FDI & FII IN INDIA

A COMPARATIVE ANALYSIS

A PROJECT REPORT

SUBMITTED BY

ARJYA CHAKRABARTI

(Under the guidance of Prof. S.S. SAHA)

IN PARTIAL FULFILMENT FOR THE AWARD OF THE DEGREE

IN

BACHELOR OF COMMERCE (HONOURS)

ST. XAVIER’S COLLEGE (AUTONOMOUS)

UNDER THE UNIVERSITY OF CALCUTTA

ACADEMIC YEAR 2010-2011

ROLL NUMBER: 563

ROOM NUMBER: 32

SEMESTER: 6

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ACKNOWLEDGEMENT

A project cannot be completed alone. It requires the effort of many individuals. I take this opportunity to thank all those people who helped me to complete this project.

I express my sincere and deep gratitude to Father Dominic Savio, Vice Principal (St. Xavier’s College, Kolkata) for giving me the privilege of being part of the ‘Project’ in partial fulfillment of the requirement in regard to B.com 3rd year degree course.

I express my sincere gratitude to Prof. S.S. SAHA for giving us the opportunity to undergo this project. I further thank him for lending a helping hand when it came to solving my problems related to this project. This project would not have been possible without his valuable time and support.

This project is an attempt to talk about the SCENARIO OF FDI & FII IN INDIA IN THE LAST DECADE.

Last but not the least I am very much thankful to all the sources which I have approached and collected data from.

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Table of contents

Serial no. TITLE Pages

1. Chapter – I : Introduction 5

1.1 A Brief Summary 6

1.2 Research Problem 7

1.3 Literature Review 8

1.4 Research Methodology 10

1.5 Limitations 10

2. Chapter – II : FDI & FII An Overview 11

2.1 Foreign Direct Investment 12

2.2 Foreign Institutional Investment 22

3. Chapter – III : FDI vs FII, Comparative Analysis 29

4. Chapter – IV : Conclusion 39

4.1 Areas Of Further Research 40

4.2 References & Bibliography 41

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List of Tables

Serial no. TITLE Pages

1. Sectors attracting highest FDI 17

2. SEBI Registered FIIs 27

3. Net Foreign Institutional Investment (FII) in the last 10 Years 30

4. Foreign Direct Investment in India in the last 10 Years 31

5. A Comparison between the Net FII, FDI & the Sensex 33

6. A Comparison between the GDP, Net FII & FDI of the last 10 Years 35

7. Foreign Exchange Rate, Net FII & FDI Inflow of last 10 Years 37

List of Charts

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Serial no. TITLE Pages

1. FDI Across Various Sectors 19

2. Pictorial Representation of Registered FIIs 29

3. Net Investments shown graphically 31

4. Graphical Representation of FDI 32

5. FDI & FII Inflows in the last 10 Years - A Comparison 33

6. Diagram showing comparison between FDI Inflow & Sensex 34

7. Diagram showing comparison between net FII & Sensex 35

8. Diagram showing comparison between GDP & FDI 36

9. Diagram showing comparison between GDP & Net FII 37

10. Graphical representation of Net FII & the Foreign Exchange Rate 38

11. Graphical representation of FDI & the Foreign Exchange Rate 39

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CHAPTER – I

INTRODUCTION

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A BRIEF SUMMARY

The Government of India has recognized the key role of the foreign direct investment (FDI) and foreign

institutional investment (FII) in its process of economic development, not only as an addition to its own

domestic capital but also as an important source of technology and other global trade practices. In order to

attract the required amount of FDI and FII, it has bought about a number of changes in its economic policies and

has put in its practice a liberal and more transparent FDI and FII policy with a view to attract more foreign direct

institutional investment inflows into its economy. These changes have heralded the liberalization era of the

foreign investment policy regime into India and have brought about a structural breakthrough in the volume of

FDI and FII inflows in the economy.

Growth of Indian economy is playing hide and seek with the double digit growth (Gross Domestic Product)

mark. The latter is a key index, which the foreign investors check before committing large sums of money for

investment. Of its own, the Indian economy will find it difficult to reach this target, except for an occasional

burst of activity; like the one in 2003. To sustain it, outside help is needed and domestic house is to be placed

under strict discipline.

Democracy is a great buzzword, if it translates into order and political stability. Labor unrest, political

opportunism and corporate irregularities are a few issues, which tarnish democracy and discourage outside

investors.1 But the current government in both its terms has opened up the economy to welcome foreign

investment to keep up with the strong domestic demand for quality goods and services.

This has attracted unprecedented amount of foreign investment in the last decade, but of the two forms of

foreign investment – foreign portfolio investment (FPI)2 and foreign direct investment (FDI), the former has

reached our shores much more than the latter.

As FPI essentially interacts with the real economy via the stock market, the effect of stock market on the

country’s economic development will also be examined. Research shows that the perceived benefits of foreign

portfolio investment have not been realized in India. It can be seen that the mainstream argument that the entry

of foreign portfolio investors will boost a country's stock market and consequently the economy, does not seem

be working in India. The influx of FIIs has indeed influenced the secondary market segment of the Indian stock

market. But the supposed linkage effects with the real economy have not worked in the way the mainstream

model predicts. Instead there has been an increased uncertainty and skepticism about the stock market in this

country. On the other hand, the surge in foreign portfolio investment in the Indian economy has introduced some

serious problems of macroeconomic management for the policymakers like inflation, currency appreciation etc.

On the other hand FDI is what the government really needs to attract in various sectors like infrastructure,

education etc. it is much more stable than the foreign institutional investment which comes via the stock market

route, and has more accountability and brings fundamental and tangible benefits to the economy.

1 Hari Sud. Paper no. 1208; South Asia Analysis Group

2 Foreign Portfolio Investment: Entry of funds into a country where foreigners make purchases in the country’s stock and bond markets, sometimes for speculation.

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The dependence on FPI is pushing many developing countries, including India, towards a more stock market

oriented financial system. This makes it imperative to evaluate the relative merits and demerits of a stock market

based financial system in a developing country as compared to the Chinese model where conditions are

conducive to foreign investment in the real sector. The global recession in 2008 proved how volatile the money

pumped in by the FIIs into the secondary segment of the financial market is, leading to huge losses for the

domestic investors who had to bear the brunt even though the economy as such was insulated from the adverse

effects of the recession. Whereas the sectors where there was FDI didn’t experience such knee-jerk reactions.

In this context, this report is going to analyze the trends and patterns of foreign direct investment (FDI) and

foreign institutional investment (FII) flows into India during the post liberalization period.

RESEARCH PROBLEM

The opening up of the Indian economy served as a great boon for our country as the foreign investors saw vast

opportunities in it and started investing through the various routes allowed by the government of India. It is

important to keep record of all such inflows to form strict regulatory procedures, search for areas or sectors that

needs more investment etc, which is what this research proposes to do i.e. collect data regarding inflow of

foreign direct investment and foreign institutional investment from credible sources for a specified timeline and

tabulate such data to perform trend analysis of these investments to understand whether these investments

fluctuate rapidly or move in a fixed pattern and also what provides impetus to these investments or what are the

parameters that trigger a massive pull-out of them. As it is seen that FII is a volatile investment as compared to

FDI the factors affecting the inflow of both types of investment are explored and their investment annually is

compared on the basis of certain common parameters.

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LITERATURE REVIEW

1. Institutional investors have grown in importance in the mature economies in recent years and come to

supplant banks as the primary custodians of people's savings.

- T .T Ram Mohan,

Economic and Political Weekly, Vol. 40, No. 24 (Jun. 11-17, 2005), pp. 2395-2399

2. It is time to realize that in spite of the impression given by the financial media, the movements on the

stock markets and the Sensex do not necessarily imply any fundamental changes in the economy and

these movements affect a very small minority of the country's population.

- Parthapratim Pal

Economic and Political Weekly, Vol. 40, No. 8 (Feb. 19-25, 2005), pp. 765-772

3. The main emerging feature of India's equity market is its gradual integration with the global market

and its consequent problems due to the hot money movement by Foreign Institutional Investors (FIIs).

- Kishore C. Samal

Economic and Political Weekly, Vol. 32, No. 42 (Oct. 18-24, 1997), pp. 2729-2732

4. One must prevent the inflow/outflow of speculative 'hot money'. That can be achieved partially (though

very successfully) by a reasonably high 'capital gains' tax.

- Arun Ghosh

Economic and Political Weekly, Vol. 30, No. 21 (May 27, 1995), pp. 1235-1237

5. The combination of trading driven substantially by conditions in other markets and large price

pressures from the trading of foreigners raises the possibility that foreign trading can be destabilizing in

emerging markets.

- Anthony Richards

The Journal of Financial and Quantitative Analysis, Vol. 40, (Mar 2005), pp. 1-27

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6. Thus the impact of the reforms in India on the policy environment for Foreign Direct Investment

presents a mixed picture. The industrial reforms have gone far, though they need to be supplemented

by more infrastructure reforms, which are a critical missing link.

- Kulwinder Singh

Centre for Civil Society, New Delhi

Research Internship Programme, 2005

7. If at all, it would seem that foreign firms have greater credibility amongst consumers for offering

quality products and providing customer satisfaction.

- S. Ganesh

Economic and Political Weekly, Vol. 32, No. 22 (May 31 - Jun. 6, 1997), pp. 1265-1274

8. For a country that quarantined its economy from the rest of the world for much of the last 60 years,

India has increasingly relied on foreign investment in recent years. It has helped bridge the gap

between domestic savings and the growing capital needs of the private sector and the government,

which is borrowing money to pay for welfare programs and subsidies.

- Vikas Bajaj

The New York Times; India Finds Itself Awash in Foreign Investment

REVIEW GAP

It is seen that that eminent scholars have greatly established the ill effects of ‘speculative’ 3 money or ‘hot’

money and suggested ways to put forth stricter norms and procedures to control the flow of such money and

protect the financial markets from getting artificially inflated and create a bubble which could explode at the

slightest provocation. Also it can be gathered from previous studies that there is a clamour for easing of policy

restrictions to allow more foreign direct investment. Policies regarding FDI have not moved with the same pace

as the policies regarding FII i.e. the former’s policies are still considered conservative by the foreign investors.

Therefore this study makes a humble effort to get an overview of both types investments first then study their

trends and make a comparative analysis between the two to see which factors are they most sensitive to, whether

the two types of investment are equally sensitive to the same factors, which is more stable and also which type

of investment direct or portfolio is preferred by an emerging economy like India.

RESEARCH METHODOLOGY

3 Speculation: Speculation typically involves the lending of money or the purchase of assets, equity or debt but in a manner that has not been given thorough analysis or is deemed to have low margin of safety or a significant risk of the loss of the principal investment.

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The research has been carried out by collection of secondary data with the use of primarily the internet, books

on banking and finance, various business magazines, journals, newspapers. No primary data has been used here

like face to face interviews or telephonic interviews, questionnaires etc.

The secondary data collected regarding the foreign direct investment and foreign institutional investment is for a

time period of ten years starting from the year 2000-01 till 2009-10. The denomination for the inflows has been

converted to rupees in crores from US dollars by taking an average exchange rate for both types of investments.

For the purpose of comparison between FDI and FII the raw data has been arranged into a table for better

observation and then this numerical data has been incorporated into bar charts and line charts. These are

statistical tools used to read their pattern and conduct trend analysis.

The FDI and FII have been compared with various variables that affect their inflow in to the country by the

above mentioned tools with the use of spreadsheets.

LIMITATIONS

Limitations are conditions that restricts the scope of the study period or may affect the results of the research. It

cannot be controlled by the researchers and can even affect the analysis of reseach adversely.

One of the limiting factors of my project was that I have taken only three variables for a time period of ten years

for analysis due to time constraints. Since the sample size is small so the results can be different from actual

facts and may not give an appropriate judgement.

Also all the data have been collected from secondary sources. Information collected first hand from

professionals and scholars through interviews would have given the report a larger perspective.

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Chapter – II

FOREIGN DIRECT

INVESTMENT & FOREIGN

INSTITUTIONAL INVESTMENT

– AN OVERVIEW

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Foreign direct investment (FDI)

It is defined as a company from one country making a physical investment into building a factory in another

country. It is the establishment of an enterprise by a foreigner.

Its definition can be extended to include investments made to acquire lasting interest in enterprises operating

outside of the economy of the investor. The FDI relationship consists of a parent enterprise and a foreign

affiliate which together form an international business4 or a multinational corporation (MNC).

Types of Foreign Direct Investors

A foreign direct investor may be classified in any sector of the economy and could be any one of the following:

1) An individual

2) A group of related individuals

3) An incorporated or unincorporated entity

4) A public company or private company

5) A group of related enterprises

6) A government body

7) An estate (law)

8) Trust or other societal organization

9) Any combination of the above

Pre-liberalization Period (1947–1991)

Indian economic policy after independence was influenced by the colonial experience, which was seen by

Indian leaders as exploitative, and by those leaders' exposure to democratic socialism as well as the progress

achieved by the economy of the Soviet Union. Domestic policy tended towards protectionism, with a strong

emphasis on import substitution, industrialization, economic interventionism, a large public sector, business

regulation, and central planning, while trade and foreign investment policies were relatively liberal. Five-Year

Plans of India resembled central planning in the Soviet Union. Steel, mining, machine tools, water,

telecommunications, insurance, and electrical plants, among other industries, were effectively nationalized in

the mid-1950s.

4 International business is a term used to collectively describe topics relating to the operations of firms with interests in multiple countries.

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Post-liberalization Period (since 1991)

In the late 1970s, the government led by Morarji Desai eased restrictions on capacity expansion for incumbent

companies, removed price controls, reduced corporate taxes and promoted the creation of small scale industries

in large numbers. However, the subsequent government policy of Fabian socialism hampered the benefits of the

economy, leading to high fiscal deficits and a worsening current account. The collapse of the Soviet Union,

which was India's major trading partner, and the first Gulf War, which caused a spike in oil prices, caused a

major balance-of-payments crisis for India, which found itself facing the prospect of defaulting on its loans.

India asked for a $1.8 billion bailout loan from the International Monetary Fund (IMF), which in return

demanded reforms. In response, Prime Minister Narasimha Rao, along with his finance minister Manmohan

Singh, initiated the economic liberalization of 1991. The reforms did away with the License Raj (investment,

industrial and import licensing), reduced tariffs and interest rates and ended many public monopolies, allowing

automatic approval of foreign direct investment in many sectors. By the turn of the 20th century, India had

progressed towards a free-market economy, with a substantial reduction in state control of the economy and

increased financial liberalization. This has been accompanied by increases in life expectancy, literacy rates and

food security, although the beneficiaries have largely been urban residents.

Categories of Foreign Direct Investment: An Overview

FDIs can be broadly classified into two types: outward FDIs and inward FDIs. This classification is based on the

types of restrictions imposed, and the various prerequisites required for these investments. An outward-bound

FDI is backed by the government against all types of associated risks. This form of FDI is subject to tax

incentives as well as disincentives of various forms. Risk coverage provided to the domestic industries and

subsidies granted to the local firms stand in the way of outward FDIs, which are also known as 'direct

investments abroad.'

Different economic factors encourage inward FDIs. These include interest loans, tax breaks, grants, subsidies,

and the removal of restrictions and limitations. Factors detrimental to the growth of FDIs include necessities of

differential performance and limitations related with ownership patterns.

Other categorizations of FDI exist as well. Vertical Foreign Direct Investment takes place when a multinational

corporation owns some shares of a foreign enterprise, which supplies input for it or uses the output produced by

the MNC. Horizontal foreign direct investments happen when a multinational company carries out a similar

business operation in different nations.

Foreign Direct Investment is guided by different motives. FDIs that are undertaken to strengthen the existing

market structure or explore the opportunities of new markets can be called 'market-seeking FDIs.' 'Resource-

seeking FDIs' are aimed at factors of production which have more operational efficiency than those available in

the home country of the investor.

Some foreign direct investments involve the transfer of strategic assets. FDI activities may also be carried out to

ensure optimization of available opportunities and economies of scale. In this case, the foreign direct investment

is termed as 'efficiency-seeking.'

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Foreign Direct Investment in India

In India, Foreign Direct Investment Policy allows for investment only in case of the following form of

investments:

Through financial alliance

Through joint schemes and technical alliance

Through capital markets, via Euro issues

Through private placements or preferential allotments

Foreign Investment through GDRs (Euro Issues) –

Indian companies are allowed to raise equity capital in the international market through the issue of Global

Depository Receipt (GDRs). GDR investments are treated as FDI and are designated in dollars and are not

subject to any ceilings on investment. An applicant company seeking Government's approval in this regard

should have consistent track record for good performance (financial or otherwise) for a minimum period of 3

years. This condition would be relaxed for infrastructure projects such as power generation, telecommunication,

petroleum exploration and refining, ports, airports and roads.

1. Clearance from FIPB – There is no restriction on the number of Euro-issue to be floated by a company or a

group of companies in the financial year. A company engaged in the manufacture of items covered under

Annex-III of the New Industrial Policy whose direct foreign investment after a proposed Euro issue is likely to

exceed 51% or which is implementing a project not contained in Annex-III, would need to obtain prior FIPB

clearance before seeking final approval from Ministry of Finance.

2. Use of GDRs – The proceeds of the GDRs can be used for financing capital goods imports, capital

expenditure including domestic purchase/installation of plant, equipment and building and investment in

software development, prepayment or scheduled repayment of earlier external borrowings, and equity

investment in JV/WOSs in India.

Foreign direct investments in India are approved through two routes –

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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 sector wise 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 – FIPB stands for Foreign Investment

Promotion Board which approves all other cases where the parameters of automatic approval are not met.

Normal processing time is 4 to 6 weeks. Its approach is liberal for all sectors and all types of proposals, and

rejections are few. It is not necessary for foreign investors to have a local partner, even when the foreign

investor wishes to hold less than the entire equity of the company. The portion of the equity not proposed to be

held by the foreign investor can be offered to the public.

Foreign Direct Investment in India is not allowed under the following industrial sectors:

Arms and ammunition

Atomic Energy

Coal and lignite

Rail Transport

Mining of metals like iron, manganese, chrome, sulfur, gold, diamonds, copper, zinc

FDI in India across Different Sectors -

Hotel & Tourism

Hotels include restaurants, beach resorts and business ventures providing accommodation and food facilities to

tourist. Tourism would include travel agencies, tour operators, transport facilities, leisure, entertainment,

amusement, sports and health units.

100 per cent FDI is permitted for this sector through the automatic route.

Trading

For trading companies 100 per cent FDI is allowed for

Exports

Bulk Imports

Cash and Carry wholesale trading.

Power

For business activities in power sector like electricity generation, transmission and distribution other than atomic

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plants the FDI allowed is up to 100 per cent.

Drugs & Pharmaceuticals

For the production of drugs and pharmaceutical a FDI of 100 per cent is allowed, subject to the fact that the

venture does not attract compulsory licensing, does not involve use of recombinant DNA technology.

Private Banking

FDI of 49 per cent is allowed in the Banking sector through the automatic route provided the investment adheres

to guidelines issued by RBI.

Insurance Sector

For the Insurance sector FDI allowed is 26 per cent through the automatic route on condition of getting license

from Insurance Regulatory and Development Authority (IRDA).

Telecommunication

For basic, cellular, value added services and mobile personal communications by satellite, FDI is 49

per cent.

For ISPs with gateways, radio-paging and end to end bandwidth, FDI is allowed up to 74 per cent. But

any FDI above 49 per cent would require government approval.

Business Processing Outsourcing

FDI of 100 per cent is permitted provided such investments satisfy certain prerequisites.

NRI's And OCB's

They can have direct investment in industry, trade and infrastructure

Up to 100 per cent equity is allowed in the following sectors

34 High Priority Industry Groups

Export Trading Companies

Hotels and Tourism-related Projects

Hospitals, Diagnostic Centers

Shipping

Deep Sea Fishing

Oil Exploration

Power

Housing and Real Estate Development

Highways, Bridges and Ports

Sick Industrial Units

Industries Requiring Compulsory Licensing Industries Reserved for Small Scale Sector

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Table 1: Sectors attracting highest FDI

Rank Sector

Cumulative Inflows

(from August 1991

to March 2007)

Amount in Rs. Cr

Percentage with total

inflows (%)

1. Electrical Equipments 36034 24.82

2. Services Sector 34238 23.58

3. Telecommunications 16691 11.49

4. Transportation Industry 15427 10.62

5. Fuels (Power + Oil

Refinery)

12105 8.33

6. Chemicals 9510 6.55

7. Construction Activities 6396 4.40

8. Drugs &

Pharmaceuticals

5281 3.63

9. Food Processing

Industries

5143 3.54

10. Cement & Gypsum

Industries

4329 2.98

TOTAL FDI INFLOWS 145154

Source: Department of Industrial Policy & Promotion (www.dipp.nic.in)

Chart 1: FDI Across Various Sectors

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25%

24%

11%

11%

8%

7%

4%4%

4% 3%

Cumulative FDI InflowsElectrical Equipments Services Sector TelecommunicationsTransportation Industry Fuels (Power + Oil Refinery) ChemicalsConstruction Activities Drugs & Pharmaceuticals Food Processing IndustriesCement & Gypsum Industries

The Importance of foreign direct investment

Foreign direct investment (FDI) provides a major source of capital which brings with it up-to-date technology. It

would be difficult to generate this capital through domestic savings, and even if it were not, it would still be

difficult to import the necessary technology from abroad, since the transfer of technology to firms with no

previous experience of using it is difficult, risky, and expensive.

Over a long period of time FDI creates many externalities in the form of benefits available to the whole

economy which the TNCs cannot appropriate as part of their own income. These include transfers of general

knowledge and of specific technologies in production and distribution, industrial upgrading, work experience for

the labor force, the introduction of modern management and accounting methods, the establishment of finance

related and trading networks, and the upgrading of telecommunications services. FDI in services affects the host

country's competitiveness by raising the productivity of capital and enabling the host country to attract new

capital on favorable terms. It also creates services that can be used as strategic inputs in the traditional export

sector to expand the volume of trade and to upgrade production through product and process innovation.

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Advantages of FDI

Attracting foreign direct investment has become an integral part of the economic development strategies for

India. FDI ensures a huge amount of domestic capital, production level, and employment opportunities in the

developing countries, which is a major step towards the economic growth of the country. FDI has been a

booming factor that has bolstered the economic life of India, but on the other hand it is also being blamed for

ousting domestic inflows. FDI is also claimed to have lowered few regulatory standards in terms of investment

patterns. The effects of FDI are by and large transformative. The incorporation of a range of well- composed

and relevant policies will boost up the profit ratio from Foreign Direct Investment higher. Some of the biggest

advantages of FDI enjoyed by India have been listed as under:

Economic growth-

This is one of the major sectors, which is enormously benefited from foreign direct investment. A remarkable

inflow of FDI in various industrial units in India has boosted the economic life of country.

Trade

Foreign Direct Investments have opened a wide spectrum of opportunities in the trading of goods and services in

India both in terms of import and export production. Products of superior quality are manufactured by various

industries in India due to greater amount of FDI inflows in the country.

Employment and skill levels

FDI has also ensured a number of employment opportunities by aiding the setting up of industrial units in

various corners of India.

Technology diffusion and knowledge transfer

FDI apparently helps in the outsourcing of knowledge from India especially in the Information Technology

sector. It helps in developing the know-how process in India in terms of enhancing the technological

advancement in India.

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Linkages and spillover to domestic firms

Various foreign firms are now occupying a position in the Indian market through Joint Ventures and

collaboration concerns. The maximum amount of the profits gained by the foreign firms through these joint

ventures is spent on the Indian market.

Disadvantages of FDI

The disadvantages of foreign direct investment occur mostly in case of matters related to operation, distribution

of the profits made on the investment and the personnel. One of the most indirect disadvantages of foreign direct

investment is that the economically backward section of the host country is always inconvenienced when the

stream of foreign direct investment is negatively affected.

The situations in countries like Ireland, Singapore, Chile and China corroborate such an opinion. It is normally

the responsibility of the host country to limit the extent of impact that may be made by the foreign direct

investment. They should be making sure that the entities that are making the foreign direct investment in their

country adhere to the environmental, governance and social regulations that have been laid down in the country.

The various disadvantages of foreign direct investment are understood where the host country has some sort of

national secret – something that is not meant to be disclosed to the rest of the world. It has been observed that

the defense of a country has faced risks as a result of the foreign direct investment in the country.

At times it has been observed that certain foreign policies are adopted that are not appreciated by the workers of

the recipient country. Foreign direct investment, at times, is also disadvantageous for the ones who are making

the investment themselves.

Foreign direct investment may entail high travel and communications expenses. The differences of language and

culture that exist between the country of the investor and the host country could also pose problems in case of

foreign direct investment.

Yet another major disadvantage of foreign direct investment is that there is a chance that a company may lose

out on its ownership to an overseas company. This has often caused many companies to approach foreign direct

investment with a certain amount of caution. At times it has been observed that there is considerable instability

in a particular geographical region. This causes a lot of inconvenience to the investor.

The size of the market, as well as, the condition of the host country could be important factors in the case of the

foreign direct investment. In case the host country is not well connected with their more advanced neighbors, it

poses a lot of challenge for the investors.

At times it has been observed that the governments of the host country are facing problems with foreign direct

investment. It has less control over the functioning of the company that is functioning as the wholly owned

subsidiary of an overseas company.

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This leads to serious issues. The investor does not have to be completely obedient to the economic policies of

the country where they have invested the money. At times there have been adverse effects of foreign direct

investment on the balance of payments of a country. Even in view of the various disadvantages of foreign direct

investment it may be said that foreign direct investment has played an important role in shaping the economic

fortunes of a number of countries around the world.

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Foreign Institutional Investment (FII)

An investor or investment fund that is from or registered in a country outside of the one in which it is

currently investing. Institutional investors include hedge funds, insurance companies, pension funds and mutual

funds.

The term is used most commonly in India to refer to outside companies investing in the financial markets of

India. International institutional investors must register with the Securities and Exchange Board of India to

participate in the market. One of the major market regulations pertaining to FIIs involves placing limits on

FII ownership in Indian companies.

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 Government under 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 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.

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

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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 sensitive, a mere change

in perception about an economy can prompt them to pull out investments from a country.

The following factors contributed significantly to the FII flows to India -

• Regulation and Trading Efficiencies:

Indian stock markets have been well regulated by the stock exchanges, SEBI and RBI leading to high levels of

efficiency in trading, settlements and transparent dealings enhancing the confidence level of FIIs in increasing

allocations to India.

• F and O Segment:

The highly successful derivatives market in India has provided additional depth to the markets with high traded

volumes and multiple instruments by which investors can participate in the Indian equity markets. In fact the

Single Stock Futures (SSF) market in India is one of the most successful SSF market in Asia after Korea.

• New Issuance:

We have witnessed extremely high quality issuance during the year from companies such as NTPC, ONGC and

TCS leading to strong FII participation with successful new issuance of over $ nine billion, yet another record

for the year.

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:

i) 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.

24

ii) 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.

FIIs registered with SEBI fall under the following categories:

a) 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.

b) 100 % debt-fund FIIs- those who are permitted to invest only in debt instruments.

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 to be 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.

Prohibitions on Investments:

FIIs 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:

1. Business of chit fund

2. Nidhi Company5

3. Agricultural or plantation activities

5 Nidhi Company is a company registered under Companies Act and notified as a nidhi company by Central Government under Section 620-A of Companies Act. It is a non-banking finance company doing the business of lending and borrowing with its members or shareholders.

25

4. 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).

5. Trading in Transferable Development Rights (TDRs)

Registration Process of FIIs

FIIs are required to obtain a certificate by SEBI for dealing in securities. SEBI grants the certificate 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:-

(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.

26

(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 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.

27

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

Source: www.sebi.gov.in

Chart 2: Pictorial Representation of Registered FIIs

2000-016%

2001-026%

2002-036%

2003-046%2004-05

8%

2005-0610%

2006-0711%

2007-0814%

2008-0915%

2009-1019%

Number of FIIs

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: California Public Employees' Retirement System

(CalPERS), United Nations for and on behalf of the United Nations Joint Staff Pension Fund, Public School

Retirement System of Missouri, Commonwealth of Massachusetts Pension Reserves Investment Trust,

Treasurer of the State North Carolina Equity Investment Fund Pooled Trust, the Growth Fund of America, and

AIM Funds Management Inc.

28

1.

CHAPTER – III

FDI vs FII

A COMPARATIVE ANALYSIS

29

Table 3: Net Foreign Institutional Investment (FII) in the

last 10 Years

(Rs. Crores)

Year Net FII 2000-01 99332001-02 87632002-03 26892003-04 457642004-05 458802005-06 414672006-07 308412007-08 661792008-09 -458112009-10 142658

Source: SEBI Annual Report

After the liberalization of the economy the net investments made by the foreign investors started thronging the

Indian markets via the portfolio investment route. As Indian industries grow with more and more firms have

used the capital markets to raise their finances. Now due to strong demand in the domestic market these

companies have been doing well pushing our economy to high levels of GDP (Gross Domestic Product) growth

rate thus luring huge foreign investment in the secondary capital market as the foreign fund managers saw this

as a great opening for getting high returns on their funds at a pretty low risk. This boom in the Indian industry

coupled with easy entry requirements has given an impetus to the FIIs who show an increasing trend. It was

only in 2008 when the global recession broke out that the net investments declined sharply due to heavy selling

pressure from the FIIs i.e. they pulled out virtually all the monies invested in the stock market thus causing a

crash in the benchmark indices of the country.

Chart 3: Net Investments shown graphically

30

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

-100000

-50000

0

50000

100000

150000

200000

Net FII (Rs.Cr)

Net FII (Rs.Cr)

Table 4: Foreign Direct Investment in India in the last 10 Years (Rs. Crores)

Year FDI Inflow2000-01 126452001-02 193612002-03 149322003-04 141032004-05 121172005-06 246132006-07 706302007-08 986642008-09 1229192009-10 123377

Source: Department of Industrial Policy & Promotion (www.dipp.nic.in)

It can be seen that the flow of FDI has consistent and gradually increasing over the years. There has been an

increase of 94% i.e. Rs. 11968 Crores from the year 2000-01 to 2005-06 while the increase from 2005-06 to

2009-10 has been a phenomenal 401% i.e. from Rs. 24613 Cr to Rs. 123377 Cr which can be attributed to

relaxation of foreign investment rules. Despite the global financial credit squeeze brought by the recession India

continues to be an attractive destination for investment as there is tremendous potential for growth in the vast

and diverse markets of our country.

Chart 4: Graphical Representation of FDI

31

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

0.00

20,000.00

40,000.00

60,000.00

80,000.00

100,000.00

120,000.00

140,000.00

FDI Inflow

FDI Inflow

The bars from 2000-01 to 2004-05 have been almost hovering the same levels but importantly haven’t gone

down which is because the foreign investors saw immense potential but were not getting enough incentives to

enter with huge business propositions. The breakout came from the year 2005-06 when the investment nearly

doubled as compared to 2000-01, after which there was no looking back as consistent economic growth, de-

regulation, liberal investment rules, and operational flexibility helped increase the inflow of Foreign Direct

Investment or FDI. So much so that even during the year 2008-09 when the recession had taken its toll on the

western countries there was no indication of falling investment via the FDI route as can be seen from the chart.

In fact during 2008-09 the chart shows that FDI breached the Rs. 1 lakh crore mark. In percentage terms FDI

inflow increased by 25% from 2007-08 to 2008-09.

Chart 5: FDI & FII Inflows in the last 10 Years - A Comparison

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

-100000

-50000

0

50000

100000

150000

200000

Net FII (Rs.Cr)FDI Inflow

32

This presents an important picture from where a number of things can be gathered. The first three years i.e. from

2000-01 to 2002-03 the FDI was higher than FII but in the next three years the opposite case happened where

the FII was greater than FDI from 2003-04 to 2005-06. But the difference between the FDI and FII was not

much during the first three years but in the next three years when the FII went past FDI the difference between

them were huge as can be seen from the blue and red bars in the chart. Now from the year 2006-07 to 2008-09

again FDI was greater than FII and this time by big margins. Also during the year 2008-09 net foreign

institutional investment was in the negative indicating heavy selling and virtually no buying but the foreign

direct investment on the other hand rose by 25% from the previous year. This is significant because as it proves

that the effects of recession apparently did not affect the inflow of FDI at all whereas it totally sent the FII out of

the country. But it can also be said that the policies governing the entry of FII were relaxed and made less

complex which made investment via the FII route attractive for the foreign investors.

Table 5: A Comparison between the Net FII, FDI & the Sensex

Year Sensex Close Net FII (Rs.Cr) FDI Inflow (Rs.Cr)

2000-01 3262 9933 126452001-02 3377 8763 19361

2002-03 5839 2689 14932

2003-04 6603 45764 14103

2004-05 9398 45880 12117

2005-06 13787 41467 246132006-07 20287 30841 706302007-08 9647 66179 98664

2008-09 17465 -45811 122919

2009-10 20509 142658 123377Source: www.bseindia.com

The Sensex has increased by 10525 points between 2000-01 and 2005-06, an increase of more than 320%. In the

corresponding period net FII has increased by more than 315% and the FDI has gone up by 94%. From 2005-06

to 2009-10 the Sensex gained 6722 points, an increase of 49% and in the corresponding period the net FII went

up by 244% and the FDI inflows went up by 401%. The Sensex fell down by 10640 points in early 2008 i.e. by

52% due to heavy selling by the FIIs who pulled out their money from the stock market due to the sub-prime

crisis, credit crunch, bankruptcy, speculation etc. This turned the FIIs into net sellers and hence during 2008-09

the net FII figure is in negative. The FDI on the other hand surged ahead at Rs. 122919 Cr, an increase of nearly

25%. This implies that FDI inflow did not get affected by the recession worldwide and even if it was it is not

possible to pull out money invested through the FDI route as easily as it could be done in the case of FII.

Chart 6: Diagram showing comparison between FDI Inflow & Sensex

33

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-100

20000

40000

60000

80000

100000

120000

140000

0

5000

10000

15000

20000

25000

Sensex CloseFDI Inflow (Rs.Cr)

The blue and red line depicting Sensex and FDI respectively have been tracked for the last 10 years and it can be

seen that the Sensex peaked during 2006-07 whereas the FDI line has peaked during 2008-09 almost at the same

time when the Sensex crashed as the blue line can be seen falling sharply going down and even below the

10,000 level which is the time when the recessionary effects took place. The blue line or the Sensex has a rapid

rise from the years 2000-01 to 2006-07 after which it goes down in early 2008 i.e. in 2007-08 but recovers from

2008-09 and goes past the 15000 mark in 2008-09 and finally breaches the 20000 mark again in 2009-10.

The red line or the FDI from 2000-01 to 2004-05 shows an even path with a slight decline but has taken off

2004-05 itself and shown a rapidly increasing trend as the red line can be seen rising sharply upwards breaching

the Rs. 1 lakh crore mark roughly in 2007-08 and after peaking in 2008-09 with more than Rs. 1.2 lakh crore of

investment becomes stable.

Chart 7: Diagram showing comparison between net FII & Sensex

34

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

-100000

-50000

0

50000

100000

150000

200000

0

5000

10000

15000

20000

25000

Sensex CloseNet FII (Rs.Cr)

The red line denoting the net FII can be called a volatile line 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

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.

Table 6: A Comparison between the GDP, Net FII & FDI of the last 10 Years

Year GDP (at factor cost) Net FII (Rs. Crores) FDI Inflow (Rs.Crores)

2000-01 4.4 9933 12645

2001-02 5.8 8763 19361

2002-03 3.8 2689 14932

2003-04 8.5 45764 14103

2004-05 7.5 45880 12117

2005-06 9.5 41467 24613

2006-07 9.7 30841 70630

2007-08 9.2 66179 98664

2008-09 6.7 -45811 122919

2009-10 7.4 142658 123377

Source: www.rbi.org.in

The GDP has increased from 4.4% to 7.4% from 2000-01 to 2009-10, peaking in 2006-07 at 9.7% when the net

FII declined from Rs. 41467 Crs to Rs. 30841 Crs a fall of almost 26%., whereas the FDI grew by 187% and

stood at Rs. 70630 Crs. The GDP fell from 9.2% in 2007-08 to 6.7% in 2008-09 which can be attributed to very

35

slow industrial growth specially the manufacturing sector, the exports dried up, inflationary pressure etc. India

felt just the tip of the iceberg of the destructive economic recession, as it can be seen how the net FII turned into

negative figures, which hit the western countries hard. The GDP remained above the 9% mark for three years

from 2005-06 to 2007-08. In the corresponding period the FDI increased by 300% and the net FII increased by

60%.

Chart 8: Diagram showing comparison between GDP & FDI

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

0

2

4

6

8

10

12

0

20000

40000

60000

80000

100000

120000

140000

GDP at factor costFDI

The GDP growth rate was around the reasonably healthy levels of 4.4 and 5.8 percent during 2000-01 and 2001-

02 but it declined to 3.8 percent in 2002-03 which happened due to the massive drought caused by the monsoon

failure resulting in low production of agricultural products. Also in the industrial sectors barring the sub-sector

of electricity, gas and water supply, growth in all industrial and service sub-sectors slowed in the third quarter of

2002-03 compared to what was recorded in the second quarter of the year. In some sectors (manufacturing is

one) the slowdown was marginal; in others (financial services, for example), the deceleration was substantial. In

the same year the FDI can be seen falling by 23%. After 2002-03 the GDP has shown an increasing trend as

well as the FDI as can be seen from the blue and red lines in the chart. The pattern can said to be roughly

familiar.

Chart 9: Diagram showing comparison between GDP & Net FII

36

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

-100000

-50000

0

50000

100000

150000

200000

0

2

4

6

8

10

12

GDP at factor costNet FII

The FII curve (red line) is one with many sharp fluctuations and presents at first an increasing trend from 2000-

01 to 2003-04 and then becomes stable but has a very gradual declining slope from 2003-04 to 2006-07 going

down from Rs. 45764 Crs to Rs. 30841 Crs, a decrease of 33% whereas in the corresponding the GDP increases

from 8.5% to 9.7%. Both the net FII and GDP showed sharp declines in the year 2008-09 owing to various

factors like the global recession, sluggish manufacturing industry, inflation, low demand for Indian goods

abroad hurting exports, rising interest rates etc. in 2009-10 the FII shows again a very steep rise breaching the

Rs. 1 lakh Crore mark. Similarly the GDP has also recovered but gradually from 6.7% to 7.4%.

Table 7: Foreign Exchange Rate, Net FII & FDI Inflow of last 10 Years

Year USD in terms of Indian Rupee

Net FII (Rs. Crores) FDI Inflow (Rs. Crores)

2000-01 47.22 9933 12645

2001-02 48.63 8763 19361

2002-03 46.59 2689 14932

2003-04 45.26 45764 14103

2004-05 44.00 45880 12117

2005-06 45.19 41467 24613

2006-07 41.18 30841 70630

2007-08 43.39 66179 98664

2008-09 48.33 -45811 122919

2009-10 45.65 142658 123377

Source: www.ratesfx.com, SEBI Annual Report

37

In the ten years from 2000-01 to 2009-10 the net effect has been a decline of Rs 1.57 or 3.3%. During the year

2008-09 the FIIs turned sellers and hence net FII went into negative figures while the FDI increased by 25%.

The foreign exchange rate became the lowest in 2006-07 at Rs. 41.18.

Chart 10: Graphical representation of Net FII & the Foreign Exchange Rate

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

-100000

-50000

0

50000

100000

150000

200000

36

38

40

42

44

46

48

50

USD in terms of INRFII (Rs. Crores)

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 green line (Net FII) goes

down. The exchange rate has steadily declined from Rs. 48.63 in 2001-02 to Rs. 41.18 in 2006-07 and

correspondingly the Net FII has increased from Rs. 8763 Crs in 2001-02 to Rs.30841 Crs in 2006-07. In 2008-

09 when the Net FII has crashed and went into negative figures the exchange rate went from Rs.43.39 in 2007-

08 to Rs. 48.33 in 2008-09.

Chart 11: Graphical representation of FDI & the Foreign Exchange Rate

38

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

0

20000

40000

60000

80000

100000

120000

140000

36

38

40

42

44

46

48

50

USD in terms of INRFDI (Rs. Crores)

Not much relationship can be gathered between these two variables from the chart. The green line denoting FDI

has an overall increasing trend after being stable and rather gradually declining during the period 2000-01 to

2004-05. The foreign exchange rate sharply declines from around Rs. 45 to Rs.41 from 2005-06 to 2006-07 due

to unrestricted inflow of dollars thus increasing its supply thereby reducing the exchange rate but in the same

period the FDI has increased from Rs. 24613 Crs to Rs. 70630 Crs. The exchange rate again recovers from

2006-07 and rises again till 2008-09 after which we can again see a sharp decline in 2009-10 but the FDI line

remains stable.

39

Chapter – IV

CONCLUSION

40

What does India Need - FDI or FII 

FDI usually is associated with export growth. It comes only when all the criteria to set up an export industry are

met. That includes, reduced taxes, favorable labor law, freedom to move money in and out of country,

government assistance to acquire land, full grown infrastructure, reduced bureaucratic involvement etc. IT,

BPO, Auto Parts, Pharmaceuticals, unexplored service sectors including accounting; drug testing, medical care

etc are key sectors for foreign investment. Manufacturing is a brick and mortar investment. It is permanent and

stays in the country for a very long time. Huge investments are needed to set this industry. It provides

employment potential to semi skilled and skilled labor. On the other hand the service sector requires fewer but

highly skilled workers. Both are needed in India. If India plays its cards right India may be the hub for the

service sector. Still high end manufacturing in auto parts and pharmaceuticals should be India’s target.  

The FII (Foreign Institutional Investor) is monies, which chases the stocks in the market place. It is not exactly

brick and mortar money, but in the long run it may translate into brick and mortar. Sudden influx of this drives

the stock market up as too much money chases too little stock. Where FDI is a bit of a permanent nature, the FII

flies away at the shortest political or economical disturbance. The Global Recession of 2008 is a key example of

the latter. Once this money leaves, it leaves ruined economy and ruined lives behind. Hence FII is to be

welcomed with strict political and economical discipline.  

China receives mainly the FDI. They do not have instruments to receive the FII i.e. laws, institutions and

political and judicial framework. On the contrary, India should welcome both and work hard to retain both. 

Areas of Further Research

This report can be further stretched to include other factors affecting the FDI inflow and net FII like interest

rates determined by the Reserve Bank of India, inflation rate, industrial growth etc. Also research can be carried

out to determine why various caps on investment set by the government across various sectors like

infrastructure, pharmaceuticals, insurance should be removed and how much inflow would be required in those

sectors to fulfill the strong domestic demand which cannot be met by the Indian companies either due to lack of

technical expertise or shortage of funds etc.

41

REFERENCES & BIBLIOGRAPHY

Aggarwal R., Klapper L., and Wysocki PD., 2002. Portfolio Preferences of Foreign Institutional

Investors, Working Paper

Kishore C. Samal., Economic and Political Weekly, Vol. 32, No. 42 (Oct. 18-24, 1997), pp. 2729-2732

Batra, A., 2003. The Dynamics of Foreign Portfolio Inflows and Equity Returns in India. Working

Paper No. 109. ICRIER, New Delhi, India.

Kohli Renu., Economic and Political Weekly, Vol. 38, No. 8, Money, Banking and Finance (Feb 22-

28, 2003), pp. 761-762+764-768

SEBI, Annual Report 2009-10

www.dipp.nic.in

www.sebi.gov.in

www.bseindia.com

www.rbi.org.in

www.mbaknol.com

www.wikipedia.org

www.authorstream.com

www.thehindu.com

Pal Parthapratim., Economic and Political Weekly, Vol. 40, No. 8 (Feb 19-25, 2005), pp. 765-772

Richards Anthony., The Journal Financial and Quantitative Analysis, Vol. 40, No. 1 pp. 1-27

Ghosh Arun., Economic and Political Weekly, Vol. 30, No. 21 (May 27, 1995) pp. 1235-1237

Banaji J., 1998, Foreign Portfolio Investment in Indian Equity Markets: Has the Economy Benefitted?

42