Final Economics Project

7/30/2019 Final Economics Project

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Foreign Institutional Investments (FIIs) &

IndiaInternational Economics Project

MET PGDM

SEMESTER III - FINANCE

SUBM ITTED BY SUBM ITTED TO -

Nishant Shah (PG12053) Prof. P.A. Johnson

Dashang Ashar (PG12064)

Karishma Vora (PG12072)

Pratik Mehta (PG12077)

Monil Dagli (PG12091)


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ACKNOWLEDGEMENT

We take this opportunity to express our profound gratitude and deep regards to our guide

Prof. P.A. Johnson for his exemplary guidance, monitoring and constant encouragement

throughout the course of this thesis.

The help and guidance given by him time to time shall carry us a long way in the journey of

life on which we are about to embark.

We would also like to thank MET Management Centre for their constant support and

encouragement to undertake this project. And finally, doing this project has indeed been a

very enriching and a great learning experience for us and will definitely help us in our future

endeavours.


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INDEX

S. NO. PARTICULARS PAGE NO.

1

2

34

5

6

7


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FOREIGN INSTITUTIONAL INVESTMENTS (FIIS) A BRIEF

OVERVIEW

The economic landscape of India underwent a paradigm change when the economy was

liberalized in 1991. It also laid the foundation for a strong regulatory network. India

witnessed stellar economic performance through the period 2003-09 .This was manifested

through an average 8.59 percent GDP growth rates, rising domestic savings and investment

levels and the amount of foreign capital flowing into the country. Foreign investments can be

any of the three forms:

Portfolio investments in Indian companies Foreign Institutional Investor (FII)

route essentially entailing transactions executed on stock exchanges in India;Direct investment into Indian companies Foreign Direct Investment(FDI) route;

Private Equity investmentsForeign Venture Capital Investor (FVCI) route.

Foreign Institutional Investors (FIIs) are entities who are established or incorporated

outside India & invest in India. They invest mostly in secondary markets & government

securities. There has been a consistent upsurge in foreign institutional investment since 2002

2003. These FIIs have started playing a significant role in the Indian capital market &

India has become an attractive destination for FIIs, as it has immense potentiality for

overseas investment. The inflow of foreign capital, in search of a better riskreturn trade-

off, helps the home country to share risks with foreign investors.

Institutional investors have grown in importance in the mature economies in recent years &

come to supplant banks as the primary custodians of peoples savings.

Flows of private capital through FIIs have in recent years augmented forex reserves in

emerging markets. In India, over the past decade, FIIs have displaced domestic mutual fundsin importance in the equity market. There shareholding in the Sensex companies is large

enough for them to be able to move the market. The volatility in portfolio inflows to India has

been modest, compared to other emerging markets. As domestic funds grow in size &

pension funds enter the equity market, which would provide a measure of self insurance

against volatility occasioned by FII flows. The real problem caused by variations in FII

inflows from year to year is not stock market volatility, but the difficulties posed in

management of money supply & exchange rate.


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The FII inflows from capital surplus countries to capital scarce countries contributed to the

enhancement of productivity & efficiency of capital at global level. A critical analysis of

portfolio investment patterns in Indian companies highlights this trend.

Good foreign institutional investments have resulted in contemporary changes in the

corporate governance structures on the agency costs of the publicly traded companies & it

was found that FIIs are effective monitors in reducing the agency costs. Agency cost is the

sum of bonding costs, monitoring costs & residual loss. Though developments in the wake of

economic reforms signalled new opportunities for foreign investments in several sectors of

Indian economy, these are subject to significant restrictions, norms, regulation in terms of

percentage caps on foreign equity ownership & other factors.

In this globalised age significant amount of capital is invested into developing economies

from developed world. Significant amount of these investment are bought to developing

economies by the way of portfolio investments by foreign institutional investors (FII).

Foreign institutional investors have gained a significant role in Indian capital markets.

Availability of foreign capital depends on many firm specific factors other than economic

development of the country. Since 1990-91, the Government of India embarked on

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

economic growth and move towards globalization of the economy. As a part of the reforms

process, the Government under its New Industrial Policy revamped its foreign investment

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

technology transfer, augmentation of foreign exchange reserves and globalization of the

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

investments from abroad by foreign institutional investors in the Indian capital market.

The entry of FIIs seems to be a follow up of the recommendation of the Narsimhan

Committee Report on Financial System. While recommending their entry, the Committee,

however did not elaborate on the objectives of the suggested policy. The committee only

suggested that the capital market should be gradually opened up to foreign portfolio

investments.


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SIGNIFICANCE OF FIIS / DIFFERENCE BETWEEN FDI & FII

SIGNIFICANCE OF FIIS

A) MEANING

FII (Foreign Institutional Investors) is used to denote an investor; it is mostly of the form of

an institution or entity which invests money in the financial markets of a country. The term

FII is most commonly used in India to refer to companies that are established or incorporated

outside India, and is investing in the financial markets of India. These investors must register

with the Securities & Exchange Board of India (SEBI) to take part in the market.

Foreign institutional investment is liquid nature investment, which is motivated by

international portfolio diversification benefits for individuals and institutional investors in

industrial country. Currently, the following entities are eligible to invest under FII route:

1) As FIIso Overseas pension funds,o Mutual funds,o Investment trusts,o Asset management companies,o Nominee companies,o Banks,o Institutional portfolio managers,o University funds,o Endowments foundations,o Charitable trusts,o Charitable societies,o Trustee oro Power of attorney holders

Asset Management Companies, Institutional Portfolio Managers, Trustees and Power of

Attorney Holders proposing to invest on behalf of broad-based funds too are eligible to

register as FII.


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Broad Based Fund means a fund established or incorporated outside India, which has at least

twenty investors with no single individual investor holding more than 10% shares or units of

the fund.

2) As Sub-AccountsThe sub account is generally the underlying fund on whose behalf the FII invests. The

following entities are eligible to be registered as sub-account

o Partnership firms,o Private company,o Public company,o Pension fund,o Investment trust ando Individuals

3) Domestic EntitiesA domestic portfolio manager or a domestic asset management company shall also be eligible

to be registered as FII to manage the funds of sub-accounts.

B) AGENCIES REGULATING FIIS IN INDIA

RBI : The apex bank FIPB : Reviews all foreign investment proposals SEBI : Regulates Indias capital market

C) TYPES OF FIIS

FII investment in India can be of two types

1. Normal FIIs: FII allocation of its total investment between equity and non-equity

instruments (including dated government securities and treasury bills in the Indian capital

market) should not exceed the ratio of 70:30. Equity related instruments would include fully

convertible debentures, convertible portion of partially convertible debentures and tradable

warrants.

2. 100% Debt FIIs: FII that can invest the entire corpus in dated government securities

including treasury bills, non-convertible debentures/bonds issued by an Indian company

subject to limits, if any. A FII needs to submit a clear statement that it wishes to be registered

as FII/sub-account under 100% debt routes.


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DIFFERENCE BETWEEN FDI & FII

BASIS FDI FII

Explanation

Foreign direct investmentmeans funds committed to a

Foreign enterprise. The

investor may gain partial or

total control of the

enterprise.

Foreign Institutional Investmentmeans investment in a foreign

stock market by the specialized

financial intermediaries

managing savings collectively

on behalf of investors

Investor

That can be done through

joint ventures, technical

collaborations and by

taking part in management

of a concern.

FIIspresently includes foreign

pension funds, mutual funds,

charitable/endowment/university

funds etc. as well as asset

management companies and

other money managers operating

on their behalf.

ControlThe basic motive of FDI is

to have control on the

enterprise in which they are

investing.

FIIs are not interested in

managing control.

Termination Period

FDI have lasting interest intheir company and stay with

it through thick or thin.

FIIs are fair weather friends,who come when there is money

to be made and leave at the first

sign of impending trouble.

Interference

FDI have the active power

to make the interference in

the decisions of the

enterprise.

FIIs are the investors who share

the project and business risk

without interfering in the critical

decisions of the company.

Volatility

FDI bring stability in the

market because theycontribute to fundamental

strength in the economy.

FIIs might make market more

volatile because they are calledfair weather friends.


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ENTRY OF FIIS IN INDIA

After the launch of the reforms in the early 1990s, there was a gradual shift towards capital

account convertibility. From September 14, 1992, FIIs and overseas corporate bodies (OCBs)were permitted to invest in financial instruments, with suitable restrictions. The policy

framework for permitting FII investment was provided under the Government of Indias

guidelines, vide a press note dated September 14, 1992, which enjoined upon FIIs to obtain

an initial registration with the SEBI and also the RBIs general permission under the FERA.

Both the SEBIs registration andthe RBIs general permissions under the FERA were to hold

good for 5 years, and were to be renewed after that period. The RBIs general permissions

under the FERA would enable the registered FII to buy, sell, and realize capital gains on

investments made through an initial corpus remitted to India, to invest on all recognized stock

exchanges through a designated bank branch, and to appoint domestic custodians for the

investments held. The government guidelines of 1992 also provided the eligibility conditions

for registration, such as track record, professional competence, financial soundness, and other

relevant criteria, including registration with a regulatory organization in the home country.

The guidelines were suitably incorporated under the SEBI (FIIs) Regulations, 1995. These

regulations continue to maintain the link with the government guidelines through a clause

that was added to the effect that the investment by FIIs should also be subject to government

guidelines. This linkage has allowed the government to indicate various investment limits,

including those in specific sectors. With the Foreign Exchange Management Act (FEMA),

1999 coming into force in 2000, the Foreign Exchange Management (Transfer or Issue of

Security by a Person Resident Outside India) Regulations, 2000 were issued to provide the

foreign exchange control context where foreign exchange-related transactions of FIIs were

permitted by the RBI. A philosophy of preference for institutional funds and the prohibition

of portfolio investments by foreign natural persons have been followed, except in the case of

non-resident Indians, where direct participation by individuals takes place. Right from 1992,

FIIs have been allowed to invest in all securities traded on the primary and secondary

markets, including shares, debentures, and warrants issued by companies that were listed or

were to be listed on the stock exchanges in India and in schemes floated by domestic mutual

funds.


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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:-

o The ceiling for overall investment of FII was increased 24% of the paid up capital ofIndian company.

o Allowed foreign individuals and hedge funds to directly register as FII.o Investment in government securities was increased to US$5 billion.o Simplified registration norms.


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GROWTH OF FIIS IN INDIA OVER YEARS

Growth in FII Investments in India

Growth in FII registrations in India

0

500

1000

1500

2000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

No. of FII's registered with SEBI

Source - SEBI


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PROS & CONS OF FIIS IN INDIA

PROS OF FIIS IN INDIA

1. Reduced Cost of Equity Capital

FII inflows augment the sources of funds in the Indian capital markets. In a common sense

way, an increase in the supply of funds reduces the required rate of return for equity and

enhances stock prices. Simultaneously, it fosters investment by Indian firms in the country.

2. Imparting Stability to Indians Balance of Payment / Increases Forex Reserves

For promoting growth in India, there is a need to augment domestic investment, over and

beyond domestic savings, through capital flow. The excess of domestic investment over

domestic savings result in a current account deficitand this deficit is financed by the capital

flow in the balance of payment. Foreign institutional investment as opposed to debt-creating

flows isimportant as safer and more sustainable mechanism for funding the currentaccount

deficit.

3. Knowledge FlowsThe activities of international institutional investors help strengthen financial system. 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 spill over of human capital by exposing market participants to modern financial

techniques and international best practices and systems.

4. Strengthen Corporate GovernanceDomestic institutional investors and individual investors, who are used to the ongoing

practices of domestic corporates, 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 shareholders). FII participation in domestic capital markets

often-lead vigorous advocacy of sound corporate governance practices, improved efficiency

and better shareholder value.


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5. Improve Market Efficiency

A significant presence of FIIs can improve market efficiency through two channels. First,

when adverse macroeconomic news, such as bad monsoon, unsettles many domestic

investors, it may be easier for a globally diversified portfolio manager to be more

dispassionate about a countrys prospects, and engage in stabilizing trades. Second, at the

level of individual stocks and industries, FIIs may act as a channel through which knowledge

and ideas about valuation of a firm or an industry can more rapidly propagate into market.

For example, foreign investors rapidly assess the potential of firms like Infosys, which are

primarily export-oriented, by applying valuation principles that prevailed outside India for

software services companies.

6. Managing uncertainty & controlling risks

FII inflows help in financial innovation and development of hedging instruments which helps

to control risks to a greater extent.

Also, it not only enhances competition in financial markets, but also improves the alignment

of asset prices to fundamentals.

CONS OF FIIS IN INDIA

1. 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. This is the case which

Indian economy is facing in the current situation.

2. Complexities of Monetary Management

A policy maker trying to design the ideal financial system has three objectives. The policy

maker wants to continue national sovereignty in the pursuit of interest rate, inflation and

exchange rate objectives; financial markets that are regulated, supervised and cushioned; and

the benefits of global capital markets. Unfortunately, these three goals are incompatible. They

form the impossible trinity. Indias openness to portfolio flows and FDI has effectively made

the countrys capital account convertible for foreign institutions and investors. The problems

of monetary management in general and maintaining a tight exchange rate regime, reasonable

interest rates and moderate inflation at the same time in particular have come to the fore in


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recent times. The problem showed up in terms of very large foreign exchange reserve inflows

requiring considerable sterilization operations by the RBI to maintain stable macroeconomic

conditions. The government of India had to introduce a Market Stabilization Scheme (MSS)

from April 1, 2004.

3. Problems ofInflation

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.

4. Problems for small investor

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 thus have

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.

5. 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.

6. Problem of Hot Money

Hot money refers to funds that are 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 financial repercussions 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

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

funds.

These are the benefits and harm of the foreign institutional investors. If proper rules are

established and implemented by the regulatory body, the harms of the FIIs can be eliminated.
http://www.mbaknol.com/managerial-economics/definition-of-inflation-and-its-types/http://www.mbaknol.com/managerial-economics/definition-of-inflation-and-its-types/


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