26406648 Impact of FDI and FII on India Mehul

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Academy of Management Studies 2

A

TERM PAPER

ON

FDI AND FII IN INDIA

SUBMITTED BY:

Priyanka Parija




INTRODUCTION

The FDI and FII is the process by which the resident of one country (the source

country) acquire the ownership of assets for the purpose of controlling the production,

distribution and other productive activities of a firm in another country(the host

country).

According to the international monetary fund (IMF), FDI and FII is defined as ³an

investment that is made to acquire a lasting interest in an enterprise operating in an

economy other than that of investor´.

The effect of foreign investment, however, varies from country to country. It can

affect the factor productivity of the recipient country and can also affect the balance

of payments. Foreign investment provides a channel through which countries can gain

access to foreign capital. It can come in two forms: FDI and foreign institutional

investment (FII). Foreign direct investment involves in direct production activities

and is also of a medium- to long-term nature. But foreign institutional investment is a

short-term investment, mostly in the financial markets. FII, given its short-term

nature, can have bidirectional causation with the returns of other domestic financial

markets such as money markets, stock markets, and foreign exchange markets. Hence,

understanding the determinants of FII is very important for any emerging economy as

FII exerts a larger impact on the domestic financial markets in the short run and a real

impact in the long run. India, being a capital scarce country, has taken many measures

to attract foreign investment since the beginning of reforms in 1991.

India is the second largest country in the world, with a population of over 1 billion

people. As a developing country, India¶s economy is characterized by wage rates that

are significantly lower than those in most developed countries. These two traits

combine to make India a natural destination for FDI and foreign institutional

investment (FII). Until recently,however, India

has attracted only a small s

hare of

global FDI and FII primarily due to government restrictions on foreign involvement in

the economy. But beginning in 1991 and accelerating rapidly since 2000, India has

liberalized its investment regulations and actively encouraged new foreign




investment, a sharp reversal from decades of discouraging economic integration with

the global economy.

The world is increasingly becoming interdependent. Goods and services followed by

the financial transaction are moving across the borders. In fact, the world has become

a borderless world. With the globalization of the various markets, international

financial flows have so far been in excess for the goods and services among the

trading countries of the world. Of the different types of financial inflows, the FDI and

foreign institutional investment (FII)) has played an important role in the process of

development of many economies. Further many developing countries consider FDI

and FII as an important element in their development strategy among the various

forms of foreign assistance.

The FDI and FII flows are usually preferred over the other form of external finance,

because they are not debt creating, nonvolatile in nature and their returns depend upon

the projects financed by the investor. The FDI and FII would also facilitate

international trade and transfer of knowledge, skills and technology.

The government of India (GOI) has also recognized the key role of the FDI and FII in

its process of economic development, not only as an addition to its own domestic

capital but also as an important source of technology and other global trade practices.

In order to attract the required amount of FDI and FII it has bought about a number of

changes in its economic policies and has put in its practice a liberal and more

transparent FDI and FII policy with a view to attract more FDI and FII inflows into its

economy. These changes have heralded the liberalization era of the FDI and FII

policy regime into India and have brought about a structural breakthrough in the

volume of FDI and FII inflows in the economy. In this context, this report is going to

analyze the trends and patterns of FDI and FII flows into India during the post

liberalization period that is 2006 to 2009 year.




FOREIGN DIRECT INVESTMENT

In this section we are going to discuss or describe the main business of the report i.e.

analysis of secondary data. It includes data in an organized form, discussion on its

significance and analyzing the results. For this we had divided this section in further

two subsections i.e. the first subsection fulfill the requirement of first objective which

is pertaining to FDI.

Objective 1: Examine the trends and patterns in the FDI across different sectors

and from different countries in India during 2000 to 2009.

I.

About foreign direct investment.Is the process whereby residents of one country (the source country) acquire

ownership of assets for the purpose of controlling the production, distribution, and

other activities of a firm in another country (the host country). The international

monetary fund¶s balance of payment manual defines FDI as an investment that is

made to acquire a lasting interest in an enterprise operating in an economy other than

that of the investor. The investors¶ purpose being to have an effective voice in the

management of the enterprise¶. The united nations 1999 world investment report

defines FDI as µan investment involving a long term relationship and reflecting a

lasting interest and control of a resident entity in one economy (foreign direct investor

or parent enterprise) in an enterprise resident in an economy other than that of the

foreign direct investor ( FDI enterprise, affiliate enterprise or foreign affiliate).

II. Foreign direct investment: Indian scenario

FDI is permitted as under the following forms of investments ±

· Through financial collaborations.

· Through joint ventures and technical collaborations.

· Through capital markets via Euro issues.

· Through private placements or preferential allotments.




Forbidden Territories:

y Arms and ammunition

y Atomic

E

nergyy Coal and lignite

y R ail Transport

y Mining of metals like iron, manganese, chrome, gypsum, sulfur, gold,

diamonds, copper, zinc.

Foreign Investment through GDRs (Euro Issues) ±

Indian companies are allowed to raise equity capital in the international market

through the issue of Global Depository R eceipt (GDR s). GDR investments are treated

as FDI and are designated in dollars and are not subject to any ceilings on investment.

An applicant company seeking Government's approval in this regard should have

consistent track record for good performance (financial or otherwise) for a minimum

period of 3 years. This condition would be relaxed for infrastructure projects such as

power generation, telecommunication, petroleum exploration and refining, ports,

airports and roads.

1. Clearance from FIPB ±

There is no restriction on the number of Euro-issue to be floated by a company or a

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

items covered under Annex-III of the New Industrial Policy whose direct foreign

investment after a proposed Euro issue is likely to exceed 51% or which is

implementing a project not contained in Annex-III, would need to obtain prior FIPB

clearance before seeking final approval from Ministry of Finance.

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

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

and investment in software development, prepayment or scheduled repayment of

earlier external borrowings, and equity investment in JV/WOSs in India.




III. Foreign direct investments in India are approved through

two routes ±

1. Automatic approval by RBI ±

The R eserve Bank of India accords automatic approval within a period of two weeks

(subject to compliance of norms) to all proposals and permits foreign equity up to

24%; 50%; 51%; 74% and 100% is allowed depending on the category of industries

and the sectoral caps applicable. The lists are comprehensive and cover most

industries of interest to foreign companies. Investments in high priority industries or

for trading companies primarily engaged in exporting are given almost automatic

approval by the R BI.

2. The FIPB Route ± Processing of non-automatic approval cases ±

FIPB stands for Foreign Investment Promotion Board which approves all other cases

where the parameters of automatic approval are not met. Normal processing time is 4

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

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

even when the foreign investor wishes to hold less than the entire equity of the

company. The portion of the equity not proposed to be held by the foreign investor

can be offered to the public.




iii. Analysis of sector specific policy for FDI

Sr. No. Sector/Activity FDI cap/Equity Entry/Route

1. Hotel & Tourism 100% Automatic

2. NBFC 49% Automatic

3. Insurance 26% Automatic

4. Telecommunication:

cellular, value added services

ISPs with gateways, radio-

paging

Electronic Mail & Voice Mail

49%

74%

100%

Automatic

Above 49% need

Govt. licence

5. Trading companies:

primarily export activities

bulk imports, cash and carry

wholesale trading

51%

100%

Automatic

Automatic

6. Power(other than atomic

reactor power plants) 100% Automatic

7. Drugs & Pharmaceuticals 100% Automatic

8. R oads, Highways, Ports and

Harbors

100% Automatic

9. Pollution Control and

Management

100% Automatic

10 Call Centers 100% Automatic

11. BPO 100% Automatic

12. For NRI's and OCB's:

i. 34 High Priority

Industry Groupsii. Export Trading

Companies

iii. Hotels and Tourism-

related Projects

100% Automatic




iv. Hospitals, Diagnostic

Centers

v. Shipping

vi. Deep Sea Fishing

vii. Oil Exploration

viii. Power

ix. Housing and R eal

Estate Development

x. Highways, Bridges and

Ports

xi. Sick Industrial Units

xii. Industries R equiring

Compulsory Licensing

xiii. Industries R eserved for

Small Scale Sector

13. Airports:

Greenfield projects

Existing projects

100%

100%

Automatic

Beyond 74% FIPB

14 Assets reconstruction

company

49% FIPB

15. Cigars and cigarettes 100% FIPB

16. Courier services 100% FIPB

17. Investing companies in

infrastructure (other than

telecom sector)

49% FIPB




iv. Analysis of FDI inflow in India

From April 2000 to August 2009

(Amount US$ in Millions)

S.No Financial Year Total FDI

Inflows

% Growth Over

Previous Year

1. 2000-01 4,029 ----

2. 2001-02 6,130 (+) 52

3. 2002-03 5,035 (-) 18

4. 2003-04 4,322 (-) 14

5. 2004-05 6,051 (+) 40

6. 2005-06 8,961 (+) 48

7. 2006-07 22,826 (+) 146

8. 2007-08 34,362 (+) 51

9. 2008-09 35,168 (+) 02

10. 2009-10( Up to August

2009)

16,232 ----

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

TOTAL FDI INFLOWS

TOTA

¡ ¢

I I£ ¡

OW ¤




v. Analysis of share of top ten investing countries FDI equity

in flows


(Amount in Millions)

Sr. No Country Amount of FDI Inflows % As To

Total FDI

Inflow

1. Mauritius 19,18,633.61 44.01

2. Singapore 3,80,142.56 8.72

3. U.S.A. 3,32,935.60 7.64

4. U.K. 2,40,974.98 5.53

5. Netherlands 1,78,047.76 4.08

6. Japan 1,50,129.05 3.44

7. Cyprus 1,32,448.04 3.04

8. Germany 1,12,242.06 2.57

9. France 61,686.39 1.42

10. U.A.E. 50,915.59 1.17

Mauritius

Mauritius invested R s.19,18,633 million in India Up to the August 2009, equal to

44.01 percent of total FDI inflows. Many companies based outside of India utilize

Mauritian holding companies to take advantage of the India- Mauritius Double

Taxation Avoidance Agreement (DTAA). The DTAA allows foreign firms to bypass

Indian capital gains taxes, and may allow some India-based firms to avoid paying

certain taxes through a process known as ³round tripping.´

The extent of round tripping by Indian companies through Mauritius is unknown.

However, the Indian government is concerned enough about this problem to have

asked the government of Mauritius to set up a joint monitoring mechanism to study

these investment flows. The potential loss of tax revenue is of particular concern to

the Indian government. These are the sectors which attracting more FDI from




Mauritius Electrical equipment Gypsum and cement products Telecommunications

Services sector that includes both non- financial and financial Fuels.

Singapore

Singapore continues to be the single largest investor in India amongst the Singapore

with FDI inflows into R s. 3,80,142 crores up to August 2009.

Sector-wise distribution of FDI inflows received from Singapore the highest inflows

have been in the services sector (financial and non financial), which accounts for

about 30% of FDI inflows from Singapore. Petroleum and natural gas occupies the

second place followed by computer software and hardware, mining and construction.

U.S.A.

The United States is the third largest source of FDI in India (7.64 % of the total),

valued at 732335 crore in cumulative inflows up to August 2009. According to the

Indian government, the top sectors attracting FDI from the United States to India are

fuel, telecommunications, electrical equipment, food processing, and services.

According to the available M&A data, the two top sectors attracting FDI inflows from

the United States are computer systems design and programming and manufacturing

U.K.

The United Kingdom is the fourth largest source of FDI in India (5.53 % of the total),

valued at 2,40,974 crores in cumulative inflows up to August 2009.

Over 17 UK companies under the aegis of the Nuclear Industry Association of UK

have tied up with Ficci to identify joint venture and FDI possibilities in the civil

nuclear energy sector.

UK companies and policy makers the focus sectors for joint ventures, partnerships,

and trade are non-conventional energy, IT, precision engineering, medical equipment,

infrastructure equipment, and creative industries.

Netherlands

FDI from Netherlands to India has increased at a very fast pace over the last few

years. Netherlands ranks fifth among all the countries that make investments in India.

The total flow of FDI from Netherlands to India came to R s. 1, 78,047 crores between




1991 and 2002. The total percentage of FDI from Netherlands to India stood at 4.08%

out of the total foreign direct investment in the country up to August 2009.

Following Various industries attracting FDI from Netherlands to India are:

y Food processing industries

y Telecommunications that includes services of cellular mobile, basic telephone,

and radio paging

y Horticulture

y Electrical equipment that includes computer software and electronics

y Service sector that includes non- financial and financial services




vi. Analysis of sectors attracting highest FDI equity inflows


(Amount in Millions)

Sr. No Country Amount of FDI

Inflows

% As To

Total FDI

Inflow

1. Service Sector

(Financial & Non Financial)

9,65,210.77 22.14

2. Computer Software & Hardware 4,13,419.03 9.48

3. Telecommunication 3,68,899.62 8.46

4. Housing & R eal Estate 3,25,021.36 7.46

5. Construction Activities 2,65,492.96 6.09

6. Automobile Industry 1,90,172.22 4.36

7. Power 1,79,849.92 4.13

8. Metallurgical Industries 1,25,785.57 2.89

9. Petroleum & Natural Gas 1,11,957.00 2.57

10. Chemical 1,01,680.18 2.33

The sectors receiving t

he largest s

hares of total FDI inflows up to August 2009 were

the service sector and computer software and hardware sector, each accounting for

22.14 and 9.48 percent respectively. These were followed by the telecommunications,

real estate, construction and automobile sectors. The top sectors attracting FDI into

India via M&A activity were manufacturing; information; and professional, scientific,

and technical services. These sectors correspond closely with the sectors identified by

the Indian government as attracting the largest shares of FDI inflows overall.

The ASSOCHAM has revealed that FDI in Chemicals sector (other than fertilizers)

registered maximum growth of 227 per cent during April 2008 ± March 2009 as

compared to 11.71 per cent during the last fiscal. The sector attracted USD 749

million FDI in FY µ09 as compared to USD 229 million in FY ¶08.




During the year 2009 government had raised the FDI limit in telecom sector from 49

per cent to 74 per, which has contributed to the robust growth of FDI. The telecom

sector registered a growth of 103 per cent during fiscal 2008-09 as compared to

previous fiscal. The sector attracted USD 2558 million FDI in FY µ09 as compared to

the USD 1261 million in FY ¶08, acquired 9.37 per cent share in total FDI inflow.

India automobile sector has been able to record 70 per cent growth in foreign

investment. The FDI inflow in automobile sector has increased from USD 675 million

to 1,152 million in FY ¶09 over FY ¶08.

The other sectors which registered growth in highest FDI inflow during April ± March

2009 were housing & real estate (28.55 per cent), computer software & hardware

(18.94 per cent), construction activities including road & highways (16.35 per cent)

and power (1.86 per cent).




FOREIGN INSTITUTIONAL INVESTMENT

Objective 2: Influence of FII on movement of Indian stock exchange during the

post liberalization period that is September 2006 to September 2009.

I. Introduction to FII

Since 1990-91, the Government of India embarked on liberalization and economic

reforms with a view of bringing about rapid and substantial economic growth and

move towards globalization of the economy. As a part of the reforms process, the

Government under its New Industrial Policy revamped its foreign investment policy

recognizing the growing importance of foreign direct investment as an instrument of

technology transfer, augmentation of foreign exchange reserves and globalization of

the Indian economy. Simultaneously, the Government, for the first time, permitted

portfolio investments from abroad by foreign institutional investors in the Indian

capital market. The entry of FIIs seems to be a follow up of the recommendation of

the Narsimhan Committee R eport on Financial System. While recommending their

entry, the Committee, however did not elaborate on the objectives of the suggested

policy. The committee only suggested that the capital market should be gradually

opened up to foreign portfolio investments.

From September 14, 1992 with suitable restrictions, FIIs were permitted to invest in

all the securities traded on the primary and secondary markets, including shares,

debentures and warrants issued by companies which were listed or were to be listed

on the Stock Exchanges in India. While presenting the Budget for 1992-93, the then

Finance Minister Dr. Manmohan Singh had announced a proposal to allow reputed

foreign investors, such as Pension Funds etc., to invest in Indian capital market.

II. Market design in India for foreign institutional investors

Foreign Institutional Investors means an institution established or incorporated

outside India which proposes to make investment in India in securities. A Working

Group for Streamlining of the Procedures relating to FIIs, constituted in April, 2003,

inter alia, recommended streamlining of SEBI registration procedure, and suggested




that dual approval process of SEBI and R BI be changed to a single approval process

of SEBI. This recommendation was implemented in December 2003.

Currently, entities eligible to invest under the FII route are as follows:

i) As FII: Overseas pension funds, mutual funds, investment trust, asset

management company, nominee company, bank, institutional portfolio

manager, university funds, endowments, foundations, charitable trusts,

charitable societies, a trustee or power of attorney holder incorporated or

established outside India proposing to make proprietary investments or

with no single investor holding more than 10 per cent of the shares or units

of the fund.

ii) As Sub-accounts: The sub account is generally the underlying fund on

whose behalf the FII invests. The following entities are eligible to be

registered as sub-accounts, viz. partnership firms, private company, public

company, pension fund, investment trust, and individuals.

FIIs registered with SEBI fall under the following categories:

a) R egular FIIs- those who are required to invest not less than 70 % of their

investment in equity-related instruments and 30 % in non-equity instruments.

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

The Government guidelines for FII of 1992 allowed, inter-alia, entities such as asset

management companies, nominee companies and incorporated/institutional portfolio

managers or their power of attorney holders (providing discretionary and non-

discretionary portfolio management services) to be registered as FIIs. While the

guidelines did not have a specific provision regarding clients, in the application form

the details of clients on whose behalf investments were being made were sought.

While granting registration to the FII, permission was also granted for making

investments in the names of such clients. Asset management companies/portfolio




managers are basically in the business of managing funds and investing them on

behalf of their funds/clients. Hence, the intention of the guidelines was to allow these

categories of investors to invest funds in India on behalf of their 'clients'. These

'clients' later came to be known as sub-accounts. The broad strategy consisted of

having a wide variety of clients, including individuals, intermediated through

institutional investors, who would be registered as FIIs in India. FIIs are eligible to

purchase shares and convertible debentures issued by Indian companies under the

Portfolio Investment Scheme.

iii. Prohibitions on Investments:

FIIs are not permitted to invest in equity issued by an Asset R econstruction Company.

They are also not allowed to invest in any company which is engaged or proposes to

engage in the following activities:

1) Business of chit fund

2) Nidhi Company

3) Agricultural or plantation activities

4) R eal estate business or construction of farm houses (real estate business does not

include development of townships, construction of residential/commercial premises,

roads or bridges).

5) Trading in Transferable Development R ights (TDR s).

iv. Trends of Foreign Institutional Investments in India.

Portfolio investments in India include investments in American Depository R eceipts

(ADR s)/ Global Depository R eceipts (GDR s), Foreign Institutional Investments and

investments in offshore funds. Before 1992, only Non-R esident Indians (NR Is) and

Overseas Corporate Bodies were allowed to undertake portfolio investments in India.Thereafter, the Indian stock markets were opened up for direct participation by FIIs.

They were allowed to invest in all the securities traded on the primary and the

secondary market including the equity and other securities/instruments of companies

listed/to be listed on stock exchanges in India. It can be observed from the table below




that India is one of the preferred investment destinations for FIIs over the years. As of

March 2009, there were 1609 FIIs registered with SEBI.

SEBI Registered FIIs in India

Year End of March

1992-93 0

1993-94 3

1994-95 156

1995-96 353

1996-97 439

1997-98 496

1998-99 450

1999-00 506

2000-01 527

2001-02 490

2002-03 502

2003-04 540

2004-05 685

2005-06 882

2006-07 996

2007-08 12792008-09 1609




v. FII trend in India

Year Gross

Purchases

(a) (Rs. crore)

Gross Sales (b)

(Rs.crore)

Net

Investment

(a-b)

(Rs. crore)

% increase

in FII inflow

1992-93 17 4 13 -

1993-94 5593 466 5127 39338.46

1994-95 7631 2835 4796 -6.45

1995-96 9694 2752 6942 44.75

1996-97 15554 6979 8575 23.52

1997-98 18695 12737 5958 -30.52

1998-99 16115 17699 1584 126.59

1999-00 56856 46734 10122 739.02

2000-01 74051 64116 9935 -1.85

2001-02 49920 41165 8755 -11.88

2002-03 47061 44373 2688 69.30

2003-04 144858 99094 45764 1602.53

2004-05 16953 171072 45881 0.26

2005-06 346978 305512 41466 -9.62

2006-07 520508 489667 30841 -25.62

2007-08 896686 844504 52182 69.20

2008-09 548876 594608 -45732 187.64




There may be many other factors on which a stock index may depend i.e. Government

policies, budgets, bullion market, inflation, economic and political condition of the

country, FDI, R e./Dollar exchange rate etc. But for my study I have selected only one

independent variable i.e. FII and dependent variable is indices of nifty.

-200000

0

200000

400000

600000

800000

1000000

FII I FLOW

GrossPurchases

(a)

(R s.crore)

GrossSales (b)

(R s.crore)

NetInvestment

(a-b)

(R s.crore)




vi. Co ± relation with Indices

Indices Co-relation with FII

Sensex 0.80

Bankex 0.18

Power 0.33

IT 0.13

Capital Goods 0.44

From the above table we can say that FII has a positive impact on all the indices

which means that if FIIs come in India then it is goods for the Indian economy. FIIs

have more co-relation with Sensex so we can say that they are mostly invest in big

and reputed companies which are included in Sensex.

Power and Capital Goods sector have more co-relation with FII investment which

shows more interest of FIIs in those sectors.




vii. Hypothesis Test

VAR 00003 VAR 00004

VAR 00003 Pearson Correlation 1 .801**

Sig. (2-tailed) .000

N 35 35

VAR 00004 Pearson Correlation .801** 1

Sig. (2-tailed) .000

N 35 36

**. Correlation is significant at the 0.01 level (2 -tailed).

Here the correlation 0.8 which shows that both have positive relation if FII increase

then Sensex will also increase. But if we compare the significance with the degree of

freedom then null hypothesis is accepted because (0.00<0.01) so it shows that FIIs

will have no significant impact on the Sensex.




CONCLUSION

Objective 1:

A large number of changes that were introduced in the country¶s regulatory economic

policies heralded the liberalization era of the FDI policy regime in India and brought

about a structural breakthrough in the volume of the FDI inflows into the economy

maintained a fluctuating and unsteady trend during the study period. It might be of

interest to note that more than 50% of the total FDI inflows received by India during

the period from 2000 - 2009 came from Mauritius, Singapore and the USA. The main

reason for higher levels of investment from Mauritius was that the fact that India

entered into a double taxation avoidance agreement (DTAA) with Mauritius were

protected from taxation in India. Among the different sectors, the service sector had

received the larger proportion followed by computer software and hardware sector

and telecommunication sector.

Objective 2:

According to findings and results, we have concluded that FII did have significant

impact on Sensex but there is less co-relation with Bankex and IT.

One of the reasons for high degree of any linear relation can also be due to the sample

data. The data was taken on monthly basis. The data on daily basis can give more

positive results (may be). Also FII is not the only factor affecting the stock indices.

There are other major factors that influence the bourses in the stock market.



BIBLIOGRAPHY

Sites

http://dipp.nic.in

www.bseindia.com

www.financeexpress.com

www.tradechakra.com

www.madaan.com

www.indianembassy.com

www.sebi.gov.in

26406648 Impact of FDI and FII on India Mehul

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