Investment From Abroad is Right or Wrong?

INTRODUCTION				the free float available has been bagged by FIIs -
One of the outstanding features of globalization in				despite the fact that they invest in just a few
the financial services industry is the increased				highly liquid stocks.
access provided to non-local investors in several				Though India receives hardly 1 percent of the FII
major stock markets of the world. Increasingly,				investments in emerging markets, the portfolio
stock markets from emerging markets permit				flows to India have been less volatile when
institutional investors to trade in their domestic				compared with that of many other emerging
markets. Indian stock market opened to Foreign				markets (Gordan and Gupta, 2003). FIIs by
Institutional Investors in 14th September 1992,				adopting a bottom-up approach seem to invest in
initially with lot of restrictions. The regulation on				top-quality, high growth, large cap stocks (Gordan
them are liberalized and minimized now, since 1993				and Gupta, 2003). Sytse et al. (2003) provide
has received a considerable amount of portfolio				empirical evidence that foreign institutional
investment from foreigners in the form if FIIs				investors in India, invest in large, liquid companies
investment in equities. This has become a turning				which enable them to exit their positions quickly at
point of India stock market. The government of				relatively lower cost and also that the foreign
India announced the policy of the government to				institutional owners have a larger impact than
permit the FII investment in India capital market.				foreign corporate owners when performance is
According to the SEBI modified the regulation on				measured using stock market valuation criterion.
14-11-1995. In order to make investment in India				India is one of the fastest growing economies in
equity market they wanted to register with				South Asia, promising a growth of over 9
Security Exchange Board of India as foreign				percent, second only to China, it would not be a
institutional investors. It is possible for foreigners				surprise to see increased FII flows to India in the
to trade in India securities without registering as				future. FIIs are now looking at the economy as a
Foreign Institutional investors, but such cases				whole, with the macro-economic factors also
require approval from Reserve Bank of India or				playing their role in attracting foreign investors.
the Foreign Institutional Promotion Board. They				Factors like a strong currency, key reforms in the
are generally concentrated in secondary market.				banking, power and telecommunications sector,
Domestic market alone not able to meet the				increased consumer spending and stable policies
growing capital requirement of the country and				are expected to play a major role in attracting
financing from mutilated institution has lost				FIIs to India. The Securities Exchange Board of
primary in the emerging in the global order				India (SEBI) along with the Institute of Chartered
.Besides aimed primarily at ensuring non-debt				Accountants of India (ICAI) jointly monitor the
creating capital inflows at a time of extreme				markets and announces the regulatory measures
balance of payment crisis. It was to tie over the				thus making the Indian companies more
balance of payment crisis in the early 1990s				transparent and more disciplined.
Portfolio flows often referred to as 'hot- money'				According to the April 2005 report on corporate
are notoriously volatile capital flows. They have				governance by CLSA Emerging Markets, India
also responsible for spreading financial crisis				ranks fourth with a score of 55.6 percent. Banaji
causing contagion in international market. Evan				(2000) emphasizes that the capital market
though, the FIIs have been plying a key role in				reforms like improved market transparency,
the financial markets since their entry into this				automation, dematerialization and regulations on
country. The explosive portfolio flow by FII brings				reporting and disclosure standards were initiated
with them great advantages as they are engine				because of the presence of the FIIs. But FII
of growth, lowering cost of capital in many				flows can be considered both as the cause and
emerging market. This opening up of capital				the effect of capital market reforms. The market
markets in emerging market countries has been				reforms were initiated because of the presence
perceived as beneficial by some researchers while				of FIIs and this in turn has lead to increased flows.
others are concerned about possible adverse				The Government of India gave preferential
consequences.				treatment to FIIs till 1999-2000 by subjecting
Clark and Berko (1997) emphasize the beneficial				their long term capital gains to lower tax rate of
effects of allowing foreigners to trade in stock				10 percent while the domestic investors had to
markets and outline the “base-broadening”				pay higher long-term capital gains tax. The
hypothesis. The perceived advantages of				Indo-Mauritius Double Taxation Avoidance
base-broadening arise from an increase in the				Convention 2000 (DTAC), exempts
investor base and the consequent reduction in risk				Mauritius-based entities from paying capital gains
premium due to risk sharing. Other researchers				tax in India - including tax on income arising from
and policy makers are more concerned about the				the sale of shares. This gives an incentive for
attendant risks associated with the trading				foreign investors to invest in Indian markets
activities of foreign investors. They are particularly				taking the Mauritius route. Consequently, we now
concerned about the herding behavior of foreign				see investments coming from Mauritius while
institutions and the potential destabilization of				there were none before 2000.
emerging stock markets.				The country wise distribution of the FIIs
This study addresses these issues in the context				registered in India, with majority of them coming
of foreign institutional investors’ (FII) trading				from USA and UK. Chakrabarti (2002) and Rao et
activities in a big emerging market – India.				al. (1999) point out the fact that due to existing
India liberalized its financial markets and allowed				inter-linkages, the source of the FII investment
FIIs to participate in their domestic markets in				might not be the country from where the
1992. Ostensibly, this opening up resulted in a				institution operates. Nevertheless, the figure gives
number of positive effects. First, the stock				us an idea of the country wise distribution of the
exchanges were forced to improve the quality of				FIIs in India. So as to encourage long term
their trading and settlement procedures in				investments in the Indian market, Budget 2003
accordance with the best practices of the world.				proposed that investors who buy stocks of listed
Second, the information environment in India				companies from March 1, 2003 be exempt from
improved with the advent of major international				paying tax on the gains they make on their
financial institutional investors in India. On the				investments, provided they hold them for more
negative side we need to consider potential				than one year. With so much to benefit from, the
destabilization as a result of the trading activity of				FII investment in India is likely to increase in the
foreign institutional investors. This is especially				future.
important in an emerging country that has				Regulation on FII
embarked upon reforms to open up its market.				Investment by FII was jointly regulated by
OBJECTIVES The objectives of this study were				Securities and Exchange Board of India (SEBI)
as follows;				through the SEBI (Foreign Institutional Investors)
(1) To study the role of FII investment in the				Regulations, 1995 and by the Reserve Bank of
Indian stock market, ( 2 ) To examine the causal				India through Regulation 5(2) of the Foreign
relationship between net FII investment and BSE				Exchange Management Act (FEMA), 1999. The
sensex using granger causality test (3) To				promulgation of legislation pertaining to foreign
examine the causal relationship between net FII				investment by SEBI in 1995 market a watershed
investment and NSE sensex using granger				for FII flows to India; this led to a significant
causality test (4 )To examine whether FIIs were				increase in the level of FII equity inflows in the
a channel of global disturbance into the Indian				pre-Asian crisis period. The SEBI FII Regulations
stock market.				and RBI policies are amended and modified from
TOOLS: Study was carried out with the help of				time to time in response to the gradual maturing
unit root test, co integration test, causal				of the Indian financial market and changes taking
regression and F statistics for FII investment and				place in the global economic scenario.
index from BSE and NSE				In order to trade in India equity market, foreign
LETERATURE REVIEWS				corporation need to register with SEBI as Foreign
Gayathri Devi .R in 2003, she conducted study on				Institutional Investors. Without registration they
“Causal Relationship between FIIs and Stock				can invest, but cases require the approval from
Market: A critical study”. It revealed that				RBI. They are generally concentrated in
there was long run relationship between net FII				secondary market. FII are allowed to invest ina)
investment and sensex, FII investment did not				Securities in primary and secondary market
respond the short-run changes or				including shares, debentures and warrant of
technical-position of the market and they were				companies, unlisted, listed or to be the listed in
more driven by fundamentals, and FII				India.b) Units of mutual fundsc) Dated government
investments did granger cause India stock				securitiesd) Derivative traded in a recognized
market. “Selen Serisoy Guerin” in 2006,				stock market ande) Commercial papers
conducted study on “The Role of Geography				FII can invest their own funds as well as invest on
in Financial and Economic Integration: A				behalf of their over seas clients registered as
comparative Analysis of foreign direct investment,				such with SEBI. These client accounts that the FII
Trade and Portfolio Investment Flows”.. It				manages are known as 'sub accounts'. FII sub
found support for the argument that most FDI				accounts include those foreign corporate, foreign
among Industrial countries were horizontal,				individual, institution funds or portfolio established
whereas most FDI investment in developing				or incorporated out side India.
countries was vertical and our results indicated				FII may issue deal in or hold off share derivative
that portfolio investment flows compared to FDI,				instrument such as participatory notes (PN). The
were highly sensitive to change in GDP per capita,				entities that can subscribe to the PN are : a) Any
this implied that if there was a negative output				entity incorporated in a jurisdiction that requires
stock, portfolio investment flows would be more				filing of constitutional or other documents with a
volatile than FDI. A.Julia Priya, D. Lazar and Joseph				registrar of companies or comparable regulatory
Jeyapual in 2005, they conducted study on				agency or body under the applicable companies
“Role of Foreign Institutional Investors on				legislation in that jurisdiction; b) Any entity that is
stock market development in India”, Results				regulated, authorized or supervised by a central
revealed that sensex, market capitalization of				bank, such as the Bank of England, or any other
NSE, Turnover of BSE and NIFTY without market				similar body provided that the entity must not
capitalizations were influenced by Foreign				only be authorized but also be regulated by the
Institutional Investors“Suchismita Bose and				aforesaid regulatory bodies; c) Any entity that is
Dipankor coondoo” in 2004, they conducted				regulated, authorized or supervised by a securities
study on “The Impact of FII Regulation in				or futures commission, such as the Financial
India”,. These results strongly suggested The				Services Authority or other securities or futures
liberalization policies had the desired expansionary				authority or commission in any country , state or
effect and had either increased the mean level of				territory ; d) Any entity that is a member of
FII inflows and/or the sensitivity of these flows				securities or futures exchanges such as the New
to a change in BSE returns and /or the				York Stock Exchange or other self-regulatory
Parthapratim pal in 2004 conducted study entitled				securities or futures authority or commission
as “Recent volatility in stock markets in India				within any country, state or territory provided
and foreign institutional investors. Findings of this				that the aforesaid mentioned organizations which
study indicated that Foreign institutional investors				are in the nature of self- regulatory organizations
had emerged as the most dominant investor				are ultimately accountable to the respective
group in the domestic stock market in India.				securities financial market regulators.
Particularly, in the companies that constitute the				Investment limit
Bombay stock market sensitivity index, their level				As per the September 1992 policy permitted
of control was very highinertia of these flows.				foreign institutional investment registered FII could
“sandhya Ananthanaryanan, Chandrasekhar				individually invest in a maximum of 5% of a
krishnamurthi and Nilajan Sen in 2003 conducted				company's issued capital and all FIIs together up
study as “Foreign institutional Investors and				to a maximum of 24%. From November 1996
Security Returns: Evidence from Indian Stock				are allowed to make 10 percentage investment in
Exchanges”, It found strong evidence				debt securities subject to the specific approval
consistent with the base-broadening hypothesis.It				from SEBI as a separate category of FIIs or sub
did not find compelling confirmation regarding				accounts as 100% debt fund investment such
momentum or contrarian strategies being				investment were of occurs subjected to the fund
employed by FIIs.It supported price pressure				specific ceiling prescribed by SEBI and had to be
hypothesis.				within overall ceiling US 1.5 $. The investment was
It did not find any substantiation to the claim that				however, restricted to the debt instrument of
foreigner’ destabilize the market. J.S. Pasricha				companies listed or to be listed on the stock
and Umesh.C.Singh in 2001, tried to analyze the				exchanges. In 1997, the aggregate limit on
impact of FIIs investment on Indian capital				investment by FIIs was allowed to be raised from
market. Their study revealed that FII are here to				24% to 30% by then board of directors of
stay and have become the integral part of Indian				individual companies by passing a resolution in their
capital market. Their entry has led to greater				meeting and by special resolution to that effect in
institutionalization of the market. They have				the company's Board meeting. In June 1998 the
brought transparency in the market				5% individual limit was raised to 10%.In March
operations.S.S.S. Kumar in 2001, attempted in his				2000, the ceiling on aggregate FII portfolio
study to find the effect of FIIs on the Indian				investment increased to 49%.This was
stock market. The inference analysis of the paper				subsequently raised to 49%, on March 8 2001,
suggests that FII investments are more driven by				Finance minister announced February 28 2002
market fundamentals rather than by short term				that foreign institutional investors can invest in
changers or technical position of the market. As				accompany under the portfolio investment rout
per K. Seethapathi and V. Subbulakshmi study				beyond 24% of the paid up capital of the
entitled “Foreign investment: Need for				company with the approval of the general body
focus”, They concluded that, the flows have				of the share holders by a special resolution.
to pick up. The political will is to be demonstrated				Benefits and costs of FII investments
by the government. In addition, the regulators				The terms of reference asking the Expert Group
have to identify the reasons for failure in				to consider how FII inflows can beencouraged and
converting approvals into actual investments and				examine the adequacy of the existing regulatory
those issues are to be addressed immediately. E.				framework to adequately address the concern
Han Kim and Vijay Singal in 1997, they conducted				for reducing vulnerability to the flow of
study entitled “Are open market Good for				speculative capital do not include an examination
Foreign Investors and Emerging Nations?”,				of the desirability of encouraging FII inflows. Yet,
Conclusion revealed as. Integrating the emerging				for motivating the consideration of the policy
stock markets into world markets has had				options, it is useful to briefly summarize the
benefits, and will continue to have benefits for				benefits and costs for India of having FII
both global investor and host countries. The end				investment. Given the Group’s mandate of
result of integrated markets a better allocation of				encouraging FII flows, the available arguments
resources, improved productivity of capital, and a				that mitigate the costs have also been included
higher standard of living.				under the relevant points.
THEORETICAL REVIEW				Benefits
Between late 1990 and the middle of 1991, the				Reduced cost of equity capital
economy faced severe balance of payment				FII inflows augment the sources of funds in the
difficulties, coming close to defaulting on its				Indian capital markets. In a commonsense way,
external payment obligations in January and June				the impact of FIIs upon the cost of equity capital
of 1991. In January 1991, the Government				may be visualized by asking what stock prices
negotiated with the International Monetary Fund				would be if there were no FIIs operating in India.
(IMF) for loans. What followed was the				FII investment reduces the required rate of
implementation of the conventional IMF-World				return for equity, enhances stock prices, and
Bank prescription of short-term				fosters investment by Indian firms in the country.
‘stabilization’, consisting of devaluation,				Imparting stability to India's Balance of Payments
temporary import compression, fiscal and				For promoting growth in a developing country
monetary compression with a rise in interest				such as India, there is need to augment domestic
rates, followed by more long-term ‘structural				investment, over and beyond domestic saving,
adjustment’ measures, seeking to restructure				through capital flows. The excess of domestic
the domestic economy.				investment over domestic savings result in a
The New Economic Policy was an outcome of				current account deficit and this deficit is financed
implementation of the ‘structural				by capital flows in the balance of payments. Prior
adjustment’ program. The ‘economic				to 1991, debt flows and official development
reforms’ or ‘economic liberalization’				assistance dominated these capital flows. This
program, which began to be implemented with				mechanism of funding the current account deficit
the announcement of the New Economic Policy				is widely believed to have played a role in the
(NEP), included wide-ranging changes in industrial				emergence of balance of payments difficulties in
policy, trade policy and foreign investment policy,				1981 and 1991. Portfolio flows in the equity
a redefinition of the role of the public sector in the				markets, and FDI, as opposed to debt-creating
economy and redesigning the architecture of the				flows, are important as safer and more
domestic financial system. By narrowing down the				sustainable mechanisms for funding the current
topic, first it concentrates on capital account				account deficit.
liberalization.				Knowledge flows
CAPITAL ACCOUNT LIBERALIZATION				The activities of international institutional investors
The process of capital account liberalization in India				help strengthen Indian finance. FIIs advocate
needs to be situated in its wider context, for it				modern ideas in market design, promote
was shaped by the reality in the national context				innovation, development of sophisticated products
and the conjuncture in the international context. In				such as financial derivatives, enhance competition
response to the external debt crisis, which				in financial intermediation, and lead to spillovers of
surfaced in 1991, the government set in motion a				human capital by exposing Indian participants to
process of stabilization, adjustment and reform.				modern financial techniques, and international best
Economic liberalization and structural reforms				practices and systems.
sought to increase the degree of openness of the				Strengthening corporate governance
economy through trade flows, investment flows,				Domestic institutional and individual investors, used
technology flows and capital flows. The process				as they are to the ongoing practices of Indian
began the introduction of convertibility on trade as				corporates, often accept such practices, even
quantitative restrictions on imports, except for				when these do not measure up to the
with consumer goods were dismantled and tariff				international benchmarks of best practices. FIIs,
levels were reduced. It was combined with a				with their vast experience with modern corporate
liberalization of the regimes for foreign investment				governance practices, are less tolerant of
and foreign technology. And restrictions on				malpractice by corporate managers and owners
international economic transactions, including capital				(dominant shareholder). FII participation in
movements, were progressively reduced. This				domestic capital markets often lead to vigorous
process was also influenced by the gathering				advocacy of sound corporate governance
momentum of globalization which was associated				practices, improved efficiency and better
with increasing economic openness in trade flows,				shareholder value.
investment flows and financial flows.				Improvements to market efficiency
The approach to capital account liberalization in				A significant presence of FIIs in India can improve
India was much more cautious. What was				market efficiency through two channels. First,
liberalized was specified. Everything else remained				when adverse macroeconomic news, such as a
restricted or prohibited. The contours of				bad monsoon, unsettles many domestic investors,
liberalization of the capital account were, in large				it may be easier for a globally diversified portfolio
part, shaped by the salutary lessons of the				manager to be more dispassionate about India's
external debt crisis which surfaced in early 1991				prospects, and engage in stabilsing trades. Second,
and brought India close to default in meetings its				at the level of individual stocks and industries, FIIs
international obligations. The balance of payments				may act as a channel through which knowledge
situation, then, was almost unmanageable.				and ideas about valuation of a firm or an industry
The vulnerability was accentuated by two factors:				can more rapidly propagate into India. For
it became exceedingly difficult to roll-over				example, foreign investors were rapidly able to
short-term debt in international capital markets				assess the potential of firms like Infosys, which
and there was capital flight in the form of				are primarily export-oriented, applying valuation
withdrawals from deposits held by non-resident				principles that prevailed outside India for software
Indians. This experience dictated the parameters				services companies.
of capital account liberalization8. It prompted strict				Costs
regulation of external commercial borrowing				Herding and positive feedback trading
especially short-term debt. It led to a systematic				There are concerns that foreign investors are
effort to discourage volatile capital flows				chronically ill-informed about India, and this lack of
associated with repatriable non-resident deposits.				sound information may generate herding (a large
Most important, perhaps, it was responsible for				number of FIIs buying or selling together) and
the change in emphasis and the shift in				positive feedback trading (buying after positive
preference from debt creating capital flows to				returns, selling after negative returns). These
non-debt creating capital flows. To some extent,				kinds of behavior can exacerbate volatility, and
the liberalization that was introduced was also				push prices away from fair values. FIIs’
influenced by the perceived needs of the				behavior in India, however, so far does not exhibit
economy: financing the current account deficit,				these patterns. Generally, contrary to
mobilizing resources for investment and attracting				‘herding’, FIIs are seen to be involved in
international firms. But capital account convertibility				very large buying and selling at the same time.
remained, fortunately, in the realm of rhetoric.				Gordon and Gupta (2003) find evidence against
The Mexican crisis in late 1994 was, ironically				positive-feedback trading with FIIs buying after
enough, a blessing in disguise for India. It was not				negative returns and vice versa.
just an early warning signal. It dampened the				BoP vulnerability
enthusiasm of those who advocated capital				There are concerns that in an extreme event,
account liberalization with a big bang. It lent				there can be a massive flight of foreign capital
support to those who questioned the wisdom of				out of India, triggering difficulties in the balance of
capital account convertibility that would have been				payments front. India's experience with FIIs so
premature in every sense. The contours of capital				far, however, suggests that across episodes like
account liberalization in India were determined by				the Pokhran blasts, or the 2001stock market
these factors.				scandal, no capital flight has taken place. A billion or
In sketching these contours, it is necessary to				more of US dollars of portfolio capital has never
distinguish between different forms of private				left India within the period of one month. When
capital inflows and outflows, as there are				juxtaposed with India's enormous current account
important differences between these categories in				and capital account flows, this suggests that there
the nature and the degree of liberalization. A				is little evidence of vulnerability so far.
complete description would mean too much of a				Possibility of taking over companies
digression. For our purpose, it would suffice to				While FIIs are normally seen as pure portfolio
consider the contours of liberalization in the				investors, without interest in control, portfolio
following categories of capital account transactions:				investors can occasionally behave like FDI
• Direct investment,				investors, and seek control of companies that
• Portfolio investment, and				they have a substantial shareholding in. Such
• Non-resident deposits.				outcomes, however, may not be inconsistent with
Foreign Direct Investment				India's quest for greater FDI. Furthermore, SEBI's
It is defined as a long-term investment by a				takeover code is in place, and has functioned fairly
foreign direct investor in an enterprise resident in				well, ensuring that all investors benefit equally in
an economy other than that in which the foreign				the event of a takeover.
direct investor is based. The FDI relationship				Complexities of monetary management
consists of a parent enterprise and a foreign				A policymaker trying to design the ideal financial
affiliate which together form a transnational				system has three objectives. The policy maker
corporation (TNC). In order to qualify as FDI the				wants continuing national sovereignty in the pursuit
investment must afford the parent enterprise				of interest rate, inflation and exchange rate
control over its foreign affiliate.				objectives; financial markets that are regulated,
The liberalization of the policy regime for direct				supervised and cushioned; and the benefits of
foreign investment began in July 1991 with two				global capital markets. Unfortunately, these three
major decisions. First, direct foreign investment				goals are incompatible. They form the
with up to 51 per cent equity was to receive				“impossible trinity.” India's openness to
automatic approval in selected high priority				portfolio flows and FDI has effectively made the
industries subject only to a registration procedure				country’s capital account convertible for
with the Reserve Bank of India. Second, a Foreign				foreign institutions and investors. The problems of
Investment Promotion Board was constituted to				monetary management in general, and maintaining
consider all other proposals for direct foreign				a tight exchange rate regime, reasonable interest
investment where approval was not constrained				rates and moderate inflation at the same time in
by pre-determined parameters and procedures. In				particular, have come to the fore in recent times.
effect, this created a dual route for inflows of				The problem showed up in terms of very large
direct foreign investment. The approval was				foreign exchange reserve inflows requiring
automatic, within the specific parameters, from				considerable sterilization operations by the RBI to
the Reserve Bank of India, while all other inflows				maintain stable macroeconomic conditions. The
were subject to approval through the Foreign				Government had to introduce a Market
Investment Promotion Board. The access through				Stabilization Scheme (MSS) from April1, 2004.
the automatic route has been progressively				With the foreign exchange invested in highly liquid
enlarged over time. Needless to add, outflows				and safe foreign assets with low rates of return,
associated with direct foreign investment are not				and payment of a higher rate of interest on the
subject to any restrictions, but this was so even				treasury bills issued under MSS,sterilization involves
in the era of capital controls.				a cost. With a rapid rise in foreign exchange
Foreign Portfolio Investment (FPI)				reserves and the need for having an MSS-based
Portfolio investment represents passive holdings				sterilization involving costs, questions have been
of securities such as foreign stocks, bonds, or				raised about the desirability of encouraging more
other financial assets, none of which entails active				foreign exchange inflows in general and FII inflows
management or control of the securities' issuer by				in particular. While there is indeed the issue of
the investor; where such control exists, it is				timing the policy of encouragement appropriately
known as foreign direct investment.				to avoid the pitfalls of throwing the baby with the
The liberalization of the policy regime was				bath water, there can not be a turnaround from
extended to portfolio investment in				the avowed policy of gradual liberalization, including
September1992. To begin with, foreign institutional				the cap ital account. All modern market
investors such as pension funds or mutual funds				economies have evolved policies to reconcile
were allowed to invest in the domestic capital				prudent monetary management with the benefits
market subject simply to registration with the				of a liberal capital account. There is no scope for
Securities and Exchange Board of India. Guidelines				any diffidence in India also moving in the same
issued by the Reserve Bank of India permitted				direction.
such foreign institutional investors to invest in the				CONCLUSION
secondary market for equity subject to a ceiling				The liberalization policies had the desired
of 5per cent (subsequently raised to 10 per cent)				expansionary effect and had either increased the
for individual foreign institutional investors in a				mean level of FII inflows and/or the sensitivity of
single Indian firm with an overall limit at 24 per				these flows to a change in BSE returns and /or
cent of equity (later relaxed to 30 per cent of				the inertia of these flows. On the other hand, the
equity at the option of the firm) for total foreign				restrictive measures aimed at achieving greater
institutional investment in a single Indian firm.				control over FII flows also did not show any
Foreign portfolio investment further classified into				significant negative impact on the net inflows, it
1. FIIs				had found that these policies mostly render FII
2. ADR/GDR, and				investment sensitive to the domestic market
3. Offshore funds.				returns and raise the inertia of the FII flows.
Foreign institutional investors (FIIs)				Foreign institutional investors had emerged as the
One who propose to invest their proprietary				most dominant investor group in the domestic
funds or on behalf of "broad based" funds or of				stock market in India. Particularly, in the
foreign corporates and individuals and belong to				companies that constitute the Bombay stock
any of the under given categories can be				market sensitivity index, their level of control was
registered for FII.				very high. Data on shareholding pattern showed
• Pension Funds				that the FIIs were currently the most dominant
• Mutual Funds				non-promoter shareholder in most of the sensex
• Investment Trust				companies and they also controlled more tradable
• Insurance or reinsurance companies				shares of sensex companies than any other
• Endowment Funds				investor groups .The sensex, market capitalization
• University Funds				of NSE, Turnover of BSE and NIFTY without
• Foundations or Charitable Trusts or Charitable				market capitalizations were influenced by Foreign
Societies who propose to invest on their own				Institutional Investors. FIIs investment was not
behalf, and				across the shares listed in the stock exchange
• Asset Management Companies				but instead it was very concentrated on the top
• Nominee Companies				few company’s shares. Though there was a
• Institutional Portfolio Managers				role by FII on Indian stock market. It was to be
• Trustees				taken very cautiously because their influences
• Power of Attorney Holders				were on the very few shares in the stock
• Bank				market, which influenced the indicator included in
Access was provided to foreign institutional				the study but which might not help the Indian
investors in the secondary market for debt. Soon				economy to grow
thereafter, foreign institutional investors were also				The influence of FIIs on the movement of
allowed investment or placement in the primary				sensex became apparent after general election in
market, subject to approval from the Reserve				India, during this period sensex experienced its
Bank of India, with a maximum limit of 15per cent				worst single-day decline in its history and in the
of the new issue. It was some time before				three month period between April to June 2004, it
foreign institutional investors were permitted				declined by about 17 percent. Moreover, this
investment in government securities in the				study also showed that even sharp changes in
primary and secondary markets. This came in				sensex did not necessarily indicted a significant
1996-97 and was subject to the ceiling for				alteration of actual shareholding pattern of
external commercial borrowing. Subsequently, in				different investor groups even in sensex
1998-99, foreign institutional investors were also				companies. The activities of foreign institutional
permitted to invest in treasury-bills. There is no				investors in emerging economies following the
reserve requirements stipulated for, or taxes				opening-up of the capital account were not simply
imposed on, these capital inflows. It also needs to				positive for these countries but could also exert
be said that foreign institutional investors are				adverse effects. The reasons were derived from
allowed to repatriate the principal, the capital gains,				asymmetric distributions of information between
the dividends, the interest and any other receipt				local and foreign investors and between fund
from the sale of such financial assets, without any				holders and mangers. Foreign institutional investors
restriction, at the market exchange rate. The				could be assumed to have relatively little
income tax rate for dividends on such portfolio				information on specific developments in emerging
investment for foreign institutional investors is 20				markets so that ‘diluted information’ and
per cent, which is much lower than the corporate				‘illusive competition’ could result. Their
income tax rate for domestic or foreign firms.				influence on these markets was likely to worsen
But foreign institutional investors are subject to a				the relative position of local investors which leads
higher short-term capital gains tax at 30 per cent				to ‘unbalanced diversification’. Moreover,
compared with 20 per cent for domestic				due to their incentives they were likely to amplify
investors, while the long-term capital gains tax is				occurring imbalances or even trigger financial
the same at 10 per cent. Sales of such financial				shocks leading to what they call ‘obscure
assets for the purpose of repatriation are				risks’ and ‘booming contagion’. The
absolutely unrestricted, provided the sales are				was long run relationship between net FII
through stock exchanges. However, disinvestment				investment and sensex, FII investment did not
through any other route, or in any other form,				respond the short-run changes or
requires approval from the Reserve Bank of India.				technical-position of the market and they were
Global Depositary Receipt:				more driven by fundamentals, and FII
Global Depositary Receipt A negotiable certificate				investments did granger cause India stock
held in the bank of one country representing a				market. The FIIs investments are highly
specific number of shares of a stock traded on				concentrate in terms of their market value in
an exchange of another country. American				very small number of companies. There seemed
Depositary Receipts make it easier for individuals				to be a clear distinction in the FIIs shareholding in
to invest in foreign companies, due to the				nifty and non-nifty companies. There was a wide
widespread availability of price information, lower				gap between the actual investments by FIIs and
transaction costs, and timely dividend distributions.				the investments allowed as per the cap.The gap in
Also called European Depositary Receipt.				their investments existed both in nifty and
The option of portfolio investment was also made				non-nifty companies
available to domestic corporate entities from				REFERENCES
September 1992. Indian firms were allowed				1 “Parthapratim pal” in 2006, he conducted
access to international capital markets through				study on “Foreign Portfolio Investment, Stock
global depository receipts or Euro convertible				market and Economic Development: A case study
bonds which converted debt into equity after				of India”,
stipulated period. This access, however, was not				2 “Selen Serisoy Guerin” in 2006,
automatic. Individual applications, drawn up				conducted study on “The Role of Geography
inconformity with the general guidelines of the				in Financial and Economic Integration: A
government, were subject to approval. This				comparative Analysis of foreign direct investment,
process remains unchanged.				Trade and Portfolio Investment Flows”
Offshore Funds:				3 Keneeth A. Froot and Tarun Ramadorai in 2005,
An offshore fund is a collective investment				they conducted study on “The information
scheme domiciled in an Offshore Financial Centre,				content of international portfolio flows”,
for example British Virgin Islands, Luxembourg,				4 A.Julia Priya, D. Lazar and Joseph Jeyapual in
Cayman Islands or Dublin.				2005, they conducted study on “Role of
Similar facilities for portfolio investment were				Foreign Institutional Investors on stock market
subsequently extended to Offshore funds,				development in India”,
non-resident Indians (as individuals) and overseas				5 Keneeth A. Froot and Tarun Ramadorai in 2005,
corporate bodies, only for investment in shares or				they conducted study on “Currency Returns,
debentures through stock exchanges, on the				Intrinsic value, and Institutional-Investor flows”,
same terms as foreign institutional investors, but				6 Megumi Suto and Masashi Toshino in 2005, they
subject to a ceiling of 5 per cent for individual				conducted a study entitled as “Behavioral
non-resident Indians or overseas corporate bodies				Biases of Japanese Institutional Investors: fund
in a single Indian firm.				management and corporate governance”
Among the various components of portfolio				7 “Suchismita Bose and Dipankor
investment, FII comprises the bulk of portfolio				coondoo” in 2004, they conducted study on
inflows. The main objective of foreign institutional				“The Impact of FII Regulation in India”,
investors is to minimize risk and maximize returns				8 Lakshmi sharma in 2004, he studied, “A
by diversifying their portfolios internationally. Major				Gap Analysis of FIIs Investment-An estimation of
determinants of investment decisions of FII are				FIIs investment Avenues in Indian Equity Market.
country and region specific.				9 Parthapratim pal in 2004 conducted study
Portfolio flows often referred to as 'hot- money'				entitled as “Recent volatility in stock markets
are notoriously volatile capital flows. They have				in India and foreign institutional investors.
also responsible for spreading financial crisis				10 “Michael Frenkel and Lukas Menkhoff”
causing contagion in international market. Evan				in 2004, they conducted study on “Are
though, the FIIs have been plying a key role in				Foreign Institutional Investor Good for Emerging
the financial markets since their entry into this				Markets?”,
country. The explosive portfolio flow by FII brings				11 “Brian Bushee” in 2004, he conducted
with them great advantages as they are engine				study on “Identifying and attracting the
of growth, lowering cost of capital in many				“right” investors: evidence on the behavior
emerging market. This opening up of capital				of Institutional investors”,
markets in emerging market countries has been				12 “Christophe faugere and Hany A. Shaby in
perceived as beneficial by some while others are				2003, they analyzed study on “Volatility and
concerned about possible adverse consequences.				Institutional Investor holdings in a declining market:
Among the most active FIIs are Morgan Stanely				A study of NASDAQ during the year 2000”.
Asset Management, jardine Fleming, Capital				13 Gayathri Devi .R in 2003, she conducted study
International, J. Henery schorder, templeton,				on “Causal Relationship between FIIs and
Warburg Pinkers, Internatioanl Alliance and				Stock Market: A critical study”
Quantum fund.				14 “sandhya Ananthanaryanan, Chandrasekhar
Foreign Institutional Investors in India				krishnamurthi and Nilajan Sen in 2003 conducted
India opened her doors to foreign institutional				study as “Foreign institutional Investors and
investors in September, 1992. This event				Security Returns: Evidence from Indian Stock
represents a landmark event since it resulted in				Exchanges”,
effectively globalizing its financial services industry.				15 Stuart L. Gillan and Laura T. Starks in 2003,
Initially, pension funds, mutual finds, investment				they conducted study as “corporate
trusts, Asset Management Companies, nominee				Governance, corporate ownership, and the Role
companies and incorporated/institutional portfolio				of Institutional Investors: A Global
managers were permitted to invest directly in the				perspective”,
Indian stock markets. Beginning 1996-97, the				16 “Vihang Errunza” in 2001, he conducted
group was expanded to include registered				study entitled as “foreign portfolio equity
university funds, endowment, foundations,				investments, financial liberalization and economic
charitable trusts and charitable. Since then, FII				development
flows which form a part of foreign portfolio				17 J.S. Pasricha and Umesh.C.Singh in 2001, tried to
investments have been steadily growing in				analyze the impact of FIIs investment on Indian
importance in India. Other than in the year 1998,				capital market.
the net flows have been positive. The nuclear				18 S.S.S. Kumar in 2001, attempted in his study to
tests and East Asian crisis did slow down the				find the effect of FIIs on the Indian stock
flows but as stated by Gordan and Gupta (2003),				market.
their effects were short lived. That the				19 “Rajesh chakrabarti” in 2000 conducted
percentage of total net turnover of BSE, the				study on “FII Flows to India: Nature and
share of average of FII sales and purchases				Causes”
increased from 2.6 percent in 1998 to 5.5 percent				20 C.H. Rajeswar in 2000, he conducted study
in 2002. The cumulative net FII investment in India				entitled “Foreign Institutional Investors – A
as on August 2003 is approximately $17400				new force of support and discipline”
million. As of August 2003 net FII investment was				21 As per K. Seethapathi and V. Subbulakshmi
9 percent of the BSE market capitalization which				study entitled “Foreign investment: Need for
is small compared to the size of the market.				focus”,
However, in the words of Banaji (2002), it is not				22 Ila Patnik and Deepa Vasudevan in 1998, their
the market capitalization that matters but what is				study entitled “foreign portfolio investment to
important is the level of the free float, that is, the				India
shares that are actually publicly available for				23 “Rene M. Stulz” in 1999, he analyzed
trading. With floating stock in the Indian market				study on “international portfolio flows and
being less than 25 percent, about 35 percent of				security markets”.

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Investment From Abroad is Right or Wrong?