final project fdi

7/31/2019 Final Project Fdi

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A

Project report

On

FDI & FII IMPACT ON INDIAN ECONOMY

In partial fulfillment of the requirements of

the Summer Internship of

Post Graduate Diploma in Business Management

Through

Rizvi Academy of Management

under the guidance of

Prof. Furquaan

Submitted by

Salman Khan

MMS

Batch: 2011 2013.


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EXECUTIVE SUMMARY Foreign Direct Investment (FDI) flows are usually preferred over other forms of

external finance because they are non-debt creating, non-volatile and their returns depend

on the performance of the projects financed by the investors. FDI also facilitates

international trade and transfer of knowledge, skills and technology. In a world of

increased competition and rapid technological change, their complimentary and catalytic

role can be very valuable.

Over the years, FDI inflow in the country is increasing. However, India has

tremendous potential for absorbing greater flow of FDI in the coming years. Serious

efforts are being made to attract greater inflow of FDI in the country by taking several

actions both on policy and implementation front. An essential requirement of the foreign

investing community in making their investment decision is availability of timely and

reliable information about the policies and procedures governing FDI in India.

Foreign direct investment (FDI) in India has played an important role in thedevelopment of the Indian economy. FDI in India has - in a lot of ways - enabled India to

achieve a certain degree of financial stability, growth and development. This money has

allowed India to focus on the areas that may have needed economic Attention, and

address the various problems that continue to challenge the country. India has continually

sought to attract FDI from the worlds major investors. In 1998 and 1999 , the Indian

national government announced a number of reforms designed to encourage FDI and

present a favorable scenario for investors. FDI investments are permitted through

financial collaborations, through private equity or preferential allotments, by way of

capital markets through Euro issues, and in joint ventures.


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METHODOLOGY

In order to accomplish this project successfully we will take following steps.

Data collection:

Secondary Data: Internet, newspapers, journals and books, other reports and projects,

literatures

FDI :

The study takes into account a sample of top 10 investing countries e.g. Mauritius,

Singapore, USA etc. and top 10 sectors e.g. service sector, computer hardware and

software, telecommunications etc. which had attracted larger inflow of FDI from

different countries.It also takes into account the impact of FDI on the GDP growth of

India,Poverty reduction and also makes a comparative study of the various states in India

as to how they have harnessed the benefits of FDI.

FII:

Correlation: We have used the Correlation tool to determine whether two ranges

of data move together that is, how the Sensex,Foreign exchange reserves and

exchange rates are related to the FII which may be positive relation, negativerelation or no relation.

Hypothesis Test: If the hypothesis holds good then we can infer that FIIs have

significant impact on the Indian capital market. This will help the investors to

decide on their investments in stocks and shares. If the hypothesis is rejected, or


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in other words if the null hypothesis is accepted, then FIIs will have no significant

impact on the Indian bourses.

OBJECTIVES

Examines the trends and patterns in the FDI across different sectors and from

different countries in India during 2002 to 2011. To study how FDI has impacted the GDP growth,Poverty etc

Influence of FII on movement of Indian stock exchange during period that isMarch 2007 to March 2012.

INTRODUCTION

Foreign direct investment (FDI) plays an extraordinary and growing role in global business. It

can provide a firm with new markets and marketing channels, cheaper production facilities,

access to new technology, products, skills and financing. For a host country or the foreign

firm which receives the investment, it can provide a source of new technologies, capital,

processes, products, organizational technologies and management skills, and as such can

provide a strong impetus to economic development.Foreign direct investment, in its classic

definition, is defined as a company from one country making a physical investment into

building a factory in another country. The direct investment in buildings, machinery and

equipment is in contrast with making a portfolio investment, which is considered an indirect

investment. In recent years, given rapid growth and change in global investment patterns, thedefinition has been broadened to include the acquisition of a lasting management interest in a

company or enterprise outside the investing firms home country. As such, it may take many

forms, such as a direct acquisition of a foreign firm, construction of a facility, or investment

in a joint venture or strategic alliance with a local firm with attendant input of technology,


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licensing of intellectual property, In the past decade, FDI has come to play a major role in

the internationalization of business. Reacting to changes in technology, growing liberalization

of the national regulatory framework governing investment in enterprises, and changes in

capital markets profound changes have occurred in the size, scope and methods of FDI. New

information technology systems, decline in global communication costs have made

management of foreign investments far easier than in the past. The sea change in trade and

investment policies and the regulatory environment globally in the past decade, including

trade policy and tariff liberalization, easing of restrictions on foreign investment and

acquisition in many nations, and the deregulation and privitazation of many industries, has

probably been the most s ignificant catalyst for FDIs expanded role.One of the most striking

developments during the last two decades is the spectacular growth of FDI in the global

economic landscape. This unprecedented growth of global FDI in 1990 around the worldmake FDI an important and vital component of development strategy in both developed and

developing nations and policies are designed in order to stimulate inward flows. Infact, FDI

provides a win win situation to the host and the home countries. Both countries are directly

interested in inviting FDI, because they benefit a lot from such type of investment. The

home countries want to take the advantage of the vast markets opened by industrial growth.

On the other hand the host countries want to acquire technological and managerial skills and

supplement domestic savings and foreign exchange. Moreover, the paucity of all types of

resources viz. financial, capital, entrepreneurship, technological know- how, skills and

practices, access to markets- abroad- in their economic development, developing nations

accepted FDI as a sole visible panacea for all their scarcities. Further, the integration of global

financial markets paves ways to this explosive growth of FDI around the globe.

A SHORT HISTORY

After getting independence in 1947, the government of India envisioned a socialist

approach to developing the countries economy broadly based on the USSR system. The

government decided to adopt an economic agenda that would follow five year plans.


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Each five year plan was focused on certain sectors of the economy that the government

felt needed to be developed for the countries progress. The government followed an

interventionist policy and dictated most of the norms of running a business by favoring

certain sectors and ignoring others.

Until 1991, India was primarily a closed economy. The industrial environment in India

was highly regulated and a license system known as licence raj - was in place to

ensure compliance with the government regulations and directives. Under the Industries

Development and Regulations act (1951) starting and operating any industry required

approval - in the form of a licence - from the government. Any change in production

capacity or change in the product mix also called for obtaining government approval.This led to the development of increasingly complex and opaque procedures for obtaining

a licence and led to a burgeoning bureaucracy. The licence system thus shifted lot of

power and perverse incentives in the hands of fil e pushing bureaucrats (or Babus ). This

directly led to increased corruption as the procedure for obtaining a licence was vaguely

defined and left open to individual interpretations. In addition, there was no monitoring

system in place to ensure speedy disposal of licence applications. Also, the labor markets

were highly regulated and the government did not allow the companies to lay off its

workers. This meant that even in severe downturns the companies kept bleeding but

could not rationalize its workforce. Eventually these companies - majority of them public

sector companies would become chronically sick and the government kept subsidizing

them at huge costs to the taxpayer.

One draconian measure was the introduction of the Foreign Exchange Regulation act

(FERA) of 1973 which curtailed foreign investment to 40% in Indian companies. in

1973. Foreign companies also came under the Monopolies and Restrictive Policy

(MRTP), 1969 Act during this period. MRTP (1969) Act restricted companies on the size

of operation and the pricing of products and services. The Reserve Bank of India geared

itself to implement the above act. As a result, many companies that did not want to


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increase equity participation of Indians as per section (2) of FERA, 1973 decided to cease

their operations in India. As many as 54 companies applied to wind up their operations by

1977-78 since the implementation of the above Act in 1974 and 9 companies applied to

wind up their operations in 1980-81

(Annual Reports, Reserve Bank of India 1977, 1978, 1981).

This had a very adverse impact and companies such as Coca-Cola and IBM exited the

country. The government also adopted a policy of import substitution and the idea was to

help the domestic industry improve in a safe environment until the local industries could

compete internationally. This was implemented by levying extremely high tariffs or

completely banning imported goods. Due to the governments protection most of the

industries failed to catch up with the technological innovations taking place around the

world. As they were shielded from imports due to extremely high import tariffs the

industries had no incentive to improve their operations. This led to a vicious circular

logic where the tariffs were not reduced since domestic companies could not compete and

the high tariffs prevented industries from innovating. Corruption and opaqueness of the

system added to the difficulties and the situation became extremely complex.

THE BOP CRISIS

Gulf war broke out in 1990 and the resulting oil shock was enough to trigger a serious

balance of payment (BoP) crisis for India in 1991. The cost of oil imports went up to

10,820 crores from the estimated 6,400 crores . Traditionally, India received lot of

remittances from the expatriates working in the Gulf countries and this source also dried

up as the migrant Indian workers were forced to return home due to the war. The problem

was compounded due to an extremely high inflation of about 16% and a fiscal deficit of

about 8.5%. The situation was so severe that India had foreign reserves of only around $1

Billion - barely enough to cover two weeks of its payment obligations. Indias credit

rating was downgraded as its debt servicing capability was critically impaired and the

government had to pledge its gold reserves to soothe creditors. Ostensibly, the trigger for

the BoP crisis was the oil shock but the deeper issue was that the governments heavy


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hand in trying to regulate businesses and to move the country towards economic progress

had failed to produce results and drastic measures were now called for.

Faced with these insurmountable problems, the Indian government turned to the IMF and

thus began a series of far reaching reforms in the India economy which envisionedtransforming the countrys economy from a n interventionist and overly-regulated

economy to a more market oriented one.

THE BEGINING OF A NEW ERA

The year 1991 marks a new growth phase of FDI in India with an all time high flow of

FDI. Following the Industrial Policy (1991) , a large number of foreign companies fromdifferent parts of the world rushed into India. In this period, in addition to thousands of

foreign collaborations in India, as many as 145 foreign companies registered in India

within a span of 10 years from 1991-2000. Companies like General Motors, Ford Motors,

and IBM that divested from India in the 1950s and 1970s reentered India during this

period. A large number of Asian companies like Daewoo Motors, Hyundai Motors and

LG Electronics from S. Korea, Matsushita Television and Honda Motors from Japan

invested in India during this period.

With the legislation of the Industrial Licensing Policy, 1991, industrial licensing was

abolished except for 18 industries. FDI up to 51% equity was allowed in 34 formerly high

priority industries and the concept of phased manufacturing requirement on foreign

companies was removed. Further, the tariffs on imports have been steadily reduced in

every budget since 1991. Subsequently, GOI replaced FERA, 1973 that regulated all

foreign exchange transactions with Foreign Exchange Management Act (FEMA), 1999.

The objectives of FEMA have been to facilitate external trade and payments and to

promote orderly development and maintenance of foreign exchange market. The total

number of foreign collaborations increased from 976 in the year 1991 to 2144 in the year

2000.


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WHAT IS FOREIGN DIRECT INVESTMENT?

Is the process whereby residents of one country (the source country) acquire ownership

of assets for the purpose of controlling the production, distribution, and other activities of

a firm in another country (the host country). The international monetary f unds balance of

payment manual defines FDI as an investment that is made to acquire a lasting interest in

an enterprise operating in an economy other than that of the investor. The investors

purpose being to have an effective voice in the management of the enterprise. The united

nations 1999 world investment report defines FDI as an investment involving a long

term relationship and reflecting a lasting interest and control of a resident entity in one

economy (foreign direct investor or parent enterprise) in an enterprise resident in an

economy other than that of the foreign direct investor ( FDI enterprise, affiliate enterprise

or foreign affiliate).

TYPES OF FDI


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A)BY DIRECTION

Inward FDIs:

Inward FDI for an economy can be defined as the capital provided from a foreign direct

investor (i.e. the coca cola company) residing in a country, to that economy, which is

residing in another country. (i.e. India's economy).

EXAMPLE: General Motors decides to open a factory in India. They are going to need

some capital. That capital is inward FDI for India.

Different economic factors encourage inward FDIs. These include interest

loans, tax breaks, grants, subsidies, and the removal of restrictions and limitations.

Outward FDIs:

A business strategy where a domestic firm expands its operations to a foreign country

either via a Green field investment, merger/acquisition and/or expansion of an existing

foreign facility. Employing outward direct investment is a natural progression for firms

as better business opportunities will be available in foreign countries when domestic

markets become too saturated.

In recent years, emerging market economies (EMEs) are increasingly becoming a source

of foreign investment for rest of the world. It is not only a sign of their increasing

participation in the global economy but also of their increasing competence. More

importantly, a growing impetus for change today is coming from developing countries

and economies in transition, where a number of private as well as state-owned enterprises

are increasingly undertaking outward expansion through foreign direct investments

(FDI). Companies are expanding their business operations by investing overseas with aview to acquiring a regional and global reach.

B) BY TARGET

Greenfield investment:
http://www.economywatch.com/foreign-direct-investment/http://www.economywatch.com/foreign-direct-investment/


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A form of foreign direct investment where a parent company starts a new venture in a

foreign country by constructing new operational facilities from the ground up. In addition

to building new facilities, most parent companies also create new long-term jobs in the

foreign country by hiring new employees.

Green field investments occur when multinational corporations enter into developing

countries to build new factories and/or stores.Developing countries often offer

prospective companies tax-breaks, subsidies and other types of incentives to set up green

field investments. Governments often see that losing corporate tax revenue is a small

price to pay if jobs are created and knowledge and technology is gained to boost the

country's human capital.

Horizontal FDI:

Horizontal FDI arises when a firm duplicates its home country-based activities at the

same value chain stage in a host country through FDI. For example, Ford assembles cars

in the United States. Through horizontal FDI, it does the same thing in different host

countries such as the United Kingdom (UK), France, Taiwan, Saudi Arabia, and India.

Horizontal FDI therefore refers to producing the same products or offering the same

services in a host country as firms do at home.

Vertical FDI:

Vertical Foreign Direct Investment takes two forms:

1. Backward vertical FDI: where an industry abroad provides inputs for a firm'sdomestic production process like exploiting the available raw materials in the hostcountry.

2. Forward vertical FDI: in which an industry abroad sells the outputs of a firm'sdomestic production i.e to be nearer to the consumers through the aquisition of distribution outlets.


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C) BY MOTIVE

Resource seeking:

Investments which seek to acquire factors of production that are more efficient than those

obtainable in the home economy of the firm. In some cases, these resources may not beavailable in the home economy at all (e.g. natural resources, anover words - naturally

occurring materials such as coal, fertile land, etc., that can be used by man, and cheap

labor). This characterizes Foreign Direct Investment into developing countries, for

example seeking cheap labor in India and China, or natural resources in the Middle East

and Africa.

Market seeking:

Market seeking FDI is driven by access to local or regional markets. Investing locally can

be driven by regulations or to save on operational costs such as transportation. General

Motors investment in China is mar ket seeking because the cars built in China are sold in

China,the size and growth of host country markets are among the most important FDI

determinants.

Efficiency seeking:

Investments which firms hope will increase their efficiency by exploiting the benefits of

economies of scale and scope, and also those of common ownership. It is suggested that

this kind of Foreign Direct Investment comes after either resource or market seeking

investments have been realized, with the expectation that it further increases the

profitability of the firm.

Efficiency seeking FDI is commonly described as offshoring, or investing in foreign

markets to take advantage of a lower cost structure. A credit card company opening a call

center in India to serve U.S. customers is a form of efficiency seeking FDI.


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ADVANTAGES OF FDI1. Raising the Level of Investment : Foreign investment can fill the gap between

desired investment and locally mobilised savings. Local capital markets are often not

well developed. Thus, they cannot meet the capital requirements for large investment

projects. Besides, access to the hard currency needed to purchase investment goods

not available locally can be difficult. FDI solves both these problems at once as it is adirect source of external capital. It can fill the gap between desired foreign exchange

requirements and those derived from net export earnings.

2. Upgradation of Technology : Foreign investment brings with it technological

knowledge while transferring machinery and equipment to developing countries.

Production units in developing countries use out-dated equipment and techniques that

can reduce the productivity of workers and lead to the production of goods of a lowerstandard.

3. Improvement in Export Competitiveness : FDI can help the host country improve

its export performance. By raising the level of efficiency and the standards of product

quality, FDI makes a positive impact on the host countrys export competitiveness.


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3. Foreign firms reinforce dualistic socio-economic structure and increase income

inequalities. They create a small number of highly paid modern sector executives.

They divert resources away from priority sectors to the manufacture of sophisticatedproducts for the consumption of the local elite. As they are located in urban areas,

they create imbalances between rural and urban opportunities, accelerating flow of

rural population to urban areas.

4. Foreign firms stimulate inappropriate consumption patterns through excessive

advertising and monopolistic market power. The products made by multinationals for

the domestic market are not necessarily low in price and high in quality. Theirtechnology is generally capital-intensive which does not suit the needs of a labour-

surplus economy.

5. Foreign firms able to extract sizeable economic and political concessions from

competing governments of developing countries. Consequently, private profits of

these companies may exceed social benefits.

6. Profit distribution, investment ratios are not fixed: Continual outflow of profits is

too large in many cases, putting pressure on foreign exchange reserves. Foreign

investors are very particular about profit repatriation facilities.

7. Political Lobbying: Foreign firms may influence political decisions in developing

countries. In view of their large size and power, national sovereignty and control over

economic policies may be jeopardized. In extreme cases, foreign firms may bribe

public officials at the highest levels to secure undue favours. Similarly, they may

contribute to friendly political parties and subvert the political process of the host

country.


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DETERMINANTS OF FDITo understand the scale and direction of FDI flows, it is necessary to identify their majordeterminants. The relative importance of FDI determinants varies not only between

countries but also between different types of FDI. Traditionally, the determinants of FDI

include the following.

1. Size of the Market : Large developing countries provide substantial markets where

the consumers demand for certain goods far exceed the available supplies. This

demand potential is a big draw for many foreign-owned enterprises. In many cases,

the establishment of a low cost marketing operation represents the first step by a

multinational into the market of the country. This establishes a presence in the

market and provides important insights into the ways of doing business and possible

opportunities in the country.

2.

Political stability : In many countries, the institutions of government are stillevolving and there are unsettled political questions. Companies are unwilling to

contribute large amounts of capital into an environment where some of the basics

political questions have not yet been resolved.

3. Macro-economic Environment : Instability in the level of prices and exchange rate

enhance the level of uncertainty, making business planning difficult. This increases

the perceived risk of making investments and therefore adversely affects the inflowof FDI.

4. Legal and Regulatory Framework : The transition to a market economy entails the

establishment of a legal and regulatory framework that is compatible with private


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sector activities and the operation of foreign owned companies. The relevant areas in

this field include protection of property rights, ability to repatriate profits, and a free

market for currency exchange. It is important that these rules and their administrative

procedures are transparent and easily comprehensive.

5. Access to Basic Inputs : Many developing countries have large reserves of skilled

and semi-skilled workers that available for employment at wages significantly lower

than in developed countries. This provides an opportunity for foreign firms to make

investments in these countries to cater to the export market. Availability of natural

resources such as oil and gas, minerals and forestry products also determine the

extent of FDI.

The determinants of FDI differ among countries and across economic sectors. These

factors include the policy framework, economic determinants and the extent of business

facilitation such as macro-economic fundamentals and availability of infrastructure.


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Recent global and regional FDI trends

The rise of FDI flows in 2011 was widespread in all three major groups devel-oped, developingand transi-tion economies. Developing economies continued to absorb nearly half of global FDIand transition econo-mies another 6 per cent.

This graph gives a pretty good indicator of how relative FDI inflows have changed since 2002 wecan see that right from the year 2002 there has been an increase in FDI investments in the


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developing economies.The increase in the GDP growth or the bull phase which most of thedeveloping economies experienced from 2003-2008 could be attributed to the increased FDI.

FDI flows, by region, 2009 2011

Amount in billions of dollarsSource UNCTAD

In 2011, FDI inflows increased in all major economic groups develo ped, developing

and transition economies. Developing countries accounted for 45 per cent of global FDI

inflows in 2011. The increase was driven by East and South-East Asia and Latin

America. East and South-East Asia still accounted for almost half of FDI in developing

economies. Inflows to the transition economies of South-East Europe, the

Commonwealth of Independent States (CIS) and Georgia accounted for another 6 per

cent of the global total.


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INVESTMENT ACCORDING TO TYPE OF INVESTMENT

Cross-border mergers and acquisitions are rising, but greenfield investment still dominates, as

the following graph shows.

Greenfield investment and M&A differ in their impacts on host economies, especially in the

initial stages of investment. In the short run, M&As clearly do not bring the same development

benefits as greenfield investment projects, in terms of the creation of new productive capacity,

additional value added, employment and so forth. The effect of M&As on, for example, host-

country employment can even be negative, in cases of restructuring to achieve synergies.


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TNCs top prospective ho st economies for 2012 2014

The importance of developing regions to TNCs as locations for international production

is also evident in the economies they selected as the most likely destinations for their FDI

in the medium term. Among the top five, four are developing economies .Indonesia rose

into the top five in this years survey, disp lacing Brazil in fourth place. South Africa

entered the list of top prospective economies, ranking 14th with the Netherlands and

Poland. Among developed countries, Australia and the United Kingdom moved up from

their positions in last years survey , while Germany maintained its position.

Source:UNCTAD survey 2011


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If we analyse the above survey it can be said that the global capital which is not

providing good returns in the developed economies is moving rapidly towards

developiong economies.

Major developing economies like India,China,Brazil etc have emerged as the topdestinations for FDI worldwide because the potential impact of the economic crisis

enforce the shifting of geographical focus to developing and transition economies

because of their much better economic performance than the developed countries .Factors

such as weaker economic growth in developed countries and abnormal functioning of the

world credit are putting pressures on the pace of recovery of FDI flows towards

developed economies

Foreign direct investments in India are approved through tworoutes


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1. Automatic approval by RBI

The Reserve Bank of India accords automatic approval within a period of two weeks

(subject to compliance of norms) to all proposals and permits foreign equity up to 24%;

50%; 51%; 74% and 100% is allowed depending on the category of industries and the

sectoral caps applicable. The lists are comprehensive and cover most industries of interest

to foreign companies. Investments in high priority industries or for trading companies

primarily engaged in exporting are given almost automatic

approval by the RBI.

2. The FIPB Route Processing of non-automatic approval cases

FDI in activities not covered under the automatic route requires prior approval of the

Government which are considered by the Foreign Investment Promotion Board (FIPB),

Department of Economic Affairs, Ministry of Fina nce. Indian companies having foreign

investment approval thr ough FIPB route do not require any further clearance from the

Reserve Bank of India for r eceiving inward remittance and for the issue of shares to the

non-resident investors.

SECTOR SPECIFIC CONDITIONS ON FDI

PROHIBITED SECTORS.

1. Retail Trading (except single brand product retailing)

2. Lottery Business including Government /private lottery, online lotteries, etc.

3. Gambling and Betting including casinos etc.4. Chit funds

5. Nidhi company

6. Trading in Transferable Development Rights (TDRs)

7. Real Estate Business or Construction of Farm Houses


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8. Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or of

tobacco

9. substitutes

10. Activities / sectors not open to private sector investment e.g. Atomic Energy and

11. Railway Transport (other than Mass Rapid Transport Systems).

PERMITTED SECTORS

In the following sectors/activities, FDI up to the limit indicated against each

sector/activity is allowed, subject to applicable laws/ regulations; security and other

conditionalities. In sectors/activities not listed below, FDI is permitted upto 100% on theautomatic route, subject to applicable laws/ regulations; security and other conditions.

Sr.

No.

Sector/Activity FDI cap/Equity Entry/Route

1. Hotel & Tourism 100% Automatic

2. NBFC 49% Automatic

3. Insurance 26% Automatic

4. Telecommunication:cellular, value added services

ISPs with gateways, radio-paging

Electronic Mail & Voice Mail

49%

74%

100%

Automatic

Above 49% need

Govt. licence

5. Trading companies:

primarily export activities

bulk imports, cash and carry

wholesale trading

51%

100%

Automatic

Automatic

6. Power(other than atomic reactor

power plants) 100% Automatic

7. Drugs & Pharmaceuticals 100% Automatic

8. Roads, Highways, Ports and Harbors 100% Automatic


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Chart 1: DIFFERENT SECTORS ATTRACTING HIGHEST FDI EQUITY INFLOWS

ANALYSISThe sectors receiving the largest shares of total FDI inflows up to January 2012 were theservices sector, Telecommunications each accounting for 20 % and 8% respectively.

These were followed by the Computer software and Hardware, real estate, construction

and Drugs and Pharma sectors.

20

8

77

7

6

5

4

4

SECTORWISE FDI SERVICES SECTOR

TELECOMMUNICATION

COMPUTER SOFTWARE ANDHARDWARE

HOUSING AND REAL ESTATE

CONSTRUCTION ACTIVITIES

DRUGS AND PHARMACEUTICALS

POWER

AUTOMOBILE INDUSTRY

METALLURGICAL INDUSTRIES


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Service sectorThe services sector covers a wide range activities from the most sophisticated

information technology (IT) to simple services provided by the unorganized sector, such

as the services of the barber and plumber. National Account classification of the services

sector incorporate trade, hotels, and restaurants; transport, storage and communication;

financing, insurance, real estate, and business services.In World Trade Organization

(WTO) and Reserve Bank of India RBI classifications, construction is also included.

Source:Economic review 2011-2012

The services sector has been a major and vital force steadily driving growth in the

Indian economy for more than a decade. The economy has successfully navigated

the turbulent years of the recent global economic crisis because of the vitality of this

sector in the domestic economy and its prominent role in Indias external economic

nteractions.

In 2010, the share of services in the US$63 trillion world gross domestic product (GDP)

was nearly 68 per cent, as in 2001. Indias pe rformance in terms of this indicator is not

only above that of other emerging developing economies, but also very close to that of

the top developed countries. Among the top 12 countries with highest overall GDP in


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2010, India ranks 8 and 11 in overall GDP and services GDP respectively. While

countries like the UK, USA, and France have the highest share of services in GDP at

above 78 per cent, Indias share of 57 per cent is much above that of China at 41.8

per cent. In 2010 compared to 2001, India is the topmost country in terms of increase in

its services share in GDP

If we look at the above graph it is clearly seen that the service sector GDP growth clearly

outperforms the overall GDP growth by a considerable margin so the growth in service

sector GDP can be attributed to the continued inflow of FDI in that sector.

TELECOM SECTOR

Sr. No. Sector/Activity FDI Cap/Equity Entry route


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FDI policy for the Telecom Sector is as under:

India is one of the world's fastest growing telecom markets, and this has acted as the

primary driver for foreign and domestic telecommunication companies investing into the

sector. Massive investments have been made in the telecom sector of India, both by the

private and government sector.

The telecom industry has witnessed significant growth in subscriber base over the lastdecade, with increasing network coverage and a competition-induced decline in tariffs

acting as catalysts for the growth in subscriber base. The growth story and the potential

have also served to attract newer players in the industry, with the result that the intensity

of competition has kept increasing.

1. Basic and cellular,

Unified Access Services,

National/International

Long Distance, and other

value added telecom

services

74% (including FDI, FII,

NRI, FCCBs, ADRs,

GDRs, convertible

preference shares, and

proportionate foreign

equity in Indian

promoters /Investing

Company)

Automatic upto 49%.

FIPB beyond 49%

2. ISP with gateways, radio-

paging, end-to-end

bandwidth.

74% Automatic upto 49%

FIPB beyond 49%

3. a) ISP without gateway.

b) Infrastructure provider

providing dark fibre, right

of way, duct space, tower.

c) Electronic mail and

voice mail

100% Automatic up to 49%

FIPB beyond 49%

4. Manufacture of telecom

equipments

100% Automatic


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The market share of the telecom companies reflects the fragmented nature of the industry,

with as many as 15 players. As of January 31, 2012, Bharti telecom led the market with

19.6 per cent share, Reliance (16.7 per cent), Vodafone (16.4 per cent), Idea (11.9 per

cent), BSNL (10.8 per cent), Tata (9.3 per cent), Aircel (6.9 per cent), with the remaining

share being held by other smaller operators, according to Telecom Regulatory Authority

of India (TRAI) database.

Telecom Sector FDI Equity Inflows (US $ Million)

Note:FDI inflow for 2011-12 only uptil january 2012

Source: Department of Industrial Policy & Promotion

Teledensity in India

1261

2558 2554

1665

1,992

0

500

1000

1500

2000

2500

3000

2007-08 2008-09 2009-10 2010-11 2011-12

U S $ i n m i l l i o n

YEAR

FDI in telecom

FDI in telecom


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Source :DOT

Telecom sector FDI inflows increased by more than 100 % since 2007-2008.we can see

robust FDI inflows in the two succeeding years from 2007-08 and that has contributed

significantly to the rise of the telecom sector in IndiaSome of the biggest FDI inflows

into the country relate to this sector viz. The NTT DOCOMO-Tata Teleservices joint

venture worth $2.70 billion,the Vodafone deal which was worth US$11.1

billion,according to its chairman Mr. Analjit Singh Vodafone has invested USD 26

billion in India from the time they came in 2007 till now. They have contributed USD 6

billion to the exchequer.

The FDI investments in the sector went down considerably since 2010-11mainly due to

the 2g scam and various other policy related matters.even though the investments have

gone sown but the base for telecom revolution in India was created by the investments

done prior to 2010-11 and that can be seen in the increase in teledensity in India.Totalnumber of telephone connections have grown from 98 million in 2005 to 846 million in

2011 i.e a whopping increase of more than 760% in 6 years.


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Pharma Sector

The DIPP data suggests that the drugs and pharmaceuticals sector has attracted an

impressive level of FDI worth US$ 1,882.76 million during April 2000 to March 2011.

Industrial licenses are not required in India for most of the drugs and pharmaceuticalproducts. Manufacturers are free to produce any drug duly approved by the Drug Control

Authority.

Since 2006, as many as six big Indian pharma companies have been taken over by foreign

firms. About $4.73 billion or 50 percent of the recorded FDI in the sector since the year

2000 has been in the form of mergers and acquisitions. In the year 2006, Matrix Lab was

sold to the US-based company Mylan. In 2008, Dabur Pharma was bought by Singapore-

based Fresenius Kabi. Again in the same year, Ranbaxy was taken over by the Japanese

company, Diachii Sankyo. The year 2009 witnessed two major deals in which Shantha

Biotech was taken over by the French major Sanofi Aventis and the US-based company

Hospira took over Orchid Chemicals. The latest example is of Piramal Healthcare, which

was bought in the year 2010 by the US multinational, Abbot Laboratories.


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COUNTRY-WISE INFLOW OF FDIDIFFERENT COUNTRIES ATTRACTING HIGHEST FDI EQUITY INFLOWS:

DIFFERENT COUNTRIES ATTRACTING HIGHEST FDI EQUITY INFLOWS:


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Indias 83% of cumulative FDI is contributed by eight countries while remaining 17 perc

ent by rest of theworld. Indias perception abroad has been changing steadily over the

years. This is reflected in the ever growing list of countries that are showing interest to

invest in India. Mauritius emerged as the most dominant source of FDI contributing 39%of the total investment in the country since 2000. Singapore was thesecond dominant

source of FDI inflows with 10% of the total inflows. However, USA slipped to fourth

position by contributing 6% of the total inflows.Japan moved to third with investments of

8%

FDI from Mauritius to India is the highest in comparison with all the other countries that

invest in India. FDI from Mauritius to India is the highest due to the special treatment of tax given in India to the investments that come through Mauritius. The India-Mauritius

Double Taxation Avoidance Agreement (DTAA) was signed in 1982 and has played an

important role in facilitating foreign investment in India via Mauritius. It has emerged as

the largestsource of foreign direct investment (FDI) in India, accounting for 39 per cent

-3

1

5

9

13

17

21

2529

33

37

41

45

0.00

50,000.00

100,000.00

150,000.00

200,000.00

250,000.00

300,000.00

A m o u n t

( i n R s c r )

FDI (in Rs cr)

%age


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of inflows between April 2000 and February 2011. A large number of foreign

institutional investors (FIIs) who trade on the Indian stockmarkets operate from Mauritius

A large number of Foreign Institutional Investors who trade on the Indian stock markets

operate from Mauritius. According to the tax treaty between India and Mauritius, CapitalGains arising from the sale of shares is taxable in the country of residence of the

shareholder and not in the country of residence of the Company whose shares have been

sold. Therefore, a company resident in Mauritius selling shares of an Indian company

will not pay tax in India. Since there is no Capital gains tax in Mauritius, the gain will

escape tax altogether.

For instance, a company from the UK may desire to invest in India. It may initiate,

conduct and conclude all negotiations and agreements from the UK. But before the actual

investment, it may purchase a shell company in a tax haven, say, Mauritius, and route its

investment through that Mauritian company.

Since technically or artificially the investment is made from out of a Mauritian company,

it may seek to claim the Indo-Mauritian DTAA rather than the Indo-UK DTAA and, as

such, would capitalize on the tax-effectiveness of the former treaty.

This way, either India or the UK may be deprived of their share of higher revenue

available to them under the Indo- UK DTAA. Since such investing company `shop

around treaties artificially (rather than DTAA to which they are naturally subject), it is

graphically described `treaty shopping.


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TOP 10 FDI EQUITY INFLOW CASES(APRIL 2000 TO JANUARY2011)

Name of Indian Name of Foreign RBI Regional

Company Collaborator Office

(In US$

mill ion)

IDEA CELLUR LTD RBI TM I M AURITIUS LTD AHM EDABADTELEPHONECOMMUNICATIONSERVICES

7,294.48 1,600.95

CAIRN (I) LTD. RBI CAIRN UK HOLDING MUMBAIBUSINESS SERVICES NOTELSEWHERE CLASSIFIED

6,663.24 1,492.82

ORACLE GLOBAL

( MAURITIUS) LTDINDIA DEBTMANAGEMENT LTD

RBIMAURITIUS DEBTMANAGEMENT LTD

MUMBAICOMMERCIAL LOANCOMPANIES ACTIVITIES

3,800.00 956.39

BHAIK INFOTEL PVT.LTD.

FIPBVODAFONEMAURITIUS LTD.

NEW DELHITELEPHONECOMMUNICATIONSERVICES

3,268.12 801.37

ETISALAT DBTELECOM PVT LTD

RBIETISALAT MAURITIUSLTD.

MUMBAITELEPHONECOMMUNICATIONSERVICES

3,228.45 667.93

HOUSINGDEVELOPMENTFINANCE CORPN.LTD.

RBI CMP ASIA LTD. MUMBAIHOUSING FINANCECOMPANIES

2,638.25 653.74

DSP MERRILL LYNCHLTD.

RBI MERRILL LYNCH(MAURITIUS) LTD.

REGION NOTINDICATED

FINANCIAL SERVICESPROVIDER

2,230.02 483.55

- -

ADITYA BIRLATELECOM LTD.

FIPBP S ASIA HOLDINGINVESTMENT(MAURITIUS)

MUMBAITELEPHONECOMMUNICATIONSERVICES

2,098.25 419.13

INFRASOFTTECHNOLOGIES LTD

RBIBARING INDIA PVTEQUITY LTD

REGION NOTINDICATED

SOFTWAREDEVELOPMENT

2,096.25 531.55

Grand Total 40,282.99 9,141.49

1,083.99

DABHOL POWERCOMPANY LTD

FIPB MUMBAI 2,160.35 450.07

(In Rs crore)

I FLIEX SOLUTIONS

LTDRBI

REGION NOT

INDICATED

SOFTWARE

DEVELOPMENT.4,805.58

FDI Route Item of Manufacture Amount of FDI Inflows


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FOREIGN INSTITUTIONAL

INVESTMENT (FII) Background

Indian Markets have been one of the most attractive investment places for the FII's. India

being a developing nation attracts the foreign flows looking at the growth potential in

the Indian Economy. The FII's contribute a major chunk of volumes on the Indian

bourses and this in turn impacts the market moves. In case of recession in the world

economies, the foreign investors look for saver bets and India with a rising GDP

where other nations GDP / Growth is shrinking has always offered greater investment

avenues. Indian Markets have been the clear outperformers vis-a-vis the global markets

in the past years.

HISTORY OF FOREIGN INSTITUTIONAL INVESTORS

Since 1990-91, the Government of India embarked on liberalization and economic

reforms with a view of bringing about rapid and substantial economic growth and move

towards globalization of the economy. As a part of the reforms process, the Governmentunder its New Industrial Policy revamped its foreign investment policy recognizing the

growing importance of foreign direct investment as an instrument of technology transfer,

augmentation of foreign exchange reserves and globalization of the Indian economy.

Simultaneously, the Government, for the first time, permitted portfolio investments from

abroad by foreign institutional investors in the Indian capital market. The entry of FIIs

seems to be a follow up of the recommendation of the Narsimhan Committee Report on

Financial System. While recommending their entry, the Committee, however did not

elaborate on the objectives of the suggested policy. The committee only suggested that

the capital market should be gradually opened up to foreign portfolio investments. From

September 14, 1992 with suitable restrictions, Foreign Institutional Investors were

permitted to invest in all the securities traded on the primary and secondary markets,

including shares, debentures and warrants issued by companies which were listed or were
http://www.mbaknol.com/managerial-economics/an-overview-of-foreign-direct-investment-fdi-in-india/http://www.mbaknol.com/managerial-economics/an-overview-of-foreign-direct-investment-fdi-in-india/


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to be listed on the Stock Exchanges in India. While presenting the Budget for 1992-93,

the then Finance Minister Dr. Manmohan Singh had announced a proposal to allow

reputed foreign investors, such as Pension Funds etc., to invest in Indian capital market.

Foreign Institutional Investment

As defined by the European Union Foreign Institutional Investment is an investment in

a foreign stock market by the specialized financial intermediaries managing savings

collectively

on behalf of investors, especially small investors, towards specific objectives in term of

risk, return and maturity of claims.

SEBIs Definition of FIIs presently includes foreign pension funds, mutual funds,

charitable/endowment/university funds, asset management companies and other money

managers operating on their behalf in a foreign stock market. Foreign institutional

investment is liquid nature investment, which is motivated by international portfolio

diversification benefits for individuals and institutional investors in industrial country.

Portfolio Investment

It refers to the purchase of stocks, bonds, debentures or other securities by an FII. FIIs

include pension funds, mutual funds, investment trusts, asset management companies,

nominee companies and incorporated/institutional portfolio managers.

In contrast to FDI, FIIs do not invest with the intention of gaining controlling interest in a

company. They typically make short-term investments. These investments are made-to-

book profits. Compared to FDI, a portfolio investor can enter and exit countries with

relative ease. This is a major contributing factor to the increasing volatility and instability

of the global financial system. Because of the very nature of such investment, FII money

is also called hot money. The rapid outflow of hot money, in the recent past, has

created exchange-rate problems in Argentina and in Southeast Asia. Since FIIs are very


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sensitive, a mere change in perception about an economy can prompt them to pull out

investments from a country.

Market design in India for foreign institutional investors in India

Foreign Institutional Investors means an institution established or incorporated outside

India which proposes to make investment in India in securities. A Working Group for

Streamlining of the Procedures relating to FIIs, constituted in April, 2003, inter alia,

recommended streamlining of SEBI registration procedure, and suggested that dual

approval process of SEBI and RBI be changed to a single approval process of SEBI. This

recommendation was implemented in December 2003.

Currently, entities eligible to invest under the FII route are as follows:

As FII: Overseas pension funds, mutual funds, investment trust, asset management

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

endowments, foundations, charitable trusts, charitable societies, a trustee or power of

attorney holder incorporated or established outside India proposing to make proprietary

investments or with no single investor holding more than 10 per cent of the shares or

units of the fund.

As Sub-accounts : The sub account is generally the underlying fund on whose behalf the

FII invests. The following entities are eligible to be registered as sub-accounts, viz.

partnership firms, private company, public company, pension fund, investment trust, and

individuals. A domestic portfolio manager or a domestic asset management company

shall also be eligible to be registered as FII to manage the funds of sub-accounts.

FIIs registered with SEBI fall under the following categories: Regular FIIs - those who are required to invest not less than 70 % of their

investment in equity-related instruments and 30 % in non-equity instruments.

100 % debt-fund FIIs - those who are permitted to invest only in debt

instruments.


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The Government guidelines for FII of 1992 allowed, inter-alia, entities such as asset

management companies, nominee companies and incorporated/institutional portfolio

managers or their power of attorney holders (providing discretionary and non-

discretionary portfolio management services) to be registered as FIIs. While the

guidelines did not have a specific provision regarding clients, in the application form the

details of clients on whose behalf investments were being made were sought.

While granting registration to the FII, permission was also granted for making

investments in the names of such clients. Asset management companies/portfolio

managers are basically in the business of managing funds and investing them on behalf of

their funds/clients. Hence, the intention of the guidelines was to allow these categories of

investors to invest funds in India on behalf of their 'clients'. These 'clients' later came tobe known as sub-accounts. The broad strategy consisted of having a wide variety of

clients, including individuals, intermediated through institutional investors, who would be

registered as FIIs in India. FIIs are eligible to purchase shares and convertible debentures

issued by Indian companies under the Portfolio Investment Scheme.

Who can be registered as an FII?The applicant should be any of the following categories:

1. Pension funds

2. Mutual funds

3. Investment trust

4. Insurance or reinsurance companies

5. Endowment funds6. University funds

7. Foundations or charitable trusts or charitable societies who propose to invest on

their own behalf and

a) Asset management companies

b) Nominee companies


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c) Institutional portfolio managers

d) Trustees

e) Power of attorney holders

f) Bank

Who propose to invest their proprietary funds or on behalf of broad based funds or

on of foreign corporate and individuals.

Prohibitions on Investments:

Foreign Institutional Investors are not permitted to invest in equity issued by an Asset

Reconstruction Company. They are also not allowed to invest in any company which is

engaged or proposes to engage in the following activities:

Business of chit fund Nidhi Company

Agricultural or plantation activities

Real estate business or construction of farm houses (real estate business does not

include development of townships, construction of residential/commercial premises,

roads or bridges)

Reasons for strong flow of FIIs in IndiaFIIs attracted by the fast growing economy of India and strong performance of Indian

companies have been attracted towards India to an extent that India has gone on to

become the preferred investment destination.

The primary reasons for India being a preferred destination for FIIs are:

Global liquidity into the equity markets. Improved performance and competitiveness of Indian firms. Opening up of Indian economy. Cheap labor and other factors of production. Highly developed stock market and high degree of vigilance over it. Tax Incentives. Regulation and Trading Efficiencies F and O Segment


44/62

Role of FIIs: The Indian stock market has come of age and has substantially aligned itself with

the international order.

Market has also witnessed a growing trend of 'institutionalization' that may be

considered as a consequence of globalization.

It is influence of the FIIs which changed the face of the Indian stock markets.

Screen based trading and depository are realities today largely because of FIIs.

FII which based the pressure on the rupee from the balance of payments position

and lowered the cost of capital to Indian business.

FIIs are the trendsetters in any market. They were the first ones to identify the

potential of Indian technology stocks. When the rest of the investors invested in

these scrips, they exited the scrips and booked profits.

Rolling settlement was introduced at the insistence of FIIs as they were

uncomfortable with the badla system.

The FIIs are playing an important role in bringing in funds needed by the equity

market.

The increase in the volume of activity on stock exchanges with the advent of onscreen trading coupled with operational inefficiencies of the former settlement

and clearing system led to the emergence of a new system called the depository

System.

Flow of money into Indian economy via FIIs has been increasing at a rapid rate.

This has forced economist and policy makers to consider impacts of this inflow

on the macro economic factors as well. This has resulted in deeper analysis of

factors like Interest Rate, Inflation Rate, GDP and Exchange Rate etc. both inshort term as well as long term

Registration Process of FIIs


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FIIs are required to obtain a certificate by SEBI for dealing in securities. SEBI grants thecertificate SEBI by taking into account the following criteria:

i) The applicant's track record, professional competence, financial soundness, experience,

general reputation of fairness and integrity.

ii) Whether the applicant is regulated by an appropriate foreign regulatory authority.

iii) Whether the applicant has been granted permission under the provisions of the

Foreign Exchange Regulation Act, 1973 (46 of 1973) by the Reserve Bank of India for

making investments in India as a Foreign Institutional Investor.

iv) Whether the applicant is a) an institution established or incorporated outside India as a

pension fund, mutual fund, investment trust, insurance company or reinsurance company.

b) an International or Multilateral Organization or an agency thereof or a Foreign

Governmental Agency or a Foreign Central Bank. c) an asset management company,

investment manager or advisor, 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 and its proprietary funds in if any or d) university

fund, endowments, foundations or charitable trusts or charitable societies.

v) Whether the grant of certificate to the applicant is in the interest of the development of

the securities market.

vi) Whether the applicant is a fit and proper person.

The SEBIs initial registration is valid for a period of three years from the date of its grant

of renewal.

Investment Conditions and Restrictions for FIIs:

1. A Foreign Institutional Investor may invest only in the following:-


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(a) Securities in the primary and secondary markets including shares, debentures and

warrants of companies, unlisted, listed or to be listed on a recognized stock exchange in

India.

(b) Units of schemes floated by domestic mutual funds including Unit Trust of India,whether listed or not listed in a recognized stock exchange

(c) Dated Government securities.

(d) Derivatives traded on a recognized stock exchange.

(e) Commercial paper.

(f) Security receipts

2. The total investments in equity and equity related instruments (including fully

convertible debentures, convertible portion of partially convertible debentures and

tradable warrants) made by a Foreign Institutional Investor in India, whether on his own

account or on account of his sub- accounts, should not be less than seventy per cent of the

aggregate of all the investments of the Foreign Institutional Investor in India, made on his

own account and on account of his sub-accounts. However, this is not applicable to any

investment of the foreign institutional investor either on its own account or on behalf of

its sub-accounts in debt securities which are unlisted or listed or to be listed on any stock

exchange if the prior approval of the SEBI has been obtained for such investments.

Further, SEBI while granting approval for the investments may impose conditions as are

necessary with respect to the maximum amount which can be invested in the debt

securities by the foreign institutional investor on its own account or through its sub-

accounts. A foreign corporate or individual is not eligible to invest through the hundred

percent debt route.

Even investments made by FIIs in security receipts issued by securitization companies or

asset reconstruction companies under the Securitization and Reconstruction of Financial

Assets and Enforcement of Security Interest Act, 2002 are not eligible for the investment


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limits mentioned above. No foreign institutional investor should invest in security

receipts on behalf of its sub-account.

Increasing Trend of FIIs

Portfolio investments in India include investments in American Depository Receipts(ADRs)/ Global Depository Receipts (GDRs), Foreign Institutional Investments and

investments in offshore funds. Before 1992, only Non-Resident Indians (NRIs) and

Overseas Corporate Bodies were allowed to undertake portfolio investments in India.

Thereafter, the Indian stock markets were opened up for direct participation by FIIs. They

were allowed to invest in all the securities traded on the primary and the secondary

market including the equity and other securities/instruments of companies listed/to be

listed on stock exchanges in India. It can be observed from the table below that India is

one of the preferred investment destinations for FIIs over the years.

Table 2: SEBI Registered FIIs

Year Number of FIIs

2000-01 527

2001-02 490

2002-03 502

2003-04 540

2004-05 685

2005-06 882

2006-07 996

2007-08 1219

2008-09 1334

2009-10 1729

2010-11 17672011-12 1758

Source: http://www.bseindia.com/about/st_key/bus_tran_fii2012.asp

2011-12 data till june 2012
http://www.bseindia.com/about/st_key/bus_tran_fii2012.asphttp://www.bseindia.com/about/st_key/bus_tran_fii2012.asphttp://www.bseindia.com/about/st_key/bus_tran_fii2012.asphttp://www.bseindia.com/about/st_key/bus_tran_fii2012.asp


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The diversity of FIIs has been increasing with the number of registered FIIs in India

steadily rising over the years. The names of some prominent FIIs registered are: United

Nations for and on behalf of the United Nations Joint Staff Pension Fund, Public SchoolRetirement System of Missouri, Treasurer of the State North Carolina Equity Investment

Fund Pooled Trust, the Growth Fund of America,AIM Funds Management Inc,etc.

FII trend in India

FII Activity for previous years

YearGross Purchase Gross Net

(Cr) Sale Investment(Cr) (Cr)

2012 277,696.30 235,201.50 42,494.702011 611,055.60 613,770.80 -2,714.202010 766,283.20 633,017.10 133,266.802009 624,239.70 540,814.70 83,424.202008 721,607.00 774,594.30 -52,987.402007 814,877.90 743,392.00 71,486.302006 475,624.90 439,084.10 36,540.202005 286,021.40 238,840.90 47,181.902004 185,672.00 146,706.80 38,965.802003 94,412.00 63,953.50 30,459.002002 46,479.10 42,849.80 3,629.60

SOURCE:INDIA INFOLINEData for 2012 upto may 2012.


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market analysts or the Finance Minister knew that this seemingly ordinary statement

would have the potential to inflict a deadly free fall of the market indices. The markets

crashed by a staggering 9% within few hours, registering one of the biggest absolute fall

in Indian stock market history. The consequences were so severe that the markets had to

be closed down for an hour and Mr. Chidambaram had to call a press conference to

rephrase his statements. It was yet another alarming call to the domestic investors that

woke them up to the rising dominance and influence of the FIIs on Indian Stock Markets.

The Alternate View

There is another set of experts who believe that FIIs are life blood for an emerging

economy like India. They augment domestic saving without increasing foreign debt,

provide vital liquidity to Indian companies to sustain road to growth, reduce cost of

equity capital and help reduce deficit of Balance of payments (BOP). Also these experts

believe that FIIs, like any other investors buy or sell according to prevailing sentiments in

the market, rather than creating any sentiments that drive the markets. Hence there lies a

conflict between the pros and cons of FIIs and the all important question regarding the

role of FIIs in deciding the fate of our stock markets.


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Analysis

YEAR NET FII INVESTMENTS BSE SENSEX CLOSING2005 47181.9 9397.932006 36540.2 13786.912007 71486.3 20286.992008 -52987.4 9647.312009 83424.2 17464.812010 133266.8 20509.12011 2714.2 15454.92012 42263.3 16950

From the above charts it is clear that net FII investments at BSE show a similar pattern to the

Yearly average closings. The blue bars denoting the net FII can be called a volatile from the

chart as there are sudden sharp drops and sharp rises. It has no fixed pattern. The net FII

started declining from 2007-08 till the middle of 2008-09 which caused a sharp fall in

Sensex also which went below the 10000 level in 2007-08 falling by almost 52% as

9,398

13,787

20,287

9,647

17,465

20,509

15,45516,950

0

5000

10000

15000

20000

25000

-100000

-50000

0

50000

100000

150000

2005 2006 2007 2008 2009 2010 2011 2012 B S E S n e n s e x

A m o u n

t i n R s

C r

NET FII INVESTMENTS BSE SENSEX CLOSING


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compared to the previous year. But the FIIs started pouring in again from the end of 2009

after the governments abroad started providing bail-out packages, sops and various other

incentives to the ailing companies. The Sensex also rises sharply from 2008-09 after the

FIIs turned into net buyers and hence a similar pattern can be found between these two.

Conclusion & Recommendations

The study conducted for the time frame from 2005 to 2012, supports the FII inducing

volatility and driving the market indices theory to a substantial level. Compared to

security markets in developed economies, Indian markets being narrower and shallower,

allows foreign investors with access to significant funds, to become the dominant player

in determining the course of markets. Because of their over sensitive investment

behaviour and herding nature, FIIs are capable of causing severe capital out flightabruptly, tumbling share prices in no time and making stock markets unstable and

unpredictable. In the process, more often than not, the domestic individual investors are

on the receiving end, losing their precious savings in such outrageous speculative trading.

India as an emerging economic power cannot afford to be intimidated down by the FIIs

every now and then. We need formidable Domestic Investors which can pump in

liquidity even during cash crunch circumstances thereby fuelling the development. With

savings to the tune of roughly 35% of GDP, India can use this to its strength by

formulating policies which ensure that domestic funds like Pension Funds, Provident

Funds & other Large Corpus Funds have a greater exposure to the equity market. The

foreign investment in India should be encouraged, but only from a strategic long term

perspective. Derivative instruments which facilitate long term foreign investment with

specified lock in periods should be introduced. Sustained long term foreign investments

would not only contribute to India's growth but also help in curbing volatility,

maintaining currency stability and creating environment for inclusive economicdevelopment.


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The above diagram brings to light a very important occurrence regarding Net FII and the

Foreign Exchange Rate. It can be seen that whenever the red line (foreign exchange rate)

goes up the blue line (Net FII) goes down. If we look at the graph for the last 5 years we

find that during the recession of 2008 when the FIIs pulled out money from nearly every

emerging economy including India,we see that there is an appreciation in the value of

ruppe from 39 to around around 48,Similar relation can be concluded from the year 2010

and 2011.

0

5

10

15

20

25

30

35

40

4550

55

60

-100000

-50000

0

50000

100000

150000

2007 2008 2009 2010 2011 2012 I N R

/ U S D R a t e

A m o u n t i n R s C r

FIIs AND EXCHANGE RATES(2007-2012)

Net purchase/Sales in Rs Cr Exchange rate INR-US $


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Here also we can clearly see that when the FIIs were net purchasers in the month of

january and february the $ rates came down from 49.68 to 48.94 and similarly the ruppe

started appreciating from the month of April when the FIIs turned net sellers.The fall in

April started after the passing of the union budget which leads us to conclude that the fall

in the value was majorly the implications of GAAR provisions which speaks about

retrospective taxation and also due to the worsening condition in the Eurozone.

44

46

48

50

52

54

56

58

-5000

0

5000

10000

15000

20000

25000

30000

January February March April May June

I N R

/ U S D R a t e


FIIs AND EXCHANGE RATES(JAN-JUN)



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This data is presented for a very short run period from May 28 to June 28.the value of the

ruppee appreciated from 55.1846 on 28 may to 57.0147 on 25 June, this can be

considered to be a very big rise in less than a month and on may 28 the US dollar settled

at INR 56.8554.The reason for this is that FIIs have been net sellers for the major part of

june from the dates for which the data has been collected they have sold worth Rs 2212

Cr and purchased worth Rs 1077.Now the appreciation in the ruppe in the last few days

that is on 29 th june can be attributed to the government giving a clarification on GAAR

which is related to the FIIs coming to India via Mauritius and also to the European Union

leaders sensible decision to create a single supervisory bo dy for Eurozone banks with

active involvement of the European Central bank by the end 2012.

54

54.5

55

55.5

56

56.5

57

57.5

-800

-600

-400

-200

0

200

400

600

28 1 4 8 11 15 18 22 25 28

I N R

/ U S D R a t e


FIIs AND EXCHANGE RATES(MAY-JUN)



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Issues concerning fii in india

Participatory Notes

Participatory Notes commonly know as P-Notes or PNs are instruments issued byregistered foreign institutional investors to overseas investors, who wish to invest in the

Indian stock markets without registering themselves with the market regulator, the

Securities and Exchange Board of India (SEBI).Indian-based brokerages buy India-based

securities on behalf of these unregistered overseas investors and then issue participatory

notes to foreign investors. Any dividends or capital gains collected from the underlying

securities go back to the investors.SEBI permitted FIIs to register and participate in the

Indian stock market in 1992.Investing through P-Notes is very simple and hence very popular amongst FIIs.

Participatory notes have attracted significant market attention recently because of huge

inflow of foreign funds into Indian stock markets through this route. Since the ultimate

beneficiary of transactions carried out using participatory notes is not known to the market

regulator and the tax authorities, there is scope for misuse and tax avoidance. Also, since

participatory notes do not attract the attention of the market regulators of the countries in

which they are issued, the entities holding participatory notes virtually go unregulated.

As per the latest data available with market regulator Sebi, the total value of PNs in Indian

markets stood at about Rs 1,30,012 crore (about USD 25 billion) at the end of April 2012,

down from Rs 1,83,151 crore at the end of February and Rs 1,65,832 crore as on March

31, 2012.

Participatory Notes Crisis of 2007On the 16th of October, 2007, SEBI (Securities & Exchange Board of India) proposed

curbs on participatory notes which accounted for roughly 50% of FII investment in 2007.

SEBI was not happy with P-Notes because it is not possible to know who owns the

underlying securities and hedge funds acting through PNs might therefore cause volatility

in the Indian markets.


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However the proposals of SEBI were not clear and this led to a knee-jerk crash when the

markets opened on the following day (October 17, 2007). Within a minute of opening

trade, the Sensex crashed by 1744 points or about 9% of its value - the biggest intra-day

fall in Indian stock-markets in absolute terms. This led to automatic suspension of trade

for 1 hour. Finance Minister P.Chidambaram issued clarifications, in the meantime, that

the government was not against FIIs and was not immediately banning PNs. After the

markets opened at 10:55 am, they staged a remarkable comeback and ended the day at

18715.82, down just 336.04 from Tuesdays close after tumbling to a days low of

17307.90.

This was, however not the end of the volatility. The next day (October 18, 2007), the

Sensex tumbled by 717.43 points 3.83 per cent to 17998.39, its second biggest fall.

The slide continued the next day when the Sensex fell 438.41 points to settle at 17559.98

at the end of the week, after touching the lowest level of that week at 17226.18 during the

day.

The SEBI chief, M.Damodaran held an hour long conference on the 22nd of October to

clear the air on the proposals to curb PNs where he announced that funds investing

through PNs were most welcome to register as FIIs, whose registration process would be

made faster and more streamlined. The markets welcomed the clarifications with an 879-

point gain its biggest single-day surge on October23, thus signalling the end of the

PN crisis. SEBI issued the fresh rules regarding PNs on the 25th of October, 2007 which

said that FIIs cannot issue fresh P-Notes and existing exposures were to be wound up

within 18 months. The Sensex gave a thumbs up the next day - Friday, 26 October by re-

crossing the 19,000 barrier with a 428 point surge. The coming Monday (October 29,

2007) history was created when the Sensex leaped 734.5 points to cross the hallowed

20,000 mark.


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GAAR

GAAR originally proposed in the Direct Taxes Code, is targeted at arrangements or

transactions made specifically to avoid taxes. The government had decided to advance

the introduction of GAAR and implement it from the current financial year itself. More

than 30 countries have introduced GAAR provisions in their respective tax codes to

check evasion.

GAAR allows tax authorities to call a business arrangement or a transaction

'impermissible avoidance arrangement' if they feel it has been primarily entered into to

avoid taxes.Once an arrangement is ruled 'impermissible' then the tax authorities can

deny tax benefits. Most aggressive tax avoidance arrangements would be under the risk

of being termed impermissible. The rule can apply on domestic as well as overseastransactions.It is a very broadbased provision and can easily be applied to most tax-

saving arrangements. Many experts feel that the provision would give unbridled powers

to tax officers, allowing them to question any taxsaving deal.Foreign institutional

investors are worried that their investments routed through Mauritius could be denied tax

benefits enjoyed by them under the Indo-Mauritius tax treaty. The proposal has hit the

stock market as FII inflows dropped on concerns, and the rupee hit an all time low to the

dollar.

The Indian law taxes gains derived from the sale of shares irrespective of whether the

shareholder is a resident or nonresident. Under India's tax treaty with Mauritius, gains

derived by a resident of Mauritius from the sale of shares in an Indian company are

taxable only in Mauritius and as it does not tax capital gains, the transaction escapes tax

in both countries. Foreign investors have been using the Mauritius holding company

structure to make investments in India right from the early 1990s. Following the

liberalization of the Indian economy, the Indo-Mauritius DTAA, was "discovered" as an

effective mechanism to avoid capital gains tax on sale of shares in Indian companies.A

Foreign enterprise can set up a subsidiary in Mauritius, and use it to derive capital gains

from acquisition and sale of shares. Although India follows the source rule for taxation of

non-residents, which makes this transaction taxable under the Income Tax Act, 1961,

Article 13(4) of the DTAA gives Mauritius the right to tax this transaction. Since such


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gains are exempt from tax in Mauritius, the transaction becomes completely tax exempt,

resulting in double non-taxation. As a result, much of the Mauritian investment into India

is actually round tripping by Indian companies setting up a Mauritian entity to avoid

capital gains tax in India.

Source:SEBI

The above figure illustrates daily movement of FII flows in India from 16 th March, 2012

when the Finance Minister announced the implementation of GAAR. It can be observed

there has been an outflow of dollars to the effect of $ 1 bn during this period. This has

also had an impact on the exchange rate which has depreciated from Rs 50.31 on March

16th, 2012 to Rs 51.16 on March-end and further to Rs 52.51 and Rs 53.72 on April end

and May 4th, 2012 respectively. This was notwithstanding the fact that forex reserves had

remained largely stable, increasing from $294.8 bn on March 16th to $ 295.4 bn on April

27th.Clearly the sentiment was affected which drove the rupee down further.


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Response of the Government GAAR will now be applicable from April 1st, 2013. Further this rule would only be

invoked when there are specific complaints and it will not be easy for assessing tax

officers to invoke GAAR. The onus to prove that an arrangement is 'impermissible' will

lie with the tax department. Also to provide greater clarity and certainty in the matters

relating to GAAR, a Committee has been constituted under the chairmanship of Director

General of Income Tax to give recommendations for formulating the rules and guideline

for implementation of GAAR provision and to suggest safeguards so that the provisions

are not applied indiscriminately.

HOT MONEY Hot money is a term that is most commonly used in financial markets to refer to the

flow of funds (or capital) from one country to another in order to earn a short-term profit

on interest rate differences and/or anticipated exchange rate shifts. These speculative

capital flows are called "hot money" because they can move very quickly in and out of

markets, potentially leading to market instability

large and sudden inflows of capital with short term investment horizon have negative

macroeconomic effects, including rapid monetary expansion, inflationary pressures, real

exchange rate appreciation and widening current account deficits. Especially, when

capital flows in volume into small and shallow local financial markets, the exchange rate

tends to appreciate, asset prices to rally and local commodity prices to boom. These

favorable asset price movements improve national fiscal indicators and encourage

domestic credit expansion. These, in turn, exacerbate structural weakness in the domestic

bank sector. When global investors' sentiment on emerging markets shift, the flows

reverse and asset prices give back their gains, often forcing a painful adjustment on theeconomy

The following are the details of the dangers that hot money presents to the receiving

country's economy:


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Inflow of massive capital with short investment horizon (hot money) could

cause asset price to rally and inflation to rise. The sudden inflow of large amounts

of foreign money would increase the monetary base of the receiving country (if

the central bank is pegging the currency), which would help create credit boom.

This, in turn, would result in such a situation in which "too much money chase too

few goods". Consequences of this would be inflation. Furthermore, hot money

could lead to exchange rate appreciation or even cause exchange rate

overshooting. And if this exchange rate appreciation persists, it would hurt the

competitiveness of respective country's export sector by making the country's

exports more expensive compared to similar foreign goods and services.

Sudden outflow of hot money , which would always certainly happen, would

deflate asset prices and could cause the collapse value of the currency of

respective country. This is especially so in countries with relatively scarce

internationally liquid assets. There is growing agreement that this was the case in

the 1997 East Asian Financial Crisis. In the run-up to the crises, firms and private

firms in South Korea, Thailand and Indonesia accumulated large amounts of short

term foreign debt (a type of hot money). The three countries shared a commoncharacterestic of having large ratio of short term foreign debt to international

reserves. When the capital starts to flow out, it caused a collapse in asset prices

and exchange rates. The financial panic fed on itself causing foreign creditors to

call in loans and depositors withdraw funds from banks, all of these magnified the

illiquidity of the domestic financial system and forced yet another round of costly

asset liquadations and price deflation. In all of the three countries, the domestic

financial institutions came to the brink of default on their external short termobligations

final project fdi

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