This study analyzes the impact of foreign capital inflows, including foreign direct investment (FDI) and foreign institutional investment (FII), on rupee volatility in India from 2006-2012. Using regression analysis, the study finds that FDI and FII have significant positive relationships with rupee volatility. Specifically, the regression model shows that for every unit increase in FDI, rupee volatility increases by 11.236 units, and for every unit increase in FII, rupee volatility increases by 6.668 units. The study recommends reducing fiscal deficits and relaxing some regulatory norms to attract more foreign investment and support reforms while cautiously managing rupee volatility.

1. AN EMPIRICAL STUDY OF FOREIGN CAPITAL WITH REFERENCE
TO RUPEE VOLATILITY IN INDIA
Author : Abhishek Pande
Institute : Orange School of Business
ABSTRACT
The rupee has lost almost a fourth of its value against the dollar in last one year. This fall has
created a chorus of demands from industry as well as sections of the political establishment
that the Reserve Bank of India (RBI) should step in and use its foreign exchange reserves to
stabilise the value of the rupee.If the rupee falls, it is bound to impact the price of the
commodity even if it is being procured locally. Thus, volatility impacts the entire economy,
not just large importers or exporters.So far, managing volatility and the associated currency
risks has been a function of the RBI.We are already seeing this trend emerging with
management and audit committees of companies across the board, not just importers and
exporters, spending more time in assessing rupee volatility and finding ways to mitigate
them.
Keywords – foreign direct investment,foreign institutional investment,volatility.
JEL Classifications : E4,E5,E6
INTRODUCTION
Higher current account deficit and high inflation tend to go hand in hand. This itself is less of
an issue for global investors, provided we can maintain growth. If we are able to push growth
up even to the 7%, global capital flows will return and this will bolster the rupee. To do this,
what we need is a more open market access to a wider, exchange-based system of hedging
risks. The present restrictive system leaves too much onus on RBI.In the long run, the only
way to control volatility as well as stop the rupee from falling further is to open up our
economy further and do away with controls on FDI in sectors like insurance and multi-brand
retail.It not only helps bridge the current account deficit but also does not add volatility to the
markets. But, most important, it adds productive capacity, new technologies and new
expertise that further helps the growth of the economy.

2. REVIEW OF LITERATURE
Theoretically, a direct linkage between exchange rate volatility and macroeconomic variables
of any country is described, but empirical investigation shows that there is no consensus
about it because of mixed pattern of results found in those studies. Adubi et al. (1991)
evaluated the impact of price volatility and exchange rate volatility on agricultural trade flow.
Bleany et.al. (1999) analyzed through a model that if exchange rate of developing countries is
pegged to exchange rate of developed countries, the inflationary expectations in developing
countries may be reduced. Frey (1999) investigated the impact of short run volatility of
exchange rates on the volume of exports. Cooper (1999) compared the scope of different
exchange rate choices availed by rich and developing countries. Liwang (2000) studied the
impact of exchange rate volatility on flow of international trade. Kawai et al. (2001)
discussed conceptual and empirical issues relevant to exchange rate policies. Larrain et al.
(2002) put light on the question of which exchange rate arrangement middle income countries
should adopt.Esquivel et al. (2003) described the exchange rate volatility of G-3 countries.
Rollemberg et al. (2004) emphasized the relationship between alternative exchange rate
regimes and the different concepts of money and the role of the market as an economic
regulator. Zhang (2005) reviewed China’s foreign exchange reforms and analyzed their
impact on the balance of trade and inflation. Maskey (2006) reviewed the patterns of
economic shocks affecting the SAARC member countries.
FOREIGN CAPITAL INFLOWS
The government needs to start building a political consensus on such pending FDI issues such
as insurance and pensions.When faced with hardship, the instinctive reaction of most
policymakers and regulatory authorities is to clamp down and levy additional controls. It may
seem counter-intuitive, but what is really needed is more openness and transparency.Global
linkage and dependence of the economy is now a challenge for all policymakers.To benefit
from these, we need to go beyond the halfway house that the economy now finds itself
into.India’s decision to allow overseas companies to own as much as 51% of retailers selling
more than one brand will help curb inflation rate in some way.

3. Providing a stable and predictable macroeconomic environment is a challenge and the need to
reduce fiscal deficits both at the Centre and in the states to stabilise the debt-GDP ratios at
sustainable levels is a tough task.
RUPEE VOLATILITY AND FDI TRENDS IN INDIA
The relative rate at which the price of a security moves up and down is called volatility.
Volatility is found by calculating the annualized standard deviation of daily change in price.
If the price moves up and down rapidly over short time periods, it has high volatility. If the
price almost never changes, it has low volatility.
Rupee-dollar exchange rate
FDI is regarded as a potential catalyst for raising productivity in developing host countries
through the transfer of technology and managerial know-how, and for facilitating access to
international markets (World Economic and Social Survey 2012).
There are two routes through which FDI can take place in India :
1. Automatic Route
2. Government Approval Route

4. Foreign individuals or enterprises may take FDI in the form of acquiring shares of existing
Indian company, establishment of a new subsidiary with 100% share, joint venture, and
collaborations or by establishing new branches or expanding existing ones. FDI investment is
a long-term relationship with domestic company by participating actively in the management
of affairs of that company. So in essence, FDI in all these cases, results either in setting up of
new units of business or acquisition of controlling authority by acquiring major share in
equity capital.
RESEARCH DESIGN
The main objective of the present study is to quantify the affect of foreign capital inflows,
which include FDI and FII’s on economic growth of India. India has been receiving
significant amount of foreign capital via these routes after India liberalised its policy
regarding foreign capital.Thus the reference period for the present study has been chosen
from 2006-2012.Different researchers have under taken various studies to examine the impact
of foreign capital on the economic growth. Most of the studies have focused on the impact of
foreign direct investments on economic growth.Foreign Institutional Investors (FII’s) and
Foreign Direct Investment (FDI) have emerged as an important component in various
developing countries including India.Thus the relationship of Indian economic growth has
been studied with reference to FDI and FIIs investments flows. Consequently rupee volatility
has been taken as dependent variable and FDI and FIIs investment flows have been taken as
independent variables. Total 17 observations over the period of study 2006–2012 have been
used for analysing the relationship. The data for the study have been taken from the
Handbook of Statistics on Indian Economy published by Reserve Bank of India.
EMPIRICAL ANALYSIS
In order to judge the contribution of various components (FDI and FIIs) of foreign investment
on rupee volatility in India, Ordinary Least Square (OLS) method of regression analysis has
been applied using the annual data of Rupee Volatility (RV), FDI and FIIs. Symbolically, the
impact of FDI and FII on Rupee Volatility of India under OLS may be expressed as follow.

5. RV = β1 FDI + β2 FII + ε …………………. (i)
In this regression equation RV has been presented as dependent variable and all other
variables as independent or predictor variables. Here, in this regression equation:
RV – Rupee Volatility
FDI – Foreign Direct Investments
FII – Foreign Institutional Investments
β1 – Regression coefficient to measure the change in rupee volatility with change in FDI
β2 – Regression coefficient to measure the change in rupee volatility with change in FII
ε – Error term
Table 1.Regression analysis explaining the variations in RV of India during the period
2006-2012 ( no of observations =17)
Model Unstandardized Standard Standardized t Significance
Coefficients β Error Coefficients
β
FDI 11.236 1.317 .899 9.263 .000
FII 6.668 2.645 .244 2.450 .022

6. R2 = 0.846
Adjusted R2 = 0.851
Dependent variable in model = Rupee Volatility
Independent variables : FDI and FII
The beta values or coefficients indicate the strength of relationship between independent
variable and dependent variable. These regression coefficients have been used to construct an
OLS equation to test the relationship of each independent variable with dependent variable.
The model equation has been estimated on the basis of quantitative data for the entire
variables from financial year 2006 to financial year 2012. The total number of entered
observations is 17.
As visible from Table 1, the beta coefficients for FDI and FII have been found to be
significant. As per the result of Multiple Regression method, the following multiple
regression equation has been developed:
RV = 11.236 FDI + 6.668 FII………………………. (ii)
Positive regression coefficients of independent variables indicate a positive relationship with
the dependent variable. R2 known as the coefficient of determination, measures the
proportion of the total variation in dependent variable by the presence of all independent
variables simultaneously. So the model is statistically significant in the case of Indian
environment as it is explaining 86% variation in rupee volatility of Indian economy. Adjusted
R2 value is another measure of the success of the model. Adjusted R2 in this case is 0.851,
which means 85% of the variance in rupee volatility can be explained by the independent
variables jointly.
Table 2 shows the overall significance of the model. The value of the F-Statistic at 46.605 is
significant at 1% level of Significance. So model developed using the Multiple Regression is
statistically significant.

7. Table 2.Model Summary and analysis of Variance (ANOVA)
Model Sum of squares Df Mean square F Statistics Significance
Regression 6215779963500 2 3107889981749 46.505 0.000
Residual 933600437611.9 14 66685745543.6
Total 7149380401112 16
Predictors : FDI,FII
Dependent variable : Rupee Volatility
RECOMMENDATIONS AND CONCLUSION
In charting a roadmap for rupee consolidation, we need to be mindful of the quality of fiscal
adjustment —which is to weed out unproductive expenditure and protect, if not enhance,
growth-promoting foreign players.Also the optimistic view is rupee's recent weakness against
the dollar will likely be short-lived as it is due to global factors and India's economy remains
strong.It is widely acknowledged that current account deficit is by far one of the most binding
constraints to accelerating growth.Given its fiscal compulsions, the Government should
mobilize its resources by promoting the influx of FDI and FII’s in the country.In order to
support recent reforms,the RBI should cautiously relax regulatory norms.These include
higher exposure norms in respect of single borrowers and borrower groups, permitting
foreign players to invest in Infrastructure Debt Funds (IDFs) and to enter into infrastructure
financing.

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