
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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 present. 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 researchers4have found evidence of persistent home bias in the portfolios of investors
in industrial countries in the 90s. This home bias the tendency to hold disproportionate
amounts of stock from the home country suggests substantial potential for further portfolio
flows as global market integration increases over time.5
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 flow themselves,
4French, Kenneth R & Poterba, James M, (1991), Why is there a Home Bias? An Analysis ofForeign Portfolio Equity Ownership in Japan, American Economic Association vol. 81(2),pages 222-26, May.5 Tesar, Linda L. & Werner, Ingrid M., (1995), Home bias and high turnover, Journal of
International Money and Finance, vol. 14(4), pages 467-492, August.
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along with greater trade flows will tend to cause different national markets to increasingly
become parts of a more unified global market, reducing their diversification benefits. Which of
these two effects will dominate is, of course, an empirical issue, but given the extent of the
home bias it is likely that for quite a few years to come, FII flows would increase with global
integration.
In recent years, international portfolio flows to developing countries have received the attention
of scholars in the areas of finance and international economics alike. In the 90s several papers
have explored the causes and effects of cross-border portfolio investment. Previous research has
also attempted to identify the factors behind these 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.
As for the motivation of US equity investment in foreign markets, recent research3
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
3 Bohn, Henning & Tesar, Linda L, (1996), US equity investment in foreign market,American Economic Association, vol. 86(2), pages 77-81, May.
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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 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.4 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
4 Clark and Berko (1997), Emerging market finance, Journal of Empirical Finance, Volume10, Issues 1-2, February 2003, Pages 3-56
Crisis countries dropped sharply in 1997 and 1998 from their pre-crisis levels; it is generally held
that the flows reacted to the crisis (possibly exacerbating it) rather than causing it.
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More recent studies5 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 countrys 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 area 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 countrys returns should affect these flows.
Examine the impact of uncertain capital flows on the growth of 60 developing countries during
the 1990s. They distinguished between total capital flows, official capital flows and private
capital flows. For the three types of capital flows, they derived a yearly uncertainty measure.
They have used the yearly uncertainty measures in Ordinary Least Square (OLS) as we as
Generalized Method of Moments (GMM) estimates, to explain the impact of uncertain capital
5 Froot, Kenneth A. & O'Connell, Paul G. J. & Seasholes, Mark S., (2001) "The portfolio flowsof international investors", Journal of Financial Economics, Elsevier, vol. 59(2), pages 151-193, February.flows on growth. They conclude that both types of estimates suggest that uncertain capital flows
have a negative effect on financial market and growth in developing countries.
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capital flows and its impact on the capital formation and economic growth taking into the
variable as net private capital flows, net direct investment, net official flows, net portfolio
investment and other net investments in 22 countries during 1992 to 2000. 6 If capital Inflows
were volatile or temporary, the country would have to go through an adjustment process in both
the real and financial market. Inflows, which take the form of direct foreign investment, are
generally considered more permanent in character. Capital flows can be promoted purely by
external factors which may tend to be less sustainable than those induced by domestic factors.
Both capital inflows and outflows when they are large and sudden have important implication for
economies. When capital inflows are large, they can lead to an appreciation of real exchange
rate. He concludes that the capital account liberalization is not a discrete event.
Examines the macro economic impact on Indian capital market7 as well as the corporate sector
and what is the macro economic effects on inflows of capital to Indian and micro economic
effects on the capital market during 1989 to 2002. He took the macro variable as FDI, FPI, NRI
deposits, external assistance and GDP/GDS/GNP. He tells that entry of international capital
flows helps to provide greater depth to the domestic capital market and reduce the systematic
risk of the economy. He argues that advanced for liberalizing capital market for liberalizing
capital market and opening them to foreign investor are to increase the availability of capital
6 Rangarajan, C (2000), Capital Flows: Another Look, Economic Political Weekly, Dec.9,PP-4421-27.7Khanna, Sushil (2002), Has India Gained from Capital Account Liberalization? Private
Capital Flows and Indian Economy in the 1990s, Paper Presented at the IDEAS Conference,International Money and Developing Countries, Dec.16-19.
with domestic industries and 9 commercial firms. On the other hand, the Indian stock market is
today largely dominated by a small group of FIIs, are able to move the market by large
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intervened. He concludes that in case of India, the microanalysis of stock market also fails to
provide any evidence that the entry of FII has reduced the cost of Indian corporate sector.
How capital flows affect a range of economic variables such as exchange rates, interest rates of
foreign exchange reserves, domestic monetary condition and financial system in India during the
period 1986 to 2001.8 She has examines how capital inflows induce real exchange rate
appreciation, stock market and real estate boom, real accumulation and monetary expansion as
well as effects on production and consumption. She investigates the impact on capital flows upon
the domestic financial sector in India. Inflows of foreign capital have a significant impact on
domestic money supply and stock market growth, liquidity and volatility. At the conclusion, the
domestic financial sector that is the banking sector and capital market in the event of a heavy
inflow of foreign capital in India. Correlation between domestic and foreign financial market
highlights Indias vulnerability to external financial shocks. For India on the relationship
between portfolio flows and some stock market indicators suggest that market price are not
unaffected by capital inflows. So far the difference between net capital inflows and current
account deficit has been positive in India.
Explaining the effects of inflows of private foreign capital on some major macroeconomic
variables in India using quarterly data for the period 1993-99.9 She analyses of trends in private
foreign capital inflows and some other variables indicate instability. She has taken the net
8Kohli, Renu (2003), Capital Flows and Domestic Financial Sector in India, Economic
Political Weekly, Feb. 22. PP-761-68.9Chakrabarti, Rajesh (2001), FII Flows to India: Nature and Causes, Money and Finance,
VOL.2, Issue 7. Oct-Dec.inflows of private foreign capital as well as macro-economic variables foreign currency assets,
wholesale price index, money supply, real and nominal effective exchange rates and exports. The
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Co integration test confirms the presence of long-run equilibrium relationships between a few
pairs of variables. But the dependence of each variable on private capital flows invalidates such
co integration except in two cases: co integration exists between foreign currency assets and
money supply and between nominal effective exchange rate and exports, even after controlling
for private capital flows. The Granger Causality Test shows unidirectional causality from 10
private capital flows to nominal effective exchange rates- both trade-based and export
based-,which raises concern about the RBI strategy in the foreign exchange market. Finally,
instability in the trend of foreign currency assets could be partially explained by the instability in
private capital flows with some lagged effect. The characteristic of international capital flows
since 1970 and summarizes some of the findings of the research conducted in the 1990s on the
effects of globalization.10 Even if international capital flows do not trigger excess volatility in
domestic financial market; it is still true that large capital flows can spark off inflation in the
presence of fixed exchange rate. He said globalization allows capital to more to its more
attractive destination, fueling higher growth. He suggests that in the short run, globalization
triggers bankruptcy of the financial system and protracted recession. The exploration of capital
flows to emerging markets in the early and mid-1990s and the recent reversal following the
crisiss around the globe have ignited once again a heated debate on how to manage international
capital flows. He indicates capital outflows worry policy makers, but so do capital inflows as
they may trigger bubbles in asset market and foster an appreciation of the domestic currency and
a loss of competitiveness.
10 Kaminsky, Graciela (2005), International Capital Flows, Financial Stability and Growth,DESA Working Paper, No.10, December.
CHAPTER: 3
RESEARCH METHODOLOGY
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A research methodology defines what the activity of research is, how to proceed, how to measure
progress, and what constitutes success.
NEED OF THE STUDY
Foreign Institutional Investors (FIIs) in Indian capital market playing an important role. FIIs in
India include Assets Management Companies, Pension Funds, Mutual Funds, Incorporated
Portfolio Managers, Charitable Trusts and charitable societies etc. SEBI acts as the nodal point in
the entire process of FIIs regulations. It frames legal framework for FIIs. Investment in India is
regulated under SEBI (FII) regulations 1995.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 percent FII in which case it can make its entire investment in debt
instrument).FIIs can buy or sell securities on stock exchange. They can also invest in listed and
unlisted securities outside stock exchange, where the price has been approved by RBI. FII
investment is frequently referred to as hot money for the reason that it can leave the country at
the same speed at which it comes in. In any country stock market (and its return) is considered as
symbol of countrys growth and FII would like to invest in those countries that provide better
return. Same is the case with India, so study will explore the impact of selected variable on
Foreign Institutional Investor flow in the Indian stock market.
OBJECTIVES OF THE STUDY
To study the relationship between FIIs flows and Bombay Stock Exchange returns.
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To find out the impact of macroeconomic variable (such as Industrial Production) on FIIs
flow to Indian stock market.
To find out the relationship between exchange rate and net FIIs flows to Indian Stock
Market.
SCOPE OF THE STUDY
The study will explore the relationship of net FIIs flow to Indian stock market with its possible
co-variants based on the monthly data set for period January 2009 to January 2010.
RESEARCH DESIGN
A research design specifies the methods and procedures for conducting a particular study. It is an
exploratory research because secondary data is used for purpose of research and in this research
following research methods has been used.
DATA COLLECTION METHODS
Secondary Data
All the data has been collected data from the available sources like internet, journals, newspaper,
published data etc.
Research Instrument
Correlation, Regression has been used as a research instrument.
DATA PROCESSING
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Data has been analyzed with the help of MS-EXCEL and is presented with the help of graphical
and tabulation techniques.
LIMITATIONS OF THE STUDY
(1) Sampling period is very small (one year) so it may or may not be the true representative of
the rest of the years.
(2) Data have been collected from secondary sources so I have to rely on that.
(3) The conclusion given regarding FII flow and other variables are based on present economic
conditions.
CHAPTER: 4
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DATA ANALYSIS AND INTERPRETATION
FII FLOW AND BOMBAY STOCK EXCHANGE RETURNS
Some descriptive statistics about returns of Bombay Stock Exchange which has been used in the
analysis of the paper are given in the Table 1 of Appendix I. while all the returns of BSE has
been diagrammatically presented in Figure 4.1 Returns of Bombay Stock Exchange remained
highly volatile during sample period. Result shows that in the month of January 2009 returns
were in negative (-3.46%). Whereas in the month of March it has touched the level of 16.63%.
Returns remained positive for next consecutive two months where it has touched the highest
level of return 31.978% (in the month of May). Following the trends of January and February
2009 returns once again became negative in the month of June. On an average BSE has provided
DIAGRAMATIC REPRESTENTATION OF BSE RETURNS FROM JANURAY 2009 TO
JANUARY 2010
FIGURE: 4.1
7% return between July and September 2009. Fifth time during sample period BSE returns went
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negative (-6.4%) in the month of January 2010. Average return during sample period was around
5.5%. While analyzing the returns company wise we come to know that highest return was
provided by Tata Motor 14.76% followed by Infosyss who gave13.71% return during sample
period whereas lowest return provided by Bharti Airtel -5.32% and 0.1695% by HUL.
FII flow has been used as a dependent variable to find out relation with BSE return.
Diagrammatically representation of FII flow from January 2009 to January 2010 has been shown
in Figure 4.2. FII flow for the first three months was negative (January, $ -614 million, February,
$-1058, March $-909 million). In the month of April it became positive for the first time during
sample period where it reached up to $2245 million after that it touched $ 5639 million mark
FIGURE: 4.2
highest during sample period followed by ups and downs but in the month of August once again
FII flow became negative ($-29 million). In the month of September institutional investor once
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again shown positive attitude and net FII investment reached up to $4999 million and same trend
of positive investment remained till January 2010 when FII flow was $ 3093 million.
After analysis we come to know that FII flows and stock returns are strongly correlated in India.
The correlation coefficient between FII flows and market returns on the Bombay Stock
Exchange during sample periods is shown in table 3 and table 4 of Appendix 1 Diagrammatically
representation of correlation between two variables has been shown in Figure 4.3. While the
correlation remained moderate throughout the sample period. These positive correlations have
often been held as evidence of FII actions determining Indian equity market returns
RETURNS AND FII FLOW BETWEEN JANUARY 2009 AND JANUARY 2010
FIGURE 4.3
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Further statistical tool regression has been used to find out impact of BSE return on FII flow.
Here BSE return has been used as independent variable while FII flows are dependent variables.
After statistical analysis (see table 5 of Appendix I) we have following equation
Y = 1145.46 + 83.37 X
This equation has been used to estimate the FII flow to India (see table 6 of Appendix I). The
estimates show that moment BSE return increases FII will increase. Suppose X which shows
BSE RETURN and its expected returns in the month of February is 16% then ultimately
expected FII flow goes to $2477.96 million which is more than the average FII flow during
sample period. It shows the moment BSE return increases, FII flow increases further it proves
that there is strong positive correlation between these two variables.
However, correlation itself does not imply causality. A positive relationship between portfolio
inflows and stock returns is consistent with at least four distinct theories: 1) the omitted
variables hypothesis; 2) the downward sloping demand curve view; 3) the base-broadening
theory; and 4) the positive feedback strategy view. The omitted variables view is the classic
case of spurious correlation that the correlated variables, in fact, have no causal relationship
between them but are both affected by one or more other variables missed out in the analysis.
The downward sloping demand curve view contends that foreign investment creates a buying
pressure for stocks in the emerging market in question and causes stock prices to rise much in the
same way as suddenly higher demand for a commodity would cause its price to rise. 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. Consequently the risk of
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IIP, the acceleration in growth has been skewed. The top five of the 17 manufacturing industries,
with a combined weight of 24.1 per cent in IIP, grew by 12.7 per cent and contributed 60.3 per
cent of the IIP growth during April-November 2009. This suggests that there is scope for further
acceleration as the recovery becomes broader based. In terms of use-based classification, there
was sharp acceleration in the growth of basic goods, intermediate goods and consumer durables
during April-November 2009. The recovery began with a steady acceleration in growth of the
intermediate goods sector during the current financial year. This was followed by the recovery in
capital goods sector, to a growth of 11.4 percent during August-November 2009, from the
decline in output during March-May 2009, indicating an improvement in investment sentiments.
Consumer nondurables output witnessed growth since July 2009, despite being weighed down by
the decline in food products, beverages and tobacco products and jute and other vegetable fibre
FIGURE: 4.4* GROWTH IN INDEX OF INDUSTRIAL PRODUCTION (Y-O-Y)
*Source: Central Statistical Organization
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textiles (except cotton). The overall growth in the consumer goods during April-November 2009-
10 has been driven by a sharp double digit growth in the durable segment, with significant
contribution coming from automobiles production.
There is positive correlation between Industrial Production and FII flow to Indian equity market.
The correlation coefficient between FII flow and industrial production during sample period has
shown in table 7 of Appendix I. While the level of correlation between growth of industrial
production and FII flow to Indian Market was low throughout the sample period. (See table 7
and 8 of Appendix I). Diagrammatically presentation of relationship between FII and growth of
IP shown in Figure 4.5
FIGURE 4.5: IIP AND FII FLOW BETWEEN JANUARY 2009 AND JANUARY 2010
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Further statistical tool regression has been used to find out impact of Industrial Production on FII
flow. Here Industrial Production has been used as independent variable while FII flows are
dependent variables. After statistical analysis (see table 9 of Appendix I) we have following
equation
Y = 819.61 + 127.96 X
With the help of this equation we can estimate the future value FII flow to Indian market. Study
shows that whenever there is increase in industrial production it has resulted increase in FII Flow
(see table10 of appendix I). Suppose X which shows INDUSTRIAL PRODUCTION increases to
12% then ultimately FII flow goes to $2356.08. Similarly when industrial production growth was
2.1 % FII flow was $ 1088.32 million. It shows whenever there is increase in Industrial
Production, FII flow would like to increases. So we can say that industrial production is a strong
microeconomic variable which determine the FII flow to India and can be used to find out the
expected FII flows to Indian Market.
EXCHANGE RATE
An exchange rate has been defined as a relative price of two national currencies. More
specifically, it can be stated that the exchange rate is "the ratio between a unit of one currency
and the amount of another currency for which that unit can be exchanged at a particular time."
(FASB 1975) As such, it can be seen that exchange rates are designed to facilitate the actual
exchange of one currency for another. It would appear that exchange rates are relatively
straightforward. However, this is unfortunately not the case.
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Exchange rates are normally quoted in terms of a buying rate, a flat rate, and a selling rate. The
buying rate is that which a bank will pay for a foreign currency, the selling rate is the rate a bank
will charge for the currency, and the flat rate is an average of the buying and selling rates. In
addition, the exchange rate which is quoted will often depend on various factors such as the
market sector and type of foreign-exchange instrument involved. The foreign-exchange market
can be divided into four main sectors: (I) retail--dealings with the general public; (2) wholesale--
trading among banking institutions and, where permitted, between large firms and brokers; (3)
foreign--dealings between domestic and foreign banks; and (4) supranational--dealings among
large multinational corporations and large private banks. The basic types of foreign-exchange
instruments include foreign currencies, bank transfers, bills of exchange, letters of credit, and
forward exchange contracts.2
These varied circumstances call for different exchange rates, 3 which can usually be classified
into three main categories: spot rates, forward rates, and differential rates. Spot rates are the rates
quoted for immediate delivery of a currency (usually two days). Forward rates are those quoted
for delivery of a currency at a specified future date (usually within one year, but after the period
for the spot rate). Differential rates may be either preferential or penalty rates which are limited
to special markets or customers. They are normally found in economies where the government
controls foreign exchange and differ from the spot and forward rates. In such cases, the
government will often establish exchange rates based on the status of the transaction involved. If
the government considers a transaction to be economically favorable, the exchange rates attached
2 Desai, Meghnad, The Anarchy of Exchange Rates, The Financial Express 13 April, (2010)3 Bhagwati, Jaimini, Is appreciation of rupee inevitable? Business Standard 15 April, (2010)
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to it will often reflect that fact. That is, the government will often establish more favorable
exchange rates for those transactions that it wishes to encourage. On the other hand, the
government will also establish less favorable exchange rates for those transactions that it wishes
to discourage. "Where controlled rates differ widely from the free-market rate for a currency,
black-market rates usually appear as an equalizing mechanism. Consequently, the mere existence
of a black-market rate is evidence of an overvalued currency." Exchange rate is also an important
aspect for Foreign Institutional Investor they may use exchange rate for the purpose of
FIGURE: 4.6 EXCHANGE RATE BETWEEN JANURAY 2009 TO JANUARY2010
diversification of resources. So here we try to find out is there any relationship between foreign
investment flow and exchange rate. There were lots of fluctuations in the exchange rate during
sample period. In January it stands at Rs 49.71 where as in March it has touched the level of Rs
52.61. From May to September it remained at the level of Rs 48 from September onwards it has
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started gaining value against dollar and in the month of January 2010 it has touched the level of
46.17. Diagrammatical representation of exchange rate has shown in Figure 4.6
There is negative lower level correlation between exchange rate and FII flow during sample
period (See table 11 and table 12 of Appendix I). It states that the moment rupee will appreciate
flow of FII will decrease and when the value of rupee will decrease FII flow will increase. But
the rate increase and decrease on FII flow is low. Diagrammatical presentation of two variables
(FII flow and Exchange rate) has shown in Figure 4.7 Correlation level between these two
variable (FII Flow and Exchange Rate) is very low. Further statistical tool regression has been
used to find out impact of Exchange rate on FII flow or the expected values of FII flow with the
help of exchange rate.
EXCHANGE RATE AND FII FLOW BETWEEN JAN.2009 TO JAN.2010
FIGURE: 4.7
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Here exchange rate has been used as independent variable while FII flows has been used as a
dependent variable. After statistical analysis (see table 13 and 14 of Appendix I) we have
following equation.
Y = 1452.87 + 3.25 X
With the help of this equation we can make estimates regarding FII flows. Suppose X which
shows Exchange Rate goes to Rs 50 it ultimately increases FII Flow to $ 1615.37 million.
Similarly if rupee value goes to 46 it will ultimately decrease the FII flow to $ 1602.48 million
and when rupee will be 40 FII flow would be $ 1582.87 million. It shows whenever there is
increase in rupee value FII flow would like to decrease and vice versa. But the rate of increase
and decrease is slow in comparison to rupee value appreciation or depreciation. It is because the
is lower level correlation between these two variables.
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CHAPTER: 5
FINDINGS
Foreign Institutional Investors (FIIs) in Indian capital market playing an important role. FIIs in
India include Assets Management Companies, Pension Funds, Mutual Funds, Incorporated
Portfolio Managers, Charitable Trusts and charitable societies etc. SEBI acts as the nodal point in
the entire process of FIIs regulations. It frames legal framework for FIIs. Investment in India is
regulated under SEBI (FII) regulations 1995.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 percent FII in which case it can make its entire investment in debt
instrument).FIIs can buy or sell securities on stock exchange. They can also invest in listed and
unlisted securities outside stock exchange, where the price has been approved by RBI. FII
investment is frequently referred to as hot money for the reason that it can leave the country at
the same speed at which it comes in.
OBJECTIVES OF THE STUDY
To study the relationship between FIIs flows and Bombay Stock Exchange returns.
To find out the impact of macroeconomic variable (such as Industrial Production) on FIIs
flow to Indian stock market.
To find out the relationship between exchange rate and net FIIs flows to Indian Stock
Market.
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The empirical investigation of FII flows to India has elicited the following stylized facts about
such flows:
a) There is positive moderate level correlation between FII flow and return in the Indian markets
during sample period. Further statistical tool (regression) shows that BSE returns has strong
impact over FII flow. Expected values shows that wherever there is increase in BSE return the
FII flow has increased and vice-versa.
b) Study shows that there is correlation between Industrial Production and FII flow to Indian
market. Although correlation was low during sample period. Statistical tool (such as regression)
shows the impact of industrial production on FII flow. Calculated expected values (in regression)
shows that when there is increase the value of Industrial Production the amount of FII flow has
increased. It shows that industrial production has strong impact on FII flow to Indian market.
c) To find out whether foreign institutional investors use the exchange rate for purpose of
diversification. Correlation between Exchange Rate and FII flow has been studied. Study shows
that there is negative low level correlation between exchange rate and FII flow. It shows the
moment the value of rupee decrease FII flow increases , but the correlation between two variable
is very low it shows that foreign institutional investor dont use exchange for the purpose of
diversification of their funds.
The stylized facts listed above lead to a better understanding of FII flows to India. This study
provides a preliminary analysis of FII flows to India and their relationship with several relevant
variables especially returns in the Indian stock market. FII flows which now account for a
significant part of the capital account balance in our balance of payments. The extent to which
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FII participation in Indian markets has helped lower cost of capital to Indian industries is also an
important issue to investigate. A more detailed study by using daily data can be useful in
understanding of the nature and determinants of FII flows to India.
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Tesar, Linda L. & Werner, Ingrid M., (1995), Home bias and high turnover Journal ofInternational Money and Finance, vol. 14(4), pages 467-492, August.
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http://www.bseindia.com/stockinfo/stockprc.aspxhttp://www.sebi.gov.in/Index.jsp?contentDisp=Department&dep_id=10http://mospi.nic.in/mospi_iip.htmhttp://www.rbi.org.in/scripts/BS_ViewBulletin.aspxhttp://www.bseindia.com/stockinfo/stockprc.aspxhttp://www.sebi.gov.in/Index.jsp?contentDisp=Department&dep_id=10http://mospi.nic.in/mospi_iip.htmhttp://www.rbi.org.in/scripts/BS_ViewBulletin.aspx -
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APPENDIX I
TABLE: 1
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TABLE: 2
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TABLE: 3
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TABLE: 4
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TABLE: 5
REGRESSION EQUATION OF BSE RETURNS (X) AND FII FLOW (Y)
REGRESSION EQUATION OF Y ON X
Y = a + b x
The two normal equations are:
Y = Na + b X .. (i)
XY = a X + b X2 (ii)
Putting the value in equations
20943 = 13a + b 72.59 (i)
253085.2 = 72.59 a + b 2038.97 . (ii)
Multiply (i) by 5.58
253085.2 = 72.59 a + b 2038.97 . (ii)
116861.94 = 72.59 a + b 405.052 (iii)
Subtracting (iii) from (ii)
136223.26 = 1633.91 b
b = 83.37
Putting the value of b in equation (i)
20943 = 13a + (83.37) 72.59
a = 1145.46
Y = a + b X
Y = 1145.46 + 83.37 X
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TABLE: 7
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TABLE: 8
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TABLE: 9
REGRESSION EQUATION OF INDUSTRIAL PRODUCTION (X) AND FII FLOW (Y)
REGRESSION EQUATION OF Y ON X
Y = a + b x
The two normal equations are:
Y = Na + b X .. (i)
XY = a X + b X2 (ii)
Putting the value in equations
20943 = 13a + b 80.4 (i)
160243.1 = 80.4 a + b 737.7 . (ii)
Multiply (i) by 6.18
160243.1 = 80.4 a + b 737.7 . (ii)
129427.74 = 80.4 a + b 496.87 (iii)
Subtracting (iii) from (ii)
30815.36 = 240.82 b
b = 127.96
Putting the value of b in equation (i)
20943 = 13a + (127.96) 80.4
a = 819.61
Y = a + b X
Y = 819.61 + 127.96 X
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TABLE: 10
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TABLE: 11
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TABLE: 14