Volatility in indian stock market and foreign institutional investor


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Volatility in indian stock market and foreign institutional investor

  5. 5. ACKNOWLEDGEMENTI would like to extent my sincere gratitude to allthose people who have helped in the successfulcompletion of my project entitled ―VOLATILITYIN INDIAN STOCK MARKET AND FOREIGNINSTITUTIONAL INVESTORS ―I would also like to express my deep sense ofmy gratitude to Mrs. REENA PILLAI, the facultymember, for her help and untrying effortsconstant inspiration and stimulating guidance tome in my academics endeavor and in myproject.I would also like to thank the college for givingme this opportunity for doing this project. I wouldalso like to thank my family for giving me thesupport to do the same.I would also like to express my sincere thanks toall my friends who help me in finding theinformation and support for the successfulcompletion. PRANJAL CHOPADA
  6. 6. LIST OF ABBREVATIONBSE : Bombay Stock ExchangeCAPM : Capital Asset Pricing ModelCMR : Call Money RateEMEs : Emerging market economiesEMEs : Emerging Market EconomiesFII : Foreign Institutional InvestmentFIIN : Net Foreign Institutional InvestmentFIIP : Foreign Institutional Investment- PurchaseFIIS : Foreign Institutional Investment-SaleFPI : Foreign Portfolio InvestmentGDP : Gross Domestic ProductIIP : Index of Industrial ProductionKYC : Know Your ClientNRIs : Non-Resident IndiansNSE : National Stock ExchangeOCBs : Overseas Corporate BodiesQIPs : Qualified Institutional placementsRBI : Reserve Bank of IndiaSEBI : Securities and Exchange Board of IndiaVAR : Vector Auto Regression
  8. 8. CHAPTER 1Volatility in Indian Stock Markets and Foreign Institutional InvestorsThe safe way to double the money is to fold it over once and put it in your pocket.
  9. 9. CHAPTER: 1 VOLATILITY IN INDAIN STOCK MARKET AND FOREIGN INSTITUTIONAL INVESTORSMany developing countries, including India, restricted the flow offoreign capital till the early 1990s and depended on external aid andofficial development assistance. Later, most of the developingcountries opened up their economies by dismantling capital controlswith a view to attracting foreign capital, supplementing it withdomestic capital to stimulate domestic growth and output.Since then, portfolio flows from foreign institutional investors (FII)have emerged as a major source of capital for emerging marketeconomies (EMEs) such as Brazil, Russia, India, China and SouthAfrica. Besides, the surge in foreign portfolio flows since 1990s canbe attributed to greater integration among international financialmarkets, advancement in information technology and growing interestin EMEs among FIIs such as private equity funds and hedge funds soas to achieve international diversification and reduce the risk in theirportfolios.Economic growth is a function of, among other things, capitalformation. As FII flows are a source of non-debt creating capital forthe economy, many EMEs have been competing with each other to
  10. 10. attract such flows through flexible investment norms/regulations or byoffering fiscal sops. Further, FIIs have been assured decent returnson their investments, enabling continuous and sustainable investmentflows.FII flows into India registered substantial growth from a meager US$4million in 1992–93 to over US$ 32 billion in 2010–11 (SEBI, 2011:76). FII inflows underwent a sea-saw movement in India during thelast decade. They registered spectacular growth especially since themiddle of 2003 due to the higher growth rate in Indian GDP, robustcorporate performance and an investment-friendly environment.Portfolio investment flows into India turned negative (outflow of US$12 billion) during 2008–09 (ibid.) mainly due to the heightened riskaversion of foreign investors, emanating from the global financialmeltdown.Ever since foreign portfolio investors were allowed to invest in Indianfinancial markets in September 1992, there have been extensivedeliberations on the impact of such flows. It is said that portfolio flowsfrom FIIs inject global liquidity into the capital markets, raise the price-to-earnings ratios, thereby reducing the cost of capital. This, in turn,leads to further issues of equity capital and stimulates investmentgrowth in the host economy, apart from bringing in best internationalcorporate governance practices. Yet, FIIs have been targets ofcriticism due to characteristics such as return chasing behaviour,
  11. 11. herd mentality, hot money flows, short-term speculative gains andtheir influence on domestic policy-making.Though numerous research studies have been conducted in respectof FII flows into India, most of them have been confined to assessingthe impact of such flows on stock markets. Very few studies havefocused on the overall impact of FII flows on all segments of theIndian financial markets, viz., the capital market, the foreignexchange market, the money market and other macro-economicvariables, such as inflation, money supply and Index of IndustrialProduction (IIP). Given this background, it is all the more relevant toundertake a cause and-effect study of FII flows into Indian financialmarkets in a holistic manner, by considering various macro-economicparameters, such as IIP, interest rates, inflation, exchange rates,apart from the BSE Sensex, so as to enable policymakers to takeinformed decisions in this regard. The present study examines thecauses and effects of FII net flows into Indian financial markets withthe support of empirical data for the period April 2003–March 2011,i.e., a time span of eight years, covering the period before, during andafter the eruption of the global financial crisis.
  12. 12. ABOUT THE REPORT Title of the study: The present study is titled as A PROJECT REPORT ON ―Volatility in India n Stock Markets and Foreign Institutional Investors‖. The study made with special reference to Foreign Institutional Investors. Objectives of Study: • To study in depth FDI & FII & its role in Indian stock market. • To know the changing scenario of Indian stock market after FII investment and various aspects of FII. Data and Methodology: For the purpose of the present study Secondary data were used. The data is collected from Books , Journals & websites. Limitations of the Study: • The study has got all the limitations of using Secondary data and Inferences were made based on that.
  13. 13.  SCOPE OF THE STUDY:The report examines The Impact of Foreign Institutional Investmentsand Foreign Direct Investment on Equity Stock Market in India. Thescope of the research comprises of information derived fromsecondary data from various websites. The various information andstatistics were derived from the websites of BSE, NSE, MoneyControl, RBI and SEBI. Sensex and Nifty was a natural choice forinclusion in the study, as it is the most popular market indices andwidely used by market participants for benchmarking.
  14. 14. Chapter Layout:The Present study is arranged as follows.Chapter 1 – Gives an Introduction to volatility in Indian stock market and foreign institutional investors.Chapter 2 – Deals with the Theoretical view of Indian Stock Market.Chapter 3 – Deals with the impact of FIIs on stock market instability.Chapter 4 – Summarizes the result of study.Chapter 5 – Annexure - milestones of foreign institutional investment in Indian stock market
  15. 15. CHAPTER 2 DEALS WITHINDIAN STOCK MARKET– A THEORETICAL VIEWIf you want to rear financial blessings, you have to sow financially.
  16. 16. CHAPTER 2. INDIAN STOCK MARKET - A THEORETICAL VIEWDiversifying globally i.e., holding a well diversified portfolio ofsecurities from around the globe in proportion to marketcapitalizations, irrespective of investor‘s country of residence, haslong been advocated as means to reduce overall portfolio risk andmaximize risk-adjusted returns by the traditional capital asset pricingmodel (CAPM). Foreign investment inflow depends on returns in thestock market, rates of inflation (both home and foreign), and extantrisk. In terms of magnitude, the impact of stock market returns andthe ex-ante risk turned out to be the key determinants of FII inflows.An investment will always carry the consideration of risk factor in itsrisk-return behaviour. In an investment friendly environment thebullish behaviour dominates the trends and at a given huge volume ofinvestments, foreign investors may play a role of market makers andbook their profits, i.e., they can buy financial assets when the pricesare declining thereby jacking-up the asset prices and sell when theasset prices are increasing (Gordon & Gupta, 2003). Hence, there isa possibility of bi-directional relationship between FII and the equityreturns. Although FII flows help supplement the domestic surplusresources and augment domestic investments without rising theforeign debt of the recipient countries, helps to maintain stabilizedbalance of payments particularly current account segment. Entry of
  17. 17. FII may also leads to decrease the required rate of return for equity,and improve stock prices of the host economies / nations. However,there are uncertainties about the defenselessness of recipientcountry‘s capital markets to such flows. FII flows, often referred to ashot money (i.e., short-term and overly tentative), are extremelyunstable in character compared to other forms of capital flows.Foreign portfolio investors are regarded as fair weather friends whocome in when there is money to be made and leave at the first sign ofimpending trouble in the host country thereby destabilizing thedomestic economy of the recipient country. Often, they have beenblamed for exacerbating small economic problems in the host nationby making large and concerted withdrawals at the slightest hint ofeconomic weakness. It is also alleged that as they make frequentmarginal adjustments to their portfolios on the basis of a change intheir perceptions of a countrys solvency rather than variations inunderlying asset value, they tend to spread crisis even to countrieswith strong fundamentals thereby causing contagion in internationalfinancial markets.Several research studies on FII flows to emerging market economies(EMEs) over the world have found that financial market infrastructurelike market size, market liquidity, trading cost, extent of informationaldissemination etc., legal mechanisms relating property rights,harmonization of corporate governance, accounting, listing and otherrules with those followed in developed economies etc., are some ofthe important determinants of foreign portfolio investments into
  18. 18. emerging markets. The Securities and Exchange Board of India(SEBI) and Reserve Bank of India (RBI) have initiated severalmeasures such as allowing overseas pension funds, mutual funds,investment trusts and asset management companies, banks,institutional portfolio managers, universal funds, endowments, easingthe norms for registration of FIIs, reducing procedural delays,lowering the fees of registration, mandating strict disclosure norms,improved regulatory mechanisms etc. all these are supported bystrong fundamentals, have made India as one of the attractivedestinations for FIIs. The following table highlights the registered FIIsin India during the period from 2006 to 2010.From the above table it is clear that there is constant growth in thenumber of registered FIIs in India. In the year 2006(January, 2006),the number of registered FIIs were 833 only. The same number hasbeen increased to 1697 by the year 2010 (January 2010). Thenumber has been increased by more than 100 per cent. In spite ofthe global financial crisis the number of registered FIIs has shown asignificant increase. Irrespective of the situation in Indian stock
  19. 19. markets these FIIs has earmarked their presence. But the investmentmade by FIIs has experienced drastic decline in the recent past. Thisis mainly because of the global economic meltdown. Though thenumber of registered FIIs increased the net investments were notincreased proportionately. The important reasons for growth innumber of registered FIIs are easing of registration norms, loweringthe registration fees, reducing the procedural delays. The mostimportant is strong economical foundation of Indian economy.Though the entire globe affected with the global financial meltdown,India could face the global financial meltdown effectively. Comparedtoo many other markets Indian markets are offering attractive returnson the investments. The growth rates of Gross Domestic Product(GDP) even during the financial crisis was attractive than many othereconomies. This resulted in increased number of registered FIIs inthe last half decade. The following table (Table 2) provides a crosssection of data on the FIIs inflow and stock market movement fromthe year 2000 to 2011(31stMay). The FIIs and hedge funds hadpulled out money mainly due to higher interest rates in U.S. afterFederal Reserve increased 7interest rates to 4.5% under their newgovernor. Similar changes took place many times in the history sinceopening and few times in the study.
  20. 20. Additional indicators and data reflect that movements in theSENSEX during the two years have clearly been driven by thebehaviour of foreign institutional investors (FIIs), who wereresponsible for net equity purchases of as much as $6.6 and $8.5billion respectively in 2003 and 2004. The Pearson correlationvalues indicate positive correlation between the foreigninstitutional investments and the movement of Sensex. (Thevalue of Pearson correlation is 0.570894)The above table (Table:3) shows the proportion of investmentmade by the FIIs in Sensex scrip‘s. It is observed that almost
  21. 21. half of the companies are equipped with FII investment to thetune of 10% to 20%. Nearly 25% of the companies (Sensex 30scrip‘s) are having the FII investment between 30% and 40%.Another important thing is all the thirty scrip‘s are showing thepresence of foreign institutional investment. The pattern of change isalso very minimal in respect of these companies regard to FIIs areconcerned. It can be understood that the FIIs may enter and exitfrequently form the other scrip‘s but not the Sensex scrip‘s. Theabove table depicts the consistency of FIIs over a period of time.From the above table (Table:3) it can be understood that fifty percentof the companies which are included in BSE SENSEX are havingfifteen to twenty percent of capital from the overseas. Thisindicates the level of influence by the foreign institutional investmenton those companies particularly and on the stock market in general.Any withdrawal of foreign institutional investment may result inhuge volatility in the market as well as share price movements.Similarly, any increase in the shareholding pattern by the foreigninstitutional investors may result huge rally in the market. The
  22. 22. psychology of domestic investors is also affected by the decisions offoreign institutional investors.Being an agricultural based economy India has faced largenumber of problems while establishing industries. Afterindependence, to establish core industries such as Iron & Steel,Cement, Electrical and construction of Roads, buildings etc. it tookdecades. Indian economy has experienced the problem of capital inmany instances. Particularly, to start large scale industries wherecapital requirement was more. While planning to start the steelcompanies under government control, due to shortage ofresources it has taken the aid of foreign countries. Likewise wehave received aid from Russia, Britain and Germany for establishingBhiloy, Rourkela and Durgapur steel plants. The foreigninstitutional investment was increased during the years 2006 and2007. Later on, due to global financial crisis the investments by FIIswere reduced.ADVANTAGES OF FII IN INDIAN MARKET• Enhanced flows of equity capital• FIIs have a greater appetite for equity than debt in their assetstructure. The opening up the economy to FIIs has been in line withthe accepted preference for non-debt creating foreign inflows over
  23. 23. foreign debt. Enhanced flow of equity capital helps improve capitalstructures and contributes towards building the investment gap.• Managing uncertainty and controlling risks.• FII inflows help in financial innovation and development ofhedging instruments. Also, it not only enhances competition infinancial markets, but also improves the alignment of asset prices tofundamentals.• Improving capital markets.• FIIs as professional bodies of asset managers and financialanalysts enhance competition and efficiency of financial markets.• Equity market development aids economic development.• By increasing the availability of riskier long term capital forprojects, and increasing firms‘ incentives to provide more informationabout their operations, FIIs can help in the process of economicdevelopment.• Improved corporate governance.• FIIs constitute professional bodies of asset managers andfinancial analysts, who, by contributing to better understanding offirms‘ operations, improve corporate governance. Bad corporategovernance makes equity finance a costly option. Also,institutionalization increases dividend payouts, and enhancesproductivity growth.
  24. 24. DISADVANTAGES OF FII IN INDAIN MARKET• Problems of Inflation: Huge amounts of FII fund inflow into thecountry creates a lot of demand for rupee, and the RBI pumps theamount of Rupee in the market as a result of demand created.• Problems for small investor: The FIIs profit from investing inemerging financial stock markets. If the cap on FII is high then theycan bring in huge amounts of funds in the country‘s stock marketsand thus have great influence on the way the stock markets behaves,going up or down. The FII buying pushes the stocks up and theirselling shows the stock market the downward path. This createsproblems for the small retail investor, whose fortunes get driven bythe actions of the large FIIs.• Adverse impact on Exports: FII flows leading to appreciation ofthe currency may lead to the exports industry becominguncompetitive due to the appreciation of the rupee.• Hot Money: ―Hot money‖ refers to funds that are controlled byinvestors who actively seek short-term returns. These investors scanthe market for short-term, high interest rate investment opportunities.―Hot money‖ can have economic and financial repercussions oncountries and banks. When money is injected into a country, theexchange rate for the country gaining the money strengthens, whilethe exchange rate for the country losing the money weakens. Ifmoney is withdrawn on short notice, the banking institution willexperience a shortage of funds.
  25. 25. FII and FDI connection:The relationship between FII and FDI (Foreign Direct Investment) isintertwined. In 1998 – 1999 a number of reforms were initiated, thatwere designed specifically for attracting FDI. In India FDI is allowedthrough FII‘s. This is done through private equity, preferentialallotment, joint ventures and capital market operations. The onlyindustries in which FDI isn‘t allowed are arms, railways, coal, nuclearand mining. 100% financing by FDI is allowed in infrastructuralprojects such as construction of the bridges and the tunnels. In thefinancial sector, insurance and banking operations can have foreigninvestors.Differences between FII & FDI:FDI and FIIs are two important sources of foreign financial flows intoa country. FDI (Foreign Direct Investment) the acquisition abroad ofphysical assets such as plant and equipment, with operating controlresiding in the parent corporation. It is an investment made to acquirea lasting management interest (usually 10 percent of voting stock) inan enterprise operating in a country other than that of the investor,the investor‘s purpose being an effective voice in the management ofthe enterprise. It includes equity capital, reinvestment of earnings,other long-term capital, and short-term capital. Usually countriesregulate such investments through their periodic policies. In Indiasuch regulation is usually done by the Finance Ministry at the Centrethrough the Foreign Investment Promotion Board).
  26. 26. Types of Investments:FDI typically brings along with the financial investment, access tomodern technologies and export market. The impact of the FDI inIndia is far more than that of FII largely because the former wouldgenerally involve setting up of production base - factories, powerplant, telecom networks, etc. that enables direct generation ofemployment. There is also multiplier effect on the back of the FDIbecause of further domestic investment in related downstream andupstream projects and a host of other services. Korean Steel makerPasco‘s USD 8 billion steel plants in Orissa would be the largest FDIin India once it commences. Maruti Suzuki has been an exemplarycase in the Indias experience. However, the issue is that it putsan impact on local entrepreneur as he may not be able toalways successfully compete in the face of superior technologyand financial power of the foreign investor. Therefore, it is oftenregulated that Foreign Direct Investments should ensure minimumlevel of local content, have export commitment from the investor andensure foreign technology transfer to India.FII investments into acountry are usually not associated with the direct benefits in terms ofcreating real investments. However, they provide large amounts ofcapital through the markets. The indirect benefits of the marketinclude alignment of local practices to international standards intrading, risk management, new instruments and equitiesresearch. These enable markets to become more deep, liquid,feeding in more information into prices resulting in a betterallocation of capital to globally competitive sectors of the
  27. 27. economy. Foreign Institutional Investors Since, these portfolio flowscan technically reverse at any time, the need for adequate andappropriate economic regulations are imperative.Government Preference:FDI is preferred over FII investments since it is considered to be themost beneficial form of foreign investment for the economy as awhole. Direct investment targets a specific enterprise, with the aim ofenhancing capacity and productivity or changing its managementcontrol. Direct investment to create or augment capacity ensuresthat the capital inflow translates into additional production. In thecase of FII investment that flows into the secondary market, theeffect is to increase capital availability in general, rather thanavailability of capital to a particular enterprise. Translating an FIIinflow into additional production depends on production decisionsby someone other than the foreign investor — some localinvestor has to draw upon the additional capital made availablevia FII inflows to augment production. In the case of FDI that flowsin for acquiring an existing asset, no addition to production capacitytakes place as a direct result of the FDI inflow. Just like in the case ofFII inflows, in this case too, addition to production capacity does notresult from the action of the foreign investor – the domestic seller hasto invest the proceeds of the sale in a manner that augmentscapacity or productivity for the foreign capital inflow to boostdomestic production. There is a widespread notion that FII
  28. 28. inflows are hot money — that it comes and goes, creatingvolatility in the stock market and exchange rates. While thismight be true of individual funds, cumulatively, FII inflows have onlyprovided net inflows of capitalStability:FDI tends to be much more stable than FII inflows. Moreover, FDIbrings not just capital but also better management and governancepractices and, often, technology transfer. The know-how thustransferred along with FDI is often more crucial than the capitalper se. No such benefit accrues in the case of FII inflows, althoughthe search by FIIs for credible investment options has tended toimprove accounting and governance practices among listedIndian companies.Types of FIIs:FII investments in India can be of the TWO types:1. Normal FIIs: FII allocation of its total investment betweenequity and non-equity instruments (including dated governmentsecurities and treasury bills in the Indian capital market) shouldnot exceed the ratio of 70:30. Equity related instruments wouldinclude fully convertible debentures, convertible portion ofpartially convertible debentures and tradable warrants.
  29. 29. 2. 100% Debt FIIs: FII that can invest the entire corpus in datedgovernment securities including treasury bills, non-convertibledebentures/bonds issued by an Indian company subject to limits,if any. A FII needs to submit a clear statement that it wishes to beregistered as FII/sub-account under 100% debt routes.Entities which can register as FIIs:Entities who propose to invest their proprietary funds or onbehalf of "broad based" funds (fund having more than twentyinvestors with no single investor holding more than 10 per centof the shares or units of the fund) or of foreign corporate andindividuals and belong to any of the under given categories can beregistered for FII. Pension Funds Mutual Fund Investment Trust Insurance or reinsurance companies Endowment Funds University Funds Foundations or Charitable Trusts Charitable Societies who propose to in On their own behalf, and
  30. 30.  Asset Management Companies Nominee Companies Institutional Portfolio Managers Trustees Power of Attorney Holders Banks Foreign Government Agency Foreign Central Bank International or Multilateral Organization or an AgencyTrends in FIIs:In 1993, when investments in FII s were introduced, PicketUmbrella Trust Emerging Markets‘ Fund, an institutional investorfrom Switzerland, Indian market. While in 1994, no new registrationswere reported, between 1995 and 2003, an average of 51 new FIIsbegan operations in the country each year. The graph below clearlyindicates the steep increase in number of FII to the number ofregistered FII‘s at the end of each calendar year). Currently, there are1,695 registered FIIs and 5,264 registered sub accounts (As on 11thSeptember, 2009).
  31. 31. Since 1993 when FII‘s were first allowed to enter the India,there has always been a preference towards investing in equitythan debt. The following graph shows the debt and equity FII flows.FII investments through QIPs:QIPs are private placements or issuances of certain specifiedsecurities by Indian listed companies to qualified institutionalbuyers in accordance with the provisions of SEBI guidelines.
  32. 32. Qualified Institutional placements or QIPs were introduced in mid-2006.Indian companies that are listed on stock exchanges havingnationwide terminals — the BSE and NSE have been raising capitalthrough the QIP route. Quarterly Institutional buyers are preferredprimarily because these entities have a large risk appetite,possess the general expertise and have the experience to make aninformed decision.In August 2008, SEBI liberalized the pricing conditions for QIPs byreducing the period of reckoning to an average of two weeks‘stock price, prior to the relevant date, against the earlierrequirement of taking the higher of the previous six months‘ or 15days‘ average price. The pre-existing slowdown in the markets led toattractive valuations for the investors.Companies have taken advantage of this revision in pricingguidelines .Unitech, raised Rs 1,621 cores in April 2009 at Rs38.50 per share, and again raised Rs. 2,760 crores in July2009 at Rs 81 per share. Other companies which successfullyraised capital through QIPs were HDIL, Shobha Developers, Network18, Dewan Housing and Bajaj Hindustan. Most of the companieswhich came out with QIPs were in the real-estate/infrastructuresector. However, some companies like GMR Infrastructure werenot so successful and had to withdraw their issue and GVKPower and Infrastructure had to scale down by nearly 60% dueto problems in the valuations. Domestic institutional investors,
  33. 33. especially life insurers kept away from the QIPs on valuationconcerns. However, FIIs which were net sellers had purchased Rs9,500 crores in the same period.This led several FIIs to pick up the target stocks via QIP beforethe July 6thBudget and offload the same after the budgetsession. As per a CRISIL study, 10 out of 13 QIPs are currentlyquoting below the offer price. Since most of QIPs were in thereality and infrastructure sectors, one explanation is that FIIs came inexpecting some quick gains from significant sops to the infrastructureand housing sectors in the Budget. It is also possible that the rushfor QIPs was driven largely by short-term considerations, wherethe FIIs hedged their bets by taking short positions in the issuers‘stock even as they bought into the offers.New sources of FII funds:The Securities and Exchange Board of India is in talks with theCayman Islands Monetary Authority (Cima), over allowing fundsbased in the Caribbean into the country. Cayman Islands is oneof the world‘s largest tax havens and a lot of global hedge funds arebased out of Cayman Islands Sebi has received numerousapplications from Cayman-based funds since June when Cima wasadmitted as a full member of the international body of securitiesmarket regulators, the International Organization of SecuritiesCommissions (Iosco).
  34. 34. Ioscos constituents regulate more than ninety percent of the worldssecurities markets. Funds from Cayman Islands were usually notfavoured by SEBI owning to lack of transparency and difficulty inestablishing the owner base. Consequently, these investments wereviewed unfavorably and any Cayman fund seeking to invest in Indiahad to be carefully examined.Post Cayman‘s admission to Iosco, Sebi is now determiningwhich grades of investment funds can be admitted expeditiouslyand which should be examined more carefully. Presently, there are19 registered foreign institutional investors from Cayman Islands,taking the total to 19. The two recent additions have been Fir TreeCapital Opportunity Master Fund and Fir Tree Value Master Fund.The fund base of Cayman Islands is huge. There are about 9870funds based there. Indian markets can expect more inflow fromCayman Island if SEBI agrees to let them come in.REASONS FOR FDI:Invest by Companies OverseasCompanies choose to invest in foreign markets for a number ofreasons, often the same reasons for expanding their operationswithin their home country. The economist John Dunning has identifiedfour primary reasons for corporate foreign investments.Market seeking -
  35. 35. Firms may go overseas to find new buyers for goods and services.Market-seeking may happen when producers have saturated sales intheir home market, or when they believe investments overseas willbring higher returns than additional investments at home. This isoften the case with high technology goods.Resource seeking -Put simply, a company may find it cheaper to produce its production aforeign subsidiary- for the purpose of selling it either at home or inforeign markets. The foreign facility may be able to obtain superior orless costly access to the inputs of production (land, labor, capital andnatural resources) than at home.Strategic asset seeking -Firms may seek to invest in other companies abroad tohelp build strategic assets, such as distribution networks or newtechnology. This may involve the establishment of partnershipswith other existing foreign firms that specialize in certain aspects ofproduction.Efficiency seeking -Multinational companies may also seek to reorganize their overseasholdings in response to broader economic changes.Fluctuations in exchange rates may also change the profitcalculations of a firm, leading the firm to shift the allocation ofits resources.
  36. 36. ACTS AND RULES: FII registration and investment are mainly governed by SEBI (FII) Regulations, 1995. ELIGIBILITY FOR REGISTRATION AS FII: Following entities / funds are eligible to get registered as FII: 1. Pension Funds 2. Mutual Funds 3. Insurance Companies 4. Investment Trusts 5. Banks 6. University Funds 7. Endowments 8. Foundations 9. Charitable Trusts / Charitable Societies Further, following entities proposing to invest on behalf of broad based funds (a fund established or incorporated outside India, which has at least twenty investors with no single individual investor holding more than 10% shares or units of the fund), are also eligible to be registered as FIIs: Asset Management Companies Institutional Portfolio Managers Trustees Power of Attorney Holders
  37. 37. INVESTMENT OPPORTUNITIES FOR FIIsThe following financial instruments are available for FII investmentsa) Securities in primary and secondary markets including shares,debentures and warrants of companies, unlisted, listed or to be listedon a recognized stock exchange in India;b) Units of mutual funds;c) Dated Government Securities;d) Derivatives traded on a recognized stock exchange;e) Commercial papers.Investment limits on equity investmentsa) FII, on its own behalf, shall not invest in equity more than 10% oftotal issued capital of an Indian company.b) Investment on behalf of each sub-account shall not exceed 10% oftotal issued capital of an India company.c) For the sub-account registered under Foreign Companies/Individual category, the investment limit is fixed at 5% of issuedcapital. These limits are within overall limit of 24% / 49 % / or thesectoral caps a prescribed by Government of India / Reserve Bank ofIndia.
  38. 38. Investment limits on debt investmentsThe FII investments in debt securities are governed by the policy ifthe Government of India. Currently following limits are in effect:For FII investments in Government debt, currently following limits areapplicable:For corporate debt the investment limit is fixed at US $ 500 million.TAXATION:The taxation norms available to a FII are shown in the table below.Nature of Income Tax RateLong-term capital gains 10%Short-term capital gains 30%Dividend Income NilInterest Income 20%Long term capital gain: Capital gain on sale of securities held for aperiod of more than one year.Short term capital gain: Capital gain on sale of securities held for aperiod of less than one year.
  39. 39. CHAPTER 3 Impact of FIIs onStock Market InstabilityThe real measure of your wealth is howmuch you’d be worth if you lost all your money.
  40. 40. CHAPTER 3 IMPACT OF FIIS ON STOCK MARKET INSTABILITYInvestment of FIIs are motivated not only by the domestic andexternal economic conditions but also by short run expectationsshaped primarily by what is known as market sentiment. Theelement of speculation and high mobility in FII investment canincrease the volatility of stock return in emerging markets. Infact, a widely held perception among academicians andpractitioners about the emerging equity markets is that price orreturn indices in these markets are frequently subject to extendeddeviations from fundamental values with subsequent reversals andthat these swings are in large part due to the influence of highlymobile foreign capital. Volatility is an unattractive feature that hasadverse implications for decisions pertaining to the effectiveallocation of resources and therefore investment. Volatility makesinvestors averse to holding stock due to increased uncertainty.Investors in turn demand higher risk premium so as to ensure againstincreased uncertainty. A greater risk premium implies higher costof capital and consequently lowers physical investment. Inaddition, great volatility may increase the ―option to wait‖ therebydelaying investment. Also weak regulatory system in emergingmarket economies (EMEs) reduce the efficiency of market
  41. 41. signals and the processing of information, which furthermagnifies the problem of volatility. But some researchers have theopposite assumption of non-disestablishing hypothesis that says FIIshave no adverse impactTrading by FIIs happens on a continuous basis and therefore has alasting impact on the local stock market. There is, however,surprisingly little empirical evidence on the impact of FIIs trading onthe host country‘s stock return volatility, thereby making it imperativethat this aspect of local equity markets, which is important forboth risk analysis and portfolio construction, be examined. Thischapter attempts to fill the gap. Beside the introduction, this chapter isclassified into two parts.• Part I presents the impact of foreign institutional investors onthe Indian stock market volatility.• Part II shows the structure of the volatility before and afterintroduction of the foreign institutional investors in Indian stockmarket.The scope of the study is limited to the India which has become anattraction for FIIs in recent years, in fact the emerging markets ofmany developing countries have been attracting large inflows ofprivate capital in recent years. The surge in capital flows occurredfirst in Latin America, then South East Asia and is now clearly visible
  42. 42. in South Asia. A significant feature of these capital flows is theincreasing importance of foreign portfolio investment (FPI), whosebuying and selling of stocks on a daily basis determines themagnitude of such capital flows. A significant improvement hasalso taken place in India relating to the flow of foreign capitalduring the period of post economic reforms. The major changein the capital flows particularly in Foreign Institutional Investors(FIIs) investments has taken place following the changes intrade and industrial policy. Over the past 15 years or so Indiahas gradually emerged an important destination of global investors‘investments in emerging equity markets. In 2006, India had a shareof about 0.55% of global investment which is quite high in comparisonto year 2001 in which India‘s share was only 0.12%. On the otherhand some of the developed countries have shown a downwardtrend.
  43. 43. The foreign financial inflows, beside other factors, helped the Indianstock market to rise at a great height according to financial analysts.Sensex crossed a new high. It crossed 20000- mark in December2007, which was 13786.91 in December 2006 and9397.93 In December 2005. This historical movement is also due tothe other parameters of the economy, which are favorable for theinvestment. The returns on investment are also much favorable. Theprofit performance of the firms may explain the reasons forHigh return on investment. There are other factors such asfavorable tax laws and relaxation on the caps of various kindsof investments. The policy measures and economic factors are alsothe reasons for the investor‘s confidence.during 1981-90, period of real sector reforms, were significantlyhigher than those found pre-liberalization period (i.e.1961-80).Interestingly, return and volatility increase further to 0.074 and 1.92respectively. In era of first generation reforms financial sector reforms
  44. 44. (i.e. 1991-2000).It is appreciable to see from the table that thesecond generation reforms have brought in more cheers for thecapital market as the risk (i.e. Standard Deviation of return)decreased but the stock return went up in the period. Clearlythe volatility has declined in Indian stock market after year 2000.Table 5 further reveals that the stock return has remainedaround half (0.06%) after the arrival of FIIs as compared to thatobtained (0.15%) during 1986 to 1992 period. Simultaneously, thestandard deviation which measures the volatility has declinedfrom 2.1598 percent during 1986-92 to 1.59 percent during1992-2007. Thus, both volatility and return have declined after theopening up of domestic stock market for FIIs. Time period 1994to 2001 gave a serious setback to stock market performance. Increase cap on G-Sec Bond Markets:Currently, the cap on FII investments in the bond market is USD 6Billion. As per the new budget, proposes to borrow Rs.4.5 lakhcrore in 2009-10 to support its infrastructure and otherdevelopmental projects. This could be opened up to the FIIs so thatthey can take part in India‘s hitherto almost closed debt market. TheIndian debt markets are not fully developed and see low volumes.The lifting of the cap on FIIs will increase the traded volumesand it will also help in preventing the ‗crowding out‘ of investment forprivate enterprises.
  45. 45.  Allow dollar settlements in India:The suggestion by SEBI to permit dollar settlements for FIIs wouldrevolutionize the way in which they invest in the country. This will helpmitigate risks of currency fluctuations for FIIs, and help in improve thevolume and liquidity of the derivatives market. With dollarsettlements, many participants, who want to take exposure toIndian markets through index buying, will be able to participatefreely. This, in turn, will give stability to Indian markets as there willbe buying of underlying stocks by the sellers of these contracts toFIIs.At present, settlements in India are done in rupee denominations. Asa result, a number of FIIs, who intend to trade in Nifty futures, takethe Singapore route where CNX Nifty index futures are traded onSGX.About 50 per cent of the total open interest (OI) build-up in Niftyfutures takes place on the SGX, which allows settlements in USdollar. This enables different types of FIIs to operate there. Also, lowtransaction costs due to the absence of securities transaction tax,stamp duty and P-note complications have resulted in a gradualshift of FIIs into offshore markets. Settlements in dollar wouldalso help in reducing the volatility in dollar-rupee conversionvalue caused due to FII flows. Each time a settlement is done, aseller of futures contracts to an FII would buy an equivalent amount ofunderlying stocks to hedge his/her exposure due to the sale. This
  46. 46. would increase the trading volume and liquidity of Indian markets,once dollar settlement is allowed. Stricter implementation of regulation to curb p-notes etc.To prevent the misuse of the participatory notes, there shouldbe stricter implementation of the regulations. Toughimplementation of KYC norms should be done. In the long run, thegroup is of the opinion that registration procedures for FIIsshould be made simpler after which P-Notes should be done awaywith.
  47. 47. CHAPTER 4 CONCLUSION Those who start with too little money aremore likely to succeed than those who startwith too much. Energy and imagination are the springboards to wealth creation.
  48. 48. CHAPTER 4. CONCLUSIONA number of studies in the past have observed that investments byFIIs and the movements of Sensex are quite closely correlated inIndia and FIIs wield significant influence on the movement of Sensex(Rangarajan 2000, Samal 1997, Pal 1998). NSE (2001) alsoobserves that in the Indian stock markets FIIs have adisproportionately high level of influence on the market sentimentsand price trends. This is so because other market participantsperceive the FIIs to be infallible in their assessment of the market andtend to follow the decisions taken by FIIs. This ‗herd instinct‘displayed by other market participants amplifies the importance ofFIIs in the domestic stock market in India.It is clear that the FIIs are influencing the Sensex movement to agreater extent. Further it is evident that the Sensex has increasedwhen there are positive inflows of FIIs and there were decrease inSensex when there were negative FII inflows. It has been perceivedin some quarters that FII flows are major drivers of stockmarkets in India and hence a sudden reversal of flows may harmthe stability of its markets. The nature of relationship between FIIflows and Indian stock market returns can be explained in terms of―cumulative informational disadvantage‖ of foreign portfolio investorsvis-a-vis domestic investors. The theory says that domestic investors
  49. 49. posses better knowledge about Indian financial markets thanforeign investors and this information asymmetry leads to „positivefeedback trading‟ by the foreign portfolio investors. There is nodoubt FIIs are influencing the movement of Sensex to a greaterextent.The whole process also highlights another disturbing feature. Duringthe post election period, the sudden volatility in the stock market andthe subsequent decline of Sensex was almost treated as a nationalemergency in India by the financial media and to a certain extent, bythe incoming UPA government. It is very difficult to understand whythe government feels so concerned about speculative investors andthe movements in Sensex. Most studies have shown that Sensex isneither a good barometer of economic fundamentals it is not anindicator of future growth prospects of the economy. Moreover, thisstudy also shows that even sharp changes in Sensex do notnecessarily indicate a significant alteration of actual shareholdingpattern of different investor groups even in the Sensex companies. Asfar as the real economy is concerned, the stock market has a verylimited role to play. In India, for the year 2002-03, new capital issuesby non- government public limited companies raised a combinedcapital of Rs 1,878 crores from ordinary shares, preference share anddebentures. This amount is only 0. 33 percent of gross domesticcapital formation of the economy and about 1. 6 percent of grossdomestic capital formation by private corporate sector for that year.This is not surprising because even in developed stock market s like
  50. 50. USA, the stock market has not been a significant source of financefor new investments. Also, stock markets mobilize a very s mallfraction of household financial saving in India. As the recent RBIHandbook of Statistics shows, investment in shares anddebentures10 and units of UTI account for only 1.37 percent of totalhousehold financial savings for t h e y ear 2003- 04. In comparison,bank deposits account for about 42 .8 percent of household financialsavings for the same year. Under this circumstance s, it is not clearwhy so much importance is given to the stock market and portfolioinvestors by policy makers in India. It is high time to realize that inspite of the impression given by the financial media, movements ofstock markets and Sensex do not necessarily imply anyfundamental changes in the economy and these movements affect avery small minority of the country ‘s population. It will beunfortunate if movements of speculative capital and the resultantstock market gyrations are allowed to influence macro-economicpolicy making in India.Results of this study show that not only the FIIs are the major playersin the domestic stock market in India, but their influence on thedomestic markets is also growing. Data on trading activity of FIIs anddomestic stock market turnover suggest that FII‘s are becoming moreimportant at the margin as an increasingly higher share of stockmarket turnover is accounted for by FII trading. Moreover, thefindings of this study also indicate that Foreign Institutional Investorshave emerged as the most dominant investor group in the domesticstock market in India. Particularly, in the companies that constitute
  51. 51. the Bombay Stock Market Sensitivity Index (Sensex) and NSE Nifty,their level of control is very high. Dominant position of FIIs in theSensex companies, it is not surprising that FIIs are in a position toinfluence the movement of Sensex and Nifty in a significant way.Since FIIs are dominating the Indian Market, individual investors areforced to accept the dictates of major FIIs and hence join the groupby entering the Mutual Fund group. Many Mutual Funds floatedspecific funds for the sectors favored by the FIIs. An implication ofMFs gaining strength in the Indian stock market could be that unlikeindividual investors, whose monies they manage, MFs can createmarket trends whereas the small individual investors can only followthe trends. The situation becomes quite difficult if the funds gain avested interest in certain sectors by floating sector specific funds.One can even venture to say that the behaviour of MFs in India hasturned the very logic that mutual funds invest wisely on the basis ofwell-researched strategies and individual investors do not have thetime and resources to study and monitor corporate performance,upside down. Thus, the entry of FIIs has not resulted in greater depthin Indian stock market; instead it led to focusing on only a fewsectors. Ultimately to provide a level playing field, even the domesticinvestors had to be offered lower rates of capital gains tax.
  52. 52. CHAPTER 5 ANNEXUREFortune knocks once, but misfortune has much more patience.
  53. 53. ANNEXUREMILESTONES OF FOREIGN INSTITUTIONALINVESTMENT IN INDIAN STOCK MARKET India embarked on a programme of economic reforms in the early1990s to tie over its balance of payment crisis and also as a steptowards globalisation. An important milestone in the history of Indian economic reformshappened on September 14, 1992, when the FIIs (ForeignInstitutional Investors) were allowed to invest in all the securitiestraded on the primary and secondary markets, including shares,debentures and warrants issued by companies which were listed orwere to be listed the stock exchanges in India and in the schemesfloated by domestic mutual funds. Initially, the holding of a single FII and of all FIIs, NRIs (Non-Resident Indians) and OCBs (Overseas Corporate Bodies) in anycompany was subject to a limit of 5% and 24% of the companys totalissued capital respectively. ( In order to broad base the FII investment and to ensure that suchan investment would not become a camouflage for individualinvestment in the nature of FDI (Foreign Direct Investment), acondition was laid down that the funds invested by FIIs had to have atleast 50 participants with no one holding more than 5%. Ever since
  54. 54. this day, the regulations on FII investment have gone throughenormous changes and have become more liberal over time. ( From November 1996, FIIs were allowed to make 100%investment in debt securities subject to specific approval from SEBIas a separate category of FIIs or sub-accounts as 100% debt funds.Such investments were, of course, subjected to the fund-specificceiling prescribed by SEBI and had to be within an overall ceiling ofUS $ 1.5 billion. The investments were, however, restricted to thedebt instruments of companies listed or to be listed on the stockexchanges. In 1997, the aggregate limit on investment by all FIIs was allowedto be raised from 24% to 30% by the Board of Directors of individualcompanies by passing a resolution in their meeting and by a specialresolution to that effect in the companys General Body meeting. (From the year 1998, the FII investments were als allowed in the odated government securities, treasury bills and money marketinstruments. (In 2000, the foreign corporates and high net worth individualswere also allowed to invest as sub-accounts of SEBI-registered FIIs.FIIs were also permitted to seek SEBI registration in respect of sub-accounts. This was made more liberal to include the domesticportfolio managers or domestic asset management companies. (40% became the ceiling on aggregate FII portfolio investment inMarch 2000.
  55. 55.  (This was subsequently raised to 49% on March 8, 2001 and to thespecific sectoral cap in September 2001. (As a move towards further liberalization a committee was set upon March 13, 2002 to identify the sectors in which FIIs portfolioinvestments will not be subject to the sectoral limits for FDI. (Later, on December 27, 2002 the committee was reconstitutedand came out with recommendations in June 2004. The committeehad proposed that, In general, FII investment ceilings, if any,may be reckoned over and above prescribed FDI sectoralcaps. The 24 per cent limit on FII investment imposed in 1992 whenallowing FII inflows was exclusive of the FDI limit. The suggestedmeasure will be in conformity with this original stipulation. Thecommittee also has recommended that the special procedure forraising FII investments beyond 24 per cent up to the FDI limit in acompany may be dispensed with by amending the relevantregulations. (Meanwhile, the increase in investment ceiling for FIIs in debt fundsfrom US $ 1 billion to US $ 1.75 billion has been notified in 2004. TheSEBI also has reduced the turnaround time for processing of FIIapplications for registrations from 13 working days to 7 working daysexcept in the case of banks and subsidiaries. All these are indications for the countrys continuous efforts tomobilize more foreign investment through portfolio investment by FIIs.The FII portfolio flows have also been on the rise since September1992. Their investments have always been net positive, but for 1998-99, their sales were more than their purchase.
  56. 56. CHAPTER 6 BIBLIOGRAPHYNo matter how hard you hug your money, it never hugs back.
  58. 58. CHAPTER 7 WEBLIOGRAPHYI don’t think about financial success as the measurement of my success.
  59. 59. WEBLIOGRAPHYhttp://www.moneycontrol.com/http://www.rbi.org.in/http://www.sebi.gov.in/http://www.nseindia.com/