Role of FII in Indian Capital Market

7/29/2019 Role of FII in Indian Capital Market

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Role Of FII in Indian Capital Market

Bachelor of Commerce

Financial Markets

Semester V

In Partial Fulfillment of the requirements

For the Award of Degree of Bachelor of

Commerce Financial Markets

Submitted by

LAVINA JAIN

Roll No.25

H.R. COLLEGE OF COMMERCE & ECONOMICS

123, D.W. Road, Churchgate, Mumbai 400 020.


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College Name

(With Address)

CERTIFICATE

This is to certify that Shri / Miss Lavina Jain of B.Com.-Financial Markets Semester V (2013 -

2014 ) has successfully completed the project on Role of FII in Indian Capital Market under

the guidance of Ms.Poonam Jain.

Course Co-ordinator Principal

Project Guide / Internal Examiner

External Examiner


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ACKNOWLEDGEMENT

DECLARATION

I Lavina Jain the student of B.Com.- Financial Markets Semester V (2013 - 2014 ) hereby

declare that I have completed the Project on Role of FII in Indian Capital Market

The information submitted is true and original to the best of my knowledge.

Signature of the Student

Name of the Student

Roll No.


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ROLE OF FINANCIAL INSTITUTION IN CAPITAL MARKET IN INDIA

Sr.No.

Particulars Page No.

1 Abstract


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2 Executive Summary3 Introduction4 Types of Institutional Investors5 History of FII6 Procedure for registration

7 Regulation related to FII operation8 Indian Capital Market9 Influence of FII on Indian Capital Market10 Effects of FII on Indian Economy11 BSE SENSEX and FII Investment Correlation12 Institutional Investors registered in India13 Major Institutional Investors in India14 Investment trends of Institutional Investors15 Reasons for growth in FII Investment

16 FII a cost benefit analysis17 Determinants of FII18 Comparison between FII and Mutual Fund

Investment19 Role of Institutional Investors in Indian Capital

Market20 Study of Major episodes of Volatility21 Statistical analysis22 Recommendation

23 Conclusion24 Reference


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ABSTRACT:

An economy, apart from everything else, is a highly fluid transmission mechanism.

Its beauty lies in how the smallest of changes have the most complex trickle-down

effects. A paradigmatic example of how seemingly minor policy changes can jump

start the economy can be illustrated by examining the effects of liberalization on

capital market in India. The FIIs have been playing key role in the Indian capitalmarket, since their entry in the early 1990s.

Globalization had led to widespread liberalization and implementation of financial

market reforms in many countries, mainly focusing on integrating the financial

markets with the global markets. Indian Capital Market has also undergone

metamorphic reforms in the past few years. Every segment of Indian Capital

Market viz primary and secondary markets, derivatives, institutional investment

and market intermediation has experienced impact of these changes which has

significantly improved the transparency, efficiency and integration of Indian market

with the global markets.

This is one of the prime reasons why the foreign portfolio investments have been

increasingly flowing into the Indian markets. A significant part of these portfolio

flows to India comes in the form of Foreign Institutional

Investors(FIIs)investments , mostly in equities . Ever since the opening of the

Indian equity markets to foreigners, FII net investments have steadily grown.Thus, we can see that there has been a consistent rise in the FII inflows in to the

country.

While the concerns such as FII pulling back their investments and the kind of

destabilizing effect on the capital market in India are all well-placed,

comparatively less attention have been paid so far to analyzing the FII flows data

and understanding their key features. A proper understanding of the nature and

determinants of these flows, however, is essential for a meaningful debate about

their effects as well as predicting their chances of their sudden reversals. Thusthis project aims at studying the role of these Institutional investors and its impact

on the capital markets in India. This also aims to find out the various factors and

determinants for their investments and also cite out scenarios where in these

investments when pulled back by these FII could really affect the capital markets

in India.


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EXECUTIVE SUMMARY:

The objective of the project is to find the different role of institutional investors in

the capital market in India and then to find the role of institutional investors in the

major volatile episode in the capital market in India. Finally, to find the

relationship between the Sensex variation with the variation of the investments

made by the institutional investors. India opened its stock markets to foreign

investors in September 1992 and has, since 1993, received considerable

amount of portfolio investment from foreigners in the form of Foreign

Institutional Investors (FII) investment in equities. While it is generally held thatportfolio flows benefit the economies of recipient countries, policy makers

worldwide have been more than a little uneasy about such investments.

Portfolio flows-often referred as hot money-are notoriously volatile compared to

other types of capital inflows. Investors are known to pull back portfolioinvestments at the slightest hint of trouble in the host country often leading

to disastrous consequences to its economy. They have been blamed for

exacerbating small economic problems in a country by making large and

concerted withdrawals at the first sign of economic weakness. The methodology

used to is regression analysis. The degree of association helps us to quantify

the relationship between the variation in sensex due to the variation in the

net investments made by the institutional investors.

After completing the project I could recommend that Government should

certainly encourage foreign institutional investment but should keep a check on

the volatility factor. Long term funds should be given priority and encouraged

some of the actions that could be taken to ensure stability are strengthening

domestic institutional investors Operational flexibility to impart stability to the

market Knowledge activities and research programs.

To conclude with I would say that the foreign funds is certainly one of the most

important cause of volatility in the Indian stock market and has had a considerableinfluence on it. Although it would not be fair enough to come to any conclusion

as there are a lot of other factors beyond the scope of the study that effect

returns and risks .it is not easy to predict the nature of the macroeconomic

factors and their behavior but it has a great significance on any economy and its

elements. Although generally a positive relation has been seen between the

stock market returns and the FII inflows it is not easy to say which is the cause

and which is the effect.


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INTRODUCTION:

Till 1980s Indian economy has remained quite closed towards the foreign

investments but it was well realized by the government during 1990s that the

foreign investment can play significant role to promote economic growth. It was

the time when the wave of economic reforms also touched the capital market. The

objective was all clear, i.e., to fasten the pulse of development in all economic

activities. At the initial stages of reforms with regard to FIIs the credit can be given

to the New Industrial Policy, 1991 framed by the government to focus on the

importance of foreign direct investment in order to augment technological updating

in a globalized world. In order to give further push to foreign investment,

Government of India permitted the portfolio investment made by foreign

institutional investors in India. The initial guidelines regarding the flow of capital by

FIIs was suggested by Narsimhan Committee Report on financial system of India.Figure 1 given below has showed the trend of number of FIIs and Net Investment

made by them during last decade. The information of the same has been obtained

through the report published by SEBI. The capital market of India was gradually

opened for foreign institutional investors. They were allowed to invest in all traded

securities on the primary market and secondary markets including various

financial products, viz., shares, debentures and warrants etc. India has always

been an attractive destination for foreign investors as Indian economy has always

been a good performer among other Asian countries. But whenever a crisis hasbeen identified on Indian capital market or a financial crisis occurring at world

level, it has always impacted the capital flows by portfolio investors. Therefore

continuous evidences are obtained by researchers indicating the volatility shifts on

the stock market due to the behavior of foreign institutional investors.


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TYPES OF INSTITUTIONAL INVESTORS:

A. DOMESTIC INSTITUTIONAL INVESTOR

Domestic Institutional Investor is used to denote an investor - mostly of the form

of an institution or entity, which invests money in the financial markets of its owncountry where the institution or entity was originally incorporated. In India, there

are broadly four types of institutional investors.

DEVELOPMENTAL FINANCIAL INSTITUTIONS like Industrial Finance

Corporation of India (IFCI), Industrial Credit and Investment Corporation of

India (ICICI), Industrial Development Bank of India (IDBI), the State

Financial Corporations, etc. The role played by these financial institutions

(FIs) is to extend funds to the companies for both long terms financing and

(more recently) working capital financing. The financial institutions extendboth debt and equity financing to their nominee directors in the companies.

INSURANCE COMPANI ES l ike the Life Insurance Corporation (LIC),

General Insurance Corporation (GIC), and their subsidiaries.
http://en.wikipedia.org/wiki/Investorhttp://en.wikipedia.org/wiki/Institutional_investorhttp://en.wikipedia.org/wiki/Financial_marketshttp://en.wikipedia.org/wiki/Financial_marketshttp://en.wikipedia.org/wiki/Institutional_investorhttp://en.wikipedia.org/wiki/Investor


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BANKS: Earlier banks used to finance only the working capital of

the companies. But now they are also extending long-term finance to the

companies.

ASSET MANAGEMENT COMPANIES all the mutual funds including Unit

Trust of India (UTI). The mutual funds collect funds from both individuals

and corporate to invest in the financial assets of other companies. In India,

the mutual funds participate largely in the equity capital of the companies.

The mutual fund industry which is the major institutional investors in India

started in 1963 with the formation of Unit Trust of India, at the initiative

of the Government of India and Reserve Bank.

The history of mutual funds in India can be broadly divided into four distinctphases

First Phase: 1964-1987, Unit Trust of India (UTI) was established on 1963 by

an Act of Parliament.

Second Phase : 1987- 1993, Entry of Public Sector Funds .1987 marked the

entry of non- UTI, public sector mutual funds set up by public sector banks and

Life Insurance Corporation of India(LIC) and General Insurance Corporation

of India (GIC).

Third Phase: 1993-2003, Entry of Private Sector Funds in 1993. Kothari

Pioneer (now merged with Franklin Templeton) was the first private sector

mutual fund registered in July 1993.As at the end of January 2003;there were

33 mutual funds with total assets of Rs. 1, 21,805 crores. The Unit Trust of India

with Rs.44, 541 crores of assets under management was way ahead of other

mutual funds.

Fourth Phase: 2003-2007, In Feb 2003 the Unit Trust of India Act 1963

UTI was bifurcated into two separate entities. The Specified Undertaking of Unit

Trust of India, functioning under an administrator and under the rules framed by

Government of India. The second is


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the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is

registered with SEBI and functions under the Mutual Fund Regulation,

B.FOREIGN INSTITUTIONAL INVESTOR: The term Foreign Institutional

Investor is defined by SEBI as under:

"Means an institution established or incorporated outside India which

proposes to make investment in India in securities. Provided that a

domestic asset management company or domestic portfolio manager who

manages funds raised or collected or brought from outside India for

investment in India on behalf of a sub-account, shall be deemed to be a

Foreign Institutional Investor."

Foreign Investment refers to investments made by residents of a country

in financial assets and production process of another country.

Entities covered by the term FII include Overseas pension funds, mutualfunds, investment trust, asset management company, nominee company,

bank, institutional portfolio manager, university funds, endowments,

foundations, charitable trusts, charitable societies etc.(fund having more

than 20 investors with no single investor holding more than 10 per cent of

the shares or units of the fund) (GOI (2005)). FIIs can invest their ownfunds as well as invest on behalf of their overseas clients registered as

such with SEBI. These client accounts that the FII manages are known as

sub-accounts.

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 Securities & Exchange Board of India (SEBI)

to participate in the market. One of the major market regulations pertaining

to FII involves placing limits on FII ownership in Indian companies. They

actually evaluate the shares and deposits in a portfolio.WHY FIIS REQUIRED?

FIIs contribute to the foreign exchange inflow as the funds from

multilateral finance institutions and FDI (Foreign direct investment) are

insufficient. Following are the some advantages of FIIs.

It lowers cost of capital, access to cheap global credit.

It supplements domestic savings and investments.


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It leads to higher asset prices in the Indian market.

And has also led to considerable amount of reforms in capital market andfinancial sector.

INVESTMENTS BY FIIS

There are generally two ways to invest for FIIs.

EQUITY INVESTMENT

100% investments could be in equity related instruments or up to 30%

could be invested

in debt instruments i.e.70 (Equity Instruments): 30 (Debt Instruments)

100% DEBT

100% investment has to be made in debt securities only

EQUITY INVESTMENT ROUTE: In case of Equity route the FIIs caninvest in the following instruments:

A. Securities in the primary and secondary market including shares which

are unlisted, listed

or to be listed on a recognized stock exchange in India.

B. Units of schemes floated by the Unit Trust of India and other domestic

mutual funds,

whether listed or not.

C. Warrants

100% DEBT ROUTE: In case of Debt Route the FIIs can invest in the

following instruments:


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A. Debentures (Non Convertible Debentures, Partly Convertible

Debentures etc.)

B. Bonds

C. Dated government securities

D. Treasury Bills

E. Other Debt Market Instruments

It should be noted that foreign companies and individuals are not be

eligible to invest through the 100% debt route.

HISTORY OF FII

India opened its stock market to foreign investors in September 1992, and

in 1993, received portfolio investment from foreigners in the form of

foreign institutional investment in equities. This has become one of the

main channels of FII in India for foreigners. Initially, there were terms and

conditions which restricted many FIIs to invest in India. But in the course

of time, in order to attract more investors, SEBI has simplified many terms

such as:-

The ceiling for overall investment of FII was increased 24% ofthe paidup capital of Indian company.

Allowed foreign individuals and hedge funds to directly register as FII.

Investment in government securities was increased to US$5 billion.

Simplified registration norms.

PROCEDURE FOR REGISTRATION: The Procedure for registration ofFII has been given by SEBI regulations. It states- no person shall buy,sell or otherwise deal in securities as a Foreign Institutional Investor

unless he holds a certificate granted by the Board under these

regulations. An application for grant of registration has to be made inForm A, the format of which is provided in the SEBI (FII) Regulations,

1995.

THE ELIGIBILITY CRITERIA FOR APPLICANT SEEKING FII

REGISTRATION IS AS FOLLOWS:


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Good track record, professional competence and financial soundness.

Regulated by appropriate foreign regulatory authority in the samecapacity/category where registration is sought from SEBI.

Permission under the provisions of the Foreign Exchange ManagementAct, 1999 (FEMA) from the RBI.

Legally permitted to invest in securities outside country or itsincorporation/establishment.

The applicant must be a fit and proper person.

Local custodian and designated bank to route its transactions.

ELIGIBLE SECURITIES

A FII can make investments only in the following types of securities:

Securities in the primary and secondary markets including shares,debentures and warrants of unlisted, to- be-listed companies or

companies listed on a recognized stock exchange.

Units of schemes floated by domestic mutual funds including Unit Trustof India, whether listed on a recognized stock exchange or not, and units

of scheme floated by a Collective Investment Scheme.

Government Securities

Derivatives traded on a recognized stock exchange like futures andoptions. FIIs can now invest in interest rate futures that were launched at

the National Stock Exchange (NSE) on 31st August, 2009.

Commercial paper.

Security receipts

REGULATION RELATING TO FII OPERATION

Investment by FIIs is regulated under SEBI (FII) Regulations, 1995 andRegulation 5(2) of FEMA Notification No.20 dated May 3, 2000. SEBI acts

as the nodal point in the entire process of FII registration.

FIIs are required to apply to SEBI in a common application form induplicate. A copy of the application form is sent by SEBI to RBI along with


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their 'No Objection' so as to enable RBI to grant necessary permission

under FEMA.

RBI approval under FEMA enables a FII to buy/sell securities on stockexchanges and open foreign currency and Indian Rupee accounts with a

designated bank branch.

FIIs are required to allocate their investment between equity and debtinstruments in the ratio of 70:30. However, it is also possible for an FII to

declare itself a 100% debt FII in which case it can make its entire

investment in debt instruments.

All FIIs and their sub-accounts taken together cannot acquire more than24% of the paid up capital of an Indian Company. Indian Companies can

raise the above mentioned 24% ceiling to the Sectoral Cap / StatutoryCeiling as applicable by passing a resolution by its Board of Directors

followed by passing a Special Resolution to that effect by its General

Body.

Further, in 2008 amendments were made to attract more foreign investors

to register with SEBI, these amendments are:

The definition of broad based fund under the regulations was

substantially widened allowing several more sub accounts and FIIs toregister with SEBI.

Several new categories of registration viz. sovereign wealth funds,foreign individual, foreign corporate etc. were introduced,

Registration once granted to foreign investors was made permanentwithout a need to apply for renewal from time to time thereby substantially

reducing the administrative burden,

Also the application fee for foreign investors applying for registration hasrecently been reduced by 50% for FIIs and sub accounts. Also,

institutional investors including FIIs and their sub-accounts have been

allowed to undertake short-selling, lending and borrowing of Indian

securities from February 1, 2008.


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INDIAN CAPITAL MARKET:

The Bombay Stock Exchange (BSE), which began formal trading in1875,

is one of the oldest in Asia . Over the last decade, there has been a rapid

change in the Indian securities market, both in primary as well as the

secondary market. Advanced technology and online-based transactionshave modernized the stock exchanges. In terms of the number of

companies listed and total market capitalization, the Indian equity market

is considered large relative to the countrys stage of economicdevelopment. Currently, there are 40 mutual funds, out of which 33 are in

the private sector and 7 are in the public sector. Mutual funds were

opened to the private sector in 1992. Earlier, in 1987, banks were allowed

to enter this business, breaking the monopoly of the Unit Trust of India

(UTI), which maintains a dominant position. Before 1992, many factorsobstructed the expansion of equity trading. Fresh capital issues were

controlled through the Capital Issues Control Act. Trading practices were

not transparent, and there was a large amount of insider trading.

Recognizing the importance of increasing invest or protection, several

measures were enacted to improve the fairness of the capital market. The

Securities and Exchange Board of India (SEBI) was established in 1988.

There have been significant reforms in the regulation of the securities

market since 1992 in conjunction with overall economic and financialreforms. In1992, the SEBI Act was enacted giving SEBI statutory status as

a nap ex regulatory body. And a series of reforms was introduced to

improve investor protection, automation of stock trading, integration of

national markets, and efficiency of market operations. India has seen a

tremendous change in the secondary market for equity.

Among the processes that have already started and are soon to be fully

implemented are electronic settlement trade and exchange-traded

derivatives. Before 1995, markets in India used open outcry, a tradingprocess in which traders shouted and hand signaled from within a pit. One

major policy initiated by SEBI from1993involvedtheshiftofallexchangesto

screen-based trading, motivated primarily by the need for greater

transparency. The first exchange to be based on an open electronic limit

order book was the National Stock Exchange (NSE), which started trading

debt instruments in June 1994 and equity in November 1994. In March

1995, BSE shifted from open outcry to a limit order book market. Before

1994, Indias stock markets were dominated by BSE. In other parts of the


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country, the financial industry did not have equal access to markets and

was unable to participate informing prices compared with market

participants in Mumbai (Bombay). As a result, the prices in markets

outside Mumbai were often different from prices in Mumbai. These pricing

errors limited order flow to these markets. Explicit nationwide connectivityand implicit movement toward one national market has changed this

situation. NSE has established satellite communications which give all

trading members of NSE equal access to the market. Similarly, BSE and

the Delhi Stock Exchange are both expanding the number of trading

terminals located all over the country. The arbitrages are eliminating

pricing discrepancies between markets.

The Indian capital market still faces many challenges if it is to promote

more efficient allocation and mobilization of capital in the economy.

First, market infrastructure has to be improved as it hinders the efficient

flow of information and effective corporate governance.

Second, the trading system has to be made more transparent.

Third, India may need further integration of the national capital market

through consolidation of stock exchanges.

Fourth, the payment system has to be improved to better link the bankingand securities industries.

The capital market cannot thrive alone; it has to be integrated with the

other segments of the financial system. The global trend is for the

elimination of the traditional wall between banks and the securities market.

Securities market development has to be supported by overall

macroeconomic and financial sector environments. Further liberalization of

interest rates, reduced fiscal deficits, fully market-based issuance of

Government securities and a more competitive banking sector will help inthe development of a sounder and a more efficient capital market in India.


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INFLUENCE OF FII ON INDIAN MARKET

Positive fundamentals combined with fast growing markets have made

India an attractive destination for foreign institutional investors (FIIs).

Portfolio investments brought in by FIIs have been the most dynamic

source of capital to emerging markets in 1990s. At the same time there isunease over the volatility in foreign institutional investment flows and its

impact on the stock market and the Indian economy.

Apart from the impact they create on the market, their holdings will

influence firm performance. For instance, when foreign institutional

investors reduced their holdings in Dr. Reddys Lab by 7% to less than18%, the company dropped from a high of around US$30 to the current

level of below US$15. This 50% drop is apparently because of concerns

about shrinking profit margins and financial performance. These instances

made analysts to generally claim that foreign portfolio investment has a

short term investment horizon. Growth is the only inclination for their

investment.

Some major impact of FII on stock market:

They increased depth and breadth of the market.

They played major role in expanding securities business. Their policy on focusing on fundamentals of share had caused efficientpricing of share.

These impacts made the Indian stock market more attractive to FII & also

domestic investors. The impact of FII is so high that whenever FII tend to

withdraw the money from market, the domestic investors fearful and they

also withdraw from market.


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Now we analyze the net investment graph from 2000-01 to Nov 30,2011.

From this, we can see that there is an increase in net investment till 2005-

06 and there is a small decrease in investment in 2006-07 and then again,

increase in 2007-08 and then again decrease in 2008-09. But there was asteep increase in the year 2009-10, 2010-11. This was the best period in

the India Stock Market where stock prices were increased and the market

was in good mood.

Effects of FII on Indian Economy

POSITIVE IMPACT: it has been emphasized upon the fact that the stock

market reforms like improved market transparency, automation,

dematerialization and regulations on reporting and disclosure standardswere initiated because of the presence of the FIIs. But FII flows can be

considered both as the cause and the effect of the stock market reforms.

The market reforms were initiated because of the presence of them and

this in turn has led to increased flows.

A.ENHANCED FLOWS OF EQUITY CAPITAL: FIIs are well known for a

greater appetite for equity than debt in their asset structure. For example,

pension funds in United Kingdom and United States had 68 per cent and

64 per cent, respectively, of their portfolios in equity in 1998. Not only it

can help in supplementing the domestic savings for the purpose of

development projects like building economic and social infrastructure but

can also help in growth of rate of investment, it boosts the production,

employment and income of the host country.

B.MANAGING UNCERTAINTY AND CONTROLLING RISKS: FIIs

promote financial innovation and development of hedging instruments.

These because of their interest in hedging risks, are known to havecontributed to the development of zero-coupon bonds and index futures.

FIIs not only enhance competition in financial markets, but also improve

the alignment of asset prices to fundamentals. FIIs in particular are known

to have good information and low transaction costs. By aligning asset

prices closer to fundamentals, they stabilize markets. In addition, a variety

of FIIs with a variety of risk-return preferences also help in dampening

volatility.


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C. IMPROVING CAPITAL MARKETS: FIIs as professional bodies of

asset managers and financial analysts enhance competition and efficiency

of financial markets. By increasing the availability of riskier long term

capital for projects, and increasing firms incentives to supply more

information about them, the FIIs can help in the process of economicdevelopment.

D. IMPROVED CORPORATE GOVERNANCE: Good corporate

governance is essential to overcome the principal-agent problem between

share-holders and management. Information asymmetries and incomplete

contracts between share-holders and management are at the root of the

agency costs. Bad corporate governance makes equity finance a costly

option. With boards often captured by managers or passive, ensuring the

rights of shareholders is a problem that needs to be addressed efficientlyin any economy. Incentives for shareholders to monitor firms and enforce

their legal rights are limited and individuals with small share-holdings often

do not address the issue since others can free-ride on their endeavor. FIIs

constitute professional bodies of asset managers and financial analysts,

who, by contributing to better understanding of firms operations, improvecorporate governance. Among the four models of corporate control -

takeover or market control via equity, leveraged control or market control

via debt, direct control via equity, and direct control via debt or relationshipbanking-the third model, which is known as corporate governance

movement, has institutional investors at its core. In this third model, board

representation is supplemented by direct contacts by institutional

investors.

NEGATIVE IMPACT: If we see the market trends of past few recent years

it is quite evident that Indian equity markets have become slaves of FIIs

inflow and are dancing to their tune. And this dependence has to a great

extent caused a lot of trouble for the Indian economy. Some of the factorsare:

A. POTENTIAL CAPITAL OUTFLOWS:Hot money refers to funds thatare controlled by investors who actively seek short-term returns. These

investors scan the market for short-term, high interest rate investment

opportunities. Hot money can have economic and financialrepercussions on countries and banks. When money is injected into a

country, the exchange rate for the country gaining the money strengthens,

while the exchange rate for the country losing the money weakens. If


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money is withdrawn on short notice, the banking institution will experience

a shortage of funds.

B. INFLATION: Huge amounts of FII fund inflow into the country creates a

lot of demand for rupee, and the RBI pumps the amount of Rupee in the

market as a result of demand created. This situation leads to excessliquidity thereby leading to inflation where too much money chases too few

goods.

C. PROBLEM TO SMALL INVESTORS: The FIIs profit from investing in

emerging financial stock markets. If the cap on FII is high then they can

bring in huge amounts of funds in the countrys stock markets and thushave great influence on the way the stock markets behaves, going up or

down. The FII buying pushes the stocks up and their selling shows the

stock market the downward path. This creates problems for the small retail

investor, whose fortunes get driven by the actions of the large FIIs.

D. ADVERSE IMPACT ON EXPORTS: FII flows leading to appreciation of

the currency may lead to the exports industry becoming uncompetitive due

to the appreciation of the rupee.

BSE SENSEX AND FII INVESTMENT CORRELATION

Sensex is the commonly used name for the Bombay Stock ExchangeSensitive Index an index Composed of 30 of the largest and mostactively traded stocks on the Bombay Stock Exchange (BSE). The term

FII is used most commonly in India to refer to outside companies investing

in the financial markets of India. FII investment is frequently referred to as

hot money for the reason that it can leave the country at the same speed

at which it comes in. In country like India; statutory agencies like SEBI

have prescribed norms to register FIIs and also to regulate such

investment flowing in through Fii .


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DateGross

Purchase(Cr)

Gross

Sale(Cr)

Net

Investment(Cr)

Cummulative

Investment($Mn)

03-Sep-13 2,078.70 2,805.00 -726.30 -108.59

02-Sep-13 2,516.20 2,014.40 501.80 76.19

FII Activity for the Year so far

MonthGrossPurchase

(Cr)

GrossSale

(Cr)

NetInvestment

(Cr)

CummulativeInvestment

($Mn)

January 2013 77,858.80 55,799.80 22,059.20 4,059.32

February 2013 78,888.30 54,449.10 24,439.30 4,575.56

March 2013 66,766.60 57,642.70 9,124.30 1,675.48
http://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Januaryhttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Februaryhttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Marchhttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Marchhttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Februaryhttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/January


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April 2013 61,007.30 55,593.10 5,414.10 1,000.27

May 2013 74,468.90 52,300.40 22,168.60 4,067.42

June 2013 55,321.40 66,348.50 -11,026.90 -1,852.15

July 2013 60,371.00 66,624.20 -6,253.30 -1,042.88

August 2013 69,308.40 75,231.10 -5,922.50 -902.51

September 2013 11,011.80 11,336.40 -324.60 -47.44

FII Activity for previous years

Year

Gross

Purchase

(Cr)

Gross

Sale

(Cr)

Net

Investment

(Cr)

Cummulative

Investment

($Mn)

2012 669,184.40 540,823.90 128,360.70 24,372.19

2011 611,055.60 613,770.80 -2,714.20 -357.83

2010 766,283.20 633,017.10 133,266.80 29,361.83

2009 624,239.70 540,814.70 83,424.20 17,458.14

2008 721,607.00 774,594.30 -52,987.40 -11,974.30

2007 814,877.90 743,392.00 71,486.30 17,655.80

2006 475,624.90 439,084.10 36,540.20 8,107.00

2005 286,021.40 238,840.90 47,181.90 10,706.30

2004 185,672.00 146,706.80 38,965.80 8,669.80

2003 94,412.00 63,953.50 30,459.00 6,627.60

2002 46,479.10 42,849.80 3,629.60 749.50
http://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Aprilhttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Mayhttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Junehttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Julyhttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Augusthttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Septemberhttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2012http://www.indiainfoline.com/MarketStatistics/FII-Activity/2011http://www.indiainfoline.com/MarketStatistics/FII-Activity/2010http://www.indiainfoline.com/MarketStatistics/FII-Activity/2009http://www.indiainfoline.com/MarketStatistics/FII-Activity/2008http://www.indiainfoline.com/MarketStatistics/FII-Activity/2007http://www.indiainfoline.com/MarketStatistics/FII-Activity/2006http://www.indiainfoline.com/MarketStatistics/FII-Activity/2005http://www.indiainfoline.com/MarketStatistics/FII-Activity/2004http://www.indiainfoline.com/MarketStatistics/FII-Activity/2003http://www.indiainfoline.com/MarketStatistics/FII-Activity/2002http://www.indiainfoline.com/MarketStatistics/FII-Activity/2002http://www.indiainfoline.com/MarketStatistics/FII-Activity/2003http://www.indiainfoline.com/MarketStatistics/FII-Activity/2004http://www.indiainfoline.com/MarketStatistics/FII-Activity/2005http://www.indiainfoline.com/MarketStatistics/FII-Activity/2006http://www.indiainfoline.com/MarketStatistics/FII-Activity/2007http://www.indiainfoline.com/MarketStatistics/FII-Activity/2008http://www.indiainfoline.com/MarketStatistics/FII-Activity/2009http://www.indiainfoline.com/MarketStatistics/FII-Activity/2010http://www.indiainfoline.com/MarketStatistics/FII-Activity/2011http://www.indiainfoline.com/MarketStatistics/FII-Activity/2012http://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Septemberhttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Augusthttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Julyhttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Junehttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/Mayhttp://www.indiainfoline.com/MarketStatistics/FII-Activity/2013/April


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2001 51,761.20 38,651.00 13,128.20 2,806.40

2000 74,791.50 68,421.60 6,370.08 1,532.60
http://www.indiainfoline.com/MarketStatistics/FII-Activity/2001http://www.indiainfoline.com/MarketStatistics/FII-Activity/2000http://www.indiainfoline.com/MarketStatistics/FII-Activity/2000http://www.indiainfoline.com/MarketStatistics/FII-Activity/2001


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INSTITUTIONAL INVESTORS REGISTERED IN INDIA:

MUTUAL FUNDS REGISTERED IN INDIA:

From the bar chart above it is clearly evident that the mutual fundindustry is still at a nascent stage as compared to the FII s. Since itsinception in 1964 when the first mutual fund i.e. UTI had the monopoly for

25 years. It was thus in the year after 1989 that public sector banks and

financial institution started their AMC .Finally in the third phase when

private players entered the arena, it lead to a fierce battle to hold the top

slot in the Indian mutual fund industry .The growing number of mutual

fund companies corroborates the fact that Indian public are now looking

for different avenues to invest their earnings and are confident on theworking of capital market in India. This shows that SEBI has in a way

restored the faith of these investors in spite of the different scams that

rocked the capital market in India.

FII REGISTERED IN INDIA:

Lets look at some of the data to get an idea about the trend of FIIs inIndia, and also to see the future direction of their movement.

India had 528 FIIs were registered with SEBI by end of 2001 and by endof Feb-2008 the number increased to1303. The trend in the number of

registered FIIs has been consistently on the rise as can be seen from

the table; showing the significant amount of confidence that Indian

Capital market has developed in the last few years.


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Not only has been the number increasing on a consistent basis, but the

amount of inflow into Indian market has also seen a manifold increased.

The gross purchase, sales and net investment figure on an annual basis

gives a fair idea about the consistency of their investments in our

country.

As we can see in the investment trends table, except for 1998, the net

investment by the FIIs in the Indian market has always been positivesince liberalization which to a large extent tells about the consistency of

their presence in Indian market. This is also evident from the fact that

the number of FII registering in India is increasing in spite of the fact that

SEBI has declined to issue any further PN notes and also asked them to

get registered. This shows that India still remains the hot spot for the

foreign investors in the coming years.


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MAJOR INSTITUTIONAL INVESTORS IN INDIA

The total number of Domestic institutional investors specially the mutual

funds is 40 in number. Similarly insurance companies and other banks arevery large in number. But out of these there are some heavy weights

which solely by their investments are among the top 5 domestic

institutional investors in India. Among the total FII registered i.e. 1303 by

the end of Feb. 2008 the top 5 FII in terms of their investment in India are

listed below.

DOMESTIC INSTITUTIONAL INVESTORS

LIFE INSURANCE CORPORATION OF INDIA.

Life Insurance in its modern form came to India from England in the year

1818. The first two decades of the twentieth century saw lot of growth

in insurance business. From 44 companies with total business-in-force as

Rs.22.44 crore, it rose to 176 companies with total business-in-force as


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Rs.298 crore in 1938. During the mushrooming of insurance companies

many financially unsound concerns were also floated which failed

miserably. However, it was much later on the 19th of January, 1956,

that life insurance in India was nationalized. About 154 Indian

insurance companies, 16 non-Indian companies and 75 provident wereoperating in India at the time of nationalization. Nationalization was

accomplished in two stages; initially the management of the companies

was taken over by means of an Ordinance, and later, the ownership too

by means of a comprehensive bill. The Parliament of India passed the

Life Insurance Corporation Act on the 19th of June

1956, and the Life Insurance Corporation of India was created on 1st

September,

1956, with the objective of spreading life insurance much more widely

and in particular to the rural areas with a view to reach all insurable

persons in the country, providing them adequate financial cover at a

reasonable cost.

LICs emergence as the biggest investor in the country should notsurprise anyone. The state-owned company is 51 years old and

enjoyed a state-sanctioned monopoly over the life insurance business

till 2000. The firm has issued 220 million policies and earned totalpremium income of Rs39, 541 crore in 2006-07. It is allowed to invest 35%

of its funds in equities.

The largest chunk in LICs portfolio is the stake it owns in listedengineering giant Larsen and Toubro Ltd. The 15.7% stake in L&T is

valued at more than Rs19, 642 crore. Other major investments include a

4.14% stake in Reliance Industries Ltd, the largest Indian company by

market capitalization, 7.2 % in ICICI Bank Ltd,

13.4% in ITC Ltd and 4.2 % in Reliance Communications Ltd.


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RELIANCE MUTUAL FUNDS:

Reliance Mutual Fund (RMF) is one of Indias leading Mutual Funds,with Average Assets Under Management (AAUM) of Rs. 90,938 Crores

(AAUM for Mar 08 ) and an investor base of over 66.87 Lakhs.Reliance

Mutual Fund, a part of the Reliance - Anil Dhirubhai Ambani Group, is one

of the fastest growing mutual funds in the country. Reliance Capital Ltd.

is one of Indias leading and fastest growing private sector financialservices companies, and ranks among the top 3 private sector financial

services and banking companies, in terms of net worth. Reliance Capital

Ltd. has interests in asset management, life and general insurance, privateequity and proprietary investments, stock broking and other financial

services.

ICICI PRUDENTIAL FUNDS:

ICICI Prudential Asset Management Company enjoys the strong

parentage of prudential plc, one of UK's largest players in the

insurance & fund management sectors and ICICI Bank, a well-

known and trusted name in financial services in India. ICICI

Prudential Asset Management Company, in a span of just over

eight years, has forged a position of pre-eminence in the Indian

Mutual Fund industry as one of the largest asset management

companies in the country with assets under management of Rs.

37,906.24 crore (as of March 31, 2007). The Company

manages a comprehensive range of schemes to meet the varying

investment needs of its investors spread across 68 cities in the

country. Upon its inception in May

1998 it manages 2 funds of Rs 160 Cr and has grown to manage 35

Funds worth Rs 62,008.95 Cr.


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UTI MUTUAL FUNDS:

UTI Mutual Fund came into existence on 1st February 2003. Bank of

Baroda (BOB), Punjab National Bank (PNB) and State Bank of India

(SBI) and Life Insurance Corporation of India (LIC) are the sponsors of

the UTI Mutual Fund. UTI Mutual Fund is managed by UTI Asset

Management Company Private Limited (AMC). UTI AMC is a

registered portfolio manager under the SEBI (Portfolio Managers)Regulations, 1993 for undertaking portfolio management services and

also acts as the manager and marketer to offshore funds. UTI Mutual

Fund has a nationwide network consisting 70 UTI Financial Centers

(UFCs) and UTI International offices in London, Dubai and Bahrain. The

fund has a track record of managing a variety of schemes catering to the

needs of every class of citizenry.

HDFC MUTUAL FUND:

HDFC (Housing Development Finance Corporation Limited) is one of the

dominant players in the Indian mutual fund space. HDFC was incorporated

in 1977 as the first specialized Mortgage Company in India. HDFC

Mutual Funds are handled by HDFC Asset Management Company

Limited. HDFC Asset Management Company was incorporated under the

Companies Act, 1956, on December 10, 1999, and was approved to act

as an Asset Management Company for the Mutual Fund by SEBI on July 3,

2000. The company also provides portfolio management / advisory

services.

FOREIGN INSTITUTIONAL INVESTORS:


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DEUTSCHE GROUP:

DWS Investments part of Deutsche Asset Management, was founded in

1956 in Frankfurt/Main. With fund assets under management of euro 267

bn, the company is one of the Top 10 companies worldwide. In Europe,

DWS is one of the leading mutual fund companies and currently manageseuro 173 bn. In excess of more than euro 147 bn assets under

management, DWS represents 22, 3% of the fund market in Germany,

making it the unchallenged number one.

The International nature of its business differentiates DWS significantly

from its domestic and international competitors. DWS Investmentsactivities span all the key European markets. In the USA, DWS is

represented by DWS Scudder and manages assets of euro 86 bn. In

spring 2006, it launched its first funds as well as the DWS brand inSingapore and India, continuing its successful expansion in the Asia-

Pacific region.


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CITIGROUP:

The formation of Citigroup in 1998 created a new model of financial

services organization to serve its clients financial needs. As the company

continues to grow and evolve, its increasingly evident that such a large,complex grouping of businesses can indeed succeed. With 275,000employees working in more than 100 countries and territories, Citigroupsglobality and diversity contribute to its continued success.

HSBC GLOBAL INVESTMENTS:

HSBC Investments is one of the world's premier

fund management organizations. It has established a strong

reputation with institutional investors including corporations, governments,insurance companies and charities the world over for delivering

consistently superior returns. In India we offer fund management

services for institutional as well as retail investors. Our array of products

includes Equity Funds Income /Debt Funds.

MORGAN STANLEY &CO INTERNATIONAL LTD:

Morgan Stanley is a global financial services firm and a market leader in

securities, investment management and credit services. It has more than

600 offices in 27 countries and manages $421 billion in assets for

institutional and individual clients around t h e world. Stanley

Investment Management (MSIM), the asset management company of

Morgan Stanley was established in 1975. Morgan Stanley entered Indian

market in 1989 with the launch of India Magnum Fund. In 1994, Morgan

Stanley launched Morgan Stanley Growth Fund (MSGF). It is one of the

largest private sector schemes investing in equities.

DSP MERRILL LYNCH :

DSP Merrill Lynch Mutual Funds are managed by DSP Merrill Lynch

Fund Managers. DSP Merrill Lynch Ltd. (DSPML) is a premier financial

services provider and Merrill Lynch (ML) holds 90% stake in DSPML.

DSPML was originally called DSP Financial Consultants Ltd. The firm traces

its origins to D. S. Purbhoodas & Co., a securities and brokerage firm

with over 140 years of experience in the Indian market. Merrill Lynch is one

of the world's leading wealth management, capital markets and advisory


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companies with offices in 37 countries and territories and total client assets of

approximately $1.5 trillion.

INVESTMENT TRENDS OF INSTITUTIONAL INVESTORS:

INVESTMENT TRENDS OF INDIAN MUTUAL FUND INDUSTRY:

The Assets under Management of UTI was Rs.4563 Cr by the end of

1987. Let me concentrate about the performance of mutual funds in India

through figures. From Rs.04563 Cr. the Assets under Management rose to

Rs. 32977 Cr in March 1993.

The net asset value (NAV) of mutual funds in India declined when stockprices started falling in the year 1992. Those days, the market regulations did

not allow portfolio shifts into alternative investments. There was rather no

choice apart from holding the cash or to further continue investing in shares.

A lone UTI with just one scheme in 1964 now competes with as many as

400 odd products and 34 players in the market. In spite of the stiff

competition and losing market share, Last six years have been the most

turbulent as well as exiting ones for the industry. New players have come in,

while others have decided to close shop by either selling off or merging withothers. Product innovation is now pass with the game shifting to

performance delivery in fund management as well as service. The industry is

also having a profound impact on financial markets. While UTI has always

been a dominant player on the bourses as well as the debt markets, the

new generations of private funds, which have gained substantial mass, are

now flexing their muscles. Fund managers, by their selection criteria for

stocks have forced corporate governance on the industry. Rewarding honest

and transparent management with higher valuations has created a system ofrisk- reward created where the corporate sector is more transparent then

before.

Funds collection has been increasing in last 5 years which can be attributed

to the fact of sound economic growth and the confidence of the retail

investors on the capital market of India.


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FOREIGN INSTITUTIONAL INVESTMENT

(FII) is one of the main channels of foreign investment in India. Foreign

institutional investors (FIIs) were permitted to invest in Indian securities

market in 1993. Since then, their investments into Indian equity market havegrown by leaps and bounds. In fact, FIIs, as a class of institutional

investors, have assumed a major role in mature and emerging market

economies, in recent years. The FII in the Indian equity markets has risen

steadily since 2003-04. The gross purchases of debt and equity together by

FIIs increased by 50.0 per cent to Rs. 5,20,508 crore in 2006-07 from Rs.

3,46,978 crore in 2005-06

INVESTMENTS BY FOREIGN INSTITUTIONAL INVESTORS

The gross sales by FIIs also rose by 60.3 per cent to Rs. 4, 89,667 crore

from Rs. 3, 05,512 crore during the same period. However, the net

investment by FIIs in 2006-07 declined by 25.6 per cent to Rs. 30,840 crore

in 2006-07 from Rs. 41,467 crore in 2005- 06 mainly due to large net

outflows from the equity segment. But the cumulative net investment by FIIs

in Indian stock market (since 1993) crossed USD 50 billion at the end of

March 2007. As on March 31, 2007, the cumulative net investment by FIIswas USD 52 billion. The cumulative net investment by FIIs at acquisition

cost, which was USD 15.8 billion at the end of March 2003, had risen to

USD 45.3 billion at the end of March 2006. The FII in equity, which was

high in the previous years, declined in 2006-07. During 2006-07, FIIs

reduced their investment, in both equities as well as debt securities. The net

FII investment in equity during 2006-07 was Rs. 25,236 crore, at its lowest

in past three years. This was mainly due to large net sales in some months of

2006-07.


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INVESTMENT TRENDS BY FII

As far as the investment trends of FII are considered we can see that the

trend and the actual investment go hand in hand except in 98-99 and 2003-

2004.The net investment flows by FIIs were negative during 1998-99

primarily because of the uncertainty that prevailed after India tested a series

of nuclear bombs in May 1998 and the imposition of economic sanctions by

the US, Japan and other industrialized countries but the FIIs portfolio flows

quickly recovered and have become a positive net investment from the

subsequent years onwards.

REASONS FOR GROWTH IN FII INVESTMENTS

Global liquidity is, of course, the primary cause of the recent surge in Asian

markets including India. Also low interest rate regime has led foreign

investors to look for fresh avenues to invest. This has resulted in most

emerging markets seeing heavy inflows.

FIIs see India as a good destination to invest in and make money. They arehappy with the Indian government's commitment to economic reforms.

They are also looking closely at sectors (and companies within these

sectors) which they think have potential. Infact, the growing competitivenessof Indian companies is an enticing factor.

Long-Term Capital Gains Tax: which is the tax an investor pays when he

sells his shares after more than a year -- has been abolished; thus one can

sell his shares without having to pay the government any kind of tax.

Rupee Appreciation: The dollar has been falling in value vis--vis

other currencies. As a result, FIIs dont find the thought of investing in the USmarket all that attractive. They know they will make more money if they invest

elsewhere. Economic Growth: As mentioned earlier we witnessed a GDP

growth rate of about 8.5% last year. Our industries like Telecom, Banking etc

are doing relatively well. All these make our country very attractive to invest

in.


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The sheer size of India and the relative stability the country offers are other

obvious plus points. Whatever the case may be, a perception is gaining

momentum that foreign investors are here to stay at least in the short-term.

FOREIGN INSTITUTIONAL INVESTMENT: A COST BENEFIT ANALYSIS

The role of foreign investment over the years cant be ignored . It certainlyhas had an impact on the Indian stock market with a lot of benefits but along

with these benefits there are a few costs attached with it. Therefore it is

useful to summarize the benefits and costs for India of having foreign

inflows.

BENEFITS

a)Re

ducedcost ofequity

FII inflows augment the sources of funds in the Indian capital markets. FII

investment reduces the required rate of return for equity, enhances stock

prices, and fosters investment by Indian firms in the country. The impact of

FIIs upon the cost of equity capital may be visualized by asking what stock

prices would be if there were no FIIs operating in India.

b) Stability in the balance of payment

For promoting growth in a developing country such as India, there is needto augment domestic investment, over and beyond domestic saving, through

capital flows. The excess of domestic investment over domestic savings

result in a current account deficit and this deficit is financed by capital flows

in the balance of payments. Prior to 1991, debt flows and official

development assistance dominated these capital flows. This mechanism of

funding the current account deficit is widely believed to have played a role

in the emergence of balance of payments difficulties in 1981 and 1991.

Portfolio flows in the equity markets, and FDI, as opposed to debt-creatingflows, are important as safer and more sustainable mechanisms for funding

the current account deficit.

c) Knowledge flows

The activities of international institutional investors help strengthen Indian

finance. FIIs advocate modern ideas in market design, promote innovation,

development of sophisticated products such as financial derivatives,

enhance competition in financial intermediation, and lead to spillovers of


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human capital by exposing Indian participants to modern financial

techniques, and international best practices and systems.

d) Strengthening corporate governance

Domestic institutional and individual investors, used as they are to theongoing practices of Indian corporate, often accept such practices, even

when these do not measure up to the international benchmarks of best

practices. FIIs, with their vast experience with modern corporate

governance practices, are less tolerant of malpractice by corporate

managers and owners (dominant shareholder). FII participation in domestic

capital markets often lead to vigorous advocacy of sound corporate

governance practices, improved efficiency and better shareholder value.

e) Improving market efficiency

A significant presence of FIIs in India can improve market efficiency through

two channels. First, when adverse macroeconomic news, such as a bad

monsoon, unsettles many domestic investors, it may be easier for a

globally diversified portfolio manager to be more dispassionate about

India's prospects, and engage in stabilizing trades. Second, at the level of

individual stocks and industries, FIIs may act as a channel through whichknowledge and ideas about valuation of a firm or an industry can more

rapidly propagate into India. For example, foreign investors were rapidly

able to assess the potential of firms like Infosys, which are primarily export-

oriented, applying valuation principles that prevailed outside India for software

services companies.


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COSTS

a) Hedging and positive feedback training

There are concerns that foreign investors are chronically ill informed about

india, and this lack of sound information may generate herding (a largenumber of FIIs buying or selling together) and positive feedback (buying

after positive returns, selling after negative returns).These Kinds of

behavior can exacerbate volatility ,and push prices away from fair values.

b) Balance of payment vulnerability

There are concerns that in an extreme event, there can be a massive flight

of foreign capital out of India, triggering difficulties in the balance of

payments front. India's experience with FIIs so far, however, suggests thatacross episodes like the Pokhran blasts, or the 2001 stock market scandal,

no capital flight has taken place. A billion or more of US dollars of portfolio

capital has never left India within the period of one month. When

juxtaposed with India's enormous current account and capital account

flows, this suggests that there is little vulnerability so far.

c) Possibility of takeovers

While FIIs are normally seen as pure portfolio investors, without interest in

control, portfolio investors can occasionally behave like FDI investors, and

seek control of companies that they have a substantial shareholding in.

Such outcomes, however, may not be inconsistent with India's quest for

greater FDI. Furthermore, SEBI's takeover code is in place, and has

functioned fairly well, ensuring that all investors benefit equally in the event

of a takeover.

DETERMINANTS OF FOREIGN INSTITUTIONAL INVESTMENT

After the initiation of economic reforms in the early 1990s, the movement of

foreign capital flow increased very substantially. There are a lot of factors

that determine the nature and cause of foreign institutional investment in a


41/60

country a few of them being inflation exchange rate equity returns,

government policies, price earring ratio and risk. Now if we try to analyze

the relation of each of these factors with the level of foreign inflow in the

country, we might have a better understanding. Let us broadly classify the

factors into inflation, risk and stock market returns and understand the basicprinciple behind the inflows.

a) Equity returns- An increase in the return in the foreign market will

induce investors to withdraw from the Indian (domestic) stock market to

invest in the foreign market. Investors are believed to follow a higher return,

hence when the return in the domestic market increases, FII flows to the

domestic market. While the flows are highly correlated with equity returns in

India, they are more likely to be the effect than the cause of these returns. .

It is assumed that the equity returns have a positive impact on the FIIinflow but foreign investors can also get involved in profit booking. They

can buy financial assets when the prices are declining, thereby jacking-up

the asset prices and sell when the asset prices are increasing and hence

be the cause of such returns so making it more of a bi-directional

relationship.

b) Risk- Investors are considered to be risk averse, hence when risk in

the domestic market increases they will withdraw from the domestic

market, when risk in the foreign market increases, investors will withdraw

from the foreign market and invest in the Indian (domestic) market.

Investments, either domestic or foreign, depend heavily on risk factors.

Hence, while studying the behavior of FII, it is important to consider the risk

variable. Risk can be divided into ex-ante and unexpected risk. While the

ex-ante risk certainly has an inverse relation with the foreign investment

nothing can be clearly said about the unexpected risk.

c) Inflation- The inflation no doubt has an inverse relation with the foreigninvestment inflow as the investor would keep in mind the purchasing power

of the funds invested and as inflation increase i.e. the purchasing power

declines the investor is most likely to withdraw his money. When inflation in

the domestic country increases, the purchasing power of the funds invested

declines, hence investors will withdraw from the domestic market. Similarly,

when inflation in the foreign country increases, the purchasing power of

funds invested in the foreign country declines, causing institutional


42/60

investors to withdraw from the foreign market and make investment in

the domestic (Indian) market.

d) Exchange rateWhen the value of the home currency is stronger theFII investments will also increase as the percentage of returns the FII get

automatically increases and vise versa.

So it can be said that the inflation and risk in the domestic country and

return in the foreign country adversely affect the FII flowing to the domestic

country, whereas inflation and risk in the foreign country and return in the

domestic country have a favorable effect on the flow of FII.


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COMPARISON BETWEEN FIIs AND MUTUAL FUNDS INVESTMENTS

The comparison between the FII purchases and net investment with Mutual

funds for the period reveals some interesting information.

The amount of mutual fund investment in our country is very meager ascompared to that of FIIs. It means that Indian public is still not putting its bet

on mutual funds and.

FIIs are much more aggressive in nature than mutual funds, which seem to

have been very constant in their approach to the Indian equity market.

Since May04, when the stock market crashed by 800 points in a day, themarket has recovered smartly and the FIIs have been able to cash on to

the gains by buying Value stocks during the lean periods, or buying on thedips. While the mutual funds have seems to taken a different routealtogether and have been net sellers for most of the period since May04.

But after the year 2004 mutual Fund investment have also a tremendous

increase. There activity is the proof of the condition that has prevailed in

the capital market recently that has created a lot of faith among the retail

investors also.

Also in the year 2007 has so far been the best year for mutual fund

industry as it has shown a tremendous growth in terms of net investment.

This corroborates the fact that now Indian public has started recognizing

mutual fund as tool for investing in the capital market in India.


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ROLE OF INSTITUTIONAL INVESTORS IN CAPITAL MARKET IN INDIA:

As the Indian capital market opened its gates for the foreign institutional

investors. With time there has been an increasing trends of their

participating in the capital market. With there increasing participation there

has been a lot of effect on many parameters of the Indian capital market.

The major effect of the increasing participation of the institutional investors

has been observed in the following areas.

Liquidity: Market liquidity is a business, economics orinvestment term that

refers to an asset's ability to be easily converted through an act of buying or

selling without causing a significant movement in the price and with

minimum loss of value. An act of exchange of a less liquid asset with a more

liquid asset is called liquidation. Liquidity also refers both to that quality of a

business which enables it to meet its payment obligations, in terms of

possessing sufficient liquid assets; and to such assets themselves.

A liquid asset has some or more of the following features. It can be sold (1)

rapidly, (2) with minimal loss of value, (3) anytime within market hours. The

essential characteristic of a liquid market is that there are ready and willing

buyers and sellers at all times. An elegant definition of liquidity is also the

probability that the next trade is executed at a price equal to the last one. A

market may be considered deeply liquid if there are ready and willing buyersand sellers in large quantities. This is related to a market depth, where

sometimes orders cannot strongly influence prices. The liquidity of a product

can be measured as how often it is bought and sold; this is known as

volume. Often investments in liquid markets such as the stock exchange or

futures markets are considered to be more liquid than investments such as

real estate, based on their ability to be converted quickly. Some assets with

liquid secondary markets may be more advantageous to own, are willing to

pay a higher price for the asset than for comparable assets without a liquidsecondary market.

Price building mechanism: With the increasing participation of the

institutional investors in the capital market, it has also helped the different

companies to raise funds for their use through the capital market in India.

Earlier the companies use to go for debt financing which has a cost

attached to it and also in those days the cost of issuing an IPO was higher

as compared to the funds that were being generated by the companies.
http://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Economicshttp://en.wikipedia.org/wiki/Investmenthttp://en.wikipedia.org/wiki/Pricehttp://en.wikipedia.org/wiki/Market_depthhttp://en.wikipedia.org/wiki/Investmenthttp://en.wikipedia.org/wiki/Stock_exchangehttp://en.wikipedia.org/wiki/Futures_marketshttp://en.wikipedia.org/wiki/Real_estatehttp://en.wikipedia.org/wiki/Real_estatehttp://en.wikipedia.org/wiki/Futures_marketshttp://en.wikipedia.org/wiki/Stock_exchangehttp://en.wikipedia.org/wiki/Investmenthttp://en.wikipedia.org/wiki/Market_depthhttp://en.wikipedia.org/wiki/Pricehttp://en.wikipedia.org/wiki/Investmenthttp://en.wikipedia.org/wiki/Economicshttp://en.wikipedia.org/wiki/Business


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With the help of FII the market has become more competitive, fair value of

their.

Role of speculation: Generally people transact for three reasons hedging

speculating and arbitraging Hedgers are those to intend to hedge their risk.

Speculation may be defined as the purchase or sale of a good with a view to

resale or repurchase at a later date, where the motive behind such action is

the expectation of changes in the prices.

Speculation is one of the most watched activity in any capital market its

importance varies in different countries in countries like in US it forms an

integral part of the market whereas in developing countries like India itstaken as a threat. It is often believe that speculators even out the price

fluctuation by due to change in demand and supply condition but the

concerns about the adverse effects of speculation come from two

sources. First, the possibility that speculation, instead of evening out price

fluctuations, may end up exacerbating such fluctuations. Second, is

the problem of speculation destabilizing rather than stabilizing prices

and hence affecting resource allocation. Through speculation, future

expected price not only depends on, but also has an impact on the spot

price.

The market for shares is subject to much larger fluctuations than themarket for bonds or even commodities. Shares represent a share in the

expected future profits of a company.

When fortunes of companies both in the short run as well as in themedium to long run fluctuate, so do share prices. Uncertainty regardingthe future leads to heavy discounting of future profits, and to focus on

short-period expectations about capital value rather than long-period

prospects of the company.

The effect of foreign speculative activity in emerging markets can be

particularly beneficial if in the emerging market, liquidity is poor First,

the potential of market manipulation is acute in small emerging markets

and liquidity is often poor. Although there are many policy initiatives that

could increase liquidity and reduce the degree of collusion among large

traders, there may not be a sufficient mass of domestic speculators to

ensure market liquidity and efficiency. Second, opening the market to


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foreign speculators may increase the valuation of local companies, thereby

reducing the cost of equity capital.

Volatility: Volatility most frequently refers to the standard deviation ofthechange in value of a financial instrument with a specific time horizon. It is

often used to quantify the risk ofthe instrument over that time period.

Volatility is typically expressed in annualized terms, and it may either be an

absolute number ($5) or a fraction of the mean (5%). Volatility is often

viewed as a negative in that it represents uncertainty and risk. However,

volatility can be good in that if one shorts on the peaks, and buys on the

lows one can make money, with greater money coming with greater

volatility. The possibility for money to be made via volatile markets is how

short term market players like day traders hope to make money, and is in

contrast to the long term investment view ofbuy and hold. In today's

markets, it is also possible to trade volatility directly, through the use of

derivative securities such as options and variance swaps. Foreign

institutional investment is certainly volatile in nature and its volatility has

certainly posed some threats to the Indian stock market considering its

influence on the market. Given the presence of foreign institutional investors

in Sensex companies and their active trading behavior, small and periodic

shifts in their behavior lead to market volatility. Such volatility is an

inevitable result of the structure of Indias financial markets as well.Markets in developing countries like India are thin or shallow in at least

three senses. First, only stocks of a few companies are actively traded in

the market. Thus, although there are more than 8,000 companies listed on

the stock exchange, the BSE Sensex incorporates just 30 companies,

trading in whose shares is seen as indicative of market activity. Second, of

these stocks there is only a small proportion that is routinely available for

trading, with the rest being held by promoters, the financial institutions andothers interested in corporate control or influence. And, third the number of

players trading these stocks is also small.

In such a scenario investment by the foreign institutional investors leads to

a sharp price increase this provides incentives to FII investment and

enhances investment and when the correction in the stock prices begins it

would have to be a pull out by the FII and can result in sharp decline in the

prices. The other reason for volatility is that the foreign institutional investors
http://en.wikipedia.org/wiki/Standard_deviationhttp://en.wikipedia.org/wiki/Financial_instrumenthttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Short_sellinghttp://en.wikipedia.org/wiki/Day_tradershttp://en.wikipedia.org/wiki/Investmenthttp://en.wikipedia.org/wiki/Buy_and_holdhttp://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Variance_swaphttp://en.wikipedia.org/wiki/Variance_swaphttp://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Buy_and_holdhttp://en.wikipedia.org/wiki/Investmenthttp://en.wikipedia.org/wiki/Day_tradershttp://en.wikipedia.org/wiki/Short_sellinghttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Financial_instrumenthttp://en.wikipedia.org/wiki/Standard_deviation


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are attracted to a market by the expectation of price increase that tend to

be automatically realized, the inflow of foreign capital can result in an

appreciation of the rupee vis--vis the dollar This increases the return earned

in foreign exchange, when rupee assets are sold and the revenue

converted into dollars. As a result, the investments turn even moreattractive triggering an investment spiral that would imply a sharper fall

when any correction begins. Apart from that the growing realization by the

FIIs of the power they wield in what are shallow markets, encourages

speculative investment aimed at pushing the market up and choosing an

appropriate moment to exit. This manipulation of the market would

certainly enhance the volatility and in volatile markets even the

domestic investors try to manipulate the market when the prices are really

high. Overall the foreign institutional investors have been bullish on the

Indian stocks but the problem is that this bullish nature might be a result of

the activities outside the Indian market it might be due to the performance of

their equity market or their non equity returns. Therefore they seek out for

best returns and diversified geographical portfolio in order to hedge their risk

and when they make some adjustments in their portfolio and make shifts in

favor or against a country it borings about sharp changes.


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A STUDY OF MAJOR EPISODES OF VOLATILITY

Asian Major Episodes of Volatility

Excess volatility induced by the foreign investment is often taken as an

argument against liberalization with such incidences happening in thepast. Let us now try to find out whether the foreign investors in particular

destabilize the capital market beyond a level. The two most common

examples of such destabilization caused by the portfolio investment

particularly the hedge funds are the Asian crisis of 1997 and the ERM

crisis of 1992.

I. ERM crisisThe high-profile ERM crisis of 1992 came with speculatorsbetting that the member countries of the European Monetary System

(EMS) were converging to the European Monetary Union (EMU), andhigh-inflation countries would have to realign their exchange rates, but the

extent of depreciation would be less than the interest rate differential

between the high-inflation and low-inflation countries. The expectation

regarding the extent of exchange rate adjustment led to carry tradeborrowing from the low interest ERM countries and lending to the high

interest countries, or in the forward currency market, taking a long position

in the higher yielding currency and shorting the lower-yielding currency. In

spite of the material impact of hedge fund activities in the ERM crisis, therole of the hedge funds in the crisis was limited. The practice of extending

lines of credit to offshore entities on a non-recourse basis against collateral

was not widely accepted by most banks, and foreign exchange trading was

primarily an inter-bank activity.

East Asian crisis After ten years (198697) of pegging of the Thai baht tothe U.S. dollar, on July 2, 1997, the peg had to be abandoned, and this

created pressure on other Asian currencies, and eventually brought down

the Malaysian ringgit, the Indonesian rupiah, the Philippine peso, and theKorean won. By end-1997, these currencies had lost between 44 and 56

percent of their value against the U.S. dollar, bankrupting many Asian

corporations and banks that had borrowed in foreign currencies, and

leading to a significant contraction of the economies. This episode is

known as the East Asian crisis or Asian crisis.Foreign investors were often

blamed for the dramatic difficulties of the East Asian countries at the times

of the 1997 crisis. It was believed that the developing countries were more

vulnerable to vacillations in international flows than ever before A variety of


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reasons are adduced to explain why foreign investors can have a

destabilizing effect on capital markets in emerging economies. Foremost

among them are the pursuit of a positive feedback strategy that is buying

when prices are rising and selling when prices are falling, thereby

exacerbating both the upswings and downswings. Positive feedback leadsto bubbles when prices depart from fundamentals and to crashes when

bubbles burst. It is also believed that the Asian financial crisis was the result

of a panic created in the market Prime Minister Mahathir Mohammed of

Malaysia accused hedge funds of being the modern equivalent of

highwaymen in breaking the Asian currencies. Aggressive flow of thecarry trade down the credit spectrum in Asia during the 1990s fromsovereign credit, to top -tier domestic commercial banks, to lower-tier

commercial banks and finance companies, and finally to firms. The

excessive build-up of foreign debt, they attribute to the confidence of

domestic companies and banks in the fixed official exchange rate. FII

investment in equities had little role to play in the crisis. Fung, Hsieh, and

Stsatsaronis (2000) report At the height of the episode, some Asiangovernment officials accused speculators and hedge funds of attacking the

currencies and causing their downfall. A public debate ensued, and the

International Monetary Fund (IMF) responded by examining the role of

hedge funds in the Asian currency crisis.

During the stock market scam which shook the capital market in India the

FII were also one of the major factors which exacerbate the fall in the

sensex. During the Black Monday episode the FII were also on a heavy

selling spree which ultimately lead to some major fall in the sensex value.

FII investment behavior during these four specific events indicates that

these events did affect the behavior of the foreign portfolio investors. But,

these events did affect domestic investors behavior as well.

These experiences show that FII outflow of as much as a billion dollars in

a month which corresponds to an average of $40 million or Rs.170 croreper day has never been observed. These values Rs.170 crore per day

are small when compared with equity turnover in India. In calendar2004, gross turnover on the equity market of Rs.88 lakh crore contained

Rs.5 lakh crore of gross turnover by FIIs. This suggests that as yet, FIIs

are a small part of the Indian equity market. Transactions by FIIs of Rs.5

lakh crore in a year might have been large in 1993, but the success of a


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radical new market design in the Indian equity market have led to enormous

growth of liquidity and market efficiency on the equity market. Through this,

Indias ability to absorb substantial transactions on the equity marketappears to be in place.

The net FII inflows into India have been less volatile compared to

other emerging markets this stability could be attributed to several

factors: Strong economic fundamentals and attractive valuation of

companies. Improved regulatory standards, high quality of disclosure and

corporate governance requirement, accounting standards, shortening of

settlement cycles, efficiency of clearing and settlement systems and risk

management mechanisms. Product diversification and introduction

derivatives. Strengthening of the rupee dollar exchange rate and low interest

rates in the US.

Post 2004 Major Volatile Episodes:

As from the above graph it is clear that in the month of jan 2008 the BSE

sensex was already moving down due to the weak global cues and US

recession and similarly the FII investment fell drastically during that period

running panick among the investors

and further exacerbating the fall. But in the case of mutual fund investment

went up during the time shows that the the domestic institutional investors

cash on the fall of sensex because of the strong fundamentals of the Indian

capital market.

By looking at the above graph we can very well say that this time around the

fall of BSE sensex was majorly due to the FII which went on a selling spree

which lead to the fall of the market during this Crash.FII acted in this fashion

because of the weak global cues i.e at that point of time other emerging

markets were also down .The fall of 769 points by sensex on Dec 17,2007 was attributed to the fact

mainly due to the subprime losses and also was exacerbated due to the

withdrawal of investments by the FII. As the subprime losses mainly hit the

US economy and the majority of FII participating in the Indian capital market

are from US .To cover there losses in US they started selling in India which

lead to the fall of sensex on that particular day and subsequent days.


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During the month of October 2007 Indian Govt. took some strict measure to

control the usage of the Participatory notes. The restrictions proposed by

SEBI in regulating participatory notes in a sudden announcement wrought

havoc in the operations of the share market causing a fall of over 1,700

points in the Sensex on W

Role of FII in Indian Capital Market

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